This post contains the text of a recent amicus brief filed with the United States Supreme Court in the case of Goldman Sachs Group, Inc., v. Arkansas Teacher Retirement System. The case relates to claims about false or misleading statements that are intended to maintain inflated valuations. Amici argued that such claims should be upheld under the federal securities laws. The brief is authored by several former senior SEC officials, including former Chairmen Arthur Levitt and William Donaldson, as well as GFMC Nonresident Fellow, Tyler Gellasch. The full brief can be accessed here.
From the inception of the federal securities laws, Congress recognized that securities markets incorporate publicly available information into their pricing. Congressional regulation thus targets the manipulation of securities prices through false or misleading statements and omissions. More specifically, federal reporting and disclosure regimes are designed to ensure that publicly available information is truthful and accurate. When that goal is achieved, securities are more efficiently priced — and are perceived by investors as fairer — ensuring the integrity of the securities markets. Recent history illustrates the wisdom of these principles and the dramatic and destructive impact that false or misleading statements or omissions can have on markets and investor confidence.
Such false or misleading statements and omissions come in two primary forms: Falsehoods that are propagated by affirmative comments that artificially boost a stock price (known as “inflation-introducing statements”). And falsehoods that are disseminated by confirmative remarks, actions, or omissions that maintain an artificially-elevated stock price (known as “inflation-maintaining statements”). But regardless of form, the economic and legal effects are the same: the fair price of securities is skewed to the detriment of shareholders and investor confidence is undermined.
Amici, drawing upon their considerable experience at the helm of the SEC, address two key points in this case.
First, combating inflation-maintaining statements is important to preserving efficient securities markets. In some cases, the SEC itself explicitly files suit on the basis of inflation-maintaining statements. In other cases, the SEC relies upon the core logic of inflation-maintenance, either in combination with other securities law claims or in pursuit of market manipulation more broadly. Were this Court to cast doubt upon the validity of such claims, it could adversely limit the range of tools at the SEC’s disposal. Robust deterrence of inflation-maintaining statements is also important because companies and corporate executives can have considerable incentives to maintain a falsehood that is propping up a stock price in order to reap short-term benefits.
Second, private suits are a valuable complement to the SEC’s enforcement actions and resources, as this Court and the SEC have recognized on numerous occasions – and that also applies to individual and collective suits about inflation-maintenance. Although Petitioners and their amici have raised the specter of unsubstantiated securities litigation, Congress has already addressed such concerns and the existing judicial management tools are more than sufficient safeguards.
All told, amici urge this Court to tread carefully in this area of securities regulation where federal enforcement, private litigation, and public trust intersect, and to decline Petitioners’ invitation to create special rules for class certification in cases involving inflation-maintaining statements.
The Inflation-Maintenance Theory is Important to Preserving Well-Functioning Securities Markets
Inflation-maintaining statements can undermine well-functioning markets and violate the securities laws. “[A]s the Second, Seventh, and Eleventh Circuits . . . recognize, misrepresentations that are effectively repeated over many months or years may ‘cause’ inflation . . . simply by maintaining existing market expectations, even if the level of inflation in the stock price does not increase immediately following the misrepresentation.” Likewise, a recent survey found “not a single district court rejected the [inflation-maintenance] theory” – and that this “resounding consensus was not for lack of trying on the part of defendants . . . .” This Court’s decision in Basic v. Levinson itself involved a form of price-maintenance, since the shareholders there “were injured by selling Basic shares at artificially depressed prices in a market affected by [the company’s] misleading statements.”
While Petitioners now impliedly ask the Court to denounce this type of claim, e.g., Pets. Br. 4 (“a theory this Court has never endorsed”), the United States and the SEC conspicuously choose not to cast doubt on the core validity of the claim in their brief. Br. of U.S. at 16, 33. See also Br. of the U.S., First Solar, Inc. v. Mineworkers’ Pension Scheme, 2019 WL 2153153 at *10 (U.S. 2019). This Court should likewise decline the invitation for two added reasons, infra I.A-B.
Combatting Inflation-Maintaining Statements is an Important Enforcement Tool for the SEC
Combating inflation-maintaining statements is central to the SEC’s central responsibility for maintaining public trust in the markets.
In some cases, the SEC squarely brings a 10b-5 enforcement action on the basis of an inflation-maintenance theory. See, e.g., Sec. & Exch. Comm’n v. Compass Capital Grp., Inc., No. 2:08-CV-457-ECR-PAL, 2009 WL 10693516, at *2 (D. Nev. Mar. 24, 2009) (“The SEC alleges that [defendants] agreed on issuing press releases pursuant to a set schedule, which misled the public and served to maintain [their] stock price at an [artificially] inflated value.”); id. at *4 (“The SEC also alleges [defendant] violated section 10(b) and Rule 10b–5 by reviewing and approving [] false and misleading press releases.”); id. (concluding that “[t]hese allegations [about the false and misleading press releases] are pleaded with the requisite particularity.”).
In other cases, the SEC relies upon the logic of inflation-maintenance and/or continued misrepresentations in ways that mix 10b-5 claims with other Securities Act and Exchange Act violations. See, e.g., In the Matter of L&L Energy, Inc. et al., Release No. 9565 (Mar. 27, 2014)
at 2 (company “continued to misrepresent that the purported Acting CFO was in fact the company’s Acting CFO”); id. at 7 (“[defendant] directed [] not disclose this information to anyone . . . [and said] that if this information became publicly known, [the company’s] stock price would drop.”); id. at 7-9 (“By engaging in the conduct described above [defendants] violated . . . Section 10(b) of the Exchange Act and Rule 10b-5 thereunder,” as well as Section 17(a) of the Securities Act, Section 13(a) of the Exchange Act, Section 302 of Regulation S-T of the Exchange Act, and other rules). See also SEC v. Nacchio et al., Civil Action No. 05-MK-480 (Mar. 15, 2005) at 15 (“[defendants] continued the fraudulent scheme to keep [] stock price high to complete the announced merger”); SEC v. Goldstone et al., Case No. 12-257 (Mar. 13, 2012) at 26-27 (“[Defendants] Continued to Deceive . . . the Investing Public and Implicitly Acknowledged that [their Filings] Did Not Fully and Accurately Reflect [the Company’s] Financial Condition”). The SEC can base these claims on a variety of public statements, ranging from press releases to required reports and annual filings, like Form 10-K.[1]
Indeed, because the effects of inflation-maintaining statements are economically identical to other types of misstatements or market manipulation, the SEC’s settlement orders across a range of factual scenarios do not always expressly distinguish between a 10b-5 inflation-maintenance claim and other forms of ongoing fraud or continued misrepresentations. These shades of gray further caution against this Court establishing a categorical bar to inflation-maintenance claims. See also Br. of U.S. at 17 (“The categorical rule for generic misstatements that petitioners advocated below therefore would be unsound even as a rule of materiality.”).
The logic of inflation-maintenance imbues other securities actions too. In the context of market manipulation, for example, the SEC regularly brings enforcement actions about artificially maintaining stocks at an elevated price. See, e.g., S.E.C. v. Gordon, 822 F. Supp. 2d 1144, 1152 (N.D. Okla. 2011), aff’d, 522 F. App’x 448 (10th Cir. 2013) (“[defendants] coordinated their sales of [stocks] to avoid flooding the market and provided buy-side support to maintain the artificially inflated share prices.”); In the Matter of Daniel R. Lehl et al., Opinion of the Commission (Rel. No. 8102, May 17, 2002), (“[respondent] purchased [] stock that was offered at a relatively low price in order to maintain [the stock’s] artificially high value.”).
The reliance upon inflation-maintenance logic across various domains of securities enforcement underscores the SEC’s need to remain flexible in applying the range of tools at its disposal to fast-moving securities markets and products. See also Lorenzo v. Sec. & Exch. Comm’n, 139 S. Ct. 1094, 1104 (2019) (“Congress intended to root out all manner of fraud in the securities industry. And it gave to the Commission the tools to accomplish that job.”).
The SEC relies on these types of claims for good reason, because they are a natural outgrowth of the plain text of 10b-5: It is unlawful to “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. . . .” 17 C.F.R. § 240.10b–5(b). Especially in the context of a stock price that is already artificially high, the economic effects of affirmatively telling a lie, omitting the truth, and maintaining a misleading impression are the same.
Lower courts recognize this logical overlap too: “Every investor who purchases at an inflated price—whether at the beginning, middle, or end of the inflationary period—is at risk of [loss] when the truth underlying the misrepresentation comes to light.” FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282, 1315 (11th Cir. 2011). “We decline to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity.” Id. “The ‘maintenance’ theory of inflation simply reflects the reality . . . that in a case where a company repeatedly makes statements that omit information about its liquidity risk, it is reasonable to conclude that each misstatement played a role in causing the inflation in the stock price (whether by adding to the inflation or helping to maintain it) . . . .” In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512, 562 (S.D.N.Y. 2011), aff’d sub nom. In re Vivendi, S.A. Sec. Litig., 838 F.3d 223 (2d Cir. 2016).
Inflation-Maintaining Statement Can Cause Significant Harms to Markets, Investors, Employees, and Others.
Combating inflation-maintaining statements is also important for other practical and economic reasons.
As a practical matter, companies and corporate executives can have enormous incentives to issue false or misleading statements to prevent a stock price fall and to reap the benefits. Specifically, companies can benefit from maintaining artificially-inflated stock prices by issuing overpriced stock to investors, or using it to acquire other target companies in stock-for-stock M&A transactions. Corporate executives can benefit from maintaining artificially-inflated stock prices by hitting stock price targets, receiving and exercising option grants, and selling their shares into the market at inflated prices. See e.g., Urska Velikonja, The Cost of Securities Fraud, 54 Wm. & Mary L. Rev. 1887, 1903 (2013) (“managers and insiders benefit from false disclosures,” so “[t]o reduce their incentive to lie, or to look the other way, enforcement is necessary to confront the malefactors with the cost of their violation.”). SEC staff regularly consider benefits like this when seeking disgorgement and calculating a wrongdoer’s net profits.
Moreover, the incentive of a company or its executives to maintain a falsehood is often greater than the incentive for attempting to falsely inflate a stock’s price in the first place. See, e.g., Velikonja, supra, at 1904 (“knowing that sanctions follow discovery, managers of fraudulent firms spend resources trying to conceal fraud and avoid punishment”). See generally Rachel Croson et al., Cheap talk in bargaining experiments: lying and threats in ultimatum games, 51 J. Econom. Behav. Organ. 143 (2003); Vincent P. Crawford, Lying for Strategic Advantage: Rational and Boundedly Rational Misrepresentation of Intentions, 93 Am. Econ. Rev. 1 (March 2003); University College London, How lying takes our brains down a ‘slippery slope,’ ScienceDaily (Oct. 24, 2016), (the negative neurological response to lying “fades as we continue to lie, and the more it falls the bigger our lies become,” potentially “lead[ing] to a ‘slippery slope’ where small acts of dishonesty escalate into more significant lies.”).
As an economic matter, inflation-maintaining falsehoods can be just as harmful to investors and employees, and to public confidence in the stock market, as inflation-inducing misstatements – both in terms of monetary damages and undermining market integrity. Namely, company employees who work hard for stock options or stock-based compensation are harmed when they receive equity that is worth less than they believed it to be. Additionally, as the SEC explained in Basic Inc. v. Levinson, “[t]he importance of accurate and complete issuer disclosure to the integrity of the securities markets cannot be overemphasized” because if “investors cannot rely upon the accuracy and completeness of issuer statements, they will be less likely to invest, thereby reducing the liquidity of the securities markets to the detriment of investors and issuers alike.” 1987 WL 881068 at 18 n.20 (U.S. 1987) (citation omitted).
Economically, allowing false statements to persist – by omission or commission – can also disrupt the fair pricing of securities more broadly. The close relationship between market prices and publicly available information—including in particular the need to protect the integrity of market prices from the influences of false and fraudulent information—has been a cornerstone of federal securities regulation from the beginning. Indeed, Congress made its concern with the integrity of market prices explicit when it enacted the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. 78 et seq.
Section 2 of the Act, entitled “Necessity of regulation,” 15 U.S.C. 78b, “focuses almost exclusively on the critical importance of market prices.” Steve Thel, The Original Conception of Section 10(b) of the Securities Exchange Act, 42 Stan. L. Rev. 385, 391 (1990). A key goal of the Act was to “insure the maintenance of fair and honest markets.” 15 U.S.C. 78b. But Congress found that “the prices of securities on [securities exchanges and over-the-counter markets] are susceptible to manipulation and control, and the dissemination of such prices gives rise to excessive speculation, resulting in sudden and unreasonable fluctuations in the prices of securities.” 15 U.S.C. 78b(3). In particular, false and fraudulent information disseminated by market participants has an effect on securities prices, at least until the truth ultimately comes out. Congress found that the result of that distortion of market prices can be to precipitate or prolong “widespread unemployment and the dislocation of trade, transportation, and industry, and [to] burden interstate commerce and adversely affect the general welfare.” 15 U.S.C. 78b(4). The system of federal securities regulation is thus designed in part to combat threats to the integrity of market prices, i.e., to ensure that honest, not fraudulent, information is reflected in market prices, on which investors may then rely.
The committee reports on the Exchange Act reflect the need to ensure that market prices reflect honest, not fraudulent, information. As the House Report explained, “[t]he idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers . . . brings about a situation where the market price reflects as nearly as possible a just price.” H.R. Rep. No. 1383, 73rd Cong. 2d Sess. 11 (1934). Although “[t]he disclosure of information materially important to investors may not instantaneously be reflected in market value, . . . truth does find relatively quick acceptance on the market.” Id. See S. Rep. No. 1455, 73rd Cong. 2d Sess. 68 (1934) (“Insofar as the judgment of either [buyer or seller] is warped by false, inaccurate, or incomplete information regarding the corporation, the market price fails to reflect the normal operation of the law of supply and demand.”).
Congress’s concerns in the 1930s are, if anything, even more cogent today. In many ways, modern markets have increased the possibilities for fraud and manipulation by means of false, deceptive, or fraudulent information that infects the market and is quickly reflected in market prices. On the New York Stock Exchange alone, average daily trading volume has increased from 1.5 million shares in 1930-1939 to 2.3 billion today; another 1.7 billion shares trade on the NASDAQ, which did not even exist in the 1930s.[2] Ticker tapes have been replaced by instantaneous transmission of news and high-speed trading. The growth of the markets and technology since the 1930s have tightened the relationship between information flow and market price.
Furthermore, the modern tax code and other incentives encourage individuals to rely on the integrity of the markets. For instance, the nation’s private retirement funding and college savings regime rests on tax-favored vehicles, such as IRAs, 401(k) plans, and 529 plans. These plans typically employ passive investment strategies and make routine purchases of well-diversified portfolios on a periodic (e.g., pay-period) basis. Typically, the investor does not exercise individual discretion or have specific knowledge of the securities being purchased, let alone the opportunity to closely scrutinize and rely upon an issuer’s statements. The massive funds that are invested in registered securities each month through these plans are predicated on retail investors being able to rely upon the integrity of the market and of securities prices.
Indeed, the investor confidence concerns arising here are akin to institutional legitimacy concerns this Court has expressed with respect to other aspects of the securities laws and in other financial contexts. See, e.g., United States v. O’Hagan, 541 U.S. 642, 658 (1997) (explaining that trading on misappropriated information can undermine investor confidence in the securities markets); United States v. Arthur Young & Co., 465 U.S. 805, 819 n.15 (1984) (“rather than protecting the investing public by ensuring the accuracy of corporate financial records, insulation of tax accrual workpapers from disclosure might well undermine the public’s confidence in the independent auditing process”); Fed. Deposit Ins. Corp. v. Mallen, 486 U.S. 230, 240–41, 108 S. Ct. 1780, 1788 (1988) (“The legislation under scrutiny is premised on the congressional finding that prompt suspension of indicted bank officers may be necessary . . . to maintain public confidence in our banking institutions. This interest is certainly as significant as [others] . . . we deemed sufficiently important . . . to justify a brief period of suspension prior to . . . a hearing.”). Well-functioning and well-regulated securities markets and other financial institutions have wide-ranging benefits for the economy as a whole.
Private Inflation-Maintenance Suits Complement the SEC’s Enforcement Efforts
The SEC and this Court have long recognized that “meritorious private actions to enforce federal antifraud securities laws are an essential supplement to criminal prosecutions and civil enforcement actions brought . . . by the Department of Justice and the [SEC].” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007); see, e.g.,Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 310 (1985) (“[W]e repeatedly have emphasized that implied private actions provide ‘a most effective weapon in the enforcement’ of the securities laws and are ‘a necessary supplement to Commission action’”) (quoting J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964)).
In recent years alone, the Commission has repeatedly informed the Court of its view that private actions serve an essential role in its filings in Erica P. John Fund, Inc. v. Halliburton Co., 2014 WL 466853 (2011); Merck & Co., Inc., v. Reynolds, 2009 WL 3439204 (2010); Tellabs, Inc. v. Makor Issues & Rights, Ltd., 2007 WL 460606 (2007); and Dura Pharmaceuticals v. Broudo, 2004 WL 2069564 (2005). As then-Chairman Richard Breeden explained in congressional testimony, the SEC “does not have adequate resources to detect and prosecute all violations of the federal securities laws,” private actions therefore “perform a critical role in preserving the integrity of our securities markets,” and such actions are “also necessary to compensate defrauded investors.” Securities Investor Protection Act of 1991: Hearing Before the Subcomm. On Securities of the Senate Comm. On Banking, Housing and Urban Affairs, 102d Cong. 1st Sess. 15-16 (1991).
Class actions in particular are an indispensable complement to SEC enforcement, because private litigation on an individual basis – one shareholder and one trial at a time – is frequently impracticable and an inefficient use of both judicial and private resources. See, e.g., Basic, 485 U.S. at 242 (requiring individualized proof could overwhelm common questions).
Moreover, private enforcement of 10b-5 claims may be increasingly important in a world in which the SEC is torn between other historic crises and pressing priorities, such as COVID-19 response and disclosures and structural market stressors. See, e.g., SEC, Coronavirus (COVID-19) Response (modified Dec. 29, 2020). While amici on the other side conjure up hypothetical litigation involving the travel and biotechnology industries’ statements during COVID-19, see Amicus Brief of Former SEC Officials and Law Professors in Support of Petitioners at 17-18, if anything, their concerns point in the opposite direction. In the rapidly changing environment of the pandemic, publicly traded companies should be particularly circumspect about the accuracy of their statements.
Finally, Petitioners raise the specter of “effectively guarantee[d] class certification in virtually any securities class action based on inflation-maintenance theory.” Pets. Br. 5. Cf. Amicus Brief of Former SEC Officials and Law Professors in Support of Petitioners at 19-20 (warning about rendering class certification “a mere formality in virtually any securities class action premised on the inflation maintenance theory”). In amici’s experience, however, such warnings about baseless litigation are unwarranted. Cases premised on immaterial statements can, should, and typically are dismissed before reaching the class certification stage.[3] Compare Janeen McIntosh and Svetlana Starykh, Recent Trends in Securities Class Action Litigation: 2020 Full-Year Review at 3 (Jan. 25, 2021), (showing approximately 160 filings per year for 10b-5 claims, between 2011 and 2020) with Laarni T. Bulan et al., Securities Class Action Settlements—2019 Review and Analysis, Harvard Law School Forum on Corporate Governance (Mar. 11, 2020), (showing approximately 58 settlements per year for 10b-5 claims between 2011 and 2019). To the extent that dismissal of questionable statements is denied on the ground that further factual development is needed, defendants can avoid trial through moving for summary judgment. See Fed. R. Civ. Proc. 56(b) (“a party may file a motion for summary judgment at any time until 30 days after the close of all discovery.”). Petitioners offer no concrete grounds for concern that federal district courts will regularly certify classes based on statements that did not affect market prices or to allow cases based on immaterial statements to survive summary judgment.
Additionally, as this Court has noted before, complaints about the functioning of Rule 23 in the context of the securities laws are better directed to Congress than to the judiciary. See Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U.S. 455, 474-78 (2013). Indeed, Congress responded to concerns about the abuse of securities class actions when it enacted the Private Securities Litigation Reform Act of 1995 (“PSLRA”), 109 Stat. 737. Cf. Amgen, 569 U.S. at 475-76 (describing specific provisions of PSLRA designed to curtail abusive litigation). Neither Petitioners nor their amici offer any support for the notion that this Court should alter the balance that Congress struck between addressing such abuse on the one hand and, on the other, “deterring wrongdoing and providing restitution to defrauded investors.”[4] Id. at 475. Vague and unsubstantiated claims about abusive litigation cannot defeat Congress’s considered legislative judgment.
Conclusion
For the foregoing reasons, this Court should affirm.
[1] The SEC often relies upon the risk factors that companies articulate in a 10-K filing as statements of fact and retrospective depictions that are actionable for enforcement purposes and closely scrutinized by the market. See e.g., Br. of U.S. at 16-17 (“Reasonable investors may sometimes attach significance to even very general statements about a company’s practices.”). While some risk factors may appear more sweeping than others, if courts were to consider them categorically irrelevant as a matter of a law, as Petitioners urged below, Arkansas Teacher Retirement System, 955 F.3d at 267 (“in Goldman’s words, ‘immaterial as a matter of law’”), and Amici Former SEC Officials and Law Professors hint here, Br. at 17-19, that would significantly complicate SEC enforcement. See also Br. of U.S. at 13 (“No categorical rule exists under which misstatements phrased in general terms can be deemed legally incapable of affecting a security’s price, regardless of other evidence. On the contrary, courts considering particular facts may appropriately credit evidence that seemingly generic statements would have been significant to the trading decisions of reasonable investors, or that a generally efficient market acted inefficiently on specific occasions and reacted to the statements even though doing so was objectively unreasonable.”).
[2] The New York Stock Exchange volume was extracted from http://web.archive.org/web/20130620172530/http://www.nyse.com/financials/1022221393023.html and https://www.cboe.com/
us/equities/market_share/. The NASDAQ data is available at http://www.nasdaqtrader.com/Trader.aspx?id=marketshare.
[3] As this Court reiterated in Halliburton II, materiality is a merits issue, not one of class certification. 573 U.S. at 282. But dismissal for failure to state a claim can occur before a court considers class certification.
[4] Amici Former SEC Officials and Law Professors claim that class certification based on “generic statements of corporate principle would be contrary to . . . congressional intent as reflected in the” PSLRA. Brief at 18. Notably, these amici do not claim that such class certification in such cases would violate the actual text of the statute, much less the careful balance that Congress struck. Nor, as noted supra n.5, is there any basis for a “generic statement” blanket exception either to the securities laws or to the possibility that a particular statement or statements had an impact on market price.
