Frances Unger, William Patterson, Lead Gordon Ellis, Lead v. Amedisys Inc.

Citations: 401 F.3d 316; 2005 U.S. App. LEXIS 2778; 2005 WL 375684Docket: 03-30965

Court: Court of Appeals for the Fifth Circuit; February 17, 2005; Federal Appellate Court

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The case involves Frances Unger and other plaintiffs against Amedisys Inc. concerning securities fraud under the Securities Exchange Act of 1934. The plaintiffs allege that Amedisys manipulated Medicare's Prospective Payment System (PPS) to inflate cost estimates, thereby artificially increasing its reported earnings and stock price. Amedisys acknowledged revenue overstatements in a June 2001 statement, causing a drop in stock prices. The plaintiffs sought class certification for individuals who purchased Amedisys stock between November 15, 2000, and June 13, 2001. The district court initially certified the class under Rule 23(b)(3) based on a fraud-on-the-market theory. However, the Fifth Circuit determined that the district court applied an insufficient standard of proof in its certification inquiry. Consequently, the appellate court vacated the class certification and remanded the case for further proceedings, emphasizing the necessity of rigorous certification standards and reliance on adequate admissible evidence.

The Amedisys defendants filed a timely interlocutory appeal concerning two issues related to class certification: the adequacy of the lead plaintiffs' qualifications and the sufficiency of evidence supporting the fraud on the market presumption. Class certification is at the discretion of the trial court, which must adhere to Rule 23 requirements. If a district court misunderstands the law, it may abuse its discretion. Rule 23 mandates that a proposed class meet certain criteria, including numerosity, commonality, typicality, representativeness, and additional requirements for class actions seeking monetary damages, such as predominance and superiority. The predominance requirement is notably stringent, necessitating that common issues outweigh individual questions, ensuring class cohesiveness for representation.

The Supreme Court has emphasized the need for rigorous analysis of Rule 23 prerequisites to address due process concerns for both plaintiffs and defendants. Courts must take a "close look" at claims and evidence during the certification process, although class certification hearings should not devolve into mini-trials. The court must understand claims, defenses, relevant facts, and applicable laws, and may permit controlled discovery to facilitate this understanding. The court is required to find facts favoring class certification rather than simply assume them.

The appellants challenged the qualifications of the class representatives under Rule 23(a)(4), asserting that the representatives must be adequately informed and manage the litigation independently of their counsel. The district court was found not to have abused its discretion regarding this requirement, as it thoroughly evaluated evidence, including depositions and testimonies, and made legally sound and factually supported findings. Further discussion of this issue would require unnecessary recounting of case-specific evidence.

The appeal centers on the district court's determination of predominance under Rule 23(b)(3) regarding class certification for securities fraud claims. The court expressed doubt about applying the precedent set in Castano, which pertains to tobacco fraud cases, to securities fraud actions. However, Castano's reasoning has been upheld in the context of securities fraud by multiple circuit and district courts. A critical point from Castano is that a district court must analyze whether class members' fraud claims rely on individual proof of reliance; if reliance varies among plaintiffs, the class does not meet the predominance requirement.

For plaintiffs to establish a classwide presumption of reliance on alleged misstatements, they must invoke the fraud on the market theory, as articulated in Basic, Inc. This theory posits that in an efficient market, stock prices reflect all available information, making misleading statements detrimental to stock purchasers, even without direct reliance on those statements. To support this presumption, plaintiffs must demonstrate that the security in question is traded in an efficient market, particularly crucial for small-cap stocks in less organized markets. Without such proof, individual reliance must be established, which would undermine the class certification under the predominance requirement. Courts typically apply strict standards of proof for this market efficiency determination, recognizing its significance in the certification process and its potential impact on settlement outcomes.

Courts assess the degree of proof required for class certification by drawing parallels to standards used in preliminary injunction hearings and jurisdiction contests. While a court's class certification determination may be revisited by the ultimate factfinder, it cannot assume facts favoring an efficient market. Several factors are utilized to evaluate whether a stock trades in an "efficient market," including: 1) weekly trading volume as a percentage of outstanding shares, 2) number of analysts covering the stock, 3) activity of market makers and arbitrageurs, 4) eligibility for SEC registration Form S-3, 5) empirical evidence linking corporate events to stock price reactions, 6) market capitalization, 7) bid-ask spread, and 8) float (trading volume excluding insider-owned stock). Courts have employed these factors variably, emphasizing the need for an analytical weighing of each rather than mere counting. Some courts have determined that certain markets, such as over-the-counter, do not exhibit efficiency as a matter of law. In this case, the district court inadequately evaluated market efficiency factors, concluding Amedisys stock traded efficiently based on three factors: high trading volume, market maker activity, and a cause-and-effect relationship between corporate events and price changes. However, the court failed to verify the actual trading volume of Amedisys shares, relying instead on unverified claims and incomplete data, leading to unreliable conclusions.

The district court found that the presence of twenty-two market makers for Amedisys stock supported a conclusion of market efficiency, relying on an Internet printout and unchallenged affidavits from plaintiffs' witnesses. However, the court overlooked criticisms in the economic literature regarding the number of market makers as a valid measure of market efficiency, which should consider trade volume and price. Additionally, the court identified a causal connection between Amedisys's corporate events and stock price movements but failed to account for numerous other factors influencing stock prices, such as overall market conditions, economic news, and competitor activities. The court's reliance on specific stock price reactions to company announcements was deemed insufficient for determining a causal connection based on empirical evidence. Moreover, the court did not properly weigh the absence of securities analysts following Amedisys stock or the company's ineligibility to file an SEC Form S-3, both of which negatively impact the market efficiency analysis. The ruling highlighted the necessity for a comprehensive evaluation of all relevant factors, both supportive and detrimental, in assessing the "fraud on the market" theory.

Class certification decisions by district courts are afforded significant deference; however, the current order cannot be upheld due to insufficient support. A comprehensive analysis is essential when evaluating class certification under the fraud on the market theory, requiring courts to weigh pertinent factors, necessitate justifications from both parties, and base decisions on admissible evidence. Market efficiency must be analyzed just like any other certification issue, and decisions cannot rely solely on unsubstantiated allegations or one-sided evidence.

Consequently, the class certification order is vacated and remanded for further proceedings. The document reiterates the requirements of Rule 23(a) for class actions, emphasizes the necessary elements for a 10b-5 claim, and notes criticisms of the efficient market theory as articulated in a recent law review article. It also discusses the prerequisites for filing SEC Forms and the role of expert testimony in assessing market efficiency during class certification, highlighting that while expert testimony can be relevant, a rigorous evaluation of its reliability is crucial before proceeding with class certification. Lastly, the court neglected to consider specific financial metrics related to Amedisys, which may impact the certification analysis.

Circuit Judge Dennis concurs with the outcome but disagrees with the majority's interpretation regarding the degree of proof necessary for determining market efficiency in class action certifications. He clarifies that the Fourth Circuit's Gariety v. Grant Thornton and the Seventh Circuit's Szabo v. Bridgeport Machines do not actually compare standards of proof from other legal proceedings. Instead, these cases present models for district courts to analyze class action certifications without violating the Supreme Court's guidance in Eisen against considering the likelihood of a class prevailing on the merits during certification. 

Dennis emphasizes that while courts conduct factual inquiries similar to those in preliminary injunctions and jurisdictional contests, these do not set binding standards for class certification. He notes that the standards for class certification are more nuanced and require a thorough examination rather than a determination of likely success on the merits. He reiterates that a proper certification analysis must involve an intense factual investigation into the claims without adjudicating their merits. Ultimately, while agreeing that the district court failed to properly assess market efficiency factors, he firmly rejects the majority's reading of Gariety and Szabo as supporting the application of specific proof standards in this context.