In a decision with potentially far-reaching effects, the United States Court of Appeals for the Second Circuit recently toughened the standard for granting class certification under Rule 23 of the Federal Rules of Civil Procedure. In In re Initial Public Offering Securities Litigation, No. 05-3349-cv (Dec. 5, 2006), the court reversed an order granting class certification in six consolidated securities fraud actions brought by thousands of investors against major investment banks alleging that they had inflated market prices and received secret commissions when underwriting IPOs. This decision may affect all areas of law influenced by class actions, including employment, antitrust, consumer protection and product liability.

This Update summarizes the key issues addressed in the court's decision and its potential effect on class action litigation.

The Decision in In re IPO

Plaintiff Seeking Class Certification Must Meet Each Rule 23 Requirement. The court in In re IPO held that a plaintiff seeking class certification must demonstrate that it has met each of the requirements under Rule 23, even when such a ruling requires addressing the merits of the underlying case. Rule 23 allows certification of a prospective class if the class meets six criteria:

    • the proposed class has many members;

    • questions of law or fact are common to the class;
    • the claims or defenses of the representative parties are typical of those of the class;
    • those parties will fairly and adequately represent the interests of the class;
    • the common questions predominate over individual questions; and
    • a class action is superior to other methods of adjudication.

In re IPO reverses a district court ruling that plaintiffs could meet the requirements of Rule 23 merely by making "some showing" of meeting these requirements, such as through submission of documents, affidavits or expert reports that are not "fatally flawed." The Second Circuit instead established a more stringent standard of proof, holding that district courts must assess all available evidence to determine whether the six requirements of Rule 23 are met, even if this review includes some analysis of the merits of the underlying case. Applying this heightened standard to the IPO cases on review, the court found class action status inappropriate because individual questions predominated over common questions. These individual questions of fact included whether each plaintiff relied on the allegedly misleading information and whether each plaintiff knew of the alleged schemes of the defendant banks.

Effect of the Decision — Fewer IPO Lawsuits?

The courts' general tendency to give the benefit of the doubt to plaintiffs seeking class treatment over the past several years has eroded defendants' ability to challenge class certification. This decision reverses this trend and places the burden squarely on plaintiffs to demonstrate that they have satisfied the requirements to proceed with a class action. This decision also effectively ends the thousands of similar IPO lawsuits filed after the collapse of the Internet boom because in these cases the individual questions will likewise predominate over common questions and the vast majority of plaintiffs lack sufficiently large disputes to justify individual litigation.

In re IPO is only binding precedent in the Second Circuit, and several other circuits, including the Ninth Circuit, have not directly addressed either the standard of proof required under Rule 23 or whether class certification rulings can assess the merits of the case. However, the influential nature of the Second Circuit, combined with the rigorous analysis employed by the court in reaching its decision, creates the possibility that other circuits, or even the United States Supreme Court, may adopt the holding of In re IPO.

Class action defendants facing a class certification motion now have new strong arguments and authority to challenge class certification that the In re IPO decision provides.

Available Information

You can find the full text of the Second Circuit's opinion in In re Initial Public Offering Securities Litigation at http://online.wsj.com/public/resources/documents/ipo.pdf. You can find discussions of other recent cases, laws, regulations and rule proposals of interest to public companies on our website.


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