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From Securities Regulation Daily, January 22, 2019

Basic presumption rebutted, class certification denied where DOJ memo was not a corrective disclosure

By Mark S. Nelson, J.D.

The court suggested materialization of risk is helpful to generalized reliance for purposes of showing predominance under the FRCP, but it cannot support class certification if a risk materializes after revelation of some truth about the company.

Investors suing an operator of private prison facilities over allegedly false statements about the quality of the company’s services failed to obtain class certification because the investors were unable to allege reliance based on either the Basic or Affiliated Ute presumptions of reliance. In the context of the case, reliance was important because it would have served to help establish predominance under Rule 23(b)(3) of the Federal Rules of Civil Procedure (FRCP). Ultimately, the court concluded that Basic reliance did not apply because there was no price impact, a decision that further hinged on whether a DOJ memo issued after an inspector general (OIG) report was a corrective disclosure. Affiliated Ute reliance also did not apply because the case was about affirmative statements and not a failure to make disclosures. The court emphasized that its ruling meant only that individual reliance must be shown and not that CoreCivic could not have misled investors (Grae v. Corrections Corporation of America, January 18, 2019, Trauger, A.).

CoreCivic, Inc. is a real estate in investment trust that operated private prison facilities contracted by the federal Bureau of Prisons. An OIG report highlighted instances in which private prisons generally lacked medical, staffing, and safety and security resources. As an example, a riot at a CoreCivic facility resulted in the death of one of its correction officers. The OIG report was followed by a DOJ memo issued by then-Obama Administration Deputy Attorney General Sally Yates calling for the BOP to curb its use of private prison facilities; the memo was later rescinded by then-Trump Administration Attorney General Jefferson Sessions. Although the OIG report had little, if any, impact on CoreCivic’s stock price, the company’s shares fell dramatically after issuance of the DOJ memo.

Fraud-on-the-market presumption. The question of whether the plaintiff alleged predominance for FRCP Rule 23(b)(3) purposes via the fraud-on-the-market presumption of reliance under the Supreme Court’s Basic opinion hinged on whether the OIG report or the DOJ memo had any impact on the price of CoreCivic’s stock. CoreCivic conceded for purposes of class certification that the fraud-on-the-market presumption was otherwise satisfied, but contended that, under the Supreme Court’s Halliburton II opinion, there was no price impact.

CoreCivic argued that the OIG report was a corrective disclosure without price impact. CoreCivic’s economics expert concluded that the result of the DOJ memo was a "reevaluation" by the market of CoreCivic’s business (the expert also said Trump Administration policy had since "dispelled" the markets’ reaction). CoreCivic also had argued that the impact of the DOJ memo was primarily political. But the court noted: "When a company chooses, like CoreCivic has, to enter into a line of business that requires it to rely on government customers, then there is no neatly separating its client relationships from the underlying politics. Perhaps the Yates Memorandum did reflect a political decision—the political decision to not keep using such low-quality services." The court’s remark followed a discussion of the materialization of risks theory under which risks can be revealed by events, not just admissions, although some part must be attributable to admissions or revelations.

But the court next explained: "There is no basis for treating the materialization of a risk as the equivalent of a corrective disclosure if the materialization occurred only after the truth had already been revealed. If the market learns the truth about an underlying risk to a company prior to the risk’s materializing, then materialization has no concealed truth to reveal. The value of the company’s shares still might go down—but that reduction in value would be due to the damage done by the materialized risk itself, not the market’s having been in the dark about the risk’s existence or severity."

The court concluded that the DOJ memo was not a corrective disclosure because it merely announced a policy decision following the revelations made by the OIG report. In reaching this conclusion, the court rejected an analysis offered by plaintiffs’ expert suggesting that the reason for no price impact on CoreCivic’s stock after the OIG report was published was the inclusion in that report of reply letters that offset the impact of the report. The court also rejected as a "scaled-down version of relying on the Yates Memorandum" plaintiffs’ expert’s alternative theory that the federal government’s cancelation of a major contract with CoreCivic at least partially revealed some truth about the quality of CoreCivic’s services and, thus, could function as a corrective disclosure.

Affiliated Ute presumption. The Affiliated Ute presumption required the court to mull whether the case against CoreCivic was primarily about CoreCivic’s failure to make certain discloses or was about its affirmative statements. According to the court, Affiliated Ute must be construed narrowly to avoid creating an overbroad exception.

Here, the plaintiffs argued that even if the Basic presumption of reliance was unavailable, the Affiliated Ute presumption of reliance was available because CoreCivic withheld material facts about the quality of its services. However, the court concluded that the case had been treated as being about affirmative statements from the beginning and that the Affiliated Ute presumption of reliance was likewise unavailable.

The case is No. 3:16-cv-2267.

Attorneys: Brian Schall (Goldberg Law PC) for Nikki Bollinger Grae. Anna E. Berces (Latham & Watkins) and Milton S. McGee, III (Riley Warnock & Jacobson, PLC) for Corrections Corp. of America.

Companies: Corrections Corporation of America; Amalgamated Bank; LongView Collective Investment Fund; CoreCivic, Inc.

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