Second Circuit Sends Goldman Sachs Investors Back to the Drawing Board

(CN) – Investors must refile for class certification in a suit accusing Goldman Sachs of putting favored clients’ interests ahead of others’, because the lower court may have imposed the wrong burden of proof on the bank, the Second Circuit ruled.

In a 2011 lawsuit, shareholders who purchased shares of  the investment bank between 2007 and 2011 accused Goldman Sachs of misrepresenting its efforts to avoid conflicts of interest.

They claim the bank acted in direct conflict with investors’ interests in four collateralized debt obligation (CDO) transactions involving subprime mortgages between 2006 and 2007.

In one specific transaction, known as the Abacus transaction, Goldman Sachs allegedly permitted a favored client to participate in the asset selection process for a CDO without telling other investors that the client held a short position, and thus had a motive to select particularly risky mortgages that it hoped would fail.

Goldman settled claims brought by the Securities and Exchange Commission related to the Abacus transaction for $550 million.

The disclosure of this conduct saw Goldman Sachs’ share price to fall 18% from $184.27 to $145.20, investors claim.

A federal judge certified a class action in the case, but the Second Circuit vacated the ruling on January 12.

While investors are entitled to a presumption that they actually relied on defendants’ misrepresentations when choosing to buy or sell stock, established in Basic Inc. v. Levinson, Goldman Sachs presented evidence to rebut this presumption purporting to show that declines in its share price were not related to the disclosure of conflicts of interest mistakes with the CDOs.

The Second Circuit found uncertainty in how the lower court handled this testimony.

“It is unclear to us whether the court required more of defendants than a preponderance of the evidence [to rebut the Basic presumption],” Judge Richard C. Wesley states, writing for the three-judge panel. “We therefore vacate the District Court’s order.”

On remand, the investors will have another chance to convince the judge to certify a class.

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