On July 7, the Second Circuit affirmed in part and vacated in part an order by Judge Rakoff of the S.D.N.Y. certifying two classes in the In re Petrobras Securities litigation, — F.3d –, 2017 WL 2883874 (2d Cir., July 7, 2017). In doing so, the Second Circuit joined several other circuits in declining to adopt a “heightened” version of the implied class certification requirement of ascertainability, which arose in the Third Circuit. Having rejected defendants’ arguments on this point, however, the Second Circuit applied Morrison v. National Australia Bank, 561 U.S. 247 (2010), in assessing whether the plaintiffs had met the predominance standard for class certification, and held that they had failed to do so, because individual questions of transactional domesticity—which under Morrison must often be considered when the territorial scope of the securities laws is at issueprevailed over common ones.

Petrobras is a multinational oil and gas company based in Brazil and majority-owned by the Brazilian government. Plaintiffs in Petrobras were holders of Petrobras equity and debt securities, who alleged that value of these securities fell dramatically following the revelation of a long-term money-laundering and kickback scheme at the company. Defendants included Petrobras and a number of its executives. In re Petrobras, 2017 WL 28883874 at *1.

The district court certified two classes of plaintiffs, the first asserting claims under the Exchange Act, and the second asserting claims under the Securities Act. On appeal, defendants challenged class certification on the grounds that (1) these classes were not sufficiently “ascertainable”; and (2) plaintiffs had not met the Rule 23(b)(3) requirement “that questions of law or fact common to class members predominate over any questions affecting only individual members.” In an opinion written by Judge Garaufis of the E.D.N.Y. (sitting by designation), and joined by Judges Hall and Livingston, the Second Circuit rejected defendants’ acertainability argument, but sided with them on their predominance argument. Id. Specifically, the court of appeals found that the district court had “erred in conducting its predominance analysis without considering the need for individualized Morrison inquiries.” Id. at *6.

The ascertainability requirement for class certification does not appear in Rule 23 itself, but is instead an “implied” mandate that a class be “sufficiently definite so that it is administratively feasible for the court to determine whether a particular individual is a member.” Id. at *5 (quoting Brecher v. Republic of Argentina, 806 F.3d 22 (2d Cir. 2015)). In several opinions, including Byrd v. Aaron’s Inc., 784 F.3d 154 (3d Cir. 2015), the Third Circuit has interpreted the ascertainability requirement as requiring a showing of administrative feasibility at the class certification stage—that is, a showing by plaintiffs that there will be an administratively feasible means of determining whether class members fall within the class definition. Petrobras, 2017 WL 2883874 at *11.

In Petrobras, the Second Circuit joined the Sixth, Seventh, Eighth and Ninth Circuits in rejecting this “heightened” ascertainability standard, and clarified its own ruling in Brecher, holding that ascertainability should not be evaluated with reference to administrative feasibility, but rather whether the proposed class is “defined by objective criteria.” Id. at *10. In Petrobras, this “modest threshold requirement” was met, because the proposed classes were concretely defined to include “persons who acquired specific securities during a specific time period, as long as those acquisitions occurred in ‘domestic transactions.’” Id. at *12.

Having rejected defendants’ arguments regarding ascertainability, however, the Second Circuit nonetheless vacated the district court’s certification order on the ground that it did not adequately consider domestic territoriality as defined by Morrison in evaluating the Rule 23 predominance requirement.

In Morrison, the Supreme Court held that the US securities laws are presumed to apply only to (1) transactions in securities listed on domestic exchanges; and (2) “domestic transactions” in other securities. In a subsequent case, Absolute Activist v. Ficeto, 677 F.3d 60 (2d Cir. 2012), the Second Circuit elaborated on the second prong of Morrison, holding that transactions in securities not listed on domestic exchanges are “domestic” if “irrevocable liability is incurred or title passes within the United States”; and also ruled that transactional domesticity is a “merits” question of the kind that can considered in a Rule 12(b)(6) motion.

In Petrobras, there was no doubt that the equity transactions at issue fell within Morrison’s first prong, given that the Petrobras equity securities were traded on the NYSE. There was also no doubt that the debt transactions did not fall within the first prong, since the debt securities did not trade on any U.S. exchange, and were instead traded on various over-the-counter markets. The hard question in Petrobras was whether the over-the-counter debt securities transactions fell into the category of “domestic transactions” notwithstanding the fact that they were not conducted on domestic exchanges—a question rendered more difficult by the fact that these transactions differed in their particulars. Id. at 3.

The district court did consider Morrison-based challenges to plaintiffs’ claims before issuing its class certification order, dismissing two named plaintiffs from the case after finding that their over-the-counter debt securities transactions did not qualify as domestic under Morrison and Absolute Activist. Id. at *7-8. But the Second Circuit nonetheless found that the district court did not adequately address Morrison in the certification context. Id. at *14-16.

Generally speaking, a plaintiffs seeking to demonstrate that a particular over-the-counter transaction was domestic may offer “evidence ‘including, but not limited to, facts concerning the formation of the contracts, the placement or purchase orders, the passing of title, or the exchange of money.’” Id. at *14 (quoting Absolute Activist, 677 F.3d at 70). As the Second Circuit observed in Petrobras, “these transaction-specific facts are not obviously ‘susceptible to [ ] class-wide proof.’” Id. (quoting Tyson Foods v. Bouaphakeo, 136 S.Ct. 1036, 1045-46 (2016)).

The district court approved two class representatives with claims based on over-the-counter transactions in debt securities. For each of these two plaintiffs, domesticity was not seriously at issue, as they placed their purchase orders in the United States and procured their securities directly from U.S. underwriters. But the Second Circuit described these two class representatives as “the easy case,” and concluded that the district court’s certification order “offers no indication that [it] considered the ways in which evidence of domesticity might vary in nature or availability across the many permutations of transactions in Petrobras Securities.” Id. at *15.

According to the Second Circuit, these likely intra-class differences give rise to a predominance problem, because “the investigation of domesticity appears to be an ‘individual question’ requiring putative class members to ‘present evidence that varies from member to member.’” Id. at *14 (quoting Tyson Foods, 136 S.Ct. at 1045). In this case, the Second Circuit concluded, “it cannot be said that the class members’ Morrison inquiries will ‘prevail or fail in unison.’” Id. at *16. On this basis, the Second Circuit vacated the district court’s certification of the two classes insofar as they included all otherwise-eligible members who acquired their Petrobras securities in “domestic transactions”—allowing, however, that the district court might, on remand, properly certify one or more classes that would capture some or all of the members of the vacated classes. Id. at *16.

Finally, the Second Circuit also addressed a ruling by the district court, with respect to the Exchange Act class, that plaintiffs were entitled to a presumption of reliance under the “fraud on the market” theory established in Basic v. Levinson, 485 U.S. 224 (1998). While the defendants pointed to the fact that plaintiffs provided no empirical data showing that the price of the relevant Petrobras securities moved up and down predictably in response to news about the company, the Second Circuit noted that such data may suffice but is not necessary to show market efficiency, and held that the district court properly considered other forms of direct and indirect evidence in ruling that the Basic presumption applied for purposes of class certification. Id. at *20.