Full opinion text
ORDER WALKER, District Judge. The complaints in these consolidated securities fraud cases allege that due to improper conduct by the defendants, the price of Sea-gate common stock was fraudulently inflated for a period of several months. During this time, defendants allegedly made several partially curative disclosures. These partial disclosures caused the trading price of the stock to decline gradually, instead of dropping suddenly as is usually the ease when a one-time full disclosure of fraud is released. As a result, some of those purchasing stock during this period also sold some or all of their shares at prices reflecting these partial disclosures. As will be developed here, these purchasers have very different stakes in shaping the pertinent evidence from those purchasers who held their stock until after the fraud had been fully revealed. These divergent interests, which stem primarily from the measure of damages currently in use in fraud-on-the-market cases, may be so pervasive that the interests of the class members are not sufficiently aligned to satisfy the prerequisites of FRCP 23 and fundamental due process requirements. Accordingly, this litigation may be precluded from proceeding as a class action. Apart from these concerns, defendants have established that this litigation can proceed only as to plaintiffs’ allegations that defendants failed to disclose material information they were under a duty to disclose; any claims based on alleged affirmative misstatements by defendants cannot succeed. I During 1988, Seagate Technology, Inc. (“Seagate”), the issuer of a single class of NASDAQ-quoted common stock, encountered adverse conditions in its principal line of business, the manufacture of 5/4 inch rigid disk drives for personal computers. Instead of fully disclosing “the truth concerning its financial condition and business prospects,” Second Consol Amended Compl ¶ 53 at 30, plaintiffs allege that, starting with a press release on July 18, 1988, Seagate made a series of “grudging admissions of certain adverse facts — no one of which was fully curative.” Pis Submission re Ending Date of Class Period, June 3, 1991, at 2. Plaintiffs claim that the dissemination of these half-truths continued until October 5, 1988, when Seagate issued a press release announcing a loss for the quarter ended September 30 and the resignation of two sales executives. Second Consol Amended Compl at 33. With each disclosure, the trading price of Seagate common stock ratcheted down, dropping from $22 per share on April 13, 1988, to about $7 per share following Seagate’s October 5 press release. See In re Seagate Technology II Securities Litigation, 802 F.Supp. 271, 272-74 (N.D.Cal.1992). This litigation followed. Plaintiffs contend that defendants’ fraudulent nondisclosures and their “grudging” partial disclosures distorted, to varying degrees, the price of Sea-gate common over the period from April 13, 1988, to October 5, 1988. On August 21, 1991, another judge, to whom this litigation was then assigned, provisionally certified a class action, but established subclasses of the security’s purchasers more or less keyed to the dates of the partial disclosures. The order tersely stated: Certification for this period is provisional and subclasses shall be certified for the period 1) April 13,1988 to July 19,1988; 2) July 20, 1988 to August 7,1988; 3) August 8,1988 to September 24,1988; 4) September 25, 1988 to October 7, 1988. Although the litigation has thus far proceeded pursuant to that order, the parties now disagree on the effect of the order for purposes of completing pretrial preparation and trial. The prior judge’s decision provisionally to certify subclasses, rather than a single class, indicates serious misgivings about the suitability of this case for class treatment. In fact, as will be explained, any securities fraud case involving the slow leakage of partially curative disclosures into an active securities market creates the potential for troubling antagonisms among those purchasing the security during the relevant period. Evidently, the prior judge hoped that these conflicts could be avoided by the use of subclasses. Upon further analysis, as explained below, the court concludes that the subclassing contemplated by the prior judge is wholly inadequate to the task of resolving this problem. Instead, detailed factual analysis is necessary to determine the extent and severity of the conflicting interests, so that the court can evaluate whether due process requirements and the prerequisites of FRCP 23 are satisfied. For this purpose, the court concludes that an evidentiary hearing is warranted. In addition to the class certification dispute, the court has before it defendants’ motion for summary judgment. Defendants base their motion on three arguments. First, defendants mount a so-called “truth on the market” defense, arguing that Seagate’s stock price was not distorted by any misstatements or omissions of defendants. In support of this contention, defendants offer a statistical analysis of the trading price of Seagate common throughout the class period. Second, defendants suggest that they had no affirmative duty to disclose adverse financial information to the public any sooner than they actually did so. Third, defendants claim that they are entitled to summary judgment on the issue of scienter. In response, plaintiffs have brought a cross-motion for partial summary judgment, contending that Sea-gate’s stock price was biased by defendants’ misstatements/omissions as a matter of law. Before discussing the conclusions the court has reached on these various issues, it is imperative to set in perspective the FRCP 23 prerequisites to class certification, the elements of a Rule 10b-5 claim, and the measure of damages currently used in securities fraud cases; this follows presently. Part II then reviews the impact of the fraud-on-the-market theory on the substantive law of Rule 10b-5. As will be shown, this theory dramatically amplified the importance of certain types of class conflicts, rendering them serious obstacles, under the requirements of FRCP 23, to class certification. Part III details two such disturbing conflicts, the “seller-purchaser” conflict and the “equity” conflict, both of which are present in the case before the court. Part IV demonstrates that these conflicts may be particularly troublesome in cases, such as the instant one, involving partial curative disclosures. Finally, Part V addresses the summary judgment motion of defendants, and the partial summary judgment motion brought by plaintiffs. A The prerequisites to class certification are by this time well known. To qualify for class treatment, an action must first meet the requirements of FRCP 23(a): One or more members of a class may sue or be sued as a representative on behalf of all if (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class, and (4) the representative parties will fairly and adequately protect the interests of. the class. In addition to satisfying the prerequisites of FRCP 23(a), the action must also meet one of the three sub-parts of FRCP 23(b). Securities fraud cases in which damages are sought, however, are almost exclusively certified under FRCP 23(b)(3). See Herbert Newberg and Alba Conte, 4 Newberg on Class Actions § 22.44 (McGraw-Hill, 3d ed. 1992) (hereinafter, “Newberg”). This so-called “(b)(3)” class action requires the court to find: [Tjhat the questions of law or fact common to the members of the class predominate over any questions affecting only individual members, and that a class action is superi- or to other available methods for the fair and efficient adjudication of the controversy. Therefore, in order to certify a class action under FRCP 23(b)(3), six elements must be established: numerosity, commonality, typicality, adequacy of representation, predominance, and superiority. Of these six, the numerosity, commonality and predominance prerequisites are relatively straightforward and require little discussion; the remaining three, however, require some explanation. Typicality exists where: the [named] plaintiffs claims * * * arise from the same event or practice or course of conduct that gives rise to the claims of the other class members, and his or her claims [are] based on the same legal theory. In these circumstances, the plaintiff will advance the interests of the class members by advancing her or his own self-interest. Newberg, § 22.17 at 22-58 (footnotes omitted). The adequacy of representation requirement has come to encompass two inquiries: (1) whether there is an absence of antagonism between the named plaintiff and the other class members; and (2) whether the absent class members can be assured of a vigorous prosecution by the named plaintiff and his or her counsel. See Newberg, § 22.24 at 22-102. Only if both questions can be answered affirmatively can the named plaintiff be deemed an “adequate representative.” Finally, in determining whether a class action is the superior means of proceeding, the court is to be guided by numerous factors, including: (A) the interest of members of the class in individually controlling the prosecution or defense of separate actions; (B) the extent and nature of any litigation concerning the controversy already commenced by or against members of the class; (C) the desirability or undesirability of concentrating the litigation of the claims in the particular forum; (D) the difficulties likely to be encountered in the management of a class action. FRCP 23(b)(3). B The elements of a Rule 10b-5 claim are hardly as clear as the prerequisites to class certification under FRCP 23. Because the private cause of action is one implied from Rule 10b-5, the courts have had to define its contours. See generally, Thomas Lee Hazen, 2 The Law of Securities Regulation § 13.2 (West, 2d ed 1990) (hereinafter, “Hazen”). Given the fact that Rule 10b-5 was intended to be an “antifraud” provision, it is not surprising that courts have often looked to the elements of common law fraud in developing the requirements of a 10b-5 claim. Although Rule 10b-5 has been invoked to redress a wide variety of deleterious tactics in the trading of securities, of particular concern here is its use to remedy improper “corporate disseminations.” See Hazen, § 13.7 at 117. This phrase refers to either of two things: (1) affirmative misstatements made by corporate officers or directors in information releases issued by the corporation; or (2) omissions of information which render the statements actually made in such a release misleading. In order to prevail on a Rule 10b-5 claim for an improper corporate dissemination, a plaintiff must establish, inter alia: (1) a misstatement or omission; (2) the materiality of the misstatement or omission; (3) scienter on the part of those making the misstatement or omitting the information; (4) reliance by the plaintiff if a misstatement is alleged; (5) the damages suffered by the plaintiff; and (6) a causal link between the plaintiff’s damages and the issuer’s misstatement or omission making the latter the proximate cause of the former. See generally Louis Loss and Joel Seligman, IX Securities Regulation Ch. 11.C.4.d (Little, Brown & Company, 3d ed. 1992) (hereinafter, “Loss”). C The heretofore widely accepted measure of damages in securities fraud litigation is the so-called out-of-pocket measure. See Affiliated Ute Citizens v. United States, 406 U.S. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972). This measure of damages looks to the plaintiffs loss as opposed to the gain of the defendant. See, e.g., Arrington v. Merrill Lynch, Pierce, Fenner & Smith, 651 F.2d 615, 621 (9th Cir.1981) (“the difference between the value of the consideration [plaintiff] gave and the value of the security [plaintiff] received”); Foster v. Financial Technology, Inc., 517 F.2d 1068, 1071 (9th Cir.1975); Note, Rule 10b-5 Damage Computation: Application of Financial Theory To Determine Net Economic Loss, 51 Fordham L.Rev. 838, 838-39 (1983); Note, The Measure of Damages Under Section 10(b) and Rule 10b-5, 46 Md.L.Rev. 1266, 1268 (1987). An oft-cited explanation of the method of calculating damages under the out-of-pocket rule was provided in Judge Sneed’s concurring opinion in Green v. Occidental Petroleum Corp., 541 F.2d 1335, 1341 (9th Cir.1976). Judge Sneed’s analysis starts with the rather simple concept that where the fraud-on-the-market is one involving either a false positive statement or a failure to disclose a negative fact, the price of the security will remain at a level above its unbiased value until a full corrective disclosure is issued. Accordingly, Judge Sneed put forth the concepts of a “price line” and a “value line,” in order to trace the degree of price inflation at various points in time. The price line is relatively easy to obtain, as it is merely á plot, over time, of the various prices at which trades in the security occurred. Obtaining the value line, however, is a much more difficult task and warrants some explanation before any detailed discussion of Judge Sneed’s methodology is undertaken. 1 Decoding how much of the price behavior of a security is attributable to alleged market manipulation requires statistical analysis. A first step in such an analysis is the elimination of non-fraud related influences. Note, Estimating Aggregate Damages in Class-Action Litigation Under Rule 10b-5, 59 Fordham L.Rev. 811 (1991). These include, among others, overall conditions in the securities markets. Securities, after all, compete with other investments (e.g., real estate and commodities), and different types of securities compete among themselves (e.g., computer stocks with consumer product stocks). Overall securities market conditions are often eliminated by using a broad-based standard market index such as the Standard & Poor’s 500 stock index or the Wilshire 5000 index. Securities prices are, of course, also influenced by economic conditions in the industry in which the issuer competes. As a result, it is necessary to eliminate these economic factors through the use of industry indices. Industry indices reflect the price behavior of similar types of securities issued by publicly traded companies. Usually, industry indices need to be specially constructed because most companies do not fit neatly into a single industry category. The next step in the analysis consists of compiling the daily returns for a period not affected by the alleged fraud and then, using a regression model, calculating correlation coefficients or betas for each index. These coefficients are used with the index values for the period of the fraud to determine the unexplained random error term or portion of price behavior that cannot be explained by the market or industry indices. An analysis of these residual or unexplained price changes is undertaken to determine which of these might be explained by the influence of firm-specific, but non-fraud related, information, and which might be attributed to the fraud alleged. By separating out the fraud-related component of a security’s price behavior in this fashion, it is possible to obtain the price profile the security likely would have exhibited had there been no fraud. This, by definition, is the- “value line” Judge Sneed envisioned. Judge Sneed recognized that drawing the “value line” could be “difficult and complex,” but, with sunny optimism about the capabilities of district judges, thought it nonetheless “practicable.” Green, 541 F.2d at 1341. 2 Having constructed the price line and the value line for the appropriate period, Judge Sneed’s analysis proceeds as follows. First, Judge Sneed recognized that there are potentially two types of plaintiffs — those who suffered “retention” damages and those who suffered “in/out” damages. Retention damages arise where a plaintiff purchased securities during the period of inflation, and then held the securities throughout the remainder of the class period. In/out damages, on the other hand, arise where the plaintiff purchases a number of securities during the price inflation, but then also sells all of those securities before the end of the class period. It is even possible for a single plaintiff to have both types of damages, provided he purchased a certain number of securities during the class period and sold a smaller number before the end of the period. Judge Sneed’s description of the method for calculating an individual plaintiffs damages, whether retention or in/out damages, can be conveniently represented in the following mathematical form: D = P * (PLp - VLP) - S * (PLS - VLS), where D represents damages to the individual; P represents the number of securities purchased in the class period; PLp represents the price read from the price line at the time of purchase; VLP represents the value taken from the value line at the time of purchase; S represents the number of securities sold in the period, with the added condition that the maximum value of S is equal to P; PLS and VLS represent, respectively, the amounts taken from the price line and value line at the point of sale. In this formula, the first product [P * (PLp — VLP) ] represents the loss to the plaintiff caused by the fraudulent price inflation — i.e., the “extra” amount plaintiff was forced to pay in purchasing his securities. The second product [S * (PLS — VLS) ], on the other hand, represents the amount by which plaintiff benefited from the fraud if and when he sold his shares. The determination of retention damages is relatively straightforward. The retention plaintiff is injured when required to pay an inflated price for the securities at the date of purchase. Since the retention plaintiff never sells any securities, he never benefits from the fraudulently inflated price in any manner. Hence, his damages are simply the difference, at the time of purchase, between the price line and the value line, multiplied by the number of securities bought. Turning to the above formula, since the retention plaintiff has not sold any shares in the period, S = O. Therefore, the second term drops out, and the purchaser’s damages are wholly captured by the first term, i.e., P * (PLp - VLp). In/out damages require a slightly more elaborate discussion. Assuming for the moment that the in/out plaintiff sold, in the class period, securities equal in number to those he purchased in the period, the analysis is as follows. Just as the retention plaintiff, the in/out plaintiff is injured when forced to pay an inflated price at the time of purchase. Unlike the retention plaintiff, however, the in/out plaintiff recoups at least some (perhaps all) of his loss when he sells at the inflated price. Thus, in awarding him damages, it is only fair to subtract from his injury upon purchase the amount of his recoupment upon sale. In other words, the plaintiffs profits from reselling are deducted from his losses. If the plaintiff resells all the securities purchased during the period, then in the above formula P = S, and the formula reduces to: D = P*[(PLp - VLP) - (PLS - VLS)] The first product generated by the foregoing formula represents the injury the in/out plaintiff suffered when he purchased the securities (P), while the second product is the recoupment he enjoyed upon selling those securities. From this it is clear that if the degree of price inflation upon sale (PLS - VLS) is equal to the price inflation at purchase (PLp VLP), then the two terms cancel out, leaving D = O. If the inflation upon sale is greater than the inflation at purchase [i.e., (PLS - VLS) > (PLp - VLP) ], then the second product is greater than the first, leaving D negative (D < 0). This, of course, means that as a result of the fraud, the trader has actually “recouped” more upon sale than he lost upon purchase; thus, he is entitled to no relief. Legally cognizable damages exist only if the degree of inflation upon sale is less than that existing at purchase — i.e., if (PLS - VLS) < (PLp - VLP). Furthermore, the damage recovery mil be maximized the greater the disparity between the inflation at sale and the inflation at purchase. Finally, if the plaintiff is one who has suffered both in/out damages and retention damages, the same formula may be used. Mathematically, the “combination” plaintiff poses the situation in which the number of shares purchased in the period exceeds the number sold in the period, i.e., P > S. Therefore, the existence and amount of damages will depend on the relative magnitudes of the purchases, sales, and amounts of fraudulent price inflation prevailing at the corresponding dates. II The use of the class action device has long been the favored approach of courts faced with a Rule 10b-5 action in which numerous traders have allegedly been injured. Apart from the usual advantages in judicial economy conferred by the class action, the securities field has been characterized as “particularly well suited for representative litigation under [FRCP] 23.” Newberg, § 22.10 at 22-5. Two strong sentiments seem to underlie a great many class certification decisions. First, because the damages suffered by any one securities action plaintiff are often too small to justify litigation, the class action affords a large number of plaintiffs with relatively small claims a chance to obtain redress through aggregation. Second, the class action device is viewed as a necessary and desirable supplement to the enforcement efforts of the Securities and Exchange Commission. Thus, courts have concluded that in securities cases, “any doubts should be resolved in favor of allowing a class action,” that the court “should err in favor of allowing the class to go forward,” and that “the requirements of Rule 23 should be liberally construed in favor of class actions.” These strong sentiments may have precipitated, at least in part, the advent of the fraud-on-the-market theory of liability. As developed below, this theory eased satisfaction of the “predominance” prerequisite of FRCP 23, thus apparently making the class action device more readily available in securities fraud cases. At the same time, however, adoption of the theory had another effect that was surely unintended and has yet to be acknowledged: certain forms of class conflicts have taken on a central role in the class certification process. In order to appreciate fully the impact of the fraud-on-the-market theory, it is instructive to compare class certification decisions made before the theory with those made afterwards. A Prior to the Basic plurality’s adoption of the fraud-on-the-market theory, a plaintiff, in order to state a valid Rule 10b-5 “corporate dissemination” claim, had to establish each of the six requirements discussed above — i.e., a misstatement or omission, materiality, scienter, reliance, damages, and proximate causation. A court contemplating class certification in such a case, of course, had to ensure that the six prerequisites of a “(b)(3)” class action were satisfied — i.e., numerosity, commonality, typicality, adequacy of representation, predominance, and superiority. In corporate dissemination securities fraud cases involving shareholders or traders in a publicly traded or listed security, the numerosity requirement of FRCP 23 was almost always satisfied. Newberg, § 22.09 at 22-20. In addition to the fact that such cases often involved large numbers of potential plaintiffs, id., these plaintiffs were often geographically widely dispersed. Id. at 22-28. Because both of these factors tended to make joinder impracticable, defendants rarely contested class certification on numerosity grounds. Id. at 22-20. Likewise, the commonality requirement did not pose a significant obstacle to class certification; plaintiffs could ordinarily point to a number of questions of law and fact that would be common to their individual suits. The first element of a 10b-5 claim, the existence of a misstatement or omission, obviously posed numerous common factual inquiries concerning the knowledge and actions of the defendants. Additionally, the materiality inquiry necessitated by a 10b-5 claim always posed a “common question” — i.e., whether there was a substantial likelihood that a reasonable investor would consider the information significant in the total mix of information. See Basic, 485 U.S. at 231-232, 108 S.Ct. at 983. Finally, the third element of a 10b-5 claim, scienter, also constituted a common question, since the relevant inquiry was into the intent of the defendants. Therefore, three of the six elements of a 10b-5 claim— i.e., misstatement/omission, materiality, and scienter — posed common questions. The typicality requirement of FRCP 23 was also generally satisfied without great difficulty. Where a number of plaintiffs sought recovery based on a single misstatement or omission, typicality was easily satisfied since all claims arose “from the same event,” and were “based on the same legal theory.” See Newberg, § 22.17 at 22-58. Similarly, where the plaintiffs alleged a series of misstatements or omissions which arguably constituted a scheme to defraud, or a “course of conduct,” typicality was also met. Id. In essence, if the elements which the named plaintiff had to prove to prevail were substantially similar to those elements which the class members had to establish, typicality was satisfied. Id. at 22-86. The sixth element to FRCP 23(b)(3) class certification is a finding of superiority. This requirement, in the context of Rule 10b-5 corporate dissemination cases, often possessed little independent content. In some cases, the courts stated that a class action was superior to individual actions due to the fact that small-claim plaintiffs may not be able to sue individually. See, e.g., Simon v. Westinghouse Electric Corp., 73 F.R.D. 480, 487 (E.D.Pa.1977); Herbst v. Able, 47 F.R.D. 11, 17 (S.D.N.Y.1969); Feldman v. Lifton, 64 F.R.D. 539, 549 (S.D.N.Y.1974). In other cases, the court addressed the manageability inquiry specified by FRCP 23(b)(3)(D), see supra, by suggesting that class conflicts could be made manageable through the use of subclasses. See, e.g., Simon, 73 F.R.D. at 487; Koenig v. Smith, 88 F.R.D. 604, 610 (E.D.N.Y.1980); Jenson v. Continental Financial Corp., 404 F.Supp. 806, 814 (D.Minn. 1975). In still others, courts have referred to general notions of judicial economy as supporting the superiority of proceeding by class action. See, e.g., Herbst v. Able, 47 F.R.D. at 17; Jenson, 404 F.Supp. at 814. Given that the courts, in discussing the superiority requirement, often merely reiterated points made in considering other FRCP 23 requirements, it is not surprising that the superiority element of FRCP 23(b)(3) rarely precluded class certification. The only significant hurdles to class certification in the era before the fraud-on-the-market theory were provided by the remaining two prerequisites of FRCP 23 — predominance and adequacy of representation. 1 In considering the predominance requirement of FRCP 23, courts sometimes had difficulty. As mentioned above, three of the six Rule 10b-5 elements (misstatement/omission, materiality, and scienter) provided common questions of law and/or fact, thus satisfying the commonality requirement. Prior to the adoption of the fraud-on-the-market theory, the remaining three Rule 10b-5 elements — reliance, damages, and proximate cause — all constituted individual questions of law and/or fact. Each plaintiff had to show that he personally relied on the particular misstatement at issue. Similarly, each plaintiff had to establish the existence and amount of his own damages and prove that these damages were proximately caused by the defendants’ misstatement/omission. The relevant inquiry was thus whether the three common questions “predominated” over the three individual ones. The specter of individual determinations of reliance and/or damages, for a large plaintiff class, rightly gave the courts serious cause for concern about whether the common questions could predominate. Nonetheless, due perhaps to the sentiment for “liberal” application of FRCP 23 in the securities fraud context, see supra p. 1350, courts routinely found the predominance requirement satisfied despite the presence of extensive individual issues. See, e.g., Koenig, 88 F.R.D. at 607; Simon, 73 F.R.D. at 486; Jenson, 404 F.Supp. at 814; Herbst v. International Telephone & Telegraph, 495 F.2d 1308, 1321 (2d Cir.1974); Feldman, 64 F.R.D. at 548; Herbst v. Able, 47 F.R.D. at 16. As stated by the Second Circuit, in an often-cited passage: [defendant] earnestly argues that each person injured must show that he personally relied on the misrepresentation in order to recover and thus any common issues of misrepresentations do not predominate over the individual questions of reliance. Even if [defendant] is correct in its assertion of the need for proof of reliance * * * we must still reject the argument. Carried to its logical end, it would negate any attempted class action under Rule 10b-5, since as the District Courts have recognized, reliance is an issue lurking in every 10b-5 action. * * * We see no sound reason why the trial court, if it determines individual reliance is an essential element of the proof, cannot order separate trials on that particular issue, as on the question of damages, if necessary. The effective administration of 23(b)(3) will often require the use of the “sensible device” of split trials. Green v. Wolf Corp., 406 F.2d 291, 301 (2d Cir.1968). As exemplified by this passage, the conclusions of various courts that common questions predominated over individual ones suffered from two fundamental flaws. First, these holdings, instead of being based on actual comparisons of the relative weights of the common questions and the individual questions, were driven primarily by vague policy considerations. Thus, it appears that the courts may have certified classes in situations where the individual issues actually equalled or outweighed the common questions. The second flaw in these holdings is that the “solution” of using separate or split trials on the individual questions is illusory. As one court noted: [u]se of the bifurcation method * * * does not resolve what appears to be an inherent conflict between proof of the reliance element of a 10b-5 action and the “predominance of common issues” requirement of Rule 23(b)(3); it merely delays resolution of the problem until a later date. * * * That is, if actual individual reliance in its common law sense need be proved by each class member, the trial of that issue, even at a later stage in the proceedings, would tax the court’s (and counsels’) resources to an intolerable extent. Accordingly, the court is constrained to deal with the reliance enigma at the outset in making its determination of whether a class should be certified. Grad v. Memorex, Inc., 61 F.R.D. 88, 98 (N.D.Cal.1973). Nonetheless, the predominance requirement of FRCP 23(b)(3), though giving the courts some grounds for concern, failed to prevent class certification. Relying on the possibility of split trials, the courts appeared satisfied that the predominance requirement was met, and they regularly certified plaintiff classes. 2 The final requirement of FRCP 23, adequacy of representation, also minimally troubled the courts. As detailed above, one of the functions of this requirement is to ensure that there are no conflicts among members of the plaintiff class. In the 10b-5 corporate dissemination cases arising before the fraud-on-the-market theory, class members were most likely to have conflicting interests in establishing the “damages” element. As might have been expected, the defendants in these cases often attempted to prevent class certification by alerting the court to this antagonism. See, e.g., Koenig v. Smith, 88 F.R.D. 604 (E.D.N.Y.1980); Simon v. Westinghouse Electric Corp., 73 F.R.D. 480 (E.D.Pa.1977); Jenson v. Continental Financial Corp., 404 F.Supp. 806 (D.Minn. 1975); Feldman v. Lifton, 64 F.R.D. 539 (S.D.N.Y.1974); Madonick v. Denison Mines Ltd., 63 F.R.D. 657 (S.D.N.Y.1974); B & B Investment Club v. Kleinert’s, Inc., 62 F.R.D. 140 (E.D.Pa.1974); Herbst v. Able, 47 F.R.D. 11 (S.D.N.Y.1969). When presented with such arguments, however, the courts were generally unmoved. Given the plaintiffs’ common interest over the more immediate liability question, any conflict arising merely over damages, the. courts reasoned, could not defeat class certification. As one court put it: [the] conflicts * * * relate only to damages and thus are peripheral to the central issues in this case. Such conflicts potentially are presented in every securities fraud case involving a prolonged class period, but have been rejected consistently by the courts as grounds for denying class certification. Simon, 73 F.R.D. at 484 (citations omitted). Similarly, the court in B & B Investment Club responded to an assertion of antagonism by stating: Initially, the primary issue will not be the amount of damages but rather whether there is any liability on the part of defendants at all and any future conflicts can be handled by the formation of subclasses or further delineation of the class. B & B Investment Club, 62 F.R.D. at 144 (citations omitted). This latter suggestion of using subclasses at a later date to handle “future conflicts” over damages was made quite often by the courts, usually en route to a decision to certify a plaintiff class. See, e.g., Koenig, 88 F.R.D. at 609; Jenson, 404 F.Supp. at 811 n. 5; Feldman, 64 F.R.D. at 549; Madonick, 63 F.R.D. at 659; Herbst, 47 F.R.D. at 15. Quite apart from the feasibility of using subclasses, the important point is that the courts established that they were generally unwilling, at the class certification stage, to deal with conflicts arising over the proof and calculation of damages. The only way that antagonism over damages could possibly preclude certification, a number of courts held, was if the conflict went “to the heart of the controversy.” Koenig, 88 F.R.D. at 608 (quoting Gates v. Dalton, 67 F.R.D. 621, 630 (E.D.N.Y.1975)). See also Jenson, 404 F.Supp. at 811 (to prevent class certification, a conflict must go to “the very subject matter of the litigation”). Such conflicts, however, were rarely perceived. But see Wood v. Rex-Noreco, Inc., 61 F.R.D. 669 (S.D.N.Y. 1973) (conflict as to damages was serious enough to preclude certification); Ruggiero v. American Bioculture, Inc., 56 F.R.D. 93 (S.D.N.Y.1972) (damages conflict enough to prevent class certification). It appears, therefore, that although conflicts were often alleged to exist among plaintiff class members over the “damages” element of a Rule 10b-5 claim, the courts were not impeded in certifying a plaintiff class. Instead, the courts merely deferred serious consideration of these conflicts to a later stage in the proceedings, casually mentioning the use of subclasses as a possible solution to deal with this otherwise “peripheral” issue. B The fraud-on-the-market theory of liability received its first judicial endorsement as early as 1975, in the case of Blackie v. Barrack, 524 F.2d 891 (9th Cir.1975). This theory, as discussed further below, essentially raises a presumption of reliance in Rule 10b-5 corporate dissemination cases involving securities traded in efficient markets. In short, a plaintiff seeking Rule 10b-5 recovery under such circumstances need not prove that he personally relied on the misstatement or omission. In the years between 1975 and 1988, seven of the remaining ten circuits followed the Blackie court in adopting, in one form or another, the fraud-on-the-market theory; during the same period, no circuit explicitly rejected it. Loss, Ch. ll;C.4.d at 4396 n. 460. 1 In 1988, the fraud-on-the-market theory received the approval of a plurality of the Supreme Court in Basic, Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). In addition to the usual import which attends the affirmation of a new theory by the Supreme Court, the holding of Basic had great significance for at least two other reasons. First, the plurality’s opinion provided a coherent and cogent explanation of the foundations which make the fraud-on-the-market doctrine an acceptable basis for Rule 10b-5 liability. Second, the holding established a uniform fraud-on-the-market theory to replace the numerous versions previously in use in the various circuits. Because the Basic plurality’s explication of the fraud-on-the-market doctrine is now the controlling authority, only that version of the theory is reviewed here. In Basic, the plurality laid down a rule of legal liability for misstatements made impersonally by issuers of securities, and related parties, in connection with the active trading of the issuer’s securities. This rule draws its intellectual sustenance not from law, but from the efficient capital market hypothesis, a theory of financial economics which posits that information regarding a company’s expected future value is quickly and accurately incorporated into the price at which the company’s securities actively trade on an open and well-developed market. See Jonathan R. Macey and Geoffrey P. Miller, Good Finance, Bad Economics: An Analysis of the Fraud-on-the-Market Theory, 42 Stan.L.Rev. 1059, 1076-83 (1990); Ronald J. Gilson and Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 Va.L.Rev. 549, 561 (1984). The essence of the fraud-on-the-market theory of liability is that a plaintiff seeking to recover under Rule 10b-5 for an improper corporate dissemination need not prove his own personal reliance on the particular misrepresentation; instead, reliance is to be presumed. Basic, 485 U.S. at 247, 108 S.Ct. at 991-92. This conclusion was arrived at by the Basic plurality through a three-step analysis. First, the efficient capital market hypothesis allows a court to assume that any material misrepresentation made by an issuer of securities will quickly and accurately be reflected in the market price of that issuer’s securities, so long as the market involved is an “efficient” one. Id. at 244, 108 S.Ct. at 290. Next, it is presumed reasonable for an investor to rely on the integrity of the market price of any such security. Id. at 246-47, 108 S.Ct. at 291-92. And finally, because an investor who trades in a particular security can be presumed to have done so based on the market price of that security, if that market price reflects some misrepresentation made by the issuer of the security, the trader can be deemed to have relied on the misrepresentation itself. Id. at 247, 108 S.Ct. at 991-92. As summarized by the Ninth Circuit in In re Convergent Technologies Securities Litigation, 948 F.2d 507, 512 n. 2 (9th Cir.1991), “[a]n investor’s reliance on the market * * * is equivalent to reliance on statements made to the market or to nondisclosures of material information.” The Basic plurality characterized this presumption of reliance as “rebuttable” by a showing that the misrepresentation did not distort the price of the security, “or [that] an individual plaintiff traded or would have traded despite his knowing” of the misrepresentation. Basic, 485 U.S. at 248, 108 S.Ct. at 992. To some extent, however, this is misleading. The first of these methods, a showing of a lack of price distortion, does not directly “rebut” the reliance presumption as much as it attacks the foundational prerequisites to application of the fraud-on-the-market theory. Provided that a plaintiff can establish the materiality of the misinformation, such proof merely establishes that the market is not an “efficient” one which transmits material information via the pricing mechanism; since the fraud-on-the-market theory only applies to efficient markets, a presumption of reliance is therefore inappropriate. To the extent the market is an efficient one, however, the presumption of reliance cannot be rebutted by this first technique. The second manner in which the presumption of reliance may allegedly be rebutted, through proof that the plaintiff would have traded in the security despite knowledge of the misrepresentation, was recognized by the dissenters in Basic to be “virtually impossible in all but the most extraordinary case.” Basic, 485 U.S. at 256 n. 7, 108 S.Ct. at 996 n. 7 (White, J., dissenting). The reason for this skepticism, as articulated by the Ninth Circuit when it first adopted the fraud-on-the-market theory in Blackie v. Barrack, 524 F.2d 891, 906 n. 22 (9th Cir.1975), is that it is “doubt[ful] that a defendant would be able to prove in many instances to a jury’s satisfaction that a plaintiff was indifferent to a material fraud.” See also In re LTV Securities Litigation, 88 F.R.D. 134, 143 n. 4 (N.D.Tex. 1980) (suggesting that if a fraud-on-the-market theory were adopted, any attempt to rebut a presumption of reliance “would likely be futile in the vast number of cases”). Therefore, for securities trading in an efficient market, the Basic plurality’s holding created, for all practical purposes, “a nonrebuttable presumption of reliance in future Rule 10b-5 cases.” Basic, 485 U.S. at 256 n. 7, 108. S.Ct. at 994 n. 7 (White, J., dissenting) (emphasis added). 2 As should be evident from the foregoing discussion, the adoption of the fraud-on-the-market theory, and its concomitant presumption of reliance, represented an important alteration in the procedures by which Rule 10b-5 corporate dissemination cases were formerly litigated. An examination of class certification decisions under the theory highlights the pertinent changes. The analysis of the numerosity requirement changed only slightly under the fraud-on-the-market theory. By substituting a presumption of reliance for proof by each plaintiff of actual individual reliance, the theory actually increased the number of investors who could claim injury. Under the theory, even those who never heard the alleged misstatement can recover therefor, whereas such persons would otherwise be unable to recover for lack of reliance. Thus, satisfaction of the numerosity requirement has been made even easier by the fraud-on-the-market theory. The finding of typicality necessitated by FRCP 23(a) also remained unchanged by the fraud-on-the-market theory. As detailed above, an allegation of a “course of conduct” on the part of the defendants previously sufficed to ensure that the named plaintiffs claims were “typical” of those of the class. See supra, p. 1851. Under the fraud-on-the-market theory, plaintiffs’ ability to allege a course of conduct remains unchanged; thus typicality is still easily established. See, e.g., In re Unioil Securities Litigation, 107 F.R.D. 615, 620 (C.D.Cal.1985); Seidman v. Stauffer Chemical Corp., [1986-1987] Fed. Sec.L.Rep. (CCH) ¶ 92,868 at 94,233, 1986 WL 9803 (D.Conn. Jan. 17, 1986); Greene v. Emersons Ltd., 86 F.R.D. 47, 58 (S.D.N.Y. 1980); Tucker v. Arthur Andersen & Co., 67 F.R.D. 468, 483 (S.D.N.Y.1975); see, generally, In re AM International, Inc. Securities Litigation, 108 F.R.D. 190 (S.D.N.Y.1985); In re LTV Securities Litigation, 88 F.R.D. 134 (N.D.Tex.1980). Similarly, the superiority requirement, previously possessing little independent content, see supra pp. 1351-1352, still remains flexible enough so as to ensure that class certification will not be precluded on this ground. Instead, the most pronounced effects of the fraud-on-the-market theory occurred with respect to the commonality and predominance prerequisites on the one hand, and the adequacy of representation requirement on the other. a The commonality and predominance prerequisites were dramatically altered by the fraud-on-the-market theory. As discussed above, the three Rule 10b-5 elements of misstatement/omission, materiality, and scienter formerly provided the common questions of law or fact, while the remaining three elements — reliance, damages, and proximate causation — constituted individual questions. See supra p. 1351. Despite serious concerns, courts regularly found that the three common questions predominated over the three individual ones. See supra pp. 1351-53. To understand how the fraud-on-the-market theory altered this state of affairs, it is necessary to examine more closely the implications of the theory. The most visible effect brought on by the fraud-on-the-market theory has to do, of course, with the “reliance” element of Rule 10b-5. Under pre-existing law, each plaintiff had to prove his own personal reliance on the misrepresentation, thus making this an individual issue. See supra pp. 1351-52. The fraud-on-the-market theory, however, allows a presumption of reliance for all plaintiffs, provided that a material misrepresentation/omission is transmitted through an efficient market via the pricing mechanism. See supra pp. 1354-55. It should be apparent, then, that the fraud-on-the-market theory caused the “reliance” element to “cross-over” from being an individual question to becoming a common question. This shift in the balance between common and individual questions did not go unnoticed by the courts. See, e.g., Basic, 485 U.S. at 242, 108 S.Ct. at 989; Seidman, [1986-1987] Fed.Sec.L.Rep. at 94,232; In re LTV Securities Litigation, 88 F.R.D. at 134; Tucker, 67 F.R.D. at 480. In fact, the adoption of the fraud-on-the-market theory appears to have been motivated, at least in part, precisely by a desire to tip this balance in favor of the common questions. For instance, the plurality in Basic noted: [requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones. The District Court found that the presumption of reliance created by the fraud-on-the-market theory provided “a practical resolution to the problem of balancing the substantive requirement of proof of reliance in securities cases against the procedural requisites of [FRCP] 28.” The District Court thus concluded that * * * common questions predominated over individual questions * * *. Basic, 485 U.S. at 242, 108 S.Ct. at 989. Similarly, the district court in In re LTV Securities Litigation, in adopting the fraud-on-the-market theory, observed: If we are [faced] with 100,000 trials of questions of reliance, it becomes obvious that there is no predomination * * * If we add as a common issue the questions of fraud on the market and the [degree of price inflation] there is an immediate flip in result. These common issues would predominate and the class would be manageable (if with great effort). In re LTV Securities Litigation, 88 F.R.D. at 141-142. The impact of the fraud-on-the-market theory, however, did not stop with the transformation of the “reliance” element. An analysis of the manner in which the presumption of rebanee was justified reveals the other effects brought on by the adoption of the theory. Central to the fraud-on-the-market theory is the efficient capital market hypothesis, which posits that ab misinformation introduced into an efficient market is transmitted via the pricing mechanism. In particular, the making of a false positive statement or the omission of a negative fact wib result in a market price which is artificiaby inflated above that level which would otherwise prevab; conversely, a false negative statement or an omission of a positive fact wib cause artificial price deflation. Under the fraud-on-the-market theory, this concept of “price inflation” is the hnchpin of the plaintiffs’ Rule 10b-5 corporate dissemination case. First, the presumption of rebanee itself assumes that the price of the relevant security has transmitted the misrepresentation; in other words, the price on which the investor rebed must have been artificiaby inflated as a result of the misstatement/omission. See supra pp. 1354-1355. Next, under the out-of-pocket measure of damages, a plaintiff who purchases stock suffers damages only if there is some degree of misrepresentation-induced price inflation at the time of purchase. See supra part I.C.2. Third, the “proximate cause” element is also substantiaby aided by proof of price inflation. Because the plaintiffs damages flow directly from any existing price inflation, if a causal link can be shown between the misstatement/omission and the price inflation, the plaintiffs damages can be deemed to have been “proximately caused” by the defendants’ acts. In other words, price inflation serves as an intermediary, hnking damages to the misrepresentation. Finally, the existence of price inflation traceable to the defendants’ misrepresentation is evidence of the “materiahty” of that misstatement/omission; only information which a reasonable investor would consider significant would have an inflationary impact on the price of a security. This somewhat circular demonstration confirms the fact that the proof of price inflation plays a central role in estabbshing babibty in Rule 10b-5 corporate dissemination eases. As summarized by one commentator: [acceptance of the logic of the fraud on the market theory * * * leads to the conclusion that there is no need in a securities fraud case for separate inquiries into materiahty, rebanee, causation, and damages. These inquiries are necessary in a face-to-face transaction where each party must make a subjective valuation of information provided by the other party, but irrelevant in open market transactions where the market price transmits ab relevant information. The relevant inquiry in open market transactions should be whether the market price was in fact artificially affected by false information. Daniel R. Fischel, Use of Modem Finance Theory in Securities Fraud Cases, 38 Bus. Law 1, 13 (1982). Viewed in this light, the implications of the fraud-on-the-market theory are quite far-reaching. Because proof of the existence of a misstatement or omission, scienter, and price inflation all constitute questions of law and fact common to the class, virtually no individual questions remain, and the predominance prerequisite is easily satisfied. b The fraud-on-the-market theory has also had a significant effect on the adequacy of representation element of FRCP 23. While the theory simplified matters on the predominance front, it gravely complicated matters on the issue of adequacy of representation. Particularly, certain types of class conflicts have taken on much greater significance under the theory. To appreciate this fact, it is only necessary to recall the central role which price inflation plays under the fraud-on-the-market theory. See supra p. 1357. Therefore, to the extent class members have conflicting interests in establishing the existence and/or amount of price inflation, such a dispute infests four of the six Rule 10b-5 elements; only the “misstatement/omission” and “scienter” elements are unaffected. And as discussed below, conflicts over price inflation are likely to arise in the great majority of corporate dissemination cases. The courts, however, have largely focused solely on the connection between price inflation and the “damages” element, thus ignoring the nexus between price inflation and the reliance, materiality, and proximate cause requirements. A typical example of this approach was provided by the Ninth Circuit in the early fraud-on-the-market decision in Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975). The court first noted that while some class members would desire to maximize the degree of price inflation, others would seek to minimize it. Id. at 908. The court continued by observing: courts have generally declined to consider conflicts, particularly as they regard damages, sufficient to defeat class action status at the outset unless the conflict is apparent, imminent, and on an issue at the very heart of the suit. * * * Here, the conflict, if any, is peripheral, and substantially outweighed by the class members’ common interests. Id. at 909. In other words, a dispute over the existence or amount of price inflation was considered to be one simply over “damages;” and, just as courts had done before the fraud-on-the-market theory, the Blackie court did not consider conflicts “merely” over damages to be sufficient to defeat class certification unless they were at the “very heart of the suit.” The problem with this analysis, of course, is that antagonism over price inflation cannot be equated solely with a difference in interests over the “damages” element; instead, it implicates the reliance, materiality, and proximate cause elements as well. So viewed, it is apparent that a conflict over price inflation is at the “heart of the suit,” and can hardly be called “peripheral.” Furthermore, consideration of a dispute over price inflation cannot be deferred until a later stage in the proceedings, because such a dispute presents not only an eventual problem with the damages element, but also an immediate problem with proof of the reliance, materiality, and proximate cause elements. Driven perhaps by an overarching desire to effectuate the securities laws and provide relief for small-claim plaintiffs, the courts have failed to address the importance that the fraud-on-the-market theory gives to class conflicts over price inflation. These conflicts are not only serious, but they are pervasive enough to threaten to preclude satisfaction of the adequacy of representation element of FRCP 23. Ill In proving the existence and amount of price inflation, two specific forms of conflict may appear in the plaintiff class. First, there is likely to arise a conflict between those in/out traders who sold securities on a particular day, and those plaintiffs who purchased on that same day. Second, there may be conflicting interests between those persons who still hold some of the relevant securities on the date of suit, and those who have divested themselves of all such holdings. And as a variant of this latter conflict, antagonism may even surface amongst those holding securities on the date of suit. These are taken up in turn, and the efficacy of subclasses as to each is scrutinized. A The most serious type of class conflict is one which was hinted at by Judge Sneed in Green, 541 F.2d at 1341. Judge Sneed observed that in/out plaintiffs benefit from maximizing the difference between inflation at purchase and inflation at sale. Therefore, in establishing the price and value lines, the in/out plaintiffs interest lies in minimizing the degree of price inflation existing at the date of sale. A retention plaintiff buying on that date (or, for that matter, another in/out plaintiff buying on that date) has an exactly opposite interest; i.e., such a person would seek to maximize the degree of price inflation existing on that date. In other words, different plaintiffs have conflicting incentives in shaping the evidence. This “seller-purchaser” conflict has been raised by defendants in numerous courts, usually to no avail. Some courts have explained the conflict in some detail; see Blackie v. Barrack, 524 F.2d 891, 908 (9th Cir.1975); In re LTV Securities Litigation, 88 F.R.D. 134, 149 (N.D.Tex.1980); Koenig v. Smith, 88 F.R.D. 604, 607-608 (E.D.N.Y. 1980); Tucker v. Arthur Andersen & Co., 67 F.R.D. 468, 482 (S.D.N.Y.1975); Feldman v. Lifton, 64 F.R.D. 539, 549 (S.D.N.Y.1974); Greene v. Emersons Ltd., 86 F.R.D. 47, 61 (S.D.N.Y.1980) (citing Blackie, 524 F.2d at 908); other courts have engaged in only a brief discussion of the conflict. See Simon v. Westinghouse Electric Corp., 73 F.R.D. 480, 484 (E.D.Pa.1977); B & B Investment Club v. Kleinert’s, Inc., 62 F.R.D. 140, 144 (E.D.Pa.1974); In re Unioil Securities Litigation, 107 F.R.D. 615, 622 (C.D.Cal.1985); In re AM International, Inc., Securities Litigation, 108 F.R.D. 190, 196 (S.D.N.Y.1985); Seidman v. Stauffer Chemical Corp., [1986-1987] Fed.Sec.L.Rep. ¶ 92,868 at 94,233, 1986 WL 9803 (D.Conn.1986). The common thread running through these cases is that despite the existence of the seller-purchaser conflict, a plaintiff class was certified. The justifications advanced for such decisions have varied. In In re LTV Securities Litigation, 88 F.R.D. 134 (N.D.Tex.1980), LTV had issued a restatement of earnings allegedly necessitated by questionable accounting procedures. After adopting the fraud-on-the-market theory and the out-of-pocket measure of damages, the court went on to address the possibility that the seller-purchaser conflict should preclude class certification. Id. at 149. The court rejected this contention and certified the class, noting that: available techniques of proof such as econometric modeling are sufficiently demanding of internal consistency as to reduce the opportunity for such manipulation of data. Id. Similarly, the court later stated: [d]efining the [amount of price inflation] through the class period as it follows the ups and downs of market activity within the traded security can be done only with sophisticated techniques of market analyses. This method reduces to one of remoteness the opportunity for any class representative to feather their [sic] own nest. Id. at 152. This assertion that the nature of econometric analysis precludes individual plaintiffs from shaping evidence is, admittedly, an interesting one. Without the assistance of qualified econometricians, however, this court has great reservations about seeking comfort in such a sweeping generalization. The court cannot, therefore, conclude that this contention adequately resolves the seller-purchaser conflict. One of the most insightful treatments of the seller-purchaser conflict appeared in an unrelated context, in Foltz v. U.S. News & World Report, Inc., 111 F.R.D. 49 (D.D.C. 1986). Foltz involved a suit filed by former employees of U.S. News & World Report (“USNWR”) alleging that the company, along with other named defendants, had purposefully undervalued the company’s assets for an eight-year period. The plaintiffs were participants in USNWR’s benefits plan, which distributed bonus shares of USNWR stock to the employees according to a predetermined formula. The number of shares issued each year was inversely dependent on the value of the company; the higher the value, the fewer the shares received. Because the company was not publicly traded, an outside auditor was called in to provide yearly appraisal services. When an employee separated from USNWR, he was required to offer back to the company all bonus shares he then held. These shares were redeemed in accordance with the most recent appraised value of the company. The defendants moved for decertification of the class, asserting conflicting interests between the plaintiffs. The defendants argued that each plaintiff would seek to prove that the company was undervalued in the year in which he separated in order to prove that he received too little when he redeemed his bonus shares. On the other hand, a plaintiff-employee of USNWR who received bonus shares that same year (and separated in a later year) would have the opposite goal, because if the appraisal that year was too low, this plaintiff received too many shares. Thus, the conflict in Foltz arose among class years, since all employees separating from the company in any given year had a unified interest in establishing undervaluation in that year. At a minimum, therefore, eight representatives would be needed, one for each year of the class period. Defendants claimed that each of these eight named plaintiffs would seek to maximize undervaluation in his own year, while disproving any undervaluation in the other class years. In response to this argument, the court observed: t