Taking "Efficient Markets" out of the Fraud-on-the-Market Doctrine after the Private Securities Litigation Reform Act

By Oldham, Jeffrey L. | Northwestern University Law Review, Winter 2003 | Go to article overview

Taking "Efficient Markets" out of the Fraud-on-the-Market Doctrine after the Private Securities Litigation Reform Act


Oldham, Jeffrey L., Northwestern University Law Review


INTRODUCTION

In Basic, Inc. v. Levinson,1 the Supreme Court opened the federal court doors far wider than ever before to securities fraud class action plaintiffs. Before Basic, plaintiffs bringing a Rule 10b-5(2) securities fraud claim against a company were required to prove that they had actually relied upon the company's alleged misrepresentation when deciding to trade the company's security. In Basic, however, the Court did away with the need for plaintiffs to show such actual reliance in class action cases involving open market securities transactions.3 Recognizing the "fraud-on-the-market" theory, the Court reasoned that when a company whose securities trade in an open and developed market allegedly makes a misrepresentation about its securities, the market price of its securities will reflect that misrepresentation. Since investors purchase or sell the securities in reliance upon the integrity of the market price, they indirectly rely upon the alleged misrepresentation because they buy or sell the security at a price that reflects the misrepresentation. For this reason, the Court held that the company's alleged misstatement acts as a fraud on the entire market and that the plaintiffs' reliance on the market price indirectly suffices to establish the reliance requirement.4 This approach drastically modified existing doctrine and revolutionized Rule 1 Ob-5 securities fraud class action suits.5 IMAGE FORMULA5

Prior to the Court's endorsement of the fraud-on-the-market presumption in Basic, there were two forms of the fraud-on-the-market theory developed by lower courts and scholars. Initially, some scholars6 argued that where a plaintiff class could prove that an alleged misrepresentation caused a change in the market price of a company's securities, i.e., where the plaintiffs could show loss causation,7 then showing individualized reliance on the misstatement would be unnecessary because the plaintiffs' reliance on the market price, which reflected the misrepresentation, constituted indirect reliance.8 Other scholars more radically applied the "efficient market theory" from financial economics to the fraud-on-the-market theory and proposed a form of the fraud-on-the-market doctrine that would essentially presume both the earlier loss-causation inquiry and the reliance element.9 These scholars posited that where a plaintiff class could show that the security at issue traded on an efficient market,10 it would be likely that the stock price reflected the alleged misrepresentation and that the stock price changed as a result. Thus, this second form of the theory amounted to a double presumption that would presume both loss causation11 and reliance: IMAGE FORMULA7

whereas the earlier fraud-on-the-market concept was triggered by a showing that the purported misrepresentation caused the stock price to change, this new version was triggered by a mere showing of an efficient market. Since the new presumption would be rebuttable, the practical effect of the double presumption was to relieve plaintiffs from having to prove either loss causation or reliance affirmatively, and to shift the burden to the defendant to disprove both.

While the Basic Court did not expressly state which of these two forms of the fraud-on-the-market theory it was endorsing, the Court's analysis reveals its acceptance of the second form of the presumption. For example, it explicitly set up the presumption so that defendants could rebut it by disproving either loss causation or reliance. Furthermore, commentators agree that Basic's analysis can be logically justified only with the efficient market theory as its underlying basis, giving support to the notion that the Court adopted the double presumption. Moreover, lower courts have uniformly interpreted Basic's fraud-on-the-market presumption to be closely wedded to the efficient market theory, and therefore have implicitly applied it as a double presumption of both the loss-causation trigger and reliance upon a showing of an efficient market.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Taking "Efficient Markets" out of the Fraud-on-the-Market Doctrine after the Private Securities Litigation Reform Act
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.