Fraud on the Market - The Attack on Basic v. Levinson (1988)
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Transcript of Fraud on the Market - The Attack on Basic v. Levinson (1988)
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Prof. George W. ConkGuest lecturer: Wallace Showman, Esq.
Room 409
212-636-7446
Adjunct Professor of Law &
Senior Fellow
Stein Center for Law & Ethics
Remedies
Spring 2014
10b-5 Securities Fraud ActionsFraud on the market presumption of reliance under
attack
Fraud on the market - 10 (b)(5) actions 1
mailto:[email protected]:[email protected] -
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Rule 23 Class Actions - Fed. R. Civ. Pro.
(a) Prerequisites. One or more members of a class
may sue or be sued as representative parties onbehalf of all members only if:
(1) the class is so numerousthat joinder of allmembers is impracticable;
(2) there are questions of law or fact commonto the class;
(3) the claims or defenses of therepresentative parties are typicalof the claimsor defenses of the class; and
(4) the representative parties will fairly andadequately protect the interests of the class.
Fraud on the market - 10 (b)(5) actions 2
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The Six Elements of the 10b-5 Action
(1) a material misrepresentation (oromission)
(2) scienter, i.e.,a wrongful state ofmind
(3) a connection with the purchase orsale of a security
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Elements of the 10b-5 Action
(4) reliance or "transactioncausation"
(5) economic loss
(6) "loss causation," i.e., a causal
connection between the materialmisrepresentation and the loss
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17 CFR 240.10b-5
It shall be unlawful for any person,
directly or indirectly (a) To employ any device, scheme, or
artifice to defraud,
(b) To make any untrue statement ofa material fact or to omit to state amaterial factnecessary in order to
make the statements made, in thelight of the circumstances underwhich they were made, notmisleading, or
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17 CFR 240.10b-5.
(c) To engage in any act, practice, orcourse of business which operates or
would operate as a fraud or deceit
upon any person, in connection with
the purchase or sale of any security.
(Sec. 10; 48 Stat. 891; 15 U.S.C. 78j)
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Fraud-on-the-market
presumption
Basic Inc. v. Levinson,
485 U.S. 224 (1988)
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Prerequisites for market price
incorporation of information
(1) misrepresentation publicity
(2) misrepresentation materiality
(3) market efficiency, and
(4) plaintiff traded the shares
between thetime themisrepresentations were made and
the time the truth was revealed.Fraud on the market - 10 (b)(5) actions 8
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Materiality
"an omitted fact is material if there is
a substantial likelihood that... the
disclosure of the omitted fact wouldhave been viewed by the reasonable
investor as having significantly
altered the 'total mix' of information
made available. Basic
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Reliance
Reliance provides the requisitecausal connection between adefendant's misrepresentation and a
plaintiff's injury. Basic
Falsity, materiality, reliance, damageare the common law elements offraud
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Basic: we must adapt to modern
conditions
The modern securities markets,literally involving millions of shareschanging hands daily, differ from the
face-to-face transactionscontemplated by early fraud cases,and our understanding of Rule 10b-
5's reliance requirement mustencompass these differences
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Fraud on the market - Basic
[I]n an open and developed securities
market, the price of a company's stock
is determined by the available material
information regarding the company andits business. . . . Misleading statements
will therefore defraud purchasers of
stock even if the purchasers do not
directly rely on the misstatements. . .
Fraud on the market - 10 (b)(5) actions 12
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Rebuttable Presumption of Reliance
on the Integrity of the Market Price
Presumptions typically serve to assist
courts in managing circumstances in
which direct proof, for one reason or
another, is rendered difficult.
See, e.g., D. Louisell & C. Mueller, FederalEvidence 541-542 (1977).
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Rebuttable Presumption of Reliance
on the Integrity of the Market Price
Requiring a plaintiff to show a speculativestate of facts, i.e., how he would haveacted if omitted material information had
been disclosed, ... or if themisrepresentation had not been made...would place an unnecessarily unrealisticevidentiary burden on the Rule 10b-5
plaintiff who has traded on an impersonalmarket.
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Rebuttable Presumption of Reliance
Because most publicly available
information is reflected in market price, an
investor's reliance on any public material
misrepresentations, therefore, may be
presumed for purposes of a Rule 10b-5
action. Fraud on the market - 10 (b)(5) actions 15
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Rebutting the presumption
Any showing that severs the linkbetween the alleged
misrepresentation and either the
price received (or paid) by the
plaintiff, or his decision to trade at a
fair market price, will be sufficient to
rebut the presumption of reliance.
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Markets are imperfect
n28 By accepting this rebuttablepresumption, we do not intend
conclusively to adopt any particular
theory of how quickly and completely
publicly available information is
reflected in market price.
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Three Presumptions - Goldberg &
Zipursky 1) Legally cognizable injury is shown by
purchaseof securities at a market pricedistortedby the defendantsmisrepresentations
2) Distortion is presumed if amisrepresentation is material,disseminated to the public, and securities
are sold on an efficient market 3) Reliance is presumed but may be
rebutted
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Langevoort Judgment Day
What Basic does, as much as
anything, is create an entitlement to
an undistorted stock price via, as Ihave described it, an act of juristic
grace.
This is no different from what
happens in the common law of fraud.Fraud on the market - 10 (b)(5) actions 19
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Langevoort Judgment Day
In a face-to-face negotiation betweenstrangers, there is no reason necessarilyto assume that what the counterparty issaying is the truth. Yet the law creates
a right to rely on sufficiently factualmisrepresentations to promote efficienteconomic exchange in the face of palpable
uncertainty about honesty, by making itsafe to assume honesty
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Amgen v. Connecticut Retirement
Plans 133 S. Ct. 1184 (2013)
Ginsburg (6-3) Materiality is an essential
element of a 10b-5 action common to
entire class.
FRCP 23 commonality not threatened by
failure of proof on materiality
AlitoBasics flawed economic
assumption warrants its reconsiderationFraud on the market - 10 (b)(5) actions 21
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The attack on Basic
FOTM is a judge-made rule
Materiality essential to classcertification
Basics economic assumptions flawed Presumption difficult to administer
in terrorem effect of certification
Class cert places materialitydetermination in jurys hands
Transaction-specific proofs reqd
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Amgen 133 S. Ct. 1184 (2013)
Materiality of misrepresentation
goes to the merits
[B]ecause materiality is established
by evidence common to all
plaintiffs...a failure to prove
materiality will cause all plaintiffs'individual claims to fail
Fraud on the market - 10 (b)(5) actions 23
2013 A j it Cl
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2013 - Amgen majority - Class
certification does not require proof
of materiality 6-3 split - Ginsburg for 5, Alito concurs,Scalia, Thomas, Kennedy dissent
"While [a putative class] certainlymust prove materiality to prevail on
the merits, we hold that such proof is
not a prerequisite to class
certification....Fraud on the market - 10 (b)(5) actions 24
omas: mgen ssen
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omas: mgen ssenMateriality must be proven at
class certification Materiality was central to the
development, analysis, and adoption
of the fraud-on-the-market theory
both before Basic and in Basic itself.
Fraud on the market - 10 (b)(5) actions 25
omas: mgen ssen
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omas: mgen ssenMateriality must be proven at
class certification Materiality, therefore, must be
demonstrated to prove fraud on the
market Until materiality of an alleged
misstatement is shown there is no
reason to believe that all marketparticipants have relied equally on it.
Fraud on the market - 10 (b)(5) actions 26
omas: mgen ssen
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omas: mgen ssenMateriality must be proven at
class certification Otherwise individualized questions of
reliance remain. This history confirms that materiality
must be proved at the time that thetheory is invoked--i.e., at
certification.Fraud on the market - 10 (b)(5) actions 27
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Archdiocese of Milwaukee/ Erica P.
John Fund v. Halliburton Co.
Fraud on the market - 10 (b)(5) actions 28
Halliburton sustained its share pricevia three misrepresentations
* Asbestos liability understated
* Cost overrun revenue over-estimated
* Dresser merger efficienciesknowingly misstated
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Erica P. John Fund v. Halliburton
(5th Cir. 2013) following Amgen
Common question predominance isrelevant to class certification
Only issues bearing directly oncommon question predominance andpropriety of class resolution shouldbe addressed at class certification
Proof of price impact or its absencegoes only to the merits.
Fraud on the market - 10 (b)(5) actions 29
H llib t C V E i P J h F d
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Halliburton Co. V. Erica P. John Fund
Cert. granted 11/15/ 2013
Questions presented 1. Whether this Court should overrule
or substantially modify the holding of
Basic Inc. v. Levinson to the extent
that it recognizes a presumption of
classwide reliance derived from the
fraud-on-the-market theory.
Fraud on the market - 10 (b)(5) actions 30
H llib t C V E i P J h F d
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Halliburton Co. V. Erica P. John Fund
Cert. granted 11/15/ 2013
Questions presented 2. Whether, in a case where the
plaintiff invokes the presumption ofreliance to seek class certification,the defendant may rebut thepresumption and prevent classcertification by introducing evidence
that the alleged misrepresentationsdid not distort the market price
of its stock.Fraud on the market - 10 (b)(5) actions 31
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The Halliburton Attack on Basic
Implicit in the notion of an efficient
marketeven a mechanicallyefficient market as courts understandthe securities market to beis the
assumption that the market actsrationally.
Fisher, Does 15 the Efficient Market
Theory Help Us Do Justice in a Time ofMadness?, 54 Emory L.J. 843, 898 (2005).
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The Halliburton Attack on Basic
But a goodly section of academic
thought now challenges this coretenet of Basic, id. at 899, because toomany recent events disprove it.
E.G. 1998-2001 technologybubblethe market actedirrationally, with stock prices far
away from fundamental values
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The Halliburton Attack on Basic
Theeconomic crisis of 2008 even
further undermined efficient
markets theory.
Posner, On the Receipt of the Ronald H.
Coase Medal, 12 Am. L. & Econ. Rev. 265,278 (2010).
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United States as amicusin support
of Erica P. John Fund
The Basic presumption reflects the
common sense understanding that
price reflects available information
It has proven workable.
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United States as amicusin support
of Erica P. John Fund
Congress has had many chances
to replace the judicially created
doctrine and has not done so.
F d h k 10 (b)(5) i 36