fraud on the market - the attack on basic v. levinson (1988)

8/13/2019 Fraud on the Market - The Attack on Basic v. Levinson (1988)

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Prof. George W. ConkGuest lecturer: Wallace Showman, Esq.

[email protected]

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.



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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. . .



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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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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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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


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.


omas: mgen ssen


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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.


omas: mgen ssen


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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.


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.


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.


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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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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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

fraud on the market - the attack on basic v. levinson (1988)

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