The U.S. Supreme
Court has agreed to review the fraud-on-the-market doctrine and its attendant
presumption of reliance in securities fraud actions. The grant of certiorari
gives the Court the opportunity to examine its 1988 ruling in Basic, Inc, v. Levinson, 485 U.S.
In the BasicInc. decision, the Court endorsed
the fraud-on-the-market theory under which a plaintiff in a securities fraud
action can invoke a rebuttable presumption of reliance on misrepresentations
regarding securities trading in an efficient market. This action poses the
question of whether the
Court should overrule or substantially modify its 1988 holding in Basic Inc. v. Levinson, to the extent
that it recognizes a presumption of class-wide reliance derived from the
fraud-on-the-market theory.
Fraud-on-the-market. The fraud-on-the-market presumption is
generally invoked to establish reliance. Under the presumption, when a company
makes public material misstatements in an efficient market, the misstatements
are reflected in the price of the stock and it is presumed that the investor
relied on the misstatements when he or she purchased the stock at the market
price.
In an earlier amicus brief
the National Association of Manufacturers and the U.S. Chamber of Commerce had
urged the Court to grant the petition for certiorari (which it has now done)
and overrule or modify the fraud-on-the-market theory endorsed in the Basic Inc. decision.
This theory, explained
the Chamber, allows investors to establish the reliance element in a securities
fraud class action merely by showing that they traded stock around the time of
the public misrepresentations. This approach, argued the Chamber, has led to doctrinal
confusion among the lower courts and enabled a wave of frivolous class action
litigation. The Chamber also noted that the presumption of reliance is based on
an efficient-market theory, which today's economists increasingly reject.