Key Securities Fraud Ruling Challenged

By Dennis McCarthy – (213) 222-8260 – –

US Public companies should take note. A key US Supreme Court ruling which backstops most securities fraud litigation is being challenged.  If the Supreme Court reverses this ruling, the plaintiff’s securities litigation bar loses an important tool.

Since 1986, securities fraud cases have relied on a key ruling that stock prices reflect all publicly available information.  This is known as the efficient market hypothesis.

Applying the efficient market hypothesis enabled the US Supreme Court in Basic v. Levinson to conclude that any shareholder buying or selling stock while fraudulent information was publicly available suffered from that fraudulent information.  A shareholder didn’t have to read and rely on the specific fraudulent information, it was already reflected in the stock price.

Now, compare that position with a tougher standard which some believe is the correct standard.

What if, in order to sue for securities fraud, a shareholder had to show that he actually read and relied on the fraudulent information.  Given that relatively few shareholders, buying or selling, actually read company’s publicly available information, that would set a much higher standard.

That standard would make today’s class action securities fraud lawsuits less likely.  It would remove key leverage used by the plaintiff’s bar.

 To give you an idea of the magnitude of what’s at stake here, Cornerstone Research, a financial and economic consulting firm, determined that there were over 3000 securities litigation cases brought over the last 15 years.  During this period, companies and their insurers paid over $73 billion in settlements and judgments.  The plaintiff’s bar collected $17 billion in fees.

So the stakes are high and many of us noticed when a company involved in a long-running securities litigation, petitioned the US Supreme Court to overturn the decision in the “Basic” case and apply the tougher standard.   

We’ll be watching whether the Supreme Court takes up the issue and, if it does, whether this key ruling applying the efficient market hypothesis will be overturned.

I’ve attached an excellent article on this topic by Steven M. Davidoff writing in The New York Times “Dealbook”.

Please contact me to help your company to complete any capital market project.

Click here to go to the New York Times “Dealbook” article.

Click the download button to read an article by Latham & Watkins, the law firm, on the case and implications of potential outcomes.

Update – US Supreme Court takes up question of the use of the efficient market theory which is the basis of the “Basic v Levinson” case – read Forbes background.

Postscript: In my research, I came across a blog “The D&O Diary” with several articles providing background on trends in securities litigation following the demise of the law firm Milberg Weiss and a review of the book “Circle of Greed” about the fall of Bill Lerach.