Securities Fraud Ruling Under Review By US Supreme Court

A case currently before the US Supreme Court sets the stage for a review of a key tenet of US securities fraud cases, the “fraud on the market” or “efficient market” theory.

If the US Supreme Court materially changes the way courts apply this key tenet or, overturns its use entirely, securities fraud plaintiff’s attorneys will lose a valuable tool to obtain class certification and, therefore, lose the leverage they currently enjoy against public companies.

I addressed the history and issues at stake in prior posts:

It appears from questions posed by several Justices that some are considering a modification of the ruling, not the elimination of the ruling preferred by corporations and their counsels.

In a now famous 1988 court case, the US Supreme Court ruled that fraudulent information was reflected in the stock price under the efficient market theory.  Therefore, all parties who bought and sold stock were impacted whether they read and relied on the fraudulent information.  This has made obtaining class action certification relatively easy.

Several law professors filed a “friend of the court” brief which proposed what has been characterized as a “midpoint” modification.  In this modification, plaintiffs would be required to show that fraudulent information had a significant effect on the stock price.

One of the professors commented that the proposed modification would make it more difficult to obtain class certification but would not prevent it.

If this modification makes it more difficult for securities fraud plaintiff’s attorneys to qualify for class action status, I believe it will have a dramatic effect.  It will eliminate key leverage enjoyed by the plaintiff’s attorneys.  Statistics show that once a securities fraud class has been certified, companies commonly settle.

We will share developments in this case as it progresses.

Click here to read a Reuters article on the US Supreme Court proceedings.

Click here to read an article on JD Supra, the online legal magazine by Sutherland, a law firm on the proceedings. Plus another article by Akin Gump, the law firm.

Last but not least, click here to read an article on SECActions about this case.

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.