764. Lucian A. Bebchuk & Allen Ferrell, Rethinking Basic, 2/2014.
Abstract: Next spring, in the Halliburton case, the United States Supreme Court is expected to reconsider the Basic ruling that, twenty-five years ago, adopted the fraud-on-the-market theory and has since facilitated securities class action litigation. In this paper we seek to contribute to the expected reconsideration.
We show that, in contrast to claims made by the parties, the Justices need not assess the validity or scientific standing of the efficient market hypothesis; they need not, as it were, decide whether they find the view of Eugene Fama or Robert Shiller more persuasive. Class-wide reliance, we explain, should depend not on the “efficiency” of the market for the company’s security but on the existence of fraudulent distortion of the market price. Indeed, based on our review of the large body of research on market efficiency in financial economics, we show that, even fully accepting the views and evidence of market efficiency critics such as Professor Shiller, it is possible for market prices to be distorted by fraudulent disclosures. Conversely, even fully accepting the views and evidence of market efficiency supporters such as Professor Fama, it is possible for market prices not to be distorted by fraudulent disclosures. In short, even assuming the Court was somehow in a position to adjudicate the academic debate on market efficiency, market efficiency should not be the focus for determining class-wide reliance.
We put forward an alternative approach – focused on the existence of fraudulent distortion – to those advanced by petitioners and those opposing certiorari in Halliburton. We further discuss the analytical tools that would enable the federal courts to implement our alternative approach, as well as the allocation of the burden of proof, and we explain that a determination of fraudulent distortion would not usurp the merits issues of materiality and loss causation.
The proposed approach avoids reliance on the efficient market hypothesis and thereby avoids the problems with current judicial practice identified by petitioners (as well as those stressed by Justice White in his Basic opinion). It provides a coherent and implementable framework for identifying class-wide reliance in appropriate circumstances. It also has the virtue of focusing on the economic impact (if any) of the actual misstatements and omissions at issue, rather than general features of the securities markets.