Rethinking basic

Business Lawyer

Volumn 69, Issue 3, 2014, Pages 671-697

  Bebchuk, Lucian A ^a   Ferrell, Allen ^a  

^a HARVARD LAW SCHOOL   (United States)

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EID: 84973136910     PISSN: 00076899     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (65)

1. The lower court decision can be found at Erica P. John Fund, Inc. V. Halliburton Co., 718 F.3d 423 (5th Cir. 2013).
2. We wish to emphasize that, in this paper, we are not addressing the purely legal question of whether, as a matter of statutory interpretation, "actual reliance" is a necessary condition for establishing "reliance" for Rule 10b-5 purposes. For a discussion of these issues, see Joseph A. Grundfest, Damages and Reliance Under Section 10(b) of the Exchange Act, 69 BUS. LAW. 307 (2014).
3. See Transcript of Oral Argument at 10, Halliburton Co. V. Erica P. John Fund, Inc., No. 13-317 (U.S. Mar. 5, 2014) [hereinafter Halliburton Transcript], available at http://www.supremecourt.gov/oral-arguments/argument-transcripts/13-317-e18f.pdf.
4. The issue of fraudulent distortion is explicitly raised in the second question presented, is referenced at various points in the Basic opinion itself (as we discuss), and is reflected in the academic literature on securities class action litigation. See, e.g., Jill E. Fisch, The Trouble with Basic: Price Distortion After Halliburton, 90 WASH. U. L. REV. 895 (2013)
5. Donald C. Langevoort, Basic at Twenty: Rethinking Fraud on the Market, 2009 WIS. L. REV. 151
6. Jonathan R. Macey, Geoffrey P. Miller, Mark L. Mitchell & Jeffry M. Netter, Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson, 77 VA. L. REV. 1017, 1021 (1991) (discussing disconnect between market efficiency and price impact).
7. See Amanda Frost, Academic Highlight: Rethinking Securities Class Actions, SCOTUSBLOG (Mar. 7, 2014, 4:21 PM), http://www.scotusblog.com/2014/03/academic-highlight-rethinking-securities-class-actions/.
8. Petition for Writ of Certiorari at 3, Erica P. John Fund, Inc. V. Halliburton Co., No. 13-317 (U.S. Sept. 9, 2013).
9. Brief for Chamber of Commerce of the United States of America and National Association of Manufacturers as Amici Curiae in Support of Petitioners at 6, Erica P. John Fund, Inc. V. Halliburton Co., No. 13-317 (U.S. Oct. 11, 2013).
10. Brief in Opposition at 37, Erica P. John Fund, Inc. V. Halliburton Co., No. 13-317 (U.S. Oct. 11, 2013).
11. Basic Inc. V. Levinson, 485 U.S. 224, 246 (1988) ("Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.").
12. Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 J. FIN. 383, 383 (1970) [hereinafter Fama, Efficient Capital Markets].
13. Michael C. Jensen, Some Anomalous Evidence Regarding Market Efficiency, 6 J. FIN. ECON. 95 (1978).
14. See Fama, Efficient Capital Markets, supra note 19, at 383.
15. See Burton G. Malkiel, The Efficient Market Hypothesis and Its Critics, 17 J. ECON. PERSP. 59, 60 (2003).
16. Robert A. Jarrow & Martin Larsson, The Meaning of Market Efficiency, 22 MATHEMATICAL FIN. 1, 2 (2012).
17. This definition is in line with the explanation of efficiency provided by the Supreme Court in Amgen Inc. V. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1192 n.4 (2013)
18. (citing RICHARD A. BREALEY, STEWART C. MYERS & FRANKLIN ALLEN, PRINCIPLES OF CORPORATE FINANCE 330 (10th ed. 2011) ("[I]n an efficient market, there is no way for most investors to achieve consistently superior rates of return.")).
19. This is a quotation from the thoughtful and detailed 56-page survey of the academic literature (discussing some 220 academic papers and books) on asset pricing. See 2013 ECON. SCIS. PRIZE COMM. OF THE ROYAL SWEDISH ACAD. OF SCIS., SCIENTIFIC BACKGROUND ON THE SVERIGES RIKSBANK PRIZE IN ECONOMIC SCIENCES IN MEMORY OF ALFRED NOBEL 2013: UNDERSTANDING ASSET PRICES 9 (2013) [hereinafter NOBEL SURVEY], available at http://www.nobelprize.org/nobel-prizes/economic-sciences/laureates/2013/advanced-economicsciences2013.pdf. The survey includes a discussion of the work of Nobel Laurates Eugene Fama, Lars Hansen, and Robert Shiller in the context of the overall academic literature on efficient markets.
20. Paul A. Samuelson, Proof that Properly Anticipated Prices Fluctuate Randomly, INDUS. MGMT. REV., Spring 1965, at 6, 44.
21. For research documenting some modest level of short-run predictability, see generally ANDREW W. LO & A. CRAIG MACKINLAY, NON-RANDOM WALK DOWN WALL STREET (1999) (finding short-run return predictability for certain stock indexes)
22. see also Andrew W. Lo & A. Craig MacKinlay, Stock Market Prices Do Not Follow Random Walks: Evidence from a Simple Specification Test, 1 REV. FIN. STUD. 41 (1988).
23. Robert J. Shiller, Stock Prices and Social Dynamics, 1984 CARNEGIE ROCHESTER CONF. SERIES ON PUB. POL'Y 457.
24. John Y. Campbell & Robert J. Shiller, The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors, 1 REV. FIN. STUD. 195 (1988)
25. John Y. Campbell & Robert J. Shiller, Stock Prices, Earnings, and Expected Dividends, 43 J. FIN. 661 (1998).
26. See generally JOHN COCHRANE, ASSET PRICING (2001). These papers are also discussed at NOBEL SURVEY, supra note 26, at 17-20.
27. See, e.g., Burton G. Malkiel, The Efficient Market Hypothesis and Its Critics, 17 J. ECON. PERSP. 59, 65 (2003) ("These findings are not necessarily inconsistent with efficiency. Dividend yields of stocks tend to be high when interest rates are high, and they tend to be low when interest rates are low. Consequently, the ability of initial yields to predict returns may simply reflect the adjustment of the stock market to general economic conditions.")
28. Eugene F. Fama, Efficient Capital Markets: II, 46 J. FIN. 1575, 1583 (1991) [hereinafter Fama, Efficient Capital Markets: II] ("The predictability of stock returns from dividend yields (or E/P) is not in itself evidence for or against market efficiency.").
29. Robert J. Shiller, Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?, 71 AM. ECON. REV. 421 (1981)
30. see also Robert J. Shiller, The Use of Volatility Measures in Assessing Market Efficiency, 36 J. FIN. 219 (1981).
31. It is worth noting that tests of excessive volatility are mathematically equivalent to certain tests of long-run return predictability. John H. Cochrane, Volatility Tests and Efficient Markets: A Review Essay, 27 J. MONETARY ECON. 463, 471 (1991)
32. For instance, Terry A. Marsh & Robert C. Merton argue, in Dividend Variability and Variance Bounds Tests for the Rationality of Stock Market Prices, 76 AM. ECON. REV. 483 (1986), that if (i) firms smooth dividends over time and (ii) firm earnings follow a geometric random walk, then the efficient market hypothesis actually predicts the results documented by Shiller.
33. For further papers in this literature, see, for example, Alan Kleidon, Variance Bounds Tests and Stock Price Valuation Models, 94 J. POL. ECON. 953 (1986)
34. John Y. Campbell & Robert J. Shiller, Cointegration and Tests of Present Value Models, 95 J. POL. ECON. 1062 (1987)
35. For some papers on this topic, see Harrison Hong & Jeremy C. Stein, A Unified Theory of Under-reaction, Momentum Trading, and Overreaction in Asset Markets, 54 J. FIN. 2143 (1999)
36. Kent Daniel, David Hirshleifer & Avanidhar Subrahmanyam, Investor Psychology and Security Market Under-and Over-reactions, 53 J. FIN. 1839 (1998)
37. Nicholas Barberis, Andrei Shleifer & Robert Vishny, A Model of Investor Sentiment, 49 J. FIN. ECON. 307 (1998)
38. see also NOBEL SURVEY, supra note 26, at 41. As with our other purported examples of market inefficiency, findings of market underreaction have been challenged in the literature. See, e.g., Eugene Fama, Market Efficiency, Long-term Returns, and Behavioral Finance, 49 J. FIN. ECON. 283 (1998).
39. On the impossibility of perfectly efficient markets, see Sanford J. Grossman & Joseph E. Stiglitz, On the Impossibility of Informationally Efficient Markets, 70 AM. ECON. REV. 222 (1980).
40. Fama, Efficient Capital Markets: II, supra note 32, at 1575.
41. One early paper exploring this topic is Lawrence J. Summers, Does the Stock Market Rationally Reflect Fundamental Values?, 41 J. FIN. 591 (1986)
42. see also Robert F. Stambaugh, Discussion, 41 J. FIN. 601 (1986).
43. Andrew W. Lo, Efficient Market Hypothesis, in THE NEW PALGRAVE: A DICTIONARY OF ECONOMICS 12 (L. Blume & S. Durlauf eds., 2d ed. 2007).
44. Some amicus briefs submitted to the Court expressed views that are consistent with this conclusion. The brief of the solicitor general correctly stated that "whatever the state of academic debate⋯ there is widespread agreement on the basic point that public disclosure of material information generally affects the prices of securities traded on efficient markets." Brief for the United States as Amicus Curiae Supporting Respondent at 25, Erica P. John Fund, Inc. V. Halliburton Co., No. 13-317 (U.S. Feb. 5, 2014).
45. On a similar note, an amicus brief on behalf of financial economists (including Professor Fama) explained, "[E]conomists do not generally disagree about whether market prices respond to new material information. In particular, there is little doubt that the stock price will increase reasonably promptly after favorable news about a company is released and decline after unfavorable news." Brief for Financial Economists as Amici Curiae in Support of Respondent at 25, Erica P. John Fund, Inc. V. Halliburton Co., No. 13-317 (U.S. Feb. 5, 2014).
46. Amgen Inc. V. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1190 (2013).
47. Basic Inc. V. Levinson, 485 U.S. 224, 253 (1998) (White, J., concurring in part and dissenting in part).
48. Affiliated Ute Citizens of the State of Utah v. United States, 406 U.S. 128 (1972)
49. see also In re Merrill Lynch Auction Rate Sec. Litig., 704 F. Supp. 2d 378, 397 (S.D.N.Y. 2010).
50. For a recent example of the use of Affiliated Ute to certify a class, see In re Dynex Capital, Inc., 1:05-cv-01897-HB-DCK (S.D.N.Y.).
51. The Cammer factors are (1) the stock's trading volume, (2) the number of analysts that followed and reported on the stock, (3) the number of market makers, (4) the eligibility to file an S-3 Registration Statement, and (5) the reaction of the stock price on unexpected new events. See Cammer v. Bloom, 711 F. Supp. 1264, 1286-89 (D.N.J. 1989).
52. In the well-known case of Krogman v. Sterritt, 202 F.R.D. 467 (N.D. Tex. 2001), the court identified three additional market efficiency factors to be used in determining reliance: market capitalization, bid-ask spreads, and the percentage of shares held by the public. Id. at 474.
53. In re Polymedica Corp. Sec. Litig., 432 F.3d 1, 18 (1st Cir. 2005).
54. For a discussion of this issue, see Bradford Cornell & James C. Rutten, Market Efficiency, Crashes, and Securities Litigation, 81 TUL. L. REV. 443 (2006).
55. We will not spend time discussing the well-known mechanics of conducting an event study. See generally JOHN Y. CAMPBELL, ANDREW W. LO & A. CRAIG MACKINLAY, THE ECONOMETRICS OF FINANCIAL MARKETS 150-81 (1997).
56. On the issue of how to calculate abnormal stock price dollar movements rather than stock return movements, see Allen Ferrell & Atanu Saha, Event Study Analysis: Correctly Measuring the Dollar Impact of an Event (Apr. 18, 2011) (unpublished manuscript available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=1814236).
57. Jonathan R. Macey, Geoffrey P. Miller, Mark L. Mitchell & Jeffry M. Netter, Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson, 77 VA. L. REV. 1017 (1991) (discussing as well using an event study at time of misstatement to determine price impact).
58. See generally Allen Ferrell & Atanu Saha, Forward-casting 10b-5 Damages: A Comparison to Other Methods, 37 J. CORP. L. 365 (2012).
59. Esther Bruegger & Frederick C. Dunbar, Estimating Financial Fraud Damages with Response Coefficients, 35 J. CORP. L. 11 (2009).
60. Basic Inc. V. Levinson, 485 U.S. 224, 245 (1988).
61. Pre-Amgen this was the position of the U.S. Court of Appeals for the Second Circuit. See In re Salomon Analyst Metromedia Litig., 544 F.3d 474, 483 (2d Cir. 2008) ("the burden of showing that there was no price impact is properly placed on defendants at the rebuttal stage").
62. See, e.g., Kevin LaCroix, Dump "Fraud on the Market" Yet Preserve Securities Plaintiffs' Ability to Establish Reliance?, D&O DIARY (Jan. 8, 2014), http://www.dandodiary.com/2014/01/articles/securities-litigation/dump-fraud-on-the-market-yet-preserve-securities-plaintiffs-ability-to-establish-reliance/.
63. See Supreme Court Reconsiders Fraud on the Market, ROPES & GRAY ALERT (Mar. 10, 2014), http://www.ropesgray.com/news-and-insights/Insights/2014/March/Supreme-Court-Reconsiders-Fraud-on-the-Market.aspx.
64. The facts of this hypothetical are similar to those at issue in Dura Pharmaceuticals, Inc. V. Broudo, 544 U.S. 336 (2005).
65. One common way to try to establish loss causation is to attribute the economic losses to the dissipation of fraudulent distortion resulting from a corrective disclosure. See Allen Ferrell & Atanu Saha, The Loss Causation Requirement for Rule 10b-5 Causes of Action: The Implications of Dura Pharmaceuticals, Inc. V. Broudo, 63 BUS. LAW. 163 (2007).