The Less than Efficient Capital Markets Hypothesis: Requiring More Proof from Plaintiffs in Fraud-on-The-Market Cases

Abstract

In 1988, the United States Supreme Court in Basic Inc. v. Levinson created a "rebuttable" presumption of reliance for all members of a class alleging misstatements or omissions of material fact in their purchase or sale of securities of an issuer. The Basic Court founded its decision in reliance upon the fraud on the market theory, which is premised upon the efficient markets hypothesis (EMH). We discuss developments in the study of the EMH since 1988 and argue that the evidence against the universality of the EMH should mean that tests of whether it holds for a particular security should be undertaken before it is invoked. We discuss the tests often used in prior cases and argue that they are not as useful as an alternative test discussed that more directly examines whether news affects a security's price.

Keywords: Market efficiency, securities fraud

JEL Classification: K22, K41, G14