Fraud Created the Market
Michael J. Kaufman
Loyola University Chicago School of Law
John M. Wunderlich
Institute for Investor Protection
June 17, 2011
Alabama Law Review, Forthcoming
Loyola University Chicago School of Law Research Paper No. 2011-015
Class actions are vital to protecting investors. Without class certification, individual damages may be de minimis, and investors would be unlikely to bring a securities fraud suit. This underenforcement allows those who defraud investors to skate liability and impugn the integrity of the marketplace. Presumptions of reliance facilitate classwide resolution of securities fraud claims. Under Rule 10b-5 for securities fraud the Supreme Court has presumed reliance to facilitate class actions where there is an omission in the face of a duty to disclose or where there is a fraud on the secondary market. The new frontier is whether federal courts should likewise presume reliance where fraud occurs on the primary market, giving rise to the fraud-created-the-market theory. Although some federal courts embraced the theory decades ago, a sharp conflict has arisen in the wake of the Court’s decision in Stoneridge Investment Partners v. Scientific-Atlanta, and the Third and Ninth Circuits have set the pace for rejecting the theory. In this Article, however, we show that the fraud-created-the-market theory is consistent with the fundamental bases for all presumptions in the law, comports with the Supreme Court’s interpretations of the federal securities laws as properly understood, and serves the investor-protection and market-integrity design of securities regulation.
We undertake a comprehensive definition and defense of the fraud-created-the-market theory and show why critics’ concerns regarding the presumption are unfounded. Properly understood, the fraud-created-the-market theory is about materiality and scienter - defendants should be held liable under the securities laws for committing fraud that is so material, without it, the securities never would have made it to market. In this regard, we show that a presumption of reliance for newly issued securities and the primary market is consistent with the Supreme Court’s collapsing the elements of securities fraud into a single inquiry whether the omission or misrepresentation was material. We build upon Professor Donald C. Langevoort’s fresh interpretation of the fraud-on-the-market presumption and his interpretation of Stoneridge, to show that the fraud-created-the-market presumption is grounded in the Court’s jurisprudence. We also find support for a judicially crafted presumption in the context of new issues in the securities laws themselves and in the common-law bases for presumptions. There is a pressing need for an answer to whether federal courts should adopt the fraud-created-the-market theory. The fraud-created-the-market theory will play an increasingly important role in actions against those involved in fraud relating to the issuance of subprime mortgage-backed securities.
Number of Pages in PDF File: 60
Date posted: June 21, 2011