The Trouble with Basic: Price Distortion after Halliburton

Abstract

Many commentators credit the Supreme Court’s decision in Basic, Inc. v. Levinson, which allowed courts to presume reliance rather than requiring individualized proof, with spawning a vast industry of private securities fraud litigation. Today, the validity of Basic’s holding has come under attack as scholars have raised questions about the extent to which the capital markets are efficient. In truth, both these views are overstated. Basic’s adoption of the Fraud on the Market presumption reflected a retreat from prevailing lower court recognition that the application of a reliance requirement was inappropriate in the context of impersonal public market transactions. And, contrary to arguments currently being made to the Supreme Court in the Amgen case, FOTM does not require a strong degree of market efficiency – merely that market prices respond to information. The Basic decision had another less widely recognized effect, however; it began shifting the nature of private securities fraud claims from transaction-based claims to market-based claims, a shift that was completed by the Court’s later decision in Dura. The consequence of this shift was to convert the nature of the plaintiff’s harm from a corruption of the investment decision to one of transacting at a distorted price. The legal significance of price distortion was at the heart of the Halliburton decision. The lower court confused two temporally distinct concepts: ex ante price distortion, which is part of the reliance inquiry and ex post price distortion, which is a component of loss causation. The Supreme Court limited its holding in Halliburton to identifying this confusion, leaving examination of the appropriate role of price distortion for future cases. In Amgen, the Court may be forced to tackle this question. This Article argues that Amgen highlights the incongruity of considering price distortion at the class certification stage and provides an opportunity for the Court to reconsider and reject Basic’s insistence on retaining a reliance requirement.

Keywords: securities litigation, fraud-on-the-market, market efficiency, rule 10b-5, class action, behavioral finance

JEL Classification: G02, G14, G30, K22