We Have a Consensus on Fraud on the Market - And It's Wrong

48 Pages Posted: 19 Jul 2016 Last revised: 30 Nov 2017

See all articles by James C. Spindler

James C. Spindler

University of Texas School of Law; McCombs School of Business, University of Texas at Austin

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Date Written: June 28, 2016


Recent scholarship overwhelmingly contends that the fraud on the market securities class action has neither deterrent nor compensatory effect and should be cut back or even abandoned entirely. This scholarship largely focuses on two critiques: circularity, which holds that shareholder class action claimants are suing themselves, making compensation impossible; and diversification, which holds that fraud constitutes a diversifiable risk, such that diversified shareholders both gain and lose from fraud in equal measure and hence are not negatively impacted. These critiques are arguably the most important and widely-used theoretical development of the last two decades in securities law, and enjoy a broad consensus.

Unfortunately, these critiques are wrong. After tracing the evolution of these critiques, this paper demonstrates economically that, despite widespread acceptance, none of the principal claims of these critiques are correct. In particular: fraud on the market does indeed compensate defrauded purchasers despite circularity (under certain conditions, perfectly); and diversified investors do have expected losses from fraud and have incentives to undertake deadweight precaution costs. Further, the fraud on the market remedy deters both precaution costs and, under certain conditions, fraud itself. The critiques are fundamentally flawed, the academic consensus on fraud on the market is incorrect, and the panoply of reform proposals based on these critiques is without foundation. These critiques have fueled a trend of cutbacks and ongoing existential challenges to fraud on the market (as in Halliburton) that, in light of these results, should be rethought.

Suggested Citation

Spindler, James C., We Have a Consensus on Fraud on the Market - And It's Wrong (June 28, 2016). Harvard Business Law Review, Vol. 7, 2017, Available at SSRN: https://ssrn.com/abstract=2811318 or http://dx.doi.org/10.2139/ssrn.2811318

James C. Spindler (Contact Author)

University of Texas School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States

McCombs School of Business, University of Texas at Austin ( email )

Austin, TX 78712
United States

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