The Logic and Limits of Event Studies in Securities Fraud Litigation

Abstract

Event studies have become increasingly important in securities fraud litigation, and the Supreme Court’s 2014 decision in Halliburton Co. v. Erica P. John Fund, Inc., heightened their importance by holding that the results of event studies could be used to obtain or rebut the presumption of reliance at the class certification stage. As a result, getting event studies right has become critical. Unfortunately, courts and litigants widely misunderstand the event study methodology leading, as in Halliburton, to conclusions that differ from the stated standard.

This Article provides a primer explaining the event study methodology and identifying the limitations on its use in securities fraud litigation. It begins by describing the basic function of the event study and its foundations in financial economics. The Article goes on to identify special features of securities fraud litigation that cause the statistical properties of event studies to differ from those in the scholarly context in which event studies were developed. Failure to adjust the standard approach to reflect these special features can lead an event study to produce conclusions inconsistent with the standards courts intend to apply. Using the example of the Halliburton litigation, we illustrate the use of these adjustments and demonstrate how they affect the results in that case.

The Article goes on to highlight the limitations of event studies and explains how those limitations relate to the legal issues for which they are introduced. These limitations bear upon important normative questions about the role event studies should play in securities fraud litigation.

Keywords: Civil procedure, evidence, Supreme Court of the United States, SCOTUS, Halliburton Co. v. Erica P. John Fund, Inc., Basic, Inc. v. Levinson, fraud on the market, event study methodology, fraudulent information, significance, error rates, one-sided SQ test, securities fraud, 10b-5 litigation

JEL Classification: C20, D53, G14, K22, K42