Fact or Fiction: Flawed Approaches to Evaluating Market Behavior in Securities Litigation

Abstract

Courts entertaining class actions brought under Section 10(b) of the Securities Exchange Act are required to make numerous factual judgments about the economic effects of the alleged misconduct. For example, they must determine whether and for how long publicly-available information has exerted an influence on security prices, and whether an alleged fraud caused economic harm to investors. Judgments on these matters dictate whether cases will proceed to summary judgment and trial, whether classes will be certified and the scope of such classes, and the damages that investors are entitled to collect.

Over the years, courts have developed a variety of common law doctrines to guide these inquiries. As this Essay will demonstrate, collectively, these doctrines operate in such an artificial manner that they no longer shed light on the underlying factual inquiry, namely, the actual effect of the alleged fraud on investors. The result is that determinations of market impact and investor loss have become, in a real sense, fictional: the size and effects of the fraud are determined based on abstract doctrine rather than any empirical assessment of market behavior. Ultimately, these stylized approaches to assessing market evidence interfere with the ability of the Section 10(b) cause of action to fulfill its modern function as a mechanism for deterring fraud.

This Essay therefore recommends that, to the extent possible, these inquiries should be replaced with alternative schemes that award damages based on some combination of statutory formulas and evidence of investors’ reliance on the fraud. These alternatives would be easier for courts to administer, and would re-align the fraud-on-the-market action with its fundamental goals.

Keywords: securities, section 10(b), fraud on the market