Fraud on the Market Meets Behavioral Finance

78 Pages Posted: 26 Oct 2005

See all articles by Frederick C. Dunbar

Frederick C. Dunbar

U.S. Securities and Exchange Commission

Dana Heller

National Economic Research Associates, Inc. (NERA)


The efficient market hypothesis, in its current form, dates academically from 1970 and it was first accepted by a Federal Court in a shareholder class action in 1975, providing plaintiffs with a rebuttable presumption of reliance based on the fraud-on-the-market theory. By 1988, the fraud-on-the-market theory was the law in most Circuits and was affirmed by the Supreme Court in Basic v. Levinson. Since then, the efficient market hypothesis has not been rebutted in any case involving actively traded securities, and its impact on securities litigation and regulation extends well beyond class certification to materiality, causation and damages. Somewhat ironically, over the same time period, financial economics was, first, finding anomalies in securities markets that were not consistent with the Supreme Court's version of the efficient market hypothesis and, second, using concepts borrowed from behavioral economics to develop theories of securities price formation to explain, among other things, the stock price bubble of the late 1990s. In fact, even proponents of the efficient market hypothesis have claimed that securities were mispriced during this episode. If courts were to adopt behavioral finance explanations of securities market behavior, then prior precedent would not be appropriate in a number of areas of securities fraud including reliance, materiality, causation and damages. We explore the implications of how analysis of these issues would be changed by application of behavioral finance.

Keywords: behavioral finance, bubbles, fraud-on-the-market, market efficiency, securities law

JEL Classification: G14, K22, D40, D80

Suggested Citation

Dunbar, Frederick C. and Heller, Dana, Fraud on the Market Meets Behavioral Finance. Delaware Journal of Corporate Law, Vol. 31, No. 2, 2006, Available at SSRN:

Frederick C. Dunbar (Contact Author)

U.S. Securities and Exchange Commission ( email )

100 F Street, NE
Washington, DC 20549
United States
202-551-3615 (Phone)

Dana Heller

National Economic Research Associates, Inc. (NERA) ( email )

1166 Avenue of the Americas, 34th Floor
New York, NY 10036
United States

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