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From Securities Regulation Daily, November 15, 2013

U.S. Supreme Court will examine fraud-on-the-market doctrine and presumption of reliance

By Jim Hamilton, J.D., LL.M.

The U.S. Supreme Court has agreed to review the fraud-on-the-market doctrine and its attendant presumption of reliance in securities fraud actions. The grant ofcertiorari gives the Court the opportunity to examine its 1988 ruling in Basic, Inc, v. Levinson, 485 U.S. 224. The vehicle for the Court’s review of fraud-on-the-market is Halliburton v. Erica P. John Fund, Dkt. No. 13-317.

In the BasicInc. decision, the Court endorsed the fraud-on-the-market theory, under which a plaintiff in a securities fraud action can invoke a rebuttable presumption of reliance on misrepresentations regarding securities trading in an efficient market. This action poses the question of whether the Court should overrule, or substantially modify, its 1988 holding in Basic Inc. v. Levinson to the extent it recognizes a presumption of class-wide reliance derived from the fraud-on-the-market theory.

Fraud-on-the-market. The fraud-on-the-market presumption is generally invoked to establish reliance. Under the presumption, when a company makes public material misstatements in an efficient market, the misstatements are reflected in the price of the stock and it is presumed that the investor relied on the misstatements when he or she purchased the stock at the market price.

In an earlier amicus brief, the National Association of Manufacturers and the U.S. Chamber of Commerce had urged the Court to grant the petition for certiorari(which it has now done) and overrule or modify the fraud-on-the-market theory endorsed in the Basic Inc. decision.

This theory, explained the Chamber, allows investors to establish the reliance element in a securities fraud class action merely by showing that they traded stock around the time of the public misrepresentations. This approach, argued the Chamber, has led to doctrinal confusion among the lower courts and enabled a wave of frivolous class action litigation. The Chamber also noted that the presumption of reliance is based on an efficient-market theory, which today’s economists increasingly reject.

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