Mismatch: The Misuse of Market Efficiency in Market Manipulation Class Actions

ABSTRACT Plaintiffs commonly bring two distinct types of claims under section 10(b) of the Securities Exchange Act of 1934: (1) claims of material misrepresentations or omissions, and (2) claims of trade-based market manipulation. Despite the distinctive features of the two types of claims, courts have tended to treat them identically when applying the "fraud on the market" doctrine. In particular, courts have required both types of plaintiffs to make identical showings that the relevant security was traded in an "efficient market" in order to gain a presumption of reliance. The reasons for requiring such a showing by plaintiffs in a misrepresentation case are, however, inapplicable in market manipulation cases. Plaintiffs alleging market manipulation should not be required to demonstrate an efficient market in order to benefit from the fraud on the market doctrine's presumption of reliance. If plaintiffs are made to make any showing at all, it should be a showing of loss causation. TABLE OF CONTENTS INTRODUCTION I. 10B-5 ACTIONS AND THE FRAUD ON THE MARKET DOCTRINE A. Origins of the 10b-5 Action B. The Fraud on the Market Doctrine 1. Theoretical Underpinnings of the Fraud on the Market Doctrine 2. Basic Inc. v. Levinson 3. Implementation by the Lower Courts--The Requirement of an "Efficient Market" II. MARKET MANIPULATION A. Defining Market Manipulation B. Real-Life Examples of Alleged Market Manipulation 1. United States v. GAF Corporation 2. United States v. Milken 3. United States v. Mulheren 4. In re IPO Securities Litigation 5. Desai v. Deutsche Bank Securities C. Conditions for Successful Market Manipulation 1. Liquidity and Demand Effects 2. Information Effects III. THE "EFFICIENT MARKET" REQUIREMENT IN MANIPULATION CLAIMS IV. IPO AND DESAI--THE "EFFICIENT MARKET" REQUIREMENT IN ACTION A. In re IPO Securities Litigation 1. Initial District Court Proceedings 2. Appeal to the Second Circuit--IPO III 3. Back to the District Court B. Desai v. Deutsche Bank Securities 1. Minnesota District Court 2. California District Court 3. The Ninth Circuit Opinion V. OUT OF THE MUDDLE: A "Loss CAUSATION" REQUIREMENT CONCLUSION INTRODUCTION On May 20, 2009, the SEC filed a civil complaint against eight participants in an alleged scheme to manipulate the prices of at least four "penny stocks" (1)--a scheme which allegedly netted the participants illicit profits of at least $6.2 million. (2) The allegations regarding one of the four companies, Asia Global Holdings Corporation, are representative. Asia Global shares trade over-the-counter, (3) and traded for around $0.11 per share in August of 2006, just prior to the manipulation. (4) Average trading volume was extremely light, with only a few hundred thousand shares--less than $100,000 worth changing hands in a typical trading week. (5) On August 9, 2009, the manipulators sprang into action and began to engage in massive "wash sales, matched orders, and other manipulative trading, to give the market the false impression that there was real demand for these securities." (6) Trading volume jumped to more than ten million shares per week, and the share price jumped to an intraday high of $0.41 on August 25. (7) Between August 30 and September 5, a week during which trading volume peaked at more than forty million shares, (8) the manipulators dumped nearly eight million shares into the wave of demand, netting approximately $1.3 million. (9) By December of 2006, Asia Global stock was selling below $0.05 per share, and it now trades at around $0.003 per share, with an average weekly volume of only a few hundred thousand shares. (10) That these manipulations took place in small, thinly traded stocks--far from the glare of Wall Street analysts and the financial press--is wholly predictable. …