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BASIC, INC. V. LEVINSON, 485 U. S. 224 (1988) - US SUPREME COURT DECISIONS ON-LINE
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BASIC, INC. V. LEVINSON, 485 U. S. 224 (1988)
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Basic, Inc. v. Levinson, 485 U.S. 224 (1988)
1. The standard set forth in TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438, whereby an omitted fact is material if there is a substantial likelihood that its disclosure would have been considered significant by a reasonable investor, is expressly adopted for the § 10(b) and Rule 10b-5 context. Pp. 485 U. S. 230-232. chanroblesvirtualawlibrary
Page 485 U. S. 225
BLACKMUN, J., delivered the opinion of the Court, in which BRENNAN, MARSHALL, and STEVENS, JJ., joined, and in Parts I, II, and III of which WHITE and O'CONNOR, JJ., joined. WHITE, J., filed an opinion concurring in part and dissenting in part, in which O'CONNOR, J., joined, post, p. 485 U. S. 250. REHNQUIST, C.J.,and SCALIA and KENNEDY, JJ., took no part in the consideration or decision of the case. chanroblesvirtualawlibrary
Page 485 U. S. 226
Prior to December 20, 1978, Basic Incorporated was a publicly traded company primarily engaged in the business of manufacturing chemical refractories for the steel industry. As early as 1965 or 1966, Combustion Engineering, Inc., a company producing mostly alumina-based refractories, expressed some interest in acquiring Basic, but was deterred from pursuing this inclination seriously because of antitrust concerns it then entertained. See App. 81-83. In 1976, however, regulatory action opened the way to a renewal of chanroblesvirtualawlibrary
Page 485 U. S. 227
Combustion's interest. [Footnote 1] The "Strategic Plan," dated October 25, 1976, for Combustion's Industrial Products Group included the objective: "Acquire Basic Inc. $30 million." App. 337.
Beginning in September, 1976, Combustion representatives had meetings and telephone conversations with Basic officers and directors, including petitioners here, [Footnote 2] concerning the possibility of a merger. [Footnote 3] During 1977 and 1978, Basic made three public statements denying that it was engaged in merger negotiations. [Footnote 4] On December 18, 1978, Basic asked chanroblesvirtualawlibrary
Page 485 U. S. 228
The District Court adopted a presumption of reliance by members of the plaintiff class upon petitioners' public statements that enabled the court to conclude that common questions of fact or law predominated over particular questions pertaining to individual plaintiffs. See Fed.Rule Civ.Proc. 23(b)(3). The District Court therefore certified respondents' class. [Footnote 5] On the merits, however, the District Court granted chanroblesvirtualawlibrary
Page 485 U. S. 229
786 F.2d 749.
The Court of Appeals joined a number of other Circuits in accepting the "fraud-on-the-market theory" to create a rebuttable presumption that respondents relied on petitioners' material chanroblesvirtualawlibrary
Page 485 U. S. 230
misrepresentations, noting that, without the presumption, it would be impractical to certify a class under Federal Rule of Civil Procedure 23(b)(3). See 786 F.2d 750-751.
Pursuant to its authority under § 10(b) of the 1934 Act, 15 U.S.C. § 78j, the Securities and Exchange Commission promulgated Rule 10b-5. [Footnote 6] Judicial interpretation and application, chanroblesvirtualawlibrary
Page 485 U. S. 231
legislative acquiescence, and the passage of time have removed any doubt that a private cause of action exists for a violation of § 10(b) and Rule 10b-5, and constitutes an essential tool for enforcement of the 1934 Act's requirements. See, e.g., Ernst & Ernst v. Hochfelder, 425 U. S. 185, 425 U. S. 196 (1976); Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723, 421 U. S. 730 (1975).
"there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the
Page 485 U. S. 232
reasonable investor as having significantly altered the 'total mix' of information made available."
Petitioners urge upon us a Third Circuit test for resolving this difficulty. [Footnote 10] See Brief for Petitioners 20-22. Under this chanroblesvirtualawlibrary
Page 485 U. S. 233
approach, preliminary merger discussions do not become material until "agreement-in-principle" as to the price and structure of the transaction has been reached between the would-be merger partners. See Greenfield v. Heublein, Inc., 742 F.2d 751, 757 (CA3 1984), cert. denied, 469 U.S. 1215 (1985). By definition, then, information concerning any negotiations not yet at the agreement-in-principle stage could be withheld or even misrepresented without a violation of Rule 10b-5.
Three rationales have been offered in support of the "agreement-in-principle" test. The first derives from the concern expressed in TSC Industries that an investor not be overwhelmed by excessively detailed and trivial information, and focuses on the substantial risk that preliminary merger discussions may collapse: because such discussions are inherently tentative, disclosure of their existence itself could mislead investors and foster false optimism. See Greenfield v. Heublein, Inc., 742 F.2d 756; Reiss v. Pan American World Airways, Inc., 711 F.2d 11, 14 (CA2 1983). The other two justifications for the agreement-in-principle standard are based on management concerns: because the requirement of "agreement-in-principle" limits the scope of disclosure obligations, it helps preserve the confidentiality of merger discussions where earlier disclosure might prejudice the negotiations; and the test also provides a usable, bright-line rule for determining when disclosure must be made. See Greenfield v. Heublein, Inc., 742 F.2d 757; Flamm chanroblesvirtualawlibrary
Page 485 U. S. 234
v. Eberstadt, 814 F.2d 1169, 1176-1178 (CA7), cert. denied, 484 U.S. 853 (1987).
None of these policy-based rationales, however, purports to explain why drawing the line at agreement-in-principle reflects the significance of the information upon the investor's decision. The first rationale, and the only one connected to the concerns expressed in TSC Industries, stands soundly rejected, even by a Court of Appeals that otherwise has accepted the wisdom of the agreement-in-principle test. "It assumes that investors are nitwits, unable to appreciate -- even when told -- that mergers are risky propositions up until the closing." Flamm v. Eberstadt, 814 F.2d 1175. Disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress. We have recognized time and again, a "fundamental purpose" of the various Securities Acts, "was to substitute a philosophy of full disclosure for the philosophy of caveat emptor, and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 375 U. S. 186. Accord, Affiliated Ute Citizens v. United States, 406 U. S. 128, 406 U. S. 151 (1972); Santa Fe Industries, Inc. v. Green, 430 U.S. at 406 U. S. 477. The role of the materiality requirement is not to "attribute to investors a child-like simplicity, an inability to grasp the probabilistic significance of negotiations," Flamm v. Eberstadt, 814 F.2d 1175, but to filter out essentially useless information that a reasonable investor would not consider significant, even as part of a larger "mix" of factors to consider in making his investment decision. TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 426 U. S. 448-449.
The second rationale, the importance of secrecy during the early stages of merger discussions, also seems irrelevant to an assessment whether their existence is significant to the trading decision of a reasonable investor. To avoid a "bidding war" over its target, an acquiring firm often will insist that negotiations remain confidential, see, e.g., In re Carnation chanroblesvirtualawlibrary
Page 485 U. S. 235
Co., Exchange Act Release No. 22214, 33 S.E. C. Docket 1025 (1985), and at least one Court of Appeals has stated that "silence pending settlement of the price and structure of a deal is beneficial to most investors, most of the time." Flamm v. Eberstadt, 814 F.2d 1177. [Footnote 11]
We need not ascertain, however, whether secrecy necessarily maximizes shareholder wealth -- although we note that the proposition is at least disputed as a matter of theory and empirical research [Footnote 12] -- for this case does not concern the timing of a disclosure; it concerns only its accuracy and completeness. [Footnote 13] We face here the narrow question whether information concerning the existence and status of preliminary merger discussions is significant to the reasonable investor's trading decision. Arguments based on the premise that some disclosure would be "premature" in a sense are more properly considered under the rubric of an issuer's duty to disclose. The "secrecy" rationale is simply inapposite to the definition of materiality. chanroblesvirtualawlibrary
Page 485 U. S. 236
We therefore find no valid justification for artificially excluding from the definition of materiality information concerning merger discussions, which would otherwise be considered significant to the trading decision of a reasonable investor, merely because agreement-in-principle as to price and structure has not yet been reached by the parties or their representatives. chanroblesvirtualawlibrary
Page 485 U. S. 237
". . . In analyzing whether information regarding merger discussions is material such that it must be affirmatively disclosed to avoid a violation of Rule 10b-5, the discussions and their progress are the primary considerations. However, once a statement is made denying the existence of any discussions, even discussions that might not have been material in absence of the denial are material because they make the statement made untrue."
786 F.2d 748-749 (emphasis in original). [Footnote 15] chanroblesvirtualawlibrary
Page 485 U. S. 238
SEC v. Texas Gulf Sulphur Co., 401 F.2d 849. Interestingly, neither the Third Circuit decision adopting the agreement-in-principle test nor petitioners here take issue with this general standard. Rather, they suggest that, with respect to preliminary merger discussions, there are good reasons to draw a line at agreement on price and structure.
SEC v. Geon Industries, Inc., 531 F.2d 39, 47-48 (1976). chanroblesvirtualawlibrary
Page 485 U. S. 239
We agree with that analysis. [Footnote 16]
Whether merger discussions in any particular case are material therefore depends on the facts. Generally, in order to assess the probability that the event will occur, a factfinder will need to look to indicia of interest in the transaction at the highest corporate levels. Without attempting to catalog all such possible factors, we note by way of example that board resolutions, instructions to investment bankers, and actual negotiations between principals or their intermediaries may serve as indicia of interest. To assess the magnitude of the transaction to the issuer of the securities allegedly manipulated, a factfinder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material. [Footnote 17] chanroblesvirtualawlibrary
Page 485 U. S. 240
As we clarify today, materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information. [Footnote 18] The fact-specific inquiry we endorse here is consistent with the approach a number of courts have taken in assessing the materiality of merger negotiations. [Footnote 19] Because the standard of materiality we have chanroblesvirtualawlibrary
Page 485 U. S. 241
adopted differs from that used by both courts below, we remand the case for reconsideration of the question whether a grant of summary judgment is appropriate on this record. [Footnote 20]
"The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business. . . . Misleading statements will therefore
Page 485 U. S. 242
defraud purchasers of stock even if the purchasers do not directly rely on the misstatements. . . . The causal connection between the defendants' fraud and the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations."
This case required resolution of several common questions of law and fact concerning the falsity or misleading nature of the three public statements made by Basic, the presence or absence of scienter, and the materiality of the misrepresentations, if any. In their amended complaint, the named plaintiffs alleged that, in reliance on Basic's statements, they sold their shares of Basic stock in the depressed market created by petitioners. See Amended Complaint in No. C79-1220 (ND Ohio), �� 27, 29, 35, 40; see also id. � 33 (alleging effect on market price of Basic's statements). Requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones. The District Court found that the presumption of reliance created by the fraud-on-the-market theory provided
The District Court thus concluded that with reference to each public statement and its impact upon the open market for Basic shares, common questions predominated over individual questions, as required by Federal Rules of Civil Procedure 23(a)(2) and (b)(3). chanroblesvirtualawlibrary
Page 485 U. S. 243
The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face chanroblesvirtualawlibrary
Page 485 U. S. 244
transactions contemplated by early fraud cases, [Footnote 21] and our understanding of Rule 10b-5's reliance requirement must encompass these differences. [Footnote 22]
In re LTV Securities Litigation, 88 F.R.D. 134, 143 (ND Tex.1980). Accord, e.g., Peil v. Speiser, 806 F.2d 1161 ("In an open and developed market, the dissemination of material misrepresentations or withholding of material information typically affects the price of the stock, and purchasers generally rely on the price of the stock as a reflection of its value"); Blackie chanroblesvirtualawlibrary
Page 485 U. S. 245
v. Barrack, 524 F.2d 891, 908 (CA9 1975) ("[T]he same causal nexus can be adequately established indirectly, by proof of materiality coupled with the common sense that a stock purchaser does not ordinarily seek to purchase a loss in the form of artificially inflated stock"), cert. denied, 429 U.S. 816 (1976).
Arising out of considerations of fairness, public policy, and probability, as well as judicial economy, presumptions are also useful devices for allocating the burdens of proof between parties. See E. Cleary, McCormick on Evidence 968-969 (3d ed.1984); see also Fed.Rule Evid. 301 and Advisory Committee Notes, 28 U.S.C.App. p. 685. The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the 1934 Act. In drafting that Act, chanroblesvirtualawlibrary
Page 485 U. S. 246
Congress expressly relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an investor's reliance on the integrity of those markets:
The presumption is also supported by common sense and probability. Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well developed markets reflects all publicly available information, and, hence, any material misrepresentations. [Footnote 24] It has been noted that "it is hard to imagine that chanroblesvirtualawlibrary
Page 485 U. S. 247
there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?" Schlanger v. Four-Phase Systems Inc., 555 F.Supp. 535, 538 (SDNY 1982). Indeed, nearly every court that has considered the proposition has concluded that, where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed. [Footnote 25] Commentators generally have applauded the adoption of one variation or another of the fraud-on-the-market theory. [Footnote 26] An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action. chanroblesvirtualawlibrary
Page 485 U. S. 248
786 F.2d 751. [Footnote 27] The court acknowledged that petitioners may rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price or that an individual plaintiff traded or would have traded despite his knowing the statement was false. Id. at 750, n. 6.
Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff or his decision to trade at a fair market price will be sufficient to rebut the presumption of reliance. For example, if petitioners could show that the "market makers" were privy to the truth about the merger discussions here with Combustion, and thus that the market price would not have been affected by their misrepresentations, the causal connection could be broken; the basis for finding that the fraud had been transmitted through market price would be gone. [Footnote 28] Similarly, if, despite petitioners' allegedly fraudulent attempt chanroblesvirtualawlibrary
Page 485 U. S. 249
to manipulate market price, news of the merger discussions credibly entered the market and dissipated the effects of the misstatements, those who traded Basic shares after the corrective statements would have no direct or indirect connection with the fraud. [Footnote 29] Petitioners also could rebut the presumption of reliance as to plaintiffs who would have divested themselves of their Basic shares without relying on the integrity of the market. For example, a plaintiff who believed that Basic's statements were false and that Basic was indeed engaged in merger discussions, and who consequently believed that Basic stock was artificially underpriced, but sold his shares nevertheless because of other unrelated concerns, e.g., potential antitrust problems, or political pressures to divest from shares of certain businesses could not be said to have relied on the integrity of a price he knew had been manipulated.
3. We also reject the proposition that "information becomes material by virtue of a public statement denying it." chanroblesvirtualawlibrary
Page 485 U. S. 250
Respondents initially sought to represent all those who sold Basic shares between October 1, 1976, and December 20, 1978. See Amended Complaint in No. C79-1220 (ND Ohio), � 5. The District Court, however, recognized a class period extending only from October 21, 1977, the date of the first public statement, rather than from the date negotiations allegedly commenced. In its certification decision, as subsequently amended, the District Court also excluded from the class those who had purchased Basic shares after the October, 1977, statement but sold them before the September, 1978, statement, App. to Pet. for Cert. 123a-124a, and those who sold their shares after the close of the market on Friday, December 15, 1978. Id. at 137a.
"(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. . . ."
Reasoning backwards from a goal of economic efficiency, that Court of Appeals stated: "Rule 10b-5 is about fraud, after all, and it is not fraudulent to conduct business in a way that makes investors better off. . . ." 814 F.2d 1177.
See, e.g., Brown, Corporate Secrecy, the Federal Securities Laws, and the Disclosure of Ongoing Negotiations, 36 Cath.U.L.Rev. 93 145-155 (1986); Bebchuk, The Case for Facilitating Competing Tender Offers, 95 Harv.L.Rev. 1028 (1982); Elamm v. Eberstadt, 814 F.2d 1177, n. 2 (citing scholarly debate). See also In re Carnation Co., Exchange Act Release No. 22214, 33 S.E. C. Docket 1025, 1030 (1985) ("The importance of accurate and complete issuer disclosure to the integrity of the securities markets cannot be overemphasized. To the extent that investors cannot rely upon the accuracy and completeness of issuer statements, they will be less likely to invest, thereby reducing the liquidity of the securities markets to the detriment of investors and issuers alike").
To be actionable, of course, a statement must also be misleading. Silence, absent a duty to disclose, is not misleading under Rule 10b-5. "No comment" statements are generally the functional equivalent of silence. See In re Carnation Co., Exchange Act Release No. 22214, 33 S.E.C. Docket 1025 (1985). See also New York Stock Exchange Listed Company Manual § 202.01, reprinted in 3 CCH Fed.Sec.L.Rep. � 23,515 (1987) (premature public announcement may properly be delayed for valid business purpose and where adequate security can be maintained); American Stock Exchange Company Guide §§ 401-405, reprinted in 3 CCH Fed.Sec.L.Rep. �� 23,124A-23,124E (1985) (similar provisions).
It has been suggested that, given current market practices, a "no comment" statement is tantamount to an admission that merger discussions are underway. See Flamm v. Eberstadt, 814 F.2d 1178. That may well hold true to the extent that issuers adopt a policy of truthfully denying merger rumors when no discussions are underway, and of issuing "no comment" statements when they are in the midst of negotiations. There are, of course, other statement policies firms could adopt; we need not now advise issuers as to what kind of practice to follow, within the range permitted by law. Perhaps more importantly, we think that creating an exception to a regulatory scheme founded on a pro-disclosure legislative philosophy, because complying with the regulation might be "bad for business," is a role for Congress, not this Court. See also id. at 1182 (opinion concurring in judgment and concurring in part).
We recognize that trading (and profit making) by insiders can serve as an indication of materiality, see SEC v. Texas Gulf Sulphur Co., 401 F.2d 851; General Portland, Inc. v. LaFarge Coppee S.A., [1982-1983] CCH Fed.Sec.L.Rep. 1199, 148, p. 95,544 (ND Tex.1981). We are not prepared to agree, however, that,
See, e.g., SEC v. Shapiro, 494 F.2d 1301, 1306-1307 (CA2 1974) (in light of projected very substantial increase in earnings per share, negotiations material, although merger still less than probable); Holmes v. Bateson, 583 F.2d 542, 558 (CA1 1978) (merger negotiations material although they had not yet reached point of discussing terms); SEC v. Gaspar, [1984-1985] CCH Fed.Sec.L.Rep. � 92,004, pp. 90,977-90,978 (SDNY 1985) (merger negotiations material although they did not proceed to actual tender offer); Dungan v. Colt Industries, Inc., 532 F.Supp. 832, 837 (ND Ill.1982) (fact that defendants were seriously exploring the sale of their company was material); American General Ins. Co. v. Equitable General Corp., 493 F.Supp. 721, 744-745 (ED Va.1980) (merger negotiations material four months before agreement-in-principle reached). Cf. Susquehanna Corp. v. Pan American Sulphur Co., 423 F.2d 1075, 1084-1085 (CA5 1970) (holding immaterial "unilateral offer to negotiate" never acknowledged by target and repudiated two days later); Berman v. Gerber Products Co., 454 F.Supp. 1310, 1316, 1318 (WD Mich.1978) (mere "overtures" immaterial).
The Sixth Circuit rejected the District Court's narrow reading of Basic's "no developments" statement, see n 4, supra, which focused on whether petitioners knew of any reason for the activity in Basic stock, that is, whether petitioners were aware of leaks concerning ongoing discussions. 786 F.2d 747. See also Comment, Disclosure of Preliminary Merger Negotiations Under Rule 10b-5, 62 Wash.L.Rev. 81, 82-84 (1987) (noting prevalence of leaks and studies demonstrating that substantial trading activity immediately preceding merger announcements is the "rule, not the exception"). We accept the Court of Appeals' reading of the statement as the more natural one, emphasizing management's knowledge of developments (as opposed to leaks) that would explain unusual trading activity. See id. at 92-93; see also SEC v. Texas Gulf Sulphur Co., 401 F.2d 862-863.
The Court of Appeals held that, in order to invoke the presumption, a plaintiff must allege and prove: (1) that the defendant made public misrepresentations; (2) that the misrepresentations were material; (3) that the shares were traded on an efficient market; (4) that the misrepresentations would induce a reasonable, relying investor to misjudge the value of the shares; and (5) that the plaintiff traded the shares between the time the misrepresentations were made and the time the truth was revealed. See 786 F.2d 750.
Even when compared to the relatively youthful private cause of action under § 10(b), see Kardon v. National Gypsum Co., 69 F.Supp. 512 (ED Pa.1946), the fraud-on-the-market theory is a mere babe. [Footnote 2/1] Yet today, the Court embraces chanroblesvirtualawlibrary
Page 485 U. S. 251
this theory with the sweeping confidence usually reserved for more mature legal doctrines. In so doing, I fear that the Court's decision may have many adverse, unintended effects as it is applied and interpreted in the years to come.
At the outset, I note that there are portions of the Court's fraud-on-the-market holding with which I am in agreement. Most importantly, the Court rejects the version of that theory, heretofore adopted by some courts, [Footnote 2/2] which equates "causation" with "reliance," and permits recovery by a plaintiff who claims merely to have been harmed by a material misrepresentation which altered a market price, notwithstanding proof that the plaintiff did not in any way rely on that price. Ante at 485 U. S. 248. I agree with the Court that, if Rule 10b-5's reliance requirement is to be left with any content at all, the fraud-on-the-market presumption must be capable of being rebutted by a showing that a plaintiff did not "rely" on the market price. For example, a plaintiff who decides, months in advance of an alleged misrepresentation, to purchase a stock; one who buys or sells a stock for reasons unrelated to its price; one who actually sells a stock "short" days before the misrepresentation is made -- surely none of these people can state a valid claim under Rule 10b-5. Yet, some federal courts have allowed such claims to stand under one variety or another of the fraud-on-the-market theory. [Footnote 2/3] chanroblesvirtualawlibrary
Page 485 U. S. 252
But even as the Court attempts to limit the fraud-on-the-market theory it endorses today, the pitfalls in its approach are revealed by previous uses by the lower courts of the broader versions of the theory. Confusion and contradiction in court rulings are inevitable when traditional legal analysis is replaced with economic theorization by the federal courts. chanroblesvirtualawlibrary
Page 485 U. S. 253
The "wrong turns" in those Court of Appeals and District Court fraud-on-the-market decisions which the Court implicitly rejects as going too far should be ample illustration of the dangers when economic theories replace legal rules as the basis for recovery. Yet the Court today ventures into this area beyond its expertise, beyond -- by its own admission -- the confines of our previous fraud cases. See ante at 485 U. S. 243-244. Even if I agreed with the Court that "modern securities markets . . . chanroblesvirtualawlibrary
Page 485 U. S. 254
involving millions of shares changing hands daily" require that the "understanding of Rule 10b-5's reliance requirement" be changed, ibid., I prefer that such changes come from Congress in amending § 10(b). The Congress, with its superior resources and expertise, is far better equipped than the federal courts for the task of determining how modern economic theory and global financial markets require that established legal notions of fraud be modified. In choosing to make these decisions itself, the Court, I fear, embarks on a course that it does not genuinely understand, giving rise to consequences it cannot foresee. [Footnote 2/5]
For while the economists' theories which underpin the fraud-on-the-market presumption may have the appeal of mathematical exactitude and scientific certainty, they are -- in the end -- nothing more than theories which may or may not prove accurate upon further consideration. Even the most earnest advocates of economic analysis of the law recognize this. See, e.g., Easterbrook, Afterword: Knowledge and Answers, 85 Colum.L.Rev. 1117, 1118 (1985). Thus, while the majority states that, for purposes of reaching its result it need only make modest assumptions about the way in which "market professionals generally" do their jobs, and how the conduct of market professionals affects stock prices, ante at 485 U. S. 246, n. 23, I doubt that we are in much of a position chanroblesvirtualawlibrary
Page 485 U. S. 255
to assess which theories aptly describe the functioning of the securities industry.
To define the term "integrity of the market price," the majority quotes approvingly from cases which suggest that investors are entitled to "rely on the price of a stock as a reflection of its value.'" Ante at 485 U. S. 244 (quoting Peil v. Speiser, 806 F.2d 1154, 1161 (CA3 1986)). But the meaning of this phrase eludes me, for it implicitly suggests that stocks have some "true value" that is measurable by a standard other than their market price. While the scholastics of medieval times professed a means to make such a valuation of a commodity's "worth," [Footnote 2/6] I doubt that the federal courts of our day are similarly equipped. chanroblesvirtualawlibrary
Page 485 U. S. 256
I do not propose that the law retreat from the many protections that § 10(b) and Rule 10b-5, as interpreted in our prior cases, provide to investors. But any extension of these laws, to approach something closer to an investor insurance chanroblesvirtualawlibrary
Page 485 U. S. 257
scheme, should come from Congress, and not from the courts.
Yet this provision was roundly criticized in congressional hearings on the proposed Securities Exchange Act, because it failed to include a more substantial "reliance" requirement. [Footnote 2/8] chanroblesvirtualawlibrary
Page 485 U. S. 258
Subsequent drafts modified the original proposal and included an express reliance requirement in the final version of the Act. In congressional debates over the redrafted version of this bill, the then-Chairman of the House Committee, Representative Sam Rayburn, explained that the "bill as originally written was very much challenged on the ground that reliance should be required. This objection has been met." 78 Cong.Rec. 7701 (1934). Moreover, in a previous case concerning the scope of § 10(b) and Rule 10b-5, we quoted approvingly from the legislative history of this revised provision, which emphasized the presence of a strict reliance requirement as a prerequisite for recovery. See Ernst & Ernst v. Hochfelder, supra, at 425 U. S. 206 (citing S.Rep. No. 792, 73d Cong., 2d Sess., 12-13 (1934)).
A second congressional policy that the majority's opinion ignores is the strong preference the securities laws display for widespread public disclosure and distribution to investors of material information concerning securities. This congressionally adopted policy is expressed in the numerous and varied disclosure requirements found in the federal securities chanroblesvirtualawlibrary
Page 485 U. S. 259
law scheme. See, e.g., 15 U.S.C. §§ 78m, 780(d) (1982 ed. and Supp. IV).
Shores v. Sklar, 647 F.2d 483 (Randall, J., dissenting).
Finally, the particular facts of this case make it an exceedingly poor candidate for the Court's fraud-on-the-market theory, chanroblesvirtualawlibrary
Page 485 U. S. 260
and illustrate the illogic achieved by that theory's application in many cases.
Second, there is the fact that, in this case, there is no evidence that petitioner Basic's officials made the troublesome misstatements for the purpose of manipulating stock prices, or with any intent to engage in underhanded trading of Basic stock. Indeed, during the class period, petitioners do not chanroblesvirtualawlibrary
Page 485 U. S. 261
appear to have purchased or sold any Basic stock whatsoever. App. to Pet. for Cert. 27a. I agree with amicus, who argues that "[i]mposition of damages liability under Rule 10b-5 makes little sense . . . where a defendant is neither a purchaser nor a seller of securities." See Brief for American Corporate Counsel Association as Amicus Curiae 13. In fact, in previous cases, we had recognized that Rule 10b-5 is concerned primarily with cases where the fraud is committed by one trading the security at issue. See, e.g., Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723, 421 U. S. 736, n. 8 (1975). And it is difficult to square liability in this case with § 10(b)'s express provision that it prohibits fraud "in connection with the purchase or sale of any security." See 15 U.S.C. § 78j(b) (emphasis added).
Third, there are the peculiarities of what kinds of investors will be able to recover in this case. As I read the District Court's class certification order, App. to Pet. for Cert. 123a-126a; ante at 485 U. S. 228-229, n. 5, there are potentially many persons who did not purchase Basic stock until after the first false statement (October 1977), but who nonetheless will be able to recover under the Court's fraud-on-the-market theory. Thus, it is possible that a person who heard the first corporate misstatement and disbelieved it -- i.e., someone who purchased Basic stock thinking that petitioners' statement was false -- may still be included in the plaintiff class on remand. How a person who undertook such a speculative stock investing strategy -- and made $10 a share doing so (if he bought on October 22, 1977, and sold on December 15, 1978) -- can say that he was "defrauded" by virtue of his reliance on the "integrity" of the market price is beyond me. [Footnote 2/10] chanroblesvirtualawlibrary
Page 485 U. S. 262
And who will pay the judgments won in such actions? I suspect that, all too often, the majority's rule will "lead to large judgments, payable in the last analysis by innocent investors, for the benefit of speculators and their lawyers." Cf. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 867 (CA2 1968) (en banc) (Friendly, J., concurring), cert. denied, 394 U.S. 976 (1969). This Court and others have previously recognized that "inexorably broadening . . . the class of plaintiff[s] who may sue in this area of the law will ultimately result in more harm than good." Blue Chip Stamps v. Manor Drug Stores, supra, at 421 U. S. 747-748. See also Ernst & Ernst v. Hochfelder, 425 U.S. at 425 U. S. 214; Ultramares Corp. v. Touche, chanroblesvirtualawlibrary
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255 N.Y. 170, 179-180, 174 N.E. 441, 444-445 (1931) (Cardozo, C.J.). Yet such a bitter harvest is likely to be the reaped from the seeds sewn by the Court's decision today.
Cases illustrating these factual situations are, respectively, Zweig v. Hearst Corp., supra, at 1271 (Ely, J., dissenting); Abrams v. Johns-Manville Corp., [1981-1982] CCH Fed.Sec.L.Rep. �98,348, p. 92, 157 (SDNY 1981); Fausett v. American Resources Management Corp., 542 F.Supp. 1234, 1238-1239 (Utah 1982).
This is what the Court's rule boils down to in practical terms. For while, in theory, the Court allows for rebuttal of its "presumption of reliance" -- a proviso with which I agree, see supra, at 485 U. S. 251 -- in practice, the Court must realize, as other courts applying the fraud-on-the-market theory have, that such rebuttal is virtually impossible in all but the most extraordinary case. See Blackie v. Barrack, 524 F.2d 906-907, n. 22; In re LTV Securities Litigation, 88 F.R.D. 134, 143, n. 4 (ND Tex.1980).
The ease with which such a post hoc claim of "reliance on the integrity of the market price" can be made, and gain acceptance by a trial court, is illustrated by Abrams v. Johns-Manville Corp., discussed in 485 U. S. 3, supra.