Opinion ID: 499747
Heading Depth: 2
Heading Rank: 2

Heading: The Integrity of the Market

Text: 21 Zlotnick argues that, as a short seller, he relied upon the integrity of the market. Though he believed the price of the stock overvalued at the time of the short sale, he relied on the market's ability, given accurate information, to correct its valuation of the stock and set a better price. By falsely inflating the price of the stock, defendants interfered with the market's ability to correct itself. Once he had sold short, Zlotnick was unable to protect himself from this fraud. Therefore, he argues, requiring him to prove individual reliance on defendant's misrepresentations  'imposes an unreasonable and irrelevant evidentiary burden.'  Peil, 806 F.2d at 1160 (quoting Blackie v. Barrack, 524 F.2d 891, 907 (9th Cir.1975), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976)). 22 Reliance on the integrity of the market in a stock differs from reliance on the integrity of the market price in that stock. An investor relying on the integrity of a market price in fact relies on other investors to interpret the relevant data and arrive at a price which, at the time of the transaction, reflects the true worth of the company. By contrast, an investor relying on the integrity of the market relies on the continuing ability of investors to interpret data subsequent to the transaction; he relies on future conditions. In the context of a short sale, the difference between these two types of reliance is more pronounced. The traditional purchaser depends on the market to determine a present value for the stock that allows the purchaser an adequate return on his investment. On the other hand, the short seller depends for a return on his investment on the market realizing that the value of the stock at the time of the short sale does not allow for an adequate return on the investment. This realization is what drives the price of the stock down and allows the short seller his profit. 23 More important, reliance on the integrity of the market price is actual, if indirect, reliance. The short seller is not injured because he knew of or depended on the misrepresentation; he is injured because others investing in the stock so relied. The fraud of which Zlotnick complains was truly perpetrated on the market, and not, even indirectly, on Zlotnick as an investor in the market. We are mindful that reliance is not an abstract requirement in the securities laws: plaintiff must prove reliance in order to prove that the misrepresentation caused actual injury. Reliance is therefore one aspect of the ubiquitous requirement that losses be causally related to the defendant's wrongful acts. Sharp v. Coopers & Lybrand, 649 F.2d 175, 186 (3d Cir.1981), cert. denied, 455 U.S. 938, 102 S.Ct. 1427, 71 L.Ed.2d 648 (1982). Zlotnick may, as discussed above, be able to prove his own actual, indirect reliance upon the market price. However, to the extent Zlotnick argues he is entitled to recover for the reliance of third parties, we reject his claim. 24 Zlotnick alleges that defendants misrepresented the truth, and that such misrepresentations caused the price of the stock to rise at the time he sold short. He concludes that since the fraudulently-induced rise in the stock caused him to lose money, he is entitled to recover. Under Zlotnick's theory, he would be allowed to recover even if he purchased after deciding, based solely on accurate information, that the stock was not overvalued and his short sale was ill-conceived. 8 Yet, in such a case, Zlotnick is no different from the traditional purchaser who buys at a fraudulently-inflated price but actually relies solely on accurate information in purchasing: both have made bad valuations of the stock, but those valuations were independent of any alleged fraud. Zlotnick cannot recover his loss on his covering purchase unless he shows that his decision to cover was somehow connected with the fraud.