Opinion ID: 160012
Heading Depth: 3
Heading Rank: 2

Heading: Fraud-Created-the-Market Presumption

Text: Mr. Joseph contends that in any event he is entitled to a presumption of reliance under the “fraud-created-the-market” doctrine, which permits a plaintiff to maintain an action under section 10(b) by proving the defendant’s fraud allowed securities that otherwise would have been unmarketable to come into and -19- exist in the market. 2 In other words, investors can be presumed to rely on the integrity of the market to contain only genuine securities. The first case to articulate this doctrine was Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en banc). The defendants there had engaged in an elaborate scheme to create a bond issue so lacking in basic requirements it would never have been approved absent the massive fraud. See id. at 464 n.2. The Fifth Circuit stated that the plaintiff would be entitled to a presumption of reliance if he could establish that “the defendants knowingly conspired to bring securities onto the market which were not entitled to be marketed, intending to defraud purchasers.” Id. at 469. The court made clear that the plaintiff could not recover if he “proves no more than that the bonds would have been offered at a lower price or a higher rate, rather than that they would never have been issued or marketed.” Id. at 470. This court explicitly adopted the reasoning of Shores in T.J. Raney & Sons, Inc. v. Fort Cobb, Oklahoma Irrigation Fuel Auth., 717 F.2d 1330, 1333 (10th 2 This presumption of reliance is not to be confused with its more established cousin, the “fraud-on-the-market” presumption. The latter doctrine, endorsed by the Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988), recognizes that in an open, efficient, and developed market, where millions of shares are traded daily, the investor must rely on the market to perform a valuation process which incorporates all publicly available information, including misinformation. See id. at 241-47. Thus, the reliance of individual plaintiffs on the integrity of a price in such a market, and implicitly the misinformation that contributed to that price, may be presumed. See id. at 247. The fraud-createdthe-market presumption, by contrast, applies where there is no preexisting, wellestablished market. -20- Cir. 1983). The defendant in T.J. Raney issued bonds for the construction of a gas distribution facility. The offering circular was deceptive, the bond proceeds were mishandled, and the bonds went into default. The trial court found that the defendant was not a valid public trust and, as such, was actually prohibited from issuing bonds under state law. We noted that “the securities could not have been issued” but for the fraud, and held that the plaintiff had “reasonably relied on the availability of the bonds as indicating their lawful issuance.” Id. We also made clear the limitations of the doctrine: This holding does not imply in any way that the regulatory body considers the worth of the security or the veracity of the representations made in the offering circular . . . . It merely extends the protection of Rule 10b-5 to those cases in which the securities were not qualified legally to be issued. Id. Thus, we require the securities to be unmarketable in order to invoke the presumption of reliance based on fraud creating the market. Cases discussing the issue define “unmarketable” strictly. The Sixth Circuit breaks the term into two categories: (1) “economic unmarketability,” which occurs when a security is patently worthless, and (2) “legal unmarketability,” which occurs when a regulatory or municipal agency would have been required by law to prevent or forbid the issuance of the security. Ockerman v. May Zima & Co., 27 F.3d 1151, 1160 (6th Cir. 1994). Cf. Ross v. Bank South, 885 F.2d 723, 729 (11th Cir. 1989) (en banc) (“[T]he fraud must be so pervasive that it goes to the very existence of the bonds and the validity of -21- their presence on the market.”). Mr. Joseph does not argue that his debentures lacked all economic value. Although he suffered a substantial loss, the record indicates Mr. Joseph was able to sell the debentures for $8,147. See Rec., vol. II at 725. If we adhere to a strict definition of economic unmarketability, he should not be entitled to a presumption of reliance. See Rosenthal, 945 F. Supp. at 1418-19 (refusing to apply doctrine where plaintiff’s bonds “had some economic worth”); Bank of Denver v. Southeastern Capital Group, Inc., 763 F. Supp. 1552, 1558 (D. Colo. 1991) (plaintiff must prove that securities “would not have been offered on the market at any price”). Even if we look to the slightly different definition of economic unmarketability advanced in Abell, 858 F.2d at 1122, Mr. Joseph remains unsuccessful. 3 Abell recognized that “saleable assets may bless even the most worthless enterprise,” and allowed investors a presumption of reliance if “the enterprise itself was patently worthless,” illegitimate, or a sham. Id. In this case, Mr. Joseph alleges that MiniScribe engaged in fraudulent business and accounting practices, eventually declaring bankruptcy, and that several of the defendants pled 3 There is more than one definition of “economic unmarketability” being used by the federal courts. Because we conclude that Mr. Joseph’s debentures do not meet either definition of economic unmarketablity, we need not determine which of these definitions is preferable. -22- guilty to criminal securities violations. While all of these charges indicate that MiniScribe was a seriously troubled enterprise, they do not lead to the conclusion that MiniScribe was an illegitimate or sham business. Nor does Mr. Joseph claim the debentures were issued without lawful authority and therefore legally unmarketable. Instead, he alleges that, “[h]ad the adverse facts defendants concealed been disclosed, the public offering of MiniScribe’s debentures in May 1987 would not have been possible.” Rec., vol. II at 708. Mr. Joseph merely seems to be advancing the unremarkable proposition that the investors would not have bought MiniScribe securities if they had known about the Company’s economic problems. Applying the fraud-created-the-market doctrine in this situation would require us to ignore the limitations we placed on it in T.J. Raney. 4 There is a significant difference between securities which should not be marketed because they involve fraud, and securities which cannot be marketed because the issuers lack legal authority to offer them. Mr. Joseph’s allegations only encompass the former scenario. Because he has not alleged that his debentures were economically or legally unmarketable, Mr. Joseph is not 4 Indeed, by this logic every securities offering involving fraud would qualify for the presumption because “[w]ho would knowingly roll the dice in a crooked crap game?” Schlanger v. Four-Phase Sys., Inc., 555 F. Supp. 535, 538 (S.D.N.Y. 1982). -23- entitled to this presumption of reliance. 5