Opinion ID: 1314093
Heading Depth: 2
Heading Rank: 3

Heading: Legal Standard for Establishing the Fraud-on-the-Market Presumption

Text: Defendants next argue that the district court erred by not placing the burden on plaintiffs to prove that the alleged misrepresentations moved the market, i.e., had a measurable effect on the stock price. In short, defendants argue that the concept of materiality in Basic, which plaintiffs must demonstrate for the fraud-on-the-market presumption to apply, refers to a material affect on the market price. This is a misreading of Basic. Basic was a two-part opinion. In the first part of the opinion, the Basic Court undertook to explain the meaning of material in Rule 10b-5. [7] The Basic Court expressly adopt[ed] the TSC Industries standard of materiality for the § 10(b) and Rule 10b-5 context that `to fulfill the materiality requirement there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available.' Basic, 485 U.S. at 231-32, 108 S.Ct. 978 (quoting TSC Indus. Inc., v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976)). See also Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir.2002) (The touchstone of the inquiry is ... whether defendants' representations or omissions, considered together and in context, would affect the total mix of information and thereby mislead a reasonable investor regarding the nature of the securities offered.). The Court underscored that `[t]he determination of materiality requires delicate assessments of the inferences a reasonable shareholder would draw from a given set of facts and the significance of those facts to [the shareholder].' Basic, 485 U.S. at 236, 108 S.Ct. 978 (quoting TSC Indus., 426 U.S. at 450, 96 S.Ct. 2126, alterations omitted). Later in the opinion, the Court explained the advantage of framing the question of materiality in terms of how the information would be viewed by a reasonable investor, rather than in terms of actual impact on market price: Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted if material information had been disclosed, or if the misrepresentation had not been made, would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market. Id. at 245, 108 S.Ct. 978 (citations omitted). In the second part of the opinion, the Basic Court drew on this fair and manageable definition of materiality to devise a method of establishing reliance on misrepresentations affecting the modern securities markets: if plaintiffs can show that the alleged misrepresentation was material and publicly transmitted into a well-developed market, then reliance will be presumed, for if a reasonable investor would think that the information would have significantly altered the `total mix' of information, id. at 232, 108 S.Ct. 978 (quoting TSC Indus., 426 U.S. at 449, 96 S.Ct. 2126), then it may be presumed that, in an efficient market, investors would have taken the omitted information into account, thereby affecting market price, see id. at 244-45, 108 S.Ct. 978. Although the Basic Court noted that empirical studies tended to confirm the premise that markets absorb material information, the Court emphasized that it was not determin[ing] by adjudication what economists and social scientists have debated through the use of sophisticated statistical analysis and the application of economic theory. Id. at 246 n. 24, 108 S.Ct. 978. Rather, it was drawing on Congress' premise that the market price of shares traded on well-developed markets reflects ... any material misrepresentations. Id. at 246, 108 S.Ct. 978. In a pivotal passage, the Court stated that the presumption was justified not by scientific certainty, but by considerations of fairness, probability, judicial economy, congressional policy, and common sense. Id. at 245-46, 108 S.Ct. 978. This is how we explained the Basic presumption in our early cases interpreting that decision. See Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb Inc., 967 F.2d 742, 748 (2d Cir.1992) noting that the presumption was appropriate in the fraud-on-the-market situation due to the extreme difficulty in demonstrating transaction causation[, i.e., reliance]. To saddle a plaintiff with proving `the generally indeterminable fact of what would have happened but for the omission [or the misrepresentations that skewed the market value of stock] would reduce the protection against fraud afforded by Section 10(b).' The reliance presumption ... reallocates the risks of mistaken adjudications, resolving questions of doubt in favor of the investors that section 10(b) seeks to protect. (quoting duPont v. Brady, 828 F.2d 75, 78 (2d Cir.1987)). Thus, plaintiffs do not bear the burden of showing an impact on price. The point of Basic is that an effect on market price is presumed based on the materiality of the information and a well-developed market's ability to readily incorporate that information into the price of securities. We said as much in Hevesi, The fraud-on-the-market doctrine, as described by the Supreme Court in Basic v. Levinson , creates a rebuttable presumption that (1) misrepresentations by an issuer affect the market price of securities traded in an open market, and (2) investors rely on the market price of securities as an accurate measure of their intrinsic value. 366 F.3d at 77 (emphasis added); see also Basic, 485 U.S. at 246 n. 24, 108 S.Ct. 978 (For purposes of accepting the presumption of reliance in this case, we need only believe that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.). Under Basic, as Judge Lynch held, the burden of showing that there was no price impact is properly placed on defendants at the rebuttal stage. Salomon Analyst II, 236 F.R.D. at 222 n. 12. Basic made clear that defendants could 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.... 485 U.S. at 248, 108 S.Ct. 978 (discussing the Eighth Circuit's decision below). Any showing that severs the link between the alleged misrepresentation and... the price ... will be sufficient to rebut the presumption of reliance. Id. (emphasis added); see Ceres Partners v. GEL Assocs., 918 F.2d 349, 360 (2d Cir.1990) ( Basic ... creates a rebuttable presumption of reliance and shifts to the defendant the burden of proof as to that element of the claim....). The structure of this analysis does not vary according to the identity of the speaker. Defendants worry that if no heightened test is applied in suits against non-issuers, any person who posts material misstatements about a company on the internet could end up a defendant in a Rule 10b-5 action. The worry is misplaced. The law guards against a flood of frivolous or vexatious lawsuits against third-party speakers because (1) plaintiffs must show the materiality of the misrepresentation, [8] (2) defendants are allowed to rebut the presumption, prior to class certification, by showing, for example, the absence of a price impact, and (3) statements that are predictions or opinions, and which concern uncertain future event[s], such as most statements made by research analysts, are generally not actionable. See In re Int'l Bus. Machs. Corporate Sec. Litig., 163 F.3d 102, 107 (2d Cir.1998). Thus, no heightened test is needed in the case of research analysts.