Opinion ID: 201963
Heading Depth: 2
Heading Rank: 2

Heading: The Meaning of Market Efficiency

Text: The efficient market hypothesis began as an academic attempt to answer the following question: Can an ordinary investor beat the stock market, that is, can such an investor make trading profits on the basis of new information? In an efficient market, the answer is no, because the information that would have given the investor a competitive edge and allowed the investor to beat the market is already reflected in the market price. See Lynn A. Stout, The Mechanisms of Market Inefficiency: An Introduction to the New Finance, 28 J. Corp. L. 635, 639 (2003) (stating that [t]he common definition of market efficiency . . . is really a shorthand for the empirical claim that 'available information' does not support profitable trading strategies or arbitrage opportunities) (internal quotation marks and citation omitted).12 12 Commentators note that [c]onventional finance recognizes this cannot be absolutely true, or no one would have incentive to trade on information in a way that leads to the incorporation of that information into prices. Stout, supra, at 640 n.24. As further discussed below, efficient markets are understood to possess enough profit opportunities to allow a small subset of professional investors, so-called arbitrageurs, to engage in competition with each other, thereby moving the price of stock to reflect such -17- There is, therefore, no bargain from which an investor can benefit. Since the stock price fully reflects the information, an investor cannot take advantage of it by either purchasing the stock (if the information indicates the stock is underpriced) or selling the stock (if the information indicates the stock is overpriced). See Philip H. Dyvig & Stephen A. Ross, Arbitrage, in 1 The New Palgrave Dictionary of Money and Finance 48 (Peter Newman et al. eds., 1992) (stating that [t]he intuition behind [the efficient market hypothesis] is that if the price does not fully reflect all available information, then there is a profit opportunity available from buying the asset if the asset is underpriced or from selling the asset if the asset is overpriced). One way information gets absorbed into the market and reflected in stock price is through arbitrageurs, who obtain and analyze information about stocks from a variety of sources, including from the issuer, market analysts, and the financial and trade press. In re Verifone Sec. Litig., 784 F. Supp. 1471, 1479 (N.D. Cal. 1992); see generally Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549, 566 (1983) (discussing variety of mechanisms by which new information is incorporated into stock price). These arbitrageurs immediately attempt to profit from such information (for instance, information. -18- through short sales13), thereby causing the stock to move to a price which reflects the latest public information concerning the stock, where it is no longer possible to generate profits. See Eckstein v. Balcor Film Investors, 8 F.3d 1121, 1129 (7th Cir. 1993) (stating that [c]ompetition among savvy investors leads to a price that impounds all available information); see also Stout, supra, at 638 n.15 (noting that if arbitrageurs observe a difference between price and value, they immediately eliminate it by their trading) (internal quotation marks and citation omitted).14 The capacity of arbitrageurs to seek out new information and evaluate its effects on the price of securities distinguishes 13 In a short-sale transaction, the seller borrows shares that the seller believes to be overvalued from a broker, and pays the broker a so-called loan fee for the right to borrow the shares plus collateral (in cash) for the value of the shares (which is held in an interest-bearing margin account). The seller agrees to return shares of a similar type and amount to the broker at an unspecified date in the future. The seller then sells the borrowed stock. Assuming the price of the stock later decreases, the seller's profit will be the positive difference between the price the seller pays to replace the borrowed shares (a process known as covering), and the price at which the seller sold the stock. If the price increases before the seller covers its position, the seller suffers a loss. 14 Plaintiff offers the following example of an arbitrage opportunity. Assume that the price of gold trading on the New York commodities market was $100.50 per ounce, while on the London market, which opened five hours earlier, the price was only $100 per ounce. The arbitrageur could first sell an ounce of gold short in New York, receiving $100.50 in return, and then purchase an ounce of gold in London for $100, retaining a profit of $0.50. In an efficient market, the New York market would have swiftly moved to match the London market price as arbitrageurs moved to exploit the imbalance in the two markets. -19- them from ordinary investors, who lack the time, resources, or expertise to evaluate all the information concerning a security, and are thus unable to act in time to take advantage of opportunities for arbitrage profits. Robert G. Newkirk, Comment, Sufficient Efficiency: Fraud on the Market in the Initial Public Offering Context, 58 U. Chi. L. Rev. 1393, 1409 (1991). In an efficient market, then, an ordinary investor who becomes aware of publicly available information cannot make money by trading on it because the information will have already been incorporated into the market by arbitrageurs. Stout, supra, at 640. An example would be an investor who decides to sell a stock upon the public announcement of a decline in corporate earnings, who finds that by the time she calls her broker, the price has already dropped. Id.15 According to the prevailing definition of market efficiency, an efficient market is one in which market price fully 15 The efficient market hypothesis is not without its critics, some of whom argue that since not all investors have the means to seek out information on stocks or the expertise to decipher it, the price of any given stock is not the same as it would be if all participants were informed; instead it merely reflects 'the actions of a mix of informed and uninformed participants.' Brian E. Pastuszenski & Inez H. Friedman-Boyce, Back to Basic: Challenging the Application of the Efficient Market Hypothesis in Federal Securities Lawsuits, SK080 A.L.I.-A.B.A. 907, 919 (2005). Others challenge what they interpret to be the efficient market hypothesis' faulty assumptions about human behavior, that is, that human beings are rational actors with stable preferences who are never mislead by emotion and who never make foolish mistakes. Stout, supra, at 660 (internal quotation marks omitted). -20- reflects all publicly available information. Stout, supra, at 639 (citing Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 J. Fin. 383 (1970)).16 This definition has been adopted by many lower courts as a prerequisite for applying the fraud-on-the-market presumption of reliance. PolyMedica urges us to do likewise, arguing that an efficient market is an open and developed one, in which a stock price will move quickly to reflect all publicly available information. 16 Courts and commentators have noted that this prevailing definition of market efficiency is consistent with the semistrong form of the efficient market hypothesis. See, e.g., In re Res. Am. Sec. Litig., 202 F.R.D. 177, 189 (E.D. Penn. 2001) (stating that [t]he Basic court adopted the semi-strong form of market efficiency as a prerequisite for a fraud on the market presumption); Jonathan R. Macey & Geoffrey P. Miller, Good Finance, Bad Economics: An Analysis of the Fraud-on-the-Market Theory, 42 Stan. L. Rev. 1059, 1077-78 (1990). There are three competing forms of this hypothesis – weak, semi-strong, and strong – each of which makes a progressively stronger claim about the kind of information that is reflected in stock price. Under the weak form, an efficient market is one in which historical price data is reflected in the current price of the stock, such that an ordinary investor cannot profit by trading stock based on the historical movements in stock price. Under the semi-strong form, an efficient market is one in which all publicly available information is reflected in the market price of the stock, such that an investor's efforts to acquire and analyze public information (about the company, the industry, or the economy, for instance) will not produce superior investment results. Finally, under the strong form, an efficient market is one in which stock price reflects not just historical price data or all publicly available information, but all possible information – both public and private. Based on this form of an efficient market, not even an inside trader can outperform other investors because all such information is reflected in market price. Macey & Miller, supra, at 1077-78. Commentators have noted that both strong-form and weak-form market efficiency are incompatible with the fraud-on-the-market theory. Id. at 1078-79. -21- The district court, on the other hand, expressly declined to adopt this prevailing definition of market efficiency. Relying upon language gleaned from the Supreme Court's decision in Basic, the district court held that the 'efficient' market required for [the] 'fraud on the market' presumption of reliance is simply one in which 'market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices'; it is not one in which a stock price rapidly reflects all publicly available material information. In re PolyMedica Corp. Sec. Litig., 224 F.R.D. at 41 (emphasis in original) (quoting Basic, 485 U.S. at 246 n.24). Plaintiff agrees with the district court's definition, which, he contends, is drawn directly from language used by the Supreme Court in Basic. PolyMedica argues that the district court's definition of market efficiency, while rooted in a footnote in Basic, defies the controlling language of Basic, the cases upon which Basic relied, and the subsequent cases interpreting Basic, all of which support the prevailing definition of market efficiency. Specifically, PolyMedica argues that the definition adopted by the district court wrongly focuses on the thought processes of unidentified market professionals and whether stock prices are in some way affected by their consideration of most (but not necessarily all) material public information. The prevailing definition, on the other hand, requires a more searching inquiry into whether stock prices fully -22- reflect all publicly available information. We must assess these conflicting positions of the parties. C. The Standard for Determining an Efficient Market
While endorsing the fraud-on-the-market presumption of reliance in Basic, the Supreme Court did not explicitly address the meaning of an efficient market. See Gariety, 368 F.3d at 368 (stating that Basic offers little guidance for determining whether a market is efficient). PolyMedica points to various passages in Basic purportedly showing a preference for the prevailing definition of an efficient market, noting the Supreme Court's statements that [t]he market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price, and that the market price of shares traded on well-developed markets reflects all publicly available information, and hence, any material misrepresentations. Basic, 485 U.S. at 244, 246 (emphasis added) (internal quotation marks and citation omitted). Elsewhere, however, the Basic decision suggests that something less than all publicly available information may be required, noting that an investor's reliance may be presumed [b]ecause most publicly available information is reflected in market price, id. at 247 (emphasis added). In separate footnotes -23- of the decision, the Court further appeared to resist PolyMedica's suggested definition of an efficient market. As pointed out by the district court, the Supreme Court, after listing several academic articles, noted that: [w]e need not determine by adjudication what economists and social scientists have debated through the use of sophisticated statistical analysis and the application of economic theory. 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. Id. at 246 n.24. In addition, the Court noted that by accepting a rebuttable presumption of reliance, it d[id] not intend conclusively to adopt any particular theory of how quickly and completely publicly available information is reflected in market price. Id. at 249 n.28. While the Supreme Court's language in Basic provides support for both the district court's definition of an efficient market as well as the prevailing definition urged by PolyMedica, the cases relied upon by the Supreme Court in Basic favor the latter definition. In Peil, cited extensively in Basic, the Third Circuit noted that [t]he 'fraud on the market' theory rests on the assumption that there is a nearly perfect market in information, and that the market price of stock reacts to and reflects the available information. Peil, 806 F.2d at 1161 n.10. Likewise, in In re LTV Sec. Litig., 88 F.R.D. 134 (N.D. Tex. 1980), which the -24- Supreme Court also cited, the district court stated that [t]he central assumption of the fraud on the market theory [is] that the market price reflects all representations concerning the stock. . . . [E]fficient capital markets exist when security [sic] prices reflect all available public information about the economy, about financial markets, and about the specific company involved. Id. at 144. Other cases cited in Basic, including the decision of the Sixth Circuit under review in Basic, similarly support the prevailing definition. See Levinson, 786 F.2d at 750 (stating that [t]he fraud on the market theory is based on two assumptions: first, that in an efficient market the price of stock will reflect all information available to the public . . . and, second, that an individual relies on the integrity of the market price when dealing in that stock); T.J. Raney, Inc. & Sons v. Fort Cobb Irrigation Fuel Auth., 717 F.2d 1330, 1332 (10th Cir. 1983) (stating that [t]he [fraud-on-the-market] theory is grounded on the assumption that the market price reflects all known material information). Given the Supreme Court's disclaimer that it was not adopting any particular economic theory in applying the fraud-onthe-market presumption of reliance, on the one hand, and its embrace of the holdings of cases adopting the prevailing definition of market efficiency on the other hand, the most that can be said of Basic is that it did not directly address the meaning of an -25- efficient market, choosing instead to leave the development of that concept to the lower courts. See Abell v. Potomac Ins. Co. of Ill., 858 F.2d 1104, 1120 (5th Cir. 1988) (stating that Basic essentially allows each of the circuits room to develop its own fraud-on-the-market rules), vacated on other grounds sub. nom. Fryar v. Abell, 492 U.S. 914 (1989). Basic is therefore not the benchmark for deriving a definition of market efficiency. We must turn to the decisions of the lower courts, post-Basic, for further guidance.
Efficiency PolyMedica correctly notes that in the wake of Basic, many lower courts have accepted a definition of market efficiency which requires that stock price fully reflect all publicly available information. The district court conceded as much: I also note that the definition I have derived from Basic differs from much of the existing case law. Most cases define an 'efficient' market as a market in which prices incorporate rapidly or promptly all publicly available information. In re PolyMedica Corp. Sec. Litig., 224 F.R.D. at 42. The district court's observation was apt. The precedents from other circuits overwhelmingly favor the definition advanced by PolyMedica. See Gariety, 368 F.3d at 368 (stating that in an efficient market, 'the market price has integrity[;] . . . it -26- adjusts rapidly to reflect all new information') (quoting Macey & Miller, supra, at 1060); Greenberg v. Crossroads Sys., Inc., 364 F.3d 657, 662 n.6 (5th Cir. 2004) (stating that where securities are traded in an efficient market, it is assumed that all public information concerning a company is known to the market and reflected in the market price of the company's stock); No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp., 320 F.3d 920, 947 (9th Cir. 2003) (stating that in a modern and efficient securities market, the market price of a stock incorporates all available public information); GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 208 (3d. Cir. 2001) (defining efficient marketplace as one in which stock prices reflect all available relevant information about the stock's economic value); Joseph v. Wiles, 223 F.3d 1155, 1164 n.2 (10th Cir. 2000) (stating that in an efficient market the investor must rely on the market to perform a valuation process which incorporates all publicly available information, including misinformation); Kowal v. MCI Communications Corp., 16 F.3d 1271, 1276 n.1 (D.C. Cir. 1994) (stating that in an efficient securities market all publicly available information regarding a company's prospects has been reflected in its shares' price); Raab v. Gen. Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993) (reasoning that fraud-on-the-market presumption of reliance assumes the market price has internalized all publicly available information); -27- Freeman, 915 F.2d at 198 (stating that [t]he fraud on the market theory rests on the assumption that the price of an actively traded security in an open, well-developed, and efficient market reflects all the available information about the value of a company). The prevailing definition of an efficient market is also consistent with language in our pre-Basic decision in Roeder v. Alpha Industries, Inc., 814 F.2d 22 (1st Cir. 1987). There, we stated that under the fraud-on-the-market theory, [t]he market price of stock is taken to be the basis for investment decisions; because the price reflected all available information, investors are presumed to have been misled by the nondisclosure. Id. at 27.17
Definition of Market Efficiency PolyMedica points to statements made by the United States Securities and Exchange Commission (SEC) supporting the prevailing definition of market efficiency. See Brief for the Securities and Exchange Commission as Amicus Curiae, Basic v. 17 We did not, however, determine the standard for market efficiency in Roeder. That case required us to decide whether the fraud-onthe-market theory creates an affirmative duty to disclose material information to the public. We concluded that it does not, and stated that once plaintiffs have demonstrated breach of a duty to disclose material information, the fraud-on-the-market theory merely obviates the need for a plaintiff to prove reliance on the nondisclosure. We noted in dicta that this presumption of reliance stems from a plaintiff's reliance on market price which necessarily reflects that nondisclosure. -28- Levinson, 485 U.S. 224 (1988) (No. 86-279), available at 1987 WL 881068, at  (stating that fraud-on-the-market theory rests on proposition that in an active secondary market, the price of company's stock is determined by all material information regarding the company and its business); see also Arthur Levitt, Chairman, U.S. Securities and Exchange Commission, Testimony before House Subcomm. on Telecomm. & Fin., 104th Cong. 13 (Feb. 10, 1995), available at http://www.sec.gov./news/testimony/testarchive/1995/ spch025.txt. PolyMedica also argues with some force that the district court's definition is logically inconsistent. By requiring that an efficient market need only be affected by most but not all material information in order to be efficient, the district court's definition allows some information to be considered material and yet not affect market price. Cf. In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1425 (3d Cir. 1997) (stating that [i]n the context of an 'efficient' market, the concept of materiality translates into information that alters the price of the firm's stock).
On the basis of the authorities and considerations cited, we conclude that the definition of market efficiency adopted by the district court is inconsistent with the presumption of investor -29- reliance at the heart of the fraud-on-the-market theory. By rejecting the prevailing definition of market efficiency advocated by PolyMedica, and focusing instead on the general consideration by market professionals of most publicly announced material statements about companies, the district court applied the wrong standard of efficiency. For application of the fraud-on-the-market theory, we conclude that an efficient market is one in which the market price of the stock fully reflects all publicly available information. Anticipating the possibility of this definition, Plaintiff complains that it forces him to prove that market price correctly reflects a stock's fundamental value18 before a market will be considered efficient. This argument misconstrues the conclusion that market price must fully reflect all publicly available information. The words fully reflect have two distinct meanings, each of which points to a different concept of market efficiency. 5. Informational v. Fundamental Value Efficiency The first meaning of fully reflect focuses on the ability of the market to digest information, thereby preventing 18 As we discuss in further detail below, fundamental value is a technical concept which depends on the present value of expected future cash flows (e.g., dividends, interest or principal payments, liquidations values), as estimated by well informed and capable analysts. Jonathan R. Macey et al., Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson, 77 Va. L. Rev. 1017, 1022 (1991). -30- trading profits: market price fully reflects all publicly available information when prices respond so quickly to new information that it is impossible for traders to make trading profits on the basis of that information. Stout, supra, at 651. This is known as informational efficiency, and is best understood as a prediction or implication about the speed with which prices respond to information. Id. at 640; see also Daniel R. Fischel, Efficient Capital Markets, the Crash, and the Fraud on the Market Theory, 74 Cornell L. Rev. 907, 913 (1989) (stating that [u]nder this definition, a market is efficient if it is impossible to devise a trading rule that systematically outperforms the market . . . absent possession of inside information). With many professional investors alert to news, markets are efficient in the sense that they rapidly adjust to all public information . . . . West, 282 F.3d at 938. Where the market reacts slowly to new information, it is less likely that misinformation was reflected in market price and therefore relied upon. See City of Monroe Employees Ret. Sys. v. Bridgestone Corp., 399 F.3d 651, 676 (6th Cir. 2005) (stating that in an open and efficient securities market[,] information important to reasonable investors (in effect, the market) is immediately incorporated into stock prices) (internal quotation marks and citation omitted); Freeman, 915 F.2d at 199 (stating that [a]n efficient market is one which rapidly reflects new information in price) (quoting -31- Cammer, 711 F. Supp. at 1276 n.17); Fischel, supra, at 912 (stating that the more rapidly prices reflect publicly-available information, the more sensible it is to apply the [fraud-on-themarket theory]). Determining whether a market is informationally efficient, therefore, involves analysis of the structure of the market and the speed with which all publicly available information is impounded in price. See Fischel, supra, at 912 (enumerating factors relevant to determination of trading-rule [i.e., informational] efficiency, including whether a stock is actively traded, and whether it is followed by analysts and other market professionals. . . . , [and] the speed of price adjustment to new information [which] can be tested directly by use of widelyaccepted statistical techniques). The second, and much broader meaning of fully reflect, focuses on the price of the stock as a function of its fundamental value: market price fully reflects all publicly available information when it responds to information not only quickly but accurately, such that market prices mirror the best possible estimates, in light of all available information, of the actual economic values of securities in terms of their expected risks and returns. Stout, supra, at 640. This is known as fundamental value efficiency. See Fischel, supra, at 913 (stating that fundamental value efficiency focuses on the extent to which -32- security prices reflect the present value of the net cash flows generated by a firm's assets). Determining whether a market is fundamental value efficient is a much more technical inquiry than determining informational efficiency. Depending on the method of valuation used, a stock's fundamental value turns on an assessment of various factors, including present operations, future growth rates, relative risk levels, and the future levels of interest rates. Newkirk, supra, at 1399; see, e.g., Stout, supra, at 641, 643-44 (discussing valuation of stocks based on Capital Asset Pricing Model, which focuses on expected risks and returns); cf. Fischel, supra, at 914 (stating that the results of certain kinds of tests which measure how closely prices reflect value, such as those which measure whether the variability of prices is greater than the variability of dividends over time . . . . have been extremely controversial). Courts and commentators often use these two concepts of market efficiency interchangeably. See Newkirk, supra, at 1407 (stating that [t]he manner in which the courts apply the [efficient market hypothesis] is problematic because courts often fail to distinguish between value efficiency and information efficiency).19 In fact, informational and fundamental value 19 The parties, themselves, appear to confuse these two concepts. In its briefs to this Court, PolyMedica does not mention accuracy -33- efficiency often are [] made to go hand-in-hand, with fundamental value efficiency flowing naturally from informational efficiency. See Stout, supra, at 641. Despite this blurring of concepts, one thing is clear: a market can be information efficient without also being fundamental value efficient. Stout, supra, at 651 (stating that informational efficiency and fundamental value efficiency are distinct concepts); see also Fischel, supra, at 913-14. While fundamental value efficiency may be the more comprehensive of the two concepts, encompassing both speed and accuracy, '[e]fficiency' is not an all-or-nothing phenomenon. Eckstein, 8 F.3d at 1130. of stock price as a condition of market efficiency, and explicitly states that an efficient market need not always set a statistically 'correct price' at each instant. However, the report of PolyMedica's expert, Dr. Neumann Martin, together with PolyMedica's surreply to the district court, contend that market efficiency requires proof that the resulting stock price fully and correctly reflected the news. PolyMedica's surreply goes on to state that the case law makes clear that the market for a particular stock must absorb all publicly available information to bring about the 'correct price' in order for a market to be efficient, and furthermore, that in an efficient market, the price must accurately reflect the stock's value based on that information. Thus, while PolyMedica purports to argue that the PolyMedica market was not efficient in the informational sense, PolyMedica occasionally uses language that reflects the broader concept of fundamental value. By the same token, in his reply brief to this Court, Plaintiff objects to PolyMedica's application of a correct price approach to market efficiency. However, in his response to PolyMedica's surreply to the district court, Plaintiff appears to embrace this approach by quoting Hurley v. FDIC, 719 F. Supp. 27 (D. Mass. 1989), for the proposition that an efficient market is one that obtains material information about a company and accurately reflects that information in the price of the stock. Id. at 33 (emphasis added). -34- Therefore, by requiring that stock price in an efficient market fully reflect all publicly available information in order to establish the fraud-on-the-market presumption, we do not suggest that stock price must accurately reflect the fundamental value of the stock. This distinction is well-supported by the legal and economic commentary. See Jill E. Fisch, Picking a Winner, 20 J. Corp. L. 451, 464 (1995) (book review) (stating that [s]tock prices regularly and persistently depart substantially from present value models as well as from financial variables that would appear to supply most of the information relevant to a calculation of fundamental value); Baruch Lev & Meiring de Villiers, Stock Prices and 10B-5 Damages: A Legal, Economic, and Policy Analysis, 47 Stan. L. Rev. 7, 20 (1994) (stating that overwhelming empirical evidence suggests that capital markets are not fundamentally efficient); Newkirk, supra, at 1399 (noting that a major drawback to fundamental value theory is that it requires a great deal of specific, sometimes unobtainable, information). Our focus on whether a particular market has absorbed all available information (and misinformation) – such that an ordinary investor cannot beat the market by taking advantage of unexploited profit opportunities – is not a fundamental value inquiry. See Stout, supra, at 651 (stating that when finance economists define market efficiency in terms of the difficulty of making arbitrage profits, they have implicitly abandoned the more-powerful claim -35- that efficient markets price securities accurately). On the contrary, for purposes of establishing the fraud-on-the-market presumption of reliance, investors need only show that the market was informationally efficient. See In re Verifone Sec. Litig., 784 F. Supp. at 1479 n.7 (stating that the fraud-on-the-market theory does not require proof that the market correctly reflects some 'fundamental value' of the security. To apply the fraud-on-themarket theory, it is sufficient that the market for a security be 'efficient' only in the sense that market prices reflect the available information about the security.). The fraud-on-themarket theory is concerned with whether a market processes information in such a way as to justify investor reliance, not whether the stock price paid or received by investors was correct in the fundamental value sense. Still, as a matter of logic, we cannot say that fundamental value efficiency has no place in applying the fraud-onthe-market presumption of reliance at the class-certification stage. Evidence bearing on a stock's fundamental value may be relevant to the efficiency determination as, for example, circumstantial evidence that arbitrageurs are not trading in the market, with the result that securities prices do not fully reflect all publicly available information. In other words, evidence of fundamental value may be relevant to the extent that it raises questions about informational efficiency. But there are practical -36- limits on the evidence a court can or should consider during the class-certification proceedings. Courts which choose to consider such fundamental value evidence at the class-certification stage run the risk of turning the class-certification proceeding into a mini-trial on the merits, which must not happen. See Eisen, 417 U.S. at 178 (stating that [i]n determining the propriety of a class action, the question is not whether the plaintiff or plaintiffs . . . will prevail on the merits, but rather whether the requirements of Rule 23 are met) (internal quotation marks and citation omitted). 6. Evidence Necessary to Prove Presumption of Reliance It is important to remember that the application of the fraud-on-the-market presumption only establishes just that – a presumption of reliance. That reliance can be rebutted at trial. See Cammer, 711 F. Supp. at 1290 (stating that if it were concluded after a hearing [that] the market appeared efficient, and [that] plaintiffs could proceed under the rebuttable presumption, [the defendant] would be entitled to prove to a jury that the market was inefficient, thereby rebutting the presumption); see also Lehocky v. Tidel Techs., Inc., 220 F.R.D. 491, 505 n.16 (S.D. Tex. 2004) (stating that [a]t [the class-certification] stage of the proceedings, the Court need only inquire whether the stock traded in an efficient market and not examine the merits of the -37- case. . . . Thus, the Court will not address whether Defendants' [sic] can rebut the presumption of reliance). As the notes of the Advisory Committee on Rule 301 of the Federal Rules of Evidence, cited in Basic, make clear, a party need only establish basic facts in order to invoke the presumption of reliance. See Basic, 485 U.S. at 245 (citing Rule 301 and Advisory Committee Notes in support of statement that presumptions are . . . useful devices for allocating the burden of proof between parties); see also Cammer, 711 F. Supp. at 1291 n.48 (stating that under the notes of the Advisory Committee on Rule 301, the nonmoving party has the burden of establishing the nonexistence of the presumed fact once the party invoking the presumption establishes the basic facts giving rise to it) (emphasis in original) (internal quotation marks omitted). The question of how much evidence of efficiency is necessary for a court to accept the fraud-on-the-market presumption of reliance at the class-certification stage is therefore one of degree. District courts must draw these lines sensibly, mindful that evidence of fundamental value may be relevant to the determination of informational efficiency, but other more accessible and manageable evidence may be sufficient at the certification stage to establish the basic facts that permit a court to apply the fraud-on-the-market presumption. -38- We have no illusions that this line-drawing is easy. Knowing the high stakes in the class-certification decision,20 the parties will try to move the court in different directions, with plaintiffs arguing for less evidence of efficiency and defendants for more, some of it highly technical. Exercising its broad discretion, and understanding the correct definition of efficiency and the factors relevant to that determination, the district court must evaluate the plaintiff's evidence of efficiency critically without allowing the defendant to turn the class-certification proceeding into an unwieldy trial on the merits. In this highly variable setting, these generalities are the best we can do.