Opinion ID: 499747
Heading Depth: 2
Heading Rank: 1

Heading: Fraud on the Market

Text: 16 Zlotnick asks this court to presume reliance because defendants have committed a fraud on the market. In Peil v. Speiser, 806 F.2d 1154 (3d Cir.1986), this court accepted that the showing of a fraud on the market may create a rebuttable presumption of reliance in favor of the plaintiff in certain cases. Where the purchaser of a stock shows he purchased in an open and developed market and that defendant has made a material misrepresentation, this court will presume that the misrepresentations occasioned an increase in the stock's value that, in turn, induced the plaintiffs to purchase the stock. Id. at 1161. While we will allow Zlotnick the opportunity to prove his reliance, based on the allegations in his complaint, we decline to presume it. 17 Underlying the presumption of reliance we made in Peil is a theory of indirect actual reliance. The purchaser relies on the market price of the stock as an indication of its value. Id. at 1160. In other words, the market price of the stock is itself a representation on which a purchaser may rely. Because the market price has been infected by fraud, that price is--at least to the extent it is artificially inflated--a misrepresentation. Compare, In re Associated Securities Corp., 40 S.E.C. 10, 14 (1960) (price not reasonably related to value is fraudulent), aff'd, 293 F.2d 738 (10th Cir.1961). Though the market actually sets the improper price, the defendant has participated in the setting of the price by making false statements in order to affect that price. Thus, the purchaser has in fact relied on the false statement of the defendant, if indirectly. 5 In Peil, we accepted this theory of reliance, and shifted to the defendant the burden of disproving such reliance. 18 The fraud-on-the-market theory creates a threefold presumption of indirect reliance. First, this court presumes that the misrepresentation affected the market price. Second, it presumes that a purchaser did in fact rely on the price of the stock as indicative of its value. Third, it presumes the reasonableness of that reliance. All of these presumptions are necessary to establish actual reliance. The first presumption is necessary to find that a misrepresentation was in fact made to the purchaser. Thus, if defendant rebuts this presumption by showing that the market did not respond to the misrepresentation, it does no more than show that the market price was not misrepresentative, and thus that no misrepresentation was made to the purchaser of the stock. The second presumption is necessary for a court to find that the plaintiff did in fact rely on the misrepresentation. Thus, a defendant may rebut this presumption by showing that the plaintiff would have purchased even if he had known about the misrepresentation. The final presumption, that reliance on the market price is reasonable, may be rebutted by showing that the plaintiff knows that a representation is false. If the plaintiff knows of a misrepresentation, he has reason to believe that the market price has been affected by it. In such a case, this court will not presume his reliance on that price reasonable. 6 19 This court will presume reliance only where it is  'logical to do so.'  Peil, 806 F.2d at 1161 n. 11 (quoting Sharp v. Coopers and Lybrand, 649 F.2d 175, 188 (3d Cir.1981), cert. denied, 455 U.S. 938, 102 S.Ct. 1427, 71 L.Ed.2d 648 (1982)). We do not find it logical in this case to make any of the presumptions discussed above. In Peil, we presumed that the market price reflected defendant's misrepresentation because we found that an open and developed market likely reflects all available information. 7 Here, Zlotnick sold short because he believed the market price of the stock overvalued Technicom's present earnings and underestimated its potential competition. Given Zlotnick's belief that in January, 1983, the market in Technicom stock did not reflect all available information, we do not find it logical to presume that the market did reflect all available information in March, 1983, when he made his covering purchases. 20 A presumption that Zlotnick relied on the price of the stock in making his investment decision is also unwarranted. An investor like Zlotnick sells short because he believes the price of a stock overestimates its true value. While it is possible that, when he decided to cover, Zlotnick did rely on the stock's price to determine investment value, this court will not presume such a fundamental change in investment strategy. Similarly, since Zlotnick decided that the market price was not an accurate valuation of the stock at the time of his short sale, we should not presume that it was reasonable for him to rely on the market price at the time of his purchase. We therefore decline to presume that Zlotnick relied on defendant's alleged misrepresentations in deciding to cover his purchase. While we believe that Zlotnick should be allowed to proceed with this action and prove all the necessary facts at trial, he should not be awarded the considerable additional advantage of the presumptions in his favor which he seeks through his analogy to the Peil decision.