William & Mary Business Law Review


J. B. Heaton


Securities litigation is a hotbed of junk science concerning market efficiency. This Article explains why and suggests a way out. In its 1988 decision in Basic v. Levinson, the Supreme Court endorsed the fraud on the market presumption for securities traded in an efficient market. Faced with the task of determining market efficiency, courts throughout the nation embraced the ad hoc speculations of a first-mover district court that proclaimed, in Cammer v. Bloom, how to allege (and presumably prove) facts that would do just that. The Cammer court’s analysis did not rely on financial economics for its notions, but instead regurgitated the assertions of a single plaintiff’s expert affidavit—from a securities law professor, not a financial economist—and a securities law treatise equally uninformed by the relevant field. The result has been thirty years of junk science in securities adjudication. This Article traces the development of the fraud on the market theory from its pre-efficient-markets-hypothesis roots through a brief “gilding the lily” phase where an appeal to social science results on market efficiency was only an ancillary, bolstering argument for already-sufficient precedent for the fraud on the market presumption, to the requirement that litigants plead and prove efficiency using indicia with no support in financial economics. The way out of this embarrassing state of affairs is to return to the roots of fraud on the market in the non-technical notion of “a free and open public market” that inquires only whether the market for the security at issue is open to active buyers and sellers and is not subject to substantial seller lockups or bans on short selling. It is reasonable to presume that prices in such free and open public markets can be distorted by fraud, a presumption that is then rebuttable by establishing (1) that the alleged fraud in fact had no price impact; (2) that there are substantial limits on the ability of active investors to buy and sell in the market, such that the market is not a “free and open public” one; or (3) that the plaintiff would have made their purchase or sale at the affected price even knowing of the falsity of the alleged misrepresentation. This formulation is consistent with all controlling Supreme Court opinions.