Stock market lawsuit

Posted: Postal23 Date of post: 01.06.2017

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Every once in a while a company will announce bad news and its stock price will go down. When this happens, enterprising lawyers will sue the company, saying that it should have announced the bad news earlier and that innocent shareholders were tricked into buying stock because they didn't know about the bad news. These lawsuits are informally called "stock-drop lawsuits," and a lot of people think they're Bad, because they mostly are.

Supreme Court issued an important decision in a stock-drop lawsuit called Halliburton Co. This seems sensible enough, but it comes wrapped in a hard candy shell of efficient-markets flummery, and I don't know what to tell you. The story is this. If you're an enterprising lawyer and you want to bring a stock-drop case, the first important hurdle is to get "class certification," in which the court agrees that you can represent all the investors who bought the stock during the period leading up to the announcement of bad news.

So plaintiffs' lawyers really want to get a class certified, and defense lawyers really want to prevent that. Now, to win a securities-fraud lawsuit -- and stock-drop cases are securities-fraud cases -- you need to prove a bunch of things, including, in particular, 1 that the company made false statements, 2 that those false statements were material and 3 that you relied on them. You can't even prove that every shareholder read the company's statements. Most of them probably didn't.

The solution to this problem is a U. Supreme Court decision called Basic Inc.

stock market lawsuit

Levinson, in which the court ruled that you don't actually have to show reliance to get a class certified. Instead, you can rely on the normal way people buy stocks: They see the price, assume that it reflects the market's judgment of all disclosed and required-to-be-disclosed information, and decide whether they like the stock.

So plaintiffs can get a "rebuttable presumption of reliance" by showing:. This is called the "fraud on the market" theory, and it has been controversial ever since it was announced.

First, because it allows for lots of stock-drop lawsuits, which people think are Bad, and second, because some people get all worked up about "well, actually, markets aren't totally efficient. The court said no. This seems straightforward enough, and yet. For one thing, if the stock didn't go down, why would anyone sue?

For another thing, how much of a dispute can there really be over whether the stock went down?

stock market lawsuit

The answer is "probably a lot": You can debate whether the stock went down because of the bad news or because of some other, unrelated thing in the company's news release, or market conditions, or whatever, so the company could introduce evidence that the concealed-and-then-disclosed bad news isn't what actually caused the stock drop.

Here's another weird bit, though. Obviously, as the court says, Halliburton would have a chance to argue that its failure to disclose bad news didn't prop up the stock price, and that revealing that news didn't cause the price to drop. The question is just whether it can argue that before class certification -- as part of this fraud-on-the-market inquiry -- or afterward.

After the class certification, Halliburton can make all sorts of arguments, including that its omissions weren't material: But Halliburton can't argue materiality before class certification, because it has nothing to do with whether a court should certify a class. EPJ Fund argues that much of the foregoing could be said of price impact as well. But price impact differs from materiality in a crucial respect. Given that the other Basic prerequisites must still be proved at the class certification stage, the common issue of materiality can be left to the merits stage without risking the certification of classes in which individual issues will end up overwhelming common ones.

And because materiality is a discrete issue that can be resolved in isolation from the other prerequisites, it can be wholly confined to the merits stage. Price impact is different. The fact that a misrepresentation "was reflected in the market price at the time of [the] transaction" -- that it had a price impact -- is " Basic 's fundamental premise.

The Supreme Court is saying here that whether a misrepresentation "was reflected in the market price" is a totally different question from whether it "would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available. This may be true. It suggests that reasonable investors should care about news that doesn't affect the stock price or should not care about news that does. Whether information is important, and whether it affects prices, are two separate questions.

This is not exactly new to this case.

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But it's an increasingly important question, as prosecutors pursue more insider-trading cases which also turn on materiality and as regulators try to extend the law of insider trading to computer-driven activities that they label " Insider Trading 2. If it affects the price, 11 it's material; if not, not.

But that's not the rule. For the Supreme Court, whether market prices reflect material public information remains a mystery, to be considered on a case-by-case basis. That's not much of an endorsement of efficient markets at all. This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors. The Supreme Court sums up the arguments:. The second point is the most important one. So current shareholders pay the settlement, and former and also some current!

The counterargument is, essentially, that the threat of these lawsuits deters misconduct and makes companies more likely to be honest with shareholders. There is probably something to that. But each actual lawsuit feels like sort of a loss for society. The main efforts in Congress are the Private Securities Litigation Reform Act of and the Securities Litigation Uniform Standards Act of , both of which were partially successful efforts to cut down on these lawsuits.

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I'm being a little tendentious about how I describe some of these things. Here's how the court describes the class in Halliburton:. According to EPJ Fund, between June 3, , and December 7, , Halliburton made a series of misrepresentations regarding its potential liability in asbestos litigation, its expected revenue from certain construction contracts, and the anticipated benefits of its merger with another company -- all in an attempt to inflate the price of its stock.

Halliburton subsequently made a number of corrective disclosures, which, EPJ Fund contends, caused the company's stock price to drop and investors to lose money.

EPJ Fund moved to certify a class comprising all investors who purchased Halliburton common stock during the class period. This is a little different in emphasis, though not in substance, from my characterization of "a company will announce bad news and its stock price will go down. Supreme Court opinions, the final bastion of the correct usage of "comprising. Or that's the claim.

The plaintiffs' lawyers in Halliburton disagree, and they make some decent points citations omitted:. The full list, again from the Halliburton opinion:.

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Quoting the Halliburton opinion's summary of Basic. Actually, I wrote about it when the case was argued, so just read that.

Everyone wants to determine if markets are "really" efficient, without putting any intellectual rigor around what that might mean , but the question of "do stocks tend to drop when fraud is revealed?

Particularly goofy is Justice Clarence Thomas's concurrence in the judgment, which has more amateur criticism of the efficient-markets hypothesis than I can handle. Don't take investment advice from Justice Thomas is my advice! That's the Supreme Court's materiality standard, from Basic v. The theory is that the materiality of Halliburton's statements is an objective-ish fact that is only about those statements, not the shareholders, while reliance is a fact about the shareholders.

stock market lawsuit

So to certify a class you need to not exactly prove reliance, but demonstrate that all of the shareholders will probably have the same reliance theory that is, fraud on the market. If you can show that, then it makes sense to treat all the shareholders as one big class; if not, not. Materiality, on the other hand, will be the same question no matter who's in the class, so there's no need to decide it before certifying a class.

We've talked about the difference, in the amusing context of insider trading in the wrong stocks: News about Nest can affect the price of Nestor stock, whose only relationship to Nest is that they have similar names. If you're a high-frequency trader, a 0. To contact the author on this story: Matthew S Levine at mlevine51 bloomberg. To contact the editor on this story: Brooke Sample at bsample1 bloomberg. Bloomberg Anywhere Remote Login Software Updates Manage Contracts and Orders.

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There Will Always Be Stock-Drop Lawsuits But only if there's a stock drop. A daily take on Wall Street, finance, companies and stuff.

Before it's here, it's on the Bloomberg Terminal. Matt Levine is a Bloomberg View columnist.

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