CA1: Securities litigation and law and economics bonanza

The First Circuit issued two securities opinions today, and here goes... but you have to look under the fold because they are quite large.

In re Polymedica Corp. Securities Litigation, No. 05-1220, is an appeal under FRCP 23(f) of certification of a class in a “securities fraud action under § 10(b) of the Exchange Act and Rule 10b-5.... Plaintiff alleges that PolyMedica artificially inflated the market price of its stock by misrepresenting sales, revenues, and accounts receivable, and by issuing false press releases, causing Plaintiff and other members of the class to purchase stock at artificially inflated prices. "  The court holds that the District Court was wrong to hear expert testimony on the issue of “market efficiency.”  Although the court acknowledges that some circuits don’t fee the way it does, it notes that “We have already expressed our preference for the majority view. In Waste Management Holdings, Inc. v. Mowbray, 208 F.3d 288 (1st Cir. 2000)...”  As to the substance of the certification, the court reviews what the “fraud-on-the-market theory” of investor reliance is, which essentially allows a plaintiff to prevail by arguing that where he bought a security based on its market price, he was defrauded by the plaintiff’s bad behavior on the market which caused the market price to lack integrity.  The court then discusses the theory of market efficiency, and how information gets absorbed into market prices.  Rejecting the argument that Basic v. Levinson, 485 U.S. 224 (1988) provides a definition of “efficient” market, and reviewing lots of lower court cases, the court concludes that market efficiency that:

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."

And therefore, “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.”  Likewise, “...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.”

Therefore, the District Court has to figure out, again, what constitutes market efficiency, and “At the class-certification stage, a party need only establish "basic facts" in order to invoke the presumption of reliance. The question of how much evidence of efficiency is necessary to establish the fraud-on-the-market presumption of reliance is one of degree. While district courts have broad discretion to draw these lines, they must do so sensibly, understanding the correct definition of efficiency and the factors relevant to that determination.”

In re Xcelera.com Securities Litigation, No. 05-1221, appears in just about the same procedural and factual posture, but the court affirms, citing PolyMedica.  The court also discusses the "historical cause-and-effect relationship between company disclosures and an immediate response in stock price."  These are obviously very interesting questions, and would be great for a law review article.  But, now you know where to look.

DoTD comments here and here and 10-b Daily does so here.