Fraud On The Market - Part.1

Prof. George W.
Conk
Guest lecturer: Wallace Showman, Esq.
gconk@law.fordham.edu
Room 409
212-636-7446

Adjunct Professor of Law &
Senior Fellow
Stein Center for Law & Ethics
Remedies
Fall 2014

10b-5 Securities Fraud Class Actions
part 1

Fraud on the market - 10 (b)(5) actions 1
The `10b-5 Action
An implied statutory cause of action
in tort
Derived from the Securities and
Exchange Act of 1934
A private damages action
Resembling but not identical to,
common-law tort actions for deceit
and misrepresentation
Typically pursued as class action
(FRCP 23)
10(b)(5) action for deceit in connection
with securities sale
Common law Fraud Elements
(1) a material representation was made
(2) the representation was false
(3) when the representation was made,
the speaker knew it was false or made it
recklessly without any knowledge of the
truth and as a positive assertion

The Securities Exchange Act of 1934
AN ACT
To provide for the regulation of securities
exchanges and of over-the-counter markets
operating in interstate and foreign commerce and
through the mails, to prevent inequitable and unfair
practices on such exchanges and markets, and for
other purposes.
JUNE 6, 1934
As amended
Common law Fraud Elements
(4) the speaker made the representation
with the intent that the other party should
act upon it

(5) the party acted in reliance on the
representation and

(6) the party thereby suffered injury.

In re First Merit Bank, N.A., 52 S.W.3d 758 (Tex. 2001)
The Federal Securities
Fraud Cause of Action
15 U.S.C. 78j(b)
The Federal Securities Fraud
Cause of Action
Section 10(b) of the Securities Exchange
Act of 1934 forbids
(1) the "use or employ[ment] . . . of
any . . . deceptive device,"
(2) "in connection with the purchase
or sale of any security," and
(3) "in contravention of" Securities
and Exchange Commission "rules and
regulations."
The Federal Securities Fraud
Cause of Action

Commission Rule 10b-5 forbids:
the making of any "untrue statement
of a material fact" or the omission of
any material fact "necessary in order
to make the statements made . . . not
misleading."
17 CFR 240.10b-5 (2004).

The Elements
(1) a material misstatement or
omission
(2) scienter (wrongful state of mind)
(3) in connection with the purchase
or sale of a security
(4) reliance on the statement or
omission ('transaction causation)
(5) economic loss
(6) loss causation

Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341 (2005)
Statutory requirements
15 U.S.C. 78a et seq.,
78u-4(b)(4)
Congress has imposed statutory
pleading and other requirements on
that private action, such as prescribing
the measure of damages, threats of
sanctions, limits on discoveryand on
attorneys fees.
[15 USC 78a et seq.
78u-4(b)(4)]
(e) (1) Limitation on damages.
the award of damages shall not exceed
the difference between the purchase
or sale price paid or received and
the mean trading price of that
security during the 90-days
beginning on the date on [corrective]
information correcting the
misstatement or omission
Particularized pleading requirement
15 USCS 78u-4
The complaint shall specify each
statement alleged to have been
misleading
the reason or reasons why the
statement is misleading
if an allegation is made on
information and belief,
the complaint shall state with
particularity all facts on which that
belief is formed.
Scienter
In any complaint alleging and untrue
or statement or misleading omission
(2) Required state of mind.
the complaint shall, with respect to
each act or omission alleged to
violate this title state with
particularity facts giving rise to a
strong inference that the defendant
acted with the required state of
mind.
Scienter
P must allege facts that

(1) constitute circumstantial evidence of conscious
or reckless behavior or
(2) establish a motive to commit fraud and an
opportunity to do so.
In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 268-69 (2d
Cir. 1993)
Or
facts giving rise to a strong inference of
recklessness."
In re Comshare, 6
th
Cir.,1999 WL 595194
Or
facts "that constitute circumstantial evidence of
deliberately reckless or conscious misconduct."
In re Silicon Graphics, 9
th
Cir., 1999 WL 446521
Fraud on the market
Proving Loss Causation
Materiality
Reliance
Loss Causation
Plaintiff must prove
the fraudulent statement or omission
was the cause of loss suffered
by concealing something from the
market that
when disclosed or corrected
negatively affected the value of the
security.
Loss Causation
a concealed risk which materializes
and causes a loss.
it is not enough to allege that a
defendant's misrepresentations caused a
disparity between the price paid for the
security and its true investment quality at
the time of the acquisition.
Easing the burden- Basic v. Levinson, 485
U.S. 224 (1988)
Individual reliance not required
Requiring a plaintiff to show a
speculative state of facts, i.e., how he
would have acted if material information had
been disclosed, or if the misrepresentation
had not been made, would place an
unnecessarily unrealistic evidentiary
burden on the Rule 10b-5 plaintiff who
has traded on an impersonal market.
A Rebuttable Presumption
Basic v. Levinson creates a rebuttable
presumption that
(1) misrepresentations by an issuer
affect the market price of securities
traded in an open market, and
(2) investors rely on the market price
of securities as an accurate measure
of their intrinsic value
Materiality Reasonable investor
standard
if a reasonable investor would think
that the information would have
"significantly altered the 'total mix'
of information
In re Salomon Analyst Metromedia Litig.), 544
F.3d 474 (2d Cir. N.Y. 2008)
Presumption -The fraud-on-the-market
doctrine
It may be presumed that, in an
efficient market, investors would have
taken the omitted [material]
information into account, thereby
affecting market price.
In re Salomon Analyst Metromedia Litig.), 544 F.3d
474 (2d Cir. N.Y. 2008)
The Class Certification
Obstacle
Millowitz v. Citigroup Global Markets,
Inc. (In re Salomon Analyst
Metromedia Litig.), 544 F.3d 474 (2d
Cir. N.Y. 2008)
The Basic presumption is
rebuttable
"Any showing that severs the link between
the alleged misrepresentation and . . . the
price . . . will be sufficient to rebut the
presumption of reliance.
Ceres Partners v. GEL Assoc., 918 F.2d 349,
360 (2d Cir. 1990)
"Basic . . . creates a rebuttable
presumption of reliance and shifts to the
defendant the burden of proof as to that
element of the claim . . . "

In Re Salomon Smith Barney, 2d Cir, 2008
Class certification requires finding a
factual basis for the Basic presumption
We remand to allow defendants the
opportunity to rebut the Basic
presumption [on causal link] prior to
class certification.
Discovery allowable but hearing
should not become a mini- trial
In Re Salomon Analyst - 2008
Compare Rakoff in Lehman Brothers
Judge Rakoff held that plaintiff needs only
to adduce admissible evidence that . . .
makes a prima facie showing that the
analyst's statements alleged to be false or
fraudulent materially and measurably
impacted the market price of the
security..."
Lehman Bros., 222 F.R.D. at 247
Compare Rakoff in Lehman Brothers
By contrast, we hold that plaintiffs must
show that the statement is material (a prima
facie showing will not suffice).

However, once that is done, the burden shifts
to the defense to show that the allegedly
false or misleading material statements did
not measurably impact the market price of
the security.

Q. What about the 7
th
Amendment?
In re Salomon Analyst Metromedia Litig. (2008)
External Analyst Liability
Millowitz v. Citigroup Global Markets,
Inc. (In re Salomon Analyst
Metromedia Litig.), 544 F.3d 474 (2d
Cir. N.Y. 2008)
Liability not limited to issuer
Jack Grubman a research analyst for
Salomon Smith Barney, investment
banking arm of Citigroup sought
business from Metromedia
He made allegedly false statements
regarding a credit line extended by
Citibank to SSB
the premise of Basic is
in an efficient market
share prices reflect "all publicly
available information, and, hence
any material misrepresentations.
It does not matter, for purposes of
establishing entitlement to the
presumption, whether the
misinformation was transmitted by
an issuer, an analyst, or anyone else.
No 3
rd
party liability for aiding &
abetting under 10 (b)(5)
Aiding and abetting a fraud even by
reckless conduct is not actionable
Unlike common law fraud 10(b) requires
reliance
Reliance supplies the essential causal link
Central Bank of Denver, N. A. v. First
Interstate Bank of Denver, N. A., 511 U.S.
164, 191 (1994)

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