Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson

Abstract

In Basic v. Levinson the Supreme Court ruled that plaintiffs alleging securities fraud need not prove actual reliance on a defendant's misrepresentations so long as they suffered harm trading in a market shown to be "efficient." In an efficient market, the Court reasoned, informed buyers and sellers drive the price of the security to a level reflecting all publicly available information, and plaintiffs may be presumed to rely on the "integrity of the market price" in making their trading decisions. Basic thus establishes market efficiency as the touchstone of the "fraud-on-the-market" theory: plaintiffs who traded in an efficient market need not prove actual reliance on specific misrepresentations, but their counterparts who traded in an inefficient market must. Whereas Basic in one sense widens the scope of the securities fraud action by lowering the burden of proof for a particular class of plaintiffs, at the same time it limits the scope by withholding effective legal redress from another class of plaintiffs, traders in inefficient markets.