The Evolution of Securities Class Action Law: The Fraud on the Market Theory

The 1934 Act created broad restrictions on corporate dishonesty and, through Section 10(b) and SEC Rule 10b-5, a cause of action for investors to sue. Traditionally, however, when an investor sued under Rule 10b-5 they had to show that they actually relied on a misleading statement in deciding to buy or sell a security. This was not easy to prove in court.

If an investor bought or sold a security soon after a misleading statement was made, it was hard to demonstrate in a legally sufficient manner that their decision was based on the misleading statement. Perhaps they had made the investment decision for their own reasons, or perhaps they were just following a herd of other investors. It was often difficult to prove that a specific investor even knew about a misleading statement, much less that they had relied on it.

The requirement of proving actual reliance was especially an obstacle to Rule 10b-5 class actions. Basic v. Levinson (1988) and Halliburton II (2014) provided a path forward. Basic v. Levinson (1988) established the fraud on the market theory, which allows class actions to proceed without proof that all class members actually relied on a misleading statement. While Halliburton II (2014) upheld the fraud on the market theory, ending speculation that Basic would be reversed, it also allowed defendants to introduce evidence to rebut the presumption of price impact under fraud on the market.

 Read full article to learn the impact these cases had on the class action industry.