485 U.S. 224
No. 86-279.
Argued November 2, 1987
Decided March 7, 1988
We turn to the question of reliance and the fraud-on-the-market theory. Succinctly put:
"The fraud on the market
theory is based on the hypothesis that, in an open and developed securities
market, the price of a company's stock is determined by the available material
information regarding the company and its business. . . . Misleading statements
will therefore [485 U.S. 224, 242]
defraud purchasers of stock even if the purchasers do not directly rely on the
misstatements. . . . The causal connection between the defendants' fraud and
the plaintiffs' purchase of stock in such a case is no less significant than in
a case of direct reliance on misrepresentations." Peil v. Speiser, 806
F.2d 1154, 1160-1161 (CA3 1986).
Our task, of course, is not to assess the general validity
of the theory, but to consider whether it was proper for the courts below to
apply a rebuttable presumption of reliance, supported in part by the
fraud-on-the-market theory. Cf. the comments of the dissent, post, at 252-255.
This case required resolution of several common questions of law and fact concerning the falsity or misleading nature of the three public statements made by Basic, the presence or absence of scienter, and the materiality of the misrepresentations, if any. In their amended complaint, the named plaintiffs alleged that in reliance on Basic's statements they sold their shares of Basic stock in the depressed market created by petitioners. See Amended Complaint in No. C79-1220 (ND Ohio), 27, 29, 35, 40; see also id., 33 (alleging effect on market price of Basic's statements). Requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones. The District Court found that the presumption of reliance created by the fraud-on-the-market theory provided "a practical resolution to the problem of balancing the substantive requirement of proof of reliance in securities cases against the procedural requisites of [Federal Rule of Civil Procedure] 23." The District Court thus concluded that with reference to each public statement and its impact upon the open market for Basic shares, common questions predominated over individual questions, as required by Federal Rules of Civil Procedure 23(a)(2) and (b)(3). [485 U.S. 224, 243]
Petitioners and their amici complain that the fraud-on-the-market theory effectively eliminates the requirement that a plaintiff asserting a claim under Rule 10b-5 prove reliance. They note that reliance is and long has been an element of common-law fraud, see, e. g., Restatement (Second) of Torts 525 (1977); W. Keeton, D. Dobbs, R. Keeton, & D. Owen, Prosser and Keeton on Law of Torts 108 (5th ed. 1984), and argue that because the analogous express right of action includes a reliance requirement, see, e. g., 18(a) of the 1934 Act, as amended, 15 U.S.C. 78r(a), so too must an action implied under 10(b).
We agree that reliance is an element of a Rule 10b-5 cause of action. See Ernst & Ernst v. Hochfelder, 425 U.S., at 206 (quoting Senate Report). Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury. See, e. g., Wilson v. Comtech Telecommunications Corp., 648 F.2d 88, 92 (CA2 1981); List v. Fashion Park, Inc., 340 F.2d 457, 462 (CA2), cert. denied sub nom. List v. Lerner, 382 U.S. 811 (1965). There is, however, more than one way to demonstrate the causal connection. Indeed, we previously have dispensed with a requirement of positive proof of reliance, where a duty to disclose material information had been breached, concluding that the necessary nexus between the plaintiffs' injury and the defendant's wrongful conduct had been established. See Affiliated Ute Citizens v. United States, 406 U.S., at 153-154. Similarly, we did not require proof that material omissions or misstatements in a proxy statement decisively affected voting, because the proxy solicitation itself, rather than the defect in the solicitation materials, served as an essential link in the transaction. See Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384-385 (1970).
The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face [485 U.S. 224, 244] transactions contemplated by early fraud cases,21 and our understanding of Rule 10b-5's reliance requirement must encompass these differences.22
"In face-to-face transactions,
the inquiry into an investor's reliance upon information is into the subjective
pricing of that information by that investor. With the presence of a market,
the market is interposed between seller and buyer and, ideally, transmits
information to the investor in the processed form of a market price. Thus the
market is performing a substantial part of the valuation process performed by
the investor in a face-to-face transaction. The market is acting as the unpaid
agent of the investor, informing him that given all the information available
to it, the value of the stock is worth the market price." In re LTV
Securities Litigation, 88 F. R. D. 134, 143 (ND Tex. 1980).
Accord, e. g., Peil v. Speiser, 806 F.2d, at 1161 ("In
an open and developed market, the dissemination of material misrepresentations
or withholding of material information typically affects the price of the
stock, and purchasers generally rely on the price of the stock as a reflection
of its value"); Blackie [485 U.S.
224, 245] v. Barrack, 524 F.2d 891, 908 (CA9 1975) ("[T]he same
causal nexus can be adequately established indirectly, by proof of materiality
coupled with the common sense that a stock purchaser does not ordinarily seek
to purchase a loss in the form of artificially inflated stock"), cert.
denied, 429
U.S. 816 (1976).
Presumptions typically serve to assist courts in managing circumstances in which direct proof, for one reason or another, is rendered difficult. See, e. g., 1 D. Louisell & C. Mueller, Federal Evidence 541-542 (1977). The courts below accepted a presumption, created by the fraud-on-the-market theory and subject to rebuttal by petitioners, that persons who had traded Basic shares had done so in reliance on the integrity of the price set by the market, but because of petitioners' material misrepresentations that price had been fraudulently depressed. Requiring a plaintiff to show a speculative state of facts, i. e., how he would have acted if omitted material information had been disclosed, see Affiliated Ute Citizens v. United States, 406 U.S., at 153-154, or if the misrepresentation had not been made, see Sharp v. Coopers & Lybrand, 649 F.2d 175, 188 (CA3 1981), cert. denied, 455 U.S. 938 (1982), would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market. Cf. Mills v. Electric Auto-Lite Co., 396 U.S., at 385.
Arising out of considerations of fairness, public policy, and probability, as well as judicial economy, presumptions are also useful devices for allocating the burdens of proof between parties. See E. Cleary, McCormick on Evidence 968-969 (3d ed. 1984); see also Fed. Rule Evid. 301 and Advisory Committee Notes, 28 U.S.C. App., p. 685. The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the 1934 Act. In drafting that Act, [485 U.S. 224, 246] Congress expressly relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an investor's reliance on the integrity of those markets:
"No investor, no speculator,
can safely buy and sell securities upon the exchanges without having an
intelligent basis for forming his judgment as to the value of the securities he
buys or sells. The idea of a free and open public market is built upon the
theory that competing judgments of buyers and sellers as to the fair price of a
security brings [sic] about a situation where the market price reflects as
nearly as possible a just price. Just as artificial manipulation tends to upset
the true function of an open market, so the hiding and secreting of important
information obstructs the operation of the markets as indices of real
value." H. R. Rep. No. 1383, at 11.
See Lipton v. Documation, Inc., 734 F.2d 740, 748 (CA11
1984), cert. denied, 469
U.S. 1132 (1985).23
The presumption is also supported by common sense and probability. Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.24 It has been noted that "it is hard to imagine that [485 U.S. 224, 247] there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?" Schlanger v. Four-Phase Systems Inc., 555 F. Supp. 535, 538 (SDNY 1982). Indeed, nearly every court that has considered the proposition has concluded that where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed.25 Commentators generally have applauded the adoption of one variation or another of the fraud-on-the-market theory.26 An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action. [485 U.S. 224, 248]
The Court of Appeals found that petitioners "made public, material misrepresentations and [respondents] sold Basic stock in an impersonal, efficient market. Thus the class, as defined by the district court, has established the threshold facts for proving their loss." 786 F.2d, at 751.27 The court acknowledged that petitioners may rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price or that an individual plaintiff traded or would have traded despite his knowing the statement was false. Id., at 750, n. 6.
Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance. For example, if petitioners could show that the "market makers" were privy to the truth about the merger discussions here with Combustion, and thus that the market price would not have been affected by their misrepresentation, the causal connection could be broken: the basis for finding that the fraud had been transmitted through market price would be gone.28 Similarly, if, despite petitioners' allegedly fraudulent attempt [485 U.S. 224, 249] to manipulate market price, news of the merger discussions credibly entered the market and dissipated the effects of the misstatements, those who traded Basic shares after the corrective statements would have no direct or indirect connection with the fraud.29 Petitioners also could rebut the presumption of reliance as to plaintiffs who would have divested themselves of their Basic shares without relying on the integrity of the market. For example, a plaintiff who believed that Basic's statements were false and that Basic was indeed engaged in merger discussions, and who consequently believed that Basic stock was artificially underpriced, but sold his shares nevertheless because of other unrelated concerns, e. g., potential antitrust problems, or political pressures to divest from shares of certain businesses, could not be said to have relied on the integrity of a price he knew had been manipulated.
In summary:
5. It is not inappropriate to apply a presumption of reliance supported by the fraud-on-the-market theory.
6. That presumption, however, is rebuttable.
The judgment of the Court of Appeals is vacated, and the case is remanded to that court for further proceedings consistent with this opinion.
It is so ordered.
[Footnote 21] W. Keeton, D. Dobbs, R. Keeton, & D. Owen, Prosser and Keeton on Law of Torts 726 (5th ed. 1984) ("The reasons for the separate development of [the tort action for misrepresentation and nondisclosure], and for its peculiar limitations, are in part historical, and in part connected with the fact that in the great majority of the cases which have come before the courts the misrepresentations have been made in the course of a bargaining transaction between the parties. Consequently the action has been colored to a considerable extent by the ethics of bargaining between distrustful adversaries") (footnote omitted).
[Footnote 22] Actions under Rule 10b-5 are distinct from common-law deceit and misrepresentation claims, see Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 744-745 (1975), and are in part designed to add to the protections provided investors by the common law, see Herman & MacLean v. Huddleston, 459 U.S. 375, 388-389 (1983).
[Footnote 23] Contrary to the dissent's suggestion, the incentive for investors to "pay attention" to issuers' disclosures comes from their motivation to make a profit, not their attempt to preserve a cause of action under Rule 10b-5. Facilitating an investor's reliance on the market, consistently with Congress' expectations, hardly calls for "dismantling the federal scheme which mandates disclosure." See post, at 259.
[Footnote 24] See In re LTV Securities Litigation, 88 F. R. D. 134, 144 (ND Tex. 1980) (citing studies); Fischel, Use of Modern Finance Theory in Securities Fraud Cases Involving Actively Traded Securities, 38 Bus. Law. 1, 4, n. 9 (1982) (citing literature on efficient-capital-market theory); Dennis, Materiality and the Efficient Capital Market Model: A Recipe for the Total Mix. 25 Wm. & Mary L. Rev. 373, 374-381, and n. 1 (1984). We need not determine by adjudication what economists and social scientists have debated [485 U.S. 224, 247] through the use of sophisticated statistical analysis and the application of economic theory. For purposes of accepting the presumption of reliance in this case, we need only believe that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.
[Footnote 25] See, e. g., Peil v. Speiser, 806 F.2d 1154, 1161 (CA3 1986); Harris v. Union Electric Co., 787 F.2d 355, 367, and n. 9 (CA8), cert. denied, 479 U.S. 823 (1986); Lipton v. Documation, Inc., 734 F.2d 740 (CA11 1984), cert. denied, 469 U.S. 1132 (1985); T. J. Raney & Sons, Inc. v. Fort Cobb, Oklahoma Irrigation Fuel Authority, 717 F.2d 1330, 1332-1333 (CA10 1983), cert. denied sub nom. Linde, Thomson, Fairchild, Langworthy, Kohn & Van Dyke v. T. J. Raney & Sons, Inc., 465 U.S. 1026 (1984); Panzirer v. Wolf, 663 F.2d 365, 367-368 (CA2 1981), vacated and remanded sub nom. Price Waterhouse v. Panzirer, 459 U.S. 1027 (1982); Ross v. A. H. Robins Co., 607 F.2d 545, 553 (CA2 1979), cert. denied, 446 U.S. 946 (1980); Blackie v. Barrack, 524 F.2d 891, 905-908 (CA9 1975), cert. denied, 429 U.S. 816 (1976).
[Footnote 26] See, e. g., Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N.C. L. Rev. 435 (1984); Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. 1143 (1982); Note, Fraud on the Market: An Emerging Theory of Recovery Under SEC Rule 10b-5, 50 Geo. Wash. L. Rev. 627 (1982).
[Footnote 27] The Court of Appeals held that in order to invoke the presumption, a plaintiff must allege and prove: (1) that the defendant made public misrepresentations; (2) that the misrepresentations were material; (3) that the shares were traded on an efficient market; (4) that the misrepresentations would induce a reasonable, relying investor to misjudge the value of the shares; and (5) that the plaintiff traded the shares between the time the misrepresentations were made and the time the truth was revealed. See 786 F.2d, at 750.
Given today's decision regarding the definition of materiality as to preliminary merger discussions, elements (2) and (4) may collapse into one.
[Footnote 28] By accepting this rebuttable presumption, we do not intend conclusively to adopt any particular theory of how quickly and completely publicly available information is reflected in market price. Furthermore, our decision today is not to be interpreted as addressing the proper measure of damages in litigation of this kind.
[Footnote 29] We note there may be a certain incongruity between the assumption that Basic shares are traded on a well-developed, efficient, and information-hungry market, and the allegation that such a market could remain misinformed, and its valuation of Basic shares depressed, for 14 months, on the basis of the three public statements. Proof of that sort is a matter for trial, throughout which the District Court retains the authority to amend the certification order as may be appropriate. See Fed. Rules Civ. Proc. 23(c)(1) and (c)(4). See 7B C. Wright, A. Miller, & M. Kane, Federal Practice and Procedure 128-132 (1986). Thus, we see no need to engage in the kind of factual analysis the dissent suggests that manifests the "oddities" of applying a rebuttable presumption of reliance in this case. See post, at 259-263.