What Is An Efficient Market?

The fraud-on-the-market theory states that reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market. What is an efficient market? Courts have frequently interpreted the U.S. Supreme Court’s decision in Basic v. Levinson (which adopted the fraud-on-the-market theory) as incorporating the economic definition of an “efficient market.” That is to say, an efficient market is one in which the stock price rapidly reflects all publicly available information. See, e.g., Gariety v. Grant Thornton, LLP, 368 F.3d 356, 367 (4th Cir. 2004).

At least one court, however, has taken a hard look at the Basic decision and disagrees. In In re Polymedica Corp. Sec. Litig., 2004 WL 1977530 (D. Mass. Sept. 7, 2004), the court found that an efficient market is simply one in which “‘market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.'” As a result, the court declined to consider the defendants’ argument (asserted as part of an opposition to class certification) that the fraud-on-the-market theory could not be applied because the market price of Polymedica stock did not fully and rapidly reflect public information.

Holding: Class certification granted (after excluding short sellers from the proposed class).

Quote of note: “When legal precedent is available, I follow it, not economic or academic literature. And though the First Circuit has not issued an opinion on the matter, Supreme Court precedent exists. Furthermore, it is plain in Basic that the Court did not want to adopt the ‘economic’ or ‘academic’ definition of efficient market.”