Applying The Fraud-On-The-Market Theory To Research Analysts

Whether and how to apply the fraud-on-the-market theory (i.e., reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market) to research analyst statements continues to be controversial.

In DeMarco v. Lehman Brothers, 222 F.R.D. 243 (S.D.N.Y. 2004), a case alleging that a Lehman analyst made buy recommendations for RealNetworks, Inc. stock while secretly holding negative views of the stock, Judge Rakoff denied the motion for class certification based on the plaintiffs’ inability to provide sufficient evidence that the fraud-on-the-market theory was applicable. The court noted that there is a “qualitative difference” between a statement of fact from an issuer and a statement of opinion by a research analyst. In particular, a “well-developed efficient market can reasonably be presumed to translate the former into an effect on price, whereas no such presumption attaches to the latter.” As a result, the court held that the fraud-on-the-market doctrine can apply to a case based on research analyst statements “only where the plaintiff can make a prima facie showing that the analyst’s statements materially impacted the market price in a reasonably quantifiable respect.”

Another district judge in the S.D.N.Y., however, has disagreed with that standard and granted class certification in a similar case. In DeMarco v. Robertson Stephens, 2005 WL 12033 (S.D.N.Y. Jan. 20, 2005), Judge Lynch addressed a case alleging that a Robertson Stephens’ analyst and certain corporate officers maintained a buy rating on Corvis Corp. stock while privately selling their own holdings. (An earlier post on the case can be found here). In determining whether the fraud-on-the-market theory could be applicable, the court “decline[d] to adopt a higher standard at class certification for plaintiffs alleging securities fraud by research analysts and their employers.” The court found that “by presenting a mix of market activity evidence, logical arguments, and statistical studies of the influence of at least some analyst statements, plaintiffs have made ‘some showing’ of their ability to make a common legal and factual presentation on reliance to an eventual factfinder.”

The Second Circuit has come close to deciding this issue before, only to be thwarted by a settlement. It may get another chance.

Addition: The New York Law Journal has an article (via – free regist. req’d) on the decision.

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