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. But what is an efficient market? The PolyMedica securities litigation has offered a thorough examination of this issue.
In considering class certification, the district court originally held (contrary to most other courts) 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.” On appeal, the U.S. Court of Appeals for the First Circuit rejected this definition in a decision – In re PolyMedica Corp. Sec. Litig., 432 F.3d 1 (1st Cir. 2005) – issued late last year. The appellate court held that an efficient market “is one is which the market price of the stock fully reflects all publicly available information.” In other words, the market price must respond “so quickly to new information that ordinary investors cannot make trading profits on the basis of such information.”
On remand – In re PolyMedica Corp. Sec. Litig., 2006 WL 2776669 (D. Mass. Sept. 28, 2006) – the district court focused on the expert evidence concerning whether there was a “cause-and-effect relationship, over time, between unexpected corporate events or financial releases and an immediate response in [PolyMedica’s] stock price.” The plaintiffs’ expert provided an analysis demonstrating that PolyMedica’s stock price moved in response to significant news events on certain days within the portion of the proposed class period in question, but the district court found that this analysis was insufficient to establish either causation or that the news was reflected “fully” and “quickly” in the stock price. Moreover, the district court found defendants’ expert evidence that (1) short selling in PolyMedica stock was difficult and (2) the price of PolyMedica stock exhibited positive serial correlation (the direction in which the stock moved on a given day was a statistically significant predictor of how it would move the next day) was sufficient to suggest that the First Circuit’s standard for market efficiency had not been met.
Holding: Class certification as to a portion of the proposed class period denied.
Quote of note: “Nothing in [plaintiffs’] analysis tends to show that all reactions to any news event were regularly complete within any given time frame, let alone ‘quickly.’ . . . It may be true, as [plaintiffs’ expert] suggests, that one ‘can observe a lot just by watchin,’ but Yogi Berra is hardly a competent expert in market efficiency.”
The 10b-5 Daily 