Saturday, July 7, 2018
One of the topics I’ve repeatedly discussed in this space is how layers of doctrine have been so piled on top of inquiries like materiality and loss causation in the Section 10(b) context that the legal analysis has become completely unmoored from the ultimate factual inquiry, namely, did the fraud actually result in losses to investors. As I put it in one post:
[A]ll of our measures of impact and harm and loss are, at this point, so far removed from reality as to border on complete legal fiction. Materiality is a construct from case law, with numerous additional doctrines piled on to it by courts without any heed for actual evidence of how markets behave. …. [W]hat we call “harm” and “damage” for the purpose of private securities fraud lawsuits have become so artificial that it no longer seems as though we’re even trying to measure the actual real-world effects of fraud. I believe private lawsuits are an essential supplement to SEC action but a system of fines or statutory damages would make so much more sense.
This week, I call attention to another recent example of the phenomenon. In Mandalevy v. BofI Holding, 2018 WL 3250154 (S.D. Cal. June 19, 2018), the plaintiffs alleged that the defendant BofI Federal Bank lied about various money laundering offenses and falsely denied that federal authorities were looking into the matter, in violation of Section 10(b). The court dismissed their claims on various grounds, including that the plaintiffs had failed to show that they had experienced any losses caused by the defendant’s false denial of an SEC investigation. The plaintiffs alleged that BofI’s stock price dropped after publication of a New York Post article disclosing the SEC’s interest, but the court observed that the story was based on information that the reporter had obtained by making a FOIA request. Information available via FOIA, the court concluded, is information generally available to the public, and, by extension, the market. As a result, the article itself was deemed to have merely summarized previously-public information, and could not qualify as a corrective disclosure that revealed the truth. As the court explained its reasoning:
The efficient market theory presumes that interested, “information-hungry” market participants are actively and continuously trading a company’s stock. Basic Inc. v. Levinson, 485 U.S. 224, 249 n.29 (1988). One obvious source of information about a particular company is its regulator, particularly when—as we have here—the company has denied the existence of a regulatory investigation in response to reports stating the contrary. The Court must assume that, in the nearly seven months between BofI’s denial [of the investigation] and the October 25 article, a market participant would have made the sensible step of asking the SEC whether BofI’s denial was accurate. The fact that a market participant would have had to jump through a bureaucratic hoop to obtain this information does not mean that the information was not “public.” To the contrary, the Court must assume that “information-hungry” market participants seeking an edge in trading BofI’s stock would expend at least some effort to obtain material information about the company. The Court’s understanding of an efficient market’s collective reach, in other words, cannot be limited to information one can find on Google….
Having been offered no reason to believe that any other market participant could not have made a FOIA request from the SEC about BofI prior to October 25, the Court must assume that he or she did. The CAC therefore fails to allege with particularity a revelation of the falsity of BofI’s March 31 statement.
Let’s take a moment to unpack the factual inferences here that the court is willing to draw at the 12(b)(6) stage: that unspecified investors made a FOIA request, that they got their response faster than the reporter’s own inquiry, and that they used that information to trade in sufficient quantities to completely offset the effects of the initial lie. And that despite the fact that markets, apparently, can be expected to behave in this manner, these investors believed, ex ante, it would be cost-efficient to justify the time and expense of making the FOIA request in the first place so that they could exploit the information that the request – might! – reveal.
And, it should be noted, in drawing these inferences, the court remained untroubled by the fact that the stock did, in fact, drop upon publication of the Post article.
Forgive me if I have a little trouble accepting – without any additional evidence – that markets are imbued with this kind of near-mystical perfection. Indeed, as the Supreme Court made clear, they don’t need to be in order to justify the fraud on the market presumption. Yet, as Stephen Bainbridge and Mitu Gutali put it, “federal judges are claiming--at least implicitly--a level of expertise about the workings of markets and organizations that, in some areas, not even the most sophisticated researchers in financial economics and organizational theory have reached.” Stephen M. Bainbridge & G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does—Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory L.J. 83 (2002).
To be fair, plenty of other courts approach market evidence with more humility. For example, in Pub. Empls. Ret. Sys. of Miss., Puerto Rico Teachers Ret. Sys. v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014), the Fifth Circuit concluded that publicly-available raw data – later analyzed and reported in a Wall Street Journal article – could not be presumed to have impacted stock prices because “it is plausible that complex economic data understandable only through expert analysis may not be readily digestible by the marketplace.” Similarly, in In re Massey Energy Co. Sec. Litig., 883 F. Supp. 2d 597 (S.D. W. Va. 2012), the court refused to presume that information in a public database was sufficiently available to the market to offset defendants’ lies about their safety record. (Notably – as I previously posted – the Massey court’s intuition that raw data would not be easily digested by investors was subsequently validated by an empirical study of the impact on such information on stock prices.)
That said, despite my snarky subject line, the goal here is less to attack this particular opinion – which follows a line of similar cases that, while perhaps not quite as aggressive, are also willing to draw broad conclusions about market behavior on a thin record – than to question the value of this entire mode of analysis. It seems increasingly likely that an alternative system that avoids judicial measures of market impact (like, for example, a system of a statutory damages) would better serve investors and deter misconduct.