Lucian A. Bebchuk and Allen Ferrell (Harvard Law School and Harvard Law School) have posted Rethinking Basic on SSRN. Here is the abstract:
In the Halliburton case, the United States Supreme Court is expected to reconsider next spring the Basic ruling that, twenty-five years ago, adopted the fraud-on-the-market theory and has facilitated securities class action litigation. In this paper we seek to contribute to the expected reconsideration. We show that, in contrast to claims made by the parties, the Justices need not assess, or reach conclusions regarding, the validity or scientific standing of the efficient market hypothesis; they need not, as it were, decide whether they find the view of Eugene Fama or Robert Shiller more persuasive. We explain that class-wide reliance should not depend on the “efficiency” of the market for the company’s security but on the existence of fraudulent distortion of the market price. Indeed, based on our review of the large body of research on market efficiency in financial economics, we show that, even fully accepting the views and evidence of efficiency critics such as Professor Shiller, it is possible for market prices to be distorted by fraudulent disclosures. Conversely, even fully accepting the views and evidence of market efficiency by supporters such as Professor Fama, it is possible that market prices were not distorted by a fraudulent disclosure. In short, the academic debate on market efficiency, even assuming the Court was somehow in a position to adjudicate the relative merits, should not be the focus in determining class-wide reliance. We put forward and analyze the merits and applicability of a modified rule that would make class-wide reliance depend on the existence of fraudulent distortion of market prices. We further discuss (i) how such a rule would retain some of the key insights behind the Basic rule but would avoid key drawbacks of it (including those identified by Justice White in his critique of the Basic opinion); (ii) the tools that would enable the federal courts to apply it effectively; and (iii) the allocation of the burden of proof.