As we have shown in a series of prior Articles, and as scholars have accepted since, class actions are vital to protecting investors. Presumptions of reliance facilitate class-wide resolution of securities fraud claims. Without class certification, individual damages may be de minimis, and thus investors would be unlikely to bring a securities fraud suit. This underenforcement allows those who defraud investors to skate liability and impugn the integrity of the marketplace. Under Rule 1Ob-5, for securities fraud the Supreme Court has presumed reliance to facilitate class actions where there is an omission in the face of a duty to disclose or where there is a fraud on the secondary market. The new frontier is whether federal courts should likewise presume reliance where fraud occurs on the primary market, giving rise to the fraud-created-the-market theory. While some federal courts embraced the theory decades ago, a sharp conflict has arisen in the wake of the Supreme Court's decision in Stoneridge, and the Third and Ninth Circuits have set the pace for rejecting the theory. In this Article we show, however, that the fraud-created-the-market theory is consistent with the fundamental basis for all presumptions in the law, comports with the Supreme Court's interpretations of the federal securities laws as properly understood, and serves the investor-protection and market-integrity design of securities regulation.
We undertake the seminal comprehensive definition and defense of the fraud-created-the-market theory, and show why critics' concerns regarding the presumption are unfounded Properly understood, the fraud-createdthe- market theory is about materiality-fraud is so material, without it, securities never would have made it to market. In this regard, we show that a presumption of reliance in the newly issued-securities context and the primary market is consistent with the Supreme Court's collapsing the elements of securities fraud into a single inquiry whether the omission or misrepresentation was material. We build upon Professor Donald C. Langevoort's fresh interpretation of Basic's fraud-on-the-market presumption and his interpretation of Stoneridge to show that the fraudcreated- the-market presumption is grounded in the Court's jurisprudence. We also find support for a judicially crafted presumption in the context of new issues in the securities laws themselves and in the common-law bases for presumptions. Relying on scholarship both old and new, we support judicial recognition of the fraud-created-the-market theory, specifically in cases involving bonds, in which the primary market may be informationally efficient, and cases involving manipulative conduct, in which market efficiency is irrelevant. The need for an answer to whether federal courts should adopt the fraud-created-the-market theory is pressing. The fraudcreated- the-market theory will play an increasingly important role in actions against those involved in fraud relating to the issuance of subprime mortgage-backed securities.
Copyrigiht 2012 Michael J. Kaufman.