First Circuit Weighs in on Market Efficiency

If you’re a market efficiency buff (and let’s face it, who isn’t), then break out those reading glasses and your slide rule (not sure why you need the slide rule, but you'll look awfully academic carrying it, and you're certain to impress your local judiciary) and get ready to check out the First Circuit’s twin decisions that came out last month on the issue. What did they find, you ask? Well, that “an efficient market is one in which the market price of the stock fully reflects all publicly available information. By ‘fully reflect,’ we mean that market price responds so quickly to new information that ordinary investors cannot make trading profits on the basis of such information. This is known as ‘informational efficiency,’” and “we reject a second and much broader meaning of ‘fully reflect,’ known as ‘fundamental value efficiency,’ which requires that a market respond to information not only quickly but accurately, such that the market price of a stock reflects its fundamental value.”

So, “while evidence of a stock's fundamental value may be relevant to the extent that it raises questions about informational efficiency, courts which choose to consider such fundamental value evidence at the class-certification stage run the risk of turning the class-certification proceeding into a mini-trial on the merits, which must not happen. The fraud-on-the-market presumption, after all, only establishes a presumption of reliance which can be rebutted at trial. At the class-certification stage, a party need only establish ‘basic facts’ in order to invoke the presumption of reliance. The question of how much evidence of efficiency is necessary to establish the fraud-on-the-market presumption of reliance is one of degree. While district courts have broad discretion to draw these lines, they must do so sensibly, understanding the correct definition of efficiency and the factors relevant to that determination.”

Result? Investors in the Xcelera action had their class certification upheld, while those in the Polymedica will have their class certification order re-reviewed under the market efficiency standard set by the Panel.

You can read In re Xcelera and In re Polymedica, issued December 13, 2005, at 430 F.3d 503 and 2005 U.S. App. LEXIS 27173, or search for them here under Opinions.

Nugget: “Given the various factors relevant to an efficiency determination, and the abundant evidence that can be developed with respect to each factor, the determination of whether a market is efficient is a fact-dominated inquiry. ”