Alito and Securities Law: Part II
posted by Dave Hoffman
As Prof. Ribstein notes, there has been a significant amount of interest, both on the internet and offline, in Judge Alito’s record as a “business friendly” jurist. The emerging consensus is (for marketeers) bullish. Forbes quotes Ted Frank as saying “All and all, business wins,” and then (rather wistfully) the magazine continues that the “stock market may have signaled its agreement on Monday; the Dow Jones Industrial Average had risen 49 points at midday.”
In any event, I’ve done a bit more research into Judge Alito’s record as a judge in securities cases, and I think defense attorneys may not want to uncork the champagne just yet.
As I noted when discussing the Burlington Coat factory case, the Judge does not appear hostile (as some do) to securities claims as a general matter. Rather, he appears to want to force plaintiffs to plead scienter with particularity, and to measure materiality by its market impact. In this post, I’ll continue my analysis of two additional Alito securities decisions that Prof. Ribstein didn’t focus on.
The first is Oran v. Stafford, 226 F.3d 275 (2000). Oran is a gem of a case. Except for the facts, which are tedious.
In Oran, Judge Alito once again focused on market impact as a bright-line rule to measure materiality.
In Burlington . . . this Court fashioned a special rule for measuring materiality in the context of an efficient securities market. This rule was shaped by the basic economic insight that in an open and developed securities market like the New York Stock Exchange, the price of a company’s stock is determined by all available material information regarding the company and its business. In such an efficient market, “information important to reasonable investors … is immediately incorporated into the stock price.” Burlington, 114 F.3d at 1425. As a result, when a stock is traded in an efficient market, the materiality of disclosed information may be measured post hoc by looking to the movement, in the period immediately following disclosure, of the price of the firm’s stock.
As I explained previously, I think there are some problems with this approach (even though I seem to support it at places here.) Nevertheless, Judge Alito’s strong reaffirmation of the ECMH in 2000 suggests that he may be quite resistant to attacks on the construct using behavioral research, which, in the end, may result in decisions that securities plaintiffs like much more than securities defendants. For example, Alito in Oran found that evidence of price movement (even without a loss causation analysis) meant that a disclosure was material, per se. In a paper analyzing around 500 securities cases from the Second Circuit, I found only a handful of judges willing to find materiality as a matter of law as a result of price movement. It is a testament to Judge Alito’s intellectual honesty that he was willing to do so in this case.
An earlier decision, In re Westinghouse Securities Litigation, 90 F.3d 696 (1996) provides a look at the Judge’s view of the (very troublesome) bespeaks caution doctrine. The bespeaks caution doctrine, for those of you who are not professionally enthralled by securities law, holds that where a company’s allegedly misleading predictions are paired with specific cautionary warnings about the fallibility of the corporation’s oracular abilities, and the ways in which the future might go badly, there can be no liability. The bespeaks caution doctrine is an increasingly popular way that judges dismiss securities claims early in litigations, removing such cases from judicial dockets before the costly (and truth-uncovering) discovery stage.
Judge Alito was surprisingly hostile to the BC doctrine in Westinghouse. Although the defendants had made many cautionary statements, Alito found that they were not targeted at the representation at issue - - that the defendant knowingly misrepresented their financial state. That is, defendants’ statements about the potentially grim future would not protect their lies about their present condition.
A reasonable investor might well be willing to take some chances with regard to the future of the economy, but might be quite unwilling to invest in a company that knew that its reserves were insufficient under current conditions and knew it would be taking another major write-down in the near future (as plaintiffs allege). Thus, notwithstanding the cautionary language stressed by defendants, we think that there is a substantial likelihood that defendants’ alleged misrepresentations . . . would have assumed actual significance to a reasonable investor contemplating the purchase of securities.
Sounds uncontroversial. But as I have found in my research, judges have been willing to apply the BC doctrine with abandon in recent years, and Judge Alito’s decision reversing the district court on this issue suggests that he is not reflexively in favor of deregulating the securities markets, as some of his partisans might hope.
October 31, 2005 at 10:03 pm
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Responses (9)
Kaimi - October 31, 2005 at 11:23 pm
Dave,
Nice thoughts. I think you’re completely right about the effects of ECMH. Fraud-on-the-market is such a weapon in plaintiff arsenals that if it could be undermined by behavioral work, it would be a huge coup for defendants. If Alito keeps FOM alive as an option, then he’s a net win for plaintiffs. (And discovery as truth-seeking? My goodness, when did you become such a big plaintiffs’-sider?)
A few questions/thoughts:
-What do you take from the fact that this case comes from 1996, which was a particularly interesting year for Bespeaks Caution? After all, it comes down one year after the PSLRA. If judges are supposed to be being business-friendly (however that is defined) at any point in time, it should be in 1996, after the extensive committee findings about perceived securities class action abuse.
-What’s your take on Alito’s likely impact on the interplay between ECMH and loss causation? Has he written anything on the topic? In particular, anti-ECMH and “noise” arguments are potentially _huge_ when it comes to loss causation. If he’s a true believer in ECMH, then does it remove some of the teeth from the relatively new loss causation provisions of the PSLRA? Do we have any indication what he thinks of loss causation?
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Ted - November 2, 2005 at 9:51 am
Are these really exceptional decisions? Even Judge Easterbrook isn’t willing to give blanket protections for the forward-looking statement safe harbor. Asher v. Baxter Int’l Inc. (7th Cir. 2004).
Dave Hoffman - November 2, 2005 at 11:00 am
Ted: All I can say is that based on my research, many judges are applying the BC doctrine uncritically. I didn’t say these were “exceptional” decisions, but I do think they provide a counter-point to your claim that business interests necessarily “win” if Judge Alito were to be confirmed. However, given that the sample size of Judge Alito’s business related opinions is tiny, and given that he had no prior business litigation experience, prediction here is risky.
Kaimi: I had a theory that judges should have reacted to the PSLRA by *increasing* securities law enforcement, as a part of a dynamic process to encourage optimal disclosure. At least in my preliminary research, however, I found no significant shifts in materiality win percentages based on changes in the governing law. But a follow-on project currently underway may change that result.
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