Traditional Fraud Research Articles

Accounting for Bad News: Securities Fraud Litigation and the Equal Application of Market Efficiency

The Fraud-on-the-Market theory holds that high volume markets, such as the New York Stock Exchange, effectively incorporate all available information of present and expected value into a security’s price. As endorsed by the United States Supreme Court, fraud on the market serves an important procedural role within the context of securities litigation by providing a general reliance presumption for all investors. An investor, or class of investors, is able to sue upon a claim of management misrepresentation without having to show actual reliance on the fraudulent information. When a market is assumed to be efficient, misinformation is deemed to defraud investors who have relied upon the integrity of the market itself. The presumption of market efficiency may thus be seen as an aspirational device, for placing the costs of rebuttal upon a corporation is said to encourage market transparency and the very same integrity of information that is assumed theoretically. For the soundness of market information to be encouraged through such a litigation presumption, the effect should not become counter-distorting through the double compensation of litigation loss. If fraud on the market is to be applied with consistent logic, then one must assume that the instant a misrepresentation is made public that rational investors will automatically discount the stock price to account for the inevitable class action suit that will arise. A post misrepresentation fall in share price generally serves as the basis for securities fraud claims of loss. Yet, this entails that plaintiffs are able to recover on a market valuation that includes both the diminishment in the asset due to fraud and the anticipated cost of its future litigation. Unlike traditional fraud recovery, the operation of an anticipatory market incorporates litigation outcomes into asset valuation at the time of awareness. Accordingly, damage recovery may unwittingly grant relief on a loss assessment that is composed of two factors: 1) the market assessment of asset devaluation due to fraud; and 2) the market prediction of the very same plaintiff recovery. One can then see that plaintiffs have their litigation recovery count twice: as they receive it from the court, and as it formed the basis of the very amount of claimed loss. In response to this problem, the following paper draws upon methods of alternative company valuation to arrive at a simple formula for filtering out anticipated litigation loss from securities damages.

Stock Market Insider Trading: Victims, Violators And Remedies-Including An Analogy To Fraud In The Sale Of A Used Car With A Generic Defect

This Article discusses following two questions: (1) Is act of stock market insider trading (as opposed to accompanying nondisclosure or lie) a victimless crime? (2) Is stock market insider trading fraud? The Article also briefly addresses two additional questions: (1) When does insider trading or tipping violate federal securities law? (Included is an analysis of classical relationship triangle.) (2) Under federal securities law, what are some remedies and sanctions against a stock market insider trader or tipper? To demonstrate that each act of stock market insider trading has specific, although anonymous, victims, Article employs two used car analogies: solitary defect hypothetical and generic defect hypothetical. In solitary defect hypothetical, only one automobile is a lemon. In contrast, in generic defect situation, many individuals are buying and selling cars, all same year model and all with same defect. In generic defect hypothetical, Mr. Greedie, an executive employed by General Motors, receives material, nonpublic information that all 1998 Cadillacs have a major defect. By coincidence, Greedie personally owns a 1998 Cadillac and immediately sells it to a car dealer. Assume in alternative that (1) dealer does not ask Greedie about any defect, or (2) dealer asks Greedie about defects, and Greedie LIES. With both alternatives, problem of demonstrating injury is same. During period between Greedie's sale and time of defect's public announcement, many individuals are buying and selling 1998 Cadillacs, all with same defect. At time of defect's announcement, there are a fixed number of 1998 Cadillacs. If Greedie has one less Cadillac at time of public announcement, someone else must have one more. That someone is victim of Greedie's sale. I call this the of conservation of used automobiles. If Greedie's sale of one car on inside information to automobile dealer causes even a slight lowering of dealer's prices for 1998 Cadillacs, that decline may dissuade or induce a transaction. In other words, dealer may pass injury to another by altering prices and readjusting inventory to level preferred. If dealer's prices do not change (or if price declines fail to dissuade or induce a trade), loss falls on car dealer (an induced buyer). Under law of conservation of used automobiles, Greedie's sale must induce a purchase or preempt a sale. The generic defect example resembles stock market insider trading, especially large block trades between an institutional investor and a block positioner. Such block transactions have aspects of face-to-face dealing. Stock market insider trading has some features of fraud, but differs from traditional fraud in several ways. Disclosure to party on other side or to public may breach other duties. Also, such disclosure would not save victim of insider trade if victim is a preempted trader. Whether a court classifies insider trading as fraud depends in part on whether court is judicially conservative or activist.