02-8001 West, et al. v. Prudential Securities, Inc.

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“Causation is the shortcoming in this class certification. [Basic, Inc. v. Levinson, 485 U.s. 224 (1988)] describes a mechanism by which public information affects stock prices, and thus may affect traders who did not know about that information. Professional investors monitor news about many firms; good news implies higher dividends and other benefits, which induces these investors to value the stock more highly, and they continue buying until the gains are exhausted. With many professional investors alert to news, markets are efficient in the sense that they rapidly adjust to all public information; if some of this information is false, the price will reach an incorrect level, staying there until the truth emerges. This approach has the support of financial economics as well as the imprimatur of the Justices: few propositions in economics are better established than the quick adjustment of securities prices to public information. See Richard A. Brealey, Stewart C. Myers & Alan J. Marcus, Fundamentals of Corporate Finance 322-39 (2d ed. 1998).

“No similar mechanism explains how prices would respond to non-public information, such as statements made by ofman to a handful of his clients. These do not come to the attention of professional investors or money managers, so the price-adjustment mechanism just described does not operate. Sometimes full-time market watchers can infer important news from the identity of a trader (when the corporation’s CEO goes on a buying spree, this implies good news) or from the sheer volume of trades (an unprecedented buying volume may suggest that a bidder is accumulating stock in anticipation of a tender offer), but neither the identity of Hofman’s customers nor the volume of their trades would have conveyed information to the market in this fashion. No one these days accepts the strongest version of the efficient capital market hypothesis, under which non-public information automatically affects prices.

That version is empirically false: the public announcement of news (good and bad) has big effects on stock prices, which could not happen if prices already incorporated the effect of non-public information. Thus it is hard to see how Hofman’s non- public statements could have caused changes in the price of Jefferson Savings stock. Basic founded the fraud-on-the- market doctrine on a causal mechanism with both theoretical and empirical power; for non-public information there is nothing comparable.”

Reversed.

On Petition for Leave to Appeal from the United States District Court for the Southern District of Illinois, Murphy, J., Easterbrook, J.