decided: March 7, 1988.
BASIC INCORPORATED, ET AL., PETITIONERS
MAX L. LEVINSON ET AL.
ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT.
Blackmun, J., delivered the opinion of the Court, in which Brennan, Marshall and Stevens, JJ., joined, and in Parts I, II, and III of which White and O'connor, JJ., joined. White, J., filed an opinion concurring in part and dissenting in part, in which O'connor, J., joined, post, p. 250. Rehnquist, C. J., and Scalia and Kennedy, JJ., took no part in the consideration or decision of the case.
[ 485 U.S. Page 226]
JUSTICE BLACKMUN delivered the opinion of the Court.
This case requires us to apply the materiality requirement Of § 10(b) of the Securities Exchange Act of 1934, 48 Stat. 881, as amended, 15 U. S. C. § 78a et seq. (1934 Act), and the Securities and Exchange Commissions Rule 10b-5, promulgated thereunder, see 17 CFR § 240.10b-5 (1987), in the content of preliminary corporate merger discussions. We must also determine whether a person who traded a corporation's shares on a securities exchange after the issuance of a materially misleading statement by the corporation may invoke a rebuttable presumption that, in trading, he relied on the integrity of the price set by the market.
Prior to December 20, 1978, Basic Incorporated was a publicly traded company primarily engaged in the business of manufacturing chemical refractories for the steel industry. As early as 1965 or 1966, Combustion Engineering, Inc., a company producing mostly alumina-based refractories, expressed some interest in acquiring Basic, but was deterred from pursuing this inclination seriously because of antitrust concerns it then entertained. See App. 81-83. In 1976, however, regulatory action opened the way to a renewal of
[ 485 U.S. Page 227]
Combustion's interest.*fn1 The "Strategic Plan," dated October 25, 1976, for Combustion's Industrial Products Group included the objective: "Acquire Basic Inc. $30 million." App 337.
Beginning in September 1976, Combustion representatives had meetings and telephone conversations with Basic officers and directors, including petitioners here,*fn2 concerning the possibility of a merger.*fn3 During 1977 and 1978, Basic made three public statements denying that it was engaged in merger negotiations.*fn4 On December 18, 1978, Basic asked
[ 485 U.S. Page 228]
the New York Stock Exchange to suspend trading in its shares and issued a release stating that it had been "approached" by another company concerning a merger. Id., at 413. On December 19, Basic's board endorsed Combustion's offer of $46 per share for its common stock, id., at 335, 414-416, and on the following day publicly announced its approval of Combustion's tender offer for all outstanding shares.
Respondents are former Basic shareholders who sold their stock after Basic's first public statement of October 21, 1977, and before the suspension of trading in December 1978. Respondents brought a class action against Basic and its directors, asserting that the defendants issued three false or misleading public statements and thereby were in violation of § 10(b) of the 1934 Act and of Rule 10b-5. Respondents alleged that they were injured by selling Basic shares at artificially depressed prices in a market affected by petitioners' misleading statements and in reliance thereon.
The District Court adopted a presumption of reliance by members of the plaintiff class upon petitioners public statements that enabled the court to conclude that common questions of fact or law predominated over particular questions pertaining to individual plaintiffs. See Fed. Rule Civ. Proc. 23(b)(3). The District Court therefore certified respondents' class.*fn5 On the merits, however, the District Court granted
[ 485 U.S. Page 229]
summary judgment for the defendants. It held that, as a matter of law, any misstatements were immaterial: there were no negotiations ongoing at the time of the first statement, and although negotiations were taking place when the second and third statements were issued, those negotiations were not "destined, with reasonable certainty, to become a merger agreement in principle." App. to Pet. for Cert. 103a.
The United States Court of Appeals for the Sixth Circuit affirmed the class certification, but reversed the District Court's summary judgment, and remanded the case. 786 F.2d 741 (1986). The court reasoned that while petitioners were under no general duty to disclose their discussions with Combustion, any statement the company voluntarily released could not be "'so incomplete as to mislead.'" Id., at 746, quoting SEC v. Texas Gulf Sulphur Co. 401 F.2d 833, 862 (CA2 1968) (en banc), cert. denied sub nom. Coats v. SEC, 394 U.S. 976 (1969). In the Court of Appeals' view, Basic's statements that no negotiations were taking place, and that it knew of no corporate developments to account for the heavy trading activity, were misleading. With respect to materiality, the court rejected the argument that preliminary merger discussions are immaterial as a matter of law, and held that "once a statement is made denying the existence of any discussions, even discussions that might not have been material in absence of the denial are material because they make the statement made untrue." 786 F.2d, at 749.
The Court of Appeals joined a number of other circuits in accepting the "fraud-on-the-market theory" to create a rebuttable presumption that respondents relied on petitioners' material
[ 485 U.S. Page 230]
misrepresentations, noting that without the presumption it would be impractical to certify a class under Fed. Rule Civ. Proc. 23(b)(3). See 786 F.2d, at 750-751.
We granted certiorari, 484 U.S. 1083 (1987), to resolve the split, see Part III, infra, among the Courts of Appeals as to the standard of materiality applicable to preliminary merger discussions, and to determine whether the courts below properly applied a presumption of reliance in certifying the class, rather than requiring each class member to show direct reliance on Basic's statements.
The 1934 Act was designed to protect investors against manipulation of stock prices. See S. Rep. No. 792, 73d Cong., 2d Sess., 1-5 (1934). Underlying the adoption of extensive disclosure requirements was a legislative philosophy: "There cannot be honest markets without honest publicity. Manipulation and dishonest practices of the market place thrive upon mystery and secrecy." H. R. Rep. No. 1383, 73d Cong., 2d Sess., 11 (1934). This Court "repeatedly has described the fundamental purpose' of the Act as implementing a philosophy of full disclosure.'" Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477-478 (1977), quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963).
Pursuant to its authority under § 10(b) of the 1934 Act, 15 U. S. C. § 78j, the Securities and Exchange Commission promulgated Rule 10b-5.*fn6 Judicial interpretation and application,
[ 485 U.S. Page 231]
legislative acquiescence, and the passage of time have removed any doubt that a private cause of action exists for a violation of § 10(b) and Rule 10b-5, and constitutes an essential tool for enforcement of the 1934 Act's requirements. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 196 (1976); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730 (1975).
The Court previously has addressed various positive and common-law requirements for a violation of § 10(b) or of Rule 10b-5. See, e.g., Santa Fe Industries, Inc. v. Green, supra ("manipulative or deceptive" requirement of the statute); Blue Chip Stamps v. Manor Drug Stores, supra ("in connection with the purchase or sale" requirement of the Rule); Dirks v. SEC, 463 U.S. 646 (1983) (duty to disclose); Chiarella v. United States, 445 U.S. 222 (1980) (same); Ernst & Ernst v. Hochfelder, supra (scienter). See also Carpenter v. United States, 484 U.S. 19 (1987) (confidentiality). The Court also explicitly has defined a standard of materiality under the securities laws, see TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), concluding in the proxy-solicitation context that "an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." Id., at 449.*fn7 Acknowledging that certain information concerning corporate developments could well be of "dubious significance," id., at 448, the Court was careful not to set too low a standard of materiality; it was concerned that a minimal standard might bring an overabundance of information within its reach, and lead management "simply to bury the shareholders in an avalanche of trivial information -- a result that is hardly conducive to informed decisionmaking." Id., at 448-449. It further explained that to fulfill the materiality requirement "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the
[ 485 U.S. Page 232]
reasonable investor as having significantly altered the 'total mix' of information made available." Id., at 449. We now expressly adopt the TSC Industries standard of materiality for the § 10(b) and Rule 10b-5 context.*fn8
The application of this materiality standard to preliminary merger discussions is not self-evident. Where the impact of the corporate development on the target's fortune is certain and clear, the TSC Industries materiality definition admits straightforward application. Where, on the other hand, the event is contingent or speculative in nature, it is difficult to ascertain whether the "reasonable investor" would have considered the omitted information significant at the time. Merger negotiations, because of the ever-present possibility that the contemplated transaction will not be effectuated, fall into the latter category.*fn9
Petitioners urge upon us a Third Circuit test for resolving this difficulty.*fn10 See Brief for Petitioners 20-22. Under this
[ 485 U.S. Page 233]
approach, preliminary merger discussions do not become material until "agreement-in-principle" as to the price and structure of the transaction has been reached between the would-be merger partners. See Greenfield v. Heublein, Inc., 742 F.2d 751, 757 (CA3 1984), cert. denied, 469 U.S. 1215 (1985). By definition, then, information concerning any negotiations not yet at the agreement-in-principle stage could be withheld or even misrepresented without a violation of Rule 10b-5.
Three rationales have been offered in support of the "agreement-in-principle" test. The first derives from the concern expressed in TSC Industries that an investor not be overwhelmed by excessively detailed and trivial information, and focuses on the substantial risk that preliminary merger discussions may collapse: because such discussions are inherently tentative, disclosure of their existence itself could mislead investors and foster false optimism. See Greenfield v. Heublein, Inc., 742 F.2d, at 756; Reiss v. Pan American World Airways, Inc., 711 F.2d 11, 14 (CA2 1983). The other two justifications for the agreement-in-principle standard are based on management concerns: because the requirement of "agreement-in-principle" limits the scope of disclosure obligations, it helps preserve the confidentiality of merger discussions where earlier disclosure might prejudice the negotiations; and the test also provides a usable, bright-line rule for determining when disclosure must be made. See Greenfield v. Heublein, Inc., 742 F.2d, at 757; Flamm v. Eberstadt,
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F.2d 1169, 1176-1178 (CA7), cert. denied, 484 U.S. 853 (1987).
None of these policy-based rationales, however, purports to explain why drawing the line at agreement-in-principle reflects the significance of the information upon the investor's decision. The first rationale, and the only one connected to the concerns expressed in TSC Industries, stands soundly rejected, even by a Court of Appeals that otherwise has accepted the wisdom of the agreement-in-principle test. "It assumes that investors are nitwits, unable to appreciate -- even when told -- that mergers are risky propositions up until the closing." Flamm v. Eberstadt, 814 F.2d, at 1175. Disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress. We have recognized time and again, a "fundamental purpose" of the various securities acts, "was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963). Accord, Affiliated Ute Citizens v. United States, 406 U.S. 128, 151 (1972); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477 (1977). The role of the materiality requirement is not to "attribute to investors a child-like simplicity, an inability to grasp the probabilistic significance of negotiations," Flamm v. Eberstadt, 814 F.2d, at 1175, but to filter out essentially useless information that a reasonable investor would not consider significant, even as part of a larger "mix" of factors to consider in making his investment decision. TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 448-449.
The second rationale, the importance of secrecy during the early stages of merger discussions, also seems irrelevant to an assessment whether their existence is significant to the trading decision of a reasonable investor. To avoid a "bidding war" over its target, an acquiring firm often will insist that negotiations remain confidential, see, e.g., In re Carnation Co.,
[ 485 U.S. Page 235]
Exchange Act Release No. 22214, 33 SEC Docket 1025 (1985), and at least one Court of Appeals has stated that "silence pending settlement of the price and structure of a deal is beneficial to most investors, most of the time." Flamm v. Eberstadt, 814 F.2d, at 1177.*fn11
We need not ascertain, however, whether secrecy necessarily maximizes shareholder wealth -- although we note that the proposition is at least disputed as a matter of theory and empirical research*fn12 -- for this case does not concern the timing of a disclosure; it concerns only its accuracy and completeness.*fn13 We face here the narrow question whether information concerning the existence and status of preliminary merger discussions is significant to the reasonable investor's trading decision. Arguments based on the premise that some disclosure would be "premature" in a sense are more properly considered under the rubric of an issuer's duty to disclose. The "secrecy" rationale is simply inapposite to the definition of materiality.
[ 485 U.S. Page 236]
The final justification offered in support of the agreement-in-principle test seems to be directed solely at the comfort of corporate managers. A bright-line rule indeed is easier to follow than a standard that requires the exercise of judgment in the light of all the circumstances. But ease of application alone is not an excuse for ignoring the purposes of the securities acts and Congress' policy decisions. Any approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding such as materiality, must necessarily be over- or underinclusive. In TSC Industries this Court explained: "The determination [of materiality] requires delicate assessments of the inferences a 'reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him. . . ." 426 U.S. at 450. After much study, the Advisory Committee on Corporate Disclosure cautioned the SEC against administratively confining materiality to a rigid formula.*fn14 Courts also would do well to heed this advice.
We therefore find no valid justification for artificially excluding from the definition of materiality information concerning merger discussions, which would otherwise be considered significant to the trading decision of a reasonable investor, merely because agreement-in-principle as to price and structure has not yet been reached by the parties or their representatives.
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The Sixth Circuit explicitly rejected the agreement-in-principle test, as we do today, but in its place adopted a rule that, if taken literally, would be equally insensitive, in our view, to the distinction between materiality and the other elements of an action under Rule 10b-5:
"When a company whose stock is publicly traded makes a statement, as Basic did, that 'no negotiations' are underway, and that the corporation knows of 'no reason for the stock's activity,' and that 'management is unaware of any present or pending corporate development that would result in the abnormally heavy trading activity,' information concerning ongoing acquisition discussions becomes material by virtue of the statement denying their existence.
In analyzing whether information regarding merger discussions is material such that it must be affirmatively disclosed to avoid a violation of Rule 10b-5, the discussions and their progress are the primary considerations. However, once a statement is made denying the existence of any discussions, even discussions that might not have been material in absence of the denial are material because they make the statement made untrue." 786 F.2d, at 748-749 (emphasis in original).*fn15
[ 485 U.S. Page 238]
This approach, however, fails to recognize that, in order to prevail on a Rule 10b-5 claim, a plaintiff must show that the statements were misleading as to a material fact. It is not enough that a statement is false or incomplete, if the misrepresented fact is otherwise insignificant.
Even before this Court's decision in TSC Industries, the Second Circuit had explained the role of the materiality requirement of Rule 10b-5, with respect to contingent or speculative information or events, in a manner that gave that term meaning that is independent of the other provisions of the Rule. Under such circumstances, materiality "will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity." SEC v. Texas Gulf Sulphur Co., 401 F.2d, at 849. Interestingly, neither the Third Circuit decision adopting the agreement-in-principle test nor petitioners here take issue with this general standard. Rather, they suggest that with respect to preliminary merger discussions, there are good reasons to draw a line at agreement on price and structure.
In a subsequent decision, the late Judge Friendly, writing for a Second Circuit panel, applied the Texas Gulf Sulphur probability/magnitude approach in the specific context of preliminary merger negotiations. After acknowledging that materiality is something to be determined on the basis of the particular facts of each case, he stated:
"Since a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death, we think that inside information, as regards a merger of this sort, can become material at an earlier stage than would be the case as regards lesser transactions -- and this even though the mortality rate of mergers in such formative stages is doubtless high."
SEC v. Geon Industries, Inc., 531 F.2d 39, 47-48 (CA2 1976).
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We agree with that analysis.*fn16
Whether merger discussions in any particular case are material therefore depends on the facts. Generally, in order to assess the probability that the event will occur, a factfinder will need to look to indicia of interest in the transaction at the highest corporate levels. Without attempting to catalog all such possible factors, we note by way of example that board resolutions, instructions to investment bankers, and actual negotiations between principals or their intermediaries may serve as indicia of interest. To assess the magnitude of the transaction to the issuer of the securities allegedly manipulated, a factfinder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.*fn17
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As we clarify today, materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.*fn18 The fact-specific inquiry we endorse here is consistent with the approach a number of courts have taken in assessing the materiality of merger negotiations.*fn19 Because the standard of materiality we have
[ 485 U.S. Page 241]
adopted differs from that used by both courts below, we remand the case for reconsideration of the question whether a grant of summary judgment is appropriate on this record.*fn20
We turn to the question of reliance and the fraud-on-the-market theory. Succinctly put:
" The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business. . . . Misleading statements will therefore
[ 485 U.S. Page 242]
defraud purchasers of stock even if the purchasers do not directly rely on the misstatements. . . . The causal connection between the defendants' fraud and the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations." Peil v. Speiser, 806 F.2d 1154, 1160-1161 (CA3 1986).
Our task, of course, is not to assess the general validity of the theory, but to consider whether it was proper for the courts below to apply a rebuttable presumption of reliance, supported in part by the fraud-on-the-market theory. Cf. the comments of the dissent, post, at 252-255.
This case required resolution of several common questions of law and fact concerning the falsity or misleading nature of the three public statements made by Basic, the presence or absence of scienter, and the materiality of the misrepresentations, if any. In their amended complaint, the named plaintiffs alleged that in reliance on Basic's statements they sold their shares of Basic stock in the depressed market created by petitioners. See Amended Complaint in No. C79-1220 (ND Ohio) paras. 27, 29, 35, 40; see also id., at para. 33 (alleging effect on market price of Basic's statements). Requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones. The District Court found that the presumption of reliance created by the fraud-on-the-market theory provided "a practical resolution to the problem of balancing the substantive requirement of proof of reliance in securities cases against the procedural requisites of [Fed. Rule Civ. Proc.] 23." The District Court thus concluded that with reference to each public statement and its impact upon the open market for Basic shares, common questions predominated over individual questions, as required by Fed. Rule Civ. Proc. 23(a)(2) and (b)(3).
[ 485 U.S. Page 243]
Petitioners and their amici complain that the fraud-on-the-market theory effectively eliminates the requirement that a plaintiff asserting a claim under Rule 10b-5 prove reliance. They note that reliance is and long has been an element of common-law fraud, see e.g., Restatement (Second) of Torts § 525 (1977); Prosser and Keeton on The Law of Torts § 108 (5th ed. 1984), and argue that because the analogous express right of action includes a reliance requirement, see, e.g., § 18(a) of the 1934 Act, as amended, 15 U. S. C. § 78r(a), so too must an action implied under § 10(b).
We agree that reliance is an element of a Rule 10b-5 cause of action. See Ernst & Ernst v. Hochfelder, 425 U.S. at 206 (quoting Senate Report). Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury. See, e.g., Wilson v. Comtech Telecommunications Corp., 648 F.2d 88, 92 (CA2 1981); List v. Fashion Park, Inc., 340 F.2d 457, 462 (CA2), cert. denied sub nom. List v. Lerner, 382 U.S. 811 (1965). There is, however, more than one way to demonstrate the causal connection. Indeed, we previously have dispensed with a requirement of positive proof of reliance, where a duty to disclose material information had been breached, concluding that the necessary nexus between the plaintiffs' injury and the defendant's wrongful conduct had been established. See Affiliated Ute Citizens v. United States, 406 U.S., at 153-154. Similarly, we did not require proof that material omissions or misstatements in a proxy statement decisively affected voting, because the proxy solicitation itself, rather than the defect in the solicitation materials, served as an essential link in the transaction. See Mills v. Electric Auto-Lite Co., 396 U.S. 375, 384-385 (1970).
The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face
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transactions contemplated by early fraud cases,*fn21 and our understanding of Rule 10b-5's reliance requirement must encompass these differences.*fn22
"In face-to-face transactions, the inquiry into an investor's reliance upon information is into the subjective pricing of that information by that investor. With the presence of a market, the market is interposed between seller and buyer and, ideally, transmits information to the investor in the processed form of a market price. Thus the market is performing a substantial part of the valuation process performed by the investor in a face-to-face transaction. The market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price." In re LTV Securities Litigation, 88 F. R. D. 134, 143 (ND Tex. 1980).
Accord, e.g., Peil v. Speiser, 806 F.2d, at 1161 ("In an open and developed market, the dissemination of material misrepresentations or withholding of material information typically affects the price of the stock, and purchasers generally rely on the price of the stock as a reflection of its value"); Blackie v. Barrack,
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F.2d 891, 908 (CA9 1975) ("the same causal nexus can be adequately established indirectly, by proof of materiality coupled with the common sense that a stock purchaser does not ordinarily seek to purchase a loss in the form of artificially inflated stock"), cert. denied, 429 U.S. 816 (1976).
Presumptions typically serve to assist courts in managing circumstances in which direct proof, for one reason or another, is rendered difficult. See, e.g., D. Louisell & C. Mueller, Federal Evidence 541-542 (1977). The courts below accepted a presumption, created by the fraud-on-the-market theory and subject to rebuttal by petitioners, that persons who had traded Basic shares had done so in reliance on the integrity of the price set by the market, but because of petitioners' material misrepresentations that price had been fraudulently depressed. Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted if omitted material information had been disclosed, see Affiliated Ute Citizens v. United States, 406 U.S. at 153-154, or if the misrepresentation had not been made, see Sharp v. Coopers & Lybrand, 649 F.2d 175, 188 (CA3 1981), cert. denied, 455 U.S. 938 (1982), would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market. Cf. Mills v. Electric Auto-Lite Co., 396 U.S. at 385.
Arising out of considerations of fairness, public policy, and probability, as well as judicial economy, presumptions are also useful devices for allocating the burdens of proof between parties. See E. Cleary, McCormick on Evidence 968-969 (3rd ed. 1984); see also Fed. Rule Evid. 301 and notes. The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the 1934 Act. In drafting that Act,
[ 485 U.S. Page 246]
Congress expressly relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an investor's reliance on the integrity of those markets:
"No investor, no speculator, can safely buy and sell securities upon the exchanges without having an intelligent basis for forming his judgment as to the value of the securities he buys or sells. The idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers as to the fair price of a security brings [sic] about a situation where the market price reflects as nearly as possible a just price. Just as artificial manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the operation of the markets as indices of real value." H. R. Rep. No. 1383, supra, at 11.
See Lipton v. Documation, Inc., 734 F.2d 740, 748 (CA11 1984), cert. denied, 469 U.S. 1132 (1985).*fn23
The presumption is also supported by common sense and probability. Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.*fn24 It has been noted that "it is hard to imagine that
[ 485 U.S. Page 247]
there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?" Schlanger v. Four-Phase Systems Inc., 555 F. Supp. 535, 538 (SDNY 1982). Indeed, nearly every court that has considered the proposition has concluded that where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed.*fn25 Commentators generally have applauded the adoption of one variation or another of the fraud-on-the-market theory.*fn26 An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.
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The Court of Appeals found that petitioners "made public material misrepresentations and [respondents] sold Basic stock in an impersonal, efficient market. Thus the class, as defined by the district court, has established the threshold facts for proving their loss." 786 F.2d, at 751.*fn27 The court acknowledged that petitioners may rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price or that an individual plaintiff traded or would have traded despite his knowing the statement was false. Id., at 750 n. 6.
Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance. For example, if petitioners could show that the "market makers" were privy to the truth about the merger discussions here with Combustion, and thus that the market price would not have been affected by their misrepresentations, the causal connection could be broken: the basis for finding that the fraud had been transmitted through market price would be gone.*fn28 Similarly, if, despite petitioners' allegedly fraudulent attempt
[ 485 U.S. Page 249]
to manipulate market price, news of the merger discussions credibly entered the market and dissipated the effects of the misstatements, those who traded Basic shares after the corrective statements would have no direct or indirect connection with the fraud.*fn29 Petitioners also could rebut the presumption of reliance as to plaintiffs who would have divested themselves of their Basic shares without relying on the integrity of the market. For example, a plaintiff who believed that Basic's statements were false and that Basic was indeed engaged in merger discussions, and who consequently believed that Basic stock was artificially underpriced, but sold his shares nevertheless because of other unrelated concerns, e.g., potential antitrust problems, or political pressures to divest from shares of certain businesses, could not be said to have relied on the integrity of a price he knew had been manipulated.
1. We specifically adopt, for the § 10(b) and Rule 10b-5 context, the standard of materiality set forth in TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 449.
2. We reject "agreement-in-principle as to price and structure" as the bright-line rule for materiality.
3. We also reject the proposition that "information becomes material by virtue of a public statement denying it."
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. Materiality in the merger context depends on the probability that the transaction will be consummated, and its significance to the issuer of the securities. Materiality depends on the facts and thus is to be determined on a case-by-case basis.
5. It is not inappropriate to apply a presumption of reliance supported by the fraud-on-the-market theory.
6. That presumption, however, is rebuttable.
7. The District Court's certification of the class here was appropriate when made but is subject on remand to such adjustment, if any, as developing circumstances demand.
The judgment of the Court of Appeals is vacated and the case is remanded to that court for further proceedings consistent with this opinion.
It is so ordered.
THE CHIEF JUSTICE, JUSTICE SCALIA, and JUSTICE KENNEDY took no part in the consideration or decision of this case.
786 F.2d 741, vacated and remanded.
JUSTICE WHITE, with whom JUSTICE O'CONNOR joins, concurring in part and dissenting in part.
I join Parts I-III of the Court's opinion, as I agree that the standard of materiality we set forth in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), should be applied to actions under § 10(b) and Rule 10b-5. But I dissent from the remainder of the Court's holding because I do not agree that the "fraud-on-the-market" theory should be applied in this case.
Even when compared to the relatively youthful private cause-of-action under § 10(b), see Kardon v. National Gypsum Co., 69 F. Supp. 512 (ED Pa. 1946), the fraud-on-the-market theory is a mere babe.*fn1 Yet today, the Court embraces
[ 485 U.S. Page 251]
this theory with the sweeping confidence usually reserved for more mature legal doctrines. In so doing, I fear that the Court's decision may have many adverse, unintended effects as it is applied and interpreted in the years to come.
At the outset, I note that there are portions of the Court's fraud-on-the-market holding with which I am in agreement. Most importantly, the Court rejects the version of that theory, heretofore adopted by some courts,*fn2 which equates "causation" with "reliance," and permits recovery by a plaintiff who claims merely to have been harmed by a material misrepresentation which altered a market price, notwithstanding proof that the plaintiff did not in any way rely on that price. Ante, at 248. I agree with the Court that if Rule 10b-5's reliance requirement is to be left with any content at all, the fraud-on-the-market presumption must be capable of being rebutted by a showing that a plaintiff did not "rely" on the market price. For example, a plaintiff who decides, months in advance of an alleged misrepresentation, to purchase a stock; one who buys or sells a stock for reasons unrelated to its price; one who actually sells a stock "short" days before the misrepresentation is made -- surely none of these people can state a valid claim under Rule 10b-5. Yet, some federal courts have allowed such claims to stand under one variety or another of the fraud-on-the-market theory.*fn3
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Happily, the majority puts to rest the prospect of recovery under such circumstances. A nonrebuttable presumption of reliance -- or even worse, allowing recovery in the face of "affirmative evidence of nonreliance," Zweig v. Hearst Corp., 594 F.2d 1261, 1272 (CA9 1979) (Ely, J., dissenting) -- would effectively convert Rule 10b-5 into "a scheme of investor's insurance." Shores v. Sklar, 647 F.2d 462, 469, n. 5 (CA5 1981) (en banc), cert. denied, 459 U.S. 1102 (1983). There is no support in the Securities Act, the Rule, or our cases for such a result.
But even as the Court attempts to limit the fraud-on-the-market theory it endorses today, the pitfalls in its approach are revealed by previous uses by the lower courts of the broader versions of the theory. Confusion and contradiction in court rulings are inevitable when traditional legal analysis is replaced with economic theorization by the federal courts.
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In general, the case law developed in this Court with respect to § 10(b) and Rule 10b-5 has been based on doctrines with which we, as judges, are familiar: common-law doctrines of fraud and deceit. See, e.g., Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 471-477 (1977). Even when we have extended civil liability under Rule 10b-5 to a broader reach than the common law had previously permitted, see ante, at 244, n. 22, we have retained familiar legal principles as our guideposts. See, e.g., Herman & MacLean v. Huddleston, 459 U.S. 375, 389-390 (1983). The federal courts have proved adept at developing an evolving jurisprudence of Rule 10b-5 in such a manner. But with no staff economists, no experts schooled in the "efficient-capital-market hypothesis," no ability to test the validity of empirical market studies, we are not well equipped to embrace novel constructions of a statute based on contemporary microeconomic theory.*fn4
The "wrong turns" in those Court of Appeals and district court fraud-on-the-market decisions which the Court implicitly rejects as going too far should be ample illustration of the dangers when economic theories replace legal rules as the basis for recovery. Yet the Court today ventures into this area beyond its expertise, beyond -- by its own admission -- the confines of our previous fraud cases. See ante, at 243-244. Even if I agreed with the Court that "modern securities
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markets . . . involving millions of shares changing hands daily" require that the "understanding of Rule 10b-5's reliance requirement" be changed, ibid., I prefer that such changes come from Congress in amending § 10(b). The Congress, with its superior resources and expertise, is far better equipped than the federal courts for the task of determining how modern economic theory and global financial markets require that established legal notions of fraud be modified. In choosing to make these decisions itself, the Court, I fear, embarks on a course that it does not genuinely understand, giving rise to consequences it cannot foresee.*fn5
For while the economists' theories which underpin the fraud-on-the-market presumption may have the appeal of mathematical exactitude and scientific certainty, they are -- in the end -- nothing more than theories which may or may not prove accurate upon further consideration. Even the most earnest advocates of economic analysis of the law recognize this. See, e.g., Easterbrook, Afterword: Knowledge and Answers, 85 Colum. L. Rev. 1117, 1118 (1985). Thus, while the majority states that, for purposes of reaching its result it need only make modest assumptions about the way in which "market professionals generally" do their jobs, and how the conduct of market professionals affects stock prices, ante, at 246, n. 23, I doubt that we are in much of a position
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to assess which theories aptly describe the functioning of the securities industry.
Consequently, I cannot join the Court in its effort to reconfigure the securities laws, based on recent economic theories, to better fit what it perceives to be the new realities of financial markets. I would leave this task to others more equipped for the job than we.
At the bottom of the Court's conclusion that the fraud-on-the-market theory sustains a presumption of reliance is the assumption that individuals rely "on the integrity of the market price" when buying or selling stock in "impersonal, well-developed market[s] for securities." Ante, at 247. Even if I was prepared to accept (as a matter of common sense or general understanding) the assumption that most persons buying or selling stock do so in response to the market price, the fraud-on-the-market theory goes further. For in adopting a "presumption of reliance," the Court also assumes that buyers and sellers rely -- not just on the market price -- but on the "integrity" of that price. It is this aspect of the fraud-on-the-market hypothesis which most mystifies me.
To define the term "integrity of the market price," the majority quotes approvingly from cases which suggest that investors are entitled to "'rely on the price of a stock as a reflection of its value.'" Ante, at 244 (quoting Pell v. Speiser, 806 F.2d 1154, 1161 (CA3 1986)). But the meaning of this phrase eludes me, for it implicitly suggests that stocks have some "true value" that is measurable by a standard other than their market price. While the Scholastics of Medieval times professed a means to make such a valuation of a commodity's "worth,"*fn6 I doubt that the federal courts of our day are similarly equipped.
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Even if securities had some "value" -- knowable and distinct from the market price of a stock -- investors do not always share the Court's presumption that a stock's price is a "reflection of [this] value." Indeed, "many investors purchase or sell stock because they believe the price inaccurately reflects the corporation's worth." See Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N. C. L. Rev. 435, 455 (1984) (emphasis added). If investors really believed that stock prices reflected a stock's "value," many sellers would never sell, and many buyers never buy (given the time and cost associated with executing a stock transaction). As we recognized just a few years ago: "Investors act on inevitably incomplete or inaccurate information, [consequently] there are always winners and losers; but those who have 'lost' have not necessarily been defrauded." Dirks v. SEC, 463 U.S. 646, 667, n. 27 (1983). Yet today, the Court allows investors to recover who can show little more than that they sold stock at a lower price than what might have been.*fn7
I do not propose that the law retreat from the many protections that § 10(b) and Rule 10b-5, as interpreted in our prior cases, provide to investors. But any extension of these laws, to approach something closer to an investor insurance
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scheme, should come from Congress, and not from the courts.
Congress has not passed on the fraud-on-the-market theory the Court embraces today. That is reason enough for us to abstain from doing so. But it is even more troubling that, to the extent that any view of Congress on this question can be inferred indirectly, it is contrary to the result the majority reaches.
In the past, the scant legislative history of § 10(b) has led us to look at Congress' intent in adopting other portions of the Securities Act when we endeavor to discern the limits of private causes of action under Rule 10b-5. See, e.g., Ernst & Ernst v. Hochfelder, 425 U. S. 185, 204-206 (1976). A similar undertaking here reveals that Congress flatly rejected a proposition analogous to the fraud-on-the-market theory in adopting a civil liability provision of the 1934 Act.
Section 18 of the Act expressly provides for civil liability for certain misleading statements concerning securities. See 15 U. S. C. § 78r(a). When the predecessor of this section was first being considered by Congress, the initial draft of the provision allowed recovery by any plaintiff "who shall have purchased or sold a security the price of which may have been affected by such [misleading] statement." See S.2693, 73d Cong., 2d Sess., § 17(a) (1934). Thus, as initially drafted, the precursor to the express civil liability provision of the 1934 Act would have permitted suits by plaintiffs based solely on the fact that the price of the securities they bought or sold was affected by a misrepresentation: a theory closely akin to the Court's holding today.
Yet this provision was roundly criticized in congressional hearings on the proposed Securities Act, because it failed to include a more substantial "reliance" requirement.*fn8
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Subsequent drafts modified the original proposal, and included an express reliance requirement in the final version of the Act. In congressional debates over the redrafted version of this bill, the then-Chairman of the House Committee, Representative Sam Rayburn, explained that the "bill as originally written was very much challenged on the ground that reliance should be required. This objection has been met." 78 Cong. Rec. 7701 (1934). Moreover, in a previous case concerning the scope of § 10(b) and Rule 10b-5, we quoted approvingly from the legislative history of this revised provision, which emphasized the presence of a strict reliance requirement as a prerequisite for recovery. See Ernst & Ernst v. Hochfelder, supra, at 206 (quoting S. Rep. No. 792, 73d Cong., 2d Sess., 12-13 (1934)).
Congress thus anticipated meaningful proof of "reliance" before civil recovery can be had under the Securities Act. The majority's adoption of the fraud-on-the-market theory effectively eviscerates the reliance rule in actions brought under Rule 10b-5, and negates congressional intent to the contrary expressed during adoption of the 1934 Act.
A second congressional policy that the majority's opinion ignores is the strong preference the securities laws display for widespread public disclosure and distribution to investors of material information concerning securities. This congressionally-adopted policy is expressed in the numerous and varied disclosure requirements found in the federal securities
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law scheme. See, e.g., 15 U. S. C. §§ 78m, § 78o(d) (1982 ed. and Supp. IV).
Yet observers in this field have acknowledged that the fraud-on-the-market theory is at odds with the federal policy favoring disclosure. See, e.g., Black, 62 N. C. L. Rev., at 457-459. The conflict between Congress' preference for disclosure and the fraud-on-the-market theory was well expressed by a jurist who rejected the latter in order to give force to the former:
"Disclosure . . . is crucial to the way in which the federal securities laws function. . . . The federal securities laws are intended to put investors into a position from which they can help themselves by relying upon disclosures that others are obligated to make. This system is not furthered by allowing monetary recovery to those who refuse to look out for themselves. If we say that a plaintiff may recover in some circumstances even though he did not read and rely on the defendants' public disclosures, then no one need pay attention to those disclosures and the method employed by Congress to achieve the objective of the 1934 Act is defeated." Shores v. Sklar, 647 F.2d, at 483 (Randall, J., dissenting).
It is no surprise, then, that some of the same voices calling for acceptance of the fraud-on-the-market theory also favor dismantling the federal scheme which mandates disclosure. But to the extent that the federal courts must make a choice between preserving effective disclosure and trumpeting the new fraud-on-the-market hypothesis, I think Congress has spoken clearly -- favoring the current pro-disclosure policy. We should limit our role in interpreting § 10(b) and Rule 10b-5 to one of giving effect to such policy decisions by Congress.
Finally, the particular facts of this case make it an exceedingly poor candidate for the Court's fraud-on-the-market theory,
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and illustrate the illogic achieved by that theory's application in many cases.
Respondents here are a class of sellers who sold Basic stock between October, 1977 and December 1978, a fourteen-month period. At the time the class period began, Basic's stock was trading at $20 a share (at the time, an all-time high); the last members of the class to sell their Basic stock got a price of just over $30 a share. App. 363, 423. It is indisputable that virtually every member of the class made money from his or her sale of Basic stock.
The oddities of applying the fraud-on-the-market theory in this case are manifest. First, there are the facts that the plaintiffs are sellers and the class period is so lengthy -- both are virtually without precedent in prior fraud-on-the-market cases.*fn9 For reasons I discuss in the margin, I think these two facts render this case less apt to application of the fraud-on-the-market hypothesis.
Second, there is the fact that in this case, there is no evidence that petitioner's officials made the troublesome misstatements for the purpose of manipulating stock prices, or with any intent to engage in underhanded trading of Basic stock. Indeed, during the class period, petitioners do not
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appear to have purchased or sold any Basic stock whatsoever. App. to Pet. for Cert. 27a. I agree with amicus who argues that "imposition of damages liability under Rule 10b-5 makes little sense . . . where a defendant is neither a purchaser nor a seller of securities." See Brief for American Corporate Counsel Association as Amicus Curiae 13. In fact, in previous cases, we had recognized that Rule 10b-5 is concerned primarily with cases where the fraud is committed by one trading the security at issue. See, e.g., Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 736, n. 8 (1975). And it is difficult to square liability in this case with § 10(b)'s express provision that it prohibits fraud " in connection with the purchase or sale of any security." See 15 U. S. C. § 78j(b) (emphasis added).
Third, there are the peculiarities of what kinds of investors will be able to recover in this case. As I read the District Court's class certification order, App. to Pet. for Cert. 123a-126a; ante, at 228-229, n.5, there are potentially many persons who did not purchase Basic stock until after the first false statement (October 1977), but who nonetheless will be able to recover under the Court's fraud-on-the-market theory. Thus, it is possible that a person who heard the first corporate misstatement and disbelieved it -- i.e., someone who purchased Basic stock thinking that petitioners' statement was false -- may still be included in the plaintiff-class on remand. How a person who undertook such a speculative stock-investing strategy -- and made $10 a share doing so (if he bought on October 22, 1977, and sold on December 15, 1978) -- can say that he was "defrauded" by virtue of his reliance on the "integrity" of the market price is beyond me.*fn10
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And such speculators may not be uncommon, at least in this case. See App. to Pet. for Cert. 125a.
Indeed, the facts of this case lead a casual observer to the almost inescapable conclusion that many of those who bought or sold Basic stock during the period in question flatly disbelieved the statements which are alleged to have been "materially misleading." Despite three statements denying that merger negotiations were underway, Basic stock hit record-high after record-high during the 14-month class period. It seems quite possible that, like Casca's knowing disbelief of Caesear's "thrice refusal" of the Crown,*fn11 clever investors were skeptical of petitioners' three denials that merger talks were going on. Yet such investors, the savviest of the savvy, will be able to recover under the Court's opinion, as long as they now claim that they believed in the "integrity of the market price" when they sold their stock (between September and December, 1978).*fn12 Thus, persons who bought after hearing and relying on he falsity of petitioner's statements may be able to prevail and recover money damages on remand.
And who will pay the judgments won in such actions? I suspect that all too often the majority's rule will "lead to large judgments, payable in the last analysis by innocent investors, for the benefit of speculators and their lawyers." Cf. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 867 (CA2 1968) (en banc) (Friendly, J., concurring), cert. denied, 394 U. S. 976 (1969). This Court and others have previously recognized that "inexorably broadening . . . the class of plaintiff[s] who may sue in this area of the law will ultimately result in more harm than good." Blue Chip Stamps v. Manor Drug Stores, supra, at 747-748. See also Ernst v. Ernst v. Hochfelder, 425 U. S., at 214; Ultramares Corp. v. Touche,
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N. Y. 170, 179-180, 174 N. E. 441, 444-445 (1931) (Cardozo, C. J.). Yet such a bitter harvest is likely to be the reaped from the seeds sewn by the Court's decision today.
In sum, I think the court's embracement of the fraud-on-the-market theory represents a departure in securities law that we are ill-suited to commence -- and even less equipped to control as it proceeds. As a result, I must respectfully dissent.
* Briefs of amici curiae urging reversal were filed for the American Corporate Counsel Association by Stephen M. Shapiro, Andrew L. Frey, Kenneth S. Geller, Daniel Harris, and Mark I. Levy; for Arthur Andersen & Co. et al. by Victor M. Earle III, Carl D. Liggio, Donald Dreyfus, Harris J. Amhowitz, Kenneth H. Lang, Richard H. Murray, Leonard P. Novello, and Eldon Olson; and for the American Institute of Certified Public Accountants by Louis A. Craco.
Solicitor General Fried, Deputy Solicitor General Cohen, Jerrold J. Ganzfried, Daniel L. Goelzer, Paul Gonson, Jacob H. Stillman, Eric Summergrad, Katharine B. Gresham, and Max Berueffy filed a brief for the United States as amicus curiae.