Basic Inc. v. Levinson
Encyclopedia
Basic, Inc. v. Levinson, 485 U.S. 224 (1988), was a case in which the Supreme Court of the United States
articulated the "fraud-on-the-market theory" as giving rise to a rebuttable presumption
of reliance in securities fraud
cases.
Basic, Inc., and had engaged in discussions with Basic's officers
and directors
. Three months after these discussions began, Basic asked 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
. Basic president Max Mueller publicly denied Basic's involvement in any merger discussions. The next day, Basic's board approved Combustion's tender offer
for all outstanding shares
.
Plaintiff
Max L. Levinson was a Basic shareholder who brought a class action
suit
against Basic and its directors, alleging that he and other shareholders were injured by selling Basic shares at artificially depressed prices in a market affected by—and relying on—Basic's misleading statements. Plaintiffs alleged that Basic's misrepresentations violated § 10(b) of the Securities Exchange Act of 1934
and SEC Rule 10b-5
.
The United States District Court for the Northern District of Ohio
certified the class, finding that plaintiffs were entitled to a presumption of reliance on Basic's public statements, and therefore that common questions of fact or law predominated over particular questions pertaining to individual plaintiffs. However, on the merits the court granted Basic's motion
for summary judgment
, finding the statements to be immaterial.
The United States Court of Appeals for the Sixth Circuit
affirmed class certification, joining a number of other circuits in accepting the fraud-on-the-market theory. The Court of Appeals also reversed and remanded the decision on summary judgment, holding that although Basic did not have an affirmative duty to disclose the merger discussions, it could not release misleading statements. The U.S. Supreme Court then granted certiorari
to resolve a circuit split
on the materiality issue and determine the propriety of the fraud-on-the-market theory.
, writing for the majority, first examined the underlying policy
behind the Securities Exchange Act: to protect investors against manipulation of stock prices. The Securities and Exchange Commission promulgated Rule 10b-5 to prevent fraud and enforce the Act's requirements.
, 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." This standard was then expressly adopted for § 10(b) and Rule 10b-5.
Blackmun reviewed and rejected the Third Circuit
test that merger discussions become material only when an agreement in principle has been reached, finding that standard too "rigid" and "artificial." Blackmun also rejected the Sixth Circuit test, which held that publicly denying the existence of merger discussions makes those discussions material by virtue of denying their existence. He reasoned that it is not enough for a statement to be untrue if it is insignificant. Blackmun declined to adopt a test that hinged on a single event, holding instead that the materiality of merger discussions is always a function of the probability of the completion of the merger and the magnitude of the transaction.
Observing that the reality of modern securities markets is such that face-to-face transactions are rare, Justice Blackmun noted that requiring a showing of actual reliance would effectively prevent plaintiffs from ever proceeding as a class action. Also finding that investors often rely on market price, he found the rebuttable presumption of reliance (through the fraud-on-the-market theory) to be a reasonable compromise between the requirements of Federal Rules of Civil Procedure
23 and the securities fraud
element of reliance. Blackmun further noted that both Congress' intent and recent empirical studies reflect the idea that open markets incorporate all material information into share price.
The Court thereby adopted a rebuttable presumption of reliance, based on the fraud-on-the-market theory. Blackmun noted that defendants could rebut the presumption by showing that there was no link between the misstatements and plaintiff's price paid or received. Blackmun vacated the decision of the Court of Appeals and remanded the case.
Supreme Court of the United States
The Supreme Court of the United States is the highest court in the United States. It has ultimate appellate jurisdiction over all state and federal courts, and original jurisdiction over a small range of cases...
articulated the "fraud-on-the-market theory" as giving rise to a rebuttable presumption
Rebuttable presumption
Both in common law and in civil law, a rebuttable presumption is an assumption made by a court, one that is taken to be true unless someone comes forward to contest it and prove otherwise. For example, a defendant in a criminal case is presumed innocent until proved guilty...
of reliance in securities fraud
Securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a practice that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of the securities laws....
cases.
Facts and procedural history
Combustion Engineering, Inc. sought to acquireMergers and acquisitions
Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...
Basic, Inc., and had engaged in discussions with Basic's officers
Corporate title
Publicly and privately held for-profit corporations confer corporate titles or business titles on company officials as a means of identifying their function in the organization...
and directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
. Three months after these discussions began, Basic asked the New York Stock Exchange
New York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
to suspend trading in its shares and issued a release stating that it had been "approached" by another company concerning a merger
Mergers and acquisitions
Mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can help an enterprise grow rapidly in its sector or location of origin, or a new field or...
. Basic president Max Mueller publicly denied Basic's involvement in any merger discussions. The next day, Basic's board approved Combustion's tender offer
Tender offer
Tender offer is a corporate finance term denoting a type of takeover bid. The tender offer is a public, open offer or invitation by a prospective acquirer to all stockholders of a publicly traded corporation to tender their stock for sale at a specified price during a specified time, subject to...
for all outstanding shares
Stock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
.
Plaintiff
Plaintiff
A plaintiff , also known as a claimant or complainant, is the term used in some jurisdictions for the party who initiates a lawsuit before a court...
Max L. Levinson was a Basic shareholder who brought a class action
Class action
In law, a class action, a class suit, or a representative action is a form of lawsuit in which a large group of people collectively bring a claim to court and/or in which a class of defendants is being sued...
suit
Lawsuit
A lawsuit or "suit in law" is a civil action brought in a court of law in which a plaintiff, a party who claims to have incurred loss as a result of a defendant's actions, demands a legal or equitable remedy. The defendant is required to respond to the plaintiff's complaint...
against Basic and its directors, alleging that he and other shareholders were injured by selling Basic shares at artificially depressed prices in a market affected by—and relying on—Basic's misleading statements. Plaintiffs alleged that Basic's misrepresentations violated § 10(b) of the Securities Exchange Act of 1934
Securities Exchange Act of 1934
The Securities Exchange Act of 1934 , , codified at et seq., is a law governing the secondary trading of securities in the United States of America. It was a sweeping piece of legislation...
and SEC Rule 10b-5
SEC Rule 10b-5
SEC Rule 10b-5, codified at 17 C.F.R. § 240.10b-5, is one of the most important rules promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under § 10 of the Securities Exchange Act of 1934...
.
The United States District Court for the Northern District of Ohio
United States District Court for the Northern District of Ohio
The U.S. District Court for the Northern District of Ohio is the federal trial court for the northern half of Ohio...
certified the class, finding that plaintiffs were entitled to a presumption of reliance on Basic's public statements, and therefore that common questions of fact or law predominated over particular questions pertaining to individual plaintiffs. However, on the merits the court granted Basic's motion
Motion (legal)
In law, a motion is a procedural device to bring a limited, contested issue before a court for decision. A motion may be thought of as a request to the judge to make a decision about the case. Motions may be made at any point in administrative, criminal or civil proceedings, although that right is...
for summary judgment
Summary judgment
In law, a summary judgment is a determination made by a court without a full trial. Such a judgment may be issued as to the merits of an entire case, or of specific issues in that case....
, finding the statements to be immaterial.
The United States Court of Appeals for the Sixth Circuit
United States Court of Appeals for the Sixth Circuit
The United States Court of Appeals for the Sixth Circuit is a federal court with appellate jurisdiction over the district courts in the following districts:* Eastern District of Kentucky* Western District of Kentucky...
affirmed class certification, joining a number of other circuits in accepting the fraud-on-the-market theory. The Court of Appeals also reversed and remanded the decision on summary judgment, holding that although Basic did not have an affirmative duty to disclose the merger discussions, it could not release misleading statements. The U.S. Supreme Court then granted certiorari
Certiorari
Certiorari is a type of writ seeking judicial review, recognized in U.S., Roman, English, Philippine, and other law. Certiorari is the present passive infinitive of the Latin certiorare...
to resolve a circuit split
Circuit split
In the context of United States federal courts, a circuit split exists when two or more circuits in the United States court of appeals system have different interpretations of federal law....
on the materiality issue and determine the propriety of the fraud-on-the-market theory.
Decision
Justice BlackmunHarry Blackmun
Harold Andrew Blackmun was an Associate Justice of the Supreme Court of the United States from 1970 until 1994. He is best known as the author of Roe v. Wade.- Early years and professional career :...
, writing for the majority, first examined the underlying policy
Policy
A policy is typically described as a principle or rule to guide decisions and achieve rational outcome. The term is not normally used to denote what is actually done, this is normally referred to as either procedure or protocol...
behind the Securities Exchange Act: to protect investors against manipulation of stock prices. The Securities and Exchange Commission promulgated Rule 10b-5 to prevent fraud and enforce the Act's requirements.
Materiality of preliminary merger discussions
Blackmun reviewed the standards of materiality, including the holding in TSC Industries, Inc. v. Northway, Inc.TSC Industries, Inc. v. Northway, Inc.
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 , was a case in which the Supreme Court of the United States articulated the requirement of materiality in securities fraud cases.-Facts and procedural history:...
, 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." This standard was then expressly adopted for § 10(b) and Rule 10b-5.
Blackmun reviewed and rejected the Third Circuit
United States Court of Appeals for the Third Circuit
The United States Court of Appeals for the Third Circuit is a federal court with appellate jurisdiction over the district courts for the following districts:* District of Delaware* District of New Jersey...
test that merger discussions become material only when an agreement in principle has been reached, finding that standard too "rigid" and "artificial." Blackmun also rejected the Sixth Circuit test, which held that publicly denying the existence of merger discussions makes those discussions material by virtue of denying their existence. He reasoned that it is not enough for a statement to be untrue if it is insignificant. Blackmun declined to adopt a test that hinged on a single event, holding instead that the materiality of merger discussions is always a function of the probability of the completion of the merger and the magnitude of the transaction.
Reliance and the fraud-on-the-market theory
The fraud-on-the-market theory is the idea that stock prices are a function of all material information about the company and its business. It applies in open and developed securities markets, where it can be assumed that all material information is available to investors. The theory states that under these conditions, there is a causal link between any misstatement and any stock purchaser, because the misstatements defraud the entire market and thus affect the price of the stock. Therefore, a material misstatement's effect on an individual purchaser is no less significant than the effect on the entire market. The question before the court was whether this entitles an individual stock purchaser a presumption of reliance, even if the purchaser did not directly rely on the misstatements.Observing that the reality of modern securities markets is such that face-to-face transactions are rare, Justice Blackmun noted that requiring a showing of actual reliance would effectively prevent plaintiffs from ever proceeding as a class action. Also finding that investors often rely on market price, he found the rebuttable presumption of reliance (through the fraud-on-the-market theory) to be a reasonable compromise between the requirements of Federal Rules of Civil Procedure
Federal Rules of Civil Procedure
The Federal Rules of Civil Procedure govern civil procedure in United States district courts. The FRCP are promulgated by the United States Supreme Court pursuant to the Rules Enabling Act, and then the United States Congress has 7 months to veto the rules promulgated or they become part of the...
23 and the securities fraud
Securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a practice that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of the securities laws....
element of reliance. Blackmun further noted that both Congress' intent and recent empirical studies reflect the idea that open markets incorporate all material information into share price.
The Court thereby adopted a rebuttable presumption of reliance, based on the fraud-on-the-market theory. Blackmun noted that defendants could rebut the presumption by showing that there was no link between the misstatements and plaintiff's price paid or received. Blackmun vacated the decision of the Court of Appeals and remanded the case.
See also
- List of United States Supreme Court cases, volume 485
- List of United States Supreme Court cases
- Lists of United States Supreme Court cases by volume
- List of United States Supreme Court cases by the Rehnquist Court