Hillary Sale and Robert Thompson have published a new article to SSRN discussing the role of 10b-5 class actions, and, in particular, how private class actions function to protect the goals of securities regulation more broadly, including investor protection and general confidence in U.S. securities markets.  One of their key insights is that the concept of market efficiency is critical both to the current system of regulation, and to the 10b-5 class action – and that there is a basic hypocrisy when large, publicly-traded issuers take advantage of the concept of market efficiency to reduce their regulatory disclosure burdens while simultaneously arguing against market efficiency to defeat securities claims.  They contend the presumption of reliance – and what should be a very narrow space for defendants’ rebuttal of price impact, thus allowing classes to be certified – fits well with the class action’s role in protecting markets.

I agree with their thesis generally, namely, the role that securities class actions play in policing markets, rather than as a direct system for compensating defrauded investors.  In fact, I argued in a recent paper that courts have altered their definitions of organizational scienter to account for the changing role of the securities class action, namely, one focused more on policing markets and promoting the various goals of our regime of securities regulation rather than compensating investors for their losses.  And I believe there’s a strong case to be made – which James Park has explored – that there is value to having private actors, in addition to the SEC, play a role in deterrence/enforcement. 

The problem, of course, is that right now, the 10b-5 cause of action is in something of a transitional stage.  The element of reliance – as constructed via the fraud on the market mechanism – is well-suited to a deterrence/enforcement purpose, but other elements (including damages and loss causation) are not.  These elements remain tied to some construct of specific investor harm that becomes harder and harder to determine the more than the “front end” of the securities class action focuses on marketwide distortion/corruption.   If class actions are deterrent devices rather than compensatory ones, there needs to be some kind of rational calculation regarding appropriate damages due to degree of market harm, balanced against the wrongfulness of the defendants’ conduct.  Right now, nothing in the cause of action provides space for that kind of calculation – instead, all we have are the increasingly artificial constructs of price impact, materiality, and loss causation, which, I believe, is at least one of the reasons for courts’ incoherence  on this subject.