BASIC INCORPORATED, ET AL., PETITIONERS V. MAX L. LEVINSON, ET AL. No. 86-279 In the Supreme Court of the United States October Term, 1986 On Writ of Certiorari to the United States Court of Appeals for the Sixth Circuit Brief For The Securities And Exchange Commission As Amicus Curiae TABLE OF CONTENTS Questions Presented Interest of the Securities and Exchange Commission Statement Summary of argument Argument I. The materiality of ongoing merger activity must be judged on the facts of each case, taking into account the significance the merger would have for the company and the likelihood of its occurrence A. Ongoing merger discussions may be material before an agreement to merge is reached B. The agreement in principle test adopted by the Third and Seventh Circuits is inconsistent with the objectives of the securities laws C. This case should be remanded for an assessment of materiality under the correct standard II. Respondents were entitled to a rebuttable presumption of reliance under the fraud on the market theory Conclusion QUESTIONS PRESENTED 1. Whether the court of appeals employed the correct standard for determining that a corporation's merger negotiations were material to investors, for purposes of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. 240.10b-5. 2. Whether a plaintiff who traded in a corporation's stock on a securities exchange after the issuance of a materially false statement by the corporation is entitled to a rebuttable presumption that he relied on the market price in so trading. Interest Of The Securities And Exchange Commission The Securities and Exchange Commission is the agency responsible for the administration and enforcement of the federal securities laws. This case presents two important questions arising under the antifraud provisions of those laws. The first is the proper standard for assessing the materiality of corporate merger negotiations and other pre-merger activity. In this case, the issue arises in the context of a private damage action against a corporation that was a party to a proposed merger. The same question also arises in other fraud cases, such as private damage actions alleging unlawful insider trading by persons in possession of material, non-public information about merger activity, and in enforcement actions brought by the SEC. The second question is whether a plaintiff who alleges that a corporate misstatement constituted a "fraud on the market" in which he traded is entitled to a rebuttable presumption of reliance. Under the fraud on the market theory, which has been adopted by every court (including eight courts of appeals) to address it, it is presumed that any material corporate misstatement was reflected in the market price of the security and that investors, in making decisions to trade, relied on the integrity of the market price and thus indirectly relied on the misstatement. While the issue does not arise in Commission actions, in which reliance need not be shown, it is often important in private actions to enforce the securities laws, which are a "necessary supplement" to the Commission's enforcement actions. Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 310 (1985) (quoting J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964)). STATEMENT 1. Respondents, former shareholders of Basic Incorporated (Basic), brought this class action against petitioners -- the corporation and certain of its officers and directors -- alleging that petitioners issued three false or misleading public statements in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. 240.10b-5. Respondents claim that they sold shares of Basic stock in a market artificially affected by these statements (Pet. App 2a). Following unusual trading activity in the company's stock, Basic released a public statement on October 21, 1977, reciting that "the company knew no reason for the stock's activity and that no negotiations were under way with any company for a merger" (Pet App 5a). Respondents claim that when Basic issued that public statement the company was in fact engaged in merger negotiations with Combustion Engineering, Inc. (Combustion), which eventually acquired Basic (see id. at 4a-5a). The second and third allegedly false public statements were made on September 25, 1978, and November 6, 1978. On both occasions, Basic announced that its management was "unaware of any present or pending corporate development(s)" that would account for a recent upsurge in trading activity in Basic stock. Respondents contend that these statements were false or misleading because Basic in fact continued to engage in merger negotiations with Combustion (see id. at 5a-7a). On December 20, 1978, Basic announced its approval of a tender offer by Combustion to acquire all of Basic's outstanding shares at a price of $46 per share (id. at 22a). The respondent class consists of persons who sold shares of Basic stock on the New York Stock Exchange on various dates between October 21, 1977 and December 15, 1978, allegedly as a result of one or more of the three statements, at prices allegedly affected by the statements and substantially below $46. The district court certified the class after determining that common issues predominated over individual issues (pet. App. 119a, 127a). An important factor in this determination was the court's conclusion that under the "fraud on the market theory" reliance by each class member on the company's statements could be presumed and that there was no need for each class member to prove subjective reliance (id. at 118a). The district court granted summary judgment for the defendants. It found (see Pet. App. 9a) that Basic's first statement on October 21, 1977 was not false or misleading because there were no negotiations occurring at that time, and that the second (September 25, 1978) and third (November 6, 1978) statements, although made while negotiations were occurring, were not materially false or misleading because the negotiations were not "destined with reasonable certainty, to become a merger agreement in principle" (id. at 103a). In so ruling, the court relied on a modified version of the test for the materiality of merger negotiations announced by the Third Circuit in Staffin v. Greenberg, 672 F.2d 1196 (1982). Under that test, as subsequently reaffirmed and refined by the Third Circuit in Greenfield v. Heublein, Inc., 742 F.2d 751 (1984), cert. denied, 469 U.S. 1215 (1985), merger negotiations are not material until the parties reach an agreement in principle (defined as agreement on price and structure). 2. The Sixth Circuit reversed, concluding that all three of the challenged statements were false or misleading and expressly disagreeing with the Third Circuit's test for materiality. The court of appeals held that, at least where false or misleading corporate statements (rather than a mere failure to disclose) are involved, merger negotiations need not reach an agreement in principle before they become material (Pet App. 13a-15a). With respect to the negotiations here, the court stated that it was "inconceivable" that Basic stockholders would not find the fact that discussions were occurring between Combustion and Basic, in light of Basic's statements, to be important and, therefore, material to making normal reasonable investment decisions" (id. at 13a). The court of appeals added that where, as here, a company chooses to make public statements denying corporate developments, events "that might not have been material in absence of the denial are material because they make the statement made untrue" (id. at 13a-15a). As to class certification, the Sixth Circuit agreed with the district court that under the fraud on the market theory respondents were entitled to a presumption of reliance, that common class issues therefore predominated over individual issues, and that class certification was appropriate (Pet. App. 19a). SUMMARY OF ARGUMENT 1. Except in certain limited circumstances, a company has no affirmative duty to disclose ongoing merger negotiations. If, however, a company chooses to speak publicly, it must not misstate a "material" fact or omit a "material" fact if the omission makes the statement misleading. A fact is "material" if there is a "substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision about the company's stock. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Where the fact is the possible merger, its 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 the light of the totality of the company('s) activity" (SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976 (1969)). Under this standard, discussions and other activities looking toward a possible merger (merger activity) may be material to investors before there is an agreement in principle to merge. Tentative overtures or inquiries will often be immaterial. But if negotiations or other corporate activity not yet disclosed has significantly increased the possibility of a merger that can be expected to affect the value of an investment in the company's securities, that significantly increased possibility will normally be material information. The courts that have held that merger activity is not material until an "agreement in principle" is reached have done so not because they view all prior merger activity as unimportant to a reasonable investor but because of three concerns about the consequences of earlier disclosure. One concern, that disclosure prior to an agreement in principle will inevitably be misleading, is unfounded: corporate officials and their advisers should be capable of accurately describing the situation without understanding or overstating the likelihood that a merger will occur. A second concern, that corporations need a "bright line" test of when merger activity becomes material, also does not warrant use of the agreement in principle standard. Inherent in the Northway "reasonable person" standard of materiality is the understanding that many decisions as to materiality will require the exercise of judgment by persons responsible for corporate disclosure; any bright line rule would inevitably be overinclusive or underinclusive. The third concern, that accurate disclosure may affect or scuttle some negotiations, is an important one, but it does not warrant the conclusion that information is not material prior to an agreement in principle. In most circumstances, the company has the option of remaining silent or declining to comment. Where disclosure is required, many of the details may often be kept secret. In any event, concerns about affecting the course of negotiations do not justify allowing corporations to make materially false or misleading statements on which investors may rely. 2. The courts below properly applied a persumption of reliance by a plaintiff who alleges that corporate misstatements constituted a "fraud on the market." The fraud on the market theory, which has been adopted by all eight courts of appeals that have considered the matter, consists of two rebuttable presumptions: that all information, including corporate misstatements, disseminated into an active secondary market is reflected in the price of securities traded in that market; and that investors who buy and sell after a misstatement has been made rely on the integrity of the market price and are therefore relying indirectly on the misstatement. Under this theory, direct reliance on a corporate misstatement need not be proved. The fraud on the market theory is amply supported by extensive empirical evidence about the functioning of capital markets and by common-sense observations about investor behavior. The presumption of reliance promotes judicial efficiency; it is consistent with basic assumptions regarding the operation of capital markets that underlie the federal securities laws; it promotes the integrity of those markets by facilitating the prosecution of private securities fraud actions; and it eliminates the need for investors to meet often impractical evidentiary burdens. ARGUMENT I. THE MATERIALITY OF ONGOING MERGER ACTIVITY MUST BE JUDGED ON THE FACTS OF EACH CASE, TAKING INTO ACCOUNT THE SIGNIFICANCE THE MERGER WOULD HAVE FOR THE COMPANY AND THE LIKELIHOOD OF ITS OCCURRENCE A. Ongoing Merger Discussions May Be Material Before An Agreement To Merge Is Reached 1. As the court below recognized, a company generally has no affirmative duty under the federal securities laws to disclose ongoing merger activity and may elect to remain silent even if the information would be material to investors (see Pet. App. 9a). Disclosure is required only in certain limited circumstances, such as where a company is trading in its own stock, and thus has a duty to disclose all material information, /1/ where the company is responsible for leaks into the market /2/ or where regulations promulgated by the Commission require disclosure. /3/ But it is a different situation when a company chooses to make "assertions * * * in a manner reasonably calculated to influence the investing public." SEC v. Texas Gulf Sulfur Co., 401 F.2d 833, 862 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976 (1969). Then the company violates Rule 10b-5 when the information it disseminates contains a material misstatement or omits to state a material fact whose omission renders the statement misleading. Ibid. 2. In general, a fact is material "if there is a substantial likelihood that a reasonable shareholder would consider it important" in making an investment decision or if it would have "significantly altered the 'total mix' of information made available" to the shareholder. TSC Industries, Inc. v Northway, Inc., 426 U.S. 438, 449 (1976). /4/ Where a corporate development is certain, its significance to investors depends on its importance to the company's fortunes. But where a potential future event is not certain to occur, as is the case with a possible merger, the assessment of 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('s) activity." SEC v. Texas Gulf Sulphur Co., 401 F.2d at 849. Accord, SEC v. MacDonald, 699 F.2d 47, 50 (1st Cir. 1983); SEC v. Mize, 615 F.2d 1046, 1051 (5th Cir.), cert. denied, 449 U.S. 901 (1980); Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 887-888 (2d Cir. 1972). Ordinarily, neither the probability nor the magnitude of a prospective event can be stated with mathematical precision. See Northway, 426 U.S. at 448. But imprecision is inherent in the Northway standard of materiality, of which the probability/magnitude formula is a part. See id. at 450 ("(t)he 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"). 3. In accordance with these principles, the materiality of merger discussions must be judged in each case on its facts. For example, in SEC v. Shapiro, 494 F.2d 1301 (2d Cir. 1974), the court, in considering the materiality of merger discussions, refused to "establish a rule as to when information * * * becomes material" because such a determination must be made "'according to the fact pattern of each specific transaction.'" Id. at 1306 (quoting Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d at 888). Accord, Grigsby v. CMI Corp., 765 F.2d 1369, 1373, 9th Cir. 1985) ("The materiality of preliminary merger negotiations depends on the facts of the case."). A merger is often such a significant event that, even where agreement is far from certain, the existence of merger activity may be material to investors. /5/ In SEC v. Geon Industries, Inc., 531 F.2d 39, 47-48 (2d Cir. 1976) -- a case in which "embryonic" merger talks were held to be material -- Judge Friendly stated that 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," negotiations "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 states is doubtless high." /6/ The possibility of a merger may have an immediate importance to investors in the company's securities even if no merger ultimately takes place. For example, in SEC v. Gaspar, (1984-1985) Fed.Sec. L. Rep. (CCH) Paragraph 92,004 (S.D.N.Y. 1985), the company's announcement of preliminary (though ultimately unsuccessful) merger talks sent the stock's price soaring by more than 40% on greatly increased volume. /7/ And, as recent events illustrate, enormous illegal profits may be obtained by insiders privy to early merger discussions and by their tippees who trade in the target's stock before an agreement in principle has been reached. /8/ Not every conversation or other activity that might eventually lead to a merger is material. As this Court stated in Northway, "(s)ome information is of such dubious significance that insistence on its disclosure may accomplish more harm than good" (426 U.S. at 448). The possibility of acquisition exists, in varying degrees, for many companies much of the time, and overtures unlikely to lead anywhere are common. /9/ But if events not yet disclosed have significantly increased the possibility of an acquisition at a premium price (or on any terms that are likely to affect the value of an investment in the company's securities), that significantly increased possibility is material information even if no agreement on price and structure has been reached: it is obvious that a reasonable investor would attach importance to such a development. /10/ The willingness of securities professionals to spend enormous sums to trade while in possession of information about early merger activity is ample evidence of the information's significance. /11/ When a target company and an acquiror have both exhibited serious interest in an acquisition, there is ordinarily a significantly increased possibility that it will occur. The degree of interest of the target company and the potential acquiror is of course evidenced not only by their overt expressions but also by their conduct, including the time and resources devoted to the possible acquisition, the level in each company at which it is considered, the extent to which experts, such as outside counsel or investment bankers, are involved, and similar factors. An agreement on price and structure is surely a sufficient, but not a necessary, indicator of enough mutual interest to show that the possibility of a consummated transaction has been significantly increased. There will also be instances where merger activity is material before the target has expressed any interest. In appropriate circumstances, the mere fact that an offer is to be made can be material. Some offers may be so attractive that they are very unlikely to be refused. In addition, friendly offers are commonly a prelude to hostile tender offers (see 1 M. Lipton & E. Steinberger, Takeovers & Freezeouts Section 6.04(1), at 6-47 (1986)), the materiality of which is beyond doubt. /12/ If it has received (or knows it will receive) such an offer, a company cannot truthfully tell its shareholders that there are no significant corporate developments. B. The Agreement In Principle Test Adopted By The Third And Seventh Circuits Is Inconsistent With The Objectives Of The Securities Laws In contrast to the discerning inquiry that Northway requires and which many courts have undertaken (see note 6, supra), the Third and Seventh Circuits have adopted the rule that as a matter of law merger negotiations are not material until the parties reach an agreement in principle, defined as agreement on "price and structure." E.g., Staffin, 672 F.2d at 1207; Heublein, 742 F.2d at 757; /13/ see Flamm v. Eberstadt, No. 86-1754, (7th Cir. Mar. 9, 1987), slip op. 16; Jordan v. Duff & Phelps, Inc., No. 86-1611 (7th Cir. Mar. 17, 1987), slip op. 1. /14/ The agreement in principle rule is not based on the conclusion that no earlier merger activity is important to the reasonable investor. See Flamm, slip op. 9 (the notion that preliminary merger negotiations are not important to investors "is simply another cause for wonderment at the legal mind"). Rather, it has been defended on the basis of three policy considerations related to the Northway standard: first, that disclosure of early negotiations "may itself be misleading to shareholders," since investors may be lured into false optimism about merger prospects that fail to materialize (Heublein, 742 F.2d at 756; see also Staffin, 672 F.2d at 1206); second, that the agreement in principle test provides "a useable and definite measure for determining when disclosures need be made" (Heublein, 742 F.2d at 757; see also Flamm, slip op. 15); and third, that earlier disclosure "might seriously inhibit such acquisitive ventures" (Heublein, 742 F.2d at 757; see also Flamm, slip op. 10, 12-15; Staffin, 672 F.2d at 1206-1207). /15/ The first rationale -- essentially that accurate disclosure of merger activity is impossible -- has no plausible basis; it assumes that companies and investors lack the capacity, respectively, to communicate and comprehend. But the proposition that the English language is incapable of supplying words that disclose merger activity without overstatement or understatement is a frontal assault on the disclosure philosophy of the securities laws. As the Seventh Circuit recently observed (Flamm, slip op. 10-11), the proposition that shareholders will inevitably misunderstand: assumes that investors are * * * unable to appreciate -- even when told -- that mergers are risky propositions up until the closing. * * * To attribute to investors a child-like simplicity, an inability to grasp the probabilistic significance of negotiations, implies that they should not be told about new plants, new products, new managers, or any of the other changes in the life of the corporation. The second justification for the agreement in principle test, the purported need for a "bright line" rule to provide corporate certainty, touches on matters of more substance. Clear-cut guides to conduct are desirable, but they also have their drawbacks especially where, as in this field, the topography is too uneven to permit the drawing of bright-line rules that serve the statutory objectives. Some measure of uncertainty is inherent in the Northway test of materiality because decisions about whether corporate information is material depend on all the circumstances. Any rule that makes a single event (such as the reaching of an agreement in principle) the conclusive determinant of materiality in all cases will either excuse some falsehoods about significant matters or impose liability on account of misstatements of trivial information, a result against which Northway cautioned. /16/ The third rationale for the agreement in principle test is that disclosure may affect or stifle merger negotiations. This is an important concern, but it does not warrant the conclusion that information is not material prior to an agreement in principle. As we have explained, companies have no general affirmative duty under the federal securities laws to disclose even material merger negotiations. Even in the face of inquiries, a company generally may remain silent, or say "no comment." /17/ Furthermore, even if some facts regarding negotiations are disclosed, many details, including the identity of the other party to the talks and the precise terms discussed, may often remain secret. /18/ It is also very possible that fears that accurate disclosure will inhibit negotiations have been greatly exaggerated. /19/ But the fundamental point is that the anti-fraud provisions of the federal securities laws, and the philosophy on which they are based, simply do not permit corporate managements to utter materially misleading statements in order to achieve the greater good for some (or even all) shareholders. /20/ No rule of law condones fraud simply so that other corporate goals might thereby be served. /21/ C. This Case Should Be Remanded For An Assessment of Materiality Under the Correct Standard While the decision below correctly rejected the agreement in principle test, it did not evidence the careful inquiry we have described. Instead, it suggested that "information concerning ongoing acquisition discussions becomes material by virtue of the statement denying their existence" (Pet. App. 13a (emphasis in original)), and 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" (id. at 14a-15a (footnote omitted)). This apparent equating of falsehood and materiality has no basis under Northway and would appear to render any false statement, regardless of how trivial, per se material. /22/ Because the court of appeals confused the falsity of a statement with the materiality of negotiations, it failed to specify the factors to be considered in assessing materiality and failed to apply the correct standard to the facts of this case. Accordingly, the judgment below should be vacated and the case should be remanded for a determination of materiality on the basis of the principles set forth above. We believe there is sufficient evidence for a trier of fact to find that at the time of the second and third statements, the events had created a significantly greater possibility of a value-affecting acquisition than investors had reason to expect on the basis of publicly available information. We therefore disagree with the district court's conclusion that those events were immaterial as a matter of law and with its grant of summary judgment as to Basic's second and third public statements. Reviewing the events in the months prior to the two statements (Pet. App. 100a), the district court concluded "that, considered most favorably for the plaintiffs, they represented preliminary merger discussions between Combustion and Basic." The possibility of a merger between Combustion and Basic was being seriously discussed at the highest levels of the two companies. Basic's chairman (and chief executive officer) was personally involved in discussions with a senior officer of Combustion, who in turn, the district court found, was keeping his superiors advised of the state of discussions (id. at 70a-71a). Far from rebuffing Combustion's overtures, Basic at least entertained the prospect of a merger, the companies had begun to discuss price (id, at 77-78a, 101a), and Basic provided confidential financial information to Combustion to assist it in preparing an offer (id. at 71a-73a, 81a-85a, 101a). Basic's first statement was issued approximately fourteen months before a merger agreement was reached and almost a year before the second statement. The courts below viewed the evidence of merger activity prior to the first statement differently. The district court indicated that, prior to that statement, Combustion on several occasions expressed interest in acquiring Basic (Pet. App. 50a, 53a-55a), but that there was no evidence that other conversations between the companies, alleged by plaintiffs to be merger discussions, related to an acquisition rather than to other business (id. at 48a, 55a-56a). In the district court's view, Basic had expressed no reciprocal interest in a merger at that point (id. at 55a) and was, in fact, not interested (id. at 45a), although it gave Combustion confidential financial information that could be found to have been given "in connection with" Combustion's expression of interest (id. at 52a). /23/ This description of the events would support a conclusion that although, like many companies at most times, Basic was a subject of some acquisition interest, events had not yet significantly increased the possibility that the company would be acquired. The court of appeals read the record on the motion for summary judgment differently. It said that in September 1976, a year before the first statement, Basic's chairman had been approached by Combustion's vice president to discuss the possibility of a merger (Pet. App. 3a-4a), and that the companies had "numerous" telephone conversations and meetings to discuss a possible merger (id. at 4a). The court also stated that Basic gave Combustion confidential financial information, that Basic's lawyers discussed a possible Combustion bid, and that Basic and its investment bankers discussed preparation of an evaluation of Basic to use in merger negotiations (id. at 4a-5a). On remand, the court of appeals will have to determine whether summary judgment as to the first statement was warranted under the proper standard of materiality. II. RESPONDENTS WERE ENTITLED TO A REBUTTABLE PRESUMPTION OF RELIANCE UNDER THE FRAUD ON THE MARKET THEORY The court of appeals in this case correctly held, as has every other court to consider the issue, /24/ that a plaintiff alleging fraud under Rule 10b-5 may, in circumstances where a materially false or misleading corporate statement has been disseminated into the trading market, invoke a rebuttable presumption of reliance upon the integrity of the market price. Reliance is generally part of the logical chain needed to establish that a defendant's misrepresentation or omission was the cause in fact of the plaintiff's injury. See List v. Fashion Park, Inc., 340 F.2d 457, 462, (2d Cir.), cert. denied, 382 U.S. 811 (1965). Although the requirement is ordinarily met by showing the plaintiff's actual subjective reliance on the defendant's statement (see 3 L. Loss, Securities Regulation 1430-1432 (2d ed. 1961)), courts have held that proof of such direct reliance is not necessary in certain cases, including those alleging a "fraud on the market. The fraud on the market theory rests on two propositions (see Pet. App. 17a): that in an active secondary market the price of a company's stock is determined by all material information available regarding the company and its business; /25/ and that investors rely on the integrity of market prices when making investment decisions. See, e.g., Peril v. Speiser, 806 F.2d 1154, 1161, (3d Cir. 1986); Blackie v. Barrack, 524 F.2d 891, 907 (9th Cir. 1975), cert. denied, 429 U.S. 816 (1976). These propositions together establish that such investors rely, albeit indirectly, on material misrepresentations concerning actively traded securities (Pet. App. 17a). See Blackie v. Barrack, 524 F.2d at 907. /26/ Courts could have placed on the plaintiff the burden of demonstrating in a particular case that the market price reflected corporate misstatements and that he in fact relied on the integrity of the market price. In practice, however, every court that has adopted the fraud on the market theory in the context of an active secondary market has also applied a presumption in favor of the plaintiff as to these matters. Three well-founded reasons support this approach. First, the empirical and common-sense evidence in support of the two propositions comprising the theory is so strong that it is sensible, as a matter of logic and judicial efficiency, to apply a rebuttable presumption that the propositions are true. Second, the presumption facilitates important policy objectives underlying the federal securities laws. /27/ Finally, the presumption relieves the plaintiff of an evidentiary burden it is not practical to place on him. Studies have firmly established that active secondary markets are efficient transmitters of corporate information and that prices in such markets reflect that information. /28/ In In re LTV Securities Litigation, 88 F.R.D. 134, 135, 144 (N.D. Tex. 1980), the court summarized the point, saying that numerous economic studies demonstrated that "the market price of (widely-followed securities of larger corporations) reflects all available public information -- and hence, necessarily, any material misrepresentations as well." Many other courts have accepted the overwhelming empirical evidence that the prices of securities traded in active secondary markets reflect information disseminated into those markets. /29/ Courts have similarly accepted the common-sense observation that most investors rely on the integrity of the market in making trading decisions. /30/ As one court has noted, "it is hard to imagine that 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 (S.D.N.Y. 1982). The fact that investors are in the market at all is evidence that they rely on the assumption "that the market is not being manipulated as a result of anybody's false statement or misleading omission." Ibid. The presumptions underlying the fraud on the market theory also promote important policies under the federal securities laws. The federal securities laws were adopted in large measure to restore integrity to, and invesotr confidence in, the securities markets. The House Report recommending enactment of the Securities Exchange Act notes that honest corporate information is essential to assure that the markets reflect the "real value" of securities (H.R. Rep. 1383, 73d Cong., 2d Sess. 11 (1934) (emphasis added)): 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 judgment 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. A fundamental premise of the Securities Exchange Act is, in short, that the markets are affected by information, to that "(t)here cannot be honest markets without honest publicity" (ibid.). An equally fundamental premise is that investors rely on the integrity of markets. A defendant contending that these basic premises are not true in a particular case should bear the burden of proving it. The courts have viewed the fraud on the market theory, and the accompanying presumption of reliance, as a means of furthering the statutory goal of ensuring honest securities markets. See, e.g., Lipton v. Documation, Inc., 734 F.2d 740, 748 (11th Cir. 1984), cert. denied, 469 U.S. 1132 (1985) ("The theory thus actually facilitates Congress' intent * * * by enabling a purchaser to rely on an expectation that the securities markets are free from fraud."); In re LTV Securities Litigation, 88 F.R.D. at 145. To the extent that private securities fraud actions may be prosecuted more efficiently by adoption of the fraud on the market theory and its presumption of reliance, the enforcement of the securities laws, and the underlying goal of honest markets, are furthered. /31/ Finally, placing the burden of proof on a plaintiff alleging fraud on the market would impose an unrealistic evidentiary burden. See Lipton v. Documation, Inc., 734 F.2d at 743; Panzirer v. Wolf, 663 F.2d at 367; Blackie v. Barrack, 524 F.2d at 907; Rosenberg v. Digilog, Inc., 648 F.Supp. 40, 43 (E.D. Pa. 1985). /32/ Of course, a plaintiff could offer evidence that he relied on the integrity of the market in making his investment decision. But proving affirmatively that the market price of a security was affected by corporate misstatements may be difficult. A plaintiff might have to present extensive and hard to obtain evidence as to who in fact traded in the stock following the corporate statement, how many of those traders were in fact aware of the statement and whether they in fact relied on the statement in making their trading decisions. Cf. Mills v. Electric Auto-Lite Co., 396 U.S. 375, 385 (1970) (misleading proxy statements). /33/ The fraud on the market theory merely accommodates these various concerns by recognizing the obvious, that market prices generally reflect corporate information and that investors generally rely on the integrity of the market price, and by relieving plaintiffs of the need to reprove these matters in each case. /34/ The theory does not dispense with the requirement of reliance in Rule 10b-5 cases but places the burden on the defendant to prove that a particular case is atypical. In so doing, the fraud on the market theory facilitates securities fraud actions by injured investors, allows those actions to be prosecuted with greater judicial efficiency, and promotes important goals of investor protection under the federal securities laws. CONCLUSION The judgment of the court of appeals should be affirmed in part and vacated in part, and the case should be remanded for further proceedings. Respectfully submitted. CHARLES FRIED Solicitor General LOUIS R. COHEN Deputy Solicitor General JERROLD J. GANZFRIED Assistant to the Solicitor General DANIEL L. GOELZER General Counsel PAUL GONSON Solicitor JACOB H. STILLMAN Associate General Counsel ERIC SUMMERGRAD Assistant General Counsel KATHARINE B. GRESHAM MAX BERUEFFY Attorneys Securities and Exchange Commission APRIL 1987 /1/ See, e.g., Jordan v. Duff & Phelps, Inc., No. 86-1611 (7th Cir. Mar. 17, 1987), slip op. 10; Staffin v. Greenberg, 672 F.2d 1196, 1205 (3d Cir. 1982); Arber v. Essex Wire Corp., 490 F.2d 414, 418 (6th Cir.), cert. denied, 419 U.S. 830 (1974). See generally Dirks v. SEC, 463 U.S. 646 (1983); Chiarella v. United States, 445 U.S. 222 (1980). /2/ See, e.g., State Teachers Retirement Bd. v. Fluor Corp., 654 F.2d 843, 850 (2d Cir. 1981). /3/ For example, a company is required to disclose on Schedule 14D-9 merger negotiations undertaken in response to a tender offer. 17 C.F.R. 240.14d-101, Item 7. See In re Revlon, Inc., Exchange Act Release No. 23,320, 35 S.E.C. Dkt. 1541, 1550-1552 (June 16, 1986). See also Item 3(b) of Schedule 14D-1, 17 C.F.R. 240.14d-100; Item 3(b) of Schedule 13E-3, 17 C.F.R. 240.13e-100; Item 504 of Regulation S-K, Instruction 6, 17 C.F.R. 229.504. The fact that a Commission form or schedule requires disclosure does not necessarily mean that the information would be material in the absence of that disclosure requirement. /4/ Northway arose under the proxy solicitation provisions of the Securities Exchange Act, but subsequent decisions have applied its test of materiality in cases arising under Section 10(b) and Rule 10b-5, involving purchases and sales of securities. See, e.g., McGrath v. Zenith Radio Corp., 651 F.2d 458, 466 n.4 (7th Cir.), cert. denied, 454 U.S. 835 (1981); Goldberg v. Meridor, 567 F.2d 209, 218 (2d Cir. 1977), cert. denied, 434 U.S. 1069 (1978); Healey v. Catalyst Recovery of Pennsylvania, Inc., 616 F.2d 641, 647 (3d Cir. 1980). /5/ See, e.g., Dennis & McConnell, Corporate Mergers and Security Returns, 16 J. Fin. Econ. 143, 154 (1986) (average increase of 8.56% in price of acquired companies' shares in two-day period surrounding announcement of a merger); Jensen & Ruback, The Market for Corporate Control, 11 J. Fin. Econ. 5, 7-8 (1983) (average gain to target company shareholders of 20%); Economic Report of the President 197 (1985) ("recent studies find average gains (from successful takeovers) in the range of 16 to 34 percent of the value of the target's shares"). /6/ See also SEC v. Shapiro, 494 F.2d 1301, 1306-1307 (2d Cir. 1974); Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 368 (2d Cir.), cert. denied, 414 U.S. 910 (1973); Holmes v. Bateson, 583 F.2d 542, 558 (1st Cir. 1978) (merger negotiations that had not yet reached the point of discussing terms were nonetheless material); Rogen v. Ilikon Corp., 361 F.2d 260, 266 (1st Cir. 1966) ("(e)ven with the possibility of (their) collapse," negotiations could be material); Dungan v. Colt Industries, Inc., 532 F. Supp. 832, 837 (N.D. Ill. 1982) (fact that the defendants were seriously exploring the sale of their company was material); American General Insurance Co. v. Equitable General Corp., 493 F. Supp. 721, 744-745 (E.D. Va. 1980) (merger negotiations were material four months before agreement in principle was reached); Levin v. Marder, 343 F. Supp. 1050, 1058 (W.D. Pa. 1972) ("'preliminary proposal' of merger "may well be material"); Schlanger v. Four-Phase Systems, Inc., 582 F. Supp. 128, 131-132 (S.D.N.Y. 1984) ("no corporate developments" statement issued by a company in the fact of unusually heavy market activity in its stock could be materially false or misleading in that it failed to disclose pending merger negotiations that had not reached the point of agreement); In re Carnation Corp., Exchange Act Release No. 22,214, 33 S.E.C. Dkt. 1025, 1031-1034 (July 8, 1985) (materially misleading to issue two "no corporate developments" statements in response to unusual market activity at a time when the company was engaged in preliminary merger discussions that were far from certain to result in an agreement). /7/ See also Mikkelson & Ruback, An Empirical Analysis of the Interfirm Equity Investment Process, 14 J. Fin. Econ. 523, 535 (1985) (finding an average 7.74% increase in stock price following Commission filings by persons who acquire 5% or more of a company's stock and indicate that they are considering acquiring control, but only 3.24% increase where investment intent only was expressed). Other studies show a consistent price rise in the potential target's securities over a substantial period leading up to the day of the public announcement of a merger or merger negotiations; this is presumably due either to illegal trading by those with access to information about the merger activity, or legal trading by persons trading on educated speculation or rumors about a possible merger, or both. See Office of the Chief Economist, SEC, Stock Trading Before the Announcement of Tender Offers: Insider Trading or Market Anticipation? 17-20, 27-29, Table 7 (Feb. 24, 1987); Keown & Pinkerton, Merger Announcements and Insider Trading Activity: An Empirical Investigation, 36 J. Fin. 855 (1981). /8/ See, e.g., SEC v. Boesky, No. 86 Civ. 8767 (S.D.N.Y. Nov. 14, 1986), discussed in Lit. Release No. 11,288, 37 S.E.C. Dkt. 78 (Dec. 2, 1986); SEC v. Levine, No. 86 Civ. 3726 (S.D.N.Y. May 12, 1986), discussed in Lit. Release No. 11,095, 35 S.E.C. Dkt, 1212 May 27, 1986); SEC v. Katz, No. 86 Civ. 6,088 (S.D.N.Y., filed Aug. 7, 1986), discussed in Lit. Release No. 11,185, 36 S.E.C. Dkt. 448 (Aug. 19, 1986); SEC v. Thayer, No. CA-3-84-0471-R (N.D. Tex. May 7, 1985), discussed in Lit. Release No. 10,746, 33 S.E.C. Dkt. 74 (May 21, 1985); SEC v. Gaspar, (1984-1985) Fed. Sec. L. Rep. (CCH) Paragraph 92,004; SEC v. Siegel, No. 87 Civ. 0963 (S.D.N.Y., filed Feb. 13, 1987), discussed in Lit. Release No. 11,354, 37 S.E.C. Dkt. 1276 (Mar. 3, 1987). One commentator has noted (Olson, Revealing Merger Talks: When, How Are Critical, Legal Times, Oct. 14, 1985, at 22 (emphasis in original)): As market activity based on acquisition rumors in case after case has shown, preliminary merger or takeover discussions are significant to investors in the target's securities and no amount of well-intentioned judicial rationalization in the search for bright-line rules can make that simple fact of materiality disappear. /9/ See, e.g., Susquehanna Corp. v. Pan American Sulphur Co., 423 F.2d 1075, 1085 (5th Cir. 1970), in which the court held immaterial a "unilateral offer to negotiate" made by a large shareholder of the potential acquiror that was repudiated two days later by the potential target's board, was never acknowledged by the potential target and "never got off the ground". See also List v. Fashion Park, Inc., 340 F.2d 457, 464 (2d Cir.), cert. denied, 382 U.S. 811 (1965) (president of company knew nothing more than the name of a potential purchaser); Bucher v. Shumway, (1979-1980 Transfer Binder) Fed. Sec. L. Rep. (CCH) Paragraph 91,142, at 96,302 (S.D.N.Y. Oct. 11, 1979) ("mere overtures or inquiries"), aff'd without opinion, 622 F.2d 572 (2d Cir.), cert. denied, 449 U.S. 841 (1980); Berman v. Gerber Products Co., 454 F. Supp. 1310, 1316, 1318 (W.D. Mich. 1978) ("mere overtures"); Scott v. Multi-Amp Corp., 386 F. Supp. 44, 65 (D.N.J. 1974) ("casual inquiry"). /10/ The stage at which merger activity becomes material depends in part on the likelihood of a premium price or other effect on value. For example, the effect of acquisitions on the prices of securities of acquiring companies, which generally are larger than acquired companies, is less certain. See, e.g., Jensen & Ruback, The Market for Corporate Control, 11 J. Fin. Econ. 5, 16-17 (1983); Dodd, Merger Proposals, Management Discretion and Stockholder Wealth, 8 J. Fin. Econ. 105, 134-135 (1980). Thus, merger activity might become material to investors trading in the potential acquiror's stock at a later stage than to investors in the potential target. /11/ For example, in one case recently brought by the Commission, an investment banker retained by the Carnation Company was alleged to have tipped an arbitrageur about a possible friendly takeover of Carnation by Nestle Corporation. The tipping occurred over a period three to five months before an agreement in principle was reached. The arbitrageur purchased 1.7 million shares of Carnation common stock and realized a profit of approximately $28.3 million after the merger was announced. See SEC v. Siegel, No. 87 Civ. 0963 (S.D.N.Y., filed Feb. 13, 1987), discussed in Lit. Release No. 11,354 37 S.E.C. Dkt. 1276 (Mar. 3, 1987). At least two months after the tipping alleged in the Siegel case, Carnation issued statements denying the existence of any corporate developments that would account for price surges in the company's stock. The Commission found that those statements were materially false and misleading. See In re Carnation Co., Exchange Act Release No. 22,214, 33 S.E.C. Dkt. 1025 (July 8, 1985). /12/ Numerous cases in recent years have charged that persons traded illegally in target company stocks while in possession of non-public information regarding a tender offer to be made for the company. See, e.g., United States v. Newman, 664 F.2d 12, aff'd after remand, 722 F.2d 729 (2d Cir. 1981), cert. denied, 464 U.S. 863 (1983); SEC v. Materia, 745 F.2d 197 (2d Cir. 1984), cert. denied, 471 U.S. 1053 (1985); SEC v. Siegel, No. 87 Civ. 0963 (S.D.N.Y. Feb, 13, 1987); SEC v. Boesky, No. 86 Civ. 8767 (S.D.N.Y. Nov. 14, 1986); SEC v. Levine, No. 86 Civ. 3726 (S.D.N.Y. May 12, 1986). /13/ The district court in this case applied a modified version of the Staffin/Heublein standard, holding that merger negotiations are not material, as a matter of law, until agreement in principle is "reasonably certain" (Pet. App. 65a). /14/ In Flamm and Jordan the Seventh Circuit applied the agreement in principle test to what it treated as mere failures to disclose. The Seventh Circuit reserved the question whether it would apply the agreement in principle test in a case involving false or misleading corporate statements. Flamm, slip op. 18. Contrary to petitioners' suggestion, we do not believe that in Reiss v. Pan American World Airways, Inc., 711 F.2d 11 (1983), the Second Circuit abandoned its traditional standard of materiality in favor of the agreement in principle test. See Gov't Amicus Br. in Support of Pet. 12 n.13. /15/ The policy considerations articulated by the Third and Seventh Circuits do not apply in all fraud cases. In particular, they do not apply in an insider trading case, since a corporate insider need not make disclosure at all (indeed, it probably would be a breach of duty to do so), but can simply refrain from trading. See, e.g., Chiarella v. United States, 445 U.S. at 227. Thus, a separate objection (beyond those discussed in the text) to skewing the definition of materiality on account of these policy considerations is that doing so would make the same facts material in some legal contexts but not others, a result for which there is no warrant. The alternative, applying the agreement in principle test in all cases, would allow insider trading on highly significant information about pending acquisitions. /16/ See Staff of House Comm, on Interstate and Foreign Commerce, 95th Cong., 1st Sess., Report of the Advisory Comm. on Corporate Disclosure to the Securities and Exchange Commission 327 (Comm. Print 1977): Although the Committee believes that ideally it would be desirable to have absolute certainty in the application of the materiality concept, it is its view that such a goal is illusory and unrealistic. The materiality concept is judgmental in nature and it is not possible to translate this into a numerical formula. The Committee's advice to the Commission is to avoid this quest for certainty and to continue consideration of materiality on a case-by-case basis as problems are identified. /17/ It has been suggested that a "no comment" response is impractical. In Flamm, slip op. 16-17, the Seventh Circuit stated that since companies may ordinarily wish to deny false rumors of corporate developments, a "no comment" response will effectively confirm that there are developments. But this dilemma is not resolved by allowing a company to make false denials of corporate developments. If false denials were permitted, then truthful denials would lose meaning, because the market would know that the company could be lying. For the market to have confidence in corporate statements, a consistent policy of truthfulness about material matters is essential (see note 20, infra). /18/ For example, the instructions to Commission Schedule 14D-9 expressly draw a distinction, for purposes of disclosure of merger negotiations in Item 7 of that Schedule, between disclosing the fact of negotiations and disclosing the parties to the negotiations and the terms being discussed. The latter need not be disclosed if it would harm the negotiations. The limitations on the scope of disclosure required under Schedule 14D-9 were adopted in response to industry concerns that too much disclosure would stifle negotiations. See Exchange Act Release No. 6,158, 18 S.E.C. Dkt. 1053, 1070 (Nov. 29, 1979). Although this degree of disclosure may often also be sufficient for purposes of the antifraud provisions of the securities laws, it should be noted that under some circumstances additional disclosure might be necessary under those provisions. Ibid. /19/ One recent commentator notes that "(t)he notion that early disclosure prevents mergers has never been empirically confirmed. * * * Courts have relied solely on assertions of the business community and representatives of the stock market." Comment, Disclosure of Preliminary Merger Negotiations Under Rule 10b-5, 62 Wash. L. Rev. 81, 94 (1987) (footnote omitted). /20/ Such misstatements also impair capital markets. As the Commission stated in In re Carnation Corp., 33 S.E.C. Dkt. at 1030: The importance of accurate and complete issuer disclosure to the integrity of the securities markets cannot be overemphasized. To the extent that investors cannot rely upon the accuracy and completeness of issuer statements, they will be less likely to invest, thereby reducing the liquidity of the securities markets to the detriment of investors and issuers alike. /21/ The Seventh Circuit has suggested that a corporation may have a duty to its shareholders to remain silent as to the state of merger negotiations. See Flamm, slip op. 12-15. The court reasoned that while some shareholders may, as a result of corporate silence, sell their stock at less than they might have received if they had known of the prospective merger, the silence helps to assure that the shareholders overall will benefit from a successful merger. But where silence would be fraudulent, such as where the company is trading in its own securities, the company cannot remain silent. And, if the company chooses to speak, basic principles prohibit it from lying about material events and thereby misleading both shareholders and the trading market. Cf. 2 F. Harper, F. James & O. Gray, The Law of Torts Section 7.2 at 388 (2d ed. 1986) (footnote omitted) (even at common law, "(a) plaintiff is within the scope of the duty not to deceive where defendant intended him to act on the misrepresentation whether or not defendant's motives were benign or altruistic."). /22/ The court may not have intended such a result. One of the judges on the basic panel, concurring in the denial of rehearing en banc, expressly took the position that the decision does not stand for this result (Pet. App. 145a-146a). /23/ The court also stated that Basic's internal discussions of Combustion's interest in acquiring Basic took place in the context of discussing several companies' interest in Basic (Pet. App. 45a-46a, 51a), and that Basic met with its investment bankers to discuss possible acquisitions by Basic of two companies, not Combustion's possible acquisition of Basic (id. at 56a). /24/ See Peil v. Speiser, 806 F.2d 1154 (3d Cir. 1986); Harris v. Union Electric Co., 787 F.2d 355, 367 & n.9 (8th Cir. 1986), cert. denied, No. 85-2036 (Oct. 6, 1986); Lipton v. Documation, Inc., 734 F.2d 740 (11th Cir. 1984), cert. denied, 469 U.S. 1132 (1985); T.J. Raney & Sons, Inc., v. Fort Cobb, Oklahoma Irrigation Fuel Authority, 717 F.2d 1330 (10th Cir. 1983), cert. denied, 465 U.S. 1026 (1984); Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981), cert. denied, 459 U.S. 1102 (1983); Panzirer v. Wolf, 663 F.2d 365 (2d Cir. 1981), vacated as moot after cert. granted, 459 U.S. 1027 (1982); Ross v. A.H. Robins Co., 607 F.2d 545, 553 (2d Cir. 1979), cert. denied, 446 U.S. 946 (1980); Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975), cert. denied, 429 U.S. 816 (1976). See also Flamm v. Eberstadt, supra; Wachovia Bank & Trust Co. v. National Student Marketing Corp., 650 F.2d 342, 358 (D.C. Cir. 1980), cert. denied, 452 U.S. 954 (1981); In re LTV Securities Litigation, 88 F.R.D. 134, 142 (N.D. Tex. 1980); Schlanger v. Four-Phase Systems, Inc., 555 F. Supp. 535, 538 (S.D.N.Y. 1982). /25/ Thus, the price of a stock may reflect, and be distorted by, any material misrepresentation about the company. See, e.g., Peil v. Speiser, 806 F.2d at 1160-1161; Blackie v. Barrack, 524 F.2d at 906; In re LTV Securities Litigation, 88 F.R.D. at 143-144; Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. 1143, 1154-1156 (1982). See Flamm, slip op. 19; Seaboard World Airlines, Inc. v. Tiger International, Inc., 600 F.2d 355, 361-362 (2d Cir. 1979). /26/ To rebut the presumption, a defendant must show either that the market price did not reflect the corporate statements, or that the plaintiff did not rely on market price in trading (Pet. App. 18a n.6). See Blackie v. Barrack, 524 F.2d at 906; Peil v. Speiser, 806 F.2d at 1161. Some courts have extended the fraud on the market theory to initial public offerings. See, e.g., T.J. Raney & Sons, Inc. v. Fort Cobb, Oklahoma Irrigation Fuel Authority, 717 F.2d at 1330; Shores v. Sklar, 647 F.2d at 462; Arthur Young & Co. v. United States District Court, 549 F.2d 686 (9th Cir.), cert. denied, 434 U.S. 829 (1977). That issue is not present in this case and we do not address it. /27/ Presumptions are often applied to aid favored contentions or handicap disfavored ones. For example, "(a) classic instance (of a policy-based presumption) is the presumption of ownership from possession, which tends to favor the prior possessor and to make for the stability of estates." C. McCormick, Evidence Section 343, at 968 (3d ed. 1984) (footnote omitted). /28/ See, e.g., E. Fama, Foundations of Finance 320-382 (1976); J. Lorie & M. Harriston, The Stock Market 70-97 (1973); Gilson & Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549, 551 (1984); Note, The Efficient Capital Market Hypothesis, Economic Theory and the Regulation of the Securities Industry, 29 Stan. L. Rev. 1031, 1034-1057 (1977). /29/ See, e.g., Flamm, slip op. 19; Peil v. Speiser, 806 F.2d at 1163; Harris v. Union Electric Co., 787 F.2d at 367 & n.9; Seaboard World Airlines, Inc. v. Tiger International, Inc., 600 F.2d at 361-362; Blackie v. Barrack, 524 F.2d at 907; Schlanger v. Four-Phase Systems, Inc., 555 F. Supp. at 538. /30/ Petitioners contend (Pet. 26-27) that even if a presumption of reliance is appropriate in a fraud on the market case brought by purchasers, it is inappropriate in a case brought by sellers. They argue that, even assuming persons might make decisions to purchase securities in the open market on the "relatively common basis" of market price, there is no reason to make the same assumption regarding decisions to sell, which might be made for other reasons, the most obvious being a need for cash. But petitioners point to no authority for the proposition that sellers are oblivious to price. In fact, at least one case did involve sellers. Schlanger v. Four-Phase Systems, Inc., 555 F. Supp. at 535. See, generally Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. at 1153-1156. While sellers may have various reasons for selling, the vast majority rely on price to decide when and what security to sell. An investor needing cash, for example, would presumably evaluate the stock's market price in relation to other options, including borrowing money using the stock as collateral. /31/ This Court has "repeatedly * * * emphasized * * * that implied private actions (under Rule 10b-5) provide 'a most effective weapon in the enforcement' of the securities laws and are 'a necessary supplement to Commission action.'" Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 310 (1985) (quoting J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964)). /32/ Petitioners argue (Pet. 22) that the presumption has been applied improperly to facilitate class certification. The district court in this case, however, expressly disclaimed any intention of seeking to facilitate class actions (Pet. App. 129a). The court of appeals, although recognizing that the presumption does facilitate class actions, did not use that circumstance to justify its decision. Contrary to petitioners' assertion, the presumption of reliance in a fraud on the market case is grounded on characteristics of the securities markets and investor behavior, as well as on policy objectives, that are equally applicable to individual and class actions. See Note, Fraud on the Market: An Emerging Theory of Recovery Under SEC Rule 10b-5, 50 Geo. Wash. L. Rev. 627, 645-653 (1982); Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. at 1154-1156. /33/ In Mills, this Court adopted a presumption that a misleading proxy statement caused injury alleged to have resulted from a shareholders' vote in favor of a merger. The Court rejected the argument that a plaintiff should be required to prove that the proxy statement had a decisive effect on the vote. So long as the misstatements were material, and the proxy solicitation was an "essential link" in effecting the merger, this Court held, "a shareholder has made a sufficient showing of causal relationship between the violation and the injury for which he seeks redress * * *" (396 U.S. at 385). Such a result, the Court said, "will avoid the impracticalities of determining how many votes were affected, and, by resolving doubts in favor of those the statute is designed to protect, will effectuate the congressional policy of ensuring that the share holders are able to make an informed choice * * *" (ibid.). /34/ While the fraud on the market theory permits a presumption that material misstatements affected the market price, the plaintiff retains the burden of establishing, in a manner that will vary from case to case, the amount of his damages.