Damages and Reliance under Section 10(b) of the Exchange Act

A textualist interpretation of the implied private right of action under Section 10(b) of the Exchange Act concludes that the right to recover money damages in an aftermarket fraud can be no broader than the express right of recovery under Section 18(a) of the Exchange Act. The Act’s original legislative history and recent Supreme Court doctrine are consistent with this conclusion, as is the Act’s subsequent legislative history.

Section 18(a), however, requires that plaintiffs affirmatively demonstrate actual “eyeball” reliance as a precondition to recovery and does not permit a rebuttable presumption of reliance. Accordingly, if the Exchange Act is to be interpreted as a “harmonious whole,” with the scope of recovery under the implied Section 10(b) private right being no greater than the recovery available under the most analogous express remedy, Section 18(a), then Section 10(b) plaintiffs must either demonstrate actual reliance as a precondition to recovery of damages, or the Court should revisit Basic, as suggested by four justices in Amgen, and overturn Basic’s rebuttable presumption of reliance. A textualist approach thus provides a rationale for reversing Basic that avoids the complex debate over the validity of the efficient market hypothesis, an academic dispute that the Supreme Court is not optimally situated to referee.

Experience also demonstrates that Basic’s presumption of reliance, which is nominally rebuttable, is effectively irrebuttable once it attaches. This observation provides a further basis upon which to challenge Basic’s continuing vitality.

The implications of this analysis are potentially profound. If plaintiffs must affirmatively demonstrate actual reliance, then many Section 10(b) securities fraud class actions become uncertifiable because individual questions will predominate. Private securities fraud litigation would then likely be dominated by class actions asserting violations of Section 11 of the Securities Act as well as by a scrum of individual actions brought by larger investors with significant damage claims in major cases. The battle would then likely move to Congress which could legislate a rebuttable presumption of reliance, or otherwise amend the statute to reform the securities litigation process.

The paper first provides an overview of the operation of the implied private right of action under Section 10(b) and Rule 10b-5 under current law, engages in a detailed analysis of the doctrines governing the definition of the elements of the Section 10(b) implied private right of action, and concludes that plaintiffs have an affirmative obligation to demonstrate actual “eyeball or eardrum” reliance as a precondition to the recovery of money damages. Legislative activity subsequent to enactment of Section 10(b) has little if any influence on the current Court’s construction of the elements of the implied private right, but the paper demonstrates that subsequent legislative activity supports the imposition of an actual reliance requirement. The paper also reviews the tests for reliance and damages as currently applied by the lower courts, and, among other matters, demonstrates that the presumption of reliance is de facto irrebuttable, and that the Court has been internally inconsistent in its logic adopting the presumption as a mechanism designed to facilitate class actions while simultaneously insisting that the presumption is rebuttable. Policy perspectives will likely play little role in determining the outcome of the Court’s analysis, but as demonstrated in the paper, the Court will have no trouble finding a large academic literature supporting whichever conclusion decides to reach if it ever reconsiders Basic. The paper then observes that an actual reliance requirement imposed either as a precondition to the recovery of damages or as a rationale for reversing Basic will dramatically reduce the economic incentives to bring Rule 10b-5 class action securities fraud actions and will often make class certification of these actions impossible. Critics of the actual reliance requirement will have to address their concerns to Congress. The paper also catalogues a broad range of reform measures that have been proposed in the academic literature.

The full paper is available for download here.