Fraud on the Market After Amgen

Duke Journal of Constitutional Law & Public Policy, Dec 2013

James D. Cox

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Fraud on the Market After Amgen

See supra notes FRAUD ON THE MARKET AFTER AMGEN JAMES D. COX There are multiple ways investors decide to purchase or sell a security. The classic perspective envisions the investor studiously poring through complex financial information with the particular information relied upon coming from a variety of sources.1 Such classical investing, of course, does not require that the investors do their own evaluation; they frequently rely on intermediaries such as brokers, investment advisors, and even financial columnists. Such information mediation is efficient for the classic investor and creates the demand side of the burgeoning market for the financial intermediaries. Good investment advice leads to the same favorable effect as the better mousetrap: The world beats a path to that advisor's door. By whatever method the classic investor uses to be informed, what motivates the classic investor is the belief that there are opportunities for a reasonable return by the astute deciphering of publicly available information. A variation of the classic investor model is the professional trader that has armed itself with a proprietary algorithm for detecting “buy” and “sell” opportunities.2 The inputs to such a model vary greatly and may not even include the security's price, but likely focus on a range of other performance data the investor believes predictive of performance by the security. To be sure, the professional trader relies on publicly available information but not always the same - Copyright © 2013 James D. Cox. * Brainerd Currie Professor of Law, Duke University School of Law. The author is grateful for the thoughtful comments of Ann Lipton as well as the research assistance of Messrs. Robert Blaney, Jevon Conroy, and Dan Rowe. 1. See, e.g., BENJAMIN GRAHAM & DAVID L. DODD, SECURITY ANALYSIS passim (5th ed. 1951) (describing processes to analyze financial statements and determine intrinsic value of shares as prelude to identifying whether a security offers the prospect of a positive return). 2. The professional trader may be guided by a proprietary algorithm keyed to financial information regarding the firm or various market developments. See Tom C.W. Lin, The New Investor, 60 UCLA L. REV. 678, 689–93 (2013) (describing the rising role of such traders in capital markets). 2 information as the classic investor. Thus, a kernel of information that may well be dispositive to the classic investors may not be to the professional trader and vice versa.3 At the other extreme from either the classical investor or professional trader is the proverbial dart thrower whose decision to purchase or sell is guided not by analysis, but by the fortuity of the dart’s path.4 Just why throw darts is an interesting question. Some may counsel throwing darts as the natural response/unqualified obeisance to the teachings of the efficient market hypothesis: Security prices reflect all publicly available information so that it is not possible to earn an above average return on the basis of public information. Better to read a book than analyze dense financial information; knowledge improves the mind, but pursuit of underpriced or overpriced securities is not productive.5 In addition, an ever-growing investment strategy is indexing.6 Indexers seek to mimic the performance of a particular index, such as the Standard & Poor’s Industrial 500. Indexers and dart throwers may share a common position: It is not possible to beat the market. Whereas the indexer is more systematic in how it responds to this believed-reality of the market, the dart thrower is neutral on what the proper weight should be for any single stock in her portfolio and simply casts her fate to the winds. Indexers may have other reasons not to invest classically. Some financial institutions are so large that it would be extraordinarily burdensome, practically and financially, to 3. See, e.g., GAMCO Investors, Inc. v. Vivendi, S.A., 927 F. Supp. 2d 88, 101–02 (S.D.N.Y. 2013) (holding that even though the misrepresentation impacted the price of Vivendi shares, the facts that were misrepresented did not assume importance in the professional trader’s investment model). 4. See Georgette Jasen, Investment Dartboard: A Brief History of Our Contest, WALL ST. J., Oct. 7, 1998, at C1 (recounting the extensive history—100 six-month contests—of pitting dart throwers against selected analysts, where the dart throwers’ average gain of 4.5 percent fell short of the 6.8 percent average gain of the Dow Industrials and the 10.9 percent average return garnered by analysts). 5. For example, Brad M. Barber and Douglas Loeffler suggest that the greater return by the analysts was due to their selecting riskier securities—adjusted for risk they earned only 4.06 percent greater than the dart throwers—and likely “piling on” by investors who learned of the analysts’ recommendations before the six-month measurement period ended. Brad M. Barber & Douglas Loeffler, The “Dartboard” Column: Sec (...truncated)


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James D. Cox. Fraud on the Market After Amgen, Duke Journal of Constitutional Law & Public Policy, 2013, Volume 9, Issue 1,