Non-public information can't cause fraud on market.

• Date: 18 March 2002

Byline: David Ziemer

Investors cannot maintain a class action based on the fraud-on-the-market doctrine, where the false information at issue was not made available to the public, the Seventh Circuit Court of Appeals held on Mar. 7.

Imprudent Information

James Hofman, a stockbroker for Prudential Securities, told 11 of his customers that Jefferson Savings Bancorp was "certain" to be acquired, at a big premium, in the near future, and continued making this statement for seven months.

However, the statement was a lie, for no acquisition was impending.

During the course of Hofman's lies, the stock price rose approximately 20%.

A class action was subsequently filed in the Southern District of Illinois against Prudential, on behalf of all investors who purchased Jefferson stock during the months when Hofman was making the false statements.

District Judge G. Patrick Murphy certified the class, invoking the fraud-on-the-market doctrine of Basic, Inc. v. Levinson, 485 U.S. 224, 241-49 (1988), and scheduled the matter for trial.

In Basic, the U.S. Supreme Court held, "Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action." 485 U.S. at 247.

The theme of Basic and other fraud-on-the-market decisions is that public information reaches professional investors, whose evaluations of that information and trades quickly influence securities prices.

Prudential filed a petition for leave to appeal, which the Seventh Circuit granted. The court then reversed in a decision by Judge Frank H. Easterbrook.

"Basic" distinguished

The court concluded that the plaintiffs were unable to show that Hofman's fraud caused the stock price to...