Law School Case Brief
West v. Prudential Sec., Inc. - 282 F.3d 935 (7th Cir. 2002)
The basis of the fraud-on-the-market doctrine is that public information reaches professional investors, whose evaluations of that information and trades quickly influence securities prices.
According to the complaint in this securities-fraud action, James Hofman, a stockbroker who was working 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. Hofman continued making this statement for seven months (repeating it to some clients); it was a lie, for no acquisition was impending. And even if the statement had been true, then Hofman was inviting unlawful trading on the basis of material non-public information. He is a securities offender coming or going, pursuant to Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 86 L. Ed. 2d 215, 105 S. Ct. 2622 (1985), as are many customers who traded on what they thought to be confidential information--if Hofman said what the plaintiffs allege, a subject still to be determined. What we must decide is whether the action may proceed, not on behalf of those who received Hofman's "news" in person but on behalf of everyone who bought Jefferson stock during the months when Hofman was misbehaving. The district judge certified such a class, invoking the fraud-on-the-market doctrine of Basic, Inc. v. Levinson, 485 U.S. 224, 241-49, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988).
Did the fraud-on-the-market doctrine apply?
The court of appeals held that the fraud-on-the-market doctrine did not apply because the information was not made available to the public. The investors failed to identify any causal link between the non-public information and securities prices. Thus the record did not support the extension of the fraud-on-the-market doctrine to the alleged non-public statements.
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