Fraud on a Noisy Market

Abstract

Behavioral finance raises questions about market efficiency, suggesting that noise, and not just information, moves securities prices. This creates a conundrum for the fraud on the market theory. While some fraud remedy is arguably necessary to ensure adequate disclosure, behavioral finance raises doubt about the efficiency of fraud remedies in noisy markets. These issues are particularly important in the wake of the Supreme Court's opinion in Dura v. Broudo Pharmaceuticals, Inc., which tightens proof of loss causation in fraud on the market cases and creates uncertainty about the future of the fraud on the market theory. This paper argues for interpreting Dura to sharply constrain the fraud on the market theory. It also proposes dealing with the need to deter fraud by allowing state courts and legislatures to supplement federal liability. More broadly, this paper suggests that, contrary to the assertions of many of its proponents, the indeterminacy of behavioral economics generally, and behavioral finance in particular, may support reducing rather than increasing legal paternalism.