Third Circuit Rejects Shores v. Sklar Securities Fraud Theory

Whether to treat a securities fraud case on a class basis often turns on whether the court may presume that class members relied on false statements or omissions by the defendants. 

The most common form of presumption -- the fraud on the market theory -- won the Supreme Court's okay in Basic, Inc. v. Levinson, 485 U.S. 224 (1988).  

A more exotic breed -- the Affiliated Ute variety -- provides for a presumption of reliance on material facts that the defendant failed to disclose despite a duty to do so.  See Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972). 

A third, and even more rare, means for presuming reliance came in Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en banc), where the court recognized a "fraud-created-the-market" presumption, which posits the notion that investors probably assume the lawfulness of a security's issuance and that courts may therefore presume that they so assumed.

Yesterday, the Third Circuit joined the Seventh in rejecting Shores v. Sklar.  Malack v. BDO Seidman, LLP, No. 09-4475, slip op. at 12 (3d Cir. Aug. 16, 2010) (citing Eckstein v. Balcor Film Investors, 8 F.3d 1121, 1130-31 (7th Cir. 1993)).  The court also held that a variant of the theory would not work in the case before it.  See id. at 33 (distinguishing T.J. Raney & Sons, Inc. v. Fort Cobb, Oklahoma Irrigation Fuel Authority, 717 F.2d 1330 (10th Cir. 1983)).

The court affirmed an order denying class certification under Rule 23(b)(3) on the ground that common issues of fact did not predominate.

Comments

[Stock Fraud Attorney]

SEC approval of a securities registration statement does not provide a reasonable basis to presume that the securities offered are free from fraud, because the SEC's role is limited. The court noted that the SEC does not conduct merit regulation of securities, seeking to determine whether the offered securities are, in fact, a good investment. Nor does the SEC endorse offering documents or vouch for their truthfulness.

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