Document Type

Article

Publication Date

1-2008

Abstract

I begin in Part II by explaining the wrong turn that the Court took in Basic. The Basic Court misunderstood the function of the reliance element and its relation to the question of damages. As a result, the securities class action regime established in Basic threatens draconian sanctions with limited deterrent benefit. Part III then summarizes the cases leading up to Stoneridge and analyzes the Court's reasoning in that case. In Stoneridge, like the decisions interpreting the reliance requirement of Rule 10b-5 that came before it, the Court emphasized policy implications. Sometimes policy implications are invoked to broaden the reach of the Rule 10b-5 cause of action. More recently, policy implications have been invoked to narrow its reach. Part IV explores the policy choices made by Congress in the express private causes of action in the securities laws, and the implications of those choices for securities fraud class actions under Rule 10b-5. The choices reflected in those explicit causes of action suggest that the Basic Court erred by failing to calibrate the damages measure in Rule 10b-5 class actions to accord with the attenuated version of reliance that it adopted. In secondary-market class actions, I argue, damages should be measured by disgorgement of unlawful gains rather than compensation of defrauded shareholders. Doing so would bring damages closer in line with social costs; more importantly, such a reform promises to make securities fraud class actions a more cost-effective mechanism for deterring fraud. I then turn in Part V to the question of who can reform securities class actions. Which institution-the Court, Congress, the SEC, or shareholders-is most likely to bring about the needed changes to the damages measure? The available evidence suggests that the three government actors in this list are largely paralyzed from overhauling securities class actions in a meaningful way. I argue that shareholders, the parties who bear the costs of the current regime, must take matters into their own hands. I briefly outline the path by which shareholders could opt out of the current dysfunctional class action regime, replacing it with a more precisely targeted deterrent scheme focused on disgorgement. Part VI concludes.

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