The econometrics of fraud-on-the-market securities fraud

Fraud-on-the-market (FOTM) is a judicially created cause of action based on the semistrong form of the efficient capital markets hypothesis (ECMH). Its legal basis derives from Sec. 10(b) of the Securities Exchange Act of 1934 and Securities Exchange Commission Rule 10b-5. A typical FOTM plaintiff class consists of all shareholders of the defendant corporation who are passive investors and were harmed in their stock trades during a period between the defendant company's dissemination of allegedly false information and the time the purported truth was disclosed. A discussion argues that to the extent that FOTM is intended to provide a remedy to passive investors whose stocks are affected by real securities fraud, it fails on several counts: 1. To the extent real securities fraud is distinguishable from ordinary theft, FOTM amounts to diversifiable risk. 2. Stock price data from the FOTM suits themselves suggest that the courts' concern that the NYSE and AMEX can be used to facilitate fraud appears less than well-founded.