- civil procedure •
- evidence •
- financial economics •
- fraud on the market •
- event study methodology •
- statistics •
- fraudulent information •
- significance •
- class actions & certification •
- securities fraud •
- 10b-5 litigation •
- Securities and Exchange Commission •
Event studies, a half-century-old approach to measuring the effect of events on stock prices, are now ubiquitous in securities fraud litigation.
This paper, written for legal academics, judges, and policy makers, makes three contributions. First, it contributes to a nascent literature demonstrating that the standard event-study methodology can be problematic in securities litigation. In particular, the paper documents the tradeoff between power and confidence level and the ensuing impact on the likelihood that valid claims of fraud will erroneously be rejected. In so doing, the article highlights that the choice of confidence level is a policy judgment about the appropriate balance between the costs of litigation and the costs of securities fraud. Second, the article argues that the SEC has both the legal power and the institutional competence to develop litigation standards that balance these costs.
Third, the article provides a novel and feasible framework through which the SEC can implement such litigation standards. The framework relies on an assessment of the defendant firm’s market capitalization and abnormal returns distribution to determine the maximum confidence level (minimum significance level) that is consistent with the minimum required power of detecting a fraud of the benchmark magnitude. The SEC is uniquely positioned to make this determination based on the information it possesses about the level of fraud in the capital markets and the role of private litigation in deterring fraud.