Copyright (c) 2012 Virginia Law & Business Review Association
Virginia Law & Business Review
ARTICLE: THE CURIOUS INCIDENT OF THE DOG THAT DIDN'T BARK AND ESTABLISHING CAUSE-AND-EFFECT IN CLASS ACTION SECURITIES LITIGATION+
+ Copyright 2012. Michael L. Hartzmark and H. Nejat Seyhun. All rights reserved. The authors wish to gratefully acknowledge the valuable comments and insights of Jeff Leibell of the Garden City Group, Ran Wei of Navigant Economics, David Tabak of NERA and Ivana Mrazova of University of Michigan. In Silver Blaze, by author Sir Arthur Conan Doyle, the following exchange takes place between Sherlock Holmes and Inspector Gregory, the Scotland Yard detective:
Inspector Gregory "Is there any other point to which you would wish to draw my attention?' Sherlock Holmes "To the curious incident of the dog in the night-time.' Inspector Gregory "The dog did nothing in the night-time.' Sherlock Holmes "That was the curious incident,' ... . ... . Sherlock Holmes "Before deciding that question I had grasped the significance of the silence of the dog, for one true inference invariably suggests others. The Simpson incident had shown me that a dog was kept in the stables, and yet, though someone had been in and had fetched out a horse, he had not barked enough to arouse the two lads in the loft. Obviously the midnight visitor was someone whom the dog knew well.'
Sir Arthur Conan Doyle, Silver Blaze, in The Memoirs of Sherlock Holmes 1, 23, 27 (Oxford University Press ed., 1993) (1894).
Virginia Law & Business Review
6 Va. L. & Bus. Rev. 415
Michael L. Hartzmark++ and H. Nejat Seyhun+++
THIS paper introduces an innovative tool, empirical test, and a new approach - what we call a reverse event study methodology - to help properly determine whether a security trades in an efficient market. Using our approach, the courts can properly evaluate whether "empirical facts show a cause-and-effect relationship between unexpected corporate events" 1 and disclosures to support a claim of fraud-on-the-market.
To establish whether the preponderance of evidence supports a conclusion that the security trades in an efficient market, parties frequently present courts with empirical analyses based on a naive assumption that, "theoretically, in a perfectly efficient market there should be no significant price movements without some identifiable news event" 2 or, conversely, that there should be significant price movements only with some identifiable news event. 3 In this paper, we argue that these assumptions are misleading, wrong, and need to be rejected. We show why, in an efficient market, it is expected that there will be some price movements with no disclosures, and conversely, why it is expected that there will be some material disclosures without price movements.
We demonstrate that the difficulties experts have in showing whether empirical facts support cause-and-effect in this context emanate from six primary sources. First, often there is an observed "effect" (price reaction) without an observed "cause" (disclosure) because there may be an unobserved change in the market's expectations (i.e. the dog didn't bark). 4 Second, the statistical methods employed to evaluate systematic cause-and-effect relationships are imperfect, ...
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