Legal Definitions - fraud-on-the-market theory

Fraud-on-the-market theory is a legal concept that says if a company makes a false or misleading statement that affects its stock price, investors who bought or sold the stock can sue the company for securities fraud. This theory is often used in class action lawsuits where a large group of investors claim they were harmed by the company's actions.

For example, let's say a company announces that it has discovered a new product that will revolutionize the industry and cause its stock price to soar. However, the company knows that the product doesn't actually exist and is lying to investors. When the truth comes out, the stock price drops, and investors who bought the stock based on the false information lose money. Under the fraud-on-the-market theory, these investors could sue the company for securities fraud.

The fraud-on-the-market theory was established by the Supreme Court in the case of Basic v. Levinson in 1988. The Court ruled that investors who traded in a company's stock during a period when false or misleading information was publicly available could be presumed to have relied on that information, even if they didn't know about it directly. This made it easier for investors to bring securities fraud lawsuits against companies.