Market efficiency in the world of high-frequency trading

High-frequency trading, which employs computer algorithms to facilitate trading at extremely high speeds, leads to more efficient markets. Indeed, high-frequency trading can enable market participants to capitalize upon the most current information reflected in stock prices. Against this backdrop, the recent decision of the 2nd U.S. Circuit Court of Appeals in Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017), makes eminent sense -- and should provide persuasive guidance for courts within the 9th Circuit.

Background

Barclays, a London-based international financial services provider, was the subject of a number of investigations and suits involving the misrepresentation of its borrowing data submitted for the calculation of the London Interbank Offered Rate, known as LIBOR. The suits alleged that Barclays manipulated LIBOR, which is an important set of benchmarks for international interest rates.

Barclays operated an alternate trading system known as Barclays' Liquidity Cross, or LX. LX belonged to a particular subset of alternate trading systems known as "dark pools," which permitted investors to trade securities in a largely anonymous manner. Barclays made numerous statements asserting that LX was safe from high-frequency trading practices.

On June 25, 2014, the New York attorney general commenced an action alleging that Barclays was violating New York law in operating its dark pool, causing the price of Barclays' American depository shares to fall nearly 9 percent in the span of two days. The plaintiffs then filed a complaint alleging that Barclays had violated Section 10(b) of the Securities Act of 1934 and Securities and Exchange Commission Rule 10b-5 by making false statements and omissions about LX.

After the district court denied the defendants' motion to dismiss, the plaintiffs sought class certification, arguing that the element of reliance under Section 10(b) was satisfied by the presumption of reliance recognized by the U.S. Supreme Court in Basic, Inc. v. Levinson, 485 U.S. 224 (1988). In support of their motion, the plaintiffs submitted a report and an "event study" (a "regression analys[is] that seek[s] to show that the market price of the defendant's stock tends to respond to pertinent publicly reported events") from Dr. Zachary Nye applying the five factors identified in Cammer v. Bloom, 711 F. Supp. 1264, 1286-87 (D.N.J. 1989), and the three factors identified in Krogman v. Sterritt, 202 F.R.D. 467, 478 (N.D. Tex. 2001), and concluded that all eight factors demonstrated that the market for Barclays' American depository shares was efficient.

The district court certified the class, concluding that the presumption of reliance for omissions applied based upon Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972), and that, alternatively, the Basic presumption of reliance for misrepresentations applied. The district court determined that despite Dr. Nye's event study, "direct evidence of price impact under [the fifth] Cammer [factor] was not necessary to its determination that the market for Barclays' ADS was efficient during the class period." The district court held further that the defendants had not rebutted the Basic presumption.

The Barclays Ruling

The 2nd Circuit agreed with the defendants' contention that the Affiliated Ute presumption was inapplicable, but held that the district court's decision regarding the Affiliated Ute presumption for omissions was "harmless" because it affirmed the district court's class certification order. First, the 2nd Circuit held that "a plaintiff seeking to demonstrate market efficiency need not always present direct evidence of price impact through event studies."

Second, the 2nd Circuit held that "the district court's decision not to rely on direct evidence of price impact under [the fifth] Cammer [factor] in this case fell comfortably within the range of permissible decisions." The 2nd Circuit reasoned that "[u]nder the circumstances here" -- where "Barclays is one of the largest financial institutions in the world" -- "the district court was not required to reach a conclusion concerning direct evidence of market efficiency" when the indirect factors clearly demonstrated efficiency.

Finally, after determining that "defendants seeking to rebut the Basic presumption must demonstrate a lack of price impact by a preponderance of the evidence at the class certification stage rather than merely meet a burden of production," the 2nd Circuit held that "the district court did not abuse its discretion when it concluded that the Defendants had failed to rebut the Basic presumption."

Barclays' Potential Impact in 9th Circuit

The 9th Circuit does not yet appear to have directly addressed whether a plaintiff seeking to demonstrate market efficiency in a securities fraud class action need always present direct evidence of price impact through an event study. The recent decisions of several district courts within the 9th Circuit, however, align with the 2nd Circuit's determination that market efficiency can be established by indirect indicia of market efficiency. See, e.g., Baker v. SeaWorld Entertainment, Inc., 14CV2129-MMA (AGS) (S.D. Cal. Nov. 29, 2017) ("Defendants cannot rebut the presumption of reliance by only arguing that the alleged misrepresentations did not affect the stock price"); Todd v. STAAR Surgical Co., CV-14-05263-MWF-RZ (C.D. Cal. Jan. 5, 2017) ("Furthermore, the fact that STAAR's stock was traded on the NASDAQ strongly favors a finding of market efficiency."); Hayes v. MagnaChip Semiconductor Corp., 14-CV-01160-JST (N.D. Cal. Dec. 22, 2016) ("the fact that MagnaChip trades on the NSYE, though not dispositive of market efficiency, certainly helps to confirm that conclusion"); but see In re Finisar Corp. Sec. Litig., 5:11-CV-01252-EJD (N.D. Cal. Dec. 5, 2017) ("Defendants have rebutted the Basic presumption of fraud-on-the-market reliance by demonstrating through a preponderance of evidence that Gertel's December 2nd statement had no price impact when made or thereafter.").

As the 2nd Circuit recognized, "[t]he Cammer and Krogman factors are simply tools to help district courts analyze market efficiency in determining whether the Basic presumption of reliance applies in class certification decision-making." "But they are no more than tools in arriving at that conclusion, and certain factors will be more helpful than others in assessing particular securities and particular markets for efficiency."

Conclusion

The Barclays decision acknowledges the reality of information exchange in today's modern era in determining market efficiency. The 2nd Circuit's well-reasoned decision should provide persuasive guidance to courts within the 9th Circuit in determining efficiency in securities class actions.