U.S. District Judge Shira Scheindlin of the Southern District of New York recently certified a class in Strougo v. Barclays PLC, 14 Civ. 5797 (SAS), (S.D.N.Y. Feb. 2, 2016), a high-profile securities class action based on the “price maintenance” theory. The plaintiffs alleged that Barclays made false or misleading statements by overstating the transparency and safety of Barclay’s “Liquidity Cross,” or “LX,” a private trading space where investors can trade in relative anonymity. Those statements, the plaintiffs claim, were belied by certain incentives Barclays used to lure “predatory” high-frequency traders (“HFT”) into LX, including allegedly reduced fees and the alleged placement of HFT computer servers in close proximity to Barclays own computer systems, thereby giving the HFTs priority access to key trading data. After the New York Attorney General’s Office sued Barclays for allegedly concealing information about LX, the price of Barclays PLC’s American Depository Shares (“ADS”) dropped more than 7 percent.

The plaintiffs’ case is based on a theory of a “fraud on the market” that artificially maintained the price of Barclays ADS. The plaintiffs did not allege that the misleading statements about LX caused the price to drop, but rather that those statements maintained a falsely inflated price. Under this theory, had Barclays been honest about how it operated LX, Barclays ADS shares would have traded at a substantially lower price.

In opposition to the plaintiffs’ motion for class certification, Barclays and several of its current and former officers (the “Defendants”) attacked this theory in two ways. First, they argued that the plaintiffs failed to establish that the ADS traded in an efficient market, a prerequisite to the “fraud on the market” theory under Basic v. Levinson, 485 U.S. 224 (1988) and its progeny. While the Second Circuit has not adopted a definitive test for market efficiency, it is often analyzed through the five-factor test set forth in Cammer v. Bloom, 711 F.Supp. 1264, 1286-87 (D.N.J. 1989). The fifth Cammer factor, the only one at issue in Strougo, requires empirical evidence of price changes in response to unexpected information to show market efficiency – empirical evidence often demonstrated through a regression analysis known as an event study.

Judge Scheindlin rejected the Defendant’s argument that the plaintiffs had to satisfy the fifth Cammer factor as a prerequisite to invoking the Basic presumption. Quoting Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2410 (2014), Judge Scheindlin held that the “fraud on the market” theory is a “fairly modest premise [that] market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” In contrast, she found that an event study measures the more precise issue of whether information is “impounded immediately” into the stock price. This, the court found, is more than the Basic presumption requires. Moreover, she reasoned, event studies are less reliable when conducted on a single firm, as opposed to 25 to 100 firms. As such, she held that the plaintiffs could demonstrate market efficiency without the use of an event study.

Judge Scheindlin also rejected the Defendants’ second argument, which was that the plaintiffs’ theory did not fit the price maintenance theory because the stock price inflation occurred prior to the alleged misstatements. The court rejected this argument, reasoning that an omission or misrepresentation can also prevent a noninflated stock price from falling, thereby introducing inflation caused by omission or misrepresentation. In other words, the alleged misstatements created investor confidence that artificially maintained the stock price. When the alleged truth was revealed, so the theory went, the stock price fell to an allegedly “true” value.

While it appears there is a growing body of case law holding that the fifth Cammer factor is not a prerequisite to finding market efficiency, it will be interesting to see if other courts follow Judge Scheindlin’s lead and credit similar “fraud on the market” theories based on price maintenance.