Financial experts spar over ‘market efficiency’ in Groupon litigation

BVWireIssue #152-1
May 6, 2015

The market efficiency theory has sparked a lively debate among financial experts and plays a critical role in securities fraud litigation. A Daubert ruling in the Groupon class action suit discusses what’s required to show a company’s stock traded in an efficient market.

Bad deal: Groupon, the deal-of-the-day company, went public in November 2011. Investors subsequently sued under Section 10(b) of the Exchange Act and Rule 10b-5, alleging harm from the company’s misrepresentations. Under the efficient market hypothesis—increasingly under attack by economists—the market price of a company’s stock embodies all public information about the company. In litigation, this means investors do not have to show direct reliance on the misstatements but can proceed on the automatic assumption that significant misstatements caused share prices to fall.

Detractors argue that many investors do not rely on the integrity of the market at all. What an investor is willing to pay for a company depends on a host of other factors (and may not reflect the value of a company at all, as Professor Aswath Damodaran has shown).

Unexpected earnings news: Here, the investors retained an experienced expert who performed an event study to show cause and effect between unexpected company events and movement in the stock price. He said he looked for "big news days" during the relevant period by identifying significant, unexpected earnings-related news. He concluded that only two dates met his objective criteria. Admittedly this was a low number, he said, but one that was not uncommon for a class period that was only seven weeks. Further, he used a one-year period to control for standard volatility. However, changing the length of the control period would not affect the results, he said. He concluded that Groupon’s stock traded in an efficient market.

The defendants’ expert attacked the study on numerous grounds, but his criticisms had no traction with the court. The investors’ expert “correctly analyzed ‘market efficiency’ from the perspective of whether unexpected information quickly affected Groupon stock price—not whether the price of Groupon stock accurately reflected all information,” the court determined. Although the defendants’ expert was “clearly an expert in efficient capital markets,” he failed to understand that the law did not require a perfectly efficient market to show fraud on the market.

Takeaway: Courts are reluctant to adopt the changing view on market efficiency coming from the academic community. Debates “about the degree to which the market price … reflects public information about the company” are “largely besides the point” in terms of determining market efficiency under legal precedent, the court in this case said.

Find an expanded discussion of In re Groupon Securities Litigation, 2015 U.S. Dist. LEXIS 27334 (March 5, 2015), in the June edition of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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