Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

US court rules that IPO market is inherently inefficient

The ruling
of the US Court of Appeal in Miles et al v Merrill Lynch et al (In Re:
Initial Public Offering Securities Litigation is a sweeping judgement
on the inherent inefficiency of the IPO market that effectively makes
it impossible to use private litigation to deal with IPO fraud. The
court not only tightened the legal standard for class action but then
went on to decide the matter itself rather than remand it to the
District Court. In the process it presented a dim view of the IPO
market that effectively puts many kinds of wrong doing in this market
beyond the purview of a class action law suit. This effectively rules
out private litigation and makes the market dependent entirely on
timely action by the regulator. This is extremely unfortunate.

The court’s views on the IPO market are as follows:

In the first place, the market for IPO shares is not efficient. As
the late Judge Timbers of our Court has said, sitting with the Sixth
Circuit, “[A] primary market for newly issued [securities] is
not efficient or developed under any definition of these terms.”
Freeman v. Laventhol & Horwath, 915 F.2d 193, 199 (6th Cir. 1990)
(internal quotation marks omitted); accord Berwecky v. Bear, Stearns &
Co., 197 F.R.D. 65, 68 n.5 (S.D.N.Y. 2000) (The fraud-on-the-market
“presumption can not logically apply when plaintiffs allege
fraud in connection with an IPO, because in an IPO there is no
well-developed market in offered securities.”). As just one
example of why an efficient market, necessary for the Basic
presumption to apply, cannot be established with an IPO, we note that
during the 25-day “quiet period,” analysts cannot report
concerning securities in an IPO, see 17 C.F.R. 230.174(d),
242.101(b)(1), thereby precluding the contemporaneous
“significant number of reports by securities analysts”
that are a characteristic of an efficient market. See Freeman, 915
F.2d at 199.

Some good might still come out of it if these strong words induce
the SEC to drop the unwarranted quiet period during IPOs.


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