485 U.S. 224 (1988)



[In December, 1978, Basic Incorporated agreed to merge with Consolidated Engineering. Prior to the merger,

Basic made three public statements denying it was involved in merger negotiations. Shareholders who sold their stock after the first of these statements and before the merger was announced sued Basic and its directors under Rule 10b-5, claiming that they sold their shares at depressed prices as a result of Basic's misleading statements. The District Court decided in favor of Basic on the grounds that Basic's statements were not material and therefore were not misleading. The Court of Appeals reversed and the Supreme Court granted certiorari.]




We granted certiorari to resolve the split among the Courts of Appeals as to the standard of materiality

applicable to preliminary merger discussions, and to determine whether the courts below properly applied a

presumption of reliance in certifying the class, rather than requiring each class member to show direct reliance on Basic's statements.


The Court previously has addressed various positive and common-law requirements for a violation of 5 10(b)

or of Rule 10b-5. The Court also explicitly has defined a standard of materiality under the securities laws, see TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), concluding in the proxy-solicitation context that "[an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." . . . We now expressly adopt the TSC Industries standard of materiality for the 5 10(b) and Rule 10b-5 context.


The application of this materiality standard to preliminary merger discussions is not self-evident. Where the impact of the corporate development on the target's fortune is certain and clear, the TSC Industries materiality definition admits straight-forward application. Where, on the other hand, the event is contingent or speculative in nature, it is difficult to ascertain whether the "reasonable investor" would have considered the omitted information significant at the time. Merger negotiations, because of the ever-present possibility that the contemplated transaction will not be effectuated, fall into the latter category.


Even before this Court's decision in TSC Industries, the Second Circuit had explained the role of the

materiality requirement of Rule 10b-5, with respect to contingent or speculative information or events, in a

manner that gave that term meaning that is independent of the other provisions of the Rule. Under such

circumstances, materiality "will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity." SEC v. Texas Gulf Sulphur Co., 401 F.2d, at 849.


Whether merger discussions in any particular case are material therefore depends on the facts. Generally, in

order to assess the probability that the event will occur, a factfinder will need to look to indicia of interest in the transactions at the highest corporate levels. Without attempting to catalog all such

possible factors, we note by way of example that board resolutions, instructions to investment bankers, and actual negotiations between principals or their intermediaries may serve as indicia of interest. To assess the magnitude of the transaction to the issuer of the securities allegedly manipulated, a factfinder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular event or factor short of closing the transaction need to be either necessary or sufficient by itself to render merger discussions material.


As we clarify today, materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information. The fact-specific inquiry we endorse here is consistent with the approach a number of courts have taken in assessing the materiality of merger negotiations. Because the standard of materiality we have adopted differs from that used by both courts below, we remand the case for reconsideration of the question whether a grant of summary judgment is appropriate on this record.


We turn to the question of reliance and the fraud on-the-market theory. succinctly put:


"The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available information regarding the company and its business . . . . Misleading statements will therefore defraud purchasers of stock eve if the purchasers do not directly rely on the misstatements . . . The causal connection between the defendants' fraud and the plaintiffs purchase of stock in such a case of direct reliance on misrepresentations. Peil v. Speiser, 806 F.2d 1154, 1160-1161 (CA3 1986).


We agree that reliance is an element of a Rule 10b-5 cause of action. Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiffs misrepresentation and a plaintiffs injury. There is, however, more than one way to demonstrate the causal connection.


Presumptions typically serve to assist courts in managing circumstances in which direct proof, for one reason or another, is rendered difficult. The courts below accepted a presumption, created by the fraud-on-the-market theory and subject to rebuttal by petitioners, that persons who had traded Basic shares had done so in reliance on the integrity of the price set by the market, but because of petitioners' material misrepresentations that price had been fraudulently depressed. Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted if omitted material information had been disclosed, or if the misrepresentation had not been made, would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market.


Arising out of considerations of fairness, public policy, and probability, as well as judicial economy,

presumptions are also useful devices for allocating the burdens of proof between parties. The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the 1934 Act. . . .


The presumption is also supported by common sense and probability. Recent empirical studies have tended to

confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations. It has been noted that "it is hard to imagine that there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?" Schlanger v. Four-Phase Systems, Inc., 555 F.Supp. 535, 538 (SDNY 1982). . . . An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.


The judgment of the Court of Appeals is vacated and the case is remanded to that court for further proceedings consistent with this opinion.