49 Bus. Law. 545 (1993-1994)
The Role of Financial Economics in Securities Fraud Cases: Applications at the Securities and Exchange Commission

handle is hein.journals/busl49 and id is 573 raw text is: The Role of Financial Economics in Securities
Fraud Cases: Applications at the Securities and
Exchange Commission
By Mark L. Mitchell and Jeffry M. Netter*
Litigants, including the Securities and Exchange Commission (SEC),
increasingly have applied modem financial economics in securities fraud
cases. One of the most important applications of financial economics for
securities law comes from the efficient markets hypothesis. This Article
presents an overview of areas where securities fraud law has adopted some
of the reasonings and applications of the efficient markets hypothesis and
provides examples of the use of financial economics in SEC enforcement
actions. Specifically, this Article discusses how techniques developed by
financial economists can be used to establish the materiality of information
allegedly used in securities fraud, and to compute profits (or losses avoided)
resulting from fraudulent actions. It then shows how the methodology was
applied in recent SEC enforcement cases.
A leading expert on the efficient markets hypothesis, Professor Eugene
F. Fama of the University of Chicago's Graduate School of Business, re-
cently reviewed the empirical evidence on the efficient markets hypothesis
and defined market efficiency with the simple statement that security prices
fully reflect all available information.1 Fama noted that, while no market
is perfectly efficient, the idea that prices quickly adjust to the release of
new information is a useful tool to analyze many situations, especially when
information and transactions costs are low, as in the United States stock
An event study, a technique developed and refined by financial econ-
omists, can be very useful in securities fraud cases. An event study relates
changes in stock prices to the release of new information. Researchers
have applied event studies to all types of events ranging from mergers to
regulatory actions. In securities fraud law, event studies are particularly
*Both authors formerly worked at the United States Securities and Exchange Commission.
The views expressed here are those of the authors and do not necessarily reflect the views
of the Commission.
1. Eugene F. Fama, Efficient Capital Markets: 11, 46 J. FINANCE 1575 (1991).

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