Fraud on the Market theory applied to Analysts

This week, Citigroup agreed to settle its WorldCom class action lawsuit with a huge payment. An article in the WSJ, says Citigroup may have been motivated by an unsual friend-of-the-court brief filed by the SEC in this case. Some quotes from the article:

Citigroup said it settled in part because the Securities and Exchange Commission filed a legal brief in the case saying investors need not show they relied on misrepresentations by analysts to prevail in a suit over flawed research -- because such public statements are reflected in a stock's price. Citigroup had argued this "fraud on the market" doctrine applied only to corporate executives, not analysts... Citigroup and other banks defending shareholder lawsuits involving WorldCom and other alleged corporate frauds had been arguing that because multiple analysts make recommendations, it is difficult to parse exactly what influenced an investor's decision to buy. The SEC's position, if adopted by the courts, would make that argument moot.

The SEC's brief (see PDF or HTML) interprets a 1988 Supreme Court case (Basic v Levinson) to conclude that the fraud-on-the-market theory applies to anyone who disseminates material information that is assumed to be refected in the stock price relied on by investors, and that includes analysts. What's special about this brief from my point is that it makes its case by quoting extensively from published and recent research in finance and accounting research on analysts and analyst forecast. Kudos to my academic colleagues Scott Stickel, Kent Womack, Brad Barbar, N. Jegadeesh, Roby Lehavy, Charles Lee, and other academic colleagues whose work was cited by the SEC in support of its brief. I am surprised, however, that the SEC brief doesn't cite Larry Brown's extensive research on analysts. Larry is by far the most published researcher in this field.

Bala Dharan