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PolyMedica Corporation, a provider of healthcare products and related services, reported record revenues and earnings from 1998 to 2001, prompting substantial increases in the price of its stock. However, when its share price dropped, plaintiff Thomas Thuna sued for damages, alleging that PolyMedica fraudulently inflated the price of its stock by misrepresenting revenues and earnings and by issuing false press releases. In January 2004, the plaintiff moved for class certification, which was granted at the district court level in 2005. PolyMedica appealed the district court’s decision, arguing that the lower court was incorrect to conclude that the market for its stock was efficient during the latter part of the class period.

NERA Senior Vice President Dr. Denise Martin served as an expert witness for PolyMedica. Dr. Martin argued that the so-called Cammer factors considered by plaintiffs’ expert were insufficient to support a conclusion of market efficiency. In particular, she argued that an appropriate test for market efficiency was that the stock price reacted quickly and fully to news. Given the extraordinarily high costs of shorting and a reported inability of market participants to find shares to short, Dr. Martin argued that PolyMedica’s stock price did not trade in an informationally efficient market.

Judge Kermit Lipez of the US Court of Appeals for the First Circuit overturned the lower court’s decision on the class certification question and held that “an efficient market is one in which the market price of the stock fully reflects all publicly available information,” a corner piece of the academic definition of market efficiency put forth by Dr. Martin. The First Court of Appeals found that the district court had erred in its definition of market efficiency, vacated class certification based on that definition, and remanded the case back for reanalysis based on its ruling.

Former NERA Senior Vice President Dr. Fred Dunbar submitted a supplemental report and provided oral testimony at the district court hearing on remand. Dr. Dunbar argued that plaintiffs’ expert’s analysis was unscientific and that the stock traded in an inefficient market as defined in the appellate court’s new guidance.

The district court found Dr. Dunbar’s “testimony particularly credible and informative.” In particular, the Court credited NERA’s findings showing that short selling was costly and that violations of put-call parity in the options market for PolyMedica’s stock were substantial and persistent. This, in turn, meant that investors were unable to take advantage of arbitrage possibilities caused by new information and, as a result, PolyMedica’s stock price would not rapidly or completely impound information. The Court also agreed with Dr. Dunbar that positive serial correlation in PolyMedica’s stock returns was evidence that the stock price did not quickly and fully respond to material information. The Court concluded that defendants had sufficiently rebutted plaintiffs’ claims of market efficiency and as a result denied class certification for the relevant time period.