Zlotnick v. Tie Communications

836 F.2d 818, 3d Cir., 1988


P claims that D misrepresented that fact that a stock had an inflated price.  P claims he relied on D’s misrepresentation to engage in a short sale, which is a technical way of profiting from a stock with a falling price.  The relevant timeframe is as follows:

  • Early 1982 – Tie issues common stock
  • Rest of 1982 – Stock rises, selling at six times its offering price
  • Jan 6, 1983 – P short sells D’s stock, based on a valuation that the value of the stock was 50 times its annualized earnings and was facing future competition. P cuts his losses at this point to sustain a loss of no more than the $35K he’s already lost.  He does this by purchasing the stock at its higher price to pay back the broker.
  • 1983, After P short sells – D issued false press releases to “inflate artificially the price of Technicom stock.”
  • Price of stock increases further and P’s short sale costs him $35,000.
  • Summer of 1983 – Stock finally begins to fall due to “realistic statements” by D
  • The share price eventually settles as 90% less than its former high.

P seeks use of the “fraud on the market theory” of reliance, namely that his reliance is presumed in selling at a loss.

P seeks use of the “integrity of the market” theory, which relies on “other investors to interpret the relevant data and arrive at a price which, at the time of the transaction, reflects the true worth of the company.”


(1) Whether P’s reliance can be assumed via a “fraud on the market” theory adoption.

(2)  Whether P as a short seller can rely on the integrity of the market.

(3)  Whether P’s reliance can be shown through his proving that fraud in the market price was a “material factor in his decision to cover.”


The idea behind fraud on the market theory is that the purchaser “relies on the market price of the stock as an indication of its value” The price itself is something the purchasers relies and the fraud’s impact is already built into the price through artificial inflation.  Thus the reliance is indirect, because the buyer of a stock purchased at a higher price and the price is higher because of fraud.


Remanded, D has not sufficiently proven P’s reasons for covering.  P is entitled to a chance to prove his actual reliance at trial.

(1)  No, it is not logical to apply fraud on the market theory to the case.  P’s short sale demonstrates that he didn’t believe in the theory that the price itself is reflective of existing conditions.  This is speculation.

(2) No.  The “investor relying on the integrity of a market price in fact relies on other investors to interpret the relevant data and arrive at a price which, (after the transaction and in the future) reflects the true worth of the company.”  Under this theory the short seller is injured because others relied on the false or misleading statements.  However, P cannot recover because, once again, the false statements came after his repurchase of the stock.

(3)  Yes.  P might have changed his investment strategy and could have relied on the inflated price.  “The rise in price itself may have changed his opinion of the stock’s value.”  The rise in price may have also let him to conclude that he should cover his position because the price would take far too long to fall.

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