Materiality, Informal Disclosure, Soft Information, and Forward Looking Statements under Securities Laws

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1 373 ALI-ABA Topical Courses Fundamentals of Securities Law July 26-29, 2010 Video Replay of an ALI-ABA Annual Course of Study Originally Presented May 13-15, 2010 Materiality, Informal Disclosure, Soft Information, and Forward Looking Statements under Securities Laws By Alan J. Berkeley K&L Gates LLP Washington, D.C.

2 374 MATERIALITY, INFORMAL DISCLOSURE, SOFT INFORMATION, AND FORWARD LOOKING STATEMENTS UNDER SECURITIES LAWS I. INTRODUCTION Alan J. Berkeley K&L Gates LLP 1 Washington, D.C. April 2010 The federal securities laws require public companies to make formal disclosure of information deemed to be important to investors through periodic reports under the Securities Exchange Act of 1934 ( Exchange Act ) and filings made with the Securities and Exchange Commission ( SEC ) under the Securities Act of 1933 ( Securities Act ). While most public companies are familiar with the timing and scope of formal disclosure, these same companies often lack knowledge with respect to informal disclosure or soft information disseminated through press releases and communications with analysts or reporters. While the legal requirements regarding informal communications may not be as well defined as they are for formal communications, the potential for liability resulting from informal disclosure may be equally great. II. ANTIFRAUD PROVISIONS Section 10(b) of the Exchange Act prohibits the use of manipulative and deceptive devices in connection with the purchase and sale of securities. Rule 10b-5, which is promulgated under Section 10(b), makes it unlawful to make an untrue statement of a material fact or to omit to state a material fact in connection with the purchase or sale of any security. The Supreme Court of the United States addressed the in connection with the purchase and sale of any security element of Section 10(b) and Rule 10b-5 in SEC v. Zandford, 535 U.S. 813 (2002). In that case, a broker misappropriated assets from an investment account over which he had investment discretion. The broker sold his customer s securities and then used the proceeds for his own benefit without the customer s knowledge or consent. The Supreme Court found that although the broker did not manipulate the price of a particular security, his fraudulent scheme in which the securities transactions and breaches of fiduciary duty coincided was 1 With the assistance of Erin E. Troy and Peter W. Denton of K&L Gates, Washington, D.C. DC v

3 375 in connection with securities sales within the meaning of Section 10(b). Many other securities fraud cases are often based on a claim that a company or its representative either misstated or failed to state certain material information concerning the company. Courts after Zandford have emphasized that fraudulent conduct must reach the level of misstatements or omissions to be actionable. United States v. Tambone, 417 F. Supp. 2d 127, 135 (D. Mass. 2006). See also SEC v. Terry s Tips., Inc. 409 F. Supp. 2d 526 (D. Vt. 2006); but see SEC v. KPMG, LLP, 412 F. Supp. 2d 349, 378 (S.D.N.Y. 2006) (it would be improper to impose liability for fraud by designating as a manipulative device what was actually a misstatement). Thus, a company should first determine what constitutes material information and then determine whether it has a duty to disclose such information. III. MATERIALITY A. Whether a fact is material depends on the significance the reasonable investor would place on the withheld or misrepresented information. Basic Inc. v. Levinson, 485 U.S. 224, 240 (1988). A misrepresentation or omission is material if the information would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Since materiality is a mixed question of law and fact, it is decided as a matter of law only if reasonable minds could not differ on the issue. Id. at 450. Nevertheless, in many cases courts have decided as a matter of law that facts were immaterial. 1. Examples of cases in which courts held that facts were immaterial as a matter of law include: ABC Arbitrage Plaintiffs Group, et al. v. Tchuruck, et al., 291 F. 3d 336 (5th Cir. 2002) (shareholders contentions that defendants concealment of the financial difficulties of the corporation s subsidiary, overstatement of the corporation s financial results and corporation s contract losses to avoid compromising a stock-for-stock acquisition of a communications company were immaterial because they would not have affected a reasonable investor s decision to purchase the corporation s stock); Demaria v. Andersen, 318 F.3d 170 (2d Cir. 2003) (erroneous disclosure contained in an electronically filed prospectus as well as start-up company s failure to include revenue information for the most recent quarter preceding its IPO was not materially misleading, because a reasonable investor would not have been led to overestimate past or future performance potential); Greenhouse v. MCG Capital Corp., No (4th Cir. 2004) (CEO s misrepresentation about finishing college was not actionably material because it was not substantially likely that reasonable investors would devalue the stock when viewed against the total mix of true information available about the company); In re Blockbuster Inc., 2004 U.S. Dist. LEXIS 7173 (N.D. Tex. April 26, 2

4 ) ( Generalized, positive statements about the company s competitive strengths and future prospects are not actionable because no reasonable investor would consider such vague statements material and because investors and analysts are too sophisticated to rely on vague expressions of optimism rather than specific facts ); In re Midway Games, Inc., 2004 U.S. Dist. LEXIS (N.D. Ill. Aug. 27, 2004)(statements as to product development efforts and that existing portfolio of products was the strongest home video game lineup in the Company s history and these products will produce record home video game results in 2002 were immaterial because no reasonable investor, much less the market itself, would rely on such general statements); In re CDNOW, Inc., Sec. Litig., 138 F. Supp. 2d 624 (E.D. Pa. 2001) (principals of corporation had no duty to disclose the imminent collapse of the merger until it actually collapsed or the audit letter until it was actually received; information regarding the likely merger termination and the anticipated going concern qualification was not material because, prior to the occurrence of each event, they were speculative or contingent); Klein v. General Nutrition Companies, Inc., 186 F.3d 338 (3d Cir. 1999) (non-disclosure of information deemed to be public knowledge immaterial as a matter of law as an investor would be expected to know the knowledge; statements that company plans might not be achieved and if achieved might not be profitable provide adequate caution rendering an alleged omission immaterial as a matter of law; statements regarding contingent or speculative events, such as the potential impact of the ability of another company to continue to provide free advertising, are immaterial as a matter of law due to the difficulty of ascertaining whether a reasonable investor would have considered the omitted information significant at the time); In re Rockefeller Center Properties, Inc. Sec. Litig., 311 F.3d 198 (3d Cir. 2002) (failure to disclose existence and value of air rights of company real property prior to shareholder decision on merger held immaterial as a matter of law because uncertainty as to existence and value was unknown as to whether such air rights would be sold post-merger); Levitin v. Painewebber, Inc., 159 F.3d 698 (2d Cir. 1998) (certain information is so basic, such as the concept of the time value of money, that an investor is expected to know it and such information cannot be a material omission); In re International Business Machines Corporate Sec. Litig., 163 F.3d 102 (2d Cir. 1998) (statements regarding uncertain future events such as the payment of dividends are, as a matter of law, opinions and not guarantees where management lacked authority to declare dividends); Grossman v. Novell, Inc., 120 F.3d 1112 (10th Cir. 1997) (vague generalized statements of corporate optimism, such as statements that defendant had substantial success in 3

5 377 integrating employees in merger, that the merger process was proceeding faster than we thought, and that the merger presented a compelling set of opportunities for the defendant were not material); In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997) (a general, non-specific statement of optimism or hope that a trend will continue was immaterial as a matter of law); Abromson v. American Pacific Corp., 114 F.3d 898 (9th Cir. 1997), cert. denied, 118 S. Ct (1998) (failure to disclose possible adverse effects of early prepayment of loan not material; balancing test applied: When assessing materiality, we consider both the magnitude of the potential loss and the likelihood that it will actually take place. ); Gasner v. The Board of Supervisors of the County of Dinwiddie, 103 F.3d 351 (4th Cir. 1996) (extensive and meaningful cautionary language in offering statement negated materiality as a matter of law); Connett v. Justus Enterprises of Kansas, Inc., 68 F.3d 382 (10th Cir. 1995), cert. denied, 516 U.S (1996) (appraisal information omitted from a statement prepared in connection with a bond offering was immaterial as a matter of law, since the omissions did not significantly alter the information available); Searls v. Glasser, 1994 U.S. Dist. LEXIS (N.D. Ill. Sept. 23, 1994) aff'd., 64 F.3d 1061 (7th Cir. 1995) (CEO's statement that firm was recession-resistant was too vague, and thus immaterial as a matter of law); Herman v. Legent Corp., 50 F.3d 6 (4th Cir. 1995) (commonplace commercial puffery is immaterial as a matter of law); Hillson v. Adage, Inc., 42 F.3d 204 (4th Cir. 1994) (vague predictions were immaterial as a matter of law); Kowal v. MCI Communications Corp., 16 F.3d 1271 (D.C. Cir. 1994) (failure to state that competitive position was deteriorating, that funds were insufficient to compete effectively, and that a competitor placed great pressure on the company was immaterial as a matter of law); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993) (cautionary language rendered alleged misstatements and omissions concerning predicative statements immaterial as a matter of law), cert. denied, 114 S. Ct (1994); United States v. Bingham, 992 F.2d 975 (9th Cir. 1993) (defendant's misrepresentation of his name and status as an officer and director of company was immaterial as a matter of law); Lewis v. Chrysler Corp., 949 F.2d 644 (3d Cir. 1991) (predictions about cost of plan amendments were immaterial as a matter of law); Steinberg v. PRT Group, Inc., 88 F. Supp. 2d 294 (S.D.N.Y. 2000) (ambiguous statements regarding recruiting and employee assessment tools were immaterial as a matter of law as a reasonable investor would be concerned with the end result of the recruiting process rather than the process itself); Berkowitz v. Conrail, Inc., Fed. Sec. L. Rep. (CCH) 99,549 (E.D. Pa. 1997) (in announcing a proposed merger, the failure to disclose that another 4