Who Should Do the Math? Materiality Issues in Disclosures that Require Investors to Calculate the Bottom Line
Stefan J. Padfield
University of Akron School of Law
Pepperdine Law Review, Vol. 34, 2006
U of Akron Legal Studies Research Paper No. 06-11
Corporations sometimes tread a fine line by disclosing the data necessary to calculate the bottom line impact of a particular set of facts, while failing to disclose the bottom line itself. For example, in 2002, Merck & Co., Inc., disclosed that one of its subsidiaries had recognized as revenue co-payments it never actually received, but failed to disclose that the total amount so recognized was $5.54 billion for the year 2001. When plaintiffs challenge such incomplete disclosure, courts routinely dismiss their claims based upon what I call the Simple Math rule. The Simple Math rule states that, assuming a material bottom line, disclosing the data necessary to calculate the bottom line suffices to make failure to do the math for investors an immaterial omission as a matter of law. This is, in fact, what the Third Circuit concluded in the Merck case. I argue, however, that courts should apply what I call the Reasonably Available Data rule, which builds upon existing materiality doctrines to analyze each particular omission on its own facts. Specifically, I argue that when courts are presented with the question of whether failure to explicitly disclose the bottom line constitutes a material omission, they should ask: (1) whether all the relevant pieces of data necessary to calculate the bottom line were disclosed proximately to one another and the place where a reasonable investor would expect to find them; (2) whether the data was cross-referenced to; and (3) whether the import of the data was sufficiently highlighted to alert the reasonable investor. In addition, where the bottom line was omitted in a corrective disclosure, that fact should weigh in favor of finding materiality. Finally, a presumption of materiality should be applied where the bottom line is subsequently made public and the market reacts negatively to that disclosure. This proposed approach is consistent with the Supreme Court's admonition against the use of bright-line rules in the context of materiality determinations. Furthermore, it makes sense from a policy standpoint because it continues to serve the safety-valve function of the Simple Math rule by allowing courts to dismiss frivolous claims, while avoiding the erosion of a materiality standard that is so integral to our modern disclosure regime.
Number of Pages in PDF File: 47
Keywords: securities regulation, materiality
JEL Classification: K1, K10, K2, K20, K22
Date posted: September 8, 2006
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