A Coherent Approach to Misleading Corporate Announcements, Fraud, and Rule 10b-5
Albany Law Review, Vol. 52, p. 957, 1988
37 Pages Posted: 29 May 2009
Date Written: 1988
Basic Inc. v. Levison represents a significant expansion of the Supreme Court’s view of the scope of liability under rule 10b-5. The expansion inheres less in the Court’s adoption of the fraud on the market theory for dispensing with the reliance requirement in situations in which fraudulent misrepresentations have pegged efficient market prices at an artificial level than in its unquestioned and unanalyzed acceptance of the application of clause (b) of rule 10b-5 to persons who have not traded. The effect of this approach, which results from treating rule 10b-5 as a disclosure provision rather than a fraud provision, is to place most of the weight in determining liability on the materiality issue. This leaves little room for taking into consideration other factors that should bear on the scope of liability, such as degree of culpability or overall benefit to shareholders generally. The effect will be a result-oriented analysis of largely irrelevant facts as courts seek to limit liability in proper cases and, paradoxically, a weakened disclosure system as companies learn that the safest path is now a flat no comment to all inquiries, whether or not a materially substantive response is available.
This article suggests that more coherent limits can and should be placed on rule 10b-5 by treating it as a fraud provision. The disclosure-oriented clause (b) is held in check by limiting liability for material misrepresentations and half-truths, absent further proof of a fraudulent scheme, to defendants who have transacted with the plaintiff. This analytical approach is general and applicable to a wide variety of securities regulation situations. In cases like Levinson, involving misleading corporate announcements but no trading or other direct benefit to those responsible for the announcements, the analysis must proceed under clauses (a) and (c) and the issue is whether the defendant’s conduct is properly characterized as fraud. The degree and effect of any wrongful disclosure constitute an important part of that analysis, but all other relevant factors, such as degree of culpability, are naturally included.
Keywords: Basic Inc. v. Levison, 17 C.F.R. § 240.10b-5 (1988), Misleading Corporate Announcements
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