Chapter 2-4 Officer and Director Liability—Liability for Securities Fraud
| Jurisdiction | United States |
2-4 Officer and Director Liability—Liability for Securities Fraud73
2-4:1 Overview
2-4:1.1 Related Causes of Action
Fraud by Non-Disclosure, Common Law Fraud, Statutory Fraud, Officer and Director Liability, Breach of the Duty of Loyalty, Breach of Partnership Duty, Antitrust
MUST READ CASES
Basic Inc. v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988)
Dirks v. S.E.C., 463 U.S. 646, 103 S. Ct. 3255, 77 L. Ed. 2d 911 (1983)
2-4:2 Elements
2-4:2.1 Rule 10b-5 General Fraud
(1) A person uses any means or instrumentality of interstate commerce or of the mails or of any facility of any national securities exchange to:
• This jurisdictional hook is to be interpreted flexibly and broadly.74
• It is sufficient that any portion of the transaction utilize the means or instrumentality of interstate commerce.75
• The intrastate use of telephones is sufficient to confer jurisdiction.76
(1)(a) Make a misrepresentation or fail to disclose
• The defendant must make a misrepresentation or fail to disclose a fact.77
• However, silence absent a duty to disclose is not considered to be misleading.78• Mere mismanagement or breach of fiduciary duty will not suffice.79
(1)(b) A material fact
• There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.80
• When analyzing future events, materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company's activities.81
• A finding of materiality does not require proof that the plaintiff would have changed her mind.82
• However, proving reliance might require such a showing.83
(1)(c) In connection with the purchase or sale of any security
• This language is to be construed broadly84
• However, a plaintiff must have actually purchased or sold securities.85
(1) (d) With scienter
• The defendant must:
• Know of the falsity of the information; and
• Intend to deceive, manipulate, or defraud.86
• An opinion or prediction is actionable if there is a gross disparity between prediction and fact.87
(2) Which the plaintiff reasonably relies upon
• A plaintiff must establish his reasonable reliance on the misrepresentation or omission.88
• The relevant question in determining reliance is: had the investor known the truth, would he have acted differently?89
• A plaintiff is afforded a rebuttable presumption of reliance if the securities are traded in an open and developed market.90
• A plaintiff is afforded a rebuttable presumption of reliance if the defendant fails to disclose a material fact.91
• A plaintiff must also exercise due diligence in examining other information available to the plaintiff with regard to the transaction.92
• This element is often referred to as "transaction causation."93
(3) Which proximately causes the plaintiff injury
• This element is often referred to as "loss causation."94
• The misrepresentation or omission must touch upon the reasons for the investment's decline in value.95
2-4:2.2 Rule 10b-5 Insider Trading
(1) A person uses any means or instrumentality of interstate commerce or of the mails or of any facility of any national securities exchange to
• This jurisdictional hook is to be interpreted flexibly and broadly.96
• It is sufficient that any portion of the transaction utilize the means or instrumentality of interstate commerce.97
• The intrastate use of telephones is sufficient to confer jurisdiction.98
(2) Purchase or sell any security
• The defendant must purchase or sell a security.99
(3) On the basis of information which is:
• "On the basis of" means awareness of that information.100
(3)(a) Material
• There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.101
• When analyzing future events, materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company's activities.102
• A finding of materiality does not require proof that the plaintiff would have changed his mind.103
• However, proving reliance might require such proof.104
(3) (b) Non-public
• The information must be non-public.105
• Non-public information is information intended to be available only for a corporate purpose and not for the personal benefit of anyone.106
(4) In violation of a fiduciary duty owed to the issuer or the source of the information There is a duty to disclose information when:
• The insider occupies a fiduciary relationship to the corporation; or
• The corporation had placed their trust and confidence in that person.107
(5) The insider does not publicly disclose the information before trading on it.
• The insider does not publicly disclose the information before trading on it.108
2-4:2.3 Rule 14e-3 Tender Offers
(1) A person trades in securities
• A defendant must:
• Purchase or sell securities; or
• Cause securities to be purchased or sold.109
(2) On this basis of information that is reasonably known to be material, non-public information
• On this basis of information that is reasonably known to be material, non-public information.110
• Materiality:
• There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.111• Non-public:
• When analyzing future events, materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company's activities.112
• A finding of materiality does not require proof that the plaintiff would have changed his mind.113
• However, proving reliance might require such proof.114
• Non-public information is information intended to be available only for a corporate purpose and not for the personal benefit of anyone.115
(3) With reason to believe such information was acquired from: (a) the offering person; (b) the issuer; or (c) any agent of the offering person or issuer
• With reason to believe such information was acquired from
• The offering person;
• The issuer; or
• Any agent of the offering person or issuer.116
(4) Not publicly disclosing such information
• The person does not publicly disclose the information before trading on it.117
2-4:2.4 Short Swing Profits
(1) An insider
• An insider means:
• A director;
• An officer; or
• A beneficial owner of 10% of any class of any security.118
(2) Of a corporation which must register its securities
• A covered corporation is one which must register its securities under Section 12 of the Securities Act of 1933.119
(3) (a) Who purchases and then sells his corporation's securities within six months of each other.120
(3)(b) Who sells and then purchases his corporation's securities within six months of each other.121
2-4:2.5 Common Law Fraud
See Fraud by Non-Disclosure, Common Law Fraud.
Special Note On Duty
The general rule is that an officer or director owes no duty to disclose information to shareholders.122
However, an officer or director must disclose any knowledge of special matters relating to the corporate business—e.g., merger, assured sale, etc.—that may affect the value of the stock.123
2-4:3 Damages and Remedies
2-4:3.1 Out-of-Pocket
Out-of-pocket damages are the traditional measure of damages for a Rule 10b-5—General Fraud violation.124
2-4:3.2 Benefit-of-the-Bargain
Benefit-of-the-bargain damages are available for a Rule 10b-5 violation.125
2-4:3.3 Disgorgement
Disgorgement in favor of the issuing corporation is an appropriate remedy for a Short Swing Profits suit.126
Profits to be disgorged are calculated by using the highest sale price and lowest purchase price, or highest purchase price and lowest sale price, in any given six month period.127
Disgorgement of profits or loss avoided is the appropriate measure of damages for a Rule 10b-5—Insider Trading violation.128
Each person who traded in the security during the relevant time frame shares in the recovery pro rata.129
2-4:3.4 Rescission
Rescission is available for Securities Exchange Act violations, such as:
• Rule 10b-5—General Fraud;
• Rule 10b-5—Insider Trading;
• Tender Offers; and
• Short Swing Profits.130
2-4:3.5 Exemplary Damages
Generally, exemplary damages are not available for a federal cause of action.131
However, exemplary damages are available for common law fraud.132
2-4:3.6 Consequential Damages
Consequential damages are available for a Rule 10b-5 violation.133
2-4:3.7 Common Law Fraud Damages
For a complete list of common law fraud damages, See Fraud by Non-disclosure, Common Law Fraud.
2-4:4 Defenses
2-4:4.1 10b-5-1 Plan
A sale of shares in accordance with a 10b-5-1 plan is an affirmative defense to suit alleging a violation of Rule 10b-5.134
A person's purchase or sale is not "on the basis of" material non-public information if the person making the purchase or sale demonstrates that:
• Before becoming aware of the information, the person had:...
• Entered into a binding contract to purchase or sell the security;
•
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