Half-truths: protecting mistaken inferences by investors and others.

• Author: Langevoort, Donald C.
• Position: Securities law

A nice puzzle in the law of fraud has to do with the half-truth--a statement that is literally true but omits some material fact, thereby making it misleading. By all accounts, half-truths are actionable.(1) But exactly why this is so, or how we should decide when a tree statement is deceptive in such a way as to give rise to liability, are questions that have received almost no critical attention.(2) Because half-truth claims are so frequently made in litigation, this leaves an unfortunate risk of confusing precedent.(3) Such confusion, in turn, causes people a good deal of trouble in knowing how to act (or advise their clients) free of legal risk, something particularly problematic given how often we are all tempted to be evasive.

The law's murkiness should not be surprising. Half-truths trigger a high level of both moral and social ambiguity. People often defend themselves against charges of deception by pointing out the technical accuracy of what they said, expecting significantly less blame if not total absolution.(4) If the listener inferred any more than what the statement actually said without seeking clarification, the victim deserves responsibility for assuming too much. In many settings, moreover, half-truths seem to be expected, or at least tolerated. Instructions to tell the "whole truth" notwithstanding, it is generally not considered perjury in a trial or deposition for a witness to give a technically true but evasive answer.(5) Nor is the whole truth expected of lawyers in advocacy settings.(6) In many highly adversarial business or legal negotiations (e.g., contested settlement talks), the baseline norm may not be an iota more than grudging technical accuracy.(7) Given such contingent societal expectations, the potential for misunderstanding legal obligations is all the greater.

Confusion aside, there is also an efficiency-based cause for concern. Though the law of nondisclosure is fluid and fuzzy, there is widespread recognition that parties to a negotiation are privileged to withhold at least some crucial information from the other, lest there be a disincentive to the socially beneficial production or discovery of that sort of information.(8) Yet the half-truth doctrine is sufficiently open-textured that it can apply and override this seemingly strong privilege almost anytime a person opens his mouth. To address a subject at all can always lead to the argument that failure to address it fully was misleading.(9) And it is very difficult in any negotiation to avoid touching in some way or another on a subject that is material to the bargain.(10)

My primary interest in this subject stems from the important role that the half-truth doctrine--and the law of omissions and nondisclosures generally-plays under the federal securities laws. Again, there is no doubt that the doctrine applies.(11) Section 17(a)(2) of the Securities Act of 1933 explicitly bars persons from obtaining money or property by means of "any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading...."(12) Similar phrases appear in the express private rights of action for investors under Sections 11(13) and 12(a)(2)(14) of the Securities Act. In mm, the text from Section 17(a) was incorporated verbatim by the Securities and Exchange Commission (SEC) into what has become the most litigated antifraud prohibition of the securities laws, Rule 10b-5 under the Securities Exchange Act of 1934.(15) Courts are asked to apply these words scores of times each year, with particular frequency in cases where a company issues a press release or an executive grants an interview, commenting publicly on some topic. Does that comment trigger a duty to disclose to the investing public other important things company managers know about that subject, regardless of how confidential, sensitive, or embarrassing?

Judges regularly give answers one way or another,(16) but to date none has offered any grounded half-truth theory. Courts tend to declare something a half-truth or not--using exactly the same standard invoked under common law--and move on.(17) Yet a close reading of the cases suggests that the outcomes are often different: Courts seem more inclined to dismiss half-truth claims in securities law settings, especially open-market cases, than in common law settings.

What follows is an effort to explain this divergence and thereby advance our understanding of the half-truth doctrine. Like nearly all subjects in the law of fraud, the half-truth resists anything approaching a bright-line restatement. But that should not deter us, for we do not expect an extraordinarily high level of determinacy in the law of fraud anyway. Fraud is about human discourse, which is necessarily contextual and fact-specific. What we can gain, however, is a better sense of the situations in which a person, having opened her mouth and begun to speak, can stop talking at a point short of complete candor. My sense is that some insight can be achieved by situating the half-truth on a continuum roughly half way between the duty to avoid affirmative misrepresentations and the more controversial and contingent duty to reveal hidden private information, both of which have received thoughtful attention in the economics literature. This, in mm, demands that the law seek to capture some sense of the "background norms" of communication in a particular setting--in other words, an assessment of what people are reasonably entitled to expect out of a particular speaker in terms of candor.

A fleshed-out conceptual understanding of the half-truth can then be used as the basis for a better articulation of corporate disclosure obligations under the securities laws. My main argument here is that there has been a failure to acknowledge explicitly the crucial differences that arise when information is publicized by corporations not directly for the benefit of investors, but for some other corporate reason. The proper inferences that investors should draw will vary depending on these differences. Hence, the divergence in outcomes between the common law cases and the open-market securities fraud cases is neither surprising nor unjustified. Indeed, what I will begin to develop is a metatheory of corporate discourse: what the law says about how investors should understand what firms are--or are not--saying when they speak. This theory, in mm, can also illuminate related questions such as when companies have a duty to update previously accurate statements and when a person who expresses excessive optimism violates Rule 10b-5.

1. COMMON LAW: THE ESSENCE OF THE HALF-TRUTH

   The Restatement (Second) of Torts provides a standard definition of the half-truth doctrine. Section 529 says that a "representation stating the troth as far as it goes but which the maker knows or believes to be materially misleading because of the failure to state additional or qualifying matter is a fraudulent misrepresentation."(18) The Restatement's first illustration of this rule is straightforward.(19) A is selling a tract of land to B and explicitly warns him that the city plans two streets that may lead to a small part of the land being condemned. That is true, but he omits reference to a third planned street that would have a far more severe adverse impact. A commits a fraud.(20)

   This seems to be an easy case, and I take it as correct. But why? B could have asked if A knew of any related planned encumbrances and clarified the situation, but failed to do so. It also strikes me as too easy an example, not telling us whether the same result would follow, for example, if A knew not of another planned street by the city but some other comparably adverse action contemplated by a neighbor or private developer.

   A number of facts about this hypothetical seem important. A's communication occurs in an arms-length negotiation setting where A is volunteering information because he wants to induce B to pay a good price for the land. Presumably there were prior conversations about the nature and value of the property, and the information is being offered to B (and B alone) solely for its relevance to this transactional decision. A's disclosure also carries with it a fairly clear implication that the two streets are the only streets planned. I suspect that almost all people would see it that way unless already on notice (as with an adverse witness in a trial setting) that the person is not to be trusted in the first place. Indeed, the law of half-truths is all about determining what, if any, implication follows from one party's statements that would entitle the other party to rely without seeking further clarification. Here, it is hard to imagine any reason why A would volunteer information about the two streets but not the third except to lull B into a false sense of security. A seems to be taking advantage of an influence technique well known to psychologists and salespeople: disarming suspicions and building trust by divulging a fact that is contrary to his own self-interest.(21) This apparent manipulation bolsters the intuition that A's actions are wrongful.

   Another important observation: Suppose A had said nothing at all about the two planned streets. Might he nonetheless have an affirmative duty to disclose the city's plans? Though we would want more facts here, the answer under contemporary common law--well recognized in a separate section of the Restatement (Second) of Torts(22)--is that he could well have such a duty. Throughout this century, courts in many jurisdictions have expanded the category of affirmative disclosure duties to situations where the seller of real property knows of a material defect relating to value that is not discoverable by ordinary inquiry.(23) In other words, depending on the difficulty of discovery, it is possible that the half-truth aspect of this case is actually superfluous to the...