By Rodney F. Tonkovic, J.D.
A petition for certiorari has been filed concerning securities fraud in a context the Supreme Court has yet to address: a privately held corporation trading in its own stock. In this case, a privately held company purchased its employees' shares without disclosing that it was pursuing a lucrative merger. With the exception of the Eleventh Circuit, the petitioner says, every circuit to address the issue has concluded that a corporation's insider status gives rise to a duty to disclose (Fried v. Stiefel Laboratories, Inc., May 31, 2016).
From 1987 through 1997, the petitioner was the CFO of Stiefel Labs, which was, at the time, a family-owned pharmaceutical company. In 2009, Stiefel repurchased its stock from its shareholders, including the petitioner, who held shares as part of a pension plan as well as non-pension shares. Stiefel, however, failed to disclose that it was actively engaged in merger negotiations, and, in fact had consistently maintained that it would never sell out or go public. The negotiations culminated in a merger in which the remaining shareholders were paid roughly four times the price Stiefel had paid shareholders like the petitioner.
Incorrect statement of law. The petitioner sued Stiefel on several grounds, including fraud under the Exchange Act. The fraud claim went to the jury, which returned a verdict in favor of Stiefel. On appeal to the Eleventh Circuit, the petitioner argued that an insider's failure to disclose all material facts when trading in the corporation’s stock is an omission under Rule 10b-5(b) and that the jury instructions should have said that Stiefel had a "duty to disclose all material information." The Eleventh Circuit panel disagreed, however, noting that this interpretation is contrary to the plain text of the rule, which prohibits "mak[ing] an untrue statement of material fact or omit[ting] 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." The court also said that the requested jury instruction did not correctly state the law because it did not state the elements of a claim for insider trading under Rule 10b-5(a) or (c) because it did not require the jury to find that Stiefel traded “on the basis of” material information.
Duty to disclose. The petition asks whether the elements of a Section 10(b) and Rule 10b-5 private securities fraud claim based on the failure of a privately held corporation to disclose material information to shareholders before directly purchasing their stock are the same six elements the Supreme Court has held comprise a private securities fraud claim. The petition also asks whether, in order to prove that a defendant traded "on the basis of" undisclosed material information, it is necessary to prove that the defendant used the information, or only that the defendant was in knowing possession of the information.
According to the petitioner, this case presents the opportunity to clarify the contours of an Exchange Act fraud claim in this context for an alleged violation of the duty to disclose. The Eleventh Circuit's insistence that this relationship-based duty to disclose must proceed under Rule 10b-5 (a) or (c) and satisfy the elements of a classical insider trading claim conflicts with the approach taken by the Second, Ninth, and Tenth Circuits. These three circuits take a less formalistic approach, the petitioner says, and require only that the six elements of a fraud claim be applied. The Eleventh Circuit explicitly considered and rejected this more flexible approach to the rule.
The case can also clarify the standard defining what conduct constitutes insider trading. Here, the Eleventh Circuit's embrace of a "use" requirement to define trading "on the basis of" material non-public information conflicts with the Second Circuit's less-exacting "knowing possession" threshold, an approach that has been endorsed by the SEC. According to the petition, the Eleventh Circuit ignored the SEC's interpretation of Section 10(b), and Rule 10b5-1, and relied on its own precedent that predated the enactment of Rule 10b5-1 in 2000. The conflict over the interpretation of "on the basis of" has persisted for nearly twenty years, the petition says.
The petition is No. 15-1458.