Corporate Disclosure Obligations and the Parameters of Rule 10b-5: Basic v. Levinson and Beyond

Disclosure of information concerning business operations and activities is one of the most important legal issues facing the corporation today. Disclosure requirements, opportunities, and possible liabilities challenge companies on a daily basis. Inside the corporation, information officers and in-house legal counsel spend a substantial amount of time on issues of compliance. A burgeoning group of outside consultants and attorneys also assists companies in their continuing efforts to juggle the competing corporate concerns for publicity and confidentiality in a manner consistent with legal disclosure obligations. The necessity and content of corporate communications form a substantial portion of the regulation of publicly-held companies by the Securities Exchange Commission (SEC). Much of this regulation comes in the form of specific disclosures mandated in connection with particular and readily identifiable corporate activity, such as those required by the Securities Act of 1933 (1933 Act), in connection with a public offering of securities. Other requirements concern the form and content of periodic filings mandated by the Securities Exchange Act of 1934 (1934 Act). The 1934 Act also allows the SEC to impose important disclosure obligations in connection with episodic but readily identifiable corporate events, such as proxy solicitations and tender offers. Beyond the disclosures specifically and systematically prescribed by these federal statutes and regulations lies an abyss of potential liability in connection with corporate disclosures and nondisclosures. It is here that the determination of whether, when, and what to disclose retreats to the common law of deceit and fiduciary duty, and the requirements of several antifraud provisions in the 1933 Act and 1934 Act. Successfully specifying the scope of disclosure is a daily struggle for the best of companies and the ablest of lawyers. This Article explores corporate disclosure obligations and liability in the absence of specific regulatory requirements. For simplicity, and with the continuing assumption that no specific regulatory prescription governs, any requirements of disclosure in this context will be referred to as transient disclosure obligations. The liability that results from the failure to fulfill these obligations will be described as transient disclosure liability. The lawyer counseling in the area of transient corporate disclosure must think in terms of duties. The developments in this area of the law flow from the idea of duty that “there is a duty to disclose when.” The lawyer must think in terms of policy as well. Absent a specific statutory requirement of disclosure, the duty must be justified by a purpose or rationale: that is, “there is a duty to disclose in this context because.” Only by thinking in terms of duties and policies can a lawyer hope to provide guidance to a client, and to comprehend the theories of liability that have developed, primarily through judicial decisions. Transient corporate disclosure obligations arise in three distinct contexts. First, there is the duty to speak truthfully. Whether termed deceit, misrepresentation, or simply lying, there are legal and ethical obligations not to mislead. Moreover, misinformation is economically counterproductive. The duty to speak truthfully is embedded in the common law and carried over into several federal statutory provisions governing corporate communications. Second, there may be a duty either to speak or to refrain from using undisclosed information for personal advantage. Such an obligation may arise in the publicly-held corporation whenever the corporation (or its representatives) engages in trading in the company’s own securities, a practice generally referred to as insider trading. The genesis of this obligation is traceable to the duty of disclosure required between those involved in relationships of trust and confidence, often where a person acts as an agent for another. The policy is intended to foster the fiduciary relationship by requiring complete candor. Third, there may be a duty to speak even though one has not spoken on the subject, does not desire to speak, and does not plan to benefit personally from knowledge of the undisclosed information. The source of this duty draws both from the policies prohibiting deceit and from those surrounding fiduciary relationships. However, it does not fit neatly within either policy. Moreover, specifying the parameters of this affirmative duty poses substantial difficulties in the corporate context. Indeed, this duty may require affirmative disclosure of corporate developments or corporate activities at times when the corporation perceives and receives no benefit from such disclosure. This Article explores the boundaries of these duties, particularly in the context of the private enforcement aspect of section 10(b) of the 1934 Act through rule 10b-5. As the Supreme Court stated last term in Basic Inc. v. Levinson, the private right of action under rule 10b-5 “constitutes an essential tool for enforcement of the 1934 Act’s requirements.” Moreover, from the perspective of the typical corporation, rule 10b-5 casts the widest net of potential transient disclosure liability. The basic elements for finding liability pursuant to rule 10b-5 apply with equal force to all transient disclosure obligations, irrespective of the nature of the duty that gives rise to the obligation. The Supreme Court’s decision in Basic addressed two of these elements: materiality and reliance. More fundamentally, the Supreme Court highlighted the fact that there is widespread confusion over the nature of the elements of rule 10b-5 liability and the interrelation of these elements. Effective analysis of these parameters of liability constitutes the first and most important step in ascertaining and controlling possible transient disclosure liability for the corporation today.