Opinion ID: 151993
Heading Depth: 3
Heading Rank: 2

Heading: Southern Farm's Duty to Disclose Directly to PSC Shareholders

Text: Southern Farm further argues that, even if it had a duty to disclose certain material facts to PSC in the course of negotiations regarding the debenture purchase, [1] Jury Instruction 11 erred by imposing on Southern Farm a duty to disclose those facts directly to PSC shareholders. Any duty to disclose, Southern Farm argues, would have been satisfied by disclosure to PSC's officers or directors. This objection was clearly preserved before the district court. We agree that Instruction 11 was erroneous for this reason, and accordingly reverse the judgment on this ground. Instruction 11 states, in relevant part: [I]f the Plaintiffs prove that the Defendant knew or was severely reckless as to whether material information had not been fully disclosed to the shareholders or that the disclosures made by the Defendant to the corporation were materially misleading, then the Defendant had a duty to disclose the material information directly to the shareholders, to insure that the shareholders got proper disclosure or to decline to enter the transaction. The district court formulated Instruction 11 upon determining that [t]he law imposes a duty to make full disclosure to whomever the investor or decision maker is in this case. Trial Tr., Dkt. 256 at 151. The court therefore reasoned that, because the shareholders had the right to vote on the debenture sale, Southern Farm's duty to disclose material information in relation to the sale ran directly to the shareholders. This is an incorrect statement of the law. In fact, courts have uniformly declined to find a duty to disclose running from one party in an arm's-length securities transaction to the shareholders of the counterparty to the transaction, absent some fiduciary or other special relationship between them. See Regents of Univ. of Ca. v. Credit Suisse First Boston, Inc., 482 F.3d 372, 384 (5th Cir.2007) (stating that general duty of banks not to engage in a fraudulent scheme did not create on behalf of banks a duty to disclose to a company's investors a series of transactions between banks and the company, because banks were not fiduciaries and were not otherwise obligated to the investors); Arent v. Distrib. Scis., Inc., 975 F.2d 1370, 1373-74 (8th Cir.1992) (holding that party to a potential merger had no duty to disclose to counterparty's shareholders fact that merger would fall through because unrelated parties to a merger agreement normally deal at arms' length until the merger is consummated, unless a different relationship is defined in the agreement to merge); Kidwell, 597 F.2d at 1295 (noting that purchaser of corporate assets owed no duty to disclose material facts to members of selling corporation, in part because selling corporation should be presumed to have known as much about its own assets and affairs as purchaser in an arm's-length deal); Wright v. Heizer, 560 F.2d 236, 248 (7th Cir.1977) (holding that corporate lender and shareholder who did not control nor serve on the board of the corporation was entitled to act solely in its own interest in dealing with the corporation's management, whose responsibility it was to advise the corporation's shareholders); In re Digital Island Sec. Litig., 223 F.Supp.2d 546, 551-52 (D.Del.2002) (citing Sheehan, infra, to hold that an acquiring company owes no duty to the target shareholders, absent a special relationship); Sheehan v. Little Switzerland, Inc., 136 F.Supp.2d 301, 310 (D.Del.2001) (holding that, although the defendants committed an omission giving rise to a duty to disclose, only the shareholders' own board of directors, not the acquiring corporation, were liable under § 10b-5 for failure to disclose because the acquiring corporation owed no duty to the [] shareholders or the plaintiffs in this case); Lerner v. FNB Rochester Corp., 841 F.Supp. 97, 103 (W.D.N.Y.1993) (stating that an acquiring corporation owes no duty of disclosure to target company's shareholders); Gordon v. Diagnostek, Inc., 812 F.Supp. 57, 60 (E.D.Pa.1993) (holding that an acquiring corporation owed no special fiduciary responsibility to the shareholders of a separate corporation whose stock it was planning to acquire as part of an arms-length transaction); see also Chiarella, 445 U.S. at 229, 100 S.Ct. at 1115 (A purchaser of stock who has no duty to a prospective seller because he is neither an insider nor fiduciary has been held to have no obligation to reveal material facts.). In addition to this great weight of authority, we also note that Plaintiffs cite no precedent for the proposition that, in the absence of some fiduciary or special relationship, a duty to disclose directly to shareholders could arise in a situation such as this. The district court, and Plaintiffs on appeal, relied primarily on Wright v. Heizer for the proposition that Southern Farm's duty to disclose the allegedly omitted material facts ran directly to PSC's shareholders. The argument is grounded in Wright 's assertion that [w]hen shareholder approval is required by state corporation law ... it is the shareholders who represent the corporation and it is they who are entitled to disclosure of all material facts. 560 F.2d at 247. It appears the district court reasoned from this statement that if Southern Farm had a duty to disclose material facts related to the debenture sale, that duty ran directly to PSC shareholders because the shareholders were entitled to vote on that transaction. The Plaintiffs now urge us to accept the same reasoning. The flaw in the district court's reasoning is that Wright applied that principle, and imposed that duty, only when determining the obligations of a defendant who owed a fiduciary duty to the shareholders. The Plaintiffs' argument elides important facts about the relationships between the Wright parties giving rise to the duty to disclose in that case, and in doing so misstates Wright 's holding. The Wright plaintiffs, who were minority shareholders of IDC, brought a derivative action alleging that the defendant, Heizer Corporation, defrauded IDC in a series of five transactions by failing to make appropriate disclosures about those transactions. Id. at 245-46. The court determined that Heizer was only liable for omitting material information concerning the final two transactions because Heizer exercised voting control over IDC during those transactions, and therefore occupied a fiduciary position with respect to IDC: In the first three transactions Heizer was a lender to, and shareholder of, a corporation it did not control and on whose board it was not represented. We may assume that as such it was entitled to act solely in its own interest in dealing with IDC's management, whose responsibility it was to advise the shareholders. By the time of the fourth transaction, however, Heizer had gained voting control of IDC and had placed two of its officers on IDC's board of directors. Thus it stood in a fiduciary position and could no longer act for itself alone. When Heizer chose to continue its participation in communications to the IDC shareholders, it owed them the duty of full disclosure. As we have already noted, Heizer breached that duty by failing to disclose any of the material facts concerning the transaction. Id. at 248. The rule properly derived from Wright is that a party to a transaction has a duty to disclose to the counterparty's shareholders only when failure to disclose would result in the breach of a fiduciary or other duty. The Plaintiffs have never asserted the existence of any fiduciary relationship between Southern Farm and PSC. Thus, Wright does not support the district court's conclusion that Southern Farm owed a duty to disclose material information directly to PSC's shareholders. The district court's application of Wright conflates two distinct questions: (1) whether shareholders are owed disclosure of certain material facts, and (2) whose duty it is to disclose those facts. While Wright supports the proposition that PSC shareholders had a right to disclosure of material facts related to the debenture sale, it does not, contrary to the district court's reasoning, support the proposition that such a duty fell to Southern Farm. Rather, any duty to disclose pursuant to Wright must fall on parties who occupy a fiduciary or other special relationship to the shareholders. In this case, such a duty would fall on PSC's officers and directors rather than on Southern Farm. [2] In addition to finding no support in the law, the direct disclosure requirement advocated by PSC also raises practical concerns. The district court's rule would have required Southern Farm to circumvent both Brashear, with whom Southern Farm was negotiating, and the PSC board of directors in order to issue its own statement to the PSC shareholders. It is unclear whether it is even feasible for a company such as Southern Farm to make a statement directly to another company's shareholders. For example, there is no reason to assume that Southern Farm even has access to a list of PSC shareholders to which to send such a statement. Because it is undisputed that the transaction in this case occurred at arm's-length, we need not define the parameters of a buyer's duty to disclose to shareholders of a seller's corporation under circumstances in which the buyer has conspired with or otherwise exerted improper influence over the seller's board of directors. Here, there is no suggestion that Southern Farm exerted improper control over PSC's officers or board of directors, or that Southern Farm conspired with PSC's agents to deprive PSC shareholders of material information. Cf. Schoenbaum v. Firstbrook, 405 F.2d 215, 219 (2d Cir.1968) (en banc) (affirming district court's dismissal of a complaint alleging securities fraud upon determining that there is no reason to believe that [the defendant] was in any position to influence the judgment of the [plaintiff's board of directors] by any improper means). Finally, we note that if PSC's shareholders believe that they were materially misinformed with regard to the debenture sale, they are free to sue PSC's agents for breaching their fiduciary duties. In conclusion, Jury Instruction 11's statement that Southern Farm's duty to disclose ran directly to PSC shareholders is an incorrect statement of the law. We are convinced that this instruction mis[led] the jury with respect to the applicable principles of law, Yun, 327 F.3d at 1281, and requires reversal of the judgment against Southern Farm.