The Muddled Duty to Disclose under Rule 10b-5

Article excerpt

In recent years, courts have struggled with the affirmative duty to disclose in private securities litigation, particularly under Rule 10b-5. This Article survey a series of "muddles" in the law of securities fraud - relating to obligations pursuant to SEC line-item requirements, fiduciary duties, issuer sales and repurchases, prior and contemporaneous disclosure and the remnants of "flexible duty" analysis - to show how courts became confused and what the consequence of that confusion has been. In general, this confusion reflects a combination of ambiguous signals from the Supreme Court and judicial disagreement about what the normative basis is for thinking through hard "duty" problems. On the latter, this Article distinguishes between two plausible theories for answering duty questions - a "tort-type" approach that simply asks whether a reasonable investor would likely be misled by the nondisclosure, and a "property-type" approach that more aggressively creates expectations on which investors can rely. It ends with a set of suggestions for simplifying the problems in the case law. To this end, the Article suggests that insider trading reasoning and dicta be confined to that specific subject and not readily applied to other kinds of disclosure questions. It urges that issuer disclosure questions be addressed in a "tort-type" fashion, essentially leaving this body of law to the SEC to address by rule if more aggressive informational entitlements are appropriate. It contends that SEC line-item requirements do create a duty to disclose under Rule 10b-5. And it argues that the "flexible duty" approach retains vitality. Finally, connecting to concerns raised by others in this Symposium, it shows that concerns about private securities litigation abuse have contributed to some of the law's confusion, creating an unfortunate legacy even after Congress intervened to resolve those problems by other means.

Because the federal securities laws are, at heart, about disclosure, the question of whether and when there is a duty to disclose is often the central question in any given case. Certainly, the Securities & Exchange Commission (SEC) has broad powers to compel disclosures by issuers and certain others and has crafted a mandatory disclosure regime that creates many explicit duties. For a variety of reasons, however, this explicit regime falls short of a comprehensive answer to the duty question. For some sixty years now, the hardest duty questions have been addressed under the rubric of fraud, mainly under Rule 10b-5, the principal antifraud provision of the securities laws.1

Over those years, some questions have been settled. For example, a person who chooses to speak in a manner reasonably calculated to influence investors assumes the duty to speak truthfully.2 The difficult duty questions arise mainly when there is silence about some material fact, either because the person in question has said nothing at all or because what was said was not a clear misrepresentation of the truth.

There is a considerable amount of confusion in the case law on the duty question, which motivates this Article.3 This confusion is surprising precisely because duty is so central and because the courts (and the SEC) have had so long to work on it. The story is one of twists and turns. Prior to 1980, the courts and commentators were struggling with the affirmative duty to disclose mainly by invoking flexible, open-ended obligations.4 This was so both in insider trading the area that generated the largest number of duty questions - and in other settings, such as the issuer's duty to disclose some facts immediately rather than wait for its next mandatory filing. This approach shifted abruptly in Chiarella v. United States, when the Supreme Court announced in dicta that "[w]hen an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak" and that such a duty arises only when one party has information "that the other is entitled to know because of a fiduciary or similar relation of trust and confidence between them. …