Saturday, October 1, 2016
I have to say, it pains me that this is even news – that price maintenance as a form of fraud on the market should, I believe, be unexceptionable, indeed, necessary for the theory to function properly.
But the idea has been at least somewhat rejected by the Fifth Circuit – see Greenberg v. Crossroads Sys., 364 F.3d 657 (5th Cir. 2004) – and defendants are vigorously disputing the legitimacy of price maintenance elsewhere.
So it comes as something of a relief that in In re Vivendi, S.A. Sec. Litigation, 2016 U.S. App. LEXIS 17566 (2d Cir. Sept. 27, 2016), the Second Circuit has now joined the Eleventh Circuit, see FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282 (11th Cir. 2011), and the Seventh Circuit, see Glickenhaus & Co. v. Household Int’l, Inc., 787 F.3d 408 (7th Cir. 2015), with a full-throated endorsement of the idea that even if a fraudulent statement does not introduce “new” inflation into a stock’s price – even if it simply maintains existing inflation by confirming an earlier false impression – that too violates Section 10(b) and is actionable using the fraud on the market doctrine.
Beyond this simple holding, though, there are some interesting nuggets buried in the reasoning that are worth exploring.
First, the Second Circuit discussed the policy reasons for recognizing price maintenance as a form of fraud. It offered a hypothetical example of a company where – due to its past operating history – investors make certain assumptions about the quality of its products. Those assumptions are false with respect to a new product. Under such circumstances, the stock price is inflated, but not because of any fraud by the company. In that situation, if price maintenance is not actionable, the company would be completely free to fraudulently confirm investors’ false assumptions.
I’d only add to that that there are plenty of situations where the initial inflation might be due not to investors’ faulty assumptions, but due to the company’s own actions. In FindWhat, for example, the initial inflation was introduced by the company’s own false statements – but the Eleventh Circuit concluded that the original statements were not made with scienter, so they were inactionable. If price maintenance theory is not accepted, then once a company negligently misinforms the market, it is free to intentionally do so (but see the duty to correct, discussed below).
Similarly, in IBEW Local 98 Pension Fund v. Best Buy Co., 818 F.3d 775 (8th Cir. 2016) (which I previously discussed here, the initial false statements were immunized by the PSLRA’s safe harbor. If price maintenance theory is not accepted, companies can simply lie via forward looking statements, and use the resulting artificial inflation to lie about related facts.
The second thing worth discussing is that one of Vivendi’s arguments was that even if a statement confirmed previous (false) information, that statement could only have “propped up” the previously-inflated price if silence would have revealed the truth. That is, in Vivendi’s view, if simply remaining silent would have had the same effect as the confirmatory false statement (and silence was an option, i.e., there were no affirmative disclosure requirements in play), then the statement cannot be said to have impacted price.
That’s an argument that’s been endorsed by Don Langevoort (see Compared to What? Econometric Evidence and the Counterfactual Difficulty, 35 J. Corp. L. 183 (2009); see also Judgment Day for Fraud-on-the-Market: Reflections on Amgen and the Second Coming of Halliburton, 57 Ariz. L. Rev. 37 (2015)), and I’ve also gone back and forth about here and in my essay Searching for Market Efficiency, 57 Ariz. L. Rev. 71 (2015).
But the Second Circuit rejected the silence comparator wholeheartedly. Part of the reasoning was kind of a burden-shifting idea: we’ll never know what would have happened if the company remained silent, because Vivendi chose to speak. And Vivendi is responsible for that.
But additionally, the Second Circuit fell back on the point that once a company chooses to speak, it has a duty to speak fully and accurately. In other words, once Vivendi chose not to remain silent, it did not have the option of failing to reveal the truth.
The reason I find this striking is that it’s a roundabout way of getting at what would have been a much simpler frame: The duty to correct.
The duty to correct is fairly uncontroversial in theory. See, e.g., Overton v. Todman & Co., 478 F.3d 479 (2d Cir. 2007); Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001)). Once a company knows it has issued false statements, it has a duty to correct them.
Here, the plaintiffs must have proven that Vivendi was aware of the fraud – we wouldn’t even be discussing price maintenance if it was unaware – so presumably, Vivendi did not have an option of remaining silent; it was legally obligated to confess.
But the duty to correct has always been a bit tough to parse, if for no other reason than it is difficult to pinpoint which person precisely in the corporation has that duty. See United States v. Schiff, 602 F.3d 152 (3d Cir. 2010); but see Barrie v Intervoice-Brite, 409 F.3d 653 (5th Cir. 2005). In Vivendi, the jury found the corporate defendant liable but absolved the individual ones, which renders the problem more complex.
Moreover, it's not clear how the duty to correct comes into play if the original statements were immunized - like, say, via the PSLRA safe harbor.
So rather than discuss whether Vivendi had an affirmative duty to speak once it realized that earlier statements were false, the Second Circuit instead simply said that the confirmatory statements were themselves the equivalent of half-truths that gave rise to a duty of a full confession. As the Second Circuit put it, “in suggesting that, had it remained silent, the misconception‐induced (whether or not fraud‐induced) inflation would have persisted in the market price, Vivendi assumes it is even relevant what would have happened had it chosen not to speak. Yet in framing the argument this way, Vivendi misunderstands the nature of the obligations a company takes upon itself at the moment it chooses, even without obligation, to speak. It is well‐established precedent in this Circuit that ‘once a company speaks on an issue or topic, there is a duty to tell the whole truth…’”
In any event, the upshot is: Price maintenance as an argument solidly prevails; we’ll see if defendants have better luck with their opposition in other circuits.