Corporate Secrecy, the Federal Securities Laws, and the Disclosure of Ongoing Negotiations

Catholic University Law Review Volume 36 Issue 1 Fall 1986 Article 7 1986 Corporate Secrecy, the Federal Securities Laws, and the Disclosure of Ongoing Negotiations J. Robert Brown Jr. Follow this and additional works at: https://scholarship.law.edu/lawreview Recommended Citation J. Robert Brown Jr., Corporate Secrecy, the Federal Securities Laws, and the Disclosure of Ongoing Negotiations, 36 Cath. U. L. Rev. 93 (1987). Available at: https://scholarship.law.edu/lawreview/vol36/iss1/7 This Article is brought to you for free and open access by CUA Law Scholarship Repository. It has been accepted for inclusion in Catholic University Law Review by an authorized editor of CUA Law Scholarship Repository. For more information, please contact [email protected]. CORPORATE SECRECY, THE FEDERAL SECURITIES LAWS, AND THE DISCLOSURE OF ONGOING NEGOTIATIONS J. Robert Brown, Jr.* Few disclosure issues cause more trepidation and anxiety among corporate officials than the disclosure of ongoing negotiations, whether negotiations over prospective sales contracts, aquisitions, mergers, or other material developments. Most major arms length agreements are preceded by a period of negotiations tln t typically take place behind a veil of secrecy. Disclosure is often delaye' : ntil an agreement has been reached. Corporate officials fear that premature disclosure may result in a competitive disadvantage or may jeopardize continuation of the negotiations.' The often legitimate corporate predilection for secrecy, however, cannot be viewed in isolation; it must be juxtaposed against the disclosure philosophy of the federal securities laws.2 These laws dictate that, under certain * Assistant Professor of Business Administration, Franklin & Marshall College; Coun- sel, Stevens & Lee; B.A. 1978, College of William & Mary; J.D. 1980, University of Maryland School of Law; M.A. 1984, Georgetown University; Law Clerk 1981-1982, Honorable Frank M. Johnson, Jr., United States Court of Appeals for the Eleventh Circuit; Attorney, Office of the General Counsel, Securities and Exchange Commission, Washington, D.C., 1984-86. The views expressed in this Article are those of the author and do not necessarily reflect the views of the author's colleagues, including those on the staff of the Commission. The author would like to thank Sherry Stephen for her many hours of typing and Beth Blechman for her longstanding support that helped make this Article possible. 1. See generally Greenawalt & Noam, Confidentiality Claims of Business Organizations, in BUSINESS DISCLOSURE: GOVERNMENT'S NEED TO KNOW 378 (H. Goldschmid ed. 1979). 2. A principal purpose of the federal securities laws was to ensure that investors had sufficient information to make informed investment decisions. See S. REP. No. 47, 73d Cong., 1st Sess. 1 (1933); H.R. REP. No. 85, 73d Cong., 1st Sess. 8 (1933) ("The purpose of these sections is to secure for potential buyers the means of understanding the intricacies of the transaction into which they are invited."); see also 78 CONG. REC. 2931 (1933) ("The theory upon which [the 1933 Act] has been drawn is to give the public complete information as to the security offered for sale .... ") (statement of Rep. Wolverton). Articulated another way, the laws were meant "to substitute a philosophy of full disclosure for the philosophy of caveat emptor." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963); accord, Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195 (1976). As the House Report to the Securities Exchange Act of 1934, Pub. L. No. 73-291, 48 Stat. 74 (codified as amended in scattered sections of 15 U.S.C.), noted: No investor, no speculator, can safely buy and sell securities upon the exchanges Catholic University Law Review [Vol. 36:93 circumstances, the public be apprised of all material developments. The concept of materiality is sufficiently broad to encompass ongoing negotiations.3 The difficulty in reconciling the disclosure requirements of the federal securities laws with the corporate need for secrecy has caused much judicial consternation. Some courts have shown a marked hesitancy to impose liability for nondisclosure of ongoing negotiations, even where the federal securities laws seem to so dictate.4 Viewing disclosure as potentially harmful to without having an intelligent basis for forming his judgment as to the value of the securities he buys or sells. The idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers as to the fair price of a security brings about a situation where the market price reflects as nearly as possible a just price. Just as artificial manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the operation of the markets as indices of real value. There cannot be honest markets without honest publicity. H.R. REP. No. 1383, 73d Cong., 2d Sess. 11 (1934). 3. See infra text accompanying notes 99-109. 4. In fairness, part of the judicial hesitancy to require disclosure of speculative information may have been a similar hesitancy evinced by the Securities and Exchange Commission. Historically, the Commission prohibited the use of speculative information such as projections and appraisals in agency filings. See Guidelines for the Release of Information, Securities Act Release No. 5180, [1970-1971 Transfer Binder] Fed. Sec. L. Rep. (CCH) 78,192 (Aug. 16, 1971) (companies should avoid making projections, forecasts, or predictions in any prospectus). See also Walker v. Action Indus., 802 F.2d 703 (4th Cir. 1986), cert. denied, 55 U.S.L.W. 3512 (U.S. Jan. 27, 1987) (No. 86-860) ("Historically, the Securities and Exchange Commis- sion (SEC) has discouraged the disclosure of financial projections and other 'soft' information such as asset appraisals .... "); Flynn v. Bass Bros. Enter., 744 F.2d 978, 985 (3d Cir. 1985) ("The reasons underpinning the SEC's longstanding policy against disclosure of soft information stem from its concern about the reliability of appraisals, [and] its fear that investors might give greater credence to the appraisals or projections than would be warranted .... "); Re- source Exploration v. Yankee Gas & Oil, Inc., 566 F. Supp. 54, 63 (N.D. Ohio 1983) ("The rationale for omitting such information is that it is apt to create more potential for misunder- standing than enlightenment."). Contrary to the interpretation of some courts, however, the Commission did not consider projections and appraisals inherently misleading. Instead, the agency was concerned primarily with the use of soft information in documents filed with the Commission. See Statement by the Commission on Disclosure of Projections of Future Economic Performance, Securities Act Release No. 5362, (1972-1973 Transfer Binder] Fed. Sec. L. Rep. 79,211, at 82,666 (Feb. 2, 1973) ("It has been the Commission's long standing policy generally not to permit projections to be included in prospectuses and reports filed with the Commission."). While the Commis- sion does not and cannot pass on the merits of any prospectus or filing or otherwise attest to its accuracy, see the Securities Act of 1933, Pub. L. No. 73-22, § 23, 48 Stat. 74, 87, 15 U.S.C. § 77w (1982), the mere fact that a document is filed with the Commission may give it added weight in the eyes of shareholders. By prohibiting the use of soft information in filings, it appears that the Commission was not trying to deny shareholders access to the information, but was trying to avoid attributing to such speculative information the added weight that might accrue from its inclusion in a filing. By the mid-1970s, the Commission reversed its long-standing position with respect to the 1986] CorporateSecrecy shareholders and stressing the corporate need for secrecy, several recent decisions have, under the rubric of materiality, sought to severely curtail the instances in which ongoing negotiations must be disclosed. These courts have held that, absent an "agreement in principle," ongoing negotiations are immaterial as a matter of law.' Moreover, the term "agreement in principle" has been narrowly construed. In the context of a merger or a change in control, an "agreement in principle" exists only if the parties have agreed upon the share price and the post-merger corporate structure.6 The effect of these decisions is to impose a rigid, bright-line test for determining the materiality of ongoing negotiations. These cases contain faulty analysis and overbroad dictum. The courts go to great lengths to stretch and contort the federal securities laws in order to avoid imposing liability for nondisclosure. Typically, these courts accept without challenge the contentions that disclosure of the negotiations will damage the negotiation process and mislead investors. Although propitious sounding, these arguments are often incorrect. Moreover, even where cor- rect, they do not always justify nondisclosure. While few would gainsay at least the occasional need for secrecy, secrecy must nevertheless sometimes give way to the need for disclosure.7 Judicial unanimity on the subject, however, does not exist; not all courts agree with the use of a bright-line test. Instead, some courts use an analysis that examines the materiality of the ongoing negotiations on a fact-intensive, use of projections and appraisals in filings and began affirmatively to encourage their use. See Guides for Disclosure of Projections of Future Economic Performance, Securities Act Release No. 5992, [1978 Transfer Binder] Fed. Sec. L. Rep. (CCH) 81,756 (Nov. 7, 1978). Regula- tion S-K, the standard instructions for all periodic filings under the integrated disclosure sys- tem, encourages the use of projections. 17 C.F.R. § 229.10(b) (1986); see also Regulation S-K, item 303, 17 C.F.R. § 229.303 (1986) (forward-looking information may be included in man- agement's discussion and analysis); Regulation S-X, 17 C.F.R.

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