To be a public company in the United States is to be subject to an array of federally-imposed disclosure requirements. In my forthcoming article, Reviving Reliance, I describe how the private causes of action available to enforce these requirements have failed to keep pace with the changing purposes of mandatory disclosure. I trace the problem to the functional elimination of the element of reliance from claims brought under Section 10(b) of the Securities Exchange Act via the adoption of the fraud-on-the-market doctrine. I ultimately conclude that courts can better effectuate federal policy by drawing distinctions between actual reliance and fraud-on-the-market reliance claims, affording greater rights to plaintiffs who allege the former.
The relationships among corporations, managers, and investors are subject to regulation at the state and federal levels. In the most simplistic telling, state law is responsible for regulating the substance of these relationships, including how power is allocated between shareholders and managers. Federal law is mainly concerned with ensuring that the details of corporate operations are disclosed so that investors – and more generally, the market – understand the investment’s character.
This traditional division of regulatory labor is reflected in the private causes of action available to enforce federal law. Section 10(b), the general antifraud statute, provides the broadest and most flexible cause of action, yet, as the Supreme Court held in Santa Fe Industries v. Green, it is unavailable for plaintiffs who merely allege breaches of fiduciary duties. Substantive objections to management conduct are, according to Santa Fe, more properly brought as claims under state law.
Since Santa Fe, however, federal law has expanded its footprint. Though state law has traditionally afforded stockholders few rights within the governance structure, federal law has sought to expand shareholder power with a mix of affirmative rights, elimination of older restrictions, and – most relevant here – expansion of corporate disclosure obligations. Among other things, federal law has required disclosure of compensation arrangements, oversight of risk-taking, board diversity and independence, ethics codes, and managerial oversight of information flow. Shareholders themselves, granted expanded access to the corporate proxy, have imposed their own disclosure requirements on such matters as political spending, diversity, and sustainability. These types of disclosures are intended less to help investors value a company than to grant shareholders a greater voice in corporate operations.
As I argue in my article, Section 10(b) is inadequate to police these kinds of disclosures, creating a lacuna in private enforcement. The reason has less to do with Section 10(b) per se, and more to do with a series of interpretive doctrines that courts have developed in their attempts to maintain Santa Fe’s line in the sand.
The problem begins with the fraud-on-the-market doctrine. That doctrine accords plaintiffs the presumption that any material false statements publicized about a widely-traded stock will distort that stock’s prices, thereby injuring all who transact at the market price. Fraud-on-the-market thus relieves plaintiffs of the obligation to demonstrate their individual reliance on a deceptive statement, easing their evidentiary burdens and making it possible for Section 10(b) claims to be brought as class actions. Today, Section 10(b) is largely interpreted in the context of fraud-on-the-market.
Given the extensive disclosure requirements imposed on public corporations, it is likely that whenever unfavorable information is concealed by a corporation for any length of time, plaintiffs’ attorneys will be able to identify some public statement that was arguably false when it was issued. And because fraud-on-the-market does not require investors to prove that they relied on the statement, there is a real chance that there will always be a potential Section 10(b) claim when that information was known to management (which is necessary, due to Section 10(b)’s scienter requirement). As a result, it is the substantive conduct – rather than the ostensibly false statement – that becomes the center of gravity for many Section 10(b) claims. This is particularly so when courts expand Section 10(b) to permit claims based on pure omissions of mandated information (an issue that the Supreme Court will be taking up next term). Yet to permit such broad applications of Section 10(b) is apparently contrary to the Supreme Court’s command in Santa Fe.
Courts addressing Section 10(b) claims are thus tasked with discriminating between deception claims and governance claims without reference to the most obvious distinguishing factor: the presence of a deceived investor. As an alternative, they have crafted a series of doctrines that serve to cabin Section 10(b)’s scope. These doctrines – puffery, definitions of loss causation and damages, and varying approaches to omissions claims – police an increasingly-obsolete line between disclosure and governance, and thus interfere with federal efforts to use disclosure as a governance tool.
Moreover, courts’ artificial governance/disclosure distinction has the secondary effect of inscribing into the case law a rigid and limited view of the shareholders’ role, depicting investors as ruthlessly wealth-maximizing, possessing no interests outside of the corporation itself, and passively uninvolved in the details of corporate governance – precisely the opposite of the type of shareholder that federal law has been attempting to cultivate.
In my article, I propose that courts revive the legal significance of reliance by treating actual reliance claims differently from claims that utilize the fraud-on-the-market presumption. When investors establish their reliance on corporate misstatements, there is no need for courts to use doctrinal proxies to maintain Santa Fe’s distinction between the separate regulatory spheres of state and federal law. Moreover, by rewarding investors who actually rely on corporate disclosures with greater damages and a broader range of permissible claims, courts can facilitate shareholders’ participation in the corporate governance structure and compensate investors who inhabit the role of corporate monitor.
 15 U.S.C. § 78j.
 430 U.S. 462 (1977).
 15 U.S.C. § 78n.
 17 C.F.R. § 229.407.
 17 C.F.R. § 229.406.
 17 C.F.R. § 240.13a-14.
 See, e.g., Ross Kerber, BlackRock vows new pressure on climate, board diversity, Reuters (Mar. 13, 2017), at http://www.reuters.com/article/us-blackrock-climate-exclusiveidUSKBN16K0CR; Randall Smith, Investors Sharpen Focus on Social and Environmental Risks to Stocks, N.Y. Times, Dec. 15, 2016, at B1.
 See Basic Inc. v. Levinson, 485 U.S. 224 (1988).
 See Leidos, Inc. Indiana Public Retirement System, Supreme Court No. 16-581.
This post comes to us from Ann M. Lipton, the Michael M. Fleishman Associate Professor in Business Law and Entrepreneurship at Tulane University Law School. It is based on her recent article, “Reviving Reliance,” forthcoming in the Fordham Law Review and available here.