485 U.S. 224 (1988)
- Ds made certain chemical components for the steel industry.
- Combustion Engineering sought D for acquisition, and it was rumored that the two were in talks.
- As a result of the discussions, trading volume of the Ds company increased.
- D publicly stated that there was no ongoing discussion whatsoever, thus denying outright the existence of any talks.
- Then, D made an official request to suspend trading of the stock to proceed with the merger talks.
- P was a shareholder who had sold his stock after the announcement that merger talks weren’t occurring, but before the eventual announcement requesting suspending of trading.
- P claims the false information resulted in his loss of share price and filed a suit claiming a violation of rule 10b-5.
- Whether the false statements by P regarding the merger enough to successfully sue under 10b-5.
- If the misleading statements would have changed the mind of a reasonable investor, the statements are subject to suit under 10b-5. This principle includes statements and omissions.
- D argued that the standard for evaluation should be an “agreement in principle test” – which only accounts for misstatements post-merger agreements for liability.
- The court states that each case will be fact-based. The court suggested that the probability that the event would not occur should be weighed against the importance of the facts.
- In this case, the court held that there was a violation of 10b-5, because the stock price was impacted by the existence or non-existence of merger talks.
- D also argued that the probability of a failed merger justified the false statements, since such information could incorrectly impact the stock price if the merger did not occur.
- The court believed this logic was wrong and felt that disclosure of talks was more prudent. The price would have adjusted based on the best existing information in the market at the time.
- Mergers are extremely important events in corporate affairs. Thus the existence of negotiations (especially of the serious nature) should be disclosed to the public.
- The court adopted what’s known as the “fraud on the market theory.” This theory says that a stock price is a reflection of available, public information. When that information is false or misleading, the shareholder is harmed because the stock price is adversely impacted.