Silence, and Truth, Is Golden
While Congress and federal regulators fret about what, if anything, to do about the merger mania that still grips the nation’s corporations, the U.S. Supreme Court has weighed in with a decision that should make it a bit harder for corporate managers to hatch these schemes. On its face, the majority opinion in the case of Basic Inc. vs. Levinson is neither pro-merger nor anti-merger. But by making public companies and their managers liable to stockholder suits if they lie about whether merger talks are under way, the court majority has opted for a policy of full disclosure that, at the least, stands to slow down the frantic pace of mergers and help individual investors.
Mergers and takeovers are usually conceived in secret, so corporate managers had argued before the high court that there should be no duty to tell the truth about such negotiations, under the 1934 Securities Exchange Act, until there was a firm agreement to go through with a deal. The majority, in an opinion by Justice Harry A. Blackmun, rejected that standard. Blackmun left to case-by-case adjudication the issue of exactly when merger talks qualify as a “material fact” under the 1934 law, which says that false or incomplete statements about “material facts” constitute fraud. But Blackmun made it clear that corporations can no longer plead that maintaining secrecy is invariably in the stockholders’ best interests. “Disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress,” he wrote.
Blackmun left managers a loophole. In a footnote, he reminded them that they can simply opt for silence if asked whether a merger is pending; the law prohibits only false or misleading statements, not silence. Undoubtedly, many will continue to try to shroud their moves in secrecy--even though stock exchanges, investors and the press will pressure them to make some kind of public statement about rumored mergers or unusual trading. Even a “no comment” is likely to be taken as confirmation that a merger is in the works.
The most controversial aspect of the court’s judgment was its acceptance of the so-called “fraud on the market” theory, which makes it easier for investors to win securities-fraud cases. Instead of proving that they suffered directly by relying on a company’s false statements, investors need only show that what the company said distorted the true market value of the stock; fraud is presumed if they lost out on a big profit by, say, selling their stock at a low price just before its value was sent soaring by the announcement of a merger.
The “fraud on the market” idea, promoted by the University of Chicago theorists who want us to subject law to economic analysis, has many problems--not the least of which is that it would take a posse of philosophers to figure out a stock’s true value. It really should be up to Congress to decide whether this radical new idea should be incorporated into securities laws that are more than half a century old. Perhaps the Supreme Court’s decision also will nudge our legislators toward some general action on still-rampant mergers and takeovers that can impoverish healthy companies, divert capital from more productive investments and enrich no one except investment bankers and lawyers.
