SEC v. Talbot; Disclosure of Merger Negotiations

A NYSE company (Fidelity National Financial, Inc. ("FNF")) owns approximately 10% of a Nasdaq company (LendingTree--the "Issuer"). The CEO of the Issuer informs an officer of FNF that the Issuer is in merger negotiations, the acquiror will pay a premium to market, a majority of the Issuer's board is in favor of the transaction, and the acquiror will want FNF's support of the transaction. Three or four days later, the board of FNF holds a regular meeting and the CEO conveys the information about the pending deal. He advises the board that FNF will make about $50 million on its investment in the Issuer. All but one member of the board present considers the information about the pending deal confidential. The one who didn't, Talbot, an experienced businessman and attorney, buys 10,000 shares of the Issuer in two transactions before the Issuer's announcement of the deal on May 5, 2003. He later testifies that he thought the information about the deal was simply a "rumor." He made some $68,000 on his purchases of the Issuer's stock. After the SEC commenced its investigation of his and other Issuer employees' purchases of the Issuer's stock in September 2003, Talbot resigns from the FNF board.

What is surprising about this case is that it got as far as it did. In the SEC's civil enforcement action against Talbot, the lower court ruled for Talbot and against the Commission on cross-motions for summary judgment, finding that, since FNF owed no fidiciary duty of confidentiality to the Issuer, the requisite "chain of fiduciary relationships" did not exist for application of the "misappropriation theory" of Rule 10b-5 liability blessed by the Supreme Court in United States v. O'Hagen, 521 U.S. 642 (1997). The Ninth Circuit batted that finding down, concluding that all that is required is a fiduciary duty of loyalty and confidentiality to the source of the confidential information--here, FNF, the company on whose board Talbot sat. Held: Talbot engaged in "textbook" misappropriation of confidential information, on which he traded, from FNF. This finding doesn't strike this observer as a stretch: Talbot really blew it in purchasing Issuer shares after learning of its pending merger at the FNF board meeting.

What is somewhat surprising is that both the lower court and the Ninth Circuit concluded there was a genuine issue of material fact on the materiality of the information Talbot received about the pending deal, thus precluding summary judgment in favor of the Commission. To the SEC (as stated in its briefs before the Ninth Circuit) it was "obvious" that the information received by the FNF board was material, but the lower court and the Ninth Circuit cited Talbot's "rumor" testimony and that of another director with a similarly foggy recollection of the report on the pending deal in refusing to decide the issue on summary judgment. It strikes this observer that, if the CEO of a public company advises a 10% shareholder that a deal is in the works, a majority of his board is in favor of it, and the acquiror wants the support of the 10% shareholder, you're in materiality-land.

Let's assume the disclosure was material so that Talbot's trading on it violates Rule 10b-5. How about LendingTree? If the information disclosed by the Issuer's CEO to FNF was material, does that mean LendingTree should have simultaneously disclosed the pending deal in a press release or in a 8-K report? Can information be material for one purpose (precluding trading on the information by insiders) but not be material for another (requiring disclosure by the target of the pending deal)?

We know from the Supreme Court's decision in Basic, Basic Inc. v. Levinson, 485 U.S. 224, 241 n. 18 (1988), that what is material is not context-specific, so the answer to the last question is that if information is material for one purpose it is material for all purposes relevant to Rule 10b-5. So should LendingTree have disclosed the pending deal when its CEO spilled the beans to FNF? Under Regulation FD, disclosure of material nonpublic information to market professionals selectively is taboo, and, if it occurs, must be publicly disclosed (simultaneously in the case of intentional disclosure and "promptly" in the case of non-intentional disclosure (with "intentional" defined in Rule 101)). The Regulation also applies to selected disclosures to any shareholders of the issuer "under circumstances in which it is reasonably foreseeable that the [shareholder] will purchase or sell the issuer's securities on the basis of the information." Rule 100(b)(1)(iv). (There is an exception from FD's disclosure requirements for persons to whom disclosure is made "who expressly agree[] to maintain the disclosed information in confidence . . .", Rule 100(b)(2)(ii), but that would not help LendingTree in this case because the CEO made the disclosure to FNF before LendingTree presented a confidentiality agreement to FNF).

Leaving aside whether LendingTree tripped over Regulation FD in its first disclosure to FNF, the answer to whether it should have made disclosure before it did is, by custom, no. As the Court in Basic noted in its famous note 17, "[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5." While we are in a "continuous" disclosure world, it it still the case that just because information is material does not mean an issuer has to immediately announce it. This is certainly the practice with respect to the disclosure of deals, which typically are announced when the definitive agreement is signed, and not before. See 1 A. Fleischer and A. Sussman, Takeover Defense Section 2.03[C]; NYSE Company Manual Section 202.01. Exceptions come into play when the issuer knows or should know that unusual market activity is attributable to leaks from the issuer or its agents. But otherwise, silence or a "no comment" response when asked represent best practice when it comes to disclosing merger negotiations before entry into a definitive agreement.

It should also be best practice for a general counsel, when attending a board meeting such as FNF's, where deal disclosure is made, to loudly and clearly admonish the directors and officers present that trading on such information is verboten. Such advice can save those present a lot of grief. Just ask Talbot.