Can you, as a bank executive, be held criminally liable for failing to correct information in the marketplace, even when your bank's financial statements are accurate?
Most of us would assume the answer to that question is a resounding "no." But the Department of Justice just tried — and failed — to hold an executive criminally liable in a similar situation. While the trial court and appeals court both correctly rejected the DOJ's novel theories of liability, this case demonstrates the lengths to which the government will go in the current enforcement environment to hold corporate officers liable for perceived misstatements made on behalf of companies.
In United States of America v. Schiff, the government indicted two former high-ranking executives in a pharmaceutical company who allegedly participated in a scheme to encourage wholesale purchasers to acquire excess inventory. According to the government, the pharmaceutical company eventually recognized that the wholesale purchasers' inventory had exceeded "desirable" levels and, as a result, the company's prior sales estimates had been overstated. When the company announced that it had determined its prior sales estimates were "dramatically offtrack," the market responded with a stock drop of 14.7%.
The U.S. Court of Appeals for the Third Circuit found that the government introduced "new legal theories" that appeared designed to find "creative" ways to hold the former executives liable, even though, by the government's own admission, the company's SEC filings contained no affirmative misstatements.
As a result, the government eventually settled on attempting to hold the former executives liable for omissions. The government alleged that one of the former executives should have corrected statements in analyst calls and that the executive's duty to make these corrections arose out of a general fiduciary obligation of "high corporate executives." The court rejected this view as too far-reaching, and held that the antifraud provisions of the federal securities laws "do not contemplate the general failure to rectify the misstatements of others."
In addition to rejecting liability for a failure to correct, the court also held that the executive could not be held liable for a failure to update. Courts traditionally have viewed the duty to update narrowly, and as applying only where there are "fundamental changes" in a company? such as a merger, liquidation or takeover attempt? or when subsequent events produce an "extreme" or "radical change" in the continuing validity of an initial statement.
In this case, the court held those statements "do not come close to fitting within the narrow range of this duty."
This decision shows how aggressively the government — both the DOJ and the SEC — is attempting to hold corporations and individuals liable for what it believes is securities fraud. While Schiff involves executives at a pharmaceutical company, the government's theory of liability could just as easily have been applied to other industries, including banking: the government could have alleged that aggressive lending practices systematically overstated revenues.
Perhaps now, as a consequence of this decision, the government might justifiably pause before attempting to expand liability under the federal securities laws.