To Speak, or Not to Speak: Is Silence a Breach of Fiduciary Duty?

Photo Credit: News.ArtNet.com, Sarah Cascone

By: Anthony Anello
Member, American Journal of Trial Advocacy

The infamous rule 10b-5, better known as the “Employment of Manipulative and Deceptive Practices” act, was created in an attempt to make investing in securities safer.[1] Rule 10b-5 of the Securities Exchange Act of 1934 deems it illegal

for any person . . . (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.[2]

Since its commission in 1934, this rule has been the Securities Exchange Commission’s (“SEC”) flagship vessel for investigating security fraud claims.[3] Governing a majority of fraud claims, 10b-5 includes regulation of topics such as insider trading, making of false statements, and any ploy or scheme used to manipulate stock prices.[4]

Imagine this situation: a trusted colleague in an exclusive investment group encourages the other members to purchase stock in a new tech company,[5] such as Pear Computers. Based on the colleague’s resume and profitable investment suggestions in the past, all members of the investment club vote to buy into Pear Computers. Weeks later, it is discovered that the trusted colleague made a small fortune from the commission on the investment club’s purchases. The investors feel as though they have been betrayed for not hearing of the earned commission prior to buying into Pear Computers. Did the trusted colleague have a duty to disclose that he would be profiting off of the transactions?[6]

Who has a duty?

Who has a fiduciary duty to speak? Do only company executives have to speak up? Or does the neighbor down the road who stops his lawnmower to share some investing information have a duty as well? Where is the line of who has a fiduciary duty to speak? Rule 10b-5 makes it clear: “[A]ny person” portraying material information “in connection with the purchase or sale of securities” holds a fiduciary duty.[7] Therefore, not only does it cover the analyst at a Fortune 500 company, but also Uncle Eddy when he spares some knowledge at the Christmas party.

When is there a duty?

After establishing who has a duty to speak, the question turns to when does that person have that duty?[8] This question’s answer is not so clearly presented within 10b-5. The Supreme Court held, in Chiarella v. United States,[9] “[w]hen an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak.”[10] Simply, although 10b-5 is a fraud catchall, it only applies to actual fraud. A person simply possessing nonpublic information is not enough to be considered fraudulent. Fraud can only occur when one of the parties “has information ‘that the other party is entitled to know because of a fiduciary or similar relation of trust and confidence between them.’”[11] The court concluded by stating “administrative and judicial interpretation have established that silence in connection with the purchase or sale of securities may operate as fraud actionable under § 10(b) despite the absence of statutory language or legislative history specifically addressing the legality of nondisclosure.”[12] By choosing to use the word “may,” the court sidestepped the issue, leaving it open to district court’s discretion in deciding the issue.

Circuit Splits

Three circuits, the Second, Third, and Ninth, have all complied generally with the Supreme Court in Chiarella, but have incorporated their own specific tests. The Second Circuit focused on the deceptive device aspect of 10b-5.[13] For example, in Securities and Exchange Commission v. Dorozkho,[14] the defendant was charged with hacking a financial reporting company.[15] The district court, finding for the SEC, held, “[A] breach of a fiduciary duty of disclosure was required for any deceptive conduct under § 10(b).”[16] The appellate court agreed, but remanded the issue for further information concerning the hacking.[17] Depending on the method used in the hacking, the actions may, or may not, have been a deceptive device prohibited by rule 10b-5.[18] If the hacking was classified as a deceptive device, Dorozkho would have had a fiduciary duty, making it necessary for him to disclose the information prior to purchasing the securities.[19] Citing multiple Supreme Court cases,[20] the Second Circuit’s review of the case held that nondisclosure can be classified as a device to defraud, which is a breach of 10-b’s fiduciary duty.[21] Since Dorozkho did not disclose of information that the financial reporting company would likely want to have, his actions constituted a breach of that duty, and, therefore, was actionable under 10b-5.[22]

Inversely, the Third Circuit found that an individual with a general fiduciary duty does not automatically have a duty to speak.[23] In United States v. Schiff,[24] Fredrick Schiff was the Chief Financial Officer (“CFO”) of a pharmaceutical company.[25] Schiff and a codefendant were charged under rule 10b-5 because of alleged misstatements and omissions in SEC filings that were deemed misleading.[26] The Third Circuit held that the Government’s argument, “Schiff’s duty to disclose in SEC filings derive[d] from a general fiduciary obligation of ‘high executives’ to the company’s shareholders,” was too broad and “reache[d] too far.”[27] Additionally, the court noted that “[a]bsent a [specific] duty to disclose, silence is not fraudulent or ‘misleading under Rule 10b-5.’”[28] In concluding, the Court presented the only three circumstances in which the court may require a duty to disclose under 10b-5: “when there is [1] insider trading, [2] a statute requiring disclosure, or [3] an inaccurate, incomplete or misleading prior disclosure.”[29] Absent these situations, the Third Circuit found that silence was not a breach of duty.[30]

Finally, the Ninth Circuit, in Paracor Finance, Inc. v. General Electric Capital Corp.,[31] established a five-factor test for the district court to use in determining if disclosure was required.[32] The Paracor Finance court held out that the following factors be balanced to determine if there was a duty to disclose:

(1) the relationship of the parties [involved], (2) [the investor’s] relative access to information, (3) the benefit that the [informant] derives from the relationship, (4) the [informant’s] awareness that the [investor] was relying upon the relationship in making his investment decision, and (5) the [informant’s] activity in initiating the transaction.[33]

After considering all factors, subjectively, the Ninth Circuit held that General Electric did not have a duty to disclose.[34]

Thoughts and concerns

Unfortunately, due to the Supreme Court’s holding in Chiarella, and the lack of uniformity from the Second, Third, and Ninth Circuits, there is no clear answer for those individuals seeking to remain silent about topics that may or may not be material to making investment decisions. The Second Circuit’s deceptive devices test,[35] the Third Circuit’s three circumstances,[36] and the Ninth Circuit’s five factor test,[37] show that the Supreme Court must step in and establish a clearly stated rule in order to find universal uniformity among the circuits. In a state with a highly subjective test, non-disclosure, followed by a lawsuit, may be more harmful to a company’s finances and reputation than disclosing the withheld information. Observing the governing states’ statutes about disclosure requirements may be the only guide for these situation-by-situation holdings.


[1] Investopedia, Rule 10b-5 (February 2, 2018, 7:47 PM) https://www.investopedia.com/terms/r/rule10b5.asp.

[2] Legal Information Institute, 17 CFR 240.10b-5 – Employment of Manipulative and Deceptive Devices, https://www.law.cornell.edu/cfr/text/17/240.10b-5  (emphasis added).

[3] Investopedia, supra note 1.

[4] Id.

[5] See Lucy Gauthier, Speak Now or Forever Hold Your Peace: A Split of a Fiduciary’s Duty to Speak, Sunday Splits (February 2, 2018, 7:53 PM) http://sundaysplits.com/2016/11/27/speak-now-or-forever-hold-your-peace-a-split-on-a-fiduciarys-duty-to-speak/.

[6] Id.

[7] Legal Information Institute, supra note 2.

[8] Gauthier, supra note 5.

[9] 445 U.S. 222 (1980).

[10] Chiarella, 445 U.S. at 234.

[11] Gauthier, supra note 5 (quoting Chiarella, 445 U.S. at 228).

[12] Chiarella, 445 U.S. at 230 (emphasis added).

[13] SEC v. Dorozkho, 574 F.3d 42, 45 (2d Cir. 2009) (citing Rule 10b-5(a) it is illegal “for any person . . . to employ any device . . . to defraud.”).

[14] 574 F.3d 42 (2d Cir. 2009).

[15] Dorozkho, 574 F.3d at 44 (citing SEC v Dorozhko, 606 F. Supp. 2d 321, 330 (S.D.N.Y. 2008).

[16] Id.

[17] Id. at 50-51.

[18] Id. at 51.

[19] Id.

[20] Id. at 46. The Second Circuit reviewed the following Supreme Court cases: SEC v. Zandford, 535 U.S. 813 (2002); United States v. O’Hagan, 521 U.S. 642 (1997); Chiarella, 445 U.S. 222 (1980).

[21] Dorozkho, 574 F.3d at 45.

[22] Id.

[23] United States v. Schiff, 602 F.3d 152, 162 (3d Cir. 2010).

[24] 602 F.3d 152.

[25] Id. at 155-56.

[26] Id. at 156.

[27] Id. at 162-63.

[28] Id. at 162 (citation omitted).

[29] Schiff, 602 F.3d at 162 (quoting Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir. 2000))

[30] Schiff, 602 F.3d at 162.

[31] 96 F.3d 1151 (1996).

[32] Paracor, 96 F.3d at 1157.

[33] Id.

[34] Id. at 1168.

[35] SEC v. Dorozkho, 574 F.3d 42, 49 (2d Cir. 2009) (“Absent a controlling precedent that ‘deceptive’ has a more limited meaning than its ordinary meaning, we see no reason to complicate the enforcement of Section 10(b) by divining new requirements.”).

[36] Schiff, 602 F.3d at 162 (quoting Oran v. Stafford, 226 F.3d 275, 285-86 (3d Cir. 2000) (“[A] duty to disclose under Rule 10b–5 may arise in three circumstances: ‘when there is [1] insider trading, [2] a statute requiring disclosure, or [3] an inaccurate, incomplete or misleading prior disclosure.’”)).

[37] Paracor, 96 F.3d at 1157 (“A number of factors are used to determine whether a party has a duty to disclose: (1) the relationship of the parties, (2) their relative access to information, (3) the benefit that the defendant derives from the relationship, (4) the defendant’s awareness that the plaintiff was relying upon the relationship in making his investment decision, and (5) the defendant’s activity in initiating the transaction.”).

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