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The line between civil and criminal
violations of the securities laws is, at best, difficult to discern. That
difficulty is compounded by the increasing criminalization of the federal
securities laws. In some instances, this had led to overreaching by prosecutors
in an effort to establish the charges filed as discussed here. In others, it has
resulted in shifting theories of liability. Each of these should raise a red flag
that the charges brought are inappropriate. Unfortunately, the red flags are at
U.S. v. Schiff, No. 08-1903 & 08-1990 (3rd
Cir. Apr. 7, 2010) is a case where the red flags were ignored, resulting in
criticism from the district court of shifting legal theories and ultimately the
dismissal of some charges. The Third Circuit affirmed.
Securities fraud charges were
brought against the former CFO of Bristol-Myers Squibb, Frederick Schiff, and
Richard Lane, another company executive. The fraud charges arose from
statements made in an earnings call and corporate filings regarding a sales
strategy implemented by the drug manufacturer. Under that strategy,
Bristol-Myers paid millions of dollars each quarter to its wholesales as incentives
to spur buying of its products in excess of demand projections. Mr. Schiff
approved the payment of these sales incentives which were supposed to cover
carrying costs and guarantee a return on the investment of the wholesales until
the products were sold.
The government claimed that
Defendants Schiff and Lane made false and misleading statements in analyst
calls and SEC filings to conceal these practices from investors. For example,
in analyst calls in April, July, October and December 2001, either Mr. Schiff
or Mr. Lane stated that the company was closely watching wholesaler stocking
inventories and no unusual items were observed. However, in an April 1, 2002
10-K, the company stated that average wholesaler inventories had increased
during 2001 and exceeded levels the company considered desirable. Accordingly,
the company stated that is was developing a plan to reduce those levels which
will negatively impact its financial results in future periods. In an April 3,
2002 analysts call, the CEO of Bristol announced that Mr. Lane was leaving the
company and reiterated the fact that current wholesaler inventory levels
significantly exceeded the level considered desirable.
The government charged Messrs.
Schiff and Lane with securities fraud based in part on statements he made as
well as those of the other executive. In ruling on Mr. Schiff's motion to
dismiss the third superseding indictment in view of a bill of particulars filed
by the government, the district court dismissed theories of fraud liability
based on omissions. Specifically, the court dismissed a theory of duty based on
the alleged falsity of reported sales and earnings in the SEC filings and a
second theory called "all of a piece." Under that theory, raised for the first
time one month before trial, the government claimed Mr. Schiff is liable for
omissions in the SEC filings stemming from prior misleading statements made on
analyst calls. The theory thus sought to link alleged prior statements in the
analyst calls to claimed omissions in the SEC filings. The district court
rejected this theory and criticized the government for shifting theories,
concluding it would permit no further "legal theory morphs." The government
only appealed on the "all of a piece" theory.
The Third Circuit affirmed. First,
the court rejected the government's claim that Mr. Schiff had a fiduciary duty
to rectify the alleged misstatements of another executive. A duty to disclose
only arises in three circumstances: 1) insider trading; 2) a statutory
requirement; and 3) an inaccurate, incomplete or misleading prior disclosure.
The court rejected the government's claim that as a high corporate executive
such as Mr. Schiff had a duty to rectify misstatements made by another.
Second, the court rejected the
government's theories of liability based on Mr. Schiff's statements. Here, the
government argued three theories: 1) "all of a piece;" 2) duty to update; and
3) duty to correct. Under the "all of a piece" theory the government claimed
that statements made at the analysts calls were tied together with the
statements in the SEC filing as essentially one event. The government, however,
had stipulated that its theory of liability was based only on omissions, not
misrepresentations. Under these circumstances, the court held that that it was
"not logical" to conclude that an utterance in an analyst conference call must
have other words written into it from a later made SEC filing. Liability under
Section 10(b) and Rule 10(b)-5 arises from each statement made. Here, there was
an insufficient nexus to tie the statements together.
The court also rejected claims of a
duty to update and correct. Both of these were new theories which the court
noted the government was trying to insert into the case at the eleventh hour. A
duty to update arises only when a statement was reasonable at the time, but
later became misleading when viewed in the context of other events. This is not
the predicate of the government's claim here. A duty to correct arises when a
historical statement that at the time was true is revealed by subsequent events
to be incorrect. Again, this is not the case here. Accordingly, the district
court's order dismissing the charges is affirmed. Clearly in its zeal to
prevail, the government missed the red flags here.
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