The Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc. - 532 U.S. 588, 121 S. Ct. 1776 (2001)

Rule:

Pursuant to Section 10(b) of the Securities Exchange Act, codified at 15 U.S.C.S. § 78j, the Securities Exchange Commission has promulgated Rule 10b-5. That rule forbids the use, in connection with the purchase or sale of any security, of (1) any device, scheme, or artifice to defraud; (2) any untrue statement of a material fact; (3) the omission of a material fact necessary in order to make the statements made not misleading; or (4) any other act, practice, or course of business that operates as a fraud or deceit.

Facts:

Petitioner The Wharf (Holdings) Limited orally granted respondent United International Holdings, Inc., an option to buy 10% of the stock in Wharf's Hong Kong cable system if United rendered certain services, but internal Wharf documents suggested that Wharf never intended to carry out its promise. United fulfilled its obligation, but Wharf refused to permit it to exercise the option. United sued in Federal District Court, claiming that Wharf's conduct violated, inter alia, § 10(b) of the Securities Exchange Act of 1934, which prohibits using "any manipulative or deceptive device or contrivance" "in connection with the purchase or sale of any security." A jury found for United, and the Tenth Circuit affirmed.

Issue:

Does Wharf’s secret intent not to honor the option it sold United violate the Securities Exchange Act?

Answer:

Yes.

Conclusion:

Wharf first argued that its conduct falls outside the Rule's scope for two basic reasons. First, Wharf points out that its agreement to grant United an option to purchase shares in the cable system was an oral agreement. And it says that § 10(b) does not cover oral contracts of sale. Wharf points to Blue Chip Stamps, in which this Court construed the Act's "purchase or sale" language to mean that only "actual purchasers and sellers of securities" have standing to bring a private action for damages. Blue Chip Stamps, however, involved the very different question whether the Act protects a person who did not actually buy securities, but who might have done so had the seller told the truth. The Court held that the Act does not cover such a potential buyer, in part for the reason that Wharf states. But United is not a potential buyer; by providing Wharf with its services, it actually bought the option that Wharf sold. And Blue Chip Stamps said nothing to suggest that oral purchases or sales fall outside the scope of the Act. Rather, the Court's concern was about "the abuse potential and proof problems inherent in suits by investors who neither bought nor sold, but asserted they would have traded absent fraudulent conduct by others." Such a "potential purchase" claim would rest on facts, including the plaintiff's state of mind, that might be "totally unknown and unknowable to the defendant," depriving the jury of "the benefit of weighing the plaintiff's version against the defendant's version." An actual sale, even if oral, would not create this problem, because both parties would be able to testify as to whether the relevant events had occurred. Neither is there any other convincing reason to interpret the Act to exclude oral contracts as a class. The Act itself says that it applies to "any contract" for the purchase or sale of a security. Oral contracts for the sale of securities are sufficiently common that the Uniform Commercial Code and statutes of frauds in every State now consider them enforceable. Any exception for oral sales of securities would significantly limit the Act's coverage, thereby undermining its basic purposes.

Wharf next argued that a secret reservation not to permit the exercise of an option falls outside § 10(b) because it does not "relate to the value of a security purchase or the consideration paid"; hence it does "not implicate [§ 10(b)'s] policy of full disclosure." But even were it the case that the Act covers only misrepresentations likely to affect the value of securities, Wharf's secret reservation was such a misrepresentation. To sell an option while secretly intending not to permit the option's exercise is misleading, because a buyer normally presumes good faith. For similar reasons, the secret reservation misled United about the option's value. Since Wharf did not intend to honor the option, the option was, unbeknownst to United, valueless.

Finally, Wharf expresses concern that interpreting the Act to allow recovery in a case like this one will permit numerous plaintiffs to bring federal securities claims that are in reality no more than ordinary state breach-of-contract claims -- actions that lie outside the Act's basic objectives. United's claim, however, is not simply that Wharf failed to carry out a promise to sell it securities. It is a claim that Wharf sold it a security (the option) while secretly intending from the very beginning not to honor the option. And United proved that secret intent with documentary evidence that went well beyond evidence of a simple failure to perform. Moreover, Wharf has not shown that its concern has proven serious as a practical matter in the past. Nor does Wharf persuade that it is likely to prove serious in the future.