Duty to correct vs duty to update

One frequently discussed issue in securities regulation is the duty to correct and the duty to update information made available to the investing public.

An issuer’s failure to correct or update a misleading statement may, under appropriate circumstances, constitute a “device, scheme, or artifice to defraud” or an act which “operates or would operate as a fraud or deceit upon any person” as to make the issuer liable under the Securities Regulation Code. Otherwise stated, an issuer, by allowing the securities markets to continue to set the price of its securities based on information that is or has become materially misleading, may well deceive its shareholders into paying too much, or receiving too little, for its securities.

While the duty to correct and the duty to update has been confused for years,  the two legal concepts have eventually been distinguished from each other. For example, in Backman v. Polaroid Corp., 910 F.2d 10 (1st Cir. 1990), the court stated that “[o]bviously, if a disclosure is in fact misleading when made, and the speaker thereafter learns of this, there is a duty to correct it.”

The court attempted to distinguish this duty to correct from the duty to update, defining the duty to update as arising where subsequent disclosure is necessary “if a prior disclosure ‘becomes materially misleading in light of subsequent events.’” Subsequently,  Stransky v. Cummins Engine Co. Inc., 51 F.3d 1329 (7th Cir. 1995), made the distinction more clearly as follows: The duty to correct “applies when a company makes a historical statement that, at the time made, the company believed to be true, but as revealed by subsequently discovered information actually was not. The company then must correct the prior statement within a reasonable time”; the duty to update, on the other hand, arises “when a company makes a forward-looking statement … that because of subsequent events becomes untrue.”

Understanding the distinction is important because the failure to perform the duty where such exists may result not only in administrative and civil liabilities but also criminal liability. Conversely, where no such  duty exists, the issuer is not liable despite protestations from the investing public.

Duty to correct

This concept gained widespread acceptance following the case of  Ross v. A.H. Robins Co.  Ross involved statements made by the A.H. Robins Co. (“Robins”) in two annual reports and a prospectus which indicated that Dalkon Shield, a contraceptive device it manufactured, was safe and effective. Shareholders of Robins asserted that the company violated the securities laws by failing to correct these statements after a research report showed that the product was not as safe or effective as earlier stated. The court concluded that Robins’ failure to correct its earlier statements was actionable under the US securities laws, particularly Rule  lOb-5.

How about statements made by other parties? Case law suggests that a “company has no duty to correct or verify rumors in the marketplace unless those rumors can be attributed to the company.” State Teachers Ret. Bd. v. Fluor Corp., 654 F.2d 843, 850 (2d Cir. 1981). This principle was exemplified in  Elkind v. Liggett & Myers Inc., 635 F.2d 156, 162 n.8 (2d Cir. 1980), where the Second Circuit held that there is nothing in the securities laws that requires a company to correct a misstatement in the press not attributable to it a company. However, “a company may so involve itself in the preparation of reports and projections by outsiders as to assume a duty to correct material errors in these projections.” Herman v. Legent, No. 94-1445, 1995 WL 115879, at *9 (4th Cir. Mar. 20, 1995) (quoting Elkind, 635 F.2d at 163).

Duty to update

The duty to update applies to forward-looking  statements. Generally, these statements refer to future plans or performance, including revenue projections and statements tied to future economic performance of a company.

A forward-looking statement may become misleading as a result of subsequent events. Such a statement, by its terms, purports to remain valid beyond the date it was made. A good example is financial projections, which may become misleading if subsequent events significantly alter the assumptions forming the basis for those projections, or otherwise render those projections inaccurate. In such a case, the issuer has the duty to update the statement so as not to mislead investors.

A non forward-looking statement, on the other hand, does not become misleading through the occurrence of subsequent events. A non forward-looking statement, by its terms, relates only to current or historical matters. It remains unaffected by subsequent events. For example, an issuer’s quarterly report on SEC Form 17-Q showing positive first quarter financial results does not become misleading as a result of a severe and unexpected economic downturn in the second quarter. Consequently, the issuer does not have a duty to update it. Corollarily, the issuer does not incur any liability for not updating it.

But if the issuer issued a statement in the first quarter projecting good financial results for the second quarter, it has the duty to update it if the downturn caused those projections to become misleading. If it does not, it may incur administrative, civil and criminal liability.

Similarly, in another case, the court held that a company did not have a duty to update statements about the safety of its product when those statements concerned only currently available safety information and were not forward-looking (In re Sanofi-Aventis Securities Litigation, No. 07-cv-10279-GBD (S.D.N.Y. Mar. 30, 2011)).

Of course, the foregoing distinction is just the tip of the iceberg, so to speak. There are finer issues of law that come with it. For example, does a  company have the duty to correct misleading statements made by a third party like an analyst? Should a forward looking statement that merely states an opinion need to be updated? Does the duty to update arise only when the forward looking statement in question is clear and factual?

Well, these questions may be the subject of another discussion in this column.

The author is senior partner of Angara Abello Concepcion Regala & Cruz Law Offices (Accralaw) and is a professor in the Ateneo Law School. He is also president of Shareholders’ Association of the Philippines (SharePHIL). The views in this column are exclusively his, and should not be attributed in any way to the institutions with which he is currently affiliated. He may be contacted through [email protected].