Yesterday, the U.S. Court of Appeals for the Third Circuit released an important decision regarding the liability of executives who allegedly omit information in quarterly filings.

United States of America v. Schiff , in which the government alleged criminal securities fraud,  should have implications beyond the criminal context. In Schiff, the Third Circuit rejected the government's attempt to expand liability for alleged failures to update or correct information in the marketplace. As a result, attempts by the SEC, as well as private litigants, to hold corporations or individuals liable for omissions or failures to update or correct filings similar to the government’s efforts in Schiff may also be found to be legally insufficient to impose liability. 

In 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 off track," the market responded with a stock drop of 14.7 percent.

As the Third Circuit found, the government introduced "new legal theories" that appeared designed to find "creative" ways to hold the former executives liable, even though the government conceded the company's filings with the SEC did not contain any affirmative misstatements. As a result, the government eventually settled on attempting to hold the former executives liable for omissions.

The government first 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 as potentially encroaching on "conduct traditionally left to state corporate law." The Court also held that the anti-fraud provisions of the 1934 Act "do not contemplate the general failure to rectify the misstatements of others."

The government also alleged that one of the executives made material misstatements in quarterly analyst calls that he failed to correct. Because the government already conceded that the company's SEC quarterly filings were accurate, and because the government could not point to an event triggering the duty to correct, the court rejected the government’s attempt to hold the executive liable for his alleged omissions.

In addition to rejecting liability for a failure to correct, the Court also held that the executive could not be liable for a failure to update. The Court held that this duty is a "narrow" one that relates to "'fundamental changes' in the nature of a company―such as a merger, liquidation, or takeover attempt―and when subsequent events produce an 'extreme' or 'radical change' in the continuing validity of that initial statement."  In the circumstances of the case before it, where the statements related ongoing sales volume, the Court held those statements "do not come close to fitting within the narrow range of this duty."

For more information on SEC enforcement, cooperation with the government, or internal investigations, please contact John C. Grugan at 215.864.8226 or, Justin P. Klein at 215.864.8606 or, M. Norman Goldberger at 215.864.8850 or, or Henry E. Hockeimer, Jr., at 215.864.8204 or

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