1. What was the legislative philosophy underlying the adoption of the extensive disclosure requirements of the 1934 act?

2. What is the standard of materiality to be applied in a merger-related context?

3. What is the “fraud-on-the-market theory”?

In December 1978, Combustion Engineering, Inc., and Basic, Inc., agreed to merge. During the preceding two years, representatives of the two companies had held meetings regarding the possibility of a merger. During this time, Basic made three public statements denying that any merger negotiations were taking place or that it knew of any corporate developments that would account for the heavy trading activity in its stock. Sometime later, it was publicly announced that there would be a merger. Certain former shareholders who had sold their Basic stock between Basic’s first public denial of merger activity and the public announcement of the merger brought a Section 10(b) and Rule 10b-5 action against Basic and some of its directors, contending that material misrepresentation had been made by Basic in its public statements denying merger activity. Basic raised the defense that the alleged misrepresentations were not material and that there was no showing of reliance by the shareholders on Basic’s statements. The Court of Appeals reversed the district court’s summary judgment for Basic that preliminary merger discussions are not material information. Basic appealed to the U.S. Supreme Court.

JUDICIAL OPINION

BLACKMUN, J.… The 1934 Act was designed to protect investors against manipulation of stock prices.… Underlying the adoption of extensive disclosure requirements was a legislative philosophy: “There cannot be honest markets without honest publicity. Manipulation and dishonest practices of the market place thrive upon mystery and secrecy.” H. R. Rep. No. 1383, 73d Cong. 2d Sess., 11 (1934). This Court “repeatedly has described the ‘fundamental purpose’ of the Act as implementing a ‘philosophy of full disclosure.’”… Pursuant to its authority under § 10(b) of the 1934 Act, 15 U.S.C. § 78j, the Securities and Exchange Commission promulgated Rule 10b-5. Judicial interpretation and application, legislative acquiescence, and the passage of time have removed any doubt that a private cause of action exists for a violation of § 10(b) and Rule 10b-5, and constitutes an essential tool for enforcement of the 1934 Act’s requirements.…

The Court previously has addressed various positive and common-law requirements for a violation of § 10(b) or of Rule 10b-5.… The Court also explicitly has defined a standard of materiality under the securities laws; see TSC Industries, Inc., v. Northway, Inc., 426 U.S. 438, 96 S. Ct. 2126, 48 L. Ed. 2d 757 (1976), concluding in the proxysolicitation context that “an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”… Acknowledging that certain information concerning corporate developments could well be of “dubious significance,” … the Court was careful not to set too low a standard of materiality; it was concerned that a minimal standard might bring an overabundance of information within its reach, and lead management “simply to bury the shareholders in an avalanche of trivial information—a result that is hardly conducive to informed decision making.”… It further explained that to fulfill the materiality requirement “there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”… We now expressly adopt the TSC Industries standard of materiality for the § 10(b) and Rule 10b-5 context.…

As we clarify today, materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.… Because the standard of materiality we have adopted differs from that used by both courts below, we remand the case for reconsideration of the question whether a grant of summary judgment is appropriate on this record.

We turn to the question of reliance and the fraudon- the-market theory. Succinctly put: The fraud-on-the-market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business.… Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.… The causal connection between the defendants’ fraud and the plaintiffs’ purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations. Peil v. Speiser, 806 F.2d 1154, 160-1161 (CA3 1986).…