Basic Inc. v. Levinson
485 U.S. 224 (1988)



Facts:Harris Associates (D) advised the Oakmark complex of mutual funds. The plaintiffs owned shares in several of the funds, and contended that the fees paid to the adviser were too high, in violation of the Investment Company Act of 1940. Section 36(b) of the Act provides that "the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services," and the plaintiffs argued that their advisor breached this duty by charging excessive fees. The district court, applying the Act, held that Harris Associates should prevail, because its fees were "ordinary," whereas a violation of § 36(b) requires a fee so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's length bargaining. The plaintiffs appealed.

Issue: Does the fraud on the market theory eliminate the need for proof of reliance in order to find liability under 10b(5)? Under a 10b-5 action must the misrepresentation be material and must the plaintiff sustain damages through reliance on the misrepresentation?

Rule:Misstatements about merger negotiations can be material statements of fact, depending on the significance that a reasonable investor would place on the withheld or misrepresented information.

Holding: On appeal, the Court of Appeals for the Sixth Circuit, affirmed in part, reversed in part and remanded. On grant of certiorari, the Supreme Court, Justice Blackmun, held that: (1) standard of materiality set forth in TSC Industries is appropriate in § 10(b) and Rule 10b-5 context; (2) materiality in merger context depends on probability that transaction will be consummated, and its significance to issuer of securities; and (3) presumption of reliance, supported in part by fraud-on-market theory may be applied, but presumption is rebuttable.

Analysis:Standard set forth in TSC Industries, whereby omitted fact is material if there is substantial likelihood that its disclosure would have been considered significant by reasonable investor, is applicable for § 10(b) and Rule 10b-5 actions. Securities Exchange Act of 1934, §§ 1 et seq., 10(b), as amended. Information concerning merger discussions, which would otherwise be considered significant to trading decision of reasonable investor is not artificially excluded from definition of materiality, for purposes of Rule 10b-5, merely because agreement-in-principle as to price and structure has not yet been reached by parties or their representatives.