In Re Merck & Co. Securities Litigation
432 F.3d 261 (2005)
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Rule of Law:
For securities fraud claims under §10(b) and §11 involving a publicly traded company on an efficient market, the materiality of disclosed information is measured by the stock's price movement in the period immediately following the disclosure. If the stock price does not experience a negative effect, the information is immaterial as a matter of law, even if the disclosure was piecemeal or opaque.
Facts:
- Merck & Co., Inc. planned an Initial Public Offering (IPO) for its wholly owned subsidiary, Medco Health Solutions, Inc., a pharmacy benefits manager (PBM).
- For years, Medco had an accounting policy of recognizing customer co-payments, which were paid directly to pharmacies and never handled by Medco, as its own revenue.
- On April 17, 2002, Merck filed a Form S-1 registration statement with the SEC which, for the first time, disclosed this revenue-recognition policy but did not state the total dollar amount of co-payments recognized.
- Following the April 17 disclosure, Merck’s stock price did not decline; it rose slightly.
- On June 21, 2002, The Wall Street Journal published an article that, using information from the S-1 filing, estimated Medco had recognized $4.6 billion in co-payments as revenue in 2001.
- Immediately following the publication of the article, Merck's stock price dropped significantly.
- Merck subsequently disclosed that Medco had recognized over $12.4 billion in co-payments as revenue over three years.
- Following the further disclosures and stock price declines, Merck canceled the Medco IPO.
Procedural Posture:
- Union Investments Privatfonds GmbH (Union), as lead plaintiff for a class of stockholders, filed a class action lawsuit against Merck & Co., Inc. and Medco Health Solutions, Inc. in the U.S. District Court for the District of New Jersey.
- The complaint alleged violations of §10(b) and §11 of the federal securities laws, as well as controlling person liability under §20(a).
- The defendants filed a motion to dismiss for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).
- The District Court granted the defendants' motion and dismissed all of Union's claims.
- Union, as the plaintiff-appellant, appealed the dismissal to the U.S. Court of Appeals for the Third Circuit.
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Issue:
Does a company's partial disclosure of a questionable accounting practice constitute a material misstatement or omission under federal securities laws (§10(b) and §11) if the company's stock price does not decline immediately following the disclosure, but drops significantly two months later when a newspaper article publicizes the full financial impact?
Opinions:
Majority - Ambro
No. The disclosure was not material under federal securities law because materiality in an efficient market is measured by the immediate price reaction of the company's stock. The court applied its 'Oran-Burlington' standard, which holds that 'the materiality of disclosed information may be measured post hoc by looking to the movement, in the period immediately following disclosure, of the price of the firm’s stock.' Because Merck’s stock price did not drop (and in fact, rose slightly) immediately after its April 17th disclosure, the information was immaterial as a matter of law. The court rejected the argument that the market's delayed reaction, which occurred only after The Wall Street Journal performed calculations on the disclosed data, could establish materiality. It reasoned that in an efficient market, sophisticated analysts are presumed to perform such calculations themselves, and the market's initial non-reaction is dispositive. The court extended this same materiality standard from §10(b) claims to §11 claims, concluding that since materiality is a shared element, the same test applies.
Analysis:
This decision solidifies the Third Circuit's strict adherence to the efficient market hypothesis in determining materiality for securities fraud claims. It establishes that the immediate stock price reaction is the dispositive test for materiality under both §10(b) and §11, creating a high bar for plaintiffs. The ruling suggests that corporations may escape liability for 'opaque' or piecemeal disclosures as long as the market does not react negatively right away, placing the burden on market analysts to immediately decipher complex or incomplete information. This bright-line rule provides predictability but may also incentivize strategic, delayed, or confusing disclosures by issuers.
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