By Thomas Lovecchio
In TSC Industries, Justice Marshall developed a new test for materially under Section 14(a) of the Securities Exchange Act. The case arose out of TSC Industries acquiring National Industries. Tsc Indus. v. Northway, 426 U.S. 438, 440 (1976). Prior to the initiation of the case, “National acquired 34% of TSC’s voting” stock and had placed five of its nominees on TSC’s board. Id. TSC’s board, notwithstanding the National members, voted to sell to National. Id. at 441. In TSC and National’s statement to its shareholders it recommended the acquisition. Id. A TSC shareholder sued TSC and National claiming the joint statement was “incomplete and materially misleading in violation of § 14(a) of the Securities Exchange Act. . ..” Id. The Court took the case because the various Courts of Appeals had different standards regarding materially. Id. at 443.
The Court rejected the test the lower court used which was “all facts which a reasonable share holder might consider important” as the test for material facts, Id. at 445, and announced a new rule based of the Act’s purpose to have companies provide information to shareholders so that they are able to make informed decisions. Id. at 448. The Court found that using the word “might” would lead to a variety of dangers, such as a company overloading shareholders with information. Id. at 448-49. Therefore, a better standard for materially and the one the Court used in the case at bar was “an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” Id. at 449. This standard requires that a reasonable shareholder would have placed some importance in their respective decision-making process. Id.
The Court had to develop a type of test that was not too strict but also was not too easy. Id. Doing so required a weighing of numerous factors and dangers that shaped the overall rule. For example, the information dump. Companies could dump information into the shareholder report to either protect themselves from liability or to just provide information so that it would take longer for shareholders to sort through already lengthy financial statements. Id. at 448-49 Justice Marshall did an excellent job writing for the Court and articulating these dangers. Acquisitions generally take a lot of time and a lot of analysis goes into the decision to acquire another company. If a company provided all of the information that pertained to the topic of the respective statement to its shareholders, those shareholders would potentially be overwhelmed with all of the information. If the information is important in deciding how that shareholder would vote, then it is imperative that a company provide the shareholders with that information. The rule set forth in TSC Industries was based of the Act’s purpose to have companies provide information to shareholders so that they are able to make informed decisions based off of the information that company provides them. Id. at 448.
Another part of the test is the “substantial likelihood” which provides a proper balancing mechanism for companies to decide what information to disclose. Under this rule companies would still have to include the obviously important information and could exclude the irrelevant information. Now, companies know how to evaluate all of the information that falls in-between obviously important and irrelevant. By using substantial likelihood, the Court paved a way so that companies do not feel compelled to do an information dump when providing information to shareholders.
Justice Marshall’s opinion in TSC Industries set forth the test for material fact under the Securities Exchange Act that is still used today. This provides a bright-line test for companies to use when deciding what information to include and exclude in its report. This test properly balances the interests of shareholders and companies to allow for better securities regulations.