Investors Who "Saw Through the Fraud" Cannot Establish Reliance For a Rule 10b-5 Action; Investors Whose Shares Rose in Value Cannot Establish Damages For a Securities Exchange Act §11 Claim
STARK TRADING v. FALCONBRIDGE LIMITED (January 5, 2009)
Brascan Asset Management (“Brascan”) owned 41% of the common stock of Noranda, Inc. (“Noranda”). Noranda owned, in turn, 59% of Falconbridge, Inc. (“Falconbridge”). Noranda and Falconbridge were both large Canadian mining companies. In March 2005, Noranda offered the minority shareholders in Falconbridge 1.77 shares of Noranda stock for each share of Falconbridge. The offer was conditioned on being accepted by holders of more than half of Falconbridge’s shares. The plaintiffs (two hedge funds) bought Falconbridge shares in the months leading up to the tender-offer expiration date in May. The plaintiffs believed that Falconbridge was grossly undervalued. Before the expiration of the tender-offer, the plaintiffs learned of many problems in the transaction. They expressed their concerns to the Canadian regulators. They exposed a conflict of interest at the investment bank that did the valuation of Falconbridge and in the internal Falconbridge committee that considered the valuation. They also warned that Noranda overstated the value of its own shares. The plaintiffs tendered their shares and the tender-offer succeeded. A few months later, Noranda and Falconbridge merged. Shortly thereafter, another mining company offered to buy the merged company for a price substantially above the tender-offer price. The plaintiffs brought this action against both the merged company and Brascan. The suit was based on the SEC’s Rule 10b-5 and section 11 of the Securities Exchange Act. The district court dismissed the suit for failure to state a claim. Plaintiffs appeal.
In their opinion, Judges Posner, Kanne and Tinder affirmed. The Court first addressed the Rule 10b-5 fraud claims. A claim of fraud cannot be maintained without proof that the plaintiffs relied on the misleading misrepresentations or omissions of the defendant. The Court concluded that plaintiffs were not deceived. They knew Falconbridge was undervalued, they knew the offer was too low, and they knew that Noranda engaged in fraud. They did not try, however, to influence other minority shareholders or even to publicly disclose the information. What they had wanted was a higher offer. Not getting it and worried about the lack of minority shareholder protection under Canadian law, they tendered their shares. Other investors may have been deceived but the plaintiffs actually saw through the fraud. The Court agreed that they could not maintain a 10b-5 action. With respect to the §11 claim, the Court noted that it does not require reliance. A person may bring an action under §11 if the registration statement of the security contains an untrue statement or material omission. The plaintiffs fare no better under §11, however, than they did under 10b-5. The measure of damages is the difference between the purchase price paid by the plaintiff and the share price when it was sold or at the time of the suit, if still owned. Here, the value of the plaintiffs’ investment was higher at the time of the suit than when they purchased the shares.
