Speak Now or Forever Hold Your Peace: A Split on a Fiduciary’s Duty to Speak

Imagine: a member of your trusted investment club approaches you encouraging you to purchase securities in a new company, which you do because your investment club always has the group’s best interests in mind. Later you learn that this member received a commission from your transaction. You feel betrayed, but did he have a duty to tell you about his stake in your investment?

Duty to Speak

In Chiarella v. United States, the Supreme Court held, “When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak.” Such a duty is found when a party has information “that the other is entitled to know because of a fiduciary or similar relation of trust and confidence between them.”

This rule, like virtually all legal rules, reflects a balancing of competing interests. On one hand, we want to believe that people are trustworthy, particularly when a person has a fiduciary duty to us. The investment adviser industry depends on people trusting that their investment advisers have their best interests at heart. If an individual recommending the purchase of securities is deriving a commission from the sale, a potential investor would want to be wary of a potential conflict of interest.

On the other hand, is it wise to impose a duty to speak on every individual who may share information about a company offering securities? With the growth of technology, communication and the sharing of information have become constant. If such a duty is imposed on every individual who recommends a security or supplies information about a company, the chain of liability would be unending.

The Split

On whom do we impose a duty to speak? Three circuits have taken different approaches.

The Third Circuit found that a general fiduciary duty does not implicate a duty to speak. In Schiff v. United States the Court held:

“The Government argues that Schiff’s duty to disclose in the SEC filings derives from a general fiduciary obligation of ‘high corporate executives’ to the company’s shareholders . . . This argument reaches too far.”

The Second Circuit held in Securities and Exchange Commission v. Dorozkho that a duty to speak should be found wherever there is a fiduciary duty.

“[These cases] all stand for the proposition that nondisclosure in breach of a fiduciary duty ‘satisfies § 10(b)’s requirement . . . [of] a deceptive device or contrivance’.”

Finally, the Ninth Circuit extends the duty to speak to a much broader class in Paracor Finance, Inc. v. General Electric Capital Corp.

“A number of factors are used to determine whether a party has a duty to disclose: (1) the relationship of the parties, (2) their relative access to information, (3) the benefit that the defendant derives from the relationship, (4) the defendant’s awareness that the plaintiff was relying upon the relationship in making his investment decision, and (5) the defendant’s activity in initiating the transaction.”

Looking Forward

While the Ninth Circuit approach allows a judge to balance factors and find whether a duty to speak exists as a matter of fairness, this approach does not seem practical in a world where people are constantly accruing and sharing information. Thus, it makes the most sense for the court to follow the Second Circuit’s approach of only finding a duty to speak where there is a fiduciary duty, which represents the middle ground of who has a duty to speak and promotes predictability.