Corporate Wrongdoing Injures Consumers and
Shareholders
Federal Securities Laws dating back to the early 1930s require that
publicly traded corporations be truthful in their communications to
shareholders and the public. This requirement, which has been bolted
into Rule 10b-5 promulgated by the Securities and Exchange Commission,
was designed to protect those who invest in publicly traded
corporations. Information distributed by a corporation is reviewed by
analysts whose work plays a role in establishing the market price for
a particular stock or security. The individual investor then relies on
the market price as an accurate reflection of that company's value.
When that market price turns out to be predicated on false
information, the revelation of which causes the stock price to
plummet, individual investors can bring claims under the Federal
Securities Laws to recover damages. Securities fraud, however is not
just about cooking the books and manipulating a corporation's finances
to make its economic performance look better.
Securities fraud may also occur when
corporate officers fail to disclose material information that a
reasonable investor would want to know, such as functionality problems
with a product, failing, or improper relations with a customer, and
any number of things that could impact share price.
Consumer Fraud as a Predicate
Shareholders are not the only victims of conduct that may ultimately
amount to securities fraud. A corporation's failure to disclose
defects within a particular product line may cause injuries to
consumers as well as constitute consumer fraud. For example, an
automobile manufacturer that knowingly manufactures a vehicle with a
defect that may cause death or serious injury engages in conduct that
potentially injures consumers, allowing them the right of redress
under consumer fraud statutes. At the same time, shareholders who have
purchased stock in that company, based on the presumption that the
product line is solid, are similarly defrauded, thus giving rise to
dual causes of action for consumer fraud and securities fraud.
The Vioxx case is one example of where a wrong done to consumers has
negatively impacted the value of the company and created dual causes
of action under consumer and securities laws. Vioxx (see article on
page 9) is a pain killer manufactured by Merck Pharmaceutical. It has
been alleged that Merck failed to disclose information indicating
adverse health effects of the drug. Recent disclosures not only
negatively impacted the price of the stock but prompted victims of the
drug to step forward and seek redress for their injuries. The Vioxx
case is a clear example of how securities fraud does not always flow
from the manipulation of a balance sheet.
How a particular product is marketed may also serve as a predicate for
both securities fraud and consumer actions. For example, many drugs
are used on an off-label basis which means that they are prescribed by
doctors for purposes other than those specifically approved of by the
Food and Drug Administration. While a company may seek the FDA's
approval for a specific purpose, this does not prevent doctors from
prescribing the drug for other purposes once the drug is released into
the market.
Psychiatric drugs, including mood stabilizers and anti-psychotics,
though often only approved for use in age groups greater than 18, are
occasionally prescribed by doctors for children, and for purposes
other than that which they have been approved by the FDA. It is not
lawful for companies to actively market FDA approved drugs for off
label usage. In theory, to the extent the company did this in order to
boost sales, there could be a dual violation of both consumer and
securities laws.
The False Claims Act
Many publicly traded corporations depend on the United States
Government and local and state governments as customers. Indeed,
revenue from government contracts often provides a material income
stream for many corporations.
During the presidency of Abraham Lincoln,
Congress passed the Federal False Claims Act, (a law that was
strengthened in the 1980s) which allows individuals to bring suit in
the name of the United States Government against anyone who has by
misrepresentation cheated the government out of money in the course of
a contractual relationship.
This law has been applied to health care
providers that overbill the Medicare system. It has also been applied
to defense contractors that provide the government with defective
products or overcharge for those products. Similarly, the law has also
been applied to the oil industry which allegedly did not pay the
government a proper share of royalties on oil pumped from federal
lands. For profit educational companies that rely on government
dollars to finance student tuition have also been a target of
government scrutiny.
The essence of the False Claims Act is
that anyone doing business with the federal government must honor the
regulations governing that business and the terms of any contract that
memorializes the relationship between the government and the private
actor. This means that a hospital which receives Medicare dollars is
required to comply with Medicare regulations as a condition of receipt
of these monies.
Corporate Governance and the False
Claims Act
Corporations are legal entities established to live in perpetuity.
Unfortunately, they are run by temporary caretakers whose short term
interests may conflict with the longer term interests of the
corporation and its shareholders. Keeping the corporation on track so
that its course is not altered by directors and officers who want to
boost profits for immediate personal gains necessitates shareholder
diligence.
The False Claims Act allows for private
citizens that have independent knowledge of a wrong committed on the
government to bring suit in a United States District Court in the name
of the Government.
Ultimately, when shareholders learn that
their corporation has derived revenue through improper means, their
recourse is through litigation under the Federal Securities Laws.
Whether the initial wrongful conduct was strictly a violation of the
securities laws or flowed from predicate violations of either consumer
laws or federal procurement laws, both shareholders and the public are
injured.
