9th Circuit Holds Forward-Looking Promise in SEC-Filed Agreement no Basis for Securities Fraud

By Cydney Posner

On June 29th, the 9th circuit issued an opinion in Reese v. BP Exploration (Alaska), Inc. that provides an interesting companion piece to the SEC's position in Titan Corporation.  The case came up on an appeal by BP of the district court's order denying BP's motion to dismiss a securities fraud class action.

You may recall that, in the report of investigation in the case against The Titan Corporation, the SEC took the position that disclosures regarding material contractual terms, such as representations, may be actionable if materially misleading, even if "the information published was contained in an agreement or other document not prepared as a disclosure document." Notwithstanding the fact that the shareholders of Titan were not beneficiaries of the particular representation regarding compliance with the FCPA (the issue in that case), the SEC, citing Basic v Levinson, contended that the inclusion of the representation in a filed merger proxy statement (even if through incorporation by reference) constituted a disclosure to investors: "Depending on the context in which the disclosure is made (including the significance of the representation or other contractual provision and the total mix of information available to the investor), a reasonable investor could conclude that the statements made in the representation describe the actual state of affairs and the information could be material." As a result, where a representation is disclosed, "if additional material facts exist, such as those contradicting or qualifying the disclosure of the original representation (for example, knowledge by the senior officers of the company that the facts described in the representation are not true), omission of which makes that disclosure misleading, a company would also be required to disclose those facts. This is particularly true when an issuer knows of new information before the original proxy statement, or amendments, are published." Failure to do so could result, where the failure involved scienter, in liability under Rule 10b-5. In effect, the SEC took the position that companies have an independent obligation arising out of the disclosure of contractual provisions to ensure, correct or disclaim their accuracy.

The instant case followed BP's temporary shut-down of its pipelines in Prudhoe Bay, Alaska, following its discovery of a leak in a pipeline and another large spill that resulted largely from internal corrosion caused by sediment buildup. In the plea agreement in the related criminal action, BP admitted that it was aware of sediment buildup before the spills and failed to clean it out in the belief that corrosion was a low probability. The class action complaint alleged that, as a consequence of the leaks and the shutdown of BP's operations, the stock price plunged and investors lost billions. Further, the complaint alleged that BP knew about the corrosion but did not take corrective action or disclose "the foreseeable risk" that it would need to curtail its oil production as a result.

The issues of concern here were whether BP made material misrepresentations in SEC filings. The key allegations concerned a royalty agreement to which BP was party that was filed as an exhibit to periodic reports filed with the SEC by a Trust formed to distribute the royalties. The agreement required BP to operate Prudhoe Bay according to a "Prudent Operator Standard," more specifically, to "conduct and carry on the development, exploration, production, maintenance and operation of [Prudhoe Bay] with reasonable and prudent business judgment, in accordance with . . . good oil and gas field practices, as a reasonable and prudent operator . . . ." The plaintiffs argued that the repeated filing of the agreement with the SEC "represented to the public" that BP was maintaining its contractual obligation to operate in accordance with the Prudent Operator Standard and that, at the time of the filings, those statements were materially false and misleading. The plaintiffs also contend that BP knew of the misrepresentations and or deliberately disregarded the truth to conceal its problems and to support its artificially inflated stock price.

The district court concluded that the plaintiffs could use, "as evidence of false or misleading statements upon which any investor was permitted to rely," the Trust's <br>quarterly filings with the SEC, which included the royalty agreement. The district court held that it was immaterial that the SEC filings were made by the Trust. Moreover, the district court was guided by the principle that a statement is false if it "affirmatively create[s] an impression of a state of affairs that differs in a material way from the one that actually exists," even if the statement was private contractual language. The district court also found a strong inference of scienter in BP's plea agreement admissions.

BP's appeal raised two issues: 

• Whether a contract to which a defendant is a party, filed in conjunction with SEC reporting requirements and promising specific conduct by the defendant, can be used as the foundation for a securities fraud action by a nonparty to the contract. 
• Whether the facts contained in a party's admission of criminal negligence as part of a misdemeanor guilty plea may be used as evidence of civil misconduct by the admitting party which requires an allegation of reckless or intentional misconduct as proof of scienter.

The 9th circuit rejected the plaintiff's contention that the Trust's filing of the agreement, in compliance with its legal obligations, would give a reasonable investor the impression that BP was in compliance with the Prudent Operator Standard provision of that agreement: "That contract provision, read literally, was ‘forward-looking' and not a misrepresentation of current fact." While some investors might presume that BP was in compliance, the "breach of a contractual promise of future performance typically does not constitute a misrepresentation that will support an action for fraud," either as a general matter or in the context of private securities litigation. Although a promise to perform in the future could "conceivably" become "'an inaccurate assertion as to a matter of past or existing fact,'… if its repeated filing 'create[s] an impression of a state of affairs that differs in a material way from the one that actually exists,' " in this case, the court was not persuaded that BP had affirmatively created that false impression. Not only was the promise forward-looking in nature, but it was also contained in a document attached to SEC filings made to fulfill unrelated regulatory requirements. In addition, cases cited by the plaintiff involved express misrepresentation of present-existing fact and not merely a promise of future performance, nor did the plaintiff contend that BP intended not to comply at the time it entered the contract. Accordingly, the court declined to hold that, because of repeated filing of a forward-looking promise alone, a reasonable investor would believe that BP made any certification of current or ongoing compliance as of the time of filing: "Given the broad nature of the provision and the Trust's filing obligations, a reasonable investor would likely view the Trust's attachment of the [royalty agreement] to its SEC filings as a statement of the rights of the Trust and its unit holders, not as certification by [BP] that all of its operations were in compliance with the Prudent Operator Standard….[BP's] contractual promise to act as a prudent operator did not expressly or implicitly assert that [BP] was in full compliance with its obligations thereunder, and we do not view the public filing of the [royalty agreement] as the sort of traditional fraudulent misrepresentation of fact that could induce investors mistakenly to buy securities. We hold that, in this case, the public filing of a contract containing a promise of future compliance did not, upon the contract's breach at a time after execution, provide an actionable misrepresentation for the purposes of a private damages action for securities fraud." Because the claim for misrepresentation failed, the court did not reach the scienter issue.

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