The Delaware Supreme Court recently held that a securities broker owes the same fiduciary duty of full disclosure of material information to clients as a corporate officer or director owes to company shareholders.
Defendant Everen Securities, Inc. ("Everen"), a full services brokerage firm, offered its clients a "money market sweep account" service through which it would periodically remove the cash in its clients' brokerage accounts and place it into a designated money market fund managed by Zurich Kemper Investments, where it could earn interest. In 1996, Everen changed its choice of money market funds for its sweep accounts after it entered into a joint venture agreement with Mentor Investment Group, Inc. ("Mentor") and several of Mentor's affiliates. Pursuant to the joint venture agreement, Everen acquired a 20.2% interest in the joint venture in exchange for agreeing to transfer management of its clients' "sweep accounts" to Mentor, and acquired the right to increase its interest in the joint venture to as much as 50% depending on the extent to which its customers invested in Mentor's funds. Everen notified its clients in writing that "unless instructed to the contrary, it would switch their sweep accounts to funds managed by Mentor on November 1, 1996," and enclosed a prospectus for the Mentor fund along with a "negative response" letter through which clients could object to the fund change. Neither the prospectus nor the negative response letter disclosed how Everen acquired its interest in the joint venture.
The plaintiffs, who maintained sweep accounts with Everen, did not object to the switch to Mentor upon receipt of these materials. Plaintiffs subsequently filed a complaint asserting claims against Everen and its directors for breach of fiduciary duty of disclosure and loyalty for acting in their own interest without full disclosure, and against Mentor and its affiliates for aiding and abetting Everen's breach of fiduciary duty. The Chancery Court dismissed the plaintiffs' complaint for failure to state a claim, finding that the prospectus and notification letter "strongly implied" the nature of Everen's interest in the joint venture, and holding that the disclosures were adequate as a matter of law.
On appeal, the Delaware Supreme Court addressed the scope of a brokers' fiduciary duties to its clients, including the adequacy of required disclosure. Applying principles of agency law, the court held that brokers owe fiduciary duties to their customers similar to those corporate directors and officers owe to their shareholders, including the fiduciary duties of good faith, fair dealing and loyalty. Specifically, the court noted that brokers must act in their customer's best interests and must refrain from self dealing unless the customer consents, after full disclosure. The court then adopted the disclosure standard applied to corporate directors as consistent with the "full disclosure" mandated for agents:
[I]n the corporate context . . . directors must disclose all material facts when seeking stockholder action and . . . materiality is measured by the following standard: 'An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. . . . It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.'
Applying this standard, the court concluded that a reasonable investor might consider the omitted material -- what Everen exchanged for its initial 20.2% share of the venture -- significant. The court reasoned that the fact that the broker used its customers' money to advance its own interest may be important not only to the customer's choice of using a sweep account, but also to the customer's choice of brokers. Therefore, the court concluded that the Chancery Court erred in granting Everen's motion to dismiss because, at the very least, there was a factual issue as to whether the information was material.
Assuming that the information was material, the court then addressed the types of statements that would satisfy the brokers' fiduciary duty of disclosure. Although the court stated that an express statement of the facts may not always be required, it held that "full disclosure requires more than strong inferences." In so holding, the court expressly rejected the Chancery Court's conclusion that a reasonable investor would have known from the disclosures that Everen was using its customer's accounts to participate in the venture. "Investors should not be required to correctly 'read between the lines' to learn all of the material facts relating to the transaction at issue," the court stated. The court also recognized that while there may be circumstances where undisclosed information naturally or inescapably follows from the disclosed facts, the disclosures contained within the prospectus and the "negative response" letter were not that clear. The court observed that those disclosures at least left open the possibility that Everen acquired its interest in the joint venture by investing its own money and not by transferring customer "sweep accounts." The Delaware Supreme Court thus ruled that an issue existed as to whether the disclosures made satisfied the defendants' fiduciary duties. *
O'Malley v. Boris, 742 A.2d 845 (Del. Sup. Ct. 1999).