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IS PUFFERY MATERIAL TO INVESTORS? MAYBE
WE SHOULD ASK THEM
Stefan J. Padfield*
"fW]hat we have here is fact versus outdated legalfiction .......
***** Assistant Professor, University of Akron School of Law. B.A., Brown University; J.D., University of Kansas. The idea for this Article was presented at the Eighth Ohio Legal Scholars Workshop, held at Capital University Law School on January 27, 2007; the Article was presented both at the Central States Law Schools Association Annual Meeting held at Wayne State University Law School on October 27, 2007, and as part of the University of Akron Faculty Workshop Series on October 10, 2007. My thanks to all the participants for their helpful comments. My thanks also to Andrew D. Martin, David A. Hoffman and Samuel P. Baumgartner for additional helpful comments. John E. Matejkovic and Sarah Cravens allowed me to survey their students, for which I am very grateful. Finally, I would like to thank the University of Akron School of Law for providing me with a summer research grant to help me complete this project.
1. Richard J. Leighton, Making Puffery Determinations in Lanham Act False Advertising Cases: Surveys, Dictionaries, Judicial Edicts and Materiality Tests, 95 TRADEMARK REP. 615, 639 (2005) (emphasis added). The context of the cited quote is as follows: In [Pizza Hut, Inc. v. Papa John's International,Inc., 227 F.3d 489 (5th Cir. 2000)], the jury found by special interrogatory that "Better Ingredients. Better Pizza." "is false or misleading and was a false or misleading description or representation of fact which deceived or was likely to deceive a substantial number of the consumers to whom the slogan was addressed." That finding by a jury (consumers all) of widespread deception as a matter of fact, was overturned by the appeals court, as a matter of law.... [T]he Fifth Circuit panel's thinking went like this: (1) "Better" is a vague and generalized description that has been found to be puffery as a matter of law in other cases where it was used to describe other products and services in similarly general terms; (2) thus, consumers never would bejustified in relying on the challenged slogan to buy pizza; (3) even if a substantial number of consumers actually did (or might) rely on it, as the jury found. It is significant that the appellate court did not (and could not) determine that such consumers were not misled by the slogan; it preemptively determined that they had no legal justification (^) for being misled. The appellate court also did not (and could not) find that no reasonable jurors could determine that such consumers were misled or that no reasonable consumers would have been misled by the claim. Thus, what we have here is fact versus outdated legal fiction, and use of the latter to nullify a jury verdict.
Id. (quoting Pizza Hut, 227 F.3d at 493 n.2). While the quoted language focuses on materiality in the context of a Lanham Act claim, I will discuss below how there is
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I. INTRODUCTION
Federal securities laws make it illegal to make a material misstatement
in connection with a securities transaction.^2 Materiality is generally
deemed to be a fact-intensive issue only to be resolved on the basis of
pretrial motions when no reasonable shareholder could find the challenged
statement material.^3 Nonetheless, and despite assertions to^ the^ contrary,
materiality is often resolved pretrial. 4 One of the doctrines relied upon^ by
courts to dismiss securities claims on the basis of immateriality is the
puffery defense. "Puffery" has been defined as ambiguous, promotional, or
hyperbolic speech commonly known as "sales talk." 5 While the puffery
doctrine has been the subject of a great deal of criticism, 6 it continues to be
relied upon by courts-in fact, its use may be increasing.'
Given this state of affairs, one issue that arises is how well judges are
applying the puffery doctrine (assuming it is valid^ at^ all).^ As^ Professor
Langevoort has noted, "here we run into the ever-troublesome distinction
between the normative and the descriptive... .Is it clear that typical
investors do not rely on puffery? There is little research that studies this
specifically, and so many judges are guessing." 8 This Article seeks to fill
sufficient overlap between materiality analysis^ in^ the^ Lanham Act^ and securities regulation contexts to warrant cross-referencing.
2. See, e.g., Securities Exchange Act of 1934 Rule, 17 C.F.R. § 240.10b-5 (2007) ("It shall be unlawful for any person ... [t]o make any untrue statement of a material^ fact^ ... in connection with the purchase or sale of any security."). 3. See TSC Indus. v. Northway, Inc., 426 U.S.^ 438,^450 (1976)^ ("Only^ if^ the established omissions are 'so obviously important to an investor, that reasonable minds cannot differ on the question of materiality' is^ the^ ultimate^ issue^ of^ materiality^ appropriately resolved 'as a matter of law' by summary judgment.") (quoting Johns Hopkins Univ. v. Hutton, 422 F.2d 1124, 1129 (4th Cir. 1970)). TSC Industries involved a challenge to a proxy statement arising under Rule 14a-9. Nonetheless, the discussion of materiality in that case is generally applicable to securities litigation. See Basic Inc. v. Levinson, 485 U.S. 224, 231-232 (1988) (adopting the TSCIndustries standard for Rule lOb-5 actions). 4. See David A. Hoffman, The "Duty" To Be a Rational Shareholder, 90 MUNN. L. REv. 537, 542 (2006) ("In this Article, I present evidence that courts dismiss securities claims on the ground of presumed immateriality in half of opinions considering materiality.").
- Jennifer O'Hare, The Resurrection of the Dodo: The Unfortunate Re-emergence of the Puffery Defense in Private Securities Fraud Actions, 59 OHIO ST. L.J. 1697, 1698 (1998). 6. See, e.g., David A. Hoffman, The Best Puffery Article Ever, 91 IowA L. REV. 1395, 1405-06 (2006) (noting "hostility from scholars"^ towards^ application^ of^ the^ puffery doctrine). 7. See id. at 1406 ("[D]efendants have been increasingly successful in obtaining dismissals based on puffery arguments.").
- Donald C. Langevoort, Taming the Animal Spirits of the Stock Markets: A BehavioralApproach to Securities Regulation, 97 Nw. U. L. REv. 135, 184 (2002); see^ also id. at 137-38 ("Securities regulation is an especially important subject in which to take
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II. BACKGROUND: SECURITIES REGULATION & PUFFERY
This section will provide a brief background of both securities
regulation generally and the puffery doctrine in particular. The discussion of securities regulation will focus on the issue of materiality, both in the context of the anti-fraud rules as well as in the context of affirmative disclosure obligations. Both the definition of materiality generally, and the role of the "reasonable investor" in the formulation of that definition, will be discussed. Reference will be made to the fact-intensive nature of^ the materiality analysis, as well as the interests the test seeks to balance. Finally, the discussion of the puffery doctrine will focus on its definition, history, and criticisms.
A. Securities Regulation
Following the stock market's Great Crash of 1929, Congress enacted the Securities Act of 1933 and the Securities Exchange Act of 1934 to restore investor confidence." The goal of these regulations is full and fair disclosure.' 2 One of the primary vehicles for ensuring full disclosure in the securities markets^ is^ antifraud^ Rule^ 1Ob-5."^3 Rule^ 1Ob-5^ makes^ it^ unlawful
11. See Robert A. Prentice, The Inevitability of a Strong SEC, 91 CORNELL L. REv. 775, 803 (2006) (describing how Congress passed^ the^ Acts^ to^ regain^ investor^ confidence^ by mandating disclosure and punishing fraud); see also Kenneth B. Firtel,^ Plain^ English:^ A Reappraisal of the Intended Audience of^ Disclosure^ Under^ the^ Securities^ Act^ of^ 1933,^^72 S. CAL. L. REv. 851, 857 (1999) ("Coupled with the goals of investor protection and deterrence was a desire to restore investor confidence in the capital markets. The Crash created a national distrust of the capital markets as average investors withdrew their capital for fear of exploitation by the issuers of securities.").
- See Firtel, supra note 11, at 856-58 ("Congress viewed the new disclosure system [of the '33 Act]^ as^ a^ means^ to^ protect^ average investors, many^ of^ whom^ had^ lost^ their savings through the Crash, by forcing issuers to divulge all facts, favorable or unfavorable, to the^ public for^ examination^ ....^ By^ mandating disclosure, Congress^ intended^ to^ protect^ the layperson from fraudulent practices in^ the^ capital^ markets.^.^.^.^ Through^ the^ '33^ Act, Congress sought to provide for full and fair^ disclosure^ to^ the^ average^ investor.");^ See generally, Stefan J. Padfield, Who Should Do the Math? MaterialityIssues in^ Disclosures that Require Investors to Calculate the Bottom Line, 34 PEPP. L. REv. 927, 931 (2007) (describing the broad goals of securities regulations in the United States^ to^ be^ fair^ and^ full disclosure).
- Securities Exchange Act of 1934 Rule, 17 C.F.R. §^ 240.10b-5^ (2007).^ Rule^ lOb- is not the only liability provision serving the purposes of our securities regulation regime. See Securities Act of 1933 § 11(a), 15 U.S.C. § 77k (2000) (creating an express right of action for damages by purchasers of securities when untrue statements of material fact or omissions of material fact are contained in a registration statement); Securities Act^ of^1933 § 12(a)(2), 15 U.S.C. § 771(a)(2) (2000) (creating a private remedy for the purchasers of securities if there was an "untrue statement of^ a^ material^ fact^ or^ [an^ omission^ of]^ a^ material fact" in connection with the sale or offer for sale of a security); Securities Act of 1933 § 17(a), 15 U.S.C. § 77q (2000) (prohibiting^ fraudulent schemes,^ "any^ untrue^ statement^ of^ a
IS PUFFERY MATERIAL TO INVESTORS?
for any person, in connection with the purchase or sale of a security, "[t]o
make any untrue statement of a material fact or to omit to state a material
fact necessary in order to make the statements made, in the light of the
circumstances under which they were made, not misleading ..... The
elements of a Rule lOb-5 claim are: "1) a misstatement or omission 2) of
material fact 3) occurring in connection with the purchase or sale of a
security, that 4) was made with scienter and 5) upon which the plaintiff
justifiably relied, 6) and that proximately caused injury to the plaintiff."^15
The element of primary significance to us here is materiality. 16 Successful
application of the puffery doctrine defense in a Rule 1Ob-5 action
undermines the ability of the plaintiff to satisfy the element of materiality. 7
Information is deemed to be material for purposes of Rule lOb-5 "'if
there is a substantial likelihood that a reasonable shareholder would
consider it important' to the investment decision.' 8 An alternative
formulation is that information is material if it would alter the "total mix"
of facts available.' 9 Thus, included in the definition of materiality is the
material fact or any omission to state a material (^) fact" in connection with the sale of securities and fraudulent transactions); Securities Exchange Act of 1934 Rule, 17 C.F.R. (^) § 240.14-9 (2007) (prohibiting false or misleading statements and omissions of statements "with respect to any material (^) fact" in connection with (^) the solicitation of proxies); (^) Securities Exchange Act of 1934 § 14(e), (^15) U.S.C. § 17n (2000) (prohibiting "untrue statements [or omissions] of a material fact ... or fraudulent, deceptive, or manipulative acts or practices, in (^) connection with any tender offer .....
14. 17 C.F.R. § 240.10b-5.
- Rubinstein v. Collins, 20 F.3d 160, 166 (5th Cir. 1994).
- Materiality (^) is not only relevant to lOb-5 actions. Professor Huang notes some additional areas of relevance. See Peter H. Huang, Moody Investing and the Supreme Court: Rethinking (^) the Materiality of Information and the Reasonableness of Investors, 13 SuP. CT. ECON. REv. 99, 109-10 (2005) ("The question of whether a particular item of information is material is central to securities litigation and enforcement. (^) Rule 408 of the Securities Act requires that registration statements contain, in addition to particular specifically required disclosures, 'such further material information ... as may be necessary to make the required statements, in the light of the circumstances under which (^) they are made, not misleading.' Rule 12b-20 of the Securities Exchange Act imposes (^) the same requirement in mandated periodic disclosures. (^) Questions of materiality arise in the anti- fraud civil liability provisions of sections 11 and 12(a)(2) of the Securities Act and Rule lOb-5 of the Securities Exchange Act, in particular insider trading cases. Regulation FD prohibits the selective disclosure of material, non-public information (^) by issuers of securities.") (footnotes omitted) (quoting the Securities Exchange Act of 1934 Rule, 17 C.F.R. § 230.408 (2002)).
- See EP Medsystems, Inc. v. EchoCath, Inc., 235 F.3d 865, 872 (3d Cir. 2000) ("Material representations must be contrasted with.. .general statements of optimism, which 'constitute no more than "puffery" and are (^) understood by reasonable investors as such."' (quoting In re Advanta Corp. Sec. (^) Litig., 180 F.3d 525, 538 (3d Cir. 1999))).
- Milton (^) v. Van Dorn Co., 961 F.2d 965, 969 (1st Cir. 1992) (quoting Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988)).
- See TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976) ("An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would
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IS PUFFERY MATERIAL TO INVESTORS?
sophisticated. ' 24^ Furthermore, conceptualizing the reasonable investor as
sophisticated for materiality purposes may impose a duty upon
shareholders to be rational, which would be contrary to the "story" of
corporate law that is based largely upon a duty-free shareholder. More
importantly, the SEC has consistently focused on protecting the "average"
investor in executing its regulatory and enforcement functions.^26 Any
definition of the reasonable investor that goes beyond this "average"
investor conceptualization places the courts in direct conflict with the
SEC-the administrative agency charged by Congress with regulating the
securities markets.2 7^ Both corporate managers and retail investors would
be on notice that various types of material information must be disclosed,
however they would be unclear whether a particular disclosure's
materiality should be assessed vis-A-vis the average retail investor or the
sophisticated institutional investor. This would likely lead to increased
costs because both corporations and investors must factor in this
uncertainty when deciding what information to disclose and how to weigh
the information that is disclosed. Perhaps the best view, then, is that the
term "reasonable investor" is meant simply to make the standard an
24. ARNOLD S. JACOBS, 5B DISCLOSURE & REMEDIES UNDER THE SEC. LAWS § 6:
available at 5b SECDRSL s 6:9 (noting that "some older opinions refer only to the protection of na've investors"). Cf Firtel, supra note 11, at 857 (noting that disclosure under the '33 Act "is intended for the unsophisticated investor").
- See Hoffman, supra note 4, at 537-38 ("American public shareholders are uniquely blessed by the freedom to do what they will with their capital. Unlike other stakeholders, shareholders owe the corporation no legal duties .... Or so the story goes. In reality, courts hold purchasers of securities to something similar to a duty of care. Courts require investors to investigate their purchases, to coldly process risk, to disregard oral statements of optimism, and in general to be economically rational. If investors fail to meet these expectations, judges deny them the protection of the securities laws. In this way, courts impose on public securities investors a special kind of legal duty, novel in scope and, I will argue, ungrounded in principle.") (footnotes omitted).
- See Langevoort, supra note 8, at 173 ("Both Congress and the SEC have a strong interest in the support of the retail investor community and the presence of strong public markets. Indeed, in some ways, a fair amount of what the Commission does, especially the Division of Corporate Finance's review and comment on registration statements, is in the name of making disclosure 'accessible' to the average investor."); Firtel, supra note 11, at 851 ("The [SEC] has maintained that disclosure should be geared toward all types of investors, from the average investor to the professional financial analyst."). But cf. id. at 853 ("[A]ny attempt to gear disclosure toward the average investor hinders the efficacy of the disclosure regime.").
- See Securities and Exchange Act of 1934 § 4, 15 U.S.C. § 78d (2000) (establishing the SEC by Congress); see also O'Hare, supra note 5, at 1723-24 ("Congress took several significant steps to restore investors' trust in statements made by companies. Most importantly, numerous anti-fraud provisions were included in the federal securities laws. The SEC was established to enforce these provisions.") (footnote omitted).
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objective one,^ excluding^ idiosyncratic^ investing^ decisions,^ rather^ than
favoring a particular level of sophistication. 28
Two further points are worth making here about the^ concept^ of^ the
reasonable investor as materiality yardstick. First, it has been argued^ that
where a security is traded in an efficient market, the market itself^ should
serve as the reasonable investor.^ As^ the^ Third^ Circuit stated^ in^ In^ re
Burlington Coat^ Factory^ (one^ of^ the^ cases^ utilized^ in^ the^ Puffery^ Survey
here):
Ordinarily, the law defines "material"^ information^ as^ information
that would be important^ to^ a^ reasonable investor^ in^ making his^ or
her investment decision.^ In^ the^ context^ of^ an^ "efficient"^ market,
the concept of materiality translates^ into^ information^ that^ alters
the price of the firm's stock. This is so because efficient^ markets
are those^ in^ which^ information^ important^ to^ reasonable^ investors
(in effect, the market)^ is^ immediately^ incorporated^ into^ stock
prices.^29
In fact, the Fourth Circuit, in another case used in this survey, Raab v.
Gen. Physics Corp.,3 seemingly defined puffery^ in^ this^ way^ when^ it^ stated
that "'puffing' statements..,^ lack^ materiality^ because^ the^ market^ price^ of^ a
share is not inflated by vague statements^ predicting^ growth."'',^ However,
there are a number of problems with^ equating^ the^ reasonable^ investor^ with
the market. Perhaps most glaring is the fact that such a formulation seems
directly at odds with the Supreme Court's^ materiality^ test,^ which^ frowns
upon the use of bright-line tests.^ As^ the^ court^ in^ No. 84^ Employer-
Teamster Joint^ Council^ Pension^ Trust^ v.^ Am.^ W^ Holding^ Corp.,^ stated:
In Basic, the^ Supreme^ Court^ expressly^ adopted^ the^ "reasonable
investor" standard set forth in TSC Industries for determining
materiality in the Section 10(b) and Rule 1Ob-5 context....
- See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 445 (1976)^ ("The^ question^ of materiality, it is universally agreed,^ is^ an^ objective^ one,^ involving^ the^ significance^ of^ an omitted or misrepresented fact to a reasonable investor."); Allan Horwich,^ The^ Neglected Relationship of Materiality and^ Recklessness^ in^ Actions^ Under^ Rule^ lOb-5,^^55 Bus.^ LAW. 1023, 1025 (2000) ("Courts generally hold that whether or^ not^ a^ fact^ is^ material^ is^ objective, it is dependent upon the 'reasonable investor.' To^ the extent^ that^ materiality^ depends^ upon the perspective of an individual plaintiff, the defendant is^ liable only^ if^ he^ is^ aware^ of^ the special concerns of that plaintiff.").
- 114 F.3d 1410, 1425 (3d Cir. 1997) (citations omitted). But see^ Padfield,^ supra note 12, at 936-37 (acknowledging that^ stock^ price^ movement^ can^ constitute^ strong evidence of materiality,^ but^ pointing^ out^ various problems^ with^ using^ price movement^ as^ a bright-line rule-particularly where^ defendants^ seek^ to use^ lack^ of^ price^ movement^ to^ prove immateriality).
- 4 F.3d 286 (4th^ Cir.^ 1993). 31. Id. at 289.
348 U. PA. JOURNAL OF BUSINESS AND^ EMPLOYMENT LAW^ [Vol.^ 10:
"normative idealized type of behavior., 35 If that is to be the standard,
however, it is highly questionable^ whether^ courts^ should^ be^ the^ ones
deciding upon the^ norms-particularly^ without^ any^ express
acknowledgement thereof.^36 "If^ what^ we^ want^ is^ some^ semblance^ of
market price integrity (i.e., unmanipulated markets),^ we^ have^ little^ other
choice, 37 except to "keep the definition [of^ materiality]^ ..^ .tied^ to^ what^ is
commonplace or^ normal,^ whether^ we^ admire^ the^ behavior^ or^ not.^
38
Beyond the definition of^ materiality^ and^ the reasonable^ investor,^ the
Supreme Court has stated that materiality determinations^ should^ only rarely
be dismissed on the basis of pretrial motions:
The determination [of materiality] requires^ delicate^ assessments
of the inferences a "reasonable shareholder" would draw^ from^ a
given set of^ facts^ and^ the^ significance^ of^ those^ inferences^ to^ him,
and these assessments are peculiarly^ ones^ for^ the^ trier^ of^ fact.
Only if the established^ omissions^ are^ "so^ obviously important^ to
an investor, that reasonable minds cannot differ^ on the^ question
of materiality"^ is^ the^ ultimate^ issue^ of^ materiality^ appropriately
resolved "as a matter of law" by summary judgment.
And, in addition to^ admonitions^ about^ the^ fact-intensive^ nature^ of
materiality determinations, the Court has^ also^ made clear,^ as^ noted^ above,
that the issue of materiality is not to be reduced^ to^ a^ set^ of^ bright-line^ rules.
Specifically, the Supreme Court^ has^ noted^ that:
A bright-line rule indeed is easier to follow^ than^ a^ standard^ that
requires the exercise of^ judgment^ in^ the^ light^ of^ all^ the
circumstances. But ease of application^ alone^ is^ not^ an^ excuse^ for
ignoring the purposes of^ the^ Securities^ Acts^ and^ Congress'^ policy
decisions. Any approach^ that^ designates^ a^ single^ fact^ or
occurrence as always determinative of^ an^ inherently^ fact-specific
finding such as materiality, must^ necessarily^ be^ overinclusive^ or
underinclusive. 40
- Huang, supra note 16, at 111; see also Langevoort, supra^ note^ 8,^ at^184 n.203^ ("To be sure, one could say that there is^ a^ normative^ dimension^ here^ and^ that^ judges^ are^ saying that investors should not rely on these things, whether^ or^ not^ they do^ in^ fact.").
- See Huang, supra note 16,^ at^ Ill^ (noting^ that^ if^ courts^ are^ in^ fact^ utilizing^ the reasonable investor standard to enforce some type^ of^ normative^ goal, "one^ can^ question whether the^ practice^ of^ courts^ continuing^ to^ utilize^ such^ a^ definition^ of^ reasonable^ investor and the related standard of materiality is^ relevant^ or appropriate").
- Langevoort, supra note 8, at 186.
- Id.
- TSC Indus. v. Northway, Inc., 426 U.S. 438,^450 (1976)^ (quoting^ Johns^ Hopkins Univ. v.^ Hutton,^422 F.2d^ 1124, 1129^ (4th Cir.^ 1970))^ (footnote^ omitted).
- Basic, Inc. v. Levinson, 485 U.S. 224, 236 (1988); see also^ Ganino^ v.^ Citizens Utilities Co.,^228 F.3d^ 154,^162 (2d^ Cir.^ 2000)^ ("Following^ Basic,^ we^ have^ consistently rejected a formulaic approach to assessing the materiality of an alleged^ misrepresentation.").
Is PUFFERY MATERIAL TO INVESTORS?
Finally, the materiality test is intended to strike a balance between
protecting investors and allowing corporate managers to disseminate
information without undue fear of liability. 4 ' There is a tension that arises
out of this balancing act, however, between the desire to protect investors
via full and fair disclosure4 2^ and the desire to avoid the negative
consequences of excessive litigation 43 and overly burdensome disclosure
requirements. 14 This tension is exacerbated by the reality that
corporations
are often under tremendous pressure to settle even frivolous claims that
survive pretrial motions to dismiss. 45 In order to manage this tension in the
course of actual litigation, courts have come up with various "safety
valves" to allow them^ to^ dispose^ of^ what^ they^ see^ as^ frivolous^ claims.^
46
One of these safety valves is the puffery doctrine.4 7
- TSC, 426 U.S. at 448-49 ("[I]f (^) the standard of materiality is unnecessarily low, not only may (^) the corporation and its management be subjected to liability (^) for insignificant omissions or misstatements, but also management's (^) fear of exposing itself to substantial liability may cause it simply to bury the (^) shareholders in an avalanche of trivial information-a result that is hardly conducive (^) to informed decisionmaking.").
- See, (^) e.g., The Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, (^116) STAT. 745 (2002) ("An Act [t]o protect investors by improving the accuracy and reliability of corporate disclosures made pursuant (^) to the securities laws.. ").
- But see Stephen M. Bainbridge & (^) G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does-Boundedly): (^) Rules of Thumb in Securities Fraud Opinions, (^) 51 EMORY L. J. 83, 121 (2002) ("[T]here is little agreement (^) in the academic community on whether there is (^) a problem of frivolous suits in this area."). 44. See, (^) e.g., Private Securities Litigation Reform Act of 1995, Pub. (^) L. No. 104-67, 109 STAT. (^737) (1995) ("An Act [t]o reform Federal securities litigation .... ").
- See generally, Padfield, (^) supra note 12, at 945 (discussing pressure to settle).
- See Hoffman, supra note 4, at 573 ("Scholars (^) have identified four common techniques in recent works: (1) puffery; (2) bespeaks (^) caution; (3) zero price change; and (4) triviality. (^) Four additional labels for courts' decisions are present in (^) the cases: (5) failure to read; (6) fraud by hindsight; (7) truth on the market; (^) and (8) failure to understand consequences.") (footnotes (^) omitted). There is another story, however, wherein courts (^) use doctrines like puffery not to strike a balance between the (^) competing interests of protecting investors (^) and not overburdening management, but rather to (^) solve their own problems of limited resources (^) and risk aversion. See, e.g., Bainbridge & Gulati, supra note (^) 43, at 114 (describing the materiality safety valve employed by courts, where once immateriality has been determined, (^) the case is closed and concluding that such court heuristics are (^) acceptable as long as they are "fact-based, vague, and a matter (^) of discretion (or reasonableness)"). Of course, the possibility that all this is merely rhetorical cover for a pro-business bias (^) has also not gone unnoticed. Cf id. (^) at 87 (identifying prior literature on procedural heuristics (^) as "criticiz[ing] (^) judicial rules (^) of thumb as being biased toward defendants").
- See Hoffman, supra note 4, at 586 ("Over time, (^) as I have explored, courts have become more willing to apply 'puffery' (^) and 'bespeaks caution' doctrines which are (1) bright-line rules that focus on the language of disclosures, (2) associated with (^) each other, and (3) more likely to appear at early stages in lawsuits.").
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IS PUFFERY MATERIAL TO INVESTORS?
reference to a none-too-flattering view of human nature. For example, in
Kimball v. Bangs, the Supreme Court of Massachusetts asserted that "[t]he
law recognizes the fact that men will naturally overstate the value and
qualities of the articles which they have to sell. All men know this, and a
buyer has no right to rely upon such statements."^50 Similarly, in Vulcan
Metals Co. v. Simmons Mfg. Co., Judge Learned Hand, before carving out
an exception for fiduciary relationships, stated that "[t]here are some kinds
of talk which no sensible man takes seriously, and if he does he suffers
from his credulity. If we were all scrupulously honest, it would not be so;
but, as it is, neither party usually believes what the seller says about his
own opinions, and each knows it." 5 '
Puffery has been described generally as "a 'vague statement' boosting
the appeal of a service or product that, because of its vagueness and
unreliability, is immunized from regulation."5 2^ In the securities regulation
context, puffery has been described as "a 'vague statement of corporate
optimism' that is said to be 'so obviously unimportant to a reasonable
investor that reasonable minds could not differ."' 5 3^ Statements of optimism
about the future are even more protected than statements concerning
current conditions.^54
The puffery doctrine has been applied in a number of areas of the law,
including "mail fraud, securities fraud, common-law fraud, legal ethics,
common-law contracts, Uniform Commercial Code warranty cases,
promissory misrepresentation, [and] false advertising... ."" Still, while
puffery is often loosely described as "vague optimism," a more precise
- Kimball (^) v. Bangs, 11 N.E. 113, 114 (Mass. 1887)
- Vulcan Metals Co. v. Simons Mfg. Co., 248 F. 853, (^856) (2d Cir. 1918)
- Hoffman, supra note (^) 6, at 1397.
- Id. at 1406 (footnotes omitted). See also Shaw v. Digital Equip. Corp., (^82) F.3d 1194, 1217 (1st Cir. 1996) (describing puffery as "rosy affirmation[s] (^) commonly heard from corporate (^) managers and numbingly familiar to the marketplace-loosely (^) optimistic statements that are so vague (^)... that no reasonable investor could find them important .... "1). 54. See Hoffman, (^) supra note 6, at 1408-09 ("[Cjourts generally h[o]ld that forward- looking puffery is only actionable (^) if it creates a 'substantial certainty' about the company's predicted course or if the statement is made (^) with 'actual knowledge' that it is false. The end result is a doctrine that is quite protective of vague but (^) intentionally false optimism about the future.") (footnote omitted); (^) id. at 1409 n.80 ("The Private Securities Litigation Reform Act of 1995, H.R. 1058, Pub. L. No. 104-67, 104th (^) Cong. (1995), provides additional safeguards for predictions under (^) its 'safe harbor' provision. 15 U.S.C. § 77z-2(c) (2000). The provision protects forward-looking statements that (^) are (1) so-identified and accompanied (^) by cautions; or (2) are themselves immaterial. See id. (^) at § 77z-2(c)(1)(A).").
- Hoffman, supra note 6 at 1396-97 (footnotes (^) omitted). Cf id. at 1398 n.20 ("There is evidence (^)... that many investors treat stock purchasing as a process (^) involving similar emotional (^) factors as ordinary purchase decisions.").
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definition to guide courts^ and^ others^ is^ elusive.^56 One^ suggested^ line^ of
demarcation distinguishes puffery^ from^ statements^ of^ fact.^ As the^ Eighth
Circuit stated in the context^ of^ a^ Lanham^ Act^ false^ advertising^ claim^ in
American Italian^ Pasta^ Co.^ v.^ New^ World^ Pasta^ Co.:
Puffery and statements of fact are mutually^ exclusive.^ If^ a
statement is a specific, measurable claim^ or^ can^ be^ reasonably
interpreted as^ being^ a^ factual^ claim,^ i.e.,^ one^ capable^ of
verification, the statement is one of^ fact.^ Conversely,^ if^ the
statement is not specific and measurable,^ and^ cannot^ be
reasonably interpreted as providing a^ benchmark^ by^ which^ the
veracity of^ the^ statement^ can^ be^ ascertained,^ the^ statement
constitutes puffery.^57
However, courts have been less^ than^ consistent^ in^ carrying^ out^ the task
of differentiating factual^ from^ non-factual^ statements.^
58
Another approach is to equate a^ seller's^ opinion^ with mere puffery.5 9
However, as Judge Learned Hand recognized almost^100 years^ ago,^ even
mere opinion can be actionable if given^ by^ a^ fiduciary^ or^ an^ expert:
"[w]hen the parties are^ so^ situated^ that^ the^ buyer^ may^ reasonably^ rely^ upon
the expression of^ the^ seller's^ opinion,^ it^ is^ no^ excuse^ to^ give^ a^ false^ one.^
6 °
This conclusion^ was echoed^ by^ the^ Supreme^ Court^ seventy-three^ years
later.^6 '
As we^ have^ seen,^ the^ puffery^ defense^ is^ rooted^ in^ the^ doctrine^ of
caveat emptor.^ However,^ the^ ubiquity^ of^ that^ doctrine^ has^ been whittled
away over time. This decline is due in^ part^ to^ increasing criticisms^ of^ two
of the doctrine's underlying assumptions: (1) "that^ the^ parties^ are^ on^ equal
footing, with equal access to information," and^ (2)^ "that^ the^ purchaser^ has
no reason to trust a seller's sales talk. 62 These have^ been called^ into
56. See id.^ at^1401 n.30^ (noting^ "the^ evident^ need^ for^ clarification^ in^ the^ law^ (in^ the securities arena particularly).").
- 371 F.3d 387, 391 (8th^ Cir.^ 2004). 58. See^ Hoffman,^ supra^ note^ 6,^ at^ 1403-04^ ("Because neither^ courts^ nor^ regulators consider empirical evidence about which claims imply facts,^ their^ application^ of^ a^ nominally coherent doctrine creates a^ host^ of^ decisions^ in^ which relatively^ similar^ language^ receives different levels of protection."); id. at 1403 & n.43^ (stating that^ while "authorities^ assume^ it is possible to distinguish factual^ from nonfactual speech^ by^ looking^ at^ the^ speech itselfl,]" researchers argue "it is not easy to distinguish speech^ conveying^ factual^ claims^ from speech that does not, and that much^ of^ the^ speech^ that^ the^ FTC^ refers^ to^ as^ puffery^ in^ fact^ implies facts, which themselves might^ be^ false.").
- See id. at 1403 (discussing^ the^ FTC's^ view^ of^ puffery^ as^ relatively^ harmless opinion).
- Vulcan Metals Co. v. Simons Mfg.Co., 248 F.^ 853,^856 (2d^ Cir.^ 1918).
- Virginia Bankshares, Inc. v.^ Sandberg,^501 U.S.^ 1083,^1092 (1991)^ ("Such statements are^ factual^ in^ two^ senses:^ as^ statements^ that^ the^ directors^ do^ act^ for^ the^ reasons given or^ hold^ the^ belief^ stated^ and^ as^ statements^ about^ the^ subject^ matter^ of^ the^ reason^ or belief expressed.").
- O'Hare, supra note^ 5,^ at^ 1705.
354 U. PA. JOURNAL OF BUSINESS AND EMPLOYMENT LAW^ [Vol.^ 10:
securities litigation dismissals involved^ materiality^ determinations.^69 To
the extent these materiality determinations^ included^ application^ of^ the
puffery defense, the doctrine is^ helping^ to^ make^ a^ mockery^ of^ the^ oft-
asserted "rule" that materiality issues^ should^ be^ left^ to^ the^ trier^ of^ fact.7 °^ As
Professors Bainbridge^ and^ Gulati note:
[I]f a^ high^ percentage^ of^ securities^ disclosure^ cases^ are^ dismissed
at the motion to dismiss stage on grounds that the information in
question was immaterial, but each opinion has in it the caveat
that "materiality is ordinarily an issue for the finder of fact, and it
is only in the rare case that it can be decided at the^ motion^ to
dismiss stage,"^ things^ do^ begin^ to^ look^ suspicious.^
71
Courts' reliance on the doctrine to dispose of cases pretrial may^ also
interfere with^ the^ sound development^ of^ the^ law.^
2
As to the second point, judicial application^ of^ the^ puffery doctrine^ also
seems to blatantly ignore the Supreme Court's admonition against the use
of bright-line rules in the materiality analysis.^73 Not only can use of the
puffery doctrine be seen as an inappropriate application of a bright-line
rule, but when viewing the doctrine through the lens of the myriad of
criticisms set forth here it arguably constitutes a^ very^ poor^ bright-line^ at
that. To the extent the current judicial administration of the puffery
doctrine "create[s] incentives for corporations to use words that they hope
for the negative consequences of taking cases from juries prematurely is not limited^ to securities regulation. See generally Arthur R. Miller, The PretrialRush to Judgment: Are the "Litigation Explosion, " "Liability Crisis,^ "^ and^ Efficiency Cliches^ Eroding^ Our Day^ in Court and^ Jury^ Trial^ Commitments?,^^78 N.Y.U.^ L. REv.^982 (2003)^ (examining^ the^ use^ of summary judgment and motions to dismiss in light of growing concerns over^ efficiency^ in the federal judicial system).
- Bainbridge & Gulati,^ supra^ note^ 43,^ at^116 n.94^ ("Of^ the^91 (out^ of^ 100)^ cases^ that were decided at the motion to dismiss stage, 64 involved materiality determinations^ in^ favor of defendants (i.e., over 70 percent).").
- See Hoffman, supra note 4, at 541-42 ("[J]urists... conclude that materiality issues in securities cases are almost always left for jury resolution .... In this Article, I present evidence that courts dismiss securities claims on the ground of presumed immateriality^ in half of opinions considering^ materiality.");^ Bainbridge^ &^ Gulati,^ supra^ note^ 43,^ at^116 n. ("[Aiccording to our survey of opinions, the question of materiality that is 'ordinarily'^ to be a question for^ the^ trier^ of^ fact^ and^ is^ to^ be^ decided^ in^ favor^ of^ the^ defendant^ at^ a^ threshold stage only if it is so 'obvious' that reasonable minds could not differ, turns out to be the subject of extensive [pretrial] discussion in the majority of cases .... In other words, what is supposed to be rare and unusual, turns out to^ be^ routine.").
- Bainbridge & Gulati, supra note 43, at 115.
- Id. at 88 ("When judges invoke substantive heuristics,^ however,^ the use^ of^ such heuristics channels, and even dominates, the ongoing evolutionary process of the (quasi- common) law of securities regulation.").
- Cf Hoffman, supra note 4, at 589-90 (noting a^ shift^ in^ judicial^ decision-making^ on determinations of materiality from standard-based model to a model based on bright-line rules).
IS PUFFERY MATERIAL^ TO^ INVESTORS?
will induce reliance,^ but^ which^ may^ be^ rendered^ legally^ irrelevant;^ [it^ is^ a]
bright-line rule[]^ that^ enable[s]^ fraud.^
74
Finally, as^ to^ this first^ broad^ criticism^ of^ the^ puffery^ doctrine, there^ is
the issue of the "total mix." The puffery^ doctrine^ generally^ fails^ to^ view
statements in context.^75 This failure^ to^ consider context^ not only^ is^ contrary
to Supreme Court guidance, but^ places^ the^ doctrine^ at^ odds with another
"safety valve" used to dismiss securities claims-the "bespeaks caution"
doctrine. The bespeaks caution^ doctrine^ allows^ "the^ presence^ of
meaningful cautionary language [to] preclude a finding that investors were
misled by^ projections^ or^ other^ forward-looking^ statements.^76 As
Professors Bainbridge and Gulati put it, "[i]f putting the statement into
context lends credence to dismiss, the bespeaks caution doctrine is invoked.
If taking a statement out of context makes dismissal more plausible,
however, puffery is invoked."^77
b. Criticisms related to securities regulationgenerally
Certainly in the securities regulation area, the philosophy of^ caveat
emptor, upon which the puffery doctrine is based, seems to stand^ in^ direct
opposition to the philosophy of full disclosure underlying the^ regulations.7 8
As the Supreme Court of the United States explained^ in^ SEC^ v.^ Capital
Gains Research Bureau:
The Investment Advisers Act of 1940 was the last in a series of
Acts designed to eliminate certain abuses in the securities
industry, abuses^ which^ were^ found^ to^ have^ contributed^ to^ the
stock market crash of 1929 and the depression of the 1930's. It
was preceded by the Securities Act of 1933, the Securities
Exchange Act^ of^ 1934,^ the^ Public^ Utility^ Holding^ Company^ Act
of 1935, the Trust Indenture Act of 1939, and the Investment
Company Act of 1940. A fundamental purpose, common to
- Id. at 588. Cf Bainbridge & Gulati, supra note 43, at 138 (positing that^ heuristics can create "safe harbors for bad behavior" if based on incorrect^ assumptions^ about^ firms^ and market behaviour).
- See O'Hare, supra note 5, at 1700 (noting that^ in^ applying^ the^ puffery^ defense^ in securities litigation "courts have improperly limited their focus to the words or language of the company's statement, while ignoring such important^ factors as who^ made the statement and where the statement was made.").
- Padfield, supra^ note^ 12,^ at^ 935.
- Bainbridge & Gulati, supra note 43,^ at^ 123.
- See^ Huang,^ supra^ note^ 16,^ at^117 ("[T]he^ SEC^ has^ been^ unwilling^ to^ dismiss enforcement actions against brokers^ based^ upon^ the^ puffery^ defense,^ holding^ that^ the puffery defense^ does^ not^ apply^ to^ such^ securities contexts.");^ Leighton,^ supra^ note 49,^ at 627 ("The Securities and Exchange^ Commission^ has^ emphatically^ rejected^ puffing^ defenses in enforcement actions, sometimes emphasizing the^ inappropriateness^ of^ such^ caveat^ emptor arguments in^ actions^ under^ consumer protection statutes.").
2008]
IS PUFFERY MATERIAL TO INVESTORS?
The courts have long used the puffery defense to insulate
securities brokers from liability for statements^ such^ as:^ "This
security is a great investment." More^ recently,^ however,^ courts
have extended the^ protections^ of^ the^ puffery^ defense^ to^ non-
broker defendants, such as corporate officers^ and^ directors.^ In
these cases, the courts used the^ puffery defense^ to^ dismiss^ actions
based on vague statements^ of^ corporate^ optimism^ concerning
future events,^ such^ as:^ "We^ expect^ significant^ growth^ in^ earnings
during the next fiscal year."^86
In spite of these apparent problems of fit between the puffery doctrine
and securities regulation, the^ doctrine continues,^ as^ already^ noted,^ to^ thrive.
Not surprisingly, this continued application and^ expansion^ of^ the^ doctrine
in the securities litigation area has been met^ with^ additional^ criticism,
particularly about the apparent disconnect between the doctrine and^ market
reality.
c. Market reality criticisms
We have already touched on^ the^ criticism^ that^ certain^ realities^ of
securities transactions-such as the^ inequality^ of^ informational^ access^ 8 7^ and
presence of^ fiduciary^ duty^ in^ many^ of^ these^ casesS--conflict^ with
fundamental assumptions^ underlying^ the^ puffery^ doctrine.^9 There^ are,
however, other criticisms^ of^ the^ puffery doctrine^ related^ to^ market reality.
These include the criticisms^ that:^ (1)^ the^ puffery doctrine^ is^ contrary^ to
empirical evidence about investor behavior; (2) the puffery doctrine is
contrary to the reasonable reliance investors^ arguably^ place^ on^ "vague"
statements by corporate officials;^ (3)^ the^ puffery^ doctrine^ is^ contrary^ to the
market's own apparent high valuation of puffery; and, (4) the^ increasing
application of the puffery defense may well impede^ the^ efficient^ flow^ of
capital.
- Id. at 1698-99. See also id. at 1699-1700 ("In short, the courts have significantly
expanded the scope of a powerful defense to^ dismiss^ potentially^ meritorious^ securities^ fraud
actions with little or no analysis or consideration of the effect of^ their decisions.").
- See^ Virginia^ Bankshares^ Inc.^ v.^ Sandberg,^501 U.S.^ 1083,^1091 (1991)
("Shareholders know that directors usually have knowledge ...far^ exceeding^ the^ normal
investor's resources ....).
- See O'Hare, supra note^ 5,^ at^1700 (stating^ that "because reasonable^ investors^ are
entitled to trust a company's vague statements of^ corporate^ optimism,^ the^ puffery defense^ is
inappropriate in private securities fraud actions.").
- See In re B. Fennekohl & Co., 41 S.E.C. 210, 216 (1962) ("The^ concept^ of^ 'puffing' is derived from the doctrine of caveat emptor and arises primarily in the sale of tangibles where it appears that examination by the purchaser may offset exaggerated statements and expressions of opinion by the salesman. It can have little application^ to the^ merchandising
of securities.").
2008]
358 U. PA. JOURNAL OF BUSINESS AND EMPLOYMENT^ LAW^ [Vol.^ 10:
The empirical literature undermines the rhetorical justifications^ that
judges give for dismissing claims under the puffery doctrine.9 °^ Indeed,
"'no behavioral studies have reported the finding, assumed by the law, that
consumers typically see^ puffery^.^.^.^ as^ meaningless."''^ In^ fact, "[e]xperimental literature^ analyzing^ puffery^ confirms that individuals^ are unable to^ ignore^ vague optimism^ and^ expressions^ of^ confidence."^92 Thus, by failing to employ empirical^ evidence^ in^ their analysis,^ it^ may^ be^ that
judges have failed to^ demonstrate^ sufficient^ competence^ in^ administering the puffery doctrine. 93 To the extent this criticism is valid,^ it^ may^ be^ related
- See Hoffman, supra note^ 6,^ at^1435 ("Jurists^ and^ regulatory authorities^ routinely assume that buyers of goods, services, and securities ignore puffing statements.^ This straightforward application of many 'individual [jurists']^ personal theorizing'^ is^ in^ tension with real-world evidence of the utility of persuasive advertising.^ In^ any^ event,^ it^ is^ simply untrue. Marketing scholars have demonstrated that puffing statements are believed on^ their own terms and^ lead^ some^ individuals^ to^ further^ imply^ facts^ about^ the^ puffed^ speech^ that^ are untrue.") (quoting Klaus^ G.^ Grunert^ &^ Konrad^ Dedler,^ Misleading^ Advertising:^ In^ Search of a Measurement Methodology, 4 J. PUB. POL'Y & MARKETING 153,^154 (1985))(alteration in original) (footnotes omitted); Huang,^ supra^ note^ 16,^ at^99 (2005)^ ("This^ Article^ develops how and why the core notions of materiality of information and^ the^ reasonable^ investor should be revised in light of recent empirical data, experimental evidence, and theoretical models of moody investing... .In particular, this^ Article^ argues^ that^ current^ judicial treatment of puffery is flawed because^ it^ neglects^ the^ power^ of^ puffery to alter^ moods.");^ id. at 118 ("The legal^ and^ policy^ implication^ of^ the^ literature^ about decision-making^ and^ moods is that unquestioning^ judicial^ acceptance^ of^ the^ so-called puffery^ defense^ is^ unwarranted."). Cf Bainbridge & Gulati, supra note 43, at 120 n.104 ("The SEC has^ expressed^ grave concerns about the market effects of false rumors^ released^ in^ Internet^ chatrooms^ by unverifiable sources, which flatly contradicts the puffery doctrine.").
- Ivan L. Preston, Puffery and Other "Loophole" Claims: How the Law's^ "Don't Ask, Don't Tell" Policy Condones FraudulentFalsity in Advertising,^18 J.L.^ &^ CoM.^ 49,^ 82- 83 (1998).
- Hoffman, supra note 4,^ at^ 587.
- See Bainbridge^ &^ Gulati,^ supra^ note^ 43,^ at^84 ("[T]he^ real^ puzzle^ is^ that^ federal judges are claiming-at least implicitly-a level of expertise about^ the^ workings^ of^ markets and organizations that, in some areas,^ not^ even^ the^ most sophisticated^ researchers^ in financial economics and organizational theory have reached.");^ id.^ at^ 120-21^ ("The^ idea that judges possess the sophisticated understanding of investor behavior and^ market^ dynamics necessary to validate the puffery doctrine, however, is^ bizarre^ ....^ Not^ one^ case^ referred^ to actual evidence that investors or markets were unaffected by vague statements of corporate optimism."); Hoffman, supra note 6, at 1398 ("The problem with puffery doctrine^ is^ not doctrinal chaos; courts and regulators have simply chosen a normative target that they are institutionally ill-suited to hit. In this context,^ walking^ the line^ between overdeterrence^ of speech and underdeterrence of fraud turns out to be beyond courts' competence. This institutional incapacity, coupled with a^ traditional^ fear^ of^ overregulating^ speech,^ leads authorities to overprotect commercial speech from liability."); see also id. at 1399 ("Courts and regulators are bad at distinguishing speech^ that^ produces 'good'^ or^ 'bad'^ consumption because they systematically^ underestimate when^ consumers^ rely^ on^ hyperbolic^ speech^ and the extent to which this speech communicates^ facts.");^ Donald^ C.^ Langevoort,^ Disclosures That "Bespeak Caution," 49 Bus. LAW. 481, 493 (1994)^ ("There^ are^ no^ broad-based empirical studies that adequately describe how the^ normal investing^ population^ makes^ its investment decisions. In the absence of good data, lawyers and judges asked^ to determine
