Securities Fraud: When Do Disclosures to the Board Reduce Liability Risks?

Securities Fraud: When Do Disclosures to the Board Reduce Liability Risks?

Determining when disclosures to a company’s board of directors can reduce liability risks in securities fraud cases can be complicated. There are a few key factors to consider regarding disclosures and liability:

Duty to Disclose Material Information

Companies and their executives have a duty under securities laws to disclose all material information to investors. Information is considered “material” if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision[1].

If executives fail to disclose material information or make misleading statements, they can face liability for securities fraud. However, disclosing material information to the board does not automatically satisfy the duty to disclose. The information still needs to be publicly disclosed to investors in SEC filings or other methods.

Good Faith Reliance Defense

Executives can raise a “good faith reliance” defense in securities fraud cases. This means they reasonably relied on others regarding disclosures. Relying on the company’s lawyers or auditors regarding disclosures can bolster this defense.

Likewise, presenting all material information to the board and relying on their judgment could potentially establish a good faith reliance claim. However, executives cannot blindly rely on others. They need to show they acted reasonably and did their due diligence regarding disclosures[2].

Directors and Officers (D&O) Insurance

Most public companies have D&O insurance policies protecting executives and board members from liability risks like securities fraud lawsuits. These policies cover legal defense costs and settlement payments or damages.

Disclosing material information to the board could potentially reduce risks under the D&O policy. The insurer cannot deny coverage for intentional fraudulent acts that board members did not know about. Showing the board was fully informed could help demonstrate executives acted in good faith[3].

Specific Defenses Regarding Disclosures

In addition to a general good faith reliance defense, executives could raise specific defenses regarding disclosures to the board, such as:

  • No Duty to Update: After initial full disclosures to the board, executives may only have a duty to update them regarding significant changes rather than any and all material developments[4]. This can limit liability risks between board meetings.
  • No Duty to Correct Forward-Looking Statements: Executives typically do not have a duty to update or correct forward-looking statements like financial projections or growth estimates[5]. Disclosing the underlying assumptions to the board could make reliance more reasonable if those statements later prove incorrect.
  • Reliance on Internal Controls: Public companies have internal controls and procedures regarding financial reporting and disclosures. Executives can point to reliance on those systems overseen by the board’s audit committee. However, generic claims about general reliance on controls tend to fail. Specific details are necessary.
  • No Scheme Liability: Executives cannot be liable for non-disclosures or misleading statements under “scheme liability” theories if they did not directly make the misstatements themselves. Keeping the board fully informed could help defeat arguments they participated in a larger scheme to defraud.

Implications and Considerations

While disclosures to the board can help executives raise good faith reliance defenses, they do not provide immunity against securities fraud claims. Plaintiffs may argue the specific disclosures were inadequate or untimely. Or that red flags should have prompted further investigation and disclosure to investors.

Executives also cannot use disclosures to the board as a total substitute for public disclosures. If information is material, it ultimately needs to reach the market through SEC filings, press releases, or other methods. Otherwise, liability risks remain.

The board itself could also face liability for participating in securities fraud depending on their level of knowledge and involvement. But showing timely and complete disclosures to the board puts executives in a better position to argue they acted reasonably and in good faith.

In summary, disclosures to the board, if handled properly, can provide helpful evidence to defeat or limit personal liability in many securities fraud lawsuits. But they are not an absolute shield, and public disclosures are still essential. Assessing liability risks involves a fact-specific inquiry into the precise timing, content, and context of disclosures to the board.


[1] What is Material Information?

[2] Reliance on professionals as a defense in securities litigation

[3] D&O Insurance: Fraud Exclusion & Directors’ Good Faith Belief

[4] No Duty to Update: When Companies Can Stay Silent

[5] Forward-Looking Statements

Reliance on Internal Controls as a Defense

Supreme Court Clarifies Scheme Liability Under Securities Laws