The Unresolved Quandary of Disclosure of Executive Illness

Allan Horwich is Professor of Practice at Northwestern Pritzker School of Law and partner at Schiff Hardin LLP. This post is based on a recent article by Professor Horwich, published in the Securities Regulation Law Journal.

Since at least the mid-1990s the question of disclosure by public companies about the health of their executives has been the subject of scholarly commentary and the business press. Interest in this issue was revived with the recent death of the CEO of CSX Corporation, Hunter Harrison. He joined CSX in March 2017. Press reports soon raised questions about his health. The first health-related disclosure by the company, however, was on December 14, 2017, when CSX announced that Harrison had taken medical leave due to unexpected complications from a recent illness. The price of CSX stock dropped 7%. He died the next day.

Notwithstanding proposals by commentators for SEC rulemaking in this area, nothing has been proposed by the SEC. In today’s regulatory climate, which concentrates on paring superfluous and overlapping disclosure rules, there is no reason to believe that the SEC will take up this sensitive issue. Thus, disclosure practices as well as liability will be governed primarily by Rule 10b-5, the SEC’s principal anti-fraud rule. (17 C.F.R. § 240.10b-5.) Several fundamental principles must be taken into account in evaluating whether any health-related disclosure, especially one that may be implicit by omission, presents a potential issue under Rule 10b-5.

Rule 10b-5(b) makes it unlawful “[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.” Thus if a company knowingly or recklessly made a materially false statement about an executive’s medical condition it would violate Rule 10b-5, exposing the company to an SEC enforcement action or a civil damage class action.

The more vexing issue is liability for the material half-truth, where the question is whether some material fact was omitted which was necessary to make what was stated not misleading. For example, if the CEO were mentally incapacitated, a statement that the senior management team is poised to execute the company’s growth plan, if not outright false, may be a misleading half-truth in failing to disclose that a primary member of that team is, in fact, not up to the task. It is arguable that the mere identification of the executive, such as in the annual proxy statement, is misleading if it fails to disclose a debilitating illness, because identifying, without qualification, someone as occupying a specific position may necessarily imply that she is capable of, and is in fact performing, the duties associated with that position. Disclosure questions of this nature may be close ones, especially where the underlying issue is the highly sensitive, and often factually complex, one of an individual’s health.

Liability arises under Rule 10b-5 only if the party who made the statement, here the corporation, acted with scienter, “a mental state embracing intent to deceive, manipulate, or defraud.” (Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197, 201 (1975)) Scienter has been held to include reckless conduct. (Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)) Thus, under Rule 10b-5 a public company must consider whether it has obvious indications of an executive’s significant infirmity, such as lengthy absences from work, aberrant behavior, or medical treatment in the office, so that it has recklessly falsely implied that he is on the job, in potential violation of Rule 10b-5.

As the text of Rule 10b-5(b) makes plain, the rule prohibits only material misrepresentations and half-truths. An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding whether to buy or sell the company’s stock. (Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988)) One of the most difficult judgments in complying with securities law disclosure requirements is determining whether a particular fact is material. This assessment is likely to be particularly difficult in the case of disclosure regarding a medical condition because the information almost invariably has a forward-looking dimension to it. Complex issues of probability arise when addressing a prognosis and the likelihood of an adverse outcome.

Resolving the materiality issue should take into account the significance of the particular executive to the company. One consideration is whether the executive is so closely identified with the company and its prospects that any impairment of his ability will be viewed by the market as significant to the value of the company, or is the executive one who is replaceable, such as where a satisfactory succession plan is in place.

There are two significant liability pitfalls for a company that chooses to make a disclosure regarding an executive’s medical condition. First, if a company made a statement regarding someone’s medical condition, such as in response to rumors of ill-health, which was believed to be accurate but the company later learned that the information had not been correct, the company has a Rule 10b-5 duty to correct the statement when it learns of the prior inaccuracy. Second, and much more problematic, is what to do when the statement, such as a medical prognosis, was accurate when made and then there is a negative reassessment. The law is murky, and varies among the Circuits, regarding whether there is a duty under Rule 10b-5 to update the earlier statement.

These issues present several underlying questions. First, what does the company know about the health of the executive, what is the executive willing to tell the company, on an ongoing basis, and how are these considerations balanced with privacy considerations.

The risks posed by all these legal issues may be mitigated by adopting the following practices: (A) The executive should agree, as part of the employment agreement, to make prompt disclosure to the company of an adverse development in his health and defer to the company to make a good faith judgment about public disclosure. (B) Any public statement about health must be made carefully, with the full verification of a medical professional. (C) Any public statements about health should be accompanied by caveats stating what could occur that would change the situation described.

The complete article is available for download here.

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