Broadcom and Backdating: The Securities Laws and the Disclosure of Substance Abuse

We are conducting a series of posts about the three backdating cases decided by the Delaware Court of Chancery.  There is a post today on the Tyson case. 

Nonetheless, an unrelated development caught our eye.  The WSJ today had an article on the backdating investigation into Broadcom.  As has sometimes been the case, the suit has expanded beyond backdating but in perhaps an entirely unexpected direction and one that shows the potential broad reach of the securities laws and their use to prosecute other offenses. 

The article reports that a former personal assistant to a former CEO filed suit alleging that he "was forced to indulge in illegal narcotics with his boss"  These developments alone would not be of interest enough to appear on this page.  Buried in the article, however, was a reference to the direction of the government's probe in the case.  The article noted that the government was engaging in an "aggressive legal theory" to determine whether Broadcom "failed to disclose to investors that [the CEO's] purported drug use hindered his ability to be CEO"  In other words, did the company have a duty to disclose drug use by the CEO under the federal securities laws? 

It is the case that considerable amount of information about the CEO must be disclosed in the annual proxy statement, particularly if, as is usually the case, the CEO sits on the board.  Moreover, the disclosure required by the rules is only the starting point.  The antifraud rules (in this case Rule 14a-9) requires disclosure of any other information necessary to make the proxy statement accurate and complete.  It is a fairly common exam question for example to ask students whether the company has to disclose a fatal illness of the CEO.

Anything that interferes with the CEO's performance could, arguably, be of importance to shareholders and subject to required disclosure.  For substance abuse (which for most CEOs would probably be more often related to alcohol abuse), there are several issues.  First, in general, companies do not have to disclose legal wrongs, only the underlying facts.  The proxy rules would not, therefore, have to characterize behavior as illegal but at most would only have to disclose the facts and circumstances.  It may be the case, therefore, that the company would have to disclose that the CEO rarely came to the office and attended large numbers of parties but might not have to disclose that he used illegal drugs.  

Second, in general, the personal life of officials is not something a company must disclose or that shareholders would find as material (albeit titillating).  Disclosure must relate to the company and the activities at the company.  Attending parties with illegal substances, interacting with prostitutes and other unsavory behavior would not generally be subject to disclosure.  It is true that a CEO's personal life can redound to the detriment of the company but it would be unlikely that the proxy rules (or the courts) would require disclosure of unsavory behavior that had not risen to the level of public information.  Otherwise, the personal life of CEOs would be fair game for proxy statements. 

Third, even if arguably related to the activities of the company, the information would have to be material.  This would require that the abuse be so severe as to interfere with a CEO's duties, something that would generally be hard to establish.  CEOs can have a myriad of distractions (marital problems, health issues, job performance concerns) and still perform their jobs.  It is up to the board of directors in its supervisory role over the top officers to make sure that the CEO was performing up to par.  To the extent the board members testified (as they most certainly would, if for no other reason than to avoid allegations that they violated their fiduciary duties) that the CEO was performing adequately despite the parties and/or drug use, it would be a very difficult case to show that the information was material. 

Finally, there is the question of who would be responsible to the extent the information is treated as material and subject to disclosure.  The company is the one with the duty to file a proxy statement.  It would generally be the case that the company would not be responsible for the disclosure of information that it reasonably does not know.  Rule 14a-9 makes actionable only negligent non-disclosure and Rule 10b-5 applies only to reckless non-disclosure.  Personal information is not the type that the company would ordinarily know about.  It is not a subject in the annual officer/director questionnaire. 

In any event, the broad policy question is whether the securities laws should be used to investigate possible illegal drug use.  There are, presumably, other laws more directly implicated by the alleged behavior, laws that, for example, do not potentially implicate the company.  Certainly serious consideration should be given by the courts, the SEC and the criminal authorities as to whether we want the securities laws to be the venue for exposing improper drug use.