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Supreme Court Applies 10b-5 to Oral Agreement to Sell Stock

Oral option contract upheld, fraud in connection with the grant of the option is actionable.

By John M. Baker, Esq.

The Supreme Court, in a unanimous opinion delivered by Justice Breyer, ruled that the sale of an oral option to buy stock while secretly intending never to honor the option violates Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Wharf (Holdings) Ltd. v. United International Holdings, No. 00-347 (May 21, 2001).

United International Holdings, Inc. assisted Wharf (Holdings) Limited in 1992 in preparing a bid for an exclusive license to operate a cable television system in Hong Kong. As consideration, a Wharf representative orally granted United an option to invest in the future system. The option was fairly specific but was never reduced to writing.

After Wharf was awarded the cable franchise, United sought to exercise its option to buy the system’s stock. Wharf, however, refused to permit United to buy any of the system’s stock, and contemporaneous internal Wharf documents suggested that Wharf had never intended to carry out its promise.

United brought a 10b-5 action against Wharf, winning a jury verdict and an affirmation in the U.S. Court of Appeals for the Tenth Circuit. The Supreme Court granted certiorari to determine whether Wharf’s oral sale of an option it intended not to honor is prohibited by Section 10(b).

The Court ruled that Wharf had already conceded that the “security” at issue was not the cable system stock, but the option to purchase that stock. Wharf argued that Section 10(b) does not cover oral contracts of sale. It pointed to Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), in which the Court ruled that only “actual purchasers and sellers of securities” have standing to bring a private action for damages. Justice Breyer distinguished Blue Chip Stamps as involving the very different question whether the 1934 Act protects a person who did not actually buy securities, but who might have done so had the seller told the truth. But United actually acquired the option (though not the underlying shares) by providing Wharf with its services.

Oral contracts for the sale of securities are sufficiently common that the Uniform Commercial Code and statutes of frauds in every state now consider them enforceable. The Court ruled, therefore, that any exception for oral sales of securities would significantly limit the 1934 Act’s coverage, thereby undermining its basic purposes.

Wharf also argued that a secret reservation not to permit the exercise of an option falls outside Section 10(b) because it does not relate to the value of a security purchase or the consideration paid and therefore does not implicate the statute’s policy of full disclosure. The Court ruled that, even were it the case that the 1934 Act covers only misrepresentations likely to affect the value of securities, the sale of an option while secretly intending not to permit the option’s exercise is such a misrepresentation (i.e., the secret intent to dishonor rendered the option valueless). The Court distinguished the hypothetical case in which a defendant simply failed to carry out a promise to sell securities. Here, the Court said, Wharf sold United a security (the option) while secretly intending from the very beginning not to honor the option.

Wharf (Holdings) Ltd. v. United International Holdings may be accessed in PDF format from http://www.supremecourtus.gov/opinions/00slipopinion.html

Copyright 2001, John M. Baker, Esq., Stradley, Ronon, Stevens & Young, LLP, 1220 19th Street, N.W., Suite 700, Washington, DC 20036 – (202) 822-9611- Fax (202) 822-0140 This article was originally posted to the FundLaw List, http://www.egroups.com/group/fundlaw. To subscribe to FundLaw, send a blank e-mail to fundlaw-subscribe@egroups.com

Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.  



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