Shariah’s Black Box

The Court began by clearly rejecting what it considered too low a threshold for materiality as adopted by the lower court. The Court considered a standard of “all facts which a reasonable shareholder might consider reasonable”[181] “‘too suggestive of mere possibility, however unlikely.’”[182] The Court went on to explain in detail the objective standard it chose for materiality:

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. Variations in the formulation of a general test of materiality occur in the articulation of just how significant a fact must be or, put another way, how certain it must be that the fact would affect a reasonable investor’s judgment.

 . . .

The general standard of materiality that we think best comports with the policies of Rule 14a-9 is as follows: An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. . . . It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.[183]

While the Court in TSC Industries set about to explain materiality in the context of proxy statements, this articulation of materiality has become the operative definition in many other contexts of securities fraud. In a Rule 10b-5 case alleging failure to disclose pre-merger negotiations, the Court utilized the TSC Industries standard in an effort to add clarity to the concept of materiality for future or contingent events. In Basic, Inc. v. Levinson[184], the Court confronted the question when pre-merger negotiations are material and ripe for disclosure. Negotiations over some contingent and future event may, it turns out, be quite material:

Even before this Court’s decision in TSC Industries, the Second Circuit had explained the role of the materiality requirement of Rule 10b-5, with respect to contingent or speculative information or events, in a manner that gave that term meaning that is independent of the other provisions of the Rule. Under such circumstances, materiality “will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.” SEC v. Texas Gulf Sulphur Co., 401 F. 2d, at 849.

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In a subsequent decision, the late Judge Friendly, writing for a Second Circuit panel, applied the Texas Gulf Sulphur probability/magnitude approach in the specific context of preliminary merger negotiations. After acknowledging that materiality is something to be determined on the basis of the particular facts of each case, he stated:

“Since a merger in which it is bought out is the most important event that can occur in a small corporation’s life, to wit, its death, we think that inside information, as regards a merger of this sort, can become material at an earlier stage than would be the case as regards lesser transactions — and this even though the mortality rate of mergers in such formative stages is doubtless high.”

SEC v. Geon Industries, Inc., 531 F. 2d 39, 47-48 (CA2 1976). We agree with that analysis.[185]

Arguably, the question whether the Shariah in SCF is a material fact that ought to be disclosed will rest on one of two analytical approaches, or possibly both. The first approach seeks to determine the materiality of Shariah in principle. This approach might be phrased in question form as follows: Would a post 9-11 reasonable investor consider the connection between Shariah and SCF important to his or her decision to invest? In other words, would a reasonable investor looking to invest in something promoted (or in some instances simply represented) as “Shariah-compliant” want to know what Shariah and its “rules and principles” say about constitutional government, treatment of infidels, the Law of Jihad, and the use of suicide-homicide bombers and other acts of terrorism? Would the reasonable investor want to know about the published statements by international terrorist leaders citing Shariah authorities as justification for their holy war against the U.S. and other Western nations? These and similarly phrased questions all attempt to get at the associational link between Shariah in principle as an authoritative set of rules and principles advocating violence and SCF. If in fact such an association exists, would it be material information to a reasonable investor?[186]