Contract-Based Defenses in Securities Fraud Litigation: A Behavioral Analysis
Robert Prentice | 2003 U. Ill. L. Rev. 337
In this article, Professor Robert Prentice takes issue with the trend of courts honoring contract-based securities fraud defenses and advocates the maintenance of a tort-based approach. Contrary to the arguments of contractarian theorists who argue that investors should be able to contractually negotiate their desired level of risk, and consequently that disclaimers and no reliance clauses should be honored, the article uses behavioral principles to undermine the assumption that humans ra-tionally contract.
Pointing to Carr v. CIGNA Securities, Inc., in which a contractual disclaimer of oral representations precluded a successful fraud suit, and Rissman v. Rissman, wherein a “no reliance” on oral representations clause was found dispositive, as examples of courts allowing contract-based defenses, Prentice argues that such defenses run counter to congressional intent. Securities fraud suits were intended to be tort-based and Congress intended to limit contract-based defenses.
As evidence of investors’ need for a purely tort-based securities law that cannot be contracted away, the article points to various behavioral instincts that advise against reading or questioning form contracts and support reliance on oral representations. The article then argues that such behavioral tendencies support not only preventing a contract-based defense for small investors but also eliminating the defense for sophisticated and institutional investors, who are equally susceptible to human behavioral tendencies.
In recognition that courts are reluctant to allow investors to break contractual promises and argue fraud, Prentice offers some behavioral tendencies that would compel investors to wrongly feel defrauded. Such tendencies are balanced by the tendency of juries to side with the defense. As alternatives to complete prohibition of contract-based defenses, Prentice suggests reviving the fraud exception to the parol evidence rule or requiring plaintiffs seeking to overturn no-reliance or merger clauses to support their position with objective evidence.