The U.S. Court of Appeals for the Third Circuit affirmed the lower court’s dismissal of certain novel theories on which the government predicated a criminal indictment against two high-ranking executives of a pharmaceutical company.

The government indicted the executives for allegedly orchestrating a massive securities fraud in violation of 15 U.S.C. Section 78j(b) and Securities and Exchange Commission Rule 10b-5, among other charges. The company’s primary sales and distribution channel for its products was through wholesalers which, in turn, supplied pharmacies, hospitals and other health care providers. Wholesalers purchased product and maintained inventory based on projected demand. The government asserted that the company entered into arrangements with the wholesalers to maintain inventory in excess of projected demand to increase short-term sales and earnings and inflate the stock price, and contended that the executives concealed this practice from its shareholders.

In order to hold the first of the two executives liable, the government proposed a theory that one executive had a fiduciary duty to rectify the alleged misstatements of the other made during analyst calls and in subsequent SEC filings. The court noted that silence is not fraudulent or misleading under the securities laws unless there is a duty to disclose, which is only the case in the certain enumerated and specific circumstances. The government argued that liability for an omitted statement could be based on a general fiduciary obligation of high corporate executives to the company’s shareholders, which compels a corrective statement in light of a misstatement by another. The court rejected this theory as overbroad and unnecessarily expansive and further found that the theory encroached on conduct typically left to state law. (U.S. v. Schiff, Nos. 08-1903, 08-1909, 2010 WL 1338141 (3d Cir. Apr. 7, 2010))