Nonpublic information considered in valuing securities

In Highland Capital Management, L.P. v. Schneider, the U.S. District Court for the Southern District of New York held that it was reasonable for a jury to conclude that material nonpublic information possessed by the defendants affected the fair market value of certain securities.

The case is significant because it seems to offer a novel interpretation of the phrase “reasonable knowledge of relevant facts” in the definition of fair market value.

Case background

The Schneider family sold their apparel company to Norton McNaughton. In connection with the sale, Norton issued several promissory notes to the Schneiders, with a total face value of $69 million, as partial payment.

The Schneiders engaged a broker to sell the notes. According to the plaintiffs, the Schneiders orally agreed to sell more than $45 million in notes for 51 cents on the dollar to the broker, who in turn had agreed to “flip” them to Highland Capital Management for 52.5 cents on the dollar.

Before the sale was consummated, however, the Schneiders learned, through nonpublic sources, that Norton would soon merge with another company and that the notes would likely be redeemed at face value (which in fact happened four months later). The Schneiders backed out of the deal, and Highland and the broker brought this lawsuit.

The jury found for the plaintiffs, awarding them more than $40 million, plus prejudgment interest. In calculating damages, the jury valued the notes at their full face value. The defendants moved for judgment as a matter of law or, in the alternative, for a new trial. The court denied the motion, upholding the jury’s verdict.

Nonpublic information was relevant

The amount of the damages was a key point of contention. The defendants argued that, in awarding damages, the jury improperly took into account “postbreach” events: namely, the Norton merger and the subsequent payment on the notes at face value to the defendants. They also claimed that the only evidence of market value at the time of the breach was Highland’s offer to the broker of 52.5 cents on the dollar.

The defendants contended that “any material nonpublic information they possessed at the time of the breach was uncertain and should have no bearing on the notes’ market value.” The district court disagreed, finding that a jury could reasonably conclude that nonpublic information possessed by the defendants had an impact on the notes’ value at the time of the breach.

Interestingly, the court found that a jury could reasonably conclude that “it was irrelevant that the individuals who were actually negotiating the agreement did not possess this material nonpublic information.”

What do they know?

Fair market value is typically defined as the price that a willing buyer and seller would agree to, “when neither party is under any compulsion to buy or sell and both parties have reasonable knowledge of the relevant facts.” (Emphasis added.)

The Highland Capital decision suggests that even nonpublic information can be a “relevant fact” and that, in some cases, it’s enough for only one of the parties to have that information. The defendant apparently had at least reasonable knowledge of a fact that could be easily construed as material and very relevant.