Managers and the Legal Environment 7th Edition by David Madsen, Constance Bagley

Exercise 14

Cameron Winklevoss, Tyler Winklevoss, and Divya Narendra (the Winklevosses) claim that Mark Zuckerberg stole the idea for Facebook from them. In the course of mediation, the Winklevosses signed a settlement agreement with Zuckerberg, stipulating that the Winklevosses would surrender ConnectU, their competing social networking site, in return for cash and Facebook stock.
Facebook later sued to enforce this settlement agreement. ConnectU argued that the agreement was unenforceable, in part because Facebook allegedly violated Rule 10b-5 by misleading the Winklevosses to believe that Facebook's stock was worth four times more than its later stated value. If Facebook did violate Rule 10b-5, the Winklevosses would be entitled to cancel the settlement agreement under section 29(b) of the 1934 Act, which renders voidable "[e] very contract made in violation of any provision of [the securities laws, rules, or regulations], and every contract... the performance of which involves [such a] violation." The Winklevosses assert that a settlement proviso that barred them from "further claims against Facebook" does not preclude their Rule 10b-5 claim because section 29(a) of the 1934 Act provides that "any condition, stipulation or provision binding any person to waive compliance with [the securities laws, rules, or regulations] shall be void."
Do the Winklevosses have a valid claim under Rule 10b-5? Should it matter that the alleged misrepresentations occurred during negotiations in a dispute rather than in the course of normal business? Would a confidentiality agreement concerning statements made during mediation, which would prevent the Winklevosses from presenting evidence for their Rule 10b-5 claim, be void under section 29(a)? Is Facebook required to disclose this dispute in the prospectus for its initial public offering? [Facebook, Inc. v. Pacific Northwest Software, Inc., 640 F.3d 1034 (9th Cir. 2011).]