As closely held companies grow, their number of shareholders often increases as well. This is frequently a sign of success, but it can create certain problems. For example, a larger or diversified shareholder base can prevent a company from becoming an S Corporation for tax purposes. Additionally, companies with too many shareholders who own small portions of the stock may find it difficult to attract financing from institutional or angel investors.
Accordingly, a company may find it necessary to decrease its shareholder base. One option is a stock redemption, where corporation buys shares back from its shareholders. The corporation’s directors or executive officers can also buy back shares in the company from the shareholders.
At the outset, an insider always must refrain from misrepresentation or intentional concealment of material facts (i.e., fraud) when transacting in company stock with a shareholder. Some courts hold that insiders must disclose all material information bearing on the value of the stock (the “minority approach”). Others insist that insiders must disclose knowledge of any substantial transaction or other fact that might substantially affect the value of the company’s stock (the “special facts doctrine”). Most commentators agree that the scope of the required disclosure under the minority approach is wider than what must be disclosed under the special facts doctrine. However, the dividing line between the two approaches is subject to interpretation, and courts around the country have struggled to articulate the proper test, and then unambiguously apply it.
Accordingly, the best practice is to, where feasible, err on the side of disclosure. When insiders buy or sell company stock with shareholders of the company, they should disclose:
- Important transactions, where the parties have agreed on a price and structure;
- Probable mergers or sales of the entire assets or business;
- Agreements with third parties to buy large blocks of stock at a high price; or
- Impending declarations of unusual dividends.
In addition, insiders should disclose information known to them by virtue of their status as insiders that a reasonable shareholder could consider material to the decision to buy or sell. Material information is information that alters the total mix of information available to the shareholder.
While erring on the side of disclosure is a best practice, insiders should note that there are situations where disclosing additional information can render the omission of other information material. These decisions are highly factual, and it is best to consult an attorney as part of any insider’s plan to buy or sell a shareholder’s stock.
 These tests were developed long ago, and their names are now misleading. The minority approach is no longer used in only a minority of jurisdictions.