The U.S. Supreme Court has agreed to take up a case that will address a recurring issue that has arisen in the securities class action litigation arena – that is, whether or not the alleged failure to make a disclosure required by Item 303 of Reg. S-K is an actionable omission under Section 10(b) and Rule 10b-5. A circuit split has emerged on this issue, with the Second Circuit holding that Item 303 does create an actionable duty of disclosure, while the Ninth and Third Circuits have held that it does not. The Court’s grant of the writ of certiorari in the case of Leidos, Inc. v. Indiana Public Retirement System will afford the Court an opportunity to resolve the circuit split and to address the question of whether Item 303 creates an actionable disclosure duty. The U.S. Supreme Court’s March 27, 2017 order granting the writ of certiorari can be found here.
Item 303 of Reg. S-K states in pertinent part that in its periodic reports to the SEC, a company is to “[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a materially favorable or unfavorable impact” on the company. Guidance provided by the SEC on Item 303 clarifies that disclosure is necessary where a “trend, demand commitment event or uncertainty is both presently known to management and reasonably likely to have material effects on the registrant’s financial conditions or results of operations.” Issuers’ Item 303 disclosures appear in the Management Discussion & Analysis (MD&A) sections of their annual reports (and in interim or quarterly reports, where there have been material changes since the last annual report).
In its October 2014 decision in In re NVIDIA Corp. Securities Litigation (here), the Ninth Circuit held that Item 303 does not create a duty to disclose for purposes of Section 10(b). In reaching this decision, the Ninth Circuit relied on language in an earlier opinion written by then-Judge (and now U.S. Supreme Court Justice) Samuel Alito, when he was on the Third Circuit, stating that because the materiality standards for Rule 10b-5 and Item 303 differ significantly, a violation of Item 303 “does not automatically give rise to a material omission under Rule 10b-5.”
In its January 2015 decision in Stratte-McClure v. Morgan Stanley (discussed here), the Second Circuit expressed its view that Judge Alito’s language merely suggested, without deciding, that in certain instances a violation of Item 303 could give rise to a material omission. The Second Circuit concluded that the language is consistent with its conclusion that an Item 303 omission can serve as the basis for a Section 10(b) securities fraud claim, but only if the other requirements to state a Section 10(b) claim – such as materiality and scienter – have been met.
The SAIC Case
The petitioner in this case, Leidos, Inc., was formerly known as SAIC, Inc. (Throughout the proceeding Leidos has been referred to in the various pleadings and rulings as SAIC.) In late 2010, federal and local investigators uncovered a billing kickback scheme involving an information technology contract in which SAIC was providing certain services to New York City. When SAIC learned of the improper billing scheme, it offered to reimburse the city for the amount of the improper billing. In June 2011, the city formally demanded repayment, which SAIC disclosed in an SEC filing two days later. In March 2012, SAIC entered a deferred prosecution agreement with the local U.S. Attorney’s office, in which, among other things, SAIC agreed to pay more than $500 million in fines and forfeitures.
In 2012, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against SAIC and certain of its directors and officers. Judge Deborah Batts granted the defendants’ motion to dismiss, ruling, among other things, that the plaintiff’s claims based on the allegation that the company’s SEC filings omitted disclosures required by Item 303 were insufficiently pled. The plaintiff appealed to the Second Circuit.
In a March 29, 2016 decision (here), the Second Circuit vacated the portion of the district court’s ruling regarding the Item 303 issue and remanded the case for further proceedings. The Second Circuit acknowledged the Ninth Circuit’s contrary ruling on the Item 303 issue, noting that its decision was at odds with the Ninth Circuit’s decision in the NVIDIA case, but chose to follow its own prior decision in the Morgan Stanley case. SAIC filed a petition for writ of certiorari.
The Cert Petition
In its cert petition (here), SAIC argued that the U.S. Supreme Court should take up the case in order to address the “deep split of authority” on the question of whether Item 303 creates an affirmative duty of disclosure. SAIC argued that because of the circuit split on the issue it faced potential liability under the federal securities laws that it would not face if the case had been filed in a different jurisdiction. SAIC argued further than in holding that Item 303 creates an actionable disclosure duty it “dramatically expanded the scope of omissions liability under Section 10(b).” The Second Circuit’s holding, SAIC contended, imposed liability for disclosure requirements that the SEC itself as “intentionally general” and as “inapposite” to standards for materiality under Section 10(b).
The Indiana Public Retirement System, the plaintiff in the underlying case, initially waived the right to respond to the petition. However, on December 8, 2016, the Court requested a response. The Retirement System then filed its opposition.
In its Opposition to the Cert Petition (here), the retirement system raised a number of preliminary points, arguing among other things that SAIC had not argued in any of the prior proceedings that Item 303 did not create an actionable duty of disclosure, but instead had merely argued that the Item 303 claim was inadequately pled. The retirement system also argued that the Second Circuit had correctly decided that “Item 303 violations, like other rules and regulations governing the disclosure of information to investors, has a place in §10(b) jurisprudence.” The retirement system argued further that contrary to SAIC’s contention that the Second Circuit had dramatically expanded omissions liability in Section 10(b) cases, the Second Circuit had “carefully restricted Item 303 to the confines of a traditional §10(b) claim by requiring a plaintiff to plead materiality, scienter, and every other recognized §10(b) element in order to properly state a claim.”
The Securities Industry and Financial Markets Association (SIFMA) and the U.S. Chamber of Commerce filed an amicus brief (here) urging the Court to grant cert. SIFMA and the Chamber argued that though Item 303’s provisions are couched in seemingly mandatory terms, “the breadth and amorphousness of Item 303’s reporting standards make it almost impossible in many instances to determine when management is obligated to make a disclosure.” As a result, the circuits other than the Second Circuit that have considered the issue have “uniformly and correctly held that Item 303 cannot be enforced through the mechanism of a Rule 10b-5 action.”
In its separate amicus brief (here), the National Association of Manufacturers argued that “the Second Circuit’s ruling departs from both the plain language of Rule 10b–5 and this Court’s precedents,” arguing further that the Second Circuit’s ruling “would give rise to liability for securities fraud based only on a material omission, even though this Court has made clear that an omission alone does not suffice” if the absence of the omitted material facts did not render an affirmative statement misleading.
At one level, I am not surprised the Supreme Court has granted cert on this issue. Indeed, in a March 2015 post in which I discussed a district court’s efforts to sort its way through the circuit split, I noted that “under the current state of play, there is the obvious risk of inconsistent outcomes on the issue between the courts in the Second Circuit and the Ninth Circuit. The existence of this type of circuit split is precisely the kind of thing that can, if teed up the right way in a particular case, attract the attention of the U.S. Supreme Court. Indeed, given the existence of the circuit split and the keen interest the Supreme Court has shown over the last eight years or so in taking up securities cases, the Item 303 issue could well wind up in the Supreme Court, perhaps sooner rather than later.”
Just the same, there is a sense in which it is a bit of a surprise that the Court granted cert. It did after all deny cert in the NVIDIA case. The difference may be that since the cert denial in NVIDIA, the circuit split has sharpened and become more apparent.
It is hard to know what impact Justice Alito’s pre-Supreme Court cameo appearance as a Third Circuit judge in the case law background on this issue will have the Court’s consideration of these issues. His prior involvement with the case might have encouraged him to vote for the Court to take up the case, as the Second Circuit’s decision arguably is inconsistent with position as a circuit court judge on the Item 303 issue (although interestingly the meaning of Alito’s statements in the Third Circuit decision is yet another issue on which the circuit courts disagree).
If for no other reason, this will be an important case because the dispute about whether or not Item 303 creates an actionable disclosure duty comes up all the time. On the other hand, as Doug Greene has contended on his D&O Discourse blog, it could be argued that the conclusion that Item 303 creates a disclosure duty doesn’t change things much, since, according to Greene, “very rarely, if ever, would there be an omitted fact that gives rise to an Item 303 claim without also rendering false or misleading one or more challenged statements.” He added that “it’s hard to imagine a case in which an issue is so major as to require Item 303 disclosure but isn’t something about which the company has spoken.”
This case is in any event the third securities law case on which the U.S. Supreme Court has granted cert during this current Court term. As discussed here, in January 2017, the Court granted cert in California Public Employees’ Retirement System v. ANZ Securities Inc. in order to consider whether American Pipe tolling applies to the Securities Act’s statute of repose, and as discussed here, and also in January 2017, the Court granted certiorari in Kokesh v. Securities and Exchange Commission to determine whether SEC disgorgement claims are subject to the five-year statute of limitations applicable to enforcement proceedings seeking civil penalties.
Securities law cases before the U.S. Supreme Court used to be rare — the Court could and often did go years between securities cases. Some day somebody will explain why the current Court seems so interested in granting cert in securities law cases.