The U.S. Supreme Court has agreed to take up a case in which the court will be asked to address the recurring question of whether the failure to make disclosure required by Item 303 of Reg. S-K is an actionable omission under Section 10(b) and Rule 10b-5. The Court apparently agreed to take up the case due to a split between the Circuits on the question of whether or not an Item 303 violation can be actionable. Because allegations based on alleged Item 303 violations are a frequent feature of securities class action complaints, the Court’s ruling in the case could potentially be significant. A copy of the Court’s September 29, 2023, order granting the petitioners’ petition for a writ of certiorari in the cases, Macquarie Infrastructure Corporation v. Moab Partners, L.P., can be found here.
Background Regarding Item 303
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).
The federal circuit courts have reached contrary conclusions on the question of whether or not Section 303 creates an affirmative duty of disclosure. The Second Circuit has held that Item 303 does create an actionable duty of disclosure, while the Ninth, Third, and Eleventh Circuits have held that it does not.
In recognition of the Circuit split on the question of the actionability under the federal securities laws of violation of Item 303, the U.S. Supreme Court in 2017 granted a writ of certiorari in the case of Leidos, Inc. v Ind. Pub. Ret. Sys., as discussed here, in order to take up the question. However, the Leidos case settled before it could be heard for argument, as discussed here.
Background Regarding the Underlying Case
Macquarie Infrastructure Corporation (MIC) operates several global infrastructure businesses, one of which is International-Matex Tank Terminals (IMTT). During the class period, as much as 40% of IMTT’s business involving storing “6-Oil,” a high-sulfur fuel. Consumption of Oil-6 has declined over time, and in October 2008, the International Maritime Organization (IMO) announced new regulations that, effective January 2020, would largely eliminate the use of 6-Oil in global shipping.
The gist of the underling complaint is that in the run up to the effective date the new IMO regulations regarding 6-Oil, MIC materially misled investors with respect to the impact of the eventual elimination of 6-Oil. In particular the plaintiffs allege that the defendants failed to disclose that the IMO-driven collapse of the 6-Oil market would “crush IMTT”s revenues.” The plaintiffs allege that company concealed from investors the company’s exposure to IMO’s impact. The “truth” emerged, the plaintiffs allege, in February 2018, when the company announced it was cutting its quarterly dividend to reflect IMTT”s declining performance, which resulted in part from a number of customers terminating contracts for 6-Oil capacity.
In April 2018, plaintiff shareholders filed the first of several securities class action lawsuits against MIC and certain of its directors and officers. In a consolidated and amended complaint, the plaintiffs presented six difference securities law claims based on MIC’s alleged misrepresentations and omissions regarding IMTT’s 6-Oil exposure. The amended complaint contains allegation based both on Securities Act of 1933 and the Securities Act of 1934.
In their ’34 claims under Section 10(b) and Rule 10b-5 thereunder, the plaintiffs alleged that defendants’ “half-truths” and failure to disclose material information required by Item 303 deceived investors.
The defendants moved to dismiss the amended complaint. In September 7, 2021 order (here), Southern District of New York Judge Vernon Broderick granted the defendants’ motion to dismiss in its entirety based on the plaintiffs’ failure to plausibly allege false statements or omissions and for failing to sufficiently allege scienter as to the Exchange Act claims. In particular, the district court held that the plaintiffs had failed to allege a violation of Item 303 or that the omission was material. The plaintiffs appealed the District Court ruling.
In an unpublished summary order dated February 23, 2023 (here), a three-judge panel of the Second Circuit affirmed in part and reversed in part the district court’s order. The appellate court reinstated the plaintiffs’ Section 10(b) claims on the grounds that plaintiffs had adequately alleged affirmative misstatements in the form of “half-truths” about the impact of the changes of the 6-Oil marketplace. The appellate court also revived the plaintiffs’ Exchange Act claims on the grounds, the appellate court found, that the plaintiffs had adequately alleged violations of Item 303. In reviving the claims based on Item 303, the appellate court cited its own prior authority that Item 303 disclosure can support a claim under Section 10(b) if the other elements have been sufficiently pleaded.
The Second Circuit declined the defendants’ petition for rehearing en banc. The defendants sought to have the Supreme Court review of the Item 303 issue.
The Cert Petition and Opposition
In their petition to the Supreme Court for a writ of certiorari, the defendants sought to frame their petition in terms of giving the Supreme Court “another chance” to review the issues that the Court had previously agreed to consider in the Leidos case, but that the Court did not in the end have the chance to review because the Leidos case settled before oral argument. The defendants said their petition poses the question “whether a Section 10(b) claim can rest on a failure to provide a disclosure required under Item 303 of SEC Regulation S-K, even without an affirmative statement that is rendered misleading by omission.” The defendants pointed out that while the Ninth, Third, and Eleventh Circuits had rejected this possibility, the Second Circuit, in express recognition that its contrary position puts it “at odds” with the Ninth Circuit, has long held that an Item 303 violation can be a basis of a Section 10(b) claim, even in the absence of an otherwise misleading statement.
Citing the possibilities of this circuit split for inconsistent results between the courts, the defendants urged the Court to take up the case in order to resolve the conflict – especially in light of the “outsized role” that the Second Circuit has in securities litigation.
Given that the U.S. Supreme Court had previously granted cert in the Leidos case back in 2017 on basically the exact same issue, the plaintiffs were in an uncomfortable position in trying to oppose cert in the case. The plaintiffs tried to argue in their opposition to the petition that the supposed conflict between the circuits as more apparent that real, in that the circuits were not, the plaintiffs sought to argue, nearly as far apart as the defendants sought to argue. The plaintiffs also sought to argue that if anything, since the court cert in the Leidos case in 2017, the apparent difference between the circuits had diminished even further.
In its September 29, 2023 order, the Court granted the defendants’ petition for writ of certiorari and agreed to take up the case. The case will be argued as part of the Court’s current 2023-2024 term and will be decided before the end of the current term, in June 2024.
It is noteworthy that the Court’s grant of the writ of certiorari in this case represents the second occasion this term in which the Court has agreed to take up a case arising under the federal securities laws. As discussed here, in June 2023, the Supreme Court, in the Jarkesy case, agreed to take up a case to consider the legality of the SEC’s use of in-house administrative tribunals, which the agency uses to enforce the federal securities laws.
Over the course of years, the Supreme Court takes up relatively few securities law cases, so the fact that the Court will hear two securities cases this term is significant in and of itself.
The core of the reason why it is significant that the Court has agree to take up these cases is that any time the Court weighs in on the securities laws, there is the incalculable possibility that the Court will say or do something that could have greater significance for future proceedings under the securities laws. The courts words can shape discourse and discussion concerning the liability claims under the securities laws for years to come.
It is arguably unsurprising that the Supreme Court has granted the writ of certiorari on the Item 303 issue in this case. After all, the split in the circuits was sufficient to convince the Court to take up the same issue back in 2017, and even though the parties’ settlement of the Leidos case prior to argument deprived the court of the chance to address the circuit split, the circuit split did not go away in the interim. Indeed, the defendants argued that the circuit split has deepened in the interval. (The plaintiffs of course argued the contrary.)
In thinking about the potential significance of this case, it is important to note that Item 303 allegations are a regular feature of securities class action complaints these days (particularly in the Second Circuit, where a substantial percentage of all securities class action lawsuits are filed). Item 303 allegations are useful for plaintiffs because they help the plaintiffs’ counsel solve a pleading problem. That is, under the U.S. Securities laws, it is generally held that absent a duty to speak, a defendant company cannot be held liable for failing to disclose information – that is, unless further disclosure is required in order to make a prior statement not misleading. Item 303 provides a way for the plaintiffs’ lawyers to argue that the defendants had a duty to speak, even if there isn’t a prior statement for which further disclosure is required in order to avoid the prior statement from being misleading.
That said, there are very few complaints that are restricted to Item 303-based allegations alone. The complaint in this case is fairly representative in that regard. The plaintiffs in this case proceeded with six claims based on different legal bases. The Item 303 allegations are only one of several claims the plaintiffs have raised against the defendants, and that is often the case. Item 303 cases are often just one part of multipart complaints. However, the fact is that Item 303 allegations do provide claimants with yet another arrow in the quiver.