The Future of Item 303-Based 10b-5 Claims
POMERANTZ MONITOR | NOVEMBER DECEMBER 2023
A major unresolved question in securities litigation is headed back to the Supreme Court this term. In Macquarie Infrastructure Corp. v. Moab Partners, L.P., SCOTUS will consider whether failing to disclose information required by Item 303 of the SEC’s Regulation S-K can support a private claim under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. For plaintiffs seeking to hold companies accountable for misleading their investors by omitting material information from SEC filings, the stakes could not be higher.
Item 303’s Disclosure Duty and the Absence of a Private Right of Action
Item 303 requires that public companies include a Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) section in their periodic SEC filings. The MD&A must describe known trends, demands, commitments, events or uncertainties that are reasonably likely to materially impact the company’s financial condition or operating performance. The SEC has made clear that Item 303 imposes an affirmative duty to disclose material information. A company violates Item 303 by omitting information about a known trend or uncertainty that investors would consider important.
However, courts have widely recognized there is no private right of action under Item 303 itself—in other words, investors cannot sue directly for a company defendants’ nondisclosures. Instead, plaintiffs are forced to seek recovery for these Item 303 violations within an existing securities fraud claim that does have a private right of action—most commonly, under Section 10(b) and Rule 10b-5.
This raises a key unsettled question–when does an Item 303 violation form the basis for an omissions case under Section 10(b)?
The Split: Can an Item 303 Violation Support a 10b-5 Claim?
To prevail on a Rule 10b-5 omission claim, plaintiffs must prove (1) the company had a duty to disclose, and (2) the omitted information was material. All courts agree that violating Item 303 breaches the duty to disclose. Where they diverge is whether an Item 303 violation, without more, makes the omission material for purposes of 10b-5.
Some circuits have held that Item 303 does not create a Section 10(b) duty to disclose. The Ninth, Third and Eleventh Circuits have held that just because a trend or uncertainty should be included under Item 303 does not mean that omitting it is a violation of Section 10(b). In their view, an Item 303 violation alone cannot establish a 10b-5 claim. Even if the omission breached Item 303, plaintiffs must separately prove materiality and scienter under 10b-5’s standards.
The Second Circuit disagrees. It has held that omitting information required by Item 303 is “indeed an omission that can serve as the basis for a Section 10(b) securities fraud claim.” Under this theory, violating Item 303 satisfies 10b-5’s materiality element automatically. Plaintiffs need only adequately allege the other 10b-5 requirements, such as scienter.
This divide is pivotal given the broad consensus among the courts that there is no private right of action under Item 303. As such, investors must look to Section 10(b) and Rule 10b-5 as one of their only avenues to obtain redress for Item 303 violations. The Circuit split thus determines whether investors can hold companies liable at all for these omissions.
This split also formed the basis for the Supreme Court’s 2017 decision to grant review in a case presenting the same question, Leidos Inc. v. Indiana Public Retirement System. However, the case settled before oral argument. Macquarie gives the Court an opportunity to finally resolve the split.
The Macquarie Litigation
In Macquarie, plaintiff Moab Partners brought 10b-5 claims against Macquarie Infrastructure and its executives. Moab alleged that Macquarie concealed the known risk that impending regulatory changes restricting use of “high-sulfur fuel oil” in shipping would materially and adversely impact its storage and transportation business. Specifically, Moab claimed Macquarie violated Item 303 by failing to disclose in its SEC filings the company’s significant exposure to high-sulfur fuel oil and the risks posed by the new regulations.
The district court dismissed the case, finding Moab failed to sufficiently allege either an Item 303 violation or scienter. The Second Circuit reversed the district court’s decision. Critically, it held that Macquarie’s omission of the fuel oil exposure and regulatory risks, in violation of Item 303’s disclosure duty, was sufficient to plead a material omission under 10b-5. The court also found scienter adequately alleged.
Macquarie’s Petition for Certiorari
Macquarie petitioned the Supreme Court for certiorari on the question of whether the Second Circuit erred in holding that “a failure to make a disclosure required under Item 303 can support a private claim under Section 10(b).” Macquarie argues that this holding improperly expands liability under 10b-5 beyond what the statute and Court precedent permit. In its view, 10b-5 reaches only “deception”—i.e., misleading statements—not pure omissions of information that Item 303 requires be disclosed. Macquarie contends that the Second Circuit’s decision conflicts with Basic v. Levinson, which held that silence, absent a duty to disclose, is not misleading under 10b-5. Macquarie argues that Item 303’s more expansive disclosure standards make it ill-suited to support 10b-5 liability, which requires materiality be plead with specificity under the PSLRA.
Macquarie further contends that allowing 10b-5 liability for Item 303 omissions will compel companies to make overly defensive disclosures and spur meritless litigation. Macquarie claims that the Circuit split causes problematic forum shopping, with plaintiffs disproportionately bringing these claims in the Second Circuit.
Moab Partners’ Opposition
In its opposition brief, Moab first argues that Macquarie’s petition should be denied because the Leidos question is not as important as it once seemed. It claims the Circuit split has proven “superficial,” with most courts dismissing Item 303-based claims on other grounds, such as immateriality or lack of scienter.
Moab defends the Second Circuit’s position as correctly reflecting 10b-5’s text and the principle that misleading omissions are actionable. It argues that Item 303 creates a mandatory disclosure duty whose breach can mislead investors. Moab distinguishes “pure omissions” from “half-truths,” arguing that Macquarie’s affirmative statements in SEC filings (like touting steady performance) also triggered a duty to disclose the Item 303 trend.
Finally, Moab argues that allowing 10b-5 liability for Item 303 omissions does not improperly expand the private right of action. Plaintiffs must still plead and prove materiality, scienter, and all other 10b-5 elements. Moab contends the robust 10b-5 requirements appropriately limit these claims.
What’s Next?
On September 29, 2023, the Supreme Court granted certiorari in Macquarie Infrastructure Corp. v. Moab Partners. The case is currently set for oral argument on January 16, 2024. For years, federal courts have disagreed on whether failing to make required Item 303 disclosures can support private securities fraud suits under Section 10(b) and Rule 10b-5. The Supreme Court will likely finally resolve this dispute.
The Second Circuit allows these suits; the Ninth Circuit bars them unless plaintiffs show the omission also made affirmative statements misleading. The Court cares about uniformity in federal securities laws, and the Second Circuit’s approach impacts markets nationwide; so the stakes are high.
Plaintiffs currently have an easier path bringing Item 303-based claims in the Second Circuit. To plead such a claim there, plaintiffs must adequately allege: (1) defendants violated Item 303; (2) the omitted information was material; (3) defendants acted with scienter; (4) plaintiffs’ purchase/sale of the securities at issue; (5) plaintiffs’ reliance on the omission; and (6) the omission caused losses.
The Ninth Circuit imposes more stringent requirements, in which plaintiffs are not only required to sufficiently allege those same elements but also show that defendants’ Item 303 nondisclosures made affirmative statements materially misleading. This increased burden steers plaintiffs to the Second Circuit whenever possible.
If the Court sides with Macquarie, it will be harder for plaintiffs to hold companies liable for misleading omissions in periodic SEC filings. Ruling for Moab keeps another tool in investors’ anti-fraud arsenal. No matter the outcome, plaintiffs likely must meet heightened pleading standards for these claims going forward. If the Supreme Court permits Item 303-based suits under 10b-5, plaintiffs still must rigorously allege facts supporting each element—especially materiality, scienter, and the PSLRA’s particularity mandate. If the Court bars these suits absent misleading affirmative statements, the path forward is harder still. Indeed, significant unknowns exist regarding the future of Item 303-based claims as the Court could impose greater requirements on investors seeking to bring these claims or issue a decision that produces more confusion than clarity, leaving the question open to further interpretation and differing applications of the law among the lower courts. Either way, more vigorous pleading and tighter case screening is the future for Item 303-based 10b-5 actions.