The Future of Section 10(b) Claims Premised on Violations of Item 303 Looks Uncertain
POMERANTZ MONITOR | JANUARY FEBRUARY 2024
On January 16, 2024, the Supreme Court held oral argument in Macquarie Infrastructure Corp. v. Moab Partners, L.P., in which the Court has been asked to decide whether “a failure to make a disclosure required under Item 303 can support a private claim under Section 10(b) [of the Securities Exchange Act], even in the absence of an otherwise misleading statement.” During the argument, nearly all of the justices voiced skepticism that a Section 10(b) claim can be based solely on a violation of Item 303. If the justices decide violations of Item 303 cannot independently support a Section 10(b) claim, an important basis for such claims, previously available in the Second Circuit, will no longer be available to securities plaintiffs.
SEC Regulation Item 303 requires publicly traded companies to disclose in their annual reports on Form 10-K all known trends or risks that are reasonably likely to materially affect the company’s income. The respondent, investor Moab Partners LP, alleges that the petitioner, Macquarie Infrastructure Corp., was required under Item 303 to disclose in the management discussion and analysis (“MD&A”) section of its 10-K filing that a proposed international ban on certain sulfur fuels would have a devastating impact on its oil storage business. Moab claims that in failing to make this disclosure, Macquarie made a misleading omission that is actionable under Section 10(b) of the Exchange Act. The Second Circuit found that such an omission of a known material risk, required to be disclosed under Item 303, is indeed actionable, in a decision that contradicted a prior holding of the Ninth Circuit on this issue. The Supreme Court granted certiorari to resolve the circuit split.
At oral argument, Justice Kagan aptly summarized the dispute between the parties as one over “how narrow or how capacious we should understand the requirement [of Section 10(b)] that there needs to be another statement that’s rendered misleading” by an omission of a risk required to be disclosed under Item 303. The U.S. Solicitor General, represented at oral argument by Ephraim McDowell and arguing on behalf of the U.S. Securities and Exchange Commission as intervenor, argued that the entire MD&A section filed to satisfy Item 303 disclosure requirements may be viewed as a single statement that may be rendered misleading by the omission of a material known risk. McDowell argued by analogy that the section of an annual report disclosing the directors of a company would be misleading if it disclosed some of the directors yet omitted one of them. Under this theory, a defendant’s MD&A section can be a misleading “half-truth” if it discloses some material risks but fails to disclose other material known risks. David Frederick of Kellogg Hansen, arguing on behalf of respondent Moab, likewise took the position that an entire MD&A section that omits a risk required to be disclosed under Item 303 is a misleading statement. Frederick also argued in the alternative that the complaint at issue pleaded that specific misstatements within the MD&A section were misleading by omission.
Petitioner Macquarie, represented by Linda Coberly of Winston & Strawn, argued in contrast that Section 10(b) and the PSLRA require that a more specific statement than the entire MD&A section of a company’s 10-K be rendered misleading by an omission. Coberly argued that a material known risk omitted from a 10-K must be “like in kind in both subject matter and specificity” to a risk disclosed in that filing in order to be actionable.
In their questioning, the justices appeared skeptical of the government’s and respondent’s argument that the entire MD&A section of a company’s 10-K may constitute a statement that may be rendered misleading by the omission of a material known risk. Only one justice, Justice Kagan, hinted at a favorable view of this theory when she noted, “if you have a set of paragraphs . . . which paints a very rosy picture of the prospects of a company, and then it turns out that you’ve omitted the thing that is actually going to crater the company next month, that rosy picture seems to be rendered misleading.”
The remaining justices floated two potential approaches for resolving the issue presented. First, several justices suggested that the parties appeared to agree on the answer to the question presented, as written: the parties appeared to agree that an omission that does not render some other statement misleading—a “pure omission”—is not actionable. Chief Justice Roberts noted that the dispute as presented turned on a distinction between “half-truths and pure omissions,” and asked whether respondent was “giving up on that distinction” and conceding that a pure omission of a risk required to be disclosed under Item 303 is not actionable. Justice Kavanaugh asked pointedly whether the justices “can . . . just say that an omission alone is not good enough, you have to identify a statement as well, and send it back?” Justice Gorsuch likewise asked, “do you want us to just go ahead and answer the narrow question presented about omissions?” Justice Alito stated, “I don’t really see a disagreement between you and Ms. Coberly on the narrow question that the Court agreed to take.”
In response, counsel for both the government and respondent rejected this offer by the justices to punt. Frederick argued for respondent that a holding that pure omissions cannot form the basis of a Section 10(b) violation would be worthless because “[t]he Second Circuit has never decided this [issue] on the basis of pure omissions.” McDowell similarly argued that “I don’t think it would do any good . . . to just basically vacate and remand and let them take another look because [the Second Circuit already] decided” that Item 303 omissions are actionable because they render the financial statements as a whole misleading.
Second, perhaps a majority of justices appeared to favor petitioner’s view that a plaintiff must identify a specific statement within the MD&A section of a 10-K, rather than the section as a whole, that is rendered misleading by the omission of a risk required to be disclosed under Item 303 in order for that omission to be actionable. Justice Kavanaugh stated, “to say that the MD&A as a whole is misleading, really kind of waters down the statement requirement,” and asked, “how can the MD&A section as a whole be misleading but not any single statement within it?” Justice Gorsuch understood Frederick to have conceded in the alternative that a more specific statement may be required and asked why, if the parties agree that such a standard is acceptable, the justices should not apply that standard? Justice Jackson similarly seemed inclined to require a more specific statement and reasoned that “it writes out of the statute something about the statement being rendered misleading to interpret that to mean anytime you are required to disclose certain information in a statement and it isn’t there, you have a misleading statement.”
A holding that securities plaintiffs must identify a specific statement within the MD&A section of a 10-K that is rendered misleading by an Item 303 omission would effectively eliminate the pleading advantage plaintiffs previously enjoyed in the Second Circuit by pleading Item 303 omissions. However the Court rules, the justices seemed unlikely to write an opinion favorable to securities plaintiffs. Tellingly, Justice Roberts framed his broad view of the Court’s role with respect to Section 10(b) cases: “we don’t want to get any further into the business of implying private rights of action,” and the Court should be disinclined to “extend the existing private right of action” found in Section 10(b). This case may turn into another cautionary tale, like Morrison, the lesson of which is that the plaintiffs’ bar, in seeking to maximize investors’ rights, should be cautious when considering whether securities cases should proceed to this Court.