By Anne Sherry, J.D.
The Supreme Court is being asked to review a Second Circuit holding that a failure to make a disclosure required under Regulation S-K Item 303 can support a private claim under Exchange Act Section 10(b), even in the absence of an otherwise misleading statement. The defendants-appellees maintain that this holding created a split with at least three sister circuits that have rejected 10(b) liability based on a violation of Item 303 (Macquarie Infrastructure Corp. v. Moab Partners, L.P., May 30, 2023).
Challenged decision. Macquarie Infrastructure Corp. was a publicly traded company that owned and operated a portfolio of infrastructure-related businesses, one of which was involved in the storage of a high-sulfur fuel oil, No. 6 oil. The plaintiffs alleged that between February 2016 and February 2018, Macquarie and its management defrauded investors by failing to predict—and disclose—that a proposed cap on sulfur in fuel oil (IMO 2020) would have a material negative impact on Macquarie’s financial performance.
The district court held that the plaintiffs failed to plead a violation of Item 303 and failed to allege scienter. The Second Circuit disagreed, holding that the plaintiffs had adequately alleged a “known trend or uncertainty” that gave rise to a duty to disclose under Item 303 and that this sufficed to establish an actionable omission and the defendants’ scienter under Section 10(b). The heightened pleading standard of the PSLRA was satisfied because the defendants were in the position of knowing that it was likely that IMO 2020 would reduce revenue, yet did not disclose as much, the Second Circuit concluded.
Circuit split. In the cert petition, Macquarie and the other petitioning defendants argue that a Section 10(b) claim cannot rest entirely on a failure to provide a disclosure required under Item 303; there needs to be some affirmative statement rendered misleading by the omission. While the SEC can inquire and bring an enforcement action for a violation of Item 303, the violation should not “open the floodgates to potentially crippling private class action liability.”
The petition argues that the Second Circuit has acknowledged its split from the Ninth Circuit’s 2014 holding in In re NVIDIA Corp. Securities Litigation, which in turn had cited a Third Circuit decision. Subsequently, the Eleventh Circuit wrote that a violation of Item 303 does not ipso facto indicate a violation of Section 10(b), and the Fifth Circuit said in dicta that it has never held that Item 303 creates a duty to disclose under the Exchange Act. Resolving the split is important because it involves the three dominant circuits for securities litigation and because different standards should not apply depending on where a plaintiff files suit, the petition asserts.
Argument. According to the petitioners, the Second Circuit’s expansion of Section 10(b) liability conflicts with the Supreme Court’s precedents. The Court has repeatedly stated that the private right of action in the Exchange Act should not extend beyond its boundaries. On its face, the petition asserts, Section 10(b) is about prohibiting manipulation or deception, not about the completeness of disclosures. This is why Rule 10b-5 makes omissions unlawful only when its disclosure is necessary to make other statements not materially misleading.
Furthermore, Item 303 is not a suitable vehicle for an implied private right of action. The SEC has explained that an issuer’s disclosure obligations under Item 303 are “intentionally flexible and general.” The rule distinguishes between required disclosures of currently known trends and optional disclosures of forward-looking information, and both types of disclosures comprise the type of “soft information” that is not objectively verifiable. Opening the door to private actions for violations of Item 303 amounts to allowing plaintiffs to plead “fraud by hindsight,” which stands in tension with established precedent.
The Second Circuit’s approach conflates the optional and required disclosure scheme of Item 303 and collapses the scienter analysis for Section 10(b) claims, the petitioners continue. When the Second Circuit first recognized a private right of action under Item 303 in Stratte-McClure v. Morgan Stanley (2d Cir. 2015), it attempted to cabin its holding by remaining mindful of the SEC’s distinction between required and optional disclosures and by making clear that scienter remained a separate and independent element of a Section 10(b) claim. The facts of the instant case make it more difficult to distinguish between an actionable expectation and a non-actionable anticipation, and by concluding that the plaintiffs had pleaded scienter based on management’s “position of knowing” the omitted trend or uncertainty, the panel effectively held that an alleged failure to make a required Item 303 disclosure is sufficient in itself to establish scienter.
Finally, the petition argues that the expansion of liability will incentivize over-disclosure, leading to increased burdens on companies and information overload for investors, as well as increase the frequency and cost of securities litigation.
The case is No. 22-1165.