On January 16, 2024, the U.S. Supreme Court held oral argument on a question that could have significant consequences for securities litigants: whether a failure to disclose information under Item 303 of Regulation S-K is, standing alone, an actionable omission under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.  While it remains to be seen what the Court will ultimately decide, the Justices’ questions signaled a narrow ruling that would foreclose such liability.

The Interplay Between Section 10(b) Liability and Disclosure Obligations Under Item 303 of Regulation S-K

Section 10(b) and Rule 10b-5 make it unlawful for securities issuers “[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”  Under the plain text of Rule 10b-5—and the later-enacted PSLRA—actionable omissions are limited to situations in which a disclosure’s absence renders an issuer’s affirmative statements misleading.

Nevertheless, securities plaintiffs often allege Rule 10b-5 claims based on a defendant’s failure to abide by independent disclosure obligations that are not necessarily tied to affirmative statements.  Securities plaintiffs frequently predicate this so-called “pure omissions” theory of liability on Item 303 of Regulation S-K.  Item 303 requires issuers to disclose, in the “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” or “MD&A” section of their annual SEC filings, “any known trends or uncertainties that have had” or that the registrant reasonably expects will “have a material favorable or unfavorable impact” on the company’s net revenues or income.  Securities plaintiffs use Item 303 to allege that an issuer’s failure to disclose a “known trend[] or uncertaint[y]” in the MD&A results in Rule 10b-5 liability even in the absence of an affirmatively misleading statement.

Courts have viewed this argument—and these pleading tactics—with skepticism.  Many courts—including the Ninth, Eleventh, and Third Circuits—have rejected pure omissions claims.  For example, in 2014, the Ninth Circuit held that Item 303 does not create a duty to disclose under Section 10(b) and Rule 10b-5.  Instead, liability “must be separately shown” on the basis of an affirmative misstatement.  In so holding, the Ninth Circuit reasoned that Rule 10b-5’s plain text differs from that of Sections 11 and 12(a)(2) of the Securities Act, which do allow for a private right of action based solely on an Item 303 violation.  Specifically, whereas Sections 11 and 12(a)(2) provide liability for an omission of “a material fact required to be stated,” Rule 10b-5 only addresses omissions that are necessary to render an issuer’s affirmative statements not materially misleading.

The Second Circuit disagrees with that analysis and has upheld “pure omission” claims.  It takes the position that a violation of Item 303 would be actionable under Section 10(b) and Rule 10b-5 if plaintiffs can show that the omitted information is material.  As the Second Circuit recently explained, regulations that obligate a party to speak, like Item 303, can trigger a broad duty to disclose because a “reasonable investor would interpret the absence of an Item 303 disclosure to imply the non-existence of known trends or uncertainties.”  Accordingly, in the Second Circuit’s view, Item 303 omissions can be a basis for Rule 10b-5 liability even in the absence of affirmative misstatements.

Case Background

The Supreme Court is poised to resolve this circuit split in Macquarie Infrastructure Corporation v. Moab Partners LP.  Moab Partners sued Macquarie Infrastructure Corporation under Section 10(b) and Rule 10b-5, alleging that Macquarie violated its obligations under Item 303 by not disclosing the potential impact that a ban on high sulfur fuels could have on its oil storage business.  The District Court dismissed the case, holding that the plaintiff had failed to allege any false statements or omissions, including Item 303 omissions.  On appeal, the Second Circuit reinstated the plaintiff’s Section 10(b) and Rule 10b-5 claims.  Macquarie then sought a writ of certiorari to the Supreme Court, which the Court granted on September 29, 2023.

The Supreme Court Hears Oral Argument and Signals a Narrow Ruling

The tenor of the Court’s January 16, 2024 oral argument foreshadowed how it may rule. The Justices’ questioning focused primarily on the language of Rule 10b-5, which, according to the Court, only contemplates liability for affirmative misstatements.  Justice Jackson, for example, emphasized the difference between the language in Section 11 of the Securities Act and the language in Rule 10b-5, opining: “When you’re required to state something and you don’t state it, Section 11 says there’s liability.  We have different language in 10b-5.”  Justice Jackson suggested that allowing Item 303 to per se support a Rule 10b-5 omission claim would “write[] out of [Rule 10b-5] something about the statement being rendered misleading.”  It would mean that “anytime you are required to disclose certain information in a statement and it isn’t there you have a misleading statement.”  Justices Alito, Barrett, Kavanaugh, and Gorsuch voiced similar concerns about adopting such an expansive interpretation of Rule 10b-5 liability.

That was not the only concern that surfaced during oral argument.  Chief Justice Roberts raised the related issue of whether allowing Item 303 to support pure omission claims would create the sort of implied private right of action that the Court has historically been hesitant to confer.  In questioning that appeared to sound the death knell for a Moab Partners’ theory of liability, he expressed reticence “to get any further into the business of implying private rights of action.”

Implications of the Supreme Court’s Ruling

Regardless of how the Court rules, one thing is clear:  the consequences of its decision are potentially far-reaching. A ruling that Item 303 violations can serve as a basis for liability under Section 10(b) and Rule 10b-5 would broaden their scope to more closely resemble Section 11 and Section 12(a)(2) liability for omissions of “a material fact required to be stated.”  It would also raise questions about whether other disclosure obligations under Regulation S-K should be afforded similar treatment.  This could have particularly significant implications for issuers given the SEC’s recent changes to Regulation S-K, including its imposition of significant new disclosure requirements related to cybersecurity risk management.

The opposite ruling—that Item 303 omissions cannot serve as an independent basis for Section 10(b) and Rule 10b-5 liability—would have a more moderate impact. While it would reduce the number of pleading tools in securities plaintiffs’ arsenal, it is unlikely to reduce the number of securities cases filed.  Few securities class action complaints are based solely on Item 303 omissions.  Thus, the more likely outcome would be a change in how omission cases are pled.  As Justice Barrett indicated in her questioning, if securities plaintiffs cannot rely on Item 303 to establish a duty of disclosure, they will be forced to re-frame pure omission claims as “misleading statement” claims.  But as Justice Kagan pointed out, this reframing would not necessarily cause a tectonic shift in securities pleadings because if an issuer’s MD&A “lists three trends, but it doesn’t list a fourth that’s actually much more consequential” and “cuts in the opposite direction,” a securities plaintiff may have satisfied its Rule 10b-5 pleading requirement even without relying on Item 303.

Regardless of how the Court rules, its decision is unlikely to change the way issuers approach their MD&A disclosures.  True, a ruling in Moab Partners’ favor could incentivize issuers to over-disclose information to ward off costly shareholder suits.  However, because issuers are already subject to SEC review and enforcement action regarding their MD&A disclosures, the Court’s ruling is likely to have a negligible effect on what registrants disclose.

Sarah Eichenberger and Jonathan Rotenberg are partners at the law firm of Katten Muchin Rosenman LLP.