On January 16, 2024, the U.S. Supreme Court will hear oral argument in the matter Macquarie Infrastructure Corporation, et al. v. Moab Partners, L.P., et al. (“Macquarie”) to resolve a circuit split over the types of corporate “non-disclosures” that may be considered actionable in class action suits brought by private plaintiffs under the federal securities laws.
At the heart of the matter is Item 303 of Regulation S-K (“Item 303”), a regulation overseen by the Securities and Exchange Commission (“SEC”). Item 303 requires public companies to include in their financial statements a discussion and analysis (known as management’s discussion and analysis, or “MD&A”) of all “material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.” The SEC designed Item 303 to encourage a more comprehensive and robust analysis by public companies, promoting transparency and aiding investors in making informed decisions.
Because Item 303 imposes an “affirmative duty to disclose” material events and uncertainties related to a company’s financial condition and results of operations, purported violations of Item 303 are oft-alleged as independently actionable omissions by private plaintiffs in federal securities class actions.
As it stands, circuits are split on whether a violation of Item 303 may, standing alone, give rise to liability as an actionable omission under the federal securities laws. In the 2015 case In re NVIDIA Corporate Securities Litigation, the Ninth Circuit, relying on the Third Circuit decision in Oran v. Stafford, held that a company’s failure to disclose a known trend or uncertainty in its financial statements, as required by Item 303, did not in and of itself give rise to liability under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) or Rule 10b-5 promulgated thereunder. Months later, the Second Circuit in Stratte-McClure v. Morgan Stanley, ruled that a failure to disclose under Item 303 can serve as the basis for a securities fraud claim under Section 10(b) and Rule 10b-5 so long as the omission satisfies the materiality requirements outlined in the seminal U.S. Supreme Court case Basic Inc. v. Levinson.
The Macquarie matter centers on Macquarie Infrastructure Corporation’s (“MIC”) alleged failure to disclose the impact that a new international fuel standard would have on the revenue of one of its subsidiaries before the standard went into effect. As alleged by lead plaintiff Moab Partners, L.P. (“Moab”), the impact the standard would have on MIC’s bottom-line created a duty to disclose under Item 303, and defendants’ failure to disclose this material event and/or uncertainty in violation of Item 303 therefore amounted to an actionable omission under Section 10(b) of the Exchange Act and Rule 10b-5. The district court dismissed the case in 2021, holding in part that Moab failed to adequately plead an actionable omission based on allegations that the defendants violated their disclosure obligations under Item 303. The Second Circuit reversed, holding that Moab had adequately alleged a “known trend or uncertainty” that gave rise to a duty to disclose under Item 303, and that a failure to make such a material disclosure as required by Item 303 “can serve as the basis for claims under Sections 11 and 12(a)(2), and for a claim under Section 10(b) if the other elements have been sufficiently pleaded.”
Opponents of the Second Circuit’s standard as set forth in Macquarie argue that expanding the scope of Item 303 to private securities actions creates problems for companies in determining whether a trend or uncertainty is material enough to be included in their MD&A disclosures and that enforcement of the rule is better suited for the SEC. Proponents, on the other hand, argue that private investors often have more resources to hold public companies accountable for failing to disclose information that would be material to a reasonable investor, and that allowing private lawsuits based on Item 303 violations enhances accountability and encourages companies to provide more robust disclosures.
Thus, the Supreme Court’s upcoming decision in Macquarie is likely to draw interest from both the financial and legal communities, as it has the potential to shape the level of transparency and accountability required of public companies in their public disclosures.