The Second Circuit held yesterday that Item 303 of SEC Regulation S-K requires issuers to disclose only those trends, events, or uncertainties about which the issuer has actual knowledge, rather than those matters about which the issuer allegedly should have known. The court’s decision in Indiana Public Retirement System v. SAIC, Inc. also reinforced prior holdings that generalized statements about high ethical standards and integrity constitute immaterial puffery and are therefore not actionable.

Item 303 Disclosures. The SAIC securities class action challenged certain financial statements that the issuer had issued in the midst of ongoing investigations of alleged abuse of government contracts. The plaintiff shareholders contended that the financial statements were false and misleading for various reasons, including the failure to disclose the alleged contract abuse and the potential risks from the alleged conduct, such as monetary risks, reputational risks, and potential loss of future business. Those omissions allegedly violated Item 303, which requires issuers to describe “any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 17 C.F.R. § 229.303(a)(3)(ii).

The issuer argued that Item 303 does not require disclosure of “known trends or uncertainties” unless the issuer actually knew about them. The Second Circuit agreed. Acknowledging that it had never directly addressed whether Item 303 requires actual knowledge, the court held that “Item 303 requires the registrant to disclose only those trends, events, or uncertainties that it actually knows of when it files the relevant report with the SEC. It is not enough that it should have known of the existing trend, event, or uncertainty.”

The court also observed that the materiality analysis for Item 303 does not necessarily depend only on quantitative materiality. Materiality can also consider qualitative factors.

Puffery. In light of the issues of alleged contract abuse underlying the case, plaintiffs challenged the issuer’s statements about its “‘culture of high ethical standards, integrity, operational excellence, and customer satisfaction’” and its “‘reputation for upholding the highest standards of personal integrity and business conduct.’” The Second Circuit held that the statements were too general to cause a reasonable investor to rely on them and thus were immaterial puffery.

The court cautioned, however, that “[t]his is not to say that statements about a company’s reputation for integrity or ethical conduct can never give rise to a securities violation.” Rather, “[s]ome statements, in context, may amount to more than ‘puffery’ and may in some circumstances violate the securities laws: for example, a company’s specific statements that emphasize its reputation for integrity or ethical conduct as central to its financial condition or that are clearly designed to distinguish the company from other specified companies in the same industry.”

Future cases might develop the line between integrity statements that are and are not “central to [the issuer’s] financial condition.” We will see whether the line ends up being clear or blurry.