The Supreme Court decided Monday to take up the question whether obligations to disclose “known trends or uncertainties” under Regulation S-K Item 303 may give rise to federal securities laws claims. Those in favor of review contend that allowing suits based on Item 303 omissions will open up a Pandora’s box for issuers trying to determine their obligations to publicly speculate about trends and uncertainties impacting the issuer’s business.
It has long been the law that issuers may be silent, even concerning material information, in the absence of a specific duty to disclose, such as when an omission makes other affirmative statements misleading. Under the Supreme Court’s 1988 Basic, Inc. v. Levinson decision, “[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5.” Accordingly, courts of appeals have recognized that “firms are entitled to keep silent (about good news as well as bad news) unless positive law creates a duty to disclose.” Gallagher v. Abbott Labs., 269 F.3d 806, 808 (7th Cir. 2001). This ability to keep silent absent an affirmative duty to disclose applies even as to information “a reasonable investor would very much like to know.” In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1432 (3d Cir. 1997) (Alito, J.).
In recent years, securities-fraud plaintiffs have increasingly turned to the regulation requiring disclosure of certain “known trends or uncertainties” and claimed that those requirements create a duty to disclose that is actionable under the federal securities laws. Under Item 303 of Regulation S-K, 17 C.F.R. § 229.303, issuers are required to include in the “management discussion and analysis,” or “MD&A,” portion of their quarterly filings a description of “any known trends or uncertainties that have had or that the issuer reasonably expects will have a material . . . unfavorable impact on net sales or revenues or income from continuing operations.”
The Supreme Court will now address whether this disclosure requirement creates a duty to disclose that can be actionable in private suits based on Section 10(b) of the Securities Exchange Act of 1934. Currently, the circuit courts are split on this question.
For example, In re NVIDIA Corp. Securities Litigation, 768 F.3d 1046 (9th Cir. 2014), involved an alleged failure to disclose trends related to product defects, which had been disclosed. The court held that Item 303 could not provide the foundation for a private securities fraud claim because the disclosure requirements under Item 303 are broader than those the Supreme Court has applied in the Section 10(b) context.
The Second Circuit has repeatedly disagreed, holding that a failure to disclose under Item 303 could give rise to a private cause of action under Section 10(b). In the case on review, the plaintiffs claim that Leidos, Inc. (previously known as SAIC) failed to disclose information concerning an investigation into improper billing practices in a contract with New York City. In Indiana Public Retirement System v. SAIC, Inc., 818 F.3d 85 (2d Cir. 2016), the Second Circuit noted that SAIC was “aware of the fraud” by the time of issuing its report but “was uncertain about its likely effect on SAIC’s current and future revenues.” The court clarified that actual knowledge of the uncertainty was necessary before an issuer is required to disclose under Item 303. Because SAIC was alleged to have knowledge of the uncertainty, the court held both that the company was required to have disclosed the manner in which the known uncertainty “might reasonably be expected to materially impact” its future revenues and also that the failure to do so gave rise to a claim under Section 10(b) of the federal securities laws.
Those in favor of review believe that the Second Circuit’s approach is contrary to the Supreme Court’s precedents limiting the duty to disclose to situations in which the omitted information is necessary to make affirmative statements not misleading. Concerns about the Second Circuit’s approach include that it could vastly expand potential liability under Section 10(b) for omissions, particularly those related to “soft information” easily manipulated by plaintiffs’ lawyers and susceptible to 20/20 hindsight.
Argument in Leidos, Inc. v. Indiana Public Retirement System, No. 16-581, will take place next term, and the Supreme Court may not reach a decision until late 2017 or in 2018.