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Private Suits Based on Item 303 Violations Remain Viable Post-Macquarie

Rachel Avan and Marco Antonio Duenas

Summary

  • The Court’s opinion in Macquarie has massive practical implications for investors.
  • After Macquarie, Item 303 violations continue to give rise to private rights of action for securities fraud under Rule 10b-5(b) whenever issuers make false and misleading statements (i.e., tell lies) and when they partially state the truth while omitting critical qualifying information (i.e., tell half-truths).
  • As a result, notwithstanding the Supreme Court’s narrow holding in Macquarie, investors should remain confident in their ability to seek recovery of investment losses stemming from revelations of omissions that violate Item 303.
Private Suits Based on Item 303 Violations Remain Viable Post-Macquarie
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On April 12, 2024, the U.S. Supreme Court unanimously held that “pure” omissions, where a public company remains silent and says nothing about a subject, are not actionable under Securities and Exchange Commission (SEC) Rule 10b-5(b). Macquarie Infrastructure Corp. v. Moab Partners, L.P., 601 U.S. 257 (2024). The Court’s holding resolved a split between the Second, Third, and Ninth Circuits over whether an issuer’s failure to disclose “known trends or uncertainties” as required by Item 303 of SEC Regulation S-K, in the absence of an otherwise misleading statement, can serve as the basis of a securities fraud claim under section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5(b). While Macquarie answers this question in the negative—finding that a failure to disclose Item 303 information cannot support a Rule 10b-5(b) claim absent an otherwise misleading statement—the Court’s opinion is perhaps more notable because it left intact every other way Item 303 violations can support private rights of action under the federal securities laws.

After Macquarie, issuers remain liable for Item 303 violations under Rule 10b-5(b) if they tell lies or “half-truths,” i.e., representations that partially state the truth while omitting critical qualifying information. While issuers are no longer liable for pure omissions involving Item 303 violations under Rule 10b-5, the Court expressly did not opine on what constitutes a lie, when a half-truth is misleading, or whether Rules 10b-5(a) and 10b-5(c)—the “scheme liability” provisions—can support a securities fraud claim for pure omissions. Issuers also remain liable for Item 303 violations under sections 11 and 12 of the Securities Act of 1933 whenever a registration statement or prospectus for an initial public offering or secondary public offering contains a lie, half-truth, or pure omission. Given the Court’s narrow holding in Macquarie, investors will continue to be able to assert private rights of action based on Item 303 violations under both the Exchange Act and the Securities Act.

Statutory and Regulatory Background

Section 13(a) of the Exchange Act requires issuers to file periodic documents, e.g., quarterly and annual reports on Forms 10-Q and 10-K, respectively. These reports include Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 303 sets forth affirmative disclosures issuers must include in it: “any known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” 17 C.F.R. § 229.303(b)(2)(ii) (2021). Further, if the issuer “knows of events that are reasonably likely to cause a material change in the relationship between costs and revenues . . . , the change in the relationship must be disclosed.” Id.

Section 10(b) of the Exchange Act prohibits issuers from using or employing, in connection with the purchase or sale of securities, “any manipulative device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe . . . for the protection of investors.” 15 U.S.C. § 78j(b). As the implementing regulation for section 10(b), SEC Rule 10b-5 makes it unlawful to “make any untrue statement of a material fact” (i.e., tell a lie) 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” (i.e., tell a half-truth) in connection with the purchase or sale of securities. 17 C.F.R. § 240.10b-5(b) (2022). Rule 10b-5 also makes it unlawful to “employ any device, scheme, or artifice to defraud” or to “engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person” in connection with the purchase or sale of securities. 17 C.F.R. § 240.10b-5(a) & (c) (2022).

Section 11 of the Securities Act makes it unlawful for an initial public offering or secondary public offering registration statement to “contain[] an untrue statement of a material fact” (i.e., a lie), “omit[] to state a material fact required to be stated therein” (i.e., a pure omission), or “omit[] to state a material fact . . . necessary to make the statements therein not misleading” (i.e., a half-truth). 15 U.S.C. § 77k(a). Section 12 of the Securities Act creates parallel liability for false and misleading statements and omissions found in an initial public offering or secondary public offering prospectus. See 15 U.S.C. § 77l(a); see also In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d Cir. 2010) (“Claims under sections 11 and 12(a)(2) are . . . Securities Act siblings with roughly parallel elements”).

For section 10(b) of the Exchange Act, the Supreme Court has “found a [private] right of action implied in the words of the statute and its implementing regulation.” Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 157 (2008). By contrast, Congress created express private rights of action in the text of sections 11 and 12 of the Securities Act. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 728 (1975).

Factual, Procedural, and Legal Background

Macquarie Infrastructure Corporation owns infrastructure-related businesses, including a subsidiary, International-Matex Tank Terminals (IMTT), that operates bulk liquid storage terminals in the United States. IMTT terminals handle and store liquid commodities, including petroleum, biofuels, chemicals, and oil products. One such liquid commodity is No. 6 fuel oil, an oil refinery by-product that historically has had a sulfur content as high as 3 percent. In 2016, the United Nations’ International Maritime Organization (IMO) formally adopted IMO 2020, capping the sulfur content of fuel oil at 0.5 percent. In the years that followed, Macquarie did not discuss IMO 2020 in its public offering documents, including for Macquarie’s November 2016 secondary public offering. In February 2018, Macquarie’s stock price fell by over 40 percent after Macquarie revealed that the amount of storage capacity contracted for use by IMTT’s customers had dropped in part due to a decline in the demand for No. 6 fuel oil. See Macquarie, 601 U.S. at 261; see also Moab Partners, L.P. v. Macquarie Infrastructure Corp., 2022 WL 17815767, at *1, *3–4 (2d Cir. Dec. 20, 2022).

A municipal pension fund filed suit in the U.S. District Court for the Southern District of New York, alleging Exchange Act and Securities Act violations against Macquarie, its manager, the underwriter for Macquarie’s November 2016 secondary public offering, and certain former executives and directors. Moab Partners, 2022 WL 17815767, at *1. The district court appointed Moab Partners L.P. as the lead plaintiff, and Moab filed a consolidated complaint. Moab alleged that Macquarie made false and misleading statements by concealing from investors that No. 6 fuel oil, which constituted “over 40% of [IMTT’s] storage capacity[,] . . . faced a near-cataclysmic ban” on much of its worldwide use due to IMO 2020. According to Moab, Macquarie had a “duty to disclose” the extent to which IMTT’s storage capacity was devoted to No. 6 fuel oil. See City of Riviera Beach Gen. Emps. Ret. Sys. v. Macquarie Infrastructure Corp., 2021 WL 4084572, at *4, *6 (S.D.N.Y. Sept. 7, 2021).

The district court dismissed Moab’s complaint, holding that Moab had “not actually plead[ed] an uncertainty that should have been disclosed” or “in what SEC filing or filings Defendants were supposed to disclose it.” Id. at *10. The Second Circuit Court of Appeals reversed, reasoning that there are “two circumstances which impose a duty on a corporation to disclose omitted facts.” Moab Partners, 2022 WL 17815767, at *1. The Second Circuit noted that, first, a duty to disclose may arise when a statute or regulation requires disclosure, such as Item 303, and second, even when no independent duty to disclose exists, “once a company speaks on an issue or topic, there is a duty to tell the whole truth.’” Id. (citations omitted). Crediting Moab’s allegations as true, the Second Circuit held that the defendants knew of IMO 2020’s significant restriction of No. 6 fuel oil use and that it was reasonably likely to have material effects on Macquarie’s financial results. Id. at *3. The Second Circuit further held that Moab had adequately alleged a “known trend[] or uncertaint[y]” that triggered a duty to disclose under Item 303, which formed the basis of Moab’s claims under sections 11 and 12(a)(2) of the Securities Act and section 10(b) of the Exchange Act. Id. at *2–4.

The Second Circuit’s holding exacerbated a growing circuit split on whether Item 303 violations can support securities fraud claims under section 10(b) of the Exchange Act and SEC Rule 10b-5. In Stratte-McClure v. Morgan Stanley, the Second Circuit had held that “Item 303’s affirmative duty to disclose . . . can serve as the basis for a securities fraud claim under Section 10(b).” 776 F.3d 94, 101 (2d Cir. 2015). By contrast, in In re NVIDIA Corp. Securities Litigation, the Ninth Circuit had held that “Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b-5” and that “[s]uch a duty to disclose must be separately shown.” 768 F.3d 1046, 1056 (9th Cir. 2014) (citations omitted). Similarly, in Oran v. Stafford, the Third Circuit had held that a violation of Item 303’s disclosure requirements “does not lead inevitably to the conclusion that such disclosure would be required under Rule 10b-5[,]” as a duty to disclose “must be separately shown.” 226 F.3d 275, 288 (3d Cir. 2000) (internal quotation marks and citations omitted). Given this circuit split, the Supreme Court granted certiorari only to resolve “whether a failure to make a disclosure required by Item 303 can support a private claim under § 10(b) and Rule 10b-5(b) in the absence of an otherwise misleading statement.” Macquarie, 601 U.S. at 262–63 & n.1 (emphasis added).

The Supreme Court’s Narrow Holding in Macquarie

Writing for a unanimous Supreme Court, Justice Sonia Sotomayor observed that “[t]his case turns on whether” SEC Rule 10b-5(b) “bars only half-truths or instead extends to pure omissions.” Id. at 263. The Court started from the premise that Rule 10b-5(b) literally prohibits “‘any untrue statement of a material fact’—i.e., false statements or lies” and the omission of “a material fact necessary ‘to make the statements made . . . not misleading[,]’”—i.e., half-truths. Id. Next, the Court explained that a pure omission occurs only when “a speaker says nothing, in circumstances that do not give any particular meaning to that silence”; whereas half-truths are “representations that state the truth only so far as it goes, while omitting critical qualifying information.” Id. (internal quotation marks and citations omitted). The Court likened the difference between pure omissions and half-truths to “the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.” Id. at 264.

Taking a textualist approach, the Court held that Rule 10b-5(b) “does not proscribe pure omissions”; rather, Rule 10b-5(b) proscribes the omission of material facts necessary to make the statements made not misleading. Id. In other words, Rule 10b-5(b) requires issuers to disclose material facts necessary to ensure that prior statements “are clear and complete (i.e., that the dessert was, in fact, a whole cake).” Id. “Logically and by its plain text,” the Court explained, Rule 10b-5(b) requires that prior affirmative statements be identified before determining if other facts must be disclosed to prevent those statements from being misleading. Id. (citations omitted).

The Court emphasized that statutory construction and context are further evidence of “what the text plainly provides.” Id. For example, section 11(a) of the Securities Act prohibits any registration statement that “contain[s] an untrue statement of a material fact or omit[s] to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” Id. (emphasis added). The Court observed that section 11 expressly proscribes lies, half-truths, and pure omissions for failure to speak on a subject; whereas section 10(b) and Rule 10b-5(b) do not contain similar language: “Neither Congress in § 10(b) nor the SEC in Rule 10b-5(b) mirrored § 11(a) to create liability for pure omissions. That omission (unlike a pure omission) is telling.” Id. at 264–65.

Accordingly, the Court held that even a duty to disclose, such as the duty triggered by Item 303, “does not automatically render silence misleading under Rule 10b-5(b).” Id. at 265. Rather, “the failure to disclose information required by Item 303 can support a Rule 10b-5(b) claim only if the omission renders affirmative statements made misleading.” Id.

Item 303 Claims’ Continued Viability after Macquarie

Importantly, the Macquarie Court stressed that it granted certiorari only to address a narrow issue: the Second Circuit’s pure omission analysis under Rule 10b-5(b), not its half-truth analysis. Indeed, the Supreme Court did not opine on “issues that are either tangential to the question presented or were not passed upon below, including what constitutes ‘statements made,’ when a statement is misleading as a half-truth, or whether Rules 10b-5(a) and 10b-5(c) support liability for pure omissions.” Id. at 266 n.2. In remanding the case for further proceedings consistent with its holding, the Supreme Court did not disturb the Second Circuit’s holdings with respect to Moab’s other claims under section 10(b) of the Exchange Act or its claims under sections 11 and 12(a)(2) of the Securities Act. Procedurally, the Supreme Court’s opinion preserved each and every other of Moab’s claims in its case against Macquarie.

The Court’s opinion in Macquarie has massive practical implications for investors. After Macquarie, Item 303 violations continue to give rise to private rights of action for securities fraud under Rule 10b-5(b) whenever issuers make false and misleading statements (i.e., tell lies) and when they partially state the truth while omitting critical qualifying information (i.e., tell half-truths). While investors can no longer base Rule 10b-5(b) claims in Item 303 violations when issuers say nothing about a subject (i.e., pure omissions), Macquarie will not impede most investors’ securities fraud claims (or recoveries) under Rule 10b-5(b) because, even before Macquarie, very few such cases alleged pure omissions as the sole basis of liability. Issuers may interpret Macquarie as incentivizing their silence regarding adverse material facts, but they should heed the Supreme Court’s warning that district courts retain discretion to interpret what constitutes a false and misleading statement and when such a statement is misleading as a half-truth. In other words, issuers may still face securities fraud liability for their silence when Item 303 omissions render affirmative statements misleading in context. Item 303 violations also continue to give rise to securities fraud claims under the “scheme liability” provisions of SEC Rules 10b-5(a) and 10b-5(c).

In addition, Item 303 violations continue to give rise to securities claims under sections 11 and 12 of the Securities Act whenever issuers file and disseminate a registration statement or prospectus for an initial or secondary public offering that contains a lie, a half-truth, or a pure omission.

As a result, notwithstanding the Supreme Court’s narrow holding in Macquarie, investors should remain confident in their ability to seek recovery of investment losses stemming from revelations of omissions that violate Item 303.

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