Washington, D.C. (October 4, 2023) - Public companies and private securities practitioners take note: The Supreme Court has agreed to rule on a circuit split regarding whether the failure to disclose information required in a company's Management Discussion and Analysis (MD&A) disclosure in its public filings (including its annual and quarterly filings, Forms 10K and 10Q) can be actionable in a private securities fraud action brought under Section 10(b) of the Securities Exchange Act of 1934.
At least three circuits, the Third, Ninth, and Eleventh, have ruled that an issuer's failure to make a disclosure required under Item 303 of SEC Regulation S-K cannot, in and of itself, support a private fraud claim without otherwise materially false or misleading affirmative misstatements. See Carvelli v. Ocwen Fin. Corp., 934 F.3d 1307, 1331 (11th Cir. 2019); In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1054, 1056 (9th Cir. 2014); Oran v. Stafford, 226 F.3d 275, 286 n.6 (3d Cir. 2000) (Alito, J.). But courts in the Second Circuit have taken the opposite approach, ruling in several district court and appellate cases, most recently in Macquarie Infrastructure Corp. v. Moab Partners, L.P., et al., No. 21-2524 (2d Cir. Dec. 20, 2022), that a private plaintiff may base Section 10(b) fraud claims on a company's omissions in its MD&A disclosures, as opposed to affirmative false statements.
This will be an important decision. It goes to the heart of a fundamental issue regarding a public company's disclosure obligations: does a company's duty to disclose arise any time there is a "statute or regulation requiring disclosure," as the Second Circuit holds, or does its duty only arise with respect to not making false or misleading statements? There is a big difference between these two standards.
As written in the Section 10(b) statute and supporting regulations, and as previously interpreted by the Supreme Court, the requirements for bringing a Section 10(b) fraud claim are stringent and narrow. Section 10(b) prohibits manipulation and deception in the purchase and sale of securities. As the Supreme Court held, this provision does not create an affirmative duty to disclose any and all material information about a company. Instead, public companies are only required to disclose information to the extent "necessary" to make an affirmative statement "not misleading." A company is thus not required to disclose everything potentially important about its current and future operations to avoid being charged with 10(b) fraud. Instead, to be actionable, the company must have made a materially false statement, a misleading half-truth, or a factual omission that it should have included to make a prior statement not misleading. In other words, a company does not have to disclose anything, but if it does, it needs to make sure that its statements are the truth, the whole truth, and nothing but the truth.
On the other hand, Item 303 of Regulation S-K requires a company to affirmatively disclose a much broader array of facts to investors. And these facts not only include current, known facts, but also projections, estimates, and predictions about future trends and uncertainties that the company subjectively believes, "are reasonably likely based on management's assessment to have a material impact on future operations." 17 CFR § 229.303. Thus, under Item 303, the company must look into its crystal ball and make reasonable predictions about where the company is going. Not an easy task. To be sure, such projections may be valuable to investors, especially if they are set forth with careful and reasoned judgment and analysis by management.
However, as the petitioners will surely argue before the Supreme Court in the upcoming Macquarie case, the problem with allowing private plaintiffs (and the SEC) to litigate over such subjective judgment calls is that it likely will have serious ramifications on future public company disclosures. For example, to avoid potential lawsuits, companies may simply resort to widescale "carpet-bombing" disclosures that opine and speculate about every possible contingency and event that could possibly affect their company. As such, MD&A sections, which are meant to be clear and concise and easy to read (see CommissionGuidanceRegarding Management's Discussion and Analysis of Financial Condition and Results of Operations: "We believe that management's most important responsibilities include communicating with investors in a clear and straightforward manner") now may become massive, watered-down, phonebook-size publications that contain little valuable information or insight for investors.
The respondents in Macquarie will certainly argue to the contrary - that allowing 10(b) claims to target omissions in MD&A disclosures about material events will only ensure that companies do a better job in assessing future trends and risks, to protect investors.
Regardless of which way the Supreme Court rules, it is guaranteed that this decision will be closely followed and much-debated by all interested stakeholders on both sides of the issue.In the meantime, public companies should work closely with experienced counsel to ensure that their disclosures take careful account of this evolving area of the law.
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