(Article from Securities Law Alert, April 2017)
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On March 27, 2017, the Supreme Court granted certiorari to resolve a circuit split on the issue of whether Item 303 of SEC Regulation S-K creates a duty to disclose that is actionable under Section 10(b) and Rule 10b-5. Leidos v. Indiana Pub. Ret. Sys. (No. 16-581).
Item 303 of Regulation S-K sets forth the disclosure requirements for the Management’s Discussion and Analysis (MD&A) section of a public company’s Form 10-Qs and other SEC filings. In relevant part, Item 303 states that a public company must “[d]escribe 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).
On January 12, 2015, the Second Circuit held that “a failure to make a required Item 303 disclosure . . . is indeed an omission that can serve as the basis for a Section 10(b) securities fraud claim.” Stratte-McClure v. Morgan Stanley, 776 F.3d 94 (2d Cir. 2015) (Livingston, J.) (Stratte-McClure).[1] However, the Second Circuit stated that “such an omission is actionable only if it satisfies the materiality requirements outlined in Basic v. Levinson, 485 U.S. 224 (1988).”
The Second Circuit in Stratte-McClure acknowledged that its ruling was “at odds” with the Ninth Circuit’s decision in In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (2014) (O’Connell, J.).[2] There, the Ninth Circuit found that “[m]anagement’s duty to disclose under Item 303 is much broader than what is required under . . .Basic,” and concluded that “Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b-5.” In so holding, the Ninth Circuit relied on the Third Circuit’s reasoning in Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000) (Alito, J.). The Oran court stated that “[b]ecause the materiality standards for Rule 10b-5 and [Item 303] differ significantly, the demonstration of a violation of the disclosure requirements of Item 303 does not lead inevitably to the conclusion that such disclosure would be required under Rule 10b-5.”
The Stratte-McClure court found that the Ninth Circuit had read the Third Circuit’s decision in Oran too broadly. The Stratte-McClure court stated that “Oran actually suggested, without deciding, that in certain instances a violation of Item 303 could give rise to a material [Rule] 10b-5 omission . . . so long as the omission is material under Basic.” Stratte-McClure, 776 F.3d 94.
On March 29, 2016, the Second Circuit relied on its prior decision in Stratte-McClure to deny a motion to dismiss a claim brought under Section 10(b) and Rule 10b-5 alleging the failure to disclose a known trend or uncertainty as required under Item 303. Indiana Pub. Ret. Sys. v. SAIC, 818 F.3d 85 (2016) (SAIC) (Lohier, J.).[3] Defendants successfully petitioned the Supreme Court for certiorari to address the question of whether the Second Circuit erred in holding that the failure to make a required Item 303 disclosure is actionable under Section 10(b) and Rule 10b-5.
The Court is expected to hear the case in October Term 2017.
[1] Please click here to read our prior discussion of the Second Circuit’s decision in Stratte-McClure.
[2] Please click here to read our prior discussion of the Ninth Circuit’s decision in NVIDIA.
[3] Please click here to read our prior discussion of the Second Circuit’s decision in SAIC.