Introduction: On September 29, 2023, the Supreme Court agreed to hear an appeal from the Second Circuit to resolve a split between the circuits over whether a failure to make a disclosure required under Item 303 of Regulation S-K––Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)––standing alone, is sufficient to give rise to a private right of action under Rule 10b-5. Specifically, the Supreme Court was asked to address: “Whether the Second Circuit erred in holding—in conflict with the Third, Ninth, and Eleventh Circuits—that a failure to make a disclosure required under Item 303 can support a private claim under Section 10(b), even in the absence of an otherwise-misleading statement.”

Item 303 of Regulation S-K: Item 303 of Regulation S-K is an administrative rule that requires companies to describe as part of their periodic reports to the SEC, “any known trends or uncertainties that have had or that the registrant reasonably expects will have a materially favorable or unfavorable impact” on the company. See 17 C.F.R. § 229.303(a)(3)(ii). The SEC has issued guidance stating that a company must make a disclosure under Item 303 regarding certain information “where a trend, demand, commitment, event or uncertainty is both presently known to management and reasonably likely to have material effects on the registrant’s financial conditions or results of operations.” See Management’s Discussion and Analysis of Financial Condition and Results of Operations at 14, Exchange Act Release No. 6835, 43 S.E.C. Docket 1330 (May 18, 1989). In 2020 when the SEC amended Item 303, it set a “reasonably likely” threshold in certain provisions of MD&A and indicated that the analysis included in MD&A should be based on objective reasonableness.

Item 303 does not provide explicitly a private right of action for investors to sue if these disclosure requirements are not met—it only serves as the basis for an SEC enforcement action.

Moab Partners, L.P. v. Macquarie Infrastructure Corp. and the Circuit Split: In 2018, investor Moab Partners, L.P. (“Moab”) filed a class action lawsuit against Macquarie Infrastructure Corp. (“MIC”), in the United States District Court for the Southern District of New York, alleging that MIC made false statements and omissions to investors regarding the possible ramifications of new international regulatory laws which would ban one of the fuels that MIC stored, No. 6 oil. City of Riviera Beach Gen. Emps. Ret. Sys. v. Macquarie Infrastructure Corp., No. 18-CV-3608 (VSB), 2021 WL 4084572 (S.D.N.Y. Sept. 7, 2021). If passed, the regulations would have long-term negative consequences on MIC’s business. After the new law came into effect, MIC’s stock price declined.

Plaintiffs alleged violations of Section 10(b) and Rule 10b-5, among others. Specifically, Moab alleged that MIC was required but failed to disclose (a) MIC’s reliance on revenue from the storage of No. 6 oil, (b) the risk that implementation of the regulations “would severely curtail ‘the demand for storage’” of No. 6 oil, and (c) the risk that MIC would “need to undertake significant capital expenditures to repurpose” some of its tanks in response to market conditions.

The defendants moved to dismiss the complaint for failure to state a claim, and the district court granted the motion. The Court rejected Moab’s argument that MIC violated a disclosure obligation under Item 303 of SEC Regulation S-K. The Court held that Plaintiffs failed to “plead facts supporting an inference that Defendants had actual knowledge of a material trend or uncertainty facing MIC’s No. 6 fuel oil storage business, and that it had this knowledge early enough to require disclosure in some pre-February 2018 securities filing,” and that the Complaint fell “short of pleading facts showing that Defendants’ statements were “not honestly believed when they were made.” Id. at *10.

Plaintiffs appealed, and the Second Circuit reversed, holding that Moab had alleged actionable omissions for purposes of Section 10(b). Moab Partners, L.P. v. Macquarie Infrastructure Corp., No. 21-2524, 2022 WL 17815767, at *3 (2d Cir. Dec. 20, 2022). The panel “agree[d] with the district court that the majority of Defendants’ alleged misstatements are not actionable,” but it concluded that Moab “ha[d] adequately alleged a ‘known trend[] or uncertaint[y]’ that gave rise to a duty to disclose under Item 303.” Id. at *2-*3.

In their petition for certiorari, Defendants highlighted how the Second Circuits’ decision in Moab contradicts the holdings of four other circuits, all of which have held that a violation of Item 303, standing alone, does not create a private right of action under Section 10(b). The Third Circuit was the first court of appeals to address the intersection between Item 303 and Section 10(b) in Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000). The explained that there are two ways in which an Item 303 violation could confer a private right of action. First, an Item 303 violation could be actionable if Item 303 “create[d] an independent private right of action,” but neither “the language of the regulation nor the SEC’s interpretative releases construing it” supported one. Id. at 287. Second, there could be liability under Section 10(b) if Item 303 “impose[d] an affirmative duty of disclosure . . . that, if violated, would constitute a material omission under Rule 10b-5.” Id. But this path was not viable either, as “the materiality standards for Rule 10b-5 and [Item] 303 differ significantly.” Id. at 288.

The Third Circuit recognized that these disclosure obligations “extend considerably beyond those required by Rule 10b-5” under Basic’s materiality test. Id. (quotation and citation omitted). “Because the materiality standards for Rule 10b-5 and [Item ]303 differ significantly,” the court held that a violation of Item 303’s disclosure requirement “does not automatically give rise to a material omission under Rule 10b-5.” Id. A “duty to disclose” under Rule 10b-5 “must be separately shown.” Id. The Ninth, Eleventh, Sixth, and Fifth Circuits have held similarly. See In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046, 1054, 1056 (9th Cir. 2014) (“Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b-5.”); Carvelli v. Ocwen Fin. Corp., 934 F.3d 1307, 1331 (11th Cir. 2019) (“Item 303 imposes a more sweeping disclosure obligation than Rule 10b-5, such that a violation of the former does not ipso facto indicate a violation of the latter.”); In re Sofamor Danek Grp., Inc., 123 F.3d 394, 403 (6th Cir. 1997) (holding that plaintiffs argument “that defendants’ disclosure duty under the Rule 10b–5 claim may stem from Item 303” was “unpersuasive”); Mun. Emps.’ Ret. Sys. of Mich. v. Pier 1 Imports, Inc., 935 F.3d 424, 436 (5th Cir. 2019) (stating that it “ha[s] never held that Item 303 creates a duty to disclose under the Securities Exchange Act.”).

Impact: If the Supreme Court adopts the Second Circuit’s approach, plaintiffs would be able to establish a duty to disclose under Section 10(b) and Rule 10b-5 when they otherwise may not be able to plead an omission case, potentially giving rise to significant enhanced liability for public companies’ disclosures pursuant to Item 303.