Macquarie says Second Circuit makes a mockery of Section 10(b)

On January 16, 2024, the Supreme Court heard argument in Macquarie Infrastructure Corporation et al. v. Moab Partners LP et al., No. 22-1165. Macquarie presents an important issue for publicly traded companies and their D&O insurers respecting the scope of Section 10(b) liability. The Second Circuit held that an omission in a company’s Item 303 can form the basis of a Section 10(b) claim, even if the plaintiff does not allege that the omission rendered another statement misleading. This decision is at odds with other Circuits that hold that Section 10(b) liability exists only where the company makes an untrue statement or omits a material fact necessary to make another statement not misleading.

The Supreme Court’s ultimate decision will be important because:

  • The Second Circuit’s approach expands the private right of action under Section 10(b) for securities fraud.
  • Securities fraud cases are expensive to defend and settle. If the private right of action for securities fraud is expanded to include pure omissions in Item 303s, costs for publicly traded companies and their D&O insurers will go up.
  • An invisible line between Item 303 liability and Section 10(b) liability could incentivize companies to err on the side of over-disclosure.
  • The current circuit split opens the door to forum shopping, which further drives up the cost of litigation. The two busiest circuits for securities litigation are the Second and Ninth Circuits, which are at odds on this issue.

Section 10(b)

Section 10(b) of the Securities Exchange Act of 1934 prohibits manipulation and deception in the purchase or sale of securities. To that end, SEC Rule 10b-5 makes it unlawful for a company to make an untrue statement or to omit a “material fact necessary in order to make the statements made not misleading.” By its own language, Rule 10b-5 does not create an affirmative duty to disclose any and all material information. Other than in the context of insider trading, Rule 10b-5 requires disclosure only to the extent necessary to “make the statements made not misleading.” Put another way, a company can limit its speech without violating Rule 10b-5. Silence is not ipso facto misleading. A company is not required under Rule 10b-5 to tell investors everything they might want to know. A company can limit its disclosure obligations by limiting what it tells the market. But if it chooses to disclose, it cannot tell misleading half-truths. A violation of this rule can give rise to a private right of action by shareholders.

Item 303

Item 303 of SEC Regulation S-K calls for additional disclosures under a different standard. Item 303 requires a company to disclose “known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact” on its financial performance. By its nature, Item 303 does not create a hard-and-fast rule about what facts must be disclosed. It depends on management’s judgment about what is reasonably likely to occur in the future. Under some circumstances, disclosure is mandatory. Under other circumstances, disclosure is optional. A question about such judgments can give rise to an SEC inquiry and a potential enforcement action.

Moab v. Macquarie

Macquarie was a publicly traded company that owned and operated liquid storage services. Macquarie stored or handled commodity and specialty chemicals, vegetable and tropical oils, and black oil. In 2008, regulators promulgated a proposed regulation that would cap the sulfur content of fuel oil used in shipping at 0.5% by 2020. Black oil contains 3% sulfur. In 2016, regulators formally fixed the 0.5% sulfur cap to go into effect in 2020. In 2017, many of Macquarie’s customers gave notice of their intent not to renew their contracts for storage of black oil.

In 2018, Macquarie announced a successful fourth quarter and year-end 2017 financial results, showing an 8% increase in cash flow. At the same time, however, Macquarie announced it was reducing its 2018 dividend guidance. Macquarie explained that the factors that led to the decision to lower the anticipated dividend included issues affecting the company’s access to capital markets, new tax incentives to reinvest in the business, and a desire to maintain a more flexible balance sheet. The decline in demand for storage of black oil due to the new regulation was also identified as one of the factors. The company’s prior Item 303s did not discuss the regulation. Following this news, Macquarie’s stock price dropped. This lawsuit followed.

Moab, a shareholder, alleged that between 2016 and 2018, Macquarie defrauded investors by failing to disclose that the sulfur cap would have a material impact on the company’s overall financial performance. Moab asserted a claim on behalf of a class of shareholders for violation of Section 10(b), among other claims.

The Second Circuit found that Moab’s complaint adequately alleged that the sulfur cap was known to the company and reasonably likely to have a material unfavorable impact on its financial performance, such that the company plausibly violated Item 303 by not disclosing the regulation sooner. Then, the Second Circuit went a step further and held that the company’s alleged Item 303 violation qualified as an actionable omission under Section 10(b).

The Second Circuit’s decision presented a circuit split on whether an alleged violation of the duty to disclose under Item 303 can, by itself, support a cause of action under Section 10(b). The Third, Ninth, and Eleventh Circuits hold that a failure to disclose under Item 303 is not sufficient on its own to support a Section 10(b) claim. The Fifth Circuit has expressed a similar view in dicta. The Second Circuit held in this case that it may.

On this basis, Macquarie petitioned to the Supreme Court. The Supreme Court agreed to review. On appeal, the company is asking the Supreme Court to affirm that Section 10(b) liability is limited to where a company makes an untrue statement or makes a statement that is misleading without further disclosure—and does not apply when the company fails to make a disclosure required by some other SEC rule.

Oral Argument

On January 16, 2024, the Supreme Court heard argument.

Macquarie attempted to appeal to the textualists on the Court by emphasizing that the text of Section 10(b) and Rule 10b-5 specifically requires that the omission render other “statements” misleading. Macquarie argued: “The text doesn’t permit eliding the statement requirement by treating the entire management narrative as misleading if one thing is left out. The PLSRA shows that Congress had something far more specific in mind by the word ‘statement’.” Macquarie argues that no specific statement in any of its Item 303s or financial statements were untrue or misleading, and that Moab is trying to bootstrap liability under Section 10(b) by arguing that the omission in the Item 303 rendered the company’s general narrative misleading. In addition, the company noted that even though an Item 303 omission cannot be the subject to a private right of action under Rule 10b-5, the SEC has the power to penalize an omission that violates Item 303, so the company is not arguing for immunity.

Moab emphasized the moral hazard that would result if Macquarie has its way: “If accepted, Petitioners’ argument would create a roadmap for fraud. Petitioners knew they were about to lose a substantial part of their business but kept their stock price artificially inflated by deliberately withholding information about their readiness to comply with an important rule change.” Moab characterized the SEC’s authority over such an omission as “meager” compared to the resources of  institutional investors and the plaintiffs’ securities bar to bring private actions.

The Justices raised a number of interesting questions, including whether Macquarie’s distinction between half-truths, which are actionable under Section 10(b), and pure omissions, which are not, would be difficult to apply in practice, and whether the MD&A section of Item 303 as a whole could qualify as a “statement.”

A decision will not likely be issued for several months.