Petitioners Make Their Case That Pure Omissions Are Not Actionable Under Section 10(b) and Rule 10b-5.

In 2024, the Supreme Court will be looking once again at the federal securities laws in Macquarie Infrastructure Corp. v. Moab Partners, L.P., Dkt No. 22-1165. The question presented to the Court this time is:  Whether the U.S. Court of Appeals for the Second Circuit erred in holding that a failure to make a disclosure required under Item 303 of SEC Regulation S-K can support a private claim under Section 10(b) of the Securities Exchange Act of 1934, even in the absence of an otherwise misleading statement. The Court thus is primed to resolve a split between the Second Circuit and three other courts—the Third, Ninth and Eleventh Circuits—and will contend with the reach of the court-created implied private right of action to enforce Section 10(b).

In this post, we review the underlying laws at issue, the circuit split created by the Second Circuit’s ruling, and the arguments made to the Court by Petitioners in their papers filed in November.

The Laws at Issue

Securities Exchange Act of 1934 Section 10(b) makes it unlawful “[t]o use or employ, in connection with the purchase or sale of any security… any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe.” 15 U.S.C. §78j(b). Further, Rule 10b-5(b) prohibits making materially false statements or omitting to state material facts necessary to make the statements made not misleading. Id. §240.10b-5(b).  The courts have recognized an implied private right of action to enforce Section 10(b) and Rule 10b-5 and, in 1995, Congress passed the Private Securities Litigation Reform Act (“PSLRA”) to govern that implied private right of action.

In contrast to the prohibitory nature of Section 10(b) and Rule 10b-5, SEC Regulation S-K imposes certain affirmative disclosure obligations on public companies. Item 303 of SEC Regulation S-K requires management of a public company to “[d]escribe 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).

Additionally relevant to this litigation is a regulation by the International Maritime Organization (“IMO”), which is a United Nations agency charged with regulating global shipping. IMO 2020 capped the sulfur content of fuel used in a shipping at 0.5% by the beginning of the year 2020. The rule was proposed in 2008 and, in 2016, the 0.5% cap was formally fixed following agency review of the proposed regulation.

Case History & District Court Ruling

Macquarie Infrastructure Corporation (“MIC”) was a publicly traded company that owned and operated infrastructure-related businesses. Brief for Petitioners filed on November 13, 2023 (“Pet. Br.”) at 10. One such business was International-Matex Tank Terminals (“IMTT”). Id. at 11. Among other storage services, since the 1970s, IMTT provided storage for a high-sulfur fuel oil referred to as No. 6 oil. No. 6 oil is a by-product of the refining process. Id. Over time, the historic demand for No. 6 oil declined due to environmental regulations. In contrast, however, the need to store this unused processing by-product increased and demand for IMTT’s storage services accordingly also increased. Id.

As noted above, in 2008, IMO proposed a new regulation, capping the sulfur content of fuel which raised a question about going-forward demand for No. 6 oil. In 2016, IMO formally fixed the cap at 0.5% by 2020.

In late 2017 and early 2018, IMTT experienced what Petitioners have described as a “sudden and unexpected” decline in demand for storage, including that a “larger-than-expected” number of customers declined to renew contracts for storage of No. 6 oil. Id. at 12.

On February 21, 2018, MIC announced a successful fourth quarter and year-end 2017 financial results, but also announced it was reducing its 2018 dividend guidance to retain greater cash flow for its businesses. MIC’s stock price dropped following this announcement. Id.

MIC’s explanation for the reduced dividend guidance identified several factors, including the “sudden and unexpected” decline in demand for storage at IMTT. Id.

A securities class action was filed against MIC and certain individuals. City of Riviera Beach General Employees Retirement System, et al. v. Macquarie Infrastructure Corp., 18-CV-3608 (VSB) (S.D.N.Y.). At issue on appeal is the allegation that MIC breached an obligation under Item 303 of Regulation S-K to disclose that IMO 2020 was reasonably likely to have a material unfavorable effect on MIC’s business, if the regulation ultimately went into effect. This omission, the complaint contended, was actionable under Section 10(b) and Rule 10b-5, even without a specific MIC public statement that was rendered misleading by the omission.

On September 7, 2021, the district court dismissed the complaint for failure to state a claim. City of Riviera Beach General Employees Retirement System, et al. v. Macquarie Infrastructure Corp., 2021 WL 4084572 (S.D.N.Y. Sept. 7, 2021). The court held that the complaint failed to plead an “uncertainty” that should have been disclosed under Item 303 of Regulation S-K or to plead in what public filing or filings MIT should have made such a disclosure. Id. at *10. The court further held that the complaint failed to allege that any omitted information was material under the relevant test for assessing Item 303 violations. Id. Finally, the court also found failure to plead scienter as to the alleged omission. Id. at *12.

Second Circuit Reversal & Circuit Split

The Second Circuit reversed the district court’s ruling, finding that “Plaintiff has adequately alleged a ‘known trend[] or uncertaint[y]’ that gave rise to a duty to disclose under Item 303.” Moab Partners, L.P. v. Macquarie Infrastructure Corp., 2022 WL 17815767, at *2 (2d Cir. Dec. 20, 2022). The Second Circuit explained, “[t]he failure to make a material disclosure required by Item 303 can serve as the basis for claims under Sections 11 and 12(a)(2), and for a claim under Section 10(b) if the other elements have been sufficiently pleaded. Id. (citing Panther Partners Inc. v. Ikanos Commc’ns, Inc., 681 F.3d 114, 119–222 (2d Cir. 2012); Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 101-02 (2d Cir. 2015)). In so holding, the Second Circuit looked to SEC’s Interpretive Release 14, which discusses disclosure of a reasonably likely material effect of a known uncertainty regarding implementation of recently adopted legislation (id.) and the Court concluded that:

IMO 2020’s significant restriction of No. 6 fuel oil use was known to Defendants and reasonably likely to have material effects on MIC’s financial condition or results of operation. In these circumstances, even if Defendants could not determine with certainty that IMO 2020 would be implemented, they were required to evaluate IMO 2020’s consequences on the assumption that it would come to fruition and to disclose its potential impact” unless they determined that a material impact was not reasonably likely to occur.

Id. at *3. The Court further noted that MIC chose to speak about its customer base, and that not disclosing IMO 2020 omitted material facts concerning the risks to the customer base that were not otherwise cured by MIC’s disclosures concerning changes in government regulations or capital expenditures to repurpose tanks. Id. at *4. Finally, the Second Circuit found that MIC and at least some executives were in a position to know that it was likely that IMO 2020 would negatively impact company revenue and that these allegations were sufficient circumstantial evidence to plead a strong inference of scienter. Id.

The Second Circuit’s ruling is directly contrary to rulings issued by the Third, Ninth and Eleventh Circuits. The Third Circuit in Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000), looked to the SEC’s guidance which specifically notes that Item 303’s disclosure obligations extend considerably beyond those required by Rule 10b-5. Id. at 288. The Oran court thus concluded “a violation of SK-303’s reporting requirements does not automatically give rise to a material omission under Rule 10b-5.” Id. The Ninth Circuit, in In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (9th Cir. 2014), and the Eleventh Circuit in Carvelli v. Ocwen Financial Corporation, 934 F.3d 1307 (11th Cir. 2019), each have reached the same conclusions.

Petitioners’ Position

Petitioners Macquarie Corp. and Individual Defendants make the following arguments in the Brief for Petitioners filed on November 13, 2023:

  • The plain language of Section 10(b) and Rule 10b-5 does not impose liability for pure omissions; liability only exists for misrepresentations and half-truths. Pet. Br. at 16, 20-25. Section 11 of the Securities Act expressly refers to omissions of material facts “required to be stated,” but Section 10(b) and Rule 10b-5 do not have any language that brings the concept of material facts “required to be stated” into the meaning of omission. at 17, 25-29.
  • The SEC “alone has the power to enforce rules and regulations it adopted under the Exchange Act, including disclosure requirements like Item 303.” at 17, 29-31.
  • The implied private right of action to enforce the Exchange Act cannot be broader than what Congress expressly provided in Section 18(a). at 18, 31-33. Moreover, the PSLRA “froze” the scope of the implied private right of action—where no case prior to its adoption allowed a claim to proceed under Section 10(b) based on a pure omission or to enforce Regulation S-K. Reinforcing the conclusion that the implied right does not extend to pure omissions, the PSLRA requires a complaint to “specify each statement alleged to have been misleading.” Id.
  • A pure omission cannot be converted into an actionable half-truth by arguing that the speaker implied that the filing was complete and in compliance with the law. Congress distinguished between half-truths and omissions and accepting an implied certification theory of liability would ignore the “indispensable element of a securities fraud claim—the pleading of a “statement” and would allow an implied right of action based on an implied representation. at 18-19, 33-41.
  • Item 303 is unsuitable for private enforcement under any statue. Its materiality standard is lower than the standard established for claims under Section 10(b) and Section 11. Item 303’s requirements are subjective and unclear, necessarily requiring a company’s judgment. at 19, 41-46. Unlike the SEC, the private plaintiffs’ bar has neither the flexibility nor the right incentives to evaluate compliance with Item 303. Id. at 20, 41-46.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.