March 31, 2017
On March 27, 2017, the United States Supreme Court granted a petition for a writ of certiorari to resolve a circuit split on whether corporate issuers’ disclosure obligation under Item 303 of SEC Regulation S-K can be an independent source of liability under Section 10(b) of the Securities Exchange Act of 1934. Leidos, Inc. v. Ind. Pub. Ret. Sys., No. 16-581. The appeal concerns a decision by the United States Court of Appeals for the Second Circuit in March 2016, which, in a departure from earlier decisions by the Third and Ninth Circuits, held that an issuer’s failure to disclose “known trends or uncertainties” under Item 303 of Regulation S-K could give rise to a securities fraud claim under Section 10(b). The Supreme Court’s consideration of the question could result in either a significant expansion or a significant narrowing of registrants’ potential exposure to securities fraud claims.
Plaintiffs in Leidos brought securities fraud claims against Leidos (formerly known as SAIC, Inc. (“SAIC”)) and several of its employees in the Southern District of New York alleging that SAIC’s various public filings were materially misleading because they failed to disclose federal and state investigations and the resulting risks of civil and criminal fines and penalties in connection with an overbilling scheme that SAIC was investigating internally. Specifically, plaintiffs claimed, among other things, that SAIC was required to disclose the risks of its potential exposure under Item 303 of Regulation S‑K, which requires that a registrant disclose “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. The District Court dismissed the complaint for failure to state a claim.
The Second Circuit reversed the District Court’s dismissal of the claim based on Item 303. The Second Circuit held that (i) Item 303 requires a registrant to disclose “those trends, events or uncertainties that it actually knows of when it files the relevant report,” and (ii) plaintiffs’ allegations supported a strong inference that SAIC actually knew about the overbilling scheme when it filed its 10-K at issue. The Second Circuit’s decision in Leidos followed another Second Circuit decision—Stratte-McClure v. Morgan Stanley, 77 F.3d 94 (2d Cir. 2015)—which had 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” if it “satisfies the materiality requirements outlined” by the Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224 (1988).
These decisions are in contrast to Third and Ninth Circuit decisions holding that a failure to disclose information required under Item 303 is not independently actionable under Section 10(b) because Section 10(b) has a different materiality standard from Item 303. Specifically, in Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000), the Third Circuit (in an opinion authored by then-Judge Alito) found that Item 303 does not “establish a private cause of action” or create a “duty of disclosure,” which, if violated, “automatically give[s] rise to a material omission under Rule 10b-5.” The Ninth Circuit subsequently followed the Third Circuit’s reasoning in In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (9th Cir. 2014), holding that “Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b-5.”
As defendant noted in its petition for certiorari, the Second and Ninth Circuits handle the largest volume of securities class actions in the country. The Supreme Court’s decision can therefore be expected to have a significant impact on a registrant’s potential liability. Notably, the appeal does not concern the application of Item 303 to cases under the Securities Act of 1933, where Section 11 and 12(a)(2) claims based on purported violations of Item 303 are frequently asserted against issuers, directors and underwriters. The Supreme Court’s resolution of the Circuit disagreement will be eagerly anticipated as an opportunity to bring clarity to a question of vital importance to both registrants and securities practitioners.