Ryan Kainz
“No comment.” Corporate spokespersons commonly use these two words in an effort to avoid misleading investors and incurring liability. But does this silence actually protect companies from potential lawsuits? On January 16, 2024,[1] the U.S. Supreme Court heard oral argument in Macquarie Infrastructure Corp. v. Moab Partners, L.P.,[2] to address a similar question: whether an issuer’s failure to include disclosures required by Item 303 of the Security and Exchange Commission (“SEC”) Regulation S-K in the Management Discussion & Analysis (“MD&A”) of a Form 10-K or Form 10-Q can give rise to liability under Section 10(b) of the Securities and Exchange Act of 1934 (“Exchange Act”) and SEC Rule 10b-5.[3]
I. Relevant Law
Item 303 of Regulation S-K requires that issuers “[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” in the MD&A of a Form 10-K.[4] This requirement is intended to “allow investors to view the registrant from management’s perspective” to better understand the issuer’s financial condition and potential risks when making an investment decision.[5]
Rule 10b-5 was promulgated by the SEC as the administrative counterpart of Section 10(b) of the Exchange Act[6] and is “coextensive with the coverage” of Section 10(b).[7] Rule 10b-5 provides plaintiffs with a private cause of action under securities laws[8] and makes it unlawful for any person “to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading . . . in connection with the purchase or sale of any security.”[9] To sufficiently plead a cause of action under Rule 10b-5, a plaintiff has the burden of showing (1) a material misrepresentation or omission; (2) made with scienter; (3) in connection with the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation.[10]
II. Procedural History
In 2018, Moab Partners, L.P. (“Moab”) filed a class action lawsuit against Macquarie Infrastructure Corp. (“Macquarie”) in the Southern District of New York for securities fraud under Section 10(b) and Rule 10b-5.[11] Moab alleged that Macquarie’s failure to disclose known trends and uncertainties in its MD&A, as required by Item 303, misled investors and caused Moab to sustain losses when Macquarie’s stock price dropped.[12]
Macquarie’s wholly owned subsidiary, International-Matex Tank Terminals (“IMTT”), stored a variety of liquid commodities.[13] These commodities included large amounts of No. 6 fuel oil:[14] a heavy residual oil from refinery operations used by international shipping vessels.[15] In 2008, the International Maritime Organization (“IMO”) announced a regulation intended to protect the environment by restricting the use of high-sulfur fuel oils, such as No. 6 fuel oil, that would become effective in January 2020.[16] Despite the imminent financial risks the IMO regulation posed for IMTT through potential “lost contracts, poor utilization rates, and expenditures to repurpose the 6-oil tanks,” Macquarie failed to disclose these risks, as required by Item 303.[17] In 2018, once these risks were disclosed to investors, Macquarie’s stock price dropped 41%.[18] In response, Moab certified a class of investors that had purchased Macquarie’s stock during the two years before this risk was disclosed and filed a complaint in 2018.[19]
The Southern District of New York granted Macquarie’s motion to dismiss, finding that Moab failed to adequately plead that the omissions were material or made with scienter, as required by Section 10(b).[20] The Second Circuit vacated the district court’s judgment and remanded the case. They held that Macquarie’s omissions were material and made with scienter and that failure to make a material disclosure required by Item 303 can serve as the basis for a Section 10(b) claim if the other elements have been satisfied.[21] This holding creates a circuit split, as it contradicts what the Third, Ninth, and Eleventh Circuits have held.[22] In May 2023, Macquarie filed a petition for writ of certiorari with the U.S Supreme Court, which the Court granted in September 2023.[23]
III. The Argument
The primary point of contention in this case centers around the common-law principle of “half-truth” fraud reflected in Rule 10b-5’s language “to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”[24] This principle imposes liability when a declarant makes a statement about a topic and omits necessary information about that topic to make the statement not misleading.[25]
Moab, supported by the Second Circuit’s analysis, argues that the MD&A, in its entirety, creates a misleading statement when certain Item 303 required disclosures about known trends or uncertainties are included while others are omitted.[26] A reasonable investor understands an MD&A to include all disclosures required by Item 303 and is misled by an issuer’s silence to believe that the types of events required to be disclosed by Item 303 have not occurred.[27] Furthermore, the MD&A, management’s narrative about the issuer’s financial outlook, is a “statement” as defined in Webster’s New International Dictionary of the English Language,which includes “‘that which is stated,’ such as ‘a narrative.’”[28] Moab asserts that this failure to make a material disclosure required by Item 303 can serve as the basis for a Section 10(b) claim if the other elements have been satisfied.[29]
Conversely, Macquarie maintains that half-truth fraud is not present without a specific, affirmative statement within the MD&A that is alleged to be misleading due to the omission, and that Moab is instead seeking to bring a claim under a “pure omission” fraud theory.[30] “Silence, absent a duty to disclose, is not misleading under Rule 10b-5.”[31] Macquarie discredits Moab’s argument that a Rule 10b-5 duty to disclose exists under Item 303 by citing Laurienti’s holding that a duty to disclose arises from the declarant’s misleading statement being made, independent of the declarant’s other duties.[32]
Macquarie reinforces that the Second Circuit’s interpretation is beyond Rule 10b-5’s intended scope by drawing attention to the language of Section 11 of the Securities Act of 1933, which creates liability if the registration statement “contain[s] an untrue statement of a material fact or omit[s] to state a material fact required to be stated therein or necessary to make the statements therein not misleading.”[33] Macquarie argues that Rule 10b-5’s failure to include specific language that liability can arise from omission of a required disclosure, as found in Section 11, demonstrates that these omissions were not intended to fall within the scope of Rule 10b-5.[34]
IV. Consequences
The outcome of this case will have lasting effects in the world of securities litigation. Presently, Section 13 of the Exchange Act provides the SEC with a cause of action when an issuer fails to disclose information required by Item 303.[35] However, Moab contends that creating a private cause of action under Section 10(b), predicated upon an issuer’s failure to make an Item 303 required disclosure, would provide investors and the SEC with greater remedies for securities fraud, ultimately affording greater protection to investors.[36] This outcome would embody “the basic purpose behind [securities] laws: ‘to substitute a philosophy of full disclosure for the philosophy of caveat emptorand thus to achieve a high standard of business ethics in the securities industry.”[37]
In contrast, Macquarie asserts that the Second Circuit’s holding would lead to unnecessary disclosure that would overwhelm investors and impede their ability to discern a company’s financial condition.[38] This holding may also cause an increase in securities-fraud litigation – placing a greater burden on issuers and the court system.[39] The Supreme Court’s decision in this case will provide clarity regarding the protections afforded to private investors and the resulting disclosure burdens placed on reporting companies.
[1] Macquarie Infrastructure Corp. v. Moab Partners, L.P., SCOTUSblog, https://www.scotusblog.com/case-files/cases/macquarie-infrastructure-corp-v-moab-partners-l-p/ (last visited Mar. 29, 2024).
[2] Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165, 2023 WL 6319659 (U.S. Sept. 29, 2023).
[3] Brief for the United States as Amicus Curiae Supporting Respondent Moab Partners, L.P. at I, Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165 (U.S. Sept. 29, 2023) [hereinafter U.S. Amicus].
[4] 17 C.F.R. § 229.303(a)(3)(ii) (2018).
[5] 17 C.F.R. § 229.303(a) (2020).
[6] Ronald B. Lee, The Measure of Damages Under Section 10(b) and Rule 10b-5, 46 Md. L. Rev. 1266, 1266–67 (1987).
[7] SEC v. Zandford, 535 U.S. 813, 816 n.1 (2002).
[8] Id.
[9] 17 C.F.R. § 240.10b-5(b).
[10] Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341 (2005).
[11] See Riviera Beach Gen. Employees Ret. System v. Macquarie Infrastructure Corp., No. 18-CV-3608 (VSB), 2021 WL 4084572, at *1 (S.D.N.Y. Sept. 7, 2021).
[12] See id.
[13] U.S. Amicus, supra note 3, at 5.
[14] Id.
[15] Residual Fuel Oil, U.S. Energy Info. Admin.: Glossary https://www.eia.gov/tools/glossary/index.php?id=Residual%20fuel%20oil (last visited Mar. 29, 2024).
[16] U.S. Amicus, supra note 3, at 5.
[17] Id. at 6.
[18] Id.
[19] See id.
[20] See id.
[21] See id. at 6–7.
[22] See, e.g., Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000); In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (9th Cir. 2014); Carvelli v. Ocwen Fin. Corp., 934 F.3d 1307 (11th Cir. 2019).
[23] Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165, 2023 WL 6319659 (U.S. Sept. 29, 2023).
[24] 17 C.F.R. 240.10b-5(b); United States v. Laurienti, 611 F.3d 530, 539 (9th Cir. 2010).
[25] See Setzer v. Omega Healthcare Invs., Inc., 968 F.3d 204, 214 n.15 (2d Cir. 2020).
[26] See U.S. Amicus, supra note 3, at 7.
[27] Id. at 7–8.
[28] Id. at 10 (quoting Webster’s New International Dictionary of the English Language 2461 (2d ed. 1942)).
[29] See U.S. Amicus, supra note 3, at 6–7.
[30] Brief of Washington Legal Foundation as Amicus Curiae in Support of Petitioners at 2, Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165 (U.S. Sept. 29, 2023) [hereinafter WLF Amicus].
[31] Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988).
[32] See WLF Amicus, supra note 29, at 6 (citing United States v. Laurienti, 611 F.3d 530, 541 (9th Cir. 2010)).
[33] WLF Amicus, supra note 29, at 12–13 (quoting 15 U.S.C. § 77k).
[34] See WLF Amicus, supra note 29, at 12–13.
[35] See 15 U.S.C. § 78u-2; 15 U.S.C. § 78m(a)(1).
[36] See WLF Amicus, supra note 29, at 33.
[37] Lorenzo v. SEC, 139 S. Ct. 1094, 1103 (2019).
[38] See WLF Amicus, supra note 29, at 27.
[39] See id. at 3.
