Supreme Court Holds “Pure Omissions” Are Not Actionable Under Rule 10b-5(b)
April 26, 2024
Resolving a circuit split, the Supreme Court has unanimously curtailed actions for securities fraud in cases of “pure omissions,” but upheld the specter of liability for omissions that result in “half-truths.” But public companies may still face liability for failing to make required disclosures under alternate avenues.
The unanimous April 12, 2024, opinion in Macquarie Infrastructure Corp. v. Moab Partners, L.P., holds that “pure omissions” are not actionable under SEC Rule 10b-5(b).1 Instead, the Court held that Rule 10b-5(b) covers omissions only if they result in misleading half-truths, which are representations that omit critical qualifying information. Plaintiff Moab Partners, L.P. argued that a public company’s failure to disclose “known trends or uncertainties” that are “reasonably likely to have a material impact” on the company’s financial condition was sufficient to support a Rule 10b-5(b) claim because such a disclosure is required by an SEC regulation, Item 303 of Regulation S-K. The Court rejected this position, resolving a Circuit split in the process, and held that Rule 10b-5(b) claims cannot be based on breach of a duty to disclose under Item 303, but rather requires a showing that an omitted fact rendered a statement in the public filing misleading. Public companies are still obligated to comply with Item 303, could still face liability under the Securities Act of 1933 for failure to do so, and could also face increased scrutiny by the SEC in light of this decision.
Item 303 of Regulation S-K: Known Trends and Uncertainties
Item 303(a) of Regulation S-K requires public companies to include in their periodic filings a section regarding “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” or MD&A, in which the company provides “material information relevant to an assessment of the financial condition and results of operations of the registrant.”
Item 303(b)(2)(ii) of Regulation S-K requires a public company to disclose in its MD&A “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.” The SEC has stated that the materiality analysis should be made “with a view to providing investors with a clearer understanding of the potential material consequences of such known forward-looking events or uncertainties.”2
Background of the Case
Macquarie Infrastructure Corporation owned and operated a portfolio of infrastructure and infrastructure-like businesses. A large portion of its revenue came from International-Matex Tank Terminals (IMTTs), which handled and stored a variety of liquid commodities, including a type of heavy oil known as “No. 6 fuel oil.”
In 2016, the United Nations’ International Maritime Organization adopted a regulation (“IMO 2020”) to phase out the use of No. 6 fuel oil by 2020. Macquarie did not mention IMO 2020 or the extent of Macquarie’s reliance on the market for No. 6 fuel oil in its periodic SEC filings, even though IMO 2020 could arguably have had a material effect on Macquarie as defined in Item 303(b)(2)(ii).
IMO 2020 caused a decline in the market for No. 6 fuel oil and a corresponding decline in demand for Macquarie’s IMTT services. In February 2018, Macquarie publicly announced this reduced demand and its intent to spend significant cash to repurpose IMTT storage tanks previously dedicated to heavy oil. Macquarie also announced that its revenues had fallen below investor expectations and proposed a significant cut to the company’s dividend for the following year. Macquarie’s stock price fell more than 40% following that announcement.
In response to the significant stock price drop, Macquarie shareholder Moab Partners, L.P. sued Macquarie and its officers under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5(b), alleging that Macquarie had a duty under Item 303 to disclose the change in the market for heavy oil due to IMO 2020, and that its breach of that disclosure duty gave rise to Rule 10b-5(b) liability.
The U.S. District Court for the Southern District of New York dismissed the case on the ground that Moab had failed to plead “an uncertainty that should have been disclosed” or “in what SEC filing or filings Defendants were supposed to disclose it.”3 The Second Circuit reversed, holding that the impact of IMO 2020 should have been disclosed under Item 303 and that the failure to do so can be the basis for a Rule 10b-5 claim.4 The Second Circuit’s decision, and its earlier decision in Stratte-McClure v. Morgan Stanley,5 conflicted with cases in other U.S. Courts of Appeals, including the Third and Ninth Circuits, holding that failure to disclose under Item 303 is not sufficient on its own to support a Rule 10b-5(b) private cause of action.6
The U.S. Supreme Court granted certiorari on the question of whether “the failure to disclose information required by Item 303 can support a private action under Rule 10b-5(b), even if the failure does not render any ‘statements made’ misleading.”7
The Supreme Court’s Opinion
Justice Sonia Sotomayor, writing for a unanimous court, held that “[p]ure omissions are not actionable under Rule 10b-5(b).”8 The Court reasoned that given the language of Rule 10b-5(b)—making it unlawful to “omit to state a material fact necessary in order to make the statements made . . . not misleading”—the case turned on whether “this . . . prohibition bars only half-truths or instead extends to pure omissions.”9 A pure omission occurs when a speaker says nothing to mislead investors, but fails to disclose a fact that it otherwise has a duty to disclose. A half-truth, in contrast, is a representation that omits critical qualifying information that render a statement misleading. The Court provided several examples, including that “the difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.”10
The Court found that Rule 10b-5(b), both “[l]ogically and by its plain text,”11 covers only misleading half-truths, not pure omissions, because the Rule requires that there already be a “statement made.” The Court contrasted this language to Section 11(a) of the Securities Act of 1933, which makes unlawful omissions of “a material fact required to be stated therein.” Rule 10b-5 does not contain similar language that would create a right of action for omitting facts that are required to be disclosed.
Although “pure omissions” do not support claims under Rule 10b-5(b), the Court concluded that private litigants may bring Rule 10b-5(b) actions “based on Item 303 violations that create misleading half-truths”12 (in addition to Section 11 claims in the context of securities offerings). The Court also acknowledged that the SEC retains authority to prosecute violations of its disclosure rules, including Item 303.13
What’s Next?
The Supreme Court’s clarification that Rule 10b-5(b) does not cover pure omissions should not make public companies more likely to disregard any disclosure obligations.
First, as the Court noted, “Congress imposed liability for pure omissions” in securities offering documents under Section 11(a) of the Securities Act,14 which “prohibits any registration statement that . . . ‘omit[s] to state a material fact required to be stated therein . . .’”15
Second, failure to disclose “material information relevant to an assessment of the financial condition and results of operations of the registrant,” or “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,” have the potential to render other statements in the SEC filing misleading, thus potentially falling within the “half-truths” proscription of Rule 10b-5(b).
Third, MD&A omissions could also be actionable under Rule 10b-5(a) (prohibiting devices, schemes, or artifices to defraud) or Rule 10b-5(c) (prohibiting acts, practices, or courses of business that operate as a fraud or deceit).16
Fourth, as the Court observed, the SEC may still prosecute violations of its own rules and regulations, including Item 303.
Fifth, the SEC has previously brought cases under Section 13(a) of the Exchange Act for failures to disclose known trends and uncertainties. For example, the SEC has issued a cease-and-desist order against a cemetery and funeral home operator and imposed civil money penalties against a dental supply company, in both instances for violations of Section 13(a) stemming from failures to make required disclosures of known trends and uncertainties in their periodic filings.17 Because the Supreme Court has now made clear that pure omissions are not actionable under Rule 10b-5(b) the SEC may increase its focus on enforcement efforts in this area.
1 Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165, 601 U.S. ___ (Apr. 12, 2024).
2 Management's Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, 86 Fed. Reg. 2,080, 2,094 (Jan. 11, 2021), available at https://www.sec.gov/files/rules/final/2020/33-10890.pdf.
3 City of Riviera Beach Gen. Emps. Ret. Sys. v. Macquarie Infrastructure Corp., 2021 U.S. Dist. LEXIS 170286, *29 (S.D.N.Y. Sept. 7, 2021).
4 Moab Partners, L.P. v. Macquarie Infrastructure Corp., 2022 U.S. App. LEXIS 35103 (2d Cir. 2022).
5 Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 101 (2d Cir. 2015) (“Item 303’s affirmative duty to disclose in Form 10-Qs can serve as the basis for a securities fraud claim under Section 10(b).”).
6 See Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000); In re NVIDIA Corp. Sec. Litig., 768 F. 3d 1046 (9th Cir. 2014).
7 Macquarie Infrastructure Corp., 601 U.S. at 1.
8 Id. at 1.
9 Id. at 5.
10 Id. at 5.
11 Id. at 5.
12 Id. at 7.
13 Id at 7-8.
14 Id. at 6.
15 Id.
16 Brief for the United States as Amicus Curiae Supporting Respondent, Macquarie Infrastructure Corp. v. Moab Partners, L.P. at 8, No. 22-1165, 601 U.S. ___ (Apr. 12, 2024).
17 See In re Dentsply Sirona Inc., Exchange Act Release No. 90681, 2020 SEC LEXIS 5183 (Dec. 16, 2020); In re StoneMor Partners L.P., Exchange Act Release No. 87732, 2019 SEC LEXIS 5133 (Dec. 12, 2019).
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