A unanimous Supreme Court has rejected private stockholder claims based on the antifraud provisions of the federal securities laws for a company’s failure to comply with SEC disclosure requirements, in the absence of an affirmative statement that was rendered materially misleading by the omission. Reversing and remanding a lower court’s decision, the Court, also resolving a split among the Circuit Courts of Appeal, ruled that a “pure omission” of information – even disclosure mandated by SEC regulations - does not violate SEC Rule 10b-5(b) because the Rule prohibits only affirmative misstatements and omissions that create “half-truths”. In colorful, if not necessarily illuminating language, the Court observed 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.”
In Macquarie Infrastructure Corp. v. Moab Partners, L.P., No. 22-1165 (April 12, 2024), Macquarie owned and operated infrastructure-related businesses, including a subsidiary that operated bulk liquid storage terminals, including No. 6 fuel oil, a high-sulfur byproduct of the refining process. In 2016, the United Nations International Maritime Organization formally adopted IMO 2020, a regulation that in four years would limit the sulfur content of fuel oil used in shipping at 0.5% compared to the 3% sulfur content in No. 6 fuel oil. Macquarie did not discuss the potential impact of IMO 2020 in its public filings. In 2018, however, Macquarie’s disclosure that the amount of storage capacity contracted for by a subsidiary’s customers had sharply declined due to changes in the No. 6 fuel oil market resulted in a 41% stock price drop.
Moab Partners, a stockholder, filed an action alleging that Macquarie and certain officer defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by failing to satisfy the disclosure requirements under Item 303 of SEC Regulation S-K, which sets forth the disclosure obligations of public companies in periodic reports filed with the SEC. Item 303 requires a public company to provide its Management Discussion and Analysis, which, among other things, requires disclosure of any “known trends . . . or uncertainties” that were known to or reasonably likely to have material effects on the company’s financial condition and operations. Moab alleged that defendants’ failure to disclose the potential financial impact of IM0 2020 violated Item 303 which in turn provided a basis for the Rule 10b-5 claim. The district court dismissed the complaint, but the Second Circuit Court of Appeals reversed, citing binding precedent in holding that a violation of Item 303 alone could sustain a Rule 10b-5 claim. By contrast, other Circuit Courts, including the Ninth Circuit, have held that Item 303 by itself does not create a duty of disclosure for purposes of Rule 10b-5.
Justice Sotomayor, writing for the Court, observed that Rule 10b-5(b) makes it unlawful 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.” The Rule prohibits false statements, lies, and half-truths, but not “pure omissions.”
A pure omission occurs “when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.” For example, if a company failed entirely to file an MD&A, the omission has no particular significance because nothing was disclosed. Half-truths, however, are representations “that state the truth only so far as it goes, while omitting critical qualifying information.” A classic example would be a seller who discloses that there may be two new roads near a property he is selling but fails to disclose that a third potential road might bisect the property. Or, as noted above, the child who tells his parents only that he had dessert but fails to disclose that he ate the whole cake.
Rule 10b-5(b) by its very text prohibits half-truths, but not pure omissions. By contrast, Section 11(a) of the Securities Act of 1933 prohibits any registration statement for a public offering that, among other things, omits “to state a material fact required to be stated therein.” Thus, Section 11 creates liability for failure to speak on a subject while Rule 10b-5(b) lacks similar language. “Silence, absent a duty to disclose, is not misleading under Rule 10b-5.” Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988). But, the Court held, even a duty to disclose does not automatically render silence misleading under Rule 10b-5(b). “Today, this Court confirms that the failure to disclose information required by Item 303 can support a Rule 10b-5(b) claim only if the omission renders affirmative statements made misleading.”
The Court swatted away the argument by Moab and the U.S. Solicitor General that a plaintiff need not plead any misleading statements rendered misleading by a pure omission because reasonable investors know that Item 303 requires disclosure of all known trends and uncertainties. Such an interpretation would read the “statements made” language out of Rule 10b-5(b) and shift the focus of the Rule and Section 10(b) from fraud to disclosure, while rendering superfluous Section 11(a)’s pure omission clause. Nor would eliminating private liability for pure omissions create broad immunity for a company’s fraudulent failure to satisfy Congressional and SEC disclosure requirements. A plaintiff can always bring claims based on violations that create half-truths and the SEC still has the ability to prosecute violations of its own regulations.
One final note: the Court’s analysis centers on the text of Rule 10b-5(b). It remains to be seen whether a pure omission of a material fact still might support liability under the “scheme liability” provisions of Rule 10b-5(a) and (c). It also remains to be seen whether the identical analysis applies to disclosure requirements for proxies and tender offer filings.
For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.
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