On April 12, 2024, the U.S. Supreme Court issued its opinion in Macquarie Infrastructure Corp. v. Moab Partners. Writing for a unanimous court, Justice Sotomayor found for the defendants and reversed the decision of the Second Circuit. The Court found that a failure to disclose information required by Item 303 in Regulation S-K can’t support a private action under Rule 10b-5(b), as long as the failure doesn’t render any prior statements misleading. In order to reach that conclusion, the Court found that Rule 10b-5(b) doesn’t create liability for pure omissions.
Everyone writing about it seems to agree that Macquarie is a big win for defendants, likely to stem the previously rising tide of securities class actions resting on Item 303-related allegations. However, upon further examination, the decision may turn out to be even more of a loss for plaintiffs than might be immediately obvious. This is because the Macquarie decision seems to call into question the continued vitality of the U.S. Supreme Court’s decision in Affiliated Ute Citizens of Utah v. United States, a case with facts which has nonetheless been helpful to securities fraud class-action plaintiffs over the 50+ years since it was decided.
Macquarie Infrastructure Corporation has a subsidiary which operates large “bulk liquid storage terminals” in the U.S. One type of liquid stored in these terminals was No. 6 fuel oil. In 2016, the United Nations’ International Maritime Organization adopted a regulation which would ban the use of sulfur-rich No. 6 fuel oil by the beginning of 2020. Macquarie didn’t make any statements about this regulation until in 2018, when it announced that its liquid storage business had dropped off, which was due in part to the decrease in No. 6 fuel storage. After that announcement, Macquarie’s stock price fell around 41%. Plaintiff Moab Partners filed a securities fraud class action against Macquarie, alleging that it violated the federal securities laws by failing to disclose a “known trend or uncertainty” as required by Section b(2)(ii) of Item 303 of Regulation S-K.
To understand the holding in Macquarie, and most of the other cases discussed in this article, it’s important to appreciate the sometimes subtle differences between misrepresentations, omissions and half-truths as they are discussed in case law.
Misrepresentations: As discussed in Macquarie, the definition of a “misrepresentation” is relatively straightforward: “false statements or lies” (though it should be noted that defendants have been known to raise nuanced defenses such as that the untrue statements in question were merely opinions or vague puffery (see In Re: Philip Morris International Inc. Securities Litigation and cases cited therein) or statements of a generic nature (see Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, discussed further below).
Omissions: According to Macquarie, “a pure omission occurs when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.”
Half-truths: In Macquarie, the Supreme Court defines half-truths (which have become an increasingly important category in recent years) as the failure to disclose “information necessary to ensure that statements already made are clear and complete.”
The first paragraph of the opinion summarizes the issue and the result with unusual brevity and clarity:
“Securities and Exchange Commission (SEC) Rule 10b-5(b) makes it unlawful to omit material facts in connection with buying or selling securities when that omission renders “statements made” misleading. Separately, Item 303 of SEC Regulation S-K requires companies to disclose certain information in periodic filings with the SEC. The question in this case is whether the failure to disclose information required by Item 303 can support a private action under Rule 10b-5(b), even if the failure doesn’t render any “statements made” misleading.
Before the Supreme Court’s ruling in Macquarie, there had been a circuit split as to whether Item 303 could serve as the basis for a private claim under Rule 10b-5(b) where no misleading statements have been made. Siding with the Ninth and Third Circuits, the Supreme Court resolved the issue once and for all, stating: “The Court holds that it cannot. Pure omissions are not actionable under Rule 10b-5(b).”
“Even a duty to disclose; however, 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”; in other words, only if the omission amounts to a half-truth.
The Supreme Court had long ago ruled that Section 10(b) of the Securities Exchange Act and Rule 10b-5, which implements it, give rise to an implied private right of action (see, for example, Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson and Blue Chip Stamps v. Manor Drug Stores), whereas Item 303 doesn’t. In part, the Court’s holding amounted to a determination that plaintiffs shouldn’t be allowed to get around the lack of a private cause of action under Item 303 by using alleged Item 303 noncompliance as a bootstrap into a 10b-5 private right of action.
The Court distinguished Rule 10b-5 claims from claims brought pursuant to Section 11 of the Securities Act of 1933, which the Court in Macquarie pointed out does create liability for pure omissions: “Statutory context confirms what the text plainly provides. Congress imposed liability for pure omissions in §11(a) of the Securities Act of 1933. Section 11(a) prohibits any registration statement that “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” 15 U.S.C. § 77k(a). By its terms, in addition to proscribing lies and half-truths, this section also creates liability for failure to speak on a subject at all. The Court found this discrepancy between Section 11 of the Securities Act and Section 10(b) of the Securities Exchange Act to be significant and dispositive of an intent to not create liability for omissions under the latter statutory provision.
When plaintiffs bring a claim for securities fraud based on misrepresentations, one of the necessary elements they must establish is reliance: that they acted because of the fraud. For the past 36 years, class action plaintiffs have been allowed to establish a rebuttable presumption of reliance based on the “fraud-on-the-market theory,” which assumes that material information is absorbed quickly into an efficient market, as established in the U.S. Supreme Court’s decision in Basic, Inc. v. Levinson. According to Basic (and its progeny), it is difficult but possible to rebut the presumption of reliance in a few ways, including by arguing that the market for the stock in question wasn’t efficient, that the misrepresentation didn’t inflate the stock price, or that the truth of the misrepresented facts were known to the market. However, the Court in Basic referenced and didn’t overrule their earlier decision in Affiliated Ute Citizens of Utah v. United States.
In Affiliated Ute, the Supreme Court considered a unique and complex fact pattern involving the sale of shares in a trust holding most of the assets of the Ute Native American tribe. The part of the decision which has been relied on by many subsequent plaintiffs involves a finding of liability against two individuals who facilitated the purchase of numerous shares from certain members of the Ute tribe to non-Ute purchasers at below-market prices. The Court found the individuals in question liable under Rule 10b-5 because of “soliciting and accepting standing orders from” [non-Ute] purchasers, and “receiv[ing] commissions and gratuities from the expectant [non-Ute] buyers, without revealing their role in market-making” to the sellers. The Court wrote that “[i]t is no answer to urge that, as to some of the petitioners, these defendants may have made no positive representation or recommendation,” going on to hold that “[u]nder the circumstances of this case, involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision” (emphasis added). This has resulted in Affiliated Ute being cited for the propositions that a claim for liability under Rule 10b-5 can be predicated purely on omissions, and that such a claim doesn’t require “positive proof of reliance.”
Although the facts were unique, and although Affiliated Ute wasn’t a class action (it was a mass action by a group of ascertainable individuals), it’s been relied on by plaintiffs in subsequent litigation for the premise that a class action based purely on omissions doesn’t require proof of reliance. Irrespective of what the Supreme Court may have intended, a line of cases developed, parallel to the misrepresentation cases, which relied on the efficient market presumption from Basic v. Levinson, in which plaintiffs who only alleged omissions and didn’t allege affirmative misrepresentations weren’t required to establish reliance.
The Court in Macquarie didn’t cite to Affiliated Ute or mention it at all. However, the holding in Macquarie — that lawsuits alleging omissions can’t support claims under Rule 10b-5(b) — seems to undermine the Affiliated Ute line of authority. Note that, in addition to escaping the need to establish reliance, Affiliated Ute omissions-only plaintiffs can achieve near-automatic class certification. Cases revolving around these issues under the Basic line of cases have been hard-fought at the class certification stage in recent years, including Halliburton v. Erica P. John Fund, Inc. (Halliburton II) (“defendants must be afforded an opportunity before class certification to defeat the presumption [of reliance] through evidence that an alleged misrepresentation did not actually affect the market price of the stock”) and Goldman Sachs (“The generic nature of a misrepresentation often will be important evidence of a lack of price impact”).
The question of Affiliated Ute’s continued vitality is important as issues centering on Affiliated Ute are currently on appeal to the Sixth Circuit following the district court’s order granting class certification in the In re FirstEnergy Corp Sec. Litigation. Specifically, at issue in FirstEnergy is whether Affiliated Ute’s presumption of reliance applies to cases alleging half-truths. The plaintiffs take the view that because Affiliated Ute applies to cases “primarily involving omissions,” it applies to cases based on half-truths because half-truths are misleading because of what they omit. The defendants, on the other hand, argue that half-truths are a species of affirmative misstatement, so Affiliated Ute’s presumption of reliance — which was intended only for the impossible situation of proving reliance on a statement that was never made — does not apply. The parties in the case have both assumed that Affiliated Ute remains a good precedent that defendants have no ability to rebut a presumption of reliance in a pure omissions case.
In a footnote, the Macquarie Court made clear that its holding only relates to subsection b of Rule 10b-5, which is the most often cited section of the Rule, and not to subsections a and c (known as the scheme liability provisions).
Here’s the full text of Rule 10b-5 (CFR section 240.10b-5):
§ 240.10b-5 Employment of manipulative and deceptive devices.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
Until recently, plaintiffs had seldom focused on subsections a and c of Rule 10b-5. The reach of those two subsections, while often disputed in litigation, has been interpreted to relate to potential liability from schemes. “Scheme liability” had been largely curtailed by the U.S. Supreme Court’s decisions in Central Bank of Denver v. First Interstate Bank of Denver (no private right of action for aiding or abetting); Stoneridge Investment Partners v. Scientific-Atlanta, Inc. (upholding Central Bank, saying that “the implied right of action in §10(b) continues to cover secondary actors who commit primary violations”; noting that the Private Securities Litigation Reform Act (PSLRA) provided the SEC with the power to bring claims against aiders and abettors, and they have used it liberally); and Janus Capital Group, Inc. v. First Derivative Traders (citing Central Bank and Stoneridge in finding no liability for mutual fund investment advisor for its behind-the-scenes involvement with statements made by the company) but was reinvigorated by the Supreme Court’s decision in Lorenzo v. Securities and Exchange Commission, which found potential liability under Rule 10b-5’s scheme liability provisions for a party which “disseminated” the false statements of another.
Notwithstanding the Macquarie Court’s purported abstention in relation to subsections a and c of Rule 10b-5, it seems that the Supreme Court already weighed in on the subject in the Lorenzo decision when it said that no liability would attach where “an individual neither makes nor disseminates false information – provided that the individual is not involved in some other form of fraud.” Since it isn’t possible to “disseminate” an omission, it’s difficult to see how a pure omission could lead to scheme liability absent other non-disclosure-related allegations of fraud.
As many commentators have noted, in recent years, securities class action complaints in “duty to disclose” cases have often been premised on Item 303 deficiencies. Hence, it seems likely that somewhat fewer securities class actions may be filed in the future for that reason alone.
However, as discussed above, the pro-defense effects of the Macquarie decision are likely to go far beyond Item 303 issues. Based on the foregoing analysis, it seems that the U.S. Supreme Court has effectively killed Affiliated Ute, at least in relation to the principle for which it’s been so often cited. Although even now parties are fighting over what it takes to qualify for a Ute free pass from having to establish reliance, it looks like when the dust settles plaintiffs may no longer be able to rely on Affiliated Ute, except in the very rare cases that sound primarily in non-disclosure-related forms of fraud. After Macquarie, all plaintiffs may be required to allege misrepresentations or at least half-truths (or actions such as dissemination of misrepresentations, as in Lorenzo, if they are alleging scheme liability), and so won’t be able to argue that Affiliated Ute allows them to avoid having to fight about class certification and reliance by pleading a case which is entirely or primarily based on pure omissions.
Private parties can still sue for half-truths and the government can still sue for omissions under 303. However, it seems that private plaintiffs will no longer be able to establish a case based entirely on “pure” omissions with no corresponding prior contrary statement[1], nor will they be entitled to a virtually irrebuttable presumption of reliance. This is a welcome development for corporate defendants. It was always counter-intuitive that plaintiffs who couldn’t allege any affirmative misrepresentations should have a litigation advantage over ones that could; sins of commission are generally regarded as more serious than sins of omission. Smoking guns are considered more damning than missing guns. Macquarie seems to have addressed this inequity, albeit silently and subtly. This could lead to fewer securities class actions being filed or more cases being dismissed on initial motions.
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