Supreme Court’s 10b-5 ruling favors public companies but doesn’t eliminate their litigation risk

In positive news for both public companies and directors and officers liability (D&O) insurers, the U.S. Supreme Court last week held that a failure to disclose information required by Securities and Exchange Commission (SEC) Regulation S-K, does not, in and of itself, create a private right of action for investors under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Despite being a clear win, it’s important that public companies continue to diligently monitor the securities litigation threats they still face.

Narrowing liability for public companies

In the underlying case — Macquarie Infrastructure Corp. v. Moab Partners, L. P. (opens a new window) — plaintiff Moab Partners, a Macquarie Infrastructure shareholder, alleged that Macquarie violated Section 10(b), misleading investors by failing to address the negative impact that an anticipated global ban on high-sulfur marine fuels would have on Macquarie’s oil storage business.

Moab claimed that Macquarie’s silence violated Item 303 of SEC Regulation S-K. Regulation S-K requires public companies to “describe any known trends or uncertainties that have had or that are reasonably likely to have a materially favorable or unfavorable impact in net sales or revenues or income from continuing operations.” A district court disagreed with the plaintiffs’ claims and granted defendant Macquarie’s motion to dismiss the complaint, but the 2nd U.S Circuit Court reversed the decision on appeal.

Relying on its previous decision (in conflict with opinions from the 3rd, 9th and 11th circuits), the 2nd Circuit held that Macquarie’s Item 303 omission was sufficient to plead a Section 10(b) claim. On April 12, however, the Supreme Court reversed and vacated the 2nd Circuit’s decision, emphasizing that “pure omissions are not actionable under Rule 10b-5.”

The text of Rule 10b-5 prohibits issuers of registered securities from “mak[ing] 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.” Noting plaintiffs’ allegations that Macquarie’s public statements were false and misleading based on its concealment of the impact of the expected fuel ban, the Supreme Court ultimately determined that Rule 10b-5 “requires disclosure of information necessary to ensure that statements already made are clear and complete.”

In other words, while Item 303 obligates public companies to disclose known concerns that may impact their operations, an investor can only bring a private right of action for an omission under Rule 10b-5 if the omission renders prior statements misleading. As the Supreme Court succinctly noted, “This Rule therefore covers half-truths, not pure omissions.”

The unanimous decision resolves the circuit split as to whether an omission, as opposed to an affirmative misrepresentation, could be the basis of a private securities fraud action in the absence of an otherwise misleading statement. The ruling in Moab v. Macquarie is not expected to reduce securities litigation filings, but it does narrow the scope of 10b-5 liability by essentially removing one avenue for securities litigation that plaintiffs had previously relied on.

Securities litigation remains a threat

A decision to uphold the Second Circuit’s opinion could have significantly expanded plaintiffs’ ability to plead securities law violations. Public companies and D&O insurers can therefore count the Supreme Court ruling as a win.

D&O policyholders should nevertheless not underestimate the risk of securities litigation they still face. Alleged Item 303 omissions are usually one of many counts asserted by plaintiffs in class action suits. And securities fraud claims remain the most significant D&O exposure for public companies.

Plaintiffs filed 215 new securities class-action suits against public companies in federal and state courts in 2023, up from 208 filings in 2022, according to Cornerstone Research. This ended a four-year decline in overall filings.

Plaintiffs filed 58 new suits through April 11, 2024, according to data from the Stanford Law School Securities Class Action Clearinghouse, down only slightly from the 60 filings made in the same period in 2023. This suggests similar overall activity should be expected this year. Also notable: The share of core federal filings with Rule 10b-5 claims in 2023 rose to the highest level in more than five years, according to Cornerstone.

Building effective insurance coverage and preparing for claims

Consequently, policyholders should remain vigilant and work with their insurance brokers to ensure they have effective D&O insurance coverage in place. Specifically, policyholders and brokers should evaluate the adequacy of limits in their D&O towers, including excess Side A coverage. They should also make sure they have appropriate retentions for securities claims.

At the same time, policyholders should ensure timely noticing to D&O insurers in the event of potential claims. That means businesses should analyze all communications regarding securities claims, including derivative demand letters and books and records requests.

It’s also important to consider new coverage options that may be available in the market. Policyholders should work with their brokers to assess the scope of SEC investigation coverage that is offered by various D&O insurers. And they should work closely with their corporate counsel on all SEC filings and disclosures that could prompt securities litigation and other claims.