A hedge fund next week will ask the US Supreme Court to approve a reading of securities law that allows investors to sue companies for failing to disclose known trends—a role that regulators typically play.
The fund, Moab Partners LP, sued Macquarie Infrastructure Corp. for failing to signal its exposure to changing fuel oil regulations in the shipping industry. Macquarie, an energy supply conglomerate, is fighting an influential appeals court’s decision in the argument before the justices on Jan. 16. That decision allowed shareholders to bring securities fraud suits citing a Securities and Exchange Commission regulation that requires disclosures of “known trends and uncertainties.”
“It’s a real circuit split that’s boiled up,” said securities defense attorney Elizabeth Gingold Clark of Alston & Bird LLP in Atlanta and New York.
A ruling for Moab could alter private securities litigation and change how attorneys think about Item 303 of the SEC’s Regulation S-K, she said. Since the report is from the perspective of management, “it would be strange to have private investors second-guess it,” she said. The purpose of the regulation is to enhance investors’ understanding of how management is viewing its business, she said. And that’s subjective, she said. “It’s not uniform across companies.”
There’s no liability for “pure omissions” of information, Macquarie said in its opening brief on the merits. And the required analysis from the perspective of management is too subjective to form the basis of a fraud claim, the conglomerate says.
But Moab, the lead plaintiff in the proposed investors’ class action, says that under Section 10(b) of the Securities and Exchange Act and implementing regulation Rule 10b-5, fraud liability encompasses misleading Item 303 statements. The requirement to report material information is a circumstance where omitting information can make other statements misleading, it said. Macquarie wasn’t silent when it wrote the report and certified the completeness of its annual filings, the investment fund said.
The US government will participate in the argument at the high court. The SEC has long taken the position that securities fraud liability is available for omissions in the “management discussion and analysis” section of the Item 303 report, the SEC and Department of Justice said in a friend-of-the-court brief supporting Moab. And private suits are “an essential supplement” to the SEC’s work, it said.
“It comes down to a question of how broad Section 10(b) is as a tool for private enforcement,” said Jill Fisch, a professor at the University of Pennsylvania Carey Law School.
Fuel Oil Tanks
Moab alleges that Macquarie knew the International Maritime Organization’s impending regulation restricting No. 6 fuel oil would materially affect the company because it owned numerous fuel tanks for holding that type of oil—tanks that would have to be repurposed at considerable expense.
But Macquarie didn’t disclose the extent of its No. 6 tank holdings, the anticipated repurposing expense, and other factors, Moab said.
The US Court of Appeals for the Second Circuit revived the case following a district court dismissal, viewing the Macquarie report as an actionable “half-truth.”
But Richard Bodnar of Rolnick Kramer Sadighi LLP in New York, who co-authored an amicus brief on behalf of institutional investors, said that the “absence of a disclosure under Item 303 conveys information to investors.”
“It is analogous to ‘the dog that did not bark in the night,’” Bodnar said, echoing the brief’s reference to a Sherlock Holmes clue sometimes cited by courts. “The absent disclosure tells investors not to concern themselves with that issue.”
And while Clark disclaimed comparisons across companies, Bodnar said pension funds and other institutional investors do exactly that. “Item 303 disclosure failures can be particularly harmful for sophisticated investors, who may be comparing trend disclosures across companies in a given sector or industry or over time for a specific issuer,” he said.
Policy questions are also before the court. “Even if you are not in favor of regulatory requirements, it’s better to rely on Rule 10b-5 rather than lots of specific rules,” said Fisch. That allows more flexibility, she said.
But Clark said a ruling affirming the Second Circuit’s decision would cost companies a great deal of money. “Securities litigation is very expensive and very protracted,” she said. That becomes expensive for the investor, she said.
The case is Macquarie Infrastructure Corp. v. Moab Partners, LP, U.S., No. 22-1165, oral argument 1/16/24.