The 2nd Circuit Court of Appeals has interpreted securities laws as requiring disclosure of information about uncertain future conditions, which potentially subjects many public companies, particularly manufacturers, to increasing and unwarranted civil suits. Because of these concerns, the National Association of Manufacturers (NAM) filed an amicus brief in November 2016, asking the U.S. Supreme Court to review the 2nd Circuit’s decision in Leidos, Inc. v. Indiana Public Retirement System. After the Supreme Court agreed to hear this case, the NAM filed another amicus brief addressing the merits of the case on June 28.
This case concerns liability for securities fraud under Section 10(b) of the Securities Exchange Act of 1934 based on a failure to disclose adverse “trends” and “uncertainties,” which requires management to use its judgment in describing known trends and uncertainties that are “reasonably likely” to occur. This is part of necessary disclosures of many reports required of publicly traded manufacturing companies under federal securities laws, including quarterly and annual reports. The 2nd Circuit’s decision calls for far more disclosure than a pure materiality standard, and it calls for disclosure of purely “soft” information, all of which makes it easily susceptible to hindsight pleading.
The Supreme Court needs to resolve this issue because there is an express circuit split between the 9th and 3rd Circuits, on the one hand and the 2nd Circuit on the other. The 9th and 3rd Circuits hold that not disclosing a “trend” or “uncertainty” does not give rise to 10(b) liability, while the 2nd Circuit has held that it does. The 2nd Circuit’s holding will open up a significant new category of securities fraud claims, and, contrary to earlier Supreme Court decisions, it subjects companies to securities fraud liability for omitting disclosures, even when the “omitted” information is not necessary to make any affirmative statement not misleading. This represents a dangerous precedent and exposes issuers to ever-increasing litigation, and the hindsight problem is exacerbated by the fact that it concerns disclosures of “soft information” that are often subjective.
If the 2nd Circuit’s ruling is allowed to stand, plaintiffs might start pleading everything as a “trend” or “uncertainty” that should have been disclosed. Public companies could be exposed to “fraud-by-hindsight” litigation if shrewd plaintiffs allege that an event was known to management as being reasonably likely to occur, including knowledge of “soft information.” This issue is a slippery slope where manufacturers may be subject to private suits for securities fraud for failing to disclose information that may not be material.
Because the 2nd Circuit’s ruling introduces more uncertainty into an area that demands certainty and predictability, the logical outcome for companies is to over-disclose potential “trends and uncertainties” so that they might mitigate the increased likelihood of being sued for securities fraud. As the Supreme Court first anticipated more than 40 years ago, such a rule of law will “lead management simply to bury the shareholders in an avalanche of trivial information—a result that is hardly conducive to informed decision-making.” A win in this case would significantly limit public company exposure to liability for securities fraud as well as provide clarity regarding disclosure obligations.