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The Sound of Silence

Under federal law, it is securities fraud, pursuant to what is commonly known as SEC Rule 10(b)-5,[i] “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 in which they were made, not misleading … in connection with the purchase or sale of a security.”


Certain things are clear about this type of fraud.  For example, merely omitting to state a fact, no matter how important it may be to an investor, does not qualify as securities fraud. But if the result of   an omission is the failure to clarify a previous misleading statement, it does. 


But what about the failure of a reporting company to make a disclosure required by law that would have been of unquestionable interest to the reasonable investor considering trading on the information (or lack of it)?  The SEC thought such an omission constitutes fraud, as did the United States Court of Appeals for the Second Circuit, although other courts disagreed.  The Supreme Court has now weighed in.


Macquarie Infrastructure Corporation owns infrastructure related businesses, including bulk liquid storage terminals.  One of the commodities stored by a Macquarie subsidiary is No. 6 fuel oil.  In 2016, the United Nations’ International Maritime Organization adopted a regulation, known as IMO 2020, that capped the sulfur content of fuel oil used in shipping at 0.5%.  The sulfur content of No. 6 fuel oil is closer to 3%. 


In February 2018, Macquarie announced that the storage capacity contracted for use of its customers had dropped because of a decline in the market. As a consequence, the price of Macquarie’s shares fell by around 41%.


Corporate disclosure is at the heart of our securities laws. So the SEC mandates that companies make any number of disclosures.  One such mandated disclosure arises from a rule, known as Item 303, which required that Macquarie “describe any known trends or uncertainties that have had or that are reasonably likely to have a material or unfavorable impact on net sales or revenues or income from continuing operations” and that might make an investment “speculative or risky.”[ii] In answering Item 303, Macquarie said nothing about the UN’s IMO 2020.


One investor, Moab Partners, L.P., sued, claiming that Macquarie’s public statements were false and misleading because they concealed the ban on the subsidiary’s largest product, No. 6 fuel oil, which had a material effect on the company’s financial condition.  The failure to disclose, in Macquarie’s response to Item 303, was, according to Moab, the functional equivalent of a misleading statement.  The Second Circuit Court of Appeals[iii] agreed and applied its long-standing rule that a duty to disclose arises when a statute or regulation requires disclosure, so that a failure to disclose in such circumstances can be the basis of a claim under Section 10(b) of the Securities and Exchange Act[iv] and Rule 10(b)-5.


The Supreme Court begged to differ.  Reading Rule 10(b)-5 literally, a unanimous court—unanimous!—in a brief (eight page) opinion, found in essence that, without a prior misleading statement to clarify, there was no securities fraud.[v] In other words, failure to disclose information required by Rule 303 cannot by itself be the basis for a fraud claim.


While Rule 10(b)-5 might not be a model of clarity, the Supreme Court’s interpretation is certainly based on a fair reading of the language of the regulation.  After all, the rule makes actionable the failure to disclose information necessary to render a prior statement not misleading, but says nothing of pure omissions.


But a basic purpose of our securities laws is to provide disclosure of material information about companies seeking to raise capital through public offerings or whose shares are already publicly traded. Item 303, which asks a question whose answer is of critical importance to any investor, is an integral part of the disclosure regime.


The Supreme Court’s reading does not discuss, much less honor, that basic purpose.  The court is saying, in practical terms, that you could be liable for fraud if you answer with, and do not later correct, a half-truth—say, if Macquarie responded to Item 303 by reporting that there was still a market for No. 6 fuel oil. But you’ll be fine if you don’t say anything about market conditions in answering a question calling for a listing of “trends or uncertainties” that are likely to impact your sales.


It’s clear that a reasonable investor would conclude from Macquarie’s silence that the company faced no headwinds such as IMO 2020 and might well trade on that conclusion.  That silence by itself is surely as misleading as a bland statement about market conditions.


And doesn’t granting immunity for pure omissions encourage them? Where a company may be on the fence about disclosing information, its default may be to disclose nothing at all.  The Supreme Court’s only response to this plausible outcome was that companies protected from a private lawsuit under Rule 10(b)-5 for the failure to mention a material fact in response to a mandated disclosure could still face an SEC prosecution for violation of an agency rule.  That answer probably didn’t provide much comfort to Moab.


So, while the Supreme Court may have read the language of Rule 10(b)-5 reasonably, the intent of the regulation, which the court did not address in its brief opinion, got short shrift.

[i]    17 C.F.R. §240.10b-5.

[ii]   17 C.F.R. 229.303(b)(2)(ii).

[iii]  Moab Partners L.P. v. Macquarie Infrastructure Corp., WL 17815767 (2d Cir. 2022).

[iv]  15 U.S.C. §78j(b).

[v]   Macquarie Infrastructure Corp. v. Moab Partners L.P., 601 U.S. _____ (decided April 12, 2024).


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