Supreme Court to Resolve Whether Failure to Disclose Under Item 303 of SEC Regulation S-K Gives Rise to Securities Fraud Claims

On March 27, the Supreme Court granted certiorari in the case of Leidos Inc., f/k/a SAIC Inc. v. Indiana Public Retirement System, a securities fraud class action. The case will resolve a circuit split over whether a failure to disclose under Item 303 of SEC Regulation S-K can give rise to a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

Investor plaintiffs brought a putative class action against Science Applications International Corporation (SAIC), now known as Leidos. Plaintiffs alleged that SAIC failed, in March 2011, to disclose that it had potential liability exposure as a result of a criminal kickback scheme concerning business with the New York City government. SAIC first disclosed the issue in June 2011, after the city formally requested repayment. Nine months later, SAIC settled with the city for $500 million.

Item 303 requires companies to, among other things, “[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” As one of their arguments, plaintiffs contended that SAIC knew of the city’s allegations and the alleged scheme well before June 2011, and that the criminal investigation alone was an uncertainty that SAIC reasonably expected would have a material and unfavorable impact and that should have been disclosed under Item 303.

In separate decisions in September 2013 and January 2014, the U.S. District Court for the Southern District of New York dismissed all of plaintiffs’ claims, reasoning that plaintiffs’ pleading was essentially a “hindsight pleading.” The district court further denied plaintiffs’ motions for relief from judgment, reasoning that any amendment to include the Item 303 claims based on the March 2011 omissions would be futile.

On appeal, the Second Circuit affirmed dismissal, with the exception of the claims asserting that SAIC omitted disclosures required under Item 303, finding that the district court erred in its futility determination. Citing its own precedent, the panel stated, “[i]n Stratte‐McClure, we held that Item 303 imposes an affirmative duty to disclose . . . [that] can serve as the basis for a securities fraud claim under Section 10(b)” and that “failure to comply with Item 303 . . . can give rise to liability under Rule 10b–5 so long as the omission is material…” (internal quotations omitted).

The Second Circuit’s position on this point reflects a circuit split on the issue. The Second Circuit held that a non-disclosure under Item 303 may, under some circumstances, give rise to private securities fraud liability. The Third and Ninth Circuits hold that it may not.

The Ninth Circuit, in In re NVIDIA Corp. Securities Litigation, and the Third Circuit in Oran v. Stafford, have taken the position that a violation of Item 303 disclosure requirements does not lead inevitably to the conclusion that such a disclosure would be required under Rule 10b-5; instead, a duty must be separately shown. The Third and Ninth Circuits reasoned that because materiality under the securities laws differed from materiality under Item 303, a violation of the latter is not a violation of the former.

This circuit split will soon be resolved by the Supreme Court, presumably in 2018.

Leidos Inc., fka SAIC Inc., v. Indiana Public Retirement System et al., No. 14-4140 (2nd Cir. Apr. 13, 2016), cert. granted No. 16-581 (U.S. Mar. 27, 2017).