Shareholder Advocate - April 2017
The Supreme Court has agreed to hear a case to clarify investors’ right to sue companies for failing to include information in shareholder reports about developments likely to impact their sales or profits.
In the case, investors sued Leidos Inc. in 2012 after share prices fell on news the company had paid $500 million to avoid prosecution over kickbacks tied to a payroll software contract with New York City. Plaintiffs argued that the company, then known as SAIC, had violated federal securities laws by not mentioning it was under investigation in its March 2011 annual report to the Securities and Exchange Commission.
At issue are different lower court interpretations over the implications of violating a provision known as Item 303 of SEC Regulation S-K, which requires companies to describe “known trends or uncertainties” that have impacted or are reasonably expected impact net sales, revenues or income.
In reviving the lawsuit after it was initially dismissed, the Second Circuit Court of Appeals agreed with plaintiffs that, in this case, running afoul of Item 303 would create a basis for a private lawsuit alleging violations of Section 10(b) of the Securities Exchange Act of 1934.
The Second Circuit’s position put it at odds with rulings by federal appeals courts in the Ninth and Third Circuits. Lawyers for Leidos appealed to the Supreme Court, asking it to resolve the circuit split and settle the question. The Court granted their petition March 27.
A Supreme Court decision upholding the Second Circuit’s opinion would “open up a whole new area to potential liabilities in other circuits,” Cohen Milstein Partner Michael Eisenkraft was quoted as saying in Law360.
That is precisely what petitioners in Leidos, Inc. v Indiana Public Retirement System fear. They believe the Second Circuit’s opinion “expands the right of private litigants to bring federal securities fraud claims far beyond the scope this Court has authorized, and in direct opposition to Congress’s intent to curb the expansion of Section 10(b) liability” in the 1990s. In addition, they say, the “stark disagreement among the circuits” is already luring plaintiffs to the friendly confines of the Second Circuit in a display of what the petitioners call “untoward forum shopping.”
In their petition to the Supreme Court, they cited other appeals court rulings that say Item 303 only creates liability if a company’s silence must be broken to correct a previous misstatement. Companies in violation of Item 303 are already subject to SEC penalties.
Lawyers for the lead plaintiff Indiana Public Retirement System had unsuccessfully argued that the Supreme Court should decline the case on a variety of grounds, including the fact that SAIC had failed to raise the Item 303 issue in previous appeals. They argued further that the Second Circuit, far from dramatically expanding a company’s duty to disclose, limited it to “appropriate cases” and required plaintiffs to meet additional standards imposed by Section 10(b) before proceeding with a fraud claim.
The Supreme Court will rule on the case during its next term, which begins in October. If Judge Neil Gorsuch’s nomination is confirmed by then, the case—likely his first involving securities litigation—will offer clues as to whether his previously expressed skepticism about the proliferation of shareholder lawsuits will carry over to the high court.