September 18, 2023

MD&A: Can Violations of Item 303 Serve as the Basis for Securities Fraud Claims?

Earlier this year, Liz blogged about a cert petition seeking clarification from the SCOTUS of the extent to which the failure to comply with the MD&A line-item disclosure requirements set forth in Item 303 of Reg S-K can serve as the basis for a securities fraud claim. That’s an issue that the circuits are split on, and earlier this month, a federal district judge in the Northern District of Illinois threw another log on this particular fire with his opinion in Phoenix Ins. Co. v. ATI Physical Therapy, (ND Ill.; 9/23). This excerpt from a recent Jim Hamilton blog on the decision summaries the Court’s analysis:

The Seventh Circuit has not yet decided whether a Section 10(b) or 14(a) claim can be premised on a violation of Item 303. In the Second Circuit, “positive law” (statutes or regulations, like Item 303) can give rise to an affirmative duty to disclose under Exchange Act Section 10(b) or 14(a). The Ninth Circuit, though, held otherwise, reasoning that Item 303’s disclosure requirement varies from the Basic test for materiality.

In the Illinois district court’s view, the Ninth Circuit conflated the distinct concepts of duty to disclose and materiality. The district court thus adopted the reasoning of the Second Circuit that failure to comply with Item 303 can give rise to Section 10(b) fraud liability if the omission is material under Basic and the other elements of the securities fraud claim are established. “That reasoning, which recognizes the difference between the legal concepts of duty to disclose and materiality, makes sense,” the Illinois court wrote. “It also likely—though not definitely—squares with an earlier case that the Ninth and Second Circuits both cite.”

The Court also held that non-compliance with Item 303 can serve as the basis of a claim under Rule 14a-9, which prohibits false or misleading statements in proxy materials, provided that Basic’s materiality standard is satisfied.

John Jenkins