Securities fraud class action lawsuits – instances where investors sue following a company’s announcement of bad news and consequent drop in stock price – are increasingly becoming commonplace. However, these lawsuits are founded on a rather uncertain historical basis. In a case to be argued later, the US Supreme Court could potentially limit an expansion of securities fraud claims in Macquarie Infrastructure Corp. v. Moab Partners.
In 1933, Congress enacted the Securities Act followed by the Securities Exchange Act in 1934, giving rise to the Securities and Exchange Commission (SEC). Section 10(b) of the Exchange Act prohibits securities fraud. Following that in 1942, the SEC adopted Rule 10b-5, which strictly prohibits making false or misleading statements and schemes to defraud. Almost all securities fraud cases are broached under Rule 10b-5.
However, despite Section 10(b) and Rule 10b-5’s significant roles in curbing securities fraud, neither explicitly provides investors with a right to sue for securities fraud. The gap was somewhat filled by a 1971 Supreme Court decision that implicitly suggested a right to sue for violations of Section 10(b) and Rule 10b-5, even though neither contains explicit language to that effect.
The case of Macquarie primarily focuses on another SEC regulation: Item 303 of Regulation S-K. This clause requires companies to disclose “known trends or uncertainties” that have, or are reasonably likely to, materially impact financial performance. Claims of companies committing securities fraud by breaching Item 303, when they fail to disclose trends are rife.
The defendants in Macquarie argue that basing securities fraud lawsuits on Item 303 sanctions make it too easy to sue companies that merely fail to predict the future accurately. They argue the regulation encourages companies to disclose overwhelming information for fear of allegations of missing a “known trend”.
Resolution of this argument could arrive via Macquarie. There is a historical argument, which leans towards the defendants’ perspective, suggesting that Item 303 is not a regulation for securities fraud. An amicus brief also supports this, explaining that the 10b−5 Rule was adopted under the Exchange Act and Item 303 under the Securities Act.
Yet, even if Item 303 serves the public interest, the fact remains that the SEC itself did not consider Item 303 to be an anti-fraud regulation when it was adopted and where it was amended. Therefore, according to the court decisions that implied an anti-fraud right of action under Rule 10b-5, as adopted under the anti-fraud Section 10(b) statute, do not apply to Item 303.
The Supreme Court’s decision in Macquarie Infrastructure Corp. v. Moab Partners LP, could thus have significant implications for securities fraud class actions in the future.