The Leidos Mixup and the Misunderstood Duty to Disclose in Securities Law

Matthew C. Turk and Karen E. Woody are assistant professors of business law at Indiana University’s Kelley School of Business. This post is based on their recent paper, available here.

The U.S. Supreme Court recently granted certiorari in a significant securities law case, Leidos, Inc. v. Indiana Public Retirement System (Leidos). [1] The legal question presented in Leidos is whether a regulation issued by the Securities and Exchange Commission (SEC), Item 303 of Regulation S-K (Item 303), creates a duty to disclose that is actionable under the anti-fraud provision set forth in Section 10(b) of the Securities Exchange Act of 1934 and the related Rule 10b-5. This is an important issue, because Item 303 concerns one of the more controversial line-item disclosures mandated under the SEC’s rules: an overview of known uncertainties facing a company’s financial future, known as “Management’s Discussion and Analysis” (MD&A).

Leidos comes before the Court due to an intensifying clash between the Second Circuit and Ninth Circuit, the two federal appellate courts that together handle more securities cases than all other circuits combined. The conflict first materialized in a decision from 2015, Stratte-McClure v. Morgan Stanley (Stratte-McClure), where the Second Circuit declared that its interpretation of the relationship between Item 303 and Rule 10b-5 was “at odds” with a Ninth Circuit case from the prior year, In re NVIDIA Corporate Securities Regulation [2] When the Second Circuit decided Leidos a year later, it closely followed the reasoning set forth in Stratte-McClureLeidos is therefore perceived as escalating a preexisting conflict among the federal appellate courts and, as the petition for certiorari states, introduces “a deep split of authority with respect to one of the most important—and frequently invoked—provisions of the federal securities law. [3]

In taking up Leidos, the Supreme Court has presumably found the narrative presented in the petition for certiorari compelling in some respects. The same narrative—that Leidos represents an intractable division among the circuit courts—has also received near unanimous approval from other commentators on the case. It reappears substantively unchanged in the amicus briefing to the Supreme Court [4] client updates released by major corporate law firms [5] academic legal blogs [6] a leading securities casebook [7] as well as a number of scholarly articles [8] As explained in our paper, however, there is something deeply odd about this consensus. Namely, the circuit split which the Supreme Court appears on course to resolve does not in fact exist.

On the core legal question at issue in Leidos, the Second Circuit and Ninth Circuit are in full agreement. The relevant cases from both circuits draw on an earlier Third Circuit opinion written by then-Circuit Judge Alito, Oran v. Stafford [9] and come to the same conclusion: a failure to comply with Item 303 may constitute a violation of Rule 10b-5 under some circumstances, but does not necessarily do so. [10] There only two alternatives to this outcome that are logically possible: (1) noncompliance with Item 303 could constitute a per se violation of Rule 10b-5; or, (2) Item 303 could provide a safe harbor, meaning any MD&A disclosure pursuant to that rule would be immune from fraud claims. Neither of those positions have been adopted by any federal court to have considered the issue. As a predictive matter, then, the Supreme Court is likely to summarily affirm the Second Circuit decision in Leidos, and on the same grounds as were articulated in Judge Lohier’s opinion for the court in that case.

More broadly, our paper argues that the various confusions which have brought Leidos before the Supreme Court are symptomatic of some fundamental misconceptions about how the securities regulation architecture works. One of these involves the role that the “duty to disclose” doctrine plays in securities law claims. An irony on this point is that, despite there being an extensive debate over the duty doctrine in commentary on Leidos, the presence of a legal obligation to disclose information relating to MD&A is simply not at issue in the case. It is uncontested that such a requirement is imposed by the SEC through Item 303 of Reg S-K. In a hypothetical scenario where factual allegations supporting a violation of Item 303 do not also give rise to a fraud claim under Rule 10b-5, the only upshot is that a private enforcement mechanism for that requirement is unavailable. The SEC can still police noncompliance with its MD&A rules through cease-and-desist orders and other forms of regulatory supervision. Thus, from a policy perspective that focuses on the flow of information to capital markets, the kinds of disclosures that the securities regulations compel firms to make to investors will remain unchanged.

The complete paper is available for download here.


1See Indiana Pub. Ret. Sys. v. SAIC, Inc., 818 F.3d 85 (2d Cir. 2016) (Lohier, J.), cert granted, 137 S. Ct. 1395 (Mar. 27, 2017) [hereinafter Leidos]. The case likely will be argued before the Court before the end of 2017, with an opinion issued by mid-2018 at the latest.(go back)

2Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 103 (2d Cir. 2015) (Livingston, J.) (citing In re NVIDIA Corp. Sec. Litig., 768 F.3d 454, 465 (9th Cir. 2014)).(go back)

3Indiana Pub. Ret. Sys., Petition for Writ of Certiorari to the United States Court of Appeals for the Second Circuit, at 1 (Oct. 31, 2016).(go back)

4Brief for the Securities Industry and Financial Markets Ass’n (SIFMA) and the Chamber of Commerce as Amici Curiae (Nov. 30, 2016); Brief of Amicus Curiae National Ass’n of Manufacturers (Nov. 30, 2016). Even the Leidos defendant’s brief in opposition to certiorari is more or less in accord. See Brief in Opposition to Leidos Plaintiff’s Petition for Certiorari at 18 (conceding that there is a “nascent circuit split” while downplaying its practical impact).(go back)

5Sullivan & Cromwell LLP, “U.S. Supreme Court Grants Certiorari to Decide Issue That Might have Significant Impact on Registrants’ Exposure for Non-Disclosure” (Mar. 27, 2017); Gibson, Dunn & Crutcher LLP (Discussed on the Forum here), “Creating A Clear Circuit Split, the Second Circuit Holds that Failure to Disclose Known Trends or Uncertainties Under Item 303 of Regulation S-K Creates Liability Under Section 10(b)” (Jan. 22, 2015).(go back)

6Audra Soloway et al., Columbia Law School Blue Sky Blog on Corporations and Capital Markets (April 6, 2017).(go back)

7James D. Cox, Robert W. Hillman & Donald C. Langevoort, Securities Regulation: Cases & Materials, 611 (8th ed. 2017).(go back)

8Eric R. Harper, “Unveiling Management’s Crystal Ball,” 77 La. L. Rev. 879, 900-908 (2017); Lauren M. Mastronardi, “Shining the Light a Little Brighter: Should Item 303 Serve as a Basis for Liability Under Rule 10b-5,” 85 Fordham L. Rev. 337, 350-60 (2016); Denise Voigt Crawford & Dean Galaro, “A Rule 10b-5 Private Right of Action for MD&A Violations?”, 43 Sec. Reg. L. J. 1 (2015).(go back)

9Oran v. Stafford, 226 F.3d 275 (3d Cir. 2000) (Alito, J.).(go back)

10Oran, 226 F.3d at 288; Stratte-McClure, 776 F.3d at 103; In re NVIDIA, 768 F.3d at 1055.(go back)

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