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E-MailJoseph A. Grundfest is William A. Franke Professor of Law and Business at Stanford Law School, as well as Senior Faculty at Stanford University Rock Center on Corporate Governance. This post is based on his recent paper.
What if the Supreme Court issued an opinion and no one cared? No one cared who won or lost. No one cared how the question presented was resolved. The prevailing party wouldn’t gain a cent from its victory and the losing party wouldn’t suffer one whit from its loss. Leidos, Inc. v. Indiana Public Retirement System, now pending before the Supreme Court, could be just that sort of case.
On its surface, Leidos poses a fundamental doctrinal challenge to the interpretation of Rule 10b-5, the most important anti-fraud provisions in all of the federal securities laws. Thousands of lawsuits have been filed and billions of dollars have passed hands litigating Rule 10b-5, and Supreme Court opinions interpreting Rule 10b-5 are often a big deal.
Leidos is not a big deal. Unless the Court deviates significantly from established precedent, Leidos will have only a cosmetic effect on the real-world push and pull of securities fraud litigation. Leidos might influence the literary style with which plaintiffs plead complaints, defendants argue motions to dismiss, and lower courts craft their opinions. But regardless of Leidos’ ultimate holding, the same companies will likely be sued on the same sets of facts, the same cases will likely be dismissed, and the same settlements will likely be paid. From a pragmatic perspective, Leidos is a nothing-burger.
The question presented in Leidos challenges the reach of Section 10(b) and Rule 10b-5 liability. Section 10(b) is not self-enforcing. It is a delegation of authority to the Commission to adopt regulations prohibiting “any manipulative or deceptive device or contrivance.” Pursuant to this delegated authority, the Commission in 1942 adopted Rule 10b-5, but nothing in the text of the statute or in the text of the rule expressly addresses liability for “pure omissions,” the omission of information that Commission regulations require to be disclosed in periodic reports, but that does not render any affirmative statement false or misleading.
Leidos takes that next step. More precisely, Leidos asks whether Rule 10b-5 also prohibits failures to disclose information that the SEC requires be disclosed in a periodic report even if the omission does not render any affirmative statement false or misleading.
Both sides in this debate should catch a breath. The complex web of SEC disclosure requirements, combined with the reality of modern communications practice, in which issuers commonly and voluntarily provide the market with quarterly earnings calls, quarterly and annual outlooks, and other information, create a thicket of affirmative disclosures. With so much affirmative information from the company entering the public domain it becomes trivially easy for plaintiffs to allege that material omissions cause affirmative statements to become materially misleading. Because half-truths are undoubtedly actionable under Rule 10b-5, and because the resolution of a half-truth claim exposes the defendant to liability identical to that arising from the resolution of the corresponding pure omission claim, it will, in general, make no practical difference whether material pure omissions are actionable as pure omissions or only as generating half-truths.
Indeed, Leidos itself proves the point: there, a single omission causes an affirmative statement to become misleading and is also alleged as a “pure omission.” Also, even a cursory reading of the annual report at issue reveals at least two additional risk factor disclosures that plaintiffs could have, but did not, allege as misleading because of the same omission. Leidos will be remanded to resolve the surviving half-truth claim and, on remand, the probability that Leidos will be dismissed, and the amount for which Leidos settles if not dismissed, will not be materially affected by the Supreme Court’s decision. Moreover, given the state of the record below, the possibility arises that this case has made it to the Supreme Court because of suboptimal pleading practices by plaintiff attorneys rather than a fundamental issue of securities law that cries out for resolution.
This is not to suggest that certiorari has been improvidently granted. There is a clear Circuit split, even if some analysts view the split as primarily semantic. But there is also virtue in semantic consistency. A clear opinion describing the scope of liability, if any, for pure omissions will contribute to judicial efficiency by eliminating complex briefing over rhetorical distinctions that don’t move the liability needle.
As for the doctrinal question presented, the better interpretation of the law is that the relevant text, history, and precedent do not support Rule 10b-5 liability for pure omissions. The Court’s recent textualist approach to the interpretation of Section 10(b) and Rule 10b-5, as well as its longstanding aversion to the expansion of implied rights of action all point to a decision in that direction. Indeed, a decision to the contrary would create substantial tension with Supreme Court precedent and generate unnecessary confusion over the application of the most important civil liability provision of the federal securities laws. The paper also examines the potential for pure omission liability arising from the Sarbanes-Oxley Section 906 certification and concludes that neither the Commission nor private parties are likely to prevail on such a claim.
The complete paper is available for download here.
