Second Circuit Confirms That Item 303 Disclosure Violations May Support Section 10(b) Liability In Reviving Claims Based On Failure To Disclose Risks From Harmful-Emission Regulation

JurisdictionUnited States,Federal
Law FirmCadwalader, Wickersham & Taft LLP
Subject MatterCorporate/Commercial Law, Energy and Natural Resources, Corporate and Company Law, Energy Law, Oil, Gas & Electricity, Securities
AuthorMr Jason Halper, Ellen V. Holloman, Adam Magid, Jonathan Watkins and Diane Lee
Published date18 April 2023

In a recent decision, Moab Partners, L.P. v. Macquarie Infrastructure Corporation,1 the U.S. Court of Appeals for the Second Circuit vacated a lower court's dismissal of claims under Section 10(b) of the Securities Exchange Act of 1934 based on an issuer's alleged failure to disclose the threat to its business posed by a regulation to reduce harmful sulfur oxide emissions from ships. The International Maritime Organization regulation, "IMO 2020," which cut the permissible upper limit on the sulphur content of ships' fuel oil from 3.5% to .5%, harmed a subsidiary's core business, storing "No. 6 fuel oil," which has a sulfur content of 3%. The Court held that the plaintiff adequately alleged that the business threat was a known trend or uncertainty that the issuer had a duty to disclose in its SEC filings under Item 303 of Regulation S-K. Reaffirming a prior Second Circuit holding, the Court confirmed that non-disclosure under Item 303 may constitute an actionable Section 10(b) omission, and, having also found scienter adequately pled, remanded the case for further proceedings.

Macquarie demonstrates that, in the Second Circuit, an issuer's failure to comply with Item 303 (and potentially other SEC disclosure rules) may create the risk of Section 10(b) liability'but (as we explain below) only if all other elements of a Section 10(b) claim are also established. Other circuits have been more skeptical of such claims, with the Ninth Circuit and others holding that Item 303 does not create a Section 10(b) duty to disclose. The divide is significant because of widespread agreement (including in the Second Circuit) that there is no private right of action under Item 303, leaving Section 10(b) as a primary mechanism for investors to seek recourse for Item 303 violations. Supreme Court guidance (or possibly contrary decisions by Second Circuit panels or a decision en banc) will be necessary to bring uniformity to the law.


The judicially created private right of action under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder allows plaintiffs to recover losses resulting from material misstatements or omissions in connection with the purchase or sale of a security.2 At the same time, a host of rules and regulations under the Exchange Act and Securities Act of 1933 impose a duty on issuers to disclose information in SEC filings. Item 303 of Regulation S-K, for example, requires issuers to identify "any known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations."3 Item 105 (formerly Item 503) also requires "a discussion of the material factors that make an investment in the registrant or offering speculative or risky."4 If an issuer fails to disclose the information required under these rules, however, it is widely recognized that there is no private right of action under Item 303 or Item 105.5 As a result, investors seeking recourse for non-disclosure under these rules must fit the violation within the framework of a recognized claim under the securities laws'in most instances, under Section 10(b) and Rule 10b-5.

The substantial challenges for plaintiffs to plead a viable claim notwithstanding an alleged Item 303 problem, and the robust defenses available for defendants, were evident in Macquarie. The case concerns Macquarie Infrastructure Corporation, then a publicly traded holding company that owned and operated various infrastructure-related businesses.6 One of Macquarie's main subsidiaries, International-Matex Tank Terminals-Bayone, Inc. (IMTT), provided storage for "No. 6 fuel oil," a group of residual fuel oils remaining at the end of the petroleum refinement process, used mainly by large shipping vessels. As alleged, storing No. 6 fuel oil was IMTT's largest business segment, constituting over 40% of its storage capacity. No. 6 fuel oil, however, contains a relatively high sulfur content, resulting in the emission of harmful sulphur oxide (SOx) when used as fuel in ships. SOx emissions have been linked to stroke, asthma, lung cancer, cardiovascular and pulmonary diseases, as well as acid rain and ocean acidification, causing harm to crops, forests, and aquatic species.

In an effort to reduce worldwide SOx emissions, in 2008, the International Maritime Organization, a United Nations agency charged with regulating global shipping, adopted "IMO 2020," which sought to ban the use of fuels with a sulfur content of .5% or greater by 2020. In 2016, the International Maritime Organization publicly reaffirmed its intention to implement the regulation by 2020. On its face, IMO 2020 would have stopped all use in global shipping of No. 6 fuel oil, which has a sulfur content of approximately 3%. At the time of the 2016 announcement, however, some believed that shippers might be able to bypass the regulation by installing abatement technology, such as scrubbers, to remove sulfur content in excess of the threshold. As a result, the precise effect of IMO 2020 on the use of No. 6 fuel oil was not certain at the time.

After the announcement, Macquarie did not publicly acknowledge that it faced a threat from the adoption of IMO 2020. Meanwhile, the company's market capitalization and stock price remained high from a historical perspective, hovering around approximately $5.5 billion and $70 per share, respectively, over the next year and a half. On February 21, 2018, however, Macquarie announced that IMTT's utilization'the amount of storage tank capacity contracted for use by its customers'had dropped by 5%, and it had missed its financial projections. The next day, on an earnings call, Macquarie's CEO pinned the downturn on a "structural decline in the 6 oil market," and revealed that, in December 2017 and January 2018, many IMTT customers terminated their contracts for No. 6 oil and exited the industry. The CEO called the change in fortunes "a surprise." The same day, Macquarie's stock price dropped by 41%.

Shareholder litigation followed, with multiple Macquarie investors filing putative class actions in the Southern District of New York. In January 2019, the District Court (Hon. Vernon S. Broderick) appointed Moab Partners, L.P., an institutional investor, as lead plaintiff...

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