The Ninth Circuit recently examined whether Item 303 of Regulation of S-K, which sets forth the MD&A rules, creates an affirmative duty of disclosure on which to pin a Rule 10b-5 case.  The case centered around a significant stock price drop after the issuer disclosed it would incur a $150 million to $200 million charge related to product defects.  Plaintiffs claimed the company knew it would be liable for the defective products long before the disclosures and made several intervening SEC filings that violated Rue 10b-5.  On appeal the plaintiffs argued the disclosure duty under Item 303 of Regulation S–K is actionable under Section 10(b) and Rule 10b-5.

The court analyzed the origin of disclosure duties under Rule 10b-5 according to the Supreme Court precedent.  Looking to the Matrixx Initiatives case, the court noted neither Section 10(b) nor Rule 10b-5 creates an affirmative duty to disclose any and all material information. Disclosure is required under these provisions only when necessary to make statements made, in light of the circumstances under which they were made, not misleading. Also, the court looked to Basic Inc. v. Levinson which stated “silence, absent a duty to disclose, is not misleading under Rule 10b-5.”

The court also examined an opinion from the Third Circuit.  The court noted that management’s duty to disclose under Item 303 is much broader than what is required under the standard pronounced in Basic.  Citing the Third Circuit case with approval, the court noted because the materiality standards for Rule 10b-5 and Item 303 differ significantly, the demonstration of a violation of the disclosure requirements of Item 303 does not lead inevitably to the conclusion that such disclosure would be required under Rule 10b-5.

The court ultimately held that Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b-5. According to the court such a duty to disclose must be separately shown according to the principles set forth by the Supreme Court in Basic and Matrixx Initiatives.

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