United States: Failure To Disclose Known Trends Or Uncertainties In Public Filings May Create Liability Under Section 10(b)

On January 12, 2015, the U.S. Court of Appeals for the Second Circuit held in Stratte-McClure v. Morgan Stanley1 that a failure to make a required disclosure under Item 303 of Regulation S-K in a Quarterly Report on Form 10-Q is an omission that can serve as the basis for a Section 10(b) securities fraud claim if (1) the omission satisfies the materiality requirements outlined in Basic v. Levinson2, and (2) all of the other requirements to sustain an action under Section 10(b) are satisfied.


Morgan Stanley entered into two trading positions regarding the sub-prime mortgage market in December 2006. First, Morgan Stanley sold a $13.5 billion long position in a super-senior tranche of a collateralized debt obligation ("CDO") in the form of a credit default swap ("CDS"). Second, Morgan Stanley purchased a $2 billion short position through another CDS that tracked a lower-rated, higher-risk tranche of another CDO. Stated in a rudimentary manner, CDSs act as a form of insurance with the buyer making "premium" payments to the seller, and the seller responsible for covering losses in the event of default or a decline in value within the contractually agreed tranche. As a result, Morgan Stanley was making premium payments on its short position, which had a higher risk of default than its long position, and was receiving premium payments on its long position with the responsibility to make payments if the specified tranche declined in value or went into default. Morgan Stanley's strategy reveals a belief that the housing market would decline (the purpose of its short position), but that the magnitude of damage would not reach the super-senior tranches (the purpose of its long position). Unfortunately, Morgan Stanley did not correctly predict the magnitude of the collapse and the resulting widespread risk the burst of the housing position posed on its long position.

As a result of the collapse, the financial losses incurred under the long position and the subsequent disclosures in Morgan Stanley's filings, the plaintiffs argued that Morgan Stanley made material omissions in their Quarterly Reports on Form 10-Q by failing to disclose (1) the existence of the long position, (2) that Morgan Stanley had sustained losses on the long position during the company's second and third quarters of 2007, and (3) that the company was likely to incur additional significant losses on the position in the future.

Item 303 of Regulation S-K

Item 303 states, in pertinent part, that a company is to "[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact" on the company. Guidance provided by the SEC on Item 303, clarifies that disclosure is necessary where a "trend, demand, commitment, event or uncertainty is both presently known to management and reasonably likely to have material effects on the registrant's financial conditions or results of operations."3

Before Stratte-McClure, both the Second Circuit and the U.S. Court of Appeals for the Ninth Circuit held that the failure to comply with Item 303 in company registration statements and prospectuses is actionable under Sections 11 and 12(a)(2) of the Securities Act of 1933, as amended.4 However, whether a breach of an Item 303 duty to disclose in the context of a public filing could give rise to liability under Section 10(b) of the Securities Exchange Act of 1934, as amended, had not been addressed until the Ninth Circuit held in In re NVIDA Corp. Securities Litigation that Item 303 does not create a duty to disclose for purposes of Section 10(b).5 As discussed below, the Second Circuit distinguished its holding from the Ninth Circuit's analysis in NVIDIA.

The Second Circuit's Holding

The Second Circuit held that a "failure to make a required Item 303 disclosure in a 10-Q filing is indeed an omission that can serve as the basis for a Section 10(b) securities fraud claim." Yet, in holding that Section 10(b) may apply to an omission under Item 303, the Second Circuit clarified that such an omission is only actionably if (1) it satisfies the materiality requirements outlined in Basic and (2) all of the other requirements to sustain an action under Section 10(b) are fulfilled as well.

Breach of an Item 303 of Regulation S-K Duty to Disclose

According to the SEC, a company has a duty to report under Item 303 after management engages in a two-part inquiry:

  1. Is the known trend likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required.
  2. If management cannot make that determination, it must evaluate objectively the consequences of the known trend on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant's financial condition or results of operations is not reasonably likely to occur.

Violation Under Basic

As stated above, despite a breach of an Item 303 duty to disclose, according to the Second Circuit, a plaintiff would only be able to proceed under Section 10(b) if the alleged omitted information satisfies Basic's test for materiality. To do so, the plaintiff must allege that the defendant failed to comply with Item 303 and then that the omitted information was material under Basic's probability/magnitude test. The plaintiff must meet the materiality test because Rule 10b-5 only makes an omission of material information unlawful where it is necessary to make statements made "not misleading."

Violation of Section 10(b)

Simplistically, Rule 10b-5, which implements Section 10(b), states that to bring a claim for securities fraud, a plaintiff must alleged that each defendant (1) made material misstatements or omissions of material fact, (2) with intent or knowledge of wrongdoing, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relied, and (5) that the plaintiff's reliance was the proximate cause of its injury.

Second Circuit's Decision

Morgan Stanley argued that they had satisfied their disclosure obligations under Item 303 by including a discussion on the decline of the real estate, credit and subprime mortgage markets and their potential adverse effects. However, the Second Circuit criticized the disclosures employed by Morgan Stanley for being too generic in nature and dispersed throughout numerous filings. To satisfy their disclosure requirements, the Second Circuit was looking not only for a discussion, but analysis that covered the decline of real estate, credit and subprime mortgage markets and that tied the particular discussion to the potential impact Morgan Stanley's significant exposure to such markets could have on their financial position.

Despite holding that Morgan Stanley breached its Item 303 duty to disclose, the Second Circuit clarified that it would not expect Morgan Stanley to disclose the details of its long position — only the consequences of having such a position. The Second Circuit believed this couched requirement comported with their reluctance to interpret the securities laws in a manner that requires companies to give competitors notice of proprietary strategies and information.

The Second Circuit was able to distinguish its holding from the Ninth Circuit's holding in NVIDIA, because the Second Circuit believed precedent was inaccurately relied upon by the Ninth Circuit — that a previous case did not imply that a breach of a company's Item 303 duty to disclose is never actionable under Section 10(b), but that the case suggested, without deciding, that in certain circumstances, a breach of an Item 303 duty to disclose could give rise to a material 10b-5 omission.

Ultimately, the Second Circuit dismissed the case, holding that (1) the plaintiffs properly alleged a breach of their Item 303 duty to disclose, and (2) that although the Second Circuit, assumed for the sake of argument, that the omission was material under Basic, the plaintiffs failed to sufficiently plead scienter (the intent or knowledge of wrongdoing).


If a company is to omit such material information from its Quarterly Reports on Form 10-Q and Annual Reports on 10-K, the company may face Section 10(b) liability if the plaintiffs can prove that there was (1) a breach of an Item 303 duty to disclose, (2) the omission was material under Basic, and (3) that the remaining requirements of Section 10(b) are satisfied.

As this disclosure has been a point of emphasis by the SEC, companies should be cognizant of the requirements under Item 303 to disclose trends or uncertainties that would have a material effect on the company. Although, in contemplating the disclosure requirements, remember that the Second Circuit's holding does not require the disclosure of a company's internal business strategy or trading positions; rather, it is only requesting an analysis of how a trend or uncertainty may have a material effect on the company. Regardless, until the U.S. Supreme Court reconciles any differences between the Second and Ninth Circuit as to whether Section 10(b) liability can attach to a breach of an Item 303 duty to disclose, the result of Stratte-McClure dictates companies continue to give heightened attention going forward to company and industry trends and uncertainties to ensure appropriate disclosure.


1. Stratte-McClure v. Morgan Stanley, 2015 WL 136312 (2d Cir. Jan. 12, 2015).

2. Basic v. Levinson, 485 U.S. at 224 (1988).

3. Management's Discussion and Analysis of Financial Condition and Results of Operations, Exchange Act Release No. 6835 (May 18, 1989).

4. See Panther Partners Inc. v. Ikanos Commc'ns, Inc., 681 F.3d 114 (2d Cir. 2012); Steckman v. Hart Brewing, Inc., 143 F.3d 1293 (9th Cir. 1998).

5. In re NVIDIA Corp. Securities Litigation, 768 F.3d 1046 (9th Cir. 2014).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions