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Leidos v. Indiana Public Retirement System

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Supreme Court of the United States
Leidos v. Indiana Public Retirement System
Docket number: 16-581
Term: 2017
Court: United States Supreme Court
Important dates
Argument:TBD
Decided: TBD
Court membership
Chief Justice John G. Roberts • Anthony Kennedy • Clarence Thomas • Ruth Bader Ginsburg • Stephen Breyer • Samuel Alito • Sonia Sotomayor • Elena Kagan • Neil Gorsuch


Leidos v. Indiana Public Retirement System was docketed for oral argument during the October 2017 term of the U.S. Supreme Court. Arguments in the case were scheduled for November 6, 2017, but on October 17, 2017, the court issued an order removing the case from its calendar pending further proceedings. The case came on a writ of certiorari to the United States Court of Appeals for the 2nd Circuit.

Writing in Law360, an online legal blog, attorneys Stephen Cohen and Daniel McLaughlin noted the significance of this case. They said,[1]

“

Leidos presents potentially far-reaching questions, ranging from the SEC’s role in interpreting Section 10(b) to courts’ role in creating a federal common law of disclosure duties. Omissions liability for required disclosures is a frequent tool in the arsenal of the SEC and prosecutors, in light of the profusion of SEC rules and the ability to target nonspeaking parties. It is also a powerful weapon in civil class actions, given that an omission case allows class plaintiffs to bypass the need to show individual reliance. Applied to forward-looking projections like those required by Item 303, it can open public companies to significant second-guessing class actions when the company faces a downturn or crisis after misjudging uncertainties that seem obvious only in hindsight.[2]

”
HIGHLIGHTS
  • The case: In a required SEC filing, a company did not disclose that it was the subject of a potential investigation for fraud. The company was later sued by investors for its failure to disclose this information. The company said that the relevant SEC regulation did not require disclosure, but the Second Circuit Court of Appeals disagreed, holding that the company's mere omission of this information from its disclosure gave the investors a cause of action for securities fraud.
  • The issue: Does Item 303 create a duty to disclose and is the failure to make an Item 303 disclosure an actionable item under Section 10(b) of the Securities and Exchange Act?
  • The outcome: The appeal is pending adjudication before the U.S. Supreme Court.


    • In brief: The U.S. Securities and Exchange Commission enforces requirements for financial disclosures under various regulations. Among the regulations used is Regulation S-K. A provision of Regulation S-K known as Item 303 requires corporate management to disclose certain financial information as well as "other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations." In a March 2011 SEC filing, Leidos, then SAIC Inc., did not disclose that it was the subject of a potential investigation for fraud. The company was later sued by investors for its failure to disclose this information. The company said that Item 303 did not require disclosure, but the Second Circuit Court of Appeals disagreed, holding that the company's mere omission of this information from its disclosure gave the investors a cause of action for securities fraud. The Second Circuit's ruling created a split among federal circuit courts over whether the mere omission of this information gives a civil plaintiff a cause of action for securities fraud under Section 10(b) of the Securities and Exchange Act. Arguments in the case were scheduled for November 6, 2017, but on October 17, 2017, the court issued an order removing the case from its calendar pending further proceedings.

    You can review the lower court's opinion here.[3]

    Background

    Types of SEC disclosures

    For all publicly traded companies, the U.S. Securities and Exchange Commission (hereafter, SEC) requires certain disclosure statements. One report, Form 10-K, is for a company's annual statement and provides a "comprehensive overview of the company's business and financial condition and includes audited financial statements." A second form, Form 10-Q, is filed as a company's quarterly statement. This form "includes unaudited financial statements and provides a continuing view of the company's financial position during the year. The report must be filed for each of the first three fiscal quarters of the company's fiscal year." A final form, Form 8-K, is "the 'current report' companies must file with the SEC to announce major events that shareholders should know about."[4][5][6]

    Disclosure requirements

    The information that is required for each of the above disclosure statements is governed by SEC regulations, specifically Regulation S-K. Regulation S-K contains a number of provisions related to the corporate background, management, and financial status of the company. One such provision under Regulation S-K is known as Item 303. Item 303 is titled "Management's discussion and analysis of financial condition and results of operations." This is also referred to as a MD&A statement.[7] Under Item 303 of Regulation S-K, management is required to disclose certain financial information as required under the regulation, as well as "other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations." This information must include a description of "any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed."[8]

    Legal provisions for failure to disclose

    A failure to provide accurate information or to withhold required information under Regulation S-K could subject a company and its corporate officers to charges of securities fraud under Section 10(b) of the Securities and Exchange Act of 1934. That section gives the SEC "power to enact rules against 'manipulative and deceptive practices' in securities trading." One such rule the SEC uses in support of that power is Rule 10(b). Of all of the provisions under Rule 10(b), the rule that is "perhaps the most important and widely used anti-fraud securities rule" is Rule 10(b)-5, which the "SEC typically uses ... to charge a person with illegal insider trading, as the rule applies to 'any person' who 'defrauds' another person in 'the purchase or sale of any security.'"[9]

    Facts of this case

    Beginning in 2000, SAIC Inc. developed and implemented an automated timekeeping program for the City of New York (hereafter, City) called CityTime. Two years later, SAIC hired Gerard Denault as deputy program manager in charge of the CityTime project. In 2003, Denault hired Technodyne to provide staffing services on the project. In time, Denault and SAIC's chief systems engineer, Carl Bell, began receiving kickback payments from Technodyne. Technodyne paid Denault and Bell for each hour an employee worked on the CityTime project. Denault and Bell hired more Technodyne workers than the project required and began to bill the City at inflated billable hourly rates and for an inflated number of hours worked. In 2006, Denault negotiated an amendment to SAIC's contract with the City whereby the risk of any cost overruns was transferred to the City. "As a result of the amendment and the cost overruns associated with the kickback scheme, SAIC billed the City approximately $635 million for CityTime through May 2011, well over the $63 million that the City initially budgeted for the contract."[3] By 2010, SAIC removed Denault from the project and hired an outside law firm to investigate for any fraudulent activities. The firm discovered and reported Denault's improper timekeeping practices to SAIC on March 9, 2011.

    On March 25, 2011, 16 days after receiving the firm's report on Denault, SAIC filed its annual statement, Form 10-K, as required by the SEC. The form, which was certified by both SAIC's chief executive officer, Walter Havenstein, and SAIC's chief financial officer, Mark Sopp, among others, did not disclose any potential liability related to the CityTime project. By the end of May 2011, Denault, Bell, and the Technodyne employees responsible for payments were charged in a federal criminal complaint. On June 2, 2011, SAIC filed a current report, Form 8-K, in which SAIC disclosed that the U.S. Attorney's office for the Southern District of New York and the City's department of investigation were conducting a joint criminal investigation into the CityTime project. SAIC's Form 8-K also disclosed details about the extent of the fraudulent allegations and that the City intended to pursue the recovery of its costs associated with the CityTime project. The next day, June 3, 2011, SAIC filed its SEC-mandated quarterly statement, Form 10-Q, which repeated much of the information in SAIC's June 2011 Form 8-K. On July 1, 2011, SAIC filed an additional Form 8-K in which SAIC included a letter from New York City Mayor Michael Bloomberg (R) in which Bloomberg demanded "that SAIC reimburse the City in the approximate amount of $600 million dollars." In March of 2012, SAIC entered into a deferred prosecution agreement with the U.S. Attorney and the City in which SAIC agreed to forfeit $40 million dollars in unpaid receivables and to reimburse the City approximately $500.4 million dollars for costs associated with the CityTime project.[3]

    Allegations of securities fraud

    A group of civil plaintiff investors led by the Indiana Public Retirement System (hereafter, IPRS) filed a lawsuit in federal district court alleging that SAIC committed various violations of the Securities and Exchange Act of 1934. Specifically, the lawsuit claimed that SAIC's March and June 2011 SEC filings on SAIC's Form 10-K, Form 10-Q, and Form 8-K "failed to disclose SAIC's potential liability arising out of the CityTime fraud or known trends or uncertainties associated with the fraud, as required by FAS 5 and Item 303."[3][10][11]

    In September of 2013, the district court dismissed most of the charges against SAIC except for the FAS 5 and Item 303 challenges related to the March 2011 Form 10-K. SAIC filed a motion for reconsideration on the court's decision not to dismiss the remaining FAS 5 and Item 303 challenges. In January of 2014, the court granted SAIC's motion and dismissed the FAS 5 and Item 303 challenges. IPRS filed two motions in March of 2014, one for relief on the judgment and one to amend their complaint against SAIC; both were dismissed by the district court for futility. IPRS appealed the district court's decision to the United States Court of Appeals for the 2nd Circuit.[3]

    A three-judge panel of the Second Circuit composed of Judges Gerard Lynch, Susan Carney, and Raymond Lohier heard the appeal. On March 29, 2016, the Second Circuit issued a unanimous panel ruling. Judge Lohier wrote the opinion for the panel. The panel vacated the lower court's dismissal of the FAS 5 and Item 303 challenges, remanded the case for further proceedings on those challenges, and affirmed the lower court ruling in all other aspects.[3]

    Item 303 analysis

    The panel relied on a 2015 Second Circuit precedent, Stratte-McClure v. Morgan Stanley, to vacate the lower court's dismissal of IPRS' Item 303 challenge. In Stratte-McClure, the Second Circuit held that a company's failure to make a required Item 303 disclosure constituted an omission that could serve as the basis for a securities fraud claim under Section 10(b). Put in legal terms, the court held that Item 303 created a duty to disclose and that the failure to make an Item 303 disclosure is an actionable item under Section 10(b) of the Securities and Exchange Act.

    In this case, SAIC insisted that its failure to disclose information related to the CityTime lawsuit in its March 2011 Form 10-K was not material to SAIC's operations as a whole. SAIC further claimed that it was required to have known of the uncertainty surrounding the lawsuit at the time of its filing. Based on these claims, SAIC alleged that its failure to disclose this information in March of 2011 did not render the affirmative statements SAIC made in its Form 10-K misleading, which is the standard for an action under Section 10(b) used in both the Third Circuit and the Ninth Circuit. The Second Circuit, however, held that merely omitting this information gave rise to a Section 10(b) challenge.[12]

    Circuit split

    In 2000, the Third Circuit held in Oran v. Stafford that Item 303 did not create a duty to disclose for purposes of Section 10(b). That opinion was written by then-Circuit-Judge Samuel Alito. Relying on that opinion, in 2014, the Ninth Circuit ruled similarly in In re NVIDIA Corp. Securities Litigation. The Second Circuit, first in Stratte-McClure and now, in this case, held differently. Under Rule 10 of the U.S. Supreme Court's rules of procedure, the court will often grant certiorari to resolve a dispute between federal appeals courts.

    Petitioner's challenge

    Leidos Inc., the petitioner, challenged the holding of the Second Circuit that Item 303 created a duty to disclose and that the failure to make an Item 303 disclosure is an actionable item under Section 10(b) of the Securities and Exchange Act.[13]

    Certiorari granted

    On October 31, 2016, Leidos Inc., the petitioner, initiated proceedings in the Supreme Court of the United States in filing a petition for a writ of certiorari to the United States Court of Appeals for the 2nd Circuit. The U.S. Supreme Court granted Leidos' certiorari request on March 27, 2017. Arguments in the case were scheduled for November 6, 2017, but on October 17, 2017, the court issued an order removing the case from its calendar pending further proceedings.[14]

    October 17, 2017 order

    On October 17, 2017, the U.S. Supreme Court issued the following order removing the argument from its calendar:[15]

    “

    The joint motion of the parties to remove the case from the argument calendar and hold in abeyance any further proceedings is granted.[2]

    		”

    Question presented

    Question presented:

    "Whether the Second Circuit erred in holding-in direct conflict with the decisions of the Third and Ninth Circuits-that Item 303 of SEC Regulation S-K creates a duty to disclose that is actionable under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5."[14]

    Audio

    • Audio of the case will be posted here if the case is rescheduled for oral arguments.

    Transcript

    • A transcript of the case will be posted here if the case is rescheduled for oral arguments.

    Outcome

    The case is pending adjudication before the U.S. Supreme Court. Arguments in the case were scheduled for November 6, 2017, but on October 17, 2017, the court issued an order removing the case from its calendar pending further proceedings.

    See also

    Footnotes

    1. ↑ Law360.com, "Big Stakes In High Court’s Securities Fraud Omissions Case," April 19, 2017
    2. ↑ 2.0 2.1 Note: This text is quoted verbatim from the original source. Any inconsistencies are attributable to the original source.
    3. ↑ 3.0 3.1 3.2 3.3 3.4 3.5 U.S. Court of Appeals for the Second Circuit, Indiana Public Retirement System et al. v. SAIC, Inc. et. al., March 29, 2016
    4. ↑ Securities and Exchange Commission, "Form 10-K," accessed September 22, 2017
    5. ↑ Securities and Exchange Commission, "Form 10-Q," accessed September 22, 2017
    6. ↑ Securities and Exchange Commission, "Form 8-K," accessed September 22, 2017
    7. ↑ U.S. Department of Justice, "Leidos v. Indiana Public Retirement System et al. - Brief of the United States of American as Amicus Curiae in support of Respondents," September 2017
    8. ↑ Cornell University's Legal Information Institute, "17 CFR 229.303 - (Item 303) Management's discussion and analysis of financial condition and results of operations," accessed September 22, 2017
    9. ↑ Findlaw, "Securities and Exchange Act Rule 10b," accessed September 22, 2017
    10. ↑ FAS 5 refers to Financial Accounting Statement Number 5, which is issued under the authority of the Financial Accountability Standards Board (FASB). According to the FASB, the statement "establishes standards of financial accounting and reporting for loss contingencies." As the FAS 5 challenge was not raised before the U.S. Supreme Court on appeal, we do not discuss the Second Circuit's holding beyond the circuit court's decision to vacate and remand the district court's order on the FAS 5 challenge.
    11. ↑ Financial Accountability Standards Board, "Summary of Statement No. 5," accessed September 22, 2017
    12. ↑ Supreme Court of United States, Leidos, Inc. v. Indiana Public Retirement System et al. - Petition for certiorari, October 31, 2016
    13. ↑ At the time of the Second Circuit's opinion, SAIC had changed its corporate name to Leidos Holdings, Inc.
    14. ↑ 14.0 14.1 Supreme Court of the United States, Leidos v. In Public Retirement, March 27, 2017
    15. ↑ Supreme Court of the United States, Order in pending case - 16-581 - Leidos, Inc. v. Indiana Public Retirement System et al., October 17, 2017
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