U.S. Backs Investors in High Court Disclosure Dispute

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By Antoinette Gartrell

SEC and Justice Department lawyers sided with investors suing government contractor Leidos Inc. over its failure to disclose in a corporate annual report its involvement in a fraudulent billing scheme.

An omission from the management narrative known as the MD&A can form the basis of a private federal securities fraud claim, the government lawyers told the U.S. Supreme Court in a Sept. 7 friend of the court brief ( Leidos, Inc. v. Ind. Pub. Ret. Sys., U.S., No. 16-581, amicus brief filed 9/7/17 ).

The MD&A—standing for Management’s Discussion and Analysis—requires companies to disclose known trends and uncertainties that could affect their business.

Leidos argued that for an MD&A omission to be actionable, the shareholders have to show that the information was needed to make another statement by the company not misleading, which wasn’t the case here.

The SEC and DOJ disagreed. This case “involves a half-truth rather than a pure omission,” the government said. The MD&A in question “appeared to be complete and thus conveyed to a reasonable investor that it disclosed all of the information [1934 Securities Exchange Act] Item 303 required,” the lawyers said.

If Leidos’ approach were accepted, “it would create a significant loophole in Section 10(b) by transforming a disclosure obligation designed to protect investors even when there is no fraud into a shelter or sanctuary for those who defraud investors,” the SEC and DOJ said. Section 10(b) is the securities laws general antifraud proscription.

Some Trends Disclosed

According to investors, Leidos artificially inflated its stock price by filing shareholder reports that disclosed some known trends and uncertainties but didn’t disclose that it had been implicated in a fraudulent overbilling scheme in the “City-Time” project with the City of New York. After full disclosure, the company’s stock price fell from $17.21 to $12.97 per share.

The district court dismissed the suit, saying investors didn’t adequately plead that Leidos’ MD&A violated Item 303 or that the company acted with scienter—culpable intent. The U.S. Court of Appeals for the Second Circuit reversed. It said Item 303 imposes an “affirmative duty to disclose” that can serve as the basis for a securities fraud claim under Section 10(b).

The case is scheduled for oral argument Nov. 6.

To contact the reporter on this story: Antoinette Gartrell in Washington at agartrell@bna.com

To contact the editor responsible for this story: Phyllis Diamond at pdiamond@bna.com

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