The Supreme Court recently answered the question of whether an issuer’s failure to disclose important information violated Rule 10b-5(b), an important anti-fraud prohibition in the federal securities laws. In addition, one AI program was not quite ready to uncover a key distinction in that case. It is worth considering both the case and the incipient AI analysis.[1]
The Supreme Court’s Opinion
In Macquarie Infrastructure Corp. et al. v. Moab Partners, L. P., et al.,[2] the court considered whether an issuer’s failure to say something in response to an express disclosure requirement violates Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(b) thereunder. A unanimous Supreme Court said that those provisions “‘do not create an affirmative duty to disclose any and all material information.’”[3]
Moab Partners[4] claimed that Macquarie (the issuer) failed to disclose that new environmental restrictions would severely harm its business.[5] Moab asserted that this silence violated the disclosure requirements of Regulation S-K Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations).[6] Moab claimed that this failure served as a predicate for a violation of Section 10(b) and Rule 10b-5(b).
The court disagreed. Justice Sotomayor, writing for the court, observed that Rule 10b-5(b) makes it unlawful “to ‘make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.’”[7] The opinion contrasts saying nothing and telling a half-truth: “[T]he difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.”
The court found that:
Rule 10b–5(b) does not proscribe pure omissions. The Rule prohibits omitting material facts necessary to make the “statements made . . . not misleading.” Put differently, it requires disclosure of information necessary to ensure that statements already made are clear and complete (i.e., that the dessert was, in fact, a whole cake).[8]
The court found that failure to disclose alone was insufficient to constitute a violation of Rule 10b-5(b). “Today, this Court confirms that the failure to disclose information required by Item 303 can support a Rule 10b–5(b) claim only if the omission renders affirmative statements made misleading.”[9] Finding otherwise would read “the words ‘statements made’ out of Rule 10b–5(b) and shift[] the focus of that Rule and §10(b) from fraud to disclosure.”[10]
The court rejected Moab’s argument that were the court to find that Rule 10b-5(b) does not address omissions, it would create immunity for fraudulent omissions. The court disagreed, stating that Section 11(a) of the Securities Act of 1933 imposes liability for pure omissions. “By its terms, in addition to proscribing lies and half-truths, this section also creates liability for failure to speak on a subject at all.”[11] On the contrary, accepting Moab’s view “would also render §11(a)’s pure omission clause superfluous by making every omission of a fact ‘required to be stated’ a misleading half-truth.”[12] Further rejecting the immunity argument, the court noted that the SEC has authority to prosecute violations of its rules, including Item 303.[13]
Artificial Intelligence Analysis
Out of curiosity, I submitted the opinion to an AI program. The AI program said that it would help me read, understand, and work with documents more efficiently. It invited me to ask a question about this document. I asked, “what is the difference between Section 11 and Rule 10b-5?” The AI program’s conclusion was:
Unlike Section 11, Rule 10b-5 focuses on the overall misleading nature of statements made in connection with the purchase or sale of securities. In summary, Section 11 primarily deals with false statements or omissions in registration statements, while Rule 10b-5 addresses the broader issue of manipulative or deceptive practices in connection with the purchase or sale of securities.[14]
The AI response does not directly explain the key issue in the case, that is, whether Rule 10b-5(b) addresses omissions in comparison to Section 11. The response only obliquely discusses some differences between the provisions. The response’s disclaimer is all too accurate: “AI-generated responses may be inaccurate or misleading.”
Conclusion
Moab is a useful decision that further defines the scope of Section 10(b) and Rule 10b-5(b).
The AI analysis is interesting, but for different reasons. Perhaps one day, AI will be able to analyze questions much more complex than the one I posed. Should we fear that day? Not at all. What is past is prologue.[15] In the 1960s, IBM mainframe computers began to dominate the business world. Many feared that they would throw everyone out of work.[16] Of course, they did the opposite and allowed workers to focus on higher-level matters using better data than they had before.
In my view, AI never will replace human reasoning and judgment. In time, AI will become a great tool and provide many benefits to its users. Until AI can help a reader understand the nuances in new judicial opinions, I suggest reading those opinions carefully, including the footnotes.
© 2024 Stuart J. Kaswell, Esq., published by permission.
“The Dog That Didn’t Bark” is a reference to Sir Arthur Conan Doyle, The Adventure of the Silver Blaze (1892) and the fictional detective Sherlock Holmes. ↑
621 U.S. ___ (2024), decided on April 12, 2024. References below are to the Slip Opinion. ↑
Id. at 6, citing Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 44 (2011). ↑
The Supreme Court’s opinion does not identify the plaintiff, Moab Partners. It is a hedge fund manager managing a small fund. The Investment Adviser Public Disclosure website of the Securities and Exchange Commission (“SEC”) lists Moab Capital Partners LLC as an exempt reporting adviser as of July 19, 2021, with an effective date of July 30, 2021. Moab Capital Partners, LLC (CRD # 154855/SEC#:802-122208). Moab indicates that it qualifies for the exemption from registration because it acts solely as an adviser to private funds and has assets under management of less than $150 million. Moab Capital Partners, Form ADV, Item 2, March 12, 2024. ↑
Slip Opinion, at 2–3. ↑
Section 13(a) of the Exchange Act and 17 CFR §229.303 of Regulation S-K. ↑
Slip Opinion, at 4. At footnote 2, the court states that it granted certiorari only on the issue of omission, not half-truths. It also states that “[t]he Court does not opine on issues that are either tangential to the question presented or were not passed upon below, including what constitutes ‘statements made,’ when a statement is misleading as a half-truth, or whether Rules 10b–5(a) and 10b–5(c) support liability for pure omissions.”
In its entirety, Rule 10b-5 provides:
§ 240.10b-5 Employment of manipulative and deceptive devices.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
- To employ any device, scheme, or artifice to defraud,
- To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
- To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security. ↑
Id. at 5. ↑
Id. at 7. ↑
Id. ↑
Id. at 6. ↑
Id. at 7. ↑
Id. ↑
The entire AI response is below, minus a link to provide feedback. For reasons of clarity, the author has removed the response’s odd paragraph numbering.
The difference between Section 11 and Rule 10b-5 is as follows:
Section 11 of the Securities Act of 1933 imposes liability for false statements or omissions in registration statements. It prohibits any registration statement that contains an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading. In other words, Section 11 focuses on the accuracy and completeness of information provided in registration statements.
Rule 10b-5 is a regulation implemented under Section 10(b) of the Securities Exchange Act of 1934. It prohibits the use of any manipulative or deceptive device in connection with the purchase or sale of securities. Rule 10b-5(b) specifically makes it unlawful to make any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading.
Unlike Section 11, Rule 10b-5 focuses on the overall misleading nature of statements made in connection with the purchase or sale of securities. In summary, Section 11 primarily deals with false statements or omissions in registration statements, while Rule 10b-5 addresses the broader issue of manipulative or deceptive practices in connection with the purchase or sale of securities.
AI-generated responses may be inaccurate or misleading. Be sure to double-check responses and sources. ↑
William Shakespeare, The Tempest. ↑
E.g., “1966 ‘Fear of Computer Automation?’ Data Processing, history (IBM 790, 7044 , NASA)),” Computer History Archives Project, posted June 20, 2019, YouTube video. ↑
