Stratte-McClure v. Stanley
2015 U.S. App. LEXIS 428
| 2d Cir. | 2015Background
- Plaintiffs (State‑Boston Retirement System and Fjarde AP‑Fonden) sued Morgan Stanley and several officers under §10(b) / Rule 10b‑5, alleging that 2007 statements and 10‑Q omissions concealed substantial exposure and losses from a proprietary subprime CDS/CDO trade (a $13.5B long / $2B short structure), causing investor losses when disclosures later revealed the true position.
- The trade generated mark‑downs in 2007 as the subprime market deteriorated; Morgan Stanley ran stress tests, formed a task force, and took some write‑downs but did not disclose the long position or anticipated material losses in its July and October 2007 Form 10‑Qs.
- Plaintiffs advanced two claims: (1) an "exposure claim" that Morgan Stanley omitted Item 303 disclosures (known trends/uncertainties) about the Long Position in 10‑Qs; and (2) a "valuation claim" that Morgan Stanley failed to mark the Long Position to market (understating third‑quarter losses tied to declines in the ABX index), causing loss causation problems.
- The district court dismissed the complaint (initially for failure to state a claim; after amendment it held Item 303 could require disclosure but dismissed for failure to plead scienter and, on the valuation claim, failure to plead loss causation). Plaintiffs appealed.
- The Second Circuit held (1) as a matter of first impression in the circuit, omission of an Item 303 required disclosure in a 10‑Q can supply the duty to disclose for a §10(b) / Rule 10b‑5 claim, but (2) affirmed dismissal because plaintiffs failed to plead a strong inference of scienter. The court assumed, without deciding, that the omitted information met Basic’s materiality test.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether failure to include Item 303 disclosures in a Form 10‑Q can give rise to a §10(b) / Rule 10b‑5 omission claim | Item 303 creates a regulatory duty to disclose known trends/uncertainties in 10‑Qs; omission therefore actionable under §10(b) | Item 303 violations do not automatically create a Rule 10b‑5 duty; Item 303 standard differs from Rule 10b‑5 materiality | A failure to make an Item 303 disclosure in a 10‑Q can form the basis for a §10(b) omission, but only if the omitted information is material under Basic and other §10(b) elements are met |
| Materiality standard applicable to Item 303 omissions in §10(b) suits | Use Item 303/SEC guidance test (likelihood + expected effect) | Use Supreme Court’s Basic probability/magnitude test for §10(b) materiality | §10(b) claims based on Item 303 omissions must satisfy Basic’s probability/magnitude materiality test |
| Scope of Item 303 disclosure obligations (must firms disclose trading positions / proprietary strategies?) | Plaintiffs: disclosure of known trend + connection to firm’s exposure and potential material impact required; may include significant positions | Defendants: Item 303 does not require disclosure of proprietary strategies or particular trading positions | Court: Item 303 requires disclosure of known trends and their reasonably expected material impact on financial condition, but does not require revealing proprietary strategies or detailed trading positions |
| Whether plaintiffs pleaded scienter for omission-based §10(b) claim | Alleged internal warnings, write‑downs, stress tests, task force, and contemporaneous market deterioration show conscious recklessness | Defendants: allegations show assessment and mitigation efforts, disclosure timing consistent with deliberation; at most negligence | Held for defendants: complaint failed to raise a strong, cogent inference of conscious recklessness or intent; dismissal affirmed |
Key Cases Cited
- Basic Inc. v. Levinson, 485 U.S. 224 (materiality test: probability × magnitude balancing)
- Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (pleading scienter requires inference at least as compelling as opposing inferences)
- Panther Partners Inc. v. Ikanos Comm’ns, Inc., 681 F.3d 114 (Item 303 omissions actionable under Securities Act claims; generic cautionary language insufficient)
- Litwin v. The Blackstone Group, L.P., 634 F.3d 706 (Item 303 can supply duty to disclose under Securities Act theory)
- Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (Rule 10b‑5 materiality principles and significance for scienter analysis)