Item 303(a) of Regulation S-K, which requires issuers to disclose known trends or events "reasonably likely" to have a material effect on operations, capital, and liquidity, has been referred to as the "sleeping tiger" of securities litigation. Item 303(a) certainly has two attributes that are attractive to plaintiffs: it requires the issuer to offer a prediction on the effects of a known trend, but the disclosure arguably is not subject to the PSLRA's safe harbor for forward-looking statements (other than two subsections dealing with off-balance sheet arrangements and contractual obligations). The use of Item 303(a) in securities litigation has a mixed history, but the Second Circuit may have woken the tiger last week.
In Litwin v. The Blackstone Group, L.P., 2011 WL 447050 (2d Cir. Feb. 10, 2011), the court considered whether the plaintiffs had adequately alleged that Blackstone failed to make required disclosures under Item 303(a) related to two portfolio companies and its real estate investment funds. The claims were brought pursuant to Section 11 and 12 of the '33 Act, based on omissions in Blackstone's registrations statement and prospectus, so the applicable pleading standard was notice pleading (i.e., enough facts that the claim is plausible on its face). Moreover, there was no dispute that there was a downturn in the real estate market at the time of Blackstone's IPO. Accordingly, the sole issue was the pleading of materiality.
The court made the following key holdings.
First, the court rejected Blackstone's argument that it was not required to make an Item 303(a) disclosure because the downturn in the real estate market was already part of the "total mix" of information available to the market. While investors knew about the downturn, the "potential future impact [on Blackstone's investments] was certainly not public knowledge."
Second, the court declined to find that Blackstone was not required to disclose information about particular portfolio companies because the investments were relatively small and the gains or losses from the investments were aggregated at the fund level. To hold otherwise, the court found, would "effectively sanction misstatements in a registration statement or prospectus related to particular portfolio companies so long as the net effect on the revenues of a public private equity firm like Blackstone was immaterial." Moreover, the portfolio company investments were in key sectors of Blackstone's business.
Finally, the court held that the plaintiffs were not required to identify specific real estate investments that had been adversely effected by the downturn. Indeed, that was the exact information, along with potential effect of the downturn, that the plaintiffs claimed was omitted. In any event, the plaintiffs had alleged enough facts connecting the real estate downturn with potential adverse effects on Blackstone's real estate investments to state a plausible claim.
So what impact will the Blackstone decision have? At a minimum, the decision seems likely to encourage the use of Item 303(a) as a vehicle for private securities litigation, although obviously not every case is amenable to an allegation that there was a known, undisclosed trend. Second, the decision can be read to create a low materiality threshold (although this case did not allege fraud and therefore was not subject to the heightened pleading standard of Rule 9(b)). While the district court relied heavily on the fact that the investment losses did not have a significant impact on Blackstone's overall financial results, the Second Circuit applied a more holistic, "what would a reasonable investor want to know," standard. Of course, the Supreme Court soon will be weighing in on the issue of materiality. Stay tuned.
Holding: Dismissal vacated and remanded for further proceedings.