Click here for PDF
Whether a public company has a duty to update prior disclosures with later-developed information is one of the knottier decisions management faces under the securities laws. In Hagan v. Khoja,1 the U.S. Supreme Court avoided the topic when it declined to review a Ninth Circuit decision2 that had allowed a securities class action to proceed. The Supreme Court’s refusal to grant the petition for certiorari disappointed those commentators who had hoped for a ruling that would bring clarity on the duty to update. However, a careful reading of the Ninth Circuit’s decision indicates that the Court was right to wait for a better case.
In Hagan, former officers of Orexigen Therapeutics, Inc. asked the Supreme Court to determine whether public companies have a duty to disclose new information to update a prior disclosure that was accurate when made as – they asserted – the Ninth Circuit had held. They urged the Court to resolve what they characterized as a split on the question among the various federal circuit courts of appeals.
Not only was the Ninth Circuit’s holding about which the officers complained fairly consistent with the positions of the other circuit courts, it was only one of a half dozen holdings in the decision that allowed the underlying case to go forward. Two of those holdings said that Orexigen should have disclosed the new information anyway, for other reasons. Accordingly, a Supreme Court reversal on the updating issue would not have had any practical effect on the case.
In a nutshell, the plaintiff in Hagan alleged that Orexigen had made a number of fraudulent public disclosures, of which four are relevant here (referred to below as Disclosure Nos. 1 – 4). Each of the disclosures related to a clinical trial that Orexigen conducted to test the safety of a drug for treating cardiac patients. At a predetermined point in the clinical trial (the “25% Analysis”), the interim results would be assessed. If they were satisfactory, the trial would continue. They were, and it did, although only for a short period because subsequent results (the “50% Analysis”) were negative.
- Orexigen disclosed results of the 25% Analysis in Disclosure No. 1.Those results were unexpectedly positive and the company emphasized their significance, causing its stock price to spike up.The Ninth Circuit held that, although the disclosure of the results might have been literally accurate, a jury could find that other facts in the company’s possession at that time made the significance statement misleading by omission. Accordingly, it allowed the plaintiff’s claim about Disclosure No. 1 to go forward.
- Two months later, Orexigen again discussed the clinical trial in Disclosure No. 2. By that time, the company had received the 50% Analysis results, which were so negative that they had already caused the trial to be stopped. However, it did not disclose them or the fact of the trial’s termination. The Ninth Circuit agreed with the plaintiff that Orexigen was obligated to disclose the 50% Analysis results because, even if the 25% Analysis results remained literally accurate, their “weight was diminished” by the 50% Analysis results.It was this holding about which Hagan and his fellow former officers petitioned for the Supreme Court review.
- In Disclosure No. 3, the same day as Disclosure No. 2, Orexigen made statements about the status of the clinical trial that, the Ninth Circuit held, could be found to be misleading because they omitted necessary information, including the 50% Analysis results. This basis for requiring disclosure of the 50% Analysis results was independent from the basis for disclosure relevant to Disclosure No. 2.
- In Disclosure No. 4, also the same day, Orexigen made further statements about the clinical trial that the Ninth Circuit held could also be found to be misleading because they also omitted necessary information, including the 50% Analysis results. Again, this basis for requiring disclosure of the 50% Analysis results was independent from the basis for disclosure relevant to Disclosure No. 2.
The foregoing does not address a number of other disclosures that the Ninth Circuit held could be found misleading and on which it also allowed the plaintiff’s claims to go forward.
The Petition for Certiorari
The former officers’ petition to the Supreme Court argued that the Ninth Circuit had made new law and created a split among the circuits by holding that a public company has a duty to disclose subsequently-learned information in order to update a prior disclosure that was accurate when made. They raised the specter of a judge-made “continuous disclosure” regime replacing the “periodic disclosure regime” that is contemplated by the system of annual (Form 10-K), quarterly (Form 10-Q) and current (Form 8-K) reports.
The plaintiff responded that the Ninth Circuit decision simply imposed the “duty to correct” standard that is, in various formulations, in effect in every circuit. That is, that a public company has a duty to disclose material facts that correct an earlier statement when the company learns that the earlier statement was materially false or misleading when made. They emphasized that Orexigen knew at the time of Disclosure No 2 that the significance of the facts described in Disclosure No. 1 wasn’t what the company had touted, so it had to be corrected.
The Supreme Court declined to grant cert.
Where We Stand Now
The Ninth Circuit caused a lot of unnecessary handwringing because it did not use the term “duty to correct” in its opinion. Some commentators may have been led astray by the petition for certiorari in which the former Orexigen officers claimed that they had been subjected to a novel duty to update (a term that the Ninth Circuit also did not use). For example, one commentator opined that the holding that further disclosure is required when the “value” or “weight” of prior accurate disclosures have been “diminished” “arguably creates a regime of continuous disclosure, where companies must continuously monitor to assess whether [the value of prior disclosures] has been diminished by subsequent events, a state of affairs that comes remarkably close to the requirements of a continuous disclosure regime.” However, the plaintiff was right. Examined closely, the Ninth Circuit holding about which the officers complained was a straightforward application of the duty to correct.
Where then does the duty to update stand? It’s not easy to tell because the various circuit courts of appeal have used different language in addressing cases with widely varying facts. However, this is largely because the situations that reach the appeals courts are nuanced, with widely varying fact patterns. Read broadly, the rulings have actually been quite consistent across the circuits and can be applied in a practical manner.
Stated simply, all the circuits pay lip service to the proposition that there is no duty to disclose newly developed information to update a purely historical statement that was correct when made. However, if the statement had a forward-looking element, the risk is greater that a court will say that new disclosure should have been made, the more so the more significant the subject matter. More particularly, if the statement has “a forward intent and connotation upon which parties may be expected to rely” (First Circuit) or “contains some factual representation that remains ‘alive’ in the minds of investors” (Second, Third and Eleventh Circuits), there is a high likelihood that a court will say that new disclosure should have been made.
The risk depends to a certain extent on the circuit in which the company is sued, not where it is located, which makes things less predictable. In any event, companies should always disclaim any duty to update forward-looking statements, as well as take advantage of the Private Securities Litigation Reform Act safe harbor for forward-looking statements by providing thoughtful, meaningful and frequently updated caveats wherever warranted.
1. No. 18-1010, Cert. Den. (May 20, 2019)
2. Koja v. Orexigen Therapeutics, Inc. et al., 899 F.3d 988 (2018)