Client Alert

The Second Circuit Second Guesses Failure to Disclose Pending SEC Investigation

06 Jun 2022

Determining whether and when to disclose an SEC investigation is a challenging judgment call for many public companies. This decision often turns on many factors, including the nature, scope, stage, and subject matter of the investigation. A recent Second Circuit decision highlights the risk that courts will find fault with decisions not to disclose a pending SEC investigation.

In Noto v. 22nd Century Group, Inc., the Second Circuit ruled that defendants’ failure to disclose an active SEC investigation was actionable as a material omission. The court reasoned: “Defendants had a duty to disclose the SEC investigation in light of the specific statements they made about the Company’s accounting weaknesses.” The court explained: “[B]y not mentioning the investigation, [defendants’] disclosures of [their] accounting deficiencies were misleading.” The court’s ruling makes it more likely that courts—particularly in the Second Circuit—will second-guess companies that do not disclose an SEC investigation in connection with statements that touch on those matters the SEC is investigating.

The Noto decision also provides helpful guidance relating to the contours of liability for statements made by others promoting a stock. The court affirmed dismissal of claims where the plaintiffs failed to allege that the defendants had ultimate authority over content published by those who were paid to promote the stock and had no independent duty to disclose such payments themselves.

Key Takeaways

  • Issuers should take Noto into account when evaluating whether they have a duty to disclose a pending SEC investigation and pay particular attention to how their public statements relating to the subject matters being investigated might trigger a duty to disclose such investigations.
  • Companies paying for media coverage of interest to investors should continue to be careful to avoid unintentionally taking steps that would convert the company into a “maker” of media statements—and where companies do exercise ultimate control over such contentthey should maintain proper procedures to ensure such statements are truthful.  Noto underscored that “only an article’s maker, not its benefactor, has a duty to disclose that it was paid for.”


The Second Circuit in Noto partially reversed dismissal of securities fraud claims by a class of investors against 22nd Century Group and its former CEO and CFO. The plaintiffs alleged defendants defrauded investors by failing to disclose an investigation by the SEC into the company’s financial control weaknesses, denying that the SEC was conducting such an investigation, and secretly paying authors to write promotional articles about the company.

Starting in 2016, 22nd Century Group reported material weaknesses in its internal financial controls until announcing in a 2018 10-Q that the company had completed the implementation and testing of a remediation plan to eliminate such weaknesses. 22nd Century Group did not mention any SEC investigation in any of those public disclosures, but news of a possible investigation into the company was made public through an internet posting in 2018 by an author going by the name Fuzzy Panda, who disclosed that the SEC—in response to a FOIA request about 22nd Century Group—refused to share information because it might “interfere with enforcement proceedings.” After Fuzzy Panda published the SEC’s FOIA response, the Company publicly denied any notice of an investigation.

Plaintiffs also alleged that Defendants paid authors to write flattering articles about 22nd Century Group. Plaintiffs alleged this constituted both a scheme to defraud investors and an omission of a material fact in violation of Rule 10b-5.

The Second Circuit reversed dismissal of the investigation-related disclosure claims, but affirmed dismissal of claims relating to statements made by third-party stock promoters and undisclosed payments therefor.


The Duty to Disclose an SEC Investigation When Speaking About Subjects Under Investigation

Before Noto, the ground rules governing whether a company must disclose the existence of an SEC investigation were well articulated by Judge Paul A. Crotty of the Southern District of New York in Richman v. Goldman Sachs Group, Inc.: “Under Section 13 of the Exchange Act, Regulation S–K Item 103, a company is required to ‘[d]escribe briefly any material pending legal proceedings ... known to be contemplated by governmental authorities,” but “[a]n investigation on its own is not a ‘pending legal proceeding’ until it reaches a stage when the agency or prosecutorial authority makes known that it is contemplating filing suit or bringing charges.”[1]

While companies sometimes find business reasons to disclose the existence of investigations by the SEC or other authorities—such as when rumors of an investigation have surfaced and a company wants to clarify the information available for public consumption—ample precedent has long offered support for declining to voluntarily disclose such investigations absent some additional circumstance triggering enhanced disclosure duties.

Noto arguably takes a more expansive view of what triggers a duty to disclose an SEC investigation. The Court began with well-settled precedent that “[e]ven when there is no existing independent duty to disclose information, once a company speaks on an issue or topic, there is a duty to tell the whole truth.”[2] In Noto, the defendants allegedly denied the existence of an SEC investigation. Had the Second Circuit held that a duty to disclose arose from that alleged denial, the Noto decision would have unremarkable.  But Noto went further.

The duty to disclose in Noto, according to the court, was triggered by defendants’ statements in quarterly SEC filings regarding material weaknesses in the company’s financial controls. The company’s SEC filings reported that its “internal controls over financial reporting were not effective and that material weaknesses existed in its internal control over financial reporting,” and “that they had solved the issue.” In light of those and similar statements by the company, the court reasoned that “the fact of the SEC investigation would directly bear on the reasonable investor’s assessment of the severity of the reported accounting weaknesses.” The Second Circuit held that having spoken on the subject, the defendants were required to disclose the SEC’s investigation into its weaknesses so that investors would not “make an overly optimistic assessment of the risk.”

The Noto court also inferred that defendants’ denial of the SEC investigation served as “an admission of the materiality of [their] non-disclosure,” opining that “[o]therwise, the Company would not have tried to hide it.” The court’s analysis arguably conflates falsity and materiality—two independent elements in securities fraud cases, and further underscores the risks that denying the existence of an SEC investigation may prove, in hindsight, to be ill-advised, creating exposure to private plaintiffs and potentially SEC enforcement actions.

An Issuer Is Not Liable Statements in Stock Promotion Materials, Even If It Benefits from Them

The Noto court also offered useful guidance on when public companies and their executives can face potential direct liability for stock-promotion efforts by others under the federal securities laws. The Noto court adhered to the Supreme Court’s Janus decision[3] and reminded readers of the distinction, under SEC Rule 10b-5, between “makers” of false statements, and those who might pay for, but not ultimately control the content of, such statements. Noto’s discussion of this difference is particularly timely given the increased use of internet postings to facilitate pump-and-dump schemes and their close cousins among actors trying to profit from a drop in stock prices, short-and-distort attacks.

For purposes of direct liability under Rule 10b-5(b), plaintiffs were required—but failed—to allege that defendants were the “makers” of any allegedly false or misleading statements. A “maker of a statement is the person or entity with ultimate authority over the statement,” and defendants here were not the makers of the statements in the allegedly paid-for articles. In affirming the dismissal of plaintiffs’ stock promotion-related claims, the Court explained defendants did not have the requisite control over the articles’ statements required under Janus to be directly liable for their contents, and plaintiffs could point to no independent duty defendants had to disclose their payments.

Plaintiffs also failed to adequately allege a claim based on any of defendants’ own statements in the Company’s annual filings. In contrast to the court’s analysis of defendants’ omission of any reference to the SEC’s investigation, the Court noted that the Company’s disclosures did not include “paid stock promotion” among the 19 factors that could lead to stock price volatility. Because the disclosures did not address the issue, defendants were not required to disclose their alleged payments to authors.

Finally, the Court considered whether plaintiffs’ stock promotion allegations were sufficient to support liability for stock manipulation under Rules 10b-5(a) and (c), but agreed with the district court that plaintiffs had not identified “a manipulative act or market activity sufficient to state a claim under those rules.” And the Court would not permit plaintiffs to use Rule 10b-5(a) and (c) as alternate liability hooks for conventional misrepresentation claims, explaining that any alleged failure to disclose payments to promoters (even if material) would be insufficient to support liability, as market manipulation claims cannot be based solely on misrepresentations or omissions.


Noto could be a simple case of bad facts making bad law, where defendants’ allegedly affirmative false denials of the existence of any investigation colored the Court’s view of previous omissions. Moreover, defendants’ statements about having “solved the issue” might have played an outsized role in triggering a duty to disclose an investigation into that issue. The Second Circuit’s decision is not clear about whether disclosures of material weaknesses alone would have supported the Court’s holding. At the very least, in the wake of Noto, companies considering whether to disclose an SEC investigations should take an even closer look at what disclosures might in some way relate to the subject matter of a pending investigation and consider—and seek advice concerning—whether omitting any reference to the SEC investigation might render other disclosures potentially misleading.

[1] Richman v. Goldman Sachs Grp., Inc., 868 F.Supp.2d 261, 272 (S.D.N.Y.2012), citing 17 C.F.R. § 229.103 (additional citations omitted).

[2] Noto v. 22nd Century Group, Inc., No. 21-0347 (2d Cir. May 24, 2022), at 15, quoting Meyer v. Jinkosolar Holdings Co., 761 F.3d 245, 250 (2d Cir. 2014).

[3] Janus Cap. Grp., Inc. v. First Derivative Traders, 564 U.S. 135 (2011).



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