Building on its recent trend of granting certiorari in securities cases at an arguably unprecedented rate, the Supreme Court has granted certiorari in a case that is likely to impact the future direction of federal securities litigation involving companies that issue securities pursuant to a registration statement filed with the SEC. The case will impact corporate officers, directors, underwriters and auditors involved in such filings as well. At issue is whether or not a plaintiff may survive a motion to dismiss by alleging that a statement of opinion contained in a registration statement was “objectively false” — that is, merely inaccurate — or whether the plaintiff must go further and allege facts showing that the opinion was “subjectively false” — meaning that the defendant did believe the statement at the time it was made.
In Indiana State District Council of Laborers v. Omnicare, the 6th Circuit held that the strict liability provisions of Section 11 of the 1933 Act apply with equal force to statements that traditionally constituted “soft” information, such as statements of opinion.
Omnicare involved a healthcare company that allegedly made false and misleading statements about its legal compliance in a registration statement filed in connection with a public stock offering. Plaintiffs alleged that the registration statement was misleading because it failed to disclose that the company was engaging in illegal kickback arrangements with pharmaceutical companies and submitting false claims to Medicare and Medicaid. Defendants originally obtained dismissal at the district court level, based in part on the fact that plaintiffs did not plead facts demonstrating that the statements regarding legal compliance were both objectively and subjectively false — in short, they had failed to plead facts demonstrating that the defendants did not actually hold the stated opinion about the company’s compliance with applicable laws and regulations.
The Omnicare opinion diverges from recent jurisprudence out of the federal appeals courts for the 2nd and 9th Circuits, with the 6th Circuit expressly “declin[ing] to follow the Second and Ninth Circuits” in holding that the U.S. Supreme Court’s ruling in Virginia Bankshares, Inc. v. Sandberg mandates that to give rise to a Section 11 claim based on a statement of opinion, a complaint must allege with particularity that statements were both objectively and subjectively false and misleading.
In Fait v. Regions Financial, the 2nd Circuit held that a bank’s accounting for goodwill impairment and the adequacy of its loan loss reserves were statements of opinion, and that in order for such statements to be actionable under the 1933 Act, the issuer must have known of the reserve’s inadequacy at the time the statement was made (i.e., the statement must have been objectively and subjectively false). The mere fact that the bank later had to restate or increase its goodwill and reserves in response to changing market conditions did not give rise to liability under Section 11. This was also the case in Rubke v. Capital Bancorp., Ltd., in which the 9th Circuit held that fairness opinions incorporated into a registration statement are a matter of opinion that could only give rise to liability under Section 11 if they were both objectively and subjectively false and misleading.
The 6th Circuit held that the 2nd and 9th Circuits read too much into Virginia Bankshares, which was a Section 14(a) case, and relied too heavily on dicta in that case. Within the 6th Circuit, “if the defendant discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.”
The importance of this decision is self-evident. If the Supreme Court decides to affirm the 6th Circuit, then companies, their officers and directors, and their underwriters and auditors potentially face greater exposure in federal securities actions, including class actions, brought under the 1933 Act. Making it easier for plaintiffs to survive a motion to dismiss by eliminating the need for allegations of “subjective falsity” would likely place additional pressure on defendants to settle such cases early.
The Omnicare decision has been heavily criticized by the defense bar for this reason. Defendants, both in and outside of the 2nd and 9th Circuits, regularly rely on the Fait and Rubke decisions to argue that actions brought under the 1933 Act should be dismissed at the pleadings stage. Without a mechanism to dispose of these cases early on, the cost of litigating cases that likely have no merit is sure to rise — an unjust result where the statement of opinion purportedly giving rise to liability was, in fact, sincerely held by the company, its officers and directors at the time it was made.
Many have observed that this decision could have implications for the future direction of federal securities litigation in general. If the Supreme Court overturns the fraud on the market presumption in the recently argued Halliburton case, then plaintiffs will be forced to look elsewhere for a vehicle to bring securities class actions. Since the 1933 Act generally does not require plaintiffs to plead reliance on purported misrepresentations, it may present an attractive alternative, especially if class action liability can be premised on whether or not a statement of opinion turned out to be correct.
Needless to say, the Omnicare case merits watching as it is briefed and argued during the next Supreme Court term.