Supreme Court to Securities Issuers: Beware What You Omit When Stating Your Opinions

Who Should Care—and Why

The decision affects anyone contemplating a public offering, and that’s a lot of companies. Initial public offerings are on the upswing (206 in 2014 versus 157 in 2013 and 93 in 2012).¹ For those who engage in public offerings, section 11 is a dangerous statute: It is a strict liability statute for the issuer² that does not require pleading and proving that the defendant had a culpable state of mind (unlike, say, Rule 10b-5); and it is frequently employed to attack registration statements (in 2014, 24 IPOs were challenged by securities class actions, versus 15 in 2013).³

The Omnicare Case

Omnicare is the nation’s largest provider of pharmacy services for nursing-home residents. Intending to make a public offering of common stock, it filed a registration statement analyzing the effect of various federal and state laws on its business model, including its acceptance of rebates from pharmaceutical companies. Two sentences in its registration statement said, “We believe our contract arrangements … and our pharmacy practices are in compliance with applicable federal and state laws” and “We believe that our contracts … are legally and economically valid arrangements ….” Slip op. at 3. Accompanying these opinions were caveats, including that several states had filed enforcement actions against pharmaceutical manufacturers challenging rebates to pharmacies, that the federal government had expressed “significant concerns” about some manufacturers’ rebates and that the laws might in the future be interpreted in a manner inconsistent with Omnicare’s interpretation. Id. Plaintiff Funds bought Omnicare stock in the offering; the federal government later sued Omnicare, alleging that the rebates violated federal law.

The Funds sued Omnicare under section 11; as is typical, the complaint disclaimed any allegations of fraud or intentional or reckless misconduct.⁴ The district court granted Omnicare’s motion to dismiss, holding that the opinions quoted above could be actionable only if the speakers knew they were untrue when made. The Sixth Circuit reversed, holding that a section 11 complaint need only allege that the opinions were “objectively false,” i.e., proved wrong by subsequent events, and it was not necessary to allege anything about the speakers’ state of mind. 719 F.3d 498. Perhaps because two other circuits had reached the contrary view—that statements of opinion are actionable only if objectively and subjectively false⁵ —the Supreme Court granted certiorari.

The Court’s Opinion—and the Concurring Opinions

The fact clause

All nine justices agreed that an honest-but-wrong-in-hindsight opinion is not, without more, actionable under the “untrue statement of a material fact” clause of section 11. To be actionable, the opinion must be both wrong in hindsight and not honestly held.⁶

The omissions clause

Section 11 penalizes not only untrue statements of material fact but also omissions of material fact “necessary to make the statement therein not misleading….”⁷ Because the Funds also had alleged that Omnicare’s opinions omitted material facts needed to make them not misleading, the Court also considered the omissions clause.⁸ And here the justices split. Justice Kagan, writing for the seven-justice majority, held that the omissions clause creates liability if a registration statement omits material facts about the statement of opinion, and if the omitted facts conflict with what a reasonable investor, reading the statement fairly and in context, would take from the statement itself. Slip op. at 10-19. Justice Scalia, concurring in part and in the judgment, argued that an honestly held opinion can never create section 11 liability. And Justice Thomas would have remanded without reaching the omissions issue, on the ground that it was not properly developed in the courts below.

The initial commentary is all over the lot: Pundits see the decision as everything from a victory for plaintiffs to a victory for defendants to no fundamental change in the law. In our view (meaning: “this is our opinion”), there is more here for defendants than plaintiffs to like, but the Court took the middle ground and gave each side something.

To start, it was a good day for opinions generally. As the Court said, section 11’s fact clause is “not, as the Court of Appeals and the Funds would have it, an invitation to Monday morning quarterback an issuer’s opinions.” Slip op. at 9. Affirmance of the Sixth Circuit’s opinion would have turned speakers into guarantors of their predictions about the future. That didn’t happen.

That much is certain. What is less certain is what guidance to take from the Court’s discussion of the omissions clause. Some are taking this as a victory for the position taken by the Solicitor General: that a statement of opinion is actionable, even if honestly held, if it lacks a reasonable basis. We disagree and think the Court’s opinion more nuanced than that. As we see it, the Court suggests the following analysis:

First

what would the reasonable investor read as implicit in the opinion, considering the registration statement as a whole? A reasonable investor might think it implicit that the opinion is honestly held, and has some basis or was the result of some inquiry. But a reasonable investor would not think it implicit that all facts are stated, or that no facts cut against the opinion. Slip op. at 12-13. “[A] reasonable investor generally considers the specificity of an opinion statement in making inferences about its basis.” Id. at 13-14 n.8. And a reasonable investor also takes into account “hedges, disclaimers, and apparently conflicting information” as well as “customs and practices of the relevant industry.” Id. at 14. “The reasonable investor understands a statement of opinion in its full context, and § 11 creates liability only for the omission of material facts that cannot be squared with such a fair reading.” Id.

Second

considering how a reasonable investor would read the opinion, including inferences reasonably drawn (id. at 17), has the plaintiff alleged “particular (and material) facts going to the basis for the issuer’s opinion–facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have–whose omissions makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context”? Id. at 18. In this regard, the Court cautioned that, on remand, “the Funds cannot proceed without identifying one or more facts left out of Omnicare’s registration statement”; recitation of the statutory language will not suffice, nor will “the Funds’ conclusory allegation that Omnicare lacked ‘reasonable grounds for the belief’ it stated respecting legal compliance.” Id. at 19. In short, the allegedly omitted material facts must render the opinions as stated misleading by showing that the speaker “lacked the basis for making the statements that a reasonable investor would expect.…” Id. at 20. “That is no small task for an investor.” Id. at 18.

Download: Supreme Court to Securities Issuers: Beware What You Omit When Stating Your Opinions

1. Cornerstone Research, Securities Class Action Filings – 2014 Year in Review 3, 10 (2015).
2. Directors, officers, accountants and experts—unlike issuers—have a due diligence defense. 15 U.S.C. § 77k(b).
3. Cornerstone Research, supra n.1, at 1, 8.
4. By disclaiming fraud, plaintiffs hope to avoid the pleading-with-particularity requirements of Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act of 1995. But this also means plaintiffs cannot claim that the opinions were not honestly held; they cannot both disclaim fraud and allege dishonesty.
5. Fait v. Regions Fin. Corp., 655 F.3d 105 (2d Cir. 2011); Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156 (9th Cir. 2009). Pillsbury represented the successful defendants in Rubke.
6. Indeed, the Court made clear that a statement of opinion not honestly believed, but “(surprise!)” true, would not be actionable either. Slip op. at 8 n.2. If, however, the statement of opinion had embedded in it statements of fact, they might be actionable if material and wrong. Id. at 8-9.
7. 15 U.S.C. § 77k(a).
8. Plaintiffs alleged, in conclusory fashion, that Omnicare and its directors and officers lacked “reasonable grounds” for the opinions. Plaintiffs also alleged that one of Omnicare’s lawyers had warned that a particular contract “‘carrie[d] a heightened risk’ of liability under anti-kickback laws.” Slip op. at 4.