One year ago today, in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S.Ct. 1318 (2015), the Supreme Court created a new test for opinion liability under Section 11 of the Securities Act, a strict liability statute that applies to material misrepresentations and omissions in a registration statement. The Court stated that under the misrepresentation prong of Section 11, even if an opinion is objectively wrong, a statement of opinion is misleading only if the defendant did not believe it or if it contained other embedded factual statements that were untrue. To hold otherwise, the Court wrote, is to ignore that a statement of opinion merely affirms “that the speaker actually holds the stated belief,” not that the belief is correct.
The Court, however, did not stop there. Section 11 also makes it unlawful to omit material facts necessary to prevent the statements made from being misleading. The Court held that under the omission prong in Section 11, “depending on the circumstances,” a reasonable investor may “understand an opinion statement to convey facts about how the speaker has formed the opinion—or, otherwise put, about the speaker’s basis for holding that view.” Under that standard, the Court stated, “if the real facts are otherwise, but not provided, the opinion statement will mislead its audience.” Thus, “if a registration statement omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then § 11’s omissions clause creates liability.”
Omnicare was a departure from existing law. Prior to Omnicare, the Second and Ninth Circuits, the most influential circuits for securities cases, held that opinions are only misleading if the speakers did not believe them. The Sixth Circuit, however, in the decision that the Supreme Court reversed in Omnicare, held that under Section 11 an opinion is misleading if it is objectively incorrect even if the speaker believed it.[1] Thus, while Omnicare reversed the Sixth Circuit pro-plaintiff standard, it also departed from the more influential, defendant-friendly standards in the Second and Ninth Circuits. Below, we consider how courts have applied Omnicare in the year since it was decided.
The Second Circuit’s Narrow Application of Omnicare
Earlier this month, the Second Circuit revisited its prior holding in Fait v. Regions Financial Corp.[2] that only subjectively-disbelieved opinions are misleading under the securities laws. In Tongue v. Sanofi, slip op. No 15-588-cv (2d Cir. Mar. 4, 2016), defendant and its predecessor had conducted “single-blind” clinical drug studies (studies in which either the researcher or the patient does not know which drug was administered) of a drug designed to treat multiple sclerosis, but, according to the complaint, the FDA had repeatedly expressed strong concern to the company and its predecessor that, without “double-blind” clinical studies (studies in which both the researcher and the patient do not know which drug was administered), the results might not support approval of the drug.[3] Plaintiffs alleged that without disclosure of the FDA’s repeated warnings that a single-blind study might not be adequate, various opinion statements were misleading. The opinions included defendants’ estimate that there was a 90% likelihood of achieving certain milestones within the cut-off date for those milestones, the projection that the FDA would approve the drug in late 2012, expressions of confidence about the anticipated launch date of the drug, a statement that the results of the clinical trials were “unprecedented,” and that they were “nothing short of stunning.” In November 2013, the FDA rejected the application based primarily on the failure to use double-blind studies. One year later, however, it approved the drug without double-blind studies.
The district court dismissed the claims based on multiple grounds: 1) they were not misleading under the Second Circuit’s subjective-belief standard in Fait, 2) they were protected by the securities law safe harbors for forward-looking statements, and 3) with respect to the claims under Section 10(b) of the Securities Exchange Act (which, unlike Section 11, requires proof of scienter), plaintiffs had failed to plead facts creating a strong inference of scienter.[4] The Second Circuit stated that it “saw no reason to disturb the conclusions of the district court,” but wrote to clarify the impact of Omnicare, which was decided after the district court issued its opinion, on prior Second Circuit law addressing whether a statement of opinion is materially misleading.
Expressions of Even Exceptional Optimism Do Not Create an Obligation to Disclose Conflicting Facts
The Second Circuit acknowledged that Omnicare changed the standard in Fait for what constitutes a materially misleading opinion under Section 11 because subjective disbelief is no longer required for a statement of opinion to be misleading. It held, however, that even under Omnicare the fact that the FDA expressed significant reservations about the company’s methodology “did not prevent Defendants from expressing optimism, even exceptional optimism, about the likelihood of drug approval.”
The court focused on the Supreme Court’s statement in Omnicare that a statement of opinion “is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way.” It stated that Omnicare imposes no obligation to disclose facts merely because they would have undermined defendants’ optimistic projections. In particular,
Defendants need not have disclosed the FDA feedback merely because it tended to cut against their projections—Plaintiffs were not entitled to so much information as might have been desired to make their own determination about the likelihood of FDA approval by a particular date….
Certainly, Plaintiffs would have been interested in knowing about the FDA feedback, and perhaps would have acted otherwise had the feedback been disclosed, but Omnicare does not impose liability merely because an issuer failed to disclose information that ran counter to an opinion expressed in a registration statement….
[D]efendants’ statements about the effectiveness of [the drug] cannot be misleading merely because the FDA disagreed with the conclusion—so long as Defendants conducted a “meaningful” inquiry and in fact held that view, the statements did not mislead in a manner that is actionable.
The “no meaningful inquiry” is a difficult standard for plaintiffs to meet, but it is based on a recognition that reasonable investors know that when a company offers an opinion, it is not stating that it is aware of no facts that cut against it, or that the company has disclosed the facts that cut the other way, or that no reasonable person could hold a different opinion based on the same facts. As the Supreme Court stated in Omnicare and the Second Circuit stated in Sanofi, the standard for opinion liability presents “no small task for an investor” seeking to plead that an opinion is misleading.
Hedges and Disclaimers Limit an Investor’s Ability to Allege that an Opinion Is Misleading
The Second Circuit also focused on the Supreme Court’s statement in Omnicare that investors read each statement within a document “in light of all its surrounding text, including hedges, disclaimers, and apparently conflicting information,” and that “an omission that renders misleading a statement of opinion when viewed in a vacuum may not do so once that statement is considered, as is appropriate, in a broader frame.” It stated that the offering materials “made numerous caveats to the reliability of projections,” and that a reasonable investor, especially investors who had dealt with complex financial instruments that arose in Sanofi, would have considered the opinions in light of those qualifications.
Post-Omnicare, Pre-Sanofi Lower Court Precedents
Even before the Second Circuit’s decision narrowly applying Omnicare, a number of district courts had dismissed opinion-related claims under Omnicare. For example, since Omnicare, courts dismissed complaints alleging that the following opinions were misleading:
The company’s “strong infrastructure and other characteristics” positioned it to “grow substantially by opening new stores at a rapid clip.”[5]
In response to plaintiff’s argument that the defendants failed to disclose the company’s generally poor infrastructure and lack of investment in improvement, the court quoted Omnicare’s statement that an opinion “is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way.” Further, the court said, defendants had identified numerous risks to growth in the company’s public filings and disclosed the basis for their projections, and Omnicare had stated that “to avoid exposure for omissions…, an issuer need only divulge an opinion’s basis, or else make clear the real tentativeness of its belief.” With regard to the argument that several of the opinions included “statements of embedded facts,” the court concluded that statements that are not “determinate or verifiable” did not constitute statements of embedded facts.
“In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of [the company.”[6]
The court stated that plaintiff’s Section 11 claim based on an omissions theory failed because “Plaintiff offers little more than the conclusory assertion” that the defendant’s opinion lacked a reasonable basis, and that under Omnicare conclusory allegations or recitations of statutory language are not enough to plead that an opinion was false or misleading.
Opinions regarding the adequacy of bad debt reserves and the collectability of receivables.[7]
With respect to the omissions prong in Omnicare, the court found that the bulk of the alleged omissions concerned circumstances that either had not occurred at the time of the offerings or were matters of general public knowledge or were not material when viewed in context of facts that were disclosed in the registration statement.
In another case involving the adequacy of reserves,[8] the court stated that reserves necessarily require judgment and thus are statements of opinion or belief, not of fact. The court stated that under Omnicare, plaintiffs must allege “not only that the financial statement ‘omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion,’ but that ‘those facts conflicts with what a reasonable investor would take from the statement itself.’”
“We believe these findings [regarding the results of certain drug trials] continue to support the robustness of the PRECEDENT trial results, particularly in the group of FR (100%) patients,” and “[W]e expect that the [European Medicines Agency] will grant the conditional marketing authorization for the two products or the products in the 28 countries in the EU probably in two to three months.”[9]
The court stated that plaintiffs had not pleaded sufficient facts to demonstrate that the defendant lacked a reasonable basis for making these statements. It stated that the company and its officers and directors were “’not required to take a gloomy, fearful or defeatist view of the future’ but were instead ‘expected to be confident about their stewardship and the prospects of the business that they manage’ within the bounds of the information that they actually had when the statements were made.’”[10]
Statements that the company did not believe an SEC investigation would have a material adverse effect on the company.[11]
The court stated that the plaintiffs had failed to provide adequate factual allegations as to why the defendants would have believed that the investigation would have a material adverse effect on the company’s financial statements.
“We believe we are in a far better financial situation than we were a year ago and the preservation of our liquidity is essential to maintain and improve our balance sheet.”[12]
With regard to plaintiff’s allegation that this omitted facts regarding the company’s liquidity issues, difficulty in paying its bills and cash flow problems, the court stated that the plaintiffs had not alleged any “facts that would cast doubt on the sincerity or reasonableness of [the defendant’s] statement of his opinion.” It cited Omnicare for the proposition that an issuer’s opinions do not become misleading because they are undercut by some facts known to the issuer.
Of course, not every opinion claim is dismissed, just as not every opinion claim was dismissed before Omnicare. One court denied dismissal of a claim based on the company’s statement that it believed it was “in substantial compliance with all laws, rules and regulations that affect its business and operations,” because, the court found, plaintiffs had adequately alleged facts that, if true, showed “that the legal compliance statements were both objectively false and disbelieved at the time they were made.”[13] Another court declined to dismiss a complaint regarding the adequacy of reserves where the complaint alleged that defendants fraudulently used a 2.2 average claim duration to calculate reserves when they knew that such duration was actually 3 years.[14] Another court rejected a motion to dismiss a complaint that it found plausibly alleged that the company “misled investors by suggesting that the company was not facing an investigation that could have a material impact on its business, when, in fact, it was facing such an investigation,” and it subsequently filed a restated 10-K that stated that an adverse outcome in the investigation could have a material effect on the company’s business, financial condition or results of operations.[15]
In the aggregate the cases suggest that even after Omnicare, pleading that an opinion was misleading is “no small task for an investor.” Plaintiffs must rely on facts, not conclusions; the omitted facts must go beyond contradicting the opinions expressed because “issuers need not disclose a piece of information merely because it cuts against their projections”; and the omitted facts must be material even in light of the qualifications and disclaimers that are also present.
No Change to the Scienter and Safe Harbor Requirements
Two other important qualifications deserve mention.
First, Omnicare was a Section 11 case, and Section 11 imposes strict liability on issuers for material misrepresentations and omissions in a registration statement. Many opinion cases, however, arise not under Section 11 but under Section 10(b) of the Securities Exchange Act, which requires plaintiffs to plead not only a materially misleading misrepresentation or omission but also facts that create a cogent inference of “scienter”—which the Supreme Court has defined as “a mental state embracing intent to deceive, manipulate, or defraud.”[16] As Judge Kaplan observed in In re Lehman Brothers Sec. and ERISA Litig.,[17] “whether such statements [of opinion] are made with the requisite scienter is, of course, another question” than whether those opinions are misleading under Omnicare. Fait, or something very close to Fait, should still be good law when it comes to Section 10(b) cases because a defendant who believes his opinion is unlikely to have acted with scienter.[18] The Sixth Circuit, in the decision that the Supreme Court reversed in Omnicare, held that an objectively wrong opinion is misleading under Section 11. But even the Sixth Circuit held that an opinion is actionable under Section 10(b) only if the defendants knew that the statements were false when made.[19] And the district court decision in Sanofi dismissed the opinion claims not only because the opinions were not misleading but, with respect to Section 10(b), because the plaintiffs had failed to plead facts creating a strong inference of scienter.
Second, many opinions are forward-looking—they express a view about the future rather than the present or the past. Subject to very limited exceptions, forward-looking statements are protected by safe harbors under the securities laws if the statements are honestly believed or if they are accompanied by meaningful cautionary statements.[20] The pleading requirements necessary to satisfy the safe harbors “are not affected by the recent Supreme Court decision in Omnicare….”[21] Indeed, in the district court Sanofi decision, the court held that many of the opinions were protected by the safe harbors in the securities laws and dismissed on that basis as well. The Second Circuit in Sanofi described the district court’s opinion as “thorough and thoughtful” and stated that it “agree[d] with the district court’s reasoning and holding.”
Conclusion
By focusing on the omissions prong in Section 11, Omnicare created a new test for opinion liability under Section 11 of the Securities Act. Sanofi and other post-Omnicare decisions, however, show that the hurdles to pleading opinion liability remain high even with regard to strict liability Securities Act claims, and are extraordinarily high when brought under Section 10(b) or when protected by the securities law safe harbors for forward-looking statements.
Notes:
[1] Compare Fait v. Regions Financial Corp., 655 F.3d 105, 110 (2d Cir. 2011) and Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156 (9th Cir. 2009) (even if an opinion is incorrect, it is actionable only if was not believed) with Council of Laborers & HOD Carriers Pension & Welfare Fund v. Omnicare, 719 F.3d 498 (6th Cir. 2013) (even if an opinion was believed, it is misleading under Section 11 if it is incorrect), rev’d sub nom Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S.Ct. 1318 (2015). See also MHC Mutual Conversion Fund, L.P. v. Sandler O’Neill & Partners, L.P., 761 F.3d 1109 (10th Cir. 2014) (considering three alternative standards for opinion liability and finding that plaintiffs failed all three).
[2] 655 F.3d 105, 110 (2d Cir. 2011).
[3] The use of a single-blind study was due in part to the drug’s unique treatment design. In contrast to other drugs used to treat multiple sclerosis, which require a daily or weekly dosing regimen, the drug at issue required only two annual treatment courses. Thus, patients would realize they were being required to undergo treatment far less frequently than under their normal drug.
[4] In re Sanofi Sec. Litig., 87 F. Supp. 3d 510 (S.D.N.Y. 2015), aff’d slip op. No. 15-588-cv (2d Cir. Mar. 4, 2016).
[5] In re Fairway Group Holdings Corp. Sec. Litig., Fed. Sec. L. Rep. (CCH) (S.D.N.Y. Aug. 19, 2015) (Report and Recommendation of Magistrate Judge Andrew J. Peck)
[6] SEPTA v. Orrstown Fin. Servs., Inc., Fed. Sec. L. Rep. (CCH) ¶ 98,550 (M.D. Pa. June 22, 2015).
[7] In re Velti PLC Sec. Litig.,2015 U.S. Dist. LEXIS 135004 (N.D. Cal. Oct. 1, 2015).
[8] City of Westland Police and Fire Ret. Sys. v. Metlife, Inc., Fed. Sec. L. Rep. (CCH) ¶98,811 (S.D.N.Y. Sept. 11, 2015).
[9] Vallabhaneni v. Endocyte, Inc., Fed. Sec. L. Rep. (CCH) ¶ 98,888 (S.D. Ind. (Jan. 4, 2016).
[10] Id., quoting Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1129-30 (2d Cir. 1994).
[11] In re Lions Gate Entertainment Corp. Sec. Litig, 2016 U.S. Dist. LEXIS 7721 (S.D.N.Y. Jan. 22, 2016).
[12] 782 F.3d 1142 (10th Cir. 2015).
[13] In re Bioscrip, Inc. Sec. Litig., 95 F. Supp.3d 711 (S.D.N.Y. 2015).
[14] In re Genworth Financial Inc. Sec. Litig., 103 F. Supp. 3d 759 (E.D. Va. 2015).
[15] Menaldi v. Och-Zipp Capital Management Group LLC, 2016 U.S. Dist. LEXIS 19083 (S.D.N.Y. Feb. 17, 2016).
[16] Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976).
[17] Fed. Sec. L. Rep. (CCH) ¶[ 98,818 at fn 103 (S.D.N.Y. Sept. 18, 2015).
[18] See Menaldi v. Och-Ziff Capital Management Group LLC, 2016 U.S. Dist. LEXIS 19083 at fn 8 (S.D.N.Y. Feb. 17, 2016) (“[I]nsofar as Omnicare supplants Fait, the distinction between the two standards may be less salient in § 10(b) cases, because in those cases—as opposed to § 11 cases – Plaintiffs must allege scienter. Because pleading scienter requires plaintiffs to address a defendant’s state of mind, eliminating the subjective prong of Fait may have less impact on analysis of whether a § 10(b) claim survives a motion to dismiss.”)
[19] Indiana State District Council of Laborers and HOD Carriers Pension and Welfare Fund v. Omnicare, Inc., 583 F.3d 935, 945 (6th Cir. 2009).
[20] 15 U.S.C. §77z-2(c)(i); 15 U.S.C. § 78u-5(c)(i).
[21] Firefighters Pension & Relief Fund of City of New Orleans v. Bulmahn, 2015 U.S. Dist. LEXIS 107198 (E.D. La. Aug. 14, 2015).
