“A foolish consistency is the hobgoblin of little minds….” Ralph Waldo Emerson.
“Consistency is the last refuge of the unimaginative.” Oscar Wilde.
“Consistency is the enemy of enterprise….” George Bernard Shaw.
“Only logicians and cretins are consistent!” Tom Robbins.
“The only completely consistent people are the dead.” Aldous Huxley.
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On October 10, 2014, the Sixth Circuit Court of Appeals issued another opinion in the class action suits against Omnicare, Inc. See Ansfield v. Omnicare, Inc., No. 13-5597 (Oct. 10, 2014) (Omnicare III). This is the third major appellate opinion in the case. The second, Omnicare II, is now before the Supreme Court on a writ of certiorari, and was discussed in our previous post “Sixth Circuit Improperly Expanded Section 11 Liability for Non-Factual Statements in Omnicare.” The latest decision reiterates the erroneous approach taken in Omnicare II on the issue of liability for non-factual statements, but it also adopts a new flawed standard for determining corporate scienter.
The Omnicare III opinion covers a lot of territory for claims asserted under section 10(b) of the Securities Exchange Act of 1934. (Omnicare II dealt with a parallel claim under section 11 of the Securities Act of 1933.) In the course of a new and purportedly improved discussion of the pleading requirements for a section 10(b) claim, the court addresses specifically how to test the sufficiency of pleadings of misrepresentations, omissions, materiality, scienter, and corporate scienter, and how those may differ for claims involving hard facts versus soft information, as well as what triggers a duty to correct previous disclosures. That’s a lot of meat to chew on, and unfortunately the court struggles with the gristle at several points.
Today we address only one of those points – the court’s inexplicable finding that plaintiffs sufficiently pleaded the existence of material misrepresentations in the form of opinions (“soft information”) even though they did not sufficiently plead facts showing actual knowledge that those opinions were incorrect. In an effort to maintain consistency with the court’s previous decisions in Omnicare II (supposedly founded on the unique attributes of section 11 claims), the court badly botched its consideration of the most fundamental aspect of section 10(b) claims: whether an actual misrepresentation or misleading omission of fact was adequately pleaded.
Recall that the allegations in this case involved statements in company disclosures that Omnicare routinely said that it materially complied with applicable federal and state laws, rules, and regulations. As discussed in our earlier post, such statements involve opinions or evaluations, not hard facts, and are therefore considered soft information. Indeed, the Omnicare III court itself notes that plaintiff admitted “that these statements concern soft information…” Slip op. at 26.
The court candidly acknowledges: “Our court has covered the standards for pleading these elements many times, and yet for all of our efforts and many pronouncements, the precise requirements for sufficiently pleading them, at least in this circuit, remain somewhat hazy and muddled,” and undertakes “to state the doctrine simply and in a straightforward manner in the hope of clearing away any confusion.” Slip op. at 15. On the standards governing the pleading of false disclosures, the court notes “we have failed to recognize that we must apply a different analytical framework to cases based on affirmative misrepresentations, as opposed to omissions, and that different rules apply when the misrepresentation or omission concerns hard, as opposed to soft, information.” Id.
What the court did next was to “muddle” the law far beyond previous efforts. It did so by, in the guise of making the analysis simpler for future judges and parties, fundamentally altering accepted standards for determining when statements of soft information are inaccurate. The apparent motive was not to simplify the analysis needed, which is not all that complex, but to create a superficial consistency between its decision to dismiss the section 10(b) claims in Omnicare III with its previous decision in Omnicare II to allow section 11 claims to proceed based on the same facts.
Addressing “affirmative statements” alleged to be “misleading or false,” the court says that statements of “hard information” – “typically historical information or other factual information that is objectively verifiable” – are actionable “if a plaintiff pleads facts showing the statement concerned a material fact and that it was objectively false or misleading.” Id. at 15-16. But in order to be actionable, a statement of “soft information” – which “includes predictions and matters of opinion” – “must additionally plead facts showing that the statement was ‘made with knowledge of its falsity.’” Id. at 16 (quoting Omnicare I, 583 F.3d at 945-46). This makes the analysis less straightforward because, in the court’s view, adding a subjective inquiry to an objective element “conflates” the elements of misrepresentation and scienter. Id. In analyzing whether a defendant has actual knowledge for these two distinct purposes, the court says: “we have muddled the analytical framework, making it more difficult for lower courts and parties to evaluate whether a plaintiff has sufficiently pleaded a cause of action.” Id.
To end this “muddling,” the court posits that “we must choose one way or the other to analyze a defendant’s actual knowledge.” Id. Why it says this is unclear. Just because multiple elements in a claim require a showing of knowledge, why must a court proceed by allocating that issue to one of those elements to the exclusion of the other? One discussion may (or perhaps may not) suffice to analyze the knowledge requirement for both elements, but that does not mean a court may ignore it for either of the elements. Doing so is especially specious when the shorthand approach allows a court to find an element sufficiently pleaded when it was not. That is exactly what the court did here.
The Omnicare III court decided that it was unnecessary to consider whether actual knowledge was pleaded as to the alleged misstatement of “soft information” by Omnicare (whether it complied materially with the law) – as the court earlier acknowledged was necessary – because it was more convenient to consider that issue in the context of the scienter element. Its reason for doing that was strikingly lame: the court declared that “[w]hether courts choose to evaluate this subjective component as part of their material-misrepresentation analysis or their scienter analysis makes little difference for the parties” because “[u]nder either approach, Plaintiffs will need to allege particular facts demonstrating that defendants had actual knowledge that their statements concerning soft information were false or misleading at the time that they were made.” Id. That is glaringly wrong. Perhaps that allows reaching the right result in the case at hand (because a wrong finding is trumped by a correct one), but it hardly provides a useful standard “for lower courts and parties” going forward. As was amply shown by the court’s opinion in Omnicare II, whether the “actual knowledge” requirement is applied to the “material-misrepresentation analysis” can be decisive in determining whether there is any misrepresentation at all. And the existence of a false statement or omission is, after all, the most basic building block of a claim founded on “a material misrepresentation or omission by the defendant” (Mattrix Initiatives, Inc. v. Siracusano, 131 S.Ct. 1309, 1317 (2011)).
Instead of doing the analysis it acknowledged was required, the Omnicare III court decided that “it makes the most sense to … conceive of this additional requirement [i.e., actual knowledge] as raising the bar for alleging scienter.” Slip op. at 16. Why? Because apparently the appellate court thought district judges have difficulty considering objective and subjective requirements in tandem: “Doing so would allow courts to evaluate materiality and whether the statement was misleading or false – two objective inquiries – under the material-misrepresentation prong and then to save all subjective inquiries for the scienter analysis.” Id. at 17. Besides, knowledge is “at bottom, a question of someone’s state of mind,” and that is “the general subject of a scienter inquiry.” Id.
The circularity of this discussion is embarrassing, and the end result unsupportable. Why would a court engage in such silliness? There can only be one reason: it was the only way to make the decision in Omnicare III consistent with the court’s prior decision in Omnicare II. In that case, as discussed in our previous post, the court did away with any requirement for pleading actual knowledge of inaccuracy of soft information to state a material misrepresentation in a section 11 claim, where scienter is irrelevant. By surgically carving subjective knowledge out of the material misstatement element in a section 10(b) claim, the court could (and did) justify saying that the section 10(b) claim could be dismissed on scienter grounds for failing to plead actual knowledge of inaccurate soft information disclosures, while still concluding a misrepresentation was sufficiently pleaded.
If the court proceeded properly, and applied to this case the governing law it acknowledged, it would have found that the section 10(b) claim failed sufficiently to plead a material misrepresentation because it involved soft information and the law states that such disclosures are not false unless they are subjectively disbelieved when made. But that would have revealed in all of its glory the blatant error in Omnicare II’s holding that a section 11 claim based on the same allegations sufficiently pleaded material misrepresentations.
Perhaps a little less consistency and a little more introspection would have left things less muddled.
We save for a future discussion the Omnicare III court’s questionable guidance on the proper approach to determining whether materiality was properly pleaded, and the court’s seriously flawed newly-coined standards for determining corporate knowledge.
October 14, 2014
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