Tag Archives: private securities litigation

On “Merger Tax” Cases, Mark Twain, Abe Vigoda, and Other Premature Death Reports

Mark Twain is famously reported as saying “Reports of my death are greatly exaggerated.”  Well, in that respect, he may have been like Yogi Berra (RIP), whose autobiography was titled “I Really Didn’t Say Everything I Said.”  A little research yielded Mark Twain’s original note, which was less pithy: “the report of my death was an exaggeration.”

Mark Twain on His Reported Death

“The report of my death was an exaggeration.”

Yogi Berra Autobiography

Mark Twain was not alone.  Samuel Taylor Coleridge overheard someone talking about a coroner’s inquest into his suicide (by hanging), and responded: “it is a most extraordinary thing that he should have hanged himself, be the subject of an inquest, and yet that he should at this moment be speaking to you.”  Many other folks have been the subject of premature death reports, including, many of us remember vividly, Paul McCartney.  This seems to be common among musicians — it also happened to Madonna, Lou Reed, Bob Seger, John Mellencamp, Lena Horne, Fats Domino, Alice Cooper, Neil Young (three times), and Gordon Lightfoot (who was at the dentist when he heard of his death).  Others in this club include Pope John Paul II (three times), Queen Elizabeth II, Ernest Hemingway (who reportedly read his obituaries every morning with a glass of champagne), P.T. Barnum (at his request, so he could see what people would say about him), Alfred Nobel (who is said to have read in his obit that he was a “merchant of death” and then decided to fund the Nobel Prize), Joe DiMaggio, Bob Hope (twice),  James Earl Jones (mistakenly identified when James Earl Ray died), Sean Connery, Steve Jobs, George Soros, Russell Crowe, Ken Kesey (who faked his own suicide to avoid criminal charges), and William “The Refrigerator” Perry (who was watching a Chicago Bears game when he saw a ticker message glide by announcing his death).  And don’t forget Abe Vigoda, whose death was reported on at least two occasions, and who, as of today, is 94 years old and has a website devoted to reporting that he remains alive: http://www.abevigoda.com/.

What do Mark Twain and all of these people have to do with securities law?  The reports of their deaths were, indeed, premature, as may be the reported death of one of the most enduring securities litigation scams – the “merger tax” litigation.

If you read this blog, you may have seen several discussions of “merger tax” litigation, that cynical sham in which virtually every merger or acquisition is met by a legal challenge regardless of whether there is any reasonable basis for doing so.  The legal challenge is not calculated to protect shareholders or increase shareholder value – in fact, it most likely victimizes them and diminishes that value.  Instead, it is calculated to delay the completion of the proposed transaction sufficiently to convince the parties to pay the plaintiffs’ lawyers to go away by settling the case for attorneys’ fees and otherwise meaningless non-monetary relief, supposedly for the benefit of shareholders, but actually worthless or even a net cost to them.

This long-standing charade is high on the list of lawyer chicanery that leads the public to view lawyers as among the least honest and most unethical professionals around.  In 2013, lawyers were ranked as having high honesty and ethical standards by only 20% of those polled, falling above only TV reporters, advertising practitioners, State officeholders, car salespeople, Members of Congress, and lobbyists, and below 15 other professions (including nursing home operators, who beat lawyers handily).  See http://www.gallup.com/poll/166298/honesty-ethics-rating-clergy-slides-new-low.aspx.

The practice of paying the “merger tax” to get rid of worthless legal challenges is the product of greed by unscrupulous plaintiffs’ lawyers, cynical deal-making by defense lawyers and their corporate clients, and “go along, get along” judges, who ultimately have to approve these sham transactions in their role of supposedly protecting the interests of the absent real parties in interest, the shareholders.  Unfortunately, most judges in this situation act like potted plants. For reasons that are hard to determine, they accept the sham and, worse, place their judicial imprimatur on the transaction.

In recent months, however, we have reported on repeated judicial decisions to say “No Mas.” We reported on Judge Melvin Schweitzer’s decision to reject a merger tax settlement in Gordon v. Verizon Communications in our Commentary on Abusive State Law Actions Following M&A Deals, which was followed by a post discussing a welcome judicial discussion of the impropriety of “merger tax” cases in City Trading Fund v. Nye: NY Court Flexes Muscles in Rejecting Bogus “Merger Tax” Settlement.  And the securities law world has taken note of several recent Delaware Chancery Court cases that excoriate the practice.  See Delaware Judge Tells Plaintiff Lawyers: The M&A ‘Deal Tax’ Game Is Over; Game Over?: Del. Chancery Court Rejects Disclosure-Only Settlement in H-P/Aruba Networks Merger Objection Lawsuit; and Transcript of Del. Chancery Court Hearing in Aruba Networks Stockholder Litigation.

On the basis of these developments, we reported that “this sordid practice may be on the wane because judges finally are doing their jobs.”  Alas, as with Mark Twain and his comrades in faux-death mentioned above, our reports of the possible impending death of “merger tax” litigation may have been premature.

Witness the settlement proposed just last week in McGill v. Hake, a case brought in the Southern District of Indiana by plaintiffs’ law firms Faruqi & Faruqi and Robbins Orroyo, with local firm Riley Williams & Pyatt.  Complicit in this legal atrocity are the defense lawyers — from Sullivan & Cromwell, Jones Day, and Taft, Stettinius & Hollister — as well as their client, Harris Corporation and its directors, but at least they have the excuse that they view themselves as acting in the short term interest of their clients or shareholders.

The complaint in McGill, filed February 12, 2015, was purportedly brought for the benefit of all shareholders of Exelis Inc., and alleged that the acquisition of 100 percent of the shares of Exelis by Harris Corp. was a breach of fiduciary duty because the value offered to Exelis shareholders ($23.75 per share) was “insufficient, as it fails to account for the Company’s significant future earning potential and falls below the premium other defense contractors have recently sold for.”  The complaint sought to enjoin the transaction or, if the transaction were completed, damages suffered by the shareholders as a result of the alleged breaches of fiduciary duty.  The claims were allegedly “based on information and belief, including the investigation of counsel and review of publicly-available information.”  The complaint can be reviewed here: Complaint in McGill v. Hake.

Fast forward to last week.  Plaintiff’s counsel filed a motion for court approval of a settlement of the claims.  The terms of the settlement: the plaintiff’s lawyers get a payment of $410,000; the shareholders get nothing of value.  Instead, the plaintiff’s lawyers negotiated for the defendants “to make certain supplemental disclosures” in a Form 8-K which purportedly “provided Exelis’ shareholders with material information concerning the fairness of the Merger and the Merger Consideration.”  Notice that there was no adjustment to the value received by the Exelis shareholders, despite the original contention that the $23.75 value per share was “insufficient.” Instead, more information was provided that supposedly allowed the shareholders to confirm that the value offered was indeed adequate.  In short, although the case was supposedly brought to remedy the “insufficient” value given to Exelis shareholders, the only pecuniary benefit provided in the settlement goes to the plaintiff’s lawyers.  The motion for approval of the settlement can be reviewed here: Plaintiff’s Motion for Approval of Merger Tax Settlement in McGill v. Hake.

This is a quintessential “merger tax” “disclosure only” settlement.  Supposedly convinced that the alleged unfair value was not in fact unfair, the lawyers walk away from the case pocketing the only money transferred.  How were they convinced that the value was sufficient?  By reviewing materials provided to them that confirmed the fairness of the valuation, and performing so-called “confirmatory discovery” after the deal was done to “confirm” the fairness of the deal.  So-called “confirmatory discovery” of a settlement deal is a transparently fictitious way to generate time and effort by the plaintiff’s lawyers that they then present to the court as a justification for the dollar fee payment the parties previously agreed would be paid to the lawyers.  Trust me on this – I’ve negotiated many such settlements.  Settlements that fail to go forward after “confirmatory discovery” are a non-existent species.

So, here we are in October 2015, following a series of cases touted as the death-knell for the “merger tax” “disclosure only” settlement, looking at precisely such a settlement proposal.  District Judge Tanya Walton Pratt, relatively new to the bench, will conduct a hearing on February 16, 2016 to consider whether to approve the proposed settlement.  See Scheduling Order in McGill v. Hake.

Judge Tanya Walton Pratt

Judge Tanya Walton Pratt

We can only hope that Judge Pratt follows the lead of her brethren on New York and Delaware and continues the process by which the lawyers’ cottage industry of “merger tax” litigation can be eliminated by judges simply doing their jobs.

Straight Arrow

October 27, 2105

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New, Thorough Academic Analysis of In re Flannery Shows Many Flaws in the Far-Reaching SEC Majority Opinion

One of the most important actions by the SEC over the past year was the far-reaching majority opinion of three commissioners in In the Matter of Flannery and Hopkins, SEC Release No. 3981, 2014 WL 7145625 (Dec. 15, 2014). That opinion can be read here: In re Flannery Majority Opinion.

Soon after Flannery was decided, we discussed the extraordinary nature of this opinion in an administrative enforcement action, in which the majority sought to create new, precedential legal standards for the critical antifraud provisions of the Securities Act of 1933 (section 17(a)) and the Securities Exchange Act of 1934 (section 10(b)).  In many respects, the standards they espoused departed significantly from judicial precedent, including Supreme Court and Courts of Appeals decisions.  The majority specifically invoked the doctrine of deference under Chevron U.S.A. Inc. v. Natural Resource Defense Council, Inc., 467 U.S. 837 (1984), as a means of pressing for the courts to defer to these expressed views instead of continuing to develop the parameters of these statutes through judicial standards of statutory analysis.  See SEC Majority Argues for Negating Janus Decision with Broad Interpretation of Rule 10b-5.

Since that time, some commentators have addressed aspects of the Flannery decision.  See, for example, ‘‘We Intend to Resolve the Ambiguities’’: The SEC Issues Some Surprising Guidance on Fraud Liability in the Wake of JanusThe decision is currently being briefed on appeal in the First Circuit under the caption Flannery v. SEC, No. 15-1080 (1st Cir.).  You can read the appellant’s brief here: Flannery Opening Appeal Brief in Flannery v. SEC, and the SEC’s opposition brief here: SEC Opposition Brief in Flannery v. SEC.  An amicus brief filed on behalf of the Chamber of Commerce can be read here: Chamber of Commerce Amicus Brief in Flannery v. SEC.

For an opinion this far-reaching, and attempting to make such extraordinary changes in the interpretation and application of two key statutes, there has been sparse commentary and analysis overall.  Perhaps this is because the majority opinion was so expansive in what it addressed (often unnecessarily, purely in order to lay down the SEC’s marker) that it was difficult to analyze comprehensively.  Fortunately, this is about to change.  The first sophisticated and in-depth analysis of key aspects of the Flannery opinion is in the final stages, written by Andrew Vollmer, a highly- experienced former SEC Deputy General Counsel, former private securities enforcement lawyer, and current Professor of Law at the University of Virginia Law School and Director of its Law & Business Program.  Professor Vollmer released a current version of an article (still being revised) on SSRN.  It is worth reading in its entirety, and is available here: SEC Revanchism and the Expansion of Primary Liability Under Section 17(a) and Rule 10(b)(5).

Professor Vollmer had the wisdom to realize that the best in enemy of the good, and limited the scope of his article to analysis of the majority opinion’s effort to expand primary liability under section 17(a) and section 10(b) and its claimed entitlement to Chevron deference.  Other provocative aspects of the opinion are left for hoped-for future analysis (by Professor Vollmer or others).  But the important issues of the majority’s attempt to alter the trajectory of judicial legal developments governing section 17(a) and section 10(b) liability, and the majority’s assertion that its views on these issues are worthy of Chevron deference by the courts, are examined with a depth and sophistication lacking in any other publication to date known to us, and well beyond the level of analysis given to these issues by the Commission majority itself.

For those who want a flavor of Professor Vollmer’s views without delving into the entire 60-page comment, I will quote at some length portions of his useful executive summary:

An exceedingly important question for those facing the possibility of fraud charges in an enforcement case brought by the Securities and Exchange Commission is the scope of primary liability under the two main anti-fraud provisions, Section 17(a) of the Securities Act and Rule 10b-5 of the Securities Exchange Act.  That subject has received close attention from the Supreme Court and lower courts, and recently the SEC weighed in with a survey of each of the subparts of Section 17(a) and Rule 10b-5 in a decision in an administrative adjudication of enforcement charges.

In the Flannery decision, a bare majority of Commissioners staked out broad positions on primary liability under Rule 10b-5(a) and (c) and Section 17(a)(1), (2), and (3) . . . .  The Commission not only advanced expansive legal conclusions, but it also insisted that the courts accept the agency’s legal interpretations as controlling.

The SEC’s decision in Flannery raises thought-provoking issues about the role of administrative agencies in the development, enforcement, and adjudication of federal law. The purpose of this article is to discuss two of those issues.

The first concerns the consistency of Flannery with the Supreme Court and lower court decisions defining the scope of primary liability under Rule 10b-5 and Section 17(a).  This article explains that much about Flannery is not consistent with, and is antagonistic to, a series of prominent Supreme Court decisions that imposed meaningful boundaries around aspects of primary liability under Rule 10b-5.  Those decisions are Central Bank of Denver, NA v. First Interstate Bank of Denver, NA, Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., and Janus Capital Group, Inc. v. First Derivative Traders.

The Commission in Flannery sought to confine and distinguish those precedents, but Part II.A below questions the SEC’s reading of the cases and explores the reasoning and analysis in Stoneridge and Janus to determine whether the opinions were, as the Commission said, limited solely to the reliance element in private cases or to subpart (b) of Rule 10b-5.  That review reveals that the effort of the Supreme Court in the cases was to draw a crisper line between primary liability and aiding and abetting and to define a primary violator as the separate and independent person with final control and authority over the content and use of a communication to the investing public.  The Court’s rationales ran to both Rule10b-5 and Section 17(a).

Part II.B then compares the reasoning and analysis in the Supreme Court cases plus a selection of court of appeals decisions with the Commission’s approach in Flannery.  One point of comparison is that the Commission used a loose and unprincipled policy of interpreting the laws flexibly to achieve their remedial purpose.  The Supreme Court long ago discredited and refused to apply that policy, but Flannery wielded it repeatedly to reach outcomes that grossly exceed the boundaries the Court appeared to be setting in Stoneridge and Janus.

For example, the Commission would extend primary liability to a person who orchestrated a sham transaction designed to give the false appearance of business operations even if a material misstatement by another person creates the nexus between the scheme and the securities market.  According to the Commission, Section 17(a)(1) goes further and covers a person who entered into a legitimate, non-deceptive transaction with a reporting company but who knew that the public company planned to misstate the revenue. These constructions disregarded the lesson of Stoneridge.  A person entering into a transaction with a public company, even a deceptive transaction, that resulted in the public company’s disclosure of false financial statements did not have primary liability when the public company was independent and had final say about its disclosures.  The Commission would extend primary liability to a person who drafted, approved, or did not change a disclosure made by another, but Janus held that a person working on a public disclosure was not the primary actor when another independent person issued and had final say about the disclosure.

A reading of the Flannery decision leaves the definite impression that a majority of SEC Commissioners aimed to use the case as a vehicle to recover much of the territory lost in the enforcement area from the Supreme Court decisions and the lower federal courts that have been following the Supreme Court’s lead.  It was an effort to supersede the court judgments by re-interpreting and extending the prohibitions in Rule 10b-5 and Section 17(a).  If these concerns have merit, the actions of the SEC, an administrative agency within the Executive Branch, are unsettling.  They take the stare out of stare decisis, rattle the stability of legal rules, upset traditional expectations about the role of the courts in the development of the law, and head toward a society ruled by bureaucratic fiat rather than ordered by laws.

 The second issue discussed in this article is whether the courts must or should treat the SEC’s legal conclusions in an adjudication as controlling under Chevron U.S.A. Inc. v. Natural Resources Defense Council, IncFlannery included an overt claim to Chevron deference.  Part III evaluates this bid for Chevron deference and concludes that the courts would have doctrinal and precedential grounds for refusing to accept the Flannery positions as controlling.  Part III.C goes through these reasons, starting with the text of the provision of the Administrative Procedure Act governing judicial review of agency actions and looking closely at the actual practice of the Supreme Court and courts of appeals when they review a legal conclusion in an agency adjudication.  Part III.E discusses particular features about Flannery that would justify a reviewing court in not giving controlling weight to the interpretations of Rule 10b-5 and Section 17(a).

The precedents identify good reasons for not granting Chevron deference to Flannery or similar agency adjudications in enforcement cases.  Giving controlling effect to the SEC’s decision in Flannery would allow the agency both to avoid the teachings of leading Supreme Court authorities and to trump the Supreme Court and other federal courts on significant matters of statutory interpretation.  It would empower the SEC to cut short and silence the normal process in the federal courts for testing and establishing the limits of liability provisions, and it would enable the SEC to tip the scales in enforcement cases by converting its litigating positions into non-reviewable legal interpretations.  The cumulative effect of an agency’s decision to roll back Supreme Court precedent and to consolidate for itself ultimate decision-making power over questions of law traditionally left to the courts would seriously alter a balance between agencies and courts long recognized in our system of government.

These two issues are not the only topics of interest in Flannery.  The Commission opinion raises many more.  Chief among them are the proper interpretations and coverage of each of the sub-parts of Section 17(a) and Rule 10b-5.  That was the main subject of Flannery, and it deserves careful study and analysis by courts, practitioners, and scholars.  The purpose of this article is not to propose conclusions on that important set of questions, although the discussion in Part II below will suggest some considerations and limitations that should bear on an appropriate construction of the statute and Rule.

Flannery touches on other points that are beyond the scope of this article. For example, the Commission majority suggested that the SEC does not need to prove either negligence or scienter for a violation of Section 17(a)(2) or (3).  Strict liability might exist, even though courts of appeals require the Commission to prove negligence.  Another example is the Commission’s position that Section 17(a)(3) prohibits pure omissions without a corresponding duty to disclose.  A third issue that deserves more attention is the Commission’s view that it could use a section of the Dodd-Frank Act to impose a monetary penalty in an administrative proceeding for conduct occurring before the enactment of the Dodd-Frank Act.  All in all, Flannery provides much fodder for rumination by the bench, bar, and academy.

Thanks to Professor Vollmer for picking up the gauntlet thrown down by three SEC commissioners in the Flannery opinion.  This is an important — a critical — battleground on which the scope of future liability for alleged securities fraud is now being fought.  Much of the commissioners’ expansive treatment of primary section 10(b) liability matters little to the SEC itself, because the SEC always has at its disposal allegations of aiding and abetting liability in its enforcement actions.  The crucial impact of the expanded scope of primary section 10(b) liability would be in private securities class actions.  The careful limits on securities class action strike suits against alleged secondary violators in the Supreme Court’s decisions in Central Bank, Stoneridge, and Janus would fall by the wayside under the majority’s expanded view of primary section 10(b) liability.  In no small respect, the three commissioners who penned the Flannery opinion are laying the foundation for the future wealth of the private securities plaintiffs’ bar more than they are creating meaningful enforcement precedent for the SEC itself.  Only the staunch, rigorous analysis of those like Professor Vollmer may stand in the way of that questionable redistribution of wealth.

Straight Arrow

July 9, 2015

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Reactions to Supreme Court Omnicare Decision Vary

Reactions to the Supreme Court in Omnicare Inc. v. Laborers District Council Construction Industry Pensions Fund, No. 13-435, have been predictably varied.  Most note that there are pluses and minuses for both plaintiffs and defendants in federal securities cases under section 11 of the Securities Act of 1933.  Dealmakers express relief that they can devise disclosures to protect against liability for opinions stated in registration statements that are part of public company mergers.  Plaintiffs’ lawyers say they now have a Supreme Court imprimatur for causes of action challenging undisclosed feeble support for company or management opinions in public offering materials.  More developments are inevitable as commentators and the courts focus on the scope and application of Justice Kagan’s concept of what I call “incomplete opinions.”  Our post on the Omnicare opinion is available here: Omnicare: Supreme Court Shoots Down 6th Circuit, but Adopts Amorphous Standard for Section 11 Opinion Liability.

Some amusing reactions discuss Justice Kagan’s unusual chatty style of writing: Minor Wordfoolery in Today’s Supreme Court Opinion (Lowering the Bar) (commenting on pronoun sniping between Kagan and Scalia); “Way overstates,” in a Supreme Court opinion (Washington Post) (commenting on a lapse into Valley girl speak by Kagan); and “Yeah, Well, That’s Just, Like, Your Opinion”:  Supreme Court Limits Securities Liability for Opinions in Omnicare (JDSupra) (in which the only stylistic comment is in the title, but it makes the point).

See for yourself.  We provide below links to commentary about the Omnicare decision.  These links will be updated in the future to include thoughts published after today (March 25, 2015):

We include at the bottom the descriptions and analyses published by various law firms.  For your convenience, if you prefer not to go through the many primary sources provided, we provide at the outset of that section a sampling of quotes from these materials with “takeaways” laid out by several firms.


Omnicare: Supreme Court Shoots Down 6th Circuit, but Adopts Amorphous Standard for Section 11 Opinion Liability (Straight Arrow Mar. 24, 2015 Blog Post)

Supreme Court’s Omnicare Decision Muddies Section 11 Opinion Liability Standards (K&L Gates)

In Omnicare the Supreme Court Provides Evidence for Opinions in Registration Statements (Wolf Haldenstein)

Deals World Rests Easy In Wake Of Omnicare Ruling (Law 360)

Lawyers Weigh In On High Court’s Omnicare Decision (Law 360)

IMHO Omnicare Doesn’t Materially Change Opinion Disclosure (The Venture Alley)

Context Is King in Supreme Court’s Omnicare Ruling (Law.com)

Omnicare: Section 11 Liability and Opinions (SEC Actions)

Facts, Opinions, Omissions, and Context: The U.S. Supreme Court Issues Omnicare Opinion (D&O Diary)

“Yeah, Well, That’s Just, Like, Your Opinion”:  Supreme Court Limits Securities Liability for Opinions in Omnicare (JDSupra)

Supreme Court’s “Omnicare” Decision Follows Middle Path (Washington Legal Foundation)

Supreme Court Sets High Bar For Challenging Exec Opinions (Law 360)

Justices stick to middle of the road in Omnicare securities opinion (Reuters)

A company’s opinion isn’t always a lie (Bloomberg)

Supreme Court Protects ‘Opinions’ From Suit — Unless They’re Contradicted By The Facts (Forbes)

High Court gives Omnicare another shot at stopping investor suit (Wall Street Journal)

Law Firm Advisories

Summary of “takeaways”:

Morrison Foerster:

The Omnicare decision will affect whether and how opinions are communicated in registration statements. It may also shape, to some extent, how courts approach liability even for statements alleged to be misleading where a material fact is omitted from other investor communications. That is because the statutory language at issue in Omnicare is similar to more than a dozen other federal securities laws provisions. One key difference, however, is that civil liability under other statutes like Section 10(b) of the Securities Exchange Act of 1934—the federal securities statute most frequently invoked by private plaintiffs—requires proof of scienter, unlike Section 11. That means that, with respect to opinion statements made outside of registration statements, plaintiffs must show not only a material misstatement or omission, but also that a defendant did not believe his or her opinion and intended to deceive investors, a high hurdle for plaintiffs to overcome.

Going forward, public companies, their speakers, and the gatekeepers who advise them (including in -house and external counsel) should give special consideration to expressions of opinion that are communicated to the investing public. A prudent approach would be to accompany statements of opinion with the actual basis for the belief, the reasons for that belief, and qualifications of the opinion, including caveats or statements of tentativeness. In addition, documents supporting the basis for every statement of opinion should be verified, preserved, and readily accessible if litigation is filed. Indeed, doing so can significantly help bolster the defense of claims relating to all types of public statements, not just statements of opinion.

Sullivan Cromwell:

Yesterday’s decision provides important guidance on how Section 11 applies to statements of opinions.  The Court’s guidance is significant in light of the critical role of pleading standards and motions to dismiss in securities litigation.  The Court’s decision confirms that Section 11 does not authorize lawsuits based on honestly held opinions in registration statements that subsequently turn out to be wrong….  [W]hen opinion statements contain embedded factual assertions—i.e., when an issuer says that it holds a particular opinion because of some fact—issuers should be careful that they have taken measures to verify the factual assertions underlying those opinions.The decision may encourage plaintiffs’ lawyers to bring litigation over whether issuers have adequately accompanied their opinions with statements about how they formed those opinions—i.e., “facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have.”  But the Supreme Court made clear that, “to avoid exposure for omissions under [Section] 11, an issuer need only divulge an opinion’s basis, or else make clear the real tentativeness of its belief.”

….  To guard against the possibility of omissions liability, issuers should consider setting forth the bases for opinion statements in disclosure documents where necessary to prevent any potential confusion.  Issuers also should consider whether there are any material assumptions underlying their opinion statements that would not be apparent from the context of the opinion and may be material to a reasonable investor….  [I]ssuers should consider accompanying their opinion statements with language making clear the opinions’ uncertainty or limited nature or scope. Although the Supreme Court’s decision rested on the language of Section 11, plaintiffs’ lawyers may seek to extend the Court’s rationale to claims under other provisions of the securities laws, such as Section 12 of the Securities Act and Sections 10(b) and 14(a) of the Securities Exchange Act of 1934, including with respect to oral or written statements of opinion not crafted with the care and forethought applied to registration statements.  The Supreme Court was clear, however, that plaintiffs have substantially less room to claim to have been misled by opinions outside the context of carefully drafted registration statements and similar documents….  Defendants may wish to resist any attempt to extend yesterday’s decision beyond litigation under Section 11 in the context of registration statements.

Fenwick West:

Notably, Section 11 cases are typically subject to a stay of discovery during the pendency of a motion to dismiss under the Private Securities Litigation Reform Act of 1995 (PSLRA), and thus plaintiffs will likely have to plead such facts without the benefit of any discovery.

It bears noting, however, that plaintiffs are increasingly filing their Section 11 cases in state court—as there is a split among district courts as to whether Section 11 cases are removable to federal court—and in so doing are arguing that the PSLRA stay of discovery does not apply.  The Omnicare decision may create further incentive for plaintiffs to file in state court to attempt to obtain discovery in order to properly plead a Section 11 claim under the Omnicare standard.

Paul Weiss:

….  The opinion [] strongly suggests that the presence of words like “I believe” may indicate a statement of opinion, rather than one of fact….  As a result, issuers may be more likely — and well advised to use such “opinion” language in their registration statements and other disclosures going forward.  The Court’s ruling, however, also leaves considerable room for lower courts to develop more precise rules about what types of statements do and do not constitute opinions….

[T]he Supreme Court’s ruling that a statement of opinion may be actionable under Section 11 under an omissions theory is likely open to a new avenue of litigation.  Plaintiffs who cannot allege that an opinion was not honestly held may instead allege that it was based on inadequate inquiry or that there was contrary information available to the speaker.  The extent to which such allegations are sufficient to avoid a motion to dismiss will require further judicial development….  [I]t will be up to lower courts to develop case law distinguishing actionable amissions from non-actionable ones, and those distinctions may depend on industry practice and other factors that the Supreme Court’s opinion references but does not conclusively determine.

….  [T]he Supreme Court’s opinion does not address the application of the standards it sets forth to claims based on statements of opinion that are asserted under provisions of the federal securities laws other than Section 11.  The Second Circuit Court of Appeals, for example, has held that the same standards for pleading an actionable misstatement of opinion that apply under Section 11—including subjective falsity—also apply to claims asserted under Section 10(b)….  The Supreme Court’s opinion in Omnicare appears to leave such lower court decisions intact —at least insofar as they concern alleged misstatements.  But, to the extent that lower courts have not drawn the same distinction as the Supreme Court did between affirmative misstatements of opinion and statements of opinion that omit material facts, the decision also raises certain unanswered questions. These include, for example, whether plaintiffs alleging that a statement of opinion is materially misleading under Section 10(b) because the defendant omits that he failed to conduct an investigation supporting his opinion would be entitled to a presumption of reliance under Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972), or whether such plaintiffs would be required to demonstrate reliance through one of the means applicable to a claim of alleged misrepresentation.


….  [T]he Court’s decision places some important restrictions on investors’ ability to challenge statements of opinion under § 11.  First, an issuer need not disclose all facts supporting or undercutting its expressed opinion. Normal principles of materiality still apply….  Second, and relatedly, an issuer can reduce the risk of § 11 liability by “including hedges, disclaimers, and apparently conflicting information.”  For example, an issuer wishing to express its belief in its compliance with law can note the existence of any private or governmental litigation – and any conflicting legal decisions – on the matter at issue and can include cautionary language warning that courts or regulators could view the factual and legal issues differently than does the issuer…. Third, issuers can take some comfort from the Court’s unwillingness to countenance generalized, conclusory assertions about alleged omissions and lack of reasonable basis for opinions expressed.  While the Court cited the general notice-pleading standard articulated in Ashcroft v. Iqbal, the Omnicare decision applies specifically in the § 11 context, so issuers will undoubtedly focus on this language if they believe that plaintiffs have not pled “particular (and material) facts going to the basis for the issuer’s opinion.”

Subsequent cases will explore whether and to what extent Omnicare applies to claims under § 10(b) of the Securities Exchange Act, which – unlike § 11 – requires plaintiffs to prove the defendants’ knowledge (or at least recklessness) as to falsity. If Omnicare allows § 11 liability where an issuer omits material information about the basis for its opinions, must a § 10(b) plaintiff prove that the issuer acted with the requisite scienter in omitting that information?

Moreover, if Omnicare applies to § 10(b) cases involving opinions, investors will presumably need to satisfy the heightened pleading standards of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) in specifying the “facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have – whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.” The pleading standard that Omnicare cited should not suffice in a PSLRA case.

Gibson Dunn:

….  As with most such decisions, the proof is in the pudding: Omnicare’s impact on Section 11 litigation will be borne out in the coming months and years as lower courts grapple with the decision.  And while Omnicare’s relevance beyond Section 11 will no doubt be debated, the opinion’s reach, particularly to federal securities law claims that require scienter, is questionable.  A more subjective standard, such as that set forth in Justice Scalia’s concurrence, likely remains more fitting for scienter-based claims….  But regardless of how the omission standard is applied to federal securities law claims requiring scienter, plaintiffs still face a high pleading burden in such cases.

Latham Watkins:

….  [T]he Court did not directly address important issues regarding how the Omnicare analysis will be applied.

The Court’s opinion provides relatively little guidance as to when an omission may give rise to Section 11 liability.  The Court stated that “to avoid exposure for omissions under [Section] 11, an issuer need only divulge an opinion’s basis, or else make clear the real tentativeness of its belief” – but left it to the lower courts to determine the extent to which the basis of an opinion should be disclosed to accord with a reasonable investor’s expectations, and what more an issuer should say about the “tentativeness” of the belief beyond the inherent uncertainty conveyed by stating the view in the form of an opinion.

The Court also did not address whether and how its analysis applies outside of Sechtion 11. Much of the Omnicare decision has the potential to be equally applicable to other statutes requiring false or misleading misrepresentations or omissions.

Haynes Boone:

As for omissions and opinions under Section 11, because Omnicare’s inquiry focuses on the speaker’s “basis for offering the opinion,” the “foundation” a reasonable investor “would expect an issuer to have,” and “reading the statement fairly and in context,” there will be considerable room for future disagreement between the defense and shareholder plaintiffs’ bars.  Nevertheless, the confirmation that these alleged omissions must be pled with specificity and must be material to a reasonable investor is helpful to issuers.

After Omnicare, it seems likely that future Section 11 complaints involving opinions will be pled strategically under an omissions theory, not as direct misstatements (absent a “smoking gun”).  Companies preparing for an offering should pay close attention to any statement that may qualify as an opinion and carefully review the “hedges, disclaimers or qualifications” directly tied to that opinion in the registration statement.  The Supreme Court instructed that this “context” is critical to determining whether an omission is material and misleading.

Moreover, in instances where an issuer is faced with an internal diversity of views about an opinion, the crafting of the disclosure language is not the only critical step for the company and its counsel. How those diverse views are resolved and memorialized may be critical, should a Section 11 suit concerning that opinion reach the discovery phase.

Arnold & Porter:

While Omnicare involved filings made under the Securities Act of 1933 (registration statements),its reasoning may be instructive for other types of filings – whether statements are materially misleading or omit material facts is a common element of many other claims under the federal securities laws, including those that govern periodic filings.  As the Court wrote, “These principles are not unique to § 11: They inhere, too, in much common law respecting the tort of misrepresentation.

”An issuer’s statement of opinion will not result in liability solely on the basis that the opinion turned out to be incorrect.  Nor, however, are issuers immunized from potential liability because statements are couched as opinions rather than facts. As the Court indicated, there are no “magic words” such as “we believe” or “we think” that will foreclose liability in all circumstances.

The Court emphasized that the evaluation of particular disclosures “always depends on context.”   Accordingly, predicting how lower courts will apply the Court’s standard to particular disclosures may be difficult.  This may be especially true with respect to statements of opinion of the type at issue in Omnicare – i.e., opinions regarding legal compliance – made by companies that could face allegations under anti-kickback laws (such as pharmaceutical or medical device companies) or other laws that are ambiguous as to the lines between lawful and unlawful conduct (such as the Foreign Corrupt Practices Act).  It remains to be seen how lower courts will apply Omnicare, especially in the context of statements of opinion about compliance with complex regulatory statutory schemes where the lines are blurred.

Shearman & Sterling:

From the defense perspective, while the Court’s repudiation of the Sixth Circuit’s “objective falsity” standard for Section 11 material misstatement claims is an important victory, the Court’s omissions analysis could invite more Securities Act claims attacking statements of opinion. Issuers frequently offer statements of opinion concerning “inherently subjective and uncertain assessments,” including, for example, with respect to matters required by GAAP (such as goodwill calculations, reserves or loss contingencies). In the wake of Omnicare, an issuer cannot be confident that Section 11 challenges to such opinions will be subject to dismissal simply because the plaintiff is unable to adequately allege subjective falsity. Accordingly, issuers may need to consider, among other things, whether or the extent to which statements of opinion can or should be coupled with appropriate caveats (beyond those that inhere in the very nature of an opinion) or with an elucidation of the rationale or basis underlying the opinion. And with relatively little guidance from the Supreme Court on how to apply a context-specific standard, the outcomes in Section 11 cases challenging statements of opinion on an omission theory can be expected to vary depending upon the judge. Having said that, the Supreme Court’s admonition that going the omissions route will be “no small task for investors, ”and its seeming requirement of a tight and specifically pleaded nexus between the opinion and a truly important omitted fact regarding its basis, bear emphasis. Properly construed, we believe the Court’s decision should allow potential opinion liability based on omissions in a relatively narrow set of cases rather than open the floodgates to opinion-focused claims.

Lowenstein Sandler:

This week the United States Supreme Court issued a landmark opinion under the federal securities laws in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, ruling that investors can in some cases recover damages for losses even for statements couched as “opinions.”  The Court found that an issuer’s opinions in a registration statement filed in connection with a public offering can be rendered misleading by the issuer’s failure to disclose certain material facts.  The Supreme Court’s opinion effectively overrules the more narrow existing standard established by federal courts in New York, which have held that an issuer’s opinions in a registration statement are actionable only if the investor can prove that those opinions were both objectively false and the issuer did not believe them at the time they were expressed.

Fried Frank:

The Omnicare decision, while on its face a victory for the issuer and protective of opinion statements, will nonetheless open up new avenues for future litigation concerning the contours of omissions liability arising from statements of opinion. In the event that, in hindsight, an opinion turns out to have been untrue, plaintiffs’ lawyers will likely challenge whether the basis of the opinion was adequately disclosed.  Although Omnicare rests on the language of Section 11, plaintiffs may seek to apply Omnicare to claims arising under other provisions of the securities laws, including statements of opinion expressed in places other than registration statements.

Kink & Spaulding:

Omnicare leaves the door open to litigation about the omissions clause of Section 11, much of which will take place at the motion-to-dismiss stage.  The Court stressed that satisfying the applicable pleading burden will be “no small task” for plaintiffs, who cannot skate by with “conclusory assertions” or allegations “that the issuer failed to reveal [the] basis” for its opinion.  Instead, “[t]he investor must identify 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 omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.”

Lower courts can expect to spend long hours applying this new standard to the prolix complaints that are regularly filed when stock prices drop in the wake of bad news.  Public companies hoping to avoid getting caught up in that process might heed Omnicare’s advice that, “to avoid exposure for omissions under § 11, an issuer need only divulge an opinion’s basis, or else make clear the real tentativeness of its belief.”  Alternatively, they might “control what they have to disclose . . . by controlling what they say to the market,” in recognition of the fact that “[s]ilence, absent a duty to disclose, is not misleading.”  Such reluctance to opine could contribute to a deepened circuit split over whether a violation of Item 303 can form the basis of a claim under the federal securities laws.

Hogan Lovells:

Claims premised on an asserted untrue statement of fact. The Omnicare decision likely will have little impact on the volume of Section 11 claims premised on an opinion that allegedly was not honestly believed. Although not an issue addressed by the Supreme Court, circuit courts consistently have held that, because such claims sound in fraud, the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure apply to the claims. Accordingly, the trend in the plaintiffs’ bar, as illustrated by the pleading in the Omnicare case itself, is to disclaim any suggestion that the Section 11 claim is premised on a knowingly false statement. Because the Omnicare decision explicitly requires, for pleading a false statement of opinion, that the plaintiff allege a knowingly disbelieved opinion, which would have to meet the stringent pleading requirements for a fraud claim, we expect the plaintiffs’ bar to avoid making such claims absent exceptional circumstances.

Claims premised on an allegedly misleading opinion. The Omnicare decision is likely to result in more Section 11 claims premised on supposedly misleading opinion statements, and potentially in a greater number of Section 11 claims that survive at least an initial motion to dismiss.

The Omnicare decision dramatically alters the standards for reviewing Section 11 claims premised on opinions in those federal circuits, such as the Second Circuit and the Ninth Circuit, that had required plaintiffs to allege both that a statement of opinion was not only “objectively” false but also “subjectively” false in that it was disbelieved by the speaker. In those circuits, plaintiffs had to allege facts raising an inference of dishonesty, which often proved an insurmountable hurdle. That bulwark against Section 11 claims directed at opinions is now no longer available. Moreover, the question of what facts a “reasonable” investor might infer from an opinion – like the issue of what facts a “reasonable” investor might consider material – may prove notoriously fact-specific and not amenable to ready resolution on a motion to dismiss or for summary judgment. The Supreme Court suggested that its ruling would not likely open the floodgates to litigation because a plaintiff must still satisfy the “facial plausibility” pleading standard of Rule 8(a) of the Federal Rules of Civil Procedure and thus “identify 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 omission makes the opinion statement” misleading to a reasonable investor “reading the statement fairly and in context.”

We anticipate that, in many cases, distilling those factual inferences that a reasonable investor might draw from an opinion and assessing whether such inferences are negated or otherwise limited by the “broader frame” of other disclosures will lead to an extended exchange of motions before disposition of a claim. In addition, we expect that courts, assessing plaintiffs’ claims only for facial plausibility (the pleading standard under Rule 8(a)), will find the factual issues too intractable to resolve at an early stage.

Implications for preparing disclosure. The Supreme Court emphasized the importance of evaluating factual inferences that reasonable investors may draw from an opinion statement in the “broader frame.” This emphasis illustrates the importance of drafting registration statements to include, in the words of the Securities Act safe harbor for forward-looking statements, “meaningful cautionary statements identifying important facts that could cause actual results to differ materially from those” in an opinion. Disclosures that meaningfully “bespeak caution” to investors are likely to substantially thwart claims that an opinion was rendered materially misleading by the omission of facts concerning the basis for the issuer’s statement. Some issuers may choose to respond to Omnicare by adding disclosures about the bases for opinions. Doing so may create a new set of risks, so issuers should exercise care and use cautionary language to limit the chances that those disclosures themselves will become grounds for an omissions claim. Because many issuers incorporate by reference their periodic reports and other Exchange Act filings into their registration statements, we advise similar care in drafting those filings. We also recommend alerting disclosure committees and other persons who are involved in preparing SEC disclosures on the need for enhanced care in disclosing expressions of opinion in light of the standard of liability articulated by the Supreme Court in Omnicare.

Here are links to those and other law firm advisories or memos on the Omnicare decision:

Litigation Alert: The Supreme Court’s Omnicare Decision Clarifies When an Opinion Stated in a Registration Statement Can Give Rise to Section 11 Liability (Fenwick)
Supreme Court Clarifies Liability for Statements of Opinion in Registration Statements (Proskauer)
The Supreme Court rules on securities issuers’ liability for misleading statements of opinion (Robins Geller)
Supreme Court Decides When A Statement Of Opinion Can Trigger Section 11 Liability (Latham Watkins)
Supreme Court Limits, But Does Not Reject, Securities Liability for Statements of Opinion in Registration Statements (Linklaters)
Context, Reasons, Hedges, and Disclaimers: The Supreme Court’s Ruling in Omnicare May Shape Whether and How Companies Express Opinions (Morrison Foerster)
United States Supreme Court Limits Investor Suits for Misleading Statements of Opinion (Paul Weiss)
Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund: Liability for Opinions in Registration Statements (Sullivan Cromwell)
Supreme Court Decides Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (Faegre Baker Daniels)
U.S. Supreme Court Issues Long-Awaited Decision in Omnicare (Gibson Dunn)
Omnicare: Supreme Court Sets Liability Tests for Issuers’ Statements of Opinion in Public Offerings (Haynes Boone)
Legal Alert: Omnicare Opinion Expands Liability for Expressions of Opinion Under Section 11 (Sutherland Asbill)
U.S. Supreme Court Clarifies When Opinions Can Be Actionable Under Federal Securities Laws (Clifford Chance)
Supreme Court Clarifies Liability for Statements of Opinion Under Section 11 of the Securities Act (Arnold & Porter)
Supreme Court Opines on Opinions v. Facts in the Sale of Securities (Michael Best & Friedrich)
We’ll hold you to that: U.S. Supreme Court in Omnicare rules that even pure opinions can create strict Securities Act liability for some omissions (Nixon Peabody)
Supreme Court Sets Standard for Section 11 Opinion Statement Liability in Omnicare Ruling (Shearman & Sterling)
High Court Opens Courthouse Doors to New York Investors Harmed by False Statements Couched as Opinions in Registration Statements (Lowenstein Sandler)
High Court Announces New Standard for Opinion Statements (Akin Gump)
Everyone Has An Opinion: Supreme Court Clarifies When Opinions Create Securities Law Liability (Fried Frank)
U.S. Supreme Court’s Omnicare Decision Leaves Open Narrowed Theory Of Liability For Statements Of Opinion Under Federal Securities Laws (King & Spaulding)
Omnicare: Statements of Opinion, Omissions, and Implication (Sidley Austin)
Supreme Court Limits — But Does Not Foreclose — Section 11 Liability for Statements of Opinion, Leaving Investors With a Steep Climb (Chadbourne)
Supreme Court’s Omnicare Decision Muddies Section 11 Opinion Liability Standards (K&L Gates)
Omnicare and the “Reasonable Investor” Standard for Statements of Opinion (Baker Hostetler)
Supreme Court clarifies liability standard under Securities Act Section 11 for statements of opinion in registration statements (Hogan Lovells)
In Omnicare, Supreme Court Clarifies the Scope of Liability for Statements of Opinion Under Section 11 of the Securities Act of 1933 (Cleary Gottlieb)
Straight Arrow

March 25, 2015

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Omnicare: Supreme Court Shoots Down 6th Circuit, but Adopts Amorphous Standard for Section 11 Opinion Liability

Today, March 24, 2015, in its decision in Omnicare Inc. v. Laborers District Council Construction Industry Pensions Fund, No. 13-435, the Supreme Court gave short shrift to the Sixth Circuit’s expansion of liability under section 11 of the Securities Act of 1933 for statements of opinion in registration statements.  At the same time, the Court approved a dangerously amorphous theory of possible omissions liability for incomplete opinions — the failure to disclose facts related to those opinions — which gives little guidance to lower courts facing future such claims.  A copy of the Supreme Court decision is available here: Supreme Court Decision in Omnicare v. Laborers District Council Construction Industry Pensions Fund.  We previously discussed the flawed Sixth Circuit opinion here: Sixth Circuit Improperly Expanded Section 11 Liability for Non-Factual Statements in Omnicare.

The Sixth Circuit ruled that a section 11 action could be founded on allegations that the defendant’s statement in a registration statement that it believed it’s business activities were in compliance with the law was inaccurate, because aspects of those activities were alleged to be unlawful, even without allegations that company management did not genuinely believe the stated view.  The justices unanimously rejected this ruling, but they disagreed on a different theory: how to treat possible failures to disclose information about the factual underpinning for management’s opinion statements.  Although the lower courts never addressed that issue, Justice Kagan spent most of her opinion discussing the standard for considering such allegations, and remanded the case for consideration of that theory.  Justice Scalia disagreed with Kagan’s analysis of that issue in a concurring opinion.  Justice Thomas thought the issue should not have been addressed by the Court because it was not properly presented for review.

The unanimous Court quickly dealt with the error in the Sixth Circuit’s approach, effectively reiterating the standard in Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991), for pleading a claim based on a falsely stated opinion: that an opinion is not a fact, and there is no such claim based on allegations that the stated view was wrong, only on allegations that the opinion was not an accurate statement of the speaker’s actual views.

Justice Kagan described the two statements in the Omnicare registration statement alleged to be inaccurate as follows:

“[T]wo sentences in the registration statement expressed Omnicare’s view of its compliance with legal requirements:

  • ‘We believe our contract arrangements with other healthcare providers, our pharmaceutical suppliers and our pharmacy practices are in compliance with applicable federal and state laws.’
  • ‘We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements that bring value to the healthcare system and the patients that we serve.’”

Slip op. at 2-3.

She then noted that these were not statements of “hard facts,” but of “opinions.”  The Sixth Circuit concluded nonetheless that a claim could be stated based on allegations “that the stated belief was ‘objectively false’; they did not need to contend that anyone at Omnicare ‘disbelieved [the opinion] at the time it was expressed.’”  Slip op. at 4 (quoting 719 F.3d at 506).  In other words, “The Sixth Circuit held, and the Funds now urge, that a statement of opinion that is ultimately found incorrect—even if believed at the time made—may count as an ‘un-true statement of a material fact.’”  Slip op. at 6.  She then exlained that was fundamentally wrong:

But that argument wrongly conflates facts and opinions.  A fact is “a thing done or existing” or “[a]n actual happening.”  Webster’s New International Dictionary 782 (1927).  An opinion is “a belief[,] a view,” or a “sentiment which the mind forms of persons or things.” Id., at 1509.  Most important, a statement of fact (“the coffee is hot”) expresses certainty about a thing, whereas a statement of opinion (“I think the coffee is hot”) does not.  See ibid.  (“An opinion, in ordinary usage . . . does not imply . . . definiteness . . . or certainty”); 7 Oxford English Dictionary 151 (1933) (an opinion “rests[s] on grounds insufficient for complete demonstration”).  Indeed, that difference between the two is so ingrained in our everyday ways of speaking and thinking as to make resort to old dictionaries seem a mite silly.  And Congress effectively incorporated just that distinction in §11’s first part by exposing issuers to liability not for “untrue statement[s]” full stop (which would have included ones of opinion), but only for “untrue statement[s] of . . . fact.”  §77k(a) (emphasis added).

Slip op. at 6.

She explained that section 11’s false-statement provision could still apply to expressions of opinion because “every such statement explicitly affirms one fact: that the speaker actually holds the stated belief.”  But the Omnicare plaintiffs “do not contest that Omnicare’s opinion was honestly held.”  They expressly stated they are not alleging “fraud or deception” (presumably in order to avoid strict pleading requirements for fraud).  Instead, they claim “that Omnicare’s belief turned out to be wrong—that whatever the company thought, it was in fact violating” the laws.  That allegation does not give rise to liability under §11 because “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong.”  Slip op. at 9.  “In other words, the provision is not . . . an invitation to Monday morning quarterback an issuer’s opinions.” Id.

Having straightforwardly rejected the theory accepted below, Justice Kagan went on to address another potential theory not discussed below – possible liability based on omissions of material facts from the registration statement related to the basis for the statements of opinion that were themselves unactionable: “the Funds also rely on §11’s omissions provision, alleging that Omnicare ‘omitted to state facts necessary’ to make its opinion on legal compliance ‘not misleading’.”  Slip op. at 10.  She rejected Omnicare’s argument that the statement of an opinion could not give rise to liability for omitting facts related to the opinions, “because a reasonable investor may, depending on the circumstances, 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.  And if the real facts are otherwise, but not provided, the opinion statement will mislead its audience.”  Slip op. at 11.

She expands on that theory, explaining that a statement of legal opinion could carry with it the implication that there is some underlying legal analysis to support it. If there was no such analysis, or if the statement is made with knowledge of reliable contrary positions taken by the government, a reasonable investor could be misled by the failure to include those facts.  “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.”  Slip op. at 12.  Thus, even if a CEO gives a genuine opinion on an issue, if that opinion is held without having considered matters a reasonable investor would expect to be considered, and that fact is not disclosed, there might be liability: “The CEO may still honestly believe in her [opinion].  But under §11’s omissions provision, that subjective belief, in the absence of the expected inquiry or in the face of known contradictory evidence, would not insulate her from liability.”  Slip op. at 12 n.6.

Realizing that she had just crafted a huge hole in the rule that there is no liability for opinion statements, Justice Kagan went on to explain that there have to be really strong allegations to support the contention that important facts about the basis for the opinion were misleadingly omitted:

An opinion statement, however, is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way.  Reasonable investors understand that opinions sometimes rest on a weighing of competing facts; indeed, the presence of such facts is one reason why an issuer may frame a statement as an opinion, thus conveying uncertainty….  Suppose, for example, that in stating an opinion about legal compliance, the issuer did not disclose that a single junior attorney expressed doubt s about a practice’s legality, when six of his more senior colleagues gave a stamp of approval. That omission would not make the statement of opinion misleading, even if the minority position ultimately proved correct: A reasonable investor does not expect that every fact known to an issuer supports its opinion statement.

Slip op. at 13.

Whether “an omission makes an expression of opinion misleading always depends on context.”  Id. at 14.  For example, in the context of a formal registration statement filed with the SEC, reasonable investors “do not, and are right not to, expect opinions contained in those statements to reflect baseless, off the-cuff judgments, of the kind that an individual might communicate in daily life.  At the same time, an investor reads each statement within such a document, whether of fact or of opinion, in light of all its surrounding text, including hedges, disclaimers, and apparently conflicting information.”  Id.

Having just invoked a standard based on amorphous and uncertain assumptions about what a “reasonable investor” would “expect” or “understand” in a particular context (and not explaining in any way how a lower court is supposed to divine such things), the opinion swings back in the other direction, purporting to explain how difficult it would be to meet that standard:

As we have explained, an investor cannot state a claim by alleging only that an opinion was wrong; the complaint must as well call into question the issuer’s basis for offering the opinion….  And to do so, the investor cannot just say that the issuer failed to reveal its basis. Section 11’s omissions clause, after all, is not a general disclosure requirement; it affords a cause of action only when an issuer’s failure to include a material fact has rendered a published statement misleading.  To press such a claim, an investor must allege that kind of omission—and not merely by means of conclusory assertions.… T o be specific: The investor must identify 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—those omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context….  That is no small task for an investor.

Slip op. at 17-18.

The opinion concludes with unusually explicit instructions on how the lower Omnicare courts should apply the omissions theory in the context of the claim against Omnicare.  That may suffice to provide guidance in this case, but one wonders how it helps courts in other cases faced with inevitable efforts by plaintiffs’ lawyers to plead section 11 cases founded on Justice Kagan’s somewhat inscrutable “incomplete opinions” omissions theory.

Justice Scalia’s concurring opinion explains in some detail why he believes Justice Kagan’s approach misstates and misapplies the law of liability for opinion statements, and is worth reading for that. The Kagan opinion stating liability for what might be called “incomplete opinions” is, however, now the law of the land.

So where does the Kagan opinion leave us in these cases?  It certainly rejects theories of section 11 liability based on allegations that opinion statements were objectively wrong.  But at the same time it opens the door for claims based on “incomplete opinions” — allegations that opinion statements were misleadingly incomplete because they failed to discuss underlying facts that reasonable investors would expect, which might alter how they interpret those opinions.

Despite Justice Kagan’s efforts to explain that the bar for such claims is high enough to make it “no small task for an investor,” lower courts are left largely adrift on how to apply this standard in real future cases.  How are they to decide on motions to dismiss what investors would expect in the particular context alleged?  How demanding should the courts be to have complaints that lay out strong factual grounds supporting the contention that there were undisclosed related facts that seriously limit the value or meaning of stated opinions?  To what extent will liability be created for statements now considered to be unactionable “soft information,” including future predictions, based on allegations that undisclosed facts about the basis for those opinions would alter investor interpretations of those statements?  To what extent will Justice Kagan’s exhortations for “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” be treated by lower courts as trumping the normal pleading standards for section 11 claims?

Until these questions are answered in district court and appellate court decisions, issuers and management would be wise to limit opinion statements to the bare minimum, and to have reliable analysis in hand to support the ones that are given.  The scope of potential liability for “incomplete opinions” may remain unclear for some time into the future.

Straight Arrow

March 24, 2015

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4th Circuit Finds Section 10(b) Scienter Allegations Sufficient with No Motive in Zak v. Chelsea Therapeutics

In Zak v. Chelsea Therapeutics Int’l, No. 13-2370, a split Fourth Circuit panel found allegations of securities fraud sufficient in a putative section 10(b) class action.  The district court dismissed the complaint for failing to make allegations sufficient to support a strong inference of scienter under the Private Securities Litigation Reform Act (PSLRA) standard.  The majority of the panel reversed, despite an apparent lack of facts showing any real objective for the alleged fraud.  The opinion is available here: Zak v. Chelsea Therapeutics Intl.

The case involved a now-common fact situation in securities class actions against pharmaceutical companies.  Chelsea was trying to gain approval for a drug treatment for “symptomatic neurogenic orthostatic hypotension,” which is “a condition in which a dramatic drop in blood pressure occurs when a person stands.”  During the course of testing for the efficacy of the drug, Chelsea executives expressed optimism about how the tests were going, and for the prospect of getting the drug approved by the FDA.  At the same time, the actual testing showed mixed results.  One trial was successful and others were inconclusive.  All of the trial results were disclosed, however.  A meeting with FDA officials was also inconclusive — they indicated that the application for the drug could move forward on the basis of the one study, which was short-term, but that it was an obstacle to approval that other studies had not shown the drug’s efficacy over a longer period.  Management optimistically described this conversation as the officials agreeing that the application could move forward on the basis of the one successful trial.

There were other instances of management expressing overly-optimistic views on the approval of the drug, without also acknowledging that there were serious obstacles.  One of these included the contents of an FDA staff report.  Management received this report, in which a staffer recommended that the drug not be approved, 8 days before it was publicly disclosed.  The company’s published description of the report said it raised questions about the sufficiency of the support for approval of the drug, but failed to state that the staffer recommended against approval.  The stock price nevertheless declined 38%.  The press release also provided the web address to obtain to actual report when it was released by the FDA, which occurred 8 days later.  At that time, the stock price declined an additional 21%.

Three days later, an FDA advisory committee recommended approval of the drug in a non-binding recommendation.  The FDA itself, however, ultimately declined to approve the drug a little over a month later.

One interesting aspect of the case is the district court’s use of Chelsea’s public SEC filings in its consideration of whether these facts adequately pled scienter under the PSLRA.  The defendants submitted SEC proxy and Form 4 filings to show that there was no evidence that management or directors tried to take advantage of any arguably misleading statements by cashing out their stock.  Although the complaint did not plead insider stock sales as a motive for the fraud, the court took judicial notice of the SEC filings and based its decision in part on the lack of evidence of efforts to profit on any of the alleged misrepresentations or omissions in the complaint.

The entire 4th Circuit panel agreed that this was improper.  The opinion acknowledges the commonly accepted rule that on a motion to dismiss, the court can consider materials outside of the complaint if they are incorporated by reference or implicated by the allegations in the complaint.  But, since insider stock trading was never alleged in the complaint, it found judicial notice of materials addressed to that issue was improper.

The majority of the panel went on the conclude that the allegations of repeatedly optimistic statements about the drug approval process which left out key developments suggesting approval was in doubt were enough to support the required strong inference of scienter.  Two things are important about this.  First, it comes from the 4th Circuit, which rarely sees a class action complaint it thinks is sufficient.  Second, it allows a complaint to proceed on the basis of a fraud which, at least from the descriptions in the opinion, shows absolutely to motivation for committing the alleged fraud.  Usually, fraudulent misrepresentations or omissions are part of an effort to obtain some advantage from the misleading disclosures.  Here, there is no such apparent motive.  That may be why the district court went beyond the complaint to the trading data.  Surely a fraud must have an objective — but none is apparent here.  This is especially so as to the most troublesome of the alleged misleading disclosures: the misleading description of the staff report about possible approval of the drug.  Since the report itself was going to be published about a week after the company’s press release about it, and the press release provided the web address for someone to read the actual report one week later, what is the purported object of a fraudulent description of that document, which would last only a week.  There appears to be none, since no action during that period suggests an effort to take advantage of the misleading disclosure.

Perhaps this goes more to the issue of materiality than scienter, which, as we have seen before, can be interrelated (see 1st Circuit: Scienter Not Alleged Where Materiality Is Questionable and Regulatory Violations Remain in Doubt).  But it would seem to encompass both; how do you find a strong inference of intent to defraud in the absence of any apparent motive?

Dissenting Judge Thacker certainly had problems with finding fraudulent conduct alleged here.  He reminded the court that even if recklessness can be sufficient to support scienter — and he reiterated that the Supreme Court still has not accepted that theory (slip op. at 33 n.2) — in the 4th Circuit i”we insist that the recklessness must be ‘severe’ — that is, ‘a slightly lesser species of intentional misconduct.'”  Slip op. at 35.  He argued that the company’s statements were not “literally” inaccurate, and there was enough support for management to express an optimistic view without committing fraud.  He concluded : “Today’s decision clears the way for more litigation, heightening the risk that shareholders will exploit the judicial process to extract settlements from corporations they chose to fund. This is exactly what Congress sought to prevent when it enacted the PSLRA.”  Slip op. at 43.

This case is a very close call.  Based on the fact descriptions in the opinion, it looks like management erred on the side of optimism, and may have elevated wish above reality, putting the best light on everything while hoping for approval of the drug.  It should give us pause on the fraud issue that the advisory committee actually did recommend approval of the drug, even with the alleged shortcomings of the trial studies.  In the end, it is the absence of any apparent planned gain or advantage from the alleged misleading disclosures that suggests to me that whatever happened here, intentional fraud was not what it was about, especially under the high scienter pleading standard of the PSLRA.

In any event, the class plaintiffs seem to have some serious uphill fighting on the materiality front.

Straight Arrow

March 17, 2015

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Update on Status of Proposed Settlement in Gordon v. Verizon Communications, Inc.

I’ve noticed a number of searches seeking further information on the status of the case Gordon v. Verizon Communications, Inc., Index No. 653084/2013, pending before Judge Melvin Schweitzer in the New York Supreme Court, New York County.  This is a putative class action challenging the acquisition by Verizon of Vodafone’s 45% minority stake in Verizon Wireless for $130 billion.  We previously discussed the objections lodged to a proposed settlement in that action, and Judge Schweitzer’s rejection of the settlement, in this post: Commentary on Abusive State Law Actions Following M&A Deals.  That was followed by a post on a scathing judicial statement on the impropriety of such “merger tax” cases (NY Court Flexes Muscles in Rejecting Bogus “Merger Tax” Settlement), which discussed a New York judge’s rejection of a proposed settlement in another knee-jerk merger challenge in the case City Trading Fund v. Nye, No. 651668/2014 (NY Sup. Ct.).  I recently received a note asking about where things stand in Gordon v. Verizon Communications, so here is an update.

The December 2014 opinion rejecting the settlement in Gordon (which can be found here: Decision and Order in Gordon v. Verizon Communications) was followed by the following:

  1.   One of the objectors, New York attorney Gerald Walpin, filed a motion for summary judgment on January 6, 2015, asking that the judge dismiss the plaintiff’s claim with prejudice.  The filing in support of that motion can be found here.  The plaintiff opposed that motion, in papers that can be found here.  Mr. Walpin filed this reply brief in favor of the summary judgment motion.  The briefing on that motion appears to have been completed on January 24, 2015.
  2.   The plaintiff then did two things: (i) on January 21, 2015, she filed a notice of appeal of the decision denying approval of the settlement (the notice of appeal can be found here); and (ii) on February 3, 2105, she filed a motion for reconsideration and reargument of the motion for approval of the settlement (the brief in support of the motion for reconsideration can be found here).  In other words, the plaintiff filed an appeal of the decision and then afterward asked that the same decision be reconsidered.  These are mutually inconsistent steps.  If the decision is appealed, the lower court loses jurisdiction over it and no longer can consider a reconsideration motion.  On the other hand, if a timely motion for reconsideration is filed, the earlier decision cannot properly be appealed until that motion is acted upon.  Filing the reconsideration motion after the notice of appeal might well be sanctionable.  The appeal seems flawed in any event because normally an appeal cannot occur before a case is finally decided.  Since Judge Schweitzer only denied a motion to approve the settlement, leaving the underlying case still pending in his court, there would appear to be no decision by him that is immediately appealable, absent a special order allowing an interlocutory appeal to occur.  The oppositions to the motion for reconsideration and reargument by the two objectors can be found here (opposition by Mr. Walpin), and here (opposition by objector Jonathan Crist).  Plaintiff’s reply brief in support of the motion for reargument is here.
  3.   As far as I can tell, no further action has occurred on either the motion for summary judgment or the motion for reconsideration of the denial of the settlement.  They each appear to be fully briefed.  Until some further action occurs, the proposed settlement is rejected and the case remains pending.

For those interested in the case, and in particular in the hearing held by Judge Schweitzer to consider the proposed settlement, a copy of the transcript of that hearing is available here:  Transcript of December 2, 2014 Hearing in Gordon v. Verizon Communications, Inc. on the motion for approval of proposed settlement.

Straight Arrow

March 2, 2015

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1st Circuit: Scienter Not Alleged Where Materiality Is Questionable and Regulatory Violations Remain in Doubt

The recent First Circuit decision in Fire and Police Pension Ass’n v. Abiomed, Inc., No. 14-1502, is noteworthy for its unusual mix of scienter and materiality analysis to affirm dismissal of a section 10(b) securities class action.  Ultimately, the court affirmed dismissal for the lack of sufficient scienter allegations under the heightened pleading standard of the Private Litigation Securities Reform Act (PSLRA), but it was the court’s mixing of scienter and materiality considerations that provokes interest.  The court also made it clear that a securities fraud claim cannot be based on an alleged failure to disclose misconduct while the resolution of the matters at issue with regulators remain uncertain.  A copy of the opinion is available here: Fire and Police Pension Ass’n v. Abiomed Inc.

The claims were founded on allegations that Abiomed, Inc., which sells medical devices, made misrepresentations about the Impella 2.5, a micro heart pump, which was Abiomed’s most important product. The alleged misrepresentations and omissions related to interactions between Abiomed and the FDA regarding marketing used to promote the Impella 2.5, and the possible promotion of off “off-label” uses of the device, that is, uses for purposes beyond those approved by the FDA.

The gist of the complaint was that Abiomed failed to disclose in its SEC filings several FDA communications warning about possible marketing and advertising improprieties, and failed to disclose that its revenues from the sales of that device were achieved in violation of FDA rules.  After ongoing communications between Abiomed and the FDA in 2010-2012, two things occurred.  In November 2012, Abiomed disclosed that federal prosecutors were investigating Abiomed’s promotional and marketing practices and published revised revenue projections, which was followed by a significant decline in stock price.  And in February 2013, the FDA gave Abiomed a “Close-Out Letter” stating its concerns had been adequately addressed by the company, and afterward, the stock price recovered its earlier losses.

The court noted that although it was “far from clear” that “plaintiffs plausibly alleged that “defendants made false or misleading statements which had a material effect on Abiomed’s stock price,” it was affirming the district court’s ruling that the plaintiffs did not sufficiently allege that defendants made those statements with a “conscious intent to defraud or ‘a high degree of recklessness.’”  Slip op. at 4 (quoting ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 58 (1st Cir. 2008)).

 The court’s consideration of the materiality of the alleged misstatements played a significant role in its scienter analysis. The court wrote:

We do address the strength of the materiality of the statements because “[t]he question of whether a plaintiff has pled facts supporting a strong inference of scienter has an obvious connection to the question of the extent to which the omitted information is material.” . . .   “If it is questionable whether a fact is material or its materiality is marginal, that tends to undercut the argument that defendants acted with the requisite intent or extreme recklessness in not disclosing the fact.” . . . The materiality of the impugned omission here — Abiomed’s failure to state that some of the increased revenues were due to off-label marketing — is marginal at best. Plaintiffs’ contention that the omission would have mattered to a reasonable investor depends on a long chain of inferences, most of which are not sufficiently substantiated by the allegations in the complaint.

Slip op. at 29 (citations omitted).  The court also took note that Abiomed’s disclosures explicitly warned about the FDA’s marketing concerns, including disclosures that concerns raised in FDA Warning Letters could have serious consequences.  Id. at 31-32.

Defense counsel should take particular note of the court’s response to the allegation that “Abiomed should have affirmatively admitted widespread wrongdoing rather than stating that the outcome of its regulatory back-and-forth with the FDA was uncertain.”  Slip op. at 32.  Class action complaints often allege fraud based on a failure to disclose that matters involving regulatory uncertainty (or other uncertainties) should have been disclosed as company shortcomings.  But the court here correctly noted that this approach would improperly mandate potentially misleading disclosures of uncertain future events:

That would be a perverse result; such an admission would have been misleading, since the off-label marketing issues had the potential to be resolved with no adverse action from the FDA.  We made a similar point in In re Boston Scientific Corp. Securities Litigation, 686 F.3d 21 (1st Cir. 2012), where we noted that “a company may behave ‘irresponsibly’ if it issues an ominous warning about an uncertain risk that ‘had not yet been adequately investigated.’” Id. at 31. … There must be some room for give and take between a regulated entity and its regulator.

 Id. at 32-33.

The opinion also addresses allegations of statements by so-called “confidential witnesses,” whose statements about the company’s operations did not support scienter because the alleged roles of these persons did not put them in a position to provide information about the knowledge and intent of company management. See id. at 35-36.  The court likewise found allegations of stock sales by insiders insufficient to support scienter because the facts alleged did not show unusual or suspicious trading. See id. at 36-38.

But the two key takeaways from this opinion are: (1) that even without showing alleged misrepresentations were immaterial as a matter of law – which is often tough on a motion to dismiss – defendants can use doubts about materiality to support arguments that scienter is not sufficiently supported under the PSLRA standard; and (2) that allegations of failure to disclose regulatory concerns fall short of fraud when the matters are being actively discussed with law enforcement authorities and it remains uncertain whether they can be resolved without any enforcement action.

Straight Arrow

January 12, 2005

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