From Sea to Shining Sea: The Ninth Circuit Aligns with the Second Circuit in Affirming “Omnicare” Decision’s Benefits for Securities-Suit Targets

Others (including these authors, here and here) viewed Omnicare as a significant victory for the defense bar for two primary reasons. First, the Court made clear that an opinion is false only if it was not genuinely believed by the speaker at the time that it was expressed, a concept sometimes referred to as “subjective falsity.” Second, Omnicare declared that whether a statement of opinion (and by clear implication, a statement of fact) was misleading “always depends on context.” Misleadingness is not a new basis for liability, but a concept that has long been embedded in the federal securities laws. The Court emphasized that showing a statement to be misleading is “no small task” for plaintiffs, and that the Court must consider not only the full challenged statement and the context in which it was made, but also other statements made by the company, as well as other publicly available information, including the customs and practices of the relevant industry. The Ninth Circuit’s recent Align decision, building upon the Second Circuit’s 2016 Sanofi decision, goes a long way to proving the doubters wrong.

In Sanofi, the Second Circuit emphasized both the Supreme Court’s ruling on falsity and the intensive contextual analysis required to show that a statement is misleading. Statements about Lemtrada, a drug being developed by Sanofi for treatment of multiple sclerosis, were at issue in the case. The plaintiffs alleged that Sanofi’s failure to disclose the Food and Drug Administration’s (FDA) repeated warnings that a single-blind study might not be adequate for approval caused various statements made by the company to be misleading—including its projection that FDA would approve the drug, its expressions of confidence about the anticipated launch date of the drug, and its view that the results of the clinical trials were “unprecedented” and “nothing short of stunning.”

The Second Circuit stated that it saw “no reason to disturb the conclusions of the district court” (which had dismissed the case), but wrote to clarify the impact of Omnicare on prior Second Circuit law. Sanofi, 816 F.3d at 209. The Second Circuit highlighted the Omnicare Court’s focus on context, taking note of its statement that “an omission that renders misleading a statement of opinion when viewed in a vacuum may not do so once that statement is considered, as is appropriate, in a broader frame.” Id. at 210. Since Sanofi’s offering materials “made numerous caveats to the reliability of the projections,” id. at 211, a reasonable investor would have considered the opinions in light of those qualifications. Similarly, the Second Circuit recognized that reasonable investors would be aware that Sanofi would be engaging in continuous dialogue with FDA that was not being disclosed, that Sanofi had clearly disclosed that it was conducting single-blind trials for Lemtrada, and that FDA had generally made clear through public statements that it preferred double-blind trials to single-blind trials. In this broader context, the court found that Sanofi’s optimistic statements about the future of Lemtrada were not misleading even in the context of Sanofi’s failure to disclose FDA’s specific warnings regarding single-blind trials.

Under the Omnicare standards, the Second Circuit thus found nothing false or misleading about the challenged statements, holding that Omnicare imposes no obligation to disclose facts merely because they tend to undermine the defendants’ optimistic projections. In particular, the Second Circuit found that “Omnicare does not impose liability merely because an issuer failed to disclose information that ran counter to an opinion expressed in a registration statement.” Id. at 212. It also reasoned that “defendants’ statements about the effectiveness of [the drug] cannot be misleading merely because the FDA disagreed with the conclusion—so long as Defendants conducted a ‘meaningful’ inquiry and in fact held that view, the statements did not mislead in a manner that is actionable.” Id. at 214.

The Ninth Circuit’s Align opinion builds nicely upon Sanofi. The Align litigation arose from Align’s $187.6 million acquisition of Cadent Holdings, Inc. in April 2011, and Align’s alleged failure to properly assess and write off the goodwill associated with the acquisition. Align’s statements regarding the fair value of goodwill, of course, were quintessential statements of opinion, because they were inherently subjective.

Align’s accounting for the acquisition resulted in $135.5 million of goodwill, $76.9 million of which was attributable to one of Cadent’s business units (the “SCCS unit”). The plaintiffs alleged that the purchase price, and thus the goodwill, was inflated due to Cadent’s channel stuffing practices prior to the acquisition, and that the defendants must have known as much after performing their due diligence. Following the acquisition, the SCCS unit’s financial results suffered due to numerous factors. Nevertheless, at the end of 2011, Align found no impairment of its recorded goodwill. Align did not perform any interim goodwill testing in the first or second quarters of 2012. Align, 2017 WL 1753276, at *2-3.

On October 17, 2012, Align finally announced it would be conducting an interim goodwill impairment test for the SCCS unit, which it said was triggered by the unit’s poor financial performance in the third quarter of 2012 and the termination of a distribution deal in Europe. That announcement led to a 20% hit to Align’s stock price. On November 9, 2012, Align announced a goodwill impairment charge of $24.7 million, and it announced subsequent goodwill charges in the following two quarters. Id. at *3. The plaintiffs alleged that the defendants made seven false and misleading statements concerning the goodwill valuation between January 30, 2012 and August 2, 2012. The plaintiffs’ allegation was that defendants deliberately overvalued the SCCS goodwill, thereby injecting falsity into statements concerning the goodwill estimates and the related financial statements. Id. at *4. The district court dismissed the complaint with prejudice for failing to adequately plead falsity and scienter. Id. at *4.

At issue in the Ninth Circuit was whether the plaintiffs had adequately pled that Align’s statements were false. The first question was what analytic framework applied, which depended in turn on whether the statements at issue conveyed facts or opinions. The plaintiffs did not dispute that five of the seven statements at issue were pure statements of opinion. However, with respect to two statements, the plaintiff alleged the opinions contained “embedded statements of fact.” Those statements were that “there were no facts and circumstances that indicated that the fair value of the reporting units may be less than their current carrying amount,” and that “no impairment needed to be recorded as the fair value of our reporting units were significantly in excess of the carrying value.” The court held that the former statement was an opinion with an embedded statement of fact, but that the latter was a pure opinion. Id. at *5.

The court next addressed the proper pleading standard for falsity of opinion statements. It concluded that Omnicare established three different standards, depending on the nature of the plaintiff’s theory:

1. Material misrepresentation: Plaintiffs must allege both subjective and objective falsity, i.e., that the speaker both did not hold the belief she professed, and that the belief was objectively untrue.
2. Materially misleading statement of fact embedded in an opinion statement: Plaintiffs must allege that the embedded fact is untrue.
3. Misleading opinion due to an omission of fact: Plaintiffs must allege that facts forming the basis for the issuer’s opinion, the omission of which makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context, were not disclosed.

The court thus overruled part of its previous holding in Miller v. Gammie, 335 F.3d 889, 900 (9th Cir. 2003) (en banc), which had allowed for pleading falsity by alleging that there was “no reasonable basis for the belief” under a material misrepresentation theory. Following Omnicare, the “reasonable basis” test is no longer a viable means of determining whether a statement of opinion is false. Align, 2017 WL 1753276, at *7.

Applying this pleading standard to the Align facts, the Ninth Circuit concluded that the plaintiffs had not met their pleading burden. Because the plaintiffs did not allege the actual assumptions the defendants relied upon in conducting their goodwill analysis, the court could not infer that the defendants intentionally disregarded the relevant events and circumstances. Accordingly, six of the seven statements that relied on the material misrepresentation theory failed to allege subjective falsity and were properly dismissed. Likewise, the failure to allege the actual assumptions used by the defendants prevented plaintiffs from pleading objective falsity as to the one statement of fact embedded in an opinion statement. Align, 2017 WL 1753276, at *8-10.

After concluding that the plaintiffs failed to allege falsity, the Ninth Circuit went on to hold that they had also failed to allege scienter, providing an additional ground for dismissing the complaint.* At most, the plaintiffs alleged that the defendants violated generally accepted accounting principles—but such a violation, even if it did occur, does not establish scienter. Likewise, the allegations concerning stock sales, the core operations inference, the temporal proximity between the challenged statements and the goodwill write-downs, the CFO’s resignation, and the magnitude of the goodwill write-downs did not create an inference of scienter. Id. at *10-13.

The Ninth Circuit’s Align decision has built on the Second Circuit’s Sanofi decision in another important way. Omnicare was a Section 11 case, thus nominally leaving open the question of its applicability to Section 10(b) cases, despite the element at issue in Omnicare—namely, a false or misleading statement—being the same in Section 11 and Section 10(b) claims. The Second Circuit in Sanofi was the first appellate court to explicitly apply Omnicare to Section 10(b) cases. See Sanofi, 816 F.3d at 209-10. The Ninth Circuit aligned itself with the Second Circuit in applying Omnicare to Section 10(b) cases. Align, 2017 WL 1753276, at *7.

Another open question following Omnicare was what kinds of statements of opinion would be included in Omnicare’s paradigm. Align helped answer that question with respect to one important category of opinions: accounting reserves. In an important pre-Omnicare case, the Second Circuit in Fait v. Regions Fin. Corp., 655 F.3d 105 (2d Cir. 2011), held that goodwill and loan-loss reserves were statements of opinion that could not be challenged absent allegations of subjective falsity. The Align decision, applying Omnicare, came to the same conclusion in assessing Align’s statements regarding its goodwill reserves. This is an important holding for companies and their accountants because it allows them to make difficult estimates regarding complex accounting reserves without concern that their good faith efforts will later be second-guessed, subjecting them to securities-fraud liability.

The Ninth Circuit’s Align decision should be viewed as another important opinion cementing the critical importance of Omnicare for securities-fraud defendants. First, and most important, the Ninth Circuit correctly applied Omnicare’s core principle of subjective falsity, and heeded the Court’s mandate to assess the challenged statements in their proper context in evaluating whether they are misleading. Second, Align’s holding applying Omnicare to Section 10(b) cases, joining the Second Circuit in Sanofi, solidifies Omnicare’s applicability to a much broader array of cases. Finally, Align should give some peace of mind to companies and their accountants that their good-faith accounting estimates and reserves will not subject them to excessive liability.

*Judge Kleinfeld concurred in the judgment. He would have upheld the district court’s dismissal based on scienter alone, leaving the weightier issue of falsity described above to a future case where such a decision was, in his view, necessary. Id. at *13-14 (Kleinfeld, J., concurring in the judgment).