By Doug Greene, Ivory L. Bishop, Jr., Genevieve York-Erwin, and Albert Lin, BakerHostetler. Mr. Greene is a Partner in the New York, NY and Seattle, WA offices and leads the firm’s Securities and Governance Litigation Team. Mr. Bishop is an Associate in the New York, NY office. Ms. York-Erwin is an Associate in the Seattle, WA office. Mr. Lin is Counsel in the Columbus, OH office.
Statements of opinion are ubiquitous in corporate communications. Corporations and their officers routinely share subjective judgments on issues as diverse as asset valuations, strength of current performance, risk assessments, product quality, loss reserves, and progress toward corporate goals. Many of these opinions are crucial to investors, providing them with unique information and insight. Yet, for decades, the law governing evaluation of opinions was a tangle, with inconsistent standards that didn’t allow executives to voice truthful opinions with confidence that they wouldn’t be unfairly second-guessed.
Five years ago last month, the Supreme Court’s landmark decision in Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 135 S. Ct. 1318 (2015), established clear standards for evaluating opinions. The Court held that a statement of opinion is only false under the federal securities laws if the speaker does not genuinely believe it, and is only misleading if it omits information that, in its full factual context, would cause the statement to mislead a reasonable investor. Omnicare improved securities law—and in our view is the most important Supreme Court securities decision since Basic v. Levinson, 485 U.S. 224 (1988)—for two reasons:
First, the Court made clear that an opinion is false only if it was not sincerely believed by the speaker at the time that it was expressed, a concept sometimes referred to as “subjective falsity.” The Court thus explicitly rejected the possibility that a statement of opinion could be false because “external facts show the opinion to be incorrect,” because a company failed to “disclose some fact cutting the other way,” or because the company did not disclose that others disagreed with its opinion. This ruling resolved two decades’ worth of confusing and conflicting case law on what makes a statement of opinion false.
Second, Omnicare declared that whether a statement of opinion—and by clear implication, a statement of fact—was misleading “always depends on context.” The Court emphasized that showing a statement to be misleading under this full-context rule is “no small task” for plaintiffs, and that the Court must consider not only the full statement being challenged and the context in which it was made, but also other statements made by the company, and other publicly available information, including the customs and practices of the relevant industry. Combined with the Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) —which held that courts must weigh fraudulent and nonfraudulent inferences from the complaint, documents incorporated by reference, and judicially noticeable documents—Omnicare confirms that courts must evaluate the full record of relevant publicly available information on a motion to dismiss to satisfy the pleading requirements under federal securities laws.
Omnicare thus has given the defense bar powerful tools to win dismissal of securities class actions. Which tools have we used well? And which tools are collecting dust?
Tools We Have Used Well
Application to Section 10(b)
Although Omnicare arose under Section 11 of the Securities Act of 1933, in our Omnicare amicus brief,1 we argued on behalf of Washington Legal Foundation that the standard for judging an opinion false or misleading should apply to Section 10(b) claims under the Securities Exchange Act of 1934 since the falsity element under both statutes is the same.2 Lower courts agree. The Second Circuit was the first to do so, in Tongue v. Sanofi,3 and the Ninth Circuit followed suit in City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc.4 Four other circuits and numerous districts courts across the country have likewise applied Omnicare to Section 10(b) claims.5
While ubiquitous use of Omnicare is critical, skilled use of the decision in Section 11 cases would yield game-changing results. We applaud the Delaware Supreme Court’s ruling in Sciabacucchi v. Salzberg,6 and hope Congress ultimately eliminates state jurisdiction of securities class actions, but winning more cases on the merits would make the biggest difference, by far.7
Omnicare plays an increasingly important role in securities class actions alleging false accounting and related statements, such as certifications of financial statements and internal controls. Although accounting entries may seem like objective facts, and plaintiffs argue that a restatement is an “admission” of falsity, courts have held that many are statements of opinion to which Omnicare applies.
The Second and Ninth Circuits have led the way. In Align, the company took a goodwill impairment charge. Applying Omnicare, the Ninth Circuit found that Align’s previous goodwill accounting and related statements were not false or misleading.8 In the Second Circuit, courts have continued to follow the pre-Omnicare decision in Fait v. Regions Fin. Corp.9 Recently, in In re AmTrust Fin. Servs., Inc. Sec. Litig.,10 Judge Kaplan applied Omnicare to restated financial statements in a thorough analysis that warrants detailed discussion.
In AmTrust, the plaintiffs brought suit after the defendant restated a number of its prior year financial statements based on several “errors” it identified and disclosed concerning warranty contract revenue recognition and how and when certain bonuses were expensed. The plaintiffs argued that the restatement of these financial metrics established that the financial statements were materially false and misleading when made and sought recovery on that basis under Sections 11 and 12(a) of the Securities Act and Section 10(b) of the Exchange Act. The court rejected this simplistic assertion, finding that whether a particular restated financial metric constituted a statement of fact or opinion depended on the nature of its underlying accounting treatment(s):
Nearly all of the alleged misstatements concern at bottom financial data presented in the company’s consolidated financial statements and the accounting principles applied to produce or arrive at that data. . . . [T]his financial data – e.g., reported income – allegedly was false or misleading because of the accounting treatment applied to certain underlying metrics. It is the accounting treatment that plaintiffs contend was erroneous and thus resulted in a false or misleading number – reported income – on the financial statements.11
Thus, the court carefully analyzed the facts and circumstances of the seven accounting treatments at issue to determine whether each was fact or opinion.12
Ultimately the AmTrust court determined that all seven accounting treatments involved significant, subjective judgment calls that rendered the resulting financial metrics statements of opinion rather than fact.13 And because the plaintiffs failed to plead facts sufficient to indicate that defendants either (1) knew at the time, or recklessly disregarded, that these accounting treatments were wrong, or (2) failed to conduct a meaningful inquiry into the proper way to handle the particular accounting treatment (thus rendering the statements of opinion misleading by omission), the court concluded the plaintiffs had failed to plead that any of these statements of opinion were false or misleading under Omnicare.14
Even before the Supreme Court’s recent decision in Omnicare, courts tended to find statements of opinion to be non-actionable on a variety of different theories (e.g., puffery, lack of falseness, immateriality, etc.). Omnicare has provided a firmer foundation for dismissal. For example, applying Omnicare, in Gillis v. QRX Pharma Ltd.,15 the court concluded that the defendants’ optimistic statements that it was “encouraged” by FDA feedback and was “confident that [its drug candidate would] receive approval” were opinions, and plaintiffs had failed sufficiently to allege that defendants did not believe them or that they were misleading in context.16 Courts are increasingly applying Omnicare to dismiss biotech claims at a higher rate than the overall securities class action dismissal rate.17
Tools Collecting Dust in the Toolbox
The Full-Context Rule
Many courts have followed Omnicare’s directive to evaluate challenged statements in context. For example, in Sanofi, the Second Circuit emphasized the larger context in which the challenged statements were made:
Plaintiffs are sophisticated investors, no doubt aware that projections provided by issuers are synthesized from a wide variety of information, and that some of the underlying facts may be in tension with the ultimate projection set forth by the issuer. . . . These sophisticated investors, well accustomed to the ‘customs and practices of the relevant industry,’ would fully expect that Defendants and the FDA were engaged in a dialogue, as they were here, about the sufficiency of various aspects of the clinical trials and that inherent in the nature of a dialogue are differing views.18
While no court has expressly refused to follow Omnicare’s context requirement, many have not used it to its fullest, or at all, in part because defense counsel have not used Omnicare to maximum advantage.
Most notoriously, in Khoja v. Orexigen Therapeutics,19 in a scathing 25-page decision, the Ninth Circuit found that the district court abused its discretion by considering various facts outside the complaint, concluding that if defendants can “present their own version of the facts at the pleading stage—and district courts accept those facts as uncontroverted and true—it becomes near impossible for even the most aggrieved plaintiff to demonstrate a sufficiently ‘plausible’ claim for relief.” In this regard, the panel noted that it perceived a “concerning pattern in securities cases … exploiting these procedures [i.e., judicial noticing and incorporation by reference] improperly to defeat what would otherwise constitute adequately stated claims at the pleading stage.”
Orexigen was wrongly decided. Coupled with Tellabs’ inference-weighing mandate, Omnicare requires courts to do exactly what Orexigen says is forbidden, namely, to allow defendants to “present their own version of the facts.” But decisions like Orexigen are not solely the courts’ fault if defense counsel doesn’t make the full-context rule argument as strongly as possible.20 Our arguments in favor of a robust record are increasingly blunt. Here is a link to our latest argument, in hopes that other defense lawyers will begin to make strong arguments as well.21
Forward-looking statements are opinions about what might happen in the future, to which Omnicare applies. Understandably, most defense lawyers focus their defense of forward-looking statements on the Reform Act’s safe harbor for forward-looking statements, which protects a forward-looking statement, whether true or false, from challenge if it was accompanied by “meaningful” cautionary language identifying “important” risk factors. However, our defense-counsel colleagues should consider first arguing that such statements are true under Omnicare and use the safe harbor as a fallback.
We strongly favor this approach for two reasons. First, focusing on falsity is necessary because of how courts analyze falsity and scienter. Although falsity and scienter are separate elements—and should be analyzed separately—courts often analyze them together.22 Arguing a lack of falsity thus provides essential ingredients for this combined analysis. Even when courts analyze falsity and scienter separately, a proper scienter analysis requires a foundational falsity analysis, because as noted above, a scienter analysis asks whether the defendant knew that a particular statement was false. Without an understanding of exactly why that challenged statement was false, and what facts allegedly demonstrate that falsity, the scienter analysis meanders, devolving into an analysis of knowledge of facts that may or may not be probative of the speaker’s state of mind related to that statement.
Second, many courts have struggled against the feeling that the safe harbor allows a company to offer intentionally false or misleading forward-looking statements so long as they are accompanied by “meaningful” cautionary language identifying “important” risk factors. That disjunctive structure led the First Circuit to describe the safe harbor as a “curious statute, which grants (within limits) a license to defraud.”23 The plaintiffs’ bar has fostered the impression that the safe harbor marks an improper return to caveat emptor. For example, leading plaintiffs’ securities lawyer William Lerach has stated that the safe harbor gave companies a “[l]icense to lie.”24 To circumvent the broad protections Congress intended with the safe harbor, courts have either committed serious legal errors,25 or ignored the statute altogether by deciding motions to dismiss on other grounds.26 Because of this judicial antipathy to the scope of the statute’s protections, the safe harbor has failed to protect forward-looking statements as Congress intended.
Omnicare improved the ability of corporate executives to express their genuinely held opinions without fear of unfair liability. It is incumbent on us defense lawyers to use Omnicare’s tools effectively, and we hope that this discussion helps sharpen those we’re already using and inspires use of those collecting dust.
- See generally Greene and Davis, Omnicare, Inc., One Year Later: Its Salutary Impact on Securities-Fraud Class Actions in the Lower Courts, Washington Legal Foundation, Working Paper Series, No. 195, .
- 816 F.3d 199 (2d Cir. 2016).
- 856 F.3d 605, 618 (9th Cir. 2017).
- See., e.g., Paradise Wire & Cable Defined Benefit Pension Plan v. Weil, 918 F.3d 312, 322 (4th Cir. 2019); Police & Fire Ret. Sys. of City of Detroit v. Plains All Am. Pipeline, L.P., 777 F. App’x 726, 730 (5th Cir. 2019); Nakkhumpun v. Taylor, 782 F.3d 1142, 1159 (10th Cir. 2015) (same); Carvelli v. Ocwen Fin. Corp., 934 F.3d 1307, 1322 (11th Cir. 2019).
- No. 346, 2019 (Del. Mar. 18, 2020).
- Sharp strategic judgment and case management are critical too. See generally Greene, Gabriel, Molina, and Song, The State of Securities Litigation after Cyan, The D&O Diary.
- Align, 856 F.3d at 616-18.
- 655 F.3d 105, 110-13 (2d Cir. 2011).
- 2019 WL 4257110 (S.D.N.Y. Sept. 9, 2019).
- Id. at *12.
- Id. at *15 (“When the ‘errors’ resulted from ‘management’s interpretation of accounting guidance, as defendants assert happened here, they are errors of opinion, not of fact.”).
- Id. at *15-22 (so holding regarding recognition of warranty contract revenue, bonus accrual, deferred acquisition costs, and capitalization of software development costs).
- Id. at *15-30, 35. Other helpful post-Omnicare accounting-related Second Circuit decisions include Querub v. Moore Stephens Hong Kong, 649 Fed. Appx. 55 (2d Cir. 2016), and Special Situations Fund III v. Deloitte Touche Thomatsu, 645 Fed. Appx. 72, 74-76 (2d Cir. 2016).
- 2016 WL 3685095 (S.D.N.Y. July 6, 2016).
- Id. at *21-23. See also, e.g., Corban v. Sarepta, 2015 WL 1505693, at *8 (D. Mass. Sep. 30, 2015); Bailey v. Esperion Therap., Inc., No. 18-CV-11438, 2019 WL 3296235, at *4 (E.D. Mich. Feb. 19, 2019); Hirtenstein v. Cempra, Inc., 348 F. Supp. 3d 530, 556 (M.D.N.C. 2018).
- See Greene, York-Erwin, and Tomasulo, Myths & Misconceptions of Biotech Securities Claims: An Analysis of Motion to Dismiss Results from 2005-2016, which the authors are in the process of updating. A link to the updated article will be included in the 2017 article.
- Sanofi, 816 F.3d at 211. Other appellate courts have applied Omnicare’s full-context rule. See, e.g., Jaroslawicz v. M&T Bank Corp., 912 F.3d 96, 113-15 (3d Cir. 2018); In re Lifelock, Inc. Sec. Litig., 690 Fed. Appx. 947, 951-52 (9th Cir. 2017).
- 899 F.3d 988, 998 (9th Cir. 2018).
- Notably, Orexigen did not cite Omnicare at all. As a result, among other flaws, the decision failed to properly balance positive statements about interim drug testing in context with the multiple disclaimers the company made about the inherently unreliable nature of interim results. Compare Orexigen, 899 F3d. at 1010-11 (giving disclaimers regarding interim testing results little weight).
- See, e.g., Ronconi v. Larkin, 253 F.3d 423, 429 (9th Cir. 2001) (“Because falsity and scienter in private securities fraud cases are generally strongly inferred from the same set of facts, we have incorporated the dual pleading requirements of 15 U.S.C. §§ 78u-4(b)(1) and (b)(2) into a single inquiry.”).
- In re Stone & Webster, Inc. Sec. Litig., 414 F.3d 187, 212 (1st Cir. 2005).
- Lori Calabro, I Told You So, CFO Magazine, Sept. 1, 2002, at 67.
- In re Quality Sys., Inc. Sec. Litig., 865 F.3d 1130 (9th Cir. 2017).
- See, e.g., Williams v. Globus Med., Inc., 869 F.3d 235, 245-46 (3d Cir. 2017) (using safe harbor as a fallback basis to affirm dismissal of forward-looking statements); IBEW Local No. 58 Annuity Fund v. EveryWare Glob., Inc., 849 F.3d 325, 328, n.2 (6th Cir. 2017) (affirming dismissal of forward-looking statements on scienter grounds).