U.S. Supreme Court Takes Up Yet Another Securities Case: To Support a Section 11 Claim, Must an Opinion Be Subjectively False?

 As if it were not enough that the Court is already considering a case that could change the face of securities class actions (that is, the Halliburton case, which will be argued this week), the U.S. Supreme Court has now agreed to take up yet another securities case.

In a March 3, 2014 order (here), the Court granted the defendant’s petition for writ of certiorari in Indiana State District Council of Laborers v. Omnicare, to determine whether or not to survive a dismissal motion it is sufficient for a plaintiff in a Section 11 case to allege that a statement of opinion was objectively false, or whether the plaintiff must also allege that the statement was subjectively false – that is, that the defendant did not believe the opinion at the time the statement was made.

The Supreme Court’s consideration of the Omnicare case will resolve a split in the circuits between those (such as the Second and Ninth Circuits) holding that in a Section 11 case allegations of knowledge of falsity are required; and those (such as the Sixth Circuit, in the Omnicare case) holding that they are not required. The case is potentially important because the absence of allegations of knowledge of falsity is a frequent basis for dismissals of Section 11 suits in the Second and Ninth Circuits, where the vast preponderance of securities suits are filed. As it is, the current split would allow cases to go forward in the Sixth Circuit that would not survive in the Second and Ninth Circuits.

Background

Omnicare provides pharmaceutical care services to long-term care facilities. The plaintiffs allege that Omnicare was engaged in various illegal activities including kickback arrangements with pharmaceutical companies and the submission of false Medicare and Medicaid claims. The plaintiffs allege that in connection with its December 15, 2005 stock offering, the company’s offering documents falsely stated that its arrangements with the drug companies were “legally and economically valid.”

As detailed here, the case, which was first filed in February 2006, has a long procedural history, and has made two separate trips to the Sixth Circuit. The most recent trip followed after the district court had dismissed the case, holding that the plaintiffs were required to but had failed to plead knowledge of falsity on the defendants’ part. The plaintiffs appealed.

In a May 23, 2013 opinion (here), a three-judge panel of the Sixth Circuit, in an opinion by Judge R. Guy Cole, Jr. reversed the district court (in relevant part), holding that “Under Section 11, if the defendant discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading fraud.” The Sixth Circuit reasoned that a showing of knowledge of falsity was not necessary for claims under Section 11, which imposes strict liability for material misrepresentations in offering documents. The court said that “no matter the framing, once a false statement has been made, a defendant’s knowledge is not relevant to a strict liability claim.” 

The Sixth Circuit expressly declined to follow the Ninth Circuit’s 2009 ruling in Rubke v. Capitol Bankcorp and the Second Circuit’s 2011 decision in Fait v. Regions Financial, which had held that in order to survive a motion to dismiss, a Section 11 plaintiff must allege that the allegedly misleading statement was both objectively false and subjectively false – that is, that the statement was untrue and that the defendant disbelieved the statement at the time it was made.

In the Sixth Circuit’s view, the Second and Ninth Circuit decisions were based a faulty reading of the U.S. Supreme Court’s 1991 decision in Virginia Bankshares v. Sandberg. The Sixth Circuit said that in its reading the Virginia Bankshares case did not require the outcome that the Second and Ninth Circuit had reached. The Sixth Circuit said that “The Virginia Bankshares court was not faced with and did not address whether a plaintiff must plead knowledge of falsity in order to state a claim. It therefore does not impact our decision today.”

The defendants filed a petition for a writ of certiorari, seeking to have the U.S. Supreme Court determine whether for purposes of a Section 11 claim it is sufficient for a plaintiff to plead that that a statement of opinion was objectively wrong (as the Sixth Circuit held) or whether the plaintiff must also allege that the statement was subjectively false—requiring allegations that the speaker’s actual opinion was different from the one expressed – as the Second and Ninth Circuits require.

In their cert petition, the defendants argued that the Sixth Circuit both misread and failed to follow the Virginia Bankshares decision. The defendants also argued that the Sixth Circuit’s approach “threatens dangerous and far-reaching consequences” because it “would expose corporations, auditors, underwriters, and other professionals to a sharp increase in the cost of litigation, as certain types of federal securities claims – particularly those under Section 11 – would become far more difficult to resolve at the pleading stage.”

In their brief in opposition to the cert petition, the plaintiffs argued that the Supreme Court’s prior case law holds that Section 11 imposes strict liability in issuers for misrepresentations in offering documents, without regard to fault or knowledge. The plaintiffs also argue that Virginia Bankshares was a Section 14 case, not a Section 11 case and therefore is not controlling, and that in any event its principles should not be extended to the Section 11 strict liability context.

Discussion

At one level, it is not surprising that the Supreme Court granted cert in this case, in light of the circuit split on the question whether a plaintiff must plead subjective falsity in a Section 11 case. As things stand, a case that would be dismissed in the Second or Ninth Circuit could proceed if it were filed in the Sixth Circuit, allowing inconsistent outcomes based on nothing other than where a case was filed. In addition, the fact that the split is attributable to differing interpretations of a Supreme Court case precedent underscores the need for the Supreme Court to step in and sort out this circuit split.

Nevertheless, while I understand why the Supreme Court might take up this case, the Supreme Court’s recent fascination with securities law issues remains inexplicable to me. As I have said before, when the time comes for future academics to write the history of the Roberts Court, one of the things they will have to explain is why in beginning in the middle of the first decade of the 21st Century, the Supreme Court suddenly became so keen to take up securities cases. Until recemtly, years would pass between securities cases at the Supreme Court. Now there are one or two securities cases every term.

The Supreme Court just issued its opinion in the Amgen case a year ago. Last week, it issued its opinion in the Chadbourne & Parke case (about which refer here). On Wednesday, the Court will hear oral argument in the Halliburton case. And now the Court has agreed to take up the Omnicare case.

Indeed, the Omnicare case may take on heightened significance depending on how the Halliburton case turns out. Many commentators have suggested that even if the Supreme Court’s decision in the Halliburton case throws out the fraud on the market theory, plaintiffs will still be able to file securities class actions under Section 11, as the fraud on the market theory only applies to Section 10 misrepresentation cases.

If the lower pleading bar to Section 11 cases that the Sixth Circuit described in its Omnicare opinion is the standard to be applied the dismissal motion stage, Section 11 cases will indeed likely be an attractive alternative for prospective securities plaintiffs (or at least those that purchased their share in a securities offering). On the other hand, if the Supreme Court rules in the Omnicare case that the higher pleading bar described by the Second and Ninth Circuit applies, it will be more difficult for Section 11 complaints to survive the dismissal motion, and so Section 11 will be a less attractive alternative.

It is always hard to predict what the Supreme Court will do, even given the current Court lineup with a majority of Justices having a conservative inclination. Though the Supreme Court has often taken a business friendly and conservative approach to securities cases, it does not always do so – as may be seen for example in the Amgen case or the recent Chadbourn & Parke case. There is no way to know what the Court will do here.

The plaintiffs’ bar likely will criticize the position urged by Omnicare for in effect trying to import a scienter requirement into Section 11 claims. The defense bar has been sharply critical of the Sixth Circuit’s Omnicare opinion for overlooking the fact that as a matter of common sense a statement of opinion cannot be “false” unless the speaker truly did not hold the opinion. For a particularly good discussion of the defense perspective on the Sixth Circuit’s Omnicare decision and the issues it raises, please see Claire Loebs Davis’s August 12, 2013 post on the D&O Discourse blog (here) (the Omnicare Court’s misreading of the Virginia Bankshares decision “an abrupt wrong turn”).

Whatever the outcome, the Omnicare case will be important. The precedent in Second and Ninth Circuit’s holding that a Section 11 plaintiff must allege knowledge of falsity has been the basis of numerous dismissals in district courts in those circuits. If the Supreme Court were to hold that that a Section 11 plaintiffs does not need to plead knowledge of falsity, many cases in those jurisdictions that are now dismissed would survive. However, it remains to be seen which view of Section 11 pleading will prevail.

The Supreme Court will consider the Omnicare case in the court term beginning in October 2014.

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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