In two decisions last week - one in the Sixth Circuit and
one in the First Circuit - federal appellate courts set aside lower court
dismissals of securities class action lawsuits. Although the two cases are
different and the two appellate opinions address different legal issues, the
two decisions both seem to suggest a similar message to the lower courts to be
a little less hasty in dismissing cases.
The Sixth Circuit opinion is particularly interesting,
because the Court not only articulated a very precise (and plaintiff-friendly)
standard for pleading strict liability in a Section 11 claim, but also
expressly declined to follow the Second and Ninth Circuits on the Section 11
pleading requirements, setting up a split in the circuits that could attract
the attention of the U.S. Supreme Court.
The Sixth Circuit Opinion
On May 23, 2013, a unanimous three-judge panel of the
Sixth Circuit entered
an opinion affirming in part and reversing in part the lower court's
dismissal of a securities class action lawsuit against Omnicare and certain of
its directors and officers [an enhanced version of the opinion is available to lexis.com
subscribers]. As discussed here, the case has an
extended procedural history, and the recent appeal represents the case's
second trip to the Sixth Circuit.
The specific issue before the appellate court in the most
recent appeal involved the question of what plaintiffs are required to plead in
order to establish a claim under Section 11. The plaintiffs claimed that in
connection with a December 2005 securities offering, the company's offering
documents had falsely stated that the company was in compliance with legal
requirements, when the company was in fact engaged in a variety of illegal
activities including kickback arrangements with pharmaceutical companies and
the submission of false claims to Medicare and Medicaid.
In February 2012, the district court granted
the defendants' motion to dismiss, finding that the plaintiffs were
required but failed to plead that the defendants knew that the statements about
the company's legal compliance were false. The plaintiffs appealed the
dismissal to the Sixth Circuit. On appeal, the plaintiffs argued that Section
11 provides for strict liability and it was therefore inappropriate for the
district court to require them to plead knowledge in connection with their
Section 11 claim.
The defendants, in reliance on the Second Circuit's 2011
decision in Fait v. Regions Financial Corporation [enhanced version], as well as Ninth Circuit
case authority, argued that in order to plead a Section 11 claim, the
plaintiffs not only had to plead not only that the allegedly misleading
statement was objectively false, but also that the defendants "disbelieved" the
statement - that is, that the plaintiffs had to plead both objective and
The Sixth Circuit rejected the defendants' arguments,
noting that, by contrast to Section 10(b) and Rule 10b-5, which require a
plaintiff to plead scienter, Section 11 is "a strict liability claim," adding
that "once a false statement has been made, a defendant's knowledge is not
relevant to a strict liability claim." Under Section 11, the Sixth Circuit
said, "if the defendant discloses information that includes a material
misstatement, this is sufficient and a complaint may survive a motion to
dismiss without pleading knowledge of falsity."
The Sixth Circuit expressly declined to follow the Second
and Ninth Circuits, based on its observation that those courts had
misinterpreted the U.S. Supreme Court's
1991 decision in Virginia Bankshares, Inc. v. Sandberg [enhanced version]. By contrast to the Second
Circuit's interpretation of the Virginia Bankshares case, the Sixth
Circuit said the Virginia Bankshares case "was not faced with and did
not address whether a plaintiff must additionally plead knowledge of falsity in
order to state a claim." Moreover, the Virginia Bankshares case involved
a Section 14(a) claim, rather than a Section 11 claim. The Sixth Circuit
observed that "it would be unwise for this Court to add an element to Section
11 claims based on little more than a tea-leaf reading in a Section 14(a)
case." Accordingly, the Sixth Circuit refused to extend Virginia Bankshares to
impose a knowledge of falsity requirement in a Section 11 claim.
The Sixth Circuit concluded that the plaintiffs'
allegations of Omnicare's alleged misrepresentations regarding its legal
compliance were sufficient to state a claim under Section 11, reversed the
district court's dismissal on the ground, and remanded the case to the lower
court. However, the Sixth Circuit did affirm the district court's dismissal of
the plaintiffs' GAAP-based misstatements and omissions.
The First Circuit's Opinion
On May 24, 2013, a unanimous three-judge panel of the
First Circuit (including former U.S. Supreme Court Justice David Souter,
sitting by designation), in an opinion
written by Judge Jeffrey
Howard, entered an order vacating the dismissal of the securities class
action lawsuit pending against CVS Caremark [enhanced version].
CVS Caremark was formed through a March 2007 merger
between CVS Corp. and Caremark Rx Inc. The plaintiffs alleged that the success
of the merger depended on the success of integrating the two companies'
operations. The plaintiffs allege that following the merger, the defendants
made a number of statements about the success of the integration efforts and
the level of service provided to important pharmaceutical services customers.
In particular the plaintiffs cited a number of statements following the merger
about the successful integration of the two companies' computer systems and
The plaintiffs allege that these statements concealed
problems the company was having with computer integration. The plaintiffs
allege that integration problems resulted in the company's loss of major
clients whose business was worth $3 billion in annual revenues to the company.
The plaintiffs allege that the truth about the company's problems was revealed
in a November 5, 2009 conference call with analysts. In the call, the company's
CEO, Thomas Ryan announced, among other things, that the company had suffered
"some big client losses" and that "service issues" had led to the loss of at
least one of the large clients. Ryan also announced that due to the loss of
business, the company would not make its previously announced projected growth
in earnings per share. Ryan also announced the unexpected retirement of the
head of the "chief architect" of the merged companies' integrated business
In their securities class action complaint, the plaintiffs
alleged that Ryan's statements revealed that the company's failure to integrate
the predecessor companies' operations had resulted in the loss of billions of
dollars of customer contracts. In support of this allegation, the plaintiffs
cited several analyst reports, which among other things, stated that the
company had "stunned" the marketplace with the information about the loss of
customer business and "the breakdown" of the Caremark business model. Following
the November 5 conference call and quarterly earnings announcement, the
company's share price declined 20 percent.
The district court granted the defendants' motion to
dismiss, holding that the plaintiffs' complaint did not plausibly allege that
Ryan's statements in the November 5 call caused the drop in the company's share
price, with one exception - Ryan's statements that the company would not make
the projected growth in earnings per share. However, because this projection
was a protected "forward looking statement,"' it could not form the basis of a
claim against the defendants. The plaintiffs appealed the district court's
ruling, except that they did not appeal the district court's conclusion
regarding the forward looking statement.
On appeal, the plaintiffs argued that Ryan's statements
in the November 5 call represented a concession that the post-merger
integration had been less successful than the company had claimed and the
resulting service quality issues and loss of client business were due to these
integration difficulties. The defendants argued that the November 5 conference
call did not represent a "corrective disclosure" because Ryan never said that
there were integration problems; that the market was previously aware of the
customer losses; and that the plaintiffs cannot bootstrap their theory that
Ryan's statements in the November 5 call caused the share price decline by
relying on statements from analysts' reports.
In its May 24 opinion, the First Circuit vacated the
district court's dismissal and remanded the case for further proceedings. In
concluding that the plaintiffs had plausibly alleged that the November 5 call
had revealed the company's problems with service and systems integration, the
First Circuit cited a number of factors: first, during the call, Ryan had for
the first time revealed that "service issues" had led to the loss of contracts;
second, the market reacted with "alarm" to the news of the magnitude of the
company's lost business and the problems that led to the loss; and third that
the unexpected retirement of the "architect" of the integration "alerted the
market to problems" with the integrated business.
The Court concluded that the plaintiffs' allegations
"indicated that the drop in CVS Caremark's share price was causally related to
its misstatements regarding the integration of CVS and Caremark, and these
allegations are sufficiently plausible to foreclose dismissal."
However, the defendants also argued that the plaintiffs
had not sufficiently pled an actionable misstatement or omission and also had
not sufficiently pled scienter. Accordingly, rather than reversing the district
court's opinion, the appellate court merely vacated the district court's
dismissal, for the court "to consider alternative grounds for dismissal if it
In each of these two cases, the appellate courts set
aside the district court's dismissal of the respective plaintiffs' securities
class action lawsuits. Although the two appeals involved different facts and
presented different legal issues, there arguably is a common message to the
district courts in the two appellate opinions. In that regard, it is worth
noting the concurring opinion of Northern District of Ohio Judge James Gwin in the
Omnicare case (Gwin sat by designation on the Sixth Circuit panel that heard
the Omnicare appeal).
Judge Gwin wrote separately to underscore district
courts' discretion under Fed. R. Civ. Proc. 54(b) to revive previously
dismissed claims while the case remains pending if newly discovered evidence so
warrants. In making this point, Judge Gwin cited Fed. R. Civ. Proc. 1, which
states that district courts are charged with enforcing rules "to secure
the just, speedy, and inexpensive determination" of an action. Judge Gwin
concluded his concurring opinion by noting, with reference to Fed. R. Civ.
Proc. 1, that "there's a reason that 'just' precedes 'speedy'".
To paraphrase Judge Gwin, the message to the district
courts seems to be - slow down there, not quite so speedy with the dismissals.
That is, for all of the statutory and case law hurdles that the plaintiffs must
overcome in order to try to state a securities claim, a quick dismissal still
is not always going to be the appropriate outcome. As formidable as the obstacles
are, the obstacles are not insurmountable.
The Sixth Circuit's holding in the Omnicare case is
particularly interesting, and seemingly holds open the prospect that it will be
substantially easier for Section 11 claimants in the Sixth Circuit to state a
claim that it will be for Section 11 claimants in the Second and Ninth
Circuits. In a May 24, 2013 column on her On the Case blog, here,
Alison Frankel quotes the defense counsel in the Omnicare case as saying that
the Sixth Circuit's ruling could "open the floodgates" for litigation in the
Circuit. The split in the Circuits, and the stark fact that claims that
could go forward in the Sixth Circuit will not go forward in the Second and
Ninth, seems likely to attract the interest of the U.S. Supreme Court -
particularly since the apparent split appears to be the result of directly
conflicting interpretations of the U.S. Supreme Court's decision in the Virginia
Although the two appellate cases were quite different
from each other in a number of respects, it is interesting to note that both
cases involved companies in the pharmaceutical business. That is, they both
parts of the larger life sciences sector that has so consistently attracted
securities class action litigation over the years (refer for example here).
In the past, it has been reassuring that though companies in the life sciences
sector disproportionately attract litigation, the cases filed in the sector
seemed to also involve a relatively high dismissal rate. The outcome of these
two appeals, at least, suggests that at least these some of the dismissals
(that is, these two cases, for instance) may not have been warranted.
It is important to note that though these respective
plaintiffs have succeeded in having the district court dismissals set aside,
the plaintiffs are a long way from home. In particular, the parties in the CVS
Caremark case will have to go back to the district court and wrangle over
threshold questions such as whether or not the plaintiffs have adequately
alleged misrepresentation and scienter. The plaintiffs in the Omnicare case,
having weathered their second appeal in the case, will have to go back and
continue to prosecute their claims in the case, which have now been pending for
years. There is nothing that says that the plaintiffs in either case will every
have anything to show for their efforts.
Even though the plaintiffs prevailed in these appeals,
these cases serve as a reminder of how challenging it is for securities class
action plaintiffs and their lawyers to take on one of these kinds of lawsuits.
The claims not only face formidable legal and procedural obstacles but also
require the claimants and their counsel to be willing to carry the case for
years. Whether or not the Sixth Circuit's opinion in the Omnicare case will
"open the floodgates," any prospective claimant seeking to rely on the decision
will still have to be come prepared with copious reserves of endurance and
Special thanks to a loyal reader for sending me a copy of
the Sixth Circuit opinion.
other items of interest from the world of directors & officers liability,
with occasional `ommentary, at the D&O Diary, a blog by Kevin LaCroix.
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