May 22, 2014

It’s Not Simply a Matter of Opinion: Pleading Standards Under Section 11 for Untrue or Misleading Opinions

Samuel L. Moultrie

Can an opinion be “untrue” or “misleading” if the party offering the opinion believes it to be true at the time the opinion was offered? To some, it would seem intuitive that an opinion is “true” (however that term is defined), or maybe more properly put, “not false or misleading,” if that opinion embodies what the speaker actually believed at the time he or she spoke. The Sixth Circuit, however, would disagree. At least in the context of a securities class action case brought under Section 11 of the Securities Act of 1933 (the Act). 

On March 3, 2014, the United States Supreme Court granted certiorari in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 719 F.3d 498, 505 (6th Cir. 2013), to address a circuit split concerning the pleading standards applicable to claims under Section 11 of the Act for untrue or misleading statement of opinion. In Omnicare, the Sixth Circuit held that plaintiffs did not need to prove that defendants knew their opinion was false in an action brought under Section 11. The decision has been very controversial and “drew the ire of the securities defense bar.” Brian Mahoney, Securities Defense Bar Has High Hopes Riding On Omnicare, Law360, Washington, (March 03, 2014, 8:09 PM ET), available at Prior to Omnicare, the Second Circuit in Fait v. Regions Financial Corp., 655 F.3d 105, 110 (2d Cir. 2011), and the Ninth Circuit in Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156, 1162 (9th Cir. 2009), held that in order to hold a defendant liable under Section 11 for untrue or misleading statements of opinion a plaintiff must plead facts showing: (1) that the opinion itself was objectively wrong, commonly referred to as “objective falsity;” and (2) that the speaker did not hold or otherwise believe the opinion expressed, otherwise known as “subjective falsity.” In reaching that conclusion, the courts in Fait and Rubke relied on the Supreme Court’s holding in Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991), for the proposition that in order for liability to attach to certain opinions under federal securities laws, a party must prove both that the statement was objectively false or misleading and that the speaker did not believe the statement at the time it was made. Some commenters, legal scholars, lawyers, and judges tend to agree with the Second and Ninth Circuits that under Virginia Bankshares statements of opinion are only actionable if the plaintiff can prove “objective falsity” and “subjective falsity.” Likewise, it seems that they would apply this principal generally to all actions for untrue or misleading statements of opinion under federal securities laws. As the Sixth Circuit noted, however, different provisions of the federal securities laws have different purposes and protections, different requirements, and, accordingly, are applied differently in different contexts. 

Virginia Bankshares v. Sandberg

The most important thing to understand about Virginia Bankshares – for the purposes of analysis under Section 11 – is not what the opinion actually says; rather, it is what the opinion does not say. Most commenters seem to believe that Virginia Bankshares purports to stand for the proposition that statements of opinion are only actionable if a plaintiff can prove both “objective falsity” and “subjective falsity.” They argue that this analysis is self-evident. In fact, according to most commenters, it is so self-evident, that the Court purportedly assumed that an opinion was not untrue unless the speaker did not hold the belief stated. Va. Bankshares, 501 U.S. at 1095–96. However, that is not necessarily what the Court said. The questions before the Court were: (1) whether an opinion can be a “material fact” actionable under Section 14(a) and Rule 14(a)-9, and (2) whether statements of opinion are actionable even if they are not objectively misleading. The Court held that a statement of opinion can be a material fact and that “disbelief or undisclosed motivation, standing alone, [is] insufficient to satisfy the element of fact that must be established under § 14(a).” Thus, in order for a statement of opinion to be a material fact that is actionable it must be objectively misleading. Never did the Court state, inversely, that an objectively misleading statement, standing alone, is insufficient to establish liability. Nor did the Court hold that a statement of opinion must be subjectively disbelieved and objectively misleading or that for an opinion to be untrue or misleading it must be disbelieved. (Importantly, the Court assumed from the jury verdict “that the directors’ statements of belief and opinion were made with knowledge that the directors did not hold the belief or opinions expressed.”) So how do these principles apply in the context of securities class actions brought under Section 11? In order to answer that question, it is important to understand the purpose of Section 11. 

Section 11: It’s Purposes and Protections

The basic purpose of Section 11 is to protect investors. It provides an express private right of action (15 U.S.C. §§ 77a-77aa) to investors that purchased securities in connection with a registration statement that “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” 15 U.S.C. § 77k(a). A registration statement is meant to provide prospective purchasers with the information needed to make an informed investment decision based on truthful and adequate disclosure of material information regarding the issuer, its associated persons, and the offering. Potential liability under Section 11 extends to include each person that signed the registration statement, every director or partner of the issuer at the time of the filing, every underwriter, and every accountant who consented to being named as having prepared or certified any part of the registration statement. An investor bringing a claim under Section 11 is not required to prove reliance or that an issuer is at fault for any untrue statements in the registration statement to prevail on that claim. Instead, an issuer is strictly liable for any untrue statement of material fact or omission that made the statements in the registration statement misleading. Once a prima facie case has been pleaded, the burden shifts to certain defendants to prove an affirmative defense such as due diligence or loss causation. 

Some have condensed Section 11 and Section 10(b) and Rule 10b-5, promulgated thereunder by the SEC, into one for the purpose of analysis. The two, however, are distinct and serve different purposes. The provisions in Section 11, as opposed to Section 10(b) or Rule 10b-5, “involve distinct causes of action and were intended to address different types of wrongdoing.” Herman & MacLean v. Huddleston, 459 U.S. 375, 381 (1983). For instance, Section 11 applies only in the limited context of a registered offering and allows only purchasers of registered security to sue certain enumerated parties. As stated in Herman, Section 11 “was designed to assure compliance with the disclosure provisions of the Act by imposing a stringent standard of liability.” Thus, a plaintiff “need only show a material misstatement or omission to establish his prima facie case. Liability against the issue of a security is virtually absolute, even for innocent misstatements.” Section 11 is meant to provide a “relatively minimal burden on plaintiff.” The reason the burden is “minimal” on a plaintiff, in contrast to Section 10(b), is because Section 11 defendants have a number of procedural protections in place. For instance, a Section 11 action may only “be brought by a purchaser of a registered security, must be based on misstatements or omissions in a registration statement, and can only be brought against certain parties.” A plaintiff may be required to post a bond for costs and the applicable statute of limitations is only one year from the date of the security was purchased. Moreover, the measure of damages is much more stringent. 

In contrast, Section 10(b) has a much broader reach. In Huddleston, 459 U.S. at 382 (citing Chiarella v. United States, 445 U.S. 222, 234–35 (1980)), the U.S. Supreme Court stated that Section 10(b) is meant to be a “catchall” provision and, as such, encompasses an extensive range of practices in connection with a “purchaser or seller of ‘any security’ against ‘any person’ who has used ‘any manipulative or deceptive device or contrivance’ in connection with the purchase or sale of a security.” (emphasis in original). Importantly, and because of the broad scope of 10(b), a plaintiff bears a much heavier burden at the pleading stage. A plaintiff must plead and ultimately prove, in addition to other requirements, certain elements including: (1) materiality, (2) scienter (by showing actual knowledge or some form of recklessness), (3) reliance, and (4) causation in order to recover damages. 

Liabilities: The Pleading Requirements

So, what does all this mean? Three points. First, Section 11 only requires that a registration statement contain “an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” As noted above, a registration statement may be misleading whether the speaker believed the opinion or not. This is especially true in the context of a statement of opinion challenged under Section 11. As Virginia Bankshares teaches us, an actionable opinion is one based on provable facts outside the control of the speaker. Therefore, a statement of opinion can be an untrue or misleading material fact within the meaning of Section 11 whether the speaker believed the opinion or not, and if such statement is in the registration statement, it is subject to Section 11’s strict liability standards. 

Second, the Court has recognized that certain statements of opinion (or terms in a commercial context) “are reasonably understood to rest on a factual basis that justifies them as accurate, the absence of which renders them misleading.” Virginia Bankshares, 501 U.S. at 1093 (emphasis added). Thus, certain opinions without a reasonable factual basis may be misleading. Whether the speaker believes the statement to be true or not is not the proper focus. But, that does not mean that all opinions are misleading; instead, only those opinions which in a commercial context are based on provable facts outside the speaker’s control may be misleading. The opinions at issue in Omnicare, that the companies’ contracts were “legally and economically valid arrangements” are the type of opinions are that are “reasonably understood to rest on a factual basis.” See Indiana State District Council of Laborers v. Omnicare, 719 F.3d 498, 501 (6th Cir. 2013). Only certain opinions that are based on provable facts are actionable and, accordingly, may be actionable regardless of what the speaker actually thought at the time he or she spoke. There is no need to plead subjective falsity. 

Finally, securities laws should be read in light of their remedial purpose. This principle is especially true when considering the purpose of Section 11, namely, to provide greater protection to purchasers of registered securities. Focusing on the speaker’s state of mind misses the whole point of Section 11. The focus, instead, should be on the investor

For example, suppose there are two directors, Director A and Director B, and that the company’s registration statement includes an opinion that the company’s dealings with another company are “legally and economically valid arrangements.” Omnicare, 719 F.3d at 501. At the time the opinions were provided, Director A knows that the dealings with another company are not legal or valid. In contrast, Director B believes the statements to be true. Suppose it turns out that the company’s dealings are not legally or economically valid. Assuming that the opinions are the type that are grounded in provable facts that are outside the control of the speaker, the issue of objective falsity is undisputed. Now turn to the issue of the speakers’ intent. Under the proposed rule that requires plaintiff to prove “subjective falsity” and “objective falsity,” liability would attach to the statement made by Director A because he or she knew that the statement was false at the time it was made. On the other hand, liability would not attach to the statement made by Director B because he or she believed the statement to be true at the time it was made. In this case, the purchaser of the security read the exact same statement from both directors. Yet, only one of the statements would be misleading. How does that make sense? How is it that the unknown state of mind of one speaker causes a statement to be misleading to an investor, yet the unknown state of mind of another speaker causes the same exact statement to not be misleading to the same investor? Furthermore, how does it comply with Section 11’s strict liability requirements? The principle of this example is to show that an opinion, based on provable facts outside the speaker’s control, can be untrue and misleading to an investor regardless of the speaker’s state of mind. Accordingly, liability under Section 11 should attach without a plaintiff pleading “subjective falsity.” 

Subjective Falsity: What Does It Mean?

What does requiring plaintiff to plead subjective falsity do to plaintiff’s claim? It has the effect of turning a strict liability case into one requiring plaintiff to show actual knowledge that the opinions were untrue or disbelieved. The Sixth Circuit stated that imposing on plaintiff the requirement that it plead facts showing that a statement was subjectively false has the effect of requiring a plaintiff to plead the equivalent of scienter. The Sixth Circuit, however, did not go into any greater detail. But, it does seem that the subjective falsity requirement is similar to the actual knowledge state-of-mind requirement in the safe harbor provision of Section 21E of the Act for forward-looking statements. Under Section 21E, a plaintiff must allege that forward-looking statements were made with actual knowledge that they were false. This standard is arguably tougher to plead than pleading scienter under Rule 10b-5. That is because plaintiffs must plead facts showing that the defendants knew that the statements of opinion were untrue or disbelieved, as opposed to merely showing recklessness as nearly every appellate court has required under 10b-5, before having access to company documents, internal records, or a chance to depose any defendants. 

Importantly, however, state-of-mind requirements are not relevant under Section 11. Recklessness or scienter, actual knowledge or subjective falsity are all in direct contrast to Section 11’s strict liability provisions. As noted above, an important characteristic of Section 11 is strict liability imposed on the issuer, even for innocent misstatements. Accordingly, once a statement of opinion is determined to be objectively untrue or misleading, plaintiffs should not be required to plead subjective falsity. Any analysis with regard to the speaker’s state of mind is not relevant to impose liability, and therefore, does not need to be pleaded. 

Some argue that this will cause a “chilling effect” on communications between directors and investors. That may be the case. But, the chilling effect will likely be very limited. First, Section 11 does not prevent directors from providing opinions in a registration statement or in any other context. It simply provides that if an opinion is provided it should be not be misleading. The law says what it says. Issuers have been strictly liable under Section 11 since its adoption in 1933. At that time, Congress decided the responsibility to the public required stricter liability. See H.R. Rep. No. 85, 73d Cong., 1st Sess., 9 (1933) (Section 11 creates “correspondingly heavier legal liability” in line with responsibility to the public). Any chilling effect on statements made in a registration is a small price to pay for assuring that all statements contained in a registration statement are true and not misleading. 

Second, a registration statement requires certain disclosures to be made which the law presumes are sufficient to protect investors purchasing securities in connection with a registration statement. To the extent that directors or others choose to disclose additional information in a registration statement they do so at their own peril. This standard does not change any rules or requirements outside of the specific context Section 11 applies to. Outside of statements in a registration statement the legal requirements or lack thereof to successfully plead securities fraud will not change. Thus, the “chilling effect” will be extremely limited in nature. For example, in the hypothetical above, if Director B made the same statement on a television program, as opposed to in the registration statement, Director B would not be liable under Section 11. That is because the registration statement does not “contain” the untrue or misleading statement. In that context, if plaintiff brought a securities fraud action, it would likely be under Rule 10b-5, and thus plaintiff would be required to plead scienter, and if Director B truly believed the opinion at the time it was made he or she would not be liable for securities fraud under Rule 10b-5.

Hopefully, the Supreme Court will recognize that the text of Section 11 along with the Court’s own precedent show plaintiffs do not need to plead “subjective falsity” in Section 11 claims to survive a motion to dismiss.

Samuel L. Moultrie

Attorney, O’Kelly Ernst & Bielli, LLC

Samuel L. Moultrie practices at O’Kelly Ernst & Bielli, LLC, in Wilmington, Delaware. The opinions expressed in this article are those of the author and do not necessarily reflect the views of O’Kelly Ernst & Bielli, LLC, or its clients.