Section 11 and Auditors' "Opinion" Statements

Section 11’s Application to “Opinion” Statements
Section 11 of the Securities Act provides a cause of action to investors who can prove that a registration statement “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). Those potentially liable under section 11 include every person who signed the registration statement, every director or partner of the issuer at the time of the filing, every underwriter and, as relevant here, every accountant who consented to being named as having prepared or certified any part of the registration statement. Id. at § 77k(a)(1)-(5). Independent auditors who consent to being named as having prepared financial statements that are later included in a registration statement are frequent targets under section 11.

Though section 11 explicitly refers to an untrue or omitted statement of “material fact,” an opinion contained in a registration statement can create similar liability for the registrant and those other statutorily enumerated parties. Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1090 (1991). Indeed, at the time Congress passed the Securities Act, future Supreme Court justice William O. Douglas observed, and perhaps predicted, that some parts of a financial statement may be “within the realm of opinion.” William O. Douglas and George E. Bates, “The Federal Securities Act of 1933,” 43 Yale L. J. 171 (1933). One court described a materially misleading opinion statement in another context by saying, “the misrepresentation is not the opinion, but is the speaker’s assertion that he or she believes the opinion, which is a question of existing or pre-existing fact.” Ohio Police & Fire Pension Fund v. Standard & Poor’s Fin. Servs., 700 F.3d 829, 842 (6th Cir. 2012).

To successfully allege that an “opinion” statement is materially misleading under section 11, the plaintiff must allege that the opinion was both objectively and subjectively false. Virginia Bankshares, 501 U.S. at 1095–96. Notably, the Supreme Court in Virginia Bankshares held only that subjective falsity alone is insufficient to establish a claim. But most lower courts have since interpreted Virginia Bankshares as requiring a dual showing of objective and subjective falsity. See, e.g., Fait v. Regions Fin. Corp., 655 F.3d 105, 110 (2d Cir. 2011); Rubke v. Capital Bancorp, Ltd., 551 F.3d 1156, 1162 (9th Cir. 2009); MHC Mut. Conversion Fund, L.P. v. United W. Bancorp, Inc., No. 11-cv-00624, 2012 WL 6645097 (D. Colo. Dec. 19, 2012).

The Expansion of What Constitutes an Opinion Statement
Numerous lower courts have long required subjective and objective falsity when a plaintiff alleges that an opinion is materially misleading. But these early cases primarily addressed conclusory opinions about the value of a merger or transaction or the expectation about future operations. See, e.g., Rubke, 551 F.3d at 1162 (fairness opinion); In re IBM Sec. Litig., 163 F.3d 102, 107 (2d Cir. 1998) (“projections of future performance” under Rule 10b-5); Freedman v. Value Health, Inc., 958 F. Supp. 2d 745, 752–53 (D. Conn. 1997) (fairness opinion). Only recently have courts considered whether financial-statement line items constitute an opinion for purposes of section 11 pleading, and thus, whether an accountant’s representation regarding its “opinion” can lead to section 11 liability. At least two courts have now held that certain financial-statement line items are “opinions” such that a plaintiff must allege that the financial-statement account was objectively and subjectively false.

In Fait v. Regions Financial Corp., the Second Circuit addressed whether goodwill and the loan-loss reserve were balance sheet “opinions.” As to goodwill, the court recognized that “[e]stimates of goodwill depend on management’s determination of the ‘fair value’ of the assets acquired and liabilities assumed, which are not matters of objective fact.” 655 F.3d at 110. Likewise, the Second Circuit found that a loan-loss reserve is similarly subject to the opinion of the accountant and registrant. That is, “loan loss reserves reflect management’s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible.” Id. at 113. Because both determinations were “inherently subjective,” the Second Circuit held that matters of opinion are actionable only if the statements “misstate the opinions or belief held, or, in the case of statements of reasons, the actual motivation for the speaker’s actions, and are false or misleading with respect to the underlying subject matter they address.” Id. at 111.

The District of Colorado faced a similar issue in MHC Mutual Conversion Fund, L.P. v. United W. Bancorp, Inc. There, the plaintiffs alleged that United Western Bancorp’s registration statement materially misstated the value of certain collateralized mortgage obligations and mortgage-backed securities. Specifically, the plaintiffs alleged that United Western Bancorp failed to timely recognize as much as $69 million in other-than-temporary impairment (OTTI), which improperly inflated the value of the underlying securities. The court ruled that the OTTI account balance constituted an opinion. In so doing, the court reasoned, all impairment analysis requires the issuer to determine an asset’s fair value, which itself takes into account such subjective indicia as “market forces, market trends, and buyers’ whims,” and it also observed that the issuer must subjectively assess its “expectation” as to whether it will recover the security’s amortized cost. 2012 WL 6645097, at *8.

The Future of Financial Statement Opinions
The MHC Mutual and Fait decisions are significant because they continue a recent trend in holding that section 11 claims relating to financial-statement amounts—if deemed to be matters of opinion—require allegations of objective and subjective falsity. Because parties frequently attack OTTI, goodwill, and, more generally, assets subject to significant impairment in litigation of this sort, these decisions are likely to have a significant impact in many other cases in which plaintiffs allege section 11 claims against their outside auditors, based on alleged misstatements made in registration statements and incorporated audit reports.

Notably, both courts relied heavily on the fair-value assumptions inherent in the calculation of goodwill, loan-loss reserves, and OTTI. But those are not the only financial-statement accounts or decisions that require significant valuation assumptions. Indeed, numerous accounts require some subjective assessment that necessarily makes that account an “opinion.” The following list—by no means exhaustive—is just an example of the types of financial-statement accounts that require some type of subjective input: bad debt reserve, inventory-spoliation reserve, pension obligations, stock-option expense under a Black-Scholes pricing model, fixed-asset impairment, and deferred income taxes. Additionally, there are some subjective decision points as to whether to classify certain assets or liabilities as current or long-term.

Ultimately, a significant number of financial-statement accounts and decisions require some degree of subjective input. If Fait and MHC Mutual are to serve as any guide, plaintiffs pursuing a section 11 claim against the registrant’s auditors must now plead that any material misstatement to such an account is both subjectively and objectively false.

Keywords: professional liability litigation, section 11, Securities Act, opinion statements, objective falsity, subjective falsity, outside auditors, registration statements, audit reports

Dana S. Douglas is a partner and Michael Rowe is an associate of Mayer Brown LLP in Chicago, Illinois.