November 20, 2014 Trial News
Supreme Court debates proof standard in securities fraud case
Alyssa E. Lambert
The U.S. Supreme Court heard oral arguments earlier this month in a case involving §11 of the Securities Act of 1933, which provides a remedy for investors who purchase securities pursuant to a registration statement that contains an untrue statement of material fact or omits a material fact. The Court has decided more than a dozen securities fraud cases since 2005, so attorneys were not surprised when it granted certiorari in this case last March. Although the Court previously held that §11 imposes strict liability against the issuer, it debated at oral argument whether a plaintiff must show only that an opinion statement was untrue or show that the company knew the statement was false at the time it was made. (Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, No. 13-435 (U.S. oral arg. Nov. 3, 2014).)
The Sixth Circuit had held that proof that the opinion was objectively false was sufficient. Omnicare appealed that decision, arguing the speaker must disbelieve a statement of opinion for it to be actionable under §11. At oral argument, none of the Supreme Court justices seemed swayed by Omnicare’s argument and focused on the idea that an opinion that summarizes objective facts must have a reasonable basis—a decision that would be favorable to plaintiff investors.
In December 2005, Omnicare—the leading U.S. pharmaceutical services provider for elderly residents in long-term care facilities—sold 12.8 million shares of common stock in a public offering. As part of the public offering, Omnicare filed a registration statement with the Securities and Exchange Commission (SEC) that said the company “operated within the law” and that its drug company contracts were “legally and economically valid arrangements.”
However, the Department of Justice (DOJ) and several states sued Omnicare for paying kickbacks to nursing homes and receiving kickbacks from drug companies for switching patients from less expensive to more expensive drugs. Omnicare also promoted certain drugs for off-label use and submitted false claims to Medicare and Medicaid. It paid nearly $150 million to settle these whistleblower claims.
In 2006, several pension funds sued Omnicare for violating §11 and other federal securities laws based on its false statements. The district court dismissed the class action, ruling the plaintiffs had failed to plead that Omnicare knowingly made an untrue statement.
The Sixth Circuit reversed, concluding that the plaintiffs had to show only that the statement was objectively untrue, not that Omnicare knew it was false at the time it was made. “Section 11 provides for strict liability and does not require a plaintiff to plead a defendant’s state of mind,” the court held. While issuers can be held strictly liable, other defendants, such as directors, underwriters, and accountants, can offer an affirmative defense: They believed the statements were true and, after diligent investigation, they had a reasonable basis for that belief.
Acknowledging its decision conflicted with the Second and Ninth Circuits, the Sixth Circuit noted those rulings relied on the Supreme Court’s 1991 decision in Virginia Bankshares, Inc. v. Sandberg, which should not apply. In that case, the Court held that corporate directors’ subjectively false statements of opinion or belief must be objectively misleading to be actionable under §14(a) of the Securities Exchange Act of 1934.
In March, the Court granted Omnicare’s petition for certiorari, and groups such as the U.S. Chamber of Commerce filed amicus briefs in support, arguing the Sixth Circuit’s ruling makes it too easy for investors to bring securities class actions.
During oral argument, Omnicare argued Virginia Bankshares should apply, contending that the registration statement’s assurances about the legality of its operations were merely a matter of “opinion,” which cannot be considered materially misleading under §11, absent allegations showing each defendant’s personal subjective knowledge of the falsity.
Nicholas Saharsky, who argued on the DOJ’s behalf, disagreed with Omnicare. “The SEC does really view this as a problem . . . the petitioner’s idea that you can just put ‘we believe’ in front of something and then not have any need to make an investigation into it or see whether it has a [reasonable] basis,” he said.
The government argued a middle-of-the road approach, but one that is in the shareholders’ favor: Statements made in a registration statement must have a reasonable basis. Saharsky said the Court should adopt this standard and vacate and remand to allow the plaintiffs to replead the claim. “A lack of a reasonable basis,” when issuing a statement, such as omitting a crucial fact, “make[s] the statement about the opinion misleading,” he said.
The justices seemed inclined to adopt the government’s position and gave short shrift to Omnicare’s argument, which the plaintiffs argued—and the Court acknowledged—would undermine the purpose of §11.
“Why is it a strict liability statute? Because Congress had some understanding, number one, that it was the issuer who knows the facts, not the readers; and number two, that it is awfully hard to show subjective intent,” Justice Elena Kagan said.
San Diego attorney Eric Isaacson, cocounsel for the plaintiffs, is optimistic that the Court will adopt the reasonable basis standard. “Adoption of the objective belief standard would be a victory for the plaintiffs in the case and investors in general,” he said. “The judgment of the Sixth Circuit was correct: It properly rejected the defendant’s contention that subjective knowledge was required. But whether we get an affirmance or a vacate and remand, I don’t think you can predict. What really matters is the standard adopted by the Court.”