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From Securities Regulation Daily, March 24, 2015

High Court clarifies Section 11 liability

By Mark S. Nelson, J.D.

The Supreme Court today explained how to apply Securities Act Section 11 to a complaint based on allegations that opinion statements ran afoul of the federal securities laws. While all nine justices agreed that Omnicare’s legal compliance statements did not contain an untrue statement of material fact, Justices Scalia and Thomas concurred in order to distance themselves from the majority’s view of Section 11’s omissions prong. Ultimately, the majority decided to vacate the Sixth Circuit’s opinion and send the case back to the lower courts regarding the plaintiffs’ omissions theory (Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, March 24, 2015, Kagan, E.).

Court gives anatomy lesson. The seven-justice majority, led by Justice Kagan, began its analysis by giving an object lesson in Securities Act anatomy. The majority disagreed with the Sixth Circuit’s and the district court’s handling of the fund plaintiffs’ Section 11 claims in a single, overarching manner. Instead, the Court said Section 11 has two distinct parts, and the Court treated each one in turn today.

First, the Court said Omnicare’s musings about legal compliance were “pure statements of opinion” for purposes of Section 11’s first part, which imposes liability for untrue statements of material fact. According to the Court, the fund plaintiffs who sued Omnicare cannot invoke two theories of liability the majority outlined in its opinion because the funds never disputed that Omnicare “honestly held” its opinions, and the funds disclaimed any fraud-based claims. Justice Kagan would later note that Omnicare’s view would “punch a hole in [Section 11] for half-truths” in contravention of Congress’s and the Roosevelt Administration’s view upon the enactment of the Securities Act in 1933 that “literal accuracy” was insufficient to meet the laws’ requirements (i.e., one cannot say one thing and yet withhold another).

The majority said Congress had already incorporated “facts” into the first part of Section 11 by not ending the relevant sentence in the law after the phrase “untrue statements.” Justice Kagan, who recently drew attention for her reference to Dr. Seuss in her dissent in Yates (definition of tangible object), said today it would be almost “silly” to have to lean on definitions of “fact” (something certain) and “opinion” (something uncertain) because people generally know the difference between them.

Reading Section 11 as enacted by Congress, the majority suggested that liability could exist for an opinion under the law’s false-statement prong if the speaker did not sincerely hold the stated belief. The Court also said liability might exist for an opinion that had facts “embedded” in it. Here, the speaker could be liable for not believing the statement or if the supporting facts were untrue.

But second, the case must go on because the funds also invoked Section 11’s omissions prong. The majority rejected Omnicare’s broad view that a speaker’s mindset cannot result in Section 11 liability (if genuinely held), regardless of any omitted facts, because that argument goes “too far.”

The Court then turned to the principle of reasonableness, a position advocated by the government as amicus in the case at oral argument, in order to set out some guidelines for handling Section 11 omissions cases. For one, a reasonable person grasps the differences between facts and opinions (perhaps more true when reading a “word-smithed” registration statement, noted Justice Kagan). But a speaker cannot be liable for an opinion only because it turns out to be wrong based on external facts.

Rather, a reasonable person may be concerned about how the speaker formed her opinion. On this point, the majority noted that the omission from a registration statement of material facts regarding the speaker’s inquiry in that opinion may result in Section 11 liability if they are at odds with a reasonable investor’s understanding of the registration statement. Still, a reasonable investor does not expect all facts known to a speaker to back her opinion. A footnote observed that “specificity” can inform a reasonable investor about the basis for an opinion; the more detailed the opinion, the more likely it has a more extensive basis.

The majority also said “context” is key. “So an omission that renders misleading a statement of opinion when viewed in a vacuum may not do so once that statement is considered, as is appropriate, in a broader frame,” said Justice Kagan. Section 11, she added, inherently looks to a reasonable person standard, which courts should be familiar with from other types of cases. Nor did the majority think its decision today would chill the types of disclosures investors may want to see in registration statements. According to the majority, Omnicare “way overstates” the risk to issuers from Section 11. By contrast, the majority said Omnicare’s view could result in near “carte blanche” for issuers’ opinions in registration statements.

On remand, the majority directed the lower courts to look at whether the funds identified any fact(s) that had been omitted by Omnicare. The lower courts also must carefully review an attorney’s warning about Omnicare’s heightened compliance risk (mentioned at oral argument) before asking if the alleged omission made Omnicare’s legal compliance opinions misleading because they lacked the basis a reasonable investor would demand.

The concurrences. Justice Scalia concurred in part and in the judgment, but wrote separately to expose the logical limits (as he sees them) of the majority’s opinion. He began by noting that the Court’s opinion gives weight to many “collateral facts” that neither he nor the common law would recognize. As an example, Justice Scalia said it is difficult for a plaintiff to meet the common law equivalent tort, which treated certain phrases (e.g., “I believe” or “in my estimation”) as disclaimers of factual assertions.

Justice Scalia also said the majority’s emphasis downplayed “common sense” understandings about statements of opinion. The gist of his view is that general statements of legal compliance should not be read to imply factual assertions about the speaker’s underlying investigation prior to stating an opinion.

“The effect of the Court’s rule is to adopt a presumption of expertise on all topics volunteered within a registration statement,” said Justice Scalia. He would accept this presumption for required disclosures in a registration statement because the company’s mangers are experts on those topics. But he said volunteered disclosures about legal compliance, couched in the language of a disclaimer, should tip off readers that the volunteered data is beyond the speaker’s expertise.

But the majority disagreed with Justice Scalia’s use of the common law. The Court said it believes Justice Scalia’s discussion of expertise backs, rather than undermines, the majority’s view. The majority also said Justice Scalia’s emphasis on the common law notion of intent to deceive was misplaced because Section 11 can result in liability for omissions that make statements misleading, regardless of the speaker’s mindset. In other words, the common law may be informative, but it does not alter the strict liability character of Section 11.

Likewise, Justice Thomas agreed with the majority’s conclusion that Omnicare’s statements contained no untrue statements of material fact. But he only concurred in the Court’s judgment because he felt the majority should not have ventured into legal theories about omissions that were not squarely before the Court.

Justice Thomas would have the lower courts first decide the question of what types of omissions can make a statement of opinion misleading. He said the majority admitted this question had not been decided by the lower courts in Omnicare. He also reiterated Justice Scalia’s observation that it is unclear how far the majority’s liability theory may reach. Moreover, he advised lower courts to pay attention to the majority’s caveat to always think of how an opinion fits into a “broader frame” of reference.

For its part, the majority disputed Justice Thomas’s claims in the first of its eleven footnotes. According to the majority, neither the plaintiffs’ inartfully drafted complaint nor the lower courts’ singular treatment of the alleged misstatements and omissions should restrain the Court’s analysis of either issue. The majority also noted that omissions were the “crux” of the case and that Omnicare did not object to the Court’s taking up the omissions theory, which the majority noted had a “starring role” during oral argument.

The case is No. 13-435.

Attorneys: Kannon K. Shanmugam (Williams & Connolly LLP) and Linda T. Coberly (Winston & Strawn LLP) for Omnicare, Inc. Eric A. Isaacson (Robbins Geller Rudman & Dowd LLP) and Thomas C. Goldstein (Goldstein & Russell, P.C.) for Laborers District Council Construction Industry Pension Fund.

Companies: Omnicare, Inc.; Laborers District Council Construction Industry Pension Fund

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