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From Securities Regulation Daily, May 28, 2013

Knowledge of Wrongdoing Not Required for Section 11 Claims

By Rodney F. Tonkovic, J.D.

A Sixth Circuit panel held that it was inappropriate for a district court to require plaintiffs to plead knowledge in connection with their Section 11 claim. Securities Act Section 11 provides for strict liability and does not require a plaintiff to plead a defendant’s state of mind (Indiana State District Council of Laborers and Hod Carriers Pension and Welfare Fund v. Omnicare, Inc., May 23, 2013, Cole, R.).

Background. The complaint alleged that a provider of pharmaceutical care services, Omnicare, Inc., and several of its officers and directors had engaged in a fraudulent scheme that artificially inflated the company’s stock price. The Section 11 claim was based on alleged violations resulting from a kickback scheme involving the submission of false claims to Medicare and Medicaid. The investors alleged that Omnicare made statements regarding its compliance with the law and business practices that made its registration statement false and misleading. The complaint alleged further that Omnicare failed to comply with GAAP to the extent that its financial statements substantially overstated its revenue.

The District Court for the Eastern District of Kentucky dismissed the claim, finding, among other conclusions, that the investors had failed to plead loss causation. The Sixth Circuit then determined that the district court had erred by requiring the investors to plead loss causation in order to state their Section 11 claim. On remand, the complaint was again dismissed after the district court concluded that the claim sounded in fraud. The district court also held that the investors were required, but failed, to plead knowledge of falsity on the part of the defendants.

Strict liability under Section 11. On appeal, the investors argued that Section 11 provides for strict liability and that it was inappropriate for the district court to require them to plead knowledge. The panel agreed. Section 11 provides for the imposition of liability if a registration statement contains an untrue statement of a material fact or omission and does not require a plaintiff to plead a defendant’s state of mind.

Omnicare argued that there are parallels between the Exchange Act’s antifraud provisions and Section 11. Statements regarding legal compliance are considered to be “soft information” that are generally not required to be disclosed, the panel noted. A defendant that is completely silent regarding soft information cannot be held liable for an omission.

In this case, however, Omnicare disclosed some “soft information” on legal compliance, and these statements were addressed by the panel in an earlier decision on the complaint’s Exchange Act fraud claims. In the earlier decision, the panel concluded that plaintiffs in Section 10(b) and Rule 10b-5 cases are required to adequately plead that the defendants knew the statements were false when made but that the investors here had failed to do so. The panel based its reasoning on decisions from other circuits stating that “soft information” becomes “hard facts” when knowledge of falsity is shown, and the duty to disclose and liability for false information attaches.

Omnicare argued that the same reasoning should apply under Section 11, but the panel disagreed. According to the panel, Section 11 provides for strict liability, and “once a false statement has been made, a defendant’s knowledge is not relevant to a strict liability claim.” The framing of the issue as a disclosure requirement was irrelevant, the panel continued: "if the defendant discloses information that includes a material misstatement, that is sufficient."

The panel then declined to follow Second and Ninth Circuit cases that impose a knowledge-of-falsity requirement upon Section 11 claims. These cases, the panel wrote, were a stretch of the Supreme Court’s holding in Virginia Bankshares, Inc. v. Sandberg. Virginia Bankshares, the panel explained, discussed the requirement to plead objective falsity in order to state a claim in the context of Section 14(a) and did not address knowledge of falsity. This decision, the panel stated, has very limited application to Section 11, which already creates strict liability.

Turning to the GAAP claims, the panel found that the district court again erred in requiring the investors to plead knowledge of falsity. The GAAP allegations concerned hard information, the panel said, and would not require pleading knowledge of falsity “under any standard.” The investors, however, failed to plead the GAAP claims with the required particularity under Rule 9(b). The details of the accounting violations were unclear, the panel concluded.

The panel reversed the district court with regard to the legal-compliance claims and remanded for proceedings consistent with its opinion. The district court’s dismissal of the GAAP-based claims was affirmed.

The case is No. 12-5287.

Attorneys: Eric Alan Isaacson (Robbins, Geller, Rudman & Dowd) for Indiana State District Council of Laborers and HOD Carriers Pension and Welfare Fund, Cement Masons Local 526 Combined Funds and Laborers District Council Construction Industry Pension Fund. Harvey Kurzweil (Winston & Strawn) and Michael Eugene Nitardy (Frost Brown Todd) for Omnicare, Inc., Joel F. Gemunder, David W. Froesel, Jr., Cheryl D. Hodges, Edward L. Hutton and Sandra E. Laney.

Companies: Omnicare, Inc.

MainStory: TopStory FraudManipulation KentuckyNews MichiganNews OhioNews TennesseeNews

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