Argument preview: When is an opinion a fact for securities fraud purposes?

Securities fraud is back in the Supreme Court in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund. This time the question relates to Section 11 of the Securities Act of 1933, which provides for strict liability – indeed almost absolute liability – if a registration statement for a public offering contains an untrue statement of a material fact. In contrast to liability under Rule 10b-5, there is no general requirement of scienter under Section 11 since the 1933 Act in essence requires disgorgement by companies that raise capital by false pretenses and is thus focused on unjust enrichment (rather than losses suffered by investors in the trading market).

The nice question raised by Omnicare is whether a statement of opinion or belief constitutes an “untrue statement of a material fact” when the stated belief turns out to have been mistaken. Although one might object that an opinion is not a fact, the Court has held that an opinion can be a fact when it is the sort of opinion that can be presumed to have a reasonable basis in fact, such as when the board of directors of a corporation tells its stockholders that the price offered in a merger is high or attractive or fair. In other words, it is a fact that the board of directors has expressed an opinion that should reflect its investigation of the facts.

To set the stage for this case, Omnicare is the largest provider of pharmacy-related services for the elderly and other residents of long-term care facilities in the United States. In December 2005, Omnicare sold 12.8 million shares of common stock in a registered public offering. Since Omnicare was already publicly traded, the registration statement was filed on the SEC Form S-3, a streamlined form that permits publicly traded companies to offer additional stock to the public by relying on disclosures in its periodic filings with the SEC (such as Form 10-K).

In describing its business as required by SEC rules, Omnicare expressed its belief that its practices complied with the law. For example, in its 2004 Form 10-K, Omnicare stated:

We believe our contract arrangements with other healthcare providers, our pharmaceutical suppliers and our pharmacy practices are in compliance with applicable federal and state laws. These laws may, however, be interpreted in the future in a manner inconsistent with our interpretation and application.

It turned out that Omnicare was not in compliance with the law (assuming the truth of the complaint). It was involved in a scheme under which Johnson & Johnson paid kickbacks in exchange for Omnicare pharmacists persuading doctors to prescribe Risperdal and other J&J drugs to nursing home patients. Following a whistleblower lawsuit (known as a qui tam action), Omnicare agreed to settlements with government agencies totaling almost $200 million, but without admitting or denying guilt.

Predictably, investors filed various securities fraud class actions based on the false statements relating to legal compliance. When the smoke cleared after numerous motions and appeals, what remained was a Section 11 claim based on the 2005 offering. Omnicare moved to dismiss the complaint for failure to state a claim, and the district court granted the motion, holding that plaintiffs had failed to plead a Section 11 claim because they had not alleged that Omnicare did not believe that it was in legal compliance. The Sixth Circuit reversed.

The Sixth Circuit acknowledged that its decision created a conflict with decisions in the Second and Ninth Circuits holding that liability for a statement of opinion or belief under Section 11 lies “only to the extent that the statement was both objectively false and disbelieved by the defendant at the time it was expressed.” But the court noted that those decisions had relied on Virginia Bankshares, Inc. v. Sandberg, a case arising under Section 14(a) of the 1934 Act (addressing proxy fraud) in which the Court held that a statement of opinion may be actionable as one of fact when the opinion is one that should be based in facts known to the speaker and the evidence indicates that the speaker did not believe the opinion expressed.

In essence, the Sixth Circuit reasoned that scienter is not required under Section 11 of the 1933 Act and thus is not required for an opinion of the sort that should be based on fact – call it an opinion-fact. In contrast, Omnicare argues that contrary belief is part of the definition of an opinion-fact. In other words, an opinion is an opinion when truly held, but it becomes a fact when falsely stated. So stated, it is difficult to imagine that the Supreme Court will not ultimately affirm.

Moreover, as the Sixth Circuit pointed out, in Virginia Bankshares, the Supreme Court was dealing with a case in which a jury had found that the defendant did not believe its statement that the price offered in the merger was in fact a high price. So it is not clear that the Supreme Court even intended the defendant’s belief to be treated as part of the definition of an opinion-fact. It may rather have been a mere statement of fact that the opinion was not in fact believed by the defendant.

The issue in Omnicare is further complicated by other factors.

First, liability under Section 14(a) falls somewhere between Section 11 and Rule 10b-5. Again, Section 11 provides expressly for a private cause of action based on notions of strict liability. Rule 10b-5 gives rise to an implied private right of action and as such has been held to require scienter. In other words, a plaintiff must allege and prove that the defendant intended to deceive – that the defendant spoke with some sort of knowledge (or at least recklessness) that the statement was false. Moreover, the plaintiff must prove reliance and loss causation.

Section 14(a) and Rule 14a-9 thereunder also give rise to an implied cause of action, but most courts have not required scienter because disclosure is mandatory for proxy solicitation purposes. And the Supreme Court has expressly declined to rule on the question.

Second, and closely related, it is arguable that the Omnicare statements about legal compliance were voluntary in some sense. To be sure, the decision to speak at all triggers a duty to speak the truth. But if the statement is outside the four corners of what is required under the 1933 Act – if there is not duty to speak – it may not be one that entails strict liability. Indeed, the idea of an opinion-fact is based on some sort of duty owed by the speaker – such as the fiduciary duty owed by directors and officers to stockholders.

Finally, it is not at all clear that opinion-facts will always be material facts. Although Section 11 does not require scienter or reliance, it does require materiality. And whether a fact is material may depend on whether investors are likely to rely on it. In this case, it is not clear that the statements relating to legal compliance would be considered as all that important by investors. Rather, they might well be interpreted to mean that the directors and officers of Omnicare did not know of any legal violations at the time. But it might not have been taken as any sort of representation that they had made a positive investigation into the matter or as some sort of guarantee of future compliance. In other words, it is not very likely that an investor would put much stock in the statements made by Omnicare about compliance – at least not so much that this statement would have made the difference for even one investor in deciding whether to buy.

On the other hand, Omnicare is a Delaware corporation, and Delaware law clearly requires that the board of directors establish and enforce reporting procedures that are adequate to assure that they will be informed about the operation of the business to the extent necessary. And where the business is subject to thoroughgoing regulation as is Omnicare – and the danger of criminal behavior among the employees such as with kickbacks – it is quite clear that the board of directors must assure themselves that they are informed about compliance. Moreover, it is often important for corporations to be able to speak to the market through opinions and beliefs because to state the underlying facts may divulge sensitive information to the competition. So business has a strong interest in legal rules that permit investors to rely on management opinions when necessary.

The bottom line is that if I had to guess how this one will turn out, I would guess that the Court will affirm the general rule that scienter is not required under the 1933 Act even for opinions that are required to be expressed in a registration statement thereunder but will find some way to hold that these statements were voluntary statements of opinion that should be viewed as outside the ambit of strict liability.

[Disclosure: Goldstein & Russell, P.C., whose attorneys contribute to this blog in various capacities, is among the counsel to the respondents in this case. However, the author of this post is not affiliated with the firm.]