9th Circuit extends Omnicare’s heightened pleading standard for opinion statements to securities fraud claims under Section 10(b) and Rule 10b-5
- The U.S. Court of Appeals for the 9th Circuit held that the heightened pleading standards for opinion statements established by the Supreme Court’s 2015 Omnicare decision are not limited to Section 11 claims—they extend to Section 10(b) and Rule 10b-5 claims as well.
- To plead falsity of opinion statements under a material misrepresentation theory, plaintiffs in the 9th Circuit cannot rely on allegations demonstrating that the speaker had “no reasonable basis” for the expressed belief. Rather, plaintiffs must allege that the speaker actually did not believe that the statement was true.
- The 9th Circuit’s decision clarifies that Omnicare applies not only to alleged misstatements and omissions in registration statements subject to Section 11, but to any alleged misstatements or omissions made in connection with the purchase or sale of securities subject to Section 10(b) and Rule 10b-5.
In City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology Inc. et al., No. 14-16814, the 9th Circuit affirmed the dismissal with prejudice of a pension fund’s securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, holding that the plaintiff failed to satisfy the pleading requirements established by Omnicare, Inc. v. Laborers District Counsel Construction Industry Pension Fund, 135 S. Ct. 1318 (2015) for allegedly false opinion statements. The 9th Circuit’s ruling clarifies that Omnicare, a case addressing Section 11, applies to Section 10(b) and Rule 10b-5 claims as well. The 9th Circuit expressly overruled Reese v. Malone, 747 F. 3d 557 (9th Cir. 2014), a Section 10(b) case decided prior to Omnicare, which had previously allowed plaintiffs to plead falsity of opinion statements by alleging that the speaker lacked a “reasonable basis” for the belief. Consistent with Omnicare, to state a claim under a material misrepresentation theory, plaintiffs in Section 10(b) cases must plead that the speaker actually did not believe the statement—not merely that the speaker had “no reasonable basis for the belief.” Such allegations, however, may suffice to state a Section 10(b) claim under an omissions theory of liability.
In a putative class action complaint, plaintiff City of Dearborn Heights Act 345 Police & Fire Retirement System (plaintiff) asserted securities fraud claims against defendant Align Technology, Inc. under Section 10(b) and Rule 10b-5, as well as a control person claim under Section 20(a) against the individual defendants. The lawsuit alleged that Align made several materially false and misleading statements regarding Align’s goodwill valuation of its subsidiary, Cadent Holdings, Inc., which Align acquired in March 2011 for $187.6 million. Plaintiff contended that, at the time of the acquisition, Align had derived the majority of that value from Cadent’s goodwill even though it knew that Cadent had artificially inflated its value. According to the complaint, it was not until October 2012 that Align began evaluating Cadent’s actual value, which led Align to announce that it would conduct goodwill impairment testing and other changes. Thereafter, Align announced a series of impairment charges reducing the value of the goodwill.
In August 2014, Judge Freeman of the U.S. District Court for the Northern District of California dismissed plaintiff’s claims with prejudice for failure to adequately plead falsity and scienter. Judge Freeman held that Align’s alleged misstatements regarding goodwill valuations were opinion statements because they “are inherently subjective and involve management’s opinion regarding fair value.” Plaintiff appealed, arguing, among other things, that the district court erred in at least two respects: (1) by construing certain alleged misstatements as opinions rather than statements of fact and (2) by applying Omnicare’s heightened pleading standard to plaintiff’s Section 10(b) claim.
9th Circuit Opinion
The 9th Circuit affirmed the district court’s ruling dismissing plaintiff’s claims. The appeals court first held that the district court properly characterized one of Align’s alleged misstatements—a qualitative assessment of Cadent’s fair value—as an opinion statement, since it could not be objectively verified. The court held that a different alleged misstatement—that there were no indications that the fair value may be less than the current carrying amount—was properly characterized as an opinion statement with an embedded statement of fact.
The court went on to analyze the appropriate pleading standards applicable to plaintiff’s Section 10(b) claim based on the alleged falsity of Align’s opinion statements. Although Omnicare concerned Section 11 claims, the 9th Circuit concluded that the Supreme Court’s reasoning was “equally applicable” to Section 10(b) and Rule 10b-5 claims. Under Omnicare, plaintiffs can plead falsity of opinion statements in three ways. First, when relying on a theory of material misrepresentation, the plaintiff must allege both that the “the speaker did not hold the belief she professed” and that the belief is objectively untrue. Second, when relying on a theory that an opinion contained an embedded statement of fact, the plaintiff must allege that the supporting fact is untrue. Third, when relying on a theory of omission, the plaintiff must allege that the undisclosed facts make the opinion statement “misleading to a reasonable person reading the statement fairly and in context.”
Having determined that Omnicare applies to Section 10(b) claims, the 9th Circuit determined that its prior holding in Reese conflicted with Omnicare in one important respect. Under Reese, a plaintiff could plead falsity of an opinion statement under a material misrepresentation theory by alleging that “there is no reasonable basis for the belief.” Because this would allow a plaintiff to plead falsity under a misrepresentation theory without alleging that the speaker actually believed that the statement was untrue, the 9th Circuit concluded that Reese was “clearly irreconcilable” with Omnicare and therefore overruled its prior decision.
Turning to plaintiff’s allegations against Align, the 9th Circuit affirmed the district court’s holding that the complaint failed to satisfy Omnicare’s pleading standards. Under Omnicare, plaintiff’s allegations that Align had “no reasonable basis” for its expressed belief that Cadent’s goodwill was such a high value were insufficient to plead falsity. Plaintiff failed to plead that Align did not actually believe that its opinion statements regarding Cadence’s goodwill were true. Plaintiff’s allegations fared no better when construed under an omissions theory because none of the alleged omissions called into question the issuer’s basis for offering the opinion.
The court went on to affirm the district court’s holding that complaint’s allegations of scienter were inadequate. Having held that plaintiff failed to plead the requisite elements of a primary securities violation, the court held that its Section 20(a) claim necessarily failed.
In a concurring opinion, Judge Kleinfeld stated that, while he “might well agree” that the Omnicare analysis applies to Section 10(b) cases, the district court should have avoided the issue and based its decision instead on plaintiff’s inadequate scienter allegations. In Judge Kleinfeld’s view, whether Omnicare overrules Reese is an “important and debatable question” due to the “considerable differences” between Sections 11 and 10(b).
The 9th Circuit’s ruling will likely make it more difficult for plaintiffs to allege securities fraud claims based on allegedly false or misleading opinion statements. As the Align decision illustrates, it can be more difficult to allege particularized facts showing that a speaker subjectively did not believe that its opinion statements were true than to allege that the speaker lacked a reasonable basis for the statement. The decision thus provides an additional tool to defendants in such cases in the 9th Circuit.
Moreover, by clarifying that Omnicare’s pleading standards apply not only to Section 11 claims, but also to Section 10(b) claims, the court’s ruling brings a larger swatch of cases within Omnicare’s scope. Whereas Section 11 concerns statements and omissions made in registration statements, Section 10(b) applies to any public statements or omissions made in connection with the purchase or sale of a security. According to a recent study, more than two-thirds of securities filings in the last five years involved Rule 10b-5 claims, while less than 15 percent of filings involved Section 11 claims during the same time period.
The 9th Circuit joins the 2nd Circuit in holding that Omnicare’s pleading standards apply to claims under Section 10(b). In other circuits, the issue remains unsettled, with at least one district court expressing doubt as to Omnicare’s application outside of the Section 11 context. See Firefighters Pension & Relief Fund v. Bulmahn, 147 F. Supp. 3d 493, 528 (E.D. La. 2015) (“That Omnicare concerned a strict liability statute suggests that the Supreme Court’s reasoning—which contemplates liability for statements of opinions that are genuinely held but misleading to a reasonable investor—does not directly apply to the statute at issue here.”). It remains to be seen how other circuits will come out on this issue.
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