In a matter of first impression in the Ninth Circuit, the court applied the Supreme Court’s Omnicare standard for pleading the falsity of a statement of opinion to a Section 10(b) claim in City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc., — F.3d —, 2017 WL 1753276 (9th Cir. May 5, 2017).

The litigation arose from Align’s $187.6 million acquisition of Cadent Holdings, Inc. in April 2011, and Align’s alleged failures to properly assess and write off the goodwill associated with the acquisition. Align’s statements regarding the fair value of goodwill, of course, were quintessential statements of opinion, because they were inherently subjective. In Omincare, the Supreme Court set the standard for pleading the falsity of an opinion claim under Section 11. Many practitioners, including Lane Powell’s securities litigation team, had opined—and the Second Circuit and other courts had held—that the rationale of Omnicare should equally apply to Section 10(b) claims, since the falsity element is the same. In Align, the Ninth Circuit agreed, and partially overturned a previous Ninth Circuit case that permitted plaintiffs to plead falsity by alleging that “there is no reasonable basis” for the defendant’s opinion.

Align’s accounting for the acquisition resulted in $135.5 million of goodwill, $76.9 million of which was attributable to one of Cadent’s business units (the “SCCS unit”). The plaintiffs alleged that the purchase price, and thus the goodwill, was inflated due to Cadent’s channel stuffing practices prior to the acquisition, and that the defendants must have known as much after performing their due diligence. Following the acquisition, the SCCS unit’s financial results suffered due to numerous factors. Nevertheless, at the end of 2011, Align found no impairment of its recorded goodwill. Align did not perform any interim goodwill testing in the first or second quarters of 2012. Id. at *2-3.

On October 17, 2012, Align finally announced it would be conducting an interim goodwill impairment test for the SCCS unit, which it said was triggered by the unit’s poor financial performance in the third quarter of 2012 and the termination of a distribution deal in Europe. That announcement led to a 20% hit to Align’s stock price. On November 9, 2012, Align announced a goodwill impairment charge of $24.7 million, and it announced subsequent goodwill charges in the following two quarters. Id. at *3. The plaintiffs alleged that the defendants made seven false and misleading statements concerning the goodwill valuation between January 30, 2012 and August 2, 2012. The plaintiffs’ allegation was that defendants deliberately overvalued the SCCS goodwill, thereby injecting falsity into statements concerning the goodwill estimates and the related financial statements. The district court dismissed the complaint with prejudice for failing to adequately plead falsity and scienter. Id. at *4.

At issue in the Ninth Circuit was whether the plaintiffs had adequately pled that Align’s statements were false. The first question was what analytic framework applied. The plaintiffs did not dispute that five of the seven statements at issue were pure statements of opinion. However, with respect to two statements, the plaintiffs alleged the opinions contained “embedded statements of fact.” Those statements were that “there were no facts and circumstances that indicated that the fair value of the reporting units may be less than their current carrying amount,” and that “no impairment needed to be recorded as the fair value of our reporting units were significantly in excess of the carrying value.” The Court held that the former statement was an opinion with an embedded statement of fact, but that the latter was an opinion. Id. at *5.

The Court also addressed the proper pleading standard for falsity of opinion statements. The panel concluded that Omnicare established three different standards depending on a plaintiff’s theory:

  1. Material misrepresentation. Plaintiffs must allege both subjective and objective falsity, i.e., that the speaker both did not hold the belief she professed, and that the belief was objectively untrue.
  2. Materially misleading statement of fact embedded in an opinion statement. Plaintiffs must allege that the embedded fact is untrue.
  3. Misleading opinion due to an omission of fact. Plaintiffs must allege that facts forming the basis for the issuer’s opinion, the omission of which makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.

Importantly, the Ninth Circuit extended this Omnicare holding from the Section 11 context to the Section 10(b) and Rule 10b-5 claims at issue in Align. Id. at *7. In doing so, the Ninth Circuit joined the Second Circuit in extending Omnicare in this regard. See Tongue v. Sanofi, 816 F.3d 199, 209-10 (2d Cir. 2016). Finally, the court overruled part of its previous holding in Miller v. Gammie, 335 F.3d 889, 900 (9th Cir. 2003) (en banc), which allowed for pleading falsity by alleging that there was “no reasonable basis for the belief” under a material misrepresentation theory. City of Dearborn Heights, 2017 WL 1753276, at *7.

Applying this pleading standard to the Align facts, the Ninth Circuit concluded that the plaintiffs had not met their pleading burden. Because the plaintiffs did not allege the actual assumptions the defendants relied upon in conducting their goodwill analysis, the court could not infer that the defendants intentionally disregarded the relevant events and circumstances. Accordingly, six of the seven statements that relied on the material misrepresentation theory failed to allege subjective falsity and were properly dismissed. Likewise, the failure to allege the actual assumptions used by the defendants prevented plaintiffs from pleading objective falsity as to the one statement of fact embedded in an opinion statement. Id. at *8-10.

After concluding that the plaintiffs failed to allege falsity, the Ninth Circuit went on to hold that plaintiffs had not alleged scienter against the defendants, providing a second ground for dismissing the complaint. At most, the plaintiffs alleged that the defendants violated generally accepted accounting principles, but such a failure does not establish scienter. Likewise, the stock sale allegations, core operations inference, the temporal proximity between the challenged statements and the goodwill write-downs, the CFO’s resignation, and the magnitude of the goodwill write-downs did not create an inference of scienter. Id. at *10-13.

Judge Kleinfeld concurred in the judgment. He would have upheld the district court’s dismissal based on scienter alone, leaving the weightier issue of falsity described above to a future case where such a decision was necessary. Id. at *13-14 (Kleinfeld, J., concurring in the judgment).

In Doshi v. Gen’l Cable Corp., ___ F.3d ___, 2016 WL 2991006 (6th Cir. May 24, 2016), the Sixth Circuit affirmed a district court order dismissing a securities fraud class action against a company and two of its executives, on the grounds that the complaint failed to plead facts sufficient to create a strong inference of scienter on the part of either the company or the individual defendants. In its holding, the Sixth Circuit refused to impute the state of mind of a senior non-defendant executive to the company for the purposes of scienter, because that executive had not made any false or misleading public statements.

Plaintiff alleged that General Cable and its CEO and CFO had violated Sections 10(b) and 20(a) of the Exchange Act, as well as Rule 10b-5, by acting at least recklessly in issuing or approving materially false public financial statements. Defendants countered that the misstatements were a product of accounting errors and theft in General Cable’s Brazilian operations, and that they had promptly remediated these problems upon learning of them. The district court granted defendants’ motion to dismiss, on the grounds that plaintiff had failed to plead scienter, and denied plaintiff’s request to file an amended complaint as futile.

In evaluating the district court’s rulings, the Sixth Circuit emphasized the standards set forth in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), which requires that allegations of scienter be assessed “holistically,” and that courts weigh the strength of scienter allegations against “plausible opposing inferences” of innocent conduct. Doshi, 2016 WL 991006 at *4 (quoting Tellabs, 551 U.S. at 323, 326). In performing the Tellabs holistic review, the Sixth Circuit examined the nine factors listed in its decision in Helwig v. Vencor, Inc., 251 F.3d 540, 552 (6th Cir. 2001) (en banc). These factors, which are not exhaustive, include the following:

(1) insider trading at a suspicious time or in an unusual amount; (2) divergence between internal reports and external statements on the same subject; (3) closeness in time of an allegedly fraudulent statement or omission and the later disclosure of inconsistent information; (4) evidence of bribery by a top company official; (5) existence of an ancillary lawsuit charging fraud by a company and the company’s quick settlement of that suit; (6) disregard of the most current factual information before making statements; (7) disclosure of accounting information in such a way that its negative implications could only be understood by someone with a high degree of sophistication; (8) the personal interest of certain directors in not informing disinterested directors of an impending sale of stock; and (9) the self-interested motivation of defendants in the form of saving their salaries or jobs.

Doshi, 2016 WL 2991006 at *4 (citing Helwig, 251 F.3d at 552).

Plaintiff’s scienter arguments as to General Cable turned in large part on the conduct of a non-defendant executive named Mathias Sandoval, who headed the “Rest of World” (“ROW”) division that included the company’s operations in Brazil. While the Sixth Circuit accepted plaintiff’s theory that Sandoval’s knowledge of the theft and accounting errors in Brazil could be imputed to General Cable, it cited its decision in Omnicare in refusing to impute Sandoval’s scienter to General Cable, because plaintiff had not alleged that Sandoval had drafted, reviewed, or approved General Cable’s erroneous public statements—in other words, that Sandoval had “made” a statement. Doshi, 2016 WL 2991006 at *5 (citing In re Omnicare, Inc. Sec. Litig., 769 F.3d 455, 476, 481 (6th Cir. 2014)). The court then concluded that seven out of the nine Helwig factors weighed against an inference of scienter on the part of the company. Although “one could infer that General Cable acted recklessly by issuing its public financial statements,” the court concluded, the facts alleged in plaintiff’s complaint established a stronger countervailing inference that the materially false statements were a product of theft and errors by local managers in Brazil and the legitimate freedom accorded to ROW to report financial data. Id. at *7.

Having concluded that plaintiff’s complaint failed to create a strong inference that General Cable acted with scienter, the Sixth Circuit turned to the two individual executive defendants. Although the court allowed that a holistic review of the facts lent “some support to an inference that [the executive defendants] consciously disregarded the obvious risks that each issued or authorized false public financial statements,” it once again concluded based on the Helwig factors that there was no strong inference of scienter, and that at most the alleged facts supported an inference that the two executives had been negligent in issuing or authorizing false statements. Id.

In considering plaintiff’s request to file an amended complaint, the Sixth Circuit evaluated plaintiff’s new proffered allegations, which included, inter alia, assertions that General Cable had disclosed FCPA violations in foreign countries that were not Brazil, and that the executive defendants could have lost previously-issued incentive compensation by disclosing the misstatements. The Sixth Circuit held that the district court had correctly decided that these proposed amendments would have been futile, given that the FCPA violations were unrelated to the theft and errors in Brazil, and the new incentive compensation allegations were too general to support a strong inference of scienter.