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 a 91-page opinion covering several important securities-litigation issues, the Second Circuit upheld the district court’s partial judgment against Vivendi following a three-month jury trial that resulted in the jury finding Vivendi liable under Section 10(b) and Rule 10b-5.

As I was preparing to summarize the opinion for this blog, I read a summary by Wiley Rein’s David Topol and Jennifer Williams in Kevin LaCroix’s blog, The D&O Diary.  Their post is excellent and comprehensive.  So instead of publishing a separate summary, I obtained their permission to refer readers of this blog to their post:

Vivendi: A Victory for Plaintiffs on the Price Maintenance Theory and on Loss Causation .

The 11th Circuit ignored the potential application of the Supreme Court’s 2015 decision in Omnicare, and instead reached back to its own precedent dating from 1979, in holding that plaintiffs are foreclosed from bringing a claim that a company misled shareholders about its real motivations for engaging in a stock repurchase program.

In its per curiam unpublished opinion in Henningsen v. ADT Corp. (“ADT”), 2016 WL 4660814 (11th Cir. 2016), the 11th Circuit affirmed the dismissal of Section 10(b) claims against ADT and its CEO, and against Corvex Management LP, and its founder, Keith Meister.

Plaintiffs alleged that Corvex had acquired more than five percent of ADT’s stock in 2012, and that after that point, Meister was outspoken in his criticism of the Company, alleging that its stock was undervalued and urging management to take on more debt so it could repurchase shares, with a goal of increasing ADT’s stock price.

The complaint alleged that Meister threatened to call a shareholder vote to replace the board if the directors did not offer him a board position and agree to take out loans for significant stock buybacks.  ADT announced a plan to repurchase $2 billion of its common stock over three years after an initial meeting with Meister.  Soon afterward, Meister was given a position on the ADT board, and the Company continued to borrow more money to repurchase more stock, ultimately causing credit rating agencies to downgrade ADT’s credit rating and ADT’s share price to drop.  After this downturn, the complaint alleges that Meister pushed for ADT to repurchase more shares on an even more accelerated timeframe, and that the directors acquiesced after Meister promised to leave the board if they agreed with his plan.

In November 2013, ADT announced that it was repurchasing Corvex’s shares and that Meister was resigning from the board.  ADT stock price dropped 6% on this news, and dropped another 30% in the following months.  Plaintiffs filed suit, claiming that ADT and Corvex had misrepresented various issues and problems at the Company, and that they had misled shareholders by concealing that they had engaged in aggressive share repurchases to appease Meister and Corvex, instead characterizing the repurchase plan as “thoughtful,” “effective,” and “optimal.” Id. at *5.

The district court dismissed most of the claims for failure to sufficiently plead falsity and scienter, and rejected the “motivation” claim because it was barred by 11th Circuit precedent, namely Alabama Farm Bureau Mutual Casualty Co. v. American Fidelity Life Insurance Co., 606 F.2d 602, 610 (5th Cir. 1979).  The 11th Circuit affirmed.

In Alabama Farm, the court held that a company does not engage in “deception” under the securities laws by failing to “disclose [its] motives in entering a transaction,” and that Section 10(b) does not require “the disclosure of an individuals’ motives or subjective beliefs.” ADT, 2016 WL 4660814, at *4 (quoting Alabama Farm, 606 F.2d at 610).

In ADT, 11th Circuit found that this precedent foreclosed plaintiffs’ claims that the “ADT Defendants misled investors by having one motive, while offering up another, for participating in an otherwise accurately-disclosed stock repurchase plan.”  The court reasoned that information about the Company’s motives was not material as long as the Company had accurately disclosed “material financial or other information concerning the nature, scope, or mechanics of the stock repurchase transaction.” Id. at *4.

The court rejected plaintiffs’ argument that such a bright-line test for materiality is no longer good law after the Supreme Court’s decisions in Basic Inc. v. Levinson, 485 U.S. 224 (1988) and Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011).  Even in light of these Supreme Court decisions expressing concern such bright-line tests might exclude information important to a reasonable shareholder, the court found that “no reasonable shareholder would have considered the alleged omissions” regarding ADT’s true motivations “significant to the decision about whether to trade ADT securities given the other disclosures regarding the stock repurchase program and ADT’s corporate financing.” Id.

Finally, the court declined to give meaningful consideration to plaintiffs’ claims that ADT and its CEO had misled its shareholders by calling the repurchase program “thoughtful,” “effective,” and “optimal,” among other descriptors.  The court did not consider the applicability to these claims of the Supreme Court’s decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015), which sets forth the criteria for deciding whether a statement of opinion was false or misleading. Instead, the court relied on pre-Omnicare precedent to dismiss these statements as nonactionable “puffery,” thus sidestepping the question of whether plaintiffs might have adequately alleged that they were false statements of opinion under the Omnicare standard. Id. at *5.

Issued just shy of the one-year anniversary of the Supreme Court’s Omnicare decision in Omnicare, the Second Circuit’s ruling in Tongue v. Sanofi, 816 F.3d 199 (2d Cir. 2016), is the most significant post-Omnicare ruling thus far. The Sanofi court not only correctly applied the Court’s rulings on the standard for evaluating statements of opinion, but also appropriately highlighted the Court’s emphasis on the importance of context in evaluating allegedly false statements.

Other circuit court decisions have recognized the impact of Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015), and the Fifth Circuit has specifically noted its importance in emphasizing that statements of both fact and opinion must be evaluated in the context in which they are made. See Owens v. Jastrow, 789 F.3d. 529 (2015) (affirming dismissal of complaint for failure to plead scienter). With Sanofi, however, the Second Circuit became the first appeals court to discuss Omnicare in detail, and to examine the changes that it brought about in the previously governing law.

The case centered around statements about Lemtrada, a drug in development for the treatment of multiple sclerosis. Sanofi, 816 F.3d at 203-04. Sanofi and its predecessor had conducted “single-blind” clinical trials for Lemtrada (studies in which either the researcher or the patient does not know which drug was administered), despite the fact that the U.S. Food and Drug Administration had repeatedly expressed concerns about these trials, and recommended “double-blind” clinical studies (studies in which both the researcher and the patient do not know which drug was administered). Id.

The plaintiffs alleged that Sanofi’s failure to disclose the FDA’s repeated warnings that a single-blind study might not be adequate for approval caused various statements made by the company to be misleading, including its projection that the FDA would approve the drug, its expressions of confidence about the anticipated launch date of the drug, and its view that the results of the clinical trials were “unprecedented” and “nothing short of stunning.” Id. at 204-06. Although the FDA eventually approved Lemtrada without further clinical trials, the agency initially refused approval based in large part on the single-blind studies concern, causing a large drop in the price of Sanofi stock. Id. at 206-07.

In an opinion issued before Omnicare, the district court dismissed the claims, in part because it found that plaintiffs had failed to plead that the challenged statements of opinion were subjectively false, under the standard previously employed by the Second Circuit in Fait v. Regions Financial Corp, 655 F.3d 105 (2d Cir. 2011). The Second Circuit stated that it saw “no reason to disturb the conclusions of the district court,” but wrote to clarify the impact of Omnicare on prior Second Circuit law. Id. at 209.

The court acknowledged that Omnicare affirmed the previous standard that a statement of opinion may be false “if either ‘the speaker did not hold the belief she professed’ or ‘the supporting fact she supplied were untrue.’” Id. at 210. However, it noted that Omnicare went beyond the standard outlined by Fait in holding that “opinions, though sincerely held and otherwise true as a matter of fact, may nonetheless be actionable if the speaker omits information whose omission makes the statement misleading to a reasonable investor.” Id.

The Second Circuit highlighted the Omnicare Court’s focus on context, taking note of its statement that “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.” Id. Since Sanofi’s offering materials “made numerous caveats to the reliability of the projections,” a reasonable investor would have considered the opinions in light of those qualifications. Id. at 211. Similarly, the Second Circuit recognized that reasonable investors would be aware that Sanofi would be engaging in continuous dialogue with the FDA that was not being disclosed, that Sanofi had clearly disclosed that it was conducting single-blind trials for Lemtrada, and that the FDA had generally made clear through public statements that it preferred double-blind trials. In this broader context, the court found that Sanofi’s optimistic statements about the future of Lemtrada were not misleading even in the context of Sanofi’s failure to disclose the FDA’s specific warnings regarding single-blind trials. Id. at 213.

Under the Omnicare standards, the Second Circuit thus found nothing false or misleading about the challenged statements, holding that Omnicare imposes no obligation to disclose facts merely because they tended to undermine the defendants’ optimistic projections. In particular, the Second Circuit found that “Omnicare does not impose liability merely because an issuer failed to disclose information that ran counter to an opinion expressed in a registration statement.” Id. at 212. It also reasoned that “defendants’ statements about the effectiveness of [the drug] cannot be misleading merely because the FDA disagreed with the conclusion—so long as Defendants conducted a ‘meaningful’ inquiry and in fact held that view, the statements did not mislead in a manner that is actionable.” Id. at 214.