In a 5-4 decision split along traditional ideological lines, the U.S. Supreme Court held in CalPERS v. ANZ Securities, Inc., 582 U.S. ___ (2017), that the statute of repose in Section 13 of the Securities Act cannot be tolled under any circumstances. In particular, the Court held that the 3-year repose period—unlike the 2-year limitations period set forth in the same section of the Securities Act—is not tolled by the filing of a securities class action under the principles of American Pipe & Constr. Co. v. Utah, 414 U.S. 538 (1974).

Under American Pipe, the statute of limitations for a claim timely asserted in a putative class action is tolled for the period that the putative class claim is pending. Thus, if class certification is denied (or if a class member later decides to opt out of the class), individual putative class members can still pursue their separate claims, even if those claims would otherwise be untimely at the time they are filed. The question presented in CalPERS was whether that tolling principle likewise applied to Section 13’s 3-year statute of repose.

The CalPERS case arose out of the collapse of Lehman Brothers in 2008. Shortly after Lehman declared bankruptcy, a plaintiff filed a putative class action complaint alleging claims under Section 11 of the Securities Act against the underwriters of several of Lehman’s securities offerings from 2007 and early 2008. The complaint alleged that Lehman’s securities offered included material misstatements or omissions. CalPERS was not one of the named plaintiffs in that suit.

In 2011—more than three years after the last of those securities was first offered—CalPERS filed a separate complaint on its own behalf, alleging identical claims to those asserted in the putative class action. Shortly thereafter, the putative class action settled, and CalPERS opted out so it could continue to pursue its claims separately. However, the defendants then successfully moved to dismiss CalPERS’ separate lawsuit as untimely under Section 13, which provides, “In no event shall any [Section 11] action be brought…more than three years after the security was bona fide offered to the public….” The Second Circuit affirmed, and the Supreme Court granted certiorari.

Justice Kennedy delivered the opinion of the Court, joined by Chief Justice Roberts and Justices Thomas, Alito, and Gorsuch. The Court began by re-emphasizing the distinction between statutes of limitations and statutes of repose that the Court had described in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014). Statutes of limitations are intended to encourage diligence on the part of plaintiffs, and are therefore typically triggered by the accrual of a cause of action. (Slip op. at 4-5.) Statutes of repose, by contrast, reflect “a legislative judgment that a defendant should be free from liability after the legislatively determined period of time[,]” and usually begin to run from the date of the defendant’s last culpable act. (Id. at 5 (quoting CTS Corp.).) The Court observed that Section 13 of the Securities Act has both types of time limits: a 2-year limitations period that runs from when the actionable untrue statement or omission was or should have been discovered, and a 3-year repose period that runs from the date the security was first offered. (Id. at 5-7.)

The Court explained that the distinction between the purposes of a statute of repose and a statute of limitations was decisive in the CalPERS case. Because the purpose of a statute of repose is to create an “absolute bar” to the defendant’s liability after a period of time, such statutes are generally not subject to tolling in the absence of some legislatively-enacted exception. (Slip op. at 7-8.) In particular, unlike statutes of limitations, statutes of repose are not subject to tolling based on equitable principles. (Id. at 8.) American Pipe tolling is based on just such equitable considerations: it was intended to serve judicial economy by obviating the need for protective motions to intervene by individual putative class members, while still serving the purpose of the statute of limitations by ensuring that the defendants were on notice of the substantive claims against them and the “generic identities” of the claimants. (Id. at 8-11 (quoting American Pipe).) Those considerations could not serve to toll a statute of repose, whose purpose “to grant complete peace to defendants….” (Id. at 11.) The Court found that “the text, purpose, structure, and history of the [Section 13] statute [of repose] all disclose the congressional purpose to offer defendants full and final security after three years.” (Id.)

The Court then quickly dispensed with the four counterarguments CalPERS had raised. First, the Court found that American Pipe was readily distinguishable based on the distinction between statutes of limitation and statutes of repose: while the first may be tolled based on equitable considerations, the second may not. (Slip op. at 11-12.) Second, the Court found that the fact that the class action put the defendant on notice of the putative class members’ claims missed the point—“the purpose of a statute of repose is to give the defendant full protection after a certain time.” (Id. at 12.) Moreover, while the defendant might be on notice of the claims generally, it would not be on notice of the “number and identity of individual suits, where they may be filed, and the litigation strategies they will use[,]” which could significantly affect a defendant’s “practical burdens” and “financial liability[.]” (Id. at 12-13.) Third, the Court found that a putative class member’s right to opt out, while important, could not override the “mandatory time limits set by statute.” (Id. at 13.) Fourth, the Court rejected the argument that its ruling would “create inefficiencies,” noting that the Court was not free to ignore the plain terms of the statute, and observing that, in any event, the Second Circuit had not seen any “recent influx of protective filings” since its rule was announced in 2013. (Id. at 13-14.)

Finally, the Court rejected CalPERS’ alternative argument that it had timely “brought” its “action” within the meaning of Section 13 because it was a member of the putative class on whose behalf the original lawsuit was brought, and that its separate action was merely part of that same “action.” The Court found that argument did violence to the term “action,” which generally refers to a particular “proceeding” or “suit.” (Id. at 14-15.) Moreover, the Court observed that the argument proved too much: if it were correct, there would be no need for American Pipe tolling at all, and even an action commenced “decades after the original securities offering” would be timely as long as a class action had been commenced within the applicable limitations and repose periods. (Id. at 15.)

Justice Ginsburg dissented, joined by Justice Breyer, Sotomayor, and Kagan. Justice Ginsburg accepted CalPERS’ alternative argument that its filing date should relate back to the filing of the original class action complaint, and that by filings its separate action, CalPERS “simply took control of the piece of the action that had always belonged to it.” (Slip op. at 2-3.) She asserted that the majority’s rule would render the right to opt out “illusory[,]” because most securities class actions reach their “critical stages” years after the initial complaint is filed. (Slip op. at 1-2, 4.) Moreover, Justice Ginsburg contended, the “harshest consequences” were likely to fall on the “least sophisticated” class members, who would be unaware of their need to file a protective claim within the repose period. (Id. at 4.) Finally, she stated that the majority’s ruling was likely to “gum up the works of class litigation” by encouraging defendants to engage in dilatory tactics and encouraging the filing of protective claims. (Id. at 4-5.)

The CalPERS decision is likely to have repercussions far beyond Section 11 securities cases. The Court’s logic would also apply to the 5-year statute of repose governing class action claims under Section 10 of the Exchange Act, which are much more common. Indeed, any federal statute of repose without an express legislative tolling provision will now be fully applicable in any class action asserting a claim governed by that statute. It will be interesting to see whether the inefficiencies predicted by Justice Ginsberg come to fruition.

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 monitoring securities cases filed around the country, I like to keep an eye out for regional trends. Historically, plaintiffs’ counsel respected the company defendant’s forum, filing in the federal court closest to the company’s headquarters.  That is certainly not true today. Many plaintiffs’ firms initiate cases in New York or California—and sometimes, a seemingly random location—against companies headquartered elsewhere.

Sometimes, these firms file outside of the headquarters forum simply because their headquarters is there, which allows them to keep litigation expenses down and avoid splitting fees with another lawyer if local counsel in the headquarters form is be required.  Along with targeting smaller companies in what I call “lawsuit blueprint” cases, this type of cost savings has allowed some smaller plaintiffs’ firms to hurdle the high barriers to entry in the plaintiffs’ securities class action market, beginning with the Chinese reverse-merger cases in 2010.  These plaintiffs’ firms have used the business strategy and returns from those cases to continue filing securities class actions, mostly against smaller companies. This expansion of the securities class action plaintiffs’ bar is one of the most significant securities litigation developments of this decade.

But, often, these plaintiffs’ firms file in a particular jurisdiction for strategic reasons.  Over the last two years, I have noticed a small surge in certain securities complaints filed in the Third Circuit, even where defendants appear to have little connection to the forum.  In particular, there has been an uptick in the number of Third Circuit cases involving foreign defendants or overseas conduct and the purchase or sale of stocks traded in over-the-counter markets or on non-registered exchanges, including the Over-the-Counter Bulletin Board (“OTCBB”) and Pink Sheets.  I believe this trend relates to the Third Circuit’s interpretation of the Supreme Court’s ruling in Morrison v. Nat’l Australia Bank, 561 U.S. 247 (2010).

Before Morrison was decided, the lower courts had applied a number of different tests in determining when and how to apply Section 10(b) of the Exchange Act to fraudulent schemes involving conduct outside the United States. In Morrison, the Supreme Court held that Section 10(b) has no extraterritorial application, and can only apply to two categories of transactions: (1) “transactions in securities listed on domestic exchanges”; and (2) “domestic transactions in other securities.”

While Morrison simplified the framework for applying Section 10(b) in cases that involve overseas conduct, it inevitably left open a number of important questions, which have been addressed in the years since by the courts of appeals.  For a good recent discussion of post-Morrison issues, please see this March 6, 2017 guest post on Kevin LaCroix’s The D&O Diary by Wiley Rein’s David Topol and Margaret Thomas: “Post-Morrison Application of U.S. Securities Laws to Foreign Issuers.”

One such question is how the Morrison test applies in cases that involve non-domestic conduct and the purchase or sale of securities in OTC markets and on non-registered exchanges.  Two years ago, the Third Circuit addressed this question in a criminal case, United States v. Georgiou, 777 F.3d 125 (3d Cir. 2015), in which the defendant, Georgiou, had been charged with participating in a stock fraud scheme that involved the purchase and sale of shares in US companies quoted on the OTCBB and the Pink Sheets.  While Georgiou manipulated the price of these securities through offshore brokerage accounts, at least one of the fraudulent transactions in each target stock was executed with a market maker based in the United States.

Applying the first prong of Morrison, the Third Circuit held that none of the trades qualified as “transactions in securities listed on domestic exchanges,” because the OTBB and Pink Sheets are not among the eighteen national securities exchanges registered with the SEC.  This reasoning has since been cited and adopted by several district courts outside the Third Circuit.  See, e.g., In re Poseidon Concepts Sec. Litig., 2016 WL 3017395 (S.D.N.Y., May 24, 2016); Stoyas v. Toshiba Corp., 191 F.Supp.3d 1080 (C.D. Cal. 2016).

Turning to Morrison’s second prong, however, the Third Circuit concluded that the trades facilitated by US market makers were “domestic transactions,” because the purchaser or seller had incurred “irrevocable liability” for these trades in the United States.  In other words, by working with a domestic market maker, a purchaser or seller makes a “commitment” to the transaction in the United States, which brings the transaction within the scope of Section 10(b). On this basis, the Third Circuit affirmed Georgiou’s securities fraud conviction.

The Third Circuit’s ruling as to the second prong of Morrison does not put it directly at odds with any other circuit.  Yet by stating unambiguously that use of a domestic market maker renders a transaction “domestic,” Georgiou offers plaintiffs’ counsel more certainty than exists elsewhere.

The year before Georgiou was decided, the Second Circuit addressed a similar issue in Parkcentral Glob. Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198 (2d Cir. 2014), but offered a more qualified ruling.  Like the Third Circuit, the Second Circuit indicated that a transaction should be considered “domestic” if irrevocable liability was incurred in the United States.  But while Georgiou suggests that Section 10(b) applies to all domestic transactions, Porche held that the domestic trades at issue in that case were beyond the territorial scope of the Exchange Act.  “While a domestic transaction or listing is necessary to state a claim under Section 10(b),” Judge Leval argued, “a finding that these transactions were domestic would not suffice to compel the conclusion that the plaintiffs’ invocation of Section 10(b) was appropriately domestic,” and it would be a mistake to “treat[ ] the location of a transaction as the definitive factor in the extraterritoriality inquiry.”

Porche involved an unusual fact pattern—foreign defendants, largely foreign conduct, and domestic trading in swaps tied to foreign securities—and it may be advisable to read the Second Circuit’s opinion narrowly.  See, e.g., Poseidon, 2016 WL 3017395 at *12-13 (holding that Porche was inapposite where plaintiff had purchased domestically a foreign stock traded on Pink Sheets in the United States).  Moreover, the Third Circuit decided Georgiou after Porche, and apparently felt no need to criticize, distinguish, or even mention the Second Circuit’s ruling.

Nonetheless, the bright-line rule that Georgiou arguably establishes—namely, that Section 10(b) applies in all cases involving a domestic transaction—currently makes the Third Circuit a more attractive destination for plaintiffs’ counsel in foreign-issuer cases, particularly in cases where other territorial factors might weigh against invoking jurisdiction.  For this reason, I expect to see more cases of this kind filed in district courts in the Third Circuit in the future.

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.

The Second Circuit has issued another confirmation of the high bar for imposing liability on external auditors under the securities laws, and of the importance of the protections created for opinions by the Supreme Court in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015). The unpublished decision, Querub v. Moore Stephens Hong Kong, __ Fed. App’x __, 2016 WL 2942415 (2d Cir. May 20, 2016), affirmed the dismissal at summary judgment of a securities claim against a Hong Kong auditor that issued “clean opinions” for the financial statements of a China-based coal supplier.

Puda, a China-based, U.S.-listed company, owned a 90% stake in Shanxi—a company that supplied coal for steel manufacturing. Id. at *1. But in 2009, Puda’s chairman transferred ownership of Shanxi to himself. Id. While shareholder meeting minutes and some filings with Chinese regulatory authorities reflected the transfer, Puda’s 2009 and 2010 financial statements included Shanxi’s assets and revenues. Id. A Hong Kong auditor—Moore Stephens—issued clean opinions for Puda’s 2009 and 2010 financial statements under Public Company Accounting Oversight Board (“PCAOB”) standards. After learning of the Shanxi transfer in 2011, Moore Stephens resigned as Puda’s auditor and stated that its opinions on the 2009 and 2010 statements could no longer be relied upon. Id.

In assessing the securities claims brought by investors against Moore Stephens, the Second Circuit examined three issues. First, the court held that the district court had appropriately struck the plaintiffs’ expert witness: the witness lacked expertise or experience in PCAOB accounting standards—the auditing standard at issue—and so was not qualified as an expert. Id. at *2. Second, the court ruled that the plaintiffs could not establish that Moore Stephens had acted with sufficient recklessness to support liability. Id. at *3. Even if expert testimony on the PCAOB standards were not required, the “red flags” that plaintiffs claimed showed recklessness showed only “fraud by hindsight.” Id. Finally, the court explained that “[a]udit reports, labeled ‘opinions’ and involving considerable subjective judgment, are statements of opinion subject to the Omnicare standard . . . .” Because there was no evidence that Moore Stephens either didn’t believe its “clean audit opinions” or that it omitted material facts about those opinions, the court ruled that plaintiffs’ claims could not survive. Id.

On April 12, 2016, the Eighth Circuit became the first court of appeals to interpret and apply Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398 (2014) (“Halliburton II”), in which the Supreme Court held that direct and indirect evidence of a lack of price impact may be presented by Rule 10b-5 defendants at the class certification stage to rebut the “fraud-on-the-market” presumption established by Basic v. Levinson, 485 U.S. 224, 241–47 (1988).

In IBEW Local 98 Pension Fund, et al. v. Best Buy Co., Inc., et al., 818 F.3d 775 (8th Cir. 2016), the majority of a divided three-judge panel held that a district court had abused its discretion in certifying a class under Rule 23, where the defendants had provided “overwhelming evidence” that statements challenged by the plaintiffs had not affected the price of Best Buy’s common stock.

Legal Background: Basic and Halliburton II

Until 1988, when the Supreme Court decided Basic, Rule 23’s commonality requirement was a major impediment to certification in securities cases, because the reliance element of a Rule 10b-5 claim often implicated facts specific to individual investors. Basic transformed the landscape of securities litigation by allowing entire classes of investors to invoke a “fraud-on-the-market” presumption of reliance, eliminating the need for each investor to demonstrate actual reliance. The Basic presumption is based on the theory that because the price of any stock traded on an efficient market reflects all public information, anyone who purchases such a stock when its price has been inflated by a material misrepresentation can be presumed to have relied upon that misrepresentation. 485 U.S. at 246–47.

In Halliburton II, the Supreme Court was given an opportunity to overrule or modify Basic but declined to do so, emphasizing instead that the “fraud on the market” presumption is rebuttable, and holding that “defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock”—a chance to show, in other words, that there was no “price impact.” 134 S.Ct. at 2416-17.

Factual Background and the District Court’s Decision

In Best Buy, plaintiffs alleged that the company and three of its executives made false or misleading statements in a press release issued at 8:00 a.m. on September 14, 2010, and an analyst conference call held at 10:00 a.m. the same day. Specifically, plaintiffs initially challenged three statements: one from the 8:00 a.m. press release increasing Best Buy’s earnings-per-share (EPS) guidance for FY 2011, and two from the 10:00 a.m. conference call, that “we are on track to deliver and exceed our annual EPS guidance” and “our earnings are essentially in line with our original expectations for the year.” Best Buy, 818 F.3d at 777-78. The district court allowed the plaintiffs to proceed based on the latter two statements, but dismissed their claim as to the press release statement, holding that increasing the EPS guidance was a forward-looking statement protected by the Safe Harbor provision of the Reform Act. Id. at 778.

With the press release statement out of the case, plaintiffs moved for class certification, relying on Basic’s fraud-on-the-market presumption to satisfy the commonality requirement. The district court stayed the plaintiffs’ motion pending the outcome of Halliburton II, then granted the motion, certifying a class of all Best Buy purchasers between the 10:00 a.m. conference call on September 14 and the release of the “corrective” earnings report three months later. Id. at 777. In doing so, the district court held that defendants had failed to rebut the Basic presumption, because while they had shown that the price of the stock did not increase after the conference call, they failed to show that the conference call statements did not artificially maintain the stock’s price. Id. at 782.

The Eighth Circuit’s Opinion

On interlocutory appeal, the Eighth Circuit focused on whether the district court had properly evaluated the price impact evidence offered by the defendants to rebut the Basic presumption—and in particular, whether the district court was correct to conclude that plaintiffs could continue to rely on the presumption even though defendants had shown that there was no “front-end” price impact immediately following the conference call.

An expert offered by plaintiffs before the district court had opined that although the forward-looking EPS guidance in the 8:00 a.m. press release led to an immediate increase in the stock price, the challenged statements in the conference call two hours later had no additional price impact. This expert also concluded that the “economic substance” of the EPS guidance in the press release was “virtually the same” that of the alleged misstatements in the conference call, and that investors gave the EPS guidance “great weight.” A defense expert agreed. Id.

In the Eighth Circuit’s majority opinion, Judge Loken held that this expert testimony constituted “overwhelming evidence of no ‘front-end’ price impact.” Id. at 782. Although the price of Best Buy stock did decline following the December 14 “corrective” earnings report, which the plaintiffs cited as evidence to support their price maintenance theory, plaintiffs’ own expert’s opinion showed that “the allegedly ‘inflated price’ was established by the non-fraudulent press release,” thereby severing “[any] link between the alleged conference call misrepresentations and the stock price at which plaintiffs purchased.” Id. at 782-83. In the absence of any additional evidence of price impact, Judge Loken concluded, the plaintiffs had failed to satisfy Rule 23, and the district court had abused its discretion in certifying the class. Id. at 783.

Judge Murphy, writing in dissent, argued that the majority had “ignore[d]” plaintiffs’ price maintenance theory, which supported an unrebutted fraud-on-the-market presumption of reliance sufficient to support class certification. Where plaintiffs rely on such a theory, she wrote, the defendant must rebut the Basic presumption “by providing evidence showing that the alleged misrepresentations had not counteracted a price decline that would otherwise have occurred”—and yet the Best Buy defendants had offered no such evidence. Id. at 784.

Judge Murphy also noted that the Seventh and Eleventh Circuits have recognized claims based on an allegation that false statements averted the decline of an artificially-inflated stock price. Id. at *8 (citing FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282, 1313-15 (11th Cir. 2011) and Schleicher v. Wendt, 618 F.3d 679, 683-84 (7th Cir. 2010)).

Although it is not clear that the Best Buy majority sought to foreclose price maintenance arguments as a general matter, the court’s rejection of plaintiffs’ theory does at least raise the possibility of a circuit split regarding their viability.

In another entry in the large field of securities fraud suits involving Chinese companies traded on U.S. exchanges, the Second Circuit affirmed in an unpublished memorandum the dismissal of investors’ claims against an auditor for failing to detect and disclose that a company’s CEO was pilfering the company’s coffers for personal gain.

In Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., __ Fed. App’x __, 2016 WL 1392280, at *1 (2d Cir. Apr. 8, 2016), a group of investors sought relief after ChinaCast, the company in which they had invested, disclosed that its CEO and other executives had engaged in fraud by embezzling funds. The suit accused Deloitte, ChinaCast’s independent auditor, of several violations, including a claim under Section 10(b) of the Exchange Act for giving ChinaCast a clean bill of health in audit opinions from 2007 to 2010 in connection with Deloitte’s review of ChinaCast’s SEC filings, and a claim under Section 18 of the Exchange Act for Deloitte’s filing its allegedly misleading audit opinions with the SEC. Id. The Second Circuit concluded that the Section 10(b) claim did not adequately allege Deloitte’s scienter, and—applying the Supreme Court’s landmark decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015)—that the plaintiffs did not adequately allege that Deloitte’s opinions were false or misleading.

The court held that to satisfy the scienter requirement for a non-fiduciary accountant like Deloitte, the plaintiffs had to allege facts showing “such recklessness [as to be] an extreme departure from the standards of ordinary care” and in fact come close to “an actual intent to aid in the fraud being perpetrated by the company.” Id. (quoting Rothman v. Gregor, 220 F.3d 81, 98 (2d Cir. 2000)). Applying this high standard, the court ruled that the alleged “red flags” Deloitte recklessly disregarded were inadequate to show scienter. These red flags included large transactions and assets on ChinaCast’s books that the plaintiffs contended Deloitte would have discovered with a more thorough audit, and certain transactions between ChinaCast subsidiaries and third parties that the plaintiffs alleged were suspicious. Id. at *2. But the court decided that these records were red flags only in hindsight, because there was no allegation that Deloitte was required to perform the investigation that the plaintiffs claim would have revealed the suspicious transactions, and the records that Deloitte had access to at the time of its audits suggested that the subsidiary transactions were not unusual. Id.

Deloitte’s audit opinions were also protected under Omnicare. The plaintiffs did not allege facts that would show either that Deloitte held a subjective belief inconsistent with the opinions, or else that any of the challenged statements of opinion omitted “material facts about the issuer’s inquiry into or knowledge concerning [the] statement of opinion . . . [which would] conflict with what a reasonable investor would take from the statement [of opinion] itself.” Id. at *3 (quoting Omnicare, 135 S. Ct. at 1329) (first alteration added). The court also affirmed the dismissal of other claims based on the underlying Section 10(b) and Section 18 claims. Id.

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.

The Ninth Circuit Court of Appeals clarified an important question surrounding the “corrective disclosure” pleading requirement in Lloyd v. CVB Financial Corporation, 811 F.3d 1200 (9th Cir. 2016), finding that disclosure of an SEC investigation can constitute a partial corrective disclosure, but only if there is a follow-on disclosure that specifically corrects a prior misstatement.

The Lloyd loss causation holding, while clarifying the law to some degree, requires a fact-specific inquiry. In order to find loss causation in an analogous situation, courts would need to piece together several facts: (1) disclosure of a government investigation resulting in a stock drop; (2) market perception that the investigation related to a previous misstatement; (3) a follow-on disclosure confirming the previous misstatement; and (4) a minimal market reaction to the follow-on confirming disclosure.

Factual Background and Procedural History

The litigation arose from pre-recession loans that issuer defendant CVB Financial Corporation (“CVB”) made to the Garrett Group (“Garrett”), a commercial real estate company. In 2008, Garrett informed CVB that it would be laying off employees and reducing salaries, and that it could not make loan payments due to CVB. CVB agreed to restructure the loans, and loaned an additional $10 million to avoid a Garrett default. In 2009, CVB refinanced Garrett’s loans again, providing an additional $53 million and agreeing to other loan modifications. Despite these efforts, in 2010 Garrett again informed CVB that it was unable to fulfill its payment obligations and was then considering filing bankruptcy. Id. at 1203.

During this time, Garrett was CVB’s largest borrower and the loans in question were material to CVB’s balance sheet. Despite Garrett’s struggles and the materiality of the loans, CVB stated in its SEC filings that it was “not aware” of any “known credit problems of the borrower [that] would cause serious doubts” about Garrett’s ability to repay the loans. In July 2010, the SEC served CVB with a subpoena seeking information about its underwriting and loan loss methodologies. The next month, in its Form 10-Q, CVB disclosed the subpoena and that the SEC inquiry regarded CVB’s underwriting and allowance for credit and loan losses and related areas. The next day CVB’s stock fell 22%. Analysts following CVB noted that the subpoena was likely related to the Garrett loans. One month later, CVB finally wrote down $34 million in Garrett loans and reclassified the remaining $48 million of Garrett loans as non-performing. Following this disclosure, CVB’s stock price dropped only six cents to $6.99. Id. at 1204-05.

Plaintiffs brought a securities class action alleging Section 10(b) and Rule 10b-5 claims. The district court concluded that the challenged statements were not made with scienter and did not cause the plaintiffs’ alleged losses, and granted CVB’s motion to dismiss the complaint.

Ninth Circuit’s Ruling

The complaint alleged four types of CVB misstatements: (1) touting of loan underwriting and quality of loan portfolio; (2) a statement that the deteriorating real estate market “could” harm its borrowers’ ability to repay; (3) violations of GAAP in financial statements; and (4) assurances in SEC filings that it was “not aware of any other loans . . . for which known credit problems of the borrower would cause serious doubts as to the ability of such borrowers to comply with their loan repayment terms.” Id. at 1206.

The Ninth Circuit quickly concluded that the first three categories of alleged misstatements were not actionable, finding that the first category of statements were vague puffery, the second category was not misleading when placed in context, and the third category of GAAP failures, without more, did not establish scienter. Id. at 1206-07. However, with respect to the last category, the court concluded that some of these statements were false and made with knowledge or recklessness, and reversed the district court’s decision. The court found that the complaint had adequately alleged that CVB, prior to making those statements, had been alerted to facts that “would cause serious doubts” about Garrett’s ability to repay its loans.  Id. at 1207-09.

Finding one category of misstatements actionable, the court then moved to the question of loss causation, examining Supreme Court and Ninth Circuit law in this area. Under the Supreme Court’s decision in Halliburton, the “burden of pleading loss causation is typically satisfied by allegations that the defendant revealed the truth through ‘corrective disclosures’ which ‘caused the company’s stock price to drop and investors to lose money.’” Id. at 1209 (quoting Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014)). The court also revisited an open question from its recent decision in Loos v. Immersion Corporation, in which it held that “the announcement of an investigation, standing alone and without any subsequent disclosure of actual wrongdoing, does not reveal to the market the pertinent truth of anything, and therefore does not qualify as a corrective disclosure.” Id. at 1209-10 (quoting 762 F.3d 880, 890 n.3 (9th Cir. 2014)).

However, the court noted that the Loos court had reserved judgment on the question of whether the announcement of an investigation, such as CVB’s announcement of the SEC subpoena, could “form the basis for a viable loss causation theory” if the plaintiff also alleged a subsequent corrective disclosure. Lloyd, 811 F.3d at 1210. The Lloyd court then answered that question in the affirmative.

The disclosure of the SEC subpoena in July resulted in a 20% stock drop. Under Loos, the court found, that disclosure alone would not qualify as a corrective disclosure. However, just one month later, CVB disclosed that it had written off millions in Garrett’s loans. This second “bombshell” disclosure resulted in hardly any market reaction. However, the court concluded from this chain of events that investors correctly understood that the disclosure of the SEC subpoena was a partial corrective disclosure acknowledging the falsity of the prior “no serious doubts” statements. Id. at 1210-11. These two disclosures, when viewed together, constituted a sufficient corrective disclosure. The court reasoned: “Indeed, any other rule would allow a defendant to escape liability by first announcing a government investigation and then waiting until the market reacted before revealing that prior representations under investigation were false.” Id. at 1210. In making its ruling, the Court noted its holding was consistent with the Fifth Circuit’s decision in Public Employees’ Retirement System of Mississippi v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014).