On November 3, 2014, the U.S. Supreme Court will hear oral argument in Laborers District Counsel Construction Industry Pension Fund v. Omnicare, Inc., which concerns the standard for judging the falsity of an opinion challenged in an action under Section 11 of the Securities Act of 1933. In the U.S. Court of Appeals for the Sixth Circuit decision under review (“2013 Omnicare decision”), the court held that a statement of opinion can be “false” even if the speaker genuinely believed the stated opinion. This holding is contrary to the U.S. Supreme Court’s decision in Virginia Bankshares, Inc. v. Sandberg, which held that a statement of opinion is a factual statement as to what the speaker believes—meaning a statement of opinion is “true” as long as the speaker genuinely believes the opinion expressed, i.e., if it is “subjectively” true.
We authored an amicus brief on a pro bono basis for Washington Legal Foundation (“WLF”) in Omnicare that emphasizes the importance of clarifying the standard for challenging “false” statements of opinion under all the federal securities laws, not just Section 11. WLF’s view that such clarification is needed was reinforced by an October 10, 2014 decision in a subsequently filed securities class action against Omnicare under Section 10(b) of the Securities Exchange Act of 1934. In re Omnicare, Inc. Sec. Litig. (“2014 Omnicare decision”). In the 2014 Omnicare decision, the Sixth Circuit appeared to embrace the proposition that a statement of opinion is not actionable if it is subjectively true—at least under Section 10(b)—but then held that the subjective falsity inquiry should be analyzed within the element of scienter. The opinion reflects the continued confusion that pervades analysis of this issue, jumbling subjective falsity with other concepts, and conflating the separate elements of falsity and scienter.
As part of its scienter analysis, the Sixth Circuit also grappled with another important question: whose state of mind counts for purposes of determining a corporation’s scienter? Although the Sixth Circuit believes the standard it enunciated constitutes a “middle ground” between restrictive and liberal tests among the federal circuit courts, its ruling misunderstands the nature of the scienter inquiry and conflicts with the Supreme Court’s 2011 ruling in Janus Capital Group, Inc. v. First Derivative Traders, and thus risks expanding corporate liability beyond the proper reach of Section 10(b).
After discussing the proper analysis of statements of opinion, and explaining errors in the 2013 Omnicare decision, we explain and analyze both holdings in the 2014 Omnicare decision.
Another Incorrect Sixth Circuit Statements-of-Opinion Opinion
The Proper Analysis of Statements of Opinion. As WLF’s amicus brief explains, opinions are ubiquitous in corporate communications. Corporate officers voice their opinions on a wide range of subjects—from financial statements to what they think about their company’s prospects—and investors particularly value these opinions. Although the 2013 Omnicare decision pending before the Supreme Court concerns statements challenged under Section 11 of the Securities Act, it poses a fundamental question: What causes an opinion or belief to be a “false statement of material fact”? The Supreme Court’s answer will affect the standards of pleading and proof for statements of opinion under other liability provisions of the federal securities laws, which likewise prohibit “untrue” or “false” statements of “material fact.”
While important, the answer to this question is not complicated; it is a straightforward application of common sense. An opinion or belief is not “false” if it turns out to be wrong, if some (or even many) people disagree with it, or if a judge later decides it was “unreasonable.” Rather, a statement of opinion is only “false” if the opinion is not genuinely held; a statement of belief is only “untrue” if the belief is not actually believed.
The Supreme Court articulated the correct standard for judging the falsity of opinions in Virginia Bankshares, in which it held that an opinion may be actionable as a false statement of “fact” to the extent it is a “misstatement of the psychological fact of the speaker’s belief in what he says.” This holding is correct as a matter of straightforward logic and statutory interpretation, and has been applied by several circuit courts—including the First, Second, Fourth, Fifth, and Ninth Circuits—to require plaintiffs to allege the subjective falsity of opinions. At the other end of the spectrum is the 2013 Omnicare decision, which holds that a speaker may be liable even for the expression of an honest opinion, if someone determines in hindsight that the opinion was “wrong.” Indiana State District Council of Laborers v. Omnicare.
The Incorrect 2013 Omnicare Decision. The muddled precedent governing statements of opinion culminated in the anomalous 2013 Omnicare decision, in which the Sixth Circuit expressly contradicted the holding of Virginia Bankshares and other circuit courts that have examined this issue. The Sixth Circuit began by drawing on precedent that is a close cousin to the doctrine of “puffery,” under which certain statements can be immaterial as a matter of law, to construct a false dichotomy between the materiality of “hard” information (facts) and “soft” information (“matters of opinion and predictions”). The court then jumbled the concepts of materiality and falsity, postulating that there is “generally no duty to disclose soft information” unless “knowledge of falsity is shown,” in which case “‘opinions cease to be soft information’ and become hard facts.” Stumbling through the maze erected by this nonsensical proposition, the court eventually concluded that this disclosure standard only applies to Section 10(b), finding that because Section 11 provides for strict liability, “if the defendant discloses information that includes a material misstatement . . . a complaint may survive a motion to dismiss without pleading knowledge of falsity.”
In its analysis, the Sixth Circuit failed to distinguish the subjective falsity inquiry from “knowledge of falsity”—which, in turn, stems from its fundamental failure to examine how an opinion is different from a fact. It is not that an opinion necessitates a stronger showing of scienter (because “knowledge of falsity” somehow transforms it into “hard information”). A statement of opinion is different because the “material fact” that it represents inherently implicates the speaker’s state of mind. Accommodation of this difference does not require an elaborate doctrine designed specifically for opinions. Rather, a straightforward application of the falsity requirement suffices: In order to show falsity, whether of facts or opinions, plaintiffs must plead that the fact represented by the statement was, in fact, “false.”
By improperly framing the question as whether “knowledge of falsity” of opinions is required, the Sixth Circuit transformed a falsity analysis into a scienter requirement, and concluded it would be “unwise for this Court to add an element to Section 11 claims” based on “tea-leaf reading” of Virginia Bankshares. But the Sixth Circuit’s holding actually removes the element of falsity from Section 11 claims challenging opinions. Under the Sixth Circuit’s rule, plaintiffs must show an opinion was false because it was not genuinely believed for a claim under Section 10(b), but not when bringing a Section 11 claim. This imposes a different standard of falsity for Section 11 claims than under the other securities laws, even though the laws employ essentially identical language.
The Sixth Circuit’s 2014 Omnicare Decision Compounds Its Incorrect Analysis
The Sixth Circuit revisited many of these issues, in the Section 10(b) context, in its 2014 Omnicare decision. Without the benefit of the Supreme Court’s upcoming ruling on the fundamental issue of subjective falsity, a new Sixth Circuit panel wrestled with the messy precedent it had been handed, starting with the artificial distinction between “hard” and “soft” information. Citing to the 2013 Omnicare decision, the court held that “hard” information requires only a showing that a statement was “objectively false or misleading,” while for soft information, “a plaintiff must additionally plead facts showing that the statement was made with knowledge of its falsity ….”
Having thus fallen into the trap of classifying subjective falsity as “knowledge of falsity” (rather than just an examination of falsity itself) the court observed that judging the falsity of a statement of opinion “has given us and other courts such trouble because it adds a subjective inquiry to an otherwise objective element, thus conflating two elements of the six-element cause of action – an actionable misrepresentation and scienter.” The Sixth Circuit then elected to “conceive of” subjective falsity “as raising the bar for alleging scienter” by requiring a plaintiff “to allege particular facts demonstrating that defendants had actual knowledge that their statements concerning soft information were false or misleading at the time they were made.”
The court thus perpetuated the core problem in its previous ruling: failing to distinguish subjective falsity from scienter. This confusion led the court in the 2013 Omnicare decision to reject the consideration of subjective falsity in a Section 11 context. But this lack of clarity is perilous even in Section 10(b) cases, as it serves to weaken both the scienter and the falsity standards. For example, some courts have applied the “recklessness” standard of scienter to subjective falsity, resulting in an incorrect holding that an opinion is false if it was “recklessly” held—the functional equivalent of showing an opinion was unreasonable. On the flip side, the conflation of falsity and scienter can also render the separate scienter requirement meaningless, as courts conclude that because subjective falsity has been shown, scienter must follow.
Proper analysis requires the preservation of scienter as an independent element. This distinction makes clear that subjective falsity is about falsity, not scienter, and that the selfsame falsity standard should be used regardless of the level of intent required by the underlying statute. It also recognizes that, where both falsity and scienter are required, they remain fundamentally different questions. Subjective falsity asks: “Did the speaker honestly hold the opinion he expressed?” This question is essential because the nature of the falsity allegation with respect to opinions necessitates inquiry into the speaker’s state of mind. While the scienter inquiry also explores the speaker’s state of mind, it asks a different question: “Did the speaker give a false opinion with an intent to mislead investors?”
Courts often lose track of this real scienter inquiry, because they have become accustomed to using shorthand to refer to scienter as “knowledge of falsity”—the same sloppy language that the Sixth Circuit uses to discuss subjective falsity. But as the Supreme Court has repeatedly made clear, in cases such as Ernst & Ernst v. Hochfelder, that scienter is about whether false statements were made with “a mental state embracing intent to deceive, manipulate, or defraud.” Similarly, where a recklessness standard is employed, it is not recklessness as to falsity, but rather recklessness as “an extreme departure from the standards of ordinary care, . . . present[ing] a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.” Sundstrand Corp. v. Sun Chem. Corp.
It is true that, in many cases, falsity and scienter are inferred from the same set of facts, such that some courts examine both elements in a single analysis. And as the 2014 Omnicare decision points out, this may frequently be the case when the falsity analysis examines subjective falsity. But just because the facts necessary to prove each of these elements may sometimes, or even often, overlap, does not mean they are the same inquiry. Indeed, it is possible to have subjective falsity without scienter, or the converse, scienter without subjective falsity. For example, a speaker could genuinely believe his or her statement of opinion, yet express the opinion as part of a broader statement designed to mislead investors.
Conversely, speakers may express opinions they do not honestly hold for a variety of reasons, only one of which is an intent to mislead investors. For instance, corporate lies may be used to advance merger or contract negotiations, promote a product, boost morale, or preserve a company’s competitive edge. A speaker may overstate his opinion because he believes “puffing” is expected, or may express a false opinion because he or she is human, and humans lie for a wide variety of reasons, ranging from the petty to the idiosyncratic to the sinister.
The correct standard thus preserves falsity and scienter as distinct inquiries, while recognizing that many of the same facts may be relevant to both. Thus, in a motion to dismiss a Section 10(b) complaint challenging an opinion, the first task should be to inquire whether plaintiffs have pleaded specific facts to show subjective falsity. If not, a scienter inquiry is unnecessary. Only if falsity has been adequately pleaded should a court turn to the question of whether plaintiffs had established a “strong inference” that the false opinion had been uttered with an intent to defraud investors, rather than for some other purpose. So while the 2014 Omnicare decision may have stumbled to the right result, by preserving the subjective falsity inquiry in some form, the process it used to get there employed a dangerous precedent for the analysis of cases with more difficult falsity and scienter questions.
The Sixth Circuit’s 2014 Omnicare Decision Rests on an Incorrect Understanding of Scienter and Conflicts with Supreme Court Precedent
After incorrectly relegating subjective falsity to the scienter analysis, the Sixth Circuit next tackled another difficult question: “[W]hose knowledge and state of mind matters” in evaluating the corporation’s scienter? “[M]ust the person misrepresenting a material fact in the name of the corporation have also done so with scienter, or is it enough that some person in the corporate structure had the requisite state of mind?” In a thoughtful discussion, the court reviewed the split in views among circuit courts and scholars, discussed the merits of each, and elected to take a “middle ground” between requiring a plaintiff to plead an individual speaking defendant’s scienter and allowing a plaintiff to plead a non-defendant’s state of mind.
The court thus articulated a new standard:
The state(s) of mind of any of the following are probative for purposes of determining whether a misrepresentation made by a corporation was made by it with the requisite scienter under Section 10(b): . . .
- The individual agent who uttered or issued the misrepresentation;
2. Any individual agent who authorized, requested, commanded, furnished information for, prepared (including suggesting or contributing language for inclusion therein or omission therefrom), reviewed, or approved the statement in which the misrepresentation was made before its utterance or issuance;
3. Any high managerial agent or member of the board of directors who ratified, recklessly disregarded, or tolerated the misrepresentation after its utterance or issuance . . . .
Although this standard is broad, it represents a reasoned attempt to devise a rule that balances competing policy considerations. On the one hand, the court said, a rule that requires a plaintiff to plead corporate scienter by pleading an individual speaking defendant’s scienter risks running counter to the open disclosure goals of the securities laws and allowing corporations to “evade liability through tacit encouragement and willful ignorance.” Id. And on the other hand, allowing any non-speaker’s state of mind to suffice to establish corporate scienter “could expose corporations to liability far beyond what Congress has authorized” and “run contrary to the [Private Securities Litigation Reform Act], which increased the scienter pleading requirements to prevent strike suits.”
Most fundamentally, a finding that corporate scienter can be detached from the scienter of a speaker misunderstands the scienter analysis. As discussed above, scienter is not “knowledge of falsity;” it is intent to mislead purchasers or sellers of securities. Thus, the fact that someone in the organization knows that another person’s statement is false is simply knowledge that someone else said something false, not the possession of an intent to mislead. Only someone who makes a false statement can intend to mislead investors by means of that statement. In other words, by definition, only the speaker of a false statement can have scienter.
To be sure, there is an attraction to a rule of law that allows a corporation to have scienter even if no individual defendant does. It seems fair in certain scenarios, including the following hypothetical posited by Judge Posner in Makor Issues & Rights, Ltd. v. Tellabs, Inc.:
Suppose General Motors announced that it had sold one million SUVs in 2006 and the actual number was zero. There would be a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company to know that the announcement was false.
We agree that inferring corporate scienter makes some sense in such a situation—but not because it bases corporate scienter on the state of mind of a non-speaker. Instead, in this hypothetical, the statement is so ridiculously false that the court is really just inferring that someone who is legally responsible for making the statement did so with an intent to mislead. This makes the corporate scienter inquiry very similar to the “core operations” inference, under which courts can infer scienter in certain situations involving such blatant falsity that it would be “absurd to suggest” that management was without knowledge of the matter. But, beyond such dramatic or absurd situations, allowing the knowledge of someone who did not make the challenged statement to count for the corporation’s scienter makes no legal sense, even if it seems right from a policy perspective. Again, scienter is an intent to mislead through the making of a false statement. If the maker of the challenged statement does not intend to mislead, the corporation can’t have scienter either, through the maker’s state of mind. If someone who did not make the challenged statement has adverse information (notice we didn’t say “scienter”), what is imputed to the corporation is that someone who didn’t make the statement knew information rendering the statement false. But, in a Section 10(b) case challenging false or misleading statements, a non-speaker, by definition, cannot have scienter—which means that there is no scienter in the first place to impute to the corporation.
Finally, a finding that detaches corporate scienter from the scienter of the speaker of the challenged statement conflicts with the Supreme Court’s ruling in Janus, which held that “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” There are non-speakers on the Sixth Circuit’s list who do not have such “ultimate authority,” and thus could not be liable under Section 10(b). It would certainly be at odds with Janus if such a person nevertheless could cause a corporation’s liability.
The Sixth Circuit’s ongoing struggles reinforce the need for the Supreme Court not only to clarify the standards for judging the falsity opinions, but also to reiterate the proper standard for analyzing scienter and other aspects of securities claims as discussed in WLF’s amicus brief. We are hopeful that the Supreme Court will not only reverse the Sixth Circuit in the upcoming Omnicare decision, but will also take the opportunity to provide this much-needed clarity.