Supreme Court Clarifies Scope of Liability Under Section 11 of the Securities Act of 1933

What you need to know:

Public companies and practitioners alike have historically relied on the “bespeaks caution” doctrine, meaning that qualifying a statement as a belief was an effective disclaimer that the statement may not always hold true. In its recent decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, the Supreme Court addressed conflicting views by the appellate courts regarding the scope of liability under Section 11 of the Securities Act of 1933 for false statements of opinion or belief in the context of a registration statement. While the ruling may narrow at the margins the “bespeaks caution” doctrine, the decision provides guidance on how to minimize potential Section 11 liability for statements of opinion, but poses difficult judgment calls for issuers and practitioners in crafting disclosure around statements of opinion.

What you need to do:

Issuers and underwriters alike should focus increased attention on statements of opinion contained in registration statements, including an evaluation of the positive and negative factors supporting (or refuting) the opinion and whether disclosure of these factors is now needed.

In the context of a public company registration statement, Section 11 of the Securities Act of 1933 establishes a strict liability standard in favor of purchasers of securities in the applicable offering for either an “untrue statement of a material fact” or “omit[ting] to state a material fact … necessary to make the statements therein not misleading”. In Omnicare, the Supreme Court clarified the circumstances under which Section 11 liability can attach to statements of opinion or belief, holding as follows:

• A statement of opinion gives rise to Section 11 liability as an “untrue statement of a material fact” only if the issuer does not actually hold the opinion at the time the statement is made or if the statement of opinion embeds an underlying fact that is untrue. On the latter, the court used the hypothetical statement to illustrate its holding: “I believe our TVs have the highest resolution available because we use a patented technology to which our competitors do not have access”, explaining that liability may attach were the company not to use patented technology. Importantly, the Supreme Court confirmed that a sincere statement of pure opinion is not an “untrue statement” even if the opinion is ultimately proven to be wrong.
• However, the same statement of opinion may give rise to Section 11 liability as “omit[ting] to state a material fact … necessary to make the statements therein not misleading” if a registration statement fails to disclose material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself.

The Supreme Court established a high bar for a plaintiff to succeed on an omissions claim, making it clear that reciting conclusory allegations would not be sufficient to survive a motion to dismiss, and that instead a plaintiff “must identify particular (and material) facts going to the basis for the issuer’s opinion – facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have – whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.”

The ability of a plaintiff to succeed on this measure may be particularly difficult, as under the Private Securities Litigation Reform Act of 1995 discovery is automatically stayed during the pendency of a motion to dismiss in federal court, making it more difficult for plaintiffs to discover the facts that they are required to allege. In an attempt to obviate this barrier, plaintiffs are increasingly attempting to bring Section 11 cases in state court under a previously little used statutory provision conferring jurisdiction on state courts (and prohibiting removal to federal courts), in the hopes of avoiding a stay of discovery.

The Supreme Court was also careful to affirm that whether a statement is misleading will always depend on context, both that made explicit within the disclosure document and also the “customs and practices of the relevant industry” and that omissions should not be evaluated in a vacuum.

The Supreme Court left for lower courts to establish the extent to which the basis of an opinion should be disclosed to be consistent with a reasonable investor’s expectations, and what an issuer should say about the tentativeness of a belief. The Supreme Court stated that “to avoid exposure for omissions under [Section] 11, an issuer need only [emphasis added] divulge an opinion’s basis, or else make clear the real tentativeness of its belief.” However, this guidance glosses over the disclosure challenges involved where an issuer’s statement of opinion is based upon the weighting of both positive and negative factors supporting (or refuting) the opinion.

In the wake of Omnicare, issuers and underwriters alike will likely have an increased focus on statements of opinion contained in registration statements, including an evaluation of the positive and negative factors supporting (or refuting) the opinion and whether disclosure of these factors is now needed. We expect that in many cases a determination may be made that exposing the positive and negative factors may increase, rather than limit, the potential of Section 11 liabilities. Regardless, we also expect that plaintiffs will increasingly focus on statements of opinion as a basis to make a claim of Section 11 liability.

The Supreme Court also did not address whether the Section 11 analysis in Omnicare would be applied to other statutes requiring false or misleading misrepresentations or omissions. It is possible that the extension of the analysis may be limited, as central to the Supreme Court’s holding in Omnicare was the heightened level of care given to statements made in a registration statement filed with the SEC.