In City of Omaha v. CBS Corp., No. 11-2575, 2012 U.S. App. LEXIS 9535 (2d Cir. May 10, 2012), the United States Court of Appeals for the Second Circuit reaffirmed its decision in Fait v. Regions Financial Corp., 655 F.3d 105 (2d Cir. 2011) [see our prior blog article here], which held that statements regarding goodwill and loan loss reserves were “opinions” that could only be actionable under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, if defendants did not genuinely believe the statements to be true at the time they were made. Separately, the Court also held that plaintiffs’ complaint did not sufficiently allege reliance upon a fraudulently inflated price where the alleged “red flags” purportedly indicating the need for earlier review of CBS’ goodwill were matters of public knowledge and thus were already incorporated into the price of the stock. This decision is notable for its recognition that the presumption that publicly available information, if material, necessarily affects the price of an efficiently traded stock, which typically is used by plaintiffs to support securities fraud complaints, can also be used by defendants to defeat securities fraud complaints.
In City of Omaha, plaintiffs alleged that CBS Corp. (“CBS”) and various members of CBS’ management made statements about CBS’s goodwill and its general financial condition that were knowingly or recklessly false. Specifically, plaintiffs alleged that, prior to an announcement by CBS in October 2008 that it was to perform an interim impairment test on its existing goodwill (and that, as a result, it expected to incur a non-cash impairment charge of approximately $14 billion), defendants knew about facts that indicated such a test was necessary at an earlier date. The United States District Court for the Southern District of New York dismissed the amended complaint, holding that plaintiffs “failed to cite a point, factually or temporally, when the defendants’ actions added up to something more than an exercise of real-time accounting judgment.” City of Omaha v. CBS Corp., No. 08 Civ. 10816, 2011 U.S. Dist. LEXIS 57647, at *12 (S.D.N.Y. May 24, 2011).
The Second Circuit affirmed. The Court relied upon its earlier decision in Fait, in which the Second Circuit held that estimates of goodwill and loan loss reserves are inherently subjective and thus constitute “opinions,” such that statements in this context could only be false or misleading if defendants did not genuinely believe them to be true at the time they were made. The Court concluded that because plaintiffs’ amended complaint was “devoid even of conclusory allegations that defendants did not believe in their statements of opinion regarding CBS’s goodwill at the time they were made,” plaintiffs’ fraud claims were properly dismissed.
The Court then turned to the element of reliance. It is well settled that to state a claim under Section 10(b) and Rule 10b-5, plaintiffs must plead reliance upon defendants’ allegedly false or misleading statements. Under Basic Inc. v. Levinson, 485 U.S. 224 (1988), plaintiffs’ reliance is presumed if, inter alia, the defendant issuer’s stock is traded in an efficient market because it is assumed that a stock price incorporates all publicly available material information. The presumption of reliance is rebuttable, however, upon any showing that the causal link between the alleged misrepresentation and the price is broken.
Here, the Second Circuit held that such causal link was severed where indications of CBS’s financial well-being were matters of public knowledge. The Court observed that plaintiffs claimed to have relied upon several indicia as to why CBS should have been aware that impairment testing of its intangible assets was required in early 2008: the widening gap between CBS’s book value and the company’s market capitalization, the declines in advertising revenues, and the expectations of analysts regarding the media business. The Court noted that these so-called “red flags,” as well as CBS’ last impairment test in 2007 prior to the appearance of these red flags, were all matters of public knowledge. Thus, “CBS’s market price would at all pertinent times have reflected the need for, if any, or the culpable failure to undertake, if any, interim impairment testing.” The Court reasoned that because market makers were aware of the alleged “red flags,” the market price would have accounted for such and would not have been affected by the alleged misrepresentations. Under such circumstances, there is no basis for finding that a fraud had been transmitted through the market price. Thus, the Court held the complaint failed to allege that CBS stock was fraudulently inflated and, consequently, failed to allege reliance upon such fraud.
Commentators have long recognized that issues of causation, reliance, materiality and price impact in securities fraud actions are interrelated. This decision moves the law closer to applying a more consistent approach to the issues. The United States Supreme Court’s decisions in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011) [see blog article here], and Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011) [see blog article here], previewed several of these issues, but a more comprehensive analysis still awaits Supreme Court consideration.