As popular targets for investor suits, officers and directors of public companies have another tool to defend against securities class actions, and specifically claims relating to the recording of goodwill. On May 5, 2017, in City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc., et al., No 14-16814 (9th Cir. 2017), the Ninth Circuit handed down a significant ruling and joined the Second Circuit in extending the standard for pleading falsity of opinion statements under Section 11 of the Exchange Act, as set forth by the Supreme Court in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, 135 S. Ct. 1318 (2015), to claims brought under Section 10(b).
As a result, the Ninth Circuit held that its prior standard for pleading falsity by alleging that there is “no reasonable basis for the belief” under a material misrepresentation theory of liability was “‘clearly irreconcilable’ with Omnicare.” By extending Omnicare’s reach, the decision creates a considerable obstacle for securities plaintiffs seeking to bring suit on the basis of opinion statements.
In Align Technology, defendant Align Technology, a manufacturer of Invisalign and other dental products, together with its CEO and CFO, allegedly misled investors regarding its recent acquisition of Cadent Holdings, Inc., a leading provider of 3D digital intra-oral scanning solutions. At issue was Align’s goodwill allocation of US$76.9 million specifically related to a computer-aided design and scanner unit (the SCCS unit).1 Plaintiff alleged that defendants were aware that statements related to the goodwill estimate, and subsequent statements disclaiming the necessity of goodwill impairment, were false or misleading because defendants knew or should have known that (1) Cadent’s 2010 annual revenue numbers were improperly inflated at the time of acquisition, and (2) the SCCS’s projected revenues were not met, and gross margins declined, due to new competition in the industry, a decline in international sales, and problems with integration efforts. The district court dismissed the case based on plaintiff’s failure to plead falsity and scienter, and the Ninth Circuit affirmed.
Importantly, as a matter of first impression in the Ninth Circuit and in agreement with Second Circuit precedent, the Ninth Circuit held that goodwill valuations are statements of opinion as they depend upon management’s determination of fair value, which are not matters of objective fact. The Court therefore found that six of the seven alleged misstatements were statements of opinion, and one was a statement of opinion with an embedded fact.
Upon making the key determination that the Section 11 Omnicare case was the controlling standard for opinion statements even under Section 10(b), the Court recounted Omnicare’s three governing standards: “First, when a plaintiff relies on a theory of material misrepresentation, the plaintiff must allege both that ‘the speaker did not hold the belief she professed’ and that the belief is objectively untrue.”; “Second, when a plaintiff relies on a theory that a statement of fact contained within an opinion statement is materially misleading, the plaintiff must allege that “the supporting fact [the speaker] supplied [is] true.’”; “Third, when a plaintiff relies on a theory of omission, the plaintiff must allege ‘facts going to the basis for the issuer’s opinion, whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.’”
The Court explained that the then-current Ninth Circuit standard—which allowed plaintiffs to establish the falsity of an opinion statement by alleging that “there is no reasonable basis for the belief”—conflicted with Omnicare’s first governing standard requiring both objective and subjective falsity. As a result, the Ninth Circuit held that Omnicare overruled its prior standard to the extent plaintiffs attempt to plead falsity under a material misrepresentation theory of liability.
In regards to plaintiff’s attempt to plead falsity of the alleged opinions under a material misrepresentation theory, the Court found that the second amended complaint contained no allegations of subjective falsity, nor had plaintiff pleaded facts sufficient to infer subjective falsity. In response to plaintiff’s contention that defendants “must have known” that the SCCS goodwill was impaired and that their goodwill valuation was false, the Court noted that plaintiff—despite relying on confidential informants—failed to plead any facts establishing that Defendants continued to use Cadent’s inflated revenue figures in conducting its goodwill impairment testing for the SCCS unit. In addition, the Court found, among other things, that the SCCS unit’s financial results and changes in the market did not compel a finding of goodwill impairment because there were positive and mitigating factors that defendants could have considered to balance or outweigh the events and circumstances that plaintiff identified. Indeed, even though plaintiff pleaded its own calculations indicating impairment, the Court found that it still failed to allege the actual assumptions that defendants relied upon in conducting their goodwill analysis, without which plaintiff’s allegations were insufficient.
Next, the Court found that plaintiff’s allegation of falsity based on defendants’ omission of facts surrounding Cadent’s inflated revenue figures and Align’s issues with declining sales, integration efforts, and changed market conditions likewise fails. The Court reiterated that plaintiff had not alleged that Cadent’s inflated revenue figures were used in defendants’ goodwill valuation and noted that the company had in fact disclosed to investors both Align’s integration issues and the risks posed by competitors.
As for the one statement which contained an embedded statement of fact—“[D]uring the fiscal year ended December 31, 2011, there were no facts or circumstances that indicated that fair value of the reporting units may be less than their current carrying amount”— the Court found that plaintiff could not demonstrate what these additional “facts or circumstances” were without specifically alleging the negative factors and assumptions defendants had incorporated into their initial goodwill valuation. The Ninth Circuit therefore affirmed the district court’s dismissal based on plaintiff’s failure to plead falsity.
The Ninth Circuit ruling in Align Technology serves as a potential barrier to securities plaintiffs in two distinct ways. First, it expands the universe of statements made by defendants that will be considered opinion statements. Specifically, matters related to accounting which require management judgment are likely to be seen as opinion statements by courts. While the line between accounting matters which require judgment and those rooted in objective standards will continue to be a point of contention, the recognition of goodwill as a statement of opinion marks a meaningful victory for defendants. Secondly, the case decides that Omnicare is now the controlling standard for opinion statements in 10(b) cases in the Ninth Circuit, thereby adding an extra hurdle of subjective falsity for plaintiffs seeking to establish liability for opinion statements based on a material misrepresentation theory. With the influential Ninth and Second Circuits deciding to apply Omnicare to Section 10(b) cases, it should not be long before courts across the nation follow suit.