On May 5, 2017, the U.S. Court of Appeals for the Ninth Circuit jettisoned its precedent for pleading the falsity of statements of opinion challenged in private securities litigation, instead embracing the more demanding standard compelled by the U.S. Supreme Court’s 2015 Omnicare decision. In doing so, the Ninth Circuit not only raised the bar for plaintiffs to plead falsity under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, but also rejected plaintiffs’ attempts to recharacterize opinion statements as factual ones in order to avoid that burden.
In City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc.,1 a putative class of investors in Align Technology, Inc. alleged that the issuer and its CEO and CFO made materially false and misleading statements concerning goodwill valuations used in connection with its acquisition of Cadent Holdings, Inc. The U.S. District Court for the Northern District of California dismissed the lawsuit in its entirety, ruling that the plaintiffs had failed to plead the falsity of the challenged statements with the particularity required under the Private Securities Litigation Reform Act and, in addition, failed to sufficiently plead that the defendants made those statements with fraudulent intent (scienter). The plaintiffs thereafter appealed that dismissal to the Ninth Circuit.
On appeal, the Ninth Circuit began by classifying each of the seven challenged statements as either statements of fact or of opinion, a critical distinction given the generally more demanding burden imposed on plaintiffs who attempt to bring securities fraud cases on a theory that the open market was mislead by subjective opinions, as opposed to challenging statements of objective fact (such as those reporting current or past financial results). In doing so, the Ninth Circuit adopted the standard prevailing in the Second Circuit—that “statements regarding goodwill valuations are opinion statements because they ‘are inherently subjective and involve management’s opinion regarding fair value’”—and, for this reason, agreed with the District Court that all seven challenged statements were properly characterized as opinions.2 On appeal, the plaintiffs argued that two of those challenged statements should not be classified as opinions because they contained “embedded statements of fact”: the first stating that there were “no facts or circumstances” indicating impairment of goodwill and the second stating that the fair value of Cadent “was significantly in excess of the carrying value.”3 The Ninth Circuit accepted the plaintiffs’ argument that, read in isolation, the phrase “no facts or circumstances” “asserts an objectively verifiable fact,” but rejected the plaintiffs’ attempt to contort the subjective, “qualitative assessment of [Cadent’s] fair value” into an objective, factual statement.
Next, the Ninth Circuit held that its then-prevailing standard for pleading falsity—requiring plaintiffs who challenge opinion statements to plead that there was “no reasonable basis for the belief”—is “clearly irreconcilable” with Omnicare when applied under a material misrepresentation theory. In so doing, the Ninth Circuit emphasized that the Supreme Court raised that pleading standard in Omnicare by requiring that: (1) under a theory of material misrepresentation, the plaintiff must allege both objective falsity and the speaker’s subjective knowledge of the untruth; (2) when assessing a fact embedded within an opinion statement, the plaintiff must allege that “the supporting fact [the speaker] supplied [is] untrue”; and (3) under a theory of omission, the plaintiff must allege “facts going to the basis for the [speaker’s] opinion . . . whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.”4
Applying that Omnicare standard, the Ninth Circuit affirmed the District Court’s dismissal because the plaintiffs had failed to allege that the defendants subjectively did not believe their opinions about the goodwill reserves. Furthermore, under an omissions theory, the Ninth Circuit found that none of the alleged omissions “call into question the issuer’s basis for offering the opinion,” again as required by Omnicare.5
As a result of this new precedent, public company issuers and management teams in the Ninth Circuit should have added confidence that their candid opinions about the business and its prospects—including valuations of goodwill and other subjective estimates—will not be easy fodder for investor class actions. To some extent, the Ninth Circuit’s alignment of its now-superseded precedent with Omnicare was overdue; the former standard was itself high, but the latter standard adopted by the Supreme Court in 2015 is still more demanding. Perhaps as significant is how decisively the Ninth Circuit rejected the plaintiffs’ efforts to essentially dodge Omnicare altogether by selectively classifying challenged opinions as statements of fact on the theory that facts were “embedded” in the opinion. Skeptical of this selective classification, the Ninth Circuit applied a more limited, defense-friendly determination of “embedded facts” because, in some sense, almost all publicly stated management opinions are articulated by reference to some underlying fact. Finally, the Ninth Circuit has again recognized that not all investor challenges to accounting statements are as straightforward as the revenue recognition cases that for years predominated private securities litigation. That is, unlike reports of past revenue, expense and margins that unquestionably may be analyzed as factual statements, issuers and their accountants should take comfort that the Ninth Circuit courts understand that goodwill valuations and other financial reports are the product of subjective, qualitative judgment that goes well beyond objective arithmetic.