Everyone is entitled to his own opinion, but not to his own facts.

At its Friday conference, the Supreme Court considered the cert petition filed in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, concerning the definition of “falsity” under the securities laws when the relevant statement expresses a matter of opinion, rather than objective fact.  I think the Court will likely deny this particular petition, but the issue is a critical one that will have to be resolved sooner or later.

[More discussion under the cut - click to read]

In Virginia Bankshares, Inc. v. Sandberg, the Supreme Court held that even matters of opinion or belief can constitute “factual” statements that can form the basis of a securities claim.  However, Bankshares is rather difficult to parse with respect to its discussion of how to determine whether an opinion is false.  As a result, a circuit split has developed over whether Virginia Bankshares should be interpreted to mean that statements of opinion must be both subjectively disbelieved, and objectively lacking in a reasonable basis, before they may be deemed false, or whether opinion statements may be deemed false if they simply lack an objectively reasonable basis.

For claims brought under Section 10(b) of the Securities Exchange Act, this dispute is largely academic, because Section 10(b) requires scienter – a showing that the defendant intentionally or recklessly deceived investors.  That requirement tends to subsume the issue of subjective falsity.

For claims brought under Section 11 of the Securities Act, however, the issue is critical, because Section 11 imposes liability for false statements in registration statements, regardless of the intent of the speaker (although some defendants are permitted a good faith/due diligence defense).  If “opinion” statements must be subjectively disbelieved merely to be rendered false, this may have the effect of importing a scienter requirement into claims brought under Section 11.

The Second and Ninth Circuits have interpreted Bankshares to require both subjective disbelief and objective falsity; in Omnicare, however, the Sixth Circuit held that objective falsity is sufficient – hence the pending cert petition.

But I tend to think the split is not ripe for Supreme Court intervention, because the Second Circuit has been maddeningly vague about what it means to “subjectively disbelieve” a statement of opinion.  District courts at first interpreted the phrase to be the equivalent of scienter, but the Second Circuit has now twice affirmed that they are not the same.  The Second Circuit has also held that subjective disbelief may pled under the notice-pleading standards of Rule 8, and not under the tougher particularity standards of Rule 9(b), which applies to fraud claims.  At present, neither the Second Circuit, nor the district courts, have come up with any explanation of how exactly one can offer a statement of opinion that one subjectively disbelieves, while simultaneously failing to act with fraudulent intent.

With the Second Circuit’s view so unclear, the Supreme Court should not – and I’m guessing will not – grant cert to resolve the split.  (On Monday, the Court will issue the order list from the Friday conference, and we’ll know for sure – unless the Court relists Omnicare for reconsideration at another conference, in which case, we won’t).

That said, the issue is a critical one, in part because of the Second Circuit’s expansive definition of what it means to be an “opinion” statement in the first place.  The Second Circuit held in Fait v. Regions Financial Corp., 655 F.3d 105 (2d Cir. 2011), that an “opinion” is essentially any matter that cannot be determined by reference to an objective standard alone, but instead requires the application of management judgment.  This means, in the Second Circuit’s view, that not only are obviously evaluative statements matters of opinion (like “high,” “fair,” “strong,” etc), but even financial statements – such as reserve and goodwill calculations – are matters of opinion, and are not “false” unless subjectively disbelieved by the speaker.

This is an extraordinarily broad holding that creates serious tensions with other areas of the securities laws – which one can only assume the Second Circuit realized, prompting its caginess on the precise definition of “subjective disbelief.” 

For one thing, many, if not most, matters of accounting involve management judgment, and the Second Circuit provides no guidance for distinguishing “factual” accounting matters from “opinion” accounting matters (with the possible exception of valuation of assets for which there is a ready market price).  It is not too hyperbolic to say that the Second Circuit’s view could result in large swaths of a company’s financial statements being classified as opinion rather than fact – which, though raising intriguing existential questions, is manifestly impractical from the standpoint of enforcement of the securities laws.  The SEC has a regulation stating that financial statements that fail to comply with Generally Accepted Accounting Principles (GAAP) are presumed false – does that mean that GAAP compliance necessarily exists if management operated in good faith?  Or is the regulation inapplicable to claims under Section 11?

And what about restatements?  It is blackletter law that a financial restatement represents an admission of falsity, but not an admission of fraudulent intent.  Yet from an accounting perspective, restatements do not depend on the presence or absence of “subjective disbelief,” but are required whenever there is a material “error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of GAAP, or oversight or misuse of facts that existed at the time the financial statements were prepared.”  Does this mean that restatements – at least those concerning goodwill, reserves, valuation of assets for which there is no objective market price, and other items that require judgment – are no longer proof of falsity?  Or does it mean that a restatement will be taken as an admission of subjective disbelief at the time the statement first issued?

Finally, in the securities law context, opinions have usually been evaluated under the same standards applicable to “forward-looking” statements – projections of future performance, plans for the future, and so forth.  In the Private Securities Litigation Reform Act (PSLRA), Congress provided that projections of future performance would get special immunities from private lawsuits (the statutory “safe harbor”) – including a requirement that the statement be made with “knowledge” that it is false before a claim can be brought (i.e., something that may be akin to a “subjective disbelief” standard).  But the “safe harbor” does not apply to financial statements.  So the Second Circuit’s interpretation of what it means to be an opinion, and what it takes to render an opinion false, is in some tension, if not direct conflict, with the PSLRA.

Unsurprisingly, Fait (and its district court predecessors) have forced district courts to draw lines that can seem arbitrary.  For example, in cases concerning mortgage-backed securities, courts have held that appraisals are statements of opinion, requiring subjective falsity – but representations regarding the methods by which those appraisals were reached (i.e., compliance with uniform standards) are representations of fact.  See, e.g., In re Bear Stearns Mortgage Pass-Through Certificates Litigation, 851 F. Supp. 2d 746 (S.D.N.Y. 2012).  It’s a clever argument, but it’s hard to believe that compliance with uniform appraisal standards (the latest of which take 400 pages to describe) does not also require some degree of judgment, which would put the whole inquiry back in the opinion box.  

Thus, unless the Second Circuit reverses course, this is definitely an issue that the Supreme Court will have to resolve.

Edit: The Court took no action on the Omnicare petition at its conference, and instead relisted it for consideration next Friday, Feb 28.

Edit again: Well, so much for my powers of prediction.  The Court ended up granting cert, and the case will be heard during the 2014 Term.  As long as it's out there, I'll be posting more about it.