It's About Civil Procedure

On Tuesday, in my Financial Crisis seminar, we discussed the types of securities claims that have been filed by investors in mortgage-backed securities.  I opened by telling my students that one of the critical takeaway points is the importance of civil procedure.  The substance of the law matters, sure, but (as I posted when discussing class action standing), cases are won and lost on procedural grounds.

Case in point: Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, which was argued before the Supreme Court on Monday.  (Transcript here.)  Omnicare concerns the question of opinion-falsity in the context of claims under Section 11 of the Securities Act of 1933. 

Section 11 of the Securities Act imposes strict liability on issuers who include false statements of material fact in registration statements.  In a case called Virginia Bankshares, Inc. v. Sandberg, the Supreme Court held that even expressions of opinion may count as “material facts” for the purposes of the securities laws – such as, for example, a proxy statement that recommends a merger as “fair” to shareholders.  In Omnicare, the Supreme Court will decide what, exactly, it means for a statement of opinion to be false. Essentially, the dispute is about whether a statement of opinion is only false if it is subjectively disbelieved by the speaker (i.e., if the speaker claims a price is “fair” while secretly believing the price is not fair) or whether a statement of opinion can be false even if the speaker believes it to be true, but the opinion lacks a basis in fact (i.e., the speaker genuinely believes the price to be fair, but has not made any investigation into fairness and so the opinion lacks a factual basis).

Joan Heminway posted about the case here, and I also had a rundown on the issues here (where I argued, at the cert stage, that the issue was not yet ripe for Supreme Court consideration).

Monday's oral argument had a lot of back and forth about specific states of mind and various types of implied representations.  After all, when you issue an opinion in the context of a securities offering, isn’t there an implied factual representation that you have a basis for that opinion, that’s independent of the speaker’s state of mind?  On the other hand, if a statement does lack a factual basis, isn’t that strong evidence of subjective disbelief? 

And while all of these are interesting existential questions, the really important issue – and what oral argument touched upon – is pleading.

The question of opinion-falsity tends to come up in three different types of private claims under the securities laws.

First, it comes up in the context of Section 11, which imposes strict liability for false statements in registration statements. 

Second, it comes up in the context of Section 14, which imposes liability for false statements in proxy statements.  Most circuits have held that Section 14 liability is rooted in negligence.

Third, it comes up in the context of Section 10(b), which imposes liability for intentionally or recklessly false statements in connection with securities transactions.

Because Section 10(b) requires a showing of scienter, the issues in Omnicare are largely rendered moot for claims under that statute – the plaintiff will have to show intentional or reckless behavior anyway, so “subjective disbelief” gets folded into the scienter inquiry.

Where the “subjective disbelief” issue really makes a difference, therefore, is in the context of Section 11 and Section 14.

Section 14 claims are subject to the heightened pleading requirements of the Private Securities Litigation Reform Act.  That statute requires that plaintiffs plead, with particularity, facts creating a “strong inference” that the defendant acted with the required state of mind.  Some courts have held that negligence is not a state of mind, so this provision does not apply; even if it is, it's often not a difficult one to plead, even under the PSLRA.

Section 11 claims are not subject to heightened pleading under the PSLRA – they are subject to ordinary standards under the Federal Rules.  Normally, because Section 11 is a strict liability statute, plaintiffs need only plead claims in accordance with Rule 8.  But most circuits agree that when a Section 11 claim “sounds in fraud” – when the plaintiffs seem to be claiming that defendants’ actions were intentional or reckless – then Section 11 claims will be subject to Rule 9(b) pleading standards.  And though there’s a circuit split on the issue, many courts would agree that Rule 9(b) also requires that plaintiffs plead facts giving rise to a “strong inference” of fraud.

If “subjective disbelief” is required to show opinion-falsity, courts are likely to treat that as the equivalent of fraudulent intent, and require heightened pleading for Section 11 and Section 14 claims.

Moreover, for securities claims, all discovery is stayed pending the resolution of a motion to dismiss.  That means that the plaintiffs must not only plead fraudulent intent in great detail, but they must also do so without discovery.

The upshot of all of this is that one of the most significant aspects of Omnicare isn't what it means for an opinion to be false, and it isn't the duties imposed on issuers of securities – it’s whether plaintiffs bringing claims under Section 11 and Section 14 are going to be subject to heightened pleading requirements.  This is especially true because the boundaries between what counts as “opinion” and what counts as “fact” are very fuzzy – a point that was made in oral argument.  After all, as I previously posted, the Second Circuit believes that even financial statements are only “opinions.”  If just about anything can be considered an opinion, a requirement that opinions be "subjectively disbelieved" will functionally raise the pleading standards for Section 11 and Section 14 claims across the board.

(Now, the Second Circuit also tried to stake out an odd middle ground, holding both that opinion statements must be “subjectively disbelieved” to be false, and that this “subjective disbelief” is something other than fraudulent intent.  That holding has caused much confusion in the district courts, and it’s difficult to imagine a similar holding coming out of the Omnicare case; and even if Omnicare dodges that point, if the Court holds that "subjective disbelief" is required, the Second Circuit's view is going to come under considerable pressure.)

In other words, the sleeper issue in this case isn't the substance of the law - it's procedure.