Supreme Court decision invokes omission clause to test liability for opinions in registration statements
With its recent decision in Omnicare v. Laborers District Council Construction Industry Pension Fund, the Supreme Court put issuers on notice: their opinions must have a reasonable basis if they are going to be included in a registration statement, because a reasonable investor would assume they do. That means that companies are now at greater risk of being liable for securities fraud under Section 11 of the Securities Act of 1933 if they fail to clearly state the basis for an opinion.
Mark Foster, securities litigation partner at Morrison & Foerster, doesn’t see that result as surprising, particularly after the oral argument. However, he believes ’many practitioners were surprised that the Court articulated a test under the omissions hook’, and even more so by the test itself.
’If a registration statement omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then Section 11’s omissions clause creates liability,’ the decision says of the test on page 12.
The Court emphasizes that its test is not carte blanche to sue based on any fact inconsistent with the opinion. ‘An opinion statement, however, is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way. Reasonable investors understand that opinions sometimes rest on a weighing of competing facts; indeed, the presence of such facts is one reason why an issuer may frame a statement as an opinion, thus conveying uncertainty.’ (Decision on page 13.)
While that acknowledgment and other statements offer some comfort, Foster says he’s not fully reassured. ‘People are looking at the test and thinking Reasonable basis, check. Have to do some inquiry, check. But then they scratch their heads and ask,But what if our reasonable inquiry does not match up with what a reasonable investor would expect? ‘ he says. ‘That potential mismatch between what a reasonable investor (aka plaintiff’s lawyer) expects and what was actually done, creates a zone of risk.’
That risk is not unmanageable, however. ‘A prudent way to minimize that risk is to give the basis along with the opinion, along with meaningful cautions and disclaimers,’ Foster says. Doing so would eliminate the need to guess what a reasonable investor would understand from the opinion, he adds.
Both before and within the Omnicare decision, the Court held that the only fact explicitly asserted by an opinion is that the issuer believed it. Thus, for an issuer to be liable for an opinion on the grounds that it was an untrue statement of material fact, it had to be proved that the issuer did not believe the opinion when stating it. Invoking Section 11’s omissions clause as a complimentary basis for liability, the Court said a reasonable investor ‘expects not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer’s possession at the time.’ (Decision on page 12.) The Court dismissed Omnicare’s assertion that such liability was inappropriate and that the subjective belief of the issuer was the only appropriate benchmark. ‘Were Omnicare right, companies would have virtual carte blanche to assert opinions in registration statements free from worry about §11. That outcome would ill-fit Congress’s decision to establish a strict liability offense promoting full and fair disclosure of material information,’ the decision states on pages 16-17.
Foster believes some courts may refuse to dismiss cases where a plaintiff can point to a plausible inconsistency between an opinion and the type of diligence to form the opinion that arguably should have been undertaken before the opinion was expressed. Whenever that happens, companies will be drawn into expensive and time-consuming discovery that centers on two subjects: first, what the issuer’s actual basis of its opinion was; and second, why the issuer did not do more to substantiate the opinion. That inquiry licenses plaintiffs, who have the benefit of hindsight, to second-guess opinions and the way they were formed, he says.
He has deceptively simple advice for issuers in order to limit their risk, comprising three steps:
- Accompany the statement of opinion with an explanation of what the basis of the opinion is;
- Make sure the articulated basis is accurate;
- Appropriately qualify it.
Foster concedes that step two is hard. ‘Often, there is not a single basis supporting an opinion. And sometimes there are a range of factors supporting an opinion, some factors cutting the other way,’ he says. ‘Providing disclosure that accurately captures the inputs and process supporting an opinion will be challenging for companies and their advisors.’
