In the wake of the economic downturn and mortgage crisis, courts around the country have seen numerous suits brought against issuers and sellers of securities based on allegedly false or misleading statements regarding the defendant’s financial health.  See, e.g., Fait v. Regions Fin’l Corp., 712 F. Supp. 2d 117 (S.D.N.Y. 2010), aff’d, No. 10-2311-cv, 2011 U.S. App. LEXIS 17515 (2d Cir. Aug. 23, 2011); Rubke v. Capitol Bancorp Ltd, 551 F.3d 1156 (9th Cir. 2009); In re Washington Mutual, Inc. Sec. Litig., 259 F.R.D. 490 (W.D. Wash. 2009).  Several of these cases have been brought against issuers of securities – as well as underwriters and accountants – under Sections 11 and 12(a)(2) of the Securities Act of 1933, 15 U.S.C. § 77k(a) and  § 77l(a)(2).  These sections, which have “roughly parallel elements,” provide a cause of action for false and misleading registration statements (Section 11) and prospectuses (Section 12) disseminated in connection with the issuance of securities.  See Fait, 712 F. Supp. 2d at 120. 

Unlike claims asserting violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), the heightened pleading requirements of Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995 ordinarily do not apply to Section 11 and 12 claims.  See Fait, 712 F. Supp. at 122.  Rather, as to issuer defendants, Section 11 normally “imposes a form of strict liability such that plaintiffs need only show that the misstatements or omissions were material in order to state a claim.”  Id.; see also In re Washington Mutual, 259 F.R.D. at 505 (denying motion to dismiss and stating Section 11 “was designed to ensure compliance with the disclosure provisions of the Act by imposing a stringent standard of liability on the parties who play a direct role in a registered offering.”).  Under Sections 11 and 12, defendants may be liable “for mere negligence” and it is not necessary to establish scienter.  Fait, 2011 U.S. App. LEXIS 17517, at *10; see also In re New Century, 588 F. Supp. 2d 1206, 1238 (C.D. Cal. 2008) (“No scienter is required for liability under § 11; defendants will be liable for innocent or negligent material misstatements or omissions.”).

Despite the typically more lenient pleading standard, recent decisions make clear that when Section 11 and 12 claims are based on allegedly false and misleading statements of opinion – as opposed to statements of fact – plaintiffs must meet Rule 9(b)’s heightened pleading standards.  See Rubke, 551 F.3d at 1162 (assessing Section 11 claim under Rule 9(b) and dismissing because plaintiffs failed to show defendants believed prior valuations in fairness opinion were incorrect); see also In re CIT Group, 349 F. Supp. 2d 685, 690 (S.D.N.Y. 2004) (“[E]ven though section 11 causes of action do not require proof of fraud, plaintiffs whose complaints sound in fraud will need to conform to the more stringent pleading requirements of Rule 9(b).”).  Specifically, courts have held that claims based on opinions of financial health are not actionable under the federal securities laws unless the complaint contains allegations sufficient to show that the statement of opinion lacked a reasonable factual basis – i.e., objective falsity – and that the defendants did not actually believe or hold the opinion at the time it was expressed – i.e., subjective falsity.  See, e.g., Washtenaw County Emp. Ret. Sys. v. Wells Real Estate Inv. Trust, Inc., No. 1:07-CV-862-CAP, 2008 U.S. Dist. LEXIS 52352, at *23 (N.D. Ga. Mar. 31, 2008) (“[s]tatements of opinion or belief are actionable only if they are both objectively and subjectively false.”); Rubke, 551 F.3d at 1162 (holding that claims related to fairness opinions “can give rise to a claim under section 11 only if the complaint alleges with particularity that the statements were both objectively and subjectively false or misleading.”).  Because plaintiffs must plead that the defendants did not actually hold the opinions expressed, claims based on allegedly false opinions necessarily sound in fraud and, consequently, Rule 9(b)’s pleading standards apply.  See, e.g., Fait, 2011 U.S. App. LEXIS 17515, at *20; In re CIT Group, 349 F. Supp. 2d at 690. 

In Fait v. Regions, No. 10-2311-cv, 2011 U.S. App. LEXIS 17517 (2d Cir. Aug. 23, 2011), the Second Circuit addressed whether statements made in the defendant bank’s registration statement regarding goodwill and loan loss reserves were actionable under Sections 11 and 12.  Specifically, plaintiffs alleged that the defendant “failed to write down ‘goodwill’ and to sufficiently increase ‘loan loss reserves’” in connection with its acquisition of another bank holding company, AmSouth.  Id. at *6.  After reporting a $5.6 billion net loss which was “largely driven by a $6 billion non-cash charge for impairment of goodwill,” and “doubling” of its loan loss reserve to $1.15 billion, the defendant’s stock price dropped, the bank’s debt was downgraded, and plaintiffs filed suit against the bank, the board members who signed the registration statement at issue, the accounting firm that served as the defendant’s independent public accountant and certified the financial statements in the 10-K at issue, and the underwriters.  Id. at *5.

In affirming the Southern District of New York’s dismissal of the plaintiff’s claims, the Second Circuit held that the statements at issue were “opinions, which were not alleged to have falsely represented the speakers’ beliefs at the time they were made.”  2011 U.S. App. LEXIS 17517, at *2.  The Second Circuit relied on Virginia Bankshares v. Sandberg, in which the Supreme Court addressed whether statements by directors in proxies that urged the minority shareholders to vote in favor of a merger were actionable under section 14(a).  501 U.S. 1083, 1095-96 (1991).  The proxies included statements by directors that the minority shareholders would “achieve a ‘high’ value” and “fair price” in the merger.  Id. at 1088.  The plaintiffs alleged the directors did not actually believe that the price offered was “fair” or would result in “high value” for the plaintiffs, and had made the statements with the ulterior motive to stay on the board.  Id.  The Supreme Court held that “statements of reasons, opinions, or belief” as to material facts are actionable under section 14(a) where the plaintiffs “prove a specific statement of reason [was] knowingly false or misleadingly incomplete.”  Id. at 1095. 

Citing Virginia Bankshares, the Second Circuit explained, “when a plaintiff asserts a claim under section 11 or 12 based upon a belief or opinion alleged to have been communicated by a defendant, liability lies only to the extent that the statement was both objectively false and disbelieved at the time it was expressed.”  Fait, 2011 U.S. App. LEXIS 17517, at *11.  The Second Circuit agreed with the district court’s description of goodwill as based on both objective facts, “the excess of the acquisition price,” and subjective facts, “the fair value of AmSouth’s assets at the time of the acquisition.”  Id. at *12 (quoting Fait v. Regions, 712 F. Supp. 2d 117, 122 (S.D.N.Y. 2010)).  Although the complaint alleged that defendants failed to value goodwill appropriately or conduct impairment tests in light of “adverse market conditions” and “the deterioration of the banking sector,” the complaint contained no allegations to support the inference “that defendant did not believe the statements regarding goodwill at the time they made them.”  Id. at *19.  Similarly, the court found that “the adequacy of the loan loss reserves is not a matter of objective fact,” is an estimate, and not based on any single, objective method used across the industry.  See id. at *20.  As a result, plaintiffs’ generalized allegation that the loan loss reserves were “materially inadequate” were not sufficient to withstand a motion to dismiss because the plaintiffs failed to allege that the defendants’ opinions as to the loan loss reserves “were both false and not honestly believed when they were made.”  Id. (citing Virginia Bankshares, 501 U.S. at 1095).  

In other cases addressing the adequacy of loan loss reserves and fairness opinions, courts similarly have held statements regarding these issues to be subjective matters of opinion and expressly required plaintiffs to satisfy Rule 9(b) where the complaint alleges the defendant did not believe the opinion when it was stated.  See, e.g., In re Washington Mutual, 259 F.R.D. at 503 (assessing plaintiff’s Section 11 and 12 claims regarding misrepresentations as to lending practices under the Rule 9(b) standard); Rubke, 551 F.3d 1156 (9th Cir. 2009).  For example, in Rubke v. Capital Bancorp Ltd, the Ninth Circuit upheld dismissal of plaintiffs’ section 11 claim that a registration statement was misleading because it incorporated allegedly unreliable fairness opinions that concluded the transaction at issue was “financially fair to minority shareholders.” 551 F.3d at 1162.   Finding the fairness opinions “are alleged to be misleading opinions, not statements of fact,” the court held the allegations must satisfy 9(b).  Id. at 1161-62.  However, the plaintiffs’ allegations regarding the unreliable nature of the fairness opinion failed to meet 9(b)’s requirements because the complaint alleged merely that defendants “should have known” that the fairness opinions were unreliable, but did not “indicate on what facts this belief [regarding the unreliable nature of the opinions] is formed.”  Id.

Although each of the cases discussed above is based on the courts’ fact-specific inquiry, in particular, Fait and Rubke offer defendants strong dismissal arguments against Section 11 and 12 claims that are based on allegedly false and misleading statements of opinion.

About the Authors:

Thomas B. Bosch is a partner in the Atlanta office of Troutman Sanders LLP.  He is a member of the firm’s Securities Litigation Practice Group. Tom focuses his practice on shareholder litigation and related intra-corporate disputes, including securities class actions and corporate governance disputes.