Recent Supreme Court Developments in the Securities Context

© 2014 Winston & Strawn LLP

Recent Supreme Court Developments in the Securities Context

July 22, 2014

©2014 Winston & Strawn LLP 2

Today’s Speakers

David A. Sakowitz Partner

New York

+1 (212) 294-2639

[email protected]

John E. Schreiber Partner

Los Angeles New York

+1 (213) 615-1850 +1 (212) 294-6850

[email protected]

mailto:[email protected]



Securities Litigation by the Numbers

• In 2013, shareholder plaintiffs: – Challenged 94% of M&A deals valued at over $100 million – Filed 166 federal securities class actions

• Since 1996, $85 billion has been paid by companies in connection with federal securities class actions


• Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71 (2006) (SLUSA preemption)

• Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007) (heightened standards for pleading scienter)

• Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008) (limiting liability of secondary actors)

• Merck & Co. v. Reynolds, 559 U.S. 633 (2010) (statute of limitations)

• Morrison v. Nat’l Australia Bank Ltd., 561 U.S. 247 (2010) (limiting extraterritorial reach of federal securities laws)

• Matrixx Initiatives, Inc. v. Siracusano, 131 S.Ct. 1309 (2011) (standards of materiality)

The Roberts Court – Securities Cases


• Erica P. John Fund, Inc. v. Halliburton Co., 131 S.Ct. 2296 (2011) (“Halliburton I”) (loss causation at class certification stage)

• Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S.Ct. 1184 (2013) (materiality at class certification stage)

The Roberts Court – Securities Cases (cont’d)

Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014)


• Implied private right of action under Section 10(b) of the Securities Exchange Act of 1934 and SEC rule 10b-5 thereunder

• Elements

1. Misstatement or omission of material fact

2. Scienter

3. Connection to purchase or sale of security

4. Reliance

5. Loss causation

Halliburton II – Federal Securities Fraud Class Actions


• Adopted in Basic v. Levinson, 485 U.S. 224 (1988)

• Premise: “the market price of shares traded on well-developed markets reflects all publicly available information and, hence, any material misrepresentations.”

• Reliance presumed if: – Alleged misrepresentation is made publicly; – Alleged misrepresentation is material; and – Security trades in an “efficient market”

Halliburton II – Fraud-on-the-Market Presumption


• Alleged misstatements related to: – Potential liability in asbestos litigation – Expected revenue from certain construction contracts – Anticipated benefits of merger with another company

• Class certified based on fraud-on-the-market presumption

Halliburton II – Background


• Whether to overrule Basic altogether

• If not, whether entitlement to fraud-on-the-market presumption requires front-end “price impact”

– Plaintiffs’ burden to demonstrate at class certification stage? – If not, may defendants rebut presumption at class certification

stage by showing lack of price impact?

Halliburton II – Issues before Supreme Court


• Court declines to overrule Basic – No “specific justification” for doing so – Basic’s “modest premise” that markets “generally” reflect public

information remains valid

• Holds that plaintiffs need not demonstrate price impact at class certification stage

• But holds that defendants must be allowed to rebut presumption by showing lack of “price impact”

Halliburton II – Decision


• Plaintiffs’ lawyers live to sue another day

• Added hurdle to class certification – Battle of experts over “price impact”

• Impact on settlement timing

• Increased focus on “omission” cases

• Increased litigation under Section 11 of the Securities Act?

Halliburton II – Implications

Omnicare, Inc. v. Laborers Dist. Council Construction Industry Pension Fund, No. 13-435


Omnicare – Securities Law Framework

• Section 5 of the Securities Act of 1933 – Offers and sales of securities must either (1) be registered under

the Securities Act or (2) qualify for an exemption from registration – Registration statement contains the prospectus that is distributed

to investors – SEC rules require detailed disclosure in the prospectus, including

information about the company's business, financial and operating data, and risk factors

– Omnicare filed a "shelf" registration statement in August 2005 and then a prospectus supplement in December 2005 relating to an offering of 12,825,000 common shares


• Due diligence

– an essential part of the process to ensure the accuracy of the factual statements in the registration statement

• Legal documentation: review material contracts, regulatory filings, board minutes and other documents

• Business diligence: discussions among the company, the underwriters, legal counsel and accountants



• Section 11 of the Securities Act

– Imposes liability when a registration statement:

"contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading."

– Liability for issuer, directors, underwriters and named experts; "due diligence" defense for everyone except for the issuer



• Language of Section 11 recurs across the Federal securities laws

– Rule 10b-5 – anti-fraud provision that applies to all offerings

– Section 14(a) – proxy rules

• Standards of liability may vary from statute to statute (e.g. strict liability v. scienter), but the standard of accuracy of the disclosure is the same: whether a material fact was misstated or omitted



• Alleged misstatements relate to Omnicare’s stated belief that it was in material compliance with applicable laws

– E.g., “[W]e believe that we are in compliance in all material respects with state and federal regulations applicable to our business.”

• “Legal compliance” statements appeared along with caveats, including:

– “These laws may, however, be interpreted in the future in a manner inconsistent with our interpretation and application.”

• No determination or admission that Omnicare has engaged in illegal practices

Omnicare – Background


• District court grants motion – Complaint failed to plead facts demonstrating that Omnicare’s

officers knew that the company was violating the law – i.e., that they did not, in fact, believe that Omnicare was in legal compliance

• Sixth Circuit reverses – Rejects district court’s holding that “plaintiffs were required to

plead that defendants knew that the statements of legal compliance were false at the time they were made.”

– Holds that a statement of opinion or belief can be “an untrue statement of material fact” if the belief is (or turns out to be) objectively erroneous, even if the statement accurately conveyed the speaker’s belief at the time.

Omnicare – Background


• For purposes of a Section 11 claim – Whether a plaintiff may plead that a statement of opinion or belief

in a registration statement constitutes an “untrue statement of a material fact” merely by alleging that the opinion itself was (or turned out to be) objectively wrong

OR – Whether the plaintiff must also allege that the statement was

“subjectively false” – requiring allegations that the speaker’s actual opinion or belief was different from the one expressed.

Omnicare – Issue before Supreme Court


• Sixth Circuit decision created an acknowledged split among the federal appellate courts

• Section 11 a “strict liability” statute – No scienter requirement

• Supreme Court’s prior precedent – Virginia Bankshares v. Sandberg, 501 U.S. 1083 (1991)

(interpreting section 14(a) of the Exchange Act) – Held that a statement of opinion or belief is an “untrue statement

of material fact” only insofar as it misstates “the psychological fact of the speaker’s belief in what he says”

Omnicare – Issue before Supreme Court


• Drafting a registration statement

– Issuer and its counsel will draft; significant input from underwriters and their counsel

– "Back-up" verification: documents the accuracy of the factual statements in the registration statement

• Issuer's internal records

• Third-party sources

Omnicare – Transactional Implications


• Some types of statements are easily verified

– Operating data about the company

• Other statements cannot be easily verified and/or are inherently subjective

– Market share and position in the industry

– Competitive strengths and business strategy

– "Forward-looking statements" – limited safe harbor



– When a factual statement is difficult to verify, the issuer may characterize it as an honestly held belief

– The SEC and the investment community historically have encouraged such statements. Markets work best when investors have more, rather than less, information.

– SEC explicitly requires a registration statement to include management's subjective views in certain cases

• e.g. Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A)



• If Sixth Circuit view prevails:

– Liability by hindsight based on facts that are discovered later on

– Possible chilling effect on large areas of disclosure

– If each statement of belief or opinion is held to an "objective falsity" standard, issuers are likely to be discouraged from expressing the honestly held judgments that are often critical to an investor's understanding

– Less disclosure could come to be seen as better and safer



• Implications for other transaction parties

– Underwriters – "due diligence" defense in Section 11 cases

• How to establish the defense when a statement of opinion is challenged?

• Potential increase in uncertainty, liability risk and cost of underwriting

– Independent accountants – Section 11 liability for "expertized" portions of the registration statement

• Audit report is fundamentally subjective – an "opinion about an opinion"

• Enhanced liability for auditors' historical role



• Effect on capital markets generally?

– Fears that securities deals will be driven to overseas markets, where disclosure standards and litigation risk are more manageable (U.S. Chamber of Commerce, SIFMA)

– Or, companies may forgo offering securities altogether

– Risk may be especially pronounced in new industries or for innovative and risky start-ups



• Effects will be felt beyond SEC-registered offerings

– Language at issue in Omnicare appears throughout the securities laws, not just in Section 11

– Rule 144A offerings and private placements are subject to Rule 10b-5; "material misstatement or omission" likely to be interpreted in the same way once SCOTUS issues its ruling



• Regardless of how the Supreme Court ultimately rules in Omnicare, best practice for counsel in preparing a registration statement would be not merely to take statements of opinion by an issuer at face value

– Should continue to do the verification work required to establish that statements of opinion in a registration statement are (a) honestly held by the issuer and (b) reasonable under the circumstances



Questions?

David A. Sakowitz Partner

New York

+1 (212) 294-2639

[email protected]

John E. Schreiber Partner

Los Angeles New York

+1 (213) 615-1850 +1 (212) 294-6850

[email protected]



Thank You

Recent Supreme Court Developments in the Securities Context

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