Securities and Shareholder Litigation & Class Actions
Opinion Liability and Scienter
The Ninth Circuit, in City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Align Tech., Inc.,
No. 14-16814 (9th Cir. May 5, 2017), affirmed the dismissal under Omnicare of a Section 10(b) complaint alleging that a company misled the market by a series of statements and financial reports declining to take a goodwill impairment that the company would later take on an acquisition. The court joined the Second Circuit in applying Omnicare to Section 10(b) goodwill claims and held that Omnicare overruled the Ninth Circuit’s previous test that had allowed statements of opinion to be challenged on the ground of lacking a reasonable basis.
Align arose from a March 2011 acquisition; the acquirer accounted for 71 percent of the purchase price as goodwill. It found no goodwill impairment in its 2011 Form 10-K and allegedly did no interim testing until it announced it was doing so in October 2012. The acquirer ultimately took three goodwill impairments between November 2012 and April 2013.
The Ninth Circuit began by explaining why Omnicare applies to Section 10(b) cases, joining the Second Circuit:
[T]he Supreme Court’s reasoning is equally applicable to Section 10(b) and Rule 10b-5 claims….The Supreme Court’s definition of opinion statements and differentiation of them from factual statements was specific to Section 11 only to the extent that Section 11 imposes liability for “untrue statement[s] of . . . fact.…” Rule 10b-5, which was promulgated pursuant to Section 10(b), contains an identical limitation of liability to “untrue statement[s]” and omissions of “fact.”
Slip op. at 17 (citations and alterations omitted). The court additionally agreed with the Second Circuit that statements about goodwill valuation, which involve the application of subjective judgment, are treated under Omnicare as statements of opinion, and contrasted two statements by the company, one of which qualified as a statement of pure opinion, the other of which could be challenged as a factual statement because the company stated that, during the prior fiscal year, “there were no facts or circumstances that indicated that the fair value” of the acquired company was less than the recorded goodwill:
Statement 3 expresses Defendants’ qualitative assessment of the…division’s fair value. Because that reference point itself is subjective, the attendant comment comparing fair value to carrying value cannot be objectively verified. However, Statement 2’s reference to “no facts or circumstances” asserts an objectively verifiable fact by identifying an aspect of Defendants’ goodwill methodology as opposed to a qualitative aspect of the valuation itself. Accordingly, while the district court properly concluded that Statement 3 is an opinion statement, Statement 2 should be considered an opinion statement with an embedded statement of fact.
Id. at 13 (emphasis added). The court then described its test for opinion statements, holding that “Omnicare affirms [the Ninth Circuit’s prior] requirement that both objective and subjective falsity must be alleged to sufficiently plead falsity for a … claim based on a material misrepresentation theory of liability.” Id. at 15. As the court explained:
Omnicare establishes three different standards for pleading falsity of opinion statements. First, when a plaintiff relies on a theory of material misrepresentation, the plaintiff must allege both that the speaker did not hold the belief she professed and that the belief is objectively untrue. Second, when a plaintiff relies on a theory that a statement of fact contained within an opinion statement is materially misleading, the plaintiff must allege that the supporting fact the speaker supplied is untrue. Third, when a plaintiff relies on a theory of omission, the plaintiff must allege facts going to the basis for the issuer’s opinion . . . whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.… Omnicare clarifies that pleading falsity by alleging that “there is no reasonable basis for the belief” is permissible only under an omissions theory of liability…. We thus hold that to the extent our current standard permits plaintiffs to plead falsity by alleging that “there is no reasonable basis for the belief” under a material misrepresentation theory of liability, it is “clearly irreconcilable” with Omnicare, and is therefore overruled.
Id. at 16-18 (citations and alterations omitted).
Turning to the application of this standard, the court found a critical failure to allege what the company had actually done to support its conclusions – under Omnicare, plaintiffs must plead these facts:
The common element underlying both flaws in Plaintiff’s theory of falsity is Plaintiff’s failure to allege the actual assumptions that Defendants relied upon in conducting their goodwill analysis. Without this allegation, it cannot be plausibly inferred that Defendants intentionally disregarded the aforementioned events and circumstances when conducting their goodwill analysis, such that the goodwill valuations were knowingly false or misleading when made…. Plaintiff’s allegation that Defendants failed to conduct any goodwill impairment testing at the end of 2011 is not a fact, but rather Plaintiff’s conclusion based on its belief that no set of reasonable assumptions could support Defendants’ determination in the fourth quarter of 2011 that the [acquired division’s] goodwill was unimpaired.
Id. at 21, 23 (emphasis added). One of the key allegations was that the acquired company had engaged in “channel stuffing” to inflate its revenue in 2010 in order to make itself a more desirable acquisition target, but the court found that the plaintiffs had failed to connect that to subsequent years’ goodwill assessments:
Plaintiff fails to plead any facts establishing that Defendants continued to use [the acquired company]’s inflated 2010 revenue figures in conducting its goodwill impairment testing for [the acquired division]. While Plaintiff relies on confidential informants to substantiate the allegations of [the acquired company]’s channel stuffing, none of these witnesses subsequently participated in [the acquirer]’s accounting or goodwill analysis. Plaintiff’s confidential informants therefore cannot link [the acquired company]’s channel stuffing to Defendants, much less the set of assumptions that Defendants used to conduct its goodwill valuation of the [the acquired division] unit at the end of 2011…. Without any allegations tying [the acquired company]’s channel stuffing to any of Defendants’ goodwill valuations, a reasonable investor would not find the fact of [the acquired company]’s channel stuffing, which occurred in 2010, to undermine [the acquirer]’s conclusion at the end of 2011 that the [acquired division’s] goodwill was not impaired.
19-20, 22 (emphasis added). The court also emphasized that it could consider “positive and mitigating events” that the company “could have found to either balance or outweigh” the negative factors. Id. at 20. This assumed significance as well in the failure to plead scienter:
[A] corporation must exercise its judgment in assessing both positive and negative factors when determining whether interim goodwill impairment testing is necessary. It therefore follows that a corporation’s mere knowledge of negative factors that potentially indicate goodwill impairment does not of itself support an inference that a corporation acted with scienter in exercising its judgment to conclude that no goodwill impairment is likely to occur. To plead an inference of scienter in this context, a plaintiff must allege additional facts that call into question the manner in which the corporation conducted its goodwill analysis.
Id. at 27 (emphasis added).
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