In two decisions last week – one in the Sixth Circuit and one in the First Circuit – federal appellate courts set aside lower court dismissals of securities class action lawsuits. Although the two cases are different and the two appellate opinions address different legal issues, the two decisions both seem to suggest a similar message to the lower courts to be a little less hasty in dismissing cases.
The Sixth Circuit opinion is particularly interesting, because the Court not only articulated a very precise (and plaintiff-friendly) standard for pleading strict liability in a Section 11 claim, but also expressly declined to follow the Second and Ninth Circuits on the Section 11 pleading requirements, setting up a split in the circuits that could attract the attention of the U.S. Supreme Court.
The Sixth Circuit Opinion
On May 23, 2013, a unanimous three-judge panel of the Sixth Circuit entered an opinion affirming in part and reversing in part the lower court’s dismissal of a securities class action lawsuit against Omnicare and certain of its directors and officers. As discussed here, the case has an extended procedural history, and the recent appeal represents the case’s second trip to the Sixth Circuit.
The specific issue before the appellate court in the most recent appeal involved the question of what plaintiffs are required to plead in order to establish a claim under Section 11. The plaintiffs claimed that in connection with a December 2005 securities offering, the company’s offering documents had falsely stated that the company was in compliance with legal requirements, when the company was in fact engaged in a variety of illegal activities including kickback arrangements with pharmaceutical companies and the submission of false claims to Medicare and Medicaid.
In February 2012, the district court granted the defendants’ motion to dismiss, finding that the plaintiffs were required but failed to plead that the defendants knew that the statements about the company’s legal compliance were false. The plaintiffs appealed the dismissal to the Sixth Circuit. On appeal, the plaintiffs argued that Section 11 provides for strict liability and it was therefore inappropriate for the district court to require them to plead knowledge in connection with their Section 11 claim.
The defendants, in reliance on the Second Circuit’s 2011 decision in Fait v. Regions Financial Corporation, as well as Ninth Circuit case authority, argued that in order to plead a Section 11 claim, the plaintiffs not only had to plead not only that the allegedly misleading statement was objectively false, but also that the defendants “disbelieved” the statement – that is, that the plaintiffs had to plead both objective and subjective falsity.
The Sixth Circuit rejected the defendants’ arguments, noting that, by contrast to Section 10(b) and Rule 10b-5, which require a plaintiff to plead scienter, Section 11 is “a strict liability claim,” adding that “once a false statement has been made, a defendant’s knowledge is not relevant to a strict liability claim.” Under Section 11, the Sixth Circuit said, “if the defendant discloses information that includes a material misstatement, this is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.”
The Sixth Circuit expressly declined to follow the Second and Ninth Circuits, based on its observation that those courts had misinterpreted the U.S. Supreme Court’s 1991 decision in Virginia Bankshares, Inc. v. Sandberg. By contrast to the Second Circuit’s interpretation of the Virginia Bankshares case, the Sixth Circuit said the Virginia Bankshares case “was not faced with and did not address whether a plaintiff must additionally plead knowledge of falsity in order to state a claim.” Moreover, the Virginia Bankshares case involved a Section 14(a) claim, rather than a Section 11 claim. The Sixth Circuit observed that “it would be unwise for this Court to add an element to Section 11 claims based on little more than a tea-leaf reading in a Section 14(a) case.” Accordingly, the Sixth Circuit refused to extend Virginia Bankshares to impose a knowledge of falsity requirement in a Section 11 claim.
The Sixth Circuit concluded that the plaintiffs’ allegations of Omnicare’s alleged misrepresentations regarding its legal compliance were sufficient to state a claim under Section 11, reversed the district court’s dismissal on the ground, and remanded the case to the lower court. However, the Sixth Circuit did affirm the district court’s dismissal of the plaintiffs’ GAAP-based misstatements and omissions.
The First Circuit’s Opinion
On May 24, 2013, a unanimous three-judge panel of the First Circuit (including former U.S. Supreme Court Justice David Souter, sitting by designation), in an opinion written by Judge Jeffrey Howard, entered an order vacating the dismissal of the securities class action lawsuit pending against CVS Caremark.
CVS Caremark was formed through a March 2007 merger between CVS Corp. and Caremark Rx Inc. The plaintiffs alleged that the success of the merger depended on the success of integrating the two companies’ operations. The plaintiffs allege that following the merger, the defendants made a number of statements about the success of the integration efforts and the level of service provided to important pharmaceutical services customers. In particular the plaintiffs cited a number of statements following the merger about the successful integration of the two companies’ computer systems and operations.
The plaintiffs allege that these statements concealed problems the company was having with computer integration. The plaintiffs allege that integration problems resulted in the company’s loss of major clients whose business was worth $3 billion in annual revenues to the company. The plaintiffs allege that the truth about the company’s problems was revealed in a November 5, 2009 conference call with analysts. In the call, the company’s CEO, Thomas Ryan announced, among other things, that the company had suffered “some big client losses” and that “service issues” had led to the loss of at least one of the large clients. Ryan also announced that due to the loss of business, the company would not make its previously announced projected growth in earnings per share. Ryan also announced the unexpected retirement of the head of the “chief architect” of the merged companies’ integrated business model.
In their securities class action complaint, the plaintiffs alleged that Ryan’s statements revealed that the company’s failure to integrate the predecessor companies’ operations had resulted in the loss of billions of dollars of customer contracts. In support of this allegation, the plaintiffs cited several analyst reports, which among other things, stated that the company had “stunned” the marketplace with the information about the loss of customer business and “the breakdown” of the Caremark business model. Following the November 5 conference call and quarterly earnings announcement, the company’s share price declined 20 percent.
The district court granted the defendants’ motion to dismiss, holding that the plaintiffs’ complaint did not plausibly allege that Ryan’s statements in the November 5 call caused the drop in the company’s share price, with one exception – Ryan’s statements that the company would not make the projected growth in earnings per share. However, because this projection was a protected “forward looking statement,”’ it could not form the basis of a claim against the defendants. The plaintiffs appealed the district court’s ruling, except that they did not appeal the district court’s conclusion regarding the forward looking statement.
On appeal, the plaintiffs argued that Ryan’s statements in the November 5 call represented a concession that the post-merger integration had been less successful than the company had claimed and the resulting service quality issues and loss of client business were due to these integration difficulties. The defendants argued that the November 5 conference call did not represent a “corrective disclosure” because Ryan never said that there were integration problems; that the market was previously aware of the customer losses; and that the plaintiffs cannot bootstrap their theory that Ryan’s statements in the November 5 call caused the share price decline by relying on statements from analysts’ reports.
In its May 24 opinion, the First Circuit vacated the district court’s dismissal and remanded the case for further proceedings. In concluding that the plaintiffs had plausibly alleged that the November 5 call had revealed the company’s problems with service and systems integration, the First Circuit cited a number of factors: first, during the call, Ryan had for the first time revealed that “service issues” had led to the loss of contracts; second, the market reacted with “alarm” to the news of the magnitude of the company’s lost business and the problems that led to the loss; and third that the unexpected retirement of the “architect” of the integration “alerted the market to problems” with the integrated business.
The Court concluded that the plaintiffs’ allegations “indicated that the drop in CVS Caremark’s share price was causally related to its misstatements regarding the integration of CVS and Caremark, and these allegations are sufficiently plausible to foreclose dismissal.”
However, the defendants also argued that the plaintiffs had not sufficiently pled an actionable misstatement or omission and also had not sufficiently pled scienter. Accordingly, rather than reversing the district court’s opinion, the appellate court merely vacated the district court’s dismissal, for the court “to consider alternative grounds for dismissal if it chooses.”
In each of these two cases, the appellate courts set aside the district court’s dismissal of the respective plaintiffs’ securities class action lawsuits. Although the two appeals involved different facts and presented different legal issues, there arguably is a common message to the district courts in the two appellate opinions. In that regard, it is worth noting the concurring opinion of Northern District of Ohio Judge James Gwin in the Omnicare case (Gwin sat by designation on the Sixth Circuit panel that heard the Omnicare appeal).
Judge Gwin wrote separately to underscore district courts’ discretion under Fed. R. Civ. Proc. 54(b) to revive previously dismissed claims while the case remains pending if newly discovered evidence so warrants. In making this point, Judge Gwin cited Fed. R. Civ. Proc. 1, which states that district courts are charged with enforcing rules “to secure the just, speedy, and inexpensive determination” of an action. Judge Gwin concluded his concurring opinion by noting, with reference to Fed. R. Civ. Proc. 1, that “there’s a reason that ‘just’ precedes ‘speedy’”.
To paraphrase Judge Gwin, the message to the district courts seems to be – slow down there, not quite so speedy with the dismissals. That is, for all of the statutory and case law hurdles that the plaintiffs must overcome in order to try to state a securities claim, a quick dismissal still is not always going to be the appropriate outcome. As formidable as the obstacles are, the obstacles are not insurmountable.
The Sixth Circuit’s holding in the Omnicare case is particularly interesting, and seemingly holds open the prospect that it will be substantially easier for Section 11 claimants in the Sixth Circuit to state a claim that it will be for Section 11 claimants in the Second and Ninth Circuits. In a May 24, 2013 column on her On the Case blog, here, Alison Frankel quotes the defense counsel in the Omnicare case as saying that the Sixth Circuit’s ruling could “open the floodgates” for litigation in the Circuit. The split in the Circuits, and the stark fact that claims that could go forward in the Sixth Circuit will not go forward in the Second and Ninth, seems likely to attract the interest of the U.S. Supreme Court – particularly since the apparent split appears to be the result of directly conflicting interpretations of the U.S. Supreme Court’s decision in the Virginia Bankshares case.
Although the two appellate cases were quite different from each other in a number of respects, it is interesting to note that both cases involved companies in the pharmaceutical business. That is, they both parts of the larger life sciences sector that has so consistently attracted securities class action litigation over the years (refer for example here). In the past, it has been reassuring that though companies in the life sciences sector disproportionately attract litigation, the cases filed in the sector seemed to also involve a relatively high dismissal rate. The outcome of these two appeals, at least, suggests that at least these some of the dismissals (that is, these two cases, for instance) may not have been warranted.
It is important to note that though these respective plaintiffs have succeeded in having the district court dismissals set aside, the plaintiffs are a long way from home. In particular, the parties in the CVS Caremark case will have to go back to the district court and wrangle over threshold questions such as whether or not the plaintiffs have adequately alleged misrepresentation and scienter. The plaintiffs in the Omnicare case, having weathered their second appeal in the case, will have to go back and continue to prosecute their claims in the case, which have now been pending for years. There is nothing that says that the plaintiffs in either case will every have anything to show for their efforts.
Even though the plaintiffs prevailed in these appeals, these cases serve as a reminder of how challenging it is for securities class action plaintiffs and their lawyers to take on one of these kinds of lawsuits. The claims not only face formidable legal and procedural obstacles but also require the claimants and their counsel to be willing to carry the case for years. Whether or not the Sixth Circuit’s opinion in the Omnicare case will “open the floodgates,” any prospective claimant seeking to rely on the decision will still have to be come prepared with copious reserves of endurance and perseverence.
Special thanks to a loyal reader for sending me a copy of the Sixth Circuit opinion.