Nicholas D. Picollelli, Jr.

In order for a company to offer securities in interstate commerce, it must comply with the requirements of the Securities Act of 1933.  The Securities Act “protects investors by ensuring that companies issuing securities . . . make a ‘full and fair disclosure of information’ relevant to a public offering.”  An issuer makes relevant disclosures in a registration statement filed with the Securities and Exchange Commission (“SEC”) prior to issuing the securities.  If the company makes the required disclosures, then it may issue securities and raise capital.  If however, the disclosures are false or misleading, the issuer may be subject to litigation as a result.  Section 11 of the Securities Act, for instance, is one avenue of litigation for potentially misled investors. Section 11 provides in relevant part:

In case any part of the registration statement, when such part became effective,     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, any person acquiring such security . . . [may] sue.

According to the United States Supreme Court’s recent opinion in Omnicare Inc. v. Laborers Dist. Council Const. Industry, § 11 creates two different ways for an investor to hold an issuer liable for a registration statement’s contents – “one focusing on what the statement says and the other on what it leaves out.”  In Omnicare, investors complained that the company omitted material facts in its registration statement regarding legal compliance, citing subsequent lawsuits filed by the Federal Government.  The investors alleged that officers and directors were warned about the possibility of litigation but omitted warnings in the company’s registration statement.  According to investors, these omissions made the registration statement “materially misleading” and subject to § 11 liability.  Thus, the relevant question presented by the investors’ allegation was whether an omission of fact could render a statement of opinion in a registration statement “materially misleading.”

Although the language of § 11 requires a statement or omission of “fact,” the Court in Omnicare recognized that there are some instances where a statement of “opinion” can convey a statement or omit a “fact.”  For example, the Court acknowledged that “every statement [of opinion] explicitly affirms one fact: that the speaker actually holds the stated belief.”  If an opinion is truly believed, without more, it cannot constitute an untrue statement of fact.  However, if the maker knows the opinion is false, then it would constitute an untrue fact – “namely, the fact of [the maker’s] own belief.”  The statements at issue in Omnicare do not fall into this category. Rather, they are statements of pure opinion and can be simplified to state, “we believe we are obeying the law.”  Furthermore, the investors did not claim the company made the statements with a false belief. This realization, however, did not end the Court’s analysis.

The Court’s analysis continued because investors also “rel[ied] on § 11’s omissions provision, alleging that Omnicare ‘omitted to state facts necessary’ to make its opinion on legal compliance ‘not misleading.’”  First, the Court recognized that a reasonable person typically distinguishes between a statement of fact and a statement of opinion when reading a registration statement.  Because an investor can distinguish between opinion and facts, “a statement of opinion is not misleading just because external facts show the opinion to be incorrect.”  However, the Court also acknowledged that an omission of fact can be misleading because a reasonable investor may interpret a statement of opinion “to convey facts about how the speaker formed the opinion . . . .”  For instance, a statement such as “we believe our conduct is lawful,” may be misleading if the maker did not consult an attorney.  The potential to mislead is increased particularly in the context of securities offerings, where the process is highly regulated and complex.  Due to extensive regulation, investors are more likely to rely on an issuer’s statements and the investor is reasonable to assume that the issuer’s statements are based on some knowledge of relevant facts.  As the Court held, “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 § 11’s omissions clause creates liability.”

Omnicare does not require issuers to disclose every fact that “cuts the other way,” because “[r]easonable investors understand that opinions sometimes rest on a weighing of competing facts ….”  Omnicare also urges that a statement should not be viewed in a vacuum because registration statements are not viewed in a vacuum.  Instead, investors view registration statements holistically “in light of all its surrounding text, including hedges, disclaimers, and apparently conflicting information.”  Finally, even though Omnicare expands the Court’s understanding of what constitutes a misleading omission, it emphasizes that the issuer is not without protection:

The investor must [still] identify particular (and material) facts going to the basis   for the issuer’s opinion – facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have – whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.

Following Omnicare, the Second Circuit decided Tongue v. Sanofi and applied Omnicare’s interpretation of § 11.  Tongue concerned declarations in a registration statement concerning the development of a new pharmaceutical drug.  The success and approval of the drug was tied to financial instruments that rewarded investors at certain milestones.  The milestones at issue concerned the expected timing of FDA approval, timing of the launch of the drug, and the drug’s trial results.  The FDA did not approve the drug by the date specified, and the value of the financial instruments plummeted. Accordingly, investors filed suit, alleging that the pharmaceutical company “misled investors by failing to disclose that the FDA had repeatedly expressed concern with [the pharmaceutical company’s] use of single-blind studies and had encouraged [the pharmaceutical company] to use double-blind studies in its clinical trials.”

In regard to the expected timing of FDA approval, the Second Circuit did not find that omitted facts “conflict[ed] with what a reasonable investor would take from the statement itself.”  Although the FDA expressed numerous times that it preferred double-blind studies and that it was concerned with the pharmaceutical company’s “methodology,” it also stated “that any deficiency could be overcome if the result showed an ‘extreme and large effect.’”  The parties did not dispute that the testing results concerning the drugs effectiveness were, in fact, significant. Moreover, the Second Circuit heeded the Supreme Court’s advice and observed the facts holistically.  In this case, investors included pension funds and other sophisticated investors who should have been aware of the constant dialogue between the pharmaceutical company and the FDA.  In the Second Circuit’s view, the investors could not claim ignorance because they are sophisticated parties and should be capable of protecting themselves.  Nor were investors protected simply because the pharmaceutical company failed to disclose facts that “cut against” the company’s registration statement’s declarations. Omnicare imposes no such burden.

For similar reasons, the Second Circuit found that statements relating to the timing of the launch of the pharmaceutical drug and the pharmaceutical drug’s trial results failed to support a claim under § 11.  Specifically, it explained that “no reasonable investor would have inferred that mere statements of confidence suggested that the FDA had not engaged in industry-standard dialogue with Defendants about potential deficiencies in either the testing or methodology or the drug itself.”  Plaintiffs failed to state a claim regarding the trial results of the pharmaceutical drug because the pharmaceutical drug was already approved for distribution in at least thirty other countries.  Thus, according to the Second Circuit, “Plaintiffs’ argument that the [pharmaceutical company] had no reason to comment on [the drug’s] success except to build investor anticipation about FDA approval has no merit – [the pharmaceutical company] had an interest in building global interest in [the drug].”  Again, an issuer is not liable for failing to disclose a fact that “cuts the other way.”

Omnicare and Tongue are instructive because they both demonstrate the importance of proper drafting.  Even though Omnicare does not require disclosure of each and every fact that “cut[s] the other way,” a careful drafter should include every relevant fact in order to avoid litigation.  For instance, in Omnicare, the issuer could have potentially avoided litigation if it had just disclosed that an attorney warned of possible litigation, but after careful review with other counsel, the company was assured that litigation was unlikely. Optimism in the face of conflicting information is not an omission subject to § 11 liability, but failing to disclose the conflicting information could be. Similarly, the pharmaceutical company in Tongue could have potentially avoided litigation by disclosing the FDA’s concerns about using single-blind studies.  The facts showed that single-blind studies were more conducive to the particular drug, but the company failed to disclose such facts and failed to disclose that the FDA might make an exception under certain circumstances. The pharmaceutical drug was eventually approved, but the damage was already done. Regardless of whether statements are an “opinion,” both cases make clear that statements must be informed and disclose all pertinent facts.  This requirement might increase the cost of preparing registration statements, but compliance with the requirement should protect issuers from subsequent litigation.  Proper drafting can be costly, but litigation can be extravagant.

Nicholas D. Picollelli, Jr. is a third-year student at Widener University Delaware Law School and a Senior Staff Member on the Delaware Journal of Corporate Law.  Nick also serves as a judicial intern to the Honorable Kevin J. Carey in the United States Bankruptcy Court for the District of Delaware.

Suggested Citation: Nicholas D. Picollelli, Jr., Applying Omnicare and Protecting Investors Under § 11 of the ‘33 Act, Del. J. Corp. L (April 26, 2016),