With just one quarter remaining in 2023, securities and derivative litigation continues to develop with new standards being articulated or clarified, particularly by decisions within the Second Circuit:

• The Second Circuit provided additional guidance regarding when statements of opinion may nevertheless be actionable; and
• In Goldman, the Second Circuit instructed the district court to decertify a class thereby highlighting the need for a searching analysis of any mismatch between a generic alleged misrepresentation and a specific corrective disclosure at the class certification stage.

When Are Opinion Statements Actionable?

The Second Circuit ruled in New England Carpenters Guaranteed Annuity & Pension Funds v. DeCarlo on August 23, 2023, that statements of opinion that reflect some subjective judgment can nevertheless be actionable under federal securities laws when such statements include embedded statements of fact that are untrue.¹ Nevertheless, the Second Circuit also affirmed the strength of the protections available to corporate officers reporting in certifications mandated by Section 302 of the Sarbanes Oxley Act (“SOX”) when officers certify the accuracy of the statements with genuine knowledge and belief.

Background

AmTrust Financial Services, Inc. (“Company”), a publicly traded property and casualty insurance company, restated five years of financial results on April 4, 2017, correcting significant errors in annual and quarterly reports filed with the Securities Exchange Commission (“SEC”).²  The stock price fell after the Company disclosed (1) “it had improperly recognized most of the expected revenue from certain extended warranty contracts at the start rather than over the life of the contracts,” and (2) “that it had improperly accounted for certain discretionary employee bonuses by treating the bonuses as expenses in the year they were paid rather than the year they were earned by employees.”³

Based on these disclosures, the appellants—all investors in securities of AmTrust Financial Services, Inc.—brought suit in the United States District Court for the Southern District of New York (“District Court”) against AmTrust, its officers, members of its board of directors, certain of its underwriters for AmTrust’s sale of securities, and the Company’s former outside auditor, alleging violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Sections 11, 12 and 15 of the Securities Act of 1933 (the “Securities Act”).⁴ The District Court (Judge Lewis A. Kaplan) dismissed the third amended complaint, determining the alleged misstatements including those about the extended warranty contracts and discretionary bonuses to be non-actionable statements of opinion and therefore not actionable under securities laws.⁵

Second Circuit Decision

The Second Circuit disagreed with the “District Court’s dismissal of the Appellants’ claims under Sections 11, 12(a)(2), and 15 of the Securities Act against AmTrust, its officers and directors, and the Underwriter Defendants related to AmTrust’s accounting for revenue generated by its extended warranty contracts and the expenses associated with discretionary employee bonuses.”⁶ The Second Circuit vacated the judgment dismissing those claims and remanded those claims to the District Court, but otherwise affirmed the District Court’s judgment, including dismissal of Section 11 claims relating to the SOX certifications and the Exchange Act Claims.⁷

Circuit Judge Lohier posed the following question: “When is a statement of opinion that reflects some subjective judgment nevertheless actionable under the federal securities laws?”⁸ The Court heavily relied on Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, 575 U.S. 175 (2015), to answer this question.⁹ It defined a fact as “a thing done or existing or an actual happening,” as distinguished from an opinion, which is “a belief, a view, or a sentiment which the mind forms of persons or things.”¹⁰ The Court wrote, “[o]pinions are thus actionable under Section 11 of the Securities Act not only when ‘the speaker did not hold the belief she professed,’ Omnicare, 575 U.S. at 185–86, but also if the statement of opinion contains embedded statements of fact that are untrue, or the statement omits information whose omission conveys false facts about the speaker’s basis for holding that view and makes the opinion statement misleading to a reasonable investor, id. at 186–88.”¹¹  Therefore, a statement of opinion may be actionable or false and misleading if it includes an “embedded statement of fact that is not true,” such as “if the embedded fact is not one as to which reasonable minds can differ.”¹²  This might occur, for example, when “there is an accepted method for assessing whether the statement is true, but the statement is not justified by the accepted method and clearly contradicts the facts on which it purports to rest.”¹³

Statements Regarding the Extended Warranties

Regarding AmTrust’s improper recognition of expected revenue from certain extended warranty contracts at the beginning the contract (rather than throughout the life of the contract), the Company argued “that assessing value to the customer on a standalone basis—that is, determining whether the administrative services revenue received from vendors who administer the warranty programs is separable from revenue generated by the warranty coverage provided to customers—is an inherently subjective enterprise.”¹⁴ However, the Court disagreed because “AmTrust has never actually contended that its customers can resell the administrative services associated with the warranty contracts at issue here on a standalone basis or that vendors are able to sell them separately,” the Complaint suggests this is not possible, and nothing in the Accounting Standards Codification AmTrust relies on or references other methods of determining value.¹⁵

The Court held that “subjective judgments about the sufficiency of historical evidence to support a particular accounting treatment presuppose the existence of some historical evidence” and “that AmTrust’s representations about the warranty contract revenue reported in its historical consolidated financial statements misled investors to conclude that the company was aware of some historical evidence in support of recognizing the revenue on a non-straight-line basis, when in (alleged) fact it was not.”¹⁶

Statements Regarding the Discretionary Bonuses

Regarding AmTrust’s practice of accounting for particular discretionary employee bonuses in the year they were paid instead of the year they were earned, the Company explained, “[i]n prior years, the Company had expensed discretionary bonuses paid to its employees in the year the bonuses were paid because the Company did not consider the discretionary bonuses to be ‘probable,’ which is the standard required for accrual.”¹⁷ However, the Court held it did not need to decide whether the Company’s financial statements were statements of fact or statements of opinion because the Complaint “adequately alleges that it was improbable that the earned bonuses would not be paid” and there was thus “no basis for AmTrust to state that the bonuses should be expensed in the year they were paid rather than earned.”¹⁸

SOX Certifications

In contrast, the Court found that the officers’ SOX certifications regarding the accuracy of AmTrust’s financial reporting and conformity with GAAP were based on the knowledge of the officers, and the Court thus affirmed the District Court’s dismissal of the Section 11 claims related to SOX certifications.¹⁹ The Court emphasized that “AmTrust’s change of opinion, standing alone, does not mean that the original certified opinions were disingenuous,” and a genuinely held opinion that turned out to be incorrect is not necessarily actionable.²⁰ The Court added the Complaint failed to “adequately allege that the AmTrust executives who signed the certifications did not believe what they certified” or “allege any facts that establish a lack of meaningful inquiry, other than the fact that the certification turned out to be wrong.”²¹

Conclusion

This case provides two key takeaways. First, it is important for a company to determine whether a statement of opinion accurately reflects the extent of or lack of factual support regarding the opinion. If the challenged statement suggests the existence of underlying factual support, when in fact no such factual support exists, the public statement is potentially actionable. Second, the Second Circuit’s opinion demonstrates that robust protections are available for corporate officers who sign SOX certifications because plaintiffs must allege the officers knew the financial statements they certified were false or misleading or that they did not sincerely believe the certified statements.

Second Circuit Issues Key Decision Decertifying a Class in a Securities Fraud Case

A major battleground in securities fraud class actions is the application of the fraud on the market presumption at the class certification stage. The presumption relieves plaintiffs from having to prove individual reliance on the theory that a stock trading in an efficient market incorporates in its price all public material information—including misrepresentations—and that investors rely on the integrity of the market price when trading.²² Defendants may rebut the presumption by showing, among other things, that the alleged misrepresentation had no impact on the price of the stock. In a key decision capping a nearly ten-year saga, the Second Circuit, in Arkansas Teacher Retirement System v. Goldman Sachs,²³ held that Goldman Sachs and certain former executives successfully rebutted the presumption and ordered the class decertified.

The plaintiffs in Goldman alleged that the defendants made material misrepresentations about Goldman’s business principles (e.g., “Integrity and honesty are at the heart of our business.”) and its management of conflicts of interest.²⁴ The plaintiffs alleged that the market learned that these statements were false when the Securities and Exchange Commission brought an enforcement action against Goldman over alleged conflicts of interest in a transaction, and when media outlets subsequently reported that the Department of Justice was also investigating and that the SEC was investigating Goldman’s conduct in another transaction. Goldman’s stock price declined following each of these alleged corrective disclosures.²⁵ In seeking class certification, the plaintiffs relied on a so-called “price maintenance” theory. That is, they did not claim that the defendants’ alleged misrepresentations caused an artificial increase in Goldman’s stock price. Instead, they argued that the alleged misrepresentations maintained inflation that was already built into the stock price and that the back-end stock price drop following the alleged corrective disclosures was a measure of the front-end stock price inflation.²⁶

The district court certified a class, and following two stops in the Second Circuit, the case made its way to the Supreme Court. The Court reversed the Second Circuit’s decision affirming class certification and remanded for consideration of how the generic nature of the alleged misrepresentations impacted the price impact inquiry.²⁷ The Court explained that the “generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly in cases proceeding under the inflation-maintenance theory,” because the inference that “the back-end price drop equals front-end inflation . . . starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure.”²⁸  Where an earlier alleged misrepresentation is generic and the later alleged corrective disclosure is specific, the Court concluded that “it is less likely that the specific disclosure actually corrected the generic misrepresentation, which means that there is less reason to infer front-end price inflation—that is, price impact—from the back-end price drop.”²⁹

On remand, the district court again certified a class. But in its most recent decision, the Second Circuit reversed and remanded with instructions to decertify the class. The Second Circuit held that the district court “pushed the inflation-maintenance theory well beyond” its limits by “requiring only a general front-end—back-end subject matter match.”³⁰ As the Second Circuit explained, “in what amounts to the crux of the district court’s misstep, the district court allowed the ‘details and severity’ . . . of the corrective disclosure to do the work of proving front-end price impact, notwithstanding that the front-end statements are, according to the district court’s own findings, ‘comfortably’ more generic than the back-end disclosures.”³¹ The Second Circuit also looked to the defendants’ expert testimony showing that market commentary during the class period did not reference the challenged conflicts disclosures as further evidence “sever[ing]” the link between back-end price drop and front-end misrepresentation.³²

The Second Circuit’s Goldman decision is an important development because it highlights the need for a searching analysis of any mismatch between a generic alleged misrepresentation and a specific corrective disclosure at the class certification stage. Where the two sets of statements are not on equal footing, and contemporaneous market commentary reveals a lack of market interest in the front-end statements, defendants will have strong grounds to challenge the application of the fraud of the market presumption and defeat class certification.

Footnotes

1. New England Carpenters Guaranteed Annuity & Pension Funds v. DeCarlo, 80 F.4th 158 (2d Cir. 2023).
2. Id. at 165.
3. Id.
4. Id.
5. Id.
6. Id.
7. Id. at 165, 176, 182-83.
8. Id. at 165.
9. Id. at 169-171.
10. Id. at 169; Omnicare, 575 U.S. at 183.
11. Id. at 171.
12. Id.
13. Id.
14. Id. at 173.
15. Id.
16. Id. at 174.
17. Id.
18. Id. at 175.
19. Id. at 176.
20. Id.
21. Id.
22. The Supreme Court adopted the presumption in Basic Inc. v. Levinson, 485 U.S. 224 (1988).
23. 2023 WL 5112157 (2d Cir. Aug. 10, 2023).
24. Id. at *2-*3.
25. Id. at *4-*5.
26. Id. at *1, *8.
27. Goldman Sachs Grp., Inc. v. Ark. Tchr. Ret. Sys., 141 S. Ct. 1951, 1963 (2021).
28. Id. at 1961.
29. Id.
30. 2023 WL 5112157, at *17, *20.
31. Id. at *19.
32. Id. at *24.