In August 2011, the U.S. Court of Appeals for the Second Circuit issued a decision that has not received much attention: Fait v. Regions Financial, 655 F.3d 105 (2d Cir. 2011), about the scope of liability under Sections 11 and 12 of the Securities Act. The court held that statements in offering documents about goodwill and loan loss reserves constituted "opinions" and that, as such, plaintiffs needed to allege that the statements were both objectively false and subjectively disbelieved. Id. As lower courts have applied Fait, two key questions have surfaced. First, what constitutes an opinion? And second, what is the difference between subjective disbelief and scienter?
The 'Fait' Decision
In Fait, the Second Circuit concluded that "statements [about goodwill and loan loss reserves] were opinions, which were not alleged to have falsely represented the speakers' beliefs at the time they were made." 655 F.3d at 107. Accordingly, the Second Circuit affirmed District Court Judge Lewis Kaplan's dismissal of the complaint.
With regard to goodwill, the court observed that, because goodwill is the excess of an acquisition price over the fair value of the assets acquired, "[e]stimates of goodwill depend on management's determination of the 'fair value' of the assets acquired and liabilities assumed, which are not matters of objective fact." Id. at 110. Noting that plaintiff did not "point to any objective standard such as market price" that defendants should have used to determine asset value, the court concluded that the assessment of fair value was subjective. Id. at 111. The absence of an objective standard thus rendered the statements "opinions." Accordingly, goodwill could give rise to liability only if the plaintiff "plausibly allege[d] that defendants did not believe the statements regarding goodwill" at the time they were made. Id. at 112.
The allegations about loan loss reserves were deemed similarly deficient because those reserves "reflect management's opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible." Id. at 113. Again, since the court classified these statements as subjective, plaintiff's failure to allege that defendants did not "honestly believe" the loan loss statements doomed the claim. Id.
To reach these conclusions, Fait relied on the Supreme Court's decision in Virginia Bankshares v. Sandberg, 501 U.S. 1083 (1991). In that case, plaintiffs sued under Section 14(a) of the Exchange Act and alleged that the directors falsely represented that the recommended merger offered a "high" value and a "fair" price. Id. at 1088. As Justice Antonin Scalia's concurrence succinctly summarized, "the statement '[i]n the opinion of the Directors, this is a high value for the shares' would produce liability if in fact it was not a high value and the directors knew that. It would not produce liability if in fact it was not a high value but the directors honestly believed otherwise." Id. at 1108-09 (Scalia, J., concurring in part and concurring in the judgment).
The Second Circuit in Fait embraced the "logical sense" of this approach, explaining that "[r]equiring plaintiffs to allege a speaker's disbelief in, and the falsity of, the opinions or beliefs expressed, ensures that their allegations concern the factual components of those statements." 655 F.3d at 112.
The plaintiffs in Fait, however, argued against this subjective falsity standard, concerned that it was tantamount to a scienter requirement. The Second Circuit defrayed this concern and established a distinction between scienter and subjective falsity, stating that "[w]e do not view a requirement that a plaintiff plausibly allege that defendant misstated his truly held belief and an allegation that defendant did so with fraudulent intent as one and the same." Id. at 112 n.5 (emphasis supplied). The court, however, did not elaborate further.
The Nature of an Opinion
Fait's analysis of whether the statements at issue about goodwill or loan loss reserves were facts or opinions hinged on whether there existed an objective measure to make the determination. 655 F.3d at 110-11. That reasoning has since been further refined by two district court decisions.
In Abu Dhabi Commercial Bank v. Morgan Stanley, Judge Shira Scheindlin relied on Fait to determine whether credit ratings are actionable statements in a common law matter. 888 F.Supp.2d 431, on reconsideration in part, 888 F.Supp.2d 478 (S.D.N.Y. 2012).(1) In her analysis, Scheindlin delved into an extensive analysis of New York state and federal law precedent addressing whether credit ratings are opinions.
Ultimately, the court concluded that the ratings are "fact-based opinions"; hybrid statements that "are not objectively measurable statements of fact, [although] neither are they mere puffery or unsupportable statements of belief akin to the opinion that one type of cuisine is preferable to another." 888 F.Supp.2d at 454-55. The court drew the standard directly from Fait, finding that plaintiffs had presented sufficient evidence "from which a jury could infer that the ratings were both misleading and disbelieved by the Ratings Agencies when issued," and denied defendants' summary judgment motion.
Another case that wrestled with the question of what constitutes an opinion was In re General Electric Sec. Litig., 856 F.Supp.2d 645 (S.D.N.Y. 2012). There, Judge Denise Cote indicated that some misstatements are matters of fact, and not opinions, even if they are subject to the judgment of management if the misstatements are objectively measurable. Id. at 658 n.5 ("[P]laintiff claims not that GE estimated the value of its assets incorrectly, but that its valuation must be false because the company engaged in improper accounting practices. Thus, the truth or falsity of this statement is not a matter of opinion, it is an objective fact and plaintiffs need not plead subjective falsity").
Once a court determines the threshold question that the statements at issue constitute opinions, Fait mandates that plaintiffs plead subjective falsity. The question then becomes what is the difference between subjective disbelief and scienter, and what is the applicable pleading standard. The most extensive analysis appears in another decision by Cote in one of 17 residential mortgage-backed securities (RMBS) cases brought by federal housing agencies against various banks. Fed. Hous. Fin. Agency v. UBS Americas, 858 F.Supp.2d 306, 325-28 (S.D.N.Y. 2012), motion to certify appeal granted (June 19, 2012). FHFA v. UBS discussed the standard to plead subjective falsity after addressing whether the analysis of subjective falsity was limited to the subjective falsity of the defendant. Cote expanded the holding in Fait by finding liability when the opinions at issue were held by someone other than a defendant.
The parties in the case agreed that the statements regarding loan-to-value ratios depended on appraisers' estimates regarding the values of the underlying properties, and accordingly those valuations were not "matters of objective fact"—consequently, they agreed that Fait governed the plaintiff's claims. The parties' disagreement only concerned "the identity of the 'speaker' whose disbelief in the statements plaintiff must plead." Id. at 325. Plaintiffs argued that it is sufficient under Fait to allege that the appraisers did not believe their valuations were accurate, while defendants argued that Fait requires the plaintiff to allege that the defendant did not believe the appraisers' valuations.
The court acknowledged that Fait did not address "how to treat opinions that the offering materials attribute to someone other than a defendant." Id. at 325. But the court found that "Fait's reasoning…points squarely in favor of plaintiff's position, imposing upon the plaintiff the duty to plead that the person who formed the opinion did not believe the opinion when she expressed it." Id. Cote reasoned that the valuations are "the subjective judgments of the appraisers," and as such, constitute both opinion and factual statements "that the appraised value represents the appraiser's true belief as to the value of the property." Applying Fait, the court found that liability may attach to "this implied assertion—that the originator of the opinion sincerely holds the belief reported—where the assertion is shown to be false." Id. at 326. Thus, the subjective falsity required by Fait is "falsity on the part of the originator of the opinion, who may or may not be a Securities Act defendant." Id.
This bifurcation between the speaker and the defendant gave the court the opportunity to address the difference between subjective falsity and scienter. Cote noted that, "[a]lthough the Fait court was careful to emphasize that the concepts are different, see 655 F.3d at 112 n.5, courts have struggled to distinguish these two lines of inquiry," in part because they are conflated when the originator of the opinion is a defendant. 858 F.Supp.2d at 326. But the facts of FHFA v. UBS allowed for a broader distinction: "Once it is acknowledged that the 'subjective falsity' inquiry is directed at determining the truth of the statement, 'I believe,' rather than the fraudulent intent of any defendant who later reports that claim, the distinction becomes clearer." Id. at 327.
This conclusion makes sense in light of the divergent pleading standards between scienter and subjective falsity. Scienter under Section 10(b) must be pleaded in accordance with the Supreme Court's "strong inference" standard, pursuant to which plaintiffs must "plead facts rendering an inference of scienter at least as likely as any plausible opposing inference." Tellabs v. Makor Issues & Rights, 551 U.S. 308, 328 (2007). This heightened pleading standard requires courts to consider "plausible opposing inferences," and to deny a motion to dismiss "only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged." Id. at 324.
But Fait is clear that the pleading standard for subjective disbelief is plausibility. 655 F.3d at 112 n.5. Unlike scienter, the plausibility standard "does not impose a probability requirement," but simply requires a plaintiff to plead sufficient evidence "to raise a reasonable expectation" that the defendant is liable for the alleged misconduct. Bell Atl. v. Twombly, 550 U.S. 544, 556 (2007). This is consistent with Fait's reliance on Virginia Bankshares, which found sufficient evidence to support a conclusion that an opinion was false based on the objective falsity of the opinion coupled with the defendant's access to that information. 501 U.S. at 1094-98. Accordingly, Virginia Bankshares strongly suggests that it is sufficient under Fait to plead subjective falsity by alleging facts demonstrating both the objective falsity of the opinion and the defendant's access to those facts.
In sum, the threshold question of whether a statement constitutes an opinion is critical regardless of context, and the boundaries of the definition of an opinion remain open to interpretation. Fait and its progeny expanded these questions on many dimensions: the nature of opinions, whether defendants must hold the opinions, and what is required to plead subjective falsity under the new standard. Courts are only just beginning to resolve these issues.
1. In an earlier stage of litigation, the court ruled that ratings were not entitled to immunity under the First Amendment. 651 F.Supp.2d 155 (S.D.N.Y. 2009). Historically, credit ratings were deemed opinions and protected by the First Amendment, but that consensus has fractured in recent years.