Wendy Gerwick Couture recently published an article in the Louisiana Law Review entitled, “Opinions Actionable as Securities Fraud.” A draft of the paper is available on SSRN (here) with the following abstract:
This Article proposes a new analytical framework to apply to statements of opinion in securities fraud cases. Although statements of opinion form the basis of some of the most cutting-edge securities fraud claims -- such as those asserted against securities analysts and credit rating agencies -- statements of opinion do not fit squarely within the elements of securities fraud. In particular, three issues arise: (1) When is a statement of opinion "false" so as to qualify as a misrepresentation? (2) When is a statement of opinion "material"? (3) And, for that matter, what is the distinction between a statement of fact and a statement of opinion? Courts confronting these issues apply various analytically unsound and inconsistent tests. In response, this Article, drawing on the policy rationales underlying securities fraud claims, case law and scholarly commentary addressing how to apply the elements of securities fraud to statements of opinion, and comparable analyses in the contexts of common law fraud and defamation, proposes a novel approach. First, this Article argues that statements of opinion are only false if both objectively unreasonable and subjectively disbelieved. Second, this Article proposes the following new "evaluation/deduction test" to differentiate statements of opinion from statements of fact: Does the statement express the speaker's evaluation or deduction of facts? Finally, this Article proposes the following new "reasonable implication test" to distinguish opinions that are immaterial as a matter of law from those that are potentially material: Does the opinion reasonably imply an allegedly false, material fact?
As a follower of the Bainbridge school of shameless self-promotion (Why blog, if not to at least occasionally promote oneself?), I would be remiss if I did not highlight the article’s reference to my own work (available here):
[C]ourts are correct that no reasonable investor would interpret the opinion “we currently view our shares as undervalued” as a representation that the shares' fundamental value is higher than the market price, but a reasonable investor could interpret it as a representation that the company is not insolvent, rendering its shares worthless. Dismissal of opinions like this one without an inquiry into what component of the opinion is allegedly false fails to recognize this nuance.
Indeed, the results of a recent materiality survey performed by Professor Padfield are consistent with this analytical flaw. The survey presented five short factual scenarios, drawn from actual cases in which alleged misrepresentations were dismissed as immaterial, and asked participants if they would “consider the additional information important in deciding whether to buy [the company's] stock.” For example, the survey presented some background information about the demand for Telco's product, the T-6500. Then, the survey asked the following question:
Assume you are now considering buying Telco stock and you receive the following additional information: Later, in response to a question, Telco's CEO states, “On the 6500, demand for that product is exceeding our expectations.” Would you consider the additional information important in deciding whether to buy Telco stock? Yes [or] no.
Sixty-two percent of the survey's respondents answered “yes.” Professor Padfield interpreted the survey results as suggesting “that judges are too quick to grant dismissals in securities cases on the basis of puffery.”
This author agrees with Professor Padfield's conclusion but argues further that the survey highlights the importance of incorporating alleged falsity into the materiality analysis. Notably missing from the survey's factual scenarios were allegations about why the statements were false. For example, on one hand, a reasonable investor might very well consider the Telco CEO's statement to be material because it implies that the 6500 product is still in production. On the other hand, no reasonable investor would consider the CEO's statement to constitute an implied representation about a specific level of demand for the product. Asking survey participants to assess the materiality of the statement in a vacuum, effectively asking them to speculate for themselves about why a statement might be misleading, invariably leads to inconsistent results, as it did in this survey. The same lesson applies to courts.
I don’t believe the survey led to inconsistent results. True, there are additional facts that could have been provided that would have led to respondents giving different responses, but since the goal of the survey was to test investor responses to statements as they were actually analyzed by the courts, adding additional facts would not have made the results more consistent, it would simply have defeated the purpose of the survey. Having said that, to the extent Couture’s point is that courts would do a better job with their materiality determinations if they were more specific about the alternative interpretations reasonable investors could give to challenged statements—I think there may be something to that (and to the extent surveys become a part of that analysis, they should reflect that change). Certainly, it would seem to make the process more consistent with the Supreme Court’s admonition in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 450, that:
[T]he underlying objective facts, which will often be free from dispute, are merely the starting point for the ultimate determination of materiality. The determination requires delicate assessments of the inferences a “reasonable shareholder” would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact. Only if the established omissions are “so obviously important to an investor, that reasonable minds cannot differ on the question of materiality” is the ultimate issue of materiality appropriately resolved “as a matter of law” by summary judgment.