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How Should Companies Pay When They Lie?

Noah Feldman is a Bloomberg View columnist. He is a professor of constitutional and international law at Harvard University and was a clerk to U.S. Supreme Court Justice David Souter. His books include “Cool War: The Future of Global Competition” and “Divided by God: America’s Church-State Problem -- and What We Should Do About It.”
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Is it a lie if you don't know what you're saying isn't true? This eternal philosophical question, well-known to 6-year-olds everywhere, is now before the U.S. Supreme Court -- and the stakes are hundreds of millions of dollars' worth of securities class-action litigation. To be more precise, the court is considering whether Section 11 of the Securities Exchange Act of 1933, which makes issuers liable for making material false statements in their registration statements, applies when the issuer says it "believes" it is complying with the law, even when objectively speaking it isn't. The appellate courts are split on the issue, and the Supreme Court's resolution will have significant consequences for any issuing company that falls afoul of regulators and wants to avoid paying out to a shareholder class action.

The case, Omnicare Inc. v. Laborers District Council Construction Industry Pension Fund, arose in the aftermath of a $765 million public stock offering in 2005 by long-term-care giant Omnicare. In its registration statement filed with the Securities and Exchange Commission, Omnicare acknowledged that it engaged in "certain" rebate practices with pharmaceutical companies. "We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements that bring value to the healthcare system and the patients that we serve," the company said in the statement.

Private plaintiffs and, eventually, the federal and some state governments disagreed. Omnicare was sued for allegedly taking kickbacks from big pharmaceutical companies such as Johnson & Johnson in exchange for encouraging physicians connected with its facilities to prescribe high-priced, name-brand drugs. Omnicare also was accused of paying kickbacks to the physicians themselves. The company never admitted liability, but according to a brief in the Supreme Court case, it reached settlements with public and private plaintiffs in which it paid out some $200 million.

The settlements brought out the securities class-action litigators, who, depending on your perspective, are either caped crusaders committed to keeping corporate America honest or rapacious, self-interested sharks looking to make a fast buck at the expense of current shareholders. Their claims under the familiar Section 10(b)(5) of the Securities Act were dismissed. But the U.S. Court of Appeals for the Sixth Circuit allowed the plaintiffs, representing shareholders whose stock allegedly lost value as a result of Omnicare's alleged misdeeds, to go forward with their suit under Section 11 of the act.

Like 10(b)(5), Section 11 creates liability for an "untrue statement of a material fact." Unlike its counterpart, Section 11 has been interpreted by courts as creating something very close to strict liability for false statements. The plaintiffs argued that when Omnicare said its practices were legally valid, that statement amounted to a materially untrue statement; after all, certain governments later described them as illegal and extracted settlements as a result.

Crucially, the plaintiffs lacked evidence that would have enabled them to claim that Omnicare knew its actions were illegal. Their claim was that Omnicare's assertion was material because it was objectively false, not that Omnicare's executives or directors were knowingly lying when the registration was filed.

Omnicare naturally argued that its assertion that it "believed" its conduct was lawful amounted simply to an expression of opinion. Interpreting a different section of the Securities Act, the Supreme Court held in 1991's Virginia Bankshares Inc. v. Sandberg that for an opinion to be actionable, the party that expressed it must have known it was a lie when it was said in the first place. If that logic were applied to Omnicare -- and if the words "we believe" designated an expression of opinion -- the case against Omnicare should have been dismissed.

The SEC isn't a party to the case. But in a friend-of-the-court brief filed jointly with the Office of the Solicitor General, the SEC sided with the plaintiffs. Its argument is that a statement of opinion can be false in two ways: Either the speaker knows it's a lie, or the opinion lacks a reasonable basis. The government's brief adds that this "is especially true when the opinion is one about the lawfulness of the company's own conduct."

There's plenty of common sense behind the government's position. In essence, when an issuer says it is following the law, it must at least have an objectively reasonable basis to say so. If there is no reasonable way to say the company's practices are valid, then it would seem absurd for the issuer to escape liability just because it used the magic words "we believe" and so entered into an expression of opinion rather than an expression of fact.

In practice, in the involved game of securities class-action litigation, the implication is more complicated. It means that any time a company settles a major case with the government for an alleged violation, plaintiffs can proceed to question company executives and discover documents even without a shred of proof that the executives knew they were breaking the law. They can also eventually get the case before a jury -- or at least threaten to do so.

Surviving motions to dismiss and proceeding to discovery strongly increases the probability that a defendant will settle the case rather than risk a damaging disclosure or (heaven forbid) a jury trial. If the Supreme Court decides the way the Barack Obama administration advises, it would be a significant victory for the securities class-action bar.

It seems wrong to get away with a lie because you just happened to not to know that what you said was unreasonable and false. But it's far from clear that it's a good idea to punish firms doubly for breaking the law, once through the government and once through private plaintiffs. Look for a divided court on this one -- and expect the breakdown to follow familiar partisan lines.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Noah Feldman at

To contact the editor on this story:
Brooke Sample at