Category Archives: Appellate Monitor

An ongoing issue in securities litigation is to what extent a short seller’s report can act as a corrective disclosure for purposes of establishing loss causation.  The U.S. Court of Appeals for the Fourth Circuit had the opportunity to address that issue for the first time last week.

In Defeo v. IonQ, Inc., 2025 WL 1035292 (4th Cir. April, 8, 2025), the plaintiffs alleged that a short seller report had revealed to investors that IonQ, which makes quantum computing systems, did not have a working product and its revenues were driven by phony related-party transactions.  The company responded to the report with a short press release deriding the report’s inaccuracies and then later issued a longer rebuttal.  The company’s stock price declined during this period.

The district court held that the plaintiffs’ complaint did not contain any reliable sources and therefore failed to adequately plead the elements of a federal securities claim.  In addressing a subsequent amended complaint, however, the district court found that the amendment was futile solely on the basis that the plaintiffs could not adequately plead loss causation.

On appeal, the Fourth Circuit only addressed the issue of loss causation.  As to the short seller report, the court noted that while short seller reports could potentially act as corrective disclosures, in this instance the report “relies on anonymous sources for its nonpublic information and disclaims its accuracy.”  Indeed, as to the report’s use of sources, the publisher stated that some quotations “may be paraphrased, truncated, and/or summarized solely at our discretion, and do not always represent a precise transcript of those conversations.”  Under these circumstances, the Fourth Circuit concluded that the “potential evidentiary value [of the report] evaporates” and it could not form the basis for loss causation.

Alternatively, the plaintiffs argued that the company’s initial response to the short seller report, which did not provide a point-by-point rebuttal, revealed to investors that the report was to some extent accurate.  The Fourth Circuit noted it could “envision a scenario where a third party exposes some unverified bombshell about a company and the company’s tacit mea culpa could function as a verification of that bombshell” but that this “theory holds no water here.”  The company’s press release generally rejected the report’s allegations.

Holding: Judgment of the district court finding amendment futile affirmed.

Quote of note: “The Report’s publisher admits some quotations ‘may be paraphrased, truncated, and/or summarized solely at our discretion, and do not always represent a precise transcript of those conversations.’ That disclosure is particularly troubling because it gives Scorpion Capital the kind of editorial license that could allow it to say just about anything and cloak it in the imprimatur of truth in order to make a buck. For example: If an expert represented, ‘IonQ’s 32-qubit system is revolutionary. By comparison, Company Y’s system looks prehistoric,’ Scorpion Capital gave itself the freedom to say, ‘IonQ’s 32-qubit system looks prehistoric,’ and attribute that quote to an expert. In all, those disclosures lead to the conclusion that ‘the character of the’ Report ‘rendered it inadequate’ to reveal any alleged truth to the market.”

In Kolominsky v. Root, Inc., 2024 WL 1854474 (6th Cir. April 29, 2024), the plaintiffs brought claims under Section 10(b) of the Exchange Act (securities fraud) and Sections 11 and 12(a)(2) of the Securities Act (misstatements in registration statements and offerings) related to alleged misstatements about the company’s purportedly low customer-acquisition cost. The district court dismissed the claims based on the plaintiffs’ failure to adequately plead falsity. On appeal, the Sixth Circuit joined the majority of other circuits on two important issues related to Securities Act claims.

“Sounds in fraud” – Section 11 and 12(a)(2) claims do not have fraud as an element, so generally they are not subject to the heightened pleading standard of Federal Rule of Civil Procedure 9(b). When plaintiffs bring both Section 10(b) and Section 11 and 12(a)(2) claims in the same complaint, however, many courts have found that all of the claims “sound in fraud” and uniformly must be pled with particularity. In Kolominsky, the Sixth Circuit agreed that if the claims are “grounded in one fraudulent course of conduct relying on one set of facts” then Rule 9(b) applies.

“Bespeaks caution doctrine” – The bespeaks caution doctrine addresses situations where optimistic projections are coupled with cautionary language that impacts whether the statements are material or could reasonably have been relied upon by investors. The Private Securities Litigation Reform Act (PSLRA) has a safe harbor for forward-looking statements that applies to Securities Act claims, but there is an exclusion for statements made in connection with initial public offerings. In Kolominsky, the court held that the bespeaks caution doctrine has survived the codification of the PSLRA and joined its “sister circuits that hold when companies such as Root make forward-looking statements contained in a registration statement or in connection with an initial public offering, the Bespeaks Caution doctrine will shield those companies from liability when the forward-looking statements are accompanied by meaningful cautionary language so that a reasonable investor would understand the statements.”

Holding: Motion to dismiss affirmed.

The U.S. Supreme Court has issued a decision in Macquarie Infrastructure Corp. v. Moab Partners, L.P. holding that the failure to disclose information required by Item 303 of Regulation S-K can support a Rule 10b-5(b) claim only if the omission renders affirmative statements misleading.  It is a unanimous decision authored by Justice Sotomayor.

Item 303 of Regulation S-K requires companies to describe “known trends or uncertainties” that may have a material impact on the company’s operations.  There has been a circuit split over whether a company’s failure to meet its Item 303 disclosure requirement can support a private claim under Section 10(b) and Rule 10b-5(b) in the absence of an otherwise-misleading statement.  The Second Circuit has held that a private claim can be brought based on this omission, while other circuits – notably the Ninth Circuit and Third Circuit – have disagreed.

In Macquarie, the Court had little trouble concluding that the Second Circuit had gone too far in expanding the scope of potential securities fraud liability.  The Court clarified that “Rule 10b-5(b) does not proscribe pure omissions.”  Instead, it prohibits only affirmative misstatements and the omission of materials facts necessary to ensure that statements are not misleading (i.e., “half-truths”).  The failure to provide required information under Item 303 is not a half-truth, but instead is a pure omission of information.  Had Congress or the SEC wanted to make pure omissions a basis for liability under Section 10(b) or Rule 10b-5, the Court noted, they knew how to do so because that type of liability exists under Section 11 of the Securities Act for misstatements in registration statements.

Holding: Judgment vacated and case remanded for further proceedings consistent with opinion.

Quote of note:  “[T]he difference between an omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.  Rule 10b-5(b) does not proscribe pure omissions. . . . Put differently, it requires disclosure of information necessary to ensure that that statements already made are clear and complete (i.e., that the dessert was, in fact, a whole cake.)”

Disclosure:  The author of The 10b-5 Daily participated in an amicus brief in support of Macquarie filed by the Washington Legal Foundation.

To what extent can plaintiffs commission an expert report based on public information and rely on it in their complaint to adequately plead securities fraud?  The Ninth Circuit recently addressed this issue in E. Ohman J:or Fonder AB v. NVIDIA Corp., 2023 WL 5496507 (9th Cir. Aug. 25, 2023).  A majority of the panel (Judge Fletcher and Judge Wallace) found that the expert report was credible and could be relied upon, even though it did not reference any internal corporate data or witness statements.

In NVIDIA, the plaintiffs alleged that NVIDIA failed to disclose the impact of crypto-related sales of its gaming products on the company’s financial performance so as to conceal the extent to which its revenue growth depended on the volatile demand for cryptocurrency.  Accordingly, the key question in the case was whether and when NVIDIA became aware that crypto-related sales were a significant driver of its revenues.

To answer that question, the plaintiffs primarily relied upon two analyses conducted by outside entities after NVIDIA missed revenue projections in November 2018 (the end of the putative class period).  First, RBC Capital Markets published an investigative report concluding that NVIDIA had significantly understated the amount of its crypto-related sales.  Second, the plaintiffs hired an economic consulting firm, the Prysm Group, that issued a report coming to the same conclusion.

On appeal from the dismissal of the complaint, the Ninth Circuit concluded that based on the RBC and Prysm reports, statements from confidential witnesses discussing bulk purchases of the company’s gaming products for cryptocurrency mining, and the fact that NVIDIA’s earnings collapsed when cryptocurrency prices collapsed, “there is a sufficient likelihood that a very substantial part of NVIDIA’s revenues during the Class Period came from sales . . . for cryptocurrency mining.”  Moreover, the court found, the plaintiffs had adequately plead a strong inference of scienter (i.e., fraudulent intent) as to NVIDIA’s CEO based on confidential witness statements alleging that the CEO received detailed sales reports, closely monitored them, and these reports would have shown the portion of sales used for cryptocurrency mining.

The majority opinion was the subject of a strong dissent from Judge Sanchez (and there is a significant amount of back-and-forth between the judges in their opinions).  The dissent argued that the majority “essentially concluded that Plaintiffs have adequately alleged falsity merely by showing that Defendants’ statements concerning cryptocurrency-related revenues diverged from Prysm’s post hoc revenue estimates.”  The problem with that approach, according to Judge Sanchez, is that the Ninth Circuit has “never before allowed an outside expert to serve as the primary source of falsity allegations under the PSLRA where the expert relies almost exclusively on generic market research and without any personal knowledge of the facts on which their opinion is based.”  As to the scienter of NVIDIA’s CEO, the dissent carefully went through the confidential witness statements and concluded that none of them demonstrated that the CEO reviewed internal information that conflicted with the company’s public statements.

Holding:  Affirmed in part, reversed in part, and remanded.

Quote of note (majority opinion): “Prysm and RBC performed rigorous market analyses to reach their independent but nearly identical conclusions.  Contrary to our colleague’s contention, the PSLRA nowhere requires experts to rely on internal data and witness statements to prove falsity.  It merely requires that ‘the complaint state [] with particularity all facts on which [the] belief [underlying an allegation of falsity] is formed.’  Prysm did exactly that.  To categorically hold that, to be credible, an expert opinion must rely on internal data and witness statements would place an onerous and undue pre-discovery burden on plaintiffs in securities fraud cases.”

It would appear that the third time’s the charm, at least for Goldman Sachs in its long-running securities class action related to certain collateralized debt obligation (CDO) transactions.  For the past several years, the key issue in the case has been whether Goldman’s alleged misrepresentations about its business principles and potential conflicts of interest had any stock price impact, and therefore could support the presumption of reliance necessary to certify a class.  The question has been the subject of two Second Circuit appeals and a Supreme Court decision.  Late last week, as part of the third appeal to the Second Circuit, that court finally decided to deny the certification of the class.

As way of background, to certify a class on behalf of all investors who purchased shares during a class period, plaintiffs usually invoke a presumption of reliance created by the Supreme Court in the Basic case.  Under the Basic presumption, plaintiffs can establish class-wide reliance by showing (1) that the alleged misrepresentations were publicly known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time that the misrepresentations were made and when the truth was revealed.  These requirements are based on the efficient market hypothesis, which, as relevant here, posits that in an efficient market any material statements will impact a stock’s price.  If all four elements are met, any investor trading in such a market can be presumed to have relied upon the stock’s price and all material statements (or misstatements) about the stock.  Accordingly, the Court has held that the Basic requirements are merely an “indirect proxy for price impact,” which is the true underpinning of the presumption of reliance.

Without the Basic presumption, individualized issues of reliance would normally prevent any attempt to certify a class in a securities fraud class action.  Defendants have the ability to rebut the Basic presumption, and defeat class certification, by demonstrating that the alleged misrepresentations did not have a price impact.

Picking up the story at the Supreme Court, in Goldman the Court considered whether defendants can, at least in part, demonstrate a lack of price impact by pointing to the generic nature of the alleged misrepresentations.  The Court held that “a court cannot conclude that Rule 23’s requirements are satisfied without considering all evidence relevant to price impact.”  That is the true even if the evidence – like the generic nature of the alleged misrepresentations – “is also relevant to a merits question like materiality.”  Moreover, the Court noted that an inference of price impact “break[s] down” when “there is a mismatch between the contents of the misrepresentation and the corrective disclosure,” especially where “the earlier misrepresentation is generic . . . and the later corrective disclosure is specific.”  This inquiry into the nature of the alleged misrepresentations especially is relevant in cases like Goldman where plaintiffs, invoking the “inflation maintenance theory,” argue that the misrepresentations did not increase the company’s stock price, but instead merely prevented it from falling.  The Court concluded that it had some “doubt” as to whether the Second Circuit had “properly considered the generic nature of Goldman’s alleged misrepresentations” and remanded with instructions for the lower court to “take into account all record evidence relevant to price impact.”

Back at the district court level, the court once again found that Goldman had failed to demonstrate that the alleged misrepresentations did not have a stock price impact.  In particular, the district court concluded that the Supreme Court’s “mismatch” test was satisfied because the alleged corrective disclosures at issue “implicated” the same subject matter as the misrepresentations.  Goldman again appealed the district court’s decision to certify the class.

In Arkansas Teacher Retirement System v. Goldman Sachs Group, 2023 WL 5112157 (2nd Cir. August 10, 2023), the Second Circuit considered whether the district court had adequately applied the Supreme Court’s analytical framework in assessing the evidence of price impact.  In a long, and at times convoluted, opinion, the court concluded that Goldman had sufficiently severed the link between the alleged misrepresentations and any price impact.  In particular, the court found that the district court’s opinion misapplied the Supreme Court’s framework to the plaintiffs’ inflation-maintenance theory.  Having “acknowledged a considerable gap in specificity between the corrective disclosures and alleged misrepresentations,” the district court “should have asked what would have happened if the company has spoken truthfully at an equally generic level.”  Instead, the district court determined that the alleged misrepresentations had not been consciously relied upon by investors when they were made, but found that they would have been relied upon had Goldman disclosed the details and severity of its misconduct.  The Second Circuit concluded that the district court had “concoct[ed] a highly specific truthful substitute” for the alleged misrepresentations that “look[ed] nothing like the original,” thereby violating the Supreme Court’s guidance that an inference of price impact “breaks down” where the misrepresentations are more generic than the corrective disclosures.

Going forward, the Second Circuit noted that “a searching price impact analysis must be conducted where (1) there is a considerable gap in front-end-back-end genericness . . ., (2) the corrective disclosure does not directly refer . . . to the alleged misstatement, and (3) the plaintiff claims . . . that a company’s generic risk-disclosure was misleading by omission.”  The key question is “whether a truthful – but equally generic – substitute for the alleged misrepresentation would have impacted the price.”  As to the Goldman case, the Second Circuit concluded that the expert evidence put forward by the parties did not support that conclusion.

Holding: Case remanded with instructions to decertify the class.

Quote of note: “In cases based on the theory plaintiffs press here, a plaintiff cannot (a) identify a specific back-end, price-dropping event, (b) find a front-end disclosure bearing on the same subject, and then (c) assert securities fraud, unless the front-end disclosure is sufficiently detailed in the first place.  The central focus, in other words, is ensuring that the front-end disclosure and back-end event stand on equal footing; a mismatch in specificity between the two undercuts a plaintiffs’ theory that investors would have expected more from the front-end disclosure.”

Disclosure:  The author of The 10b-5 Daily participated in an amicus brief in support of Goldman filed by the Washington Legal Foundation.

When the U.S. Supreme Court issues a securities litigation opinion, it rarely is having the last word on the subject.  Lower courts still have to interpret and apply the Court’s holding.  Last month, a decision from the U.S. Court of Appeals for the Third Circuit – City of Warren Police and Fire Retirement System v. Prudential Financial, Inc., 2023 WL 3961128 (3rd Cir. June 13, 2023) –  addressed two questions about how to apply Court precedent in this area.

Opinion Falsity – In its Omnicare decision, the Supreme Court considered when an opinion statement may be false or misleading under Section 11 of the Securities Act (liability for misstatements in registration statements).  The Court found that if the speaker actually did not hold the stated belief, or the opinion omitted material facts about the stated inquiry into, or knowledge concerning, the opinion, it can be actionable as a false statement.  But does this analytical framework also apply to securities fraud claims under Section 10(b) and Rule 10b-5?

The Third Circuit held that it does.  In particular, the Prudential decision noted that Section 11 and Rule 10b-5 “use almost identical language in prohibiting misrepresentations and omissions” and “share the same standard for materiality for misleading statements.”  Under these circumstances, the Third Circuit joined every other federal circuit court to consider the issue (1st, 2d, 4th, 9th, 10th, and 11th) and found that the “more developed” Omincare standard applies to both Section 11 and Rule 10b-5 claims based on opinion statements.

Maker of False Statement – In its Janus decision, the Supreme Court held that for a person or entity to have “made” a false statement that can lead to Rule 10b-5 liability, that person or entity must have “ultimate authority over the statement, including its content and whether and how to communicate it.”  The attribution of a statement “is strong evidence that a statement was made by – and only by – the party to whom it is attributed.”  But how does this analytical framework apply to a paraphrased statement from a corporate officer contained in an analyst report?

The Third Circuit held, contrary to the district court’s decision, that the corporate officer could still be deemed a “maker” of the statement.  Even though the statement was indirect (paraphrased) and contained in a non-corporate document (analyst report), the court found that “because the report attributed the statement to the [corporate officer] and the context of the statement indicates that he exercised control over its content and the decision to communicate it to the [analyst], the statement cannot, at least at the pleading stage, be considered to have been ‘made’ by [the analyst] for purposes of Rule 10b-5.”  In other words, the corporate officer had “ultimate authority” to speak about the topic on behalf of the company, so he was still the “maker” of the statement even though it was republished by the analyst.

Holding: Dismissal affirmed in part and vacated in part.

To what extent should courts rely upon market analysts in determining the meaning of corporate statements? In Boykin v. K12, Inc., 2022 WL 17097453 (4th Cir. Nov. 22, 2022), the U.S. Court of Appeals for the Fourth Circuit considered this question in a case alleging that K12, a provider of educational software and support, falsely told investors in 2020 that the Miami-Dade public school district had entered into a lucrative deal to purchase the company’s platform and content.

In August 2020, K12 confirmed that it was entering into a partnership with Miami-Dade where it would “provide customized services, including curriculum, assessment tools, teacher training and data management.” The CEO also stated that the company was seeing an increase in school districts who wanted to use the company’s content and curriculum, “with more of those contracts this year than we’ve ever had in any one year before,” and specifically mentioned Miami-Dade. Two financial analysts covering K12 “applauded the company, respectively, for having a ‘contract signed’ and a ‘contract win.'” A couple of weeks later, however, news reports came out suggesting that Miami-Dade was not going to enter into the contract due to issues it was experiencing with the platform. Ultimately, on September 10, 2020, Miami-Dade’s board voted to terminate the partnership.

On appeal from the district court’s dismissal of the complaint, the Fourth Circuit found that the company’s statements about the Miami-Dade deal “could well have factored into the run-up of K12 shares during the summer of 2020.” As to the falsity of the statements and the defendants’ scienter (i.e., fraudulent intent), however, the court was less convinced.

First, the falsity element is based on a reasonable investor’s view of the company’s statements, “not any individual investor’s reaction.” If the analysts believed that the CEO had confirmed the existence of a done deal, they were simply incorrect given that the CEO never “attested unambiguously to having a signed agreement.” And to the extent that the CEO “was gesturing to an extensive working relationship between K12 and Miami-Dade,” that was factually accurate at the time. Indeed, Miami-Dade’s superintendent even signed the completed contract in mid-August, but it was never returned to K12.

Second, the court held that “[j]ust as certain statements are such that, to show them false is normally to show scienter as well, the inverse is also true.” The timeline was consistent with the CEO’s “anticipation in mid-August of a consummated deal with Miami-Dade.” Moreover, if the CEO’s goal had been to inflate K12’s stock price, “he could have chosen far less ambiguous language than he did.” Nor did the plaintiffs provide any facts, such as insider trading, that would support a motive for fraud.

Holding: Dismissal affirmed.

What constitutes a “scheme” or “deceptive act” for purposes of liability under the antifraud provisions of the federal securities laws? Part of the difficulty in answering that question has been that Rule 10b-5 contains three separate subsections, which prohibit in connection with a securities transaction (a) the use of any “device, scheme, or artifice to defraud,” (b) the “mak[ing] of any untrue statement” or omission of material fact, and (c) any “act, practice, or course of business which operates or would operate as a fraud or deceit.” If these subsections are read separately, then a scheme or deceptive act would appear to be something different than simply making a false or misleading statement.

In 2017, however, the U.S. Supreme Court held in Lorenzo that the Rule 10b-5 subsections overlap, at least to the extent that an individual who disseminates false statements to investors (even if the statements were made by someone else) can be primarily liable for securities fraud under subsections (a) and (c). That ruling appeared to open up a new front for securities class actions: private plaintiffs could seek to hold defendants who merely participated in the making of false statements liable for securities fraud (whereas this type of claim previously had been barred by the absence of aiding and abetting liability in private actions brought under Section 10(b) and Rule 10b-5). Moreover, to the extent that a claim was framed as a “scheme liability” claim as opposed to a “misstatement” claim, it might be possible to circumvent the PSLRA’s heightened pleading standards (which technically apply to claims based on misstatements).

In the wake of Lorenzo, at least two circuit courts have found that claims based on misstatements also can be brought under Rule 10b-5(a) and (c) (Alphabet – 9th Cir.; Malouf – 10th Cir.). In July, however, the Second Circuit sought to limit the impact of the Lorenzo decision. In SEC v. Rio Tinto, the court held that “[u]ntil further guidance from the Supreme Court (or in banc consideration here) . . . misstatements and omissions can form part of a scheme liability claim, but an actionable scheme liability claim also requires something beyond misstatements and omissions, such as dissemination.” Although dissemination is clearly sufficient under Lorenzo, the court was vague about exactly what else could constitute the “something beyond misstatements and omissions.” Indeed, the court noted that it is “a matter that awaits further development.”

One prominent commentator has argued that the “show is over” when it comes to scheme liability after the Rio Tinto decision. But many in the defense bar have been more circumspect, including questioning whether the decision is as “clear as mud.” Meanwhile, arguably there now is a circuit split on the issue of whether “something beyond misstatements and omissions” is required for scheme liability. Will the plaintiffs bar become more aggressive in testing the boundaries of scheme liability in the wake of these decisions? Stay tuned.