Category Archives: Appellate Monitor

On Monday, the U.S. Supreme Court heard oral argument in the Goldman Sachs v. Arkansas case, which addresses issues related to class certification in securities cases.

To certify a class on behalf of all investors who purchased shares during the class period, plaintiffs usually invoke a presumption of reliance created by the 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.

Defendants have the ability to rebut the Basic presumption, and defeat class certification, by demonstrating that the alleged misrepresentations did not have any price impact.  The questions presented in Goldman are whether defendants can do so by pointing to the generic nature of the alleged misrepresentations and whether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion.

At oral argument, the Court appeared peeved that the first question might not be much of a question at all.  Chief Justice Roberts asked petitioners (Goldman) whether there was “any daylight on the substantive question between the [parties] concerning the generic statements?”  And, indeed, both sides (as well as the government as amicus) agreed that the generic nature of the misstatements could be evidence of a lack of price impact.  As a result, the argument focused on two sub-issues: (a) does the court have to rely solely on experts in assessing the existence of price impact, and (b) did the Second Circuit’s decision below really fail to take the generic nature of the alleged misstatements into account.

As to whether courts need to rely solely on experts, the justices appeared sympathetic to petitioners’ argument that the court also could apply its own judgment.  Justice Breyer, in particular, noted that “Take the statement for what it’s worth. Listen to the experts, and don’t check your . . . common sense at the door. That’s what judges do. So why are we hearing that issue?”  Similarly, Justice Barrett wondered whether all that was now on the table was a “ruling on that very, very narrow issue, saying, sure, judges can also consider their common sense.”  And, indeed, both the government and the respondents argued that courts could rely on common sense in determining price impact, although respondents suggested that “the more there is expert testimony . . . the more the judge ought to be evaluating the experts” and not relying on his or her own view of “how economic markets work.”

There did appear to be a genuine disagreement, however, on whether the Second Circuit really had held that the generic nature of the alleged misstatements could not be considered.  Justice Sotomayor appeared to agree with the government and respondents that the Second Circuit’s opinion below contained some ambiguity on that point and suggested that the best approach might be to affirm the decision while clarifying the correct law.  Meanwhile, petitioners and respondents debated whether, if the Court were to decide that the correct legal standard had not been applied, the Second Circuit’s decision should be reversed (petitioners) or merely vacated and remanded with further instructions (respondents).  This issue, as the government pointed out, is meaningful to the parties, but does not impact the Court’s formulation of the law.

Finally, on the second question presented, only two justices indicated that they might support petitioners’ argument that plaintiffs should bear the burden of persuasion as to price impact given that they bear the overall burden of persuasion as to class certification.  Justice Gorsuch expressed concern that “the plaintiff might be able to do nothing and just rest on the presumption that there’s a price impact in the face of direct evidence that there wasn’t.”  Similarly, Justice Alito questioned how a judge is supposed to deal with a situation where the plaintiffs were not required to provide evidence of price impact.  On the other hand, respondents correctly pointed out that every court of appeals that has addressed the issue, including the Seventh Circuit in a decision joined by then-Circuit Judge Barrett, has found that defendants bear the burden of persuasion in rebutting the Basic presumption.  Moreover, after persistent questioning from Justice Gorsuch, respondents conceded that if plaintiffs choose to rely entirely on the presumption in the face of direct evidence of no price impact a court “absolutely can find that the defendants prevail.”

Overall, it would appear that the Court is headed for a narrow decision (a) clarifying that courts can and should take the generic nature of the alleged misstatements into account when assessing price impact, and (b) holding that defendants have the burden of persuasion in rebutting the Basic presumption of reliance.  But whether that decision, which is expected by June, will come in the form of an affirmance, reversal, or vacatur is far from clear.

Disclosure: The author of The 10b-5 Daily assisted the Washington Legal Foundation in the submission of an amicus brief in support of the petitioners.

The U.S. Court of Appeals for the Ninth Circuit has issued a series of recent decisions on the pleading of loss causation, but if anything the court’s jurisprudence in this area is becoming more unclear.

In Wochos v. Tesla, Inc., 2021 WL 246210 (9th Cir. Jan. 26, 2021), the plaintiffs alleged that Tesla made false and misleading statements about the company’s progress in building its production capacity for its mass-market electric vehicle. The district court dismissed the case on the basis that the alleged misstatements were inactionable under the PSLRA’s safe harbor for forward-looking statements.

On appeal, the plaintiffs argued that not only did the district court improperly find that the misstatements alleged in the complaint were inactionable, but it also wrongly denied them leave to amend their complaint to allege the existence of an additional misstatement. In a lengthy and careful opinion, the 9th Circuit panel held that the alleged misstatements in the complaint were either forward-looking and accompanied by meaningful cautionary language, or were otherwise inadequately plead as false. As to the issue of leave to amend, however, the panel went on an interesting tangent.

The plaintiffs argued that in August 2017, Tesla made a statement falsely suggesting that it “had completed the ‘machine-that-makes-the-machine’—that is, the automated assembly line—and had started such automated production in July.” The panel found that an amendment to the complaint to add this alleged misstatement would be futile because the plaintiffs would be unable to establish loss causation. An October 6, 2017 Wall Street Journal article revealed that the cars were still being made by hand. In the immediate aftermath of that article, Tesla’s stock price dropped from $356.88 to $342.94. However, the panel noted, “the stock price immediately rebounded, closing at $355.59 on October 10 and trading between $350 and $360 over the next week.” The panel found that this “quick and sustained” stock price recovery refuted “the inference that the alleged concealment of this particular fact caused any material drop in the stock price” and “Plaintiffs have thus failed to show that they can adequately plead loss causation.”

The panel failed to cite any real precedent for this holding. Corporate defendants will be enthused to learn that an immediate stock price rebound can refute an inference of loss causation on a motion to dismiss (as opposed to simply limiting the potential damages associated with the claim). Plaintiffs confronted with this factual scenario, however, are likely to point out that a subsequent rise in the company’s stock price could be the result of a number of factors (overall market rise, unrelated positive news about the company, etc.) that are unconnected to the alleged fraud. Stay tuned.

Holding: Dismissal affirmed.

Last month, the U.S. Court of Appeals for the Ninth Circuit held, in a securities class action brought against BofI (In re BofI Securities Lit.), that the filing of a judicial complaint can form the basis for loss causation if the market reasonably perceived the allegations in the complaint as true and acted upon them accordingly.

It turns out, however, that there are two different securities class actions pending against BofI. And this month, the Ninth Circuit is back with a new decision (by a different panel of judges) on loss causation in the second case.

In Grigsby v. BofI Holding, Inc., 2020 WL 6438912 (9th Cir. Nov. 3, 2020), the plaintiffs alleged that BofI engaged in securities fraud by falsely denying that the company was the subject of a DOJ/SEC money laundering investigation. According to the plaintiffs, this denial was revealed to be false when information received from the SEC pursuant to a Freedom of Information Act (FOIA) request uncovered the existence of an ongoing SEC investigation into BofI.

The district court held that information obtained through a FOIA request could not act as a corrective disclosure for purposes of establishing loss causation because the information was “publicly available to an information-hungry market.” While the plaintiffs alleged that the SEC had granted (in full or in part) only five other BofI-related FOIA requests during the relevant time period, and there was no reason to believe that any of these requests had revealed the existence of the investigation, the district court concluded that this did not plausibly establish that market participants had not already learned about the investigation

On appeal, the Ninth Circuit disagreed. First, the panel held “there must be some indication that the relevant information was requested and produced before the information contained in a FOIA response can be considered publicly available for purposes of loss causation.” Second, the panel held that plaintiffs were not required to disprove that this had taken place. To the extent that it was not clear from the earlier FOIA requests whether the public had learned of the existence of the investigation, the “record does not allow the conclusion that any of the other BofI-related FOIA requests resulted in the disclosure of information about an SEC investigation of BofI.”

The panel also found that (a) BofI’s denial of the existence of a DOJ/SEC money laundering investigation was sufficiently revealed to have been false by the disclosure of a SEC investigation into related topics, and (b) the district court correctly held that a Seeking Alpha article about BofI did not act as a separate corrective disclosure because the article stated that it was based on public information and the “article’s analysis did not require any expertise or specialized skills beyond what a typical market participant would possess.”

Holding: Reversing dismissal in part and remanding for further proceedings.

Additional note: The two BofI decisions from the Ninth Circuit arguably conflict on the issue of the plaintiffs’ pleading burden as to whether the information in the alleged corrective disclosure was already known to the market. In In re BofI Securities Lit., the panel held that “[t]o rely on a corrective disclosure that is based on publicly available information, a plaintiff must plead with particularity facts plausibly explaining why the information was not yet reflected in the company’s stock price.” In Grigsby, however, the panel suggested (without citation to the earlier decision) that this is an inappropriately “elevated” pleading standard and it is enough for a plaintiff to plausibly allege that the corrective disclosure revealed the fraud. Stay tuned.

Can the filing of a judicial complaint against a company constitute a revelation of the alleged fraud sufficient to establish loss causation? Courts have found that it can, but usually where there is some later, independent confirmation of the allegations in the complaint.

In Norfolk County Retirement Systems v. Community Health Systems (6th Cir. 2017), for example, the Sixth Circuit considered a case where the plaintiffs alleged that a healthcare company’s overcharging of Medicare was revealed by a rival company’s lawsuit. The court found that the stock price drop that occurred after the filing of the lawsuit could form the basis for loss causation, but specifically noted that the CEO of Community Health Systems had “promptly admitted the truth of one of the complaint’s core allegations.”

But what if no such admission ever occurs? In In re BofI Securities Lit., 2020 WL 5951150 (9th Cir. Oct. 8, 2020), the plaintiffs alleged that the defendant bank had made false or misleading statements about its loan underwriting standards, internal controls, and compliance infrastructure. The fraud supposedly was revealed by “a whistleblower lawsuit filed by a former company insider and a series of blog posts offering negative reports about the company’s operations.” The district court found that neither of these items were “corrective disclosures” because (a) the complaint contained only unsubstantiated allegations that had not been subsequently confirmed, and (b) the blog posts were based entirely on existing public information.

On appeal, the Ninth Circuit disagreed with the district court’s imposition of “bright line rules” in its decision.

(1) Whistleblower Complaint – The Ninth Circuit held (citing Norfolk County) that the relevant question for loss causation purposes is “whether the market reasonably perceived [the whistleblower’s] allegations as true and acted upon them accordingly.” It was not necessary for there to be any subsequent confirmation of the allegations so long as “the market treats allegations in a lawsuit as sufficiently credible to be acted upon as truth, and the inflation in the stock price attributable to the defendant’s misstatements is dissipated as a result.” Given that the whistleblower complaint was brought by an insider and the company’s stock price dropped significantly after it was filed, the court concluded that this standard was met.

(2) Blog Posts – The Ninth Circuit agreed with the district court that a corrective disclosure “must by definition reveal new information to the market that has not yet been incorporated into the price.” However, the court found that this new information could include an analysis of the company’s operations, based on existing public information, that the market had not yet seen. The court found that the blog posts “required extensive and tedious research involving the analysis of far-flung bits and pieces of data” and, as result, provided new information to the market. Because they were written by short sellers and expressly disclaimed their own accuracy, however, the court concluded that “it is not plausible that the market reasonably perceived these posts as revealing the falsity of BofI’s prior misstatements, thereby causing the drops in BofI’s stock price on the days the posts appeared.”

(3) Dissent – In a strongly-worded dissent, Judge Lee disagreed with the panel’s reasoning. Judge Lee noted that there have been multiple government investigations of BofI, but “so far, we have not seen any external evidence corroborating [the whistleblower’s] allegations.” The majority’s decision, in Judge Lee’s view, would have “the unintended effect of giving the greenlight for securities fraud lawsuits based on unsubstantiated assertions that may turn out to be nothing more than wisps of innuendo and speculation.” Nor does it help to say that the allegations in the judicial complaint must be plausible, because “the plausibility standard will likely stave off only lawsuits based on insider accounts that even Mulder and Scully would find unbelievable.” As to the blog posts, Judge Lee concluded that he would base the decision “on the grounds that the [blog posts] contain public information only, and that we should not credit anonymous posts on a website notorious for self-interested short-sellers trafficking in rumors for their own pecuniary gain.”

Holding: Reversing dismissal and remanding for further proceedings.

Quote of note (majority decision): “[The whistleblower] is a former insider of the company who had personal knowledge of the facts he alleged. Those facts revealed that a number of BofI’s alleged misstatements were false. If the market regarded his factual allegations as credible and acted upon them on the assumption that they were true, as the shareholders have plausibly alleged here, [the whistleblower’s] allegations established fire and not just smoke.”

Quote of note (dissent): “[The whistleblower’s] allegations are certainly ominous, and may in fact be true. But at this time, the drop in BofI’s share price can only be attributed to market speculation about whether fraud has occurred. And this type of speculation cannot form the basis of a viable loss causation theory. Before plaintiffs can establish loss causation based on an unsubstantiated whistleblower complaint, another shoe has to drop. It has not yet.”

Securities class actions brought against drug development and medical device companies often are based on alleged misrepresentations related to the regulatory approval process.  Plaintiffs assert that the company’s officers must have known that the drug or device would not be approved, because the product was key to the company’s success.  But is that a plausible way of looking at how companies interact with their investors and regulators?

In Ngyuen v. Endologix, Inc., 962 F.3d 405 (9th Cir. 2020), the plaintiff alleged that Endologix misled its investors about whether the Food and Drug Administration (FDA) would approve Nellix, the company’s aneurysm sealing product.   In particular, Endologix supposedly knew the device had encountered development problems in Europe that would manifest again in U.S. clinical trials, which would in turn lead the FDA to deny pre-market approval.  The district court dismissed the complaint, finding that the plaintiff had failed to adequately plead a strong inference of scienter (i.e., fraudulent intent).

On appeal, the Ninth Circuit questioned whether the plaintiff’s version of events was the most likely.  As the court explained, the “plaintiff’s core theory—that the company invested in a U.S. clinical trial and made promising statements about FDA approval, yet knew from its experience in Europe that the FDA would eventually reject the product—has no basis in logic or common experience.”  The court found that was especially true given that the complaint did not allege the existence of suspicious insider stock sales.  Moreover, the complaint’s reliance on statements from a former Endologix officer could not fill this gap because the information attributable to the officer “lack[ed] any detail about the supposed device migration problems that Nellix encountered in the European channel.”  Without those details, the plaintiff could not establish “a strong inference that defendants’ later statements about FDA approval were intentionally false or made with deliberate recklessness.”

Holding: Dismissal affirmed.

Quote of note: “[W]e are asked to accept the theory that defendants were promising FDA approval for a medical device application they knew was ‘unapprovable,’ misleading the market all the way up to the point that defendants were ‘unable to avoid the inevitable.’  The allegation does not resonate in common experience.  And the PSLRA neither allows nor requires us to check our disbelief at the door.”

Additional note: Interestingly, the confidential witness relied upon by the plaintiff apparently “submitted a declaration in the district court disavowing the plaintiff’s allegations, denying having ‘ma[de] many of the statements attributed to me,’ and stating that ‘most of the factual assertions attributed to me … are contrary to my understandings of fact and my opinions.'”  Neither the district court nor the appellate court, however, considered this declaration in rendering their decisions.

If a securities fraud claim is based on the nondisclosure of an illegal act, what is the plaintiff required to plead about the existence of that act?  In Gamm v. Sanderson Farms, Inc., 2019 WL 6704666 (2d Cir. Dec. 10, 2019), the plaintiffs alleged that Sanderson Farms, a poultry processing company, had failed to disclose an anti-competitive conspiracy to inflate the price of chicken by coordinating supply reductions and manipulating a chicken price index.  After a series of antitrust complaints were filed against Sanderson Farms and other chicken producers, the company’s stock price fell.

The district court dismissed the complaint based on the plaintiffs’ failure to adequately plead the existence of “a chicken supply reduction conspiracy with particularized facts.”  On appeal, the Second Circuit agreed.  To support their contention that Sanderson Farms’ financial disclosures were rendered misleading by the failure to disclose the anti-competitive conduct, the plaintiffs were required “to have alleged the basic elements of an underlying antitrust conspiracy” with particularity.   Those elements included “collusive conduct,” but the securities complaint provided “no facts alleging that Sanderson or its peers actually reduced supply, and that those reductions were the result of an agreement, or were even interrelated.”  Accordingly, the complaint was deficient.

Holding: Dismissal affirmed.

Quote of note: “A stock-issuing company like Sanderson cannot be required, whenever accused of illegal activity, to simultaneously defend itself in an accompanying securities fraud suit based on facts not alleged with the level of particularity required by the statute [PSLRA].  Such a reality would harm the company’s stock and contravene the purpose of the securities laws – to protect shareholders’ interests.”

While the Second Circuit and Ninth Circuit hear many securities cases and have a wealth of relevant case law, other circuits are still dealing with common issues that they have not yet had a chance to address.  In Carvelli v. Ocwen Financial Corp., 2019 WL 3819305 (11th Cir. Aug. 15, 2019), the Eleventh Circuit examined two issues of first impression: puffery and Item 303.

Puffery – Puffery is generalized, vague, non-quantifiable statements of corporate optimism.  Courts have found that these types of statements are immaterial as a matter of law and, as a result, cannot form the basis for a securities fraud claim.  In Carvelli, the court noted that while the Eleventh Circuit has not addressed the concept in the context of a securities case, “puffery itself—and in particular its relevance to the law—is nothing new.”  Indeed, it appears in nineteenth-century English case law, where courts found that “some advertisements—’mere puff’— clearly aren’t meant to be taken seriously.”

The Eleventh Circuit had little trouble finding that puffery can be a barrier to a securities fraud claim, but cautioned that it was not merely a matter of the court determining that the particular statement “smacks of puff.”  Instead, a “conclusion that a statement constitutes puffery doesn’t absolve the reviewing court of the duty to consider the possibility—however remote—that in context and in light of the ‘total mix’ of available information, a reasonable investor might nonetheless attach importance to the statement.”  In the instant case, however, “Ocwen’s proclamations that it was devoting ‘substantial resources’ to its problems, with ‘improved results,’ as well as its boasts that it was taking a ‘leading role’ and making ‘progress’ toward compliance are precisely the sorts of statements that our sister circuits have—we think correctly—deemed puffery and found immaterial as a matter of law.”

Item 303 – Item 303 of Regulation S-K requires issuers to disclose known trends or uncertainties “reasonably likely” to have a material effect on operations, capital, and liquidity.  In Carvelli, the plaintiffs argued that the failure to make a disclosure required under Item 303 automatically can lead to Rule 10b-5 liability based on the existence of a material omission.  The Third Circuit and Ninth Circuit (and, to a lesser extent, the Second Circuit) have rejected that argument.  The Eleventh Circuit agreed with those decisions, holding that “Item 303 imposes a more sweeping disclosure obligation than Rule 10b-5, such that a violation of the former does not ipso facto indicate a violation of the latter.”

Holding: Dismissal affirmed.

Quote of note: “As Judge Learned Hand once put it, ‘[t]here are some kinds of talk which no sensible man takes seriously, and if he does he suffers from his credulity.” Vulcan Metals Co. v. Simmons Mfg. Co., 248 F. 853, 856 (2d Cir. 1918).  Think, for example, Disneyland’s claim to be ‘The Happiest Place on Earth.’  Or Avis’s boast, ‘We Just Try Harder.’  Or Dunkin Donuts’s assertion that ‘America runs on Dunkin.’  Or (for our teenage readers) Sony’s statement that its PlayStation 3 ‘Only Does Everything.’  These boasts and others like them are widely regarded as ‘puff’—big claims with little substance.”

On Tuesday, the U.S. Supreme Court dismissed the writ of certiorari in the Emulex case as “improvidently granted.”

The author of The 10b-5 Daily has an op-ed on Law360 discussing the ramifications of the decision (which also can be viewed here).