Please Take This Case!

It has been over fifteen years since the U.S. Supreme Court’s decision in Dura Pharmaceuticals v. Broudo, where the Court held that plaintiffs in securities fraud cases must plead and prove loss causation. In the interim, the lower courts have gone in a number of different directions on crucial loss causation questions

The author of The 10b-5 Daily (Lyle Roberts) has written an article for Law360 urging the Court to grant cert in the In re BofI Securities Litigation case. In that case, the U.S. Court of Appeals for the Ninth Circuit created a clear circuit split on the issue of whether a third-party judicial complaint, standing alone, can be a “corrective disclosure” for purposes of loss causation. Here is a link to the article (may require subscription).

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Revisiting Loss Causation

In 2005, the U.S. Supreme Court decided Dura Pharmaceuticals v. Broudo, where it held that plaintiffs in a securities fraud case must plead and prove that there was a causal connection between the alleged misrepresentations and the subsequent decline in the company’s stock price. The Supreme Court did not address, however, the exact contours of that causal connection.  Lower courts have come to significantly different conclusions on questions like what constitutes an adequate corrective disclosure that reveals falsity, when can information about a company be deemed “public,” and the effect of an immediate stock price recovery.  As readers of this blog know, over the last six months the U.S. Court of Appeals for the Ninth Circuit has issued a series of decisions on these issues that arguably have created more confusion than clarity.

The author of The 10b-5 Daily has written an article for the May 19, 2021 issue of The Review of Securities & Commodities Regulation on the Ninth Circuit’s recent loss causation decisions, ultimately concluding that it is time for the Supreme Court to bring uniformity to the lower courts as to loss causation.  And, indeed, the defendants in one of the discussed decisions – In re BofI Holding, Inc. Securities Litigation – have submitted a cert petition seeking Supreme Court review.  A pre-publication copy of the article can be found here.

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Goldman Argued

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.

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Third Place Winner Redux

The 10b-5 Daily should have known better than to call a securities decision “rare.”  For the second time in a month, an applicant with the third-highest claimed damages has been appointed lead plaintiff in a securities class action.  The reasoning behind this decision, however, is quite different and illustrates the many ways an applicant can be rejected.

As previously noted, under the PSLRA, the presumptive lead plaintiff in a securities class action is the applicant with the “largest financial interest in the relief sought by the class.”  The largest financial interest is measured by assessing the approximate losses suffered and, once the court makes that determination, the contest is usually over.  But not always.  The court also has to find that the applicant meets the typicality and adequacy requirements of Federal Rule of Civil Procedure 23.

In Gelt Trading Ltd. v. Co-Diagnostics, Inc., 2021 WL 913934 (D. Utah March 10, 2021), the court determined that the top three applicants for lead plaintiff had the following claimed losses: Co-Diagnostics Investor Group (two individual investors) – $233,131, Tejeswar Tadi – $158,800, and Gelt Trading – $117,740.  The court, however, had some questions surrounding the nature of the losses suffered by the Co-Diagnostics Investor Group and Tadi.

The original complaint filed by Gelt Trading proposed a class period of February 25, 2020 through May 15, 2020.   Gelt Trading subsequently filed an amended complaint, however, proposing a shorter class period of April 30, 2020 to May 14, 2020.  Courts often question whether changes like this have been made to game the lead plaintiff process and, as a result, apply the more inclusive class period in assessing approximate losses.  In this case, however, the court found that “neither the Co-Diagnostics Investor Group nor any other movant has identified any material misstatements made by Co-Diagnostics before April 30, 2020.”  As a result, the large majority of the Co-Diagnostics Investor Group’s claimed losses, which were based on share purchases made prior to April 30, 2020, could not be counted in assessing its application.

As for Tadi, his claimed losses were based entirely on a purchase of call options for Co-Diagnostics’ stock made on May 14, 2020 (the day before the alleged corrective disclosure that ended the proposed class period).  The court found, consistent with the decisions of a number of other courts, that Tadi’s option trading would bring factual issues into the case that were irrelevant to the other class members and would subject him to unique loss causation defenses (i.e., he failed the typicality requirement).

That left Gelt Trading, the filer of the original complaint, but also the party that changed the proposed class period.  The court rejected arguments by the other applicants that Gelt Trading should be excluded because (a) it failed to file a stock trading certificate with its original complaint (the filing was made in conjunction with the amended complaint) and (b) its changing of the class period was designed to favor its lead plaintiff application.  On the second point, the court noted that the change was made before the lead plaintiff applications were submitted.  Voila – another third place winner!

Holding: Consolidating cases and appointing Gelt Trading as lead plaintiff.

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Third Place Winner

Under the PSLRA, the presumptive lead plaintiff in a securities class action is the applicant with the “largest financial interest in the relief sought by the class.”  The largest financial interest is measured by assessing the approximate losses suffered and, once the court makes that determination, the contest is usually over.  But not always.  The court also has to find that the applicant meets the typicality and adequacy requirements of Federal Rule of Civil Procedure 23, including whether the proposed lead plaintiff and its counsel will vigorously fulfill their duties to the class.

In Wasa Medical Holdings v. Sorrento Therapeutics, Inc., 2021 WL 533518 (S.D. Cal. Feb. 12, 2021), the court determined that the top three applicants for lead plaintiff had the following claimed losses: Jing Li (represented by Pomerantz) $454,341, the SRNE Investor Group (represented by Kirby McInerney) $380,908, and Andrew Zenoff (represented by Robbins Geller) $195,500.  While Jing Li was the presumptive lead plaintiff, with the SRNE Investor Group a close second, the court had some doubts as to the adequacy of both of these applicants.

According to her declaration, Jing Li is a 47-year old housewife from Singapore who had been investing in the securities markets for three years.  The court expressed concern “about whether Li possesses the requisite experience to supervise this high-stakes litigation.”  In addition, Li’s submissions to the court contained some ambiguities and errors, including stating that she could only attest to her transactions in Sorrento common stock to “the best of her current knowledge” and initially failing to note that she also was represented by the The Schall Law Firm. 

So what about the SRNE Investor Group?  Both Li and Zenoff argued that the group was “an improper amalgamation of unrelated investors without any pre-existing relationship.”  The court agreed, finding that the Group’s declaration made it clear that the individual investors in the group did not know each other before being brought together by Kirby McInerney.  The court therefore found that both Li and the SRNE Investor Group failed to meet the adequacy requirement.

In contrast, Zenoff had a larger financial interest than any individual member of the SRNE Investor Group and is “the founder of three companies, and the inventor of a maternity nursing product, which has sold millions of units for the span of 24 years.”  He also has 20 years of investing experience.  The court named Zenoff as the lead plaintiff, making him a rare “third place winner” in these contests.

Holding: Consolidating cases and appointing Andrew Zenoff and Robbins Geller as lead plaintiff and lead counsel.

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The Goldman Case

The U.S. Supreme Court is set to hear Goldman Sachs v. Arkansas next month (oral argument is scheduled for March 29).  The questions presented in the case are:

(1) Whether a defendant in a securities class action may rebut the presumption of classwide reliance recognized in Basic Inc. v. Levinson, 485 U.S. 224 (1988), by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality.

(2) Whether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion.

The author of The 10b-5 Daily – Lyle Roberts – assisted the Washington Legal Foundation (“WLF”) in the submission of an amicus brief in support of the petitioners.  He also participated yesterday in an online WLF program on the current U.S. Supreme Court Term, discussing the Goldman case and what securities litigation topics might be coming before the Court in the near future (hint: extraterritoriality and loss causation).  A direct link to the Goldman discussion can be found here.

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Compare and Contrast

NERA Economic Consulting and Cornerstone Research have released their respective 2020 annual reports on federal securities class action filings.  As usual, the different methodologies employed by the two organizations have led to slightly different numbers, although they both identify the same general trends.

The findings for 2020 include:

(1) The reports agree that there was a significant decline in filings, with less than 400 overall filings for the first time since 2017.  The reports state that a drop in M&A-related cases is responsible for most of the decline, although “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12 were also down.  NERA finds that there were 326 filings (compared with 420 filings in 2019), while Cornerstone finds that there were 334 filings (compared with 427 filings in 2019).

(2) Both NERA and Cornerstone analyzed the number of filings with COVID-19 related claims: NERA identifies 33 filings with COVID-19-related claims, while Cornerstone identifies 19 filings with COVID-19-related claims.

(3) In 2019, there was a leap in the number of standard filings in the Second Circuit, which accounted for nearly twice the number of filings as the Ninth Circuit.  In 2020, however, the numbers reverted to the norm, with the Second Circuit (NERA – 69; Cornerstone – 77) and Ninth Circuit (NERA – 79; Cornerstone – 79) having a similar number of standard filings.  The Third Circuit had the next highest number of standard filings (NERA – 25; Cornerstone – 24).

(4) The percentage of cases brought against foreign issuers continues to rise.  Cornerstone finds that there were 74 standard filings against foreign issuers in 2020 (compared to 57 filings in 2019), representing 33% of all standard filings.

(5) NERA finds that if settlements related to merger objections, settlements with no cash payment to the class, and individual cases with settlements of $1 billion or greater are removed, the annual average settlement values have been stable over the last four years, ranging from $26 million to $31 million.

The NERA report can be found here.  The Cornerstone report can be found here.

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The Rebound Defense

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.

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Back For More

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.

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The Other Shoe Hasn’t Dropped

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.”

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