Ruling addresses ‘corrective disclosures’ in securities suits

Fifteen years after the U.S. Supreme Court's seminal decision in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 347 (2005), courts continue to grapple with the pleading requirements for loss causation in securities class actions. On Oct. 8, the 9th U.S. Circuit Court of Appeals issued yet another opinion seeking to clarify what constitutes a "corrective disclosure" of fraudulent activity that satisfies the loss causation element. In re BofI Holding, Inc. Securities Litigation, 2020 DJDAR 10855. However, as the dissenting opinion warns, the 9th Circuit's decision risks "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."

In BofI, the shareholder plaintiffs alleged that the defendants falsely portrayed BofI Federal Bank as a safer investment than it actually was by misrepresenting the strength of the bank's underwriting standards, system of internal controls, and compliance structure. The district court held that the shareholder plaintiffs adequately pleaded five out of the six elements for a federal securities fraud claim: (1) a material misrepresentation or omission; (2) made with scienter; (3) in connection with the purchase or sale of a security; (4) reliance on the misrepresentation or omission; and (5) economic loss. Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258, 267 (2014). But ultimately, the district court determined that the shareholder plaintiffs failed to adequately plead the sixth element -- loss causation.

On appeal, the sole issue before the 9th Circuit was whether loss causation was adequately pleaded. To establish loss causation, a shareholder plaintiff must show that (1) "the truth became known" to the public and (2) the revelation caused the fraud-induced inflation in the stock's price to be reduced or eliminated. Dura, 544 U.S. at 347. The court recognizes that the most common way for plaintiffs to prove that "the truth became known" is to identify whether there has been a corrective disclosure. Mineworkers' Pension Scheme v. First Solar Inc., 881 F.3d 750, 753-54 (9th Cir. 2018) (per curiam). A corrective disclosure occurs when "information correcting the misstatement or omission that is the basis for the action is disseminated to the market" by any source. 15 U.S.C. Section 78u-4(e)(1).

The shareholder plaintiffs in BofI alleged two corrective disclosures: (1) a series of blog posts offering negative reports about BofI's operations, and (2) a whistleblower lawsuit filed by a former company insider. With respect to the blog posts, the 9th Circuit held that information that was already publicly available cannot form the basis of a corrective disclosure. Instead, a corrective disclosure requires revelation of new information to the market that has not yet been incorporated into the stock price.

The 9th Circuit did note one exception to this rule. To satisfy the exception, a plaintiff must allege that the publicly available information is so complex that it is implausible that the stock price actually reflects that information absent someone locating, analyzing and distilling the publicly available data. This is a high bar to meet -- indeed, the 9th Circuit determined that none of the eight blog posts identified by the shareholder plaintiffs constituted corrective disclosures despite observing that some of those posts "required extensive and tedious research involving the analysis of far-flung bits and pieces of data." (Judge Kenneth Lee concurred in the court's judgment with respect to the blog posts, but offered a dissenting opinion with respect to the weight on the whistleblower lawsuit.)

By contrast, the 9th Circuit held that the whistleblower lawsuit relied upon in the shareholder plaintiffs' complaint qualified as a corrective disclosure. The relevant question, according to the 9th Circuit, was whether "the market reasonably perceived the whistleblower's allegations as true and acted upon them accordingly." The allegations in whistleblower lawsuit -- coming from a former company insider -- were highly detailed and specific. Moreover, the disclosure of the allegations in the whistleblower lawsuit were immediately followed by a stock price plunge of over 30% on extremely high trading volume.

The 9th Circuit distinguished two prior decisions -- Loos v. Immersion Corp. and Curry v. Yelp Inc. In Loos, the 9th Circuit held that plaintiff did not sufficiently allege loss causation by relying on an announcement that the defendant company was conducting "an internal investigation into certain previous revenue transactions in its Medical line of business." Loos v. Immersion Corp., 762 F.3d 880, 885 (9th Cir. 2014). Since the announcement did not reveal any actual facts (unlike the whistleblower lawsuit), the market could only react to speculation about what the investigation would ultimately yield. Similarly, the 9th Circuit distinguished Curry, noting that the alleged corrective disclosure in Curry was based on Federal Trade Commission complaints by customers who lacked any firsthand knowledge of Yelp's practices. Curry v. Yelp Inc., 875 F.3d 1219, 1223 (9th Cir. 2017). Concluding that the BofI whistleblower's "allegations established fire and not just smoke," the 9th Circuit held that the shareholder plaintiffs sufficiently alleged loss causation.

In a dissenting opinion, Judge Lee expressed concern about the breadth of the majority's holding because of the "exorbitant cost on companies" when defending meritless securities class actions. He noted that the steep plummet in BofI's stock prices following the filing of the whistleblower lawsuit did not necessarily mean that the disclosure revealed the truth -- rather, it was better construed as a disclosure of an added risk of future corrective action. To address these issues, Judge Lee would "require additional external confirmation of fraud allegations in a whistleblower lawsuit for them to count as a 'corrective disclosure."

In sum, the 9th Circuit's decision in BofI attempts to balance two strong, countervailing interests: those of financially aggrieved shareholder plaintiffs on one hand, and those of defendants subject to enormous financial burdens defending federal securities lawsuits on the other. Although BofI seeks to clarify the standard for a corrective disclosure to balance those interests, Judge Lee's dissenting opinion correctly highlights that the court's decision may ultimately raise more questions than it resolves.