No lead plaintiff status, no standing ruling draws dissent and an appeal

In Habelt v. iRhythm Technologies, Inc., 83 F.4th 1162 (9th Cir. 2023), a split three-judge panel from the Ninth Circuit held that an investor who was the first to file a putative securities fraud class action complaint, but who did not seek appointment as the lead plaintiff under the Private Securities Litigation Reform Act (PSLRA), lacks standing to appeal an adverse decision by the district court dismissing the action. The majority decision further reinforces why investors, if they intend on ever taking an active role in an ongoing securities class action, are best suited to seek lead plaintiff status.

Background

In early 2021, Mark Habelt filed a complaint on behalf of himself and a putative class of iRhythm Technologies, Inc.’s common stock purchasers under the Securities Exchange Act of 1934. Three other putative class members moved for appointment as lead plaintiff under the PSLRA, but Habelt did not. The district court ultimately appointed the Public Employees’ Retirement System of Mississippi (PERSM) as the lead plaintiff. PERSM amended Habelt’s complaint and the defendants’ moved to dismiss it under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim. The district court granted the defendants’ motion in early 2022. PERSM did not appeal, but Habelt did.

The split decision

The majority opinion, written by the Honorable Holly A. Thomas, dismissed Habelt’s appeal “for lack of jurisdiction.” Id. at 1164. The majority reasoned that dismissal was required because Habelt was not a “party to the action” and “no extraordinary circumstances” warranted his standing to appeal as a non-party. Id. at 1164-65.

As to “standing,” the majority focused on the “well settled” rule that “only parties to a lawsuit, or those that properly become parties, may appeal an adverse judgment.” Id. at 1165. Habelt argued that he was a party “because he filed the initial complaint and is listed in the caption” of the operative complaint, but the majority disagreed. Id. at 1166. The majority reasoned that a case caption is simply “the handle to identify” the action and “the more important indication” of party status is “the ‘allegations in the body of the complaint.’” Id. The majority found the “operative pleadings,” PERSM’s second amended complaint, made no mention of Habelt or his individual claims and “makes clear that PERSM is the sole plaintiff.” Id. Additionally, Habelt’s “status as a putative class member” did not confer standing because, according to the majority, “unnamed class members” are not parties before the class is certified. Id.

Next, the majority analyzed whether “exceptional circumstances” existed to confer standing upon Habelt as a non-party. Id. at 1167. The majority cited existing Ninth Circuit authority that says “[a] non-party may have standing to appeal when she, ‘(1) ... though not a party, participated in the district court proceedings, and (2) the equities of the case weigh in favor of hearing the appeal.’” Id. Under the first prong, the majority stated that “participation” required Habelt to be “significantly involved in the district court proceedings,” concluding that Habelt’s participation “does not meet that high bar” because he “did not apply to be appointed lead plaintiff, challenge PERSM’s motion for appointment as lead plaintiff, or otherwise participate in the suit after PERSM’s appointment.” Id. Under the second prong, the majority found that equities were not in Habelt’s favor either because he was not brought into the action unwillingly, did not follow the “better practice” of filing a motion to intervene, and “is not bound by the district court’s judgment” because he can file another action against iRhythm. Id.

In a lengthy dissent, the Honorable Mark J. Bennett wrote that he would have found that Habelt remained a party because he initiated the action, remained in the caption, had claims that were “clearly covered” by the operative complaint, and “never evinced any intent to remove himself as a party” nor “received notice of termination of his party status.” Id. at 1168-72. Judge Bennett accused the majority of “elevat[ing] form over substance” by “create[ing] a new rule that a litigant’s name must be specifically listed in the body of the operative complaint to be considered a party, regardless of the history of the litigation.” Id. at 1169. Judge Bennett also pointed to “the lack of any notice” to Habelt that his party status had been terminated, which he found “inconsistent with due process.” Id. at 1170-71.

Judge Bennett also would have found “exceptional circumstances” because “the dearth of caselaw” addressing the facts of the case “illustrates that Habelt’s situation is exceptional.” Id. at 1172. Even if “the PSLRA is a trap for the unwary” that “extinguishes the involvement of other named plaintiffs,” penned Judge Bennett, “Habelt wasn’t unwary – he wasn’t a silent voice who should have assumed his silence equaled non-party status. He was the Plaintiff, who had the right to assume that a plaintiff (i.e., a party) who is never dismissed, remains a party absent something (like a statute, a court order, or a very clear binding case) telling him that some event or series of events stripped that status from him.” Id.

What’s next?

On Nov. 8, 2023, Habelt petitioned for rehearing en banc, mirroring Judge Bennett’s dissent. If the majority’s decision stands, it provides a further reason for sophisticated investors to exercise their right to apply for lead plaintiff status. Through the PSLRA, Congress encouraged sophisticated investors to seek to lead class actions. H.R. Conf. Rep. No. 104-369, at *8-9, *33-34. The majority’s decision instructs that if investors fail to exercise this right under certain circumstances, they may lose their party status and right to appeal if the party who was appointed lead plaintiff chooses to stop prosecuting the action.