The 10b-5 Daily

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 landeng破解版安卓版 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 lan灯破解版安卓版, 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.”

lanter 破解版“[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.”

A corporation’s scienter (i.e., fraudulent intent) may be imputed in a securities fraud case, under Second Circuit precedent, from (a) the scienter of an individual defendant who made the alleged misstatement, (b) the scienter of officers or directors who were involved in the dissemination of the fraud, or (c) in rare circumstances, from a statement that is so obviously incorrect that it can be inferred that the makers must have known that it was false.

In Jackson v. Abernathy, 960 F.3d 94 (2d Cir. May 27, 2020) (per curiam), the plaintiffs alleged that the company told investors that its surgical gowns were highly-rated for their protectiveness, but in fact the gowns had failed numerous quality control tests. The plaintiffs argued that the company’s scienter could be imputed based on (a) the knowledge of three lower-level employees, who testified in a different litigation that they were aware that the surgical gowns had failed quality control tests, and/or (b) the surgical gowns were a key company product, so senior management must have known about the test failures. The Second Circuit found that these allegations were insufficient to adequately plead the company’s scienter.

First, as to the lower-level employees, the Second Circuit concluded that the employees did not act with scienter because they took steps to raise warnings about problems with the gowns. Moreover, the complaint failed to plead any facts establishing that these employees were involved with the misstatements or had adequately conveyed their warnings to senior management. The court therefore was left to “only guess what role those employees played in crafting or reviewing the challenged statements and whether it would otherwise be fair to charge the [company] with their knowledge.”

Second, as to the allegation that the gowns were a key product, the Second Circuit found that this “naked assertion, without more, is plainly insufficient to raise a strong inference of collective corporate scienter.”

Holding: Affirming lower court decision that amended complaint would be futile.

To adequately plead loss causation, a plaintiff must establish the existence of a corrective disclosure that reveals to the market the pertinent truth that was previously concealed or obscured by the company’s fraud.  Determining whether an alleged corrective disclosure actually provides “new news” or is merely a restatement of previously-disclosed information, however, has proven difficult for courts.

In Luczak v. National Beverage Corp., 2020 WL 2111947 (11th Cir. May 4, 2020) (per curiam), the plaintiffs alleged that the company (a) made misleading statements regarding two sales metrics the Company purportedly touted as an important measure of growth and sales, and (b) failed to disclose that its CEO had engaged in a pattern of sexual misconduct.

As to the sales metrics statements, the plaintiffs alleged that the truth was revealed to the market by a March 2018 SEC letter questioning the company’s use of the metrics and a subsequent June 2018 media report discussing the issue.  The lower court, however, found that neither of these items were “corrective disclosures” because the SEC letter “merely confirm[ed] the SEC’s already established doubt of the veracity” of the sales metrics and the media report was just a summary of the SEC correspondence.  As to the sexual misconduct claims, the plaintiffs argued that a July 2018 Wall Street Journal article had revealed the misconduct, but the lower court found that the article only repeated allegations that had been made in publicly-filed lawsuits.

On appeal, the Eleventh Circuit rendered a split decision.  The panel found that the lower court had read the March 2018 SEC letter and the June 2018 media report too narrowly.  Although the SEC’s interest in the sales metrics was publicly known, the SEC letter and media report arguably provided “new news” that the company was failing to cooperate with the SEC in its inquiry by not providing additional information about the metrics.  Moreover, the media report could be read to suggest that this conclusion came from sources beyond the SEC correspondence.  As to the sexual misconduct claims, however, the panel agreed that the 2018 Wall Street Journal article did not provide any additional information that could not be found in the lawsuits.

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Additional note:  The decision points out that the Eleventh Circuit has never decided whether the heightened pleading standards of the PSLRA or FRCP 9(b) apply to the pleading of loss causation.  The panel declined to address the issue, however, holding that its decision would not be affected by which pleading standard was used.

NERA Economic Consulting and Cornerstone Research have released their respective 2019 annual reports on federal securities class action filings. As usual, the different methodologies employed by the two organizations have led to different numbers, although they both identify the same general trends.

The findings for 2019 include:

(1) The reports agree that there continue to be a record or near-record number of filings, with an increase in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12 offsetting a decline in M&A-related cases.  NERA finds that there were 433 filings (the same as the 433 filings in 2018), while Cornerstone finds that there were 428 filings (compared with 420 filings in 2018).

(2) Over the last few years, the Second Circuit and Ninth Circuit have had a similar number of standard filings.  In 2019, however, both NERA and Cornerstone report that the number of Second Circuit standard filings was nearly double the number of Ninth Circuit standard filings (NERA – 103 (2d) v. 52 (9th); Cornerstone 108 (2d) v. 56 (9th)).  The Third Circuit had the next highest number of filings (NERA – 28; Cornerstone – 32).

(3) Filings against foreign issuers had steadily increased from 2013-2017, with these companies facing a disproportionate (as compared to their percentage of listings) risk of securities class action litigation.  In 2018, the numbers took a dip, but they have rebounded to a record high.  Cornerstone finds that there were 57 standard filings against foreign issuers in 2019, representing 24.3% of all standard filings.

(4) NERA reports a sharp increase in standard filings based on missed earnings guidance (from an average of 20% of filings over the past four years to 32% of filings in 2019).

(5) NERA finds that the average settlement value ($30 million) held steady and the median ($12.8 million) settlement value increased slightly.  However, the median settlement values in 2018 and 2019 were more than 25% higher than the median settlement values in the previous three years, reflecting a downward trend in the proportion of cases settled for less than $10 million.

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

The author of The 10b-5 Daily (Lyle Roberts) had an op-ed in the landeng破解版安卓版 last month on the 中国vpn:2021-5-21 · yurbo v p n安卓破解版 普通节点订阅地址 不用梯子也能浏览被墙网站 六尺巷Ⅱ安卓 外网安卓app 加速器破解版免费版 安卓手机ip地址查询 国外网站 WWW.VNS867.COM 核桃vpm苹果下载 菲律宾地区加速器软件 中国排名前100的名菜 zero vpn网盘 vsco.  A link to the op-ed can be found here (no paywall).