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On August 13, 2018, the Ninth Circuit held that the district court “abused its discretion by improperly considering materials outside the [c]omplaint” in dismissing a securities fraud action. Khoja v. Orexigen Therapeutics, 2018 WL 3826298 (9th Cir. 2018) (Tashima, J.). The Ninth Circuit “note[d] a concerning pattern in securities cases” in which defendants “improperly” utilize judicial notice and the incorporation-by-reference doctrine “to defeat what would otherwise constitute adequately stated claims at the pleading stage.” The court cautioned that “the unscrupulous use of extrinsic documents to resolve competing theories against the complaint risks premature dismissals of plausible claims that may turn out to be valid after discovery.” To address these concerns, the Ninth Circuit “clarif[ied] when and how the district court[s] should consider materials extraneous to the pleadings at the motion to dismiss stage.”

Courts May Not Judicially Notice Disputed Facts

The Ninth Circuit explained that “a court may take judicial notice of matters of public record without converting a motion to dismiss into a motion for summary judgment.” However, “a court cannot take judicial notice of disputed facts contained in such public records.” The Ninth Circuit explained that “[j]ust because [a] document itself is susceptible to judicial notice does not mean that every assertion of fact within that document is judicially noticeable for its truth.”

The Ninth Circuit found the district court erred to the extent it took judicial notice of the transcript of an investor call for the purpose of determining what investors knew at the time. The Ninth Circuit explained that “[i]t is improper to judicially notice a transcript when the substance of the transcript is subject to varying interpretations, and there is a reasonable dispute as to what the transcript establishes.”

Courts May Not Incorporate by Reference Unmentioned Documents That Dispute the Complaint’s Factual Allegations

The Ninth Circuit reaffirmed that “a defendant may seek to incorporate a document into the complaint ‘if the plaintiff refers extensively to the document or the document forms the basis of the plaintiff’s claim.’” Id. (quoting United States v. Ritchie, 342 F.3d 903 (9th Cir. 2003)). The court stated that a complaint must usually refer to a document “more than once” to satisfy the “extensively” standard. However, the court noted that a single reference “may be sufficiently ‘extensive’ if [it] is relatively lengthy.”

The Ninth Circuit found that the “more difficult question is whether a document can ever form the basis of the plaintiff’s claim if the complaint does not mention the document at all.” The court stated that there are “rare instances when assessing the sufficiency of a claim requires that [a] document [not mentioned in the complaint] be reviewed, even at the pleading stage.” But the Ninth Circuit made it clear that “if the document merely creates a defense to the well-pled allegations in the complaint, then that document did not necessarily form the basis of the complaint.” The court reasoned that “[s]ubmitting documents not mentioned in the complaint to create a defense is nothing more than another way of disputing the factual allegations in the complaint,” but with the “added benefit” that “the plaintiff receives no opportunity to respond to the defendant’s new version of the facts” “unless the district court converts the defendant’s motion to dismiss into a motion for summary judgment.”

The Ninth Circuit further noted that the issue of “what inferences a court may draw from an incorporated document should also be approached with caution.” The court stated that “it is improper to assume the truth of an incorporated document if such assumptions only serve to dispute facts stated in a well-pleaded complaint.”

The Ninth Circuit found the district court abused its discretion by considering certain documents that were neither extensively referenced in the complaint, nor formed the basis of plaintiffs’ claims.