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(Article from Securities Law Alert, September/October 2020)

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On October 8, 2020, the Ninth Circuit revived a securities fraud action that the district court had dismissed on loss causation grounds. In re BofI Holding Sec. Litig., 2020 WL 5951150 (9th Cir. 2020) (Watford, J.). The Ninth Circuit held plaintiffs adequately alleged that a whistleblower complaint filed by a former employee constituted a corrective disclosure for loss causation purposes.

Ninth Circuit Addresses the Requirements for Pleading a Corrective Disclosure

The Ninth Circuit began by offering “a few basic ground rules” for determining what constitutes a corrective disclosure. First, the court emphasized that “a corrective disclosure need not consist of an admission of fraud by the defendant or a formal finding of fraud by a government agency.” Rather, “[a] corrective disclosure can instead come from any source, including knowledgeable third parties such as whistleblowers, analysts, or investigative reporters.” Second, the court noted that “a corrective disclosure need not reveal the full scope of the defendant’s fraud in one fell swoop; the true facts concealed by the defendant’s misstatements may be revealed over time through a series of partial disclosures.” Third, the court clarified that “a disclosure need not precisely mirror the earlier misrepresentation. It is enough if the disclosure reveals new facts that, taken as true, render some aspect of the defendant’s prior statements false or misleading.”

The Ninth Circuit also addressed Rule 9(b)’s particularity requirement as applied to allegations of loss causation. The court recognized that “the plaintiff will always need to provide enough factual content to give the defendant some indication of the loss and the causal connection that the plaintiff has in mind.” However, the court noted that this “effort should not prove burdensome, for even under Rule 9(b) the plaintiff’s allegations will suffice so long as they give the defendant notice of plaintiff’s loss causation theory and provide some assurance that the theory has a basis in fact.”

Unproven Whistleblower Allegations by Insiders May Constitute a Corrective Disclosure Even If Not Corroborated

The Ninth Circuit found the district court erred in determining that the whistleblower complaint could not qualify as a corrective disclosure because it “contained only unconfirmed accusations of fraud” and had not been “followed by a subsequent confirmation of the fraud.” The Ninth Circuit stated that in order to plead loss causation, plaintiffs “did not have to establish that the allegations in [the whistleblower’s] lawsuit are in fact true.” The court explained that “[f]alsity and loss causation are separate elements of a Rule 10b-5 claim,” and noted that plaintiffs “adequately alleged that [the company’s] misstatements were false through allegations attributed to confidential witnesses.” The court joined the Sixth Circuit in rejecting a “categorical rule” that unproven allegations cannot constitute a corrective disclosure unless plaintiffs “identify an additional disclosure that confirmed the truth of [those] allegations.”[1]

The Ninth Circuit held 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.” In the case before it, the court noted that the whistleblower’s “descriptions of wrongdoing [were] highly detailed and specific, and they [were] based on firsthand knowledge that he could reasonably be expected to possess by virtue of his [former] position as a mid-level auditor” at the company. The court also found it significant that the stock price dropped more than 30% following the filing of the complaint. The court reasoned that “[a] price drop of that magnitude would not be expected in response to whistleblower allegations perceived as unworthy of belief.” The court concluded that plaintiffs adequately alleged that the whistleblower complaint was a corrective disclosure.

The Ninth Circuit distinguished its prior decisions in Loos v. Immersion Corp., 762 F.3d 880 (9th Cir. 2014), and Curry v. Yelp, 875 F.3d 1219 (9th Cir. 2017). In Loos, the court held that the announcement of a government investigation, standing alone, could not constitute a corrective disclosure.[2] The Ninth Circuit explained that unlike a whistleblower complaint, the announcement of an investigation “does not reveal to the market any facts that could call into question the veracity of the company’s prior statements; all the market could react to was speculation about what the investigation will ultimately reveal.” BofI Holding Sec. Litig., 2020 WL 5951150. In Curry, the court held that customer complaints raising questions about the company’s business practices could not qualify as corrective disclosures.[3] The Ninth Circuit pointed out that while the customers in Curry had no first-hand knowledge of the company’s business practices, the whistleblower here was “a former insider of the company who had personal knowledge of the facts he alleged.”

Analyses of Publicly Available Information May Constitute Corrective Disclosures

The Ninth Circuit affirmed the district court’s determination that blog posts by anonymous short-sellers analyzing publicly available information did not constitute corrective disclosures. However, the Ninth Circuit made it clear that “[a] disclosure based on publicly available information can, in certain circumstances, constitute a corrective disclosure.”[4] The court stated that in order “[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.” The court noted that factors that are relevant to the analysis “include the complexity of the data . . . and the great effort needed to locate and analyze it.”

The Ninth Circuit found the district court erred in holding that plaintiffs must “allege facts explaining why other market participants could not have done” the same analysis of publicly available information. “For pleading purposes,” the Ninth Circuit stated that plaintiffs simply “needed to allege particular facts plausibly suggesting that other market participants had not done the same analysis, rather than ‘could not.’”

The Ninth Circuit acknowledged that the anonymous short-seller blog posts were the product of “extensive and tedious research” that arguably “provided new information to the market.” However, the court noted that the authors “had a financial incentive to convince others to sell, and the posts included disclaimers from the authors stating that they made no representation as to the accuracy or completeness of the information set forth.” The court found that “[a] reasonable investor reading these posts would likely have taken their contents with a healthy grain of salt.”

Judge Lee, Dissenting, Expressed His View That It Is Unfair to Permit Plaintiffs to Demonstrate Loss Causation Through Unproven Allegations

Judge Lee dissented from the majority opinion with respect to the question of whether a whistleblower complaint brought by a company insider may suffice as a corrective disclosure. He cautioned that the decision could “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.” He expressed his view that he would “require additional external confirmation of fraud allegations in a whistleblower lawsuit for them to count as a corrective disclosure.”