IN RE BOFI HOLDING, INC. SECURITIES LITIGATION, HOUSTON MUNICIPAL EMPLOYEES PENSION SYSTEM, Plаintiff-Appellant, v. BOFI HOLDING, INC.; GREGORY GARRABRANTS; ANDREW J. MICHELETTI; PAUL J. GRINBERG; NICHOLAS A. MOSICH; JAMES S. ARGALAS, Defendants-Appellees.
No. 18-55415
United States Court of Appeals for the Ninth Circuit
October 8, 2020
D.C. Nos. 3:15-cv-02324-GPC-KSC, 3:15-cv-02486-GPC-KSC
Before: Paul J. Watford, Mark J. Bennett, and Kenneth K. Lee, Circuit Judges.
UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT
Appeal from the United States District Court for the Southern District of California
Gonzalo P. Curiel, District Judge, Presiding
Argued and Submitted January 7, 2020 Pasadena, California
Filed October 8, 2020
Opinion by Judge Watford;
Partial Concurrence and Partial Dissent by Judge Lee
SUMMARY*
Securities Fraud
The panel reversed the district court‘s judgment dismissing a securities fraud class action brought under
Shareholders alleged that executives of BofI Holding, Inc., committed securities fraud by falsely portraying the banking company as a safer investment than it actually was. In particular, the shareholders alleged that defendants made false or misleading statements touting the bank‘s conservative loan underwriting standards, its effective system of internal controls, and its robust compliance structure. The district court concluded that the shareholders adequately pleaded the first five elements of their claim, at least as to some of the challenged misstatements, but failed to adequately plead loss causation, meaning a causal connection between defendants’ fraudulent conduct and the shareholders’ economic loss.
Finally, the panel agreed with the district court that the shareholders failed to рlausibly allege the falsity of statements concerning government and regulatory investigations.
Judge Lee concurred in judgment in Part III.B. and dissented as to Part III.A. Judge Lee wrote that he agreed with much of the analysis in the majority‘s opinion but would require additional external confirmation of fraud allegations in a whistleblower lawsuit for them to count as a corrective disclosure. Accordingly, he dissented from the majority‘s holding that plausible insider allegations, standing alone, can qualify as a corrective disclosure.
Michael J. Miarmi (argued) and Daniel P. Chiplock, Lieff Cabraser Heimann & Bernstein LLP, New York, New York; Richard M. Heimann, Katherine C. Lubin, and Michael K. Sheen, Lieff Cabraser Heimann & Bernstein LLP, San Francisco, California; for Plaintiff-Appellant.
John P. Stigi III (argued), Sheppard Mullin Richter & Hampton LLP, Los Angeles, California; Polly Towill, Sheppard Mullin Richter & Hampton LLP, Los Angeles, California; for Defendants-Appellees.
OPINION
WATFORD, Circuit Judge:
To recover damages in a private securities fraud action, the plaintiff must establish a causal connection between the defendant‘s fraudulent conduct and the plaintiff‘s economic loss—an element known as loss causation. One way to prove loss causatiоn is to show that the defendant‘s fraud was revealed to the market through one or more “corrective disclosures” and that the company‘s stock price declined as a result. In this case, the plaintiff alleged loss causation by relying on two corrective disclosures: 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 dismissed the case after concluding that neither the whistleblower lawsuit nor the blog posts could qualify as corrective disclosures. We agree as to the blog posts but reach a different conclusion with respect to the whistleblower lawsuit.
The company sued in this case, BofI Holding, Inc., is the holding company for BofI Federal Bank, a federally chartered savings association. (We refer to both entities collectively as BofI, although they now operate under a different corporate name.) In the years before this lawsuit was filed, BofI reported strong earnings growth and its stock price rose handsomely. Between August 2015 and February 2016, however, the price of the stock dropрed by more than 47%. BofI shareholders filed multiple securities fraud suits against the company and several of its officers and directors. The suits were consolidated into this class action, brought on behalf of all BofI shareholders who purchased publicly traded shares between September 4, 2013, and February 3, 2016. The district court appointed the Houston Municipal Employees Pension System as lead plaintiff to represent the class.
The shareholders allege that BofI executives committed securities fraud by falsely portraying the company as a safer investment than it actually was. In particular, as relevant for this appeal, the shareholders allege that defendants made false or misleading statements touting the bank‘s conservative loan underwriting standards, its effective system of internal controls, and its robust compliance infrastructure.
The shareholders bring this action under
As to the first element, falsity, the district court dismissed many of the alleged misstatements as non-actionable. But the court ruled that the shareholders have adequately pleaded falsity with respect to two categories of misstatements, concerning (1) the bank‘s underwriting standards and (2) its system of internal controls and compliance infrastructure. Representative of the misstatements regarding underwriting standards are the following:
- “We continue to maintain our conservative underwriting criteria and have not loosened credit quality to enhance yields or increase loan volumes.”
- “We continue to have an unwavering focus on credit quality of the bank and have not sacrificed credit quality to increase origination.”
- “[W]e continue to originate only full documentation, high credit quality, low loan-to-value, jumbo single-family mortgages and have not reduced our loan rates for these products.”
The court also found actionable two misstatements regarding internal controls and compliance infrastructure:
“We have made significant investments in our overall compliance infrastructure over the past several quarters, including BSA [Bank Secrecy Act] and AML [anti-money laundering] compliance.” - “We have spent a significant amount of money on BSA/AML compliance upgrades and new systems and new personnel. We have also been beefing up our compliance teams.”1
The shareholders predicated their showing of falsity on allegations attributed to confidential witnesses who used to work at BofI. The district court concluded that the witnesses’ allegations were reliable and based on personal knowledge, as our circuit‘s case law requires. See Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 995 (9th Cir. 2009). Assuming the witnesses’ allegations were true, thе court found “ample evidence,” with respect to underwriting standards, to suggest that “BofI was not adhering to high credit quality standards and that it had, in fact, begun to ‘sacrifice credit quality to increase origination.‘” Likewise, with respect to internal controls and compliance infrastructure, the witnesses’ allegations plausibly suggested that “BofI had not adequately staffed its BSA and AML compliance along with other internal control departments.”
BofI did not contest that the shareholders satisfied the third, fourth, and fifth elements of their
That leaves the sixth and final element, loss causation. After the district court issued the rulings described above,
The shareholders filed the operative Third Amended Complaint in response to the district court‘s ruling. To establish loss causation, the complaint relies on two corrective disclosures. The shareholders allege that these disclosures revealed the falsity of the company‘s statements regarding underwriting standards, internal controls, and compliance infrastructure and that the market reacted by driving down the price of BofI‘s stock.
The first corrective disclosure is a whistleblower lawsuit filed against BofI by Charles Erhart, a former mid-level auditor at the company, on October 13, 2015. See Erhart v. BofI Holding Inc., No. 15-cv-2287 (S.D. Cal. Oct. 13, 2015). Erhart‘s suit—the details of which were disclosed in a New York Times article published that same day—alleged rampant and egregious wrongdoing at the company, including that BofI had doctored reports submitted to the bank‘s primary regulator, the Office of the Comptroller of the Currency (OCC), and that BofI had made high-risk and illegal loans to foreign nationals. Erhart also alleged that his attempts to raise these compliance issues within the company led to retaliation and eventually to his termination. By the close of trading the next day, the price of BofI‘s shares had fallen by 30.2% on extremely high trading volume.
The second corrective disclosure consists of a group of eight blog posts published by anonymous authors on Seeking Alpha, a crowd-sourced online resource for investors, between August 2015 and February 2016. The blog posts
BofI filed a motion to dismiss the Third Amended Complaint, and in the ruling now on appeal, the district court held that the shareholders failed to plausibly allege loss causation. The court reasoned that, because the Erhart lawsuit contained only “unconfirmed accusations of fraud,” it could not have disclosed to the market that BofI‘s alleged misstatements were actually false. To qualify as a corrective disclosure, the court held, the Erhart lawsuit had to be followed by “a subsequent confirmation” of the fraud, which the shareholders have not alleged.
As for the Seeking Alpha blog posts, the district court concluded that they cannot serve as corrective disclosures because each of them relies entirely on publicly available information. In the court‘s view, the blog posts could not have “revealed” anything to the market because the information they disclosed was presumably already known to market participants and thus reflected in BofI‘s stock price.
Having identified fatal deficiencies in the shareholders’ loss causation allegations, the district court dismissed the action with prejudice after concluding that yet another opportunity to amend the complaint was unwarranted.
We agree with the district court that the shareholders have adequately alleged falsity and scienter with respect to misstatements concerning BofI‘s underwriting standards, internаl controls, and compliance infrastructure. The dispositive issue on appeal is whether the shareholders have also adequately alleged loss causation. Before tackling that question, we begin with a brief overview of the loss causation requirement, with the aim of illuminating the function this element serves in a private securities fraud action.
Like any other tort plaintiff who seeks to recover damages, a plaintiff in a securities fraud suit must plead and ultimately prove that the defendant‘s wrongful conduct caused the plaintiff‘s injury. Congress codified that requirement in the Private Securities Litigation Reform Act. Under the heading “Loss causation,” the Act provides: “In any private action arising under this chapter, the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover damages.”
In fraud-on-the-market cases like this one, the plaintiff‘s theory of loss causation begins with the allegation that the defendant‘s misstatements (or other fraudulent conduct) artificially inflated the price at which the plaintiff purchased her shares—meaning the price was higher than it would have been had the false statements not been made. Merely purchasing shares at an inflated price, however, does not
To establish loss causation in a fraud-on-the-market case, the plaintiff must show that after purchasing her shares and before selling, the following occurred: (1) “the truth became known,” and (2) the revelation caused the fraud-induced inflation in the stock‘s price to be reduced or eliminated. Dura Pharmaceuticals, 544 U.S. at 347; see FindWhat, 658 F.3d at 1310. At that point, the plaintiff has suffered an economic loss caused by the misstatements because she is no longer able to recoup in the marketplace the inflationary component of the price she originally paid. FindWhat, 658 F.3d at 1311; Madge S. Thorsen et al., Rediscovering the Economics of Loss Causation, 6 J. Bus. & Sec. L. 93, 98 (2006).
The most common way for plaintiffs to prove that “the truth became known” is to identify one or more corrective disclosures. See Mineworkers’ Pension Scheme v. First Solar Inc., 881 F.3d 750, 753–54 (9th Cir. 2018) (per curiam); Lloyd, 811 F.3d at 1209. A corrective disclosure occurs when “information correcting the misstatement or omission that is the basis for the action is disseminated to the market.”
Although deciding what qualifies as a corrective disclosure has proved more challenging than might have been expected, a few basic ground rules can be sketched out. First, a corrective disclosure need not consist of an
Even if the true facts concealed by the fraud are revealed to the market, the plaintiff must still show that the disclosure of the truth caused the company‘s stock price to decline. For a subsequent decline in price could be attributable to factors unrelated to the fraud, such as a change in economic circumstances or investor expectations. Dura Pharmaceuticals, 544 U.S. at 343. The securities laws do not protect against ordinary investment losses of that sort. See id. at 345. We have explained that loss causation does not require a showing “that a misrepresentation was the sole reason for the investment‘s decline in value.” In re Daou Systems, Inc., 411 F.3d 1006, 1025 (9th Cir. 2005). Rather, “as long as the misrepresentation is one substantial cause of
III
With that background in mind, we turn to the specific corrective disclosures at issue in this case. We address the Erhart lawsuit first, followed by the Seeking Alpha blog posts.
A
As discussed above, to prove loss causation by relying on one or more corrective disclosures, a plaintiff must show that: (1) a corrective disclosure revealed, in whole or in part, the truth concealed by the defendant‘s misstatements; and (2) disclosure of the truth caused the company‘s stock price tо decline and the inflation attributable to the misstatements to dissipate. At the pleading stage, the plaintiff‘s task is to allege with particularity facts “plausibly suggesting” that both showings can be made. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 557 (2007); see Oregon Public Employees Retirement Fund v. Apollo Group, Inc., 774 F.3d 598, 605 (9th Cir. 2014) (holding that allegations of loss causation must satisfy
To plead loss causation here, the shareholders did not have to establish that the allegations in Erhart‘s lawsuit are in fact true. Falsity and loss causation are separate elements of a
The shareholders alleged facts with particularity that plausibly suggest the market perceived Erhart‘s allegations as credible and acted upon them on the assumption that they
The district court nonetheless held that allegations in a lawsuit, standing alone, can never qualify as a corrective disclosure because they are just that—allegations, as opposed to “truth.” The court concluded that, to adequately plead loss causation, the shareholders had tо identify an additional disclosure that confirmed the truth of Erhart‘s allegations.
We join the Sixth Circuit in rejecting any such categorical rule. Norfolk County, 877 F.3d at 696. To be sure, allegations in a lawsuit do not provide definitive confirmation that fraud occurred. But short of an admission by the defendant or a formal finding of fraud—neither of which is required, see Amedisys, 769 F.3d at 324-25; Metzler, 540 F.3d at 1064—any corrective disclosure will necessarily take the form of contestable allegations of
The two cases on which the district court relied most heavily are not to the contrary. In Loos v. Immersion Corp., 762 F.3d 880 (9th Cir. 2014), the defendant company announced that it was conducting “an internal investigation into certain previous revenue transactions in its Medical line of business.” Id. at 885 (quoting the company‘s press release). We held that the plaintiff could not rest his theory of loss causation on the announcement of this investigation standing alone. Quoting the Eleventh Circuit‘s decision in Meyer v. Greene, 710 F.3d 1189 (11th Cir. 2013), we noted that “[t]he announcement of an investigation reveals just that—an investigation—and nothing more.” Loos, 762 F.3d at 890. Such an announcement 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.” Id.
Our case presents a different situation. Erhart‘s lawsuit disclosed facts that, if true, rendered false BofI‘s prior
The second case on which the district court relied, Curry v. Yelp Inc., 875 F.3d 1219 (9th Cir. 2017), is also distinguishable. There, the plaintiffs accused Yelp of falsely representing that the reviews it posted were authentic and independent. Id. at 1222. The plaintiffs alleged that the falsity of this representation was revealed to the market when the Federal Trade Commission disclosed some 2,000 complaints the agency had received “from businesses claiming that Yelp had manipulated reviews of their services” in various ways. Id.
We rejected the plaintiffs’ loss causation allegations as inadequate. Id. at 1225. Critically for our purposes, the customers who filed complaints in Curry were outsiders who lacked any firsthand knowledge of Yelp‘s practices. Thus, they could not attest to whether Yelp was actually engaged in manipulating reviews, nor to whether the reviews the company posted were authentic and independent. See id. at 1223. We refused to allow the plaintiffs to allege loss causation “merely by resting on a number of customer complaints and asserting that where there is smoke, there must be fire.” Id. at 1225.
Here, by contrast, Erhart is a former insider of the company who had personal knowledge of the facts he alleged. Those fаcts 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
One final point bears mentioning. In ruling against the shareholders, the district court emphasized that a plaintiff in a securities fraud action must plead loss causation “with particularity” under
B
We turn next to the Seeking Alpha blog posts. We agree with the district court that the shareholders failed to plausibly allege that these posts constituted corrective disclosures, although we disagree somewhat with the district court‘s rationale.
As noted earlier, each of the blog posts asserts that the information it discloses was derived from publicly available sources. Because this is a fraud-on-the-market case, that assertion makes it more difficult for the shareholders to rely on the posts as corrective disclosures. BofI‘s stock is deemed to trade in an efficient market in which all publicly available information about the company, both positive and negative, is quickly incorporated into the stock price. See Amgen, 568 U.S. at 461–62. So its stock price should already reflect whatever public information a blog post might be based upon. A corrective disclosure, though, must by definition reveal new information to the market that has not yet been incorporated into the price.
To 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 district court interpreted this requirement to mean that the shareholders had to allege facts explaining why “other market participants could not have done the same analysis and reached the same conclusion” as the authors of the blog posts. (Emphasis added.) We think that sets the bar too high. For pleading purposes, the shareholders needed to allege
Prior cases reflect the understanding that some information, although nominally available to the public, can still be “new” if the market has not previously understood its significance. For example, in In re Gilead Sciences Securities Litigation, 536 F.3d 1049 (9th Cir. 2008), a pharmaceutical company represented that demand for an HIV drug was strong and that thе company complied with federal and state regulations, despite knowing that unlawful off-label marketing was the reason for strong demand. Id. at 1051. The company then received a warning letter from the Food and Drug Administration (FDA) about its off-label marketing of the drug. Id. at 1052–53. The company‘s stock price did not incorporate the information disclosed in the letter until three months after the letter had been publicly released, when the company reported a major earnings miss attributable to decreased demand for the HIV drug. Id. at 1053–54. We concluded that the plaintiffs plausibly alleged the drop in stock price was caused by the FDA warning letter. Id. at 1058. Given the letter‘s subtle relationship to the company‘s alleged misstatements—“it did not contain enough information to significantly undermine [the company‘s] pronouncements concerning demand“—the letter itself “would not necessarily trigger a market reaction.” Id. Thus, it was “not unreasonable that physicians ... would respond to the Warning Letter” by issuing fewer prescriptions and lowering demand for the drug, “while the public failed to appreciate its significance” until its impact on revenue was made plain from the eаrnings
Similarly, in Public Employees’ Retirement System v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014), a Wall Street Journal article analyzed publicly available Medicare records to conclude that Amedisys, a home health services company, was engaging in Medicare fraud. Id. at 318. The defendant unsuccessfully pressed the same argument that BofI advances here: “[B]ecause the article proclaims on its face that its analysis was ‘based on publicly available Medicare records,’ ... [it] does not reveal any new information to the marketplace.” Id. at 323. The Fifth Circuit rejected such a rule, holding instead that “it is plausible that complex economic data understandable only through expert analysis may not be readily digestible by the marketplace.” Id. The underlying information, although publicly available, “had little to no probative value in its native state“; someone needed to put the pieces together before the market could appreciate its import. Id.
Contrary to the bright-line rule BofI urges us to adopt, these cases endorse a flexible approach to evaluating corrective disclosures. A disclosure based on publicly available information can, in certain circumstances, constitute a corrective disclosure. The ultimate question is again one of plausibility: Based on plaintiffs’ particularized allegations, can we plausibly infer that the alleged corrective disclosure provided new information to the market that was not yet reflected in the company‘s stock price? The fact that the underlying data was publicly available is certainly one factor to consider. But other factors include the complexity of the data and its relationship to the alleged misstatements, as in Amedisys and Gilead, and the great effort needed to
Even judged against this more forgiving standard, the shareholders’ allegations concerning the eight blog posts do not pass muster. We address each of the eight posts that were followed by a decline in stock price.
The August 28, 2015, blog post. The author of this post claimed to have “analyzed hundreds of BofI‘s loans,” and on the basis of that review the author levied a host of allegations against BofI: that its loan-to-value ratios were often higher than advertised; that the bank faced personnel turnover in the audit department; that it made risky loans to foreign nationals; and that the Securities and Exchange Commission (SEC) was possibly investigating the company.
The October 29, 2015, blog post. This post compared BofI‘s transcript of an earnings call with the transcripts prepared by news agencies, and it noted potentially important discrepancies. The shareholders claim that the discrepancies show BofI‘s “lack of internal controls over financial reporting and risk management.”
The November 18, 2015, blog post. This post states that the author‘s “research suggests that [BofI] has employed a former felon for over 5 years in a very senior and pivotal role,” but does not name the individual. The author postulates that BofI “had to have known of the executive‘s prior criminality” and therefore was probably “in violation of
The November 19, 2015, blog post. In this post, the author claims to have uncovered evidence that BofI provides
The December 8, 2015, blog post. This post asserts that BofI is financing another Special Purpose Entity, WCL Holdings I, LLC, that was first mentioned in the post of November 10. In the earlier post, the author claimed that BofI assigned the loans it originated with Quick Bridge to WCL, although it was unclear at that point whether BofI was also financing WCL. This post purports to show that BofI is indeed lending to WCL. BofI‘s alleged financing of an off-book entity to buy back BofI‘s own risky loans potentially contradicts BofI‘s statement that it achieved “strong loan growth ... while maintaining high credit quality standards.”
The January 6, 2016, blog post. This post unearths evidence that BofI made a roughly $32 million loan to Encore Capital, a San Diego-based debt collector. Encore‘s then-Chief Financial Officer, Paul Grinberg, was also the Chair of BofI‘s Audit Committee. The loans allegedly allowed Encore to make a major acquisition, which led to Grinberg‘s promotion. According to the author, BofI never disclosed this loan, as the SEC requires for related-party transactions, and indeed omitted the loan from the bank‘s 2014 disclosures of loans made to board members. These revelations potentially contradict BofI‘s statements about the robustness of its compliance infrastructure.
The February 3, 2016, blog post. This post details BofI‘s opening of a new Nevada branch and links it to BofI‘s
The fact that each of these blog posts relied on nominally public information does not, on its own, preclude them from qualifying as corrective disclosures. Some of the posts required extensive and tedious research involving the analysis of far-flung bits and pieces of data. The authors arrived at their conclusions after scouring through hundreds of Uniform Commercial Code filings, bankruptcy court documents, and other companies’ registration documents. While other investors undoubtedly could have reviewed registration documents, they likely would not have known to investigate Quick Bridge, On Deck, or Encore precisely because BofI had hidden its relationships with those entities. Cf. Norfolk County, 877 F.3d at 697. The time and effort it took to compile this information make it plausible that the posts provided new information to the market, even though all of the underlying data was publicly available. Cf. Amedisys, 769 F.3d at 323.
We nonetheless conclude that the shareholders have not plausibly alleged that these posts constituted corrective disclosures. Even if the posts disclosed information that the market was not previously aware of, 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. The posts were authored by anonymous short-sellers who had a financial incentive to convince others to sell, and the posts included disclaimers from the authors stating that they made “no representatiоn as to the accuracy or completeness of the information set forth in this article.” A reasonable
Therefore, the shareholders have not plausibly alleged that any of the Seeking Alpha blog posts constituted a corrective disclosure. The district court did not abuse its discretion in denying further leave to amend, as the court had already pointed out the deficiencies in the shareholders’ loss causation allegations concerning the blog posts and had given them an opportunity to correct those deficiencies. See Loos, 762 F.3d at 890–91.
IV
Finally, we take up the new category of misstatements that the shareholders alleged for the first time in the Third Amended Complaint, concerning government and regulatory investigations. We agree with the district court that the shareholders failed to plausibly allege the falsity of any of the alleged misstatements in this new category. All but three of the challenged statements are expressions of opinion, not statements of fact “capable of objective verification.” Apollo Group, 774 F.3d at 606. For example, Garrabrаnts told investors that regulatory review “is beyond a nonissue” and that “[w]e have great regulatory relations.” These vague assurances reflect Garrabrants‘s opinions and predictions, which are not actionable. See In re Cutera Securities Litigation, 610 F.3d 1103, 1111 (9th Cir. 2010).
* * *
The shareholders have adequately pleaded a viable claim under
REVERSED and REMANDED.
LEE, Circuit Judge, concurring in part III.B. in judgment and dissenting in part III.A.:
Philosophers have long debated the question, “If a tree falls in the forest but no one is around to hear it, does it make a sound?” This case perhaps presents the converse of that conundrum: If there is no fraud, can a securities fraud lawsuit still proceed?
The majority holds that a former employee‘s allegations of fraud in a whistleblower lawsuit may count as a “corrective disclosure” under
But I still fear that the decision will 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. And even meritless securities fraud lawsuits impose an exorbitant cost on companies. I would thus require additional external confirmation of fraud allegations in a whistleblower lawsuit for them to count as a “corrective disclosure.” Doing so comports with our case law and common sense. I thus respectfully dissent from the majority‘s holding that
* * * *
Charles Erhart, a mid-level auditor at BofI, sued his former employer after being terminated, claiming that it was retaliation for whistleblowing. His lawsuit against BofI will go to trial sometime next year.
The majority believes that Erhart‘s allegations in his separate whistleblower lawsuit against BofI are plausible enough to constitute a “corrective disclosure” under
But what if it turns out that Erhart‘s allegations in his lawsuit are bunk? What if he is mistaken? Perhaps he misconstrued certain information because, as a fairly junior-level employee, he did not understand or have access to all the facts. Or what if (as BofI suggests) he is a loose cannon who has a messianic zeal for seeing wrongdoing where none exists? At this point, we simply do not know, especially with no other evidence or disclosure to corroborate Erhart‘s claims in his lawsuit.
But we do know that BofI has not issued any financial disclosures that would confirm Erhart‘s allegations that he first aired in 2015. BofI has not done so, even though the U.S. Department of Justice, the Securities and Exchange
Put another way, five years have passed since Erhart first disclosed allegations of misconduct at BofI, and multiple government agencies commenced investigations into BofI. Yet so far, we have not seen any external evidence corroborating Erhart‘s allegations. So it may turn out that there may be smoke but no fire. But based solely on a mid-level employee‘s self-interested allegations in a separate lawsuit, we are allowing a securities fraud lawsuit to move forward. It is premature to do so. Erhart may ultimately be vindicated, and perhaps the government investigations will eventually expose fraud, but we should not let a securities fraud lawsuit proceed when, at this point, there may no there there. We may end up with a scenario in which Erhart loses his whistleblower trial, and the government agencies end their investigations without any action — and yet BofI may end up settling a securities fraud case for millions of dollars to avoid litigation costs.
The majority notes that not every insider allegation in a lawsuit will count as a corrective disclosure; only “plausible” ones will survive a dismissal. While the plausibility standard under Iqbal/Twombly has rooted out many meritless cases at the pleading stage, such a standard will likely be less useful in a securities fraud lawsuit based on insider allegations in a whistleblower lawsuit. An insider account will almost always have a patina of plausibility because it will likely be based on some non-public allegation that cannot be easily disputed or rebutted at the pleading stage. Indeed, like any good conspiracy theory, an insider‘s story often has some element of truth to it, even if it is largely
What‘s the harm of letting a securities fraud lawsuit go forward if the company can eventually vindicate itself at trial? Plenty. According to Cornerstone Research, approximately 8.9% of all public companies listed on a U.S. securities exchange were the target of a securities class action in 2019. See Cornerstone Research, Securities Class Action Filings: 2019 Year in Review, 11 (Jan. 29, 2020), https://bit.ly/2TpajjY. And in 2018, the median cost of a securities class-action settlement was $13 million, according to one estimate. See Chubb, From Nuisance to Menace: The Rising Tide of Securities Class Action Litigation (June 2019), https://bit.ly/3cvbIx4. If a securities fraud lawsuit survives a motion to dismiss, it likely will lead to a settlement to the tunе of millions of dollars. In the past quarter-century or so, only six securities fraud cases apparently have been tried to verdict. See Jeffrey A. Barrack, A Primer on Taking A Securities Fraud Class Action to Trial, 31 Am. J. Trial Advoc. 471, 476 (2008). In a time when trials are rare, securities fraud trials are virtually extinct. That is why the loss causation requirement acts as a critical bulwark against frivolous securities fraud lawsuits. It guards against lawsuits being used as an “in terrorem device” to bludgeon companies into settling claims to “avoid the cost and burden of litigation.” Meyer v. Greene, 710 F.3d 1189, 1196 (11th Cir. 2013) (citing Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 347–48 (2005)).
Our decision in Loos v. Immersion Corp. is instructive. There, Immersion announced an internal investigation into revenue recognition practices of its medical line of business. Loos, 762 F.3d 880, 885 (9th Cir. 2014). The company‘s stock price plummeted 23% after this disclosure. Id. A shareholder lawsuit inevitably followed. We affirmed the district court‘s dismissal of the securities fraud lawsuit, ruling that the company‘s announcement of potential problems with revenue recognition was not a corrective disclosure. While the disclosure was “ominous,” it “simply put[] investors on notice of a potential future disclosure of fraudulent conduct.” Id. at 890.
Similarly, in Curry v. Yelp Inc., Yelp‘s stock price dropped after the FTC disclosed more than 2,000 complaints from businesses alleging that Yelp had manipulated reviews. Curry, 875 F.3d 1219, 1222 (9th Cir. 2017). We acknowledged that a plaintiff “need not allege an outright admission of fraud,” but we affirmed the dismissal of the lawsuit because the “mere ‘risk’ or ‘potential’ for fraud is insufficient to establish loss causation.” Id. at 1225 (quoting Loos, 762 F.3d at 889).
Likewise here, Erhart‘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.” Loos,
In short, if a securities fraud lawsuit turns on insider allegations of wrongdoing in a whistleblower lawsuit, I would prefer a bright-line rule that requires an external disclosure or evidence that confirms those allegations. It need not be a mea culpa from the company, but perhaps a surprise restatement of earnings, an unexplained announcement about an increase in reserves, or some other information that confirms those allegations and thus acts as a corrective disclosure.1
Finally, I agree with the majority that the anonymous Seeking Alpha posts are not corrective disclosures. I would, however, base our decision on the grounds that the Seeking Alpha 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. See, e.g., Jeff Katz & Annie Hancock, Short Activism: The Rise of Anonymous Online Short Attacks, Harvard Law School Forum on Corporate Governance (Nov. 27, 2017), https://bit.ly/3kqF3fi (noting the rise of short shellers engaging in anonymous attacks and explaining that a “short seller need only prove that a fraction
I thus concur in judgment in part III.B. and respectfully dissent as to part III.A.