February 24, 2015 Articles

Courts Split on SEC Forms 4 for the Truth of Their Contents on Motions to Dismiss

To date, no federal circuit court has squarely addressed this issue

By Som P. Dalal and Howard S. Suskin

he Private Securities Litigation Reform Act of 1995 requires a plaintiff filing a securities fraud class action complaint pursuant to section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act) to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). The United States Supreme Court has explained that the “required state of mind” is “scienter, a mental state embracing intent to deceive, manipulate, or defraud.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (2007).

In attempting to plead scienter, plaintiffs sometimes allege that defendants engaged in insider trading during the putative class period. Defendants moving to dismiss securities class action complaints often attempt to rebut inferences of scienter by requesting that courts take judicial notice of their publicly filed Forms 4. Pursuant to section 16(a) of the Exchange Act, directors, officers, and individuals owning more than 10 percent of a public company’s stock must report all transactions reflecting changes in beneficial ownership on Forms 4, which are publicly filed with the Securities and Exchange Commission (SEC). See 15 U.S.C. § 78p(a)(1); 17 C.F.R. § 240.16a-3. Defendants attach Forms 4 to their motions to dismiss to argue that there was nothing unusual or suspicious about their stock trading histories.

 

District courts have split as to whether it is appropriate to consider Forms 4 for the truth of their contents on motions to dismiss securities fraud complaints. This article discusses the ways in which different courts have addressed this issue.

 

Background

Federal Rule of Evidence 201(b) instructs that a district court “may judicially notice a fact that is not subject to reasonable dispute because it: (1) is generally known within the trial court’s territorial jurisdiction; or (2) can be accurately and readily determined from sources whose accuracy cannot reasonably be questioned.”

 

The United States Supreme Court has held that a court considering a motion to dismiss in a securities fraud action “must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice.” Tellabs, 551 U.S. at 322. On that point, the Supreme Court relied on Wright & Miller, which elaborates that “[n]umerous cases . . . have allowed consideration of matters incorporated by reference or integral to the claim, items subject to judicial notice, [and] matters of public record . . . without converting the motion into one for summary judgment.” Id. at 322 (citing 5B Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure § 1357 (3d ed. 2004)).

 

The Split Between District Courts

 

Permissive approach. Several courts have concluded that it is appropriate to consider Forms 4 for the truth of their contents when adjudicating motions to dismiss securities fraud complaints.

 

In Malin v. XL Capital Ltd., 499 F. Supp. 2d 117 (D. Conn. 2007), aff’d, 312 F. App’x 400 (2d Cir. 2009), investor-plaintiffs filed a securities fraud class action. Id. at 125. The plaintiffs claimed that the defendants’ stock sales during the class period were indicative of scienter. Id. at 150. In their motion to dismiss, the defendants requested that the court take judicial notice of Forms 4 that the defendants had filed with the SEC for the truth of the transactional data set forth therein. Id. at 131–32. The district court granted the defendants’ request and ruled that “the [Forms 4] submitted to the SEC will be considered . . . as evidence of Defendants’ stock transactions for the purpose of determining whether they acted with the requisite scienter.” Id. at 134. The court reasoned that in resolving whether the plaintiffs had adequately pled scienter based on the defendants’ stock sales, the court was required to examine several factors, including “the amount of profit from the sales, the portion of stockholdings sold, the change in volume of insider sales, and the number of insiders selling.” Id. at 133. To make that determination, the court explained, it must review the relevant trading data and “the only source of that information is the [Forms 4] filed with the SEC.” Id. Significantly, the court noted that the plaintiffs themselves had relied on the defendants’ Forms 4 as the source of the transactional data contained in their complaint and thus implicitly conceded that the Forms 4 were the sole source of such trading data. Id. at 133 n.13. The court also found persuasive that Forms 4 “are required to be filed with the SEC under penalty of perjury” and “are routinely accepted by courts on motions to dismiss securities fraud complaints . . . for the truth of their contents.” Id. at 133.

 

Similarly, in Garden City Employees’ Retirement System v. Anixter International, Inc., No. 09-CV-5641, 2011 WL 1303387 (N.D. Ill. Mar. 31, 2011), the plaintiffs filed a securities fraud class action complaint and referenced the individual defendants’ stock sales during the class period to support an inference of scienter. Id. at *10. In their motion to dismiss, the defendants attached as exhibits their Forms 4 from both before and during the class period, and the plaintiffs subsequently moved to strike those exhibits. Id. The district court ruled that it could resolve the motion to dismiss without deciding whether it was proper to consider the defendants’ Forms 4 for the truth of what was contained in them. Id. at *31. However, the court suggested that

 

there is a strong argument for concluding that the amount of stock Individual Defendants sold . . . along with the date of each sale and the price at which the stock was sold, are judicially noticeable because the Forms 4 that contain these facts are publicly-filed documents, the contents of which are not in dispute.

 

Id. at *12.

 

The court found significant that the plaintiffs “[did] not challenge the authenticity of the forms or the accuracy of the financial reporting contained in them” and in fact apparently relied on data from certain Forms 4 in their complaint. Id. The court observed that “[h]aving relied on the Forms 4 filed [during the class period], it would be passing strange for Plaintiffs to argue that similar Forms 4 from [prior to the class period] are untrustworthy.” Id.

 

More recently, in City of Royal Oak Retirement System v. Juniper Networks, Inc., 880 F. Supp. 2d 1045 (N.D. Cal. 2012), the plaintiffs filed a putative securities fraud class action and pointed to stock sales made by the individual defendants to bolster an inference of scienter. Id. at 1069. The defendants moved to dismiss the suit and attached certain of the individual defendants’ Forms 4 to their motion, and the plaintiffs moved to strike those documents. Id. at 1058. The district court denied the plaintiffs’ motion to strike the Forms 4. Id. at 1059. The court noted that although the plaintiffs did not explicitly refer to the defendants’ Forms 4 in their complaint, they did expressly reference the defendants’ stock sales, which are “disclosed to the public through . . . Forms 4 filed with the SEC.” Id. Crucially, the plaintiffs did not suggest that they gleaned information regarding the defendants’ stock sales from any other source, nor did they challenge the authenticity of the Forms 4 attached to the defendants’ motion to dismiss. Id. The district court held that it could take judicial notice of the Forms 4 not only for the transactional data contained therein but also “to prove that [the individual defendants’] stock sales were made pursuant to . . . Rule 10b5–1 trading plan[s],” under which stock sales are prescheduled and occur automatically. Id.

 

Other district courts addressing this issue have reached similar conclusions. See, e.g., Abely v. Aeterna Zentaris Inc., No. 12-CV-4711, 2013 WL 2399869, at *22 (S.D.N.Y. May 29, 2013) (stating that “courts in this District routinely take judicial notice of Form 4 filings at the motion to dismiss stage, and consider them for the truth of their contents”); Cement Masons & Plasterers Joint Pension Trust v. Equinix, Inc., No. 11-CV-01016, 2012 WL 685844, at *8 (N.D. Cal. Mar. 2, 2012) (taking judicial notice of Forms 4 as proof of the transactional data contained therein and as evidence that certain stock transactions were made pursuant to Rule 10b5–1 trading plans, reasoning that plaintiffs did not dispute that the Forms 4 “[were] ‘not subject to reasonable dispute’ and ‘capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned’” (quoting Federal Rule of Evidence 201(b))); In re Bear Stearns Cos., Inc. Secs., Derivative & ERISA Litig., 763 F. Supp. 2d 423, 583 (S.D.N.Y. 2011) (holding that “[Forms 4] are required SEC disclosures and may be considered for the truth of their contents”).

 

Restrictive approach. Other courts that have addressed the issue have concluded that it is improper to consider Forms 4 for the truth of the matters asserted therein when adjudicating motions to dismiss securities fraud lawsuits.

 

In Maiman v. Talbott, No. 09-CV-0012, 2010 U.S. Dist. LEXIS 142712 (C.D. Cal. Aug. 9, 2010), the plaintiffs alleged that the defendants committed securities fraud by concealing their company’s lending practices and by making misleading statements about their company’s financial condition. Id. at *2. In a motion to dismiss, the defendants argued that any inference of scienter was undermined because the defendants did not sell any stock—and actually purchased stock—during the class period. Id. at *18. To support their argument, the defendants requested that the court take judicial notice of Forms 4 that the defendants filed during the relevant time period. Id. at *18–19. The court declined to do so, explaining that “[c]ourts may take judicial notice of ‘undisputed matters of public record,’ but generally may not take judicial notice of ‘disputed facts stated in public records.’” Id. at *20–21. “[T]his is particularly true of public documents filed with the [SEC] in a securities fraud action,” the court stated, because “the truth of the contents of the SEC reports is typically central to the dispute.” Id. at *22.

 

Likewise, in City of Sterling Heights General Employees’ Retirement System v. Hospira, Inc., No. 11-CV-8332, 2013 WL 566805 (N.D. Ill. Feb. 13, 2013), the plaintiffs filed a securities class action complaint alleging that the defendants engaged in a fraudulent scheme to artificially inflate the defendant company’s stock price. Id. at *1. The plaintiffs asserted that the individual defendants’ stock transactions during the class period constituted evidence of scienter. Id. at *25. In response, the defendants attached their Forms 4 to a motion to dismiss the complaint and argued that those Forms 4 showed that the defendants “actually acquired more shares than they sold in all but one of their stock transactions.” Id. at *12. The plaintiffs moved to strike the Forms 4. Id. The court decided that it could resolve the motion to dismiss without considering the Forms 4 but suggested that it would be improper to consider those documents for the truth of the matters asserted therein. Id. at *13. Significantly, the court noted that “it is not entirely clear where [p]laintiffs . . . obtained the alleged stock information,” id. at *13, and observed that the complaint contained no reference to the defendants’ Forms 4, id. at *12.

 

In another case, Phillips v. Triad Guaranty, Inc., No. 09-CV-00071, 2013 WL 2403281 (M.D.N.C. May 31, 2013), the plaintiff filed a securities fraud class action alleging violations of section 10(b) of the Exchange Act and SEC Rule 10b–5. Id. at *1. In connection with their motion to dismiss the plaintiff’s complaint, the defendants asked the court to take judicial notice of four Forms 4 that allegedly showed that the individual defendants actually purchased stock during the class period. Id. at *18. The plaintiff then moved to strike those four Forms 4, and the court granted the plaintiff’s motion. Id. The court explained that although in certain circumstances it may be appropriate to take judicial notice of Forms 4, in this case “there [was] no allegation of insider trading or any reliance by Plaintiff on stock sales by individual Defendants.” Id. The court further noted that it did not consider the Forms 4 to be “highly relevant” to the question of scienter. Id.

 

Other courts have similarly declined to consider Forms 4 for the truth of the transactional data they contain. See, e.g., Patel v. Parnes, 253 F.R.D. 531, 546 (C.D. Cal. 2008) (holding that “[t]he truth of the content [of SEC Forms 4], and the inferences properly drawn from them . . . is not a proper subject of judicial notice”); Riggs Partners, LLC. v. Hub Group., Inc., No. 02-CV-1188, 2002 WL 31415721, at *5 n.7 (N.D. Ill. 2002) (court declined defendants’ request to take judicial notice of their stock purchases made during the class period).

 

Conclusion

District courts are divided as to whether it is appropriate to consider SEC Forms 4 on motions to dismiss securities fraud class action complaints. To date, no federal circuit court has squarely addressed whether it is permissible to take notice of Forms 4 for the truth of their contents. Securities lawyers should be mindful of the split on this issue when determining whether to move for or oppose judicial consideration of Forms 4.