As every securities litigator knows, the first major event following a case’s filing is typically the motion to dismiss. Generally, the court’s review of the complaint’s sufficiency is confined to the four corners of the pleading itself. Two exceptions to this rule, however, permit the court to consider documents extraneous to the complaint in evaluating a motion to dismiss: request for judicial notice and the doctrine of incorporation by reference. The former permits the court to judicially notice an adjudicative fact if it is “not subject to reasonable dispute.” Fed. R. Evid. 201(b). The latter “treats certain documents as though they are part of the complaint itself,” Khoja v. Orexigan Therapeutics, Inc., 899 F.3d 988, 1002 (9th Cir. 2018), “if the plaintiff refers extensively to the document or the document forms the basis of the plaintiff’s claim,” United States v. Ritchie, 342 F.3d 903, 907 (9th Cir. 2003).
While easy to recite, these doctrines have proved difficult to properly employ, a phenomenon the Ninth Circuit commented on at length in Khoja v. Orexigan Therapeutics, Inc. In Khoja, the panel expressed its concern over the seeming “exploit[ation] [of] these procedures improperly to defeat what would otherwise constitute adequately stated claims at the pleading stage.” Writing for the court, Justice A. Wallace Tashima acknowledged that “judicial notice and incorporation-by-reference do have roles to play at the pleading stage,” but noted that “overuse and improper application of judicial notice and the incorporation-by-reference doctrine, however, can lead to unintended and harmful results.” Specifically, the court observed 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.” The panel found these risks to be “especially significant in SEC fraud matters,” given that plaintiffs must meet a heightened pleading standard under the Private Securities Litigation Reform Act and defendants possess materials to which plaintiffs do not have access prior to discovery.
After its initial comments, and before reaching the merits of the defendants’ motion to dismiss, the appellate court undertook a detailed assessment of the district court’s ruling on defendants’ request for judicial notice. The district court had judicially noticed three documents: an investors’ conference call transcript; an agency report about the drug at issue, Contrave; and defendant Orexigen’s international patent application for Contrave. The Ninth Circuit determined that the district court abused its discretion by judicially noticing the transcript and the report, faulting the lower court for failing to identify what fact or facts it was noticing in these documents. The appellate court also found that both documents’ contents were subject to varying interpretations and reasonable dispute. But the panel found the district court did not abuse its discretion with respect to the patent application because it appeared the district court noticed that document only for its filing date.
Moreover, the district court incorporated by reference twelve documents falling into four categories: analyst reports and blog entries, SEC filings, agency reports, and a patent file history. The Ninth Circuit reviewed each document incorporated by reference and found the lower court abused its discretion as to five of the documents and did not abuse its discretion as to seven. The determinative factors were whether the document was “extensively” referenced in the complaint or formed the basis for any claim contained therein. To qualify as “extensively referenced,” the panel stated a document must be cited at least more than once or be quoted from at length. To form the basis for a claim, the document must serve as the foundation for an element of the claim. See Khoja, 899 F.3d at 1005 (finding the district court did not abuse its discretion incorporating by reference an article that “revealed the materiality of Orexigan’s alleged misrepresentations and omissions”). If the document was either extensively referenced or served as the basis, then the panel found no abuse of discretion by incorporating it by reference. If, however, the document was neither, the district court’s discretion had been abused.
Considering the appellate court’s scrutiny in Khoja, litigants in the Ninth Circuit should expect district courts to engage in detailed assessments of requests for judicial notice and/or arguments that documents are incorporated by reference into a pleading, similar to Hsu v. Puma Biotechnology, Inc., 213 F. Supp. 3d 1275 (C.D. Cal. 2016), a case cited by the Khoja panel. Given this, plaintiffs’ counsel would be well advised to scrutinize any request for judicial notice or incorporation-by-reference argument made regarding a motion to dismiss. This is particularly true where defendants do not pinpoint the specific facts contained in the documents they ask the court to consider, or where the documents are being introduced to support a defense as opposed to being the basis of a claim. Meanwhile, defense counsel should carefully assess whether extraneous documents upon which they intend in support of a motion to dismiss meet the governing legal standards.
Erika Oliver is an associate with Robbins Geller Rudman & Dowd LLP in San Diego, California.