Ninth Circuit Joins Sixth Circuit in Rejecting Categorical Rule that Allegations in a Lawsuit, Standing Alone, Can Never Qualify as a Corrective Disclosure

In In re BofI Holding, Inc. Sec. Litig., No. 18-55415 (9th Cir. Oct. 8, 2020), the majority of a Ninth Circuit panel (Watford, Bennett, JJ.) reversed the district court’s judgment dismissing a securities fraud class action for failure to sufficiently allege loss causation, and remanded for further proceedings. In doing so, the panel joined the Sixth Circuit in rejecting a categorical rule that allegations in a lawsuit, standing alone, can never qualify as a corrective disclosure. The panel also affirmed the district court’s conclusions that the shareholders failed to plausibly allege the falsity of statements concerning government and regulatory investigations and that a series of blog posts offering negative reports about the company’s operations did not qualify as a corrective disclosure. In addition, while Judge Lee concurred with most of the majority’s opinion, he dissented from the majority’s holding that plausible insider allegations, standing alone, can qualify as a corrective disclosure.

As to the whistleblower allegations, the majority recognized that “[a] corrective disclosure can . . . come from any source, including knowledgeable third parties such as whistleblowers, analysts, or investigative reporters.” Opinion at 13. In taking judicial notice of the contents (but not the truth) of the whistleblower complaint at issue in BofI, the panel found that the “allegations of egregious wrongdoing in the Erhart lawsuit, if accepted as true, unquestionably revealed to the market that at least some of BofI’s alleged misstatements were false.” Id. at 15. Furthermore, the shareholders “allege[d] that BofI’s stock price fell by more than 30% on extremely high trading volume immediately after the market learned of Erhart’s allegations,” which sufficed to plausibly allege that the “drop constituted a dissipation of the inflation attributable to BofI’s misstatements instead of a reaction to some other negative news unrelated to the alleged fraud.” Id. at 16. The majority continued, explaining that “the shareholders did not have to establish that the allegations in Erhart’s lawsuit are in fact true” because “[f]alsity and loss causation are separate elements of a Rule 10b-5 claim” and “[i]n analyzing loss causation, we . . . begin with the premise that BofI’s misstatements were false and ask whether the market at some point learned of their falsity – through whatever means.” Id. (emphasis in original). “Viewed through that prism, the relevant question for loss causation purposes is whether the market reasonably perceived Erhart’s allegations as true and acted upon them accordingly.” Id. (emphasis in original). In this case, the panel credited the 30 percent stock price decline as indicia that the market credited Erhart’s allegations as credible.

In so holding, the majority joined the Sixth Circuit in rejecting a categorical rule that, “to adequately plead loss causation, the shareholders had to identify an additional disclosure that confirmed the truth of Erhart’s allegations.” Opinion at 17 (citing Norfolk County Retirement System v. Community Health Systems, Inc., 877 F.3d 687, 695 (6th Cir. 2017)). The majority explained that “[t]o 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 . . . —any corrective disclosure will necessarily take the form of contestable allegations of wrongdoing.”  Id. at 17-18 (internal citation omitted).  The panel continued, stating that “[i]f the market treats allegations in a lawsuit as sufficiently credible to be acted upon as truth, and the inflation in the stock price attributable to the defendant’s misstatements is dissipated as a result, then the allegations can serve as a corrective disclosure.”  Id. at 18 (noting that, ultimately, the “plaintiff must, of course, prove that the defendant’s misstatements were false, but that can be done through proof other than the corrective disclosure itself”) (emphasis added).

As to the blog posts, while the panel agreed with the district court that shareholders failed to plausibly allege that the blog posts constituted corrective disclosures, the panel disagreed with the district court’s rationale. The panel explained that:

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 particular facts plausibly suggesting that other market participants had not done the same analysis, rather than “could not.” If other market participants had not done the same analysis, then it is plausible that the blog posts disclosed new information that the market had not yet incorporated into BofI’s stock price.

Opinion at 21-22 (emphasis original). In rejecting the bright-line rule BofI urged the court to adopt (i.e., that a disclosure based on publicly available information cannot ever constitute a corrective disclosure), the panel noted that its flexible approach to evaluating corrective disclosures on a case-by-case basis diverged from the Eleventh Circuit’s holding in Meyer v. Greene, 710 F.3d 1189, 1198 (11th Cir. 2013). Opinion at 24. Ultimately, however, the BofI court concluded that in this case, the blog 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 representation as to the accuracy or completeness of the information set forth in this article.’” Opinion at 27. In short, “[a] reasonable investor reading these posts would likely have taken their contents with a healthy grain of salt.”  Id. at 28.

In sum, practitioners citing BofI should note that the panel (1) joined the Sixth Circuit in rejecting a categorical rule that allegations in a lawsuit, standing alone, can never qualify as a corrective disclosure and (2) split from the Eleventh Circuit in rejecting a categorical rule that a disclosure based on publicly available information cannot constitute a corrective disclosure.