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Ninth Circuit Confirms Role of Efficient-Market Theory in Loss Causation

John Michael Gildersleeve and Lauren Barnett

Ninth Circuit Confirms Role of Efficient-Market Theory in Loss Causation
Witthaya Prasongsin via Getty Images

In a pair of recent decisions, the Ninth Circuit has expressly confirmed that securities-fraud plaintiffs, who use the efficient-market hypothesis to plead reliance, cannot discard that hypothesis when pleading loss causation. That is, an efficient market works both ways. If all public statements are reflected in a company’s stock price, then so are all publicly available facts about the allegedly hidden “truth”—meaning that disclosures based on those facts cannot cause an incremental stock-price decline. By confirming this principle, even in the course of reversing dismissals, the Ninth Circuit has joined other circuits and brought more clarity to what pleading loss causation requires.

Both recent decisions involved a company formerly known as Bank of Internet. First, in In re BofI Holding, Inc. Securities Litigation, 977 F.3d 781 (9th Cir. 2020), the Ninth Circuit considered two alleged corrective disclosures: (1) a well-publicized whistleblower lawsuit and (2) a series of blog posts by short-sellers based on publicly available information. The court held that the whistleblower lawsuit could support loss causation because its “highly detailed and specific” allegations revealed new facts about the alleged fraud. Id. at 792. As to the blog posts, the court held that because BofI’s stock allegedly “trade[d] in an efficient market in which all publicly available information about the company, both positive and negative, is quickly incorporated into the stock price,” the “stock price should already reflect whatever public information a blog post might be based upon.” Id. at 794. Yet, a corrective disclosure “must by definition reveal new information to the market that has not yet been incorporated into the price.” Id. Ultimately, the court held that even if the blog posts provided new information to the market, the short-sellers’ lack of credibility made it implausible that “the market reasonably perceived these posts as revealing the falsity of BofI’s prior misstatements.” Id. at 797.

Less than a month later, in Grigsby v. BofI Holding, Inc., 979 F.3d 1198 (9th Cir. 2020), a different panel considered securities-fraud claims based on a later class period. It confirmed the same principle that the efficient-market hypothesis works both ways: “Because publicly available information in an efficient market is generally reflected in the price of a security, the disclosure of confirmatory information—or information already known by the market—will not cause a change in stock price.” Id. at 1205. It therefore held that, “[i]n general, a disclosure is not corrective if it contains information derived entirely from public filings and other publicly available sources of which the stock market was presumed to be aware.” Id. (citation and quotation marks omitted). Still, in Grigsby, the court held that information obtainable through FOIA requests is not necessarily reflected in a company’s stock price as a matter of law, because such information must be both requested and actually produced (in spite of FOIA’s exemptions). Id. at 1205–06.

Before BofI Holding and Grigsby, the notion that “the well-established ‘efficient market theory’ applies” to loss causation “ha[d] been adopted by many district courts within the Ninth Circuit.” Miller v. PCM, Inc., No. 17-CV-3364-VAP, 2018 WL 5099722, at *11 (C.D. Cal. Jan. 3, 2018). The Ninth Circuit itself, however, had not endorsed that notion so clearly and directly. That it now has done so, twice and in quick succession, is an important development that should not be obscured by the outcome of the two opinions, which reversed dismissals in part.

Other circuits also have recognized that plaintiffs cannot “have it both ways” in pleading loss causation because “[a]n efficient market for good news is an efficient market for bad news.” In re Merck & Co., Inc. Sec. Litig., 432 F.3d 261, 270 (3d Cir. 2005). Put differently, alleging an efficient market “is a Delphic sword: it cuts both ways.” Meyer v. Greene, 710 F.3d 1189, 1198 (11th Cir. 2013); see In re KBC Asset Mgmt. N.V., 572 F. App’x 356, 360 (6th Cir. 2014) (disclosure of “public information that the market absorbed long before” cannot support loss causation); Katyle v. Penn Nat’l Gaming, Inc., 637 F.3d 462, 473 n.6 (4th Cir. 2011) (“only the first revelation (or series of partial revelations) of facts apprising the market of the entire truth … will affect a stock’s price”); In re Omnicom Grp., Inc. Sec. Litig., 597 F.3d 501, 512 (2d Cir. 2010) (“negative characterization of already-public information” cannot show loss causation); cf. Bricklayers & Trowel Trades Int’l Pension Fund v. Credit Suisse Sec. (USA) LLC, 752 F.3d 82, 94-95 (1st Cir. 2014) (“gloss on public information … would not have moved AOL’s share price in an efficient market”).

The Ninth Circuit assigned to plaintiffs the burden of pleading specific facts showing why, in a given case, the efficient-market hypothesis should apply to reliance but not loss causation. It held: “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.” BofI Holding, 977 F.3d at 794. As to the blog posts, therefore, the court held that “the shareholders needed to allege particular facts plausibly suggesting that other market participants had not done the same analysis.” Id. And as to information obtained through FOIA requests, the court required “plausibly alleging that the FOIA information had not been previously disclosed.” Grigsby, 979 F.3d at 1202–03.

The specific facts needed to avoid the efficient-market hypothesis may prove hard to come by. One court already has applied BofI Holding to dismiss a complaint for “fail[ing] to sufficiently plead that [an alleged disclosure’s] analysis had not yet been done by other market participants.” Ferraro Family Found’n, Inc. v. Corcept Therapeutics Inc., No. 19-CV-1372-LHK, 2020 WL 6822916, at *25 (N.D. Cal. Nov. 20, 2020). Plaintiffs must show that “investors and analysts stood in uncomprehending suspension” until a later disclosure “brought light to the market’s darkness.” Merck, 432 F.3d at 270. Key considerations appear to be whether the alleged fraud itself misdirected the market from the relevant information, or whether the information was available only conditionally or in a limited way. See BofI Holding, 977 F.3d at 797 (investors “likely would not have known to investigate [entities] precisely because BofI had hidden its relationships with those entities”); Norfolk Cty. Ret. Sys. v. Cmty. Health Sys., Inc., 877 F.3d 687, 697 (6th Cir. 2017) (defendant’s “own alleged fraud left investors with no idea that the Blue Book … was a device to inflate [its] revenues”); see also Grigsby, 979 F.3d at 1205 (“information must be produced before it is publicly available, and not all FOIA requests yield disclosure”); Pub. Emps.’ Ret. Sys. of Miss. v. Amedisys, Inc., 769 F.3d 313, 323 (5th Cir. 2014) (“raw data itself had little to no probative value in its native state” and was “only available to a narrow segment of the public and not the public at large”).