On October 8, 2020, the Court of Appeals for the Ninth Circuit reversed the dismissal of a putative securities class action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act"), and Rule 10b-5 promulgated thereunder, against a federally chartered savings bank and its holding company (collectively the "Bank") and several of its executives, for alleged misstatements regarding the Bank's underwriting standards, internal controls, and compliance program. In re BofI Holding, Inc. Securities Litigation, No. 18-55415 (9th Cir. Oct. 8, 2020). The district court granted defendants' motion to dismiss the third amended complaint, holding that although plaintiffs adequately pled material misstatements and scienter, plaintiffs failed to sufficiently plead loss causation. The Ninth Circuit (with Judge Paul J. Watford writing for the majority) vacated the dismissal, holding that plaintiffs sufficiently pled loss causation based on a whistleblower lawsuit filed by a former employee. Judge Kenneth K. Lee concurred in part and dissented in part.
According to plaintiffs, the Bank allegedly made misstatements "touting [its] conservative loan underwriting standards, its effective system of internal controls, and its robust compliance infrastructure." The district court held that plaintiffs adequately pled falsity with respect to the underwriting standards and internal controls based on allegations from confidential witnesses, and adequately pled scienter with respect to one of the individual executive defendants based on the same. The district court further held, however, that the two corrective disclosures alleged by plaintiffs failed to adequately support their theory of loss causation, noting that the first—a whistleblower lawsuit by "a former mid-level auditor at the company" which alleged "rampant and egregious wrongdoing" such as "doctored reports submitted to the [B]ank's primary regulator, the Office of the Comptroller of the Currency (OCC), and that [the Bank] had made high-risk and illegal loans to foreign nationals"—was insufficient because the whistleblower lawsuit "contained only 'unconfirmed accusations of fraud' [and] could not have disclosed to the market that [the Bank's] alleged misstatements were false." The district court held that the second purported corrective disclosure, a series of blog posts, was similarly insufficient due to their reliance on public information which "[i]n the [district] court's view . . . could not have 'revealed' anything to the market because the information they disclosed was presumably already known to market participants" and therefore incorporated into the stock price under the efficient market presumption.
The Ninth Circuit affirmed the district court's holding with respect to falsity and scienter but disagreed in part with the district court's ruling regarding loss causation. With respect to the whistleblower lawsuit, the Ninth Circuit observed that if the allegations were accepted as true, they "unquestionably revealed to the market that at least some of [the Bank's] alleged misstatements were false" and that plaintiffs adequately alleged that the "more than 30% [stock drop] on extremely high trading volume" was in reaction to this disclosure. Notably, the Ninth Circuit added that "shareholders did not have to establish that the allegations in [the whistleblower] lawsuit are in fact true," emphasizing that "[falsity] and loss causation are separate elements." In its analysis of the district court's reasoning, the Ninth Circuit "join[ed] the Sixth Circuit in rejecting any such categorical rule," noting that "any corrective disclosure will necessarily take the form of contestable allegations of wrongdoing . . . [and what] matters for loss causation purposes 'is that some [representations] are more credible than others and thus more likely to be acted upon as truth.'" The Court distinguished certain Ninth Circuit precedent on which the district court had relied. The Court stated that while the announcement of an investigation standing alone would not suffice to plead loss causation, the whistleblower lawsuit here revealed to the market specific facts alleged by "a former insider . . . who had personal knowledge of the facts he alleged" and which, "if true, rendered false [the Bank's] prior statements." The Ninth Circuit accordingly held that plaintiffs sufficiently alleged loss causation on the basis of these allegations.
Turning next to the purported corrective disclosures in the blog posts, the Court agreed that plaintiffs "failed to plausibly allege that these posts constituted corrective disclosures," although the Court "disagree[d] somewhat with the . . . rationale." The Ninth Circuit stated that shareholders need only allege "particular facts plausibly suggesting that other market participants had not done the same analysis, rather than 'could not.'" The Ninth Circuit noted that its own precedent, along with precedent from the Fifth Circuit, establish that "information, although nominally available to the public, can still be 'new' if the market has not previously understood its significance." The Court rejected what it characterized as the "bright-line" rule advocated by defendants, stating instead that "[a] disclosure based on publicly available information can, in certain circumstances, constitute a corrective disclosure." The Ninth Circuit observed that there is a circuit split with respect to this issue, and that the Eleventh Circuit has adopted the "bright-line rule." Even applying what it referred to as a "flexible" approach, however, the Court concluded that the blog posts, despite the research involved and "time and effort" used to compile the information, were insufficient as corrective disclosures because "it is not plausible that the market reasonably perceived these posts as revealing the falsity" of the Bank's statements, and, moreover, the posts were "authored by anonymous short-sellers" and had disclaimers as to the "accuracy or completeness of the information" in the articles such that a "reasonable investor reading these posts would likely have taken their contents with a healthy grain of salt."
Accordingly, the Court reversed and remanded the case to the district court, further instructing it to reinstate the Section 20(a) claims against the individual defendants. Judge Lee concurred in part and dissented in part, noting the concerns inherent in allowing "unsubstantiated assertions that may turn out to be nothing more than wisps of innuendo and speculation" from whistleblower lawsuits to "count as a 'corrective disclosure.'" Judge Lee noted that he would "require additional external confirmation of fraud allegations" in such a lawsuit before it could serve as a corrective disclosure and doing so "comports with [Ninth Circuit] case law and common sense."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.