On December 16, 2016, the Court of Appeals for the Ninth Circuit affirmed the dismissal of class action securities fraud claims against Apollo Group in Oregon Public Employees Retirement Fund v. Apollo Group. The complaint alleged that Apollo’s disclosures about its for-profit post-secondary education business (predominantly the University of Phoenix) were materially misleading in the way they described the for-profit education business model, business and recruiting practices, and treatment of financial defaults by students, among other things. The appellate court affirmed dismissal on multiple independent grounds, finding the allegations failed to state elements of materiality, scienter, and loss causation.
Loss Causation Pleading
The most important aspect of the decision was the Ninth Circuit’s determination that the Fed. R. Civ. P. 9(b) particularity pleading requirements apply to allegations of loss causation in securities fraud claims. The court wrote: “Although it is clear that Rule 9(b) and the PSLRA apply to almost all elements of a securities fraud action, the law is less clear about the pleading standard that applies to the loss causation element.” Slip op. at 8. Although the Ninth Circuit previously resisted addressing this issue when it was not dispositive to its decision, it took a different approach here. Although it ultimately held that loss causation was insufficiently pleaded under either a Rule 9(b) or Rule 8(a) pleading standard, the court decided it was time to put the pleading standard issue to rest, at least in that circuit.
The court identified the Fifth, Seventh, and Second Circuits as having previously adopted some form of heightened particularity pleading requirement for loss causation in section 10(b) cases, and noted the Fifth Circuit had gone the other way, applying Rule 8(a) to that aspect of pleading section 10(b) claims. See id. at 9-10. It then announced its choice to apply Rule 9(b) to that loss causation pleading: “We are persuaded by the approach adopted in the Fourth Circuit and hold today that Rule 9(b) applies to all elements of a securities fraud action, including loss causation.” Id. at 10. The court gave three reasons for this choice:
(1) “[T]he law on securities fraud is derived from common law fraud.” The case law developed by the Supreme Court regarding section 10(b) is based on doctrines of common-law fraud and deceit. “The requirement of loss causation, in particular, is founded on the common law of fraud and deceit.” Since Rule 9(b) applies “to all circumstances of common-law fraud, . . . and since securities fraud is derived from common law fraud, it makes sense to apply the same pleading standard to all circumstances of securities fraud.” Slip op. at 10-11.
(2) Rule 9(b) requires pleading with particularity of “the circumstances constituting fraud or mistake.” Securities fraud encompasses six elements, including loss causation. As a result, loss causation is part of the “circumstances” constituting fraud because, without it, a claim of securities fraud does not exist. Id. at 11.
(3) This approach “creates a consistent standard through which to assess pleadings in 10(b) actions, rather than the piecemeal standard adopted by some courts.” Id.
In analyzing the complaint itself, the court first turned to materiality. It found that plaintiffs’ allegations fell short on materiality “because the material misrepresentations the Plaintiffs allege are not objectively false statements.” The court distinguished “puffing” from misrepresentation, noting that “’[p]uffing’ concerns expressions of opinion, as opposed to knowingly false statements of fact.” Investors do not rely on “vague statements of optimism” or “feel good monikers.” In contrast, statements “that are capable of objective verification are not “puffery” and can constitute material misrepresentations.” Id. at 12.
The alleged misrepresentations in this case were found to be “inherently subjective ‘puffing’ and would not induce the reliance of a reasonable investor.” In particular, statements that start “we believe,” and vague descriptions of things as “significant events” are not objective facts. “Unlike accounting calculations or ignorance of rule violations, the statements by Apollo were subjective and preceded by qualifiers, such as ‘We believe.’” Id. at 13-14.
On the issue of pleading scienter, the court said that where plaintiffs “seek to hold individuals and a company liable on a securities fraud theory, we require that the Plaintiffs allege scienter with respect to each of the individual defendants.” Employing a “holistic view,” the court concluded there were insufficient facts alleged to establish that the defendants knew or were “consciously reckless” of their deceptive practices. At best, plaintiffs alleged examples of flawed practices “rather than widespread deception, which would be necessary to establish fraudulent intent or reckless ignorance based on a holistic analysis.” Id. at 16.
As to loss causation, the court found the allegations failed under either a Rule 8(a) or Rule 9(b) standard because plaintiffs “do not allege specific statements made by the Defendants that were made untrue or called into question by subsequent public disclosures.” The complaint left it unclear which of the previous disclosures were later shown to be inaccurate. Moreover, general “expressions of concern” in a government report about the nature of Apollo’s student recruitment do not “constitute a corrective disclosure and a public admission of Apollo’s alleged fraud.” Likewise, a GAO report discussing the industry as a whole does not “specify which of the Defendants’ statements” were untrue. “As a result, the Plaintiffs have not adequately alleged that there was a causal connection between the public information contained in the GAO Report and subsequent market activity.” Slip op. at 17-18.
Because the Apollo decision stands as a new circuit court judgment on the pleading standard for loss causation in section 10(b) cases, it is significant. But in other respects it seems unlikely to be influential on future appellate decisions. The reasoning is brief, and the analysis limited. The notion that stock price declines cannot be proximately caused by public disclosures that raise general issues about the truth of previous company disclosures, without specifically identifying any of them as wrong, seems overly narrow, and appears to deprive a fact-finder of an opportunity to consider evidence that could bear on the issue. The scienter discussion, based on a nebulous “holistic” standard, does not advance the ball much, and certainly lacks the kind of serious consideration reflected in the recent Sixth Circuit decision in Ansfield v. Omnicare, Inc., No. 13-5597 (Oct. 10, 2014) (other aspects of which are discussed in this prior post). That Sixth Circuit analysis, correct or not, is at least provocative, and has been the subject of much discussion. And the notion that starting a disclosure sentence with the words “we believe” has a significant impact on materiality seems, at a minimum, overly simplistic. That very approach was rejected by the Sixth Circuit in an earlier Omnicare decision now awaiting decision on appeal in the Supreme Court on when a “we believe” statement can be materially false (although the Sixth Circuit probably reached the wrong result there for other reasons, as discussed previously here). In short, this is an unimpressive effort that supplies a data point on the pleading standard issue, but not much more.
December 17, 2014
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