Ninth Circuit Affirms Dismissal Of Putative Securities Class Action Against Information Services Company For Failure To Adequately Plead Scienter Or Loss Causation

Shearman & Sterling LLP


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On April 19, 2024, the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a consolidated putative securities class action alleging violations of Section 10(b)...
United States Litigation, Mediation & Arbitration
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On April 19, 2024, the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a consolidated putative securities class action alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against an information services company and certain of its executives. Espy v. J2 Global, Inc., et al., No. 22-55829 (9th Cir. Apr. 19, 2024). The United States District Court for the Central District of California dismissed plaintiff's second amended complaint ("SAC"), holding that plaintiff failed to adequately plead scienter. The Ninth Circuit affirmed, holding that plaintiff failed to adequately plead scienter and loss causation.

Plaintiff—on behalf of a putative class of purchasers of the Company's stock between 2015 and 2020—alleged that the Company, which uses an acquisition model to grow its business, made material misstatements by omitting key facts about certain acquisitions and investments, and allegedly concealed underperforming acquisitions from investors through consolidated accounting practices. The SAC alleged that, since 2015, the Company concealed its underperforming investments in questionable ventures and enriched Company executives and board members, while misleading investors through omissions in press releases, earnings calls, proxy statements, and SEC disclosures. The SAC alleged that the Company misrepresented its true health as a business and, as a result, artificially inflated its stock price. The district court dismissed the SAC for failure to adequately plead scienter, which the Ninth Circuit considered on appeal.

The Ninth Circuit organized its analysis into three categories of alleged "corporate malfeasance": (1) the Company's 2015 acquisition of a consulting business that was registered to the personal residence of a former officer and director of the Company (the "2015 Acquisition")—which plaintiff alleged was acquired as a "bonus" incentive; (2) a 2017 investment in a fund with ties to former officers and directors of the Company (the "2017 Investment")—which plaintiff alleged had no business justification and instead served as an "untraceable" fund for the Company's insiders to enrich themselves; and (3) the Company's alleged practice of consolidating accounting reports (the "Consolidated Accounting")—which plaintiff alleged allowed the Company to hide underperforming or overvalued acquisitions by allegedly producing two sets of consolidated financial data for its two divisions, as opposed to separate financial data for each of the hundreds of its acquired businesses.

Addressing whether plaintiff adequately pleaded scienter, the Ninth Circuit began its analysis with the allegations regarding the 2015 Acquisition, which plaintiff alleged, based on purported statements from anonymous former employees, was a bonus incentive for a former Vice President of the Company. The Court found that the majority of the former employees' purported statements "fail to establish reliability or personal knowledge, or simply amount to criticisms of [the Company's] management practices" largely because the relevant former employee allegations either relied on secondhand information or they consisted of firsthand accounts that were not specific to the 2015 Acquisition. The Court thus held that the former employees' statements could not support a strong inference of scienter of the Company's alleged failure to disclose details of the 2015 Acquisition in order to allegedly defraud investors.

The Court similarly held that plaintiff failed to adequately plead scienter as to the 2017 Investment disclosure, finding that the Company disclosed "significant details" in its 2017 proxy statement, including the amount of the investment, the calculation of annual management fees owed, and that the Company's former CEOs had interests in the investment fund. Relatedly, the Court held that plaintiff did not adequately plead why the Company's alleged omission of all its other relationships with the investment fund compelled a strong inference of scienter when the Company had disclosed the "arguably more important" relationships.

Finally, the Court held that plaintiff failed to plead scienter as to the Company's Consolidated Accounting practices generally because the former employees only attested to corporate management's "general awareness" of the Company's finances, as opposed to the specific details regarding the performance of the 2015 Acquisition and 2017 Investment. The Court held that plaintiff's allegations of scienter on the part of management were implausible because there were "'hundreds of companies' with different accounting systems incorporated into [the Company], [and] it was difficult even for financial analysts within [the Company] to 'line up the numbers.'" Moreover, the Court held that plaintiff's claims failed under the "core operations" doctrine because allegations that management "signed off" on every acquisition, received detailed reports, or were "obsessed with numbers," did not compel a strong inference that they had knowledge of the alleged omitted information about particular underperforming acquisitions or that the Company used consolidated accounting to cover them up.

The Court also held that plaintiff failed to adequately plead loss causation, primarily because the reports that plaintiff pointed to as corrective disclosures were short-seller reports that relied on publicly available information. The Court reasoned that "whether those reports [actually] 'revealed ... the truth concealed by the defendant's misstatements' is an open question" of whether the "alleged corrective disclosure provided new information to the market that was not yet reflected in the company's stock price." The Court held that the short-seller reports therefore did not qualify as corrective disclosures because (1) they contained generalized criticisms "untethered" from plaintiff's allegations in the SAC, and (2) plaintiff alleged no facts plausibly explaining why this publicly available information—requiring no "expertise or specialized skills beyond what a typical market participant would possess" to uncover and disseminate—was not yet reflected in the Company's stock price.

Having found that plaintiff failed to adequately plead scienter and loss causation, the Ninth Circuit affirmed the district court's dismissal of the SAC without leave to amend.

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