California District Court Denies Dismissal Of Securities Fraud Class Action, Finding Public Information Is Not Immaterial As A Matter Of Law

by Shearman & Sterling LLP
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On September 6, 2017, Judge Andrew J. Guilford of the Central District of California denied motions to dismiss a putative securities class action asserting claims under Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 against Banc of California (“Banc”) and its former CEO, Steven Sugarman.  In re Banc of Cal. Sec. Litig., No. 17-CV-118 (C.D. Cal. Sept. 6, 2017).  Based largely on a short seller report published online, the complaint alleged among other things that defendants omitted information regarding Sugarman’s alleged financial and business ties to Jason Galanis, an individual who pled guilty to criminal securities fraud in connection with other companies.  In denying the motions to dismiss, the Court shed light on how courts might evaluate claims based on blog posts, an increasingly common basis for claims in securities cases.

Plaintiffs’ complaint relied primarily on an anonymous short seller blog post on the SeekingAlpha website purporting to reveal ties between Sugarman and Galanis.  Specifically, the short seller’s review of publicly available documents revealed that Galanis controlled a company called COR (as well as various COR affiliates).  Sugarman was the CEO of COR, and COR was involved in the recapitalization of Banc.  Plaintiffs alleged, among other things, that the Banc’s proxy materials for a shareholder vote on the re-election of Sugarman as director were misleading because it disclosed that Sugarman was COR’s CEO but failed to disclose his or COR’s ties to Galanis.  Plaintiffs further alleged that Banc’s stock price fell by 29 percent the day after the blog post was published.        

The Court rejected each of defendants’ arguments for dismissal, including several based on the import of the short seller report.  With respect to materiality, the Court found that the alleged 29 percent drop in share price following the blog post made it at least “plausible” that the information in the post was material.  The Court also rejected defendants’ argument that the post could not have been material, i.e., altered the total mix of information, because the post itself was based on publicly available information.  According to the Court, that was not necessarily the case for purposes of a motion to dismiss because the allegedly omitted information could only be discovered “by combing through and analyzing hundreds of legal and agency documents.”  The Court also rejected defendants’ argument that the complaint should be dismissed because it was based entirely on the blog post and plaintiffs lacked personal knowledge, noting that the blog author later released a list of the documents on which the post was based.

Finally, the Court rejected defendants’ argument that a blog post based on public information cannot qualify as a corrective disclosure for purposes of alleging loss causation for the same reasons defendants’ materiality arguments were rejected.  The Court also distinguished the case from other decisions holding that analyst’s opinions ordinarily cannot serve as a corrective disclosure, lest every negative analyst report be treated as a corrective disclosure, on the ground that the blog post was based on factual conclusions rather than the author’s opinions.

As noted, the decision provides insight as to how a court might evaluate securities fraud claims that are based on short seller reports.

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