http://blogs.orrick.com/securities-litigation/files/2012/10/iStock_000013732170XSmall-1-200x150.jpgOn December 16, 2014, the Ninth Circuit affirmed the U.S. District Court of Arizona’s dismissal of a Section 10(b) class action against Apollo Education Group, Inc., a for-profit education company, and several of its officers and directors. In doing so, the Ninth Circuit held that the heightened pleading standard of Federal Rule of Civil Procedure Rule 9(b) applies to all elements of a securities fraud action, including loss causation.

Plaintiffs represented a class of investors that purchased the company’s stock between May 21, 2007 and October 13, 2010, and alleged that defendants committed securities fraud by making misleading statements and omissions regarding the company’s financial condition, business focus and revenue growth. Plaintiffs also alleged that during the class period the company’s officers and directors traded on inside information related to the alleged misstatements. The district court dismissed the amended complaint for failure to state a claim.

Upon review, the Ninth Circuit agreed that plaintiffs failed to state a claim because the alleged misstatements were not objectively false and constituted non-actionable “business puffing.” According to the court of appeals, “Unlike accounting calculations or ignorance of rule violations, the statements by Apollo were subjective and preceded by qualifiers, such as ‘We believe.’”

The Ninth Circuit also examined whether the plaintiffs’ allegations of loss causation satisfied the pleading standards under the Federal Rules of Civil Procedure. The court noted that federal law is unclear about the specific pleading standard that applies to the loss causation element in securities fraud actions. For instance, it stated that in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), the Supreme Court suggested that Rule 8(a)’s “short and plain” statement “might” apply to the loss causation element, even though Rule 9(b) and the PSLRA heightened the pleading standard for most securities fraud elements. The lack of clarity in federal law has resulted in circuit courts applying varying and inconsistent standards to the loss causation element. In particular, while the Ninth Circuit has applied the “plausibility” standard to the loss causation element – and held that a complaint is deficient if it does not allege facts that could plausibly establish loss causation – it also previously applied both Rule 8(a) and 9(b) to loss causation allegations.

In the case at bar, the Ninth Circuit held that the heightened pleading standards under Rule 9(b) applied to all elements of a securities fraud action, including the loss causation element, for three reasons. First, because Rule 9(b) applies to all circumstances of common law fraud, and securities fraud law is derived from common law fraud, it is logical to apply the same pleading standards to all circumstances of securities fraud. Second, Rule 9(b) specifically states that a plaintiff must state with particularity the circumstances constituting fraud or mistake. Because securities fraud encompasses the loss causation element, the element is part of the “circumstances” constituting fraud. Third, the application of Rule 9(b) to the loss causation element would create a consistent standard to assess pleadings in Section 10(b) actions.

Applying these principles, the Ninth Circuit held that even if plaintiffs alleged actionable misstatements or omissions, they failed to allege sufficient facts under either Rule 8(a) or Rule 9(b) to demonstrate loss causation. The Ninth Circuit also found that the plaintiffs failed to satisfy Rule 9(b) in pleading scienter. Further, because the plaintiffs failed to allege actionable misstatements and omissions, their insider trading claims failed.

This decision will undoubtedly make it harder for would-be securities fraud plaintiffs in the Ninth Circuit to pass the initial pleading stage. It also deepens the circuit split on the applicable standard for assessing loss causation elements. While the decision brings the Ninth Circuit in line with courts in the Fourth and Seventh Circuits, courts in the other circuits still assess loss causation allegations under Rule 8(a) or other standards.

 

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