(Reuters) – Last week, a three-judge panel of the 9th U.S. Circuit Court of Appeals issued a significant decision in a shareholder class action against BofI, a bank holding company. The appeals court, in an opinion by Judge Paul Watford, revived a class action alleging, among other things, that the bank’s share price plunged in response to disclosures in a whistleblower lawsuit. The 9th Circuit joined the 6th Circuit to conclude that a whistleblower complaint containing allegations from a corporate insider can serve as a “corrective disclosure” of the company’s misstatements. If the market perceives the whistleblower’s allegations to be true and reacts accordingly, the appeals court held, shareholders can base their loss causation arguments on the filing of the lawsuit.
Judge Kenneth Lee, who was nominated to the 9th Circuit by President Donald Trump and assumed office in 2019, dissented from that part of the 9th Circuit opinion. (Judge Lee concurred with his colleagues’ conclusion that blog posts based on publicly-available information are not a corrective disclosure.) Judge Lee said uncorroborated whistleblower allegations, which might prove to be “nothing more than wisps of innuendo and speculation,” should not be regarded as a corrective disclosure. It’s not enough, he said, that the market treats the whistleblower’s claims as plausible because insider accounts often have the ring of truth. But the BofI whistleblower assertions, Judge Lee said, are vehemently disputed by the company and unconfirmed by any subsequent disclosure, such as action by a regulator or a financial restatement.
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But Judge Lee’s skepticism did not stop with the facts of the BofI case. The loss causation requirement, in which shareholders must establish that the revelation of corporate misstatements caused the company’s share price to fall, serves as a “critical bulwark,” the judge said, against “frivolous securities fraud lawsuits” in which plaintiffs’ lawyers use class actions as an “in terrorem device to bludgeon companies into settling claims.”
But Judge Lee’s skepticism did not stop with the facts of the BofI case. The loss causation requirement, in which shareholders must establish that the revelation of corporate misstatements caused the company’s share price to fall, serves as a “critical bulwark,” the judge said, against “frivolous securities fraud lawsuits” in which plaintiffs’ lawyers use class actions as an “in terrorem device to bludgeon companies into settling claims.” Judge Lee cited Cornerstone Research data showing that about 9% of publicly-traded U.S. companies were sued in a shareholder class action in 2019, as well as a Chubb study that concluded the median cost of settling a securities fraud suit in 2018 was $13 million.
“Philosophers have long debated the question, ‘If a tree falls in the forest but no one is around to hear it, does it make a sound?’” Judge Lee wrote. “This case perhaps presents the converse of that conundrum: If there is no fraud, can a securities fraud lawsuit still proceed?”
I should note here that pleading standards are very tough in shareholder class actions. Plaintiffs must plausibly allege that particular corporate misstatements were fraudulent, and, for claims under the Securities and Exchange Act, that defendants specifically intended to defraud shareholders. In the BofI case, the 9th Circuit majority found that shareholders had adequately alleged falsity and fraudulent intent without relying on the whistleblower suit, which plaintiffs cited only to establish loss causation.
Nor is Judge Lee the only recently-appointed appellate judge to opine generally on shareholder class actions, reaching beyond the facts of a specific case. In June, a three-judge 3rd Circuit panel in Jaroslawicz v. M&T Bank partially revived a securities fraud suit by former shareholders of its 2015 merger partner Hudson City Bank, who alleged that the banks’ merger proxy materials failed, among other things, to disclose regulatory risks related to M&T’s anti-money-laundering practices.
But Judge Paul Matey, who was took his seat on the 3rd Circuit in March 2019 and wrote the 3rd Circuit’s opinion, took pains at the end of the decision to express “caveats, cautions and qualms” – specifically about the M&T case, in which, he said, plaintiffs might ultimately come up short, and, more broadly, about securities class actions. The judge cited a 2006 paper in which Columbia law professor John Coffee theorized that shareholder class actions do not deter corporate misconduct or compensate wronged investors. The judge also quoted Justice Clarence Thomas on the “muddled logic and armchair economics” of the market efficiency presumption that underlies securities fraud class actions.
“Despite reams of academic study, steady questions from the courts and periodic Congressional attention, the number of securities class actions continues to rise each year,” Judge Matey wrote. That trend, he said, “deserves a more searching inquiry.”
So far, Judges Lee and Matey appear to be the only recent appellate appointees to openly raise concerns about the prevalence of securities fraud class actions. I spent the morning reviewing more than two dozen appellate decisions in which judges appointed by President Trump served on panels evaluating shareholder fraud suits. The cases are a mixed bag: a handful of decisions unanimously reviving dismissed class actions; several unanimous decisions and summary orders affirming dismissals; one case, In re Allstate, in which Judge Amy Coney Barrett of the 7th Circuit agreed with two colleagues that shareholders could swap in a new investor to take over leadership of an ongoing class action; and a handful of rulings – including the 2nd Circuit’s Arkansas Teacher Retirement System v. Goldman Sachs and the 4th Circuit’s In re Willis Towers Watson plc Proxy Litigation – in which recent appointees dissented from decisions allowing shareholders to proceed. Those dissents hew to the facts of the specific cases, though.
Should shareholder lawyers worry about skepticism from Judges Lee and Matey? I’d say not yet. Remember, plaintiffs actually won both of the cases that prompted the appellate judges to express their doubts about the entire securities class action enterprise. Judge Matey, after all, put aside his “caveats, cautions and qualms” to write an opinion allowing a class action to move ahead. And U.S. Supreme Court nominee Amy Coney Barrett sided with two 7th Circuit colleagues in the Allstate decision earlier this year, which arguably favored shareholders.
But with shareholder class actions a perennial talking point for the business lobby, it’s worth remembering that at least two appellate judges are listening.
NOTE: This story has been corrected. An earlier version incorrectly reported that Judge Mark Bennett wrote the dissent in the BofI case.