Announcement of Investigation Plus Subsequent Corrective Disclosure Sufficient for Pleading Loss Causation: Ninth Circuit | Practical Law

Announcement of Investigation Plus Subsequent Corrective Disclosure Sufficient for Pleading Loss Causation: Ninth Circuit | Practical Law

In Lloyd v. CVB Fin. Corp., the US Court of Appeals for the Ninth Circuit held that the announcement of an investigation can form the basis for sufficiently pleading loss causation in a private securities fraud action if the complaint also alleges a subsequent corrective disclosure by the defendant.

Announcement of Investigation Plus Subsequent Corrective Disclosure Sufficient for Pleading Loss Causation: Ninth Circuit

by Practical Law Litigation
Law stated as of 02 Feb 2016 • USA (National/Federal)
In Lloyd v. CVB Fin. Corp., the US Court of Appeals for the Ninth Circuit held that the announcement of an investigation can form the basis for sufficiently pleading loss causation in a private securities fraud action if the complaint also alleges a subsequent corrective disclosure by the defendant.
On February 1, 2016, in Lloyd v. CVB Fin. Corp., the US Court of Appeals for the Ninth Circuit held that the announcement of an investigation can form the basis for sufficiently pleading loss causation in a private securities fraud action if the complaint also alleges a subsequent corrective disclosure by the defendant ( (9th Cir. Feb. 1, 2016)).
In 2008 and again in 2010, the Garrett Group (Garrett), a commercial real estate company, informed its largest creditor, CVB Financial Corporation (CVB), that it could not make the required payments on its loans. CVB nonetheless represented in a quarterly report in 2009 and in both an annual and a quarterly report in 2010 filed with the Securities and Exchange Commission (SEC) that there was no basis for "serious doubt" about Garrett's ability to repay its loans. In 2010, the SEC served a subpoena on CVB, seeking information about its loan underwriting methodology and allowance for credit losses. The day after CVB disclosed receipt of the subpoena, its stock dropped 22%. A month later, CVB wrote down $34 million in loans to Garrett and placed the remaining $48 million in its non-performing category.
The Jacksonville Police & Fire Pension Fund (Jacksonville) filed a putative securities fraud class action, alleging violations of Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 (17 C.F.R. § 240.10b-5). The district court granted CVB's motion to dismiss, holding that Jacksonville's Second Amended Complaint (SAC) failed to adequately allege loss causation.
The Ninth Circuit ruled that the SAC sufficiently alleged falsity and scienter as to the two alleged misrepresentations made by CVB to the SEC in 2010, where CVB stated it had "no serious doubts" as to Garrett's ability to repay its loan obligations. Joining with the Fifth Circuit Court of Appeals, the court affirmatively answered the question left open in Loos v. Immersion Corp., 762 F.3d 880 (9th Cir. 2014), of whether the announcement of an investigation can form the basis for sufficiently pleading loss causation if the complaint also alleges a subsequent corrective disclosure by the defendant. The court explained that the burden of pleading loss causation is typically satisfied by allegations that the defendant revealed the truth through corrective disclosures which caused a company's stock price to drop and investors to lose money. Here, the court ruled that the SAC plausibly alleged that:
  • CVB's disclosure of the subpoena caused its stock price to drop precipitously.
  • The market and various analysts perceived the subpoena to be related to CVB's alleged misstatements about Garrett’s ability to repay.
  • The market's fears about the subpoena were confirmed by CVB's disclosure that it was writing off $34 million in Garrett loans and categorizing the remainder as non-performing.
  • The disclosure's minimal effect on CVB's stock price indicates that the earlier 22% drop reflected, at least in part, the market's concerns about the Garrett loans.
Therefore, the court found that Jacksonville had adequately pleaded a causal connection between the material misrepresentation and the loss. As the court noted, any other rule would allow a defendant to escape liability by first announcing a government investigation and then waiting until the market reacted before revealing that prior representations under investigation were false.
For more information on pleading loss causation, see Practice Note, Exchange Act: Section 10(b) Defenses Against Loss Causation Claims.