Ninth Circuit Affirms Dismissal Of Putative Class Action Against Investment Bank For Failure To Adequately Allege Scienter
On April 8, 2021, the United States Court of Appeals for the Ninth Circuit affirmed the Central District of California’s dismissal with prejudice of a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 against an investment bank, certain of its executives, and one of its research analysts. Prodanova v. H.C. Wainwright & Co., LLC,—F.3d—, 2021 WL 1307882 (9th Cir. 2021). Plaintiff alleged that defendants had attempted to increase a company’s stock price by publishing a bullish analyst report shortly before the company announced that the bank would serve as the exclusive placement agent for an offering of the company’s shares. The Ninth Circuit held that plaintiff failed to adequately allege a strong inference of scienter.
Plaintiff alleged that the investment bank had published an analyst report setting a target price of $7 per share for the company that resulted in the company’s stock price increasing 26%. When the company announced later that same day that the bank would act as the placement agent for an offering that priced that company’s stock at $6 per share, the company’s stock price declined. Id. at *1. Citing declarations from an expert witness and a confidential witness who purportedly worked in the bank’s research department prior to the events in question, plaintiff attempted to satisfy its burden to plead scienter by alleging that the bank’s compliance department typically checked for conflicts of interest by reviewing the activities of both the research and the investment banking groups. Id. at *3.
The Court began its analysis by considering plaintiff’s theory for defendants’ purported fraudulent conduct, explaining that the lack of a plausible financial motive for the fraud makes it much less likely that a plaintiff can show a strong inference of scienter. Here, the Court held, the complaint failed to allege a plausible motive. Plaintiff generally alleged that the bank was motivated to inflate the company’s stock price in order to increase its compensation from, or the success of, the offering. Id. at *5. But the Court held that both theories were “divorced from common experience.” Id. Because the bank’s compensation was a percentage of the offering’s gross proceeds, the Court reasoned that an increased stock price would not result in higher compensation to the bank (as opposed to simply decreasing the number of shares sold at a higher price). Further, the Court found it unlikely that the bank would risk the negative consequences of fraudulent actions for “a slightly higher return,” explaining that “[g]enerally, we expect that a financial motive for securities fraud will be clear.…” Id. Similarly, the Court rejected as “speculative” plaintiff’s theory that a higher stock price would generate more interest in the offering, holding that “it strains plausibility that [the bank] believed it needed to publish the [analyst’s] Report to ensure a sold-out Offering.” Id. The Court concluded that “the only plausible explanation for [the bank’s] action is that someone there pulled a Bill Buckner and somehow let a glaring conflict pass by.” Id. But, the Court explained, “a company’s apparent error — even an embarrassing or inexplicable one — does not establish fraudulent intent, especially if the plaintiff cannot offer a plausible motive for the company’s conduct.” Id.
The Ninth Circuit further held that plaintiff did not allege “compelling and particularized facts showing fraudulent intent or deliberate recklessness,” as required to overcome the failure to allege a plausible motive. Id. at *6. In this regard, the Court rejected plaintiff’s attempt to support a corporate scienter theory by asserting that someone in the bank’s compliance department “must have approved the Report despite knowing about the Offering” and that this knowledge should be imputed to the bank. While plaintiff pointed to the confidential witness allegations and expert opinion regarding standard industry practices as to monitoring for conflicts of interest, the Court emphasized that the complaint failed to allege that any member of the bank’s compliance department had knowledge of the analyst’s report or the offering. Id. at *8.
The Court also rejected plaintiff’s argument for scienter based on the “core operations theory,” explaining that no bank executive was alleged to have been involved with the report, and that the conflict between the report and the offering was not so prominent that it was “absurd” to believe that management did not know about it. Id. at *9. The Court also refused to endorse plaintiff’s suggestion that the bank’s failure to promptly correct the report suggested scienter, noting that the Ninth Circuit and Supreme Court had not endorsed a “duty to correct,” and that even if a failure to correct were considered as part of the scienter analysis, it could not be sufficient on its own without additional facts that “demonstrated a deliberate intent to conceal information.” Id. at *10. The Court concluded that, considering all the allegations holistically, plaintiff had not established that an inference of scienter was “as compelling as an inference of nonculpable conduct,” and that it was more plausible that someone in the bank’s compliance department failed to realize that a conflict existed. Id. “A securities fraud lawsuit requires a showing of an intent to defraud investors. Mere negligence — even head-scratching mistakes — does not amount to fraud.” Id. at *1.