Ninth Circuit Dismisses Securities Class Action Because CEO’s Statements Touting Ethical Standards Were “Transparently Aspirational”
On January 19, 2017, the U.S. Court of Appeals for the Ninth Circuit affirmed the district court’s decision to dismiss a securities class action against Hewlett-Packard Co. (“HP”) and its former chief executive officer. Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co., No. 14-16433, 2017 WL 218026 (9th Cir. Jan. 19, 2017). Plaintiffs alleged that HP and its former CEO violated Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) when the CEO breached HP’s code of ethics after he and the company had publicly promoted HP’s high ethical standards. The court concluded that plaintiffs failed to allege an actionable fraud because, among other reasons, the alleged statements about HP’s code of ethics were not objectively false, but were instead “transparently aspirational.”
Plaintiffs’ claims stemmed from HP’s former CEO’s resignation after an internal investigation revealed that he had falsified expense reports and lied about his relationship with an independent contractor. According to plaintiffs, HP’s public statements about its business ethics were shown to be demonstrably false based on the CEO’s misconduct. Immediately following the CEO’s resignation, the price of HP stock dropped, resulting in an alleged loss of $10 billion to HP’s shareholders.
The district court dismissed the action, holding that the complaint failed to adequately allege that the statements at issue were objectively false or material. On appeal, the Ninth Circuit affirmed and ruled that defendants did not make any statements during the class period that were objectively false. The court explained that a code of conduct is “inherently aspirational” because it “expresses opinions as to what actions are preferable, as opposed to implying that all staff, directors, and officers always adhere to its aspirations.” The court noted that a contrary interpretation would be untenable because it could turn all corporate wrongdoing into securities fraud.
The court also ruled that the statements at issue were not material because there was not a substantial likelihood that they altered the total mix of information available to stockholders. The court noted that, although materiality is generally a mixed question of law and fact that is typically left to the fact finder, there was nothing unusual about HP’s promotion of business ethics that would have affected a reasonable investor’s decision to invest. In addition, the court rejected plaintiffs’ contention that the decline in HP’s stock price following the CEO’s resignation indicates materiality because, according to the court, “stock price movements provide no rational basis for determining whether . . . risks were adequately conveyed to the public.”
The court’s decision, which was a matter of first impression in the Ninth Circuit, establishes that where a company’s statements do not guarantee absolute compliance with ethical standards, but instead are merely aspirational, they do not give rise to a securities fraud claim if the ethical standards are later breached. In reaching this conclusion, the Ninth Circuit joins the majority of other courts that have addressed this issue.