Western District Of Washington Revives Securities Class Action Previously Dismissed For Failure To Adequately Allege Material Misstatements And Scienter
04/30/2019On April 19, 2019, Judge John C. Coughenour of the United States District Court for the Western District of Washington denied a motion to dismiss a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder against Zillow Group, Inc. and certain of its executives. In re Zillow Group, Inc. Securities Litig., No. C17-1387-JCC, 2019 WL 1755293 (W.D. Wash. Apr. 19, 2019). Plaintiffs alleged misstatements by defendants regarding a Consumer Financial Protection Bureau (“CFPB”) investigation into, among other things, potential violations of the Real Estate Settlement Procedures Act (“RESPA”) that allegedly arose out of Zillow’s “co-marketing” program between real estate agents and mortgage lenders. As discussed in our prior post, the Court had previously granted defendants’ motion to dismiss plaintiffs’ first amended complaint, but allowed plaintiffs leave to file a second amended complaint. In considering the second amended complaint, the Court explained how plaintiffs had cured the defects the Court noted in its prior ruling regarding allegations of material misstatements and scienter.
Zillow’s co-marketing program allowed participating mortgage lenders to pay a percentage of a real estate agent’s costs for placing a listing on Zillow, in exchange for the lender appearing in the listing. The Court had previously held that plaintiffs had failed to make any particularized allegations to support their claims that the co-marketing program was designed to violate RESPA, or facilitated RESPA violations, rejecting as conclusory allegations that co-marketing agents were providing referrals to lenders in exchange for unlawful kickbacks and that specific mortgage lenders were forced to pay more than fair market value for the advertising services they received.
In their second amended complaint, plaintiffs added factual allegations from confidential witnesses—sales personnel who worked at Zillow during the relevant period—about the design and evolution of the co-marketing program. Id. at *4. These allegations included that co-marketing lenders received fewer leads than their co-marketing agents but continued to participate in the program because lenders expected real estate agents to refer business, that “every agent and lender knew” that the co-marketing program was for the lender to get leads and referrals, and that “everyone knew” that the lenders paid the agents for leads and referrals. Id. at *4-5. The Court determined that these statements should be credited because the witnesses’ positions allowed them to have “working knowledge of the co-marketing program” and, in addition, because their accounts concerning the evolution of the program were corroborated by existing allegations regarding the CFPB’s investigation. Id. at *5. The Court also emphasized that the witnesses’ allegations were further corroborated by allegations about the design of the co-marketing program, pursuant to which Zillow provided agents with a list of every user who generated a lead, even when they declined to have their contact information sent to the co-marketing lender, which the Court found suggested a pay-for-referral arrangement. Id.
The Court also concluded that new allegations in the second amended complaint supported an inference that the co-marketing program did not fall within a RESPA “safe harbor” exception that would apply if the pricing was consistent with market value. In light of new allegations indicating that the pricing structure of the co-marketing program was significantly more expensive than comparable product offerings, and statements from confidential witnesses describing advertisers’ excessive payments, the Court held that the second amended complaint included factual allegations sufficient to draw a “reasonable inference” that Zillow had designed the program in a way that fell outside RESPA’s safe harbor provision. Id. at *8.
As a result of its RESPA analysis, the Court held that plaintiffs sufficiently alleged misrepresentations based on Zillow’s statements regarding its compliance with laws and regulations, the compliance of its advertisers, and Zillow executives’ descriptions of the co-marketing program. Id. at *13-16.
The Court also determined that, although the second amended complaint failed to raise a sufficient inference of scienter based on the conduct of each executive individually, the totality of the allegations “viewed holistically”—including that Zillow designed the co-marketing program in a way that violated RESPA, that Zillow was encouraging such violations, and that Zillow’s executives were familiar with the design and operation of the program—supported a strong inference that the executives were “at least deliberately reckless” in making actionable misrepresentations. Id. at *19-20. In reaching this conclusion, the Court relied on the “core operations” theory of scienter, under which high-ranking corporate offers can be presumed to have knowledge under certain circumstances. Because the second amended complaint alleged that the co-marketing program was part of Zillow’s core operations and that the executives “made numerous statements displaying their familiarity with the [co-marketing] program,” including with how the program was “put together” and “structured,” as well as awareness of the CFPB investigation of the program, the Court concluded that it was reasonable to infer that the executives would have been aware of RESPA violations at the time of the alleged misrepresentations. Id.