In Re Bofi Holding, Inc. Securities Litigation

Facts

BofI Holding, Inc. (D), is the holding company for BofI Federal Bank, a federally chartered savings association. BofI reported strong earnings growth and its stock price rose handsomely. Between August 2015 and February 2016, the price of the stock dropped by more than 47%. BofI shareholders (Ps) filed multiple securities fraud suits against the company and several of its officers and directors. The suits were consolidated into this class action. The district court appointed the Houston Municipal Employees Pension System as the lead plaintiff to represent the class. Ps alleged that Ds committed securities fraud by falsely portraying the company as a safer investment than it actually was. Ps claim Ds made false or misleading statements touting the bank's conservative loan underwriting standards, its effective system of internal controls, and its robust compliance infrastructure. Ps brought the action under § 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5. To state a claim, they had to adequately plead six elements: (1) a material misrepresentation or omission; (2) made with scienter; (3) in connection with the purchase or sale of a security; (4) reliance on the misrepresentation or omission; (5) economic loss; and (6) loss causation. The court ruled that the shareholders have adequately pleaded falsity with respect to two categories of misstatements, concerning (1) the bank's underwriting standards and (2) its system of internal controls and compliance infrastructure. Ps predicated their showing of falsity on allegations attributed to confidential witnesses who used to work at D. The district court concluded that the witnesses' allegations were reliable and based on personal knowledge, as our circuit's case law requires. As for scienter, the district court ruled that Ps were required to allege facts giving rise to a strong inference that Ds acted 'either intentionally or with deliberate recklessness.' The court held that the shareholders failed to satisfy this standard for four of the five individual Ds, but concluded that the allegations of scienter were adequate as to BofI's Chief Executive Officer, Gregory Garrabrants, and thus as to the company as well. The court based this conclusion on the confidential witness allegations mentioned above. Ds did not contest that the shareholders satisfied the third, fourth, and fifth elements of their Rule 10b-5 claim. Ps invoked the 'fraud-on-the-market' presumption, which is premised on the theory that 'the price of a security traded in an efficient market will reflect all publicly available information about a company,' including materially false or misleading statements. As a result, a plaintiff who purchases shares at an inflated price is presumed to have done so in reliance on any material misstatements reflected in the stock's price. With respect to economic loss, Psindisputably lost money on their investment when D's stock lost nearly half its value by the end of the class period. After the district court issued the rulings described above, Ds filed a motion for judgment on the pleadings, in which it argued for the first time that the shareholders had not adequately alleged loss causation. The district court agreed and dismissed the shareholders' Second Amended Complaint with leave to amend. Ps filed a Third Amended Complaint to establish loss causation. Ps allege that disclosures revealed the falsity of the company's statements regarding underwriting standards, internal controls, and compliance infrastructure and that the market reacted by driving down the price of Ds's stock. The first corrective disclosure is a whistleblower lawsuit filed against Ds by Charles Erhart, a former mid-level auditor at the company, on October 13, 2015. That suit alleged rampant and egregious wrongdoing at D from doctored reports submitted to the bank's primary regulator, the Office of the Comptroller of the Currency (OCC), and that D had made high-risk and illegal loans to foreign nationals. Erhart's attempts to raise these compliance issues within the company led to retaliation and eventually to his termination. By the close of trading the next day, the price of BofI's shares had fallen by 30.2% on extremely high trading volume. The second corrective disclosure was in eight blog posts published by anonymous authors on Seeking Alpha, a crowd-sourced online resource for investors, between August 2015 and February 2016. The posts argued that things at D were not as rosy as they seemed. The posts' specific charges varied, ranging from allegations of potential regulatory violations to evidence of risky loan origination partnerships. Each post stated that it was based on information derived from publicly available sources and that the author was 'short' D. According to the complaint, D's stock price fell on each day that one of the blog posts appeared. Ds filed a motion to dismiss the Third Amended Complaint. The court reasoned that, because the Erhart lawsuit contained only 'unconfirmed accusations of fraud,' it could not have disclosed to the market that D's alleged misstatements were actually false. To qualify as a corrective disclosure, the court held, the Erhart lawsuit had to be followed by 'a subsequent confirmation' of the fraud, which the shareholders have not alleged. As for the blog posts, the district court \concluded that they cannot serve as corrective disclosures because each of them relies entirely on publicly available information. The district court dismissed the action with prejudice. Ps appealed. 

Issues

Rule of Law

Holding and Decision

Legal Analysis

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