Metzler Inv. GMBH v. Corinthian Colls., Inc. - 540 F.3d 1049 (9th Cir. 2008)

Rule:

A plaintiff is not required to show that a defendant's misrepresentation was the sole reason for an investment's decline in value in order to establish loss causation. The plaintiff's complaint must, however, set forth allegations that, if assumed true, are sufficient to provide the defendant with some indication that the drop in the defendant's stock price was causally related to the defendant's financial misstatements.

Facts:

Metzler, an institutional investor and the lead plaintiff, brought a putative class action against Corinthian Colleges Inc., a corporation which operated vocational colleges and certain of its officers, alleging that Corinthian engaged in securities fraud which artificially inflated the price of its stock. Metzler alleged that Corinthian falsified financial aid applications and manipulated student enrollment data to increase federal fund entitlements, and that such fraud resulted in an artificial inflation of the corporation's stock price. Metzler further alleged that once Corinthian’s fraud was revealed to the market, it caused a massive drop in the value of Corinthian stock and consequently losses on Metzler’s end. After multiple motions to dismiss and subsequent amendments of the complaint, the third amendment complaint (TAC) was dismissed with prejudice.

Issue:

Was the complaint able to sufficiently adequately plead loss causation?

Answer:

No.

Conclusion:

Metzler relied on the June 24 Financial Times story disclosing the DOE investigation at the Bryman campus and the August 2 earnings announcement. In doing so, Metzler failed to adequately plead loss causation. The TAC did not allege that the June 24 and August 2 announcements disclosed--or even suggested--to the market that Corinthian was manipulating student enrollment figures company-wide in order to procure excess federal funding, which was the fraudulent activity that Metzler contended forced down the stock that caused its losses. Neither the June 24 Financial Times story nor the August 2 press release regarding earnings could be reasonably read to reveal widespread financial aid manipulation by Corinthian, and the TAC did not otherwise adequately plead that these releases did so. As for the Financial Times story, it did reveal a DOE investigation at the Bryman campus and the campus's placement on reimbursement status as a result of improper financial aid practices; but it simultaneously noted that the investigation there "does not affect the status of other Corinthian schools." The TAC did not allege that all, or even some appreciable number, of Corinthian's schools were being investigated or placed on reimbursement status. Only the Bryman campus was subject to that sanction. Indeed, the TAC itself discredited the notion that the June 24 disclosure revealed company-wide manipulation of student enrollment, by describing the June 24 disclosure as revealing to investors "the potential but real risk of all 88 colleges being placed on reimbursement status, which would have delayed Title IV funding and increased accounts receivable by up to $ 135 million company-wide." But neither Daou nor Dura supported the notion that loss causation is pled where a defendant's disclosure reveals a "risk" or "potential" for widespread fraudulent conduct. In Daou the defendant disclosed that the company actually had $ 10 million in unbilled receivables, not merely that there was some risk it might accrue such receivables. Moreover, as Corinthian noted, its stock recovered very shortly after the modest 10% drop that accompanied the June 24 announcement.

The TAC's characterization of the August 2 earnings announcement similarly failed to allege that the market became aware of, and the resulting stock drop resulted from, widespread enrollment fraud. At best, the TAC contended that the reference in the August 2 announcement to "higher than anticipated attrition" was understood by the market as Corinthian's "euphemism for an admission that they had enrolled students who should not have been signed up at all, resulting in a 45% stock drop." Metzler's appellate brief asserted that the August 2 disclosure made investors "realize[ ] that Corinthian's improper manipulation of student and enrollment records was not limited to [the Bryman campus at] San Jose, nor was it immaterial." But the TAC did not allege facts to suggest that on August 2 the market became aware that Corinthian was manipulating student records company-wide, other than an undocumented assertion that Corinthian's August 2 stock drop was, by necessity, a result of this market "realization." 

Finally, while the court assumed that the facts in a complaint are true, it was not required to indulge unwarranted inferences in order to save a complaint from dismissal. The TAC's allegation that the market understood the June 24 and August 2 disclosures as a revelation of Corinthian's systematic manipulation of student enrollment was not a "fact." It was an inference that Metzler believed was warranted from the facts that are alleged. But Corinthian persuasively explained why this was not the case. As to the June 24 disclosure, Corinthian pointed out that its stock quickly recovered from the 10% drop that followed the Financial Times story. Similarly, the August 2 announcement contained a far more plausible reason for the resulting drop in Corinthian's stock price--the company failed to hit prior earnings estimates. The August 2 announcement simultaneously reported that student population growth was up nearly 50% overall and same-school population increased 15%, making it even further unwarranted to infer that the reference to "attrition" was understood by the market to mean that Corinthian had revealed widespread misrepresentation of student enrollment to fraudulently procure excess federal funding. The TAC thus failed to allege loss causation based on the June 24 and August 2 disclosures.