As I discussed in a recent post (here), the Ninth Circuit recently reversed in part the district court’s dismissal of the Google+ user data-related securities class action lawsuit. One feature of the decision that perhaps did not attract as much attention is the appellate court’s reversal of district court’s dismissal of the plaintiff’s scheme liability claims. In the following guest post, Bruce Vanyo and Jonathan Rotenberg discuss the significance of the scheme liability portion of the Ninth Circuit’s opinion. Bruce and Jonathan are partners in the Securities Litigation practice at Katten Muchin Rosenman LLP, resident in the New York office. I would like to thank Bruce and Jonathan for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.

 

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As previously discussed here, the Ninth Circuit’s recent decision in In re Alphabet, Inc. Securities Litigation, 2021 WL 2448223 (9th Cir. 2021) (“Alphabet II”), could give new life to securities fraud claims arising out of cybersecurity incidents.  The decision may, however, ultimately be even more significant for public companies, practitioners, and courts, for the way in which it applied Lorenzo v. Securities and Exchange Commission, 139 S.Ct. 1094 (2019) (“Lorenzo”) to revive the plaintiff’s “tacked on” scheme liability claims.  It is this potential ramification of Alphabet II that we would like to address.

 

The Lorenzo Decision

Most federal securities claims arise under subsection (b) of Rule 10b-5, which generally prohibits false or misleading statements or omissions of material fact.[1]  Subsections (a) and (c) of Rule 10b-5, which prohibit schemes or practices to defraud, respectively, traditionally receive less attention in civil litigation.  Historically, this was because many Circuit Courts had ruled that claims based upon alleged misstatements or omissions could not also be brought under these provisions.[2]  In 2019, Lorenzo abrogated these decisions and held that false or misleading statements or omissions could also form the basis of scheme liability under subsection (a) of Rule 10b-5.  Still, given the duplicative nature of these types of scheme liability claims, there were questions about how much leeway future plaintiffs would receive in pleading omissions or misstatements as a factual basis for a 10b-5(a) claim.

 

The Alphabet Litigation

Since it was decided, Lorenzo has remained relatively “under the radar” in the universe of 10b-5 litigation.  Before last week, only seven appellate decisions cited to the case, and only one discussed Lorenzo in any detail.  Alphabet II could change that dynamic.  The case arose after the Wall Street Journal published an expose about security flaws in the Google+ social network—a product offering by Alphabet subsidiary Google.[3]  It soon emerged that Google executives were aware of the flaw, and failed to disclose it in quarterly filings in March and June of 2018.  When the price of Google shares fell, the class plaintiffs brought claims under Rule 10b-5(a), (b), and (c).[4]  The Rule 10b-5(b) claims alleged that Alphabet omitted material facts from its quarterly filings, while the 10b-5(a) and (c) claims alleged a fraudulent scheme to defraud shareholders by similarly withholding material and damaging information about the security flaw.[5]

 

Shortly after the plaintiffs filed their complaint, Alphabet moved to dismiss.  The trial court granted the motion.[6]  The court found that the plaintiffs failed to allege sufficient facts under controlling Supreme Court precedent to sustain a false statement claim under Rule 10b-5(b).[7]  Perhaps because neither party raised Lorenzo in their briefings, the court did not address the plaintiff’s claims under Rule 10b-5(a) or (c).  It simply dismissed all of plaintiff’s claims.

 

On appeal, the Ninth Circuit reversed.  Much of the opinion focuses on the sufficiency of the plaintiff’s pleadings in relation to the standards for Rule 10b-5(b), and the cybersecurity allegations at issue.  But the Ninth Circuit also relied on Lorenzo to revive the plaintiff’s scheme liability claims.[8]   The Ninth Circuit agreed with plaintiff that failing to raise Lorenzo in opposing the motion to dismiss did not waive the scheme liability claims, and that under Lorenzo, such claims could coexist with claims under Rule 10b-5(b).[9]  Even though the scheme liability claims were based upon the same allegations as the Rule 10b-5(b) claims that the Court discussed at length, the Ninth Circuit also criticized the district court for “sua sponte dismissing [these] claims” without any briefing on the issue. [10]

 

Key Takeaways

While the Ninth Circuit only briefly touched on Lorenzo in reinstating the scheme liability claims, its holding has significant implications for public companies, practitioners, and courts as well.  For public companies and their officers and directors, the Alphabet II decision—read alongside Lorenzo—means that even if a plaintiff fails to show the defendant made a false or misleading statement or omission for purposes of Section 10b-5(b), the plaintiff may still be able to proceed against the same or related statements under Section 10b-5(a) or (c).  For practitioners, even where a scheme claim is based on false or misleading statements, defense counsel must separately address the scheme liability claims in a motion to dismiss and cannot rely on its arguments against 10b-5(b) liability.  Similarly, courts are cautioned to analyze scheme liability claims separately in their decisions or run the risk of being reversed.

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[1] See 17 CFR §240.10b-5(b).

[2] See, e.g., WPP Luxembourg Gamma Three Sarl v. Spot Runner, Inc., 655 F.3d 1039, 1055-59 (9th Cir. 2011) (holding that omissions did not give rise to claims under Rule 10b-5(a) or (c).); Lentell v. Merrill Lynch & Co., 396 F.3d 161, 177 (2d. Cir. 2005) (same).

[3] See In re Alphabet, Inc. Securities Litigation, 2021 WL 2448223, at *1 (9th Cir. 2021).

[4] See id. at *6-7.

[5] See id.

[6] See In re Alphabet, Inc. Securities Litigation, 2020 WL 2564635, at *1 (N.D. Cal. Feb. 5, 2020) (White, J.) (“Alphabet I”).

[7] See id. at *5-6.

[8] See Alphabet II, 2021 WL 2448223, at *15.

[9] Id.

[10] Id.