Ninth Circuit Provides Additional Case Law on Determining Loss Causation in Securities Class Action

On April 5, 2024, the Ninth Circuit reaffirmed that, in determining loss causation, an artificial inflation is not merely a price increase, but a change in the natural course of the stock price that is more beneficial for the defendants than if the misstatement had not been made.  Overall, Plaintiffs won an appeal in the Ninth Circuit, which also found that statements conveying a false impression—i.e., that its stock prices were not manipulated even though it hired a stock promoter—were actionable and that the truth can be revealed by certain public information and seemingly good news.  The securities class action complaint was filed on August 18, 2020, in the Central District of California against Genius Brands International, Inc. for violations of Sections 10(b) and 20(a) of the Securities Exchange Act and implementation of Rule 10b-5(a - c).  In re Genius Brands Int'l, Inc. Sec. Litig., 97 F.4th 1171, 2024 BL 117266 (9th Cir. 2024) (Mendoza, J.).

Genius Brands International, Inc. is a “children’s entertainment company” that produced the show, Rainbow Rangers.  Id. at *1.  Allegedly, Genius concealed using a stock promoter, touted an investment from Arnold Schwarzenegger, exaggerated the weekly airtime for Rainbow Rangers on Nickelodeon Jr., retweeted speculations that Disney or Netflix would acquire Genus, and overstated its rights to the Stan Lee Universe.  Id. at *1-4.  The District Court dismissed all claims with prejudice on the bases of falsity and loss causation.  Id.

The Ninth Circuit found Defendant’s statement that it had not hired anyone to solicit purchases of its securities was misleading under falsity or omission theory.  Id. at *6-7.  The District Court found that the claim failed since the promoter’s articles did not contain anything false or misleading within them.  Id. at *4. However, the Ninth Circuit found that the promoter’s writing and disseminating of favorable articles in exchange for stock compensation amounted to being hired to promote stock purchases, thus, rending Defendant’s statement false.  Id. at *6-7.  Under the omission theory, the District Court found that there was no duty to disclose the relationship.  Id. at *4.  Although the Ninth Circuit agreed that the relationship itself didn’t create a duty, the Defendants created a duty to disclose when “Genius was not silent; it affirmatively represented…that it had not “paid or agreed to pay to any Person any compensation for soliciting another to purchase any other securities of the Company.”  Id. at *7.

On loss causation, the Ninth Circuit emphasized that loss causation requires a showing of artificial inflation, not price increase.  Id. at *10 (“initial price inflation and initial price increase are not one and the same”).  In other words, artificial inflation is when the price was higher “than it would have been had the false statements not been made,” and this can be shown by a price increase, the price remaining stable when it should have dropped, or the price decreasing at a lower rate.  Id.  The Ninth Circuit also found that the truth can be revealed by:

•    a third-party report premised on public information—i.e., Nickelodeon Jr.’s broadcast schedule that updated nearly daily—where that information was not “readily digestible” for investors until it was synthesized by the third-party (Id. at *11-12)
•    a “plainly good, albeit inaccurate, news”—i.e., a tweet about jointly owning the Stan Lee Universe—where that information was preceded by an expectation of different good news—i.e., Defendant retweeting a speculative article about a Disney or Netflix buyout and days later touting a “key business development” would be revealed (Id. at *13-14)

However, the Ninth Circuit affirmed the District Court’s finding that the false tweet that Schwarzenegger was investing in the Defendant lacked loss causation because the deception was never revealed to the market.  Id. at *8-9.  This circumstance was distinct from the Disney/Netflix buyout issue because a disclosure about compensating Schwarzenegger for work did not negate the possibility that Schwarzenegger may still be investing.  Id. at *8-9.

Thus, the Ninth Circuit remanded the case back to the district court to determine the sufficiency of the remaining elements.