In Retail Wholesale & Department Store Union Local 338 Retirement Fund v. Hewlett-Packard Co., 2017 U.S. App. LEXIS 955 (9th Cir. Jan. 19, 2017), the United States Court of Appeals for the Ninth Circuit addressed for the first time whether an undisclosed violation of a company’s code of ethics can support a claim of securities fraud. The Ninth Circuit held that general pronouncements that a company seeks to adhere to high ethical standards, despite the later revelation that the company’s chief executive officer failed to meet those standards, cannot support a claim. The Court observed that in order to support a claim for securities fraud, a statement must be capable of being shown to be “objectively false,” and noted that general, aspirational statements about adhering to corporate ethical standards are akin to immaterial puffery. A contrary result, the Court explained, would turn every instance of wrongdoing by corporate employees into a securities case. This decision reconfirms the Ninth Circuit’s strict application of the heightened pleading standards applicable in securities cases.

In 2006, Hewlett-Packard (“HP”) became embroiled in a scandal arising from whistleblower claims that, to identify the source of leaks internal company information to the press, the company had hired detectives to monitor the phone records and email accounts of HP directors, HP employees, and journalists. The scandal resulted in HP bringing criminal charges against the company’s former general counsel and chairwoman of the board. The resolution of the scandal bolstered the reputation for integrity of Mark Hurd, HP’s chief executive officer. The scandal also caused HP to redouble its efforts to improve HP’s corporate code of ethics and resulted in the company touting the integrity of its management and business practices.

Years later, in 2010, Mr. Hurd resigned from the company after internal investigations revealed various ethical lapses. Mr. Hurd misrepresented the sexual nature of his relationship with a former independent contractor, lied to investigators and doctored expense reports to conceal his relationship. In a press release after Mr. Hurd’s resignation, HP and Mr. Hurd acknowledged Mr. Hurd’s violation of the company’s code of ethics. After Mr. Hurd’s resignation, HP’s stock price dropped. The drop in HP’s stock price resulted in several securities fraud actions being filed against the company.

Prior to Mr. Hurd’s 2010 resignation, he made a series of statements concerning ethics at HP. For example, Mr. Hurd revised HP’s code of ethics to represent that HP’s employees “commit together, as individuals and as a company, to build trust in everything we do by living our values and conducting business consistent with the high ethical standards embodied in the [code of ethics].” HP published the code of ethics in the investor relations portion of HP’s website. HP also restructured its internal organization to create procedures and positions to improve compliance and ethical conduct. In addition, HP’s Chief Ethics and Compliance officer represented that ethics and compliance were a “competitive advantage” for HP.

HP’s code of ethics contained several provisions that were inconsistent with Mr. Hurd’s conduct. For example, HP represented that it maintained “accurate business records” and “create[ed] records that accurately reflect the truth of the underlying transaction or event,” but Mr. Hurd admitted to altering expense reports to hide his relationship. The code of ethics also contained general statements concerning HP’s honesty, cooperation with investigators, reporting of misconduct, anti-harassment and protection of confidential information.

The plaintiffs sued defendants for securities fraud based upon Mr. Hurd’s alleged failure to abide by HP’s code of ethics. Defendants moved to dismiss for failure to state claim. The United States District Court for the Northern District of California granted that motion, holding that plaintiffs had not alleged falsity or materiality. Plaintiffs appealed the decision to the Ninth Circuit.

On appeal, plaintiffs argued that defendants’ public statements about ethics, particularly the code of ethics itself, were demonstrably false because of the inconsistency between those norms and Mr. Hurd’s conduct. Separately, plaintiffs argued that HP had a duty to disclose Mr. Hurd’s ethical lapses. The Ninth Circuit rejected plaintiffs’ arguments and affirmed the lower court.

An alleged violation of an ethical code is not actionable because it cannot constitute a misrepresentation of fact. To be misleading, a statement must be capable of objective verification, but a lapse in violation of a purported aspirational standard is not objectively verifiable:

Defendants made no objectively verifiable statements during the Class Period. . . . [A] code of conduct is “inherently aspirational.” Such a code expresses opinions as to what actions are preferable, as opposed to implying that all staff, directors, and officers always adhere to its aspirations.

(citation omitted). A contrary interpretation, that a code of ethics can be measured for compliance, is untenable “as it could turn all corporate wrongdoing into securities fraud.” In sum, the code of ethics amounted to a representation that business ethics were important to the company. HP’s general promotion of business ethics was subjective and vague, and as a result, non-actionable.

As to materiality, the Court noted that the substance and publication of HP’s code of ethics was mandated by SEC rules. All public companies publish their ethical standards. Thus, HP’s decision to publish such information would not have been material because it would not have affected a reasonable investor’s decision to invest in HP.

Finally, the Court rejected the plaintiffs’ claim that HP was required to disclose Mr. Hurd’s alleged ethical lapses. HP’s aspirational statements of ethical compliance could not create a reasonable impression of full compliance. As a result, HP and Mr. Hurd had no duty to disclose Hurd’s misbehavior in violation of the code of ethics.

Hewlett-Packard curtails the ability of securities plaintiffs to rely upon alleged violations of vague, aspirational corporate codes to plead securities fraud. To survive a motion to dismiss, plaintiffs must identify actual, testable and material statements of existing fact that are rendered “objectively false” by other contemporaneous facts. Plaintiffs failed to do so here.