In Curry v. Yelp Inc., 875 F.3d 1219 (9th Cir. 2017), the Ninth Circuit affirmed the dismissal of Plaintiffs’ securities fraud complaint and held that (1) the disclosure of consumer complaints, without more, cannot form sufficient basis for a viable loss causation theory, and (2) allegations of suspicious insider stock sales without allegations of historical trading data does not create a strong inference of scienter.
Yelp, Inc. (“Yelp”) runs a website that is supposed to contain “firsthand” and “authentic” reviews from contributors about local businesses. Yelp also generates revenue by selling advertising to many of those businesses. In April 2014, pursuant to a Wall Street Journal request, the Federal Trade Commission (“FTC”) disclosed more than 2,000 complaints claiming that Yelp had manipulated reviews of businesses. Some complaints alleged that Yelp removed good reviews or promoted bad reviews when businesses did not agree to advertise with them, and other complaints alleged that Yelp suppressed bad reviews for companies that advertised with them. Yelp’s stock declined 6% after the FTC disclosed the complaints.
Plaintiffs then sued Yelp for securities fraud alleging that the FTC’s disclosure of the complaints about the lack of independence and authenticity of posted reviews caused the drop in stock price, and that Yelp knew its statements about posted reviews were false. To state a claim for securities fraud, a plaintiff must allege, among other things, a material misrepresentation or omission of fact, scienter, and loss causation.
In attempting to establish scienter, Plaintiffs alleged that Yelp executives’ knowledge of core operations created a strong inference that they were at least reckless in their statements about Yelp’s reviews. In particular, Plaintiffs claimed that Yelp executives knew that Yelp reviews were not based on firsthand knowledge or were authentic because Yelp used filtering software, scouts to write initial reviews, and community managers to create content. Thus, according to Plaintiffs, Yelp executives knew or deliberately disregarded the practice of retaliating against businesses that declined to advertise on Yelp and to suppress negative reviews for a fee.
The Court, however, pointed to the well-settled rule that “corporate management’s general awareness of the day-to-day workings of the company’s business does not establish scienter … absent some additional allegation of specific information conveyed to management and related to the fraud....” S. Ferry LP, No. 2 v. Killinger, 542 F.3d 776, 784-85 (9th Cir. 2008). In this case, Plaintiffs did not allege that any Yelp executive had specific information about review manipulation nor did Plaintiffs allege that any Yelp executive personally oversee reviews or advertising sales. Accordingly, Plaintiffs’ complaint did not contain enough to support an inference of scienter.
Plaintiffs further alleged that the high volume of insider stock sales also supported a strong inference of scienter. However, for stock sales to be suspicious, they must be “dramatically out of line with prior trading practices ….” Ronconi v. Larkin, 253 F.3d 423, 435 (9th Cir. 2001). Here, Plaintiffs made no allegation of prior trading history and, thus, the allegations of insider stock sales alone were insufficient to create a strong inference of scienter.
With respect to loss causation, the Ninth Circuit reiterated that it is insufficient to allege “mere risk” or “potential” for fraud. Loos v. Immersion Corp., 762 F.3d 880, 889 (9th Cir. 2014). The Court compared the facts alleged against Yelp to the facts in Looswhere the mere announcement of an investigation was insufficient to establish loss causation. Plaintiffs’ allegations against Yelp relied on even less since they only relied on customer complaints without a subsequent investigation by the FTC. Thus, the Ninth Circuit concluded that “the element of loss causation cannot be adequately made out merely by resting on a number of customer complaints and asserting that where there is smoke, there must be fire.”
Because Plaintiffs’ allegations never actually went beyond the FTC’s disclosure of the complaints, Plaintiffs failed to adequately plead loss causation and scienter. Accordingly, the Ninth Circuit affirmed the dismissal of Plaintiffs’ securities fraud complaint.
This e-Bulletin was prepared by Jerry T. Yen. Mr. Yen is a Deputy Attorney General at the Office of the California Attorney General. The views expressed in this e-Bulletin are those of Mr. Yen and do not necessarily represent the views of the Office of the California Attorney General.