On November 21, 2017, the United States Court of Appeals for the Ninth Circuit affirmed a dismissal by Judge Jon S. Tigar of the United States District Court for the Northern District of California of a putative class action against Yelp, Inc. (“Yelp”) and three of its senior executives. Curry, et al. v. Yelp, Inc., et al., Case No. 16-15104 (9th Cir. Nov. 21, 2017). Plaintiffs brought claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”), alleging that Yelp made material misstatements regarding the authenticity and independence of the reviews posted by users on its website, and that those misstatements, when brought to light in media reports, caused Yelp’s stock value to drop. The district court dismissed with prejudice plaintiffs’ amended complaint, finding that plaintiffs failed to sufficiently allege material false statements, loss causation, and scienter. TThe Ninth Circuit affirmed the district court’s decision, concluding that plaintiffs failed to adequately allege loss causation and scienter. And holding that the amended complaint fell short of the “demanding standards set for claims of federal securities law violations.”

Plaintiffs’ allegations focused on statements made by Yelp—over several months in late 2013 to early 2014—that the reviews on its website were “firsthand” and “authentic.” On April 2, 2014, after the market had closed, The Wall Street Journal (“WSJ”) reported on certain disclosures from the Federal Trade Commission (“FTC”) that businesses had filed over 2,000 complaints against Yelp for tampering with reviews. According to plaintiffs, in some instances, these customer complaints contended that Yelp employees would remove good reviews, or promote bad reviews, depending on whether businesses agreed (or not) to advertise with Yelp. Plaintiffs alleged that the disclosure of these complaints and the release of the WSJ article had caused Yelp’s stock price to drop 6% that day. As such, plaintiffs alleged that Yelp’s statements that the reviews on its website were “authentic” and “independent” constituted material misstatements that were actionable under the Exchange Act.

The district court held that plaintiffs did not sufficiently plead material falsity because Yelp had previously publicly acknowledged that its screening of reviews was imperfect, and therefore “no reasonable investor could have understood Defendants’ statements to mean that all Yelp reviews were authentic.” The district court further found plaintiffs’ loss causation allegations lacking because plaintiffs did not allege that there was fraud on the market, but that there was only potential fraud, which does not meet the particularity requirements of the Private Securities Litigation Reform Act (“PSLRA”). In addition, the district court found plaintiffs’ allegations were insufficient to connect the drop in price of Yelp’s stock to the FTC disclosures that were reported by the WSJ—in part because the WSJ article was published after the market closed on the day that the alleged stock drop occurred—and that plaintiffs failed to sufficiently allege scienter against the individual defendants. Accordingly, because plaintiffs’ Section 10(b) claim failed, the district court found that plaintiffs’ derivative Section 20(a) claim similarly failed.

On appeal, the Ninth Circuit affirmed the decision of the district court, concluding that plaintiffs did not adequately plead loss causation or scienter. Regarding loss causation, the Ninth Circuit reaffirmed that to prove loss causation, the plaintiff “must demonstrate a causal connection between the deceptive acts that form the basis for the claim of securities fraud and the injury suffered by the plaintiff.” Here, plaintiffs alleged that the disclosure of the customer complaints and related WSJ article caused the drop in Yelp’s stock price as reported by various sources. Citing its decision in Loos v. Immersion Corp., 762 F.3d 880 (9th Cir. 2014), the Ninth Circuit held that “[a]lthough a securities fraud plaintiff need not allege an outright admission of fraud to survive a motion to dismiss, the ‘mere risk or potential for fraud is insufficient to establish loss causation.’” Accordingly, the customer complaints made to the FTC without a subsequent investigation fell short of “revealing” fraudulent practices to the market. The Court emphasized that under the PSLRA, “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.” Therefore, the Court affirmed the district court’s decision that the disclosure of customer complaints, some of which referred to allegations of fraud, were insufficient to allege loss causation.

Turning to the issue scienter, the Ninth Circuit affirmed the district court’s ruling for two separate reasons. First, in response to plaintiffs’ contention that the individual defendants’ high volume of insider sales supports a strong inference of scienter, the Court held that plaintiffs failed to produce any evidence of the individual defendants’ prior trading history, which is necessary when pleading scienter based on individual defendants’ stock trades during the putative class period. The Court emphasized that in order to support an inference of scienter, stock sales must be “dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.” Therefore, because plaintiffs failed to produce any evidence of the individual defendants’ prior stock sales, plaintiffs’ allegations were insufficient to establish scienter. Notably, the Court cited the publicly-filed Form 4s in the record which indicated that “the vast majority” of the individual defendants’ stock sales were made pursuant to a Rule 10b5-1 trading plan, which allows for stock sales over a predetermined period “without concern for the market.” Second, the Court held that the individual defendants’ alleged general awareness of the day-to-day business of the company, such as its advertisement sales practices, cannot, without more, establish scienter. In this regard, plaintiffs did not allege that any of the individual defendants had specific information regarding the alleged manipulation of reviews when they were trying to sell advertising and did not personally oversee reviews or have notice of how some advertising was garnered. The Court cited to the fact that the alleged 2,000 customer complaints represented a very small percentage of the 53 million reviews that Yelp maintained on its platform, which further undermined any inference of scienter. For these reasons, the Court found that plaintiffs did not meet the heightened pleading standards of the PSLRA.

Because plaintiffs’ Section 10(b) claim failed, the Ninth Circuit similarly affirmed the district court’s dismissal of plaintiffs’ derivative Section 20(a) claim against the individuals defendants. The Court also upheld the district court’s denial of plaintiffs’ request for leave to amend, holding that plaintiffs’ first amended complaint failed to address the deficiencies in their original complaint despite explicit warnings from the district court, and that it was “clear that further amendment . . . would be futile.”

This decision serves as an important reminder that plaintiffs must meet the heightened specificity requirements of the PSLRA in support of securities fraud allegations. Allegations that amount to “where there is smoke, there must be fire,” will not suffice. This decision also serves as a reminder that plaintiffs must specifically address the deficiencies found in prior pleadings when granted leave to amend and, when they fail to do so, courts often will not give them another bite at the apple.

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