The United States Court of Appeals for the Ninth Circuit recently answered a question explicitly left open by its earlier precedent: Can the announcement of an SEC investigation form the basis for a viable loss causation theory in a securities class action if the complaint also alleges a subsequent corrective disclosure by the defendant?

In Jacksonville Pension Fund v. CVB Financial Corporation, No. 13-56838 (9th Cir. Feb. 1, 2016), the court held that loss causation was sufficiently pleaded at the motion to dismiss stage when the complaint alleged both the announcement of an SEC subpoena regarding its loan underwriting methodology and a subsequent disclosure by the company that it was charging off millions in loans from its largest borrower. The opinion is important because it clarifies the standard for loss causation in class action suits arising from stock drops following the announcement of a governmental investigation, even though the announcement itself may not reveal that the company has engaged in any wrongdoing.

In the case, the complaint alleged that early in 2010, the Garrett Group, a commercial real estate company, informed the defendant, CVB Financial Corporation (CVB), that it could not make required payments on loans issued by CVB and that it was contemplating bankruptcy. CVB nonetheless included in two SEC filings—its March 4, 2010 10-K and May 10, 2010 10-Q—a statement that there was no basis for "serious doubt" about Garrett Group's ability to repay. After an announcement that the SEC had served a subpoena on CVB seeking information about its loan underwriting methodology, CVB stock lost 22 percent of its value. A month later, CVB wrote down $34 million in loans to Garrett and recharacterized an additional $48 million as impaired. The stock price barely moved on the subsequent announcement, which an analyst characterized as "removing a major component of uncertainty in regards to problem loans." Two securities fraud actions were brought in the United States District Court for the Central District of California. After consolidation, the district court dismissed the Second Amended Complaint with leave to amend. The plaintiffs chose to appeal instead of further amending the complaint.

In its recent decision, the Ninth Circuit reaffirmed its earlier holding in Loos v. Immersion Corp., 762 F.3d 880 (2014), that "the announcement of an investigation, standing alone and without any subsequent disclosure of actual wrongdoing, does not reveal to the market the pertinent truth of anything, and therefore does not qualify as a corrective disclosure." Loos, 762 F.3d at 890 (quotation omitted). The Loos court left open the question of whether the announcement of an investigation followed by a related adverse disclosure could be sufficient to plead loss causation. Jacksonville Pension Fund holds that the answer to that question is yes. The Ninth Circuit held that the plaintiffs adequately pleaded loss causation by alleging: (1) the disclosure of an SEC investigation that caused a stock price drop; (2) market perception that the subpoena was related to alleged misstatements about the Garrett loans; and (3) a subsequent corporate disclosure confirming the market's concerns about the loans. Therefore, the court in Jacksonville Pension Fund held that the plaintiffs alleged a sufficient causal connection between the alleged misstatements in the SEC filings and the losses sustained by the putative class, even though CVB's disclosure of its write-off of loans caused very little movement in its stock price. In effect, the market's strong reaction to the SEC subpoena and muted reaction to the subsequent disclosure indicated that some part of the initial stock drop was plausibly connected to the market's concerns about the loans.

Going forward, the Jacksonville Pension Fund decision may allow plaintiffs to survive motions to dismiss on loss causation grounds when they plead an announcement of an investigation, a subsequent company disclosure, and facts (including, for example, analyst reports) sufficient to allege that the market considered the investigation to be related to potential misstatements later corrected by the company's disclosure—even if the subsequent disclosure itself does not result in a stock price drop.