Metzler Investment GMBH v. Corinthian Colleges, Inc.
2008 WL 3905427, 2008 U.S. App. LEXIS 18226, 540 F.3d 1049 (2008)
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Rule of Law:
To state a claim for securities fraud under the Private Securities Litigation Reform Act (PSLRA), a complaint must allege with particularity that a corrective disclosure revealed the defendant's specific fraudulent conduct to the market, and that this revelation, rather than other negative business news, was the direct cause of the plaintiff's economic loss. The complaint must also plead facts giving rise to an inference of scienter that is at least as compelling as any opposing, non-fraudulent inference.
Facts:
- Corinthian Colleges, Inc. ('Corinthian'), a large operator of for-profit vocational colleges, derived the majority of its revenue from federal Title IV student aid funding.
- Metzler Investment GMBH ('Metzler') alleged that during the class period of August 27, 2003, to July 30, 2004, Corinthian engaged in a scheme to inflate its stock price by falsifying student enrollment, grades, and job placement data to maximize federal funding.
- During the class period, Corinthian's CFO Dennis Beal and CEO David Moore sold over $33 million in Corinthian stock, representing 100% of Beal's holdings and 37% of Moore's.
- In December 2003, the Department of Education ('DOE') began an investigation into financial aid practices at a single Corinthian campus in San Jose, California.
- On June 24, 2004, a Financial Times article reported on the DOE investigation, noting that it did not affect Corinthian's other schools.
- On July 21, 2004, Corinthian officials met with the California Attorney General regarding the company's business practices.
- On August 2, 2004, Corinthian issued a press release that lowered its earnings guidance, disclosed the meeting with the California AG, and attributed the poor performance to several factors, including 'higher than anticipated attrition'.
Procedural Posture:
- Metzler Investment GMBH filed a putative class action suit in the U.S. District Court against Corinthian Colleges, Inc., and several of its officers for securities fraud.
- The defendants filed a motion to dismiss, and the district court dismissed the Consolidated Amended Complaint without prejudice.
- The plaintiffs filed a Second Consolidated Amended Complaint, which the district court again dismissed without prejudice.
- The plaintiffs then filed a Consolidated Third Amended Complaint (TAC).
- The district court granted the defendants' motion to dismiss the TAC, this time with prejudice, for failure to state a claim.
- Metzler, as the appellant, appealed the dismissal to the U.S. Court of Appeals for the Ninth Circuit.
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Issue:
Does a securities fraud complaint satisfy the PSLRA's heightened pleading requirements for loss causation, scienter, and falsity when it alleges a stock price drop was caused by disclosures that only revealed a potential risk of misconduct and relies on generalized allegations of managerial awareness and insider trading to establish intent?
Opinions:
Majority - Fletcher
No. The securities fraud complaint fails to satisfy the PSLRA's heightened pleading requirements because it does not adequately plead loss causation, scienter, or falsity. For loss causation, the complaint must allege that the defendant’s share price fell significantly after the truth of the specific alleged fraud became known to the market. Here, the alleged corrective disclosures—a news article about an investigation at a single campus and an earnings announcement attributing poor results to 'attrition'—did not reveal the widespread enrollment and financial aid fraud that formed the basis of the complaint. The market's negative reaction is more plausibly attributed to the announced earnings miss rather than a 'euphemism' understood as a confession of fraud. The complaint also fails to raise a 'strong inference' of scienter, as the insider trading was not dramatically out of line with prior history, general allegations of a corporate information system do not prove knowledge of fraud, and an executive's ambiguous comment about working in a 'gray area' is not compelling enough. Finally, the allegations of falsity are too vague, conclusorily claiming that all positive financial statements were false without specifying with particularity why each statement was misleading when made.
Analysis:
This case significantly reinforces the formidable pleading barriers established by the PSLRA for securities fraud plaintiffs in the Ninth Circuit. The court's stringent application of the loss causation standard clarifies that plaintiffs cannot simply link a stock drop to any negative news and then argue it was a coded revelation of fraud; the disclosure must be directly related to the specific fraudulent scheme alleged. The analysis of scienter under the Tellabs standard demonstrates the court's willingness to weigh competing non-fraudulent inferences against the plaintiff's claims, making it difficult to survive a motion to dismiss with ambiguous allegations. The decision serves as a guide for how to fail at pleading a securities fraud case, emphasizing the need for highly specific, particularized facts connecting the alleged fraud, the defendants' state of mind, and the market's reaction.
