Securities — Does LIFO or FIFO Apply in the Section 11 Traceability Context? — Since LIFO Is Used to Calculate Losses, Court Use It to Determine Traceability (First Impression)
In re LendingClub Secs. Litig.. 2017 U.S. Dist. LEXIS 174208 (N.D. Cal. )ct. 20, 2017):
ORDER RE CLASS CERTIFICATION
In this PSLRA action, lead plaintiff moves for class certification and to enjoin a parallel state action. Class representatives in the parallel state action move to intervene and, along with defendants, oppose class certification. For the reasons herein, lead plaintiff's motion for class certification is Granted. Lead plaintiff's motion for an injunction is Denied. State plaintiffs' motion to intervene is Conditionally Granted.
1. The Federal Action.
The background of this action has been set forth in a prior order (Dkt. No. 181). In brief, a number of putative class actions were filed in our district court on behalf of investors who purchased securities of defendant LendingClub Corporation in its initial public offering. The actions were consolidated and an order appointed Water and Power Employees' Retirement, Disability and Death Plan of the City of Los Angeles ("WPERP") as lead plaintiff (Dkt. No. 90). Remaining defendants [*7] include LendingClub, Renaud Laplanche (LendingClub's founder and former CEO), Carrie Dolan (LendingClub's former CFO), LendingClub directors and former directors, and the financial firms that underwrote LendingClub's IPO (Dkt. No. 126 at 5-6).
LendingClub acted as a so-called peer-to-peer lender. It operated an online marketplace that connected borrowers to investors. When a borrower and investor matched, LendingClub facilitated the loan and then acted as the loan servicer, earning fees for servicing and loan origination (Dkt. No. 126 at ¶¶ 29-30).
On December 11, 2014, LendingClub completed its IPO, selling more than 66.7 million shares of common stock at $15 per share. In connection with the IPO, it issued a registration statement, which it filed with the SEC. That statement included representations about LendingClub's internal control procedures for financial reporting, which stated that LendingClub had evaluated its disclosure controls and procedures and concluded that they were "effective at a reasonable assurance level." The registration statement further represented that LendingClub evaluated borrowers using "sophisticated risk assessment" processes and maintained an effective [*8] data-security program (Dkt. No. 126 ¶¶ 35, 57).
The registration statement also specified a 180-day "lock-up" period, beginning on December 11, 2014, during which only IPO shares were available to the public. When the lock-up period ended on June 9, 2015, both IPO and non-IPO shares became available on the open market (id. at 35, Dkt. No. 223 at 3).
WPERP began purchasing shares of LendingClub stock on May 4, 2015, and by the time the lock-up period ended on June 9, 2015, it owned 306,620 shares. WPERP continued thereafter to buy and sell LendingClub shares, never holding fewer than the 306,620 shares, eventually acquiring more than 1.7 million shares (Dkt. No. 231-1).
On May 9, 2016, less than eighteen months after the IPO and issuance of the registration form, LendingClub's CEO, Laplanche, resigned following "an internal review of sales of $22 million in near-prime loans to a single investor, in contravention of the investor's express instructions as to a non-credit and non-pricing element." LendingClub also reported that it had discovered that Laplanche had a financial stake in Cirrix Capital, L.P., a company formed for the sole purpose of purchasing LendingClub loans. One week later, LendingClub's [*9] quarterly report revealed that it had "identified material weakness," including a "[l]ack of transparent communication and appropriate oversight" in dealing with investors. These weaknesses resulted from "the aggregation of control deficiencies related to the Company's 'tone at the top,'" which deficiencies "also existed at the end of 2015" (id. ¶¶ 43, 105-06).
As these and other revelations of improprieties came to light, LendingClub's share price went into precipitous decline. Three securities actions were filed in federal court in San Francisco in June 2016. They were related to the undersigned judge, and later consolidated with WPERP appointed as lead plaintiff, and Robbins Geller Rudman & Dowd LLP as lead counsel (Dkt. Nos. 71, 90, 113). The consolidated complaint asserts claims under Section 11 and Section 15 of the Securities Act of 1933, and Section 10(b), Rule 10b-5, and Section 20(a) of the Exchange Act of 1934.
Lead plaintiff now moves for certification of a class consisting of:
All persons and entities who purchased or otherwise acquired the common stock of LendingClub Corporation ("LendingClub" or the "Company") during the period from December 11, 2014 through May 6, 2016, inclusive (the "Class Period"), and were damaged thereby, including [*10] those who purchased LendingClub common stock traceable to the Registration Statement (collectively, the "Class"). Excluded from the Class are defendants and their families, the officers, directors, and affiliates of defendants, at all relevant times, members of their immediate families and their legal representatives, heirs, successors or assigns, and any entity in which defendants have or had a controlling interest.
Defendant LendingClub and director defendants filed an opposition to the motion, which the remaining defendants join.
2. The State Action.
In February 2016, approximately three-and-a-half months before this action, a class action complaint was filed against LendingClub in the Superior Court of the State of California, County of San Mateo, alleging violations of Sections 11, 15, and 12(a)(2) of the Securities Act of 1933. In re LendingClub Corp. Shareholder Litig., Master File No. CIV537300 (Cal. Super. June 23, 2017). Like this action, the state action alleges LendingClub's registration statement contained misstatements and omissions concerning, inter alia, "material weaknesses in LendingClub's internal controls," "undisclosed related—party transactions," and the assumption of undisclosed but [*11] material credit and liquidity risks. The court in the state action certified a class in June 2017. Class Notice, however, remains unsent (Dkt. No. 227 ¶ 8; Exh. C ¶ 1).
On September 21, the date oppositions to class certification were due in the federal action, class representatives in the parallel state action moved to intervene for the limited purpose of opposing class certification of Sections 11 and 15 claims. They filed an opposition to class certification as an attachment to their motion to intervene. An order set the hearing on their motions for October 12, the same date as the hearing on this motion for class certification (Dkt. Nos. 222, 229).
All parties to both actions appeared at the October 12 hearing. This order follows full briefing and oral argument.
This order first addresses state plaintiffs' motion for intervention. It then turns to WPERP's motion for class certification, and finally addresses WPERP's motion to enjoin the state action.
State plaintiffs move for permissive intervention, and in the alternative for intervention as of right. For the reasons herein, permissive intervention is GRANTED subject to certain conditions.
For permissive intervention, the [*12] applicant need only show that (1) independent grounds for jurisdiction exist; (2) the motion is timely; and (3) the applicant's claim or defense shares a common question of law or fact with the main action. FRCP 24(b); In re Benny, 791 F.2d 712, 721-22 (9th Cir. 1986). Further, in exercising its discretion, the court should consider "whether the intervention will unduly delay or prejudice the adjudication of the original parties' rights." FRCP 24(b)(3).
WPERP opposes the motion to intervene only on the grounds of timeliness.
WPERP argues that state plaintiffs' motion is prejudicial because, by waiting to move until only three weeks before the hearing on class certification, they have denied WPERP any opportunity to take discovery that would aid WPERP in showing that it is better suited to protect the putative class (Dkt. No. 235 at 8). State plaintiffs' delay in bringing this motion, WPERP argues, was tactical. It forced WPERP either to respond without sufficient information, or to seek a continuance, which would have given state plaintiffs an opportunity to advance their case, including by distributing their class notice, which was approved on September 22 (but has not yet been sent). That notice, WPERP observes, would not inform class members [*13] of the existence of the federal suit (id. at 8-9).
Allowing the state plaintiffs to proceed and distribute notice, WPERP contends, will prejudice absent class members for a variety of reasons, chief among them that the state action's Sections 11 and 15 claims are capped at a much lower recovery amount than the federal action — a claim that state plaintiffs dispute (ibid.).
Though cognizant of the limited time WPERP had to respond to state plaintiffs' motion, this order finds that intervention is appropriate because absent class members will be best served by allowing state plaintiffs, who also purport to act in the putative class's best interest, to set forth their argument for why they are the better representative. WPERP had two weeks to prepare a response to state plaintiffs' opposition to class certification, which was adequate under these circumstances. Therefore, state plaintiffs' motion is timely for the limited purpose for which they seek to intervene.1
State plaintiffs' motion to intervene is therefore Granted on the condition that they remain under this Court's jurisdiction so that the undersigned judge may coordinate their action with the federal action to avoid any prejudice to absent class members. [*14]
To a limited degree, such coordination is already underway. At the hearing on this motion, state plaintiffs agreed they will participate in the settlement conference before Chief Magistrate Judge Joseph Spero on November 28, and have further assured the undersigned judge that they will not send class notification until this order issued. Moreover, state plaintiffs agreed that they will not discuss settlement (except at the settlement conference) until the Supreme Court issues a decision in Cyan, Inc. v. Beaver Cty. Employees Ret. Fund, U.S. , 137 S. Ct. 2325, 198 L. Ed. 2d 754 (2017), which decision has the potential to jeopardize their case by revoking state court jurisdiction over Securities Act claims.
Certain additional requirements to state plaintiffs' intervention are set forth below in the section addressing WPERP's motion to enjoin the state action. Before addressing those conditions, however, this order first turns to WPERP's motion for class certification.
2. Class Certification.
The party seeking class certification bears the burden of first showing that it meets the four prerequisites of FRCP 23(a): (1) numerosity; (2) common questions of law or fact; (3) typicality; and, (4) adequacy. FRCP 23(b) sets forth three conditions under which, if the prerequisites of FRCP 23(a) are satisfied, a class action [*15] may be maintained. Class certification is appropriate if a plaintiff meets all the prerequisites of FRCP 23(a) and at least one condition of FRCP 23(b). Abdullah v. U.S. Sec. Assocs., Inc., 731 F.3d 952, 956-57 (9th Cir. 2013). Under FRCP 23(b)(3), the district court must find "that the questions of law or fact common to class members predominate over any questions affecting only individual members," and "that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy." The Supreme Court has "cautioned that a court's class-certification analysis must be rigorous and may entail some overlap with the merits of the plaintiff's underlying claim," Wal—Mart Stores, Inc. v. Dukes, 564 U.S. 338, 350, 131 S. Ct. 2541, 180 L. Ed. 2d 374 (2011); however, "[m]erits questions may be considered to the extent — but only to the extent — that they are relevant to determining whether the Rule 23 prerequisites for class certification are satisfied." Amgen Inc. v. Conn. Ret. Plans and Trust Funds, 568 U.S. 455, 464-65, 133 S. Ct. 1184, 185 L. Ed. 2d 308 (2013).
A. FRCP 23(a).
Defendants do not challenge certification based on the numerosity element. Here, plaintiff estimates that there are thousands of members in the proposed class based on the over 394 million outstanding shares of LendingClub common stock. This is sufficient to satisfy the numerosity requirement of FRCP 23(a)(1).
Defendants likewise do not challenge certification under FRCP 23(a)'s commonality requirement. [*16] To show commonality, a plaintiff "need not show . . . that every question in the case, or even a preponderance of questions, is capable of class wide resolution. So long as there is even a single common question, a would-be class can satisfy the commonality requirement of Rule 23(a)(2)." Parsons v. Ryan, 754 F.3d 657, 675 (9th Cir. 2014). Here, WPERP's allegations that investors were defrauded by the same misleading registration statement over the same period of time, and suffered similar losses as a result are sufficient to fulfill FRCP 23(a)'s commonality requirement.
Typicality is satisfied if "the claims or defenses of the representative parties are typical of the claims or defenses of the class." FRCP 23(a)(3). "The test of typicality is whether other members have the same or similar injury, whether the action is based on conduct which is not unique to the named plaintiff[ ], and whether other class members have been injured by the same course of conduct." Wolin v. Jaguar Land Rover N. Am., LLC, 617 F.3d 1168, 1175 (9th Cir. 2010) (quotations omitted). "Under the rule's permissive standards, representative claims are 'typical' if they are reasonably co-extensive with those of absent class members; they need not be substantially identical." Hanlon v. Chrysler Corp., 150 F.3d 1011, 1020 (9th Cir. 1998). Class certification is inappropriate, however, if a putative class representative [*17] is subject to "unique defenses which threaten to become the focus of the litigation." Hanon v. Dataproducts Corp., 976 F.2d 497, 508 (9th Cir. 1992).
Defendants argue that WPERP is atypical because it is subject to unique defenses based on its trading history. Specifically, defendants argue that WPERP cannot show that its shares are traceable to IPO purchases, a necessary element of a Section 11 claim. Defendants further argue that WPERP's Sections 10(b) and 11 claims are both subject to negative loss causation defenses that threaten to predominate over common questions and render their claims atypical. Each argument is addressed in turn.
To prove a violation of Section 11, a plaintiff must show the securities it purchased were issued under a materially false or misleading registration statement. In re Century Aluminum Co. Sec. Litig., 729 F.3d 1104, 1106 (9th Cir. 2013). If a company issues multiple rounds of stock under different registration statements, this requires proof that the plaintiff's shares are traceable to the misleading statement and not to an innocent one. Otherwise, the plaintiff has not been damaged, and has no standing to sue. Ibid. "The burden of tracing shares to a particular public offering rests with plaintiffs." In re Wells Fargo Mortg. Backed Certificates Litig., 712 F. Supp. 2d 958, 963 (N.D. Cal. 2010).
Here, LendingClub issued approximately 295 million shares via private offering to insiders prior to its [*18] IPO. These were not traded during the lock-up period. WPERP did not acquire any of these shares, nor were they connected with the allegedly misleading registration statement (see Dkt. 231-10).
LendingClub then issued 67 million shares in the IPO under an allegedly false registration statement, which issuance was followed by a lock-up period from December 11, 2014, to June 8, 2015, during which only IPO shares were available for purchase. WPERP purchased IPO shares beginning in May 2016, and acquired over 300,000 shares prior to the last day of the lock-up period (Dkt. No. 223 at 3). On June 9, 2015, private shares entered the open market, and were commingled therein with IPO shares.
Therefore, only shares that were purchased in the IPO or on the open market before June 9, 2015, are traceable to the allegedly misleading disclosure statement (absent an individualized showing that post-lock-up purchases were individually traceable to the IPO). This is so because "[i]f there is a mixture of pre-registration stock and stock sold under the misleading registration statement, a plaintiff must either show that he purchased his stock in the initial offering or trace his later-purchased stock back [*19] to the initial offering." Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 n.4 (9th Cir. 1999)
It is undisputed that WPERP did not purchase or own any privately issued shares during the six month lock-up period from December 2014 to June 9, 2015. At the end of the lock-up period it owned 306,620 shares, and its holdings never dropped below this number (Dkt. No. 231-1). It is likewise undisputed, however, that WPERP traded in the post-lock-up market. In fact, it purchased and sold hundreds of thousand more shares during the post-lock-up period than it had purchased in the lock-up period (ibid.).
As a result of the post-lock-up commingling, defendants argue that WPERP cannot trace its current shares to the allegedly misleading registration statement and, therefore, lacks standing. They observe that our court of appeals has strictly construed the tracing requirement. In In re Century Aluminum Co. Sec. Litig., 729 F.3d at 1106, for example, our court of appeals held that where a plaintiff purchased stock in a mixed market (i.e., one containing both shares issued under the misleading statement and shares not alleged to be misleading) it could prove traceability in only one of two ways: (1) by showing it purchased directly in the allegedly misleading issuance, or (2) by tracing chain of title from later purchased [*20] shares back to the allegedly misleading issuance. Ibid. Further illustrating this strict requirement, the court in In re Quarterdeck Office Sys., Inc. Sec. Litig., No. CV 92-3970-DWW(GHKX), 1993 U.S. Dist. LEXIS 19806, 1993 WL 623310, at *2 (C.D. Cal. Sept. 30, 1993) (Judge David Williams) held that though the plaintiff purchased stock in a market containing 97 percent shares issued under the misleading statement, this was not enough to show traceability because its shares could have come from the innocent three percent. Traceability, it held, is not a matter of probability, but rather is construed literally and requires a showing that the shares purchased were actually the offending shares. 1993 U.S. Dist. LEXIS 19806, [WL] at *3.
These decisions, though they illustrate the strict application of Section 11's traceability requirement, are inapposite here. It is uncontested that WPERP purchased shares issued under the allegedly misleading registration statement before they were commingled with any other shares. Nobody argues otherwise and, therefore, probability does not enter into the analysis. The only question is whether WPERP retained the shares.
This, in turn, presents the question of which accounting treatment those shares should be given. WPERP correctly observes that if its transactions are afforded "last-in, [*21] first-out" ("LIFO") treatment, all of its holdings as of June 8, 2015 would remain traceable to the lock-up period (Reply at 2). If, on the other hand, the first-in, first-out ("FIFO") method is used, WPERP will be deemed to have owned no traceable shares by the corrective disclosure date.
Whether LIFO or FIFO applies is a matter of first impression in the Section 11 traceability context. In the somewhat different context of calculating estimated losses under the PSLRA, however, the majority of courts in our district have preferred the LIFO method. See Bodri v. GoPro, Inc., No. 16-CV-00232-JST, 2017 U.S. Dist. LEXIS 66188, 2016 WL 1718217, at *3 (N.D. Cal. Apr. 28, 2016) (Judge Jon Tigar) ("While the Ninth Circuit has declined to endorse a particular method" to determine which party has the greatest financial stake, "the weight of authority puts the most emphasis on the competing movants' estimated losses, using a 'last in, first out' ("LIFO") methodology.") (citations and quotations omitted); see also Nicolow v. Helwett Packard Co., No. 12-05980 CRB, 2013 U.S. Dist. LEXIS 29876, 2013 WL 792642, at *4 (N.D. Cal. Mar. 4, 2013) (Judge Charles Breyer); Perlmutter v. Intuitive Surgical, Inc., No. 10-CV-03451-LHK, 2011 U.S. Dist. LEXIS 16813, 2011 WL 566814, at *11 (N.D. Cal. Feb. 15, 2011) (Judge Lucy Koh); Richardson v. TVIA, Inc., No. C 06 06304 RMW, 2007 U.S. Dist. LEXIS 28406, 2007 WL 1129344, at *4 (N.D. Cal. Apr. 16, 2007) (Judge Ronald Whyte).
It would be incongruous to measure losses by one method, yet measure traceability by the opposite method. A lead plaintiff [*22] who suffered the greatest losses under a Section 10(b) claim might also be deemed to lack standing under a Section 11 claim based on such an incongruity. Accordingly, this order finds that the LIFO method, preferred for determining estimated loss, is likewise best suited to determine the number of IPO shares retained. Using this method, WPERP has demonstrated that it retained over 300,000 shares from the end of the IPO-period until the date it filed suit and, therefore, will not be subject to defendants' unique standing defense.***
1 State plaintiffs have met the additional requirements of permissive intervention — independent grounds for jurisdiction, and common claims — which WPERP has not opposed.
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