Tracing Meets Twombly: Ninth Circuit Sets Section 11 Pleading Standards For Aftermarket Purchasers

In a precedent setting decision, the Ninth Circuit affirmed dismissal of a putative class action in In re Century Aluminum Co. Securities Litigation, significantly raising the pleading bar in Section 11 cases. Plaintiffs alleged that Century Aluminum and its underwriters, Credit Suisse and Morgan Stanley, issued false and misleading statements in connection with a secondary offering. The Ninth Circuit applied the Twombly/Iqbal “plausibility” standard, holding that those decisions no longer make it possible for plaintiffs to simply allege without plausible supporting facts that their shares can be “traced” back to a secondary offering. The court’s decision in Century Aluminum may mean that Ninth Circuit plaintiffs filing suit under Section 11 who rely on aftermarket purchases, and cannot otherwise plead plausible facts they purchased in the secondary offering itself, face a near impossible uphill battle at the pleading stage when alleging tracing.

Section 11 provides a remedy to shareholders who purchase securities under “a materially false or misleading registration statement.” When shares are issued under only one such registration statement, this tracing requirement is not a problem. However, when shares are issued under multiple registration statements, tracing back to the allegedly misleading registration statement can be extremely difficult. The court acknowledged that tracing to a secondary offering is “often impossible,” but noted that the tracing requirement “is the condition Congress has imposed for granting access to the ‘relaxed liability requirements’ that Section 11 affords.”

Century Aluminum issued 49 million shares in an Initial Public Offering that were already trading when plaintiffs purchased their shares. In a prospectus supplement on January 28, 2009, an additional 25 million shares entered the market. Plaintiffs alleged they had standing to pursue a Section 11 claim because they “purchased Century Aluminum Common Stock directly traceable to the Company’s Secondary Offering.” In support of their tracing theory, plaintiffs argued that their shares were purchased on dates that showed sharp spikes in trading activity, indicating the flood of new shares as a result of the allegedly misleading prospectus supplement.

The court found that after Twombly and Iqbal, in addition to providing fair notice, allegations must suggest that the claim “at least has a plausible chance of success.” In holding that such bare-bones allegations fail, the court relied on “experience and common sense,” which ordinarily “tell[s] us that when a company has offered shares under more than one registration statement, aftermarket purchasers will not be able to trace their shares back to a particular offering.” Because of this, the court determined that “plaintiffs had to allege facts from which we can reasonably infer that their situation is different.” It is no longer sufficient for plaintiffs to allege facts that are merely consistent with the shares being traceable to the registration statement in question. Rather plaintiffs must now plead facts that “tend to exclude the possibility that [plaintiff’s] shares come from the pool of previously issued shares.” The court found that it was equally likely that the shares came from the pool of previously issued shares. Even where one plaintiff argued that he had directed his broker to buy from the pool of newly issued shares, the court found that it was equally likely the broker had purchased shares that were already held from the original offering.

Defendants in Section 11 cases in the Ninth Circuit will now have a powerful new weapon that will enable most cases alleging only aftermarket purchases to be dismissed at the pleading stage.