In In re Century Aluminum Co. Securities Litigation, No. 11-15599, 2013 U.S. App. LEXIS 24 (9th Cir. Jan. 2, 2013), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a claim for violations of Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k, on the ground that plaintiffs’ “tracing” allegations did not meet the pleading standard set forth in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009) (the “Twombly/Iqbal standard”). The Court held that plaintiffs who purchased their shares in the aftermarket must plead facts with “sufficient specificity” to allow the court to draw a “reasonable inference” that their shares can be traced back to those that were issued under the allegedly false and misleading offering materials. This decision marks the first time the Ninth Circuit has applied the heightened Twombly/Iqbal standard to tracing allegations in a Section 11 case.
Plaintiffs’ allegations centered on their January 2009 purchase of shares of common stock of Century Aluminum Company (“Century Aluminum”). Prior to January 2009, more than 49 million shares of Century Aluminum common stock were outstanding and trading in the public markets. On January 28, 2009, Century Aluminum issued a prospectus supplement in connection with its secondary offering of another 24.5 million shares of common stock.
Two months later, Century Aluminum restated its cash flows from operating activities. Investors in Century Aluminum shares sued, alleging that the prospectus supplement was “materially false and misleading” in violation of Section 11. Although plaintiffs acknowledged that they purchased their shares in the secondary or “aftermarket,” they alleged summarily that the shares they purchased were issued as part of — and thus could be “traced” to — the secondary offering.
The United States District Court for the Northern District of California dismissed plaintiffs’ Section 11 claim with prejudice, holding that their “naked allegations” that the shares they purchased were issued in the secondary offering were not sufficient to give them standing to assert a Section 11 claim. In re Century Aluminum Co. Sec. Litig., 2011 U.S. Dist. LEXIS 21406 (N.D. Cal. Mar. 3, 2011). Plaintiffs appealed.
The Ninth Circuit affirmed. The Court observed that, as a matter of settled law, plaintiffs alleging the sale of securities under a materially false or misleading registration statement in violation of Section 11 must have either directly purchased their shares in the offering or be able to trace the shares they purchased in the aftermarket back to the offering. See Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999). As plaintiffs here conceded that they purchased their shares in the aftermarket, they bore the burden of adequately pleading that their shares could be traced back to the offering made pursuant to the allegedly false and misleading January 28, 2009 prospectus supplement.
The Court held that plaintiffs’ complaint did not sufficiently plead tracing under the Twombly/Iqbal standard. Under the Twombly/Iqbal pleading standard, a complaint’s factual allegations must indicate that the claim has “at least a plausible chance of success” by alleging with sufficient specificity “factual content” that allows the court to “draw the reasonable inference” of the defendant’s liability. The degree of specificity necessary to support such an inference will depend upon the nature and context of the case.
Here, the Court held, a higher level of specificity was required to support a reasonable inference of liability because Century Aluminum had issued shares in multiple offerings under more than one registration statement, and tracing shares purchased aftermarket in such a situation is “often impossible.” The Court explained that for factual specificity to give rise to a reasonable inference of traceability, plaintiffs needed to plead facts tending to disprove “obvious alternative explanations.”
Plaintiffs alleged that the secondary offering shares flooded the market and caused a sharp spike in trading volume and a sharp drop in price. They asserted that their purchases of shares while those market changes were occurring indicated that their shares must have come from the secondary offering pool. The Court disagreed, noting that those facts were equally consistent with the possibility that plaintiffs’ shares were from the pool of previously issued shares. The Court held that the facts alleged remained in “neutral territory” as they were equally consistent with the possibility that the plaintiffs’ order had been filled with previously issued shares. Because plaintiffs’ allegations did not tend to exclude these alternative explanations, they were insufficient to satisfy the Twombly/Iqbal standard.
The Ninth Circuit’s decision here makes it much more difficult for an aftermarket purchaser of shares to assert a Section 11 claim. It essentially establishes a presumption against tracing, rebuttable at the pleading stage only by specific factual allegations making it more likely than not to infer that plaintiffs’ shares came from the subject offering. This will be a tough standard for Section 11 plaintiffs to satisfy.