Jacksonville Pension Fund v. CVB

When proving scienter under section 10(b) of the Securities Exchange Act, hearsay is not automatically discounted from consideration of whether the statement is sufficiently reliable for pleading purposes.

The Garrett Group was a commercial real estate company whose largest creditor was CVB Financial Corporation (CVB). Garrett faced financial trouble and twice told CVB they couldn’t meet their financial obligations and were contemplating filing bankruptcy. During this time CVB told the SEC that there was no foundation for “serious doubt” as to Garrett’s ability to pay their loans. A month after CVB was served with a subpoena seeking information about CVB’s loan underwriting and credit loss, CVB wrote down and placed in its non-performing group all of Garret’s loans. A class action was brought against CVB, alleging, in part, violations of section 10(b) of the Securities Exchange Act. The district court granted CVB’s motion to dismiss, holding that the complaint did not allege facts sufficient to show that CVB’s statements were knowingly or reckless false or caused injury to stockholders. The elements of a securities fraud action under section 10(b) are: “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission by the defendant; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” The SAC argued that CVB’s statements to the SEC that there was no basis for serious doubts about Garret’s ability to pay was false, however the district court discounted these allegations because they involved hearsay. The On appeal, the Ninth Circuit held that a hearsay statement doesn’t inevitably prohibit it from scienter consideration, finding that CVB’s assertion in its SEC filings that it wasn’t aware of serious credit issues of their borrowers were sufficiently reliable for pleading purposes. The panel then held that CVB’s statements were a misrepresentation because CVB knew there was a basis for serious doubts about Garret’s capability to repay the loans. AFFIRMED IN PART, REVERSED IN PART, AND REMANDED.