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Court Allows Volkswagen Bondholder Action to Proceed, But Expresses Doubts about the Plaintiff’s Ability to Certify a Class

As we previously noted in this post, the United States District Court for the Northern District of California dismissed the Volkswagen Bondholder Plaintiff’s first amended complaint, with leave to amend, holding that it could not rely on the Affiliated Ute or Basic presumptions to plead reliance, and that it had not sufficiently pleaded direct reliance. On April 2, 2018, the Plaintiff filed a Second Amended Bondholder’s Class Action complaint (SAC), which added allegations: (1) of direct reliance, (2) that the bonds at issue were priced and traded on an efficient market, (3) that the defendants’ alleged fraud created the market, and (4) that Volkswagen committed fraud on the regulatory process. On September 7, 2018, the court denied the defendants motion to dismiss, and ruled that that the case may proceed to discovery, but also expressed concerns about the Plaintiffs’ ability to certify a class.

The court first held that the Plaintiff had cured the deficiency in its direct reliance allegations by pleading that its authorized investment advisor, acting with complete investment discretion, had reviewed and relied upon the alleged omissions and misrepresentations contained in the relevant Offering Memorandum. The court concluded that these allegations answered the basic “who, what, when, where, and how” needed to Satisfy Rule 9(b). Specifically, the court noted that the new allegations support claims that: (1) the Plaintiff’s investment advisor was acting as an authorized agent of the Plaintiff; (2) the Plaintiff, through is agent, reviewed and relied upon the alleged omissions and misrepresentations made by the defendants; (3) the investment advisor read these statements before executing the bond purpose; and (4) the investment advisor relied on the statements by considering them before executing the bond purchase.

Having found that the Plaintiff had plausibly alleged direct reliance on the statements at issue, the court noted that it was not necessary to address whether any of the three presumptions of reliance offered by the Plaintiff was also appropriate in this case. However, the court elected to consider and discuss these presumptions, particularly because the parties had submitted extensive briefing on the question, and because it is likely that the Plaintiffs will have difficulty proving direct reliance on a class-wide basis (i.e. that the entire class relied on misstatements through investment advisors).

The Court first addressed whether the SAC plausibly alleged reliance by way of the “fraud on the market” presumption under Basic Inc. v. Levinson. In the SAC, the Plaintiff added allegations that the bonds’ original price was dependent on a number of factors, including the risk profile of Volkswagen, the credit rating of Volkswagen and the bonds, and the comparative yield of the bonds versus other investment-grade bonds. In addition, the Plaintiff alleged that these price-determinative factors reflected all publicly available information that was material to investors. The court found that the Plaintiff had again failed to plausibly plead that the bonds traded in an efficient market because, even taken as true, the new allegations did not support the Plaintiff’s position that it purchased an actively traded bond; rather the Plaintiff alleged that it purchased the VWGoAF bonds directly from two investment banks in a Rule 144A private placement, not by trading in any market.

The SAC also attempted to invoke a “fraud created the market” theory, which presumes reliance when a market for the securities that the plaintiffs purchased would not have existed but for the fraudulent scheme engaged in by the defendants. The Court first noted that this presumption has been criticized in many circuits, and that the Ninth Circuit had not adopted it. It then concluded that, even if the presumption were available, it would not be applicable in this case because “it is almost inconceivable that, but for the fraud, the credit markets would have completely shut out one of the world’s largest automakers.” The court emphasized that the price of the bonds at issue fell only 3.02% after the fraud was revealed, and were “far from worthless.” As a result, the Plaintiff had not established that the bonds at issue could not have been marketed at any price absent the fraud, a circumstance required for the fraud on the market presumption to apply.

The SAC also advanced the “fraud on the regulatory process” theory, which presumes reliance where the plaintiffs, in purchasing securities, relied at least indirectly on the integrity of the regulatory process and the truth of any representations made to regulatory agencies. The court acknowledged that circuits have differed in their determinations of the viability of the theory, but concluded that, even if the theory is still viable, it did not apply to the alleged misrepresentations related to the VWGoAF bonds. The court noted that the presumption is available only if the alleged misrepresentations are made directly to a regulatory agency such as the SEC, and concluded that the misrepresentations alleged by the Plaintiff were not made directly to such a regulatory agency, particularly because the bonds were exempt from registration with the SEC. The court rejected the Plaintiff’s assertion that the presumption should apply because the Defendants had misled regulatory agencies such as the EPA and CARB, noting that “there is no reason to believe that misrepresentations to EPA and CARB had any bearing on the viability of the bond offerings.”

The Plaintiff alternatively argued that it was entitled to a presumption of reliance under Affiliated Ute. That presumption is available to plaintiffs who allege violations of Section 10(b) and Rule 10b-5 based on omissions of material facts, and is based on a theory that proof of reliance in omission cases would otherwise require proof of a “speculative negative.” The court elected not to resolve the question of whether the Plaintiffs could invoke that presumption; it noted that Affiliated Ute was a case in which the predicate acts of fraud were omissions—not misstatements—and it highlighted the difficulty in reconciling Affiliated Ute with Ninth Circuit precedent in which the presumption was deemed available in a case that involved both misstatements and omissions. In declining to resolve the issue, the court noted that the question need not be answered at this stage in litigation, as the Plaintiff had plausibly alleged direct reliance.

Because the Plaintiff adequately pleaded direct reliance, the court denied the defendants’ motion to dismiss, and allowed the case to proceed with discovery. However, the court noted, and the parties acknowledged, that the Plaintiff may have difficulty proving direct reliance on a class-wide basis. Therefore, class certification is far from a foregone conclusion.  As a result investors may need to file individual actions to pursue claims associated with the Volkswagen Bonds at issue in this case.  Such investors will want to keep a close eye on the statute of repose, which is set to expire for the earliest transactions covered by the putative class in May of 2019.

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Joel D. Rothman

Special Counsel

Joel D. Rothman is an attorney who handles commercial, securities, insurance, and employment litigation matters for Mintz clients. Joel advises institutional investors on securities class actions, represents shareholders in merger disputes, and counsels insurers in coverage disputes.
Alain P. Mathieu is an attorney who handles civil litigation matters for public and private companies in a wide variety of industries. He also maintains an active pro bono practice. Before joining Mintz. Alain was a Summer Associate at the firm in 2016.