Ninth Circuit Clarifies "Local Controversy" Exception in CAFA

Under the Class Action Farness Act, commonly referred to as CAFA, most class actions are subject to federal court jurisdiction.  One important exception is for so-called "local controversies."  In Mondragon v. Capital One Auto Finance (, the Ninth Circuit clarified the standard of proof required to invoke that exception.  The exception is generally invoked if two-thirds of the class members are citizens of the state in which the action is filed and the primary defendants are as well (there is another more complicated version of the exception where some defendants are and others are not citizens of the state where the action was filed).  Accordingly, establishing that two-thirds or more of the class members are citizens of the forum state is a critical component of invoking the exception.  The class plaintiffs bear the burden of proof. In Mondragon, class plaintiff presented no evidence as to the citizenship of the class members; rather, he argued that the exception self-evidently applied because the class was limited to persons who purchased automobiles in California for use and registration in the state.  The Ninth Circuit held that such an inference is improper.  Actual proof of the citizenship of the class is required, unless the class definition is specifically limited to citizens.

While the Court rejected Mondragon's attempt to establish the citizenship of two-thirds of the class with no evidence, the Court indicated that a would-be plaintiff might be able to rely on reasonable inferences and presumptions drawn from evidence submitted, for example that residence of a sufficient number of plaintiffs or proof of citizenship at an earlier point in time might suffice in some circumstances to meet the evidentiary burden.

Ninth Circuit Clarifies CAFA Issues

In Visendi v. Bank of America, NA (, a panel of the Ninth Circuit Court of Appeals clarified the application of the Class Action Fairness Act ("CAFA") in the context of a proposed "mass action."  In Visendi, well over 100 aggrieved borrowers sued more than a dozen different lenders alleging bad acts in connection with mortgage lending.  The defendant lenders sought to remove the mass action under CAFA which permits mass actions of over 100 plaintiffs to be removed to federal court provided certain requirements are met.  Upon arrival in federal court, the defendants immediately argued that the claims at issue where not sufficiently similar to be tried together -- in short, that most of the plaintiffs be dismissed for misjoinder under Rule 20.  The district court remanded, concluding that defendants had conceded that there was no mass action by arguing for misjoinder.  Accordingly, the district court reasoned, CAFA's mass action provisions could not apply to allow for federal court jurisdiction. Defendant lenders appealed.  The Ninth Circuit held that so long as plaintiffs proposed to hold a joint trial of all of the claims, CAFA's mass action rules did apply.  Defendants do not waive CAFA jurisdiction by simultaneously arguing misjoinder.  Accordingly, the Ninth Circuit reversed the remand.  Then, the Ninth Circuit held that the so-called "local controversy" exception to CAFA was not jurisdictional.  Accordingly, plaintiffs' failure to argue the exception below waived the issue.  This is a significant holding which requires plaintiffs to raise the local controversy argument early on or risk waiver.  Next, the Ninth Circuit agreed with defendants that the case did not present a proper mass action and that most plaintiffs were in fact misjoined.  Thus, most of plaintiffs were ordered dismissed from the action.

The case is significant because it allows defendants to attack a class action or mass action on a dual front -- first, bringing it to federal court under CAFA and then arguing that it is not a proper class or mass action -- while still maintaining CFA jurisdiction in federal court.

Ninth Circuit Holds That Transfer Agents Are Not Necessarily Sellers for Purposes of Section 5 Liability

In SEC v. CMKM Diamonds, Inc. (, the Ninth Circuit considered a claim against a transfer agent and its principal for liability under Section 5 of the Securities Act.  Several individuals had schemed to sell unregistered securities in violation of the securities laws in a company traded on the pink sheets.  To facilitate that scheme, those individuals obtained opinion letters of counsel (who was indicted for his role in the scheme) that the sales were lawful under recognized exceptions to the registration requirements.  The transfer agent was tasked with transferring the securities subject to those sales.  Here, the transfer agent was concerned about the sales and consulted a second law firm who determined it was appropriate to rely on the opinions of the first firm.  In that basis, the transfer agent effected the transfer of the securities. The SEC brought claims against the transfer agent, asserting that the transfer agent was a "seller" within the meaning of Section 5.  Under Section 5, not only is the actual seller who passes title a "seller" but also participants in the transaction who are a "substantial factor" in the sale are deemed to be sellers.  The SEC moved for summary judgment contending that (1) the transfer agent was a seller because its act to transfer ownership of the securities was a substantial factor in effectuating the sale, and (2) Section 5 is a strict liability provision such that the transfer agent's state of mind, even if innocent, is irrelevant to the analysis.  The district court granted summary judgment.  The Ninth Circuit reversed, holding that whether the transfer agent was a "substantial factor" in the sale was a question of fact.  The Court rejected the transfer agent's argument that it should only be held liable if it acted unreasonably or with scienter.  But, the Court held that the substantial factor had to be carefully applied with respect to a transfer agent who potentially faces strict liability in connection with a transaction.

While the Court expressly rejected a state of mind requirement, the Court contrasted the transfer agent's seemingly appropriate conduct of reviewing an attorney opinion letter and seeking out a second for confirmation with more nefarious actions of other participants in previously decided cases.  The Court seemed to "back door" some state of mind consideration by reviewing not just whether the transfer agent was a participant in the transaction but rather whether the transfer agent participated in the wrongful actions.

Ninth Circuit Decision on Negative Causation

In Hildes v. Arthur Andersen LLP (, the Ninth Circuit issued an important decision regarding negative causation under Section 11 of the Securities Act of 1933.  Under Section 11, plaintiffs need not plead causation.  Nonetheless, defendants can obtain a dismissal if they can demonstrate facts from the complaint on the indisputable public record which affirmatively disprove causation.  Here, the district court dismissed Section 11 claims against Peregrine's outside directors based on negative causation.  The plaintiff had agreed to vote his shares in favor of a merger of Harbinger Corp. in which he owned shares and Peregrine, Inc. before Peregrine issued the disputed registration statement.  Accordingly, the district court held that causation could not be established.  The Ninth Circuit reversed.  The Ninth Circuit reasoned that, even though plaintiff had agreed to vote his shares in favor of the merger, he was not irrevocably bound to sell his shares because the sale would necessarily be consummated only if the merger were consummated, and, plaintiff alleged, the merger would not have been consummated if Peregrine had not made material misstatements about its financial condition in its registration statement.  Plaintiff's allegations that the merger would not have been consummated were premised on what plaintiff asserted the board and other shareholders would have done had the truth been disclosed.  While inherently speculative, the Ninth Circuit credited the allegations that the merger would not have been consummated as "plausible" and thus sufficient to survive a motion to dismiss. The case unfortunately sets a low bar for pleading around negative causation under Section 11.

Ninth Circuit Clears Up Scienter Analysis

In In re VeriFone Holdings, Inc. Securities Litigation (, the Ninth Circuit weighed in on the proper analysis for determining whether a plaintiff in a securities action has properly pled scienter.  After the Private Securities Litigation Reform Act of 1995 (PSLRA), federal courts looked to the specific individual allegations in the complaint to determine whether the plaintiff had pled the requisite strong inference of scienter.  In Tellabs, the Supreme Court clarified the scienter analysis and required that the federal courts take a "holistic" approach -- that is, to determine whether the complaint and all of its allegations as whole create a strong inference of scienter.  Particularly after a subsequent Supreme Court decision in Matrixx Initiatives, at least some federal courts had begun taking the view that only the holistic approach was proper; in other words, courts should not look at the individual allegations one by one to determine whether any individually create a strong inference of scienter.  The Nonth Circuit in VeriFone set this debate to rest in the Ninth Circuit at least, holding that courts should undertake the individual review of allegations for scienter and then step back and look at the complaint as a whole to determine if the standards are met.  The Ninth Circuit referred to this as a two step approach. At first look, it seems that the Ninth Circuit approach is plaintiff friendly.  They have two opportunities to plead scienter:  either through individual allegations so powerful that they create a strong inference of scienter or based upon the allegations of the complaint taken as a whole.  Indeed, a holistic approach only might lead a court to reject even a powerful individual allegation because taken together with all of the rest of the facts before it, there are off-setting facts that suggest an innocent explanation.

But, as a practical matter, the Ninth Circuit approach may not be so plaintiff friendly after all.  The approach allows defendants to focus courts' attention on the individual allegations and pick each apart.  If a defendant can successfully do so, it seems unlikely in most instances that a court is going to find a strong inference of scienter from a bunch of individual allegations that, standing alone, don't amount to enough.  The exercise of going through the first step may advantage defendan