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Ninth Circuit Clarifies Contours of Judicial Notice and Incorporation by Reference In Light of "Concerning Pattern In Securities Cases" of "Overuse"

By J. Whitman, Jr., Esquire and Jonathan Neumann, Esquire

Background

In considering a motion to dismiss under Federal Rule of Civil Procedure (“Rule”) 12(b)(6), a court’s review is generally “limited to the complaint.” Lee v. City of L.A.,250 F.3d 668, 688 (9th Cir. 2001). There are, however, two recognized exceptions to this general rule: (1) judicial notice; and (2) the incorporation by reference doctrine.

First, under Federal Rule of Evidence 201(b), a “court may judicially notice a fact that is not subject to reasonable dispute because it: (1) is generally known within the trial court’s territorial jurisdiction; or (2) can be accurately and readily determined from sources whose accuracy cannot reasonably be questioned.” In order for a fact to be judicially noticed, the Ninth Circuit has explained that “indisputability is a prerequisite.” Lee, 250 F.3d at 689. Thus, courts have explained that “the kind of things about which courts ordinarily take judicial notice are: (1) scientific facts: for instance, when does the sun rise or set; (2) matters of geography: for instance, what are the boundaries of a state; or (3) matters of political history: for instance, who was president in 1958.” Mat-Van, Inc. v. Sheldon Good & Co. Auctions, LLC, 2008 WL 346421, at *8 (S.D. Cal. Feb. 6, 2008). Importantly, however, facts subject to judicial notice cannot be taken as true for the purpose of disputing facts within a plaintiff’s complaint.

Second, a court may treat as incorporated into a complaint by reference “documents whose contents are alleged in a complaint and whose authenticity no party questions.” Davis v. HSBC Bank Nev., N.A., 691 F.3d 1152, 1160 (9th Cir. 2012).

To be sure, these doctrines have a legitimate purpose. Namely, both can prevent a plaintiff’s complaint from surviving a Rule 12(b)(6) motion when that pleading deliberately omits references to, or selectively quotes from, documents upon which their claims are based. See Parrino v. FHP, Inc., 146 F.3d 699, 706 (9th Cir. 1998) (noting “policy concerns” underpinning incorporation by reference doctrine). But they also have a downside risk. Namely, that a court will give undue weight to facts set forth in materials extrinsic to a plaintiff’s complaint and improperly resolve disputed facts at the pleading stage.

This risk is heightened in the context of securities litigation under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), where plaintiffs are: (1) subject to a heightened pleading standard; and (2) foreclosed from discovery, except in very limited circumstances. As the Ninth Circuit recently observed, there is a “concerning pattern in securities cases like this one: exploiting these procedures improperly to defeat what would otherwise constitute adequately stated claims at the pleading stage.” Khoja v. Orexigen Therapeutics, Inc., 899 F.3d 988 (9th Cir. 2018). These competing policy concerns led the Ninth Circuit to clarify the contours of the doctrines in its August 2018 Orexigen decision.

Orexigen Opinion

In Orexigen, the plaintiff brought claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In particular, he alleged that the defendant pharmaceutical company and its officers made false or misleading statements regarding early survey results concerning the company’s new drug. The district court dismissed the plaintiff’s claims. In so doing, the district court granted the defendants’ request to judicially notice or incorporate by reference 21 of 22 documents that defendants submitted with their motion to dismiss the complaint. The district court also relied upon the contents of certain of these documents in granting defendants’ motion. The plaintiff appealed the district court’s dismissal. The Ninth Circuit reversed, finding that the district court had abused its discretion in relying upon certain materials extrinsic to the complaint to resolve factual disputes and that the plaintiff had adequately stated a claim.

The Ninth Circuit began by recognizing the “concerning pattern” in securities cases — the “overuse and improper application of judicial notice and the incorporation-by-reference doctrine.” Orexigen, 899 F.3d at 998. It acknowledged that recent trends created for defendants the “alluring temptation to pile on numerous documents to their motions to dismiss to undermine the complaint.” Id. But the court cautioned that “the unscrupulous use of extrinsic documents to resolve competing theories against the complaint risks premature dismissals of plausible claims that may turn out to be valid after discovery. This risk is especially significant in SEC fraud matters, where there is already a heightened pleading standard, and the defendants possess materials to which the plaintiffs do not yet have access.” Id. The Ninth Circuit further observed that if “defendants are permitted to present their own version of the facts at the pleading stage — and district courts accept those facts as uncontroverted and true — it becomes near impossible for even the most aggrieved plaintiff to demonstrate a sufficiently ‘plausible’ claim for relief.” Id. at 999.[1]

With these principles in mind, the Ninth Circuit provided what has been described as a “how-to guide” with respect to judicial notice and incorporation by reference. As to judicially noticed facts, a court must first clearly identify which facts it is judicially noticing. Then, it must determine whether or not such facts are subject to “reasonable dispute.” This distinction is important because a “court may take judicial notice of matters of public record,” but it notably “cannot take judicial notice of the disputed facts contained in such public records.” Id. In other words, simply because the document itself is susceptible to judicial notice does not mean that every assertion of fact within that document is judicially noticeable for its truth.

Thus, for instance, in Orexigen, the district court properly took judicial notice of the existence of an investor conference call transcript filed with the SEC. The district court, however, erred in judicially noticing the facts contained in that transcript because “reasonable people could debate what exactly this conference call disclosed.” Id. at 1000.

Moreover, the Ninth Circuit explained, incorporation by reference is appropriate “if the plaintiff refers extensively to the document or the document forms the basis of the plaintiff ’s claims.” Id. at 1002. It further clarified that “mere mention” of a document within a complaint would not be sufficient for applying the incorporation by reference doctrine. Id. In a similar vein, documents submitted “merely to create a defense to the well-pleaded allegations in the complaint” are not properly incorporated by reference because they do not form the basis of the plaintiff ’s claims. Id. More specifically, incorporating such documents would be akin to “nothing more than another way of disputing the factual allegations in the complaint, but with a perverse added benefit: unless the district court converts the defendant’s motion to dismiss into a motion for summary judgment, the plaintiff receives no opportunity to respond to the defendant’s new version of the facts.” Id. at 1003.[2]

Applying these principles, the Ninth Circuit held, for instance, that a blog entry quoted once in a two sentence footnote was not properly incorporated by reference. Id. at 1003 (“For ‘extensively’ to mean anything . . . it should, ordinarily, at least, mean more than once.”). On the other hand, the district court properly incorporated by reference an analyst report cited in the complaint that discussed how the company’s stock price reacted to its interim results — i.e., that supported the plaintiff’s claims that the market relied on the company’s statements regarding the interim study results. Id. at 1004.

With these considerations in mind, the Ninth Circuit reversed the district court’s dismissal of the plaintiffs’ Section 10(b) claims which had been based, in part, on its improper reliance on certain extrinsic documents.

Policy Implications

Orexigen is a welcome development for plaintiffs, especially those bringing securities fraud claims. In the Ninth Circuit in particular, motions to dismiss have become increasingly complex as a result of defendants’ requests for judicial notice and incorporation by reference. Often, these requests include a vast array of documents extrinsic to the complaint they are seeking to dismiss. This has, at a minimum, led to confusion on behalf of, and additional work for, the parties and the court. In more extreme circumstances, defendants’ reliance on these doctrines has caused the exception to swallow the rule.

Orexigen should permit plaintiffs to retain more control over their own complaint. More precisely, the Ninth Circuit’s forceful admonitions regarding the “unscrupulous use of extrinsic documents” and its “concerning pattern” should discourage defendants from attempting to put tens or hundreds of documents before the court on a motion to dismiss. At a minimum, Orexigen arms plaintiffs’ with powerful authority to combat any such efforts.

The case also reminds defendants that requests for judicial notice and incorporation by reference may result in an unintended consequence. Under Rule 12(d), when “matters outside the pleading are presented to and not excluded by the court,” the Rule 12(b)(6) motion converts into a motion for summary judgment under Rule 56. Then, both parties must have the opportunity “to present all the material that is pertinent to the motion.” Id. As the Ninth Circuit explained, “it is reversible error when a court considers material outside the pleading on a Rule 12(b)(6) motion and yet fails to convert it into a motion for summary judgment.” Orexigen, 899 F.3d at 1012. Any such conversion is typically also a welcome development for plaintiffs, as it permits discovery to which securities plaintiffs ordinarily do not have access at the pleading stage. Such discovery would help alleviate the informational gap that traditionally exists between plaintiffs and defendants on a motion to dismiss.

Thus far, at least one court considering securities fraud claims has ruled on a request for judicial notice in light of Orexigen. In Wochos v. Tesla, Inc., the court granted in part defendants’ request to judicially notice certain SEC filings and investor conference call transcripts. 2018 WL 4076437, at *2 (N.D. Cal. Aug. 27, 2018). Citing to Orexigen, the court stated that it “considers them in evaluating the motion to dismiss for the sole purpose of determining what representations Tesla made to the market,” but “is not taking notice of the truth of any of the facts asserted.” Id. (emphasis in original). Tesla suggests that the benefits from Orexigen may be more nuanced. That is, even if documents are judicially noticed or incorporated by reference, courts should not consider them for their truth and instead consider them primarily for the fact of their existence.

Of course, the precise effect from Orexigen remains to be seen. But the case is noteworthy both for the policy considerations it espouses and the clarity it provides for plaintiffs facing a motion to dismiss accompanied by references to documents extrinsic to the complaint at issue.


[1] As Cornell Law School Professor Robert Hockett similarly explained: “If the court is taking notice of alleged facts without your even knowing what those facts are and without the opportunity to rebut those putative facts, then you haven’t even really gotten your day in court.” See https://www. law360.com/articles/1075115/9th-circ-opinion-could-spark-more-securities-settlements.

[2]The requirements for and consequences of converting a Rule 12(b)(6) motion to a motion for summary judgment are discussed in more detail in Part III, infra.