United States: Central District Of California Certifies Class In Securities Stock Drop Action Against Restaurant Chain, Finding Insider Trades With Private Counterparty Did Not Preclude Certification Under Section 20a

On July 3, 2018, Judge David O. Carter of the United States District Court for the Central District of California granted plaintiffs' motion to certify a class in a securities fraud action against Tex-Mex restaurant chain El Pollo Loco Holdings, Inc. (the "Company") and certain of its officers and directors. Turocy, et al. v. El Pollo Loco Holdings Inc. et al., No. 8:15-cv-01343 (C.D. Cal. July 3, 2018). Plaintiffs allege that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") by making false and misleading statements that allegedly buried the impact of new menu changes on sales and restaurant traffic and propped up the restaurant's stock price, resulting in a 20 percent stock drop when the Company later disclosed lower sales growth. Plaintiffs further allege that certain individual defendants violated Section 20A of the Exchange Act through insider sales of over $129 million in the Company's stock while in possession of non-public information concerning the Company's sale trends. We previously wrote about the Court's decision last summer denying defendants' motion to dismiss. See Shearman & Sterling LLP, Central District of California Denies Motion To Dismiss Putative Securities Class Action Against El Pollo Loco Restaurant Chain, Finding Plaintiffs' Allegations Purportedly Based On Confidential Witnesses Taken Together Raised Strong Inference Of Scienter, Need-To-Know Litigation Weekly, Aug. 15, 2017.

On December 8, 2017, plaintiffs filed their class certification motion in which they sought to (i) certify the action as a class action pursuant to Federal Rules of Civil Procedure ("FRCP") Rule 23(a) and Rule 23(b)(3), (ii) appoint certain plaintiffs as class representatives, and (iii) appoint class counsel. Defendants opposed the motion for class certification only as to the appointment of certain proposed class representatives and as to plaintiffs' claims of insider trading under Section 20A. Accordingly, the Court granted at the outset plaintiffs' class certification motion for the proposed class for the Sections 10(b) and 20(a) claims.

The Court then evaluated the class certification motion for the Section 20A claim. Section 20A of the Exchange Act provides a private right of action to any person who traded "securities of the same class" "contemporaneously" with an insider trader, and the claim must be predicated on a separate violation of the securities laws and regulations. In opposing plaintiffs' motion, defendants argued that plaintiffs could not meet the "numerosity" requirement of Rule 23(a) because the Section 20A defendants allegedly sold their stock directly to a global investment banking firm in a private Rule 144A transaction. In particular, defendants argued that plaintiffs could not have traded "contemporaneously" with those defendants, as required under Section 20A, and therefore did not suffer any economic injury because they were not parties to the private transaction. The Court rejected defendants' argument, holding that in the class certification context, "plaintiffs asserting a Section 20A claim predicated on a Section 10(b) violation, 'need [not] allege or show more than purchase(s) of a security that is actively traded in an efficient market made contemporaneous with a sale by an insider in possession of material, non-public information.'" While observing that "[t]here is no law binding on this Court as to what constitutes 'contemporaneous' trading," the Court found that the contemporaneous trading requirement is "temporal,"—which means "existing, occurring or originating during the same time"—and further "is not restricted based on the manner in which a defendant decides to structure its insider trades," including private transactions. The Court further found that "there is no binding authority suggesting that Congress, in enacting Section 20A, restricted the availability of Section 20A to those investors who could have possibly traded with an insider." The Court then noted that here, plaintiffs sufficiently alleged contemporaneous trading for purposes of certifying a class by alleging that proposed class representatives purchased the Company's common stock, that the common stock was actively traded in an efficient market, that the Section 20A defendants made their alleged insider trades on the same day that putative class members made stock purchases, and that those defendants possessed and failed to disclose information about the cause of the Company's declining sales trends. Accordingly, the Court concluded that plaintiffs had sufficiently alleged the minimum of what is required to demonstrate contemporaneous trading for the purposes of certifying a class, and held that plaintiffs satisfied all of the Rule 23 elements as to their Section 20A claim.

The Court then considered defendants' argument that two of the proposed lead plaintiffs were atypical because they had unique defenses that would become the focus of the litigation. Specifically, defendants argued that these two individuals, based on responses during their respective depositions, expressed a view that the Company's stock price was still inflated following the Company's corrective disclosure, and that they also made "unusual" purchases of the Company's stock after the date of the corrective disclosure. These facts, according to defendants, subjected those two proposed lead plaintiffs to unique loss causation and materiality defenses that would not be typical of putative class members. But the Court agreed with plaintiffs' argument that those individuals are typical of the class and that, as laypersons with no expert knowledge concerning stock price inflation as it relates to loss causation, plaintiffs will rely on experts during trial to determine these issues. The Court also agreed that it was unreasonable to expect those individuals to determine in the middle of a deposition whether the stock was artificially inflated because loss causation is often a highly contentious and complicated issue. Additionally, the Court found that although post-disclosure purchases may present typicality issues, the stock purchases at issue were not unusual because one of these individuals purchased additional shares to lower his average cost while the other purchased shares hoping the stock would perform better after the decline in price. As such, the Court found that these two proposed lead plaintiffs met the typicality requirement under Rule 23(a) and approved their appointment as class representatives.

Finally, the Court addressed defendants' argument that a third proposed class representative would not be an adequate class representative because he works 50-60 hours per week as a practicing and teaching physician and medical researcher and stated that he would need six months' lead time to attend litigation proceedings in California. The Court found that working 50-60 hours per week is not an unusual or disqualifying responsibility for a lead plaintiff, and also found that this individual has already demonstrated that he is available and engaged to "vigorously litigate the action" through to the end.

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