In Khoja, the Ninth Circuit Limits Defendants’ Ability to Argue Facts in a Motion to Dismiss

In Khoja v. Orexigen Therapeutics, Inc., the Ninth Circuit clarified the “rare circumstances” when a court may review documents extraneous to the pleadings in ruling on a motion to dismiss. Given that it has become routine for securities defendants to attach numerous documents to motions to dismiss, this decision has the potential make it easier for plaintiffs to survive a motion to dismiss. Over the next several months, it will be interesting to see whether this decision survives the defendants’ petition for en banc review, and if so, whether courts outside the Ninth Circuit follow this decision to curtail the use of extraneous documents in deciding motions to dismiss.

The plaintiffs, investors in Orexigen Therapeutics, Inc. (“Orexigen”), brought a federal securities class action against the company and its executives. Plaintiffs asserted Orexigen violated the Section 10(b) of the Exchange Act, by making statements pertaining to interim results of a drug study, the release of the those results, and eventual decision to discontinue the study. In granting defendants’ motion to dismiss, the district court considered 21 documents outside of the pleadings.

On appeal, the plaintiffs argued the district court abused its discretion by considering most of these documents. The Ninth Circuit agreed, reversed the lower court’s dismissal in part, and clarified the limited scope in which courts may consider documents extraneous to the complaint:

In reaching its decision, the Ninth Circuit noted the “concerning pattern in securities cases like this one: exploiting these procedures [of incorporation by reference and judicial notice] improperly to default what would otherwise constitute adequately stated claims at the pleading stage.” The Ninth Circuit also highlighted how the asymmetry of information in favor of securities defendants could lead to unfair results if courts rely on extrinsic documents:

The overuse and improper application of judicial notice and the incorporation-by- reference doctrine… can lead to unintended and harmful results.  Defendants face an alluring temptation to pile numerous documents to their motions to dismiss to undermine the complaint, and hopefully dismiss the case at an early stage.  Yet 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.

The Court continued that “[i]f 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 sufficiency ‘plausible’ claim for relief.”

The Ninth Circuit highlighted that courts may take judicial notice of an adjudicative fact, only if that fact is “not subject to reasonable dispute.” Here, for example, although the court could take judicial notice of the fact that an investor call occurred on a certain date, it was improper for the district court to take judicial notice of the investor call for the purpose of noting “what the investors knew . . . at that time,” as “the substance of the transcript ‘is subject to varying interpretations.”

The Ninth Circuit also ruled that courts may incorporate a document by reference in “those rare circumstances” in which “plaintiff refers extensively to the document or the document forms the basis of the plaintiff’s claim.’” Here, the Ninth Circuit found it appropriate to consider a handful of documents, which formed the basis of the plaintiffs’ claims. However,  it found the lower court abused its discretion by incorporating several other documents, including a blog post mentioned once in a footnote of the complaint, the patent file history, a press release not mentioned in the complaint, and a SEC filing that was used for defense purposes only.

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