Overview

In class action securities cases premised on misstatements and omissions made in connection with a company’s initial public offering, a complaint often alleges both claims arising under Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. Claims arising under Section 11 do not require showing a fraudulent state of mind (i.e., scienter) and therefore are governed by Rule 8(a) of the Federal Rules of Civil Procedure. Conversely, claims arising under Section 10(b) are held to the heightened pleading standard for fraud-based claims articulated in Rule 9(b) of the Federal Rules of Civil Procedure. However, where a complaint alleges both Section 11 and Section 10(b) claims, plaintiffs are often confronted with an argument that Rule 9(b)’s heightened pleading standard should be applied to both claims.

This article explores a recent decision by the Second Circuit Court of Appeals, Pappas v. Qutoutiao Inc., 2024 U.S. App. LEXIS 27250 (2d Cir. 2024), which overturned a district court’s holding that the Section 11 claims were grounded in fraud and subject to Rule 9(b), and suggests that courts should ask—“would [such allegations] be evaluated under Rule 8 if contained in a stand-alone complaint alleging violations only of the Securities Act”—in lieu of applying other tests when assessing which pleading standard applies.

A Brief Review of Section 10(b), Section 11 and the Pleading Standards

Section 10(b) provides a cause of action for any person who purchases or acquires securities against any person or entity that employed manipulative or deceptive practices to secure the sale or acquisition of said security. Section 10(b) encompasses any materially misleading statement or omission that a person made to secure the security’s sale or acquisition. To prove a Section 10(b) claim, a plaintiff must show: “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.”[1] Section 10(b) is inherently grounded in fraud and as such, to state a claim upon which relief may be granted, a complaint must “state with particularity the circumstances constituting fraud or mistake” and generally allege “[m]alice, intent, knowledge, and other conditions of a person’s mind” to meet Rule 9(b)’s heightened pleading standard.[2]^,[3]

By contrast, Section 11 provides those who purchased securities in a company’s offering a cause of action against certain persons (i.e., an issuer, director, underwriter, etc.) for any misrepresentation contained in the company’s registration statement that effected that offering.[4] To prove a Section 11 claim, a plaintiff must show that: (1) the “registration statement . . . contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading[;]” (2) that the purchased security was directly traceable to misleading registration statement; and (3) that the defendant was a person against whom such actions may be brought.[5] Section 11 claims are narrower than Section 10(b) claims because the statute only applies to misstatements and omissions made in a registration statement. Defendants are also strictly liable for such statements under Section 11 and the claims are typically premised on strict liability or negligence-based allegations. As such, to state a claim upon which relief may be granted, a complaint need only plead “a short and plain statement of the claim showing that the pleader is entitled to relief[.]”[6] However, where a Section 11 claim sounds in fraud, then the complaint must meet the heightened pleading standard for fraud claims laid out in Rule 9(b).

Tests Frequently Applied in Evaluating Whether Section 11 Claims Sound in Fraud

Courts take varying approaches to assessing whether a Section 11 claim is grounded in negligence or fraud—and consequently, which standard of review applies.

For instance, the Ninth Circuit permits a plaintiff to choose “to allege some fraudulent and some non-fraudulent conduct” or rely entirely on “a unified course of fraudulent conduct[.]”[7] If the plaintiff chooses the former, then “only the allegations of fraud are subject to Rule 9(b)'s heightened pleading requirements” rather than the whole claim.[8] However, if the plaintiff chooses to allege “a unified course of fraudulent conduct[,]” then both the Section 10(b) and Section 11 claims will be considered “‘grounded in fraud’” and both must satisfy Rule 9(b).[9]

In order to assess “‘whether the complaint ‘allege[s] a unified course of fraudulent conduct’ and ‘rel[ies] entirely on that course of conduct as the basis of a claim[,]’’” courts in the Ninth Circuit “‘close[ly]  examin[e]…the language and structure of the complaint[.]’”[10] This inquiry often involves determining whether the complaint relies on “the same alleged misrepresentations”[11] or “the exact same factual allegations[,]”[12] the latter of which raises an “assum[ption] that [the section 11 claim] sounds in fraud.”[13] Courts in the Fifth and Sixth Circuits take a similar approach.[14]^,[15]

Prior to the Second Circuit’s Pappas decision, courts in the Southern District of New York (“Southern District” or “SDNY”) often assessed an operative complaint’s structure to determine whether there was “‘a clear distinction between [the] negligence and fraud claims[,]’” including evaluating whether: (1) the complaint contains a blanket fraud disclaimer; (2) the claims employ classic fraud language; (3) the claims have been segregated into separate sections of the complaint; and (4) there are different theories and/or defendants underlying each claim.[16] Notably, Southern District courts have recognized that plaintiffs are permitted to “‘plead claims in the alternative’”—meaning that misstatement claims can be asserted as either fraud or negligence within the same complaint—and subject to correspondingly different pleading standards.[17] “The fact that the alleged misstatements supporting the Section 11 … claims are the same as those in the Section 10(b) claims is not dispositive” of whether Rule 9(b) applies.[18] Courts in the Third Circuit take a similar approach.[19]

Accordingly, although courts recognize that a plaintiff may plead in the alternative that a misstatement was fraudulent or negligent, the approaches used to assess whether a Section 11 claim sounds in fraud can inadvertently infringe on a plaintiff’s right to do so. For instance, as evidenced by the discussion below, an inquiry that focuses on whether the Section 10(b) and Section 11 claims allege the same misstatements or similar facts has the potential to improperly focus the analysis on the statements themselves or the underlying conduct, respectively, rather than allegations that carefully couch the conduct as negligence.  

The Second Circuit’s Inquiry in Pappas v. Qutoutiao Inc.

On October 28, 2024, the Second Circuit issued its opinion in Pappas v. Qutoutiao Inc., addressing whether the district court erred in applying the heightened pleading requirements of Rule 9(b) to negligence-based Securities Act claims.[20]

The underlying complaint sued Qutoutiao Inc. (“QTT”), a Chinese mobile content aggregator that makes money by selling advertisements on its app, and certain other defendants related to allegedly false and misleading statements concerning QTT’s non-compliance with Chinese laws and regulations, which prohibit entities from disseminating untrue or inaccurate advertising and entertainment content.[21] Specifically, the lead plaintiff alleged: (i) Section 10(b) claims against QTT, the Insider Defendants, and the Underwriter Defendants; and (ii) Section 11 claims against QTT, the Director Defendants, and the Underwriter Defendants, among other claims.[22] Both the Section 10(b) and Section 11 claims concerned: (i) misstatements regarding QTT’s “‘strategy of targeting users in lower tier cities in China[;]’” (ii) omissions of material facts that made the statements in in the IPO and SPO documents misleading; (iii) failure to disclose certain related party transaction information; and (iv) misstatements and omissions related to net revenue data and reasons for replacing the Company's third-party advertising.[23] Given the complaint alleged both Section 11 and Section 10(b) claims premised on some but not all the same facts and contained overlapping alleged false statements and omissions, the Qutoutiao district court assessed whether the Section 11 claims were grounded in fraud or negligence.[24]

At the outset of its analysis, the Qutoutiao district court noted that the Second Circuit and SDNY courts offer varying guidance with respect to a plaintiff’s burden to differentiate Section 11 claims from Section 10(b).[25] Expounding on this guidance, the Qutoutiao district court explained that, under Second (and Ninth Circuit) precedent, a complaint needs to do more than merely state that the Section 11 claim does not sound in fraud to preserve Rule 8(a)’s pleading standard.[26] Relying on SDNY authorities, the Qutoutiao district court then explained that a complaint’s articulation of the basis for the negligence claim or efforts to compartmentalize the fraud and non-fraud claims are factors to consider when assessing Section 11 claims from fraud-based ones.[27] Turning to its analysis of the complaint at issue, the Qutoutiao district court explained that it “attempt[ed] to differentiate the” claims from one another and “disclaim[ed] a theory of fraud” for the Section 11 claims. Nevertheless, the Qutoutiao district court held that the Section 11 claims “manifestly sound in fraud and thereby trigger the heightened Rule 9(b) pleading standard.”[28]

The Qutoutiao district court’s rationale was that the complaint’s Section 11 section employed language that exactly mirrored the language in the Section 10(b) section, including: (1) a fact section labeled “[d]efendant’s Illegal Acts” that came before both sections and alleged fraud in the offering documents and intentional placement of illegal advertisements; (2) IPO and SPO statements premised on material misstatements about “the [c]ompany’s strategy of targeting users” and omissions that the company was seeking to avoid the oversight of a superior content moderator; and (3) challenges to risk disclosures under both Section 11 and Section 10(b) that asserted the same basis. [29]

On appeal, the Second Circuit vacated the district court’s holding, finding that it had erred in determining the Section 11 claim sounded in fraud. [30] In doing so, the Second Circuit explained that the complaint’s Section 11 claims were classically framed in strict liability and negligence language, such as “[d]efendants failed to satisfy their ‘duty to make [a] reasonable and diligent investigation’ to ensure that the offering documents did not contain misstatements or omissions.”[31] The Second Circuit further noted that plaintiff made more than nominal efforts to distinguish the claims, including by: (1) expressly disclaiming fraud, scienter, and intent; (2) “painstakingly segregat[ing] the fraud and negligence claims” with each claim set forth under its own heading; and (3) “incorporat[ing] only certain factual allegations” for the securities act claims and expressly excluding allegations related to scienter and reliance.[32]

The Second Circuit elaborated, stating that even though the complaint premised its Section 10(b) claims on QTT’s intentional conduct with respect to the company’s design and implementation strategies, the Section 11 claims “charge[d] [d]efendants with negligently failing to disclose those strategies and their results[.]”[33] This was a critical distinction because, as the Court explained, “that a fact was known and not disclosed does not mean, as a matter of law, that the circumstances of the resulting omission sound in fraud” and distinguished such allegations from those claiming defendants intentionally concealed information.[34] Thus, the Second Circuit found that the Section 11 “allegations would be evaluated under Rule 8 if contained in a stand-alone complaint alleging violations only of the Securities Act” and held that those allegations would “not be held to a higher standard because [p]laintiff also exercised his right to sue [d]efendants for securities fraud under the Exchange Act.”[35]

A Case for Asking the “Stand-Alone” Question to Assess Section 11 Claims

When posed as a question, the Second Circuit’s finding has the potential to greatly simplify a court’s analysis of which pleading standard to apply to Section 11 claims. Indeed, asking whether a complaint’s allegations would be evaluated under Rule 8(a) if contained in a stand-alone complaint alleging violations only of the Securities Act focuses the inquiry solely on the Section 11 allegations and preserves a plaintiff’s right to plead the theories as alternatives.[36]

By contrast, an assessment of whether there are overlapping false statements or similar underlying facts, which focuses the inquiry on both the Section 10(b) and Section 11 claims, creates the potential that the fraudulently alleged conduct will be attributed to and overshadow carefully pled negligence allegations (as discussed above). If courts adopt an approach that considers the Section 11 claims on a stand-alone basis, then it may obviate the risk that the mere existence of a concurrently pled Section 10(b) claim will improperly result in applying the heightened pleading standard to Section 11.

[1] In re Grab Holdings Ltd., Sec. Litig., 2024 U.S. Dist. LEXIS 43193, at *34 (S.D.N.Y. Mar. 12, 2024).

[2] Fed. R. Civ. P. 9(b)

[3] A complaint that alleges a Section 10(b) claim must also meet the heightened pleading standards of the Private Securities Litigation Reform Act of 1995 (“PSLRA”) in addition to those set forth in Rule 9(b). See In re Grab Holdings Ltd., Sec. Litig., 2024 U.S. Dist. LEXIS 43193, at *33-34.

[4] 15 U.S.C. §77k.

[5] Id.; In re Grab Holdings Ltd., Sec. Litig., 2024 U.S. Dist. LEXIS 43193, at *34.

[6] Fed. R. Civ. P. 8(a)(2)

[7] Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1103-04 (9th Cir. 2003).

[8] Id. at 1104.

[9] Id. at 1103-04.

[10] In re Rigel Pharms., Inc. Secs. Litig., 697 F.3d 869, 885 (9th Cir. 2012)

[11] Id. at 886.

[12] Rubke v. Capitol Bancorp Ltd., 551 F.3d 1156, 1161 (9th Cir. 2009).

[13] Id.

[14] Police & Fire Ret. Sys. of City of Detroit v. Plains All Am. Pipeline, L.P., 777 Fed. Appx. 726, 730 (5th Cir. 2019) (“Claims under the Securities Act are evaluated under the normal pleading standards. If the claim is based on the same underlying facts and allegations as a securities fraud claim under the Exchange Act, then the pleading standard is the standard contained in Rule 9(b).”).

[15] See Kolominsky v. Root, Inc., 100 F. 4th 675, 683-86 (6th Cir. 2024) (“[W]hen a 1933 Act plaintiff brings a Section 11 … claim that does not rely on one unified course of fraudulent conduct but, rather, carefully distinguishes the fraud claims from other claims, then we apply the Rule 8(a) pleading standard to those non-fraud claims.”).

[16] Fresno Cnty. Emples. Ret. Ass’n. v. comScore, Inc., 268 F. Supp. 3d 526, 558-59 (S.D.N.Y. 2017); In re Grab Holdings Ltd., Sec. Litig., 2024 U.S. Dist. LEXIS, 43193, at *38-40; Wallace v. Intralinks, 2013 U.S. Dist. LEXIS 65958, at *33-34 (S.D.N.Y. May 8, 2013); In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 632-34 (S.D.N.Y. 2007).

[17] Fresno Cnty. Emples. Ret. Ass’n., 268 F. Supp. 3d at 558.

[18] Wallace, 2013 U.S. Dist. LEXIS 65958, at *32-33.

[19] See e.g., In re Suprema Specialties, Inc. Sec. Litig., 438 F. 3d 256, 272 (3rd Cir. 2006) (“We now hold that where, as here, individual defendants are accused in separate claims of the same complaint of having violated Section 11 … and Section 10(b), the Securities Act claims do not sound in fraud if ordinary negligence is expressly pled in connection with those claims.”); Garfield v. Shutterfly, Inc., 857 Fed. Appx. 71, 79 (3rd Cir. 2021) (explaining that negligence-based claims do not sound in fraud even where the underlying activity is the same if plaintiff “expressly disavowed fraud in their negligence claims and carefully separated the two types of claims.”)

[20] Pappas v. Qutoutiao Inc., 2024 U.S. App. LEXIS 27250 (2d Cir. Oct. 28, 2024)

[21] Id. at *2.

[22] In re Qutoutiao, Inc. Sec. Litig., 2023 U.S. Dist. LEXIS 136019, at *5-6 (S.D.N.Y. Aug. 3 2023). The Insider Defendants included Eric Tan, Lei Li, Jingbo Wang, and Xiaolu Zhu. The Director Defendants included Shaoqing Jiang, Jianfei Dong, Oliver Yucheng Chen, Yongbo Dai, James Jun Peng, and Feng Li. The Underwriter Defendants included Citigroup Global Markets Inc., Deutsche Bank Securities Inc., China Merchants Securities (HK) Co., Ltd., UBS Securities LLC, Keybanc Capital Markets, Inc., CLSA Limited, Haitong International Securities Company Limited, Jefferies Group LLC, and Lighthouse Capital International Inc. (a.k.a. Guangyuan Capital or Guangyuan Ziben). Id.

[23] Id. at *7-9, 37-38.

[24] Id. at *38-41.

[25] Id. at *38 quoting Rombach v. Chang, 355 F. 3d 164, 172 (2d Cir. 2004) citing In re Stac Elecs. Sec. Litig., 89 F. 3d 1399, 1405 (9th Cir. 1996).

[26] Id. at *38-39 citing In re Refco, Inc. Sec. Litig., 503 F. Supp. at 633; In re Ultrafem Inc. Sec. Litig., 91 F. Supp. 2d 678, 691 (S.D.N.Y. 2000); and In re Jumei Int'l Holding Ltd. Sec. Litig., 2017 U.S. Dist. LEXIS 3206, at *10-11  (S.D.N.Y. Jan. 10, 2017).

[27] Id. at *39-40

[28] Id.

[29] Id. at *40-41

[30] Pappas, 2024 U.S. App. LEXIS 27250, at *1.

[31] Id. at *5-6.

[32] Id. at *7.

[33] Id. at *7.

[34] Id. at *7-8.

[35] Id. at *6-7.

[36] See Fed. R. Civ. P. 8(d)