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In re Lendingclub Securities Litigation

United States District Court, N.D. California

May 25, 2017





         In this securities action, defendants move to dismiss in three separate motions. For the reasons stated below, the motions are Granted in part and Denied in part.


         At all relevant times, defendant LendingClub Corporation operated an online peer-to-peer marketplace to match borrowers and investors for a variety of loans. Defendant Renaud Laplanche founded the company and served as its chief executive officer and chairman of the board until May 4, 2016.

         LendingClub did not itself originate loans. Once a borrower and a lender matched in the marketplace, LendingClub would contact a partner bank, which would originate the loan, disburse funds to the borrower, and immediately sell that loan to LendingClub. LendingClub purchased the loans with funds it received from the matched lenders. It then serviced the loans on behalf of its lenders. It generated its revenue from origination fees and servicing fees (Consolidated Compl. ¶¶ 12, 29-30).

         Below is a diagram illustrating this process between a borrower, B and a lender, L, as follows: (1) B and L match from the pools of borrowers and lenders in LendingClub's marketplace, (2a) LendingClub directs a partner bank to (2b) initiate a loan to B, which loan the partner bank immediately sells (2c) to LendingClub, paid for with funds (2d) paid to LendingClub by L.

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         On December 11, 2014, LendingClub completed an initial public offering of its common stock. Defendants Morgan Stanley & Co., LLC; Goldman, Sachs & Co.; Citigroup Global Markets Inc.; Allen & Company LLC; Stiefel, Nicolaus & Company, Inc.; BMO Capital Markets Corp.; William Blair & Company LLC; and Wells Fargo Securities, LLC, all served as underwriters of the IPO (collectively, the “underwriter defendants”). As part of the IPO, LendingClub issued a registration statement, which incorporated excerpts from LendingClub's prospectus, prior quarterly reports, and a letter from CEO Laplanche. It filed that registration with the Securities and Exchange Commission.

         The registration statement and documents incorporated therein included certain representations about LendingClub's internal control procedures for financial reporting, which procedures would have prevented self-dealing, processing of improper loan applications, misleading investors, and irresponsible lending practices. Specifically, the registration statement stated LendingClub had evaluated the effectiveness of its disclosure controls and procedures, and concluded they “were effective at a reasonable assurance level” (id. ¶ 57).

         The registration statement stated that LendingClub was “continuing to earn investor confidence every day by providing equal access and with [sic] a level playing field with the same tools, data and access for all investors, small and large, within a fair and efficient marketplace” (id. ¶ 39). It further stated that LendingClub employed “Sophisticated Risk Assessment” with “proprietary algorithms, ” and that its procedures used “behavioral data, transactional data and employment information to supplement traditional risk assessment tools, such as FICO scores to assess the borrower's risk profile” (id. ¶ 45). LendingClub stated that it verified borrowers' statements from numerous data sources. Based on its stated mission of transparency, LendingClub provided the full credit profile of a borrower to potential investors and indicated which data was verified (id. ¶¶ 45-47).

         The registration statement described LendingClub's data-security protocols, as follows (id. ¶ 51):

We maintain an effective information security program based on well-established security standards and best practices, such as ISO2700x and NIST 800 series. The program establishes policies and procedures to safeguard the confidentiality, integrity and availability of borrower and inventor information. The program also addresses risk assessment, training, access control, encryption, service provider oversight, an incident response program and continuous monitoring and review.

         On February 11, 2016, LendingClub reported more than eight billion dollars in loan originations, revenues of more than four hundred million dollars, and net income of 4.6 million dollars (Bafus Decl., Exh. B at 4). Its prior years had operated with similar profit margins (see id., Exh. A at 11-13).

         In a Form 8-K filing on May 9, 2016, less than eighteen months after the IPO, LendingClub reported that its board had accepted the resignation of CEO Laplanche, the founder, chief executive officer, and chairman of LendingClub, which resignation “followed an internal review of sales of $22 million in near-prime loans to a single investor, in contravention of the investor's express instructions as to a non-credit and non-pricing element” in the prior two months. LendingClub also reported that it had discovered Laplanche's financial stake in a participant in the market, later revealed to be Cirrix (Bafus Decl., Exh. D at 2-3; Consolidated Compl. ¶¶ 105-06).

         One week later, LendingClub's quarterly report revealed that it had “identified material weakness, ” including a “[l]ack of transparent communication and appropriate oversight” in dealing with investors. These weaknesses resulted from “the aggregation of control deficiencies related to the Company's ‘tone at the top, '” which deficiencies “also existed at the end of 2015” (id. ¶ 111).

         LendingClub had previously determined that early in December 2009, CEO Laplanche had artificially inflated loan origination volume by taking thirty-two loans for himself and several family members, in order to “increase reported platform loan volume” and that LendingClub had reported inflated asset values for its subsidiaries from 2011 through 2016 (id. ¶ 60).

         LendingClub stated that it needed to correct “material weaknesses in internal control over financial reporting identified in the first quarter of 2016, ” which included the termination or resignation of three senior managers (id. ¶¶ 115-17). These deficiencies included an inability to assure compliance with the company's code of conduct and ethics policy, proper disclosure of related-party transactions, adherence to investors' purchase specifications, and communication by management with risk and financial accounting departments (id. ¶ 58).

         That quarterly statement (dated May 16, 2016) also noted that on April 1, 2016, LendingClub invested ten million dollars in Cirrix Capital, L.P., a company formed in 2012 for the sole purpose of purchasing loans from LendingClub. It also disclosed that “from inception, LendingClub . . . provided Cirrix with a credit-support agreement under which LendingClub assumed millions of dollars of risk for the loans it sold to Cirrix” (id. ¶ 43). It also revealed that Laplanche (who had already resigned as CEO) and an outside board member, together with LendingClub held limited partnership interests and an aggregate of 31% ownership in Cirrix as of April 1, 2016 (Bafus Decl., Exh. E at 55-56).

         On May 17, 2016, LendingClub acknowledged in a Form 8-K filing that it had discovered changes to the application dates on more than three hundred loans sold to one investor, after a review of a sub-committee of its board of directors found “a gap in preventative controls related to data management.” It stated it corrected the problem less than forty-eight hours later (though there is no indication of how long it took before detection). LendingClub indicated it would be implementing certain “enhancements” to better monitor internal changes to key data and to subject such changes to review by an internal audit team (id., Exh. F; Consolidated Compl. ¶¶ 52-56).

         LendingClub's loan-approval process contained “large numbers of discrepancies and inconsistencies” (id. ¶ 48(a)). Some borrowers were allowed to apply for multiple loans; others' lending history and income appeared implausible in light of their other circumstances; delinquent borrowers received new loans (to pay off their defaulted loans) at the same rates as they had before delinquency; borrowers were allowed to split larger loan requests in part, when they failed to qualify for the larger loan; and just before the IPO LendingClub reduced its loan-approval time from five-to-seven days to same-day approval (id. ¶¶ 48-50).

         As many of these revelations came to light, LendingClub's share price tumbled, and various securities rating agencies downgraded LendingClub.

         In August 2016, the chief financial officer of LendingClub, defendant Carrie Dolan, resigned from her position, after she had been asked to stay on to manage the crisis following CEO Laplanche's departure. It was later revealed, however, that CFO Dolan had sold 135, 000 shares of LendingClub stock (five percent of her holdings throughout the class period) in November and December 2015, still six months before the central issues here came to light (id. ¶ 123). Her stock holdings increased throughout the class period, however, because more than eight hundred thousand options vested (Bafus Decl., Exh. K).

         Three now-consolidated actions were filed in federal court here in San Francisco in May and June of 2016. The actions were related to the undersigned judge in July 2016 (Dkt. No. 71). An order consolidated the actions and appointed the Water and Power Employees' Retirement, Disability and Death Plan of the City of Los Angeles (“WPERP”) as lead plaintiff in August 2016 (Dkt. No. 90). In October 2016, an order approved lead plaintiff's selection of lead counsel (Dkt. No. 113).

         WPERP filed the consolidated complaint in December 2016, alleging four claims and adding seventeen new defendants, namely, the outside directors of LendingClub at the time of the IPO and the underwriters. The four claims now alleged are: (i) violation of Section 11 of the Securities Act of 1933 against all defendants; (ii) violation of Section 15 of the Securities Act against CEO Laplanche, CFO Dolan, and the director defendants; (iii) violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against LendingClub, CEO Laplanche, and CFO Dolan; and (iv) violation of Section 20(a) of the Exchange Act against LendingClub, Laplanche, and Dolan.

         Defendants now move to dismiss with three motions. LendingClub, the director defendants, and CFO Dolan all move to dismiss in one motion (Dkt. No. 139). CEO Laplanche moves separately but joins in the LendingClub defendants' motions (Dkt. No. 142). Underwriter defendants also move separately but join in the other two motions as well (Dkt. No. 149). This order follows full briefing and oral argument.


         1. Section 11.

         The consolidated complaint alleges that all defendants violated Section 11 of the Securities Act of 1933. To recover under Section 11, a plaintiff who bought stock traceable to the registration statement must show that “any part of the registration statement, when such part became effective, 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.” 15 U.S.C. 77k(a).

         The registration statement represented that LendingClub's CEO and CFO “concluded that [its] disclosure controls and procedures were effective at a reasonable assurance level” (Consolidated Compl. ¶ 57). Less than eighteen months later, LendingClub admitted its internal controls suffered from various “material weaknesses” (id. ¶ 58). Lead plaintiff contends the statement in the registration statement was untrue or omitted facts regarding (i) the weaknesses in LendingClub's internal controls, (ii) LendingClub's relationship with Cirrix, (iii) the adequacy of its loan-approval process, and (iv) the adequacy of its data integrity and security protocols.

         This order first addresses the applicable pleading standard.

         A. Applicable Pleading Standard.

         Defendants argue that our lead plaintiff's claim under Section 11 must satisfy the heightened pleading standard of Rule 9(b), which requires a plaintiff “[i]n alleging fraud [to] state with particularity the circumstances constituting fraud.” Generally, a plaintiff pursuing a claim under Section 11 “need not prove . . . that the defendant acted with any intent to deceive or defraud.” Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 575 U.S. ___, 135 S.Ct. 1318, 1333 (2015). A claim under Section 11 that is ...

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