In Retail Wholesale & Dep’t Store Union Local 228 Ret. Fund v. Hewlett-Packard Co., the plaintiffs alleged that Hewlett-Packard (“HP”) and a high-ranking corporate officer committed securities fraud by promoting its corporate code of ethics, while the officer was allegedly not personally compliant with the code. The district court dismissed the complaint, holding that the complaint failed to plead that the defendants made a material misstatement or omission, which is required to establish a violation of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. On January 19, 2017, the Ninth Circuit affirmed the district court’s dismissal of the case.
The Ninth Circuit’s decision is the latest in a line of cases that have considered the violation of a corporate code of ethics as a basis for a securities fraud claim. Prior to Retail Wholesale, however, the Ninth Circuit had not definitively adopted a framework for determining whether statements made in or about a company’s code of ethics can become material misrepresentations. In Retail Wholesale, the Ninth Circuit analyzed the materiality of these statements using an objective approach, which focuses on whether the statements can be proven false.
Prelude to the Company’s Standards of Business Conduct and Resulting Lawsuit
In 2006, a whistleblower informed several government agencies that HP had hired detectives to monitor and investigate the phone records and e-mail accounts of HP directors, employees and journalists to find the sources of leaks of company information. Soon thereafter, HP took major steps to improve its corporate practices, including reinforcing its Standards of Business Conduct (“SBC”). The SBC included an introductory message which stressed the importance of “conducting business consistent with the high ethical standards embodied within our SBC.” The SBC contained other statements emphasizing HP’s values, including the company’s commitment to reporting misconduct. In 2007, a senior HP officer resigned. HP’s share price fell 8.2% on the first trading day and 12.6% a week after his resignation. At the same time, allegations of behavior non-compliant with the SBC were reported.
In 2014, investors filed a class action claiming that HP and a former executive made false and misleading statements in issuing and promoting the SBC while an officer allegedly acted inconsistently with the SBC. The district court dismissed the plaintiffs’ claims for failure to allege materiality and falsity. The plaintiffs raised two arguments on appeal: (1) that HP and its former officer’s public statements concerning HP’s business ethics were material misrepresentations because of their inconsistency with the alleged conduct; and (2) that HP failed to disclose non-compliant behavior.
The Ninth Circuit’s Objective Approach
The Ninth Circuit adopted a two-step approach to analyze whether a company’s statements regarding a code of ethics are actionable when the company or its agents actually or potentially violates the code. First, the court determines whether the statements contain any objectively-verifiable factual misrepresentation. If there was a misrepresentation, the court then considers whether the misrepresentation was “material” to stockholders. In adopting this standard, the Ninth Circuit broke with the approach followed by the Sixth Circuit, which examines scienter and materiality simultaneously. The Ninth Circuit, in contrast, analyzes these two elements separately.
Applying its objective two-step approach, the Ninth Circuit rejected the plaintiffs’ argument that the statements regarding the SBC became material misrepresentations simply because the officer’s personal conduct may have violated the SBC. The court held that a code of ethics, like the SBC, is “inherently aspirational.” According to the court, the statements promoting the SBC were also aspirational and were not objectively verifiable, because the statements did not imply that all staff, directors, and officers will always adhere to the SBC. The plaintiffs’ claims were not saved by the fact that the defendants’ statements were made at the time HP was emerging from the 2006 scandal. At most, HP’s and its former officer’s statements could only support the interpretation that HP values ethics. This was not sufficient.
The court did note that “the case may have been closer . . . had [it] involved facts remotely similar to those presented by the 2006 scandal, as the ethical code could then have been understood as at least promising specifically not to do what had been done in 2006.” Thus, courts may potentially consider a company’s statements regarding its ethical code to be objectively falsifiable if the company’s employees engage in the same misconduct the company implicitly promised to avoid.
After concluding that the defendants’ statements were not objectively falsifiable—and thus were not misrepresentations—the court turned to the issue of materiality. Concluding that the statements were not material, the court noted that there was nothing unusual about the company’s promotion of business ethics; moreover, the substance and online publication of the SBC were required by the SEC. The court doubted that a reasonable investor’s decision to trade HP stock would be affected by HP’s compliance with SEC regulations. In response to the plaintiffs’ claims, the Ninth Circuit also found that the “[e]vidence of stock price movements provides no rational basis for determining” the materiality of HP’s and its former officer’s statements.
The court also rejected the plaintiffs’ alternative theory that the failure to disclose alleged noncompliance with the SBC amounts to an actionable omission. An omission is actionable only if there was a duty to disclose. The plaintiffs argued that HP owed a duty to disclose the noncompliance because its statements regarding the SBC were misleading. The Ninth Circuit, however, concluded that HP’s statements regarding the SBC could only be understood as expressing a desire to commit to certain values. Since HP’s statements were aspirational, potential noncompliance with the code was not misleading.
The Ninth Circuit’s decision in Retail Wholesale
has important implications for companies seeking to promote their ethical standards. The Ninth Circuit noted that the plaintiffs’ misrepresentation and omissions claims might have been actionable if HP continued the misconduct that gave rise to the 2006 scandal, while claiming that it had adopted a code of ethics in response to the scandal. In light of the Ninth Circuit’s observations in Retail Wholesale
, companies should pay close attention to the context of their public statements regarding their codes of ethics so as to avoid shareholders misconstruing those statements as guarantees of compliance.
 See, e.g., Nathanson v. Polycom, Inc., 87 F. Supp. 3d 966, 976-77 (N.D. Cal. 2015) (dismissing securities fraud claims based on violations of business code of ethics for lack of materiality only); In re Yum! Brands, Inc. Sec. Litig., 73 F. Supp. 3d 846, 864-65 (W.D. Ky. 2014) (analyzing securities fraud claims based on violations of business code of ethics by first examining materiality then falsity); City of Roseville Emps.’ Ret. Sys v. Horizon Lines, Inc., 686 F. Supp. 2d 404, 415 (D. Del. 2009) (dismissing complaint based on violations of business code of ethics for lack of objective falsity only); Andropolis v. Red Robin Gourmet Burgers, Inc., 505 F. Supp. 2d 662, 685-86 (D. Colo. 2007) (same).
 Retail Wholesale & Dep't Store Union Local 338 Ret. Fund v. Hewlett-Packard Co., 52 F. Supp. 3d 961, 967 (N.D. Cal. 2014).
 See Ind. State Dist. Council of Laborers v. Omnicare, Inc., 583 F.3d 935, 945-46 (6th Cir. 2009) (analyzing knowledge of falsity under the material misrepresentation requirement); Zaluski v. United Am. Healthcare Corp., 527 F.3d 564, 572 (6th Cir. 2008) (same); but see KBC Asset Mgmt. N.V. v. Omnicare, Inc. (In re Omnicare, Inc. Sec. Litig.), 769 F.3d 455, 472-73 (6th Cir. 2014) (analyzing actual knowledge apart from its analysis of a material misrepresentation or omission).
 17 C.F.R. § 229.406(a).
 Basic Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988).