Securities Regulation Daily Wrap Up, FRAUD AND MANIPULATION—E.D. Mich.: Adding an insider trading subclass to Rocket case would not be futile, (Feb 6, 2024)

By Rodney F. Tonkovic, J.D.

The proposed subclass representative has both Article III and statutory standing to pursue an insider trading claim.

A district court found that substituting a plaintiff under Section 20A in a fraud action against Rocket Companies would not be futile. The complaint brought fraud and insider trading claims, and after moving for class certification, the plaintiffs moved to substitute a proposed subclass representative under §20A. The court concluded that the substitution was not sought in bad faith, was not futile, and would not cause undue delay or prejudice. While stressing that it only had found that the proposed substitute has standing, the court accordingly granted leave to file an amended complaint and renewed motion for class certification reflecting the substitution (Shupe v. Rocket Companies, Inc., February 5, 2024, Ludington, T.).

Sales before crash. Rocket Mortgage is the largest U.S. mortgage lender. According to the complaint, Rocket and some of its executives made several misleading statements about how Rocket's key performance metrics were improving. In May 2021, however, Rocket disclosed lowered metrics, and on this news, its share price plummeted by 28 percent over the next six day.

This action was brought in 2021 and alleged fraud under the Exchange Act and insider trading, claiming that Rocket knew that it's financial situation would probably falter but continued to make positive public statements. Plus, as relevant here, Rocket's Chairman of the Board, Daniel Gilbert, had traded almost $500 million dollars of Rocket stock shortly before the May 2021 disclosure.

The court later denied in part Rocket's motion to dismiss the second amended complaint, finding that the complaint pleaded actionable misrepresentations. The court found Gilbert had traded Rocket stock based on material nonpublic information.

Substitute plaintiff. The plaintiffs had filed a motion for class certification with a proposed subclass under Exchange Act §20A, alleging that the subclass had traded contemporaneously with Gilbert, but at an inflated price. After the motion was filed, the proposed subclass representative bowed out, and the plaintiffs then sought to substitute an institutional plaintiff, Construction Laborers Pension Trust for Southern California (SoCal).

At issue was whether the proposed representative should be withdrawn and whether leave should be granted to add SoCal as a party. The court concluded that the substitution was not sought in bad faith, was not futile, and would not cause undue delay or prejudice.

Not futile. Rocket did not dispute the bad faith or prejudice elements, so the crux of the controversy was whether the proposed substitution was futile. Section 20A provides a private right of action for those who traded "contemporaneously" with an insider trader. Seizing on this language, Rocket argued that SoCal lacked standing because it did not buy shares directly from Rocket or because it bought shares on the day after Gilbert's alleged insider trade.

The court first found that SoCal had constitutional standing to bring a §20A claim. The court found that the plaintiffs had alleged a particularized concrete harm—insider trading—to satisfy their Article III standing. Rocket argued that the harm was not concrete because SoCal did not directly trade with Rocket or Gilbert.

This argument was based largely on Fridrich v. Bradford, a 1976 Sixth Circuit case holding that a plaintiff failed to show a connection between insider trades and their loss where the insider did not purchase from the plaintiffs. The court followed the reasoning of a 1992 case from the Southern District of Ohio in finding Fridrich to be non-binding since §20A was codified in 1988. Direct trades do not need to be alleged, the court said, concluding that the plaintiffs sufficiently pleaded SoCal's Article III standing.

Rocket then argued that SoCal's purchase was not "contemporaneous" because it did not make its purchase on the same day as the alleged insider trade. The court said that this definition of "contemporaneous" was too narrow, noting that most courts addressing the issue agree that a trade made within a few days is a reasonable period of time. In this case, the court was satisfied that a trade made one day later than the alleged insider trade was sufficiently contemporaneous to establish standing.

The case is No. 1:21-cv-11528.

Attorneys: James P. Allen (Schenk & Bruetsch PLC) and Carol C. Villegas (Labaton Keller Sucharow LLP) for Carl Shupe and Matthew Pearlman. Adam Slutsky (Goodwin Procter LLP) and Carsten Parmenter (Honigman LLP) for Rocket Companies, Inc., Jay Farner, Daniel Gilbert and Rock Holdings Inc.

Companies: Rocket Companies, Inc.; Rock Holdings Inc.

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