Ninth Circuit Sets New Standard for Intra-Quarter Disclosure in IPO Securities Cases

In a significant ruling that reshapes disclosure obligations for public companies, the Ninth Circuit Court of Appeals has established that the materiality standard, not the “extreme departure” test, governs when issuers must disclose intra-quarter financial information in registration statements for initial public offerings.

The August 29 decision in Sodha v. Golubowski involves a securities lawsuit against Robinhood Markets, Inc., the popular online brokerage platform, and addresses a critical question: when must a company disclose developing financial results that differ from previously reported figures?

“To disclose or not to disclose is the question public issuers must ask when confronted with business developments every quarter,” wrote the court in its opinion. The divided panel ruled that the test governing intra-quarter disclosure obligations under the Securities Act of 1933 hinges on whether the information would be material to investors.

This ruling aligns the Ninth Circuit with the Second Circuit’s position established in 2017 but diverges from the “extreme departure” test that has been followed by the First Circuit for nearly three decades.

The Case Against Robinhood

The lawsuit stemmed from Robinhood’s July 2021 IPO. The company’s business model relies on “payment for order flow” (PFOF), where it routes customers’ orders to market makers who pay Robinhood for the privilege. This revenue source became particularly significant during the early 2021 “meme stock” trading frenzy involving GameStop, AMC Entertainment, and other companies, as well as the cryptocurrency Dogecoin.

During this period, Robinhood experienced unprecedented transaction volume, leading to a 340% year-over-year increase in transaction-based revenues for Q1 2021. However, by the time of its IPO in late July 2021, these trends had begun to reverse.

The plaintiffs alleged that Robinhood’s registration statement omitted crucial information about deteriorating financial conditions in Q2 and early Q3 2021. Although the company disclosed strong Q1 results, it provided limited information about subsequent quarters, merely stating expectations were “in line with previous statements” while warning that the company “may not continue to grow on pace with historical rates.”

When Robinhood eventually reported Q3 2021 results in October, it revealed significant declines across key performance indicators and revenue sources. Following this announcement, the company’s stock price dropped approximately 10%.

Materiality vs. “Extreme Departure”

At the heart of the case was whether Robinhood had an obligation to disclose interim financial results showing a decline from previously reported figures.

The district court had dismissed the case, applying the “extreme departure” test established by the First Circuit in Shaw v. Digital Equipment Corporation (1996). Under this standard, companies must disclose intra-quarter results only if they represent an “extreme departure from publicly known trends and uncertainties.”

The Ninth Circuit rejected this approach, instead holding that “the proper test for the duty to disclose is the test for materiality.” This standard asks whether there is a “substantial likelihood that disclosure of the omitted information would have been viewed by a reasonable investor as having significantly altered the total mix of information available.”

In adopting this position, the court aligned with the Second Circuit’s 2017 decision in Stadnick v. Vivint Solar, Inc., which had similarly rejected the “extreme departure” test for three key reasons: courts’ familiarity with the traditional materiality standard; the ambiguity of the “extreme departure” test; and concerns that the “extreme departure” test could be “analytically counterproductive.”

Implications for Public Companies

The ruling has significant implications for companies preparing for IPOs and other securities offerings. Rather than focusing on whether interim financial results represent an “extreme departure” from previous periods, issuers must now assess whether such information would be material to investors under the traditional securities law standard.

Virginia Milstead, Mark Foster, and Alyssa Musante, the contributing attorneys who analyzed the case, note that the decision creates clearer standards but may not necessarily increase disclosure obligations.

“As Vivint Solar proved, the traditional ‘materiality’ standard is not necessarily plaintiff-friendly and may not require greater disclosure than the ‘extreme departure’ test,” they observed. “Public companies are well advised to evaluate their disclosures under the requirements imposed by the 2nd and 9th Circuits.”

In her 60-page partial dissent, Judge Johnnie B. Rawlinson criticized the majority’s approach, arguing that it “collapses the requirements for interim and annual reports” and creates “one mushy ‘materiality’ standard” rather than preserving the flexibility afforded by existing regulations.

For companies planning IPOs within the Ninth Circuit’s jurisdiction, which includes California and other western states where many technology companies are headquartered, this ruling emphasizes the need for careful consideration of developing financial trends, even within a current quarter, when preparing offering documents.

As financial markets continue to evolve at an increasingly rapid pace, this decision highlights the ongoing tension between providing timely, complete information to investors while managing disclosure obligations in a practical manner.