In 2001, more than 300 securities class actions were filed against companies and underwriters who engaged in initial public offerings in the high-tech boom years. The cases, known as the “IPO Allocation” cases, alleged that the underwriters gained increased trading commissions in exchange for access to IPO shares and that investors who were allocated IPO shares were required to buy shares in the after-market to help push up the share price.
An offshoot of this litigation is the class actions that have been brought on behalf of the companies who did IPOs alleging that the underwriters engaged in breaches of contract or fiduciary duty by engaging in these activities. An example is the case brought by Xpedior Creditor Trust against Donaldson Lufkin & Jenrette (“DLJ” – now owned by CSFB) on behalf of companies whose initial public offerings were underwritten by DLJ. On Tuesday, Judge Scheindlin denied the defendant’s motion to dismiss. Most notably, the court determined that the plaintiffs’ claims were not subject to preemption under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), which generally requires the dismissal of class actions for securities fraud that are based on state law.
The court held that, based on the Second Circuit’s recent decision in Spielman, it was not enough to rely on the plaintiffs’ characterization of their claims. Instead, the court needed to examine whether the state law claims in the case relied on misstatements or omissions made in connection with the sale or purchase of a security as a “necessary component” of the claims. “To make this determination the simple inquiry is whether plaintiff is pleading fraud in words or substance.” The court found, however, that none of the state law claims asserted by the plaintiffs – breach of contract, breach of the implied convenants of good faith and fair dealing, breach of fiduciary duty, or unjust enrichment – required misrepresentations as a necessary element and they did not sound in fraud.
Holding: Motion to dismiss denied (except as to the unjust enrichment claim on different grounds).
The Associated Press has an article on the decision, but gets the basis for the claims wrong. The decision makes it clear that Xpedior did not allege that DLJ “deliberately underpriced initial public offerings during the Internet boom,” precisely because that would have led to the likely dismissal of the case due to SLUSA preemption.