Defining The Outer Limits

In the typical securities class action, the plaintiffs allege the defendant company made material misrepresentations that inflated the value of the company’s stock. But what if the alleged misrepresentations also inflated the value of another company’s stock? Do the purchasers of the second company’s stock have standing to sue the first company?

The U.S. Court of Appeals for the Second Circuit thinks this is stretching the boundaries of Rule 10b-5 too far. In Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp., 2004 WL 1110496 (2d Cir. May 19, 2004), the court addressed whether purchasers of JDS Uniphase stock, which was in the process of selling its laser business to Nortel during the class period, had standing to sue Nortel for alleged misstatements about Nortel’s business prospects that inflated the stock prices of both companies. Based on Supreme Court precedent, the court found that the purchaser-seller requirement for Rule 10b-5 liability limits standing to those who have dealt in the security to which the misrepresentation relates. (The court left open the question, however, of whether a potential merger between two companies, which would create a more direct relationship between the companies’ stock prices, might require a different outcome.)

Holding: Affirming lower court’s dismissal.

Quote of note: “Stockholders do not have standing to sue under Section 10(b) and Rule 10b-5 when the company whose stock they purchased is negatively impacted by the material misstatement of another company, whose stock they do not purchase.”

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