Fogarazzo Revisited

The decision in the Fogarazzo research analyst case in the S.D.N.Y. (previously posted about in The 10b-5 Daily) is controversial on a number of pleading issues. Not only does the court apply a loss causation standard that, in contravention of the Second Circuit, appears to remove the need to draw any actual connection between the misrepresentations and the loss, it also runs roughshod over other S.D.N.Y. decisions on how to analyze the falsity and scienter (i.e., fraudulent intent) requirements for securities fraud claims based on statements of opinion.

In the research analyst cases, the issue is whether the defendants deliberately misrepresented their truly held opinion that the stock was not a good investment. Judges in the S.D.N.Y. (e.g., Judge Lynch in the Podany decision) have found that under these circumstances the falsity and scienter requirements are essentially identical. Since the statement (unlike a statement of fact) cannot be false at all unless the speaker is knowingly misstating his truly held opinion, the plaintiffs must allege inconsistent statements or actions by the defendants from which a factfinder could infer that a knowing misstatement was made. For example, the plaintiffs might allege that the defendants’ made statements to others that the stock was overvalued or engaged in personal sales of the stock.

In Forgarazzo, Judge Scheindlin rejected this approach. After finding that falsity must be examined separately from scienter, the court held that the falsity of the analysts’ buy recommendations was adequately plead based on allegations that the defendants: (1) wanted to obtain investment banking business from the underlying company; (2) had analysts that were subject to financial conflicts of interest; and (3) failed to maintain adequate controls to protect the objectivity of their public research. None of these allegations, however, suggests that the analyst reports were false (i.e., that the defendants actually regarded the underlying stock as a poor investment). In essence, the court found that the existence of a motive to commit fraud is enough to demonstrate that the opinions were false.

Holding: Motion to dismiss denied.

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