The WorldCom and Initial Public Offering securities litigations in the S.D.N.Y. are generating judicial opinions on a wide variety of topics, with the plaintiffs frequently getting the better of the argument. Two more opinions have come down from Judge Scheindlin in the IPO allocation cases over the holidays.
Discovery of Wells Submissions
On December 24, the court issued an opinion and order addressing whether “Wells submissions” to the SEC are discoverable in subsequent litigations. The target of a SEC investigation is permitted to file a written submission, known as a Wells submission, with the agency to respond to contemplated charges. The plaintiffs were seeking discovery of Wells submissions made by the underwriter defendants in connection with the SEC’s investigation of the same IPO allocation practices at issue in the current litigation. Although the Wells submissions contained offers of settlement, the court found that they are not “settlement material” and, in any event, they are relevant to the current litigation and therefore discoverable.
Quote of note: “Offers of settlement, however, are not intrinsically part of Wells submissions, which were intended to be ‘memoranda to the SEC presenting arguments why an enforcement proceeding should not be brought.’ To the extent that a respondent may make a settlement offer, that offer is typically clearly identified and thus easily severable from the remainder of the submission.”
Holding: The underwriter defendants are ordered to produce their Wells submissions to plaintiffs on or before January 20, 2004.
The New York Law Journal has an article (via law.com – free regist. req’d) on the decision and the Securities Litigation Watch has a post.
On December 31, the court issued an order and opinion addressing a motion for judgment on the pleadings by the underwriter defendants. The underwriter defendants argued that the Rule 10b-5 claims against them should be dismissed in light of the Second Circuit’s recent decision on the pleading of loss causation in securities fraud cases. In Emergent Capital, the Second Circuit held that allegations of artificial price inflation, without more, do not suffice to plead loss causation. (The 10b-5 Daily has posted about the decision and the current circuit split on this issue.)
In the IPO allocation cases, the underwriter defendants “allegedly required or induced their customers to buy shares of stock in the aftermarket as a condition of receiving initial public offerings stock allocations.” This conduct allegedly caused the plaintiffs to purchase the stock at an artificially inflated price. The plaintiffs have brought claims, based on different provisions of Rule 10b-5, for (1) market manipulation and (2) material misstatements and omissions.
Although the Emergent Capital decision requires more than price inflation to adequately plead loss causation (e.g., a corrective disclosure revealing the fraud and causing a stock price decline), the court noted that it is a material misstatements and omissions case. Market manipulation, the court argued, is simply different.
“A market manipulation is a discrete act that influences stock price. Once the manipulation ceases, however, the information available to the market is the same as before, and the stock price gradually returns to its true value. . . In market manipulation cases, therefore, it may be permissible to infer that the artificial inflation will inevitably dissipate. That being so, plaintiffs’ allegations of artificial inflation are sufficient to plead loss causation because it is fair to infer that the inflationary effect must inevitably diminish over time. It is that dissipation — and not the inflation itself — that caused plaintiffs’ loss.”
The court offers no citations for this analysis and it certainly reaches some broad (and potentially controversial) conclusions. As for the remaining misstatements and omission claims, the court concedes that Emergent Capital is directly on point, but simply bootstraps the claims into its earlier loss causation analysis: “The content of Underwriters’ misstatements was, in essence: ‘this is a fair, efficient market, unaffected by manipulation.’ In fact (according to plaintiffs), the market was manipulated. For the reasons discussed  above, that market manipulation was a cause of plaintiffs’ loss. Therefore, the misstatements that concealed that manipulation also were a cause of plaintiffs’ loss.” But if the plaintiffs have brought separate fraud claims based on alleged misstatements, don’t they need to establish that the alleged misstatements, separate and apart from the market manipulation, caused a loss? Apparently not.
Holding: Motion for judgment on the pleadings denied.