Category Archives: Motion To Dismiss Monitor

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.

The research analyst cases continue to generate interesting judicial opinions. Judge Gerard Lynch of the S.D.N.Y. recently denied the motion to dismiss in the DeMarco case, which involved allegedly fraudulent buy recommendations for Corvis Corp. stock made by Robertson Stephens. Last month, however, Judge Lynch came to the opposite conclusion in two facially similar cases against Robertson Stephens over buy recommendations for Redback Networks and Sycamore Networks stock. See Podany/Finazzo v. Robertson Stephens, Inc., 2004 WL 307296 (S.D.N.Y. Feb. 17, 2004). Why the difference?

In all of the cases, the issue was whether the defendants deliberately misrepresented a truly held opinion (i.e., that the stock was not a good investment). The court framed the inquiry in this manner:

“While in a misstatement of fact case the falsity and scienter requirements present separate inquiries, in false statement of opinion cases such as these, the falsity and scienter requirements are essentially identical . . . . [A] material misstatement of opinion is by its nature a false statement, not about the objective world, but about the defendant’s own belief. Essentially, proving the falsity of the statement ‘I believe this investment is sound’ is the same as proving scienter, since the statement (unlike a statement of fact) cannot be false at all unless the speaker is knowingly misstating his truly held opinion.”

In the DeMarco case, the court found, the complaint “described acts and statements inconsistent with the defendants’ published opinions about the value of Corvis stock,” including the defendants’ statements to others that Corvis stock was overvalued and their personal sales of Corvis stock. In contrast, the Podany and Finazzo complaints pointed “to no inconsistent statements or actions by defendants from which a factfinder could infer that the published opinions were not truly held.” Plaintiffs’ arguments that the opinions were not objectively reasonable, that the analyst had a motive to lie because he owned shares in companies that were being acquired by Redback and Sycamore, and that defendants had engaged in similar schemes (e.g., the Corvis allegations) were insufficient to establish any misstatements of opinion.

Holding: Motions to dismiss granted.

Quote of note: “While the commission of similar fraudulent schemes may be admissible evidence of defendants’ state of mind under Federal Rule of Evidence 404(b), alleging the existence of such other schemes does not sufficiently plead that the opinions in these cases were fraudulent.”

Titan Pharmaceuticals, Inc. (Amex: TTP) has announced that the plaintiffs in the derivative and securities class action litigation brought against the Company have voluntarily dismissed their claims without prejudice. The securities class actions, intitially filed in the N.D. of Cal. last November, had alleged that Titan made false statements regarding the development of a new drug for treating schizophrenia.

A court in the E.D. of Tex. has denied the motion to dismiss in the securities class action against Electronic Data Systems Corp. (“EDS”). The suit alleges that EDS misrepresented company earnings and facts related to its multibillion-dollar Navy/Marine Corps Intranet contract. According to an article in Computerworld, the court found that the plaintiffs had established a “strong inference that defendants were extremely reckless in continuing to recognize any revenue on the project when they were allegedly pursuing a tactic of intentionally providing goods that did not meet contract specifications.”

Quote of note: “Lawyers for the shareholders presented a significant number of documents that the court upheld as evidence supporting the allegations against EDS. Among the documents was a May 6, 2002, e-mail from the N/MCI transition manager at the Naval Air Systems Command that outlined various software problems, a failure to provide remote access for 61% of the users that were testing the new intranet, and a lack of secure Web access and help desk support.”

Addition: The opinion is now available on Westlaw – In re Electronic Data Systems Corp. Securities and “ERISA” Litigation, 2004 WL 52088 (E.D. Tex. Jan. 13, 2004).

What is necessary to adequately plead loss causation in a securities fraud case continues to be the subject of contention in the S.D.N.Y., with a number of decisions addressing the issue over the past year. The New York Law Journal has an article (via law.com – free regist. req’d) on yet another loss causation decision in DeMarco v. Robertson Stephens, Inc., 2004 WL 512232 (S.D.N.Y. Jan. 9, 2004), the securities class action against Robertson Stephens over its Corvis Corp. stock recommendations.

The suit alleges that Robertson Stephens’ analysts made buy recommendations for Corvis stock to prop up the price until the firm and some of its executives could sell off their pre-IPO shares in the company (i.e., a variation on a “pump-and-dump” stock manipulation). The alleged scheme was revealed to the market when a May 2001 article in the New York Times reported the discrepancy between Robertson Stephens’ public recommendations and the sales by its executives. In his opinion, District Judge Lynch notes that the price of Corvis stock dropped 16% within a few days of the article.

On the issue of loss causation, the defendants argued that the plaintiffs’ loss was due to the general market downturn in telecommunications stock, not any alleged misrepresentations. The court agreed that the plaintiffs could not merely allege that the price of Corvis shares had been inflated to establish loss causation (there is a circuit split on this issue), holding that “it is unlikely that loss causation could be adequately alleged in every fraud-on-the-market case that successfully pleads transaction causation because in cases where an unforseeable intervening event causes the plaintiffs’ loss, there is no causal nexus between the loss and the misrepresentation.” In the instant case, however, the court found that “the bursting of the Corvis stock bubble could reasonable be construed, at least in part, as the market’s correction of an inflated stock price, pumped up in part by defendants’ false statements about its opinions.”

The court took pains to distinguish the case from the facially similar cases against Merrill Lynch that have been dismissed by Judge Pollack. On the issue of loss causation, Judge Lynch noted that, in contrast to the Merrill Lynch cases, “in this case there is evidence that disclosure of defendants’ scheme caused a further decline in the price of Corvis stock, even after the overall bubble had burst.”

Holding: Motion to dismiss Rule 10b-5 claim denied. A motion to dismiss the insider trading claim against a Robertson Stephens executive, however, was granted.

Quote of note: “On the facts in this case, the Court must conclude that plaintiffs have adequately alleged loss causation because the decline in stock price was a forseeable consequence of defendants’ fraudulent statements that allegedly inflated the price, because in an efficient market, revelation of the misrepresentations will lead inexorably to a price correction.”

Maxim Pharmaceuticals, Inc. (Nasdaq: MAXM) has announced the dismissal, with prejudice, of the securities class action pending against the company in the S.D. of Cal. The plaintiffs had alleged that Maxim made false and misleading statements in 1999 and 2000 concerning the efficacy and clinical trial results of a cancer drug it was developing. The court had already dismissed two earlier complaints and based this dismissal on the failure to adequately plead scienter. The Securities Litigation Watch has a post on the case and has linked to the court’s order.

Amdocs, Ltd. (NYSE: DOX), a St. Louis-based supplier of billing and customer relationship management software to the telecommunications industry, has announced the dismissal, with prejudice, of the securities class action pending against the company in the E.D. of Missouri. Plaintiffs had alleged that “Amdocs and the individual defendants had made false or misleading statements about Amdocs� business and future prospects during a putative class period between July 18, 2000 and June 20, 2002.”

The Sarbanes-Oxley Act of 2002 extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation. Although the legislation clearly provides that it “shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002],” left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations.
Courts are beginning to address this issue, with mixed results. In Roberts v. Dean Witter Reynolds Inc., 2003 WL 1936116 (M.D. Fla. March 31, 2003), the district court found that Sarbanes-Oxley revived already time-barred claims because the legislative history demonstrates that Congress intended to achieve that result. The court, however, primarily relied on floor statements made by a single senator and a few sentences in a congressional analysis of the legislation in reaching this conclusion. Perhaps as a result, it certified an interlocutory appeal on the question that is currently pending before the U.S. Court of Appeals for the 11th Circuit.
In the meantime, two other district courts have issued contrary opinions. In Glaser v. Enzo Biochem, Inc., 2003 WL 21960613 (E.D. Va. July 16, 2003), the court concluded that “Congress did not unambiguously provide that the [new] limitations period would apply retroactively.” Last week, in In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig. , 03 Civ. 3752 (S.D.N.Y. Nov. 5, 2003), the court held: (a) “there is no clear language in the statute stating that it applies retroactively or that it operates to revive time-barred claims;” (b) the statute expressly disavows that it is creating any new rights of action; and (c) the legislative history examined by the Roberts court does not support a finding that Congress intended to revive time-barred claims.
Stay tuned.
Addition: The opinion is now available on Westlaw – In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig., 2003 WL 22955925 (S.D.N.Y. Nov. 5, 2003).