Category Archives: Motion To Dismiss Monitor

Apparently, it’s a good day to be a defendant. Baxter International, Inc. , a medical products maker, has announced the dismissal of the securities class action filed against it in Illinois federal court. The suit was based on earnings forecasts Baxter had made for FY2002.

The conventional wisdom on Judge Pollack’s decision in the Merrill Lynch analyst research cases is that he dismissed the cases because the plaintiffs were not Merrill Lynch clients, and therefore could not demonstrate that they reasonably relied on the brokerage’s research. Columnists for Forbes and Bloomberg continue to provide a forum for this incorrect reading of the case, which is being promoted vociferously by (surprise) attorneys representing individual Merrill Lynch clients in arbitration claims against the brokerage.
In fact, as discussed in The 10b-5 Daily here and here, Judge Pollack dismissed the cases because plaintiffs failed to establish any connection between the analyst research and the companies’ financial troubles or the collapse of the overall market. In Judge Pollack’s view, that is what actually caused plaintiffs’ losses. But as Chico Marx once said, “who are you going to believe, me or your own eyes?” Here’s the opinion again — whether you agree with Judge Pollack or not, it’s fascinating reading.

The New York Times is keeping on top of the AOL Time Warner securities class action. In a followup to its July 7 overview of the case (posted on The 10b-5 Daily), the paper has an article on the recently filed motion to dismiss. Among other things, AOL Time Warner argues that its restatement of $190 million is just 1% of its revenue over the period in question and that it disclosed all of its two-way deals with customers.

Quote of note: “The company’s motion to dismiss the suit is an expected part of the proceedings, and legal scholars consider it unlikely to succeed. But the relative strength of AOL Time Warner’s legal defense will help determine how costly it is for the company to resolve the suit, most likely through a settlement payment.”

The securities class action (along with another securities fraud case) against the former executives of Suprema Specialties, a bankrupt cheese manufacturer, have been dismissed by Judge William Walls of the D. of N.J. The Newark Star-Ledger reports that testimony and evidence in the related bankruptcy case raised questions about the validity of the company’s “hard cheese” sales, but Judge Walls held that the allegations of fictitious sales in the securities fraud cases lacked details and failed to meet the applicable pleading standards.

Quote of note: “‘The complaints certainly paint a picture of a company which was troubled and ultimately failed, a picture where, perhaps, something smelled a little funny,’ Walls wrote in his June 25 decision. ‘But the complaints lack the factual specificity demanded by (securities fraud law) and may not be so maintained.'”

The The New York Times has a lengthy article in today’s edition on the securities class action against AOL Time Warner. The author concludes that a dismissal of the case appears unlikely.

Quote of note: “In what one legal scholar called ‘the judicial equivalent of a Freudian slip,’ Judge Shirley Wohl Kram of United States District Court in Manhattan responded to a preliminary letter from shareholders’ lawyers by ordering AOL Time Warner to turn over millions of pages of documents before the lawyers filed a formal motion or the company had a chance to respond. When AOL Time Warner’s lawyers complained, she quickly rescinded the order.”

Quote of note II: “[L]egal experts say that the settlement in this case may well exceed previous benchmarks and formulas because of the political impetus among judges and regulators these days to crack down on corporate fraud. ‘There has been a regime change,’ said Joseph A. Grundfest, a law professor at Stanford and a former member of the S.E.C., adding that ‘settlements are more difficult for companies to negotiate in the post- Enron environment.'”

On Friday, the New York Times ran a news analysis on Judge Pollack’s decision in the Merrill Lynch case. Unfortunately, the author misstates the central holding in the case, leading to a number of erroneous conclusions. In support of the proposition that the decision has little precedential value, the article conflates two elements of a Rule 10b-5 claim that Judge Pollack took great pains to separate: reasonable reliance and loss causation. The article states: “The judge’s point, instead, was that even if the research was fraudulent, the plaintiffs could not prove that their losses were tied to the research because they were not Merrill Lynch clients.”

Wrong. Instead, as discussed in The 10b-5 Daily, Judge Pollack held that the plaintiffs must “allege facts which, if accepted as true, would establish that the decline in the prices of 24/7 and Interliant stock (their claimed losses) was caused by any or all of the alleged omissions from the analyst reports.” Finding that there was no alleged connection between the analyst reports and the companies’ financial troubles or the collapse of the overall market, the court held that the plaintiffs failed to meet their pleading burden.

In other words, Judge Pollack’s ruling is much broader than the New York Times suggests. The key was not whether the plaintiffs were Merrill Lynch clients and therefore could establish that they reasonably relied on Merrill Lynch’s research. Judge Pollack notes in his decision that in a fraud-on-the-market class action, price inflation is typically used as a surrogate for reliance. Instead, the court focused on loss causation and whether the plaintiffs, presumably regardless of their status as Merrill Lynch clients, had adequately alleged that their investment losses were caused by the analyst reports. And that, as they say, is a bird of a different feather.

Addition: The 10b-5 Daily should note that the article’s overall theme, that Judge Pollack’s decision does not necessarily prevent Merrill Lynch clients from successfully bringing individual arbitration claims against the brokerage, is correct. It’s simply correct for a different reason. Judge Pollack’s decision addresses a fraud-on-the-market class action based on Rule 10b-5, it does not address every type of individual claim that might be brought against Merrill Lynch by a client (including breach of fiduciary duty, breach of contract, etc.).

Having gone three-for-three in front of Judge Pollack of the S.D.N.Y. this week, Merrill Lynch is apparently optimistic that the remaining 24 securities class actions against the company based on allegedly biased research reports will be dismissed. According to a Reuters article, the general counsel of Merrill Lynch sent an e-mail to employees stating: “Although the dismissals apply only to these three class actions, we believe the reasoning of the decisions is equally applicable to other research-related class actions as well.”

For the second time in as many days, Judge Pollack of the S.D.N.Y. has dismissed a securities class action against Merrill Lynch. According to Reuters, the plaintiffs, investors in Merrill Lynch’s Global Technology Fund, had alleged “they were duped in part because the fund invested in the stock of companies that Merrill Lynch investment bankers were doing business with.”

Quote of note: “‘She (the lead plaintiff) was suing on the same general theme of having bought some shares in a fund and that Merrill Lynch was responsible for the decline in the value of the funds,’ Pollack told Reuters. ‘I tossed her out.'”

Addition: The opinion in the Global Technology Fund case can be found here. (Thanks to the Securities Law Beacon for the link.)

The Washington Post has a comprehensive article on the decisions by Judges Pollack and Baer of the S.D.N.Y. dismissing securities class actions against Merrill Lynch and other brokerages that were based on the dissemination of allegedly biased research reports about 24/7 Real Media Inc., Interliant Inc., and Covad Communications Group. The cases are part of 27 similar consolidated actions involving different stocks.

Judge Pollack’s decision in the Merrill Lynch case is sweeping in its scope, with the court finding that “plaintiffs were among the high-risk speculators who, knowing full well or being properly chargeable with appreciation of the unjustifiable risks they were undertaking in the extremely volatile and highly untested stocks at issue, now hope to twist the federal securities laws into a scheme of cost-free speculators’ insurance.” (CorpLawBlog has a post discussing the rhetoric in the decision.) The court held that the plaintiffs had failed to adequately plead their Section 10(b) claims and that the claims were, in any event, barred by the statute of limitations.

Note that when it rains loss causation cases, it pours loss causation cases. In direct contrast to the Eighth Circuit’s holding in ConAgra (discussed below), Judge Pollack found that merely alleging that the stock price was artificially inflated is not sufficient to satisfy loss causation. (Indeed, he states that to allow this “would undoubtedly lead to speculative claims and procedural intractability.”) The plaintiffs needed “to allege facts which, if accepted as true, would establish that the decline in the prices of 24/7 and Interliant stock (their claimed losses) was caused by any or all of the alleged omissions from the analyst reports.” Finding that there was no alleged connection between the analyst reports and the companies’ financial troubles or the collapse of the overall market, the court held that the plaintiffs failed to meet their pleading burden.

Quote of note (Washington Post): “‘This was something of a test case for [lawsuits] involving similar facts,’ Pollack said. ‘The question is, are the facts similar?” Pollack said he did not believe the case was a close one. “Anybody who goes out to Las Vegas and loses can’t sue the croupier,’ he said.”

Quote of note II (Washington Post): “Columbia University law professor John C. Coffee Jr. called Pollack’s decision ‘a huge victory for Merrill Lynch’ because the judge ruled that the losses were caused by the bursting of a bubble rather than the allegedly false research. ‘That’s the part of his decision that has the greatest application to other cases. It’s [also] the most debatable. He doesn’t have much factual evidence.'”

The PSLRA creates a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. There are two prongs to the safe harbor. First, a defendant shall not be liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by “meaningful cautionary statements” that alert investors to the factors that could cause actual results to differ. Second, a defendant shall not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with “actual knowledge” that it was false or misleading.

As noted by numerous commentators, the statutory scheme arguably gives companies a license to lie. If a company uses appropriate cautionary language, it can make a forward-looking statement that it knows to be false without fear of liability. Accordingly, courts have struggled with how to apply the first prong of the safe harbor where the plaintiffs allege that the defendants knew their forward-looking statements were false and merely offered cautionary language to create a smoke screen for their fraud.

In In re Seebeyond Technologies Corp. Sec. Litig., 2003 WL 21262498 (C.D. Cal. May 28, 2003), the court disagreed that the safe harbor permits knowing falsities. The key is the requirement that the cautionary language be “meaningful.” The court found that “[i]f the forward-looking statement is made with actual knowledge that it is false or misleading, the accompanying cautionary language can only be meaningful if it either states the belief that it is false or misleading or, at the very least, clearly articulates the reasons why it is false or misleading.”

This reading of the statute is subject to a number of objections, some of which the court itself raises. First, it appears to require a court to determine whether the statement was made with actual knowledge of falsity as a prerequisite for determining whether the cautionary language was meaningful. Congress did not impose a state of mind requirement in the first prong of the safe harbor; leaving that examination for forward-looking statements that are not accompanied by cautionary language. Second, other courts have held that to take advantage of the safe harbor, a defendant is not required to have identified the exact factor that ultimately rendered the statement untrue. It is enough to have cautionary language that reasonably alerted investors to the risks. The court’s holding would appear to severely weaken this principle – as long as the plaintiff adequately alleges actual knowledge, the defendant’s disclosure is never sufficient unless the exact factor that ultimately rendered the statement untrue is revealed. The bottom line: Congress is going need to solve this one.

Holding: Motion to dismiss granted in part and denied in part (plaintiffs were allowed to proceed with their claims based on forward-looking statements).

Quote of note: “Subsection (A) may still provide safe harbor where cautionary language is used, even if the defendant has actual knowledge that the statement is false or misleading. The idea that sufficient cautionary language may be used when the defendant has actual knowledge that a statement is somehow misleading (for instance, where the company is engaging in ‘puffery’ of some sort) is not so far-fetched.”