The 10b-5 Daily

Reuters reports that the securities class action pending against Juniper Networks, Inc. (Nasdaq: JNPR) in the N.D. of Cal. has been dismissed with prejudice. The suit was originally filed in 2002 and alleged among its claims that Juniper falsely recognized certain revenues.

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.”