The 10b-5 Daily

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.'”