In Re Initial Public Offering Securities Litigation

Citations: 544 F. Supp. 2d 277; 2008 U.S. Dist. LEXIS 24148; 2008 WL 819762Docket: Master File No. 21 MC 92(SAS). Nos. 01 Civ. 3857(SAS), 01 Civ. 8404(SAS), 01 Civ. 7048(SAS), 01 Civ. 9417(SAS), 01 Civ. 6001(SAS), 01 Civ. 0242(SAS)

Court: District Court, S.D. New York; March 26, 2008; Federal District Court

SummaryOriginalCytator Case TreatmentAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

The document pertains to multiple cases within the In re Initial Public Offering Securities Litigation, specifically focusing on six main cases involving various companies such as Corvis Corp and Engage Technologies, Inc. Following a reversal by the Second Circuit Court of Appeals regarding class certification on December 5, 2006, plaintiffs amended their complaints against the defendants, who include Underwriter Defendants (investment banks) and Issuer Defendants (companies that conducted the IPOs). 

Plaintiffs allege that the defendants engaged in fraudulent practices to inflate the share prices of 309 technology stocks during and after their IPOs through schemes involving tie-in agreements, undisclosed compensation, and conflicts of interest among analysts. Substantial investors were reportedly pressured by Underwriter Defendants to participate in these schemes, while Issuer Defendants and their executives benefited from the inflated stock prices by raising capital and selling shares at high prices. The plaintiffs claim they suffered significant losses when the artificially inflated prices declined.

The Amended Complaints provide specific allegations against each Issuer Defendant and outline various claims against both the Underwriter and Issuer Defendants. Additionally, an "Amended Master Allegations" document has been filed that consolidates common allegations across all cases, which the individual Amended Complaints reference. Defendants have moved to dismiss the Amended Complaints, and the court's ruling on this motion is partially in favor of the defendants.

Plaintiffs accuse the Underwriter Defendants of engaging in unlawful practices to create artificial demand for shares in the aftermarket following initial public offerings (IPOs). This was allegedly achieved by tying share allocations to agreements that required customers to purchase additional shares at escalating prices. The Underwriter Defendants purportedly monitored customer profits from IPO allocations and demanded a portion of these profits through various transactions. Specific examples include customers of the Corvis IPO who were compelled to buy shares at inflated prices to secure their initial allocations.

Additionally, plaintiffs claim that the Underwriter Defendants utilized their analysts to manipulate the aftermarket prices of IPO securities, with 97% of analyst initiations post-quiet period being positive recommendations. These recommendations often included unrealistic price targets, further inflating stock prices.

The motivations behind these actions included obtaining undisclosed compensation and leveraging increased market capitalization for lucrative investment banking opportunities, such as underwriting additional offerings and providing advisory services. The plaintiffs have filed four claims against the issuers and underwriters based on these allegations, particularly focusing on Corvis. They allege violations of the Securities Act and the Exchange Act, citing untrue statements and omissions in the registration statement and market manipulation that induced purchases at inflated prices.

Plaintiffs assert that the Underwriter Defendants breached Section 10(b) and Rule 10b-5 by making significant misrepresentations and omissions to secure and conceal Tie-in Agreements, Undisclosed Compensation, conflicts of interest, and the improper use of analysts to inflate Corvis securities prices. Additionally, they claim Corvis violated the same laws by orchestrating a scheme to artificially inflate its stock price through similar misrepresentations and omissions regarding the Underwriters' actions.

Procedurally, on October 13, 2004, the Court certified classes in six focus cases, indicating that the rulings on class certification would apply only to those cases, while also providing guidance for others. The Underwriter Defendants appealed the class certification, which was vacated and remanded by the Second Circuit on December 5, 2006. Following a denied petition for rehearing on April 6, 2007, plaintiffs amended their complaints, prompting the defendants to move for dismissal.

The Court's February 19 Opinion addressed several dismissal issues raised by defendants. It noted that the law of the case doctrine generally prevents the relitigation of previously decided issues, although the application of the doctrine is discretionary. The Court will not revisit earlier rulings unless there has been a significant change in controlling law and is bound by the Second Circuit's decisions.

In evaluating a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), the Court must accept all factual allegations in the complaint as true and draw favorable inferences for the non-moving party. However, legal conclusions masquerading as factual allegations are not afforded the same presumption. The Court can consider documents linked to the complaint and public disclosures, provided their authenticity is undisputed. To survive dismissal, a complaint must present a "short and plain statement" showing entitlement to relief, with allegations that are plausible rather than speculative, requiring some factual amplification of the claims.

Securities fraud claims require plaintiffs to meet heightened pleading standards under both Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act (PSLRA). 

1. **Rule 9(b)**: A securities fraud complaint must detail the fraud's circumstances, allowing defendants to understand the claims against them and protect their reputations. Plaintiffs must specify the fraudulent statements, identify the speaker, provide the context of when and where the statements were made, and explain their fraudulent nature. Conclusory allegations without factual support are inadequate. If false statements are alleged, the complaint must articulate specific facts that support the belief that the statements were false when made, and if defendants had access to contrary information, that information must also be identified.

2. **PSLRA**: The PSLRA mandates that complaints in private securities fraud cases specify both the facts constituting the violation and those evidencing scienter— the intention to deceive or defraud. When alleging misleading statements, the PSLRA requires a specification of each misleading statement, the reasons it is misleading, and, if based on information and belief, the factual basis for that belief.

3. **Scienter**: Scienter refers to the intent to deceive, manipulate, or defraud. It can be established by showing defendants had the motive and opportunity to commit fraud or by providing strong circumstantial evidence of conscious misbehavior or recklessness. In cases lacking clear motive, plaintiffs can still plead scienter by indicating behaviors that demonstrate an extreme departure from ordinary care standards. Concrete personal benefits to defendants from the alleged fraud must be shown, as general motives do not suffice. The PSLRA also requires a strong inference of the defendant's state of mind based on particular facts.

The Supreme Court clarified the requirements for pleading scienter in Tellabs, Inc. v. Makor Issues and Rights, Ltd., establishing that courts must evaluate the entire complaint, considering plausible opposing inferences. An inference of scienter must be cogent and at least as compelling as any inference of nonfraudulent intent. To state a claim under Rule 10b-5 for misrepresentations, a plaintiff must allege: (1) misstatements or omissions of material fact by the defendant; (2) with scienter; (3) in connection with the purchase or sale of securities; (4) upon which the plaintiff relied; and (5) that this reliance was the proximate cause of the injury. The complaint must specify facts supporting the belief that the defendant's statements were false at the time they were made and must identify any contrary information available to the defendants. General claims that defendants should have disclosed information earlier are insufficient.

For securities fraud claims, plaintiffs must demonstrate both transaction causation (reliance) and loss causation. Transaction causation requires proof that the plaintiff would not have engaged in the transaction but for the misrepresentations. Loss causation links the alleged misconduct directly to the plaintiff's economic harm, necessitating that the loss was foreseeable and stemmed from risks concealed by the fraudulent statements. In efficient markets, reliance on public misrepresentations may be presumed due to the market's reflection of all available information in security prices. Loss causation, as discussed in Dura Pharmaceuticals, Inc. v. Broudo, requires showing that the investment loss resulted from risks concealed by the alleged misrepresentations.

Loss causation requires that the loss be foreseeable and arise from the "materialization of the concealed risk." A plaintiff must demonstrate that the fraudulent statement or omission directly caused the actual loss, indicating that the misrepresentation concealed information which, when revealed, negatively impacted the security's value. The Second Circuit mandates that complaints should allege facts supporting an inference that the defendants' misstatements concealed circumstances that would have mitigated the loss had the fraud not occurred. 

There are several ways to plead loss causation, including "direct causation," "materialization of risk," and "corrective disclosure." If a misstatement hides a condition that later causes loss, the plaintiff may argue that this "materialization" led to the loss. Alternatively, the plaintiff can cite specific events that disclosed the false information and link the subsequent price drop to these disclosures. It is not necessary for disclosures to originate from the company or to follow a particular format, but merely alleging purchase of securities at inflated prices is insufficient. 

The Supreme Court's ruling in Dura clarifies that a plaintiff does not suffer a loss at the time of purchase if the inflated price is balanced by the value of the shares. If the shares are sold before the truth is revealed, or if the price drop is due to factors unrelated to the misrepresentation, the claim for loss causation may fail. 

Section 11 of the Securities Act allows individuals to sue if they acquire securities under a materially false registration statement, provided they were not aware of the falsehood at the time of purchase. A misstatement is established if material facts are omitted or misrepresented. While fraud is not a required element of a Section 11 claim, such claims can be based on fraud and will fall under Rule 9(b), which applies to all fraud allegations, emphasizing that the rule pertains to the conduct alleged rather than being limited to traditional fraud claims.

Defendants argue for the dismissal of plaintiffs' claims, asserting they are implausible because the alleged widespread market manipulation would require knowledge from thousands of participants, which would prevent successful manipulations. Plaintiffs have since refined their allegations to specify the individuals purportedly aware of the fraud and have provided supporting facts, including economic data and market behavior, sufficient to elevate their claims above mere speculation.

Plaintiffs have filed two claims under Section 10(b) and Rule 10b-5 related to securities fraud: one against the Underwriter Defendants for market manipulation and another against all defendants for material misstatements and omissions in registration statements. Both claims are examined together due to their shared factual basis. 

Regarding market manipulation, plaintiffs allege that the Underwriter Defendants artificially created demand for securities by imposing conditions on share allocations and issuing unjustifiably positive analyst reports, leading to significant price increases during IPOs that were not due to legitimate market forces. They have adequately detailed the manipulative acts, participants, timing, and market effects.

For the second claim concerning material misstatements, plaintiffs assert that the defendants failed to disclose the market manipulation. The court finds that plaintiffs have sufficiently pled this false statement claim with the required particularity.

On the issue of scienter, the court previously determined that plaintiffs had adequately alleged scienter for the Underwriter Defendants concerning both claims. Despite the defendants' motion to dismiss based on the argument that claims lack specificity, the court stands by its prior ruling, indicating that the manipulative conduct was obviously material and could not have been inadvertent. Thus, the inference of scienter is strong in relation to both claims.

The plaintiffs have not provided sufficient circumstantial evidence to suggest that the Issuer Defendants engaged in conscious misconduct or acted recklessly regarding false or misleading statements in registration statements. However, sufficient facts have been pled to establish motive and opportunity for certain Issuer Defendants, leading to an inference of scienter. The Issuer Defendants contest the strength of this motive inference, which the plaintiffs support with three types of allegations: 

1. Officers of the corporations held substantial personal stock, suggesting they could benefit from selling at inflated prices. Some officers reportedly sold shares at these inflated prices.
2. Certain Issuers used their shares as currency for stock-based acquisitions post-IPO, with specific reference to FirePond acquiring two companies using over three million shares.
3. Additional share sales at inflated prices are noted, including Sycamore’s secondary offering shortly after its IPO.

While the court previously found sufficient motive and opportunity for Issuer Defendants involved in stock-based acquisitions and secondary offerings, claims against others, including Corvis, were dismissed. The Issuer Defendants argue that mere stock holdings do not suffice to demonstrate motive, as generalized benefits do not imply scienter. The Supreme Court's guidance indicates that all facts collectively must support a strong inference of scienter rather than relying on isolated allegations. While individual officer holdings are relevant, they are not conclusive. Additionally, insider sales representing less than ten percent of an officer's total holdings do not typically indicate unusual activity to imply scienter. Notably, plaintiffs have not leveled all three types of allegations against every Issuer Defendant but assert that each used inflated shares as acquisition currency during the class period.

Defendants iXL and Sycamore are accused of raising additional capital through secondary offerings. When combined with other allegations, these claims establish a sufficient basis for asserting scienter against each issuer. An inflated share price allowed issuers to acquire other companies with reduced cash and securities outlay. This, along with claims that corporate officers benefited from appreciation due to market manipulations by Underwriter Defendants, suggests a concrete motive indicating scienter.

Regarding transaction causation and reliance, plaintiffs assert they relied on distorted market prices due to defendants' manipulations and false statements. They can only presume reliance if the market for their purchased shares is efficient. Defendants contend that the case Miles I determined the markets were not efficient; however, this is a misinterpretation. Miles I focused on the primary market for IPO shares, not the secondary market where plaintiffs purchased their shares. The court in Miles I noted inefficiency in the primary market, emphasizing that prices are set primarily by underwriters rather than the market. In contrast, plaintiffs bought shares from other investors on NASDAQ at market prices.

While Miles I raised concerns about the efficiency of the aftermarket, it specified that only analysts associated with the issuer or underwriters faced reporting restrictions during the quiet period. Plaintiffs amended their complaints to assert that numerous analysts followed the issuers before, during, and after the IPO, including the quiet period. The correct interpretation of Miles I is that it identified inefficiencies in the primary IPO market, similar to municipal bonds in Freeman. Miles II further clarified that it did not dismiss the possibility of efficiency in the aftermarket, only in the primary market.

Plaintiffs allege that the secondary market for IPO shares is efficient, supported by two key factors: the focus stocks were traded on the active NASDAQ National Market, and they received extensive analyst reports and media coverage. Plaintiffs claim that the market quickly absorbed publicly available information, influencing stock prices. The determination of market efficiency is a factual question for trial, with the current finding being relevant only for the motion to dismiss. If deemed efficient, plaintiffs benefit from a presumption of reliance; if inefficient, they must individually demonstrate reliance. Furthermore, while the market may have become efficient over time, earlier purchasers may face distinct challenges in proving efficiency at the time of their purchases.

Regarding loss causation linked to market manipulation claims, the court previously found that plaintiffs presented a detailed scheme showing how Underwriters inflated stock prices, ultimately harming investors when prices corrected. This conclusion remains unchanged. For misstatement claims, although misstatements typically do not imply loss causation, in this case, they are linked to concealing market manipulation, thus contributing to the loss. Defendants argue that plaintiffs failed to meet the heightened pleading standard established in key Supreme Court and Second Circuit cases, specifically citing the absence of a clear event causing the price drop. The court finds that these precedents do not warrant overturning its earlier ruling.

In Dura, the Supreme Court established that plaintiffs must demonstrate a direct link between misrepresentations and their losses, rejecting the assumption that artificially inflated share prices would naturally decline. Lentell reinforced this by requiring plaintiffs to show that the misstatements concealed circumstances contributing to their losses, equating loss causation with proximate cause, and asserting that losses must fall within the risk area concealed by the misrepresentations. The current case differs, as plaintiffs claim their losses stem from market manipulations obscured by false statements, asserting that without these misrepresentations, their losses would not have occurred. Consequently, they have sufficiently pled loss causation.

Regarding Section 11 claims, defendants argue for dismissal due to insufficient specificity and issues with tracing shares to the IPO. However, since plaintiffs adequately pled their Section 10(b) claims, their Section 11 claims, which arise from the same conduct, are also valid. There is a debate over the applicability of Rule 9(b) to the Section 11 claims against Issuer Defendants. The court previously ruled that these claims are grounded in fraud but later noted that the Second Circuit clarified that negligence-based claims under Section 11 are only subject to Rule 8(a). While the Underwriter Defendants face allegations of fraud, the Issuer Defendants are primarily accused of issuing misleading statements without reliance on fraudulent participation. Thus, the Issuer Defendants' Section 11 claims are governed by a less stringent pleading standard than Rule 9(b).

Allegations against the Issuer Defendants are governed by Rule 8(a), and regardless of the applicable standard, plaintiffs have met their burden. Under Section 11, a plaintiff cannot state a claim without showing damages; if a plaintiff sold securities above the offering price, they cannot claim damages, leading to the dismissal of their Section 11 claims. The measure of damages under Section 11(e) is the difference between the selling price and the offering price, limiting recovery for those who sold above the offering price.

In class certification, it was determined that the class period for Section 11 claims is limited to shares traceable to the IPO. The Underwriter Defendants moved to dismiss claims from plaintiffs who bought shares after non-IPO shares entered the market. However, this does not preclude those plaintiffs from demonstrating that their shares are traceable to the IPO.

Regarding the statute of limitations, new plaintiffs Getman, Levy, and Belcore have been added to the Sycamore Complaint, but the Defendants argue their claims are time-barred. Plaintiffs must file within one year of discovering the facts of their action, but the initiation of a class action suspends the statute of limitations until class certification is denied. The statute was tolled from July 2, 2001, when the Sycamore case was filed. The Underwriter Defendants claim that plaintiffs should have been aware of their claims earlier, citing pre-2000 news articles; however, establishing inquiry notice is a heavy burden and the evidence presented is insufficient. Additionally, the Defendants assert that the tolling under American Pipe ceased for certain new Sycamore plaintiffs after the class was not certified on October 13, 2004.

The Court certified the Sycamore class for plaintiffs who purchased shares between October 21, 1999, and January 19, 2000. Only Belcore falls within this class, having purchased shares on January 5, 2000. Claims by Levy and Getman, who bought shares after this period, are time-barred. The tolling of the statute of limitations for non-class members ceased once the class was certified, but Belcore's claim remains valid due to the ongoing possibility of her inclusion in the class. 

Regarding the iXL action, which is linked to a bankruptcy proceeding, the Issuer Defendants sought dismissal based on a court order that enjoined actions related to the debtors' bankruptcy cases. However, since the iXL action has no connection to the bankruptcy, the dismissal request is denied. 

Defendants' motion to dismiss is granted in part, specifically for Section 11 claims from plaintiffs who either sold securities above the initial offering price or purchased outside the certified class period. Leave to replead is denied as no reasonable amendments could rectify the deficiencies. The Clerk of the Court is directed to close the related motions.

Plaintiffs in two cases have claimed violations of Section 11 of the Securities Act and Section 10(b) of the Exchange Act related to secondary offerings. These claims are outlined in the Sycamore and iXL Second Consolidated Amended Class Action Complaints, which repeat the conduct and allegations already presented in primary offering claims. One focus case, In re Engage Technology Inc. Initial Public Offering Securities Litigation, involves an issuer currently in bankruptcy, preventing plaintiffs from proceeding against it. The Issuer Defendants have not dismissed the Engage action, although the Underwriter Defendants have moved to dismiss. The text references several case law precedents, including the mandate rule, which requires district courts to adhere to appellate court decisions on remand, and discusses pleading standards, emphasizing the need for plausibility in securities claims as established in Bell Atlantic Corp. v. Twombly and further clarified in subsequent cases. The excerpt highlights the importance of adherence to procedural rules and the necessity of a clear pleading standard under federal securities law.

The excerpt outlines legal standards related to securities fraud claims, particularly focusing on the concept of "scienter"—the intent or knowledge of wrongdoing. Key cases, including *Tellabs* and *ATSI*, emphasize that a complaint must present a plausible inference of scienter that is at least as compelling as any opposing inference derived from the facts alleged. It is noted that the motivations for fraudulent behavior can include a desire for the corporation to appear profitable and to maintain high stock prices for executive compensation. The document asserts that mere management optimism about future prospects, if proven unwarranted, does not equate to conscious fraud or recklessness, as executives are expected to maintain a positive outlook based on available data. 

Additionally, it discusses the importance of loss causation, which links the alleged misconduct to the economic harm suffered by the plaintiff, referencing several pivotal cases that outline these principles. The excerpt concludes by highlighting that in past rulings, plaintiffs have often failed to establish a sufficient connection between a company's misstatements and the subsequent financial losses, particularly in the context of audits.

Auditor misstatements obscured the failure to conduct audits per generally accepted accounting practices, rather than the risk of bankruptcy. The court determined that if a plaintiff's "zone of risk" includes the potential for misstatements from improper audits, then the element of misstatement would overshadow loss causation. A plaintiff establishes loss causation by showing that the loss was foreseeable to the party responsible for the misrepresentation and that the loss arose from the realization of the concealed fact. A direct relationship between the plaintiff's investment loss and the misstatement is necessary for establishing loss causation. The Second Circuit has consistently assessed concealed risks that materialized and caused market losses. Cases have highlighted the importance of corrective disclosures that expose prior statements' falsity. To plead loss causation effectively, plaintiffs must specify their economic loss and the connection to the alleged misrepresentation. When securities are purchased under a registration statement, demonstrating a material misstatement or omission suffices for a prima facie case. Defendants' claims that plaintiffs should adhere to previous pleadings do not hold, as earlier pleadings are not definitive admissions but can serve as evidence.

Amendments or withdrawals of pleadings do not eliminate previous judicial admissions but render them non-conclusive; they remain admissible as evidence, though subject to contradiction. In Kunglig Jarnvagsstyrelsen v. Dexter Carpenter, the court noted that factual allegations must be sufficient to establish a plausible claim for relief, even if the actual proof appears improbable. The court emphasized that it will not assess the plausibility of allegations at an early litigation stage, focusing instead on whether the claims, if true, warrant relief. The Underwriter Defendants' motion to dismiss based on prior court rulings was rejected, and previous findings regarding the issuers' alleged fraudulent activities were upheld, as there was sufficient opportunity for such conduct. Furthermore, while the defendants argued that Sycamore's need for capital could explain its actions, the plaintiffs contended that this need provided a motive for fraud, which the court found did not negate the inference of fraudulent intent. The plaintiffs did not present valid arguments for reconsideration of prior dismissals.

The court dismissed the complaint in Kalnit, asserting that plaintiffs failed to identify specific benefits to the defendants that were exclusive to them, as opposed to general benefits available to all corporate directors or shareholders. In the case of FirePond, while one acquisition was disregarded due to its timing post-Class Period, another acquisition remained relevant, demonstrating FirePond's motive to inflate its share price to facilitate further acquisitions, regardless of whether this inflation was ultimately successful. The Issuer Defendants contended that allegations against iXL were based solely on its use of securities for acquisitions; however, plaintiffs argued that iXL's officers were motivated by the potential for profit from selling inflated shares, noting that these officers earned over $176 million from a secondary offering. The fraud on the market theory posits that a security's price reflects all available information in an efficient market. The characteristics of an efficient market include openness, development, and responsiveness to new information. The Cammer court outlined five factors to demonstrate market efficiency, including high trading volume and the presence of analyst reports and market makers.

Eligibility for filing an S-3 registration statement and the immediate stock price movements resulting from unexpected corporate events or financial releases are critical factors in securities litigation. The Cammer test, which assesses market efficiency, is widely accepted by federal courts, as evidenced by its adoption in multiple cases, including In re PolyMedica Corp. Sec. Litig. and In re Xcelera.com Sec. Litig. Some courts, however, have included additional factors, such as those from Krogman v. Sterritt, to address market efficiency. Notably, reliance in a 10b-5 action is presumed for stocks traded on exchanges like NASDAQ, although some courts remain cautious about this presumption. Nevertheless, a NASDAQ listing is generally a strong indicator of market efficiency. Similarly, stocks on the AMEX are typically presumed to trade in an open and efficient market. The efficiency of a stock market is a factual issue best determined at trial, as highlighted in various case law, including DeMarco v. Robertson Stephens Inc., where rebutting the presumption of reliance is also left for trial. The determination of whether a market is efficient involves factual inquiries rather than legal conclusions at the motion to dismiss stage.

Resolution of the issue regarding loss causation will be determined at trial, pending further evidence. After the issuance of the February 19 Opinion, the Second Circuit's ruling in Emergent Capital Investment Management, LLC v. Stonepath Group, Inc. clarified the pleading standard for loss causation, prompting defendants to renew their motion to dismiss. However, the court denied this renewed motion. Plaintiffs acknowledged that their Section 11 claims against the Underwriter Defendants must adhere to Rule 9(b) standards. The defendants contended that the tolling of statutes ended when the Second Circuit denied class certification in Miles I, but the court previously ruled against this assertion and declined to revisit the decision. Various cases and legal standards relevant to the claims, such as those under Sections 10(b) and 11, were referenced, alongside certifications from plaintiffs in support of class certification. Plaintiffs did not challenge the limitation of the class period in the Sycamore case. Additionally, an order was referenced regarding the distribution of claims in the bankruptcy case of Scient, Inc.