In re Flag Telecom Holdings, Ltd. Securities Litigation
Docket: No. 02 CIV. 3400(WCC)
Court: District Court, S.D. New York; September 4, 2007; Federal District Court
Plaintiffs Peter T. Loftin and Norman H. Hunter have initiated a proposed class action against Citigroup Global Markets Inc. (doing business as Salomon Smith Barney Inc.) and eight individual defendants in relation to the purchase of common stock from Flag Telecom Holdings, Ltd. The class action encompasses individuals who bought Flag stock between March 6, 2000, and February 13, 2002, and those who acquired shares during Flag's initial public offering (IPO) from February 11, 2000, to May 10, 2000. The plaintiffs allege violations of federal securities laws, claiming that the defendants provided materially false and misleading information in the registration statement and prospectus, thus violating sections 11, 12(a)(2), and 15 of the Securities Act of 1933, as well as section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. Plaintiffs assert that these misrepresentations led to artificially inflated stock prices and subsequent financial losses when the truth was disclosed. Additionally, Joseph Coughlin seeks to intervene as a class representative. The court acknowledges the motions to certify the class and for Coughlin to intervene, granting both requests. The background indicates that Flag's IPO occurred on February 16, 2000, with its registration statement effective on February 11, 2000. Key individual defendants held significant roles in Flag, with most having signed the registration statement. Citigroup acted as the lead underwriter for the IPO. Plaintiffs claim damages resulting from the decline in Flag's stock value after the truth of the defendants' misleading statements was revealed. Flag was described as a telecommunications company offering infrastructure services to other telecommunications entities.
At the time of the IPO, Flag operated the Flag Europe-Asia (FEA) cable system, connecting Western Europe and Japan through various regions and covering approximately 70% of the global population. It also had terrestrial links to major European cities, offering customers broadband telecommunications capacity through Right of Use (ROUs) and Indefeasible Right of Use (IRUs) contracts. Customers could transfer capacity between network segments as needed. The Prospectus detailed ongoing network expansion efforts, including the Flag-Atlantic 1 (FA-1) cable system, a joint venture with GTS Transatlantic Holdings Ltd. to build two digital fiberoptic cables between Paris, London, and New York, designed to create a self-healing ring to prevent service interruptions. The FA-1 system was projected to have capacity exceeding fifteen times that of the most advanced existing Atlantic cable, with an estimated construction cost of $1.1 billion. Flag planned further expansions, including potential new trans-Pacific cables linking the U.S. and Japan, aiming to position FLAG Telecom as a leading global carrier by providing a variety of cost-effective capacity options.
However, plaintiffs allege that defendants had access to data indicating weak demand for FLAG’s capacity, contradicting the optimistic claims in the Prospectus. They assert that there was an oversupply of fiber optic capacity in the market. Although previous rulings determined that the general growth projections did not violate federal securities law, plaintiffs claimed the Prospectus contained a material misstatement regarding FA-1 system pre-sales, particularly alleging an improper agreement between Flag and Alcatel Submarine Networks to inflate these pre-sales figures as part of a fraudulent scheme to secure necessary financing for the FA-1 system's construction.
Plaintiffs allege that Flag and Alcatel entered into a $646 million agreement on January 12, 1999, to construct the FA-1 cable system, which was later revised on September 20, 1999, to $746 million. On October 8, 1999, Flag and Alcatel agreed on a $50 million purchase of 6.2 gigabits of capacity on the FA-1 system, a transaction disclosed in the Amended Registration Statement on February 9, 2000. Simultaneously, Flag executed a credit agreement with Barclays Bank, requiring a $100 million commitment in pre-sale capacity to secure the credit facility. Plaintiffs argue that Flag, unable to secure this commitment from credible customers, induced Alcatel to pledge a $50 million purchase for a capacity it did not need, in exchange for the increased contract price. They assert that Alcatel is a construction company, not a telecommunications provider, thus lacking genuine use for such capacity.
Plaintiffs highlight that the revised construction contract merely adjusted the price, that the capacity sales agreement allowed Flag to reduce its obligation if other customers emerged, and that the timing of the agreements suggests a lack of genuine intent from Alcatel. However, defendants provided evidence indicating that Alcatel's commitment had been reduced to zero by January 11, 2000, before the Registration Statement became effective. Despite this, plaintiffs argue that this reduction does not negate the potential that Flag improperly influenced Barclays into the credit agreement, which was critical for attracting investors. They seek permission to amend their Complaint to include allegations of other questionable pre-sale contracts that may have contributed to the reported pre-sales in the Amended Registration Statement, asserting a right to discovery on the legitimacy of these contracts.
Flag's initial public offering (IPO) took place from February 11 to February 16, 2000, during which it offered 20,592,000 common shares in the U.S. and Canada and 11,088,000 shares internationally, excluding over-allotment shares. The IPO successfully sold a total of 27,963,980 shares at $24.00 each, generating approximately $634.6 million for the company. Additionally, on February 16, 2000, Flag registered 6,763,791 shares for its Long Term-Incentive Plan, allowing certain employees to acquire shares starting August 9, 2000. Inside shareholders, including companies like Bell Atlantic Corporation and Telecom Asia Corporation, also sold shares in the IPO.
Post-IPO, Flag’s common stock began trading on NASDAQ under the symbol FTHLQ. Plaintiffs allege that Flag misled investors by issuing materially false financial statements that violated Generally Accepted Accounting Principles (GAAP) and SEC regulations, while presenting misleading press releases about strong demand for its products. Specifically, they claim Flag artificially inflated its financial results through reciprocal transactions with competitors, where companies sold unnecessary fiber optic cables to book fictitious revenues. These transactions lacked legitimate business purpose and obscured the companies' actual financial conditions.
The plaintiffs assert that Flag’s public disclosures regarding these transactions were misleading and failed to clarify the absence of genuine sales or revenues. They also argue that Flag violated accounting standards by recognizing the entire revenue from multi-year leases as a lump sum at the lease's inception instead of over its duration. Furthermore, Flag allegedly did not account for significant impairment of its FA-1 system's asset value despite known declining demand, ultimately disclosing a $359 million impairment in its 2002 SEC Form 10-K for the year ended December 31, 2001.
On February 13, 2002, Flag revealed that about 14% of its GAAP revenues for 2001 stemmed from reciprocal transactions with other telecommunications entities and indicated plans to cease operations in 2003. This announcement caused a 46% drop in Flag’s share price, with trading volume significantly exceeding the daily average. In its April 1, 2002, 10-K filing, Flag disclosed an inability to meet interest payments due on March 30, 2002, and reported an impairment charge of $359 million for its FA-1 system, stating that its carrying value exceeded fair value due to competitive pressures and declining demand. Flag filed for Chapter 11 bankruptcy on April 12, 2002, and during the proceedings, it prepared a Pro-forma Reorganized Balance Sheet showing property and equipment valued at $385 million, down from $2.3 billion reported in Q3 2001, reflecting a $1.9 billion write-down that plaintiffs allege Flag was aware of during the Class Period. Following these disclosures, a class action was initiated. Plaintiffs have moved for class certification under Fed. R. Civ. P. 23, while Coughlin seeks to intervene as a class representative alongside Loftin and Hunter. The requirements for class action certification include numerosity, commonality, typicality, and adequacy of representation, as well as predominance of common questions and superiority of the class action method for adjudication. The decision on certification is informed by recent clarifications from the Second Circuit regarding district court responsibilities in assessing class certification motions.
The Second Circuit established that a district judge must certify a class only after confirming all Rule 23 requirements are satisfied, which necessitates resolving factual disputes related to each requirement and establishing relevant underlying facts. The judge must remain persuaded that these facts meet the legal standards for certification, regardless of any overlaps with merits issues. Moreover, the judge should avoid evaluating any merits aspects that do not pertain to Rule 23 requirements. The judge has considerable discretion to limit discovery and hearings related to Rule 23 to prevent class certification motions from functioning as partial trials on the merits.
Regarding Rule 23(a)(1) on numerosity, the class must be sufficiently large that joining all members is impracticable, which encompasses difficulty rather than impossibility of joinder. The Second Circuit presumes numerosity is met with at least 40 members, and precise class member quantification is unnecessary. In securities fraud cases involving publicly traded companies, a substantial number of traded shares can fulfill this requirement. In this case, Flag common stock was actively traded on NASDAQ, with significant daily trading volumes and over twenty million shares sold in the U.S. during the Class Period, indicating thousands of potential class members nationwide, satisfying the numerosity requirement.
Rule 23(a)(2) requires common questions of law or fact among class members, where not every issue needs to be identical across all members. The commonality requirement is met if the grievances share a common question of law or fact.
Commonality under Rule 23(a)(2) does not require identical claims from all class members, but rather the presence of common issues of fact or law that merit class treatment. Courts have adopted a permissive approach, particularly in securities fraud cases, focusing on identifying a unifying thread among claims. The proposed class's common questions include: (1) whether defendants violated federal securities laws, (2) whether Flag issued false statements in its IPO Prospectus during the Class Period, (3) whether individual defendants were responsible for these misleading statements, (4) whether the defendants acted with the necessary scienter, and (5) whether the market price of Flag securities was artificially inflated due to defendants' actions. These shared issues satisfy the commonality requirement. Defendants have not contested this point, and similar allegations have been consistently found sufficient by courts. Additionally, Rule 23(a)(3) establishes that representative parties' claims must be typical of the class, which is met when claims arise from the same events and involve similar legal arguments for liability.
The typicality inquiry assesses whether the claims of class representatives align with those of the putative class, particularly when the same unlawful conduct affects both parties. Generally, if the named plaintiff and the class have been subjected to the same unlawful actions, the typicality requirement is satisfied, despite minor differences in individual claims. The focus is on whether class representatives have the motivation to prove all elements of the cause of action that individual members would pursue.
In this case, the typicality requirement is met as both the plaintiffs and the putative class members claim to have purchased Flag common stock during the Class Period and were harmed by misrepresentations in the Registration Statement. They will need to demonstrate facts regarding alleged accounting irregularities and misleading statements, along with proving defendants' intent to deceive.
Defendants contend that typicality is lacking due to a conflict between two sets of claims: one concerning misleading information in the Registration Statement under the ’33 Act, and another involving false statements about the company's financial condition under the ’34 Act. They note that those pursuing claims under the ’33 Act may face the defense of negative causation, while those under the ’34 Act must establish loss causation relating to undisclosed transactions post-IPO.
Defendants argue that if plaintiffs prove their injuries stemmed from nondisclosures and misstatements regarding reciprocal transactions under the ’34 Act, it would negate any claims related to pre-sales misstatements. The court disagrees, noting that the decline in Flag's stock price could result from both alleged fraudulent activities. Under proximate causation, harm can arise from either or both fraudulent acts. The court emphasizes that loss causation parallels proximate cause in tort law, requiring damages to be a foreseeable result of the fraud. Claims under the ’33 Act and ’34 Act can coexist without conflict, as demonstrated in prior cases. Although class members' interests might diverge when determining damages, this does not prevent class certification, since there is no current conflict affecting the lawsuit's core. Consequently, plaintiffs meet the typicality requirement of Rule 23(a). Rule 23(a)(4) mandates adequate representation, which involves assessing potential antagonism between plaintiffs' and class members' interests and the qualifications of plaintiffs' attorneys.
Class representatives must share the same interest and suffer the same injury as class members to ensure adequate representation. Courts highlight that typicality and adequacy are intertwined, as they assess whether the named plaintiffs' claims align sufficiently with those of the class. In this case, both plaintiffs and putative class members are united in their allegation of purchasing Flag common stock based on materially false and misleading information from defendants, indicating aligned interests. The argument from defendants, which suggests potential conflicts due to the indictment of Milberg Weiss, lacks persuasiveness. It is established that plaintiffs in complex securities actions are not required to have extensive knowledge of all case aspects and can depend on their counsel's expertise. Historical precedent indicates that challenges to a class representative’s adequacy based on lack of knowledge or credibility are typically inappropriate in such contexts.
Class representatives must demonstrate a basic awareness of the lawsuit's facts and not be likely to neglect their duties to fellow class members. A representative's inadequacy is only established when their lack of knowledge is so profound that they cannot protect the class's interests against conflicting interests of attorneys. The defendants argue that the proposed representatives have minimally engaged with the case documents, lack detailed understanding of the claims, have not communicated with each other, and have failed to consider the indictment of Milberg Weiss. However, evidence shows that the representatives are sufficiently informed and involved, having reviewed pleadings, consulted with Milberg Weiss, produced documents, and participated in depositions.
Loftin has in-depth knowledge of the claims and played a key role in drafting the Complaint, while Hunter regularly reviews documents and discusses them with Milberg Weiss. Coughlin has articulated the litigation's basis during his deposition. The representatives understand their roles and express willingness to consult with counsel going forward. They are aware of the Milberg Weiss indictment but do not feel the need for new counsel, believing the indictment pertains mainly to practices in California, not affecting their case in New York.
It is concluded that the proposed representatives are knowledgeable and capable of adequately representing the class. Additionally, a lack of detailed knowledge does not bar class certification, as plaintiffs can rely on their counsel for litigation needs. Despite defendants' concerns regarding the indictment, reliance on counsel is deemed appropriate, as it indicates an understanding of their knowledge limits and trust in legal expertise.
Conflicts of interest may arise for Milberg Weiss due to its indictment, potentially prioritizing the firm's interests over those of the class, particularly in seeking to resolve litigation before a criminal trial or plea agreement. Additionally, it’s possible that government prosecutors will call Loftin or other class members as witnesses in the criminal case against Milberg Weiss. Despite these speculative concerns, denying class certification based solely on Milberg Weiss's indictment would be inappropriate, given the firm’s competent representation of the plaintiffs and its qualifications in securities class actions. The firm has been actively engaged in the case since 2002, has not personally implicated any attorneys in the indictment, and possesses significant institutional knowledge due to extensive discovery and motion practice. Removing Milberg Weiss would likely prejudice the class members, who have been effectively represented.
The court emphasizes the presumption of innocence and aligns with other courts in not disqualifying Milberg Weiss based solely on the indictment allegations. The defendants challenge the adequacy and typicality of proposed class representative Loftin, arguing he lacks standing for ’33 Act claims, which the plaintiffs do not dispute. However, it is established that lead plaintiffs in class actions need not have standing for all claims in the complaint. Defendants also assert that Loftin is not typical for ’34 Act claims due to not being entitled to a presumption of reliance, which may affect his ability to represent those claims adequately. While individual factual discrepancies do not inherently preclude class certification, unique defenses against a class representative can complicate certification if they risk becoming a focal point of litigation.
The fraud-on-the-market doctrine establishes a rebuttable presumption that misrepresentations by a securities issuer influence market prices and that investors rely on these prices as indicators of intrinsic value. This presumption allows plaintiffs to fulfill the reliance requirement in securities fraud claims under the 1934 Act, unless they are unable to rebut it, in which case individual reliance must be proven. Defendants argue that Loftin is ineligible for this presumption due to his extensive experience in the telecom industry, specifically as the founder and former CEO of Business Telecom Incorporated (BTI). They assert that Loftin's familiarity with market conditions undermines his reliance on market integrity. Loftin's background includes launching BTI, which evolved from a long-distance retail company to offering local phone and internet services, and ultimately withdrawing an IPO registration due to unfavorable market conditions. Despite the defendants' claims regarding Loftin's sophistication, it is noted that an investor’s sophistication does not automatically negate reliance on market integrity. The document emphasizes that Loftin's case relies solely on the fraud-on-the-market presumption of reliance, not on actual reliance. The Supreme Court's decision in Basic outlines ways defendants may contest this presumption, such as demonstrating that market makers knew the truth behind relevant events.
Petitioners’ alleged fraudulent manipulation of market prices may be countered if credible news of merger discussions reached the market, dissipating the impact of misstatements. Consequently, traders who acted after corrective statements would lack any connection to the fraud. Furthermore, petitioners can challenge the presumption of reliance for plaintiffs who would have sold their shares regardless of market integrity. The case lacks evidence that Loftin was privy to any insider information that indicated Flag’s statements were false or misleading; reliance on market integrity is sufficiently demonstrated by the record.
Defendants argue that Coughlin lacks standing under the ’33 Act for shares purchased after May 11, 2000. However, since Coughlin purchased 250 shares on February 23, 2000, he has standing for those shares; the 100 shares bought on July 3, 2001, are not traceable to the IPO, thus he lacks standing for those.
Defendants also contend that "in-and-out" purchasers, such as Hunter, should be excluded from the class since they bought and sold shares before the alleged violations were disclosed. Specifically, they sold shares before Flag's announcement on February 13, 2002, after which stock value dropped by 46%. Defendants argue these purchasers cannot demonstrate damage from the fraud or face unique causation defenses. Nevertheless, plaintiffs assert that those who sold prior to the announcement can establish a causal link between the alleged fraud and their losses, as the truth about Flag’s financial state began to emerge before the announcement, impacting stock value. The complaint alleges that Flag continued to issue misleading statements even as competitors recognized and disclosed their financial difficulties.
Dr. Scott D. Hakala, the plaintiffs' expert, provided an analysis on loss causation, highlighting a decline in demand and concerns regarding excess capacity in the optical fiber network market that began in October 2000 and intensified between February and June 2001 due to the financial issues faced by Winstar and 360Networks. These developments revealed significant problems in the industry, including the impairment of optical fiber network values and inflated revenue figures from capacity swaps and presales. Specific negative news, particularly about Flag Telecom, led to declines in its share price throughout 2001 and into early 2002, notably after disclosures related to Global Crossing’s financial troubles. Hakala's analysis indicates that misleading statements from Flag Telecom contributed to an inflation of its share price, but investors began to realize the truth through industry news and admissions from the company between February 2001 and April 2002. The accompanying event study illustrates that although economic losses were felt throughout most of the Class Period, the full extent was not realized until April 2002. Hakala asserts that a method for analyzing economic losses and attributing them to individual investors is feasible. Plaintiffs claim they can demonstrate the “leakage” of truth before the end of the Class Period and should be allowed to explore this theory further. The court recognizes the possibility that "in-and-out" traders, who sold their shares before the fraud disclosure, may still prove loss causation against the defendants' negative causation defense, although the status of these traders in the proposed class remains undecided. This issue has been previously addressed in the Roth case, where defendants argued that such traders could not claim damages due to their prior sales.
Defendants argue that "in-and-out" trading members of the proposed class who sold BearingPoint shares before the April 20, 2005, disclosure cannot establish loss causation, as any losses from purchasing shares at inflated prices would be offset by selling them at similarly inflated prices. They cite Dura Pharms. Inc. v. Broudo to assert that an inflated purchase price does not constitute economic loss. Courts must assess whether in-and-out traders can demonstrate loss causation to determine their inclusion in the class. Although such traders often do not incur damages due to equal purchase and sale prices, circumstances with multiple disclosures may allow them to prove losses. Furthermore, the inflation from misrepresentation may diminish over time, enabling these traders to show loss causation.
It is deemed premature to evaluate the losses of in-and-out traders at the class certification stage, and they should be included in potential classes for securities fraud. Defendants oppose the inclusion of these traders but do not contest the appointment of proposed class representatives based on this issue. Courts have consistently found that this does not make a representative's claim atypical. Moreover, plaintiffs have demonstrated that in-and-out purchasers, like Hunter, could potentially counter the defendants' negative causation argument. Hunter's sale of shares in November 2001 suggests that plaintiffs will seek to substantiate their leakage theory further. As discovery is ongoing, excluding in-and-out purchasers is inappropriate at this stage.
Defendants challenge the admissibility of an affidavit by Hakala under Fed. R. Evid. 702 and 703, arguing it should not be considered in this motion.
To assess the admissibility of expert witness testimony under Fed. R. Evid. 702 and 703, the Supreme Court established a two-prong inquiry focusing on the reliability and relevance of the evidence, as articulated in Daubert v. Merrell Dow Pharms. Inc. First, a trial judge must ascertain if the expert's testimony pertains to scientific knowledge, which requires a basis in scientific methods and procedures, and transcends mere subjective belief or speculation. Second, the testimony must assist the trier of fact in understanding or determining an issue at hand, ensuring it is both relevant and reliable. Additionally, the court must evaluate the expert's qualifications, including their background and practical experience.
In this case, the defendants do not dispute the relevance of expert Hakala's opinions or his qualifications in business valuation and market efficiency. Hakala's analysis concerns the efficiency of Flag common stock's market and its reaction to significant events, which directly relates to loss causation under the ’34 Act. He also addresses the timing of unregistered shares entering the market, pertinent to tracing arguments for plaintiffs under the ’33 Act. Hakala's credentials include his role as director at CBIZ Valuation Group, a Ph.D. in Economics, a Chartered Financial Analyst designation, and experience teaching asset pricing and market efficiency.
The defendants primarily challenge the reliability of Hakala's opinions, necessitating an examination of the scientific validity of his reasoning and methodology. The Daubert decision outlines four non-exclusive factors for reliability assessment: testing of the theory, peer review or publication, potential error rates and standards, and general acceptance within the scientific community. However, this reliability inquiry is flexible, and the factors are not a strict checklist but should be adjusted to the specifics of the case.
The Court is tasked with ensuring that expert testimony maintains the same intellectual rigor found in the expert's field. In this case, expert Hakala conducted an event study from February 11, 2000, to February 13, 2002, analyzing the impact of specific events on the stock price of Flag, utilizing data from analysts’ reports, press releases, and news articles. The study involved comparing market indices and competitor companies and employed integrated regression analysis to assess the daily returns associated with each event. The results are presented in an eighteen-page chart detailing 154 events and their effects on Flag’s stock value. The Court finds Hakala’s methodology reliable, supported by precedent where similar studies have been deemed credible for evaluating market efficiency. Defendants argue that Hakala’s leakage theory fails to establish loss causation, citing a Supreme Court case emphasizing that quick sales before the truth emerges do not result in loss, distinguishing between price inflation and actual loss realization. The Court allows consideration of Hakala's affidavit under the Federal Rules of Evidence, despite defendants' objections.
When a purchaser resells shares at a lower price, that decline may result from various factors unrelated to earlier misrepresentations, such as changes in economic conditions, investor expectations, or industry-specific developments. The likelihood that these other factors caused the loss increases with the time elapsed between purchase and sale. Defendants argue that market forces, rather than company-specific information related to alleged fraud, are responsible for the decline in Flag common stock value. They assert that this undermines the claim for loss causation, referencing the Supreme Court's ruling in Dura, which stated that liability does not exist when stock value drops due to subsequent events unrelated to any fraud.
Plaintiffs counter that the defendants misinterpret Dura, which clarifies that a stock's lower price can reflect unrelated economic shifts rather than the earlier misrepresentation. Loss causation is not established if the stock's decline is due to events disconnected from the alleged fraud. However, if new information reveals the inaccuracy of earlier fraudulent statements, that corrective information can indicate loss causation.
The court in In re Winstar Communications noted that corrective disclosures must be based on factual information rather than mere opinions or speculations, although Dura did not delineate specific requirements for establishing loss causation. It emphasized the importance of "relevant truth" entering the market, without specifying how or by whom this information must be communicated. The key aspect of loss causation is the exposure of fraudulent misrepresentations, which can arise from various sources, including whistleblowers, analysts, and media reports.
Plaintiffs have shown that in-and-out purchasers can potentially counter the defendants' negative causation defense or prove loss causation due to leakage during the Class Period, warranting their inclusion in the proposed class. The Court then assesses compliance with Rule 23(b)(3), which requires that common questions of law or fact among class members dominate over individual issues and that class action is the superior method for resolving the dispute. The predominance criterion necessitates that class-wide issues can be addressed through generalized proof, which is often met in securities fraud cases.
In this instance, common legal and factual questions related to securities law violations predominate, including whether Citigroup and individual defendants misrepresented presales in the Registration Statement, made false statements regarding Flag's financial stability, neglected necessary asset write-downs, acted with requisite scienter, and caused economic loss to plaintiffs. All class members will rely on the same legal theories and facts, including the fraud-on-the-market presumption. The presence of in-and-out traders does not change the predominance of common issues, as their ability to satisfy loss causation is a unified legal question. Individual damages can be assessed at trial through expert testimony, indicating that class litigation can remain manageable and efficient despite these complexities.
There are common questions of law and fact that outweigh individual issues among class members, fulfilling the first requirement of Rule 23(b)(3). The second requirement examines whether a class action is superior to other methods for fair and efficient resolution. Key factors for this assessment include: A) class members' interest in controlling individual actions, B) existing litigation concerning the controversy, C) the desirability of concentrating claims in a particular forum, and D) potential management difficulties of a class action. This list is not exhaustive, and the overarching goals of Rule 23 should heavily influence the decision.
A class action is deemed especially suitable for securities fraud cases, particularly in this instance, as the proposed class encompasses hundreds or thousands of members nationwide. Individual litigation is impractical due to high costs and the minimal economic losses suffered by many potential plaintiffs. The likelihood of separate lawsuits would not only result in inconsistent outcomes but would also greatly increase litigation costs and place a burden on the court system. A class action would streamline these processes, reduce costs, and facilitate efficient claim management. The case does not present significant manageability issues, a point not contested by the defendants, with the determination of manageability resting within the district court's discretion. Thus, a class action is deemed superior for adjudicating this matter.
The Court confirmed that the requirements of Rule 23 are met, focusing on defining the Class Period and identifying class members. For claims under the ’34 Act, the agreed Class Period is from March 6, 2000, to February 13, 2002, reflecting market reactions to public information. In contrast, the Class Period for claims under the ’33 Act is disputed. Plaintiffs assert that secondary market purchasers who bought shares on or before May 10, 2000, can trace their shares back to the IPO, citing SEC Rule 144's prohibition on unregistered shares before that date. Defendants argue that stock options exercised by employees on March 17 and 23, 2000, possibly contaminated the market earlier. However, plaintiffs’ expert found no evidence of unregistered shares before May 10, 2000, leading the Court to favor the plaintiffs’ position. Consequently, the Class Period for the ’33 Act claims is determined to be February 11, 2000, to May 10, 2000, subject to reevaluation with new evidence. Additionally, the defendants contended that the class should only include purchasers from U.S. exchanges due to jurisdictional concerns, as the Securities Exchange Act does not explicitly address its extraterritorial application. The Second Circuit's "conduct test" will be employed to assess federal jurisdiction for claims involving shares purchased abroad.
Under the "conduct" test, federal courts establish subject matter jurisdiction if a defendant's actions in the U.S. go beyond mere preparation for fraud and directly result in losses to foreign investors. In this case, defendants engaged in activities in the U.S., such as a significant swap transaction intended to inflate revenues, satisfying the criteria for jurisdiction. These actions are linked to a broader fraudulent scheme involving the U.S. telecommunications industry, demonstrating a substantial connection to the United States. As a result, the court has determined it possesses jurisdiction to hear claims related to shares purchased on non-U.S. exchanges, allowing the class to include a wider group of plaintiffs.
Consequently, the court granted the plaintiffs' motion to certify the proposed class action under Fed. R. Civ. P. 23 and also granted Joseph Coughlin's motion to intervene. The certified class consists of all individuals or entities that purchased Flag Telecom Holdings, Ltd. common stock between March 6, 2000, and February 13, 2002, including those connected to its initial public offering. Exclusions from the class include defendants, their immediate families, entities with controlling interests in defendants, Verizon Communications, and certain other entities with board appointment rights. Peter T. Loftin, Norman H. Hunter, and Joseph Coughlin were appointed as class representatives, and Milberg Weiss LLP was designated as Class Counsel. Additionally, various lawsuits asserting federal securities law claims against Flag and associated parties were initiated in Spring 2002.
On October 18, 2002, the Court consolidated lawsuits against certain defendants, appointing Loftin as lead plaintiff and Milberg Weiss LLP as lead counsel. Loftin filed a Second Corrected Consolidated Amended Complaint (2CCAC), which was dismissed, but the plaintiff was allowed to replead. Subsequently, a Third Consolidated Amended Complaint (3CAC) was filed, adding Norman H. Hunter as a plaintiff. Motions to dismiss were filed by Citigroup, Verizon, and individual defendants. On January 12, 2005, the Court granted some motions to dismiss, dismissing claims against Flag and Evans with prejudice and against Verizon without prejudice. Hunter, who is the only proposed class representative to have purchased shares in the initial public offering (IPO), sold his shares in November 2001. Loftin purchased approximately 1.7 million shares between July and September 2000, while Coughlin bought 250 shares in February 2000 and an additional 100 shares in July 2001. The defendants opposed Coughlin’s motion to intervene, arguing he was not typical of the putative class. The Court decided to address the motions for Coughlin's intervention and class certification together. Plaintiffs contend that the individual defendants had the authority to control the misleading contents of FLAG's reports and press releases, which they received before issuance. FLAG's undersea fiberoptic cable system, a key asset, had significant capacity and served numerous customers, though the prospectus indicated uncertainty about pursuing a trans-Pacific cable. The defendants sought permission to file a motion for partial summary judgment concerning the plaintiffs' claims under specific sections of the '33 Act.
Defendants sought partial summary judgment, claiming that plaintiffs' assertion of a misleading Registration Statement was based solely on Flag's statement regarding securing over $750 million in pre-sales, which included a disputed contract with Alcatel. They contended that Flag had released Alcatel from its obligation before the Registration Statement's effective date, implying that the statement was not misleading as it did not rely on the Alcatel transaction. The court indicated it would first address plaintiffs' request to amend the Complaint, as this could significantly impact the defendants' arguments. If plaintiffs could demonstrate that Flag engaged in other questionable pre-sale contracts to reach the $750 million figure, their claims under the Securities Act of 1933 could remain valid. In a prior ruling (Flag II), the court found that plaintiffs failed to sufficiently allege that statements made before April 1, 2001, were materially false or misleading, but noted sufficient allegations regarding statements made in 2001 press releases and SEC filings. Plaintiffs detailed specific transactions, including agreements with Qwest in 2000 and 2001, which involved capacity purchases and swaps that were reported as revenue, potentially inflating financial results. They alleged that Flag improperly recorded these transactions as capital expenditures rather than expenses and used inflated fair market values in violation of GAAP, failing to disclose essential details about the non-monetary and non-recurring nature of the deals. Additionally, plaintiffs claimed Flag combined revenues from these swaps with regular revenues, misleadingly inflating reported growth percentages.
The excerpt addresses the interplay between the negative causation defense under Section 11 and the loss causation element under Section 10(b), highlighting that the burden of proof differs between the defendant and the plaintiff. Defendants contend that the overlap in class periods for claims under the '33 Act (February 11, 2000, to May 10, 2000) and the '34 Act (March 6, 2000, to February 13, 2002) results in a limited number of plaintiffs eligible for both claims. However, the court rejects this argument, noting that a plaintiff could validly pursue claims under both Acts based on different purchase dates. Defendants also question the adequacy of the proposed representative parties, citing their lack of communication; the court finds this point irrelevant to its assessment. Additionally, the excerpt includes a discussion regarding the ethical considerations surrounding the law firm Milberg Weiss, with a representative affirming that prior allegations against the firm did not significantly impact their decision to engage them. The court acknowledges that the defendants' concerns relate to Rule 23's requirements of typicality and adequacy of representation, noting that these determinations are interconnected. Finally, the excerpt contrasts the business operations of BTI and Flag, emphasizing their distinct roles within the telecommunications sector and Loftin's lack of familiarity with BTI's accounting practices.
Defendants contend that the distinction between Loftin's sophistication as an investor and the characteristics of an 'average' investor is irrelevant to the case, attempting to sidestep prior court rulings that deemed Loftin's investment history unnecessary to challenge the fraud-on-the-market presumption. The court reaffirmed its stance that Loftin’s sophistication does not affect the case, highlighting Loftin's reliance on analyst reports and company statements regarding Flag's positive outlook when making his investment decisions.
Coughlin's potential claims under the '34 Act concerning shares purchased on July 3, 2001, remain uncertain. Defendants argue that if Coughlin were to assert claims under the '33 Act, he would be atypical and unable to represent the class adequately, as he would need to demonstrate reliance on alleged misrepresentations in the Registration Statement. They reference Flag’s Form 10-K and Form 10-Q filings, asserting these documents serve as an earnings statement under Section 11(a) of the '33 Act, requiring reliance proof for shares purchased after May 15, 2001.
However, the court has determined that Coughlin lacks standing to pursue '33 Act claims for the July 3, 2001 shares, rendering the defendants’ argument moot. Furthermore, plaintiffs assert that the Forms 10-K and 10-Q contain materially misleading information, which would prevent the defendants from shifting the reliance burden to the plaintiffs under Section 11 of the '33 Act. Hunter, another investor, purchased shares in the IPO and sold them in November 2001, following a February 2002 announcement revealing significant concerns regarding Flag's liquidity and financial practices.
Plaintiffs have submitted an affidavit from Hakala regarding the efficiency of the market for Flag's common stock and its reactions to various financial disclosures. Defendants contend that original shareholders who sold before late April 2002 cannot claim losses under the 1933 Act, asserting that misstatements causing losses had not yet been revealed. However, the court found no precedent limiting class certification based on a negative causation defense at this stage. The plaintiffs have adequately claimed that their losses stemmed from corrective disclosures, and they are allowed to identify additional disclosures later in the litigation. The court is also not convinced by the defendants' argument that the class is unmanageable due to differing loss causation claims among members, as common issues can still predominate. The Daubert challenge to Hakala's testimony may be renewed later, and the court clarified that certain securities sold under SEC Rule 144 have restrictions, while shares obtained through Flag's LTIP are not considered restricted. Furthermore, Flag allegedly made misleading statements in the U.S. to inflate stock prices sold overseas.
