Petition for Writ of Certiorari — Liu v. Credit Suisse First Boston Corp., 127 S. Ct. 733 (2006) (No. 06-467)

Supreme Court, U.S.

FILED

<~ 96-467 SEP 29 2006

In the

Supreme Court of the Anited States

AMY LIU, et al.,

Petitioners,

V.

CREDIT SUISSE FIRST BOSTON

CORP., INC., et al.,

Respondents.

On Petition for a Writ of Certiorari to the United

States Court of Appeals for the Second Circuit

PETITION FOR WRIT OF CERTIORARI

J. Gusty YEAROUT

Joun G. Watts

Counsel of Record

YEAROUT & TRAYLOR, P.C.

800 SHADES CREEK PARKWAY

Suite 500

BIRMINGHAM, AL 35209

(205) 414-8160

Counsel for Petitioners

Becker Gallagher Legal Publishing, Inc. 800.890.5001

i

QUESTION PRESENTED FOR REVIEW

Whether Fed. R. Civ. P. 9(b) or Fed. R. Civ. P. 8(a)

applies to the sufficiency of a pleading for the element of loss

causation in a civil cause of action brought under §10(b) of

the Securities Exchange Act of 1934 and Rule 10b-5, in light

of this Court’s recent decision in Dura Pharms, Inc. v.

Broudo, 544 U.S. 336, 125 S.Ct. 1627, 161 L.Ed.2d 577

(2005), which decided upon a Circuit split as to the minimum

pleading requirements for loss causation but also employed

Fed. R. Civ. P. 8(a) in weighing the sufficiency of loss

causation pleadings.

il

PARTIES TO THE PROCEEDING

The Petitioners include the following individuals:

Robert W. Tenney, Amy Liu, Robert Tate, Mary

Gorton, Carla Kelly, Henry Ciesielski, Ed Grier,

Frank Turk, Jennie Papuzza, Stanley Warren, Ellen

Dulberger, Craig Mason, Sharon Brewer, and Antoine

Kasprzak.

The Respondents are as follows:

Credit Suisse First Boston Corp., Inc., Credit Suisse

First Boston (USA), Inc., Credit Suisse First Boston,

Credit Suisse Group, Efficient Networks, Inc.,

eMachines, Inc. , Lightspan Partnership, Inc. , Tanning

Technology Corp., and Tumbleweed Communications

Corp.

TABLE OF CONTENTS

Question Presented for Reviews... . 2... eee ee ees i

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pt POPES ee er eee ee Ee ee tii

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Opinions Below . OCS a ree er l

SSG 0 cele ke ae Cee Ne ea a egy ]

Relevant Federal Rules of Civil Procedure ......... l

Se eer er eee eee ee 2

Reasons for Granting the Petition ............... Z

I sa a ary Ochs Gira ted os ewe sp ae 10

Appendix

Appendix A - Second Circuit Order Denying

Rehearing, Dated July 10, 2006.............. la

Appendix B - Second Circuit Opinion,

ee A 2 I eee ed aa obs eae 3a

Appendix C - District Court Opinion and Order

ee 66 we ale Co 8 oe Ta

iV

TABLE OF CITED AUTHORITIES

Cases

Conley v. Gibson,

355 U.S. 41, 78 S.Ct. 99,

pg ef es ra maar ae 6

Dura Pharms, Inc. v. Broudo,

544 U.S. 336, 125 S.Ct. 1627,

BES Bg ay |.) as arn passim

In re: Initial Public Offering Securities Litigation,

241 F.Supp. 2d 281 (S-D.N.Y. 2003) .......... 3

In re: Initial Public Offering Securities Litigation,

277 F.Supp. 2d 1375 (Jud.Pan.Mult.Lit. 2003) .... 3

In re: Initial Public Offering Securities Litigation,

383 F.Supp. 2d 566 (S.D.N.Y. 2005) ......... 3,4

In re: Initial Public Offering Securities Litigation,

399 F.Supp. 2d 298 (S.D.N.Y. 2005) ....... Pe AB

Leatherman v. Tarrant County Narcotics Intelligence

and Coordination Unit,

507 U.S. 163, 113 S.Ct. 1160,

v8 Se ae Be |). ee param en earner crete? 6

Swierkiewicz v. Sorema,

534 U.S. 506, 122 S.Ct. 992,

RRS EE Es >: teenie Mune Sees ere 6,7

Tenney v. Credit Suisse First Boston Corp., Inc.,

2006 WL 1423785 (2d Cir. 2006) ......-2265. 5

Regulation and Statutes

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A gs ke 6 5 ba pow awe ee ty Cae ees 2

a RE Sach orb hi Oe oes ae kOe here 3

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Sa EE ns 0k < o-oo ee a 6

Rules

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OPINIONS BELOW

The Second Circuit Court of Appeals Order Denying

Rehearing.on July 10, 2006 is unreported. App. A at la-2a.

The Second Circuit Court of Appeals Opinion, issued on May

19, 2006 is unreported. App. B at 3a-6a. The Decision and

Order of the United States District Court for the Southern

District of New York, issued on June 28, 2005 is reported at

399 F.Supp.2d 298 (S.D.N.Y. 2005). App. C at 7a-3la.

JURISDICTION

The Second Circuit Court of Appeals affirmed the

judgment of the District Court on May 19, 2006.

A petition for rehearing en banc was timely filed and the

Petition was denied on July 10, 2006.

This petition is timely under 28 U.S.C. Section 2101 and

Supreme Court Rule 13(1) because it is being filed within 90

days of the entry of the order denying rehearing en banc

sought to be reviewed. This Court has jurisdiction to review

the order of the United States Court of Appeals for the

Second Circuit pursuant to 28 U.S.C. Section 1254.

RELEVANT FEDERAL RULES OF

CIVIL PROCEDURE

Fed. R. Civ. P. 8 states as follows:

(a) Claims for Relief. A pleading which sets forth a

claim for relief, whether an original claim,

counterclaim, cross-claim, or third-party claim, shall

contain (1) a short and plain statement of the grounds

upon which the court’s jurisdiction depends, unless the

2

court already has jurisdiction and the claim needs no

new grounds of jurisdiction to support it, (2) a short

and plain statement of the claim showing that the

pleader is entitled to relief, and (3) a demand for

judgment for the relief the pleader seeks. Relief in the

alternative or of several different types may be

demanded.

Fed. R. Civ. P. 9(b) states as follows:

(b) Fraud, Mistake, Condition of the Mind. In all

averments of fraud or mistake, the circumstances

constituting fraud or mistake shall be stated with

particularity. Malice, intent, knowledge, and other

condition of mind of a person may be averred

generally.

STATEMENT OF THE CASE

The jurisdiction of the District Court was invoked under

28 U.S.C. Section 1331 (general federal question

jurisdiction). The federal claims are based upon allegations

of the respondents violating § 10(b) of the Securities

Exchange Act of 1934 and Rule 10b-5, 17 C.F.R. § 240. 10b-

5, promulgated there under. Plaintiffs’ case was dismissed

pursuant to Fed. R. Civ. P. 12(b)(6). The District Court’s

sole finding on dismissal was that Plaintiffs’ complaint failed

to sufficiently plead the element of loss causation in the

securities fraud cause of action under that Circuit’s

precedents.

Plaintiffs’ case was initially filed on February 28, 2003 in

the Southern District of Florida. Over Plaintiffs’ objections,

the Judicial Panel on Multi District Litigation transferred

Plaintiffs’ case to the Southern District of New York on

3

August 12, 2003 to be coordinated before the District Court

there with the enormous consolidated action /n re: Initial

Public Offering Securities Litigation (“In re IPO”) 241

F.Supp. 2d 281 (S.D.N.Y. 2003). In the “Transfer Order,”

the Panel stated that “Centralization under [28 U.S.C.]

Section 1407 is necessary in order to ...prevent inconsistent

pretrial rulings...” 277 F.Supp. 2d = 1375, 1377

(Jud.Pan.Mult.Lit.,2003) (emphasis added). Prior to the

transfer of Plaintiffs’ case, the Jn re [PO District Court had

already ruled on February 19, 2003 on the legal pleading

requirements for all cases in the coordinated action, including

the pleading requirement for the element of loss causation.

“In this litigation, Plaintiffs have pled two securities fraud

claims: one for market manipulation and another for material

misstatements and omission in the registration statement. ...

In both cases, Rule 9(b) governs the pleading of the

remaining elements of the claims: loss causation,

transaction causation, reliance and damages.” Jn re PO, 241

F.Supp.2d 281, 335-336 (emphasis added). Plaintiffs’ case

was subjected to this District Court’s ruling regarding the

applicable pleading standards to be imposed by consequence

of the transfer and coordination.

On April 1, 2005 the District Court issued its first opinion

on Defendants’ Fed. R. Civ. P. 12(b)(6) motions to dismiss

Plaintiffs” complaint and stated as follows: “The United States

Supreme Court is now considering what pleading standard

should be applied to allegations of loss causation. '°’" In re

IPO, 383 F.Supp. 2d 566, 578 (S.D.N.Y. 2005)(in footnote

67 referencing “Dura Pharms., Inc. v. Broudo, No. 03-932.,

cert. granted by Dura Pharms., 124 S.Ct. 2904 (2004),

argued Jan. 12, 2005”). Further, the District Court stated

therein the following: “In any case, any ruling by the

Supreme Court in Dura Pharms. will certainly affect the

4

pleading standard for misrepresentation cases like this one.”

383 F.Supp.2d at 578, n.67(emphasis added).

Subsequent to the April 1, 2005 decision, Plaintiffs timely

moved on April 15, 2005 for reconsideration under Fed. R.

Civ. P. 59, which resulted in a new order dated May 16,

2005 and which granted Plaintiffs’ motion in part but still

dismissed Plaintiffs’ case on the sole basis of the District

Court’s alleged finding that Plaintiffs’ complaint failed to

sufficiently plead the element of loss causation.

On April 19, 2005, between Plaintiffs’ April 15, 2005

filing of their first motion for reconsideration and the District

Court’s subsequent May 16, 2005 decision on that motion,

this Court ruled in Dura Pharms, Inc. v. Broudo, 544 U.S.

336 (2005), specifically on the issue of the pleading

requirements for the element of loss causation in securities

fraud cases. Consequently , on May 26, 2005 Plaintiffs timely

filed a second motion for reconsideration under Fed. R. Civ.

P. 59, and raised therein, in part, this Court’s April 19, 2005

Dura Pharms, Inc. decision and its language which made

clear that the burden on Plaintiffs in pleading the element of

loss causation in a securities fraud cause of action is not

supposed to be great. Further, Plaintiffs quoted therein

clear language from Dura Pharms, Inc. in which this Court

explicitly employed Fed. R. Civ. P. 8(a)(2)-- and not Fed. R.

Civ. P. 9(b)-- in weighing the sufficiency of the pleading of

the element of loss causation.

On June 28, 2005 the District Court denied Plaintiffs’

May 26, 2005 second motion for reconsideration entirely and

dismissed Plaintiffs’ complaint with prejudice -- again solely

on a finding that Plaintiffs’ complaint failed to plead the

element of loss causation sufficiently under the precedent law

of that Circuit. In this decision, the District Court remarked

3

upon the recent Dura Pharms, Inc. decision but concluded

“... Dura did not disturb Second Circuit precedent regarding

loss causation.” 399 F.Supp.2d 298, 301.

Plaintiffs timely filed an appeal from the District Court’s

dismissal and raised at length therein the impropriety of any

heightened pleading standard beyond Fed. R. Civ. P. 8 for

pleading loss causation. On the appeal, a three-judge panel

of the Second Circuit Court of Appeals affirmed the District

Court in a Summary Order. The Order stated “we affirm,

substantially for the same reasons set out by the district court

in its detailed final opinion dismissing the complaint.” May

19, 2006 Order at 3, Tenney v. Credit Suisse First Boston

Corp., Inc., 2006 WL 1423785 (2d Cir. 2006).

Plaintiffs sought a rehearing en banc “om the Circuit

court and timely moved for such. The petition was denied by

written order dated Juiy 10, 2006. This Petition for a Writ of

Certiorari to this Court has been filed within 90 days of the

July 10, 2006, denial of the rehearing en banc petition to the

Circuit Court.

REASONS FOR GRANTING THE PETITION

This case presents an important issue of federal law on

which the Second Circuit’s precedent conflicts with this

Court’s rulings. The Second Circuit’s ruling upholds a Fed.

R. Civ. P. 9(b) heightened pleading requirement for pleading

the element of loss causation in a civil securities fraud action,

contrary to this Court’s recent opinion in Dura Pharms, Inc.,

which clearly employed Fed. R. Civ. P. 8(a) as the applicable

standard. I[t also conflicts with the clear directives given to

the Second Circuit and other lower courts by this Court in the

line of cases directing them to uphold the plain language of

Fed. R. Civ. P. 8 rather than imposing stricter pleading

6

requirements, such as Fed. R. Civ. P. 9(b), unless specifically

indicated otherwise by the Federal Rules-- even for those

types of civil actions which may have become disfavored.

See Swierkiewicz v. Sorema, 534 U.S. 506, 122 S.Ct. 992,

152 L.Ed.2d 1 (2002) (overruling the Second Circuit’s

precedent requiring a heightened pleading standard beyond

Fed. R. Civ. P. 8 for employment discrimination cases, and

finding its heightened pleading requirement directly in conflict

with Fed. R. Civ. P. 8(a)’s express language); Leatherman v.

Tarrant County Narcotics Intelligence and Coordination Unit,

507 U.S. 163, 113 S.Ct. 1160, 122 L.Ed.2d 517 (1993)

(overruling the Fifth Circuit’s “heightened pleading standard”

requirement akin to Fed. R. Civ. P. 9(b) in alleging municipal

liability under 42 U.S.C. § 1983, and finding its heightened

pleading standard directly in conflict with Fed. R. Civ. P.

8(a)’s express language); Conley v. Gibson, 355 U.S. 41, 47,

78 S.Ct. 99, 2 L.Ed.2d 80 (1957)(explaining that Fed. R.

Civ. P. 8 means what is says and facts do not need to be

pled). Consequently, the ruling at issue threatens to

undermine the clear dictates of this Court and the Federal

Rules of Civil Procedure in these cases of national importance

~ national securities cases, particularly those filed in the

Second Circuit which contains the financial heart of the

country.

The District Court explicitly stated that Fed. R. Civ. P.

9(b) applied to pleading the element of loss causation for the

securities fraud cases coordinated before it under the /n re

IPO multi-district coordination, which ultimately included

Plaintiffs’ instant case. Further, the District Court’s final

opinion of June 28, 2005, adopted by the Court of Appeals,

was Clear that it was burdening Plaintiffs’ complaint with a

pleading requirement beyond Fed. R. Civ. P. 8 under the

Second Circuit’s precedents-- “[this Circuit’s precedent]

imposes a heavy burden on plaintiffs to plead [loss

7

causation].” 399 F.Supp. 2d at 309. Subsequently, in

affirming the District Court’s application of Fed. R. Civ. P.

9(b) and the heightene* pleading requirement for loss

causation, the Second Circuit Court of Appeals even stated

that “the complaint’s theory of loss causation ...ultimately

fail{ed] to satisfy the strict pleading requirements set forth in

{this Circuit’s precedent)...” 2006 WL 1423785 at

*1 (emphasis added).

By sharp contrast, however, this Court in Dura Pharms,

Inc., 125 S.Ct. 1627, employed an entirely different and more

permissive pleading standard-- Fed. R. Civ. P. 8-- in

reviewing the adequacy of loss causation pleadings:

We concede that the Federal Rules of Civil Procedure

require only “a short and plain statement of the claim

showing that the pleader is entitled to relief.” Fed.

Rule Civ. Proc. 8(a)(2). And we assume, at least for

argument’s sake, that neither the Rules nor the

securities statutes impose any special further

requirement in respect to the pleading of proximate

causation or economic loss. ... We concede that

ordinary pleading rules are not meant to impose a

great burden upon a plaintiff. Swierkiewicz v. Sorema

N. A., 534 U.S. 506, 513-515, 122 S.Ct. 992, 152

L.Ed.2d | (2002).

Dura Pharms, Inc., 125 §.Ct. at 1634.

In addition, and of important noteworthiness, in Dura

Pharms, Inc. the defendants and their Amici argued to this

Court that a pleading- requirement greater than Fed. R. Civ.

P. 8 was required for loss causation allegations, and one

amicus brief (Sec. /nd. Ass'n Br. at 9-10, n.6) even argued

that a complaint was required to include expert testimony

8

regarding loss causation.' However, at oral argument in Dura

Pharms, Inc., several Justices reacted to the defendants’

arguments for a heightened pleading standard for loss

causation above Fed. R. Civ. P. 8 with unambiguous

skepticism.

JUSTICE O’CONNOR: Well, doesn’t the general

rule 8 governing complaints -- isn’t that adequate?

You have to plead under that every element of an

affirmative case.

JUSTICE O’CONNOR: Why is the Governinent

proposing that you have to follow rule 9 not 8 or some

other requirement?

JUSTICE GINSBURG: But, Mr. Hungar, if you

look at the forms of what’s proper pleading under the

Federal rules on causation, the sample pleadings say,

for example, for money lent, the defendant owes the

plaintiff for money lent. Period. Or for goods sold and

delivered. Nothing more. Just alleged causation.

Defendant -- plaintiff alleges 1 lost X amount and it

was caused by defendant. I thought you pointed to the

9(b) rule because fraud must be pleaded with

particularity, but causation does not, not under the

rules and not under the statute.

' Dura Pharms, Inc. briefs ~ Petitioner’s Briefs: 2004 WL

2075752, 2004 WL 2988614 (U.S.); Amici Curiae Briefs in

Support of Petitioners: 2004 WL 2045248, 2004 WL 2075751,

2004 WL 2069560, 2004 WL 2092648, 2004 WL 2069562, 2004

WL 2069561, 2004 WL 2069564, 2004 WL 2069563.

9

MR. HUNGAR [attorney for the Government]: Well,

as we said in our brief, we think 9(b) applies here.

Obviously, this is a fraud case.

JUSTICE GINSBURG: But that -- that’s to the -—to

the allegation of fraud, but not causation.

MR. HUNGAR: Weill, Congress has made very clear

that loss causation is an element of the cause of action.

The elements must be pled. In a fraud case, they must

be pled with particularity, but even -- even in a -- in

a common law -- —

JUSTICE GINSBURG: It says -- no. It said fraud

must be pleaded with particularity, not all the elements

of a fraud claim.

MR. HUNGAR: Well, with respect, Your Honor, we

think circumstances -- ‘t does not constitute fraud if

there is no loss causation. At least it certainly doesn’t

constitute securities fraud under this statute, and if the

complaint does not plead loss causation, it hasn’t pled

fraud. So we submit that --

JUSTICE STEVENS: Well, that’s not correct I don’t

think. I think there could be a completely fraudulent

statement but no -- no damages as a result of it. There

would still be fraud.

MR. HUNGAR: Yes, but in a -- in a private action

for securities fraud, loss causation is an element of the

cause of action. It’s not an element in every fraud

case.

10

JUSTICE STEVENS: It’s not an element of the

fraud. It’ s an element of the cause -- cause of action.

Dura Pharms, Inc. Tr. at 19-21, found = at

http://www.supremecourtus. gov/oralarguments/argument

transcripts/03-932.pdf (emphasis added).

CONCLUSION

The petition for a writ of certiorari should be granted so

that this Honorable Court can consider the merits of the

question for review.

Respectfully submitted,

J. Gusty Yearout

John G. Watts

Counsel of Record

Yearout & Traylor, P.C.

800 Shades Creek Parkway, Suite 500

Birmingham, Alabama 35209-4547

Telephone: (205) 414-8160

Facsimile: (205) 414-8199

e-mail: jwatts@yearout.net

Attorneys for Petitioners - Appellants

Dated: September 29, 2006

la

APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Nos. 05-3430-cv, 05-4759-cv, 05-4760-cv

[Filed July 10, 2006]

ROBERT W. TENNEY, AMY LIU, M.D.,

ROBERT TATE, MARY GORTON,

CARLA KELLY, HENRY CIESIELSKI,

ED GRIER, FRANK TURK,

JENNIE PAPUZZA, STANLEY WARREN,

ELLEN DULBERGER, CRAIG MASON,

SHARON BREWER, and

ANTOINE KASPRZAK,

Plaintiffs-Appellants-Cross-Appellees,

CREDIT SUISSE FIRST BOSTON CORP., INC.

CREDIT SUISSE FIRST BOSTON (USA), INC.,

CREDIT SUISSE FIRST BOSTON,

CREDIT SUISSE GROUP, EFFICIENT

NETWORKS, INC., eMACHINES, INC.,

LIGHTSPAN PARTNERSHIP, INC.,

TANNING TECHNOLOGY CORP. and

TUMBLEWEED COMMUNICATIONS CORP.,

)

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Defendants-Appellees-Cross-Appellants, )

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2a

ORDER

A petition for panel rehearing and a petition for rehearing

en banc having been filed herein by the Plaintiff Appellants-

Cross-Appellees Robert W. Tenney, et al. Upon

consideration by the panel that decided the appeal, it is

Ordered that said petition for rehearing is DENIED.

It is further noted that the petition for rehearing en banc

has been transmitted to the judges for the court in regular

active service and to any other judge that heard the appeal and

that no such judge has requested that a vote be taken thereon.

For the Court,

Roseann B. Mackechnie, Clerk

By: /s/

Motion Staff Attorney

APPENDIX B

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Nos. 05-3430-cv, 05-4759-cv, 05-4760-cv

[Filed May 19, 2006]

ROBERT W. TENNEY, AMY LIU, M.D.,

ROBERT TATE, MARY GORTON,

CARLA KELLY, HENRY CIESIELSK],

ED GRIER, FRANK TURK,

JENNIE PAPUZZA, STANLEY WARREN,

ELLEN DULBERGER, CRAIG MASON,

SHARON BREWER, and

ANTOINE KASPRZAK,

Plaintiffs-A ppellants-Cross-A ppellees,

Vv.

CREDIT SUISSE FIRST BOSTON CORP., INC.,

CREDIT SUISSE FIRST BOSTON (USA), INC.,

CREDIT SUISSE FIRST BOSTON,

CREDIT SUISSE GROUP, EFFICIENT

NETWORKS, INC., eMACHINES, INC.,

LIGHTSPAN PARTNERSHIP, INC.,

TANNING TECHNOLOGY CORP. and

TUMBLEWEED COMMUNICATIONS CORP.,

Defendants-Appellees-Cross-Appellants,

ee ee ee i ee ee ee Le ee a Le ee ee ee, ee, ee, ee, ee ee oe

4a

Appeal from the United States District Court

for the Southern District of New York (Scheindlin, J.)

Present: HON. THOMAS J. MESKILL, HON. CHESTER J.

STRAUB, HON. ROBERT A. KATZMANN, Circuit Judges.

SUMMARY ORDER

ON CONSIDERATION WHEREOF, IT IS HEREBY

ORDERED, ADJUDGED, AND DECREED that the

judgment of the district court is AFFIRMED.

The plaintiffs in this action brought a complaint under

Section 10(b) of the Securities Exchange Act of 1934 and

Rule 10b-5 promulgated thereunder, alleging that the six

defendants-appellees - five issuers of securities that went

public during the late 1990s (the “issuer defendants”) and the

investment bank that underwrote their initial public offerings

(Credit Suisse First Boston and its related entities, collectively

“CSFB”) - had engaged in a complex scheme to defraud

investors. Pursuant to that scheme, according to the plaintiffs,

the issuer defendants and CSFB deliberately understated their

earnings estimates while simultaneously reminding investors

of the potential for “upside surprises,” thereby creating

“excitement in the marketplace when the stocks at issue beat

estimate after estimate, conditioning the market to expect

superior performance from those stocks and artificially

inflating their prices.” See In Re Initial Pub. Offering Sec.

Litig., 383 F. Supp. 2d 566, 570 (S.D.N.Y. 2005). The

plaintiffs allege that they relied on this illusion when

purchasing stock in the various issuer defendants, and that

when this cycle eventually ended, they suffered a loss.

The district court — first in its initial opinion on the

defendants’ motion to dismiss, see id., and then in its two

Sa

opinions regarding the plaintiffs’ motions for reconsideration,

see In Re Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d

261 (S.D.N.Y. 2005); Liu v. Credit Suisse First Boston Corp.

(in re Initial Pub. Offering Secs. Litig.), 399 F. Supp. 2d 298

(S.D.N.Y. 2005) - repeatedly dismissed the complaint on

grounds that it did not adequately plead loss causation. The

plaintiffs now appeal that dismissal. Meanwhile, the

defendants cross-appeal the district court’s subsequent denial

of their motion for sanctions. See Jn Re Initial Pub. Offering

Sec. Litig., 399 F. Supp. 2d 369 (S.D.N.Y- 2005).

With regard to the plaintiffs’ appeal of the district court’s

dismissal of their complaint, we affirm. substantially for the

same reasons set out by the district court in its detailed final

opinion dismissing the complaint. See In Re Initial Pub.

Offering Sec. Litig., 399 F. Supp. 2d at 307-09.

With regard to the defendants’ cross-appeal of the district

court’s decision not to award sanctions pursuant to Rule 11 of

the Federal Rules of Civil Procedure and the Private

Securities Litigation Reform Act of 1995 (the “PSLRA”), we

also affirm. We review a district court’s decision to impose

(or not impose) sanctions pursuant to Rule 11 of the Federal

Rules of Civil Procedure and the PSLRA under an “abuse of

discretion” standard. See, e.g., Gurary v. Nu-Tech Bio-Med,

Inc., 303 F.3d 212, 219 (2d Cir. 2002). Here, we conclude

that the district court did not abuse its discretion in declining

to award sanctions. The district court acted within its

discretion in concluding that the complaint’s theory of loss

causation, while ultimately failing to satisfy the strict pleading

requirements set forth in Lentell v. Merrill Lynch & Co., Inc.,

396 F.3d 161 (2d Cir. 2005), was not frivolous. See In Re

Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d at 372.

Similarly, it was within its discretion in concluding that

sanctions were not warranted with respect to the plaintiffs’

6a

claims against Tumbleweed Communications Corp. , Tanning

Technology Corp., and eMachines, Inc., given that under a

broad reading of the amended complaint, there was a plaintiff

with standing to sue each of these defendants. See id. at 373-

75. The remaining arguments that the defendants-appellees

now press in support of sanctions were either not raised to the

district court at all, or were raised so briefly that the district

court’s lack of consideration of them cannot be considered an

abuse of discretion.

Accordingly, the decisions of the district court to dismiss

the plaintiffs’ complaint and to deny the defendants’ requests

for sanctions are therefore AFFIRMED.

FOR THE COURT:

ROSEANN B. MacKECHNIE, CLERK

By:

Ta

APPENDIX C

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEW YORK

No. 04 Civ. 03757 (SAS)

[Filed June 28, 2005] _

IN RE: INITIAL PUBLIC OFFERING

SECURITIES LITIGATION;

This document relates to:

AMY LIU, ROBERT TENNEY, ROBERT TATE,

MARY GORTON, CARLA KELLY, HENRY

CIESIELSKI, ED GRIER, FRANK TURK,

JENNIE PAPUZZA, STANLEY WARREN,

ELLEN DULBERGER, CRAIG MASON, AND

SHARON BREWER,

Plaintiffs,

Vv.

CREDIT SUISSE FIRST BOSTON CORP.,

CREDIT SUISSE FIRST BOSTON (USA), INC.,

CREDIT SUISSE FIRST BOSTON, CREDIT

SUISSE GROUP, EFFICIENT NETWORKS, INC.,

eMACHINES, INC., LIGHTSPAN

PARTNERSHIP, INC., TANNING

TECHNOLOGY CORP., AND

TUMBLEWEED COMMUNICATIONS CORP.,

Defendants.

ee ee ee ee ee i

8a

SHIRA A. SCHEINDLIN, U.S.D.J.: ~

OPINION AND ORDER

I. INTRODUCTION

In an Opinion and Order dated April 1, 2005, this Court

dismissed plaintiffs’ claims in this action, No. 04 Civ. 3757,

in their entirety.' Plaintiffs moved for reconsideration. On

May 13, 2005, I granted plaintiffs’ motion in part, but

reaffirmed the dismissal of plaintiffs’ claims because plaintiffs

had failed to plead loss causation.’ Plaintiffs now move for

reconsideration of the May 13 Opinion.’

Il. LEGAL STANDARD

A motion for reconsideration is governed by Local Rule

6.3 and is appropriate where a court overlooks “controlling

decisions or factual matters that were put before it on the

' See Liu v. Credit Suisse First Boston Corp. (In re Initial Pub.

Offering Sec. Litig.), 383 F. Supp. 2d 566, 2005 U. S. Dist. LEXIS

5339, 2005 WL 743550 (S.D.N_Y. 2005) (“Liu JI”).

> See In re IPO, 399 F. Supp. 2d 261, 2005 U.S. Dist. LEXIS

9318, No. 21 MC 92, 2005 WL 1162445 (S.D.N.Y. May 13,

2005) (“Liu Reconsideration”).

> See Plaintiffs’ Memorandum in Support of the Rule 59(e)

Motion to Alter, Amend, or Vacate the Order of May 13, 2005,

Dismissing the Plaintiffs’ Complaint (“2d Reconsideration Mem.”).

As they did in their first motion for reconsideration, plaintiffs have

styled their motion under 59(e) rather than Local Rule 6.3. As I

noted in my May 13 Opinion, there is no difference between the

two. See Liu Reconsideration, 2005 U.S. Dist. LEXIS 9318, 2005

WL 1162445, at *1. a

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underlying motion . . . and which, had they been considered,

might have reasonably altered the result before the court.”*

Alternatively, a motion for reconsideration may be granted to

“correct a clear error or prevent manifest injustice.”°

Reconsideration is an “extraordinary remedy to be employed

sparingly in the interests of finality and conservation of scarce

judicial resources. ”°

Local Rule 6.3 should be “narrowly construed and strictly

applied” to avoid repetitive arguments on issues that have

been considered fully by the Court.’ A motion for

reconsideration “is not a substitute for appeal;”® nor is it “a

‘second bite at the apple’ for a party dissatisfied with a court’s

* Range Road Music, Inc. v. Music Sales Corp., 90 F. Supp.

2d 390, 392 (S.D.N.Y. 2000) (quotation marks and citation

omitted). See also Shrader v. CSX Transp., Inc., 70 F.3d 255, 257

(2d Cir. 1995) (“The standard for granting . . . a motion [for

reconsideration] is strict, and reconsideration will generally be

denied unless the moving party can point to controlling decisions or

data that the court overlooked —- matters, in other words, that might

reasonably be expected to alter the conclusion reached by the

court.”). om

> Doe v. New York City Dep't of Soc. Servs., 709 F.2d 782,

789 (2d Cir. 1983).

° In re Health Mgmt. Sys., Inc. Sec. Litig., 113 F. Supp. 2d

613, 614 (S.D.N.Y. 2000).

” Greenes v. Vijax Fuel Corp., 2004 U.S. Dist. LEXIS 12503,

No. 02 Civ. 450, 2004 WL 1516804, at *1 (S.D.N.Y. July 7,

2004).

* RMED Int'l, Inc. v. Sloan's Supermarkets, Inc., 207 F. Supp.

2d 292, 296 (S.D.N.Y. 2002) (quotation omitted).

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ruling.”’ Courts have repeatedly been forced to warn counsel

that such motions should not be made reflexively, “to reargue

those issues already considered when a party does not like the

way the original motion was resolved.”'° A motion under

Local Rule 6.3 “shall be served within ten (10) days after the

entry of the court’s order determining the original motion.”"'

On April 19, 2005, in Dura Pharmaceuticals, Inc. v.

Broudo,” the Supreme Court rejected the Ninth Circuit's

permissive pleading standard for loss causation, which

required only that a plaintiff allege that she had bought a

security at an artificially inflated price.'? The Court noted that

“it should not prove burdensome for a plaintiff who has

suffered an economic loss to provide a defendant with some

indication of the loss and the causal connection that the

plaintiff has in mind. At the same time, allowing a plaintiff to

forgo giving any indication of the economic loss and

proximate cause that the plaintiff has in mind would bring

about harm of the very sort the statutes seek to avoid.”

9 Pannonia Farms, Inc. v. USA Cable, 2004 U.S. Dist. LEXIS

15737, No. 03 Civ. 7841, 2004 WL 1794504, at *2 (S.D.N_Y.

Aug. 10, 2004).

'© Houbigant, Inc. v. ACB Mercantile, 914 F. Supp. 997, 1001

(S.D.N.Y. 1996).

'' §.D.N.Y. Local Rule 6.3. See also Fed. R. Civ. P. 59e)

(same).

2 125 S. Ct. 1627, 1630, 161 L. Ed. 2d 577 (2005).

‘5 See Broudo v. Dura Pharms., Inc., 339 F.3d 933, 938 (9th

Cir. 2003).

'S Dura, 125 S.Ct. at 1634.

lla

Dura did not establish what would be a sufficient loss

causation pleading standard; it merely established what was.

not. However, Dura cited the stricter standards of the Second,

Third, Seventh and Eleventh Circuits’ standards as those with

whom “the Ninth Circuit’s views about loss causation

differ.”'* The Court did not explicitly modify the stricter

standards of those Circuits when it rejected the Ninth Circuit’s

lenient standard; accordingly, Dura did not disturb Second

Circuit precedent regarding loss causation.

Ii. PLAINTIFFS’ ARGUMENT

Piaintiffs’ second motion for reconsideration focuses on

the Court’s May 13 decision that plaintiffs had not adequately

pled loss causation.'® Essentially, plaintiffs contend that the

Court misconstrued the relevant- legal standard for loss

Causation, as articulated in the Second Circuit’s decision in

Lentell v. Merrill Lynch & Co., Inc.” In the May 13 Order,

I noted that:

'S Id. at 1630 (citing Emergent Capital Inv. Mgmt., LLC v.

Stonepath Group, Inc., 343 F.3d 189, 198 {2d Cir. 2003)).

'© Plaintiffs also quibble with the Court’s description of the

alleged scheme, devoting four pages to the proposition that “the

artificial inflation occurred before the actual results were announced

to have beaten the pre-existing estimates.” 2d Reconsideration

Mem. at 8. Because plaintiffs have not sufficiently alleged that the

alleged scheme caused their losses, the exact timing of the alleged

artificial inflation is irrelevant. Moreover, to the extent that

plaintiffs now raise questions of transaction causation that were

addressed in my April 1, 2005 Order, the ten-day deadline for

reconsideration motions has expired. See S.D.N.Y. Local Rule 6.3;

Fed. R. Civ. P. 59(e).

'” 396 F.3d 161 (2d Cir. 2005).

{2a

in material misstatement and omission cases, a court

Cannot presume dissipation of the inflationary effect;

a plaintiff must explicitly allege a disclosure or some

other corrective event. Moreover, to establish loss

causation, a plaintiff must allege . . . that the subject

of the fraudulent statement or omission was the cause

of the actual loss suffered, i.e., that the misstatement

Or omission concealed something from the market

that, when disclosed, negatively affected the value of

the security .'*

Plaintiffs contend that Lentell simply requires “that the

Plaintiffs’ Complaint alleges facts to support that the

misstatements or omissions were the ‘proximate cause’. . . of

the investment loss.”!® Plaintiffs contend that, under Lentell,

“‘proximate cause’ is construed broadly, except that it

logically requires that the subject of the fraudulent statement

or omission was the cause of the actual loss suffered.”

Plaintiffs argue that the corrective disclosure requirement of

Lentell was in fact just one of several possible ways for

plaintiffs to allege loss causation, and that plaintiffs’ failure to

allege any corrective disclosures has no effect on any of the

other methods by which plaintiffs may adequately plead loss

causation.”!

'8 Liu Reconsideration, 2005 U.S. Dist. LEXIS 9318, 2005

WL 1162445, at *3 (footnotes and quotation marks omitted).

' 2d Reconsideration Mem. at 5.

”

*! See id. at 5-6 (summarizing plaintiffs’ apprehension of the

Lentell test as follows: “{1] was the subject of those ‘misstatements

and omissions’ the cause of the decline in stock values that

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Plaintiffs’ confusion is understandable. As the Second

Circuit noted in Suez Equity Investors, L.P. v. Toronto-

- Dominion Bank, the Circuit has produced “somewhat

inconsistent precedents on loss causation.”” Indeed, although

the Circuit has issued several opinions dealing with loss

causation in the last few years, the standard remains

ambiguous.”

IV. DISCUSSION

A. Reconciting the Second Circuit’s Loss Causation

Standard

The Circuit’s most recent decision on loss causation,

Lentell v. Merrill Lynch, notes that “we follow the holdings

of [three earlier Second Circuit cases,] Emergent Capital,

Plaintiffs claim as their loss? or [2] was there any corrective

disclosure regarding the falsity of those ‘misstatements and

omissions’ so as to cause [] the decline in stock values that

Plaintiffs claim as their loss? [] or [3] have Plaintiffs alleged that

the Defendants concealed or misstated any risks associated with an

investment in those securities, some of which presumably caused

Plaintiffs’ losses?”) (bracketed numbers in original).

2 250 F.3d 87, 98 n.1 (2d Cir. 2001).

> See Castellano v. Young & Rubicam, Inc., 257 F.3d 171,

187 (“While loss causation is easily defined, its application to

particular facts has often been challenging.”); Emergent Capital,

343 F.3d at 198 (including a section entitled “Suez Equity

Clarified”); Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161,

173 (2d Cir. 2005) (“acknowledging that [the] opinion in Suez

Equity can be mis-read”).

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Castellano and Suez Equity.” Lentell’s loss causation

standard, though, is difficult to parse. To begin, Lentell holds

that: ,

Thus to establish loss causation, “a plaintiff must

allege ... that the subject of the fraudulent statement

or omission was the cause of the actual loss suffered,”

i.e., that the misstatement or omission concealed

something from the market that, when disclosed,

negatively affected the value of the security.

Otherwise, the loss in question was not foreseeable.”

But Lentell’s full discussion of loss causation spans several

pages, at times asserting different formulations of the loss

causation standard. For example, the Lentell decision later

posits that “this Court’s cases — post-Suez and pre-Suez —

require both that the loss be foreseeable and that the loss be

caused by the materialization of the concealed risk.””* On the

next page of the decision, the court continues to reformulate

its standard, noting that “our precedents make clear that loss

causation has to do with the relationship between the

plaintiff's investment loss and the information misstated or

concealed by the defendant. If that relationship is sufficiently

direct, loss causation is established . . . .”*’ Finally, Lentell

also states the loss causation standard in the negative: “[iJt is

not enough to allege that a defendant’s misrepresentations and

* Lentell, 396 F.3d at 174.

> Id. at 173 (quoting Suez Equity, 250 F.3d at 95) (emphasis

in Lentell).

© Lentell, 396 F.3d at 173.

7 Id. at 174 (citations omitted).

1Sa

omissions induced a purchase-time value disparity between

the price paid for a security and its true investment quality.””*

Thus, over time, the Second Circuit has advanced several

different standards for pleading loss causation, including

“direct causation,””? “materialization of risk,”*? and

*8 Jd. (quotation marks and citations omitted).

9 See id. at 174 (“If that relationship [between ‘the plaintiff’s

investment loss and the information misstated’] is sufficiently

direct, loss causation is established . . . .”}. See also Suez Equity,

250 F.3d at 98 n.1 (construing First Nationwide Bank v. Gelt

Funding Co., 27 F.3d 763, 769-70 (2d Cir. 1994) as “relying on

‘direct causation’ analysis for loss causation”). In First Nationwide,

a RICO case involving allegations that lenders were fraudulently

induced to make nonrecourse loans for the purchase of real estate,

the Circuit dismissed a complaint for a number of reasons,

including: (1) plaintiff had not adequately pled materiality; (2)

intervening factors (including a market-wide downturn in real estate

prices) likely caused plaintiff's losses; and (3) five years had

elapsed between the alleged misrepresentations and the losses

suffered. See First Nationwide, 27 F.3d at 772 (noting that “[h]ere,

no social purpose would be served by encouraging everyone who

suffers an investment loss because of an unanticipated change in

market conditions to pick through loan applications with a fine-tooth

comb in the hope of uncovering a misrepresentation.”) (quotation

marks, citation and alteration omitted).

See Lentell, 396 F.3d at 173 (requiring “that the loss be

caused by the materialization of the concealed risk”). See also Suez

Equity, 250 F.3d at 98 n.1 (calling the Seventh Circuit’s

“materialization of risk” standard —- which involves “inquiring

whether the loss at issue was caused by the materialization of a risk

that was not disclosed because of the defendant’s fraud” — “both

principled and predictable,” but noting that the Second Circuit is

“not writing on a blank slate, and believe[s] that the approach here

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“corrective disclosure,”*' all of which are referenced in

Lentell. However, a close look at the recent discussion of loss

causation by the Second Circuit reveals that the loss causation

pleading standard, although murky, is not internally

inconsistent.

Part of the problem lies in the continued expansion of the

definition of “securities fraud.” Some unlawful activities,

such as “jaywalking,” have clearly defined limits and

comprise a limited range of human behavior. Securities fraud,

by contrast, encompasses many distinct types of fraudulent

activities, each of which causes harm in different ways. For

example, a broker may “churn” a client’s investments — /.e.,

make excessive trades to generate broker commissions — and

harm the client by generating large commissions.” A broker

may assure a Client that the broker will only make “safe”

investments, and then spend the client’s money on extremely

risky securities, which lose value; in such cases, the client is

harmed when the concealed risk — the volatility of the actual

investments — lowers the value of her portfolio.’ A

manipulative potential partner may fraudulently persuade a

sole proprietor to issue shares in a closely held company, and

then dismantle the company or force out the original owner,

articulated best reconciles our precedents to date.”).

3! See Lentell, 396 F.3d at 175 n.4 (finding that, because

plaintiffs alleged no corrective disclosures, they could not establish

loss Causation).

2 See, e.g., Caiola v. Citibank, N.A., 295 F.3d 312 (2d Cir.

2002).

3 See, e.g., Louros v. Kreicas, 367 F. Supp. 2d 572, 592-93

(S.D.N.Y. 2005).

7 17a

causing the owner to lose money as the company’s profits

diminish. A corporation with a right of first refusal on its

preferred stock might assure a shareholder seeking to cash in

his preferred shares that “nothing [seriously affecting share

value] is going to change in the near future” when in fact the

corporation knows that a recapitalization likely to enhance

share prices is imminent; in such a case, the loss is caused

when the employee misses out on a surge in stock prices after

the recapitalization occurs.*°

All of these examples of securities fraud cause a loss to

the injured party. The mechanisms for such losses vary

widely. However, the common thread is that, in each

situation, “the loss be foreseeable and [] the loss be caused by

the materialization of the concealed risk.”*° This is true even

of the “somewhat inconsistent” precedents the Circuit

attempted to reconcile in Suez Equity, which resulted in a

legal standard- that itself has required numerous

clarifications.*”

In Suez Equity, the Second Circuit offered the following

as an explanation of its holding:

The standard that we have employed in this opinion

attempts to reconcile what we view as our somewhat

inconsistent precedents on loss causation. See, e.g.,

First Nationwide Bank y. Gelt Funding Co., 27 F.3d

=

See, e.g., Weiss v. Wittcoff, 966 F.2d 109 (2d Cir. 1992).

=

> Castellano, 257 F.3d at 175.

aS

® Lentell, 396 F.3d at 173 (emphasis omitted).

” Suez Equity, 250 F.3d at 98 n.1.

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763, 769-70 (2d Cir. 1994) (recognizing

“foreseeability” approach, but relying on “direct

causation” analysis for loss causation); Weiss v.

Wittcoff, 966 F.2d 109, 111 (2d Cir. 1992) (per

curiam) (following “foreseeability” approach); Mfrs.

Hanover Trust Co. v. Drysdale Secs. Corp., 801 F.2d

13, 22 (2d Cir. 1986) (finding loss causation where

“investment quality” of securities was

misrepresented). Were we unconstrained by our own

precedents, we might propose a different standard.

We note that the approach of the Seventh Circuit —

inquiring whether the loss at issue was caused by the

materialization of a risk that was not disclosed because

of the defendant’s fraud — appears to be both

principled and predictable. See Bastian v. Petren Res.

Corp., 892 F.2d 680, 685-86 (7th Cir. 1990); see also

Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d

645, 648 (7th Cir. 1997) (“To plead loss causation,

the plaintiff must allege that it was the very facts about

which the defendant lied which caused its injuries.”).

’ But, we are not writing on a blank slate, and believe

that the approach here articulated best reconciles our

precedents to date.**

Upon closer examination, however, the purportedly

“inconsistent precedents” are more consistent than they might

initially appear to be. That closer examination is warranted in

light of the apparent confusion that reigns with respect to the

element of loss causation. A chronological review may be the

best approach to the required close examination.

® Jd. (quoting the entirety of footnote one of the Suez Equity

opinion).

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In 1986, the Circuit decided Manufacturers Hanover

Trust, in which the court established the “investment quality”

standard for material misrepresentation cases.”? In that case,

the court held that the defendant had misrepresented the risks

associated with an investment in a company whose assets

were extremely unstable. Eventually, the very instability that

defendant had concealed caused the collapse of the company,

resulting in the loss of the investment. Thus the

misrepresentation went to the investment quality of plaintiff's

investment, because plaintiff “would not have contracted with

[defendant] . . . [to invest] had [plaintiff] known of the

misrepresentation . . . particularly given that the [] statements

were in part a response to the financial community’s concern

regarding [defendant’s] stability.”

In 1992, the Circuit decided the Weiss case, in which

defendants persuaded plaintiff to sell them half his company

in return for defendants’ promise to provide necessary

supplies.*' But defendants did not disclose that they had no

9 Manufacturers Hanover Trust, 801 F.2d at 22.

Manufacturers Hanover Trust addressed the question of whether the

district judge had properly instructed a jury, which ultimately

returned an award of $ 17 million, as to the legal standard for

proving — not pleading — loss causation. The Circuit found that

the district court, in its charge on “proximate cause,” had

satisfactorily instructed the jury on loss causation. Despite the

different procedural posture, Suez Equity relied on Maufacturers

Hanover Trust, as well as Weiss and First Nationwide Bank (both

pleading cases), in formulating its pleading standard for loss

Causation.

*

*' See Weiss, 966 F.2d at 110-11.

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intention of keeping their promise but rather intended to take

over plaintiff's business and force the plaintiff out. The court

held that “it was quite foreseeable that the consummation of

defendants’ secret intention not to perform their promises

would cause Weiss to suffer a loss.””

In both Manufacturers Hanover Trust and Weiss, the court

held that loss causation could be pled by alleging that

(1) defendants concealed a foreseeable risk associated with a

securities transaction between plaintiffs and defendants; and

(2) the foreseeable risk occurred causing plaintiffs’ loss. The

difference between the two cases is that one tnvolved an

investor (hence the phrase “investment quality”), and the

other involved an issuer of securities (hence the term

“foreseeability”). But both cases involved a concealment of

negative information which caused the plaintiff's loss when

the concealed information eventually caused the transaction to

fail.

In 1994, the Circuit decided the third loss causation case

cited in Suez Equity, which allegedly established a “direct

causation” requirement.*’ But First Nationwide Bank did no

such thing, for the following reasons. First, it was not a

securities case at all, but a RICO case, involving allegations

that a lender was fraudulently induced to make nonrecourse

42 Jd. at 112.

® See First Nationwide Bank, 27 F.3d at 765-66. Indeed, it is

unclear from the text of First Nationwide Bank and Suez Equity

what a “direct causation” requirement might mean in the context of

securities fraud, where statements made to no investor in particular,

but disseminated to the public, have consistently been found to have

caused investor losses when the statements concealed a risk and the

risk materialized.

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loans for purchases of real estate whose value was materially

misstated. The case addressed “proximate cause” rather than

“loss causation,” which the Lentell court later described as an

“imperfect” analogy.“ Second, the court found that several

factors prevented plaintiffs from pleading proximate cause:

(1) plaintiff offered no valid methodology for calculating the

magnitude of the misrepresentation regarding the value of the

real estate; (2) five years had elapsed between the time of the

misrepresentation and the time of the loss; and (3) a massive

market-wide downturn in real estate prices had occurred

during the interim.* Nonetheless, in articulating its standard,

“ Lentell, 396 F.3d at 173.

“S See First Nationwide Bank, 27 F.3d at 770-72. Indeed, the

Second Circuit decision on which First Nationwide Bank relies for

support of its “direct causation” requirement — Standardbred

Owners Ass'n v. Roosevelt Raceway Assocs., L.P., 985 F.2d 102,

104 (2d Cir. 1993) — refers to the requirement that plaintiff's

injuries be “directly related” to the alleged wrongdoing, not

“directly caused” by it. See Standardbred, 985 F.2d at 104 (“These

opinions emphasize the necessity of proof in a RICO case that the

defendant’s violations were a proximate cause of the plaintiff's

injury, i.e., that there was a direct relationship between the

plaintiff's injury and the defendant’s injurious conduct.”) (emphasis

added). The Supreme Court case on which both Standardbred and

First Nationwide Bank further relied, Holmes v. Securities Investor

Protection Corp, 503 U.S. 258, 117 L. Ed. 2d 532, 112 S. Ct.

1311 (1992), is a case about indirect injury in the context of the

securities laws. Holmes involved a multi-tiered chain of injury in a

securities fraud case, in which plaintiffs alleged that an individual’s

manipulation of securities caused securities prices to crash, thereby

causing injury to two broker-dealers. Those broker-dealers, in turn,

were subsequently unable to fulfill their own obligations to

plaintiffs. Holmes is a classic proximate cause decision in which the

chain of causation is too diffuse to fairly hold a defendant liable for

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First Nationwide Bank offered the following summary of the

law of proximate cause: “in addition to showing that but for

the defendant’s misrepresentations the transaction would not

have come about, the [plaintiff] must show that the

misstatements were the reason the transaction turned out to be

a losing one.”* Although First Nationwide Bank is a RICO

case, addressing “but-for” causation and “proximate cause,”

rather than the securities law concepts of transaction causation

and loss causation, it articulates requirements similar to those

of Weiss and Manufacturers Hanover Trust. A plaintiff must

allege a material misstatement (i.e., concealment of a risk),

and that misstatement must be the cause of the plaintiff's loss

(i.e., the risk must materialize).

Thus, on closer examination, all three cases involve the

concealmrent-of-a risk and the materialization of that risk.

Unfortunately, however, the court in Suez Equity resolved the

conflict in terminology by sticking with the term “investment

quality.” “Plaintiffs may allege . . . loss causation by averring

{} that . . . the defendants’ misrepresentations induced a

disparity between the transaction price and the true investment

quality of the securities at the time of the transaction.”*’

In Emergent Capital, decided only two years later, the

court essentially conceded that the legal standard stated in

Suez Equity was incomplete. “Plaintiff's allegation of a

purchase-time value disparity, standing alone, cannot satisfy

a twice-removed plaintiff's injuries. It does not articulate a standard

of loss causation stricter than the Second Circuit’s traditional

standard.

“© First Nationwide Bank, 27 F.3d at 769 (emphasis added).

? Suez Equity, 250 F.3d at 97-98 (quotation marks omitted).

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the loss causation pleading requirement.” Rather, the

Emergent Capital court noted that the Suez Equity plaintiffs

“specifically asserted a causal connection between the

concealed information — i.e., the executive’s [bad financial]

history [and incompetence] — and the ultimate failure of the

venture.”*? Thus, the Emergent Capital court applied the

earlier standard of concealment of a risk and materialization

of that risk without an explicit acknowledgment.”

Finally, in Lentell, the court paid lip service to Suez

Equity”’ but held that the Second Circuit “require{s] both that

“8 Emergent Capital, 343 F.3d at 198.

ea!

°° Indeed, even if Emergent Capital had explicitly reaffirmed

the standard of Suez Equity, which calls only for a disparity

between price and investment quality at the time of purchase — /.¢.,

artificial inflation — the standard would no longer be valid. In

Dura, 125 §.Ct. at 1630, the Supreme Court overturned the Ninth

Circuit’s permissive standard for pleading loss causation, which

required only that a plaintiff allege that a security’s value was

artificially inflated at the time of purchase.

*! See Lentell, 396 F.3d at 174 (“We follow the holding[]}

of .. . Suez Equity.”); but see id. at 173 (“We acknowledge that

the pleading principles set out in the foregoing passage require both

that the loss be foreseeable and that the loss be caused by the

materialization of the concealed risk; and we further acknowledge

that our opinion in Suez Equity can be mis-read to say that this

Circuit has rejected the ‘materialization of risk’ approach. Suez

Equity does not purport to express this Circuit’s authoritative

position, because that wording: (i) is dicta consigned to a footnote;

(ii) is framed in terms that are tentative and speculative, see [Suez

Equity, 250 F.3d] at 98 n. 1 (‘The standard that we have employed

24a

_the loss be foreseeable and that the loss be caused by the

materialization of the concealed risk.”* It is thus beyond cavil

that Lentell requires more than the bare “proximate cause”

standard asserted by plaintiffs here.”

B. Application to Liu v. CSFB

It is vital to understand the nature of the risks that

plaintiffs in the instant action allege were concealed. There

are two kinds of risk. One risk is that the market could simply

discover that the earnings estimates had been tainted by fraud,

and that confidence in the securities would diminish, causing

their prices to fall. The other risk is more central to plaintiffs’

alleged scheme. Plaintiffs have alleged that defendants’

scheme lowballed earnings estimates, warned the public that

those estimates might be too low, and then reported earnings

that exceeded those estimates. As a result, defendants induced

the public to overvalue the securities. But when the investors

eventually learned that the earnings did not always exceed

expectations, their confidence collapsed, as did the price of

the stock, causing their loss.

in this opinion attempts to reconcile what we view as our somewhat

inconsistent precedents on loss causation.’) (emphasis added); and

(iii) is expressly limited to what was (in 2001) ‘our precedents to

date,’ id. (emphasis added).”) (emphasis and parenthetica!s in

Original).

* Jd. (beginning of second full paragraph; beginning of third

full paragraph) (emphasis in original). Curiously, the exact same

language, including the emphasis, appears twice on the same page

of the Lentell decision.

* 2d Reconsideration Mem. at 3.

25a

1. Disclosure of Falsity

The first type of “concealed risk” at issue here — 1.e.,

that the public might learn that the earnings estimates were

fraudulent when made — could support a claim for securities

fraud if plaintiffs had pled a disclosing event. Lentell teaches,

however, that such a concealment can only cause losses after

it is disclosed:

plaintiffs have argued (affirmatively) on this appeal

that the falsity of Merrill’s recommendations was

made public no earlier than April 2002, when the

NYAG’s affidavit “described the inner workings of

Merrill’s Internet Group,” and that until then plaintiffs

(and presumably the market at large) therefore lacked

knowledge of the fraud. The complaints withstand the

statute of limitations on the strength of that argument.

By the same token, however, Merrill’s concealed

opinions regarding 24/7 Media and Interliant stock

could not have caused a decrease in the value of those

companies before the concealment was made public.”

The reasoning is simple. Where the alleged misstatement

conceals a condition or event which then occurs and causes

the plaintiff's loss, it is the materialization of the undisclosed

condition or event that causes the loss.*° By contrast, where

the alleged misstatement is an intentionally false opinion, the

* Lentell, 396 F.3d at 175 n.4.

*® See, e.g., Suez Equity (concealed incompetence led to

company’s collapse); Castellano, 257 F.3d at 187 (concealed intent

to recapitalize led plaintiff to sell stock in ignorance of the fact that

company would recapitalize thereby vastly increasing stock value).

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market will not respond to the truth until the falsity is

revealed — i.e. a corrective disclosure.

Plaintiffs have not alleged that defendants’ fraudulent

concealment of their true opinions was ever disclosed, and

plaintiffs have made no attempt to tie such a disclosure to

their alleged losses. Under Lentell, plaintiffs’ failure to allege

a corrective disclosure of the falsity of defendants’ opinions

precludes“any claim that such falsity caused their losses.*’

The circumstances of Lentell are strikingly similar to those

alleged in the instant case. In both cases, plaintiffs argued that

the fraud was not disclosed, if ever, until years after their

losses were realized, in successful efforts to withstand

dismissal based on the statute of limitations. Both cases

allege that plaintiffs’ losses were caused when negative

market events (i.e., a downgrading of “buy”

recommendations or a failure to meet earnings forecasts) were

followed by a decline in securities prices. In Lentell, though,

the court held that the fraudulent nature of the analysts’

*° See Lentell, 396 F.3d at 173 (“the misstatement or omission

[involving favorable analyst recommendations] concealed something

from the market that, when disclosed, negatively affected the value

of the security.); In re WorldCom, Inc. Sec. Litig., 2005 U.S. Dist.

LEXIS 2216, 2005 WL 375314, at *6 (“A concealed fact cannot

cause a decrease in the value of a stock before the concealment is

made public.”).

*? See id. at 175 n.4.

** Specifically, the concealment in Lentell was alleged to have

been disclosed when the New York Attorney General's office issued

an affidavit describing the analysts’ behavior. See id. In the instant

case, no such disclosure has been alleged.

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conduct was not revealed until “the inner workings of the

{analyst} Group” were disclosed; the downgrading of “buy”

recommendations did not disclose that the analysts’ reports

had been tainted.” In this case, the gulf between what was

%° Jd. In Lentell, the “inner workings” of the analysts’ group

showed that the analysts ignored warnings that certain companies

_ might fail. However, the analysts never lied about those specific

defects; rather, their alleged fraud was to be unfailingly upeat and

to inflate share prices through repetitive positive reviews of the

securities at issue. See id. at 165-66 (summarizing the alleged

fraud, which involved “bullish research reports,” publication of

“BUY or ACCUMULATE” recommendations, and “profoundly

unrealistic price targets,” issued pursuant to agreements to pump up

share prices and share in the investment banking proceeds). Thus,

what the analysts concealed was that they did not believe in their

own statements, and the effect of their false praise dissipated only

when their alleged fraud came to light. Compare id. with Fogarazzo

v. Lehman Bros et al., No. 03 Civ. 5194 (Order of 2/10/05), in

which I noted that plaintiffs had made the following allegations

regarding concealment of specific investment risks:

On September 7, 1999 . . . Lehman analysts resumed

{Lehman's} 1-Buy rating and evaluated RSL’s break-up

value as exceeding $40 per share. Additionally, [an] analyst

cited RSL’s Delta 3 IPO as “pure upside to our valuation”

of RSL. Documents reveal that RSL . . . in fact, thought

little about Delta 3’s long-term prospects.

Morgan Stanley . . . reiterated its Strong Buy rating and a

$ 38.00 per share price target for RSI, even though . . .

RSL announced [three days earlier] that it had taken a_

massive $32 million restructuring charge. Incredibly, in the

same [] report, Morgan Stanley characterized the $32

million charge to earnings as “a positive for RSL.”

2/10/05 Order in Fogarazzo, No. 03 Civ. 5194, at 3-4.

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alleged to have been the concealed risk and the events that

materialized is even more apparent: what was concealed was

the analysts’ belief that revenue would exceed forecasts, and

what materialized was exactly the opposite. Accordingly,

plaintiffs have never alleged any disclosure of the falsity of

defendants’ opinions.

2. The Market Conditioning Theory

With respect to the other allegedly concealed risk — that

a complicated scheme misled the public as to the true value of

the stock — the loss can only be caused when the true value

of the securities is revealed to the public. This theory depends

on the supposition that the investing public would disregard

the available objective evidence of a company’s performance

(e.g., its past verified earnings statements, its stature in the

marketplace, and its posture in mergers and acquisitions) and

instead overvalue the company by relying on the fraudulently

nurtured belief that the company would continue to exceed

earnings estimates indefinitely.

Lentell acknowledges that “systematically overly

optimistic” analysts’ reports (and, by analogy, the

systematically pessimistic earnings forecasts alleged here),

might sometimes support a claim of securities fraud.

However, “where [] substantial indicia of the risk that

materialized are unambiguously apparent on the face of the

disclosures alleged to conceal the very same risk,” Lentell

imposes a heavy burden on plaintiffs to plead their losses

© Lentell, 396 F.3d at 177.

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specifically.°' As in Lentell, the hundreds of statements that

accompanied defendants’ earnings forecasts warned that

defendants’ estimates were unreliable and could be beaten.

In such cases, “a plaintiff must allege (i) facts sufficient to

support an inference that it was defendant’s fraud — rather

than other salient factors — that proximately caused plaintiff's

loss; or (ii) facts sufficient to apportion the losses between the

disclosed and undisclosed portions of the risk that ultimately

destroyed an investment.”™

Plaintiffs have failed to allege facts sufficient to do either.

Rather, they have alleged that the concealed risks materialized

when one of three “Disclosing Events” occurred: (1) reported

®! Jd. Lentell refers to the fact that the allegedly fraudulent

analysts’ recommendations in that case (i.e, “buy” or

“accumulate”) were invariably accompanied by cautionary language

that the stock prices were volatile. In fact, the securities at issue in

Lentell were rated in the “most risky” possible category on a four-

point scale. Plaintiffs in Lentell alleged that defendants’ analyst

reports concealed the risk of volatility in share prices — i.e., the

chance that the prices could plummet despite earlier “buy”

recommendations. Thus, the “substantial indicia of the risk” were

the warnings that the stock price was volatile, and they appeared

“on the face” of the analyst reports. Put another way, Lentell

establishes a standard for those situations in which allegedly

misleading statements include cautionary language that the

statements might be wrong or misleading. In such cases, plaintiffs

must meet a heavy burden of alleging specific losses that are

connected to the risks that were actually concealed, rather than

those risks that were disclosed by defendants in their cautionary

statements. See id.

® See Exs. D, E to Third Amended Complaint.

Lentell, 396 F.3d at 177.

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revenue failed to meet or exceed earnings forecasts; (2) a

company announced such a shortfall before reporting

revenues; or (3) analysts revised their estimates downward.”

As I noted in my June 8, 2004 Opinion granting plaintiffs’

motion for leave to amend their complaint, “each Disclosing

Event was the unfortunate but commonplace event of a

publicly traded company failing to meet its revenue forecast,

coupled with a concomitant and predictable immediate drop

in share prices.”® Plaintiffs have made no effort to allege

that it was the defendants’ fraud that caused their losses. Nor

have plaintiffs alleged “facts sufficient to apportion the

losses” between that predictable immediate drop in share

prices and any loss that might be attributable to investors

abandoning their belief that earnings would exceed estimates

forever.”

Accordingly, plaintiffs have failed to allege loss causation.

“ Third Amended Complaint { 225.

& In re IPO (“Liu 1”), 341 F. Supp. 2d 328, 350 (S.D.N_Y.

2004).

® Lentell, 396 F.3d at 177.

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V. CONCLUSION

For the foregoing reasons, plaintiffs’ second motion for

reconsideration is denied in its entirety. The Clerk is directed

to close this motion and this case.

SO ORDERED:

/s/

Shira A. Scheindlin

U.S.D.J.

Dated: New York, New York

June 27, 2005