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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 2006

## Text

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
a rr rere ll
pt POPES ee er eee ee Ee ee tii
ee I ore sya a so ee oe ee iv
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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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, )
)

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

9a

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).

10a

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

13a

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”).

14a

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

16a

“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.

18a

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).

19a

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.

20a

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.

21a

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

22a

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).

23a

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.

3la

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386016_1553%3A1. Public record. Not legal advice.