that it was a leader in the area of environmental compliance; that it was committed to the "Shared Values" of "integrity," "fairness," and "social responsibility;" and that its financial condition was positive. Compl. P 2. The Complaint further alleges that plaintiffs relied on these misrepresentations and on the "integrity of the market" when purchasing AES securities, and that "had Plaintiffs and the members of the Class known the truth concerning the misrepresented and omitted facts described herein, they would not have purchased them at the prices that were paid." Compl. P 126.
Defendants are seeking discovery concerning plaintiffs' past securities investments. Specifically, defendants seek to compel plaintiffs to produce all documents reflecting any security owned, held, or sold by or for the account of any plaintiff from January 1, 1988 to 1992,
and to identify any broker or other financial advisor who has knowledge of any of plaintiffs' past securities investments.
Plaintiffs object to these requests as irrelevant, but have offered to produce documents concerning their investments in companies "in the same business" as AES.
Defendants also seek to compel third party WHB, which was identified by certain plaintiffs as an investment advisor, to produce all documents reflecting any security held by plaintiffs from January 1, 1988 to 1992, and any documents reflecting the "nature, objectives or investment criteria" of these accounts.
WHB joins plaintiffs' objections.
Pursuant to Rule 26(b)(1) of the Federal Rules of Civil Procedure, parties may obtain discovery "regarding any matter, not privileged, which is relevant to the subject matter involved in the pending action." Rule 26(b)(1) "has been construed broadly to encompass any matter that bears on, or that reasonably could lead to other matter that could bear on, any issue that is or may be in the case." Oppenheimer Fund, Inc. v. Sanders, 437 U.S. 340, 351, 57 L. Ed. 2d 253, 98 S. Ct. 2380 (1978) (citing Hickman v. Taylor, 329 U.S. 495, 501, 91 L. Ed. 451, 67 S. Ct. 385 (1947)).
Defendants argue that plaintiffs' past investments are indicative of plaintiffs' sophistication, which is relevant to two elements under Section 10(b) and Rule 10b-5: plaintiffs' reliance on the alleged misrepresentations, and the materiality of these misrepresentations. Defendants contend that they need to discover plaintiffs' past securities investments in order to procure evidence that, contrary to the Complaint's allegations, (1) plaintiffs' investment decisions were not in fact induced by AES's statements concerning its "Shared values" and environmental compliance; (2) plaintiffs did not in fact rely on the integrity of the market for the AES securities; and (3) such statements were not material to the average investor.
Plaintiffs argue that while past investments in companies in the same industry as AES may be relevant, all other investments are irrelevant to the instant case. They contend that if defendants want to rebut plaintiffs' alleged reliance, "the simplest way to do so is to ask plaintiffs, at their depositions, what they relied on in making their investments in other companies." Plaintiffs' Memorandum of Law in Opposition at 2.
It is beyond question that reliance is an essential element of a Rule 10b-5 cause of action. Basic, Inc. v. Levinson, 485 U.S. 224, 243, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988). In a class action complaint, plaintiffs may allege that class members directly relied on defendants' misrepresentations, or they may allege that they relied on the integrity of the market, i.e., the "fraud on the market" theory. Id. at 247. The fraud on the market theory is based on the premise that "an investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price." Id. As most public information is reflected in market prices, class members are entitled to a rebuttable presumption of reliance on materially misleading statements.
In the instant case, the Complaint alleges both traditional direct reliance and fraud on the market theory.
We agree with other courts that when direct reliance is alleged in the Complaint, plaintiffs' sophistication is relevant to the merits of these allegations and a defense of non-reliance. E.g., In re Harcourt Brace Jovanovich, Inc. Sec. Litig., 838 F. Supp. 109, 114 (S.D.N.Y. 1993); Forstmann Leff Assoc., Inc. v. American Brands, Inc., 1990 U.S. Dist. LEXIS 7747 at *1 (S.D.N.Y.), aff'd without op., 923 F.2d 845 (2d Cir. 1990); Davidson Pipe Co. v. Laventhol and Horwath, 120 F.R.D. 455, 460 (S.D.N.Y. 1988); Quintel Corp., N.V. v. Citibank, N.A., 596 F. Supp. 797, 801-02 (S.D.N.Y. 1984). That is not to say that a sophisticated investor is precluded from recovering under the securities laws. Rather, as explained in Davidson:
A sophisticated investor is held to a higher duty of inquiry, and so may not claim reliance upon misrepresentations which might dupe only the naive investor. Thus, evidence probative of the degree of sophistication of a plaintiff in a securities case is both admissible at trial. . . and an apt subject for discovery.