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IN RE THE AES CORP. SECS. LITIG.

UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK


April 22, 1994

IN RE: THE AES CORPORATION SECURITIES LITIGATION; This Document Relates To: All Actions

Conner

The opinion of the court was delivered by: WILLIAM C. CONNER

OPINION AND ORDER

CONNER, D.J.:

 This class action suit is brought by plaintiffs on behalf of all individuals who purchased securities of the AES corporation ("AES") between June 25, 1991, and June 23, 1992, pursuant to two public offerings. The First Consolidated and Amended Class Action Complaint ("Complaint") alleges violations of Sections 11 and 12(2) of the Securities Act of 1933; Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder; and common law fraud against AES, a number of its officers and directors, and the investment banking firms which underwrote the public offerings.

 On June 25, 1993, this Court granted in part and denied in part defendants' motion to dismiss. That opinion details the alleged facts in this case, familiarity with which is presumed.

 The case is presently before the Court on defendants' motion to compel certain documents and responses to interrogatories from members of the plaintiff class and third party WHB/Wolverine Asset Management ("WHB"). For reasons stated below, defendants' motion is granted.

 BACKGROUND

 The relevant facts for purposes of the instant motion are as follows. AES is a corporation which constructs and operates co-generation power facilities. The Complaint alleges that in order to raise funds from investors through two public offerings, AES misrepresented 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, *fn1" and to identify any broker or other financial advisor who has knowledge of any of plaintiffs' past securities investments. *fn2" 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. *fn3" WHB joins plaintiffs' objections.

 DISCUSSION

 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. *fn4"

 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. *fn5" Id.

 In the instant case, the Complaint alleges both traditional direct reliance and fraud on the market theory. *fn6"

 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.

 120 F.R.D. at 460 (citations omitted); see also Quintel, 596 F. Supp. at 801-02 ("Sophisticated investors are entitled to the protection of Section 10(b) . . . . However, [sophistication] is relevant to the adequacy of disclosure . . . and the extent of [the investor's] reliance . . . ." ). Because the discovery of prior investments is reasonably calculated to lead to evidence concerning plaintiffs sophistication in the marketplace, such documents are discoverable. *fn7"

 Plaintiffs suggest that this line of authority is inapplicable to a class action, because class members are entitled to a presumption of reliance under the fraud on the market theory. At least two courts disagree with this argument, explaining that the presumption of reliance is rebuttable. Harcourt, 838 F. Supp. at 114 ("It is axiomatic under Basic that non-reliance on the integrity of the market is critical in rebutting the presumption of reliance in a fraud on the market case."); Feldman v. Motorola, Inc., 1992 U.S. Dist. LEXIS 8157 at *2-3 (N.D.Ill. 1992) (when securities fraud class action complaint alleges fraud on the market, "this court agrees with defendants that the brokerage statements are relevant to the merits of plaintiffs' federal securities law claim"). We need not reach this issue because in the instant case plaintiffs allege both fraud on the market and traditional direct reliance. Thus defendants must rebut not only the presumption of reliance, but the direct allegations as well, to which we find sophistication relevant.

 Plaintiffs cite a line of cases for the proposition that "individual questions of reliance are not appropriate in determining whether class action is proper, and thus are not sufficient to defeat class certification." Plaintiffs' Memorandum of Law in Opposition at 4 (citing In re Boardwalk Marketplace Sec. Litig., 122 F.R.D. 4, 7 (D. Conn. 1988); Kamerman v. Ockap Corp., 112 F.R.D. 195, 198 (S.D.N.Y. 1986); Dura-Bilt Corp. v. Chase Manhattan Corp., 89 F.R.D. 87, 98 (S.D.N.Y. 1981); Green v. Wolf Corp., 406 F.2d 291, 301 (2d Cir. 1968), cert. denied, 395 U.S. 977, 23 L. Ed. 2d 766, 89 S. Ct. 2131 (1969)). First, it is not at all clear that sophistication is never relevant for purposes of class certification. *fn8" But even assuming this to be true, our holding today is not to the contrary. The cases cited by plaintiffs involved whether sophistication was relevant for purposes of defeating class certification. By contrast, the issue in the instant case is whether sophistication is relevant to rebutting plaintiffs' claim of reliance at trial. See Feldman, 1992 U.S. Dist. LEXIS 8157 at *3 (brokerage statements of class members are relevant to defense of non-reliance; whether they are relevant for class certification is separate issue). Our holding today that sophistication is relevant for merits discovery has no bearing on whether sophistication is sufficient to defeat certification of the instant class.

 CONCLUSION

 For the foregoing reasons, defendants' motion to compel is granted. Plaintiffs are ordered to produce the documents requested for the years 1988 to 1992 within 30 days of this opinion.

 SO ORDERED.

 Dated: April 22, 1994

 New York, New York

 William C. Conner

 United States District Judge


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