The opinion of the court was delivered by: BRIEANT
This class action under Section 10(b) of the Securities Exchange Act of 1934 arises out of the purchase of the common stock of Executive Telecard, Ltd. ("EXTL") by a class of investors that bought EXTL at allegedly inflated prices (the "Class") during the period of October 28, 1991, through October 27, 1994 (the "Class Period"). Plaintiffs in this fraud on the market case allege (1) that the defendants, including EXTL and several of its officers and directors and related entities, misrepresented and/or omitted various material facts regarding EXTL's operations and financial condition throughout the Class Period; and (2) defendants failed to disclose that an incarcerated felon with a history of securities violations, Mr. Richard O. Bertoli, was dispensing corporate advice to the Company through its directors and officers (for convenience, EXTL management's alleged entanglement with Mr. Bertoli is referred to hereinafter as "the Bertoli connection").
Presently before this Court is (1) defendants' motion to exclude the testimony at trial of plaintiffs' damages expert (hereinafter, the "Expert Witness"); (2) defendants' motion for summary judgment, pursuant to Fed. R. Civ. P. 56; and (3) plaintiffs' cross motion for partial summary judgment on the issue of the materiality of the defendants' alleged omission of the Bertoli connection.
The Defendants seek to exclude the testimony of plaintiffs' Expert Witness on the ground that it is insufficiently reliable to be admissible at trial. Defendants also move for summary judgment because in the absence of that expert testimony, plaintiffs would be unable to prove the requisite element of damages--a failure that would be fatal to their claim. Each of these contentions is examined in turn below.
1. The Challenge to Plaintiffs' Expert Witness
Rule 702 of the Federal Rules of Evidence, which governs the admissibility of expert testimony, provides that:
if scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise.
Such factors appear, however, to be applicable only to the "scientific . . . knowledge" testimony covered by Rule 702. Daubert turned on very specific medical and statistical issues in the area of disease causation--namely, a challenge to expert testimony on the question of whether prenatal ingestion of the prescription drug Bendectin was a risk factor for certain human birth defects. 509 U.S. at 579, 113 S. Ct. at 2789-90. Thus, the Daubert Court appears to have limited its specific guidance --i.e., the enumerated factors noted above--to the scientific testimony before it, and not to the "technical, or other specialized knowledge" testimony independently covered by Rule 702. As the Court itself noted "our discussion is limited to the scientific context because that is the nature of the expertise offered here." 509 U.S. at 590 n. 8, 113 S. Ct. at 2795 n. 8; see also United States v. Starzecpyzel, 880 F. Supp. 1027, 1038-41 (S.D.N.Y. 1995) (discussing the reach of the Daubert opinion in detail).
The valuation of damages in a securities class action such as this does not appear to be the sort of "hard science" that requires application of the specific factors set forth by Daubert. We are guided, nonetheless, by the Daubert Court's more general instruction that "the inquiry envisioned by Rule 702 is . . . a flexible one. Its overarching subject is the scientific validity and thus the evidentiary relevance and reliability--of the principles that underlie a proposed submission. The focus, of course, must be solely on principles and methodology, not on the conclusions that they generate." 509 U.S. at 594-95, 113 S. Ct. 2797. In other words, an expert's opinion should at least "have a reliable basis in the knowledge and experience" of the particular "discipline" involved. 509 U.S. at 592, 113 S. Ct. at 2796.
Accordingly, in evaluating the admissibility of plaintiffs' Expert Witness' testimony on Class damages under Rule 702, our focus must be on the reliability of his principles and methodologies.
(i) Plaintiffs' Expert Witness' Original Damages Report
In preparation for this litigation, plaintiffs retained the services of the Expert Witness, an experienced Registered Investment Advisor, Securities Analyst and Registered Representative. In December 1996, pursuant to this Court's order, plaintiffs submitted the Expert Witness' report on the damages incurred by the Class as a result of defendants' alleged fraud (the "Original Report"). See Def. Exh. 13. In that Report, the Expert Witness measured the alleged Class damages by comparing EXTL's actual historical stock price during the Class Period, to what he determined to be the stock's "true value", e.g., the price he determined the stock would have traded at absent the alleged fraud. Id. at PP 9-13. In determining the period by which to measure EXTL's "true value," the Expert Witness used the ten days following the publication of a November 14, 1994 Barron's article, which discussed the facts underlying EXTL's misstatements and omissions, including the class action complaint's allegation that EXTL had been overstating income. See Exh. 25 to the Flynn Affidavit. Using $ 4.43--EXTL's average stock price during that period--as a baseline, the Expert Witness then adjusted EXTL's price to reflect a decline in the Standard & Poor's Long Distance Telephone Index (the "Telecom Index"), an index which includes such major, well financed companies as AT&T, MCI and Cable & Wireless. From there the Expert Witness used a proprietary computerized model--which reflects adjustments for such factors as inflation, float, volume, intra day trading and short interest--to determine that total Class damages were $ 18.5 million.
(ii) The Expert Witness' Supplemental Damages Report
On January 28, 1997, the Expert Witness produced a supplemental damages report (the "Supplemental Report"). See Def. Exh. 15. In the two page narrative of that Report, the Expert Witness noted that after "continued study and analysis," he had "constructed an alternative measure of damages" using the "constant ribbon" method. This time, the Expert Witness compared the average price of EXTL's stock for the 10 days following publication of the November 14, 1994 Barron's article with the average price of EXTL's stock for the 10 days ending on October 21, 1994. While the Supplemental Report provides no explanation as to why that particular date was used to establish a comparative measuring period, it may be presumed that October 21 was chosen because that was the date that Judge Sweet issued his opinion in the EXTL proxy litigation. See Krauth et al. v. Executive Telecard. Ltd., 1994 U.S. Dist. LEXIS 15255 (S.D.N.Y. Oct. 21, 1994) ...