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IN RE INITIAL PUBLIC OFFERING SECURITIES

February 19, 2003

IN RE INITIAL PUBLIC OFFERING SECURITIES LITIGATION THIS DOCUMENT RELATES TO ALL CASES


The opinion of the court was delivered by: Shira A. Scheindlin, United States District Judge

                OPINION AND ORDER

INTRODUCTORY MATERIAL

These cases allege a vast scheme to defraud the investing public. The scheme — characterized by Tie-in Agreements, Undisclosed Compensation, and analyst conflicts, and concealed by misrepresentations and omissions — was aimed at fraudulently driving up the price of stock in hundreds of companies in the immediate aftermarket of their initial public offerings ("IPOs"). Plaintiffs allege that investment banks routinely required substantial investors to participate in the scheme in order to receive allotments of these valuable IPOs.

The companies going public and their officers profited handsomely by taking advantage of the inflated value of the stock to raise capital, enter into mergers and acquisitions, or sell their individual holdings at enormous gains. The investment banks profited by receiving kickbacks from the investors who received the IPO allocations. To hide the scheme from the investing public, the investment banks, companies, and officers violated the securities laws by making misleading statements in offering documents and by manipulating the market. Thousands of ordinary investors, who are Plaintiffs in these cases, allege that the value of their holdings plummeted as a result of this unlawful conduct.

I. INTRODUCTION

From January 1998 to December 2000, over 460 high technology and Internet-related companies raised capital by selling ownership of their company to the public.*fn1 Prior to going public, each company hired a group of investment banks to underwrite their IPO. Some, but not all, of the Underwriters allocated the IPO stock for distribution to initial purchasers ("Allocating Underwriters"). On the day of the IPO, the Allocating Underwriters sold the stock directly to those customers, usually institutional investors. The price of the stock was predetermined and set forth in a registration statement filed with the Securities and Exchange Commission ("SEC"). In general, the Underwriters received 7% of the gross proceeds (or some other fixed amount) as compensation for their services, and the Issuer received the remaining capital. See MDCM Holdings, Inc. v. Credit Suisse First Boston Corp., 216 F. Supp.2d 251, 253 (S.D.N.Y. 2002). After the offering, those who purchased on the IPO could profit by selling their stock in the aftermarket, i.e., on a stock exchange such as the Nasdaq. Indeed, from 1998 to 2000, customers who bought IPO stock often made large profits as the price of the stock dramatically surged in the aftermarket.*fn2

Plaintiffs who bought stock in the aftermarket for 309 of these high-technology and Internet-related stocks allege that the Allocating Underwriters required their customers to enter into agreements to buy additional shares of the Issuer in the aftermarket as a condition of receiving the right to purchase the IPO stock. In some instances, these customers were also required to make those purchases at predetermined escalating prices. As a result of these "Tie-in Agreements," the Allocating Underwriters created an artificial demand for the company's stock and caused the price of the stock to rise. In addition, the Underwriters used this scheme to enrich themselves by requiring customers to pay them a portion of the profits they made by selling the IPO shares in the aftermarket.

Spurred by newspaper and government investigations into the IPO allocation practices of various investment banks,*fn3 Plaintiffs filed over 1,000 Complaints in this district from January 11 to December 6, 2001, each alleging that the Underwriters perpetrated this scheme in connection with 309 IPOs. See Makaron v. VA Linux Sys., Inc., No. 01 Civ. 242 (first action filed January 11, 2001); Genduso v. Internap Network Servs. Corp., No. 01 Civ. 11247 (last action filed December 6, 2001).*fn4 Plaintiffs are suing three groups of defendants in each IPO case: the Underwriters of the IPO, the company that issued the stock ("Issuer" or "Issuer Defendant"), and the company's officers ("Individual Officers" or "Individual Defendants"). In total, Plaintiffs are suing fifty-five Underwriters, 309 Issuers, and thousands of Individual Defendants.*fn5

In an effort to coordinate the lawsuits and avoid taxing the limited judicial resources of this district, the Assignment Committee of the Southern District of New York directed that all of the actions be transferred to this Court for "coordination and decision of pretrial motions, discovery and related matters other than trial." Order, In re Initial Public Offering Sec. Litig., 21 M.C. 92 (Aug. 9, 2001). This Court subsequently consolidated the lawsuits by Issuer (e.g., In re Cacheflow Securities Litigation), thereby resulting in 309 consolidated cases that are being coordinated in the above-captioned litigation.*fn6

The Underwriters, Issuers, and Individual Defendants now move to dismiss these actions in their entirety.*fn7 In broad terms, the Defendants put forward two grounds for dismissal.

First, they argue that each of the 309 Complaints fails to comply with the pleading requirements of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Second, they contend that even if the allegations are properly pled and assumed to be true, the Complaints must be dismissed for "failure to state a claim upon which relief can be granted." Fed.R.Civ.P. 12(b)(6). For the reasons that follow, these motions are granted in part and denied in part.

II. SYNOPSIS OF HOLDINGS

It is axiomatic that when deciding a motion to dismiss, a court must accept as true the factual allegations of a complaint. Indeed, the court must draw every reasonable inference from those factual allegations in favor of the party bringing suit. It is against this backdrop that the many rulings contained in this Opinion must be understood.

The general requirements for pleading a complaint are found in the Federal Rules of Civil Procedure unless a specific statute sets forth a different pleading standard. Rule 8 requires, only a "short and plain statement of the claim showing that the pleader is entitled to relief." When pleading fraud, under Rule 9, however, "the circumstances constituting fraud . . . [must] be stated with particularity."

In addition, in the field of securities law, the PSLRA imposes a heightened pleading standard with respect to some causes of action by adding two more requirements. First, when pleading that a defendant has made a material misstatement or omission on which the investing public relies, the complaint must specify each statement alleged to have been misleading, the reason the statement is misleading, and, if the misstatement is alleged on information and belief, the facts on which that belief is formed. Second, when a securities fraud claim requires that a defendant act with fraudulent intent, the complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."

Taking the facts of the Complaints as true, the causes of action as pled, and drawing every inference in Plaintiffs' favor, Plaintiffs have alleged one coherent scheme to defraud, the entire purpose of which was to artificially drive up the price of the securities. This scheme offends the very purpose of the securities laws, namely "to provide investors with full disclosure of material information concerning public offerings of securities in commerce, to protect investors against fraud and, through the imposition of specified civil liabilities, to promote ethical standards of honesty and fair dealing."*fn8 Where insiders conspire to frustrate the efficient function of securities markets by exploiting their position of privilege, they have perpetrated a double fraud: they have manipulated the market, and they have covered up that manipulation with lies and omissions. When investors have been injured by these frauds, those insiders may be liable under the securities laws.

Plaintiffs bring six claims against various Defendants. All Defendants are alleged to have made false statements in the registration statement and prospectus related to a particular IPO, in violation of Section 11 of the Securities Act of 1933 (First Claim). The Individual Defendants are alleged to have controlled the Issuers who made those false statement in violation of Section 15 of the 1933 Act (Second Claim). All Defendants are alleged to have made false statements in the registration statement and prospectus with the intent to deceive the investing public, in violation of Section 10(b) of the Exchange Act of 1934 (Third and Fourth Claims). The Allocating Underwriters are also alleged to have engaged in a scheme to manipulate the securities markets in violation of Section 10(b) of the 1934 Act (Fifth Claim). Lastly, the Individual Defendants are alleged to have controlled the Issuers who violated Section 10(b) of the 1934 Act, in violation of Section 20 of that Act (Sixth Claim).

Because these cases are of great importance to the public, and because this Opinion is lengthy and highly technical, a synopsis of its holdings is warranted. The following constitutes, in summary form, the rulings of the Court.

Section 11 Claims

Section 11 was designed to hold those who prepare registration statements in connection with IPOs — such as the Underwriters, Issuers, and Individual Defendants here — to a stringent standard of liability for any material misrepresentations contained in those statements, although certain Defendants may raise their due diligence as an affirmative defense at trial. Pleading under Section 11 is governed solely by Rule 8 because fraud is not an element of a Section 11 claim. Plaintiffs have sufficiently pled, under the standard of Rule 8, that all those who signed the registration statement or prospectus violated Section 11 because those documents failed to disclose the fraudulent scheme — specifically, the Tie-in Agreements and the Undisclosed Compensation. Moreover, on the secondary offerings, the registration documents also failed to disclose that the analyst reports were prepared by analysts employed by the Underwriters, who consistently issued recommendations tainted by undisclosed conflicts of interest. However, those Plaintiffs who sold their shares above the offering price have no damages as a matter of law, and their claims must be dismissed.

Section 15 Claims

Section 15 was designed to hold a defendant jointly liable if it controlled a person or entity who violated Section 11. Pleading a Section 15 claim is also governed by Rule 8, and thus only requires an allegation that the defendant controlled a person or entity that violated Section 11. Here, the Individual Defendants are alleged to have controlled the Issuers who violated Section 11. While the Individual Defendants may raise lack of knowledge as an affirmative defense at trial, Plaintiffs need not plead that the Section 15 Defendants acted with the intent to defraud. Thus, the Section 15 claims are dismissed only in those cases where the Section 11 claims have been dismissed for lack of damages.

Section 10(b) Claims for Material Misstatements and Omissions

Plaintiffs have successfully pled that all of the Underwriters (both Allocating and Non-Allocating) made material misstatements and omissions, which they had a duty to disclose, with the intent to defraud the investing public. Plaintiffs have also alleged, with the required particularity, that they purchased stock based on their falsely inflated market price, and that the misrepresentations caused a significant disparity between the price of the securities and their real value, resulting in significant financial damages.

Nonetheless, Plaintiffs have failed to plead that some of the Issuers and Individual Defendants acted with the required intent to defraud. Specifically, when an Issuer exploited the inflated value of the company to engage in a merger or acquisition, or to raise even more money through further stock offerings, the intent requirement has been satisfied. Likewise, when an Individual Defendant sold large amounts of her shares at a significant profit relatively close in time to the IPO, the requisite intent has been demonstrated. In all other instances, the pleading of intent to defraud is inadequate and therefore the claims against those Issuers and Individual Defendants must be dismissed.

Section 10(b) Claim for Market Manipulation

In addition to punishing material misstatements and omissions, Section 10(b) was designed to prohibit any intentional conduct that deceives or defrauds investors by controlling or artificially affecting the price of securities. Such claims are typically described as "market manipulation" claims. Plaintiffs' pleading obligations for the market manipulation claims are identical to those for the material misstatements claims except, because there are no alleged misstatements, the PSLRA only governs the pleading of intent to defraud. Thus, Plaintiffs must plead with particularity the manipulative scheme itself, the intent to defraud the investing public, reliance on the integrity of the market (i.e., that they believed it was not manipulated) and resulting damages.

Plaintiffs have succeeded in pleading a market manipulation claim against the Allocating Underwriter Defendants. They have alleged that these Defendants acted with the requisite intent because they required their customers to engage in Tie-in Agreements and to pay Undisclosed Compensation in order to receive an initial allocation of stock. Subsequent purchases, at escalating prices, falsely inflated the price of the shares. This very conduct evinces a strong inference that Defendants intended to defraud the investing public. Plaintiffs also have alleged that these Defendants engaged in deceptive or manipulative conduct because Defendants' conduct was "designed to deceive or defraud investors by controlling or artificially affecting the price of securities."*fn9 Finally, Plaintiffs have alleged the remaining elements of these claims with the required specificity.

Section 20 Claims

Section 20 was designed to hold a defendant jointly liable if it controlled a person or entity who violated Section 10(b). The pleading of a Section 20 claim is governed solely by Rule 8, because such claims do not necessarily require proof of scienter, nor is fraud an essential element of such claims. Thus a plaintiff must allege only that a defendant controlled a person or entity who violated Section 10(b). At trial, a plaintiff must also show that the defendant was a "culpable participant" in the underlying fraud — i.e., took some action (or inaction) that furthered the underlying fraud. A defendant may then offer proof that the culpable participation was done in good faith. Because Plaintiffs have adequately alleged control, the Section 20 claims survive against those Individual Defendants who controlled Issuers liable under Section 10(b), and are dismissed only against those Individual Defendants who controlled an Issuer as to whom the Section 10(b) claims have been dismissed.

In sum, Plaintiffs have pled a coherent scheme by Underwriters, Issuers, and their officers to defraud the investing public. As such, these lawsuits may proceed.

III. SECURITIES LAW, HOT ISSUES MARKETS, AND TIE-IN AGREEMENTS

A. General Background of the Securities Act and Exchange Act

In the aftermath of the bull market of the 1920s, the 1929 stock market crash, and the subsequent Great Depression, Congress held extensive hearings to investigate the practices underlying securities trading. See generally Legislative History of the Securities Act of 1933 and Securities Exchange Act of 1934 (J. S. Ellenberger & Ellen P. Mahar eds. 1973). During these investigations, Congress repeatedly discovered instances of market manipulation and deception, which it concluded had contributed to the market's collapse. For example, Professor Steve Thel has written:

Before [President] Roosevelt was even inaugurated, [Chief Counsel of the Senate Banking and Currency Committee Ferdinand] Pecora revealed fabulous excesses in investment, commercial banking, and the financing of public utilities. Among other things, he showed that in the years before the crash, some respected bankers had controlled the market price of securities in which they held an interest by effecting huge purchases or sales as the situation required. Instances of such manipulative trading were uncovered repeatedly throughout the course of the hearings.

Steve Thel, The Original Conception of Section 10(b) of the Securities Exchange Act, 42 Stan. L. Rev. 385, 412 (1990) (footnotes omitted). Likewise, a 1934 Act Senate Committee report explained, albeit in more muted tones, how the market was manipulated:

Several devices are employed for the purpose of artificially raising or depressing security prices. . . . Among such practices are fictitious "wash" sales; "matched" orders, or orders for the purchase and sale of the same security emanating from a common source for the purpose of recording operations on the tape and thereby creating a false appearance of activity; and other transactions specifically designed to manipulate the price of a security.

In order to protect the integrity of the market and combat such practices, Congress enacted the Securities Act of 1933 ("Securities Act")*fn10 and the Securities Exchange Act of 1934 ("Exchange Act").*fn11 In general, the Securities Act regulates the initial offering of securities, see Gustafson v. Alloyd Co., 513 U.S. 561, 571-72 (1995), while the Exchange Act regulates post-distribution purchases and trading, see Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 171 (1994).*fn12

The Securities Act "was designed to provide investors with full disclosure of material information concerning public offerings of securities in commerce, to protect investors against fraud and, through the imposition of specified civil liabilities, to promote ethical standards of honesty and fair dealing." Ernst & Ernst, 425 U.S. at 195 (citing H.R. Rep. No. 73-85, at 1-5). The Exchange Act "was intended principally to protect investors against manipulation of stock prices through regulation of transactions upon securities exchanges and in over-the-counter markets, and to impose regular reporting requirements on companies whose stock is listed on national securities exchanges." Id. (citing 1934 Senate Report at 1-5). "A fundamental purpose, common to these statutes, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry."*fn13 SEC v. Capital Gains Research Bureau, 375 U.S. 180, 186 (1963) (footnote omitted). See also SEC v. Zandford, 122 S.Ct. 1899, 1903 (2002) (same). Every IPO at issue here is governed by the regulatory framework created by these Acts.

B. Hot Issues Markets, Market Manipulation, and Tie-in Agreements

When a company goes public, the initial offering price (the price paid by the first customer) is established by the company and underwriters. Once issued, the stock price is determined by the market. For at least five decades, studies have shown that IPOs generally trade on the open market at a price significantly higher than the offering price, a phenomenon known as underpricing. For example, a stock might have an initial offering price of $18 and rise to a closing market price of $20 on its first day. Such stock is underpriced by $2 (or U.S.C. § 78r (liability for misleading statements in certain periodic reports filed with the SEC); Section 20, 15 approximately 11%).*fn14 "For a long time, the standard underpricing seemed to be between five and twenty percent." Robert Prentice, Whither Securities Regulation? Some Behavioral Observations Regarding Proposals For Its Future, 51 Duke L.J. 1397, 1446 n. 230 (2002) (citation omitted).

From the perspective of the initial purchasers, the underpricing of IPO stock is wonderful because they can make a substantial profit on their investment by selling their stock in the aftermarket. The increased sales activity — and the higher stock price — are also attractive to the issuer, who benefits from the false impression that the company is so highly valued.

The issuer then exploits that impression by using its stock as currency to make acquisitions, or by raising more capital through a higher-priced secondary offering. The underpricing itself is not all good for the issuer — in one sense there was "money left on the table" because the issuer lost out on the difference between the offering price and the first day's closing market price. MDCM Holdings, 216 F. Supp.2d at 254. But the increased aftermarket trading that may attend underpriced issues is likely to make the whole process a winning proposition for the issuer.

When the price of an IPO stock rises quickly in the market, it is often referred to as a "hot issue." In turn, so-called "hot issues markets" are typically characterized by severe underpricing. See, e.g., Jay R. Ritter, The `Hot Issue' Market of 1980, 57 J. Bus. 215 (1984). Over the past four decades, there have been four such markets. The first three occurred from 1959-1962, 1967-1971, and 1979-1983,*fn15 while the most recent hot issues market lasted from 1998-2000 — the time period at the heart of this litigation. Not surprisingly, conduct of the sort alleged in these cases came to the attention of regulators in each of these hot issues markets.

1. Hot Issues Market of 1959-1962

"From 1959 until the market decline of early 1962, the distribution of securities by companies that had not made a previous public offering reached the highest level in history."*fn16 SEC Special Study at 487; see also id. at 514. "The public eagerly sought stocks of companies in certain `glamour' industries, especially the electronics industry, in the expectation that they would quickly rise to a substantial premium — an expectation that was often fulfilled." Id. at 487. "It was not uncommon for underwriters to receive, prior to the effective date, public `indications of interest' for five times the number of shares available." Id. at 515. "Within a few days or even hours after the initial distribution, these so-called `hot issues' would be traded at premiums of as much as 300 percent above the original offering price." Id. at 487. "In many cases, the price of a `hot' issue later fell to a fraction of its original offering price." Id.

In the midst of this "climate of general optimism and speculative interest," id., the SEC "addressed reports that certain dealers participating in distributions of new issues had been making allotments to their customers only if such customers agreed to make some comparable purchase in the open market after the issue was initially sold." SEC Legal Bulletin (describing Exchange Act, Release No. 6536). In response to these reports, the SEC issued the following interpretive release:

The attention of the Securities and Exchange Commission has been directed to recently published articles in business magazines and the public press which indicate that certain dealers participating in distributions of new issues have been making allotments to their customers only if such customers agree to make some comparable purchase in the open market after the issue is initially sold. The Commission wishes to call the attention of dealers to the fact that generally speaking any such arrangement involves a violation of the anti-manipulative provisions of the Securities Exchange Act, particularly Rule 10b-6 thereunder, and may involve violation of other provisions of the federal securities laws. Should evidence of such practice by individual firms be developed, the Commission will take appropriate action.

Securities Act, Release No. 4358/Exchange Act, Release No. 6536 (Apr. 24, 1961), available at 1961 WL 61584.*fn17

In 1963, the SEC transmitted to Congress the "Report of Special Study of Securities Markets of the Securities and Exchange Commission." See supra note 15. It "was the most extensive examination of the securities markets since the 1930s" and included "a thorough analysis of new issues" in response to the bull market of the previous three years. SEC Hot Issues Report at 5. "The intensive and extensive examination made by the special study reveals a picture . . . of a general climate of speculation which may rank with excesses of previous eras." SEC Special Study at 553. "More than any single activity or incident, it is this climate of speculative fervor which provides a key to the new-issue phenomenon." Id.

"The Special Study brought into sharp focus, for the first time, the role of the underwriter in the new issues markets." SEC Hot Issues Report at 6. "The underwriter played an important role in the new-issue phenomenon not only by originating and distributing stock in companies going public but also, in many cases, by encouraging the speculative climate." SEC Special Study at 553. "Many of the problems targeted by the Special Study related to underwriting practices, distribution and aftermarket trading." SEC Hot Issues Report at 6. For example, some firms "under pressure from customers and salesmen hungry for new issues, lowered their standards of quality and size of issuers whose securities they would underwrite."*fn18 SEC Special Study at 553-54.

"In the pricing of new issues, underwriters could not help but be influenced by the knowledge that the prices of many issues would subsequently rise in the immediate after-market to prices hardly justified by traditional standards of value." Id. at 554. The Special Study identified a number of problems and abuses that resulted from this knowledge. For example, some underwriters "set low offering prices in the expectation of withholding substantial portions of the issue in accounts of insiders to be sold out to the public." Id. Likewise, "[s]ome underwriters found opportunities with the strong public demand for new issues to obtain very high amounts of compensation from small speculative companies." Id.

"The Special Study also found that certain techniques employed by broker-dealers exacerbated the `hotness' of an issue, often creating immediate and substantial premiums over the initial offering price." SEC Hot Issues Report at 8. Among other manipulative techniques,*fn19 the study found that "solicitation of aftermarket purchases was common and might be actively engaged in by one or more of the major distributors." SEC Special Study at 556. "To add to the aftermarket excitement, some managing underwriters arranged for solicitation of customers at premium prices through nonparticipating firms." Id. "Demand for new issues was further stimulated in some cases by market letters, advisory recommendations, articles in the financial press and other planned publicity, usually optimistic in tone."*fn20 Id.

2. Hot Issues Market of 1967-1971

"In 1967-1971, the new issues markets experienced a resurgence," SEC Hot Issues Report at 11, this time with issues in fast food business and "space age" technology. As former SEC Chairman Arthur Levitt has recalled:

It was in the midst of the so-called "go-go years." I remember walking the halls sensing a feeling among us of unlimited potential and boundless opportunity. Our markets were experiencing an enormous volume surge, growing institutionalization and quite rampant speculation. It was big news I recall that Kentucky Fried Chicken was selling at close to 100 times earnings.

Arthur Levitt, Remarks before the 2000 Annual Meeting of the Securities Industry Association (Nov. 9, 2000).

"In response [to this market], the Commission and the NASD [National Association of Securities Dealers] created a joint task force in mid-1972 to combat the problems caused by hot issues." SEC Hot Issues Report at 11. "Teams of Commission and NASD personnel conducted intensive examinations and investigations of certain broker-dealers." Id. The SEC also "began public, fact-finding hearings on the hot issues experience." Id. (citing SEC File No. 4-148). These investigations uncovered a "considerable number" of violations of the securities laws that resulted in various enforcement actions by the SEC and NASD. Id.

Indeed, the trading abuses of the hot issues market also received scrutiny from the New York State Attorney General who requested that his office study the problems associated with the hot issues market of the late 1960s. See David Clurman, Controlling a Hot Issue Market, 56 Cornell L. Rev. 74 (1970) (discussing study made at the request of Attorney General Louis J. Lefkowitz). The Attorney General's study concluded that "a pattern emerged whereby substantial sums of money went into new and highly speculative ventures." Id. at 82.

The atmosphere became one of pure gambling, and in the process it was not too difficult to rig the game. The big winners were underwriters, insiders of the issuing companies, and those with contacts in these groups. The losers were those investors who purchased at inflated prices and the economy itself.

Id.

"The basic device used to further overheat the market was stimulating demand while simultaneously reducing supply." Id. at 76. "Brokers increased demand," for example, "by frequently emphasizing to their customers the difficulty of obtaining shares." Id. "Salesmen regularly predicted that the after-market prices would be higher than the original or current prices." Id.

"Cruder techniques [to stimulate demand] included brokers informing customers that if they did not make additional purchases in the after-market they would be cut off from further new issues." Id. "In addition, a steady flow of `tips' was fed into the market, and purchasers often stated that this type of information had stimulated their interest in a particular security." Id. at 76-77. The study also "uncovered instances where intra-office brokerage memoranda were inconsistent with offering literature." Id. at 77. In sum, "[c]ompany insiders and investment bankers took full advantage of the opportunities presented to them by the generally heated situation — a situation that was partially of their own creation." Id. at 78.

In response, the SEC "proposed a number of amendments to its rules to curb the excesses of hot issues." SEC Hot Issues Report at 12.*fn21 In particular, the SEC proposed adopting Rule 10b-20 after having received "indications that broker-dealers involved in distributing shares may be imposing requirements involving consideration in addition to the announced price of the shares."*fn22 Certain Short Selling of Securities and Securities Offerings, Exchange Act Release No. 10636, 39 Fed. Reg. 7806 (February 11, 1974). As the SEC explained:

Proposed Rule 10b-20 makes explicit the duty placed on broker-dealers (and others) to refrain from explicitly or implicitly demanding from their customers any payment or consideration in addition to the announced offering price of any securities. The Commission has received indications that in some offerings for which public demand is inadequate the purchase of such offerings['] shares may be tied to certain inducements, such as the opportunity to purchase sought after "hot" issue shares, for which demand exceeds supply. In response to these inducements, a number of persons may have been encouraged to participate in the distribution of shares for which sufficient public demand does not exist by purchasing them solely with a view to their immediate resale and merely to accommodate those marketing the offerings. The demand for offering shares crea[t]ed by the activities of these participants in the distribution process may obfuscate realistic assessments by underwriters who do not induce such participation and by investors and potential investors of the valid demand for such offerings and may artificially affect the offering price for such shares. Further, rewarding these participants with "hot" issue shares may artificially stimulate high public demand for such shares in that the prior commitment made to such participants, which unjustifiably deprives many members of the public of the opportunity to purchase such "hot" issue shares at their original offering price, relegates such persons denied shares in the offerings to making purchases in the after market.

Id. (emphasis added).

Rule 10b-20 was eventually withdrawn in 1988. See Exchange Act Release No. 26182 (Oct. 14, 1988), available at 1988 WL 999999. The SEC explained:

Id. (citing SEC Hot Issues Report at Section IV.A.3). See also SEC Hot Issues Report at Section V (entitled "Current Regulatory Authority").

3. Hot Issues Market of 1979-1983

From 1979 to 1983, another hot issues market arose. This time the companies going public were from Denver, Salt Lake City and the New York area. See SEC Hot Issues Report at 15-23. "Fad and high-technology business lines were well-represented, including robotic manufacturing, medical products, computers, video materials and entertainment."*fn23 Id. at 22-23. Once again, the SEC and NASD launched a number of investigations into broker-dealers and their underwriting practices in response to reports of abuses in the allocation process. See id. at 15-23.

The SEC provided a comprehensive review of this market when it issued its 1984 Hot Issues Report describing "the abuses identified by the Commission's regulatory and enforcement efforts" and "set[ting] forth the Commission's relevant statutory and rulemaking authority, concluding that this authority is broad enough to cover abuses that have been identified during hot issues markets." Id. at 3-4. The Report found that "selling abuses" were the most common form of misconduct. Id. at 28. "Generally, the abuses found in a hot issues market involve either artificial restrictions on supply or attempts to stimulate demand that facilitate a rapid rise in the price of a security." Id. at 29. The Commission uncovered a wide range of fraudulent activities including schemes founded upon market manipulation and domination, free-riding and withholding of stocks to shorten supply. See id. at 29-30.

"A few cases involve `tie-in' arrangements by which underwriters of hot issues require customers, as a condition of participation in a hot issue offering, either (1) to agree to purchase additional shares of the same issue at a later time and at an increased price, or (2) to participate in another hot issue offering." Id. at 37. "This practice stimulates demand for a hot issue in the aftermarket, thereby facilitating the process by which stock prices rise to a premium." Id. at 37-38. Indeed, the report highlights an example of one underwriter who was alleged to have caused the price of an IPO stock priced at $1 to rise to over $4 within a few hours of its offering. See id. at 38-39 (discussing case 13 attached to the report). The broker-dealer achieved this by (1) requiring customers to place aftermarket purchase orders for the IPO stock at substantial premiums above the offering price and (2) instructing salespersons to advise customers that the company had good financial prospects when it did not.*fn24 See id.

4. Hot Issues Market of 1998-2000

Few people may remember the glamour industries of the 1960s, the 1970s "go-go years," or the fact that Denver and Salt Lake City were at the epicenter of the 1980s IPO market. But the Internet and high-tech boom of the 1990s, "irrational exuberance," and Silicon Valley are not far removed from current events. Indeed, in recent years the rise and fall of these companies has been the subject of numerous articles, many books,*fn25 several documentaries (real and fictional),*fn26 and at least one off-Broadway play.*fn27 Two observations concerning this market bear special mention.

The first is that the underpricing of the IPOs of the late 1990s was severe when measured against any other time period. While IPOs have been historically underpriced by five to twenty percent, IPOs in the 1990s frequently surged to 100%-200% of the offering price on the first day of trading. See Jay Ritter, Big Runups of 1975-2000 (August 2001) (listing IPO stock that doubled in price on the first day of trading since 1975) available at http://bear.cba.ufl.edu/ritter/runup750.pdf. "In 1999," for example, "117 IPOs doubled on their first day. This compares with 39 during the previous 24 years combined." Id. In fact, the ten largest first-day increases in IPO stock since 1975 all took place from November 1998 to December 1999.

Indeed, the IPO market of 1998-2000 was more extraordinary than the previous three hot issues markets. The other hot issues markets that had unusual first day increases were often accompanied by a below average number of companies going public. For example, in February of 1980, the average first day increase for IPOs was 119%; in February of 2000, the average first day increase was 116%. These two averages are the first and second highest increases of the last three decades. But what makes the latter far more impressive is that only eight companies went public in February 1980, a number far below the historical average of twenty-nine companies that go public per month.*fn28 In stark contrast, fifty-five companies issued stock in February 2000. Likewise, taking into account the number of months that witnessed extraordinary first day increases, the IPO market of the 1990s substantially surpassed each of the previous hot issues markets. The table below sets forth the top fifteen months in terms of average first day increases since 1960, a majority of which occurred in the most recent hot issues market:

First Day Increase Month/Year Number of IPOs
119.1 Feb. 1980 8
116.2 Feb. 2000 55
114.6 Dec. 1999 40
103.8 Dec. 1967 11
99.5 Jan. 1999 12
97.9 Nov. 1999 54
96 May 1968 28
90.7 Apr. 1977 5
87.5 Mar. 1999 21
86.5 Jan. 2000 15
85 Mar. 2000 53
82.2 Sep. 1998 3
80 May 1978 2
77.1 Oct. 1999 56
76.8 Sep. 1999 40

The second point is that at the end of 2000, the SEC and various newspapers began to report on abuses in the IPO allocations. In August 2000, the SEC's Division of Market Regulation issued a legal bulletin stating that it had "become aware of complaints that, while participating in a distribution of securities, underwriters and broker-dealers have solicited their customers to make additional purchases of the offered security after trading in the security begins." SEC Legal Bulletin. The Bulletin sought to remind "underwriters, broker-dealers, and any other person who is participating in a distribution of securities . . . that they are prohibited from soliciting or requiring their customers to make aftermarket purchases until the distribution is completed." Id. (emphasis added).

Newspapers also reported on their own investigations into the IPO allocation process. For example, on December 6, 2000, the Wall Street Journal published a front-page article discussing how investment banks were requiring their customers to buy shares of stock in the aftermarket as a condition of receiving IPO stock allocations. See Trying to Avoid the Flippers. The article begins:

Hedge-fund trader Robert Meglio was riding high Aug. 15 when shares of Dyax Corp., a biotech company, made their trading debut at $15 and jumped to $20. His fund, Oracle Partners, had been allowed to buy 50,000 shares of the initial public offering. It scored a quick paper profit of $250,000.
So goes the new IPO playbook on Wall Street. Underwriters want robust after-market buying so that an IPO will be a success for the newly public company and will make money for ground-floor investors. And big institutional investors are happy to express their plans for such buying in hopes of getting more shares at the IPO price.

Id.

The next day, the Wall Street Journal published another article reporting that federal authorities had begun investigating how securities firms were allocating IPO stock. See Susan Pulliam & Randall Smith, U.S. Probes Inflated Commissions for Hot IPOs, Wall St. J., Dec. 7, 2000, at C1. The article explained:

The Securities and Exchange Commission along with the U.S. attorney's office in Manhattan are conducting the inquiry, which is at an early stage, the people say. A federal grand jury has also been called by the U.S. attorney's office to consider evidence. Both the U.S. attorney's office and the SEC have issued subpoenas to IPO participants, requesting trading records and other documents, these people add.
The authorities are scrutinizing ways in which Wall Street dealers may have sought and obtained larger-than-typical trading commissions in return for giving coveted allocations of IPOs to certain investors. Some of the arrangements could have included specific formulas tied to the investors' profits on the offerings, the people familiar with the probe say.

Id.

The first complaint in this litigation was filed one month later. See Makaron v. VA Linux Sys., Inc., 01 Civ. 242 (filed Jan. 11, 2001).

IV. THE COMPLAINTS

Plaintiffs have filed an Amended Complaint in 308 of the 309 consolidated cases. The Complaints detail the allegations about each Issuer's offering and set forth the various claims against the Underwriters, the Issuer and its officers. In addition, Plaintiffs have filed a document entitled "Master Allegations" that contains the allegations that are shared by all of the Complaints. The individual Complaints incorporate the Master Allegations by reference.

A. Individual Complaints

As a randomly-chosen example of the individual Complaints, I shall describe in some detail the 34-page Consolidated Amended Complaint in In re Cacheflow, Inc. Sec. Litig., 01 Civ. 5143 (filed April 24, 2002) ("Cacheflow Compl.").

1. Factual Allegations and Allegations of Market Manipulation

In 1999, Cacheflow, Inc., was a Sunnyvale, California-based company that produced appliances designed to speed up content delivery over the Internet.*fn29 See Cacheflow Compl. ¶ 17.

On November 18, 1999, Cacheflow's registration statement was approved by the SEC. See id. ¶ 5. The next day, an underwriting syndicate distributed 5,000,000 shares of Cacheflow at a price of $24.00 per share. See id. ¶ 30. The underwriting syndicate consisted of the following investment banks:

POSITION UNDERWRITER
LEAD MANAGER Morgan Stanley
CO-MANAGER CSFB Dain Rauscher
SYNDICATE MEMBERS Robertson Stephens (as successor-in-interest to Banc Boston)

BancBoston

Salomon

J.P. Morgan (as successor-in-interest to H&Q)

H&Q

Id. ¶ 14. All of the Underwriters were allocated Cacheflow's initial stock except for J.P. Morgan (H&Q).*fn30 See id. ¶¶ 14-15.

"On the day of the IPO, the price of Cacheflow stock shot up dramatically, trading as high as $139.25 per share, or more than 480% above the IPO price on substantial volume." Id. ¶ 31. Trading on the Nasdaq under the ticker symbol "CFLO", the price of Cacheflow's stock continued to rise in the weeks following the IPO. See id. ¶ 32. Indeed, the stock "hit a high of $182 1/6 per share on December 9, 1999, just prior to the end of the quiet period."*fn31 Id. At some point after the offering, "Plaintiffs Val Kay, Greg Frick, Eric Egelman and Kenneth L. Schmid . . . purchased or otherwise acquired shares of Cacheflow common stock traceable to the IPO." Id. ¶ 12.

Plaintiffs allege that this remarkable price increase in Cacheflow's stock "was not the result of normal market forces." Id. ¶ 31. Rather, "the Allocating Underwriter Defendants created artificial demand for Cacheflow stock by conditioning share allocations in the IPO upon the requirement that customers agree to purchase shares of Cacheflow in the aftermarket and, in some instances, to make those purchases at pre-arranged, escalating prices ("Tie-in Agreements")." Id. ¶ 3. "As part and parcel of this scheme . . . certain of the underwriters . . . also improperly utilized their analysts, who, unbeknownst to investors, were compromised by conflicts of interest, [to] artificially inflate or maintain the price of Cacheflow stock by issuing favorable recommendations in analyst reports." Id. ¶ 7.

Under this scheme, Cacheflow's Underwriters profited by "requir[ing] their customers to repay a material portion of profits obtained from selling IPO share allocations in the aftermarket through one or more of the following types of transactions:"

(a) paying inflated brokerage commissions;

(b) entering into transactions in otherwise unrelated securities for the primary purpose of generating commissions; and/or
(c) purchasing equity offerings underwritten by these IPO Underwriter Defendants, including, but not limited to, secondary (or add-on) offerings that would not be purchased but for the unlawful scheme alleged herein.

Id. ¶ 4. Plaintiffs collectively refer to these payments as "Undisclosed Compensation." Id.

Plaintiffs also contend that NeSmith, Malcolm and Johnson "knew of or recklessly disregarded the conduct complained of herein through their participation in the `Road Show' process by which underwriters generate interest in public offerings."*fn32 Id. ¶ 8. Moreover, these officers benefitted from the Tie-in Agreements "as a result of their personal holdings of the Issuer's stock." Id.

2. The Registration Statement's Misleading Statements and Omissions

According to the Complaint, Cacheflow's registration statement "failed to disclose, among other things . . . that the Allocating Underwriter Defendants had required Tie-in Agreements in allocating shares in the IPO and would receive Undisclosed Compensation in connection with the IPO." Id. ¶ 6. Plaintiffs further allege that the Defendants made eight specific materially false or misleading statements.

First, Plaintiffs highlight the following paragraph in the registration statement:

In order to facilitate the offering of the common stock, the underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the common stock. Specifically, the underwriters may agree to sell or allot more shares than the 5,000,000 shares of common stock Cacheflow has agreed to sell them. This over-allotment would create a short position in the common stock for their own account. To cover over-allotments or to stabilize the price of the common stock, the underwriters may bid for, and purchase, shares of common stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an underwriter or a dealer for distributing the common stock in the offering if the syndicate repurchases previously distributed shares of common stock in transactions to cover syndicate short positions, in stabilization transactions or otherwise. Any of these activities may stabilize or maintain the market price of the common stock above independent market levels. The underwriters are not required to engage in these activities and may end any of these activities at any time.

Id. ¶ 37. "[These statements] were materially false and misleading because the Allocating Underwriter Defendants required customers to commit to Tie-in Agreements and created the false appearance of demand for the stock at prices in excess of the IPO price in violation of Regulation M," a regulation promulgated by the SEC under the Exchange Act. Id. ¶ 38. Rule 101(a) of Regulation M states:

Unlawful Activity. In connection with a distribution of securities, it shall be unlawful for a distribution participant or an affiliated purchaser of such person, directly or indirectly, to bid for, purchase, or attempt to induce any person to bid for or purchase, a covered security during the applicable restricted period.

Id. ¶ 35 (quoting 17 C.F.R. § 242.101). Moreover, the SEC Legal Bulletin explains:

Tie-in agreements are a particularly egregious form of solicited transactions prohibited by Regulation M. As far back as 1961, the Commission addressed reports that certain dealers participating in distributions of new issues had been making allotments to their customers only if such customers agreed to make some comparable purchase in the open market after the issue was initially sold. The Commission said that such agreements may violate the antimanipulative provisions of the Exchange Act, particularly Rule 10b-6 (which was replaced by Rules 101 and 102 of Regulation M) under the Exchange Act, and may violate other provisions of the federal laws.
Solicitations and tie-in agreements for aftermarket purchases are manipulative because they undermine the integrity of the market as an independent pricing mechanism for the offered security. Solicitations for aftermarket purchases give purchasers in the offering the impression that there is a scarcity of the offered securities. This can stimulate demand and support the pricing of the offering. Moreover, traders in the aftermarket will not know that the aftermarket demand, which may appear to validate the offering price, has been stimulated by the distribution participants. Underwriters have an incentive to artificially influence aftermarket activity because they have underwritten the risk of the offering, and a poor aftermarket performance could result in reputational and subsequent financial loss.*fn33

Id. ¶ 36 (emphasis in original) (quoting the SEC Legal Bulletin). "At no time did the Registration Statement/Prospectus disclose that the Allocating Underwriter Defendants would require their customers to engage in transactions causing the market price of Cacheflow common stock to rise, in transactions that cannot be characterized as stabilizing transactions, over-allotment transactions, syndicate covering transactions or penalty bids." Id. ¶ 38.

Second, Plaintiffs contend that the registration statement was false and misleading because Regulation S-K requires disclosure of payments from customers who received IPO shares.*fn34 See Cacheflow Compl. ¶ 42. Item 508(e) of Regulation S-K provides:

Underwriter's Compensation. Provide a table that sets out the nature of the compensation and the amount of discounts and commissions to be paid to the underwriter for each security and in total. The table must show the separate amounts to be paid by the company and the selling shareholders. In addition, include in the table all other items considered by the National Association of Securities Dealers to be underwriting compensation for purposes of that Association's Rules of Fair Practice.

Id. ¶ 39 (emphasis in original) (quoting 17 C.F.R. § 229.508(e)). The NASD "specifically addresses what constitutes underwriting compensation in NASD Conduct Rule 2710(c)(2)(B) (formerly Article III, Section 44 of the Association's Rules of Fair Practice)[.]" Id. ¶ 40. It states:

For purposes of determining the amount of underwriting compensation, all items of value received or to be received from any source by the underwriter and related persons which are deemed to be in connection with or related to the distribution of the public offering as determined pursuant to subparagraphs (3) and (4) below shall be included.

Id. (emphasis omitted). NASD Conduct Rule 2710(c)(2)(C) requires:

If the underwriting compensation includes items of compensation in addition to the commission or discount disclosed on the cover page of the prospectus or similar document, a footnote to the offering proceeds table on the cover of the prospectus or similar document shall include a cross-reference to the section on underwriting or distribution arrangements.

Id. ¶ 41. "Contrary to applicable law, the Registration Statement/Prospectus did not set forth, by footnote or otherwise, the Undisclosed Compensation." Id. ¶ 42.

Third, the registration statement "misleadingly stated that the underwriting syndicate would receive as compensation an underwriting discount of $1.68 per share, or a total of $8,400,000, based on the spread between the per share proceeds to Cacheflow ($22.32) and the Offering price to the public ($24.00 per share)." Id. ¶ 43. "This disclosure was materially false and misleading as it misrepresented underwriting compensation by failing to include Undisclosed Compensation." Id.

Fourth, the registration statement was materially false and misleading when it stated:

The underwriters initially propose to offer part of the shares of common stock directly to the public at the initial public offering price set forth on the cover page of this prospectus [$24.00] and part to various dealers at a price that represents a concession. . . .

Id. ¶ 44. This statement was "materially false and misleading in that in order to receive share allocations from the Allocating Underwriter Defendants in the IPO, customers were required to pay an amount in excess of the IPO price set forth on the cover page in the form of Undisclosed Compensation and/or Tie-in Agreements." Id. ¶ 45.

Fifth, the investment banks that allocated Cacheflow's stock violated NASD Conduct Rule 2330(f), which states that "no member or person associated with a member shall share directly or indirectly in the profits or losses in any account of a customer carried by the member or any other member." Id. ¶ 46. "The Allocating Underwriter Defendants' scheme was dependent upon customers obtaining substantial profits by selling share allocations from the IPO and paying a material portion of such profits to the Allocating Underwriter Defendants. In this regard, the Allocating Underwriter Defendants shared in their customers' profits in violation of NASD Conduct Rule 2330(f)." Id. ¶ 47. "The failure to disclose the Allocating Underwriter Defendants' unlawful profit-sharing arrangement as described herein, rendered the Registration Statement/Prospectus materially false and misleading." Id. ¶ 48.

Sixth, the registration statement was "false and misleading due to its failure to disclose the material fact that the Allocating Underwriter Defendants were charging customers commissions that were unfair, unreasonable, and excessive as consideration for receiving allocations of shares in the IPO." Id. Plaintiffs base this allegation on NASD Conduct Rule 2440, which states in relevant part:

[A member] shall not charge his customer more than a fair commission or service charge, taking into consideration all relevant circumstances, including market conditions with respect to such security at the time of the transaction, the expense of executing the order and the value of any service he may have rendered by reason of his experience in and knowledge of such security and market therefor.

Id. ¶ 49. Moreover, according to Guideline IM-2440 of the NASD:

It shall be deemed a violation of . . . Rule 2440 for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable. . . . A mark-up of 5% or even less may be considered unfair or unreasonable under the 5% policy.

Id. ¶ 50.

Seventh, the registration statement "failed to accurately disclose which of the underwriters identified therein actually participated in the distribution of the IPO." Id. ¶ 52. For example, "J.P. Morgan (H&Q) did not receive any of the 100,000 shares listed next to its name." Id. ¶ 54. Thus, the registration statement "was materially false and misleading in that it did not inform the investing public that the shares in the IPO would be distributed only by a few of the underwriters" who were identified in the registration statement. Id. ¶ 53.

Eighth, and finally, on "December 15, 1999, just after the expiration of the `quiet period' with respect to the Cacheflow IPO, Defendants CSFB and Dain Rauscher each initiated analyst coverage of Cacheflow. Dain Rauscher issued a `Strong Buy' recommendation with a 12-month price target of $175 per share. . . . [and] Cacheflow stock closed at $141.50 per share that day." Id. ¶ 56. "The price target set forth in the Dain Rauscher report was materially false and misleading as it was based upon a manipulated price." Id. ¶ 57.

3. Claims

Based on these allegations, Plaintiffs have brought six claims against the Defendants pursuant to the Securities Act and the Exchange Act. First, that each member of the underwriting syndicate, Cacheflow, NeSmith, Malcolm and Johnson violated Section 11 of the Securities Act by including untrue statements and omitting statements of material fact in Cacheflow's registration statement. See Cacheflow Compl. ¶¶ 60-68; see also 15 U.S.C. § 77k. Second, that NeSmith, Malcom and Johnson are liable under Section 15 of the Securities Act, which holds a controlling person liable for a company's Section 11 violation. See Cacheflow Compl. ¶¶ 69-75; see also 15 U.S.C. § 77o. Third, that the Allocating Underwriter Defendants (i.e., all of the underwriters except J.P. Morgan (H&Q)) violated Section 10(b) of the Exchange Act and Rule 10b-5 by manipulating the market with Tie-in Agreements and by requiring customers to pay Undisclosed Compensation. See Cacheflow Compl. ¶¶ 84-92; see also 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. Fourth, that all Underwriter Defendants violated Section 10(b) and Rule 10b-5 by making material misrepresentations and omissions for the purpose of securing and concealing the Tie-in Agreements, Undisclosed Compensation, the conflicts of interest between the Underwriter Defendants and the analysts who reported on Cacheflow's stock or some combination thereof. See Cacheflow Compl. ¶¶ 93-103; see also 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. Fifth, that Cacheflow, NeSmith, Malcom, and Johnson violated Section 10(b) and Rule 10b-5 by carrying out a scheme to artificially inflate the price of the company's stock by making material misrepresentations and omissions to conceal the Underwriters' behavior. See Cacheflow Compl. ¶¶ 111-20; see also 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. Sixth, that NeSmith, Malcom and Johnson are liable under Section 20(a), which holds a controlling person liable for a company's Section 10(b) and Rule 10b-5 violations. See Cacheflow Compl. ¶¶ 121-24; see also 15 U.S.C. § 78t(a).

The following chart summarizes these claims:

Claim Underwriters Issuers Individuals
1. Section 11 Section 11 Section 11
2. Section 15
3. Rule 10b-5 for manipulative practices (only against Allocating Underwriters)
4. Rule 10b-5 for false statements and omissions
5. Rule 10b-5 for Rule 10b-5 for false statements false statements and omissions and omissions
6. Section 20(a)

B. Part I of Master Allegations

There are essentially three parts to the Master Allegations. Part I outlines factual allegations against the Defendants. Part II provides relevant details about twenty-two of the fifty-five Underwriter Defendants. Part III contains a brief description of each Underwriter Defendant and the number of shares received for each IPO. Part I will be the discussed in the greatest detail because it contains the most relevant factual allegations.

1. Tie-in Allegations and Undisclosed Compensation

Part I of the Master Allegations is 114-pages long and its most important paragraphs are 14-17 and 34.*fn35 Paragraphs 14-17 set forth the Plaintiffs' allegations about the alleged Tie-in Agreements and Undisclosed Compensation:

14. The Underwriter Defendants set about to ensure that there would be large gains in aftermarket trading on shares following initial public offerings by improperly creating artificial aftermarket demand. They accomplished this by conditioning share allocations in initial public offerings upon the requirement that customers agree to purchase, in the aftermarket, additional shares of stocks in which they received allocations, and, in some instances, to make those additional purchases at pre-arranged, escalating prices ("Tie-in Agreements").
15. These Tie-in Agreements did not always require that the investors receiving allocations in initial public offerings actually purchase shares in the aftermarket, although often they did. The Tie-in Agreements were designed to ensure ready demand for shares in the event the Underwriter Defendants so desired.
16. By extracting agreements to purchase shares in the aftermarket, the Underwriter Defendants created artificial demand for aftermarket shares, thereby causing the price of the security to artificially escalate as soon as the shares were publicly issued.
17. Not content with record underwriting fees obtained in connection with new offerings, the Underwriter Defendants sought, as part of their manipulative scheme, to further enrich themselves by improperly sharing in the profits earned by their customers in connection with the purchase and sale of IPO securities. The Underwriter Defendants kept track of their customers' actual or imputed profits from the allocation of shares in the IPOs and then demanded that the customers share a material portion of the profits obtained from the sale of those allocated IPO shares through one or more of the following types of transactions: (a) paying inflated brokerage commissions; (b) entering into transactions in otherwise unrelated securities for the primary purpose of generating commissions; and/or (c) purchasing equity offerings underwritten by the Underwriter Defendants, including, but not limited to, secondary (or add-on) offerings that would not be purchased but for the Underwriter Defendants' unlawful scheme (Transactions "(a)" through "(c)" above will be, at varying times, collectively referred to hereinafter as "Undisclosed Compensation").

MA ¶¶ 14-17.

"For example," according to paragraph 34, "customers who received allocations of IPO shares in the following listed IPOs fulfilled their commitments to purchase shares in the aftermarket pursuant to Tie-in Agreements, netting the Underwriter Defendants and other underwriters of the referenced offerings substantial additional trading revenue and commissions and substantially and artificially increasing the demand for the issuer's shares[.]" Id. ¶ 34. The statement made in the Master Allegations with respect to Cacheflow's IPO is representative of the allegations repeatedly made in paragraph 34:

One customer, in order to obtain shares of the Cacheflow IPO from Morgan Stanley, was required or induced to and did purchase from Morgan Stanley in the aftermarket, at prices substantially above the IPO price, thousands of additional Cacheflow shares.

Id. ¶ 34, at 16.

While paragraph 34 makes similar allegation with respect to almost every IPO — from Aclara Biosciences to Z-Tel Technologies — and fills over 71 pages of the Master Allegations, see id. ¶ 34 at 8-80, these allegations are not duplicative. The allegations in paragraph 34 differ in three significant ways. First, each allegation varies with respect to the Underwriter from whom that particular unnamed customer bought the IPO stock. For example, the allegations involving Autoweb and Backweb Technologies state:

One customer, in order to obtain shares of the Autoweb IPO from CSFB, was required or induced to and did purchase from CSFB in the aftermarket, at prices substantially above the IPO price, about twice the number of Autoweb shares allocated to that customer in the IPO.
One customer, in order to obtain shares of the Backweb Technologies IPO from Goldman Sachs, was required or induced to and did purchase from Goldman Sachs in the aftermarket, at prices substantially above the IPO price, more than three times the number of Backweb Technologies shares allocated to that customer in the IPO.

Id. ¶ 34 at 13-14 (emphasis added).

Second, the allegations differ as to the amount of stock that the customer was required or induced to buy in the aftermarket. For instance, while one customer was required or induced to purchase "thousands of additional Intersil shares," id. ¶ 34 at 37, another customer was required or induced to purchase "more than three times the number of Liberate shares allocated to that customer in the IPO," id. ¶ 34 at 40.*fn36

Third, in forty-seven of the 309 cases, Plaintiffs allege at least two examples of customers who were required or induced to buy stock in the aftermarket from a particular Underwriter.*fn37 For example, the allegations with respect to PSI Technologies state:

a) One customer, in order to obtain shares of the PSI Technologies IPO from J.P. Morgan (H&Q), was required or induced to and did purchase from J.P. Morgan (H&Q) in the aftermarket, at prices substantially above the IPO price, as many PSI Technologies shares as that [sic] allocated to that customer in the IPO.
b) One customer, in order to obtain shares of the PSI Technolog[ies] IPO from Soundview Technolog[ies] (E*Trade), was required or induced to and did purchase from Soundview Technolog[ies] (E*Trade) in the aftermarket, at prices substantially above the IPO price, four times the number of PSI Technology shares allocated to that customer in the IPO.
c) One customer, in order to obtain shares of the PSI Technolog[ies] IPO from Goldman Sachs, was required or induced to and did purchase from Goldman Sachs in the aftermarket, at prices substantially above the IPO price, thousands of additional PSI Technology shares.

Id. ¶ 34 at 59.

Paragraphs 35-56 further supplement these allegations in three ways. First, these paragraphs provide more details about the types of Undisclosed Compensation that customers paid to the investment banks. Paragraphs 41-43 state:

41. One form of Undisclosed Compensation involved the payment of inflated brokerage commissions. In that regard, investors were instructed or made to understand that allocations of IPO shares would be awarded to customers that paid per share commission rates well in excess of the ordinary and customary commission rates for these accounts, as well as the rules and regulations governing the securities industry.
42. The Underwriter Defendants also sought and received Undisclosed Compensation from customers in the form of commissions paid on trades of highly liquid securities made solely for the purpose of generating commissions. Sometimes these trades were executed in stocks for which the Underwriter Defendants were market makers and which they wanted to actively support. These trades were akin to "churned" sales or "wash" transactions, generated for the main purpose of creating financial benefits for the Underwriter Defendants.
43. The Underwriter Defendants also sought and received Undisclosed Compensation in the form of compensation earned by forcing customers to buy shares of offerings, including undesired add-on offerings, with the understanding that customers would receive IPO allocations only if they purchased such shares.

Id. ¶¶ 41-43.

Second, the paragraphs provide further detail as to how the investment banks enforced their scheme with their customers:

45. With regard to retail accounts, firms (including, for example, Morgan Stanley and Paine Webber) typically utilized a grid (or index) system whereby allocations were made to individual brokers, to then be awarded to clients, based on point totals. The higher the points, the more likely it was for a broker to be awarded an allocation of shares in an initial public offering.
46. Brokers earned points on the grid by allocating shares to clients who were required or induced to buy, and in fact bought, shares of the issuer in the aftermarket, typically at multiples of the initial shares allocated and at prices above the offering price. Brokers also earned points by selling customers shares in add-on offerings. These offerings typically were not favored investments by customers as they offered scant investment returns. However, underwriters earned large fees on add-on offerings and received sizeable commissions on sales of such shares.
47. The Underwriter Defendants' misconduct in connection with [the] initial public offerings was so pervasive and uniform from underwriting firm to underwriting firm, that retail sales personnel relocating to new firms were able to transfer their "grid" scores to new firms.

Id. ¶¶ 45-47.

Third, paragraphs 35-56 refer to various newspaper articles that have reported on the government's investigation into the IPO allocation practices of investment banks during the same time period. For example, the Master Allegations quote a May 11, 2001, New York Times article reporting on the federal grand jury testimony of hedge fund trader Walter Scott Bruan that states:

Mr. Bruan has contended that investment banks manipulated the trading of I.P.O.'s by lining up commitments from investors to buy more shares at specific prices above the offering prices. That practice, known as laddering, would help to ensure that the price of a new stock would rise on its first day of trading, fueling demand from other investors who wanted a piece of a hot stock, Mr. Bruan has said.

Id. ¶ 36 (quoting Patrick McGeehan, Hedge Fund Managers Said to Talk to Grand Jury, N.Y. Times, May 11, 2001, at C1). Likewise, the Master Allegations have similar quotations from other investigative reports on IPO allocation practices. See id. ¶ 37 (quoting from 5/25/01 USA Today article); id. ¶ 40 (quoting from 12/7/00 Wall Street Journal article); id. ¶¶ 49-52 (quoting from Red Herring articles that were published in a seven-part series beginning on 5/2/01); id. ¶ 53 (quoting from 6/29/01 Wall Street Journal article); id. ¶ 55 (quoting from 6/24/00 Wall Street Journal article).

2. Statistical Analysis

Paragraphs 57-65 fall under a heading entitled "Statistical Analysis Of The Coordinated Litigation Confirms the Misconduct Alleged Herein." Id. at 87. These paragraphs compare various data from the IPOs at issue in this coordinated litigation with other data from other IPOs during the same time period or from previous years. Specifically, Plaintiffs allege:

(1) the IPO Litigation Offerings "had the highest average first day market gain [almost 140%] of any initial public offering market of any period measured [i.e., 1980-1999]," id. ¶ 58,
(2) "although average first day gains were also higher for all IPOs during the Class Period [] (just over 60%), the first day aftermarket gains of the IPO Litigation Offerings (almost 140%) were far more dramatic," id. ¶ 59,
(3) "[w]hereas in the Prior Period IPO Market [from Jan. 1980 — June 1998], approximately one out of every ten initial public offerings fell below 10% of the offering price within three years," this happened to "more than 50% of the initial public offerings comprising the IPO Litigation Offerings," id. ¶ 60,
(4) "whereas on average the number of shares traded in the first five days after the IPO was equal to 85% of the shares offered in the Prior Period IPO Market [Oct. 1982-June 1998], the number of shares traded on average in the first five days after the IPO Litigation Offerings was equal to over 350% of the shares issued," id. ¶ 61,
(5) "part of the Underwriter Defendants' motivation for engaging in the misconduct [] was to conduct secondary offerings at a much higher price . . . [and] the percentage of IPOs that were followed by a subsequent equity offering within 6 months increased dramatically for the IPO Litigation Offerings [when compared with IPOs from 1980-June 1998]," id. ¶ 62,
(6) "[i]n the Prior Period IPO Market [January 1980-June 1998], secondary offerings followed initial public offerings on average less than 3.5% of the time . . . [while] the IPO Litigation Offerings were followed by secondary offerings within six months almost five times as often (16%)," and "[a]ll Offerings were followed by secondary offerings within six months of the IPO only slightly more than 8% of the time," id. ¶ 63,
(7) "[t]he IPO Litigation Offerings showed substantial price increases on average around the end of the quiet period, whereas initial public offerings in the Prior Period IPO Market [Jan. 1989-June 1998] showed very little price increase on average," id. ¶ 64,
(8) "[t]he IPO Litigation Offerings also contrasted markedly with All Offerings during the 1998-2000 IPO Market," id. ¶ 65.

Each of these allegations is followed by a four-colored graph illustrating the allegation.

3. Matrix Illustrating Various Relationships Among Underwriters

Paragraphs 66-85 fall under a heading entitled "Matrix." This six-page illustration shows "the relationships between the lead underwriters (`book runners') of the IPO Litigation Offerings and the underwriters who participated in such offerings." Id. ¶ 66. For example, a representative allegation states:

In the 41 IPO Litigation Offerings in which Robertson Stephens was the book-runner (or co-book-runner), the following underwriters participated in the number of IPO Litigation Offerings set forth next to their names: Bear Stearns (7); H&Q (14); SG Cowen (7); Piper Jaffray (12); Prudential (8); SureTrade (7); Weisel (7); First Albany (8); Dain Rauscher (16); CE Unterberg (8); E*Trade (16); and Needham & Co. (10).

Id. ¶ 70. The matrix illustrates the relationship that each of the twenty-one investment banks that served as book-runners or co-book-runners in the IPO Litigation Offerings had with the other investment banks. See id. ¶ 66.

4. Analyst Allegations

Paragraphs 86-108 contain the Plaintiffs' allegations that the Underwriter Defendants used their analysts "to artificially inflate and maintain the aftermarket price of [the IPO] securities." Id. ¶ 86. "[T]he Underwriter Defendants utilized their analysts to recommend such stocks at their first opportunity, typically at the end of the so-called `quiet period,' 25 days following the offering." Id. "Between 1998 and 2000, 97% of analyst initiations at the expiration of the quiet period were by managing underwriters of the initial public offering. Virtually all such coverage was positive." Id. ¶ 108. "In many instances the favorable recommendations were accompanied by unrealistic price targets, frequently reiterated throughout the relevant class periods." Id. ¶ 86. Not only did "analysts employed by the Underwriter Defendants [know] that a negative recommendation would likely lead to fewer investment banking opportunities," id. ¶ 89, but they have been "confronted with enormous pressure to issue favorable recommendations regarding shares underwritten by the various Underwriter Defendants," id. ¶ 107.

The Master Allegations allege three types of perceived conflicts. "[M]any, if not most, of the Underwriter Defendants tied their analysts' compensation to the performance of the investment banking section of the Underwriter Defendants so that the winning of new investment bank business would directly inure to the pecuniary benefit of the analyst." Id. ¶ 88. "Many analysts also suffered from conflicts of interest due to their ownership of stock in companies they were recommending." Id. ¶ 90. Finally, "analysts frequently had equity interests in entities including venture capital funds and partnerships which had investment interests in these issuers." Id. ¶ 104.

5. Motivations of the Underwriters, Issuers and Individual Defendants

The last four paragraphs of Part I, see id. ¶¶ 109-12, allege the motivations that the various Defendants had in carrying out these Tie-in Arrangements. In addition to receiving various forms of Undisclosed Compensation, see id. ¶¶ 41-43, "the Underwriter Defendants were [also] able to parlay the spectacular increase in market capitalization attendant to each offering into additional and highly lucrative investment banking opportunities for themselves," id. ¶ 109. "Examples of these additional opportunities include the underwriting of add-on offerings such as secondary and tertiary equity offerings (for which the Underwriter Defendants typically were paid a fixed percentage of the offering price), the underwriting and sales of debt and convertible offerings and advisory services including financial consulting and advising on mergers and acquisitions." Id. Likewise, during the late 1990s, "the Underwriter Defendants marketed themselves by emphasizing the prospect of substantial market gains, including the first day gains, of IPO Offerings to entice potential clients to retain those underwriters." Id. ¶ 110.

The last paragraph contains the only reference to the alleged motivation of the Issuers and the Individual Defendants to participate in this scheme. See id. ¶ 112. "The Issuers, as new publicly held corporations, benefitted financially from the misconduct as the run up of their respective stock prices afforded them with substantial opportunities to utilize their stock as currency in connection with corporate acquisitions, and to raise even more money through add-on offerings." Id. As far as the Individual Defendants are concerned, "[they] were motivated to and did benefit financially as a result of the sharp appreciation in value of the respective Issuer's stock price." Id.

C. Part II and Part III of the Master Allegations

Part III is marked with two tabs. After Tab A, Plaintiffs have listed each of the fifty-five investment banks and provided several paragraphs of information about the bank's corporate structure. After Tab B, Plaintiffs have listed the IPOs the Underwriter participated in, the IPO price and the number of shares that investment bank was allocated in that IPO. In addition, Plaintiffs have included estimates as to the amount of additional compensation that customers were required to pay in order to receive the IPO stock. For example, one summary reads:

Banc of America

IPO IPO Price Shares Allocated
Apropos $22.00 2,000
Digital Insight $15.00 2,000
Digitas $24.00 4,000
DrKoop.com $9.00 20,000
High Speed Access $13.00 8,000
Modem Media $16.00 1,000
NetRatings $17.00 2,000
Oni Systems $25.00 2,000
Repeater $9.00 1,000 Technologies
Saba Software $15.00 1,000
Ticketmaster $14.00 9,000 Online-City Search, Inc.
Utstarcom $18.00 2,000

In order to receive the above listed and other IPO allocations of securities from Banc of America, the recipients of such allocations were required or induced to pay in excess of $3.7 million in commissions to Banc of America during 1999 and 2000. These commissions were generated from trades that would not have occurred but for the allocations, and which were created predominately for the purpose of compensating Banc of America for the allocations received. All of these commissions are referred to herein as "Undisclosed Compensation". Id. Sect. III, Tab B, at 1. A similar chart and allegation follows the listing of each Underwriter.

GOVERNING LEGAL PRINCIPLES

V. PLEADING UNDER THE FEDERAL RULES OF CIVIL PROCEDURE

The individual Complaints average more than thirty pages each, comprising a total of nearly 11,355 pages. Defendants have challenged these Complaints as insufficient. The parties have submitted over 500 pages of legal briefing along with thousands of additional pages of attachments, appendixes and letters to support their arguments. Given the seriousness of these allegations, the extent of the briefing, and the fact that there are more than one thousand parties, a thorough discussion of the pleading requirements of the Federal Rules of Civil Procedure and the PSLRA is in order.

A. Rule 8(a)

Under the Federal Rules it is remarkably easy for a plaintiff to plead a claim: Unless the claim falls into one of the two exceptions set forth in Rule 9, a plaintiff must simply provide "(1) a short and plain statement of the grounds upon which the court's jurisdiction depends . . . (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." Fed.R.Civ.P. 8(a). Almost five decades ago, in Conley v. Gibson, 355 U.S. 41 (1957), the Supreme Court first considered the argument that a plaintiff must also "set forth specific facts to support [the complaint's] general allegations." Id. at 47. The Supreme Court responded unanimously:

The decisive answer to this is that the Federal Rules of Civil Procedure do not require a claimant to set out in detail the facts upon which he bases his claim. To the contrary, all the Rules require is "a short and plain statement of the claim" that will give the defendant fair notice of what the plaintiff's claim is and the grounds upon which it rests. . . . Such simplified "notice pleading" is made possible by the liberal opportunity for discovery and the other pretrial procedures established by the Rules to disclose more precisely the basis of both claim and defense and to define more narrowly the disputed facts and issues.

Id. at 47-48. "The Federal Rules reject the approach that pleading is a game of skill in which one misstep by counsel may be decisive to the outcome and accept the principle that the purpose of pleading is to facilitate a proper decision on the merits." Id. at 48.

In Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 507 U.S. 163 (1993), the Supreme Court rebuked the lower courts for imposing a more demanding rule of pleading on certain types of cases that are sometimes disfavored by the courts (e.g., section 1983 claims against municipalities, prisoner litigation, and civil rights cases). The Court (again unanimous) reaffirmed its previous decision by stating: "In Conley v. Gibson, we said in effect that the Rule meant what it said." Leatherman, 507 U.S. at 168 (citation omitted). Moreover, as if to warn the lower courts not to stray from the Rules, the Court held that heightened pleading "is a result which must be obtained by the process of amending the Federal Rules, and not by judicial interpretation. In the absence of such an amendment, federal courts and litigants must rely on summary judgment and control of discovery to weed out unmeritorious claims sooner rather than later." Id. at 168-69.*fn39

Nonetheless, last term in Swierkiewicz v. Sorema N.A., 534 U.S. 506 (2002), the Supreme Court found occasion to again remind the lower courts not to raise the bar for pleading. This time reversing a case that originated from this district, the Court (still unanimous) reiterated that "Rule 8(a)'s simplified pleading standard applies to all civil actions, with limited exceptions." Id. at 513 (emphasis added). "This simplified notice pleading standard relies on liberal discovery rules and summary judgment motions to define disputed facts and issues and to dispose of unmeritorious claims." Id. at 512. "Given the Federal Rules' simplified standard for pleading, `[a] court may dismiss a complaint only if it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations.'" Id. at 514 (quoting Hishon v. King & Spalding, 467 U.S. 69, 73 (1984)) (emphasis added). "Rule 8(a) establishes a pleading standard without regard to whether a claim will succeed on the merits." Swierkiewicz, 534 U.S. at 515.

While the meaning of "a short and plain statement of the claim" is clear on its face, Fed.R.Civ.P. 8(a)(2), the drafters removed any conceivable ambiguity by including more than a dozen sample complaints in the Appendix. See Fed.R.Civ.P.App. Forms 3-18. According to Rule 84, "[t]he forms contained in the Appendix of Forms are sufficient under the rules and are intended to indicate the simplicity and brevity of statement which the rules contemplate."*fn40 Fed.R.Civ.P. 84. It is worth emphasizing that not one of these exemplar complaints is more than half a page in length.

"For example, Form 9 sets forth a complaint for negligence in which plaintiff simply states in relevant part: `On June 1, 1936, in a public highway called Boylston Street in Boston, Massachusetts, defendant negligently drove a motor vehicle against plaintiff who was then crossing said highway.'" Swierkiewicz, 534 U.S. at 513 n. 4 (quoting Fed.R.Civ.P. App. Form 9). As the Supreme Court recognized in Swierkiewicz, one clearly written sentence can satisfy Rule 8(a)(2). See id.; see also Walker v. Thompson, 288 F.3d 1005, 1011 n. 2 (7th Cir. 2002).

If the complaint also includes statements "of the grounds upon which the court's jurisdiction depends" and "the relief the pleader seeks," the plaintiff has satisfied Rule 8.*fn41 Fed.R.Civ.P. 8(a)(1),(3).

Rule 8(a) does not require plaintiffs to plead the legal theory, facts or elements underlying their claim. There is nothing in Form 9, for example, to support plaintiff's accusation of negligence. "It does not say, for example, whether the hypothetical defendant was speeding, driving without lights, or driving on the wrong side of the road." Atchinson v. District of Columbia, 73 F.3d 418, 423 (D.C. Cir. 1996). Nor does it outline the four elements of negligence and explain how each is satisfied. "Form 9 thus treats the mere allegation of negligence as sufficient." Id. (emphasis added). Form 9's allegations are wholly conclusory: by simply describing the claim in a short and plain fashion, Form 9 satisfies the Federal Rules. See Fed.R.Civ.P. 84.

"A complaint that complies with the federal rules of civil procedure cannot be dismissed on the ground that it is conclusory or fails to allege facts." Higgs v. Carver, 286 F.3d 437, 439 (7th Cir. 2002). "The courts keep reminding plaintiffs that they don't have to file long complaints, don't have to plead facts, don't have to plead legal theories." Id. (quotation marks and citation omitted). To comply with Rule 8, plaintiffs need not provide anything more than sufficient notice to permit defendant to file an answer.*fn42 In this regard, Form 9 is the definition of short and plain: "It can be read in seconds and answered in minutes." McHenry v. Renne, 84 F.3d 1172, 1177 (9th Cir. 1996).

Indeed, plaintiffs who want to provide something more than a short complaint should be cautious because "[a] party's assertion of fact in a pleading is a judicial admission by which it normally is bound throughout the course of the proceeding." Bellefonte Re Ins. Co. v. Argonaut Ins. Co., 757 F.2d 523, 528 (2d Cir. 1985).*fn43 Plaintiffs may even plead themselves out of court at the outset of their lawsuit by pleading information that defeats their legal claim, thereby "thwarting what might, for all we know, have been a fruitful program of pretrial discovery for the plaintiff." Conn v. GATX Terminals Corp., 18 F.3d 417, 419 (7th Cir. 1994) (citing examples). See also Stone Motor Co. v. General Motors Corp., 293 F.3d 456, 464 (8th Cir. 2002) ("[A] dismissal under Rule 12(b)(6) should be granted only in the unusual case in which a plaintiff includes allegations that show, on the face of the complaint, that there is some insuperable bar to relief.") (quoting Schmedding v. Tnemec Co., 187 F.3d 862, 865 (8th Cir. 1999)).

Given these incentives, it is no surprise that courts "continue to be puzzled why lawyers insist on writing prolix complaints that can only get them into trouble." Hammes v. AAMCO Transmissions, Inc., 33 F.3d 774, 778 (7th Cir. 1994). Plaintiffs would do well to remember that in law, as in life: "He who guards his mouth and his tongue keeps himself from calamity." Proverbs 21:23 (New International Version).

B. Rule 9(b)

1. Why Rule 9(b) Requires Particularity

There are two main reasons why fraud claims must be pled with particularity: notice and deterrence.*fn44 With respect to the former, general accusations of fraud are thought to be too amorphous to provide defendants with sufficient notice to permit a response. See Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir. 2000) ("`The primary purpose of Rule 9(b) is to afford defendant fair notice of the plaintiff's claim and the factual ground upon which it is based.'") (quoting Ross v. Bolton, 904 F.2d 819, 823 (2d Cir. 1990)). "Fraud . . . embrace[s] such a wide variety of potential conduct that a defendant needs a substantial amount of particularized information about plaintiff's claim in order to enable him to understand it and effectively prepare his response."*fn45 5 Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure ("Fed. Prac.") § 1296 ("Pleading the Circumstances of Fraud or Mistake — History and Purpose").

Requiring particularity may also deter plaintiffs from filing frivolous fraud claims. Courts and commentators have offered several explanations for why fraud claims require more deterrence than other claims. One of the most common is that lawsuits based on fraud are more likely to harm a defendant's reputation than a typical lawsuit. "Accusations of fraud," even if proven to be untrue, "can do serious damage to the goodwill of a business firm or a professional person." Bankers Trust Co., 959 F.2d at 683. In addition, fraud claims should be deterred because "assertions of fraud . . . often are involved in attempts to reopen completed transactions or set aside previously issued judicial orders." 5 Fed. Prac. § 1296. Because finality has value, courts will not lightly reexamine completed transactions because one party has claimed fraud. See Ackerman v. Northwestern Mut. Life Ins. Co., 172 F.3d 467, 469 (7th Cir. 1999) (citing Stearns v. Page, 48 U.S. (7 How.) 819, 828-30 (1849)); see also Chamberlain Mach. Works v. United States, 270 U.S. 347, 348-49 (1926).

Plaintiffs may also sue defendants in order to conduct "fishing expeditions" where a party files a complaint containing general allegations of fraud in hopes that subsequent discovery will uncover enough evidence to substantiate allegations.*fn46 Finally, "fraud is frequently charged irresponsibly by people who have suffered a loss and want to find someone to blame for it." Ackerman, 172 F.3d at 469 (citing Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978) (Friendly, J.) (coining the phrase "fraud by hindsight")).

2. How Particularity Deters Claims of Fraud

Rule 9(b) deters plaintiffs from filing fraud claims in two ways. First, by requiring plaintiffs to state their claim with particularity, the Rule creates a disincentive to the filing of claims for an improper reason. For example, the claim's particularity narrows the potential scope of discovery. Likewise, because pleadings are binding judicial admissions, see supra note 43, plaintiffs cannot easily change their claims based on what they discover during litigation. Thus, requiring plaintiffs to state their claims with particularity has a certain salutary effect.

Second, particularity increases the cost of filing the complaint by forcing a plaintiff to conduct a more substantial investigation of the grounds for her claim before bringing suit. See Ackerman, 172 F.2d at 469. Because "factual contentions [must] have evidentiary support," Fed.R.Civ.P. 11(b)(3), claims that are stated with particularity will necessarily require the plaintiffs to make inquiries that are more extensive than usual. See also Fed.R.Civ.P. 11(b) (stating that attorneys must certify that they have made their pleadings to "the best of [their] knowledge, information, and belief, formed after an inquiry reasonable under the circumstances").

3. Rule 9(b) Must Be Read in Harmony with Rule 8(a)

It is worth emphasizing that Rule 9(b) and Rule 8(a) are children of the same parents: their pleading requirements only differ in degree, not in kind. "[T]his bite of Rule 9(b) was part of the pleading revolution of 1938" in which the drafters rejected arduous fact pleading in favor of providing simple notice. Williams v. WMX Techs., Inc., 112 F.3d 175, 178 (5th Cir. 1997). "[I]n applying rule 9(b) we must not lose sight of the fact that it must be reconciled with rule 8 which requires a short and concise statement of claims." Felton v. Walston & Co., 508 F.2d 577, 581 (2d Cir. 1974). Thus, in various ways, courts in this circuit and others have repeatedly emphasized that Rule 9(b) must be read in harmony with the principles established by Rule 8(a). See, e.g., Ouaknine v. MacFarlane, 897 F.2d 75, 79 (2d Cir. 1990) ("Rule 9(b) . . . must be read together with rule 8(a) which requires only a `short and plain statement' of the claims for relief."); DiVittorio, 822 F.2d at 1247 (same); Credit & Fin. Corp. v. Warner & Swasey Co., 638 F.2d 563, 566 (2d Cir. 1981) (same).*fn47

While a complaint may properly plead a cause of action under Rule 8(a) by stating "defendant negligently drove a motor vehicle against plaintiff," Fed.R.Civ.P. App. Form 9, plaintiff's mere incantation of "fraud" will not satisfy Rule 9(b)'s requirement of particularity. See, e.g., Segal v. Gordon, 467 F.2d 602, 606 (2d Cir. 1972). The additional requirements of Rule 9(b) were well described by Judge Frank Easterbrook when he wrote that "[particularity] means the who, what, when, where, and how: the first paragraph of any newspaper story." DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990) (emphasis added).

While Judge Easterbrook seems to suggest that good lawyers (or at least good reporters) should be able to write a claim of fraud in one paragraph, the Appendix to the Rules shows that it can be done in one sentence. Form 13 alleges fraud and satisfies Rule 9(b) by stating:

Defendant C. D. on or about [date given] conveyed all his property, real and personal [or specify and describe] to defendant E. F. for the purpose of defrauding plaintiff and hindering and delaying the collection of the indebtedness evidenced by the note above referred to.

Fed.R.Civ.P. App. Form 13. In less than fifty words, this model complaint answers the five questions posed by Judge Easterbrook:

• who: Defendant C. D.

• what: committed fraudulent conveyance (a type of fraud)

• when: on or about (date given)

• how: by conveying all his property, real and personal to E. F.
• why: for the purpose of hindering and delaying the collection of the indebtedness owed to plaintiff

"Official Form 13 demonstrates that even fraud may be pleaded without long or highly detailed particularity."*fn48 Guidry v. U.S. Tobacco Co., 188 F.3d 619, 632 (5th Cir. 1999).

VI. PLEADING SECURITIES FRAUD

A. Pleading Securities Fraud Before 1995

Courts have long held that complaints pleading securities fraud claims must comply with Rule 9(b) by stating the circumstances constituting fraud with particularity. See Segal, 467 F.2d at 607 (gathering citations). Unlike a pleading that satisfies Rule 8, a securities fraud claim is not properly pled if it merely repeats a statute or regulation verbatim. "A [securities] complaint cannot escape the charge that it is entirely conclusory in nature merely by quoting such words from the statutes as `artifices, schemes, and devices to defraud' and `scheme and conspiracy.'" Id. at 608. "To pass muster under [R]ule 9(b), the complaint must allege the time, place, speaker, and sometimes even the content of the alleged misrepresentation." Ouaknine, 897 F.2d at 79. See also Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993).

To prevail, plaintiffs must ultimately prove by a preponderance of the evidence that the defendant committed the alleged fraud (e.g., the misleading statement or omission) with scienter. When plaintiffs are at the pleading stage, however, scienter — "intent, knowledge, and other condition of mind" — "may be averred generally." Fed.R.Civ.P. 9(b).

Although Rule 9(b) states that scienter may be pleaded generally, for more than a generation the Second Circuit has required that plaintiffs also plead a factual basis that gives rise to a "strong inference" of fraudulent intent. The origins of this pleading requirement are found in Ross v. A.H. Robins Co., Inc., 607 F.2d 545 (2d Cir. 1979), where the court stated:

[A]t this stage of the litigation, we cannot realistically expect plaintiffs to be able to plead defendants' actual knowledge. On the other hand, plaintiffs can be required to supply a factual basis for their conclusory allegations regarding that knowledge. It is reasonable to require that the plaintiffs specifically plead those events which they assert give rise to a strong inference that the defendants had knowledge of the facts contained in paragraph 18 of the complaint or recklessly disregarded their existence. And, of course, plaintiffs must fix the time when these particular events occurred.

Id. at 558 (emphasis added). Over the next sixteen years, the Second Circuit repeatedly reaffirmed its holding that plaintiffs must provide a factual basis for their claims that defendants acted with fraudulent intent.*fn49

In 1987, the Second Circuit developed the doctrine further in Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46 (2d Cir. 1987), by holding that there are two ways for a plaintiff to plead facts supporting a "strong inference" that the defendant acted with scienter. First, the plaintiff could "allege facts showing a motive for committing fraud and a clear opportunity for doing so." Id. at 50. Second, "[w]here motive is not apparent, it is still possible to plead scienter by identifying circumstances indicating conscious behavior by the defendant, though the strength of the circumstantial allegations must be correspondingly greater." Id. (citations omitted).

B. Pleading Securities Fraud After the PSLRA

Recognizing that courts applied different standards to claims of securities fraud, Congress promulgated a nation-wide standard for pleading securities complaints in 1995 by enacting the PSLRA. The PSLRA imposes at least two pleading requirements on securities actions, referred to as paragraph (b)(1) and paragraph (b)(2). Paragraph (b)(1) applies to securities claims "in which the plaintiff alleges that the defendant" either "made an untrue statement of a material fact" or "omitted to state a material fact." 15 U.S.C. § 78u-4(b)(1). Paragraph (b)(2) applies to claims "in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind." 15 U.S.C. § 78u-4(b)(2).

1. Paragraph (b)(1)

Any claim that falls under paragraph (b)(1)'s purview must "[1] specify each statement alleged to have been misleading, [2] the reason or reasons why the statement is misleading, and [3], if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). Plaintiffs' burden with respect to the first two requirements of paragraph (b)(1) is self-evident. In order to plead a claim, a plaintiff cannot generically aver that the defendant made a material misstatement or omission, nor may she merely copy the language of the statute. Rather, plaintiff must specifically plead the statements or omissions that give rise to her cause of action and then explain why they were false or misleading. These pleadings then serve as binding judicial admissions that control the plaintiff's case throughout the course of the proceedings.

The requirements of paragraph (b)(1)'s third element are not as obvious. To begin, the third requirement does not apply to all allegations but rather only "if an allegation regarding the statement or omission is made on information and belief." 15 U.S.C. § 78u-4(b)(1). As the Second Circuit has explained: "Allegations of fraud cannot ordinarily be based `upon information and belief,' except as to `matters peculiarly within the opposing party's knowledge.'" Luce v. Edelstein, 802 F.2d 49, 54 n. 1 (2d Cir. 1986) (quoting Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 379 (2d Cir. 1974), overruled on other grounds by Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1100 n. 9, 1100-06 (1991)). See also Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990) ("[A]llegations may be based on information and belief when facts are peculiarly within the opposing party's knowledge."); Stern v. Leucadia Nat'l Corp., 844 F.2d 997, 1003 (2d Cir. 1988) (same).

In turn, "whenever plaintiffs allege, on information and belief, that defendants made material misstatements or omissions, the complaint must `state with particularity all facts on which that belief is formed.'" Novak, 216 F.3d at 312 (quoting 15 U.S.C. § 78u-4(b)(1)) (emphasis added). In Novak, however, the Second Circuit found that "notwithstanding the use of the word `all,' paragraph (b)(1) does not require that plaintiffs plead with particularity every single fact upon which their beliefs concerning false or misleading statements are based." Id. at 313. The Second Circuit's "reading of the provision focuses on whether the facts alleged are sufficient to support a reasonable belief as to the misleading nature of the statement or omission." Id. at 314 n. 1 (emphasis added). Under Novak, "plaintiffs need only plead with particularity sufficient facts to support those beliefs."*fn50 Id. at 313-14 (emphasis in original).

To summarize, two threshold questions must be answered to determine whether paragraph (b)(1)'s third element applies: First, which allegations regarding the statement or omission are made on information and belief?*fn51 Second, are those the types of allegations that may be alleged on information and belief?

If plaintiff has put forward allegations on information and belief, then whether paragraph (b)(1)'s third element is met raises three additional questions: First, what facts have the plaintiffs put forward to support that belief? Second, have the plaintiffs stated those facts with particularity? Third, are those "sufficient facts to support those beliefs[?]" Novak, 216 F.3d at 313-14.

2. Paragraph (b)(2)

Paragraph (b)(2) requires the plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). In Novak, the Second Circuit held that this requirement may be satisfied in one of two ways: the plaintiffs may plead "motive and opportunity to commit fraud" or "strong circumstantial evidence of conscious misbehavior or recklessness." See Novak, 216 F.3d at 310-11.

This is, of course, nothing more than a restatement of the Second Circuit's case law prior to 1995. The Novak court reached this holding after reviewing the text and legislative history, and ultimately concluded that when Congress passed the PSLRA, it settled the disagreement between the circuits in favor of the Second Circuit's pleading standard. See id.*fn52 In promulgating the PSLRA, Congress recognized that the Second Circuit's "pre-PSLRA standard was the most stringent in the nation." Id. at 310.

Given that the PSLRA adopts the Second Circuit's pre-1995 pleading standards,

our prior case law may be helpful in providing guidance as to how the "strong inference" standard may be met. Therefore, in applying this standard, district courts should look to the cases and factors discussed [in the case law] to determine whether plaintiffs have pleaded facts giving rise to the requisite "strong inference." These cases suggest, in brief, that the inference may arise where the complaint sufficiently alleges that the defendants: (1) benefitted in a concrete and personal way from the purported fraud, (2) engaged in deliberately illegal behavior, (3) knew facts or had access to information suggesting that their public statements were not accurate; or (4) failed to check information they had a duty to monitor.

Id. at 311 (citations omitted).

VII. PRELIMINARY ISSUES

Before turning to Defendants' arguments as to why each of Plaintiffs' claims should be dismissed, it is necessary to address some preliminary pleading issues. In addition, I will address the Defendants' argument that the pleadings should be dismissed because they are vague and incomprehensible. See, e.g., 1 Und. Mem. at 18-31.

A. Standard of Review

1. The Court Must Take the Pleadings as True and Draw All Inferences in Plaintiffs'

Favor A motion to dismiss under Rule 12 should be granted only if "`it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Weixel v. Board of Educ. of New York, 287 F.3d 138, 145 (2d Cir. 2002) (quoting Conley, 355 U.S. at 45-46 (alterations omitted)). At the motion to dismiss stage, the issue "`is not whether a plaintiff is likely to prevail ultimately, but whether the claimant is entitled to offer evidence to support the claims. Indeed it may appear on the face of the pleading that a recovery is very remote and unlikely but that is not the test.'" Phelps v. Kapnolas, 308 F.3d 180, 184-85 (2d Cir. 2002) (quoting Chance v. Armstrong, 143 F.3d 698, 701 (2d Cir. 1998)).

The task of the court in ruling on a Rule 12(b)(6) motion is "`merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof.'" Pierce v. Marano, No. 01 Civ. 3410, 2002 WL 1858772, at *3 (S.D.N.Y. Aug. 13, 2002) (quoting Saunders v. Coughlin, No. 92 Civ. 4289, 1994 WL 98108, at *2 (S.D.N.Y. Mar. 15, 1994)). When deciding a motion to dismiss pursuant to Rule 12(b)(6), courts must accept all factual allegations in the complaint as true and draw all reasonable inferences in plaintiff's favor. See Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002). Courts may not consider matters outside the pleadings but may consider documents attached to the pleadings, documents referenced in the pleadings, or documents that are integral to the pleadings. See id. at 152-53; see also Fed.R.Civ.P. 10(c).

2. Both the Defendants and the Court Must Accept the Complaints as Pled

Throughout their briefs, the Defendants refashion and redraft much of the Complaints, then argue for the dismissal of claims that are not in those Complaints. For example, the Underwriters' third and fifth briefs are respectively entitled "Memorandum in Support of the Underwriter Defendants' Motion to Dismiss Undisclosed Compensation Claims," 3 Und. Mem. (emphasis added), and "Memorandum in Support of the Underwriter Defendants' Motion to Dismiss All Analyst Claims," 5 Und. Mem. (emphasis added).*fn53 These briefs then argue that these "claims" should be dismissed.

A plain reading of the Complaint shows that there are no such claims. For example, the Cacheflow Complaint explicitly alleges six claims and even highlights the claims with headings that are bolded, underlined and capitalized. The third cause of action in the Cacheflow Complaint has the following heading: "THIRD CLAIM (FOR VIOLATIONS OF SECTION 10(b) AND RULE 10b-5 THEREUNDER AGAINST THE ALLOCATING UNDERWRITER DEFENDANTS BASED UPON DECEPTIVE AND MANIPULATIVE PRACTICES IN CONNECTION WITH THE IPO)". Cacheflow Compl. at 23. In similar fashion, each claim brought by the Plaintiffs in Cacheflow relates to alleged statutory violations committed by the Defendants; each claim contains a heading that removes any ambiguity. See supra Part IV.A.3.

While it is perfectly proper to use shorthand phrases to describe these claims, the Defendants have rewritten the Complaints in a way that they believe favors dismissal. It must be remembered, however, that Plaintiffs are the master of their complaint and "neither this Court nor the defendant have the right to redraft the complaint to include new claims."*fn54 MDCM Holdings, 216 F. Supp.2d at 258. Defendants must take the Complaints as they are written.

3. Clarity of Pleadings Is Not a Factor in Dismissal

The Defendants also argue at great length that the Complaints should be dismissed because they are "incomprehensible," "too vague" and "meaningless." 1 Und. Mem. at 18-31. This argument has no merit. The Complaints are written in plain English and are well drafted by competent counsel. No one should have any trouble understanding what has been alleged. See supra Part IV (summarizing the Complaints). Moreover, this failure, if it exists, is not a ground for Rule 12(b)(6) dismissal. If the Defendants were truly perplexed by the Complaints, they should have filed a motion under Rule 12(e), which states:

If a pleading to which a responsive pleading is permitted is so vague or ambiguous that a party cannot reasonably be required to frame a responsive pleading, the party may move for a more definite statement before interposing a responsive pleading. The motion shall point out the defects complained of and the details desired. If the motion is granted and the order of the court is not obeyed within 10 days after notice of the order or within such other time as the court may fix, the court may strike the pleading to which the motion was directed or make such order as it deems just.

Fed.R.Civ.P. 12(e).*fn55 "Perhaps tellingly," the Defendants "made no such motion here," Langadinos, 199 F.3d at 73 n. 6 (discussing Rule 12(e)), nor would such motion have been granted. See also Swierkiewicz, 534 U.S. at 514 (same).

B. The Pleading Standards for Some of the Claims Are Governed by the PSLRA; Others Are Governed by Both the PSLRA and the Federal Rules

Defendants argue in part that the Complaints are not properly pled under Rule 9(b) and the PSLRA. While the parties apparently assumed that both the Rule and the PSLRA applied to these pleadings, recent appellate decisions cast some doubt on this assumption. See In re Navarre Corp. Sec. Litig., 299 F.3d 735, 742 (8th Cir. 2002) ("Contrary to the district court's analysis, the investors technically do not need to meet the requirements of both Federal Rule of Civil Procedure 9(b) and the PSLRA, as the PSLRA supercedes reliance on 9(b) in securities fraud cases and embodies the standards of 9(b).") (emphasis in original) (citing Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1034 n. 12 (9th Cir. 2002)); City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1255 n. 13 (10th Cir. 2001); Greebel v. FTP Software, Inc., 194 F.3d 185, 193-94 (1st Cir. 1999); see also Advanta, 180 F.3d at 531.

1. The Differences Between the Scope of the PSLRA's Pleading Requirements and Rule 9(b)

While the parties have treated the requirements of the Rule and the PSLRA as interchangeable, a plain reading of the two provisions shows they are in fact quite different. The most significant difference lies in the claims they cover. Rule 9(b) applies to "all averments of fraud," Fed.R.Civ.P. 9(b) (emphasis added) including, of course, all claims of securities fraud.*fn56

In stark contrast, paragraph (b)(1) of the PSLRA only applies to a subset of claims brought under the Exchange Act. In particular, it applies to "any private action arising under this chapter [of the Exchange Act] in which the plaintiff alleges that the defendant"

(A) made an untrue statement of a material fact; or

(B) omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading.

15 U.S.C. § 78u-4(b)(1).

Consider, for example, Rule 10b-5, which makes it unlawful:

(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5(a)-(c) (emphasis added). While claims brought under Rule 10b-5(b) must always satisfy paragraph (b)(1)'s statutory requirement, claims brought under Rule 10b-5(a) or 10b-5(c) need not if they do not rely upon misstatements or omissions (e.g., if they allege market manipulation).

Paragraph (b)(2) applies to "any private action arising under this chapter [of the Exchange Act] in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind." 15 U.S.C. § 78u-4(b)(2). In contrast to paragraph (b)(1), all claims brought under Rule 10b-5 must satisfy paragraph (b)(2) because all such claims require proof that defendant acted with an intentional or reckless state of mind. See, e.g., Novak, 216 F.3d at 308.

2. The Federal Rules Still Apply to Certain Types of Securities Fraud Claims

Given that Rule 9(b) and the PSLRA differ in scope, a pivotal question is whether the Plaintiffs "need to meet the requirements of both Federal Rule of Civil Procedure 9(b) and the PSLRA." Navarre, 299 F.3d at 742 (emphasis in original). With respect to those requirements specifically imposed by paragraphs (b)(1) and (b)(2) of the PSLRA — pleading facts suggesting scienter and specifying the material misstatements and omissions — plaintiffs only need to satisfy the PSLRA. If Congress intended that paragraph (b) set a pleading standard that is higher or the equivalent of Rule 9(b) for these elements of securities fraud, then the requirements of the Rule are subsumed by the PSLRA. On the other hand, if Congress intended to set a pleading standard that is lower than Rule 9(b), that standard must govern because a statute supercedes a Rule when the two are in conflict. See Jackson v. Stinnett, 102 F.3d 132, 134 (5th Cir. 1996). See also Advanta, 180 F.3d at 531 n. 5 ("the Reform Act supersedes Rule 9(b)").

However, this leaves the question of whether Congress intended that the PSLRA supercede Rule 9(b) with regard to the remaining elements of a securities fraud claim. Consider, for example, Rule 10b-5(a) claims in which a plaintiff alleges that the defendant has "employ[ed] [a] device, scheme, or artifice to defraud." 17 C.F.R. § 240.10b-5(a). The answer is not difficult. Congress intended that the PSLRA supercede the Federal Rules only as to those elements which the PSLRA explicitly mentions (i.e., scienter and material misstatements and omissions). See S. Rep. No. 104-98, at 15. In all other respects, the Rules govern these pleadings.

3. Summary

Given that both the PSLRA and Rule 9(b) apply to claims of securities fraud — although never at the same time to the same element — it is necessary for litigants to be precise when challenging or defending a claim.*fn57 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. Each of these claims trigger the PSLRA and Rule 9(b), but in different ways.

In this regard, the following standards will apply:

1. Market manipulation under Rule 10b-5(a) or Rule 10b-5(c): Plaintiffs must satisfy Rule 9(b) by stating "the circumstances constituting fraud . . . with particularity." Fed. R. Civ. P. 9(b). Because plaintiffs must ultimately prove scienter to prevail, paragraph (b)(2) of the PSLRA also applies to this claim. Thus, the complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2).

2. Material omissions and misstatements under Rule 10b-5(b): Plaintiffs must satisfy both paragraph (b)(1) and (b)(2) of the PSLRA. It is unnecessary, however, for courts to analyze the "circumstances constituting fraud" under Rule 9(b).*fn58

In both cases, Rule 9(b) governs the pleading of the remaining elements of the claims: loss causation, transaction causation, reliance and damages.

APPLICATION OF LEGAL PRINCIPLES

With these governing legal principles firmly in mind, I will now, finally, address Defendants' motions. In order to prevail, Defendants must demonstrate that Plaintiffs have failed to meet their pleading burdens or have failed to state their claims as a matter of law.

VIII. SECTION 11 CLAIMS

A. The Section 11 Claims Have Been Properly Pled

Plaintiffs' first claims allege violations of Section 11 by the Underwriters, Issuers and Individual Officers.*fn59 See Part IV.A (summarizing Cacheflow Compl. ¶¶ 60-68). Section 11(a) states in pertinent part:

In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may . . . sue —

(1) every person who signed the registration statement;

(2) every person who was a director of (or person performing similar functions) or partner in the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted;
(3) every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner;

(5) every underwriter with respect to such security.

15 U.S.C. § 77k(a) (emphasis added).

As the Supreme Court has explained:

Section 11 of the 1933 Act allows purchasers of a registered security to sue certain enumerated parties in a registered offering when false or misleading information is included in a registration statement. The section was designed to assure compliance with the disclosure provisions of the Act by imposing a stringent standard of liability on the parties who play a direct role in a registered offering.

Herman & MacLean v. Huddleston, 459 U.S. 375, 381-82 (1983) (footnotes omitted). Under Section 11, a plaintiff need not prove that the defendants acted with scienter; "he need only show a material misstatement or omission to establish his prima facie case." Id. at 382 (emphasis added). "Although limited in scope, § 11 places a relatively minimal burden on a plaintiff." Id.

Defendants identify three pleading deficiencies in Plaintiffs' Section 11 claims. First, the Underwriters argue that Rule 9(b)'s heightened pleading standards apply to the Section 11 claims because they "sound in fraud" and that Plaintiffs have not satisfied this burden. 1 Und. Mem. at 15.

Second, the Underwriters assert that those Plaintiffs who bought their shares after the initial twelve months' earning statements were issued should be dismissed for failure to allege reliance.

See 6 Und. Mem. at 2-3. Third, the Issuers and Individual Defendants argue that the Plaintiffs fail to allege that these Defendants knew about the information that was omitted from the registration statement. See Iss. Mem. at 50-55. For the reasons discussed below, these arguments have no merit.

1. The PSLRA's Pleading Standards Do Not Apply to Claims Brought Under the Securities Act

Whether the heightened pleading requirements of the PSLRA apply to Section 11 turns on the interpretation of the phrase "any private action arising under this chapter." 15 U.S.C. § 78u-4(b)(1),(2) (emphasis added). When taken out of context, "under this chapter" is ambiguous because 15 U.S.C. § 78u-4(b) is found under Chapter 2B of Title 15 of the United States Code and entitled "Securities Exchanges." That is, all Exchange Act claims fall under Chapter 2B of Title 15. In contrast, Chapter 2A of Title 15 is entitled "Securities and Trust Indentures" and contains all of the Securities Act claims.

The question, then, is whether the phrase "under this chapter" refers to Chapter 2B (and thus paragraph (b) only applies to Exchange Act claims) or whether it refers to Chapter 2 (and thus paragraph (b) also applies to Securities Act claims).

However, if the statute's full text and structure are considered, see United States Nat'l Bank of Oregon v. Independent Ins. Agents of Am. Inc., 508 U.S. 439, 454-55 (1993), then there is no ambiguity: Congress only intended paragraph (b) of 15 U.S.C. § 78u-4 to apply to Exchange Act claims.

First, paragraph (b) is entitled: "Requirements for securities fraud actions." 15 U.S.C. § 78u-4(b). Securities fraud claims can be brought only under the Exchange Act (and regulations promulgated thereunder). See supra notes 13 and 56.

The title of paragraph (b) is therefore a strong indicator that Congress only intended it to apply to Exchange Act claims. See INS v. National Ctr. for Immigrants' Rights, Inc., 502 U.S. 183, 189 (1991) ("[T]he title of a statute or section can aid in resolving an ambiguity in the legislation's text."); United States v. Fisher, 6 U.S. (2 Cranch) 358, 386 (1805) (Marshall, C.J.) ("Where the mind labours to discover the design of the legislature, it seizes every thing from which aid can be derived; and in such case the title claims a degree of notice, and will have its due share of consideration.").

Second, and more important, in enacting the PSLRA Congress repeatedly treated the Securities Act and the Exchange Act as separate chapters. See 15 U.S.C. § 77z-1(a)(2)-(3), 78u-4(a)(2)-(3) (identical provisions concerning plaintiff certifications, appointment of lead plaintiffs, selection of lead counsel, restrictions on plaintiffs); id. §§ 77z-1(c), 78u-4(c) (identical provisions concerning sanctions for abusive litigation); id. §§ 77z-1(d), 78u-4(d) (identical provision concerning defendant's right to written jury interrogatories).

If this Court were to interpret "under this chapter" as used throughout 15 U.S.C. § 78u-4 to include the Securities Act, each of these identical provisions in the Securities Act would be entirely superfluous.*fn60 United States v. Nordic Vill., Inc., 503 U.S. 30, 36 (1992) ("a statute must, if possible, be construed in such fashion that every word has some operative effect."). See also Market Co. v. Hoffman, 101 U.S. 112, 115-16 (1879).

In sum, because the phrase "under this chapter" as used throughout 15 U.S.C. § 78u-4 only refers to the Exchange Act, the PSLRA pleading requirements have no application to claims that arise under Section 11 or other provisions of the Securities Act (e.g., Section 15).

2. Rule 8(a) Applies to Section 11

Rather than contend that Plaintiffs' Section 11 claims must satisfy the PSLRA, Defendants seek to impose a heightened pleading standard through the Federal Rules. "Because the Section 11 claims asserted here `sound in fraud,'" Defendants contend, "they must be pled in accordance with the heightened pleading standards imposed by Federal Rule of Civil Procedure Rule 9(b)." 1 Und. Mem. at 15 (citing Ellison v. American Image Motor Co., 36 F. Supp.2d 628, 639 (S.D.N.Y. 1999); Schoenhaut v. American Sensors, Inc., 986 F. Supp. 785, 795 n. 13 (S.D.N.Y. 1997); In re Chaus Sec. Litig., No. 88 Civ. 8641, 1990 WL 188921, at *10 (S.D.N.Y. Nov. 20, 1990)).

Defendants argue that several circuit courts have recognized the sound in fraud doctrine.*fn62 But this argument is somewhat exaggerated. See 11/1/02 Tr. at 205 (statement of Mark Holland that "the Ninth, the Fifth, the Third, and the Seventh" Circuits have adopted the sound in fraud doctrine, while "the Eighth Circuit goes the other way").

While the Seventh Circuit discussed the application of Rule 9(b) to Section 16(a) and Section 20 claims in Sears v. Likens, 912 F.2d 889, 893 (7th Cir. 1990), the district courts in that Circuit have refused to apply Sears to the ground that the circuit's reference to Rule 9(b) was pure dictum.*fn63 The clear holding in Sears is that the securities at issue in the case were "exempt from the provisions of the Securities Act." Sears, 912 F.2d at 892. Having disposed of the Securities Act claims on this basis, there was plainly no need to hold that Rule 9(b) governs the Section 11 claims or that the plaintiffs failed to meet that requirement.

Meanwhile, in recent years the Fifth and Third Circuits have taken steps to substantially undercut the application of the sound in fraud doctrine. In the Fifth Circuit, plaintiffs who explicitly disavow any allegation of fraud in connection with their Section 11 claim only need to satisfy Rule 8(a).*fn64 Likewise, the Third Circuit has signaled its intention to follow the Fifth Circuit by allowing plaintiffs to explicitly disavow fraud in pleading Section 11 claims.*fn65

At the time that the parties briefed the instant motions, only the Ninth Circuit had taken an unequivocal stance on the sound in fraud doctrine by stating that Rule 9(b) should apply even if a plaintiff explicitly disavows fraud in connection with its Section 11 claim. See In re Stac Elec. Sec. Litig., 89 F.3d 1399, 1405 n. 2 (9th Cir. 1996). The Ninth Circuit has now signaled its desire to move away from rigid application of the sound in fraud doctrine. In Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, No. 01-55834, 2003 WL 203124 (9th Cir. Jan. 31, 2003), the court explained that in a case where fraud is not an essential

element of the claim, and where allegations of both fraudulent and non-fraudulent conduct are made in the complaint . . . particular averments of fraud [that] are insufficiently pled under Rule 9(b) . . . should be disregard[ed] . . . or strip[ped] [] from the claim. The court should then examine the allegations that remain to determine whether they state a claim.

Id. at *5-6 (emphasis added). Thus, Rule 9(b) no longer applies to all allegations in a Section 11 claim; it applies only to the actual "averments of fraud." Id. at *5.

The Ninth Circuit is the only circuit court that has provided any rationale for its decision to accept the sound in fraud doctrine: "`Rule 9(b) serves to . . . protect professionals from the harm that comes from being subject to fraud charges.' Fraud allegations may damage a defendant's reputation regardless of the cause of action in which they appear, and they are therefore properly subject to Rule 9(b) in every case." Vess, 2003 WL 203124, at *5 (quoting Stac Elec., 89 F.3d at 1405) (ellipsis in original) (citations omitted). But even if these policy considerations apply with the same force to a claim that does not require proof of scienter, the Supreme Court has made it clear that such considerations are never a valid reason to stray from the language of the applicable statute or Rule. "Whatever merits these and other policy arguments may have, it is not the province of [the courts] to rewrite the statute [or Rules] to accommodate them." Artuz v. Bennett, 531 U.S. 4, 10 (2000). See also Badaracco v. Commissioner, 464 U.S. 386, 398 (1984) ("Courts are not authorized to rewrite a statute because they might deem its effects susceptible of improvement.").

Indeed, in the last decade the Supreme Court has twice admonished the lower courts for augmenting federal pleading requirements: "A requirement of greater specificity for particular claims is a result that `must be obtained by the process of amending the Federal Rules, and not by judicial interpretation.'" Swierkiewicz, 534 U.S. at 515 (quoting Leatherman, 507 U.S. at 168) (emphasis added). In fact, in Swierkiewicz, the Defendant tried to persuade the Court on policy grounds by asserting that "allowing lawsuits based on conclusory allegations of discrimination to go forward will burden the courts and encourage disgruntled employees to bring unsubstantiated suits." Id. at 514. The Court responded: "Whatever the practical merits of this argument, the Federal Rules do not contain a heightened pleading standard for employment discrimination suits." Id. at 514-15.*fn66

Plaintiffs rely on those cases that have allowed litigants to explicitly disclaim any allegations of fraud in connection with their Section 11 claims, as Plaintiffs have, in order to avoid Rule 9(b)'s heightened pleading standard. See 3 Pl. Mem. at 2 n. 4; see also Lone Star Ladies, 238 F.3d at 369; Westinghouse, 90 F.3d at 717. But it is obvious from the Complaints that Plaintiffs' disclaimer is superficial.*fn67 See, e.g., Cacheflow Compl. ¶ 60 ("Plaintiffs repeat and reallege the allegations set forth above as if set forth fully herein, except to the extent that any such allegation may be deemed to sound in fraud."). Ultimately, if Plaintiffs are to prevail on their Section 11 claims, they will necessarily have to prove factual allegations that also give rise to their claims of securities fraud under Rule 10b-5.*fn68 Thus, if Plaintiffs recover damages under Section 11, they will have proved that the Allocating Underwriters manipulated the market with Tie-in Agreements, a violation of Rule 10b-5(a), as well as intentionally made misstatements and omissions in the registration statements, a violation of Rule 10b-5(b). In this sense, the Section 11 claims are "grounded" in their fraud claims in a way that cannot be simply disavowed by the Plaintiffs.

This does not mean, however, that a heightened pleading standard applies to Plaintiffs' Section 11 claims. Whether Rule 8(a) or 9(b) is triggered turns on the type of claim alleged (i.e., the cause of action) rather than the factual allegations on which that claim is based.*fn69 That courts must look at the type of claim being alleged to determine which Rule applies is obvious from the plain language of Rule 8, which states that a "pleading which sets forth a claim for relief, whether an original claim, counterclaim, cross-claim, or third-party claim, shall contain . . . a short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8 (emphasis added).*fn70 Likewise, Rule 9(b) only applies to claims that fall under the category of fraud or mistake. Because a Section 11 claim is not a fraud claim, Rule 8(a) applies. That the same factual allegations also give rise to a Rule 10b-5 claim is irrelevant to this analysis.

That being so, just as the half-page model complaints in the Appendix to the Federal Rules of Civil Procedure satisfy the pleading requirements of the Federal Rules, see Fed.R. Civ. P. 84, Plaintiffs' allegations here are sufficient to state a Section 11 claim against each of the Defendants. See, e.g., Cacheflow Compl. ¶¶ 1, 5, 6, 9, 61.

3. Plaintiffs Need Not Plead Reliance in Order to State Certain of Their Section 11 Claims

Section 11(a) requires that if a plaintiff acquires the security

after the issuer has made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right of recovery under this subsection shall be conditioned on proof that such person acquired the security relying upon such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by such person.

15 U.S.C. § 77k(a) (emphasis added). Defendants argue that in approximately a dozen of these coordinated cases, "plaintiffs . . . purchased their shares after the issuers made available an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement." 6 Und. Mem. at 3. "None of those plaintiffs allege that they relied upon the registration statement they claim was misleading." Id. "As a result," Underwriters argue, "those claims should be dismissed." Id.

This argument has no merit because Rule 8 does not require plaintiffs to plead the elements of a claim. See supra Part V.A. Just as plaintiffs do not need to allege causation in order to plead a negligence claim (even though a plaintiff must ultimately prove causation to prevail), see Fed.R.Civ.P. App. Form 9, plaintiffs do not need to allege reliance on a registration statement to plead a Section 11 claim. See, e.g., In re MobileMedia Sec. Litig., 28 F. Supp.2d 901, 923 (D.N.J. 1998) ("A plaintiff need not plead fraud, reliance, motive, intent, knowledge or scienter under Section 11."). Indeed, given that the Underwriter Defendants do not claim they lack notice of the Section 11 claim, or that there are no set of facts under which plaintiffs could prevail, their argument must be rejected.

4. Plaintiffs Need Not Plead that the Issuers and Individual Defendants Had Knowledge in Order to State Section 11 Claims Against Those Defendants

Section 11 "was designed to assure compliance with the disclosure provisions of the [Securities] Act by imposing a stringent standard of liability on the parties who play a direct role in a registered offering." Herman & MacLean, 459 U.S. at 381-82 (footnotes omitted). The Supreme Court has held that, "[l]iability against the issuer of a security is virtually absolute" while "[o]ther defendants bear the burden of demonstrating due diligence." Id. at 382 (emphasis added). See also AnnTaylor Stores, 807 F. Supp. at 998 ("An issuer has absolute liability for any misrepresentations or omissions; the underwriters and signatories have an affirmative due diligence defense.") (emphasis added).

Because intent to defraud is not an element in a Section 11 claim, "only a material misstatement or omission need be shown to establish a prima facie case, and scienter need not be alleged." Degulis v. LXR Biotechnology, Inc., 928 F. Supp. 1301, 1310 (S.D.N.Y. 1996). See also In re Twinlab Corp. Sec. Litig., 103 F. Supp.2d 193, 201 (E.D.N.Y. 2000) ("Section 11 `places a relatively minimal burden on a plaintiff,' requiring simply that the plaintiff allege that he purchased the security and that the registration statement contains false or misleading statements concerning a material fact.") (quoting Herman & MacLean, 459 U.S. at 381-82). Because there is no scienter requirement in Section 11, Plaintiffs need not plead that the Defendants had knowledge of the alleged omission. See In re Turkcell Iletisim Hismetler, A.S. Sec. Litig., 202 F. Supp.2d 8, 12 (S.D.N.Y. 2001); see also Degulis v. LXR Biotechnology, Inc., No. 95 Civ. 4204, 1997 WL 20832, at *3 (S.D.N.Y. Jan. 21, 1997) ("[T]o make out a prima facie case at the pleadings stage, Plaintiffs need only allege a material misstatement or omission. Neither knowledge nor reason to know is an element in a plaintiff's prima facie case.").

Defendants cite In re Adams Golf, Inc. Sec. Litig., 176 F. Supp.2d 216 (D.Del. 2001), and In re Ultimate Corp. Sec. Litig., No. 86 Civ. 5944, 1989 WL 86961 (S.D.N.Y. June 30, 1989) (mem.), in support of their argument that Plaintiffs must plead that the Issuers and Individual Defendants had knowledge of the alleged omissions at the time of the IPO. See Iss. Mem. at 50-53. Defendants' reliance on these cases is misplaced. Ultimate decided a motion for summary judgment and thus provides little guidance at the pleading stage. Adams Golf is easily distinguished. The court granted a motion to dismiss in that case because it concluded that neither of the alleged omissions was actionable as a matter of law: one omission was simply not material, see Adams Golf, 176 F. Supp.2d at 234, and the other was a forward looking statement (i.e., something which could not have been known at the time of the omission), id. (citing Zucker v. Quasha, 891 F. Supp. 1010, 1014 (D.N.J. 1995)).*fn71 Here, all of the alleged misrepresentations are actionable. See infra Part X.B.

While some Defendants may raise an affirmative defense that the alleged omission concerned information of which it was unaware, and which it could not have discovered by the exercise of reasonable care, see Herman & MacLean, 459 U.S. at 382; AnnTaylor Stores, 807 F. Supp. at 998, Plaintiffs need not plead the converse — namely, that Defendants had the requisite knowledge. Accordingly, Plaintiffs have sufficiently pled their Section 11 claims.
B. Most Plaintiffs Have Stated Section 11 Claims Upon Which Relief May Be Granted

1. Plaintiffs Have Standing

Section 11 creates a right of action for "any person" acquiring a security offered pursuant to a misleading registration statement. 15 U.S.C. § 77k(a). Nonetheless, Underwriters argue that only individuals who purchase in the initial offering (as opposed to the aftermarket) may assert a claim. See 6 Und. Mem. at 8; 6 Und. Reply at 4-8.*fn72

The Court of Appeals has now definitively held otherwise: "aftermarket purchasers who can trace their shares to an allegedly misleading registration statement have standing to sue under § 11 of the 1933 Act." DeMaria v. Andersen, No. 01-7505, 2003 WL 174543, at *7 (2d Cir. Jan. 28, 2003). Accord Lee v. Ernst & Young, LLP, 294 F.3d 969, 976-78 (8th Cir. 2002); Joseph v. Wiles, 223 F.3d 1155, 1158 (10th Cir. 2000); Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1079-82 (9th Cir. 1999). See also Milman, 192 F.R.D. at 107 ("a secondary market purchaser who can trace her securities to a registered offering may bring suit under [section] 11"). Because Plaintiffs allege that their shares are traceable to the allegedly misleading registration statements, see, e.g., Cacheflow Compl. ¶¶ 12, 61, they unquestionably have standing.

2. Plaintiffs Have Not Pled Allegations of Knowledge Inconsistent with Their Claims

"Although reliance ordinarily need not be pled to state a Section 11 claim, under Section 11(a) a plaintiff has no claim if `it is proved that at the time of such acquisition he knew of such untruth or omission.'" 2 Und. Mem. at 9 (quoting McMahan & Co. v. Wherehouse Entm't, Inc., 65 F.3d 1044, 1047 (2d Cir. 1995)) (emphasis added). See also 15 U.S.C. § 77k(a) (providing that when a registration statement has a material misstatement or omission "any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may . . . sue [the following groups]" (emphasis added)). "Here," the Underwriters argue, "the pleadings allege on their face `common knowledge' of the alleged misrepresentation." 2 Und. Mem. at 9. "Because a court may properly dismiss a claim on the pleadings when an affirmative defense appears on its face, the Section 11 claims should be dismissed." Id. (quotation marks and citation omitted).

While the Underwriters are correct that Plaintiffs may plead themselves out of court by pleading information that defeats their legal claim because a complaint is a binding judicial admission, see supra note 43 and accompanying text, they are incorrect in their assertion that Plaintiffs have done so here. A fair reading of the Master Allegations shows that Plaintiffs have merely pled the alleged scheme was "common knowledge" among the customers who received the initial distribution of stock from the Underwriters (e.g., those who were required to enter into Tie-in Agreements). In contrast, the Plaintiffs in these cases are investors who bought the IPO stock in the aftermarket, not customers who were allocated the initial stock.*fn73 See, e.g., Cacheflow Compl. ¶ 12 (listing Plaintiffs Val Kay, Greg Frick, Eric Egelman, and Kenneth L. Schmid who purchased or otherwise acquired shares of Cacheflow common stock). Indeed, "[t]he vast majority of [the] plaintiffs in fact are retail purchasers in the aftermarket," although some institutional investors who bought stock in the aftermarket have also brought suit. See 11/1/02 Tr. at 32.

The pertinent allegations to which the Underwriters refer in making their "common knowledge" argument are paragraphs thirty through thirty-three of the Master Allegation. See 2 Und. Mem. at 2 (quoting parts of MA ¶¶ 30-33). Those paragraphs state in full:

30. Institutional and retail investors, who have received allocations in initial public offerings from various firms, have noted that it was common knowledge that the clients who were forced to pay Undisclosed Compensation to the underwriters, in the form of commissions or otherwise, and who agreed to purchase in the aftermarket received allocations in the IPO.
31. This industry-wide understanding was sometimes expressed by the Underwriter Defendants and other times implied, but nevertheless invariably communicated between those with the power to make allocations of shares in initial public offerings (the underwriters). . . .
32. For example, "Michael Sola, portfolio manager for T. Rowe Price's Developing Technology Fund, explained to USA Today [May 25, 2001] how the game was played. He said that `people know that the higher they say they are willing to buy the stock (in the after market), the bigger the allocation [of IPO shares] they are going to get.'" [Testimony of David W. Tice, David W. Tice & Associates, Inc., before the House Committee on Financial Services, Capital Markets, Insurance and Government Sponsored Enterprises Subcommittee, June 14, 2001].
33. Even institutional investors generally considered to be medium or large in terms of amount of assets under management, were told by Underwriter Defendants, in words or substance, that in order to receive IPO allocations, they had to commit to buying additional shares in the aftermarket.

MA ¶¶ 30-33 (emphasis added). When read in context, there is no ambiguity as to who had "common knowledge" of the alleged scheme: the Underwriters and their customers. See id. This allegation is entirely consistent with the Plaintiffs' allegations that in 309 IPOs, Underwriters repeatedly required their customers who received IPO stock (e.g., T. Rowe Price's Developing Technology Fund, medium, and large institutional investors) to enter into Tie-in Agreements and pay Undisclosed Compensation. At the same time, there is no concession that investors in the aftermarket — i.e., the Plaintiffs in these cases — knew about this scheme.

In arguing that the Plaintiffs have pled themselves out of court, the Underwriters point to the allegation that institutional and retail investors knew about the scheme, and thus all retail investors must have known about the scheme. See 11/1/02 Tr. at 31 (David W. Ichel stating: "It says also retail investors."). However, this interpretation reads the words "retail investor" out of context. The sentence to which the Underwriters refer states: "Institutional and retail investors, who have received allocations in initial public offerings from various firms. . . ." MA ¶ 30 (emphasis added). While it is true that Plaintiffs have pled that at least some retail investors knew about the scheme, this group is plainly limited to those investors who received stock from the Underwriters in the IPO.*fn74

The Underwriters' argument would only have merit if the Complaints had alleged that the scheme was common knowledge among all investors. But not only is there no such allegation, such an allegation would not be reasonable given that investors who buy stock in the initial allocation generally have more knowledge of the IPO process than investors who purchase stock in the aftermarket. Indeed, the SEC has long defended the importance of securities law on the ground that investors in the aftermarket have a much lower level of sophistication and knowledge about the IPO process than initial purchasers. See, e.g., SEC Special Study at 556 (arguing that disclosure provisions of the Securities Act are particularly important because "persons who bought in the after-market often [are] less sophisticated [than customers who received original allotments] and more susceptible to the allure of publicity and rumor about `hot issues.'"); SEC Hot Issues Report at 9 (same).

Nor does the allegation that the scheme was "common knowledge" among those required to participate in the scheme mean that every client knew about it.*fn75 The fact that some of the Plaintiffs are institutional investors does not necessarily mean that "at the time of such acquisition [of the securities that they] knew of [the alleged] untruth or omission [in the registration statement]." 15 U.S.C. § 77k(a). Perhaps they were one of the few institutional investors who did not know. Of course, Defendants may conduct discovery to determine the Plaintiffs' actual knowledge and seek to prove that they were fully aware of the alleged scheme. Likewise, they may use the allegation that it was "common knowledge" to try to "reduce[] the credibility of the witness" who claims she was ignorant. Tho Dinh Tran, 281 F.3d at 32. But these are ultimately issues for the trier of fact to resolve. Thus, Plaintiffs have not pled themselves out of court with respect to their Section 11 claims.

3. Those Plaintiffs Who Sold Securities Above the Offering Prices Have No Damages and Therefore No Claim Upon Which Relief Can Be Granted

Defendants are correct, however, in arguing that all Section 11 claims brought by Plaintiffs who sold securities at prices above the offering price must be dismissed because these Plaintiffs have no damages. Section 11(e), entitled "Measure of Damages," provides in pertinent part that damages under Section 11 are:

[T]he difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and . . . the price at which such security shall have been disposed of in the market before suit. . . .

15 U.S.C. § 77k(e) (emphasis added).

If a plaintiff has no conceivable damages under Section 11, she cannot state a claim upon which relief can be granted and her Section 11 claims must be dismissed. See Fed.R.Civ.P. 12(b)(6). See also In re Broderbund/Learning Co. Sec. Litig., 294 F.3d 1201, 1203-05 (9th Cir. 2002) (affirming dismissal under Rule 12(b)(6) because plaintiff's own pleadings revealed that he made a profit on the sale of his securities). Cf. Adair v. Kaye Kotts Assocs., No. 97 Civ. 3375, 1998 WL 142353, at *8 (S.D.N.Y. Mar. 27, 1998) ("For plaintiffs' Section 11 claim to be dismissed under Section 11(e) at this stage in the proceedings, defendants must conclusively establish that plaintiffs' damages are de minimus.") (citation omitted).*fn76

Defendants argue that Section 11(e) specifies that the measure of damages is the lesser of a security's purchase price and its offering price, minus its sale price, i.e., an investor who bought above the offering price must nonetheless use the offering price as the starting point for damages calculations. If that same investor then sold the security at a price above the offering price — even if the sale was for a loss — that difference would be a negative number. Thus, if a security was issued at $100, bought at $200, and sold at $150, the damages would be (-$50): $100 (the lesser of the offering price and the purchase price) minus $150 (the sale price). Negative damages are, of course, no damages at all.

Plaintiffs urge a different interpretation of Section 11(e): the parenthetical phrase "not exceeding the price at which the security was offered to the public" applies not to the "amount paid for the security," but rather to the "difference." According to Plaintiffs, the damages are $50: the $200 purchase price minus the $150 sale price.

The proper interpretation of Section 11(e) appears to be a question of first impression in this Circuit, and perhaps the entire country.*fn77 The courts that have previously "resolved" this question seem to have done so inadvertently, and uniformly without discussion.

As the Supreme Court has recently noted, "in all statutory construction cases, we begin with the language of the statute." Barnhart v. Sigmon Coal Co., 534 U.S. 438, 450 (2002). "The first step `is to determine whether the language at issue has a plain and unambiguous meaning with regard to the particular dispute in the case,'" Id. (quoting Robinson v. Shell Oil Co., 519 U.S. 337, 340 (1997)), and if it does, "there is no reason to resort to legislative history." United States v. Gonzales, 520 U.S. 1, 6 (1997) (citing Connecticut Nat. Bank v. Germain, 503 U.S. 249, 254 (1992)).

The language of Section 11(e) is plain and unambiguous. The parenthetical requirement "not exceeding the price at which the security was offered to the public" is placed after the first term in the equation, thereby requiring that it modify the first term, i.e., "the amount paid." Had Congress intended for the parenthetical limitation to apply to the difference, it could have said so.*fn78 For example, Congress could have pegged the measure of damages at "the difference (not exceeding the price at which the security was offered to the public) between the amount paid for the security" and its sale price.

Moreover, Plaintiffs' reading of Section 11(e) would make Section 11(g) entirely redundant. Section 11(g) provides that, "In no case shall the amount recoverable under this section exceed the price at which the security was offered to the public." 15 U.S.C. § 77k(g). The term "amount recoverable" found in Section 11(g) is nothing more than a cap on damages. Section 11(e), which governs the calculation of damages, uses the term "difference" to define the amount recoverable, thus the terms are synonymous. Under the reading espoused by Plaintiffs, therefore, Sections 11(e) and 11(g) are redundant; requiring that the "difference" does not exceed the offering price in Section 11(e) would be exactly the same as capping the "amount recoverable" at the offering price in Section 11(g). But canons of construction demand that the parenthetical limitation in Section 11(e) imposes an additional restriction. See Nordic Vill., 503 U.S. at 36; United States v. Menasche, 348 U.S. 528, 538-39 (1955); Montclair v. Ramsdell, 107 U.S. 147, 152 (1883); Market Co., 101 U.S. at 115; Muniz v. United States, 236 F.3d 122, 127 (2d Cir. 2001). The only plausible interpretation is to read the parenthetical limitation onto the "amount paid," which limits the class of possible plaintiffs under Section 11.

Because the statute is written in clear and unambiguous language, "judicial inquiry is complete." Marvel Characters, Inc. v. Simon, 310 F.3d 280, 290 (2d Cir. 2002) (quoting Connecticut Nat'l Bank, 503 U.S. at 254). See also Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 438 (1999) ("where the statutory language provides a clear answer, [our analysis] ends there"). However, because no court has previously passed on this issue, it is worth briefly noting that the legislative history of Section 11 also supports this conclusion.

At the time the Securities Act was passed in 1933, Section 11(e) read:

The suit authorized under subsection (a) may be either (1) to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or (2) for damages if the person suing no longer owns the security.

Nonetheless, Section 11(e) came under immediate criticism. In an influential piece worth quoting at length, then-Professor William O. Douglas wrote of the original Section 11(e):

When the Act provides for damages, it [] introduces distinct innovations. . . . It is provided that "In no case shall the amount recoverable under this section exceed the price at which the security was offered to the public." If the purchaser still owns the security he may on tendering it back to any of the parties under Section 11 recover what he paid for it, provided he paid less than the public offer price. In case he paid more than the public offer price he would be entitled to receive only an amount equal to that price. If he bought at $125, the public offering price being $100, and the price dropped to $50 he might elect to rescind and recover $100. But if he sold at $50 he might recover damages of $75. Now it has been asserted that in such a case the damages recoverable would be $50 — the difference between the public offering price and the price at which plaintiff sold. In other words it is claimed that the subsection quoted means what would have been meant if it had provided "In no case shall the amount recoverable as damages under this section exceed the amount by which the price at which the security was offered to the public is in excess of the price at which plaintiff sold the security." Section 11(g), however, does not use such a measure. If courts thus restrict the measure of damages, they may or may not be conforming to the intent of Congress. But they certainly would be reading into the Act words that are not there.

William O. Douglas & George E. Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171, 174-75 (1933) (footnotes omitted). See generally Harry Shulman, Civil Liability and the Securities Act, 43 Yale L.J. 227 (1933).

As a result of this criticism, Section 11(e) was amended by Section 206(d) of the Exchange Act, which implemented the current Section 11(e) by inserting just the language (slightly edited) that Douglas suggested.

As one scholar observed at the time,

Damages are still prima facie the difference between the amount realized on the value of the security and the amount at which the security was offered to the public. One clarification here adopts the Commissioner's view that if a security is offered at $100, purchased by the plaintiff at $200 and sold by him at $50, his damages are $50 [offering price minus sale price] and not $100 [the recissionary measure of damages] as might have been contended under the original Act.

John Hanna, The Securities Exchange Act of 1934, 23 Cal. L. Rev. 1, 8 (1934). See also 78 Cong. Rec. 8716 (1934) (Statement of FTC Commissioner James M. Landis).*fn79 Assuming the amendments were responsive to the "Commissioner's view," then Congress' intent was plainly to set the measure of damages as the lesser of the purchase price and offering price, minus the sale price of a security.

Therefore, based on the plain language of Section 11 and its legislative history, a plaintiff who sells a security above its offering price has no cognizable damages under Section 11 of the Securities Act, notwithstanding the fact that such plaintiff may have actually suffered a loss.*fn80 Accordingly, the Section 11 claims of such Plaintiffs must be dismissed.*fn81

IX. SECTION 15 CLAIMS

Section 15 states:

Every person who, by or through stock ownership, agency, or otherwise, or who, pursuant to or in connection with an agreement or understanding with one or more other persons by or through stock ownership, agency, or otherwise, controls any person liable under [Section 11] . . . shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist.

15 U.S.C. § 77o. Plaintiffs' Section 15 claims accuse Individual Defendants of controlling Issuer Defendants and thereby sharing liability for those Issuers' violations of Section 11. Defendants argue that Plaintiffs have not adequately pled these claims. See Iss. Mem. at 60-65.

In order to establish a prima facie Section 15 claim, a plaintiff need only establish (1) control, and (2) an underlying violation of Section 11 (or Section 12(a)(2)).*fn82 See In re Independent Energy Holdings PLC Sec. Litig., 154 F. Supp.2d 741, 770 (S.D.N.Y. 2001). Rule 9(b) does not apply to the pleading of a Section 15 claim because fraud is not an element of that claim.*fn83 And the PSLRA does not apply, as Section 15 does not require proof of scienter,*fn84 and because Section 15 arises under the Exchange Act. Therefore, Section 15 claims need only be pleaded under Rule 8; a defendant is only entitled to notice that she allegedly controlled an entity that violated Section 11.

Control is "`the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.'" SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1472-73 (2d Cir. 1996) (quoting 17 C.F.R. § 240.12b-2). A plaintiff is required to prove actual control, not merely control person status. See Cromer Fin. Ltd. v. Berger, 137 F. Supp.2d 452, 484 (S.D.N.Y. 2001). Naked allegations of control, however, will typically suffice to put a defendant on notice of the claims against her.*fn85

Here, Plaintiffs allege "[e]ach of the Individual Defendants was a control person of the Issuer with respect to the IPO [and] . . . [a]s a result, the Individual Defendants are liable under Section 15 of the Securities Act for the Issuer's primary violation of Section 11 of the Securities Act." Cacheflow Compl. ¶¶ 72, 74. These paragraphs, in combination with the allegations supporting the Section 11 claims, provide notice to the Individual Defendants of the claims brought against them. Thus, the Section 15 claims are adequately pled.*fn86

X. RULE 10B-5 CLAIMS FOR MATERIAL MISSTATEMENTS AND OMISSIONS AGAINST THE UNDERWRITERS, ISSUERS AND INDIVIDUAL DEFENDANTS

Plaintiffs have brought two distinct claims under Rule 10b-5, a regulation that makes it unlawful

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5.

Plaintiffs' first set of claims allege that all Defendants made material misstatements and omissions in the registration statements, either with an intentional or reckless state of mind, in violation of Rule 10b-5(b). See, e.g., Cacheflow Compl. ¶¶ 95, 99, 100, 101. Because material omissions and misstatements are an essential part of these claims, see 17 C.F.R. § 240.10b-5(b), they must satisfy the requirements of paragraph (b)(1). Similarly, because Plaintiffs must ultimately prove that the Defendants acted with scienter, these claims must also satisfy paragraph (b)(2). Rule 9(b) governs the remaining elements of these claims.

A. The Rule 10b-5 Claims for Material Misstatements Have Been Properly Pled
1. The Material Misstatement Claims Satisfy Paragraph (b)(1) of the PSLRA — Particularity

Paragraph (b)(1) requires that for any claim asserting material misstatements or omissions, "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1).

a. Paragraph (b)(1)'s First Two Requirements Have Been Satisfied

Plaintiffs have explicitly pled that seven specific material misstatements and omissions contained in the registration statement are false or misleading.*fn87 See supra Part IV.A.2. Moreover, for each misstatement or omission, Plaintiffs have stated the reasons why they believe these statements and omissions are misleading. See id. These eight statements and omissions and the alleged reasons they were false and misleading are briefly summarized as follows:

First, the registration statement failed to disclose that Allocating Underwriters had entered into Tie-in Agreement with their customers, in violation of Regulation M, 17 C.F.R. § 242.101.
Second, the registration statement did not include the Undisclosed Compensation as required by Regulation S-K, 17 C.F.R. § 229.508(e).
Third, the registration statement misleadingly stated that the underwriting syndicate would receive as compensation an underwriting discount of $1.68 per share, or a total of $8,400,000, based on the spread between the per share proceeds (e.g., $22.32) and the Offering price to the public (e.g., $24.00 per share) but failed to include the Undisclosed Compensation.
Fourth, the registration statement misleadingly stated that the Allocating Underwriters would offer the IPO shares to the public at a price set forth on the cover page because customers had to pay an amount in excess of that listed price through Tie-in Agreements and Undisclosed Compensation.
Fifth, the registration statement failed to disclose that the Allocating Underwriters were violating NASD Conduct Rule 2330(f), which prohibits underwriters from sharing in the profits or losses in any account of a customer. Sixth, the registration statement failed to disclose that the Allocating Underwriters were charging customers commissions that were unfair, unreasonable, and excessive in order to receive allocations of IPO shares, a violation of NASD Conduct Rule 2440.
Seventh, the registration statement did not accurately state which of the underwriters would actually participate in the distribution of the IPO (e.g., J.P. Morgan did not receive any of the 100,000 shares listed next to its name in the Cacheflow IPO).
Eighth, analyst reports issued just after the expiration of the "quiet period" with a "Strong Buy" recommendation and a 12-month price target (e.g., $175 per share in Cacheflow) was materially false and misleading as it was based upon a manipulated price.

Plaintiffs have satisfied the first two requirements of paragraph (b)(1). They have not generally averred that the registration statements were misleading. Nor are the proffered reasons speculative or vague. Rather, Plaintiffs have pointed to specific provisions of the statement and then provided reasonable explanations as to why they believe specific statements or omissions were false or misleading.

Although these requirements are easy to satisfy, it is worth remembering that Plaintiffs are bound by these pleadings throughout the course of the proceedings. Because Plaintiffs have specified the misstatements and omissions that they claim were misleading, the Court is able to evaluate whether they are material as a matter of law. See infra Part X.B.1.

In short, while nothing more is needed to satisfy these two requirements of paragraph (b)(1) on a motion to dismiss, the PSLRA has clearly served its purpose by putting the Defendants on notice of the specific misstatements and omissions that are at issue.

b. Paragraph (b)(1)'s Last Requirement Has Been Satisfied

On November 25, 2002, I directed Plaintiffs to identify which of their allegations were based on information and belief, and to identify for those allegations, the "facts on which that belief [was] formed." Order, In re Initial Public Offering Sec. Litig., 21 M.C. 92 (S.D.N.Y. Nov. 25, 2002) ("11/25/02 Order").*fn88 See also Lirette, 999 F. Supp. at 165 (requiring similar submission in order to establish basis for information and belief).

In response to the 11/25/02 Order, Plaintiffs submitted a chart — almost one thousand pages in length — identifying which paragraphs of the 309 Complaints and the Master Allegations were based on information and belief, and the basis for those beliefs. Plaintiffs identified eleven categories of sources: (1) confidential sources; (2) registration statements and/or prospectuses; (3) SEC filings; (4) press releases; (5) media resources, including newspapers, magazines, Internet sources, and books; (6) analyst reports; (7) letters to Plaintiffs' counsel from Underwriter Defendants' counsel; (8) academic literature; (9) congressional testimony; (10) the Order Pursuant to New York General Business Law § 354 in In re An Inquiry by Eliot Spitzer, Attorney General of the State of New York, No. 02401522 (Sup.Ct.N.Y. Co. Apr. 8, 2002); and (11) the Consent Decree in SEC v. Credit Suisse First Boston Corp., No. 1:02 CV 00090 (D.D.C. Jan.29, 2002).*fn89

This submission was "deemed to be part of the complaints," see 11/25/02 Order, and therefore supplemented the pleadings,*fn90 which already averred that:

Plaintiffs, by their undersigned attorneys, individually and on behalf of the Class described below, upon information and belief, based upon, inter alia, the investigation of counsel, which includes a review of public announcements made by Defendants, interviews with individuals with knowledge of the acts and practices described herein, Securities and Exchange Commission ("SEC") filings made by Defendants, press releases, and media reports, except as to Paragraph 12 applicable to the named Plaintiffs which is alleged upon personal knowledge, bring this Consolidated Amended Complaint (the "Complaint") against the Defendants named herein, and allege as follows:

Cacheflow Compl. at 1 (emphasis added).*fn91

For each of the Complaints, Plaintiffs identified approximately fifty paragraphs based on information and belief. It is important to note, however, that paragraph (b)(1) does not apply to each of the paragraphs identified by Plaintiffs. Rather, paragraph (b)(1) applies only to allegations regarding statements (here in the registration statements/prospectuses) alleged to be misleading. Many of the paragraphs identified by Plaintiffs plead matters of fact, see, e.g., Cacheflow Compl. ¶ 31 ("On the day of the IPO, the price of Cacheflow stock shot up dramatically, trading as high as $139.25 per share, or more than 480% above the IPO price on substantial volume.").*fn92 Other paragraphs plead conclusory allegations of motive but plead no facts — on information and belief or otherwise. See, e.g., Cacheflow Compl. ¶ 110(b) ("The Issuer [and Individual] Defendants were motivated by the fact that the artificially inflated price of the Issuer's shares in the aftermarket would enable Individual Defendants to sell personal holdings in the Issuer's securities at artificially inflated prices in the aftermarket or otherwise."). These statements and allegations are not at issue here.

What remains are a handful of paragraphs in the Complaints that allege, on information and belief, that Defendants made various material misstatements. See, e.g., id. ¶¶ 38, 43, 45, 48, 51-54. In addition, several allegations describing the unlawful scheme are critical to Plaintiffs' material misstatement allegations because, inter alia, Plaintiffs plead that Defendants made material misstatements simply by failing to disclose various aspects of the scheme. See, e.g., id. ¶¶ 34, 47, 55-57.*fn93 In sum, Plaintiffs' allegations of material misstatements are that Defendants failed to disclose their illegal conduct in their registration statements and prospectuses. See, e.g., id. ¶ 48 ("The failure to disclose the Allocating Underwriter Defendants' unlawful profit-sharing arrangement as described herein, rendered the Registration Statement/Prospectus materially false and misleading."). Plaintiffs further allege that Defendants' motive in failing to disclose the scheme was to conceal and perpetuate the scheme. See, e.g., id. ¶ 99 ("The material misrepresentations and/or omissions were made knowingly or recklessly and for the purpose and effect of, inter alia: (a) securing and concealing the Tie-in Agreements; (b) securing and concealing the Undisclosed Compensation; and/or (c) concealing that certain of the Underwriter Defendants and their analysts who reported on the Issuer's stock had material conflicts of interest."). Thus, if Plaintiffs have identified a sufficient basis to support the formation of their belief that Defendants engaged in the manipulative conduct — and that Defendants failed to disclose that conduct — they have satisfied paragraph (b)(1)'s third requirement. See Novak, 216 F.3d at 313-14.

The requirements of the PSLRA must be read consistently with its purpose. See Barrett v. Van Pelt, 268 U.S. 85, 90-91 (1925). Congress enacted the information and belief pleading requirement because "[n]aming a party in a civil suit for fraud is a serious matter. Unwarranted fraud claims can lead to serious injury to reputation for which our legal system effectively offers no redress." H.R. Conf. Rep. 104-369, at 41. The purpose of the information and belief requirement — indeed, the purpose of all of the PSLRA's heightened pleading requirements — was to weed out meritless lawsuits at the pleading stage.*fn94

On this point the rule of the Second Circuit is clear: "paragraph (b)(1) does not require that plaintiffs plead with particularity every single fact upon which their beliefs concerning false or misleading statements are based. Rather, plaintiffs need only plead with particularity sufficient facts to support those beliefs." Novak, 216 F.3d at 313-14 (emphasis in original). What facts and what level of particularity are sufficient to support a plaintiff's beliefs will vary from case to case. Under paragraph (b)(1), sufficiency and particularity are intricately related; the greater the basis for a belief, i.e., the more obviously sufficient plaintiffs' sources are, the less particularity is required in identifying them. Where an allegation stems from only one or two sources, however, it is imortant that they be identified with absolute particularity. The critical threshold is that the allegations must be made in a way that satisfies the court that plaintiff's charge of fraud is not "unwarranted."

For example, where a fraud allegation is founded on the uncorroborated allegations of one anonymous whistle-blower, it is necessary to uniquely identify that source, either by naming her or by describing her with such particularity as to satisfy the court that her information is credible. See id. at 314 (where allegations are based solely on information from confidential sources, "there is no requirement that they be named, provided they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged."). Where, as here, there are many confidential sources who all say the same thing — that they were required to enter into Tie-in Agreements — and those sources are corroborated by a vast number*fn95 of media reports*fn96 (including admissions by insiders), as well as intensive investigations by both state and federal agencies, the cumulative effect of the evidence is important. In such a case, the sheer volume of the corroboration obviates the need for absolute particularity.

Here, generic references to news articles, academic literature, and press releases are sufficiently particular to support the formation of Plaintiffs' beliefs because the substance of those beliefs — that the Defendants were perpetrating a massive fraud on the securities market in connection with most every IPO — was the stuff of daily headlines.*fn97 The alleged fraud had so permeated the news media that there can be no doubt that Plaintiffs have a sufficient basis for their information and belief, and that is all that the statute requires. The same can be said for any of the categories of sources proffered by Plaintiffs. Because there is no real doubt in these cases that Plaintiffs have ample grounds on which to base their allegations, there is no danger that the allegations here are "unwarranted" — even if they ultimately turn out to be untrue.

To ask Plaintiffs to show more than they have would be pointless, and to ask the Court to cross-reference every paragraph of every complaint against particular media reports, articles, letters, and other sources would be a waste of this Court's limited resources. Accordingly, Plaintiffs have satisfied the third requirement of paragraph (b)(1).

2. The Material Misstatement Claims Satisfy Paragraph (b)(2) of the PSLRA — Scienter

Paragraph (b)(2) provides, "In any private action . . . in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall . . . state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2) (emphasis added). In most of the Complaints, Plaintiffs have brought Rule 10b-5(b) claims for material misstatements and omissions against all Defendants: Allocating Underwriters, Non-Allocating Underwriters, Individual Officers, and Issuers. Plaintiffs allege that each of these Defendants made the seven misstatements and omissions when signing the registration statement. Plaintiffs have satisfied the requirements of paragraph (b)(2) with respect to these alleged misstatements and omissions for each Defendant.*fn98

a. Allocating Underwriters

Plaintiffs have alleged that the Allocating Underwriters engaged in a scheme that could have only happened intentionally, and which they knew must be disclosed to the investing public: "the Allocating Underwriter Defendants created artificial demand for Cacheflow stock by conditioning share allocations in the IPO upon the requirement that customers agree to purchase shares of Cacheflow in the aftermarket and, in some instances, to make those purchases at pre-arranged, escalating prices (`Tie-in Agreements')." Cacheflow Compl. ¶ 3. Under this scheme, the Allocating Underwriters profited by "requir[ing] their customers to repay a material portion of profits obtained from selling IPO share allocations in the aftermarket through one or more of the following types of transactions:

(a) paying inflated brokerage commissions;

(b) entering into transactions in otherwise unrelated securities for the primary purpose of generating commissions; and/or
(c) purchasing equity offerings underwritten by the Allocating Underwriter Defendants, including, but not limited to, secondary (or add-on) offerings that would not be purchased but for the unlawful scheme alleged herein.

Id. ¶ 4.*fn99 Finally, as part of this overall scheme, not every Underwriter who was listed on the registration statement distributed the company's shares, see id. ¶¶ 53-54, because by concentrating the Underwriters who would allocate shares, it was "easier for a select group of underwriters in various offerings to engage in the manipulative practices." MA ¶ 54.

These allegations of the Allocating Underwriters' conduct give rise to a strong inference that they made each of the seven material misstatements and omissions with the required state of mind. The alleged conduct was so obviously manipulative (and material, see infra Part X.B.1) that it could not have been done inadvertently. That Allocating Underwriters then signed registration statements that plainly failed to disclose the scheme — in the face of an obvious duty to disclose, see infra Part X.B.2 — gives rise to a strong inference that the misstatements were made intentionally for the purpose of defrauding the investing public.

Indeed, even if parts of the alleged scheme consisted of permissible stabilization practices (which is highly unlikely, see infra Part XI.B.1), the failure to disclose that conduct still would have evinced an intent to defraud. It is well-established that the SEC allows Underwriters to engage in certain acts of "stabilization." See 15 U.S.C. § 78(i)(a)(6) (granting the SEC the authority to promulgate rules that allow "pegging, fixing or stabilizing the price of [a] security"); 17 C.F.R. § 242.104 (establishing guidelines for acts of stabilization); see also Friedman v. Salomon/Smith Barney, Inc., No. 98 Civ. 5990, 2000 WL 1804719, at *3 (S.D.N.Y. Dec. 8, 2000) ("Friedman I") (describing the history and law of stabilization), aff'd, 313 F.3d 796 (2d Cir. 2002) ("Friedman II").

Samuel N. Allen, A Lawyer's Guide to the Operation of Underwriting Syndicates, 26 New Eng. L. Rev. 319, 349 (1991). While such acts manipulate the market by artificially inflating the price,*fn100 they are nonetheless lawful and do not violate either Rule 10b-5(a) or (c).

However, if an underwriter fails to disclose its stabilization practices, it is liable for making material misstatements and omissions in violation of Rule 10b-5(b), see 17 C.F.R. § 240.10b-5(b), because any act of manipulation — even a legal one — is material and must be disclosed. See Miller v. Steinbach, 268 F. Supp. 255, 274 (S.D.N.Y. 1967); see also infra Part X.B.2.

The rule — of logic as much as of law — is that whenever a defendant engages in clearly manipulative practices, and then conceals those practices by making misstatements, the concealment is presumptively done with the intent to defraud.

b. Non-Allocating

Underwriters Because Plaintiffs cannot accuse the Non-Allocating Underwriters of requiring their customers to enter into any Tie-in Agreements and pay Undisclosed Compensation, the allegations that were sufficient to show a strong inference of scienter with respect to the Allocating Underwriters do not suffice with respect to the Non-Allocating Underwriters. For example, in the Cacheflow complaint, Plaintiffs allege that J.P. Morgan (H&Q) did not allocate any stock, see Cacheflow Compl. ¶¶ 14-16. J.P. Morgan, as a Non-Allocating Underwriter, argues that it neither knew of nor recklessly disregarded the conduct of the Allocating Underwriters who were engaged in the allegedly illegal scheme, and as a result, did not knowingly or recklessly make the first six misstatements and omissions, which related to the Tie-in Agreements and Undisclosed Compensation.*fn101

Nonetheless, for at least two reasons, Plaintiffs have made other allegations that are sufficient to give rise to a strong inference that the Non-Allocating Underwriters signed the registration statement with the requisite state of mind. First, it is significant that these Underwriters were listed on the registration statements as underwriters of the IPO, but then allegedly received no allocation. This circumstance is so unusual that it supports a strong inference that the Non-Allocating Underwriters either knew about, or acted with reckless disregard towards, the entire scheme of the Allocating Underwriters when signing the registration statement.

Second, these Complaints cannot and need not be read in isolation. There are 309 Complaints against the fifty-five Underwriters in which Plaintiffs describe in painstaking detail the relationships between the various investment banks. See MA ¶¶ 66-85. Even if an Underwriter took no role in one allocation, it took an active role in others — and in those IPOs it is accused of committing illegal acts. For example, during the class period J.P. Morgan was either a Lead or Co-Lead Underwriter in twelve other IPOs in which it is alleged to have required Tie-In Agreements of its customers and taken Undisclosed Compensation.*fn102 The allegations that J.P. Morgan engaged in the same scheme in these IPOs raise a strong inference that in the Cacheflow IPO J.P. Morgan knew that the misstatements and omissions in the registration statements were misleading; or, at least, acted with reckless disregard towards their truth.

Similarly, in the Master Allegations, Plaintiffs allege that at least one customer was required or induced by J.P. Morgan to buy stock in the aftermarket at prices substantially above the IPO price in six IPOs.*fn103 These allegations also raise a strong inference that in the Cacheflow IPO J.P. Morgan knew that the misstatements and omissions in the registration statements were false or misleading because the Allocating Underwriters would and did require Tie-in Agreements and Undisclosed Compensation.*fn104 Paragraph (b)(2) has thus been satisfied.

c. Individual Defendants

On November 13, 2002, I directed Plaintiffs to submit charts summarizing their allegations of scienter as to the Individual Defendants and Issuers in each of the 309 complaints. See Order, In re Initial Public Offering Sec. Litig., No. 21 M.C. 92 (S.D.N.Y. Nov. 13, 2002) ("11/13/02 Order"). As to the Individual Defendants, Plaintiffs were directed to identify (1) their title, (2) whether they signed the relevant registration statement, (3) the source of their knowledge of the alleged misrepresentations or omissions, (4) the number of shares of the relevant Issuer that they owned, (5) the number of shares sold, (6) the dates(s) of sale, and (7) the proceeds from the sale. In response, Plaintiffs submitted a chart on November 26, 2002.*fn105 As an example, Plaintiffs submitted the following chart in connection with the Ask Jeeves Inc.*fn106 offering:

Individual Title Signed? Source of Shares Shares Sold Date(s) Proceeds Defendant Knowledge Owned Sold
Robert W. President, Yes -Road Show 189,424 Approximately 8/16/2000- Approximately Wrubel CEO and -Close 100,000 shares 2/23/2001 $1,320,000 Board interaction (Including (Including with 10,000 in $720,000 in Underwriter Secondary Secondary Defendants Offering) Offering) prior to IPO
ΒΆΒΆ 137, 138, ...

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