The opinion of the court was delivered by: Milton Pollack, Senior District Judge.
Plaintiff, a shareholder in the Merrill Lynch Global Technology Fund (the "Fund"), brings this action against the Fund, its directors, its investment adviser and affiliates, and the adviser's corporate parent, Merrill Lynch & Co., Inc. ("ML & Co."), and broker-dealer affiliate, Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF & S"). Plaintiff alleges that the Fund's Registration Statements and Prospectuses failed to disclose several material facts.
The "material facts" that Defendants allegedly failed to disclose fall into three categories. (See e.g., Compl. ¶¶ 15, 213.)*fn1 First, that the Fund invested in the securities of companies with which MLPF & S had or sought investment banking business. (See e.g., Compl. ¶¶ 15(1), (2), (3)). Second, that MLPF & S issued purportedly misleading research reports on many of the securities held in the Fund's portfolio. (See e.g., Compl. ¶¶ 15(4)-(10)). Third, that the Fund invested in companies at market prices inflated by the misleading research reports "in order to enhance [MLPF & S's] ability to obtain investment banking business from those companies, without regard to whether they were good investments for investors in the Fund." (See e.g., Compl. ¶¶ 15(11)-(15).)
The alleged conflict of interest between brokerage firms, investment bankers and research analysts that underlies the entire complaint was a matter of public knowledge for years before the amazing boom of the market initially rewarded those who disregarded such caveats. It was also public knowledge that the Fund included stocks covered by the Merrill Lynch analysts' research reports.
The additional allegation that the Fund took part in a scheme to invest disproportionately in stocks covered by Merrill Lynch research reports to the detriment of the Fund is equally insufficient to state a claim. Moreover, the Fund stated clearly in its Prospectus that it sought capital appreciation by investment in market leaders or potential leaders in the technology sector. Plaintiff has not alleged any facts demonstrating that the companies held by the Fund did not satisfy these criteria. Nor has Plaintiff alleged facts that would show that this alleged "scheme" caused concomitant loss of Fund value, or that participants in this "scheme" acted with scienter — essential elements of a federal securities law claim.
Lead Plaintiff Michal N. Merritt purchased shares of the Fund in January and February of 2000. (Compl. ¶ 24.) She seeks to represent all persons who purchased shares of the Fund between October 2, 1999 and October 1, 2002. (Compl. ¶ 1.) Plaintiff filed her lawsuit on October 1, 2002.
The Complaint conflates the various corporate Defendants into a single entity characterized as the "ML Defendants" in an attempt to attribute knowledge or conduct by any one Defendant to all the other Defendants. (See e.g., Compl. ¶ 5.) However, the named Defendants actually comprise several distinct corporations and individuals.
The Fund is a diversified open-end investment company registered with the U.S. Securities and Exchange Commission ("SEC") pursuant to the 1940 Act. (Compl.¶¶ 30, 62.)*fn2 The Fund was first offered to the public in June 1998. The Fund is an aggressive growth product that seeks long-term capital appreciation through worldwide investment in equity securities of issuers that, in the opinion of its investment adviser, Merrill Lynch Investment Managers, L.P. ("MLIM"), derive a substantial portion of their income from products and services in technology related industries. (Compl.¶ 30.) The Fund's main investment strategy is to invest in companies that MLIM believes are leaders in their product or service niches, or are likely to develop leadership positions. (Holland Decl. Ex. A, 1999 Prospectus at 3.)
The Fund's Prospectuses warn that investing in the Fund involves substantial risk. The Prospectuses state that technology related securities "historically have been very volatile" which "increases the risk that the securities may lose value." (See, e.g., id. at 9.) The Prospectuses note that the Fund may invest in smaller companies which "may be less financially secure than larger, more established companies," and that as a result "such companies may be subject to abrupt or erratic price movements and more unpredictable price changes than the stock market as a whole." (Id.) In addition, the Prospectuses state that technology related companies "may face special risks that their products or services may not prove to be commercially successful" or "may rapidly become obsolete." (Id.)
Defendant MLIM (formerly known as Merrill Lynch Asset Management, L.P.), the Fund's investment adviser, is an asset management company with its headquarters in Princeton, New Jersey. (Id. at 31.) Pursuant to its advisory agreement with the Fund, MLIM received a fee for managing the Fund, paid at the annual rate of 1% of the Fund's average daily net assets not exceeding $1 billion and 0.95% of the Fund's average daily net assets in excess of $1 billion. (Id. at 29.) MLIM is an indirect, wholly-owned subsidiary of Defendant ML & Co.
Defendant Princeton Services, Inc. is a subsidiary of ML & Co. and the general partner of MLIM. (See Holland Decl. Ex. B, 1999 SAI at 17.) Defendant FAM Distributors, Inc. (formerly known as Merrill Lynch Funds Distributor, Inc.) distributed shares of the Fund. (Compl. ¶ 32.)
Defendants Arthur Zeikel, Terry Glenn and Donald Burke are present or former executives of MLIM who served as directors and/or officers of the Fund during part or all of the Class Period. The ten other individual defendants served as independent directors of the Fund during part or all of that time. (Compl.l ¶ 38-50.)
Apart from their common ownership by ML & Co., MLPF & S and MLIM are entirely separate. They are in different businesses and are subject to different principal regulatory structures — the 1940 Act for MLIM, and the 1934 Act for MLPF & S. Plaintiff does not allege that MLPF & S and MLIM share management, employees, or offices. Nor does she allege any cross-ownership between them.
The Complaint contains six counts. Counts I and II allege violations of Sections 11 and 12(a)(2) of the Securities Act of 1933 ("1933 Act"), 15 U.S.C. § 77k, l(a)(2), respectively. (Compl.¶¶ 223-268.) Plaintiff also asserts claims in those Counts for control person liability under Section 15 of the 1933 Act, 15 U.S.C. § 77o. (Compl.¶¶ 241-245, 264-268.) Count III alleges a violation of Section 34(b) of the Investment Company Act of 1940 ("1940 Act"), 15 U.S.C. § 80a-33(b), and also asserts control person liability under the 1940 Act. (Compl. ¶¶ 269-279.) Counts IV and V allege violations of Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78b, and SEC Rule 10b-5. (Compl.¶¶ 280-339.) Finally, Count VI asserts control person liability under Section 20(a) of the 1934 Act, 15 U.S.C. § 78t. (Compl.¶¶ 340-346.)
A. Sections 11 and 12(a)(2) of the 1933 Act
1. Defendants had no Duty to Disclose the Allegedly Omitted Information
To state a claim under Sections 11 and 12(a)(2), a plaintiff must allege that the defendants had a legal obligation to disclose the allegedly omitted information. See 15 U.S.C. § 77k, l(a)(2); In re Ultrafem Securities Litig., 91 F. Supp.2d 678, 699 (S.D.N.Y. 2000) (dismissing Sections 11 and 12(a)(2) claims where the plaintiffs failed to demonstrate that the defendants were obligated to disclose the omitted language); Geiger v. Solomon-Page Group, Ltd., 933 F. Supp. 1180, 1187-88 (S.D.N.Y. 1996) (dismissing Sections 11 and 12(2) claims because the defendants were not required to disclose allegedly omitted information); accord Oxford Asset Mgmt., Ltd. v. Jaharis, 297 F.3d 1182, 1189 (11th Cir. 2002) ("[t]o avoid dismissal of a section 11 omission claim, plaintiffs must properly allege . . . [that] defendants were under a duty to disclose the omitted material information"). Plaintiff has failed to plead facts sufficient to show that the Defendants had a duty to disclose the information allegedly omitted from the Fund's Prospectuses and Registration Statements.*fn3
a. Defendants had no Duty to Disclose that the Fund invested in the securities of companies with which MLPF & S had an investment banking relationship.
First, the information required to be disclosed in mutual fund registration statements and prospectuses is specifically set forth in SEC Form N-1A. Among other things, Form N-1A requires disclosure about investment strategies and risk, management, organization, capital structure, and distribution arrangements. No portion of Form N-1A requires the disclosure of the investment banking relationships between the companies whose stocks were purchased by a fund and the broker-dealer affiliate of the fund's investment adviser.
The absence of such a requirement is not surprising. It has been well-recognized for decades that many mutual fund investment advisers are affiliated with broker-dealers and investment banks. See generally, Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 528 F. Supp. 1038, 1040-42 (S.D.N.Y. 1981) (Pollack, J.), aff'd, 694 F.2d 923 (2d Cir. 1982). Indeed, Section 17 of the 1940 Act, entitled, "Transactions of Certain Affiliated Persons and Underwriters," specifically recognizes that mutual fund investment advisers may be affiliated with broker-dealers, and regulates in considerable detail the circumstances under which the affiliated entities may, and may not, transact business. See 15 U.S.C. § 80a-17.*fn4 The SEC has also promulgated extensive rules pursuant to Section 17. See 17 C.F.R. § 270.17a-1 — 270.17j-1. Despite this extensive congressional and regulatory oversight, no statute or rule requires the type of disclosure Plaintiff advocates here.
In an analogous context, the court in In re Digital Island Sec. Litig., 223 F. Supp.2d 546 (D.Del. 2002), found no duty to disclose the alleged omission under the federal securities laws. In that case, the plaintiffs brought a securities class action following the acquisition of Digital Island, Inc. The plaintiffs alleged that the defendants had violated Section 14(e) of the 1934 Act by failing to disclose in tender offer documents several agreements that Digital Island had with third parties. See id. at 551. The court granted the defendants' motion to dismiss, reasoning that the defendants had no duty under any SEC regulation or authority to disclose deals Digital Island had with customers. See id. at 552. The court found it significant that the information required to be included in documents concerning tender offers and solicitations related to tender offers was specifically set forth in two SEC regulations, and no portion of those regulations required the disclosure of the agreements at issue. See id.; accord Geiger, 933 F. Supp. at 1187-88 ("[t]he fact that the SEC does not require disclosure" of the omitted fact "is further support for this conclusion" that the alleged omission did not give rise to liability under Sections 11 and 12(a)(2) because "it reflects the SEC's expert view that such disclosure is not required").
Second, the Defendants cannot be held liable for failing to disclose that MLPF & S provided investment banking services to companies in the Fund's portfolio if that information was already public. Sections 11 and 12(a)(2) do not require the disclosure of publicly available information. See, e.g., Klein v. Gen. Nutrition Cos., 186 F.3d 338, 343 (3d Cir. 1999) (where the information was public knowledge, "[f]ederal securities laws do not require a company to state the obvious"); Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 517 (7th Cir. 1989) ("It is pointless and costly to compel firms to reprint information already in the public domain"); Seibert v. Sperry Rand Corp., 586 F.2d 949, 952 (2d Cir. 1978) ("Although the underlying philosophy of federal securities regulations is that of full disclosure, there is no duty to disclose information to one who reasonably should already be aware of it.") (internal citations omitted).
Here, Plaintiff's own Complaint demonstrates that information concerning companies in which the Fund might invest and to whom MLPF & S provides investment banking services was publicly available. Plaintiff has attached to her Complaint an Excel spreadsheet, "Plaintiff's Exhibit 1," which purports to show that "Merrill Lynch performed investment banking services, which resulted in a consummated transaction, for at least 32.7% of the companies whose securities were held by the Fund." (Compl.¶ 133.) Plaintiff explains at length in her Complaint that she obtained information in Plaintiff's Exhibit 1 from a variety of public sources, including SEC filings. (Compl. ¶¶ 126-128.) For example, Plaintiff's Exhibit 1 asserts that Merrill Lynch performed investment banking services for Doubleclick, and that this was disclosed in a February 17, 2000 Prospectus for Doubleclick that was filed with the SEC. (See Pl.Ex. 1 at 8.) Plaintiff's Exhibit 1 also states that the Fund disclosed its investment in Doubleclick in its March 31, 2000 Annual Report that also was filed with the SEC. (See id.) Indeed, Plaintiff's Exhibit 1 identifies 66 different companies held by the Fund where publicly-available SEC filings or other public information disclosed that MLPF & S was performing investment banking services for those companies. (See id. at 23.) Plaintiff therefore cannot show that such information was concealed from the markets or from Fund investors.
b. Defendants had no Duty to Disclose that MLPF & S issued purportedly misleading research reports on many of the securities held in the Fund's portfolio.
The Plaintiff claims that "there were inherent, material conflicts of interest concerning the issuance of Merrill Lynch's research reports, and the relationship between Merrill Lynch's research and investment banking department." (Compl.¶ 14.)
According to the Complaint, the inherently conflicted research reports inflated the market price of the securities of a material number of the companies in the Fund's portfolio, and thus inflated the price paid by the Class when they purchased Fund shares. Plaintiff claims that the Fund, and those associated with the Fund, had a duty to obtain and disclose the underlying conflicts of interest which allegedly made the reports of Merrill Lynch misleading on securities held by the Fund.
Again, this claim fails if for no other reason than because the information regarding the alleged conflict of interest was public knowledge, and had been for years. As early as September 9, 1995, the Toronto Financial Post carried an article stating that conflicts of interest between underwriting and analysts in brokerage firms were becoming endemic. The Post noted that after deregulation in 1987, commission income earned by brokerage houses collapsed, and underwriting fees became essential for brokerage firm profits. Among the conflicts described was the fact that analysts' bonuses were based on revenue generated by underwriting. See Rod McQueen, The Endangered Species, The Financial Post (Toronto, Canada), Sept. 9, 1995.*fn5
In May of 1996, The Wall Street Journal also pointed out the potential for conflict, stating that investment banks "have persuaded clients to hire underwriters on the basis of their analysts' selling power" and that "[i]n turn, the analyst's worth is increasingly dependent on his or her ability to bring in deals." The article ends with the admonition that "investors, journalists and others who deal with the Street would do well to keep in mind that, often times, the analyst is wearing two hats." See Roger Lowenstein, Today's Analyst Often Wears Two Hats, The Wall Street Journal, May 2, 1996.
Soon thereafter, The Boston Globe pointed out that analysts are often overoptimistic about long-term earnings forecasts for equity offerings because "the relationship between the analysts and the investment banking business . . . pays their bills." The Globe warns that the mounting evidence suggests that you "trust [analysts] at your peril." See Steve Baily & Steven Syre, Taking Analysts' Tempting Forecasts with Grain of Salt, The Boston Globe, October 23, 1996.
The Wall Street Journal beats this drum again in 1998, pointing out that cautious investors would be "hard-pressed to scare up a bearish research report telling them which shares to dump." Of 2,066 ratings, 68% were "buys" or "strong buys," 31% were holds and less than 1% were "weak sells" or "strong sells." The reason for this bullish "speak no evil policy"? The Journal points out that analysts often won't issue a "sell" because they "don't like to anger companies that could be their firm's investment-banking clients." See John Hechinger, Heard in New England: Analysts May Hate to Say "Sell," But a Few Companies Do Hear It, The Wall Street Journal, Apr. 8, 1998.
These are but a small part of the many articles detailing the conflicts of interest that the Plaintiffs have alleged that Defendants concealed in the prospectuses. Others include: Jeffrey Laderman, Who Can You Trust?, Business Week, Oct. 5, 1998 ("brokerage firms are not about to break up the money machine that pairs analysts with dealmakers. And analysts are not about to risk offending the companies they cover. Woe to the investor who doesn't keep these two ideas in mind before investing on a stock recommendation."); Frog Spawn, The Economist, Apr. 17, 1999 (Sell is a four-letter word); SEC Chairman Aurthur Levitt, Address at the Investors' Town Meeting, Albuquerque, New Mexico (Nov. 20, 1999) ("analysts' paychecks are typically tied to the performance of their employers. You can imagine how unpopular an analyst would be who downgrades his firm's best client. Is it any wonder that today, a `sell' recommendation from an analyst is as common as a Barbara Streisand concert?"); Erick Schonfeld, The High Price of Research, Fortune, Mar. 20, 2000 ("Analysts of all stripes . . . increasingly derive a portion of their compensation, directly or indirectly, from the companies they cover."); Robert Samuelson, Newseek, Apr. 3, 2000 (quoting Professor Jay Ritter as stating that "The conflicts of interest are immense" and that stock analysts are increasingly "cheerleaders" whose pay depends on the firm's underwriting, which depends on enthusiastic research reports); Eileen Buckley, Holding Analysts Accountable, The Industry Standard, June 12, 2000 ("Research analysts writing recommendations of closely watched Internet stocks routinely face conflicts of interest.").
The above review of publicly available information pertaining to these conflicts is largely superfluous, however. Plaintiff conceded her awareness of this information in her original complaint,*fn6 when she acknowledged that "sometime during the year 2000, various publications suggested that conflicts of interest were becoming rampant in the broker-dealer industry." (Original Complaint ¶ 53.)*fn7
c. Defendants had no Duty to Disclose that the Fund Invested in Companies to Aid Investment Banking Business for Merrill Lynch
The Complaint also fails to allege sufficient facts to support Plaintiff's allegation that the Defendants chose certain companies for the Fund in order to enhance MLPF & S' investment banking business. The only facts Plaintiff cites to support this contention are: (1) MLPF & S performed investment banking services for "at least 38.9 percent" of the companies held in the Fund's portfolio, and (2) MLPF & S issued research reports on "at least 80%, and possibly more than 90%" of the companies held by the Fund. (Compl. ¶¶ 140, 149.) The Complaint then concludes:
The sheer number of these companies in the Fund's
portfolio covered by the Merrill Lynch research
department suggests that the opportunity for the
Fund's affiliates to obtain investment banking
business was a material ...