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DEMARCO v. ROBERTSON STEPHENS INC.

January 8, 2004.

ANTHONY V. DeMARCO, for himself and all others similarly situated, Plaintiffs
v.
ROBERTSON STEPHENS INC., and PAUL JOHNSON, Defendants



The opinion of the court was delivered by: GERARD E. LYNCH, District Judge

OPINION AND ORDER

This case concerns allegations that the defendant investment bank and its equity research analyst engaged in a brazen scheme to defraud buyers of stock in the Corvis Corporation ("Corvis"), in violation of § 10(b) of the Exchange Act and federal insider trading laws, by engaging in a variation on a so-called "pump and dump" stock manipulation, in which holders of securities fraudulently inflate the securities' price in order to sell at an artificial profit The proposed plaintiff class asserts that defendants manipulated the price of Corvis stock by Page 2 disseminating research analyst reports advising investors to purchase the stock at a time when defendants actually believed the stock to be greatly overvalued. The purpose of the alleged scheme, according to plaintiffs, was to maintain a high price for the stock until defendants could sell the Corvis shares they themselves held.*fn1 Defendants move to dismiss all claims on the ground that plaintiff fails to state a cause of action for which relief may be granted. For the reasons that follow, the motion to dismiss will be granted with respect to the claims alleging insider trading, and denied with respect to all other claims.*fn2

  BACKGROUND

  For purposes of this motion to dismiss, the facts alleged in the complaint must be accepted as true.

  Defendant Robertson Stephens, Inc., ("Robertson Stephens" or "RS") is a firm previously active as a broker-dealer, which provided financial services including securities underwriting, investment banking and the publication of equity analysis. (Am. Compl. ¶ 16). In the 1990s, Robertson Stephens created a number of limited partnerships that invested in companies prior to the initial public offerings of their stock. These limited partnerships included Bayview 99 I, Page 3 Bayview 99 II, and Bayview Corvis (collectively, the "Bayview Partnerships"). (Id. ¶ 19.) In November 1999, upon the recommendation of defendant Paul Johnson, a managing director and senior equity analyst at Robertson Stephens covering the networking sector, the Bayview Partnerships purchased approximately five million dollars' worth of stock in Corvis, a manufacturer of optical networking equipment (Id. ¶¶ 20, 2.) Johnson invested his own personal funds in the Bayview Partnerships, and also invested in a separate venture capital fund that purchased Corvis shares. (Id. ¶ 21.) These Corvis shares were privately issued prior to the Corvis initial public offering ("pre-IPO shares"), and subject to a "lock-up" restriction that prevented the purchasers from selling the stock for 180 days after the initial public offering. (Id. ¶ 22.)

  After the initial public offering of Corvis stock on July 27, 2000, at S36 per share (id. ¶ 23), Robertson Stephens started publishing analyst research reports containing what purported to be the firm's opinion regarding the stock, including recommendations to investors based on that opinion. Plaintiffs claim that defendants' scheme to manipulate the price of Corvis stock by publishing false statements of opinion in RS research reports began with the very first RS research report, issued on August 22, 2000, which contained a "buy" recommendation. The closing price of Corvis stock that day was $90.81. (Id. ¶ 25-26.) The second RS report, issued on October 20, 2000, when the closing price was $67.13 (an increase from the day's opening price of $59.61), also contained a "buy" recommendation. (Id. ¶ 27.) The third RS report, issued on January 16, 2001, when the stock closed at $23.94, again contained recommended a "buy." (Id. ¶ 29.) Page 4

  One week later, on January 23, 2001, the day before the expiration of the six-month lockup period preventing defendants from selling their pre-IPO stock, Johnson told a meeting of the Bayview investment committee that he would buy Corvis stock at $12 to $14 per share, effectively advising the internal committee against buying at the then-market price of approximately $24.50. (Id. ¶ 31.) On the following day, the first day defendants were permitted to sell their own Corvis stock, Johnson sold 6,550 of his personal 8,175 shares, and RS sold the shares it held through the Bayview Partnerships. The stock price closed that day at $23.06. (Id. ¶ 32.) On January 25, Corvis reported a loss of $89.7 million (id. ¶ 33), and on January 26, only three days after Johnson had told the Bayview partnerships that he believed Corvis stock was worth $12 to $14 per share, Robertson Stephens published a fourth report recommending that investors buy the stock, even as the stock closed that day at $20.50. (Id. ¶ 34.) Three days later, Johnson sold additional personally-held Corvis shares, and the stock closed at $19.43. (Id. ¶ 36.) Robertson Stephens published its fifth, final report on Corvis stock on April 27, 2001, again recommending that investors purchase the stock. (Id. ¶ 38.)

  None of the RS reports on Corvis stock informed investors that Johnson and Robertson Stephens had sold the bulk of their own Corvis holdings. However, on January 29, 2001, Johnson filed a Form 144 statement with the SEC disclosing his January 24 sale of 6,550 shares. On Sunday, May 27, 2001, the New York Times ran an article reporting that Johnson and other executives at Robertson Stephens had been selling Corvis stock while advising the public to purchase the stock. The article did not reveal that Johnson had advised the Bayview committee to sell its shares. (Id. ¶ 39.) Gretchen Morgenson, "Buy, They Say. But What Do They Do?; I.P.O. Conflicts Bedevil Analysts," New York Times, May 27, 2000, Sec. 3, p. 1. The price of Page 5 Corvis stock dropped 16% between May 25 and May 30. (P. Mot. to Correct Record, 3-4.)

  Plaintiffs brought suit on January 27, 2003, and on July 28, 2003, filed an amended complaint on behalf of all purchasers of Corvis stock between the date of the first RS analyst report (August 22, 2000), and the last day of trading before the New York Times article was published (May 25, 2001). The complaint alleges that defendants attempted to prop up the price of Corvis stock until they could sell their own pre-EPO shares by encouraging investors to buy Corvis stock even though defendants actually believed that stock to be overvalued. (Am Compl. ¶ 2.) Defendants counter that trading in Corvis stock was always volatile, that the plaintiffs did not read or rely on the RS reports, and that the market's overall disenchantment with telecommunications stock was the intervening cause responsible for plaintiffs' losses.

  DISCUSSION

 I. Standard on a Motion to Dismiss

  On a motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(6), the Court must accept as true all well-pleaded factual allegations in the complaint and view them in the light most favorable to the plaintiff, drawing all reasonable inferences in its favor. Leeds v. Meltz, 85 F.3d 51, 53 (2d Cir. 1996). The Court will not dismiss a complaint for failure to state a claim "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim that would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957). Beyond the facts in the complaint, the Court may consider "any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference." Cortes Indus., Inc. v. Sum Holding, L.P., 949 F.2d 42, 47 (2d Cir. 1991). While the Federal Rules of Civil Procedure generally require only notice pleading, where, as here, plaintiff alleges fraud, "the circumstances constituting fraud shall he Page 6 stated with particularity." Fed.R.Civ.P. 9fb): see Stern v. Gen. Elec. Co., 924 F.2d 472, 476 (2d Cir. 1991) ("[A]negations of fraud must be supported by particular statements indicating the factual circumstances on which the theory of fraud is based."). "Rule 9(b) is designed to further three goals: (1) providing a defendant fair notice of plaintiff's claim, to enable preparation of defense; (2) protecting a defendant from harm to his reputation or goodwill; and (3) reducing the number of strike suits." DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987).

 II. Section 10(b) Claims

  A. Legal Standard

  The Securities Exchange Act protects investors by proscribing,
in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
15 U.S.C. § 78j(b). Rule 10b-5, promulgated by the Commission, makes it unlawful "[t]o 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." 17 C.F.R. § 240.10b-5fb): see SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 847-48 (2d Cir. 1968) (explaining that the SEC "promulgated [Rule 10b-5] pursuant to the grant of authority given the SEC by Congress in Section 10(b) of the Securities Exchange Act of 1934," by which Congress sought "to prevent inequitable and unfair practices and to insure fairness in securities transactions generally, whether conducted face-to-face, over the counter, or on Page 7 exchanges").

  B. Heightened Pleading Requirements

  For federal securities fraud claims, the Private Securities Litigation Reform Act of 1995 ("PSLRA"), Pub. L. No. 104-67, 109 Stat. 737, reinforces the heightened pleading standards that apply to all claims of fraud or mistake under Fed.R.Civ.P. 9(b). Under the PSLRA, complaints alleging securities fraud must, first, "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)(B); and second, "with respect to each act or omission alleged . . ., state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. § 78u-4(b)(2); see Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir. 2001). That state of mind is scienter, which means "intent to deceive, manipulate or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976); see also Kalnit, 264 F.3d at 138 (same).

  The Second Circuit has made clear, however, that the PSLRA "`did not change the basic pleading standard for scienter in this circuit.'" Id., quoting Novak v. Kasaks, 216 F.3d 300, 310 (2d Cir. 2000). Both before and after the PSLRA, the law required plaintiffs bringing claims under § I0(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, to allege scienter with particularity. Id.; compare Novak, 216 F.3d at 307 (emphasizing that securities fraud allegations must "give rise to a strong inference of fraudulent intent"), with 15 U.S.C. § 78u-4(b)(2) (codifying the PSLRA's ...


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