United States District Court, S.D. New York
February 18, 2004.
IN RE MERRILL LYNCH TYCO RESEARCH SECURITIES LITIGATION
The opinion of the court was delivered by: MILTON POLLACK, Senior District Judge
ON MOTION TO DISMISS
DECISION AND ORDER
Defendants Merrill Lynch & Co., Inc. and its wholly owned
subsidiary Merrill Lynch, Pierce Fenner & Smith Incorporated
(together referred to as "Merrill Lynch") move to dismiss the
Consolidated Amended Complaint dated September 25, 2003 ("Complaint" or
"Compl.") for, among other things, (1) failure to state a claim upon
which relief can be granted, pursuant to Rule 12(b)(6) of the Federal
Rules of Civil Procedure, and (2) failure to plead fraud with
particularity, as required by the Private Securities Litigation Reform
Act of 1995 ("Reform Act"), see 15 U.S.C. § 78u-4(b), and
Rule 9(b) of the Federal Rules of Civil Procedure. Individual defendant
Phua K. Young ("Young"), a former analyst and Managing Director of
Merrill Lynch, joins the motion. For the reasons set forth below, the
motion is granted.
This is a federal securities class action to recover damages for
alleged violations of Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 (the "Exchange Act"), and Rule 10b-5 issued thereunder by the
SEC. The suit is against the Merrill Lynch companies and an individual
formerly in their employ as an analyst. It is asserted by Lead Plaintiff
Ronald Gutzwiller on behalf of himself and a putative class of all
persons who acquired the common stock of Tyco International Ltd.
("Tyco"). The purchases were made in the open market at some unspecified
date or dates during the period from January 22 to June 6, 2002 (the
"class" period); a period in which a $75 billion decline occurred in the
market capitalization of Tyco stock.
Merrill Lynch in its published research reports had publicly rated
Tyco's asset valuation range from $60-$70 per share when the stock was
trading in the $30 range. Over time the valuations by Merrill Lunch were
successively lowered during the relevant period as circumstances
During the class period Tyco was contemplating a corporate
reconstruction involving a possible sale of Tyco's financial service
subsidiary, the CIT Group, Inc. ("CIT"), the proceeds of which would be
applied to debt reduction. The plans did not eventuate during the period.
Plaintiff asserts that the putative class's losses on their purchases
were caused by a statement which appeared in a Merrill Lynch earnings
model: an estimate that CIT could be sold or spun-off for $7-$8 billion.
The complaint fails to plead that the alleged fraud was the proximate
cause of the losses claimed. Lead Plaintiff makes the conclusory
allegation that he "purchased the common stock of Tyco at an artificially
inflated price during the Class Period . . . and has been damaged
thereby." Self-evidently, such allegations are insufficient to allege
loss causation. Lead Plaintiff also alleges that the decline of Tyco's
stock from its opening price on June 6 to its opening price on June 7,
2002 was "directly attributable to Merrill Lynch's disclosure on June 6,
2002 that Defendants did not support Tyco's stock, management, and
operations." However, the language in the report that Plaintiff
characterizes as a disclosure does not actually "disclose" anything
relevant to Plaintiff's claim.
I. THE COMPLAINT FAILS TO STATE A CLAIM FOR SECURITIES FRAUD
A. Plaintiff Fails to Plead That The Alleged Fraud
Was The Proximate Cause of His Losses
Plaintiff fails to plead that the Merrill Lynch research reports were
the proximate cause of his losses. The Complaint plainly alleges that
Plaintiff "purchased the common stock of Tyco at an artificially inflated
price during the Class Period . . . and has been damaged thereby." Compl.
¶ 8. The Complaint also alleges that the alleged "wrongful conduct"
of Merrill Lynch "caused the artificial inflation of Tyco's common stock
during the Class period and caused Lead Plaintiff and members of the
Class to sustain losses when they purchased Tyco common stock at these
artificially inflated prices." Compl. ¶ 2. Such allegations are
insufficient to allege loss causation. To plead loss causation in a case
involving material misstatements and omissions, a plaintiff must allege
something more than mere price inflation or "purchase-time value
disparity." See Emergent Capital Investment Mgmt. v. Stonepath
Group. Inc., 343 F.3d 189, 198 (2003).*fn1
Plaintiff simply does not and cannot identify any factual allegations
in the Complaint from which it can be inferred that the alleged false
statements in the research reports were the foreseeable cause of the
decline in Tyco's stock price on June 6, 2002, the last day of the class
period, as opposed to the myriad negative factual information about Tyco
that entered the marketplace that same day. Plaintiff fails even to
address the requirement that he must allege facts showing that the
misrepresentations and omissions alleged in the complaint were the
proximate cause for the decline in Tyco's stock price. See
Emergent. 343 F.3d at 198.
Plaintiff challenges Merrill Lynch's projection that CIT could be sold
for $7-$8 billion. Models containing the assumption that CIT could be
sold for $7-$8 billion appeared in research reports dated 2/14/02,
2/15/02, 3/1/02, 3/19/02, 3/20/02 and 4/1/02. Another report, one issued
on April 15, 2002, opined that "if Tyco is able to announce a sale of CIT
for $7.5$8B [sic] (the
range discussed in the press three weeks ago) in cash, we believe
that the shares would react very favorably." The assumption was
superseded by the issuance of a new estimate in a June 4, 2002 Merrill
Lynch research report which downgraded Tyco's rating from a B-l-1
(Average Risk, Strong Buy) to a D-3-3 (High Risk, Neutral). The June 4th
report suggested a lower expectation for the likely proceeds from a sale
of CIT (that is, a price of $5 billion) when it noted that all the
proceeds from the private sale or IPO of CIT were "slated to pay down
debt" and then hypothesized that a possible sale or IPO of CIT would
produce $5 billion with which to pay down debt. ("Assuming that $5
billion is paid down post-CIT . . .") The June 4th report also contained
a brief section entitled "Liquidity Crisis?". But Tyco's shares actually
closed higher on the day of the report (June 4) and on June 5, 2002.
Faced with this obvious impediment to his "fraud" claim against Merrill
Lynch, Plaintiff instead chose to end the class period on June 6, 2002, a
date upon which Tyco's stock was pummeled by negative reports concerning
its former CEO's use of company funds to buy artwork, an $18 million
apartment and that the SEC had opened an investigation.
Fatal to Plaintiffs "fraud" claim is the fact that the June 6, 2002
research report does not disclose anything new about the projected size
of the proceeds from a sale, spin-off or IPO of CIT; about allegedly
insincere opinions regarding Tyco's financial position and stock price;
about an allegedly illicit relationship between Tyco, Young, and Merrill
Lynch; or about Young and Merrill Lynch's allegedly undisclosed liquidity
concerns.*fn2 Accordingly, Plaintiff has failed to assert any causal
relationship between the "fraud" alleged and the decline in the trading
price of Tyco's securities on June 6, 2002. Because the June 6 research
report did not discuss the subject matter of the alleged fraud, as a
matter of law, the decline in Tyco's trading price on that date cannot be
considered a reaction to the disclosure of the alleged "fraud." See
AUSA Life Ins. Co. v. Ernst & Young. 206 F.3d 202, 215 (2d Cir.
2000) (where alleged fraud did not manifest itself during putative class
period, no loss causation); Robbins v. Koger Props., Inc., 116 F.3d 1441,
1448-49 (11th Cir. 1997) (no showing that "artificial inflation" was removed
from the stock price during the class period)); Arduini/Messina P'ship v.
Nat'l Med. Fin. Servs. Corp., 74 F. Supp.2d 352, 361-62 (S.D.N.Y. 1999)
Plaintiff's allegations that the representation concerning the expected
proceeds from a sale of CIT caused his losses fail for the additional
reason that the allegations are too speculative and remote. See
First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 769-70 (2d
Cir. 1994). Plaintiff fails to assert any facts suggesting that Merrill
Lynch or Young could have reasonably foreseen that Young's projection
that Tyco could sell CIT for $7-$8 billion would have
caused Tyco's stock price to collapse on June 6.
"`Loss causation in effect requires that the damage complained of must
be one of the foreseeable consequences of the misrepresentation.'"
AUSA Life Ins. Co. v. Ernst and Young. 206 F.3d 202, 216 (2d
Cir. 2000) (citing Manufacturers Hanover Trust Co. v. Drysdale
Secs. Corp., 801 F.2d 13, 21 (2d Cir. 1986)): see also
Emergent. 343 F.3d at 197 (citing Castellano v. Young &
Rubicam, 257 F.3d 171, 186 (2d Cir. 2001) and Citibank. N.A. v.
K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992)); Suez Equity
Invs. L.P. v. Toronto Dominion Bank. 250 F.3d 87, 96 (2d Cir. 2001)
("The loss causation inquiry typically examines how directly the subject
of the fraudulent statement caused the loss, and whether the resulting
loss was a foreseeable outcome of the fraudulent statement.")
A sale of CIT was only one possibility: Merrill Lynch's Tyco research
reports repeatedly stated that Tyco's intention was to either
sell or spin off CIT. Tyco stated that a sale of CIT would be
"more lucrative to shareholders." On April 25, 2002, however, Tyco
announced that, rather than a sale or spinoff, it would instead divest
itself of CIT by means of an initial public offering. Thus, Young's
previously disclosed assumption regarding a projected sale
price cannot support Plaintiff's conclusory allegations of loss
causation, especially given CIT's own IPO registration statement (dated
April 25), which listed maximum proceeds to Tyco of $6.5 billion.
Information available to the market several weeks after the last
mention of a $7-$8 billion price appeared suggested that $5 billion might
be the highest amount Tyco could hope to get for CIT. On May 24, 2002, it
was widely reported that Lehman Brothers Inc., one of the bankers for the
proposed CIT offering, had made a $5 billion offer for CIT and had
promptly withdrawn it.
See, e.g., Greg Cresi and Arindam Nag, Lehman Bids
for Tyco's CIT, Then Backs Out Source. Reuters, May 24,
2002; Christopher C. Williams, Tyco Again Victim of Flip-Flop. This
Time From Lehman. Dow Jones News Serv., May 24, 2002; Steve Gelsi,
Tyco shares flip-flop on conflicting rumors of CIT buy,
CBSMarket Watch.com, May 24, 2002.*fn3
B. Plaintiff Fails to Plead Fraud with
A complaint alleging securities fraud must meet the strict mandate of
Rule 9(b) and the Reform Act and state "with particularity the
circumstances constituting the alleged fraud. See Mills v. Polar
Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993). Rule 9(b)
requires a complaint alleging securities fraud to "`(1) specify the
statements that the plaintiff contends were fraudulent, (2) identify the
speaker, (3) state where and when the statements were made, and (4)
explain why the statements were fraudulent.'" Rombach v. Chang,
355 F.3d 164, 170 (2d Cir. 2004) (quoting Mills. 12 F.3d at
Congress added Section 21D, 15 U.S.C. § 78u-4, to the Exchange Act
"to strengthen existing pleading requirements" for securities fraud, H.R.
Conf. Rep. No. 104-369, at 41 (1995), reprinted in
1995 U.S.C.C.A.N. 730, 740, and to require the complaint to "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) (emphases added). Thus,
"`to withstand a motion to dismiss plaintiffs must detail specific
contemporaneous data or information known to the defendant that was
inconsistent with the representation in question.'" Hart v. Internet
Wire. Inc., 145 F. Supp.2d 360, 368 (S.D.N.Y. 2001) (citation
omitted); see San Leandro Emergency Med. Group Profit Sharing Plan
v. Phillip Morris Cos., 75 F.3d 801, 812-13 & n.13 (2d Cir.
1996) (plaintiffs must plead specific facts showing defendants'
statements were false when made or that optimistic predictions "lacked a
reasonable basis"). The actual fraudulent statements or conduct and the
fraud alleged must be stated with particularity.
Plaintiff challenges every research report issued by Merrill Lynch
during the putative class period.*fn4 Yet the Complaint does not
sufficiently allege why and in what respects each particular research
report issued during the putative class period did not provide a "sound
basis" for "evaluating the facts concerning Tyco," or why particular
target prices for Tyco's shares "lacked any reasonable basis."
Plaintiff also fails to plead the CIT allegations with the requisite
particularity. For Plaintiff must not only allege with particularity the
statements or omissions that he contends were fraudulent, but also "the
fraud itself." See Cohen v. Koenig. 25 F.3d 1168, 1173 (2d Cir.
1994); Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir.
1996). Plaintiff alleges no facts supporting the conclusions that: (i)
During the class period Tyco appeared to the market to be "a rock solid,
blue chip conglomerate with a successful track record and a bright and
prosperous future"; and (ii) The $7-$8 billion valuation of CIT actually
inflated the trading price of Tyco shares.
II. FINDINGS REGARDING RULE 11 SANCTIONS
Section 21D(c) of the PSLRA, entitled "Sanctions for abusive
In any private action arising under this chapter,
upon final adjudication of the action, the court
shall include in the record specific findings
regarding compliance by each party and each
attorney representing any party with each
requirement of Rule 11(b) of the Federal Rules of
Civil Procedure as to any complaint, responsive
pleading, or dispositive motion.
15 U.S.C. § 78u-4(c)(1); see Rombach, 335 F.3d at 178
(remanding for specific findings regarding compliance with
Rule 11 pursuant to PSLRA).
If the court determines that there has been a violation of Rule 11,
section 21D(c)(2) imposes mandatory sanctions and adopts a rebuttable
presumption that the appropriate sanction for noncompliance "is an award
to the opposing party of the reasonable attorneys' fees and other
expenses incurred." 15 U.S.C. § 78u-4(c)(3)(A)(i)-(ii). "The PSLRA
thus does not in any way purport to alter the substantive standards for
finding a violation of Rule 11, but functions merely to reduce courts'
discretion in choosing whether to conduct the Rule 11 inquiry at all and
whether and how to sanction a party once a violation is found."
Simon DeBartolo Group. L.P. v. Richard E. Jacobs Group. Inc.,
186 F.3d 157, 167 (2d Cir. 1999). Because this dismissal with prejudice
constitutes a "final adjudication" of an action arising under the PSLRA,
this Court's Rule 11 findings with respect to Plaintiffs Consolidated
Amended Complaint are set forth below.
In resolving Defendants' motion to dismiss, the Court has thoroughly
reviewed Plaintiff's Complaint. The Court finds no indication that
Rule 11 sanctions are warranted. There is no evidence that Plaintiff filed his
Consolidated Amended Complaint for "an improper purpose" such as to
harass defendants or to cause unnecessary delay. Under the law of this
Circuit, "[a]n argument constitutes a frivolous legal position for
purposes of Rule 11 sanctions if, under an objective standard of
reasonableness, it is clear . . . that there is no chance of success and
no reasonable argument to extend, modify or reverse the law as it
stands." Morley v. Ciba-Geigy Corp., 66 F.3d 21, 25 (2d Cir.
1995) (internal quotations omitted). Although the Court finds, for the
reasons set forth above, that Plaintiff's allegations of loss causation
are insufficient, this does
not mean that Plaintiff's claim is so unreasonable that it had
absolutely "no chance" of success. Finally, as for Plaintiff's
allegations and other factual contentions, the standard for holding that
a particular allegation warrants sanctions is high. See O'Brien v.
Alexander. 101 F.3d 1479, 1489 (2d Cir. 1996) ("[S]anctions may not
be imposed unless a particular allegation is utterly lacking in
support."). Even though the Court concludes that the Consolidated Amended
Complaint warrants dismissal, the Court need not conclude that the
factual allegations are so unreasonable as to warrant Rule 11 sanctions.
Plaintiff's allegations and other factual contentions are not so weak as
to warrant sanctions.
For all of the foregoing reasons the Consolidated Amended Complaint
should be and hereby is dismissed with prejudice but without imposition
of sanctions under Rule 11.