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February 25, 2004.


The opinion of the court was delivered by: WILLIAM CONNER, Senior District Judge


Plaintiff Peter T. Loftin brings this putative class action against defendants Flag Telecom Holding Group, Ltd. ("Flag"),*fn1 Salomon Smith Barney, Inc. n/k/a Citigroup Global Markets, Inc. ("Citigroup" or the "underwriter") and Verizon Communications, Inc. ("Verizon"). Plaintiff also names eight individual defendants: Andres Bande, Larry Bautista, Andrew Evans, Dr. Lim Lek Suan, Edward McCormack, Edward McQuaid, Daniel Petri and Philip Seskin (collectively referred to as the "individual defendants").*fn2 On October 18, 2002, this Court consolidated several similar suits; Loftin was named lead plaintiff and Milberg Weiss Bershad Hynes & Lerach was appointed lead counsel.

Plaintiff alleges that all defendants are liable under §§ 11, 12(a)(2) and 15 of the Securities Act of 1933 (the "Securities Act"). Additionally, plaintiff claims that Flag and the individual defendants violated § 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 promulgated thereunder. Flag, Verizon, Citigroup and the individual defendants move to dismiss pursuant to Rules 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act ("PSLRA") for failure to state a claim. For the reasons stated herein, defendants' motions are granted. Plaintiff, however, is granted leave to replead all claims. Accordingly, plaintiff has thirty Page 2 days from the entry of this Opinion and Order to file a Second Consolidated Amended Complaint.


  Prior to filing its Chapter 11 bankruptcy petition,*fn3 Flag was a telecommunications company, co-founded by Verizon's predecessor, (Complt. ¶ 52),*fn4 that marketed itself as a "carrier's carrier" i.e. a company that owns its own telecommunications infrastructure and sells access to it on a wholesale basis. (Id. ¶ 2.) Each of the individual defendants served as officers or directors of Flag during the class period. Specifically, Bande was the Chairman and Chief Executive Officer ("CEO"), McCormack was the Chief Operating Officer ("COO"), Evans was the Chief Technology Officer, Bautista was the Chief Financial Officer ("CFO") and Petri, McQuaid, Seskin and Suan were directors.

  In early 2000, Flag made an initial public offering ("IPO") as part of an effort to expand its fiberoptic network. (Id. at ¶¶ 3-4; Prospectus at 15.) One of the largest projects disclosed in the Prospectus was a joint venture with GTS TransAtlantic ("GTS"). The companies were constructing a fiberoptic connection between London and Paris called the Flag Atlantic-1 system ("FA-1 system"). (Complt. at ¶ 4.) Flag also intended to develop its network by acquiring access to cables owned by other carriers where rapid expansion was necessary or where it was not economically Page 3 feasible to expand Flag's own infrastructure. (Prospectus at 1, 38.) In industry jargon, such unused cables are called "dark fiber."

  On January 18, 2000, Flag filed a Registration Statement that incorporated the company's Prospectus. (Complt. ¶ 70.) The effective date of the Registration Statement was February 11, 2000. (Id. ¶ 74.) Flag's IPO took place on February 16, 2000, and the company raised approximately $634.6 million from the sale of its common stock. (Id.) Citigroup served as lead underwriter. (Id. ¶ 52.) Plaintiff alleges that the Prospectus contained actionable misstatements because it created "the false and misleading impression that strong demand existed for Flag's capacity, and that demand was growing." (Id. ¶ 70.) Plaintiff also claims that the Prospectus contained actionable omissions. (Id. ¶¶ 70-72.)

  Sometime after the EPO, the telecommunications industry experienced a decline and in late 2000 and early 2001, some of Flag's competitors began to reduce forecasts and announce liquidity problems. (Id. ¶ 64.) Plaintiff claims that rather than disclose the fact that Flag was also experiencing difficulties, Flag relied on improper "swap" transactions with competitors to inflate its financial results and made misleading, or incomplete, public statements to create the sense that Flag was not suffering the same fate as some of its competitors. (Id. at ¶ 2.) The alleged misleading statements continued until Flag's announcement on February 13, 2002 that the company was "reviewing [its] business in light of deteriorating market conditions" and that 14% of its revenues for 2001 were the result of reciprocal transactions entered into with competitors. (Id. ¶ 153.) Plaintiff proposes a Class Period from February 16, 2000, the date of Flag's IPO, until February 13, 2002, the date of Flag's announcement that it was "reviewing its business." Page 4


  I. Standard of Review

  On a motion to dismiss pursuant to Rule 12(b)(6), the court must accept as true all of the well pleaded facts and consider those facts in the light most favorable to the plaintiff. See Scheuer v. Rhodes, 416 U.S. 232, 236 (1974), overruled on other grounds by Davis v. Scherer, 468 U.S. 183 (1984); Harris v. City of New York, 186 F.3d 243, 247 (2d Cir. 1999); Faulkner v. Verizon Communications, Inc., 156 F. Supp.2d 384, 390 (S.D.N.Y. 2001) (Conner, J.). On such a motion, the issue is "whether the claimant is entitled to offer evidence to support the claims." Scheuer, 416 U.S. at 236. A complaint should not be dismissed 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 which would entitle him. to relief." Padavan v. United States, 82 F.3d 23, 26 (2d Cir. 1996) (quoting Hughes v. Rowe, 449 U.S. 5, 10 (1980)). Generally, "[c]onclusory allegations or legal conclusions masquerading as factual conclusions will not suffice to prevent a motion to dismiss." 2 JAMES WM. MOORE ET. AL., MOORE'S FEDERAL PRACTICE § 12.34[1][b] (3d ed. 1997); see also Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1088 (2d Cir. 1995). Allegations that are so conclusory that they fail to give notice of the basic events and circumstances of which the plaintiff complains, are insufficient as a matter of law. See Martin v. New York State Dep't of Mental Hygiene, 588 F.2d 371, 372 (2d Cir. 1978).

  In assessing the legal sufficiency of a claim, the court may consider those facts alleged in the complaint, documents attached as an exhibit thereto or incorporated by reference, see FED. R. Civ. P. 10(c); De Jesus v. Sears, Roebuck & Co., Inc., 87 F.3d 65, 69 (2d Cir. 1996), and documents that are "integral" to plaintiff's claims, even if not explicitly incorporated by reference. Cortec Indus., Inc. Page 5 v. Sum Holding L.P., 949 F.2d 42, 46-48 (2d Cir. 1991). A company's prospectus is integral to a plaintiff's § 11 and § 10(b) claims and can be considered in its entirety even where plaintiff has quoted from it sparingly. I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d. Cir. 1991). Indeed, when considering a motion to dismiss § 11 claims, the court must consider the prospectus as a whole. Olkey v. Hyperion, 98 F.3d 2, 5 (2d Cir. 1996).

  II. plaintiff's Securities Act Claims

 A. Section 11

  Plaintiff has asserted a claim under § 11 of the Securities Act against all named defendants. (Complt. ¶¶ 198-206.) In order to state a claim under § 11, a plaintiff must allege that "the registration statement . . . 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. . . ." 15 U.S.C. § 77k(a). The truth of a statement made in the prospectus is adjudged by the facts as they existed when the registration statement became effective. In re MobileMedia Sec. Litig., 28 F. Supp.2d 901, 923 (D.N.J. 1998). A claim under this section may be asserted against every person who signed the registration statement, the directors of the issuer and the underwriter of the security. 15 U.S.C. § 77k(a). The test for determining whether the prospectus contained material misstatements or omissions is "whether the defendants' representations [made in the prospectus], taken together and in context, would have misled a reasonable investor. . . ." Olkey, 98 F.3d at 5. Plaintiff attempts to plead a § 11 claim by alleging the following:

  The Prospectus touted Flag's supposedly "state-of-the-art technology" and the vast capacity of its largest project, the FA-1 system. In particular, the Prospectus went to great lengths to create the false and misleading impression that strong demand Page 6 existed for Flag's capacity, and that demand was growing. . . . [Flag also] promoted the fact that the FA-1 system had "pre-sales in excess of $750 million," but failed to disclose that every customer who was likely to purchase capacity on the FA-1 had already done so.

 (Complt. ¶¶ 70-71.) Plaintiff argues that these statements were misleading because "a glut of supply existed that was overwhelming demand and driving down prices" and the statements created the "misleading impression that strong demand existed for Flag's capacity." (Id. ¶¶ 70-74.) Plaintiff further claims that the Prospectus was misleading because it "touted" Flag's customer base without disclosing that "Flag performed absolutely no due diligence on its customers to determine their ability to pay." (Id., ¶ 72.)

  None of the statements in the Prospectus constitutes an affirmative representation by Flag that "strong demand existed for Flag's capacity, and that demand was growing. . . ." (Id. ¶ 70.) For instance, Flag stated that a particular feature of its FA-1 system was "designed to meet the needs of major global carriers that require substantial amounts of bandwidth." (Prospectus at 38.) This statement merely indicates that Flag sought to attract major global carriers that required facilities Flag offered, not that demand for Flag's capacity was strong. While Flag announced that the FA-1 system had pre-sales of $750 million, it did not, as plaintiff claims, present this fact in an effort to exaggerate the demand for Flag's products. In fact, the statement appeared in a section of the Prospectus explaining how the project would be financed. (Prospectus at 34.) Similarly, plaintiff points to Flag's contention that "carriers have responded positively to our ability to offer" certain facilites and services. (Id. at 40.) This statement is far too vague to lead a reasonable investor to conclude that at the time of the offering Flag claimed that demand was strong for its capacity.

  Plaintiff has established that Flag represented that there was a general demand for capacity Page 7 in the telecom industry and that Flag expected to "participate in . . . important growth and strategic shifts in the international telecommunications markets." (Prospectus at 39.) Most of these representations consist of statements made by Flag concerning general market conditions and trends. (Pl. Mem. Opp. Citigroup Mot. Dismiss at 3-4.) Plaintiff has not, however, pleaded any facts that indicate any of these statements were untrue as of the effective date. In fact, the Complaint tends to establish that the decline in the telecom industry did not begin until late 2000 and early 2001. (Complt. ¶¶ 64-65.) The Prospectus also contained meaningful cautionary language explaining that the telecom industry faced significant challenges. Flag disclosed that it faced "competition and pricing pressure from existing cables, planned cables, and satellite providers." (Prospectus at 11.) Flag even predicted that prices would decline going forward. (Id. at 31.) The company explained that many of its competitors had greater resources and that advances in technology could lead to an increase in its competitors' capacity. (Id. at 11.) Furthermore, Flag frankly stated that ventures, such as its FA-1 system, that employed "state of the art technology" were subject to deployment problems that could have a material adverse effect. (Id. at 6-14.) Far from brashly "touting" its "state of the art technology" as plaintiff claims, Flag was singling out its "state of the art technology" a significant risk factor. When a prospectus contains detailed disclosures of the relevant risks involved, general statements concerning the state of the industry, such as the ones made here, are immaterial as a matter of law. See Olkey, 98 F.3d at 6.

  Plaintiff has also failed to plead an omission that will support liability under § 11. When a plaintiff claims that the defendant failed to disclose information in a prospectus, the plaintiff must plead facts demonstrating the defendant possessed the omitted information when the registration statement became effective and that the defendant had a duty to disclose that information. See, e.g., Page 8 Scibelli v. Roth, No. 98 Civ. 7228, 2000 WL 122193, at *3 (S.D.N.Y. Jan. 31, 2000) (dismissing a § 11 claim when it was alleged that the defendant failed to disclose demand was weak because the plaintiff did not plead facts demonstrating that the defendant possessed information indicating that demand was weak on the effective date); Fisher v. Ross, No. 93 Civ. 0275, 1996 WL 586345, at *3 (S.D.N.Y. Oct. 11, 1996).

  In the present case, plaintiff alleges that Flag had a duty to disclose that "a glut of supply existed that was overwhelming demand and driving down prices." (Complt. ¶¶ 70-74.) This allegation fails because plaintiff does not claim that this was true as of the effective date much less allege that Flag possessed information indicating that demand was weak on the effective date. In fact, the Complaint tends to show that demand for telecom products did not weaken until long after the EPO, (Id. ¶¶ 64-65), and the Prospectus disclosed in detail the competitive challenges facing Flag. Plaintiff also alleges that Flag's claim that it had "pre-sales in excess of $750 million" on its FA-1 system gave rise to a duty to disclose that all the customers who were likely to purchase capacity on that network had already done so. (Id. ¶ 71.) Even if this were the case, plaintiff has not pleaded facts indicating that on the effective date Flag had information that would lead to this conclusion.

  The Prospectus also contained statements concerning Flag's customer base. For example, Flag stated, "We have an established customer base of approximately 90 customers." (Prospectus at 44.) Plaintiff does not allege that Flag misrepresented its customer base. Instead, he claims that Flag had a duty to disclose that it performed no due diligence on its customers because Flag "touted" its customer base in the Prospectus. The only allegation that plaintiff provides to support this claim is that an unnamed former Finance Manager said that "when selling capacity, Flag `just wanted to Page 9 record the sale.'" (Complt. ¶ 72 (quoting former Finance Manager).) This vague statement does not indicate that Flag failed to conduct due diligence; it merely states the Manager's interpretation of Flag's desire. Indeed, the Complaint tends to establish that Flag did in fact conduct due diligence. First, it notes that Barclays Bank agreed to provide financing for the FA-1 system project (Id. ¶ 112); if a bank was willing to provide substantial funding, it is unlikely that Flag had no idea whether its customers had the ability to pay. Second, the Prospectus states that 95% of Flag's reported revenues came from its top fifty customers. (Prospectus at 52.) This suggests that Flag had dealt with its customers in the past and was therefore assured of their ability to pay. Therefore, this allegation fails because plaintiff has not alleged any facts to indicate that Flag failed to adequately investigate its customers' ability to pay. Accordingly, we conclude that plaintiff has failed to plead an actionable omission under § 11.

  Because plaintiff has failed to plead facts showing that "the registration statement . . . 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," his § 11 claims must be dismissed. 15 U.S.C. § 77k(a). The individual defendants argue that these claims should also be dismissed because they are time barred. (Indiv. Defs. Corr. Mem. Supp. Mot. Dismiss at 32.) However, accepting the allegations in the Complaint as true, it is not clear at this point that plaintiff should have discovered the allegedly misleading statements prior to the end of the Class Period. Therefore, we cannot say, as a matter of law, that plaintiff was put on inquiry notice so as to trigger the one-year statute of limitations prior to that time. See 15 U.S.C. § 77m. Page 10

 B. Section 12(a)(2) and Section 15

  Plaintiff has asserted a claim under § 12(a)(2) of the Securities Act against Flag, the individual defendants and Citigroup. (Complt. ¶¶ 207-14.) Section 12(a)(2) allows a plaintiff to proceed against "[a]ny person who . . . offers or sells a security . . . by means of a prospectus or oral communication, which includes an untrue statement of material fact or omits to state a material fact necessary in order to make the statements . . . not misleading. . . ." 15 U.S.C. § 771(a). The Supreme Court has held that a private contract for sale is not a "prospectus" under this provision, Gustafson v. Alloyd Co., 513 U.S. 561, 571 (1995). The predominant view is that under this precedent § 12(a)(2) applies only to public offerings and therefore aftermarket purchasers lack standing to bring a claim under § 12(a)(2). See, e.g., Laser Mortgage Mgmt., Inc. v. Asset Securitization Corp., No. 00 Civ. 8100, 2001 WL 1029407, at *7-8 (S.D.N.Y. Aug. 17, 2001); Waltree Ltd. v. ING Furman Selz LLC, 97 F. Supp.2d 464, 469 (S.D.N.Y. 2000). However, a party named "lead plaintiff under the PSLRA need not have standing to sue on each individual claim asserted in the complaint so long as other named plaintiff's have standing to pursue the claims at issue. In re Initial Public Offerings Sec. Litig., 214 F.R.D. 117, 123 (S.D.N.Y. 2002); In re Enron Corp. Sec. Litig., 206 F.R.D. 427, 451 (S.D. Tex. 2002); In re American Bank Note Holographics Sec. Litig., 93 F. Supp.2d 424, 436 (S.D.N.Y. 2000) ("Holographics"). Nevertheless, plaintiff's § 12(a)(2) claims must be dismissed for two other reasons: first, as discussed supra in Part II.A., the Complaint fails to plead that the Prospectus contained any actionable misstatements or omissions. Second, plaintiff has not alleged that any of the named plaintiff's purchased securities in the IPO and has thus failed to allege that any of them has standing to pursue this claim.

  Finally, plaintiff asserts a claim under § 15 of the Exchange Act against Verizon and the Page 11 individual defendants. (Complt. ¶¶ 215-18.) Section 15 of the Securities Act allows a plaintiff to proceed against "[e]very person who, by or through stock ownership, agency or otherwise . . . controls any persons liable under section 11 or 12" of the Securities Act. 15 U.S.C. § 77o. These claims must be ...

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