United States District Court, S.D. New York
March 29, 2004.
ANTHONY DEMARCO, Plaintiff -v- LEHMAN BROTHERS INC. and MICHAEL E. STANEK, Defendants; STANLEY SVED, Plaintiff -v- LEHMAN BROTHERS INC. and MICHAEL E. STANEK, Defendants; FRANCES GRAVINO, Plaintiff -v- LEHMAN BROTHERS INC. and MICHAEL E. STANEK, Defendants
The opinion of the court was delivered by: JED RAKOFF, District Judge
Plaintiffs in these three now-consolidated class actions
represent a class of purchasers who bought stock in a company
called RealNetworks, Inc. ("RealNetworks") between July 11, 2000 and July
18, 2001. See Consolidated Class Action Complaint ("Complaint")
¶ 1. RealNetworks, which initially went public in November 1997,
provides software products and services for Internet media delivery.
Id. ¶ 2.
One of RealNetworks' investment banks was defendant Lehman Brothers
("Lehman"), which served as co-managing underwriter of RealNetworks'
secondary offering of common stock in June 1999. Complaint ¶ 2.
Lehman also publishes research analyst reports on selected companies. At
all times here relevant, these reports had a five point rating system
that reflected how the analyst covering the stock and writing the report
believed the stock would perform relative to the market generally, with
"1" being the most positive in terms of recommending a purchase.
Id. ¶ 15.
The Lehman research analyst who covered RealNetworks and whose reports
are at issue in the instant case is co-defendant Michael Stanek.*fn1
Complaint ¶ 1. Stanek issued thirteen research reports on
RealNetworks during the class period, all of which rated RealNetworks as
a "1" and recommended purchase
of its stock. Complaint ¶¶ 18-36.
On April 28, 2003, the Securities and Exchange Commission ("SEC")
publicly released emails it had gathered as part of its investigation of
Lehman's research analyst reports. Complaint ¶ 37. In one of these
emails, dated July 18, 2000, Stanek told an institutional investor that
"[RealNetworks] has to be short bigtime." Id. ¶ 22. The
institutional investor replied on July 19, 2000, saying "nice call on
[RealNetworks]. . . I mean all the upside from crappy ad business . . .
why aren't people jumping up and down saying this sucked??? . . . nice
call on your part anyhow." Stanek replied in turn that "we bank these
guys so I always have to cut the benefit of the doubt." Id. In
another email, written in January 2001, Stanek stated that "if it's in my
group it's a short." Id. ¶ 34.
Shortly following the public disclosure of these emails, the plaintiffs
filed these actions, which were then consolidated. The Consolidated Class
Action Complaint, filed on September 22, 2003, alleges violations of
Section 10b (and Rule 10b-5 promulgated thereunder) and Section 20(a) of
the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and t(a).
See Complaint ¶¶ 68-79. Specifically, the Complaint
alleges that the plaintiff class was fraudulently induced to purchase
shares in RealNetworks by Lehman's allegedly inflated ratings and
recommendations, and that they suffered substantial losses when the
company's true condition became known. Id. ¶¶ 18-36.
Lehman moves to dismiss the Complaint on no fewer than five separate
grounds. For the reasons stated below, the motion to dismiss is denied in
First, Lehman argues that plaintiffs have failed to satisfy
the pleading requirements of Federal Rule of Civil Procedure 9(b) and the
Private Securities Litigation Reform Act ("PSLRA"),
15 U.S.C. § 78u-4b(1), with respect to pleading the falsity of the Lehman
reports on which plaintiffs allegedly relied. The PSLRA raises the already
heightened pleading requirements of Rule 9(b) to a requirement that, in a
securities fraud lawsuit, the plaintiff "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).
The primary statements here alleged to be misleading are the ratings
themselves and the accompanying "bullish"
analysis. Lehman argues that since the texts of the research
reports contain some language skeptical of RealNetworks' value, the
public was adequately informed of the risks involved. But the very fact
that, notwithstanding the skeptical language, the reports gave
RealNetworks the highest possible "buy" rating is tantamount to a
statement that the reader of the reports should discount the skeptical
language a materially misleading statement in light of what
Stanek actually knew and believed, as indicated by the emails. At the
very least, it is a question for the jury. See Ganino v.
Citizens Utils. Co., 228 F.3d 154, 167 (2d Cir. 2000)
(truth-on-the-market defense is "intensely fact-specific" and "rarely an
appropriate basis for [dismissal]").
Lehman responds that Stanek's two emails, written in July 2000 and
January 2001, respectively, are not sufficient to support the pleading
that all the research reports issued between July 2000 and July
2001 were misleading. But the consistency of Stanek's expression of his
secretly negative views of the stock in July 2000 and January 2001 could
support a reasonable inference that this was his view throughout this
six-month period and, indeed, throughout the period that he continued to
give RealNetworks his very highest rating (i.e., through July,
Second, Lehman argues that plaintiffs have failed to meet the
PSLRA standard for pleading scienter, i.e., "plaintiffs must
`state with particularity facts giving rise to a strong inference that
the defendant acted with the required state of mind.'" Novak v.
Kasaks, 216 F.3d 300, 311 (2d Cir. 2000). But as already indicated
with respect to the issue of falsity, supra, the stark
difference between what Stanek was effectively recommending to readers of
his reports, i.e., "buy," and what he was effectively
recommending to preferred customers in his emails, i.e. "sell,"
supports a reasonable inference of an intent to mislead and defraud the
former. Indeed, falsity and intent here overlap, for effectively the
false statement in the reports is "Based on my investigation of the
company and the application of my expertise, I honestly believe you
should buy" when the truth is "Based on my investigation of the company
and the application of my expertise, I honestly believe you should sell."
See Commissioner v. Culbertson, 337 U.S. 733, 743n.12
(1949) ("the state of a man's mind is as much a fact as the state of his
digestion") (quoting Edgington v. Fitzmaurice, 29 L.R.Ch. Div.
459, 483 (Bowen, L.J.)).*fn2
[EDITORS NOTE: THIS PAGE IS BLANK.]
Third, Lehman argues that plaintiffs' claims should be
dismissed pursuant to the "bespeaks caution" doctrine, see
Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir.
2002), because the reports in question expressed numerous reservations
about RealNetworks and the risks of investing therein. This argument,
which considerably overlaps with Lehman's first argument,
supra, fails because a reasonable fact-finder could conclude
that Lehman, in repeatedly and disingenuously giving RealNetworks its
highest "buy" rating, was effectively representing that it did not
believe the risks involved should deter a prudent investor from
purchasing RealNetworks, whereas in fact (according to Stanek's emails
taken most favorably to plaintiffs) it actually believed a prudent
investor should be selling RealNetworks. In these circumstances, a
reasonable juror could conclude that such a strong "buy" recommendation
completely overwhelmed any contrary cautions.
Fourth, Lehman argues that the complaint fails to adequately
allege "transaction causation" (as it is called in securities law
parlance), or "reliance" (as it is otherwise referred to in the law of
fraud). Plaintiffs rely in this respect on the "fraud on the market"
doctrine initially propounded in Basic v. Levinson,
485 U.S. 224 (1988), which
holds that where there has been a misrepresentation to the
securities marketplace, a rebuttable presumption arises that investors
who purchased or sold securities in an efficient market relied upon the
misrepresentation, id. at 248-9.
Lehman's initial response is to claim the Basic presumption
is inapplicable to research reports. But as Judge Cote noted in rejecting
a similar argument in In re Worldcom Inc. Sec. Litig., 02 Civ.
3288, 2003 WL 22420467, *28 (S.D.N.Y. October 24, 2003), "defendants cite
no legal authority to support this remarkable assertion" and for good
reason, for it "comports with both common sense and probability to apply
the presumption here." This Court agrees, and therefore declines to
exempt the research reports here in question whose very purpose
was to advise Lehman's readers to buy stock in a company, RealNetworks,
for which Lehman also acted as investment banker, see
Complaint, ¶ 2 from the reach of the fraud-on-the-market
Lehman argues further, however, that even if the Basic
presumption applies, it is here rebutted as a matter of law because the
market as a whole was aware of the alleged conflicts between Lehman's
investment banking and research departments since there was extensive
media coverage of such conflicts. Even aside from the fact that these
arguments are not cognizable in the context of this Rule 12(b)(6)
motion, they also fail because Lehman has not established that the market
knew Stanek was lying when he recommended RealNetworks' stock. Simply
establishing the media had reported on some generalized conflicts between
investment banking and research departments in a variety of investment
banks is not equivalent to market awareness of Stanek's
Fifth, Lehman argues that the complaint fails adequately to
allege "loss causation" except in a way that renders plaintiffs' claim
barred by the appropriate statute of limitations. But this argument
confuses two separate elements of plaintiffs' burden, both of which they
have met for pleading purposes. One element is "loss causation," which is
the securities law equivalent of "proximate cause" in tort law, "meaning
that the damages suffered by plaintiff must be a foreseeable consequence
of any misrepresentation or material omission." Emergent Capital
Investment Management, LLC v. Stonepath Group, Inc., 343 F.3d 189,
197 (2d Cir. 2003).
As with its "proximate cause" counterpart, "loss causation" is not free
from ambiguity, and some of the cases in the Second Circuit and elsewhere
suggest uncertainty as to whether or not it requires proof that the
losses suffered by
the plaintiffs can be directly attributed to the market's learning
the true facts that the previous misrepresentations concealed.
See Suez Equity Investors, L.P. v. Toronto-Dominion
Bank, 250 F.3d 87, 98n.1 (2d Cir. 2001) (discussing "somewhat
inconsistent precedents" on loss causation); In re Initial Public
Offering Securities Litigation, No. 21 MC 92, 2003 WL 23096875, *3
(S.D.N.Y. Dec. 31, 2003)(allegations of artificial inflation without more
insufficient for loss causation purposes); Weiss v. Wittcoff,
966 F.2d 109, 111(2d Cir. 1992)(explaining that central question is "was
the damage complained of a foreseeable result of the plaintiff's reliance
on the fraudulent misrepresentation?"). At this stage of this lawsuit,
however, the Court need not resolve this seeming conflict, for assuming
arguendo that plaintiffs must plead that their losses
proximately resulted from the marketplace's reaction to the revelation of
the truth that defendant's actionable statements concealed (as contrasted
to independent market forces), the Complaint adequately alleges that in
or around October, 2000 the market was finally apprised of the negative
information concerning RealNetworks that had earlier led Stanek to take a
secretly negative view of the stock and that, as the result of those
revelations, the stock declined, causing the lossees on which plaintiff
here sues. See
Complaint ¶¶ 25-36. This suffices for loss causation under any
Plaintiffs, however, could not bring suit at the point of such
disclosures and losses (that is, late 2000) because they had no basis for
believing that Stanek had intentionally lied when he issued his prior
positive reports, and without evidence of such scienter no
private action may be brought. See Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 193 (1976). Thus, while the element of
loss causation was known to plaintiffs in late 2000, the element of
scienter was not. This latter element did not become known to plaintiffs,
and even with the exercise of due diligence could not have become known
to them, until the SEC disclosed Stanek's emails to the public on April
28, 2003, shortly after which this suit was commenced. Accordingly, the
suit is not barred by the statute of limitations. See
Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir.
While Lehman raises other arguments concerning loss causation, the
statute of limitations, and still other grounds for dismissal,*fn4 the
Court, after careful consideration, finds that none of these additional
grounds is even sufficiently colorable to warrant discussion here.
For the foregoing reasons, the Court denies in its entirety defendant's
motion to dismiss.