United States District Court, S.D. New York
June 28, 2004.
IN RE WORLDCOM, INC. SECURITIES LITIGATION. This Document Relates to: IN RE TARGETS SECURITIES LITIGATION. This Document Relates To: ALL ACTIONS.
The opinion of the court was delivered by: DENISE COTE, District Judge
OPINION AND ORDER
Defendants Citigroup Inc. ("Citigroup"), Citigroup Global Markets Inc., formerly known as Salomon Smith Barney Inc.
("SSB"), and Jack Grubman ("Grubman") (collectively, "SSB
Defendants") have moved to dimiss a class action complaint
asserting federal securities law claims based on a derivative
security whose value was linked to the value of the common stock
of WorldCom, Inc. ("WorldCom"). The plaintiffs assert Sections 11
and 12(a)(2) claims under the Securities Act of 1933 ("Section
11," "Section 12(a)(2)," and "Securities Act"), and Sections
10(b) and 20(a) claims under the Securities Exchange Act of 1934
("Section 10(b)," "Section 20(a)," and "Exchange Act") in
connection with an instrument called Targeted Growth Enhanced
Terms Securities With Respect to the Common Stock of MCI
WorldCom, Inc. ("TARGETS"). For the following reasons, the motion
to dismiss is granted in part.
On June 25, 2002, WorldCom announced a massive restatement of
its financial statements. Government investigations and
prosecutions followed. WorldCom entered bankruptcy in the summer
of 2002, and has recently emerged from bankruptcy.
Civil litigation had anticipated the June 25 announcement. The
first class action concerning WorldCom securities was filed in
this district on April 30, 2002. The WorldCom class actions in
this district were consolidated on August 15, 2002, and the
WorldCom securities litigation as a whole, including many actions
bringing individual as opposed to class claims and actions filed throughout the nation and transferred here by the Judicial Panel
on Multi-District Litigation, was consolidated through Orders of
December 23, 2002, and May 22, 2003 (collectively, the
"Securities Litigation"). See In re WorldCom, Inc. Sec.
Litig., No. 02 Civ. 3288 (DLC), 2002 WL 31867720, at *1
(S.D.N.Y. Dec. 23, 2002); In re WorldCom, Inc. Sec. Litig., No.
02 Civ. 3288 (DLC), 2003 WL 21219037 (S.D.N.Y. May 22, 2003).
Two class actions have been filed in connection with derivative
securities that were linked to WorldCom's stock price. On
February 13, 2003, an action brought on behalf of purchasers of
"GOALs" was filed.*fn1 On January 6, 2004, that action was
dismissed for failure to state a claim. In re PaineWebber GOALs
Sec. Litig., 303 F. Supp.2d at 390. Of particular relevance to
this motion, the GOALs complaint was dismissed on the ground that
it failed to plead the existence of a false statement when it
relied for such an allegation on the accurate listing of
historical WorldCom stock prices in the GOALs prospectus. Id.
The first TARGETS action was filed on November 26, 2003. A second action was filed on December 18, 2003. A consolidated
class action complaint ("Complaint") was filed on March 5, 2004.
Plaintiffs seek recovery for those who purchased TARGETS between
June 22, 1999 and April 21, 2002, and were damaged thereby.
The initial TARGETS registration statement became effective on
February 3, 1999; there was an amended registration statement of
March 8, 1999. 5,600,000 of TARGETS shares were issued by an SSB
affiliate in June 1999. As the June 24, 1999 prospectus for the
TARGETS ("Prospectus") advised investors, WorldCom was not
affiliated with the issuer of TARGETS and had no obligations with
respect to TARGETS. The Prospectus reported the history of
WorldCom stock prices from 1994 to the second quarter of 1999.
TARGETS are synthetic equity-linked debt securities. Investors
in TARGETS were entitled to receive a predetermined dividend for
each quarter between purchase date and maturity date. The TARGETS
were due August 15, 2002. The redemption value at maturity was
linked to the trading price of WorldCom's common stock at that
time with a cap on appreciation that allowed purchasers to
participate in the "first 40% of appreciation in the price" of
WorldCom stock. The Complaint asserts that the price of TARGETS
in the secondary market rose and fell with the price of WorldCom
The Complaint alleges that the Prospectus failed to disclose
conflicted business relationships between the SSB Defendants and WorldCom in violation of Sections 11 and 12(a)(2).*fn3 The
complaint filed on October 11, 2002 in the consolidated WorldCom
class action describes an alleged illicit, quid pro quo
relationship between the SSB Defendants and WorldCom that was
undisclosed to investors and it is on those allegations which the
plaintiffs in the TARGETS litigation rely. The allegations are
described in some detail in the May 19, 2003 Opinion on the first
wave of motions to dismiss the WorldCom class action complaint
and that discussion is incorporated here. See In re WorldCom,
Inc. Sec. Litig., 294 F. Supp.2d 392, 404-406 (S.D.N.Y. 2003).
The Complaint also alleges violations of Sections 10(b) and
20(a), as well as Rule 10b-5, based on purported omissions from
the Prospectus and SSB's research reports on WorldCom.
The SSB Defendants have moved to dismiss on the ground that
many of the claims are time-barred; that the claims based on the
Prospectus' listing of historical WorldCom stock prices fail to
plead a misrepresentation or material omission; that the Section
10(b) claims based on the Prospectus fail adequately to plead
scienter; that the Section 10(b) claims based on the research
reports fail to plead statements made "in connection with"
TARGETS; and that the Section 12(a)(2) claim is defective to the
extent that it seeks recovery from SSB for secondary market
When considering a motion to dismiss, a court must take all
facts alleged in the complaint as true and draw all reasonable
inferences in favor of the plaintiff. Securities Investor
Protection Corp. v. BDO Seidman, LLP, 222 F.3d 63, 68 (2d Cir.
2000). "Dismissal is inappropriate unless it appears beyond doubt
that the plaintiff can prove no set of facts which would entitle
him or her to relief." Raila v. United States, 355 F.3d 118,
119 (2d Cir. 2004).
Plaintiffs' Sections 11, 12(a)(2), and 20(a) claims are
governed by the pleading standard set forth in Rule 8(a),
Fed.R.Civ. P.*fn4 See In re WorldCom, Inc. Sec. Litig.,
294 F. Supp.2d at 406-08, 415-16, 419-20, 423. Under Rule 8(a), a
complaint adequately states a claim when it contains "a short and
plain statement of the claim showing that the pleader is entitled
to relief." Swierkiewicz v. Sorema N.A., 534 U.S. 506, 512
(2002) (citing Rule 8(a)(2), Fed.R. Civ. P). Thus, under
Rule 8(a)'s liberal pleading standard, a complaint is sufficient if it
gives "fair notice of what the plaintiff's claim is and the
grounds upon which it rests." Id. (citation omitted).
Plaintiffs' Section 10(b) and Rule 10b-5 claim is governed by
Rule 9(b), Fed.R. Civ. P., and the heightened pleading standard
in the Private Securities Litigation Reform Act of 1995 ("PSLRA"), Pub.L.
104-67, 109 Stat. 737 (1995). See In re Scholastic Corp.,
252 F.3d 63, 69-70 (2d Cir. 2001); In re WorldCom, Inc. Sec.
Litig., 294 F. Supp.2d at 410.
1. Securities Act Claims
The SSB Defendants move to dismiss the Securities Act claims on
the ground, inter alia, that they are barred by the three year
statute of limitations contained in the Securities Act. In
addition, they argue that there is no Section 12(a)(2) cause of
action for aftermarket purchases. Because the Securities Act
claims must be dismissed based on these two grounds, it is
unnecessary to consider the defendants' alternative arguments in
support of dismissal.
a. Section 11
The Securities Act imposes strict liability on issuers for the
accuracy of statements in issuing documents. See In re
WorldCom, Inc. Sec. Litig., 294 F. Supp.2d at 407. In doing so,
it limits the class of potential plaintiffs. Section 11 addresses
misrepresentations and omissions in a registration
statement.*fn5 Id. at 407-08.
Section 13 of the Securities Act sets forth the statute of
limitations for Securities Act claims. It provides: No action shall be maintained to enforce any
liability created under section 77k [Section 11] or
77l(a)(2) [Section 12(a)(2)] of this title unless
brought within one year after the discovery of the
untrue statement or the omission, or after such
discovery should have been made by the exercise of
reasonable diligence. . . . In no event shall any
such action be brought to enforce a liability
created under section 77k or 77l(a)(2) of this title
more than three years after the security was bona
fide offered to the public, or under section
77l(a)(2) of this title more than three years after
15 U.S.C. § 77m (emphasis supplied). Thus, under Section 13,
plaintiffs must bring suit by the earlier of (a) three years from
the date the parties in the offering "obligate themselves to
perform," in the case of a Section 12(a)(2) claim, see Finkel
v. Stratton Corp., 962 F.2d 169, 173 (2d Cir. 1992) (citation
omitted), or three years from the date of the registration
statement, in the case of a Section 11 claim, id. at 174, or
(b) one year from the date on which they are put on actual or
constructive notice of the facts underlying the claim. Dodds v.
Cigna Secs., Inc., 12 F.3d 346, 350 (2d Cir. 1993).
The plaintiffs filed their complaint on November 26, 2003, more
than four years after the effective date of the registration
statement and the issuance of the Prospectus. All of their
Section 11 claims are therefore time-barred. While the plaintiffs
seek to preserve their argument that the Sarbanes-Oxley Act of
2002 ("Sarbanes-Oxley") extended the limitations period for their
Securities Act claims, for the reasons explained in prior
Opinions issued in the Securities Litigation, that Act did not
encompass either their Section 11 or Section 12(a)(2) claims. In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 431,
440-44 (S.D.N.Y. 2003); In re WorldCom, Inc. Sec. Litig.,
308 F. Supp.2d 214, 220-21, 224-25 (S.D.N.Y. 2004).*fn6
b. Section 12(a)(2)
For the reasons just described in connection with Section 11,
all Section 12(a)(2) claims for those who purchased TARGETS more
than three years before November 26, 2003 are also time-barred.
The defendant SSB contends that to the extent that the plaintiffs
seek to pursue Section 12(a)(2) claims for those who purchased
TARGETS securities after November 26, 2000, those claims must be
dismissed since Section 12(a)(2) does not provide a cause of
action for aftermarket purchases.*fn7
Section 12(a)(2) states, in pertinent part:
Any person who . . . offers or sells a security . . .
by means of a prospectus or oral communication,
which includes an untrue statement of a material fact
or omits to state a material fact necessary in order
to make the statements . . . not misleading . . .
shall be liable . . . to the person purchasing such
security from him.
15 U.S.C. § 77l(a)(2) (emphasis supplied). Section 12(a)(2) imposes liability without requiring "proof of either fraud or
reliance." Gustafson v. Alloyd Co., 513 U.S. 561, 582 (1995). A
plaintiff need only show "some causal connection between the
alleged communication and the sale, even if not decisive."
Metromedia Co. v. Fugazy, 983 F.2d 350
, 361 (2d Cir. 1992)
(citation omittted). The statute grants buyers the "right to
rescind without proof of reliance." Gustafson, 513 U.S. at 576.
Section 12 creates a cause of action against sellers who
"passed title, or other interest in the security, to the buyer
for value." Pinter v. Dahl, 486 U.S. 622, 642 (1988); see
also Wilson v. Saintine Exploration & Drilling Corp.,
872 F.2d 1124, 1126 (2d Cir. 1989) (applying Pinter's Section 12(1)
analysis to what is now Section 12(a)(2)); Capri v. Murphy,
856 F.2d 473, 478 (2d Cir. 1988) (same). Section 12(a)(2) "imposes
liability on only the buyer's immediate seller; remote
purchasers are precluded from bringing actions against remote
sellers. Thus, a buyer cannot recover against his seller's
seller." Cortec Indus. v. Sum Holding L.P., 949 F.2d 42, 49 (2d
Cir. 1991) (citing Pinter, 486 U.S. at 644 n. 21) (emphasis
added in Cortec).
Defendants may be liable under Section 12(a)(2) either for
selling a security or for soliciting its purchase. Cortec
Indus., 949 F.2d at 49. Persons who are not in privity with the
plaintiff may be liable if they "successfully solicit[ed] the
purchase, motivated at least in part by a desire to serve [their]
own financial interests or those of the securities owner."
Pinter, 486 U.S. at 647; see also Commercial Union Assurance
Co. v. Milken, 17 F.3d at 608, 616 (2d Cir. 1994); Wilson, 872
F.2d at 1126. Defendants must have "actually solicited" the
purchase by the plaintiffs. Capri, 856 F.2d at 479.
Relying on an extensive analysis of the requirement that a
Section 12(a)(2) claim be based on a sale "by means of a
prospectus," the Supreme Court stated in Gustafson that "[t]he
intent of Congress and the design of the statute require that
[Section 12(a)(2)] liability be limited to public offerings."
Gustafson, 513 U.S. at 579. The Court reasoned that, since the
federal securities laws require a prospectus to include
information contained in a registration statement, and only
public offerings require the filing of a registration statement,
a prospectus "is confined to documents related to public
offerings by an issuer or its controlling shareholders." Id. at
569. The Court found this reading of interlocking Securities Act
sections to be entirely consistent with the general purpose of
the Securities Act. "[T]he 1933 Act was primarily concerned with
the regulation of new offerings." Id. at 577 (citation
omitted). Moreover, the fact that Section 12(a)(2) provides
"buyers with a right to rescind, without proof of fraud or
reliance, as to misstatements contained in a document prepared
with care," was further evidence of Congressional intent to
impose such strict liability only in connection with the public
offering itself. Id. at 578. Liability under Section 12(a)(2),
therefore, does not extend to "private or secondary" sales. Id.
at 582. See also id. at 571 (Congress did not intend through
Section 12(a)(2) to create liability for "secondary market transactions").
As just noted, Section 12(a)(2) governs only those sales made
"by means of a prospectus." 15 U.S.C. § 77l(a)(2). As a
consequence, the Second Circuit and other circuit courts have
repeatedly observed that purchasers in the secondary market are
excluded from bringing Section 12(a)(2) actions. See Demaria
v. Andersen, 318 F.3d 170, 177-78 (2d Cir. 2003) (distinguishing
Section 11 claims); Lee v. Ernst & Young, LLP, 294 F.3d 969,
976 (8th Cir. 2002) (same); Joseph v. Wiles, 223 F.3d 1155,
1160-61 (10th Cir. 2000) (same); Hertzberg v. Dignity Partners,
Inc., 191 F.3d 1076, 1080-81 (9th Cir. 1999) (same). See also
In re WorldCom, Inc. Sec. Litig., 219 F.R.D. 267, 283 (S.D.N.Y.
2003) (named plaintiff who purchased in aftermarket did not have
standing to bring Section 12(a)(2) claim); In re Sterling Foster
& Co., Inc. Sec. Litig., 222 F. Supp.2d 216, 244-45 (E.D.N.Y.
2002) (collecting cases).
The plaintiffs' pleading reflects their understanding of these
principles and does not contain allegations to support a Section
12(a)(2) claim for aftermarket purchasers. For instance, the
Complaint makes no allegation that plaintiffs purchased directly
from SSB or were actually solicited by SSB in the aftermarket.
Plaintiffs allege only that SSB acted as "underwriter" for the
1999 TARGETS offering.
Plaintiffs contend that the reasoning in Feiner v. SS&C
Technologies, Inc., 47 F. Supp.2d 250 (D. Conn. 1999), compels
a different result. In rejecting the defendants' argument that Section 12(a)(2) only addresses sales in the initial distribution
of shares, Feiner held that "§ 12(a)(2) extends to aftermarket
trading of a publicly offered security, so long as that
aftermarket trading occurs by means of a prospectus or oral
communication." Id. at 253 (citation omitted). The Feiner
analysis is not persuasive. But, in any event, Feiner provides
no comfort to plaintiffs. Feiner further held that plaintiffs
who purchased shares in the aftermarket from someone other than
the defendant did not have standing to sue the defendant under
Section 12(a)(2). Id. at 254.*fn8 As already noted, the
Complaint does not allege that the aftermarket purchasers bought
TARGETS directly from SSB.
2. Exchange Act Claims
The SSB Defendants move to dismiss the Exchange Act claims on
the grounds, inter alia, that the claims based on statements in
or omissions from the Prospectus are time-barred. It is
undisputed that all of the Exchange Act claim based on the
Prospectus are time-barred unless Sarbanes-Oxley, which extended
the statute of limitations for securities fraud claims in 2002,
is retroactive. The SSB Defendants also assert that the claims based on the SSB research reports are based on statements not
made "in connection with" the TARGETS securities.*fn9
a. Statute of Limitations
Prior to the enactment of Sarbanes-Oxley, the statute of
limitations for Exchange Act claims was a one-year/three-year
regime which made any claim brought more than three years after
the occurrence of the alleged violation untimely.
15 U.S.C. § 78i(e); Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,
501 U.S. 350, 364 n. 9 (1991); Levitt v. Bear Sterns & Co.,
Inc., 340 F.3d 94, 101 (2d Cir. 2003). Sarbanes-Oxley became
effective on July 30, 2002. Section 804 of Sarbanes-Oxley
lengthened the statute of limitations for private causes of
action alleging securities fraud. See 28 U.S.C. § 1658
("Section 804"). Section 804 provides, in pertinent part, that
[A] private right of action that involves a claim of
fraud, deceit, manipulation, or contrivance in
contravention of a regulatory requirement concerning
the securities laws, as defined in section 3(a)(47)
of the [Exchange Act] [15 U.S.C. § 78c(47)], may be
brought not later than the earlier of (1) 2 years
after the discovery of the facts constituting the
violation; or (2) 5 years after such violation.
28 U.S.C. § 1658 (emphasis supplied). Sections 804(b) and (c)
also state that its provisions "shall apply to all proceedings addressed by this action that are commenced on or after the date
of enactment of this Act. . . . Nothing in this section shall
create a new private right of action." Sarbanes-Oxley Act §§
804(b) and (c), P.L. No. 107-204, 116 Stat. 745 (2002).
"A statute may not be applied retroactively  absent a clear
indication from Congress that it intended such a result." INS v.
St. Cyr, 533 U.S. 289, 316 (2001). See also Landsgraf v. USI
Film Prods., 511 U.S. 244, 280 (1994). The first step in
determining whether a statute has a retroactive effect is to
ascertain whether Congress has directed with the requisite
clarity that the law be applied retroactively. Martin v. Hadix,
527 U.S. 343, 352 (1999).
The standard for finding such unambiguous direction
is a demanding one. Cases where this Court has found
truly retroactive effect adequately authorized by
statute have involved statutory language that was so
clear that it could sustain only one interpretation.
St. Cyr, 533 U.S. at 316-17 (citation omitted).
With respect to statutes that lengthen a statute of
limitations, circuit courts have consistently held that applying
the longer statute of limitations to revive previously
time-barred claims is impermissible unless the legislature
clearly expresses the intent to revive already time-barred
actions. See Million v. Frank, 47 F.3d 385, 390 (10th Cir.
1995); Kan. Pub. Employees Ret. Sys. v. Reimer & Kroger Assocs.,
Inc., 61 F.3d 608, 615 (8th Cir. 1995); Chenault v. United
States Postal Serv., 37 F.3d 535, 539 (9th Cir. 1994);
Resolution Trust Corp. v. Artley, 28 F.3d 1099, 1103 n. 6 (11th
Cir. 1994); FDIC v. Belli, 981 F.2d 838, 842-43 (5th Cir. 1993). See also Stone v.
Hamilton, 308 F.3d 751, 757 (7th Cir. 2002); In re Apex Exp.
Corp., 190 F.3d 624, 642 (4th Cir. 1999). The Court in Hughes
Aircraft Co. v. United States, ex rel. Schumer, 520 U.S. 939
(1997), cited with approval Chenault's holding that a statute
that expands the statute of limitations does not revive
time-barred claims. Id. at 950. Hughes held that an amendment
to a statute did not renew plaintiff's previously barred qui tam
action and analogized the legal issue to a statute's ability to
revive previously time-barred claims. Id.
Sarbanes-Oxley does not revive previously time-barred private
securities fraud claims. There is no explicit language in the
statute stating that it applies retroactively or that it operates
to revive time-barred claims. Applying the statute of limitations
that was lengthened in July 2002 to claims that expired in June
2002 would affect the substantive rights of the defendants by
depriving them of a defense on which they were entitled to rely.
See Lieberman v. Cambridge Partners, L.L.C., No. Civ. A.
03-2317, 2004 WL 1396750, at *3 and n. 12 (E.D. Pa. June 21,
2004) (Sarbanes-Oxley does not revive stale claims); In re Enron
Corp. Sec., Derivative & Erisa Litig., No. MDL-1446, Civ.A.
H-01-3624, 2004 WL 405886, at *17 (S.D. Tex. Feb. 25, 2004)
(same); In re Enterprise Mortgage Accept. Co., 295 F. Supp.2d 307,
312 (S.D.N.Y. 2003) (same); In re Heritage Bond Litig.,
289 F. Supp.2d 1132, 1148 (C.D. Cal. 2003) (same). But see
Roberts v. Dean Witter Reynolds, Inc., No. 8:01-CV-2115-T-26 (EAJ), 2003 WL 1936116 (M.D. Fla. Mar. 31, 2003) (relying on
legislative history to find intent to make the statute
Plaintiffs contend that Vernon v. Cassadaga Valley Cent. Sch.
Dist., 49 F.3d 886 (2d Cir. 1995), compels a different result.
Vernon is inapposite. Vernon applied retroactively a
statutory amendment that reduced a limitations period, but
applied it to claims that were not time-barred at the time of the
amendment. Id. at 888. The Vernon plaintiffs had specific
notice of the new limitations period and an opportunity to comply
with it. Id. at 889. See Brown v. Angelone, 150 F.3d 370,
373 n. 2 (4th Cir. 1998); Zotos v. Linbergh School Dist.,
121 F.3d 356, 361-62 (8th Cir. 1997). The Second Circuit did not
address those situations in which a plaintiff would have no
opportunity to comply and thus would lose the right to sue. Id.
at 889 n. 1. See Reyes v. Keane, 90 F.3d 676, 679 (2d Cir.
1996) (it was "entirely unfair and a severe instance of
retroactivity" to apply a shorter statute of limitations to bar a
plaintiff's claim), overruled on other grounds, Lindh v.
Murphy, 521 U.S. 320, 326-27 (1997).
To the extent that the Exchange Act claims are based on the
Prospectus, they are time-barred.*fn10 Such claims had to be
brought no later than June 24, 2002, or over one year before the first complaint in the TARGETS litigation was filed. To the
extent that the Exchange Act claims are based on SSB research
reports, they are time-barred as to any reports issued before
July 30, 1999, or three years before Sarbanes-Oxley extended the
statute of limitations.
b. The "In Connection With" Requirement
The plaintiffs allege that the SSB Defendants violated Sections
10(b) and 20(a) of the Exchange Act through the allegedly
material misstatements and omissions in SSB research reports
regarding WorldCom. The SSB Defendants argue that these
statements and omissions were not made "in connection with" the
plaintiffs' purchase or sale of TARGETS securities since they
concerned "different securities issued by a different issuer."
Section 10(b) provides that:
It shall be unlawful for any person, directly or
indirectly, by the use of any means or
instrumentality of interstate commerce or of the
mails, or of any facility of any national securities
exchange . . . (b) To use or employ, 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) (emphasis supplied). Section 10(b) is designed
to protect investors by serving as a "catchall provision" which
creates a cause of action for manipulative practices by
defendants acting in bad faith. Ernst & Ernst v. Hochfelder, 425 U.S. 185
, 206 (1976).
To state a cause of action under Section 10(b) and
Rule 10b-5,*fn11 a plaintiff must allege that "the defendant, in
connection with the purchase or sale of securities, made a
materially false statement or omitted a material fact, with
scienter, and that plaintiff's reliance on defendant's action
caused injury to the plaintiff." Lawrence v. Cohn,
325 F.3d 141, 147 (2d Cir. 2003) (citation omitted) (emphasis supplied).
The "in connection with" requirement must be construed broadly
and flexibly to allow the securities fraud statute to capture
novel frauds as well as more commonplace ones. In re Ames Dep't
Stores Inc. Stock Litig., 991 F.2d 953, 964-65 (2d Cir. 1993).
In the usual case, the requisite connection between a fraud and a
purchase or sale of securities is present "when the fraud alleged
is that the plaintiff bought or sold a security in reliance on
misrepresentations as to its value." Id. at 967 (emphasis supplied). The Second Circuit has summarized that
"Congress, in using the phrase intended only that the device
employed . . . be of a sort that would cause reasonable investors
to rely thereon, and, in connection therewith, so relying, cause
them to purchase or sell a corporation's securities." In re
Carter-Wallace, Inc. Sec. Litig., 150 F.3d 153, 156 (2d Cir.
1998) (citation omitted). Where a fraud on the market theory is
employed, the "in connection with" requirement is satisfied with
"a straightforward cause and effect test under which it is
sufficient that statements which manipulate the market are
connected to resultant stock trading." Id. (citation omitted).
See also Press v. Chem. Inv. Serv. Corp., 166 F.3d 529, 537
(2d Cir. 1999).
The plaintiffs have sufficiently alleged that the SSB research
reports, containing allegedly false and misleading information
about WorldCom, were "in connection with" plaintiffs' purchase of
TARGETS. TARGETS were a derivative instrument whose redemption
value was directly tied to the value of WorldCom stock. As a
consequence, their price in the secondary market fluctuated with
the price of WorldCom stock. The Complaint alleges a direct link
between the value of the TARGETS securities and the alleged
misrepresentations and omissions regarding WorldCom, and alleges
that the plaintiffs bought TARGETS in reliance on the
misrepresentations and omissions about WorldCom. There could be
no serious argument that statements which are admittedly "in
connection with" the purchase and sale of WorldCom stock were not also statements "in connection with" the trading
in WorldCom options. Given the linkage between the value at
redemption of TARGETS and the WorldCom stock price, it requires a
very small extension of this principle to find that the
plaintiffs have alleged a fraud in connection with the purchase
and sale of TARGETS.
The SSB Defendants argue that Anatian v. Coutts Bank
(Switzerland) Ltd., 193 F.3d 85 (2d Cir. 1999), supports
dismissal. Anatian involved misrepresentations as to the
authority to loan money and the failure to carry out a loan
commitment. Id. at 88. The Anatian plaintiffs also asserted
that the defendant had inflated the value of stock pledged as
collateral for the loans in order to extend more credit. Id. at
87. The court dismissed the securities fraud claims since the
misrepresentations did not "pertain to the purchase or sale of a
security;" the securities were only "tangentially" involved in
the breach of fiduciary duty claims. Id. at 88. Anatian is
inapposite. It is undisputed that the SSB analyst reports
directly concerned the purchase and sale of securities. The
TARGETS plaintiffs contend that these reports' enthusiastic
recommendations to buy WorldCom stock contributed to the fraud
The SSB Defendants also contend that a recent decision, which
addressed the concept of standing in securities litigation, is of
assistance to them. In Ontario Public Service Employees Untion
Pension Trust Fund v. Nortel Networks Corp., 369 F.3d 27 (2d Cir. 2004), the Second Circuit held that the plaintiffs, who
had purchased the securities of a company that purchased a
business unit from the defendant, did not have standing under
Section 10(b) to sue the defendant, whose securities they had not
purchased. Id. at 30-34. The plaintiffs asserted that the
defendant had misrepresented its own financial condition. The
Second Circuit held that the class of plaintiffs who have
standing to sue is limited "to those who have at least dealt in
the security to which the prospectus, representation, or omission
relates." Id. at 32 (citation omitted).
In the course of its analysis of Ontario, the Second Circuit
acknowledged the discussion of the "in connection with"
requirement in Semerenko v. Cendant Corp, 223 F.3d 165, 174-77
(3d Cir. 2000). The Cendant court remanded its case to the
district court to determine whether the "in connection with"
requirement had been met when the plaintiffs purchased shares of
a target of a bidding war in a tender offer, and brought suit
against a company that withdrew its bid based on its own
disclosure of its accounting irregularities. Id. at 177-78.
When the defendant withdrew its offer, the price of the target's
shares fell and the plaintiffs lost money.
The Second Circuit observed that a merger creates a "far more
significant relationship" between two companies than a sale of a
business unit, but left unresolved whether a potential merger
might permit a finding of standing. Ontario, 369 F.3d at 33-34.
As this discussion reveals, Ontario did not rest its analysis on the "in connection with" requirement, and did not
face the situation in which one security's value was directly and
contractually linked to another's. While the precise issue
presented here appears to be novel, the application of
well-established principles provides ample authority to find that
alleged misrepresentations and omissions concerning WorldCom were
made "in connection with" a security whose value at maturity was
derived from the WorldCom stock price.
Defendants' motion to dismiss the Sections 11 and 12(a)(2)
claims as time-barred is granted. Plaintiffs' Sections 10(b) and
20(a) claims based on the Prospectus are also dismissed as
time-barred. Defendants' motion to dismiss the Sections 10(b) and
20(a) claims for post-July 30, 1999 purchasers of TARGETS on the
ground that the alleged false representations and omissions in
SSB research reports were not "in connection with" with the
purchase or sale of TARGETS is denied.