United States District Court, S.D. New York
July 6, 2004.
ANTHONY DEMARCO, Plaintiff,
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
OPINION AND ORDER
In its recent opinion in Hevesi v. Citigroup, Inc., 366 F.3d 70 (2d Cir. 2004), the Court of Appeals, citing the instant
action and a similar case before Judge Lynch, took "note that
several courts in the Southern District of New York are currently
grappling with the application of the fraud-on-the-market
doctrine to analyst reports." Id. at n. 9. Having so grappled,
this Court concludes that the fraud-on-the-market doctrine may in
certain conditions apply to analyst reports but that the
plaintiffs here have failed to adduce evidence adequate to
satisfy such conditions for purposes of class certification.
The allegations of the three instant consolidated actions, as
further refined in the course of motion practice, describe a
straightforward securities violation. Specifically, it is alleged
that during the latter half of the year 2000, defendant Michael
Stanek, a prominent research analyst at co-defendant Lehman
Brothers, Inc., issued public reports in which he strongly
recommended the purchase of the common stock of a computer
software company named RealNetworks, Inc., while at the same time
he privately recommended to preferred clients that they sell or
"short" the stock and confessed to them that he had inflated his
public recommendations because Lehman Brothers was also serving
as one of RealNetworks' investment bankers. Although at present
these are no more than allegations, if true they describe a clear
violation of Section 10(b) of the Securities Exchange Act,
15 U.S.C. § j(b). See DeMarco v. Lehman Bros., 309 F. Supp.2d 631
(S.D.N.Y. 2004) (denying motion to dismiss).
Having survived a motion to dismiss, however, plaintiffs now
seek to "up the ante" by moving to represent the class of all
those who purchased RealNetworks' stock during the period in
which Stanek was making his allegedly false recommendations to
the public. An obvious difficulty with this motion is that no one
presently knows which of these purchasers materially relied on
Stanek's recommendations in deciding to purchase this stock. In
the absence of such information, defendants argue, plaintiffs
cannot satisfy such prerequisites to class action status as
"numerosity," "commonality," and "typicality," see Rule 23(a),
Fed.R. Civ. P., let alone show that the questions of law or fact
common to the members of the class predominate over any questions
affecting only individual members, see Rule 23(b), Fed.R. Civ.
Plaintiffs respond, however, by arguing that Stanek's allegedly
false statements materially impacted the "mix of information"
available to the market in pricing RealNetworks' stock, and that
such "fraud-on-the-market" is a presumptive substitute for
personal reliance unless otherwise rebutted. This, they argue, is
because, as the Supreme Court held in Basic v. Levinson,
485 U.S. 224 (1988), "`in an open and developed securities market,
the price of a company's stock is determined by the available
material information regarding the company and its business. . . . Misleading statements will therefore defraud
purchasers of [the] stock even if the purchasers do not directly
rely on the misstatements.'" Id. at 242, quoting Peil v.
Speiser, 806 F.2d 1154, 1160-1161 (3d Cir., 1986).
In Basic, the information in question was the issuer's own
statements falsely denying that it was engaged in merger talks
with another company. Basic, 485 U.S. at 227. Nonetheless,
plaintiffs note, the Court in Basic did not expressly limit its
holding to a particular declarant or a particular kind of
statement. Indeed, the Court recognized that the manner in which
information about a public company gets translated into a market
price is through the intervening analyses of market
professionals. Id. at 247 ("For purposes of accepting the
presumption of reliance in this case, we need only believe that
market professionals generally consider most publicly announced
material statements about companies, thereby affecting stock
The intervening role of research analysts and other market
professionals is, indeed, critical to the pricing mechanism of
the securities market, for ordinary investors frequently lack
sufficient expertise to interpret the wealth of information, much
of it highly technical, emanating from most public companies.
Research analysts do not, however, merely digest such information
and spew it out in summary form. Rather, as the very name "analyst" suggests, they interpret the data from various
viewpoints and offer their more-or-less "expert" opinions as to
what the data show about the prospects of the issuer and the
value of its stock. Typically, as in this case, they also provide
recommendations as to what action the ordinary investor should
take with respect to the stock, such as "buy," "sell," "hold,"
Although, as discussed infra, such opinions and
recommendations may vary widely among different analysts, and
while no reasonable investor may suppose that any given analyst
can guarantee future results, see In re Merrill Lynch & Co.
Research Reports Sec. Litig., 273 F. Supp.2d 351, 358 (S.D.N.Y.
2003) (Pollack, J), a reasonable investor is entitled to assume
that the analyst is providing his honest opinion, rather than, as
here alleged, lying in order to manipulate the market for the
benefit of an issuer for which the analyst's employer is
providing lucrative services. See, e.g., In re Credit Suisse
First Boston Corp. Sec. Litig., 1998 U.S. Dist. LEXIS 16560 at
*14 (S.D.N.Y. 1998). Moreover, as in every field where
interpretation of technical information is involved, there are
research analysts who, by their reputation for accuracy,
expertise, and insight, become particularly well-known and
respected. The possibility therefore exists that some research
analysts may have the ability to influence market prices on the basis of their recommendations. Indeed, in Carpenter v. United
States, 484 U.S. 19 (1987), the Supreme Court took note that
even a newspaper columnist's views of a given stock could be a
material factor affecting the stock's price where, "[b]ecause of
the . . . column's perceived quality and integrity, it had the
potential of affecting the price of the stocks which it
examined." Id. at 22.
In Carpenter, however, the Court further noted that the
district court had found that the column's impact on the market
was "difficult . . . to quantify in any particular case." Id.
at 23, quoting United States v. Carpenter, 612 F. Supp. 827,
830 (S.D.N.Y. 1985). As it happens, this inability to quantify
was irrelevant to the decision in Carpenter, both because
Carpenter was a criminal case in which proof of reliance was
unnecessary*fn1 and because, since the column was found to
reflect the columnist's honest opinions, id. at 22-23, the case
was analyzed in terms of misappropriation of information from the
columnist's employer rather than in terms of fraud on a purchaser
or seller of securities, id. at 22-25. But for present
purposes, the issue of measurable impact is critical.
This is because there is a qualitative difference between a statement of fact emanating from an issuer and a statement of
opinion emanating from a research analyst. A well-developed
efficient market can reasonably be presumed to translate the
former into an effect on price, whereas no such presumption
attaches to the latter. This, in turn, is because statements of
fact emanating from an issuer are relatively fixed, certain, and
uncontradicted. Thus, if an issuer says its profits increased
10%, an efficient market, relying on that statement, fixes a
price accordingly. If later it is revealed that the previous
statement was untrue and that the profits only increased 5%, the
market reaction is once again reasonably predictable and
By comparison, a statement of opinion emanating from a research
analyst is far more subjective and far less certain, and often
appears in tandem with conflicting opinions from other analysts
as well as new statements from the issuer. As a result, no
automatic impact on the price of a security can be presumed and
instead must be proven and measured before the statement can be
said to have "defrauded the market" in any material way that is
not simply speculative.
In some cases, sophisticated statistical techniques may enable
a skilled investigator to determine that a given analyst's
opinion of a given security has indeed materially impacted market
price so as to warrant application of the "fraud-on-the-market" doctrine. But in other cases the claim of measurable impact on
the marketplace will be too speculative to support such an
Sensitive to these considerations, the opinion in Hevesi
notes Professor Coffee's view that "[o]nly in a case where the
publication of the [analyst] report clearly moved the market in
a measurable fashion would the `fraud on the market' doctrine
seem fairly applicable." Hevesi, 366 F.3d at 79 n. 7, quoting
John C. Coffee, Jr., Security Analyst Litigation, N.Y.L.J.
Sept. 20, 2001 at 5 (emphasis supplied). In any event, this Court
now holds that the "fraud-on-the-market" doctrine applies in a
case premised on a securities analyst's false and fraudulent
opinions or recommendations only where the plaintiff can make a
prima facie showing that the analyst's statements materially
impacted the market price in a reasonably quantifiable respect.
Whatever might need to be alleged to meet this standard at the
pleading stage, the Court further holds that to qualify for class
certification in a case where, as here, such certification is
dependent on invocation of the fraud-on-the-market doctrine, the
plaintiff must adduce admissible evidence that facially meets the
aforementioned standard, i.e., that makes a prima facie
showing that the analyst's statements alleged to be false or
fraudulent materially and measurably impacted the market price of
the security to which the statements relate. In assessing the present plaintiffs' showing in this regard,
the Court is acutely aware that under the view prevailing in this
Circuit, the Court may not consider on a class certification
motion either the contrary evidence offered by defendants or the
merits of the underlying claims. See Caridad v. Metro-North
Commuter Railroad, 191 F.3d 283 (2d Cir. 1999); but cf.
Szabo v. Bridgeport Machines, Inc., 249 F.3d 672 (7th Cir.
2001). At the same time, however, this does not relieve the
district court of conducting a "rigorous analysis  that the
prerequisites of Rule 23(a) have been satisfied." Id. at 291,
quoting General Telephone Co. v. Falcon, 457 U.S. 147, 157 n.
Nor does anything in Caridad suggest that the Court may not
require a plaintiff seeking class certification to adduce
admissible evidence that, taken most favorably to the plaintiff,
establishes a prima facie entitlement to such certification,
which, as previously noted, is dependent in this case on the
applicability of the fraud-on-the-market doctrine. Indeed, in
Hevesi, the Court of Appeals, while stating that "[w]e need not
decide what evidentiary showing, if any, the plaintiffs must make
at the class certification stage in order to benefit from the
Basic presumption in an action against research analysts and
their employers," Hevesi, 366 F.3d at 79, discussed with
seeming approval the Seventh Circuit's rejection of class
certification where the plaintiffs failed to make such an
evidentiary showing. Id. at 78, citing West v. Prudential Securities, Inc.,
282 F.3d 935, 940 (7th Cir. 2002).
Here, plaintiffs' proffered evidence does not remotely satisfy
the aforementioned burden because, even when taken most favorably
to plaintiffs, it does not warrant a finding that Stanek's
allegedly false statements materially impacted the market price
of RealNetworks' stock in any reasonably quantifiable respect.
To begin with, plaintiffs now disclaim even an attempt to prove
that the publication of Stanek's "buy" recommendations and
accompanying statements which were no different than the
similar recommendations of many other analysts at the time
increased the price of RealNetworks' stock. See transcript of
oral argument on this motion, 6/24/04, at 30. Plaintiffs'
contention, rather, is that if Stanek had instead disclosed his
true "sell" opinion, his influence was such that, despite the
others' "buy" recommendations, his "sell" recommendation would
have driven the price down. Id.*fn2 But none of the
evidence plaintiffs proffer in support of this contention warrants a
finding of measurable impact.
Specifically, they offer evidence of two kinds. The first kind
consists of Lehman Brothers' promotional materials, mostly from a
prior time period, touting Stanek's abilities and purported
influence on the market. See, e.g., Declaration of Marc I.
Gross, Esq., dated June 1, 2004, Volume II, Exhibits E-K (Lehman
Brothers' "pitchbooks" and similar literature). But such
conventional puffing does not constitute meaningful evidence that
any of Stanek's statements had in fact a measurable impact on
market prices, let alone that the hypothesized statement by
Stanek describing his real view of RealNetworks would have had a
measurable impact on the price of its stock.
Second, and primarily, plaintiffs rely on the report of their
expert, Frank C. Torchio, and his accompanying materials. See
Supplemental Declaration of Marc I. Gross, Esq., dated June 10,
2004, Ex. A. ("Revised Torchio Report" and exhibits thereto).
Superficially, Torchio purports to meet the aforementioned
standard for invocation of the fraud-on-the-market doctrine, in
that his ultimate opinion is that if Stanek had publicly
recommended "sell" rather than "buy," the price of RealNetworks' stock would have declined by 10 percent. Revised Torchio Report,
¶ 6. But the method he uses to reach these results has virtually
nothing to do with Stanek, Stanek's alleged influence on the
market (which he largely just assumes), or Stanek's actual
statements, and appears irrelevant on its face. See Fed.R. Ev.
401. Morever, his method is so transparently unreliable as to be
inadmissable as a matter of law. See Fed.R.Evid. 702;
Daubert v. Merrill Dow Pharmaceuticals, 509 U.S. 579, 597
(1993); Visa Check/MasterMoney Antitrust Litig., 280 F.3d 124,
135 (2d Cir. 2001).
Torchio first assumes as a general matter that when market
analysts downgrade their recommendations to "sell," the stock in
question declines by at least 5%. Torchio Revised Report ¶ 90.
However, Torchio bases this conclusion exclusively on a study by
Kent Womack (the "Womack Study") that measured the effect of
analysts' "sell" recommendations on 200 stocks during the period
1989-1991. Id. at ¶¶ 58, 64-69, 90.*fn3 Needless to say, a
study of analysts' impact on that pre-Internet market has little
relevance to Stanek's hypothesized impact on Internet-related
stocks like RealNetworks during the Internet "bubble" that lasted into the
year 2000 and then collapsed during the putative class period.
See In Re Merrill Lynch & Co. Inc. Research Reports Securities
Litig., 289 F. Supp.2d 416, 417 n. 6 (taking judicial notice of
the Internet bubble and its crash). Furthermore, the Womack Study
measures the impact of analysts as a group, as opposed to a
single analyst like Stanek. Finally, and perhaps most critically,
the Womack Study does not distinguish between the effect on the
market price of simultaneous similar information ("confounding
news") emanating from the issuer. Thus, there is no way to tell
if the analysts' opinions had any independent impact at all.
Nevertheless, Torchio takes the 5% measure to be the "minimum"
impact that Stanek's hypothesized "sell" recommendation would
have had on RealNetworks' price. To calculate the "maximum"
impact, he then picks three dates during the class period when
the price of RealNetworks' stock, after declining the day before,
rebounded after publication of analysts' opinions continuing to
recommend its purchase. The average increase on these three
occasions was 15.99%, see Torchio Revised Report ¶¶ 93-96, and
Torchio thereby hypothesizes that the impact of a Stanek "sell"
recommendation on RealNetworks' stock would be somewhere between
the minimum of 5% and the maximum of 15.99% say, at least 10%.
Id. at ¶ 6. But the calculation of the "maximum" impact, though different
in methodology from the Womack Report, is equally flawed on its
face. Even if Torchio had picked his three dates at random, such
a small number of dates would not likely have statistical
significance. But, in fact, he concededly did not pick the dates
at random: yet he provides no objective basis for his picking
these dates but only his subjective impression that they were
dates when "confouding news" from the issuer was "minimal."
Torchio Revised Report ¶ 92. As in the case of the Womack Report,
moreover, Torchio is here looking at the purported effect of
analysts as a group, which provides no reasonable basis for
measuring the impact of Stanek individually.*fn4 Finally, as
for Torchio's choice of a midpoint between his two flawed
measures, it appears to be based on no methodology whatsoever.
Without multiplying examples further, the net is that Torchio's
conclusions are both so facially unreliable as to be
inadmissable under Fed.R.Evid. 702 and so plainly irrelevant as
to be inadmissible under Fed.R.Evid. 401. In no way, thus, do
they, or any of the other evidence proffered by plaintiffs,
survive the "rigorous analysis," supra, that is required for
class certification. In short, because plaintiffs have not met their burden of
adducing prima facie evidence sufficient to warrant
invocation of the fraud-on-the-market presumption, on which they
rely to meet the requirements of Fed.R.Civ.P. 23,*fn5
plaintiffs' motion for class certification must be, and hereby is