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October 15, 2004.

SANDIP SHAH, Plaintiff,
MORGAN STANLEY, et al., Defendants.

The opinion of the court was delivered by: RICHARD HOLWELL, District Judge

Supplemental Memorandum Opinion to Order of September 29, 2004


This case revolves around a securities firm's alleged conflicts of interest in issuing analyst reports rating and evaluating companies while those companies were actual or potential investment banking clients of the firm. Plaintiff Sandip Shah filed this putative class action on behalf of himself and other similarly situated individuals who purchased shares of the securities firm, Morgan Stanley, during the period in which the bank "employ[ed these] undisclosed improper business practices." (Compl. ¶ 1.) Plaintiff brings this action pursuant to § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, alleging that "[t]he practices themselves and the failure [of defendants] to disclose their existence artificially inflated the prices of Morgan Stanley stock." (Id.)

  This is not the first case to address the alleged conflicts of interest between the investment banking activities and the investment advisory activities of securities firms. See, e.g., Fogarazzo v. Lehman Bros., Inc., No. 03 Civ. 5194 (SAS), 2004 WL 1151542 (S.D.N.Y. May 21, 2004); Demarco v. Lehman Bros., Inc., 309 F. Supp. 2d 631 (S.D.N.Y. 2004) (hereinafter "Demarco v. Lehman"); In re Worldcom, Inc. Sec. Litig., 294 F. Supp. 2d 431 (S.D.N.Y. 2003) (hereinafter "Worldcom III"); In re Merrill Lynch & Co. Research Reports Sec. Litig., 289 F. Supp. 2d 416 (S.D.N.Y. 2003) (hereinafter "Merrill III"); In re Worldcom, Inc. Sec. Litig., 219 F.R.D. 267 (S.D.N.Y. 2003) (hereinafter "Worldcom II"); In re Merrill Lynch & Co. Research Reports Sec. Litig., 272 F. Supp. 2d 243 (S.D.N.Y. 2003) (hereinafter "Merrill II"); Pfeiffer v. Goldman, Sachs & Co., No. 02 Civ. 6912 (HB), 2003 WL 21505876 (S.D.N.Y. Jul. 1, 2003); In re Merrill Lynch & Co. Research Reports Sec. Litig., 273 F. Supp. 2d 351 (S.D.N.Y. 2003) (hereinafter "Merrill I"). These cases, which follow on the heels of an investigation and report issued by the New York State Attorney General, are brought typically by investors in a publicly-traded company who allege that a securities firm issued false and misleading analyst reports concerning the company in order to secure or maintain lucrative investment banking business, for example, as an underwriter for the subject company's initial public offering ("IPO"). See, e.g., Fogarazzo, 2004 WL 1151542; Demarco v. Lehman, 309 F. Supp. 2d at 631; Merrill III, 289 F. Supp. 2d at 416; Worldcom II, 219 F.R.D. at 267; Pfeiffer, 2003 WL 21505876, at *1; Merrill I, 273 F. Supp. 2d at 351. In the present case, however, plaintiff is a shareholder in the securities firm rather than an investor in a company that was the subject of analyst reports prepared by the firm. As such, the fraud plaintiff alleges is not that the securities firm's analyst reports were false, but that the securities firm hid information from its shareholders about its own improper business practices in preparing the analyst reports, which practices exposed the firm to substantial undisclosed liabilities. (See Compl. ¶¶ 1, 5, 32.) Defendants Morgan Stanley, Morgan Stanley & Co., Inc. (a subsidiary of Morgan Stanley) (collectively "Morgan Stanley"), Philip J. Purcell (Chairman and Chief Executive Officer of Morgan Stanley), and Mary Meeker (a senior analyst and managing director of Morgan Stanley & Co., Inc.) (collectively "defendants") have moved to dismiss plaintiff's complaint pursuant to Fed.R. Civ. P. 12(b)(6), 9(b), and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b), and to strike certain allegations pursuant to Fed.R. Civ. P. 12(f). For the reasons stated herein, defendants' motion to dismiss the complaint is granted.


  Except as otherwise noted, the following facts are alleged in the complaint and are presumed true for the purposes of this motion.*fn1 Plaintiff purchased shares of Morgan Stanley common stock between July 1, 1999, and April 10, 2002 (the alleged "Class Period"). (See Compl. ¶¶ 1, 21.) Plaintiff alleges that, unbeknownst to him and other individuals who purchased Morgan Stanley stock during the Class Period, defendants "engaged in a series of undisclosed acts and practices that created conflicts of interest for [their] research analysts with respect to investment banking considerations." (Id. ¶ 32.)

  These questionable practices were employed to help Morgan Stanley compete for IPO business, which "resulted in lucrative banking fees and the promise of future investment banking and related businesses such as fees from secondary offerings, making bridge loans and other corporate financing transactions, and advising on mergers and acquisitions." (Id. ¶¶ 31-32.) To that end, "Morgan Stanley compensated its research analysts in large part based on the degree to which they helped generate investment banking business for Morgan Stanley, offered its research coverage as a marketing tool to gain investment banking business, and failed to establish adequate procedures to protect analysts from conflicts of interest." (Id. ¶ 32.)

  During the Class Period, defendants allegedly made false and misleading statements to hide these practices and their questionable nature. (See Compl. ¶ 34.) These statements can be grouped into six categories. The first category consists of statements that describe Morgan Stanley's stock rating system (e.g., "Strong Buy" or "Neutral"). (See id. ¶ 35, 62-63.) The second category consists of statements extolling the quality of Morgan Stanley's research (e.g., "The deep breadth of experience of Morgan Stanley's . . . equity research team is second to none," id. ¶ 38). (See id. ¶¶ 37-39, 46, 47, 49, 53, 64.) The third category consists of statements to the effect that Morgan Stanley has high ethical standards and complies with all relevant industry rules and regulations. (See id. ¶¶ 41-42, 60.) The fourth category consists of statements announcing awards that Morgan Stanley and its analysts had received (e.g., "[Morgan Stanley's] Equity Research team placed first in The's first annual `Analyst Rankings' poll," id. ¶ 44). (See id. ¶ 49, 50-51, 54.) The fifth category consists of disclaimer statements in Morgan Stanley's equity research reports (e.g., "[Morgan Stanley] may also perform or seek to perform investment banking services for those companies, id. ¶ 56). The sixth and last category consists of one statement in a "press release in response to the dismissal of a class action lawsuit concerning Meeker's research that was brought against Morgan Stanley and Mary Meeker by investors in two internet companies[:] `Our research is thorough and objective, and Mary Meeker's integrity is beyond reproach.'" (Id. ¶ 58.)

  Plaintiff alleges that all these statements violated securities laws "in that they failed to disclose that during the Class Period defendants were engaged in a series of undisclosed and improper business practices pursuant to which Morgan Stanley failed to issue quality, objective, unbiased research reports concerning the common stocks of the companies for which Morgan Stanley provided or sought to provide investment banking services." (Id. ¶ 36, 40, 45, 48, 52, 55, 57, 59, 61, 65.) Plaintiff further alleges that these statements were fraudulent because the practices, "if discovered, threatened to erode public, client and investor confidence in Morgan Stanley and expose Morgan Stanley to substantial liability from government and regulatory authorities and private litigants." (Id.)

  Notably, plaintiff does not allege that any particular analyst report for any particular company was false. Rather, plaintiff's claim is for concealment of material information about Morgan Stanley's own operations — "undisclosed and improper business practices." (Id.; see also id. ¶¶ 67 ("investors relied upon defendants' materially false and misleading statements concerning the integrity and honesty of the business practices"), 68 ("quality, legitimacy and integrity of a company's management and business practices are central factors in an investors' [sic] assessment of a company's `investment quality.'"); 70 ("Had Lead Plaintiff and the Class known the truth concerning Morgan Stanley's business practices during the Class Period . . . they would not have acquired Morgan Stanley stock"); 71 ("statements that a company makes to investors about its business practices not only foreseeable[y] relate to — but, indeed, directly impact — the stock price of a public company").)

  However, defendants' statements were not the only information available to the public during the Class Period. Prior to the Class Period, numerous newspaper articles reported on the conflicts of interest that analysts faced in the securities industry.*fn2 For example, on May 2, 1996, over three years before the alleged Class Period, the Wall Street Journal published an article revealing that "[t]he recommendations by underwriter analysts show significant evidence of bias and possible conflict of interest." Roger Lowenstein, Today's Analyst Often Wears Two Hats, Wall St. J., May 2, 1996, at C1. The source of conflict, the article explained, is that "[a]nalysts get paid, in part, according to their contribution to corporate finance." Id. The article further explained that "the analyst's incentive to nurture IPOs conflicts with his role as an objective stock-picker" and that "the analyst's worth is increasingly dependent on his or her ability to bring in deals." Id. The article concluded that "[s]ince this is unlikely to change, investors, journalists and others who deal with the Street would do well to keep in mind that, often times, the analyst is wearing two hats." Id.

  Several months later, on October 3, 1996, an article in the Boston Globe concluded that "analysts are systematically overly optimistic about long-term earnings forecasts for equity offerings [due to] the relationship between the analysts and the investment banking business that pays their bills." Steve Bailey & Steven Syre, Taking Analysts' Tempting Forecasts with Grain of Salt, Boston Globe, Oct. 23, 1996, at C1. The article continued:
"The integrity of the process was always supposed to be protected by the `Chinese wall' that separated the analysts and the investment banking business. But as commissions from trading have fallen on an increasingly competitive Wall Street, investment research hasn't been able to pay its own way. Instead, analysts have become an important sales tool for the investment bankers to land their super-profitable deals. A top analyst and the credibility he or she brings can be the difference between landing a deal or not — and the pay for the most sought-after analysts can top $5 million a year. Can that analyst then turn around and dis the firm's full-freight client? Amy Sweeney of the Harvard Business School thinks not. `It is just a huge conflict of interest for the analysts,' she says. Adams Harkness' Frankel doesn't disagree: `That pressure is clear in the industry.'" Id.
  Approximately a year before the Class Period, on April 8, 1998, the Wall Street Journal published another article stating that "analysts often won't issue a `sell' because they don't like to anger companies that could be their firm's investment-banking clients." John Hechinger, Heard in New England: Analysts May Hate to Say "Sell," But a Few Companies Do Hear It, Wall St. J., Apr. 8, 1998, at NE2. The article noted that "[t]he pressure on analysts is growing [because t]he Chinese wall that existed at most brokerage houses between analysts and investment bankers has broken down." Id. (quotations omitted). Thus, of the 2,066 analysts' stock ratings examined by the article, less than one percent stated "sell". Id.

  In addition to the articles discussing the conflicts of interest of analysts in the securities industry, multiple newspaper articles before and during the Class Period reported specifically on the conflicts of interest confronting Morgan Stanley's analysts, including Meeker, as they assisted Morgan Stanley in soliciting investment banking business. For example, an article in New Yorker magazine, published just before the Class Period on April 26, 1999, explained that although Meeker's "main responsibility is recommending technology stocks to investors, . . . she also works closely with Morgan's corporate-finance department, which specializes in underwriting [IPOs] for a hefty commission." John Cassidy, The Woman in the Bubble: How Mary Meeker helps Internet entrepreneurs become very, very rich, New Yorker, Apr. 26, 1999, at 48. The article went on to describe how Meeker used her "credibility" with investors as a selling point in soliciting IPO clients for Morgan Stanley. See id.

  Midway through the Class Period, on March 20, 2000, Fortune magazine published an article stating:
"In the best of all worlds, analysts on Wall Street and at tech-industry research firms would spend their time giving unbiased, educated opinions about companies, markets, and trends. But in this world, filled as it is with dot-com money blowing every which way, objectivity seems a luxury few can afford. Analysts of all stripes — from Morgan Stanley's Mary Meeker on down to lowly researchers at the likes of the Aberdeen Group — increasingly derive a portion of their compensation, directly or indirectly, from the companies they cover. That helps put pressure on the quality of their work and encourages them to become more like cheerleaders than independent observers. . . . [A]nalysts are increasingly answering to another master: corporate banking." Erick Schonfeld, The High Price of Research; Caveat investor: Stock and research analysts covering dot-coms aren't as independent as you think, Fortune, Mar. 20, 2000, at 118.
  On May, 14, 2001, almost a year before the end of the Class Period, Fortune magazine published an issue featuring only Meeker on the cover with a headline reading, "Can we ever trust Wall Street again?", and subheadings reading "Where Mary went wrong" and "Inside the IPO racket". See Fortune, May 14, 2001, at cover. The feature article noted that, "Meeker's refusal to downgrade her stock is only a small piece of a bigger story[;] Meeker did things that utterly compromised her as a stock picker." Peter Elkind, Where Mary Meeker Went Wrong, Fortune, May 14, 2001, at 69. The article explained: "Though it's hardly news anymore that ...

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