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December 2, 2004.


The opinion of the court was delivered by: GERARD E. LYNCH, District Judge


These three related cases concern allegations that the defendant bank Citigroup, Inc. ("Citigroup"), its division Salomon Smith Barney ("SSB"), and its research analyst Jack Grubman engaged in scheme to defraud purchasers and sellers of stock in three emerging telecommunications companies — Level 3 Communications ("Level 3"), XO Communications ("XO"), and Williams Communications Group ("Williams") — and to enrich themselves, by issuing and disseminating research analyst reports on these companies that were materially false and misleading. The purpose and motivation for the allegedly false and misleading reports was to garner lucrative investment banking business for the investment banking division of SSB, which would then increase Grubman's personal compensation. Defendants have moved to dismiss the Complaints pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim on which relief can be granted, and for failure to plead fraud with particularity as required by Federal Rule of Civil Procedure 9(b). For the reasons that follow, the motions will be granted in significant part, and denied only as to reports issued on or after April 18, 2001. BACKGROUND

For purposes of adjudicating the motion to dismiss, the facts alleged in the Complaint must be accepted as true.

  I. Common Factual Allegations

  Defendant Citigroup is one of the largest financial services firms in the world. At the relevant time, Citigroup was the parent corporation of defendant Salomon Smith Barney ("SSB"), through which Citigroup provided investment banking services to businesses, retail brokerage services to both individuals and institutional investors, and published research reports and ratings on publicly-traded securities. In April 2002, SSB changed its corporate name to Citigroup Global Markets, which maintains the same headquarters as SSB and is its successor-in-interest.*fn1 Defendant Jack Grubman was a Managing Director at SSB and was considered its leading telecommunications industry analyst; Grubman resigned from SSB by mutual agreement in 2002. During his tenure at SSB, Grubman was the firm's highest paid analyst and developed a larger-than-life reputation in the industry, with press references as the "god" of telecom or the "ax" of his sector, and the rumored ability to "make or break newcomers to the [telecom] industry." Although SSB maintained publicly that its research analyst and investment banking divisions were separate, had no conflicts of interest, and did not unduly influence each other, from at least 1997 SSB employed compensation structures and other mechanisms that created incentives for analysts to inflate their ratings of companies in order for SSB to secure lucrative investment banking business from those companies. For example, SSB paid "helper's fees" to analysts, which were based on the amount of investment banking fees earned from transactions involving companies covered by that analyst. By 2000, SSB had revamped and expanded the "helper's fee" system by creating a "scorecard" for each analyst that listed the investment banking fees earned from companies in that analyst's coverage sector, and requiring analysts to detail their contributions to investment banking transactions as part of determining the analyst's annual compensation. In addition, analysts came under direct pressure from the investment banking division to tailor their coverage to avoid angering companies that SSB was pursuing for lucrative investment banking business.

  SSB executives encouraged an interplay between research and investment banking as being in the best interest of the firm as a whole, describing analysts as "the key element in banking success," directing analysts to assist bankers in creating "pitchbooks" for business form companies in their sectors and to participate in roadshows, and advising analysts to "obtain collaborative feedback from their investment banking counterpart regarding establishing and modifying a list of coverage priorities." Training seminars conducted within the firm instructed analysts on how using more conservative assumptions in their financial modeling could relieve the short-term pressure on covered companies to meet Wall Street's projections. The overall message at these seminars was for analysts to see themselves as "partners" with the investment banking division of SSB, which was the most significant source of revenue for the firm.

  By 2001, the "tech sector" (particularly new internet and telecom companies) that had fueled much of the tremendous boom in the stock market in the nineties was imploding, with dramatic price drops across the board and numerous bankruptcy filings, and some executives at SSB were acknowledging the strain on objectivity that the firm's policies may have created and urging a different approach. Executives in the research division criticized the "excessive optimism" that had led to ever-higher target prices for some stocks and noted the "failures of analysis," particularly in the assumptions underlying financial projections, that allowed the boosterism to continue. These executives acknowledged privately that there might be "legitimate concern about the objectivity of our analysts which we must allay" going forward in 2001. Executives from SSB's retail brokerage division, faced with the wrath of customers who, like nearly all stock market investors, had seen the value of their portfolios erode considerably, also criticized the role that overly-optimistic research may have played, calling the output of SSB's research division "basically worthless" and rating Grubman SSB's worst analyst.

  Beginning in April 2001, some of these sentiments were echoed by Grubman himself. On April 18, 2001, Winstar (another telecom company covered by Grubman) filed for bankruptcy. In response, Frank Yeary, an investment banker at SSB, sent an email to a group of telecom bankers and analysts at SSB, suggesting a conference call "as soon as practicable to discuss the credit position and business prospects" of other companies in the sector, specifically naming Level 3, XO, and Williams, among others. Grubman responded the same day, noting that "to be blunt, we in research have to downgrade stocks lest our retail force . . . end up having buy-rated stocks that go under. So part of this [conference] call will be our view that [Level 3, XO, Williams, and other named telecom companies] must not remain buys." In the same email, Grubman identified a group of telecom companies that had "no funding issues" — as contrasted with the list of companies, including Level 3, XO, and Williams, in the preceding sentence. On June 25, 2001, in an email to the head of U.S. Research Management at SSB, Grubman wrote that "most of our banking clients are going to zero and you know I wanted to downgrade them months ago but got huge pushback from banking." In another internal email written the same day, Grubman expressed similar frustration, commenting to a colleague, "I have dinner with [two SSB investment bankers] I bet to discuss banking's displeasure with our commentary on some names. Screw 'em. We should have put a Sell on everything a year ago."

  Plaintiffs allege that SSB and Citigroup never disclosed to investors the conflicts of interest created by the formal and informal connections between research and investment banking.*fn2 According to the Complaints, these connections went beyond merely encouraging optimism, but became an actual scheme to defraud, in which the carrot of additional compensation and the stick of institutional pressure, including the possibility of termination, provided the motivation for SSB analysts to deliberately falsify their research reports and ratings to make them more favorable than their honestly-held opinions about the companies and their stock. In particular, plaintiffs allege that the conflict of interest created by SSB's policies and actions motivated Grubman to publish false and misleading research reports on Level 3, XO, and Williams.

  II. The Level 3 Research Reports

  Level 3 was spun off from a broad-based construction company in March 1998, and, among other things, provides telecommunications and other information services through an international fiber-optic network. Level 3 stock began trading on the NASDAQ market on April 1, 1998, with an opening-day price of $79.50 per share. SSB and Grubman began covering Level 3 on January 4, 1999, with a rating of "Outperform"*fn3 and a 12-18-month "target price" of $54 per share. The opening price for Level 3 on January 4 was $43, and the stock closed that day at $41. (Level 3 Consolidated Amended Complaint ¶¶ 53, 57, 103.)

  On February 22, 1999, Grubman issued another positive report on Level 3, noting that the company was "a great play on bandwidth" and had "a strong management team that is critical for success in this business." The February 22 report maintained the Outperform rating and raised the target price for Level 3 stock from $54 to $70 per share. (Id. ¶ 62.) Level 3 stock had closed at $57 on February 19, the previous trading day, and closed at $59 on February 22, although the price returned to $57 by February 24. (Id. ¶ 104.) On July 22, 1999, Grubman issued a report titled "Strong Second Quarter Earnings," which reiterated the Outperform rating and the target price of $70. (Id. ¶ 65.) The July 21 closing price was $63 per share, although the stock had traded as high as $93 on several occasions in the previous five months. On the day the July 22 report was issued, Level 3 stock closed down several points at $60. On October 22, 1999, Grubman upgraded Level 3 to a "Buy" rating and raised the target price to $80. (Id. ¶ 67.) The previous day's closing price was $57, and the stock had typically traded within a $10 band of that value since July. Level 3 closed at $62 on October 22. (Id. ¶ 105.) Several months later, on January 20, 2000, Grubman raised the target price for Level 3 stock to $130 per share, keeping his Buy rating. Level 3 stock had been generally trending upward since Grubman's October 1999 report, and the closing price on the day preceding the January 20 report was nearly $95 per share. The Buy rating and $130 target price were reiterated in Grubman's research reports on Level 3 throughout 2000 and early 2001 — on July 20, September 27 and 28, October 18, and January 30, 2001. (Id. ¶¶ 68, 74-77, 106.) Level 3 traded at a high of $132 on March 10, 2000, but by January 2001 was fetching prices only in the $40s. (Id. ¶¶ 107-111.)

  By April 2001, Level 3's stock had dropped dramatically, closing as low as $9.65 on April 4, 2001. On April 18, 2001, the same day in which he'd noted in an internal email his view that Level 3 "must not remain a buy" and implied that the company had "funding issues" and was at some risk of "go[ing] under," Grubman issued a report on Level 3 in which he maintained the Buy rating, but drastically slashed the target price from $130 to $20 per share. (Id. ¶ 80.) Level 3 closed at $14.90 on April 17, $13.06 on April 18, $14.43 on April 19, and $15.27 as the trading week ended on April 20. (Id. ¶¶ 112-113.)

  For the remainder of the spring, Level 3 bounced around at prices in the mid-teens, finally dropping to single-digits on June 8, 2001, when the stock closed at $9.29 per share. A week later on June 15, Level 3 closed at $7.62 per share. On Monday, June 18, 2001, Grubman issued a report downgrading Level 3 two rating categories, to Neutral, and lowering the target price from $20 to $8 per share. (Id. ¶¶ 86, 114.) Level 3 closed at $5.97 on June 18 and traded at around $5 per share over the following two weeks. (Id. ¶ 114.)

  Plaintiffs filed this litigation on August 30, 2002, and filed the Consolidated Amended Complaint ("Level 3 Complaint") on October 15, 2003.*fn4 In addition to proposing a class of all persons who purchased securities of Level 3 between January 4, 1999, and June 18, 2001, the Level 3 Complaint brings the following claims on behalf of that class: (i) against Grubman and SSB for violations of section 10(b) and Rule 10b-5 for material misstatements and omissions concerning both the ratings and reports on Level 3 and the conflicts of interest between research and investment banking, which artificially inflated the price of Level 3 securities during the class period; and (ii) against SSB and Citigroup for violations of section 20(a) as control persons of Grubman with respect to the Level 3 research reports.

  III. The XO Research Reports

  XO is a telecommunications company that provides local and long distance calling service, digital subscriber lines, internet access services, private data networking, and web hosting over its international fiber-optic broadband network. (XO Consolidated and Amended Class Action Complaint ¶ 21, 32.) Prior to September 25, 2000, XO was known as Nextlink Communications. (Id. ¶¶ 29-31.) Although SSB and Grubman had covered XO's predecessors companies since September 1997, consistently giving the stock a "Buy" rating, plaintiffs do not allege that the reports were false and misleading prior to January 18, 2000. On January 18, 2000, shortly after Nextlink had announced a merger with a company called Concentric, Grubman issued a report that reiterated the long-standing Buy rating for Nextlink and raised the target price from $70 to $115 per share. The report noted that the new target price was derived from a new valuation model that was designed to incorporate the Concentric acquisition. (Id. ¶ 77.) Reports issued on February 15 and April 25, 2000, each reiterated the Buy rating and the $115 target price for Nextlink's shares. (Id. ¶¶ 75, 79.) On July 26, 2000, Grubman lowered the target price for Nextlink to $60, keeping the Buy rating.*fn5 This lower target, and the Buy rating, was maintained over the next five reports, issued on August 23, September 25, October 30, and November 28, 2000, and February 5, 2001. (Id. ¶ 75.)

  Grubman and his analyst team used discounted cash flow (DCF) modeling to support their valuations and target prices — a common practice in the financial industry. Constructing a DCF model requires the analyst to make a number of judgment calls about a company's financial prospects and the likely future growth and profit potential of its industry, as well as growth rates for the economy as a whole, including financial and credit markets. SSB had internal guidelines for some of these underlying assumptions informing a DCF model, and the model used for XO during the relevant timeperiod allegedly deviated from those guidelines in several respects. (E.g., id. ¶¶ 65-72.)

  On April 26, 2001, about a week after Grubman noted in an internal email that XO, among other companies, "must not remain Buys," SSB issued another report on XO that reiterated the long-standing Buy rating, but sharply lowered the target price to $10 per share. (Id. ¶ 75.) On May 31, 2001, Grubman exchanged emails with one of his staff analysts, Sheri McMahon, about Merrill Lynch's decision to downgrade XO. Grubman commented "I hope we were not wrong in not downgrading," and asked McMahon to "try to talk to folks and see what they think of these downgrades. Maybe we should have done like I wanted to. Now it's too late." McMahon, who was listed as a co-author on a number of the XO research reports, replied that "XO is a lost cause, its [sic] never too late to ...

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