United States District Court, S.D. New York
June 23, 2005.
DAVID JOFFEE, CATHERINE STONE, TERENCE KRUSKA, ROBERT J. BLUME, AMALIA CONCIATORI, BOB EISELE, SYLVIA S. EISELE, BARRY KEITH HERMAN, ELLEN NYSTROM HERMAN, ALAN JAMES, MARC A. KOEHLER, SHERRIE E. KOEHLER, EDWARD B. LEINBACH, BRUCE LILES, LINDA LILES, DAVID J. MILLER, GENNUS MILLER, JEFFREY A. MORRIS, SUZANNE N. MORRIS, LDX OPTRONICS, INC., JOHN R. MURPHY, SUELLEN C. MURPHY, SUSAN C. MURPHY, TIMOTHY J. MURPHY, RYAN J. MURPHY, STUART NEWBORN, DIANE NEWBORN, JOHN POLONCHAK, MYRTLE POLONCHAK, KURT SCHMITZ, LESLIE SCHMITZ, JAMES SIMPSON, RICHARD VAZQUEZ, JEFFREY R. ZAHN, JAMES OLSON, KATHRYN OLSON, RICHARD NORDEN, DENIS CROWTHER and DARLENE CROWTHER, Plaintiffs,
LEHMAN BROTHERS, INC. KENNETH N. GOLDMAN, M.D., and DAVID M. GRUBER, M.D., Defendants.
The opinion of the court was delivered by: ROBERT SWEET, Senior District Judge
Defendants Lehman Brothers, Inc. ("Lehman"), Kenneth Goldman,
M.D. ("Goldman") and David A. Gruber, M.D. ("Gruber")
(collectively the "Defendants") have moved under Rules 12(b)(6)
and 9(b), Fed.R.Civ.P., and the Private Securities Litigation
Reform Act ("PSLRA") to dismiss the complaint of 37 individuals
and subchapter 5 corporations (the "Plaintiffs"), alleging a
fraudulent scheme to inflate the value of shares of Sunrise
Technologies, Inc. ("Sunrise"), which were purchased by the
Plaintiffs. For the reasons set forth below, the motion is granted.
The Plaintiffs filed their initial complaint on May 7, 2004.
The Defendants moved to dismiss and the Plaintiffs filed the
amended complaint and then the second amended complaint (the
"SAC"), which is the subject of the instant motion. The
Defendants' motion to dismiss the SAC was filed on November 9,
2004, and it was heard on January 26, 2005.
The following facts are drawn from the SAC, which includes "any
documents incorporated in it by reference, annexed to it as an
exhibit, or `integral' to it because it `relies heavily upon [such document's] terms and effect.'" Pollock v. Ridge,
310 F. Supp. 2d 519, 524 (W.D.N.Y. 2004) (quoting Chambers v.
Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002) (internal
quotations omitted)). All well-pleaded allegations are accepted
as true for the purpose of this motion. See Chambers,
282 F.3d at 152. The following statements do not constitute findings
of the Court.
Lehman is a broker-dealer, a purchaser of Sunrise common stock,
and an investor through a private placement. Goldman and Gruber
were Lehman securities analysts who covered Sunrise.
The Plaintiffs purchased Sunrise shares at unspecified times
between December 1999 through December 2001. Twenty-four out of
the thirty-nine plaintiffs are alleged to have purchased Sunrise
stock beyond April 3, 2001, the date that Lehman ceased research
coverage of Sunrise. None of the Plaintiffs were customers of
Between December 1999 and April 3, 2001, Goldman and Gruber
consistently maintained a "1-Buy" rating, Lehman's strongest buy
rating, and a $19-per-share target price*fn1 on Sunrise
stock. As illustrated by Figure 1 below, stock price information
from the Dow Jones and Reuters news services*fn2 indicates that during
this time period, the share price of Sunrise common stock dropped
from a closing price of $12.87 on December 3, 1999 to a closing
price of $1.43 on April 3, 2001.
Figure 1: Closing Price of Sunrise Common Stock (Based on
Price Information Provided by Dow Jones and Reuters)
The Plaintiffs have identified seven Lehman research reports
concerning Sunrise that are alleged to have contained material
misrepresentation or omissions.
First, in a report dated June 2, 2000, Gruber wrote: "We expect
a rapid ramp [sic] 2H00E with over 300% top line growth in 2001E.
Investor sentiment turns positive as doctor interest in Sunrise
technology grows and the potential for explosive growth seems
achievable." (Declaration of Jayant W. Tambe dated November 8,
2004 ("Tambe Decl.") Ex. 3 at 1.)
Second, in a report dated August 7, 2000, Gruber and Goldman
wrote that "[i]nterest among ophthalmologists remains high," and
that "Hyperion LTK is approved for the reduction of up to 2.5
diopters of hyperopia in patients older than 40 years." (Id.
Ex. 4 at 1,2.)
Third, in a report dated August 10, 2000, Gruber and Goldman
wrote that projected sales of Sunrise's Hyperion laser device had
been increased for the second half of 2000. (See id. Ex. 5 at
Fourth, in a report dated October 20, 2000, Goldman and Gruber
wrote that Sunrise warranted a 1-Buy rating "due to the
demonstrated high demand for the Hyperion laser units and early
anecdotal evidence of high utilization." (Id. Ex. 6 at 1.) The analysts further stated that "[w]e believe that Sunrise will meet
our expectations of 115 unit sales by end of year. . . ." (Id.)
Fifth, in a report dated October 25, 2000, Goldman and Gruber
wrote: "We reiterate our 1-Buy rating . . . due to the
demonstrated high demand for the Hyperion laser units and early
anecdotal evidence of high utilization that was evident at this
week's [American Academy of Ophthalmology ("AAO")] meeting."
(Id. Ex. 7 at 1.) The analysts also reiterated their projection
that Sunrise would sell 115 Hyperion laser units by the end of
2000. (See id.)
Sixth, in a report dated November 17, 2000, Goldman stated that
"doctors who already own Sunrise Hyperion lasers . . . appear?
enthusiastic about Sunrise LTK." (Id. Ex. 8 at 1.) This report
also reiterated the projected sales of 115 units by the end of
2000. (See id.)
Seventh, in a report dated April 3, 2001, Goldman and Gruber
stated that Sunrise was rated a "1-Strong Buy" and also stated
that "Lehman Brothers is terminating coverage of Sunrise
Technologies." (Id. Ex. 9 at 1.)
The SAC has alleged that the above-described statements were
false and misleading because Lehman allegedly knew and failed to
disclose the following facts: (1) that when the Sunrise laser device was used in accordance with the FDA-approved protocol,
patients experienced side effects such as induced astigmatism,
early regression and unpredictability of vision correction, (2)
that Goldman was told about the possibility of induced
astigmatism by unnamed ophthalmologists at a meeting of
ophthalmologists in Dallas in October 2000, (3) that an
ophthalmologist advised Goldman that patients experienced early
regression of effects after the laser procedure and that treating
ophthalmologists were unable consistently to predetermine the
degree of vision correction that resulted from the laser
procedure, and (4) that in November 2000, Goldman told an unnamed
investor by telephone that "all" the doctors at the October 2000
AAO meeting were "excited" with Sunrise.
The SAC has alleged that Lehman knew about, but failed to
disclose, an agreement between Sunrise and U.S. Medical
Corporation whereby U.S. Medical would purchase and distribute
twenty Sunrise laser units in return for the purchase by Sunrise
of 4% of the privately owned stock in U.S. Medical, which
approximated the cost of the twenty units. Lehman allegedly also
knew that expenditures for capital equipment by ophthalmologists
were declining. The SAC alleged that this information, along with
the limitations of the Hyperion laser, renders false Lehman's
projection of sales of 115 units by the end of 2000. The SAC
alleged that Lehman should have tempered its opinions and
projections about Sunrise with warnings concerning the omitted
information. The SAC has alleged that in response to Lehman's reports,
Sunrise's stock price would rise. For example, on the November
16, 2000, Sunrise stock closed at $3.37 per share.*fn3
(See Tambe Decl. Ex. 16 at 11.) The following day, after the
release of a Lehman report, Sunrise closed at $4.03. (See
id.) There were other instances when the issuance of Lehman
research reports allegedly caused increases in the price of
Sunrise stock. For example, the day before the June 2, 2000
report was issued, Sunrise closed at $9.71; by June 8, 2000, the
closing price had climbed to $11.00. (See id. at 10.) The day
before the October 20, 2000 report was issued, Sunrise closed at
$5.31; during the seven days after the report was issued, Sunrise
climbed to a closing price of $7.21 on October 31, 2000. (See
id. at 12.)
On April 28, 2003, consent orders were entered into between
Lehman, the Securities and Exchange Commission ("SEC") and the
Attorneys General of New York, Alabama, Utah and Connecticut and
the National Association of Securities Dealers ("NASD"). These
orders provided for the injunction of certain practices and the
payment of $80 million by Lehman. These orders describe Lehman's
participation in a fraudulent scheme arising out of its
investment banking and research functions. Pursuant to this
scheme, Lehman research analysts generated undeservedly positive
coverage of Lehman's investment banking clients in order to help secure
additional investment banking fees from those clients. Lehman has
acknowledged that this practice gave rise to conflicts of
interest between its equity research function and its investment
The SAC alleged that Lehman participated in the public offering
of Sunrise securities and invested in Sunrise and that Lehman
made false and misleading statements during the period when the
Plaintiffs were purchasing Sunrise shares. The SAC also alleged
that Lehman disseminated false information resulting in
Based on these allegations, the SAC asserts four causes of
action. Count I of the SAC alleges violation of Section 10(b) of
the Securities Exchange Act of 1934 (the "Exchange Act"),
15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder,
17 C.F.R. § 240.10b-5. Count II alleges "controlling person" liability
under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).
Count III alleges negligent misrepresentation, and Count IV
alleges common law fraud.
The resolution of the present motion hinges in large measure on
whether the Plaintiffs have adequately alleged that their losses were caused by Defendants' conduct. This question
i.e., what must be pled with respect to loss causation in order
to state a claim pursuant to Section 10(b) and Rule 10b-5 has
been considered by a number of courts in this circuit, and
perfect harmony has not been achieved among these decisions.
Compare Emergent Capital Inv. Mgmt., L.C.C. v. Stonepath Group,
Inc., 343 F.3d 189, 197 (2d Cir. 2003) (holding that mere
allegations that defendant's misrepresentation caused the price
of a security to be artificially inflated at the time of purchase
by the plaintiff are inadequate to satisfy the pleading
requirements with respect to loss causation), with Suez Equity
Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 97-98 (2d
Cir. 2001) (stating that plaintiff may allege loss causation by
alleging that "the defendants' misrepresentations induced a
disparity between the transaction price and the true `investment
quality' of the securities at the time of transaction"). The
Supreme Court has resolved this tension by holding that in order
to allege loss causation, it is not adequate for a plaintiff
merely to allege that the price paid for a security was inflated
as a result of a defendant's misrepresentations. See Dura
Pharmaceuticals, Inc. v. Broudo, 125 S. Ct. 1627, 1631 (U.S.
The revelations concerning the activities of securities firms
has presented the courts with difficult issues as those injured
by these practices seek redress. The resolution of this motion
reflects that tension. The Relevant Standards
A. Rule 12(b)(6)
In considering a motion to dismiss pursuant to Rule 12(b)(6),
the Court should construe the complaint liberally, "accepting all
factual allegations in the complaint as true, and drawing all
reasonable inferences in the plaintiff's favor." Chambers,
282 F.3d at 152 (citing Gregory v. Daly, 243 F.3d 687, 691 (2d Cir.
2001)). The issue is not whether a plaintiff will ultimately
prevail but whether the claimant is entitled to offer evidence to
support the claims." Villager Pond, Inc. v. Town of Darien,
56 F.3d 375, 378 (2d Cir. 1995) (quoting Scheuer v. Rhodes,
416 U.S. 232, 236 (1974)). Dismissal is only appropriate when "it
appears beyond doubt that the plaintiff can prove no set of facts
which would entitle him or her to relief." Sweet v. Sheahan,
235 F.3d 80, 83 (2d Cir. 2000).
B. Rule 9(b)
A claim under section 10(b) sounds in fraud and must therefore
meet the pleading requirements of Rule 9(b), Fed.R.Civ.P.
See, e.g., In re Scholastic Corp. Sec. Litig., 252 F.3d 63,
69-70 (2d Cir. 2001). Such a claim must also satisfy certain
requirements of the Private Securities Litigation Reform Act of
1995 (the "PSLRA"). See 15 U.S.C. §§ 78u-4(b)(1) & 78u-4(b)(2);
see generally Novak v. Kasaks, 216 F.3d 300, 306-07 (2d
Cir. 2000) (setting forth the heightened pleading standards of the PSLRA
that must be met by a plaintiff who alleges securities fraud
under Section 10(b) and Rule 10b-5); Shields v. Citytrust
Bancorp, Inc., 25 F.3d 1124, 1127 (2d Cir. 1994) (stating that
"[s]ecurities fraud allegations under § 10(b) and Rule 10b-5 are
subject to the pleading requirements of Rule 9(b)").
Rule 9(b) provides that "[i]n all averments of fraud or
mistake, the circumstances constituting fraud or mistake shall be
stated with particularity. Malice, intent, knowledge, and other
condition of mind of a person may be averred generally."
Fed.R.Civ.P. 9(b). The Second Circuit "has read Rule 9(b) to require
that a complaint [alleging fraud] `(1) specify the statements
that the plaintiff contends were fraudulent, (2) identify the
speaker, (3) state where and when the statements were made, and
(4) explain why the statements were fraudulent.'" Rombach v.
Chang, 355 F.3d 164, 170 (2d Cir. 2004) (quoting Mills v. Polar
Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)).
A. The Action Is Not Time-Barred
Defendants argue that this action was not timely when filed on May 7,
2004. They argue that the applicable statute of limitations began to run, at
the latest, on April 6, 2001 and that the last day on which this action could have been brought was
April 6, 2002.
Pursuant to Section 804 of the Public Company Accounting Reform
and Investor Protection Act of 2002 (the "Sarbanes-Oxley Act"),
Pub.L. No. 107-204, 116 Stat. 745 (2002), a complaint filed on
or after July 30, 2002 asserting a private securities fraud claim
"may be brought no 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(b). "`Discovery of
facts for the purposes of this statute of limitations includes
constructive or inquiry notice, as well as actual notice.'"
Newman v. Warnaco Group, Inc., 335 F.3d 187, 193 (2d Cir. 2003)
(quoting Rothman v. Gregor, 220 F.3d 81, 96 (2d Cir. 2000)
(internal quotation marks omitted)). The limitations period in
Sarbanes-Oxley applies both to claims brought pursuant to
sections 10(b) and 20(a) of the Exchange Act. See, e.g.,
Marcus v. Frome, 329 F. Supp.2d 464, 475 (S.D.N.Y. 2004); see
also Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 n. 2 (2d
Cir. 1993) (stating that a section 20 claim based on a 10(b)
violation is governed by the 10(b) statute of limitations).
The Second Circuit has held that Section 804 of the
Sarbanes-Oxley Act does not function retroactively, and,
therefore, it cannot revive claims that were stale as of July 30,
2002, the date of Sarbanes-Oxley's enactment. See Enterprise
Mortg. Acceptance Co., LLC, Securities Litigation v. Enterprise Mortg.
Acceptance Co., 391 F.3d 401, 406 (2d Cir. 2004).
Prior to the enactment of Sarbanes-Oxley,
[t]he statute of limitations for claims pursuant to
section 10(b) of the Securities Exchange Act and SEC
Rule 10b-5 [was] "within one year after the discovery
of the facts constituting the violation and within
three years after such violation." 15 U.S.C. § 78i(e)
(2000). "Discovery of facts for the purposes of this
statute of limitations includes constructive or
inquiry notice, as well as actual notice." Rothman
v. Gregor, 220 F.3d 81, 96 (2d Cir. 2000) (internal
quotation marks omitted); see also Dodds v. Cigna
Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993). "A
plaintiff in a federal securities case will be deemed
to have discovered fraud for purposes of triggering
the statute of limitations when a reasonable investor
of ordinary intelligence would have discovered the
existence of the fraud." Dodds, 12 F.3d at 350.
Newman, 335 F.3d at 193.
According to the Defendants, Plaintiffs' federal securities
fraud claims (i.e., Counts I and II of the SAC) are time-barred
because by April 6, 2001, the Plaintiffs had inquiry
notice*fn4 of the facts constituting the alleged violation
of section 10(b). According to the Defendants, these public documents, taken
together, constituted "storm warnings" that triggered a duty on
the part of the Plaintiffs to investigate whether a 10(b) claim
existed. See Arduini/Messina P'ship v. Nat'l Med. Fin. Serve.
Corp., 74 F. Supp. 2d 352, 358-59 (S.D.N.Y. 1999) (holding that
a company's investors had inquiry notice of securities fraud
claims where public documents disclosed: (1) that the company's
chief executive had made a $3,000,000 payment to a market maker
to tout the company's stock; (2) that a significant amount of the
company's revenue was generated by soon-to-expire contracts with
entities controlled by the company's chief executive; and (3)
that the chief executive had recently sold some $5,000,000 of the
company's stock); de la Fuente v. DCI Telecomm., Inc.,
206 F.R.D. 369, 382-383 (S.D.N.Y. 2002) (holding that investors had
inquiry notice of a fraud claim against a company's auditor where
(1) the company made public disclosures concerning its accounting
practices and restated its audited financial statements; (2) the
SEC had suspended trading in the company's stock for ten days
because of accounting irregularities; and (3) the company's stock
had lost 76% of its value) (citing Tregenza v. Great Am. Comm.
Co., 12 F.3d 717, 720 (7th Cir. 1993) (stating that inquiry
notice was triggered where stock described as "undervalued" lost
90 percent of its value within one year).)
As their fact patterns suggest, Arduini/Messina, de la
Fuente and Tregenza are exceptions to the general rule that "[w]hether a plaintiff had sufficient facts to place it on
inquiry notice is often inappropriate for resolution on a motion
to dismiss." Lentell v. Merrill Lynch & Co., Inc.,
396 F.3d 161, 168 (2d Cir. 2005) (internal quotation marks omitted)
(holding that news reports raising general questions about
conflicts of interest between defendant's equity research
function and its investment banking function did not give
investors inquiry notice that the defendant had issued fraudulent
research reports in order to artificially inflate the stock price
of certain of its investment banking clients); see also In
re Sumitomo Copper Litig., 104 F. Supp. 2d 314, 324 (S.D.N.Y.
2000) (stating that defendant seeking dismissal on the grounds
that plaintiff had inquiry notice of the claim and that the
statute of limitations has run bears an "extraordinary" burden)
(quoting In re Prudential Securities Inc., Ltd. Partnerships
Litig., 930 F. Supp. 68, 76 (S.D.N.Y. 1996)).
Moreover, the issue of when Plaintiffs were put on inquiry
notice and whether a reasonable inquiry could have revealed
enough information to satisfy the heightened pleading
requirements imposed pursuant to Rule 9(b) and the PSLRA, raise
factual disputes which have been held to be inappropriate for
disposition on a motion to dismiss. See Levitt v. Bear Stearns
& Co., Inc., 340 F.3d 94, 104 (2d Cir. 2003). In the statute of
limitations context, a Rule 12(b)(6) dismissal is appropriate
only if the complaint, on its face, clearly shows that the claim
is time-barred. See Harris v. City of New York, 186 F.3d 243, 250 (2d Cir.
Even if the published reports could be considered "storm
warnings," the SAC alleged that subsequent Sunrise research
reports by Goldman and Gruber were calculated to allay any
concerns among investors that the published reports might have
given rise to. The Second Circuit has stated that "there are
occasions when, despite the presence of some ominous indicators,
investors may not be considered to have been placed on inquiry
notice because the warning signs are accompanied by reliable
words of comfort from management." LC Capital Partners, LP v.
Frontier Insurance Group, Inc., 318 F.3d 148, 154 (2d Cir. 2003)
(citing Milman v. Box Hill Systems Corp., 72 F. Supp.2d 220,
229 (S.D.N.Y. 1999) (stating that "courts have been reluctant to
find that public disclosures provided inquiry notice where those
disclosures were tempered with positive statements"). Such
statements of reassurance are adequate to deprive an investor of
inquiry notice of a securities fraud claim if "an investor of
ordinary intelligence would reasonably rely on the statements to
allay [that] investor's concern." LC Capital Partners,
318 F.3d at 154.
In support of their argument that Plaintiffs had inquiry notice
by April 6, 2001 at the latest, Defendants assert that
generalized claims concerning conflicts of interest at Lehman and
other securities firms had been widely reported in the financial press as early as August 2000. However, as a general rule, such
reports are not adequate to give rise to inquiry notice. See,
e.g. Fogarazzo v. Lehman Bros., Inc., 341 F. Supp. 2d 274,
276 (S.D.N.Y. 2004) (stating that "[f]or limitations purposes,
investors were not charged with constructive knowledge of
securities fraud when media reports gave generalized indications
of investment banks' analysts' conflicts of interest").
Moreover, the SAC has properly alleged that until the
settlement of the charges brought against Lehman by the SEC, the
NASD and the Attorneys General on April 28, 2003, the Plaintiffs
had no knowledge of the alleged practices of Lehman involving
their security analysts' reports and the link to Lehman's
investment banking business. It was those practices which are
alleged to provide the required scienter for the Plaintiffs'
This Court recently observed, in an analogous context, that
"[t]o satisfy Rule 9(b) and the PSLRA, the Plaintiffs must plead
particular facts supporting their theory that the Defendants'
[inaction] was due to something nefarious, rather than simply
imperfect economic forecasting." In re Aegon N.V. Securities
Litigation, No. 03 Civ. 0603 (RWS), 2004 WL 1415973, at *8
(S.D.N.Y. June 23, 2004).
Although at least seven Sunrise reports in 2000 and 2001 are
alleged to have falsely recommended that Sunrise securities was a strong buy with a price target of $19, Plaintiffs have properly
alleged that they could not have pled that Lehman's reports were
part of a fraudulent scheme until they learned of the April 28,
2003 Global Settlement. Plaintiffs' allegations that Defendants
were motivated by such concrete pecuniary benefits are necessary
to meet the scienter requirements under the PSLRA. See In re
WorldCom, 294 F. Supp. 2d 392, 425 (S.D.N.Y. 2003).
Based on the foregoing, it is determined that the Plaintiffs
have adequately alleged that they may not have had inquiry notice
of their securities fraud claims until April 28, 2003. Therefore,
Counts I and II of the SAC cannot be judged untimely as a matter
B. The SAC Fails To State A Claim Pursuant to Section 10(b)
and Rule 10b-5
Count I of the SAC alleges that the Defendants violated Section
10(b) of the Exchange Act and Rule 10b-5. Section 10(b) provides
in pertinent part as follows:
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
. . .
(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, or any securities-based swap agreement
(as defined in section 206B of the Gramm-Leach-Bliley
Act), 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.
Rule 10b-5 provides in pertinent part as follows:
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
(a) To employ any device, scheme, or artifice to
(b) To make any untrue statement of a material fact
or to omit to state a material fact necessary in
order to make the statements made, in the light of
the circumstances under which they were made, not
(c) To engage in any act, practice, or course of
business which operates or would operate as a fraud
or deceit upon any person, in connection with the
purchase or sale of any security.
17 C.F.R. § 240.10b-5.
"The language of Section 10(b) and Rule 10b-5 does not
explicitly create a private right of action. In fact, the
legislative history fails to indicate whether Congress even
contemplated creating such a right. . . . Nevertheless, courts
long have held that a private right of action was indeed
created." Ontario Public Service Employees Union Pension Trust
Fund v. Nortel Networks Corp., 369 F.3d 27, 31 (2d Cir. 2004). To state a claim for relief under Section 10(b) and Rule 10b-5,
Plaintiffs must allege with requisite particularity that
Defendants: "(1) made misstatements or omissions of material
fact; (2) with scienter; (3) in connection with the purchase or
sale of securities; (4) upon which plaintiffs relied; and (5)
that plaintiffs' reliance was the proximate cause of their
injury." In re IBM Securities Litigation, 163 F.3d 102, 106 (2d
Defendants have moved for dismissal of Plaintiffs' claim
pursuant to Section 10(b) and Rule 10b-5 on the grounds that
Plaintiffs have failed to adequately allege (1) loss causation,
(2) falsity, and (3) scienter.
1. The SAC Fails To Allege Loss Causation
To state a claim pursuant to section 10(b) and Rule 10b-5,
Plaintiffs must properly allege both transaction causation and
loss causation. Lentell, 396 F.3d at 172. As the Second Circuit
Causation in [the 10b-5] context has two elements:
transaction causation and loss causation. See
Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374,
380-381 (2d Cir. 1974). Loss causation is causation
in the traditional "proximate cause" sense the
allegedly unlawful conduct caused the economic harm.
See id. at 380. Transaction causation means that
"the violations in question caused the appellant to
engage in the transaction in question." See id.
at 380. Transaction causation has been analogized to
reliance. See Currie v. Cayman Resources Corp.,
835 F.2d 780, 785 (11th Cir. 1988). AUSA Life Ins. Co. v. Ernst and Young,
206 F.3d 202, 209 (2d Cir. 2000). Here, the Defendants argue
that the Plaintiffs have failed to allege loss
Defendants argue that the Second Circuit has held that an
allegation of price inflation alone is not enough to establish
loss causation. See Lentell, 396 F.3d at 175; Emergent
Capital, 343 F.3d at 198; see also Citibank, N.A. v. K-H
Corp., 968 F.2d 1489
, 1495 (2d Cir. 1992).
The Plaintiffs do not address the loss causation pleading
requirements imposed by the Emergent court. Instead, they cite
other cases from this circuit Suez Equity, 250 F.3d at 95;
DeMarco v. Robertson Stephens Inc., 318 F. Supp. 2d 110, 122-23
(S.D.N.Y. 2004); In re Initial Public Offering Sec. Litig.,
297 F. Supp. 2d 668, 675 (S.D.N.Y. 2003); and In re WorldCom,
294 F. Supp. 2d at 413 to support their assertion that the SAC
properly pled loss causation.
The Supreme Court's recent decision in Dura Pharmaceuticals
is dispositive. See Dura Pharmaceuticals, 125 S. Ct. at 1631
(holding that in order to allege loss causation, it is not
adequate for a plaintiff merely to allege that the price paid for
an equity security was inflated as a result of defendant's
misrepresentation). The Dura court stated: Given the tangle of factors affecting price, the most
logic alone permits us to say is that the higher
purchase price will sometimes play a role in
bringing about a future loss. It may prove to be a
necessary condition of any such loss, and in that
sense one might say that the inflated purchase price
suggests that the misrepresentation (using language
the Ninth Circuit used) "touches upon" a later
economic loss. [Broudo v. Dura Pharmaceuticals,
Inc., 339 F.3d 933, 938 (9th Cir. 2003)]. But, even
if that is so, it is insufficient. To "touch upon" a
loss is not to cause a loss, and it is the latter
that the law requires. 15 U.S.C. § 78u-4(b)(4).
Id. at 1632. The Dura court reasoned that its loss causation
pleading requirement struck the proper balance between the policy
interests animating the notice pleading system and those
animating the federal securities statutes. The Dura court stated:
We concede that ordinary pleading rules are not meant
to impose a great burden upon a plaintiff.
Swierkiewicz v. Sorema N.A., 534 U.S. 506, 513-515
(2002). But it should not prove burdensome for a
plaintiff who has suffered an economic loss to
provide a defendant with some indication of the loss
and the causal connection that the plaintiff has in
mind. At the same time, allowing a plaintiff to forgo
giving any indication of the economic loss and
proximate cause that the plaintiff has in mind would
bring about harm of the very sort the [federal
securities statutes] seek to avoid. Cf. H.R. Conf.
Rep. No. 104-369, p. 31 (1995) (criticizing "abusive"
practices including "the routine filing of lawsuits . . .
with only a faint hope that the discovery process
might lead eventually to some plausible cause of
action"). It would permit a plaintiff "with a largely
groundless claim to simply take up the time of a
number of other people, with the right to do so
representing an in terrorem increment of the
settlement value, rather than a reasonably founded
hope that the [discovery] process will reveal
relevant evidence." Blue Chip Stamps,
421 U.S. at 741. Such a rule would tend to transform a private
securities action into a partial downside insurance
policy. See H.R. Conf. Rep. No. 104-369; at 31;
see also [Basic Inc. v. Levinson, 485 U.S. 224,
252] (White, J., joined by O'Connor, J., concurring
in part and dissenting in part). Id. at 1634.
The SAC contained no allegations of a causal connection between
the alleged misrepresentations and a subsequent economic loss
suffered by the Plaintiffs. Rather, the SAC merely alleged that
(1) Sunrise stock is publicly traded and (2) that the Defendants'
misrepresentations falsely inflated the value of Sunrise' shares.
The Dura court rejected the proposition that such allegations
are adequate to plead loss causation. See id. at 1629-30
(stating that allegation that "`[i]n reliance on the integrity of
the market, [the plaintiffs] . . . paid artificially inflated
prices for [defendant's] securities' and th[at] plaintiffs
suffered `damage[s]' thereby" were not adequate to plead loss
Based on the foregoing, it is determined that Plaintiffs have
not properly alleged loss causation.
2. The SAC Has Adequately Alleges Falsity
Defendants assert that Plaintiffs have failed to properly plead
the first element of their Section 10(b) and Rule 10b-5 claim
(i.e., that Defendants made misstatements or omissions of
With respect to this element, the PSLRA provides that "the
complaint [must] 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 [must]
state with particularity all facts on which that belief is
formed." 15 U.S.C. § 78u-4(b)(1).
Under proper circumstances, misstatements of opinion, (i.e.,
statements of opinion that are significantly at odds with that
which the declarant actually believes to be true) can give rise
to liability pursuant to Section 10(b) and Rule 10b-5. See
Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991);
Lentell, 396 F.3d at 177 (stating that "`systematically overly
optimistic' [stock] ratings of the type published by [defendant's
equities analysts] are [not] categorically beyond the reach of
the securities laws"); Novak, 216 F.3d at 315 (holding that
defendants' statements that "the[ir] inventory situation was `in
good shape' or `under control' while they allegedly knew that the
contrary was true" was actionable pursuant to Section 10(b) and
Rule 10b-5); Fogarazzo, 341 F. Supp. 2d at 295 (S.D.N.Y. 2004)
(holding that plaintiffs had properly alleged that defendants had
made misleading statements where it was specifically alleged (1)
that the defendant investment banks used equity research to
obtain and/or maintain investment banking business, (2) that
defendants caused their research analysts to maintain positive
coverage of specified stocks in order to obtain/maintain
investment banking business, (3) that analysts' independence was
thereby compromised, (4) that the defendants failed to adequately supervise the analysts to ensure
independence, and (5) that as a result of such practices, the
defendant and its analysts caused the price of a given stock to
become artificially inflated); DeMarco, 318 F. Supp. 2d at 117
(stating that "liability under § 10(b) can be predicated on
statements of opinion, where it can be shown not merely that a
proffered opinion was incorrect or doubtful, but that the speaker
deliberately misrepresented his actual opinion").
As described above, the SAC specifically identified each
statement alleged to be misleading, and it explained why each
such statement was regarded as misleading. The SAC has alleged
that Lehman maintained a practice that linked analysts'
compensation to their willingness to generate favorable reports
on the securities of investment banking clients. It is further
alleged "that the analysts' views of the securities they covered
were the exact opposite of what they recommended to the public."
(SAC ¶ 99.) These disparities are described with particularity.
The Plaintiffs have also alleged that the Sunrise research
reports at issue omitted material information and that the
omissions made the reports false and misleading. The omitted
information included the facts surrounding the sale of units by
U.S. Medical, the relationship between the Sunrise research
reports and the Lehman investment banking as revealed in the
Global Settlement (see SAC ¶ 103), and deficiencies in the
operation of Sunrise units as reported in meetings of
ophthalmologists. (see SAC ¶ 114.) Based on the foregoing, it is determined that the SAC has
properly alleged that the statements at issue were false and
3. The SAC Has Adequately Alleged Scienter
Pursuant to the PSLRA and Second Circuit precedent, Plaintiffs
must "state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of
mind." 15 U.S.C. § 78u-4(b)(2); see also Chill v. Gen. Elec.
Co., 101 F.3d 263, 267 (2d Cir. 1996) (quoting Acito v. IMCERA
Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995)). The Plaintiffs can
satisfy this scienter requirement in one of two ways: (1) by
alleging facts that demonstrate that the Defendants had motive
and opportunity to commit fraud or (2) by alleging facts that
constitute strong circumstantial evidence of conscious
misbehavior or recklessness. Kalnit v. Eichler, 264 F.3d 131,
138-39 (2d Cir. 2001).
"In general, a strong inference of scienter `may arise where
the complaint sufficiently alleges that the defendants: (1)
benefitted in a concrete and personal way from the purported
fraud, (2) engaged in deliberately illegal behavior, (3) knew
facts or had access to information suggesting that their public
statements were not accurate; or (4) failed to check information
they had a duty to monitor.'" Fogarazzo, 341 F. Supp. 2d at 295 (quoting Novak,
216 F.3d at 311 (citations omitted)).
The SAC has alleged with specificity that several divisions at
Lehman the research division, the investment banking division,
and the firm's administration were actively encouraging the
research division to publish misleading analyst reports for the
purpose of promoting companies from whom Lehman hoped to earn
additional investment banking fees. The details of this improper
arrangement between Lehman's divisions is further described in
the Global Settlement. Defendants argue that these allegations do
no more than charge Lehman with a modus operandi of preparing
and disseminating tainted analysts reports, and that such
allegations are inadequate to allege motive and opportunity with
requisite particularity. However, courts of this district have
held that allegations of this sort are adequate to plead
scienter. See, e.g., Fogarazzo, 341 F. Supp. 2d at 297. As
the Fogarazzo court stated:
It is true that some of the most specific allegations
of scienter in the complaint do not pertain to RSL
[i.e., the stock in which the plaintiffs invested],
but rather to other companies that the Banks dealt
with. The Banks argue that this is a basis for
concluding that plaintiffs have not sufficiently
alleged scienter. However, even where the heightened
pleading standards of the PSLRA and Rule 9(b) are
concerned, a court is directed to draw every
inference in favor of plaintiffs on a motion to
dismiss. Here, plaintiffs have alleged wide-spread
conflicts of interest between the analyst and
investment banking departments at three major Banks.
They have made specific allegations based on, among
other things, e-mails from the Banks' own analysts suggesting
that the Banks received investment banking business
in return for favorable analyst coverage, as part of
a standard industry practice. Moreover, they have
alleged that the Banks' relationship with RSL was the
same as with these other companies the Banks issued
positive research reports on the heels of new
investment banking business and in the face of
overwhelming information calling into question RSL's
financial health. Taken together, I can easily infer
that the Banks' relationships with RSL were subject
to the same conditions as with other companies. That
being so, plaintiffs have amply pleaded facts giving
rise to a strong inference that the Banks made the
alleged misstatements with scienter.
Id. citations omitted).
Here, as in Fogarazzo, scienter has been properly alleged.
Plaintiffs have provided detailed allegations (1) that Lehman
engaged in a general practice of providing unduly positive
research coverage to certain of its clients in order to obtain
additional investment banking fees, (2) that Sunrise was one of
Lehman's investment banking clients, (3) that certain Sunrise
research reports issued by Lehman contained statements that were
false and misleading, and (4) that the analysts covering Sunrise
were in possession of specific information that irreconcilably
contradicted the statements contained in their research reports.
Taken together, these allegations satisfy the pleading
requirements with respect to scienter. C. The SAC Fails To State A Claim Pursuant to Section 20(a)
Section 20(a) of the Exchange Act provides in pertinent part as
Every person who, directly or indirectly, controls
any person liable under any provision of this chapter
or of any rule or regulation thereunder shall also be
liable . . . to the same extent as such controlled
person . . . unless the controlling person acted in
good faith and did not directly or indirectly induce
the act or acts constituting the violation or cause
15 U.S.C. § 78t(a). Since Plaintiffs have failed to state a claim
pursuant to Section 10(b) and Rule 10b-5, it necessarily follows
that they have also failed to state a claim pursuant to Section
20(a). See Rombach, 355 F.3d at 177-78.
D. The SAC Has Failed To State A State Law Claim
The parties do not dispute that the common law claims asserted
in Counts III and IV of the SAC are governed by the law of New
1. The Negligent Misrepresentation Claim
Count III of the SAC alleges negligent misrepresentation. Under
New York law, the elements of a claim for negligent
misrepresentation are that: (1) the defendant had a duty, as a result of a
special relationship, to give correct information;
(2) the defendant made a false representation that he
or she should have known was incorrect; (3) the
information supplied in the representation was known
by the defendant to be desired by the plaintiff for a
serious purpose; (4) the plaintiff intended to rely
and act upon it; and (5) the plaintiff reasonably
relied on it to his or her detriment.
Greenberg v. Chrust, 198 F. Supp. 2d 578, 584 (S.D.N.Y. 2002)
(citing Hydro Investors, Inc. v. Trafalgar Power Inc.,
227 F.3d 8, 20 (2d Cir. 2000)).
New York's Martin Act grants the Attorney General the power to
regulate fraud and deception in the sale of securities. See
N.Y. Gen. Bus. Law § 352-c.*fn5 The New York Court of
Appeals has held that there is no implied private right of action pursuant to
the anti-fraud provisions of the Martin Act. See CPC Intern.
Inc. v. McKesson Corp., 70 N.Y.2d 268, 276, 519 N.Y.S.2d 804,
807, 514 N.E.2d 116, 118 (1987). With respect to McKesson's
effect on negligent misrepresentation claims and other common law
causes of action, it has been stated that:
[i]n precluding a private right of action under the
Martin Act the McKesson court did not explicitly
discuss the effect of the Act on the common law, but
in the years following McKesson three of the
appellate divisions interpreting the decision held
that the Martin Act preempts any common law claims
within its purview. These courts generally held that
allowing private litigants to press common law claims
"covered" by the Martin Act would upset the Attorney
General's exclusive enforcement power in exactly the
same way that it would upset the exclusive
enforcement power to allow private claims pleaded
under the Martin Act itself.
Nanopierce Technologies, Inc. v. Southridge Capital Management
LLC, No. 02 Civ. 0767 (LBS), 2003 U.S. Dist. LEXIS 15206, at
*6-7 (S.D.N.Y. Sep. 2, 2003) (citing Whitehall Tenants Corp. v.
Estate of Olnick, 213 A.D.2d 200, 201, 623 N.Y.S.2d 585, 585
(1st Dep't), appeal denied, 86 N.Y.2d 704
, 631 N.Y.S.2d 608
655 N.E.2d 705
(1995); Breakwaters Townhomes Ass'n of Buffalo,
Inc. v. Breakwaters of Buffalo, Inc., 207 A.D.2d 963, 964,
616 N.Y.S.2d 829, 829 (4th Dep't 1994); Rego Park Gardens Owners,
Inc. v. Rego Park Gardens Assocs., 191 A.D.2d 621, 622,
595 N.Y.S.2d 492, 494 (2d Dep't 1993); Eagle Tenants Corp. v.
Fishbein, 182 A.D.2d 610, 611, 582 N.Y.S.2d 218, 219 (2d Dep't
1992); Horn v. 440 E. 57th Co., 151 A.D.2d 112, 119,
547 N.Y.S.2d 1, 5 (1st Dep't 1989)). The Second Circuit has interpreted McKesson as barring breach
of fiduciary duty claims and, presumably, other common law causes
of action that are within the Martin Act's purview. See
Castellano v. Young & Rubicam, Inc., 257 F.3d 171
, 190-91 (2d
Cir. 2001). This rule has also been adopted by the majority of
the district courts that have considered the effect of McKesson
on common law claims. See, Nanopierce, 2003 U.S. Dist. LEXIS
15206, at *9 (collecting cases).
To be sure, there is at least some authority in this district
to support a contrary view. See Cromer Fin. Ltd. v. Berger,
Nos. 00 Civ. 2284 (DLC), 00 CIV. 2498 (DLC), 2001 U.S. Dist.
LEXIS 14744, at *13-14 (S.D.N.Y. Sept. 20, 2001) (stating (1)
that the New York Court of Appeals has not determined whether the
Martin Act preempts common law claims and (2) that there is a
split of authority among those intermediate appellate courts that
have considered the issue) (citing Scalp & Blade, Inc. v.
Advest, Inc., 281 A.D.2d 882, 722 N.Y.S.2d 639, 640 (4th Dep't
2001) (stating that "nothing in the Martin Act, or in the Court
of Appeals cases construing it, precludes a plaintiff from
maintaining common-law causes of action based on such facts as
might give the Attorney-General a basis for proceeding civilly or
criminally against a defendant under the Martin Act.")). However, the Cromer Finance and Scalp & Blade courts
represent minority views. The rule adopted by the majority of
state intermediate appellate courts that have considered the
issue is that claims for negligent misrepresentation, which do
not require a plaintiff to plead and prove intentional deceit,
are covered by the Martin Act and cannot be asserted by private
litigants. "[P]rinciples of federalism and respect for state
courts' interpretation of their own laws counsel against ignoring
the[se] rulings. . . ." Castellano, 257 F.3d at 190.
Based on the foregoing, the negligent misrepresentation claim
2. The Fraud Claim Is Dismissed
Count IV of the complaint alleges common law fraud. Under New
York law, the elements of a fraud claim are: (1) that the
defendant made a material false representation, (2) that the
defendant intended to defraud the plaintiff thereby, (3) that the
plaintiff reasonably relied upon the representation, and (4) that
the plaintiff suffered damage as a result of such reliance.
Manning v. Utils. Mut. Ins. Co., 254 F.3d 387, 400 (2d Cir.
2001) (quoting Bridgestone/Firestone, Inc. v. Recovery Credit
Servs., 98 F.3d 13, 19 (2d Cir. 1996)); see also Lama
Holding Co. v. Smith Barney, Inc., 88 N.Y.2d 413, 421,
646 N.Y.S.2d 76, 80, 668 N.E.2d 1370, 1373 (1996). As an initial matter, it should be noted that the Martin Act
does not preclude private litigants from bringing common law
fraud claims because such claims require a plaintiff to prove
intent or scienter. Therefore, courts allow these claims to
proceed while simultaneously dismissing negligent
misrepresentation and breach of fiduciary duty claims. See,
e.g., Whitehall, 213 A.D.2d 200, 623 N.Y.S.2d 585.
The pleading requirements for common law fraud are essentially
the same as those for claims under Section 10(b) and Rule 10b-5.
Nanopierce Technologies, Inc. v. Southridge Capital Management
LLC, No. 02 Civ. 0767(LBS), 2004 U.S. Dist. LEXIS 24168, at *34
(S.D.N.Y. Dec. 2, 2004); Nairobi Holdings Ltd. v. Brown Bros.
Harriman & Co., No. 02 Civ. 1230 (LMM), 2004 U.S. Dist. LEXIS
9100, at *5-6 (S.D.N.Y. May 20, 2004); Spencer Trask Software &
Info. Servs. LLC v. Rpost Int'l, Ltd., No. 02 Civ. 1276 (PKL),
2003 U.S. Dist. LEXIS 946, 61-60 (S.D.N.Y. Jan. 24, 2003);
Internet Law Library, Inc. v. Southridge Capital Mgmtl, LLC.,
223 F. Supp. 2d 474, 489 (S.D.N.Y. 2002); The Pits, Ltd. v.
American Express Bank Intern., 911 F. Supp. 710, 719 (S.D.N.Y.
1996). The special pleading requirements of Rule 9(b) apply to
allegations of common law fraud. See, e.g., Perma Research &
Dev. Co. v. Singer Co., 410 F.2d 572, 576 (2d Cir. 1969);
Granite Partners, L.P. v. Bear, Stearns & Co. Inc.,
17 F. Supp. 2d 275, 286 (S.D.N.Y. 1998). Here, Plaintiffs have failed to plead loss causation (i.e.,
proximate cause) with requisite particularity. Absent such
allegations of proximate cause, no common law fraud claim can be
stated. See Citibank N.A., 968 F.2d at 1496-97 (affirming
dismissal of a common law fraud claim where the plaintiff failed
to adequately allege that the damages were proximately caused by
the defendants' misrepresentations).
Based on the foregoing, Plaintiffs' common law fraud claim is
For the reasons set forth above, the complaint is dismissed in
its entirety. The Plaintiffs are granted leave to replead within
twenty (20) days of the entry of this order.
It is so ordered.