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JOFFEE v. LEHMAN BROTHERS

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,
v.
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

OPINION

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.

Prior Proceedings

  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 Facts

  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 Lehman.

  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 1.)

  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 banking function.

  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 fraud-on-the-market.

  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 Issue

  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 ...


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