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Lapin v. Goldman Sachs Groups

September 29, 2006


The opinion of the court was delivered by: Kenneth M. Karas, District Judge


This case stems from a financial securities firm's alleged conflicts of interest. The conflict alleged pitted the firm's securities analysts against the firm's actual or potential investment banking clients. It is alleged that this conflict of interest, which was not disclosed by the firm to its shareholders, artificially inflated the price of the firm's stock purchased during the relevant time period.

Lead Plaintiff, Harvey Lapin, filed this putative class action on behalf of himself and other similarly situated individuals who purchased shares of the defendant securities firm, Goldman Sachs Group, Inc. ("GS Group"), from July 1, 1999 to May 7, 2002 (the "Class Period"), a period in which the firm allegedly "employ[ed these] undisclosed improper business practices." (Second Am. Compl. ¶ 1 ("SAC") Plaintiff brings this action pursuant to section 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. Specifically, Plaintiff alleges that the GS Group, and its subsidiary, Goldman, Sachs & Co. (collectively "Goldman"), along with GS Group's then-Chairman and Chief Executive Officer, Henry M. Paulson ("Paulson"), violated section 10(b) and Rule 10b-5 when they misrepresented Goldman's research analysts as "independent" and unbiased, and failed to disclose analysts' conflicts of interest with Goldman's investment banking clients, thereby artificially inflating the stock price of GS Group.

Defendants GS Group, Goldman and Paulson (collectively "Defendants") move to dismiss the Complaint pursuant to Fed. R. Civ. P. 12(b)(6). For the reasons stated herein, Defendants' Motion to Dismiss the Complaint is granted in part and denied in part.

I. Facts

A. Plaintiff's Allegations

Except as otherwise noted, the following facts alleged in the Second Amended Complaint are presumed true for purposes of this motion.*fn1 Plaintiff purchased shares of GS Group common stock during the Class Period, see (SAC ¶ 16), and alleges that, unbeknownst to him and other individuals who purchased GS Group 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." (SAC ¶ 26) These practices were allegedly used to help Goldman compete for Initial Public Offering ("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." (SAC ¶ 25) To accomplish that goal, Goldman, "among other things, compensated its research analysts in large part based on the degree to which they helped generate investment banking business for Goldman Sachs, offered its research coverage as a marketing tool to gain investment banking business, and failed to establish adequate procedures to protect research analysts from conflicts of interest." (SAC ¶ 26)

During the Class Period, Defendants allegedly made false and misleading statements to hide these practices and their potentially fraudulent nature. (See generally SAC ¶¶ 119-34) These statements can be grouped into four categories. The first category consists of statements, including ratings of publicly traded stocks, that describe Goldman's stock research as high quality, unbiased research, which relies on objective criteria (e.g., "[u]nder [new] leadership, we will maximize our standing in the U.S. investment community and strengthen our reputation for providing insightful, unbiased research," SAC ¶ 130). (See SAC ¶¶ 119-20, 128, 130-31) The second category consists of statements trumpeting Goldman analysts who have received high rankings in industry polls, and awards that Goldman analysts had received (e.g., "[o]ur Research Department is the only one to rank in the top three in each of the last 15 calendar years in Institutional Investor's 'All-America Research Team' survey," SAC ¶ 125). (See SAC ¶¶ 125, 127). The third category consists of statements noting Goldman's high ethical standards and its compliance with industry rules and regulations (e.g., "[w]e are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us," SAC ¶ 124). (See SAC ¶ 124) The fourth and final category involves omissions, rather than affirmative statements, in which Goldman "failed to give an indication of the great extent to which individual conflicts of interest were biasing analyst opinions" in equity research reports. (SAC ¶ 122)

Plaintiff alleges that all of these statements violated securities law, because "they failed to disclose that during the Class Period defendants were engaged in a series of undisclosed and improper business practices pursuant to which Goldman Sachs failed to issue quality, objective, unbiased research reports concerning the common stocks of the companies for which Goldman Sachs provided or sought to provide investment banking services." (SAC ¶¶ 121, 123, 126, 129, 133) These practices allegedly included: compensating research analysts primarily based on the degree to which they helped generate investment baking business, offering companies research coverage by its analysts as a marketing tool to gain investment banking business, initiating or terminating research coverage and rating stocks based on investment banking business rather than an opinion of the company's prospects and business following expert research and analysis, and a general failure to establish adequate procedures to protect research analysts from conflicts of interests. (SAC ¶¶ 121, 123, 126, 129, 133) Plaintiff also alleges that these statements were false in light of Goldman's failure to abide by then-applicable NYSE and NASD regulations, (see SAC ¶ 91-103) and its failure to adequately supervise its analysts, (see SAC ¶¶ 89-90) including the implementation and oversight over a so-called "Chinese Wall" that was "required to prevent the conflicts of interest that could obviously result when a firm analyzes and recommends the very securities it has itself issued or underwritten." Shah v. Meeker, 435 F.3d 244, 247 (2d Cir. 2006)

The Second Amended Complaint alleges that Goldman's statements lauding its analysts and their reports as unbiased and objective ran counter to its internal pronouncements. For example, in "pitchbooks" used to recruit potential new investment banking clients, Goldman marketed its research coverage to suggest that Goldman's supposed objective coverage would be rose-tinted once Goldman concluded the banking transaction. (SAC ¶ 45) In other pitchbooks, Goldman portrayed the role of its investment research analysts to include "creating" and "marketing" a covered company's "story." (SAC ¶ 49) The marketing of Goldman's influential research reports as a tool to attract new banking clients was further encouraged, the Second Amended Complaint alleges, by means of Goldman's compensation and evaluation policies. (See SAC ¶¶ 30-40) Under Goldman's "360 degree review" process, for example, investment bankers were often asked to review and offer their opinions on research analysts. (SAC ¶ 31) These reviews acknowledged that research analysts often saw their primary role as generating more investment banking revenue for Goldman, as opposed to providing independent research of the covered companies. (See SAC ¶¶ 32-40) These policies and lack of internal controls, Plaintiff alleges, led Goldman's research coverage to become overly sanguine, and contrary to the analysts' internally-professed opinions. (See SAC ¶¶ 52-88)

Plaintiff alleges that in light of the research analysts' true opinions, Goldman's public statements concerning its objective and high-quality research were fraudulent because the practices, "if discovered, threatened to erode public, client and investor confidence in Goldman Sachs and to expose Goldman Sachs to substantial liability from government and regulatory authorities and private litigants." (SAC ¶¶ 121, 123, 126, 129, 133) Thus, the Second Amended Complaint alleges facts concerning whether Goldman was engaging in practices that allegedly violated NASD, SEC and/or NYSE rules which "unquestionably would be material to a reasonable investor in deciding [whether] to invest in [Goldman]." (SAC ¶ 137) Unaware of the true nature of Goldman's alleged improper business practices during the Class Period, the Second Amended Complaint alleges, purchasers of GS Group stock during the Class Period bought the stock "at prices which were artificially inflated." (SAC ¶ 138) Had purchasers of the stock known the truth concerning Goldman's business practices, Plaintiff alleges, they either would not have purchased the stock, or they would have bought it at a non-inflated "market efficient" price. (See SAC ¶¶ 138-140)

Plaintiff maintains that GS Group's price was inflated during the Class Period as a result of hiding GS Group's true business practices from investors. Plaintiff asserts that his damages, therefore, are demonstrated by the "steep slide" in GS Group's stock price once its true research practices began to emerge. (See SAC 142-153) For example, on April 8, 2002, the New York State Attorney General announced the results of a probe of a different investment bank followed by an announcement on April 10, 2002, that he was expanding his investigation into such practices to the whole industry, including Goldman. (SAC ¶ 144) As this news emerged, GS Group's stock price declined from $86.06 on April 8, 2002 to $81.24 on April 11, 2002. (SAC ¶ 147) Likewise, two weeks later, when the Justice Department and the SEC announced on April 23rd and April 25th, respectively, that they would also conduct investigations into such allegations, Goldman's stock fell further to $77.21 on April 25, 2002. (SAC ¶¶ 145, 148)

B. Public Information Regarding Analysts' Conflict of Interest

Defendants' statements were not the only publicly available pieces of information to investors before and during the Class Period. Prior to the Class Period, numerous newspaper articles reported, in general terms, on the conflicts of interests that confronted securities research analysts. See generally Shah, 435 F.3d at 247 (noting Wall Street Journal articles reporting, for example, "'significant evidence of bias and possible conflict of interest'" (citation omitted)); Merrill Lynch I, 273 F. Supp. 2d at 380-81, 383-88 (same); In re Merrill Lynch & Co. Research Reports Sec. Litig., 272 F. Supp. 2d 243, 250-52 (S.D.N.Y. 2003) (same) [hereinafter Merrill Lynch II]. Defendants maintain that such articles went beyond industry generalities and were specific to Goldman. Goldman was specifically mentioned, and general conflicts issues were raised, in four sources cited by Defendants. In a June 19, 2000, exchange between CNBC television program host, Ron Insana, and a Wall Street Journal reporter, the reporter discussed a "controversy" surrounding picks made by Anthony Noto, a Goldman analyst, of internet companies most likely to survive. The Wall Street Journal reporter noted that the list raised eyebrows because, among other things, "[e]verybody knows that research is connected to investment banking and fees, and clients get a break." CNBC News Tr., Seven of Eight Companies Recommended by Goldman Sachs Analyst are Goldman Clients; Conflict of Interest Issue Arises, June 19, 2000. A day later, on June 20, 2000, an article in the Wall Street Journal noted similar concerns about Noto's list. Susan Pulliam, Goldman's E-Commerce List Reduces Nonclients to Low Tiers, Wall St. J., June 20, 2000, at C1. However, in the same article, Noto was quoted as defending the independence and quality of his picks asserting that they "had nothing to with Goldman's banking ties," that his "research is independent from [Goldman's] corporate structure," and "Goldman's relationships are not what drove [his] thought process." Id. A little over a month later, on August 1, 2000, an article in The Philadelphia Inquirer concluded that there was an "ethical deterioration" at big brokerage firms and noted that Arthur Levitt, then chairman of the SEC, "accused analysts of sacrificing quality research to win investment-banking business for their firms." Miriam Hill, Even Research Comes with Spin, The Philadelphia Inquirer, Aug. 1, 2000, at C01. Although Goldman was among the firms listed in the article, no specific Goldman analyst or Goldman-specific practice was mentioned. Id. Finally, on February 12, 2001, The American Prospect reported that among large brokerage houses, including Goldman, "analysts are little more than cheer-leaders for the firms they cover." Ken Silverstein, Stocking Up; Why Analysts Inflate Stock Worth, The Am. Prospect, Feb. 12, 2001, at 17. Yet, the article also quoted an investment banker who recognized that while people on Wall Street understand that "[a]nalysts make their living by being friendly and supportive . . . . The problem is that individual investors don't." Id.

On June 13, 2001, a class action complaint against Goldman was filed in New York. (Wheeler Decl. Ex. E) The case, captioned Stefansky v. Goldman, Sachs & Co., alleged a breach of fiduciary duty by Goldman to its retail brokerage account holders by "favoring the interests of its investment banking clients over the interests of its retail customers." (Wheeler Decl. Ex. E ¶ 3) Specifically, the Stefansky complaint alleged that Goldman simultaneously underwrote and managed the IPO of Allied Communications Corp. ("Allied"), earning banking fees, while having its analysts cover and recommend the stock. (See Wheeler Decl. Ex. E ¶¶ 27, 41, 47) As a result, the complaint alleged, Goldman issued glowing recommendations to its retail customers to purchase Allied stock even though throughout this period Allied had "negative cash flow," and was "struggling to stay afloat." (Wheeler Decl. Ex. E ¶¶ 39-40)

II. Discussion

A. Standard of Review

On a motion to dismiss for failure to state a claim, the Court assumes the truth of facts asserted in the complaint and draws all reasonable inferences in the plaintiff's favor. See Shah, 435 F.3d at 246; Rombach v. Chang, 355 F.3d 164, 169 (2d Cir. 2004). "A complaint should only be dismissed where it appears beyond doubt that the plaintiff can present no set of facts entitling him to relief. At this stage of the proceedings, then, [the Court's] charge is not to weigh the evidence that might be presented at a trial but merely to determine whether the complaint itself is legally sufficient." Chosun Int'l, Inc. v. Chrisha Creations, Ltd., 413 F.3d 324, 327 (2d Cir. 2005) (citation omitted).

Rule 10b-5 states, in part, that it is "unlawful for any person . . . 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 light of the circumstances under which they were made, not misleading." 17 C.F.R. § 240.10b-5. To state a claim for relief under section 10(b) and Rule 10b-5, a plaintiff must adequately allege (1) that Defendants 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 his injury. See Dura Pharm., Inc. v. Proudo, 544 U.S. 336, 341 (2005); Lentell v. Merrill Lynch & Co., 396 F.3d 161, 172 (2d Cir. 2005) (quoting In re IBM Securities Litigation, 163 F.3d 102, 106 (2d Cir. 1998)). The requisite state of mind, or scienter, in a securities fraud action is "'an intent to deceive, manipulate or defraud.'" Ganino v. Citizens Utils. Co., 228 F.3d 154, 168 (2d Cir. 2000) (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976)).

Securities fraud claims brought under section 10(b) and Rule 10b-5 are also subject to the heightened pleading standards required by Federal Rule of Civil Procedure 9(b). See Rombach, 355 F.3d at 170 (citing Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)). Rule 9(b) requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). The Second Circuit has established that to state a claim for relief under section 10(b) and Rule 10b-5, Rule 9(b) requires a complaint to: "(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, 355 F.3d at 170.

The Private Securities Litigation Reform Act of 1995 ("PSLRA") further modifies the Rule 12(b)(6) analysis when reviewing a complaint in a securities fraud action. Under the PSLRA, 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 shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). The complaint must also "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).

Defendants first argue that Plaintiff's claims are time-barred. (See Mem. of Law of Defs. in Supp. of their Mot. to Dismiss the Am. Compl. 9-11 ("Defs.' Mem.")) Defendants' second argument is that the Second Amended Complaint identified no actionable statements or omissions because: (1) Goldman had no duty to disclose the alleged conflicts of interests since such information was already widely available (see Defs.' Mem. 4-9); (2) certain statements were made outside the Class Period (see Defs.' Mem. 16-17); and (3) the alleged statements were non-actionable puffery, statements related to corporate mismanagement, or statements of opinion, (see Defs.' Mem. 11-16). Defendants' third argument is that the Second Amended Complaint does not plead fraud with particularity because the allegations of scienter are inadequate. (See Defs.' Mem. 17-21) Fourth, Defendants argue that the new allegations in the Second Amended Complaint do not adequately plead both loss causation ortransaction causation. (See Mem. of Law of Defs. in Supp of their Mot. to Dismiss the Second Am. Compl. 5-9 ("Defs.' SAC Mem.")) Finally, Defendants' fifth argument is that the Second Amended Complaint fails to state a claim against the individual defendant, Paulson. (See Defs.' Mem. 21-23) The Court addresses these arguments in seriatim.

B. Statute of Limitations

Claims of securities fraud brought under section 10(b) must be "brought within one year after the discovery of the facts constituting the violation." 15 U.S.C. § 78i(e). Section 804(a) of the Sarbanes-Oxley Act of 2002 extended this limitations period to two years, 28 U.S.C. § 1658(b), "but applies only to fraud claims arising on or after the effective date of the Act -- July 30, 2002 -- and does not revive claims that were already time-barred under the prior one-year limitations period." Shah, 435 F.3d at 249 (citing In re Enterprise Mortgage Acceptance Co., 391 F.3d 401, 411 (2d Cir. 2004)). This limitations period "begins to run when the plaintiff 'obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge.'" Id. (quoting Kahn v. Kohlberg, Kravis, Roberts & Co., 970 F.2d 1030, 1042 (2d Cir. 1992)); accord In re eSpeed, Inc. Sec. Litig., No. 05 Civ. 2091, 2006 WL 880045, at *7 (S.D.N.Y. Apr. 3, 2006) ("For statute of limitations purposes, discovery of the relevant facts includes inquiry notice as well as actual notice." (citing Rothman v. Gregor, 220 F.3d 81, 96 (2d Cir. 2000))).

Inquiry notice can be triggered by information contained in articles in the financial press or in other lawsuits alleging fraud by the same defendants. See Shah, 435 F.3d at 249 (collecting cases regarding financial press). For example, inquiry notice can be satisfied by "financial, legal, or other data, such as public disclosures in the media about the financial condition of the corporation and other lawsuits alleging fraud committed by the defendants, that provide the plaintiff with sufficient storm warnings to alert a reasonable person to the probability that there may have been either misleading statements or material omissions . . . ." In re Alstom SA Sec. Litig., 406 F. Supp. 2d 402, 421 (S.D.N.Y. 2005) (citations omitted). If an investor does not undertake such inquiry, knowledge of the alleged fraud "will be imputed as of the date the duty arose." LC Capital Partners, LP v. Frontier Ins. Group, Inc., 318 F.3d 148, 154 (2d Cir. 2003). Since Plaintiff has not alleged that he undertook any inquiry before filing the Complaint in this case, knowledge of the alleged fraud is imputed to ...

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