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In re Merrill Lynch & Co.

May 8, 2008


The opinion of the court was delivered by: John F. Keenan, United States District Judge


Plaintiff Ronald Ventura ("Ventura"), a purchaser of common stock in the Internet holding company, CMGI, Inc. ("CMGI"), brought this action against defendants Merrill Lynch & Co., Inc. ("Merrill Lynch"), Merrill Lynch's broker-dealer affiliate, Merrill Lynch, Pierce, Fenner & Smith, Inc. ("MLPF&S"), and Henry Blodget, a former Merrill Lynch executive and research analyst ("Blodget") (collectively, the "Defendants"), alleging securities fraud in violation of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t, and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, as well as common law fraud.

Ventura alleges that, from December 1999 to October 2000, the Defendants issued research reports relating to CMGI that provided falsely rosy projections of CMGI's share price and gave "buy" and "accumulate" ratings for the company's stock even though Blodget, the primary author of the reports, privately believed that the stock did not deserve such ratings. The Complaint alleges that the Defendants, while issuing the reports, knew about but concealed the fact that CMGI faced serious cash liquidity problems. The Complaint further alleges that the Defendants published the false opinions in order to boost the share price of CMGI's common stock and thereby induce CMGI to give Merrill Lynch lucrative investment banking business. As a result of the fraudulent analysis contained in the reports, Ventura claims that CMGI's stock price became artificially inflated and subsequently dropped when the true extent of CMGI's cash flow crisis was finally revealed, thus resulting in Ventura's financial losses.

Defendants have moved to dismiss the Complaint under Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and Section 21D(b) of the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b). Because the Complaint fails to plead that the alleged false statements made by the defendants were the cause of Ventura's financial losses, Defendants' motion is granted and the complaint is dismissed with prejudice.


Plaintiff Ventura, like numerous other investors, lost money after he speculated in the stock of CMGI, a new Internet holding company whose share price soared during the Internet bubble and then plummeted in the spring and summer of 2000, during the sector's spectacular collapse. Ventura now seeks to blame the Defendants for what are, in essence, his gambling losses. Counter to Ventura's allegations, the Defendants' research reports -- which form the very basis for the present claims -- contained on their face full disclosure about the volatility of CMGI's stock, repeatedly warned potential investors that CMGI's fate was co-extensive with that of the Internet sector as a whole, and frankly stated that it was difficult for the Defendants' analysts to provide an accurate, objective valuation of the company. Further, Ventura has failed to assert facts to establish that any portion of his losses was due to the Defendants' alleged fraud, rather than to the collapse of the Internet sector as a whole or to other bad news about CMGI, apart from the company's liquidity problems, that the Defendants released to the marketplace. Despite his insistence that the Defendants were insincere in their favorable evaluation of CMGI's prospects, Ventura has failed to allege any facts that link the Defendants' allegedly fraudulent conduct to his financial losses.

The following facts are taken from the Complaint, documents referenced in or incorporated by the Complaint, and facts of which the Court may take judicial notice.*fn1 The Parties Plaintiff Ventura purchased and held the common stock of CMGI, a publicly traded "internet holding company that develops, operates, and invests in other internet companies." (Compl. ¶ 1.)

Defendant Merrill Lynch is a multi-national holding corporation that provides investment banking, research and brokerage services through its broker-dealer affiliate, Defendant MLPF&S. Defendant Henry Blodget was a First Vice President of Merrill Lynch and the lead research analyst of the company's Internet Group, which covered companies in the Internet sector. Blodget was employed by Merrill Lynch from February 1999 until April 8, 2002. NYAG Investigation & Class Action Lawsuits

In April 2002, the New York State Attorney General's Office (the "NYAG") filed an affidavit detailing its investigation into conflicts of interest between Merrill Lynch's Internet Group and its investment banking division. Specifically, the affidavit alleged that the Defendants regularly published misleading and/or false recommendations on Internet-based stocks in order to generate underwriting business for Merrill Lynch from the companies whose stocks were the subject of the falsely positive reports. The affidavit was offered in support of an application before the New York state courts for an order requiring Merrill Lynch employees to turn over documents and give testimony in the Attorney General's continuing investigation into whether defendants violated New York state law. In May 2002, Merrill Lynch entered into a settlement with the NYAG, in which the company agreed to pay a cash fine of $100 million.

The NYAG's highly publicized investigation into Merrill Lynch's conduct and the subsequent settlement led to the filing of numerous class action complaints against the present Defendants in courts throughout the country, on behalf of purchasers of approximately two dozen Internet-based securities, including CMGI, that had been the subject of the allegedly fraudulent Merrill Lynch research reports (the "Internet Cases"). In October 2002, the Judicial Panel on Multidistrict Litigation transferred the cases to Judge Pollack for pre-trial proceedings, under the caption In re Merrill Lynch Research Reports Securities Litigation, No. 02 MDL 1484.

In December 2002, Judge Pollack issued an order directing that the cases be consolidated according to the security that was the subject of each complaint. With regard to seven different lawsuits brought by purchasers of CMGI's stock, the order provided that those actions were to be consolidated under one lead case entitled In re Merrill Lynch & Co., Inc. CMGI Inc. Research Reports Securities Litigation, No. 02 Civ. 7218. In March 2003, the lead plaintiffs filed consolidated amended complaints in each of the actions. In April 2003, the Defendants filed motions to dismiss the complaints in cases brought by direct purchasers of common stock in the Internet companies 24/7 Real Media and Interliant. Judge Pollack stayed all proceedings apart from the motions to dismiss in the 24/7 Real Media and Interliant actions, which were designated by Judge Pollack as "test cases." See In re Merrill Lynch 24/7 Real Media Inc. Research Reports Sec. Litig. No. 02 Civ. 3210 (MP), and In re Merrill Lynch Interliant Inc. Research Reports Sec. Litig., No. 02 Civ. 3221 (MP) (the "test cases"). On June 30, 2003, Judge Pollack dismissed the complaints in the test cases with prejudice, on the ground, among others, that the plaintiffs had failed adequately to plead loss causation. See In re Merrill Lynch & Co. Research Reports Sec. Litig., 273 F. Supp. 2d at 351.*fn2 On January 20, 2005, the Second Circuit affirmed Judge Pollack's dismissal on the ground that the plaintiffs failed to plead loss causation. See Lentell v. Merrill Lynch, 396 F.3d 161, 178 (2d Cir. 2005), cert. denied, 546 U.S. 935 (2005) ("Lentell").

Subsequently, the lead plaintiffs in the Internet Cases entered into settlement negotiations with the Defendants. In January 2007, the parties entered into a stipulation setting forth the key terms of a proposed settlement. On September 5, 2007, this Court approved the final settlement of the Internet Cases. See In re Merrill Lynch & Co. Research Reports Sec. Litig., No. 02 MDL 1484, 2007 U.S. Dist. LEXIS 65372 (S.D.N.Y. Sept. 5, 2007). Ventura, a potential member of the class of plaintiffs who purchased shares of CMGI stock during the class period, opted out of the settlement. Ventura filed the present Complaint on July 23, 2007.

The Research Reports

During the "relevant time period," which the Complaint defines as running from December 20, 1999 to October 4, 1999, (Compl. ¶ 30), the Defendants issued approximately one dozen research reports that related to CMGI.*fn3 The reports, which are expressly referenced throughout the Complaint, fall into two general categories: first, sector-wide reports that contained analyses of the Internet industry and each company in the sector covered by Merrill Lynch, including CMGI; and second, reports that focused exclusively on CMGI that took the form of comments, bulletins and notes, which were generally issued in response to news from CMGI or new developments or trends affecting the company.*fn4

The reports that related exclusively to CMGI variously contained descriptions of CMGI's business model and the operations of its several subsidiary Internet companies, as well a section, entitled "Investment Highlights," that summarized the company's recent notable business activities. The reports also contained financial data that CMGI provided, including quarterly revenue and cash flow information, as well as stock data and stock performance charts. In addition, many of the reports included Merrill Lynch's analysts' valuations of CMGI's subsidiary holdings, from which, in turn, the analysts derived CMGI's overall Net Asset Value ("NAV"). Further, the reports analyzed CMGI's past performance, identified "key metrics" which Blodget and the other analysts believed to be important in valuing the company, and provided target projections for CMGI's future share price. The reports also addressed "key issues" that the analysts believed made CMGI a high-risk investment and discussed the hurdles faced by CGMI as a company operating in the Internet sector.

The analysts' calculations of CMGI's asset value, and the opinions expressed in the reports regarding projections of future earnings, profitability and share price, provided the bases for the recommendations given by the Defendants as to whether investors should purchase CMGI's stock. Each of the research reports followed Merrill Lynch's uniform stock rating system and provided a rating for CMGI that consisted of a letter, followed by four numbers, in the form "x-#-#-#." A code key was included in each of the research reports. The initial letter (either A, B, C, or D) represented Merrill Lynch's assessment of the "Investment Risk Rating" associated with the stock. CMGI, like all of the Internet-based stocks covered by Merrill Lynch, received a "D" rating, which indicated a "high" level of investment risk and was the highest risk rating that the company gave.

The pair of numbers that followed the Investment Risk Rating signified the stock's "Appreciation Potential Rating." The first number indicated the stock's appreciation potential over the intermediate term (from 0-12 months). The second number indicated the stock's long-term appreciation potential (more than twelve months). The numbers signified the following estimates: 1 -- BUY; 2 -- ACCUMULATE; 3 -- NEUTRAL; 4 -- REDUCE; and 5- SELL.*fn5 In all of the research reports devoted exclusively to CMGI that were issued during the relevant period, CMGI was given a rating of "2-1," or "ACCUMULATE/BUY." According to Merrill Lynch, companies given a "2-1" rating had "good growth prospects in a promising sector" or were dominant sector leader[s]"; were on a "clear path to profitability within the next 12-18 months"; had sufficient cash "to reach profitability"; and had "a high likelihood of appreciating more than 20% in 1-2 years." (Compl. ¶ 15.)

The relevant period began on December 20, 1999, with Merrill Lynch's issuance of its initial research report on CMGI, in which the Defendants announced their initiation of coverage of the company and bestowed on CMGI's stock a rating of "2-1", or "ACCUMULATE-BUY." In addition, the Defendants set a 12-18 month share price target of $300 (or $150 per share, after adjusting for a later two-for-one stock split) which was three times CMGI's then-current NAV of approximately $100 per share. The report also characterized CMGI as a core Internet holding. On the day the report was issued, CMGI was trading at approximately $222.19 (or, approximately $111.10 after adjusting for the later stock split). The day after the issuance of the initial report, CMGI's share price rose to $270.25, a gain of approximately 22% over the previous day's closing price, in double normal trading volume. The sharp gain was a testament to the great degree of influence wielded by Blodget, who was perhaps the most widely read Internet research analyst in the country.

Defendants issued additional research reports on January 20, March 31, June 9, June 14, August 7, August 24, and September 22, 2000 in which the favorable "ACCUMULATE-BUY" recommendation was maintained. In addition, on April 17, 2000, Merrill Lynch published a sector-wide report in which CMGI was given a rating of "1-1", or "BUY-BUY." In the June 9, 2000 report, Defendants downgraded their 12-18 month share price projection for the company, from $150 to $100 per share (after adjusting for the earlier stock split). In the report issued on June 14, 2000, Defendants stated CMGI had total liquid assets of $2.1 billion (comprising cash and marketable securities) and opined that, at CMGI's "current burn rate" of $75 million per month, the company's cash position would last "8-10 quarters." (Decl. of Scott Musoff in Support of Merrill Lynch & Co., Inc. and MLPF&S Motion to Dismiss the Complaint ("Musoff Decl.") Ex. 4 at CMGI 0018.) Defendants reiterated their 12-18 month share price projection of $100 per share. In the report issued on September 22, 2000, Defendants stated that CMGI had total liquid assets of $2.3 billion and that this cash position would last "8-9 quarters" in light of the company's July 2000 cash burn rate of $93 million per month. (Id. at CMGI 0038.)

The research report issued on October 4, 2000 forms the gravamen of Ventura's claim that the Defendants finally revealed risks they had previously concealed relating to CMGI's precarious cash position. In that report, Defendants maintained the "2-1", or "ACCUMULATE-BUY" rating but expressed certain reservations about CMGI, including the acknowledgment that "CMGI stock has been very weak recently, down 35% in the last two weeks," and that, "[a]s a proxy for the internet sector, CMGI gets hit doubly hard when the sector is weak." (Id. at CMGI 0045.) Alarmingly, the report stated that, in light of the recent marked decrease in the company's NAV and the resulting drop in share price, "improved stock performance would require multiple expansion, which is unlikely in this environment, especially because CMGI's cash position is starting to become an issue." (Id.) The report continued by stating that the company's cash holdings (excluding marketable securities) were $654 million at the end of the previous quarter, a position that would "last about 7 months," thus requiring the company to "1) raise additional cash or 2) sell some of its holdings or marketable securities, which at end of July were valued at $1.6 billion, or 3) significantly reduce its cash burn." (Id.). The report concluded that improvements in CMGI's cash position would not occur unless CMGI "can illustrate that its operating divisions are making strong progress toward turning cash flow positive." (Compl. ¶ 88.) That same day, CMGI's stock "dropped 11.5% from a close on October 3, 2000 of $24.3125 to a close of $21.50 on October 4, 2000." (Id. ¶ 89.)*fn6

The Alleged Fraud

Ventura does not allege that any of the revenue or cash flow information, or any other financial data, contained in the research reports was false. Rather, Ventura claims that Blodget issued falsely optimistic target projections for CMGI's share price and equally false recommendations to investors to "accumulate" and/or "buy" CMGI stock when, in fact, Blodget privately believed that CMGI overstated its revenues and faced a liquidity crisis, and that investors should not have bought the stock. Ventura alleges that the research reports contained false recommendations, and concealed the Defendants' concerns about CMGI's inadequate cash position, in order to boost CMGI's stock price and thus induce CMGI to give Merrill Lynch lucrative underwriting business. The fraud was motivated, Ventura claims, by Blodget's and other analysts' desire to obtain hefty bonuses, which were keyed to the amount of investment banking business the analysts brought to Merrill Lynch as a result of their issuance of the disingenuously flattering research reports. Ventura alleges that, because the stock recommendations were designed to attract investment banking business, rather than reflect the analysts' true opinion about the investment value of CMGI, the Defendants never issued any recommendation for intermediate or long term appreciation potential that was below a "3", and therefore "Merrill Lynch's five-point system was a de facto three-point system." (Compl. ¶ 22.) The Complaint also alleges that Blodget and other analysts vetted the research reports with Merrill Lynch's investment bankers and CMGI's executives before publishing them. Thus, the Defendant's research analysts, whom the Defendants represented to the public as being objective in their evaluations of publicly-traded stocks, in actuality served the interests of Merrill Lynch's investment banking division. Similarly, Ventura claims that the research reports, which were supposed to reflect the objective views of the research analysts, actually "represented the views of Merrill Lynch investment bankers and CMGI senior management." (Id. ¶ 94.)

The Complaint cites to several email exchanges involving Blodget as the basis for the claim that Blodget did not believe in the positive price projections or "buy" and "accumulate" ratings he gave to CMGI. For example, the Complaint quotes from an email sent to Blodget on January 20, 2000, from Ilona Nemeth, an executive at CMGI's competitor, Doubleclick, in which Nemeth asked, "when u break out AdForce's [CMGI holding] affiliate revenue, what is left? Do you see CMGI double or triple-counting rev[enue] amongst all various companies -- does anyone isolate this impact (Obviously, then compare to [Doubleclick] real revs) . . . ." (Compl. ¶ 64.) The Complaint alleges that Blodget, who was familiar with CMGI's financial statements and its revenue reporting practices, "did not dispute [Nemeth's] criticism directed at CMGI for double- or triple-counting revenue, or the criticism of 'what was left' when AdForce's affiliate revenue was broken out." (Id. ¶ 66.) Instead, the Complaint alleges that Blodget responded that "[t]he best approach to that stock [CMGI] is to blur vision and say 'long the internet.' Look to[o] close and it can scare you. Not so DCLK [Doubleclick]. Looking close is great . . . ." (Id.). Ventura alleges that "[t]his harsh, private assessment came only days after" Blodget named CMGI one of his "Stocks of the Year" and on the same day of the issuance of a favorable research report. (Id.) Thus, Ventura asserts that, in light of Blodget's stated misgivings, the favorable ratings and projections contained in the research reports and in other public pronouncements made by the Defendants regarding CMGI were false. Similarly, the Complaint quotes from an exchange between Blodget and an individual named "Ghachem" on April 17, 2000, the same day that Merrill Lynch's report on the Internet sector was issued in which CMGI was given a "1-1" or "BUY-BUY" rating. The Complaint quotes "Ghachem" as ...

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