Opinion ID: 796223
Heading Depth: 2
Heading Rank: 2

Heading: Application of the Correct Standards to the Pending Case

Text: 76 In some circumstances, it would be appropriate to remand a case such as this to the District Court for reconsideration of the class certification motion under the proper standards as we have explained them. We conclude, however, that remand is not appropriate because the Plaintiffs' own allegations and evidence demonstrate that the Rule 23 requirement of predominance of common questions over individual questions cannot be met under the standards as we have explicated them. 77 Reliance. The predominance requirement fails initially with respect to the issue of reliance. The Plaintiffs recognize that they must establish that they relied on the misrepresentations that they have alleged, and they also recognize that establishing reliance individually by members of the class would defeat the requirement of Rule 23 that common questions of law or fact predominate over questions affecting only individual members. See Fed.R.Civ.P. 23(b)(3). To satisfy the predominance requirement the Plaintiffs invoke the presumption from the Supreme Court's decision in Basic, 485 U.S. at 245-47, 108 S.Ct. 978, that purchasers of securities relied on price in an efficient market. The fraud-on-the-market doctrine, as described by the Supreme Court in Basic [Inc.] v. Levinson, creates a rebuttable presumption that (1) misrepresentations by an issuer affect the price of securities traded in the open market, and (2) investors rely on the market price of securities as an accurate measure of their intrinsic value. Hevesi v. Citigroup Inc., 366 F.3d 70, 77 (2d Cir. 2004). Applying the lenient some showing standard, which we have now discarded, the District Court in the pending case ruled that the Plaintiffs had sufficiently shown the existence of an efficient market to invoke the Basic presumption. IPO (Dist.Ct.), 227 F.R.D. at 107. However, the Plaintiffs' own allegations and evidence demonstrate that an efficient market cannot be established in this case under the proper standards set forth in this opinion. 78 In the first place, the market for IPO shares is not efficient. As the late Judge Timbers of our Court has said, sitting with the Sixth Circuit, [A] primary market for newly issued [securities] is not efficient or developed under any definition of these terms. Freeman v. Laventhol & Horwath, 915 F.2d 193, 199 (6th Cir.1990) (internal quotation marks omitted); accord Berwecky v. Bear, Stearns & Co., 197 F.R.D. 65, 68 n. 5 (S.D.N.Y.2000) (The fraud-on-the-market presumption can not logically apply when plaintiffs allege fraud in connection with an IPO, because in an IPO there is no well-developed market in offered securities.). As just one example of why an efficient market, necessary for the Basic presumption to apply, cannot be established with an IPO, we note that during the 25-day quiet period, analysts cannot report concerning securities in an IPO, see 17 C.F.R. §§ 230.174(d), 242.101(b)(1), thereby precluding the contemporaneous significant number of reports by securities analysts that are a characteristic of an efficient market. See Freeman, 915 F.2d at 199. 79 Moreover, the Plaintiffs' own allegations as to how slow the market was to correct the alleged price inflation despite what they also allege was widespread knowledge of the scheme indicate the very antithesis of an efficient market. Indeed, the Plaintiffs claim on appeal, in an effort to support their theory of loss causation, that whatever artificially inflated effects on share prices were allegedly caused by the Defendants' conduct continued even past the December 6, 2000, end date of the class period. See Brief for Appellees at 81. It is also doubtful whether the Basic presumption can be extended, beyond its original context, to tie-in trading, underwriter compensation, and analysts' reports. See West v. Prudential Securities, Inc., 282 F.3d 935, 938 (7th Cir.2002). 80 Without the Basic presumption, individual questions of reliance would predominate over common questions. 81 Knowledge. There is no dispute that a section 10(b) claimant must allege and prove that the claimant traded in ignorance of the fact that the price was affected by the alleged manipulation. Gurary v. Winehouse, 190 F.3d 37, 45 (2d Cir. 1999). The Plaintiffs must show lack of knowledge to recover on their section 11 claims as well. DeMaria v. Andersen, 318 F.3d 170, 175 (2d Cir.2003) ([Section] 11 provides a cause of action for `any person acquiring' a security issued pursuant to a materially false registration statement unless the purchaser knew about the false statement at the time of acquisition.). The Plaintiffs' allegations, evidence, and discovery responses demonstrate that the predominance requirement is defeated because common questions of knowledge do not predominate over individual questions. The claim that lack of knowledge is common to the class is thoroughly undermined by the Plaintiffs' own allegations as to how widespread was knowledge of the alleged scheme. Obviously, the initial IPO allocants, who were required to purchase in the aftermarket, were fully aware of the obligation that is alleged to have artificially inflated share prices. Those receiving or seeking allocations number in the thousands. 13 With respect to one IPO alone (Engage Technologies, Inc.), 540 institutions and 1,850 others received allocations. And there were more than 900 IPOs allegedly manipulated by aftermarket purchase requirements. Equally obviously, that, in response more than 11,000 induced to enter the requirements would have been known not just to the entities receiving allocations, but also to many thousands of people employed by the institutional investors. In addition, two cable television networks, MSNBC and CNBC, reported on the aftermarket purchase requirements in 1999, and in 2000 the practice was the subject of an SEC Staff Legal Bulletin and a report in Barron's discussing the bulletin. The Plaintiffs themselves refer to the industry-wide understanding that those who agreed to purchase in the aftermarket received allocations. See Master Allegations ¶¶ 30, 31. 82 The District Court sought to minimize the extent of individual questions of knowledge by redefining the proposed class to exclude those investors who exhibit the hallmarks of full participation in the alleged scheme. 227 F.R.D. at 103 (emphasis added). However, that exclusion leaves within the class those who participated in part and those who were required to remain ready to purchase in the aftermarket if the underwriters so desired, Master Allegations ¶ 15, all of whom knew of the alleged scheme. Moreover, the exclusion of full participants from the class does nothing to lessen the broad extent of knowledge of the scheme throughout the community of market participants and watchers, and it is this widespread knowledge that would precipitate individual inquiries as to the knowledge of each member of the class, even as redefined. 14 83 Payment of undisclosed compensation. Yet a further example of an aspect of this litigation bristling with individual questions is ascertainment of which putative class members have paid any undisclosed compensation to the allocating underwriter(s), IPO (Dist.Ct.), 227 F.R.D. at 102, a circumstance that, along with others, would exclude them from the class. Passing the somewhat paradoxical point as to how someone is to determine whether compensation that was undisclosed was paid, we note that individual issues arise even as to those aspects of compensation that a Plaintiff might be able to determine were within the Plaintiffs' definition of Undisclosed Compensation. As described in the Master Allegations, such compensation comprises: 84 (a) paying inflated brokerage commissions; (b) entering into transactions in otherwise unrelated securities for the primary purpose of generating commissions; and/or (c) purchasing equity offerings underwritten by the Underwriter Defendants, including, but not limited to, secondary (or add-on) offerings that would not be purchased but for the Underwriter Defendants' unlawful scheme. 85 Id. at 100 (quoting Master Allegations ¶ 17) (emphases added). 86 Each category of undisclosed compensation would require individualized determinations. Whether a brokerage commission was inflated would depend on a comparison between what brokerage the putative class member was charged and the customary commission for trades of a similar nature. Whether shares unrelated to the IPO were purchased for the purpose of generating commissions and whether shares purchased in the aftermarket would not have been bought but for the allegedly unlawful scheme would require inquiry into the subjective intent of the purchaser. A purchaser would not have paid undisclosed compensation if shares were bought entirely at the behest of the purchaser and because of an independent interest in buying shares of a particular company. Obviously, ascertaining each purchaser's intent would require an individualized determination. See Simer v. Rios, 661 F.2d 655, 669 (7th Cir.1981) (class difficult to ascertain where membership in the class depends on each individual's state of mind); Dunnigan v. Metropolitan Life Insurance Co., 214 F.R.D. 125, 135 (S.D.N.Y.2003) (Where membership in the class requires a subjective determination, the class is not identifiable.). Although it has been stated that class members must be ascertainable at some point in the case, but not necessarily prior to class certification, see In re Methyl Tertiary Butyl Ether (MTBE) Products Liability Litigation, 209 F.R.D. 323, 337 (S.D.N.Y.2002) (internal quotation marks omitted), we point out the need for numerous individualized determinations of class membership in order to provide further support for our basic conclusion that individual questions will permeate this litigation. Although ascertainability of the class is an issue distinct from the predominance requirement for a(b)(3) class, the problems we have identified on this topic further indicate the obstacles to proceeding with the focus cases as class actions.