Nine Years of Practice and Procedure Under the Private Securities ...

NINE YEARS OF PRACTICE AND PROCEDURE UNDER THEPRIVATE SECURITIES LITIGATION REFORM ACT OF 1995CURRENT DEVELOPMENTS IN FEDERAL SECURITIES LAWRitz-Carlton HotelBoston, MassachusettsJuly 8, 2005Kevin P. RoddyWilentz, Goldman & Spitzer, P.A.90 Woodbridge Center Drive, Suite 900Woodbridge, New Jersey 07095Telephone: (732) 636-8000 or (732) 855-6402E-mail: kroddy@wilentz.com

B. Specific Allegations Of Accounting Fraud Supporting Strong InferenceOf Scienter Under The PSLRA......................................................................601. Earnings/Revenue Misrepresentations .......................................................602. Violations of GAAP Can Form Part Of The Basis SupportingStrong Inference Of Scienter ...................................................................623. Improper Revenue Recognition Of A Significant Portion OfRevenues ..................................................................................................63C. The Standard Of "Recklessness" For Accountant's Liability .............................631. Plaintiff's Burden........................................................................................632. Ignoring "Red Flags" Of Accounting Fraud ..............................................64VIII. PRIMARY AND SECONDARY LIABILITY........................................................65A. Primary Liability.................................................................................................65B. Secondary Actor's Conduct May Constitute Primary Liability ..........................66C. Fraudulent Scheme Liability...............................................................................67D. "Group Published" Doctrine...............................................................................67IX. THE PSLRA’S “SAFE HARBOR” FOR "FORWARD- LOOKING"STATEMENTS AND THE "BESPEAKS CAUTION" DOCTRINE .................69A. When “Forward-Looking” Statements Are Protected ........................................69B. When Forward-Looking Statements Are Not Protected.....................................72C. The "Bespeaks Caution" Doctrine: When Cautionary Language ProtectsMisleading Statements ...................................................................................73D. Cases In Which Cautionary Disclosures Were Insufficient To “BespeakCaution” .........................................................................................................74E. Boilerplate Warnings Are Insufficient To “Bespeak Caution”...........................74F. The "Bespeaks Caution" Doctrine Is Not Applicable WhenMisrepresentations Or Omissions Concern Historical Hard Or CurrentFacts ..........................75X. LIABILITY OF SECURITIES ISSUERS AND THEIR OFFICERS AND DIRECTORS FORSECURITIES ANALYSTS' STATEMENTS ......................................................................75A. The Fraud-On-The-Market Doctrine ..................................................................76B. Causation In Securities Fraud Cases...................................................................77C. The Important Role Played By Securities Analysts............................................80iii

D. Liability Of Securities Issuers For Statements And ProjectionsDisseminated By Securities Analysts.............................................................811. Introduction ................................................................................................81E. The "Entanglement" Theory ...............................................................................83F. The "Conduit" Theory.........................................................................................86G. Securities Issuer's Review, Correction And/Or Dissemination OfSecurities Analysts' Reports...........................................................................90H. "No Comment" Policies......................................................................................92I. "Adoption" Or "Ratification" Of Analysts' Reports.............................................93J. Public Company Practices In Dealing With Securities Analysts.........................94iv

NINE YEARS OF PRACTICE AND PROCEDURE UNDERTHE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995Kevin P. RoddyWilentz, Goldman & Spitzer, P.A.Woodbridge, New JerseyBiographical InformationMr. Roddy is a member of the California, New York and Virginia bars. (His applicationto the New Jersey bar is pending.) He graduated cum laude from The Cranbrook School inBloomfield Hills, Michigan, in 1973. He received his B.A. with Honors from the University ofNorth Carolina in 1977, and his J.D. from the University of North Carolina School of Law in1980. From February 1990 to April 2000, Mr. Roddy was the managing partner of the LosAngeles office of Milberg Weiss Bershad Hynes & Lerach, LLP. From April 2000 to December2004, Mr. Roddy was the managing partner of the Los Angeles office of Hagens Berman LLP.He is now co-chair of the Class Action Department of Wilentz, Goldman & Spitzer, P.A., basedin Woodbridge, New Jersey.During the past 20 years, he has served as lead counsel for plaintiffs in numeroussecurities fraud class actions and shareholder derivative actions litigated in federal and statecourts in California and elsewhere, including cases brought under the Private SecuritiesLitigation Reform Act of 1995 and the Securities Litigation Uniform Standards Act of 1998.Among the notable shareholder and consumer class actions and/or derivative actions in whichMr. Roddy has served as lead (or co-lead counsel) for plaintiffs are ACC/Lincoln SavingsSecurities Litigation ($260 million in settlements and $3.2 billion jury verdict); McDonnellDouglas ERISA Litigation ($450 million settlement); Prudential Securities (Polaris LimitedPartnerships) Securities Litigation ($110 million settlement); Western Union Money TransferLitigation ($65 million); Pacific Enterprises Securities Litigation ($45 million settlement);Stratosphere/Grand Casinos Securities Litigation ($18 million settlement); RiaTelecommunications Money Transfer Litigation ($18 million settlement); Rexall CellaseneDietary Supplement Litigation ($16 million); Bancomer Money Transfer Litigation ($15 millionsettlement); McDonald’s ($12.5 million settlement).Mr. Roddy is President of the National Association of Shareholder and ConsumerAttorneys (NASCAT) and, since 1995, he has served as Chairman of the NASCAT AmicusCommittee. He is the author or co-author of numerous articles on securities fraud and civilRICO litigation, including G. Robert Blakey & Kevin P. Roddy, Reflections on Reves v. Ernst &Young: Its Meaning and Impact on Substantive, Accessory, Aiding and Abetting and ConspiracyLiability Under RICO, 33 AMER. CRIM. L. REV. 1345 (1996), which was published as the 25 thAnniversary Special Edition of the AMERICAN CRIMINAL LAW REVIEW, and the award-winningtwo-volume treatise, RICO IN BUSINESS AND COMMERCIAL LITIGATION (Shepard’s/McGraw-Hill, Inc. 1991).Mr. Roddy is a frequent lecturer at continuing legal education programs sponsored by theAmerican Bar Association, the American Law Institute, the Practicing Law Institute, the SECInstitute, the Securities Regulation Institute, and the Los Angeles County Bar Association.1

I. INTRODUCTIONA. The Purposes Of The PSLRAThe Private Securities Litigation Reform Act of 1995 ("PSLRA") was enacted byCongress on December 22, 1995 over President Clinton's veto. Several district courts havestated that the PSLRA was intended "to combat the filing of abusive and meritless lawsuits."Carson v. Merrill Lynch, Pierce, Fenner & Smith, No. 97-5147, 1998 U.S. Dist. LEXIS 6903, at*10, 1998 WL 34076402 (W.D. Ark. Mar. 30, 1998) (citing Conf. Rpt. on Securities LitigationReform, H.R. Rep. No. 369, 104th Cong., 1st Sess. 31 (1995), reprinted in, 1995 U.S. CODECONG. & ADMIN. NEWS 730)); see also In re American Bus. Finan. Svcs., Inc. Secs. Litig., 2004U.S. Dist. LEXIS 10200, at *3, 2004 WL 1221353 (E.D. Pa. June 3, 2004) (“The purpose behindthe PSLRA is to empower investors so that they, not their lawyers, control private securitieslitigation by allowing the Court to ensure the transfer of primary control of private securitieslitigation from lawyers to investors.”) (citations and internal quotation marks omitted); In reMilestone Scientific Sec. Litig., 187 F.R.D. 165, 174 (D.N.J. 1999) ("Congress enacted thePSLRA to remedy perceived abuses in private securities class action litigation.") (citing, interalia, In re Cendant Corp. Sec. Litig., 182 F.R.D. 144, 145 (D.N.J. 1998)). See generally EugeneZelensky, New Bully on the Class Action Block: Analysis of Restrictions on Securities ClassActions Imposed by the Private Securities Litigation Reform Act of 1995, 73 NOTRE DAME L.REV. 1135, 1135-37 (1998) (discussing legislative history).In Novak v. Kasaks, 216 F.3d 300 (2 nd Cir. 2000), the Second Circuit stated that“[l]egislators were apparently motivated in large part by a perceived need to deter strike suitswherein opportunistic private plaintiffs file securities fraud claims of dubious merit in order toextract large settlement recoveries.” Id. at 306 (citing H.R. Conf. Rep. No. 104-369, at 31 (1995)(noting “significant evidence of abuse in private securities lawsuits,” including “the routine filingof lawsuits against issuers of securities and others whenever there is a significant change in anissuer’s stock price, without regard to any underlying culpability of the issuer,” and “the abuse ofthe discovery process to impose costs so burdensome that it is often economical for thevictimized party to settle,” reprinted in 1995 U.S. CODE CONG. & ADMIN. NEWS 730); Sakhraniv. Brightpoint, Inc., 2001 U.S. Dist. LEXIS 5023, at *9, Fed. Sec. L. Rep. (CCH) 91,422 (S.D.Iowa Mar. 29, 2001). See generally Craig C. Martin & Matthew H. Metcalf, The FiduciaryDuties of Institutional Investors in Securities Litigation, 56 BUS. LAW. 1381, 1382 (2001)(“Martin & Metcalf, Institutional Investors”) (outlining PSLRA’s stated purposes and extensivelegislative history).During 1996-2004, over 1,900 securities fraud cases were filed in federal district courts.The passage of nine and one-half years and this litigation experience allows one to draw someconclusions about the effectiveness of the PSLRA and the so-called “reforms” of securities fraudclass action litigation that it heralded:First, there has been no material decrease in the volume of securities fraud class actionsfiled in federal court since the passage of the PSLRA. From 1991 through 1995, the averagenumber of cases filed was 191 cases per year. In 1996, a total of 127 cases were filed. In 1997,a total of 193 cases were filed. In 1998, a total of 269 cases were filed. In 1999, a total of 241cases were filed. In 2000, a total of 223 cases were filed. In 2001, there were 195 federal2

securities fraud class actions filed. (The 195 cases do not include an additional 303 securitiesclass actions filed in 2001 alleging fraud in the IPO underwriting process with no additionalallegations.) In 2002, there were 239 securities fraud cases filed. (The 239 cases do not includean additional 40 “analyst cases.”). In 2003, 210 cases were filed. (The 210 cases do not includean additional 14 “analyst cases.”). During 2004, 212 cases were filed. A recent commentaryexplicates the trends in securities case filings:The pace of filings dropped in 2003 for the second year in a row, bringingthem back in line with the long-term trend. Federal courts received 224 filings in2003, down 55 percent from the all-time high of 503 in 2001 and 20 percent from279 in 2002. However, over these three years, filing rates were affected by theladdering and analyst cases, both of which were likely one-time phenomena.There were only 195 standard filings in 2001, excluding 303 laddering cases andfive analyst cases. The laddering cases allege that newly-public companies andtheir underwriters engaged in unfair initial public offering (IPO) allocationpractices and manipulation of the early aftermarket; the analyst cases alleged thatanalyst recommendations were influenced by the investment banks’ interest inwinning business from the recommended companies. The analyst casesaccounted for another 40 filings in 2002 and 14 in 2003. If the laddering andanalyst cases are excluded from each year’s filings, the remaining 210 filings in2003 are in line with the average of 212 filings each year since the passage of the[PSLRA] in December 1995.Elaine Buckberg, Todd Foster & Stephanie Plancich, Recent Trends in Securities Class ActionLitigation: 2003 Update, 5 CLASS ACTION REPORT 304 (2004). These commentators also statethat “[o]ver a five-year period, . . . if the 2003 filing rate continues, the average publiccorporation will face a 9 percent probability that it will face at least one securities class actionlawsuit.” Id.Second, since passage of the PSLRA, a larger percentage of litigation activity centers onallegations of accounting fraud, with revenue recognition issues emerging as particularlysignificant causes of securities fraud litigation.Third, the dollar magnitude of settlement has increased noticeably, particularly in thesettlement of “mega-cases.” There have been ten post-PSLRA settlements worth $300 million ormore, and three of the top ten securities class action settlements occurred during 2004:3

TABLE ONETHE TEN LARGEST SECURITIES LITIGATION SETTLEMENTS (1996-2004)SettlementRanking Company YearSettlementValue ($MM)1 Cendant Corp. 2000 $ 3,5282 WorldCom, Inc. 2004 $ 2,5753 Lucent Technologies, Inc. 2003 $ 5174 BankAmerica Corp./NationsBank 2002 $ 4905 Raytheon Co. 2004 $ 4606 Waste Management 2002 $ 4577 RiteAid Corp. 2003 $ 3208 Bristol-Myers Squibb Co. 2004 $ 3009 DaimlerChrysler AG 2003 $ 30010 Oxford Health Plans, Inc. 2003 $ 300Even excluding the $3.52 billion settlement of the Cendant litigation, the averagesettlement amount for 2002 of $23.5 million, $20.3 million for 2003, and $27.1 for 2004 – athree-year average of $23.6 million – significantly exceed the average settlement amount of$13.5 million for the preceding six-year period (1996-2001). The average settlement amountsare listed by year as follows:4

the mediation settlement amount where an institutional investor was not involved as a leadplaintiff was 6.0 million. (The corresponding amounts for cases settled during 2001 were $9.0million and $4.5 million, respectively.) However, institutional investors have tended toparticipate in larger securities fraud cases and, consistent with this fact, “they have been involvedwith cases that have settled for a lower percentage of estimated damages, relative to cases thathave not involved institutions in a lead plaintiff role.” Cornerstone Research, Post-Reform ActSecurities Case Settlements, at 7.C. The PSLRA’s Effective DateThe PSLRA, Pub. L. No. 104-67, 109 Stat. 737 (1995), which amended the SecuritiesAct, 15 U.S.C. §§ 77a-77bbbb, and the Exchange Act, 15 U.S.C. §§ 78a-78lll, applies to privatesecurities class actions brought pursuant to the Federal Rules of Civil Procedure. See 15 U.S.C.§ 77z-1(a)(1); Lax v. First Merchants Accep. Corp., No. 97-C-2715, 1997 U.S. Dist. LEXIS11866, at *5, 1997 WL 461036 (N.D. Ill. Aug. 6, 1997). The statutory text makes clear that itdoes not apply to shareholder derivative actions brought under Fed. R. Civ. P. 23.1. The PSLRAamended the Exchange Act by adding Section 21D, which is codified at 15 U.S.C. § 78u-4.Section 21D(a)(i), 15 U.S.C. § 78u-4(a)(1), entitled "Private class actions," states that theprovisions of that subsection "shall apply in each private action arising under this chapter that isbrought as a plaintiff class action pursuant to the Federal Rules of Civil Procedure." See SimonDeBartolo Group, 985 F. Supp. at 430 (Congress intended to limit application of § 21D(a) ofPSLRA to securities fraud class actions).The PSLRA does not apply to actions commenced before and pending on its effectivedate: December 22, 1995. See Pub. L. No. 104-67, 109 Stat. 737, 758, § 108; compare Stevensv. O'Brien Environ. Energy, Inc., Civil Action No. 94-4577, 1999 U.S. Dist. LEXIS 6660, at *3n.1, 1999 WL 310550, Fed. Sec. L. Rep. (CCH) 90,475 (E.D. Pa. May 10, 1999) (PSLRA"do[es] not apply to this action because it was commenced before the Reform Act becameeffective") (citation omitted); Lyons v. Scitex Corp., 987 F. Supp. 271, 273 n.3 (S.D.N.Y. 1997)(PSLRA did not apply to securities class action "commenced on December 14, 1995") withSimon DeBartolo Group, L.P. v. Richard E. Jacobs Group, Inc., 985 F. Supp. 427, 429(S.D.N.Y. 1997) ("The PSLRA applies here because SDG's complaint, which asserts claimsunder the Exchange Act, was filed on September 5, 1997, and related to events which occurredin 1997."), aff'd in part, rev'd in part on other grounds, 186 F.3d 157 (2d Cir. 1999); In reWestinghouse Sec. Litig., 982 F. Supp. 1031, 1036 (W.D. Pa. 1997) (same: because dismissedsecurities class action complaint was filed after enactment of PSLRA, district court was requiredto make findings regarding whether plaintiff has complied with requirements of Rule 11(b)); seealso Wilson Land Corp. v. Smith Barney, Inc., 1999 U.S. Dist. LEXIS 12879, at *46, 1999 WL1939270 (E.D.N.C. May 17, 1999) (PSLRA applied to securities fraud case filed in 1997).Obviously, given the passage of six years since the PSLRA’s passage, this issue is of less interestthan it once was.What if the securities class action was filed after December 22, 1995, but concernsalleged wrongdoing committed by defendants before the PSLRA's effective date? In one case,In re Stratosphere Corp. Sec. Litig., 1 F. Supp. 2d 1096 (D. Nev. 1998), plaintiffs' securitiesfraud claims arose out of a secondary stock offering commenced on December 19, 1995, and thealleged class period continued until July 1996, thereby "straddling" the effective date of the8

PSLRA (December 22, 1995). On motion to dismiss, Judge Pro held that the PSLRA could beapplied retroactively to encompass defendants' alleged wrongdoing in connection with thatsecurities offering, reasoning that retroactive application would not result in the impairment ofany rights because intentional material misstatements of the type alleged by plaintiffs wereactionable before and after enactment of the PSLRA. Id. at 1104-06.D. Elimination Of So-Called "Professional Plaintiffs"One supposed problem confronting private securities litigation when the PSLRA wasenacted was the so-called "professional plaintiff," defined by one court as "persons who purchasea nominal number of securities and then bring [complaints alleging] violations of the federalsecurities laws in the hope that defendants will quickly settle to avoid the expense of litigation."Carson, 1998 U.S. Dist. LEXIS 6903, at *11 (citing 1995 U.S. CODE CONG. & ADMIN. NEWS731-32); see also Gluck v. CellStar Corp., 976 F. Supp. 542, 543-44 (N.D. Tex. 1997).In this regard, the PSLRA clearly changed the rules of the game, requiring plaintiffs whobring securities class actions to comply with certain procedural requirements and limiting thenumber of times that a plaintiff may serve as Lead Plaintiff. See 15 U.S.C. §§ 77z-1(a) and 78u-4(a); see also Aronson v. McKesson HBOC, Inc., 79 F. Supp. 2d 1146, 1156 (N.D. Cal. 1999)(district court disqualifies institutional investor - Florida State Board of Administration - as leadplaintiff because it was already serving as lead plaintiff in six other securities fraud classactions). It is unclear, however, whether these statutory limitations was meant to apply toinstitutional investors. See, e.g., Smith v. Suprema Specialities, Inc., 206 F. Supp. 2d 627 (D.N.J.2002) (appointed a pension fund as lead plaintiff, notwithstanding its recent service as leadplaintiff in other actions; the “professional plaintiff” qualification of the PSLRA was not anabsolute bar to its selection, and should not be applied to institutional investors); see alsoMeeuwenberg v. Best Buy Co., 2004 U.S. Dist. LEXIS 7686, at *7 (D. Minn. Apr. 29, 2004)(“The majority of courts have held institutional investors exempt from the statutory professionalplaintiff restriction.”) (citations omitted); Tracinda v. DaimlerChrysler AG, 216 F.R.D. 291, 299(D. Del. 2003) (same); Martin & Metcalf, Institutional Investors, 56 BUS. LAW. at 1388-89(collecting cases: “Although some district courts have held that this requirement does not applyto institutional investors, other courts have reached the opposite conclusion.”) (footnotes andcitations omitted).E. Small vs. Institutional ShareholdersJudge Coar has asserted: "'The manifest intent of the [PSLRA] is determining the plaintiffmost capable of pursuing the action and representing the interests of the class.'" Lax, 1997 U.S.Dist. LEXIS 11866, at *5 (quoting Fischler v. Amsouth Bancorp., 1997 U.S. Dist. LEXIS 2875,at *2, 1997 WL 118429 (M.D. Fla. Feb. 6, 1997)).Judge Black has stated that the PSLRA "appears to reflect a congressional intent totransfer power from counsel who win the race to the courthouse to those shareholders whopossess a sufficient financial interest in the outcome to maintain some supervisory responsibilityover both the litigation and their counsel." In re Horizon/CMS Healthcare Corp. Sec. Litig., 3 F.Supp. 2d 1208, 1212 (D.N.M. 1998) (citing Michael Y. Scudder, Comment, The Implications of9

Market-Based Damages Caps in Securities Class Actions, 92 NW. U. L. REV. 435, 437 (1997),and Note, Investor Empowerment Strategies in the Congressional Reform of Securities ClassActions, 109 HARV. L. REV. 2056, 2058 (1996)). Once again citing these law review articles,Judge Black stated that "Congress appears to have harbored the hope that substantial institutionalinvestors ... would advance their resources and expertise to fulfill this responsibility."Horizon/CMS, 3 F. Supp. 2d at 1212 n.5 (citations omitted). See also Pitt, Promises Made, 33SAN DIEGO L. REV. at 882-83 ("Part of Congress' intent in adopting the [PSLRA] was to ...attempt[] to encourage, but not require, institutional shareholders to supervise this litigation, andto select their own counsel whom these institutions would monitor and supervise."); Fisch, ClassAction Reform, 39 ARIZ. L. REV. at 537-41 (same); Martin & Metcalf, Institutional Investors, 56BUS. LAW. at 1383 (same).Given the passage of eight and one-half years since the enactment of the PSLRA and thefiling of approximately 1,500 securities class actions during that period, it could be asserted thatthis supposed salutary purpose of the statute has largely gone unfulfilled; however, ProfessorWeiss stated in 1997:It is far too early to draw many definitive - or even tentative-conclusions. Indeed,given the pace at which securities class actions typically had proceeded, and theslower pace at which they seem to be proceeding under the [PSLRA], it probablywill be five years or more before we have enough data to reach more than verytentative conclusions as to how the lead plaintiff provisions have affected theconduct of securities class actions.Elliott J. Weiss, The Impact to Date of the Lead Plaintiff Provisions of the Private SecuritiesLitigation Reform Act, 39 ARIZ. L. REV. 561, 563 (1997) ("Weiss, The Impact to Date").In his 1997 law review article, Professor Weiss could point to only one reported case inwhich a "major institutional investor has moved successfully to be appointed lead plaintiff andhas appointed new lead counsel," id. at 565 (referring to Judge Buchmeyer's 1997 decision in theCellStar litigation), and he acknowledged that Professor Jill Fisch has identified a number offactors which may well preclude institutional investor participation in securities class actions.Id. at 563 n.16; see also Fisch, Class Action Reform, 39 ARIZ. L. REV. at 541-50; Pitt, PromisesMade, 33 SAN DIEGO L. REV. at 882-90 (discussing institutional investors' motivations vis-a-visparticipating in securities litigation). As two securities practitioners have stated:The number of institutional investors who have sought to participate as leadplaintiffs in securities class actions has still remained relatively few. In recentcases where institutional investors have undertaken to participate, however, courtshave refrained from automatically conferring lead plaintiff status upon them, insome cases ordering that the role be shared instead. Such judicial resistance likelywill only continue the trend of institutional investors "shying away" frompursuing the role of lead plaintiff in class actions, thus undermining one of theimportant purposes of the PSLRA.Saparoff & Sisitsky, Two Years Later, SECURITIES NEWS at 11. More recently, however, wehave seen substantial settlements in securities fraud class actions in which institutional investors10

served as lead plaintiffs. See Part I.A, supra; Max W. Berger et al., Securities Law for the NextMillennium: A Forward-Looking Statement: Institutional Investors as Lead Plaintiffs: Is Therea New and Changing Landscape?, 75 ST. JOHN’S L. REV. 31 (2001).II.THE PSLRA’S DISCLOSURE REQUIREMENTSA. Plaintiff’s Sworn CertificationThe PSLRA imposes strict disclosure requirements upon plaintiffs in securities fraudactions, requiring that a plaintiff "seeking to serve as a representative party on behalf of a classshall provide a sworn certification" with the complaint. 15 U.S.C. §§ 77z-1(a)(2)(A) and 78u-4(a)(2)(A). The sworn statement must certify that the plaintiff (1) reviewed and authorized thefiling of the complaint; (2) did not purchase the securities at the direction of counsel or in orderto participate in a lawsuit; and (3) is willing to serve as the lead plaintiff on behalf of the class.Id. In addition, the statement must also identify any of the plaintiff's transactions in the securitythat is at issue. Id.; see Carson, 1998 U.S. Dist. LEXIS 6903, at *11-12 (explicating disclosuresrequired in securities class action complaints under PSLRA); Gluck, 976 F. Supp. at 544 (same).In Blaich v. Employee Solutions, Inc., Fed. Sec. L. Rep. (CCH) 90,403 (D. Ariz. 1997),the court held that institutional investors seeking to become lead plaintiffs after the filing of aninitial complaint need not comply with the certification requirement. However, one commentarystates that “[i]n light of the important information provided by this certification, including astatement of the potential lead plaintiff’s interests in the action, it would seem prudent for thecourts to require all plaintiffs, including institutional investors, to file such certifications.”Martin & Metcalf, Institutional Investors, 56 BUS. LAW. at 1384-85.The PSLRA's certification requirement has not impeded the filing or effectiveprosecution of securities class actions. Moreover, a plaintiff's filing of a sworn certificationobviates the need for expensive and time-consuming "class certification discovery" thatdefendants' counsel often seek to engage in once plaintiffs have filed a motion for classcertification under Fed. R. Civ. P. 23. In Epstein v. MCA, 54 F.3d 1422, 1423 (9 th Cir. 1995), apre-PSLRA securities tender offer case, the Ninth Circuit reversed a trial court's order thatplaintiff investors and their counsel be held in contempt for refusal to comply with irrelevantdiscovery requests. Defendants had sought discovery of what the appellate court described as"detailed information" about whether plaintiffs owned MCA shares, how they invested theirtender offer proceeds, whether their investment history made it likely they would have elected toreceive preferred stock instead of cash and whether they would pay taxes on cash proceeds theyreceived. As the Ninth Circuit stated: "The first piece of information Matsushita sought toobtain through discovery – whether plaintiffs owned MCA stock – is without doubt relevant tothe subject matter of this litigation. The other information Matsushita sought to discoverhowever, is not."). See also Schlagal v. Learning Tree Int'l, No. CV 98-6384 ABC (Ex), 1999U.S. Dist. LEXIS 2157, at *14-18, 1999 WL 672306, Fed. Sec. L. Rep. (CCH) 90,435 (C.D.Cal. Feb. 25, 1999) (granting plaintiffs' class certification motion and denying defendants'request to conduct discovery of proposed lead plaintiffs and class representatives; plaintiffssuccessfully argued that the lead plaintiffs’ sworn certifications provided all the information thatdefendants needed in order to challenge plaintiffs’ adequacy); compare In re DIGI Int'l, Inc. Sec.11

Litig., Master File No. 97-5, Memorandum Order (D. Minn. Feb. 24, 2000) (refusing to permitdefendants to depose co-lead plaintiffs who had not been identified as proposed classrepresentatives) with In re Grand Casinos, Inc. Sec. Litig., 181 F.R.D. 615, 619-21 (D. Minn.1998) (recognizing need for defendant, in securities fraud litigation, to be able to depose namedplaintiffs so as to be able to rebut presumption of reliance provided by fraud-on-the-markettheory).B. Notice Requirements1. Statutory TextSection 21D(a)(3) sets forth procedures for early notice to potential class members of thefiling of a securities class action. The relevant statutory provision states:Not later than 20 days after the date on which the complaint is filed, the plaintiffor plaintiffs shall cause to be published, in a widely circulated national businessorientedpublication or wire service, a notice advising members of the purportedplaintiff class:(i) of the pendency of the action, the claims asserted therein, and thepurported class period; and(ii) that, not later than 60 days after the date on which the notice ispublished, any member of the purported class may move the court to serve as leadplaintiff of the purported class.15 U.S.C. §§ 77z-1(a)(3)(A)(i) and 78u-4(a)(3)(A)(i). See Yousefi v. Lockheed Martin Corp., 70F. Supp. 2d 1061, 1066 (C.D. Cal. 1999) (detailing notice procedures under PSLRA); accordTarica v. McDermott Int’l, Inc., 2000 U.S. Dist. LEXIS 5031, at *7-10, 2000 WL 377817, Fed.Sec. L. Rep. (CCH) 90,946 (E.D. La. Apr. 13, 2000); see also Pitt, Promises Kept, 33 SANDIEGO L. REV. at 883 (discussing notice provision); Weiss, The Impact to Date, 39 ARIZ. L. REV.at 564-65 (same).2. Application Of Notice ProvisionsIf multiple actions are filed on behalf of a class asserting substantially the same claim orclaims arising under either the Securities Act or the Exchange Act, only the plaintiff -- orplaintiffs -- who filed first shall be required to cause notice to be published. See id.; Julia C.Kou, Note, Closing the Loophole in the Private Securities Litigation Reform Act of 1995, 73N.Y.U.L. REV. 253, 265-66 (1998) ("Kou, Closing the Loophole") (explicating notice provisionsof PSLRA).3. Timing And Content Of NoticeUnder these statutory provisions, the named plaintiff in the first filed action must filenotice within twenty (20) days of filing suit in order to inform potential class members of their12

ight to file a motion seeking to be appointed lead plaintiff. See 15 U.S.C. §§ 77z-1(a)(3)(A)(i)and 78u-4(a)(3)(A)(i); Fitzgerald v. CitiGroup, Inc., 2004 U.S. Dist. LEXIS 5066, at *6, 2004WL 613107 (S.D.N.Y. Mar. 26, 2004) (explicating notice procedures); Kou, Closing theLoophole, 73 N.Y.U.L. REV. at 265-66 (same).This notice must identify the claims alleged in the lawsuit and the purported class period,and shall inform potential class members that within sixty (60) days they may move to serve asthe lead plaintiff. See In re USEC Secs. Litig., 168 F. Supp. 2d 560 (D. Md. 2001) (notice heldsufficient where it described the shortcomings of the prospectus, gave date on which allegedmisstatements occurred, and described loss causation; notice also included case caption, name ofjudge to whom case had been assigned, and court’s address); Lax, 1997 U.S. Dist. LEXIS 11866,at *10-16 (explicating notice requirements of PSLRA); accord In re Aetna, Inc. Secs. Litig.,1999 U.S. Dist. LEXIS 12546, at *2-3, 1999 WL 624514 (E.D. Pa. Aug. 6, 1999); see also Kou,Closing the Loophole, 71 N.Y.U.L. REV. at 265-66. Judge Waters has stated: "The noticerequirement was included in the PSLRA to provide a method for determining the most adequateplaintiff." Carson, 1998 U.S. Dist. LEXIS 6903, at *12 (citing 1995 U.S. CODE CONG. &ADMIN. NEWS 732).In Haung v. Acterna Corp., 220 F.R.D. 255 (D. Md. 2004), the notice was published inThe New York Times ten (10) days after the securities fraud lawsuit was commenced. Thatnotice stated in full:Notice is hereby given that a class action lawsuit was filed in the United StatesDistrict Court for the District of Maryland on behalf of all purchasers of ActernaCorporation ("Acterna" or the "company") (NASDAQ:ACTR) from August 1,2001 through October 31, 2002, inclusive (the "Class Period"). The complaintalleges that Acterna, in an effort to grow its communications testing business,began to acquire market competitors and as a result, assumed a tremendousamount of good will. The Company repeatedly characterized its goodwill asunimpaired and continuously portrayed itself as having a future in thecommunications test sector, despite experiencing a record decrease in its business.Eventually, the Company revealed that it would have to take a charge of $ 388million for impaired goodwill. By this time, the stock price had fallen to $ .30 pershare, down from a Class Period high of $ 6.03 per share. If you are a member ofthe class described above, you may, not later that (sic) June 26, 2003, move theCourt to serve as lead plaintiff of the class, if you so choose. In order to serve aslead plaintiff, however, you must meet certain legal requirements. CONTACT:Schiffrin & Barroway, LLP.Id. at 257. Judge Chasanow, however, held that the PSLRA’s notice requirements had not beenmet, and the court held that “plaintiff must re-publish, in an appropriate publication, a moreinformative notice and send such notice directly to the largest financial and institutional investorsas identified by defendants.” Id. at 259. As the court analyzed the statutory notice requirements:Although the PSLRA gives little indication of how much detail is required in thenotice, it is understood to require enough notice to inform the reader of thegeneral nature of the claim and to provide an avenue for further inquiry. The13

notice in this case provides only the broadest indication that the company'simpaired goodwill is based on a failure to disclose. It does not inform the readerthat the legal basis of the claim is an alleged violation of the Securities ExchangeAct. Even more disturbing, the notice does not provide any information uponwhich a reader may rely to conduct an independent inquiry into the matter. Itdoes not provide a case name or docket number, the name of the plaintiffs or ofthe judge to whom the case was assigned, or the address of the court. As it is, thenotice provided appears more likely intended to "accumulate members of the classrather than to inform." The only way for the reader, or a member of the purportedclass, to learn more about the case or the legal requirements of a lead plaintiff isto contact counsel directly or through the establish hotline number or email listedat the bottom of the notice. The notice reserves for the attorney the ability toscreen lead plaintiffs and discourage greater participation by activist investors.This is precisely what the PSLRA seeks to avoid.Additionally, the PSLRA requires publication in a "widely-circulated nationalbusiness-oriented publication or wire service." Although it does not clearlydefine this phrase, the publication requirement expresses Congress' intent thatpublication be "reasonably calculated to reach, at the least, sophisticated andinstitutional investors." The Movants argue that The New York Times is anacceptable publication, but the authority they provide as support does not evenaddress The Times at all. Based on the showing made thus far, the court is notsatisfied that The New York Times meets the standards of the PSLRA. For theforegoing reasons, movants have failed to satisfy the notice requirements of thePSLRA.Id. at 257-58 (citations omitted).4. Publication Of NoticeUnder the PSLRA, notice must be published in a "widely circulated national businesspublication or wire service." See Kou, Closing the Loophole, 73 N.Y.U.L. REV. at 265-66. InLax, 1997 U.S. Dist. LEXIS 11866, at *15, Judge Coar rejected the contention that publication ofnotice in Investor's Business Daily failed to satisfy the statutory requirement:The PSLRA does not define "widely circulated." Thus, the court must make itsown interpretation as to what the term means. In this case, the court finds that,while Investor's Business Daily might not have as large a circulation as the WallStreet Journal, it is nevertheless widely circulated and, more importantly,apparently read by sophisticated investors. The likelihood of a First Merchants'investor actually seeing a notice in the Investor's Business Daily "is arguably asgreat as finding such information by skimming the back pages of the Wall StreetJournal."Id. (quoting Greebel v. FTP Software, 939 F. Supp. 57, 63 (D. Mass. 1996)). Accord In re NiceSys. Sec. Litig., 188 F.R.D. 206, 216 & n.8 (D.N.J. 1999); see also D'Hondt v. Digi Int'l, 199714

U.S. Dist. LEXIS 17700, at *5, 1997 WL 405668 (D. Minn. Apr. 2, 1997) ("Defendants do notchallenge the sufficiency of the Notice provided by means of Business Wire and, in fact, at leastone Court has held that this wire service adequately seeks to provide notice to potential classmembers, including institutional investors, of pending class claims that are subject to theprovisions of the [PSLRA]") (citing Greebel, 939 F. Supp. at 64); Tarica, 2000 U.S. Dist. LEXIS5031, at *9 (“Courts have repeatedly recognized Business Wire as a business-oriented wireservice within the meaning of the PSLRA, and as an acceptable means of publishing notice underthe statute) (citation omitted); Yousefi, 70 F. Supp. 2d at 1067 ("Since the passage of the[PSLRA], district courts, including this Court, have repeatedly recognized that the Business Wireas a 'widely circulated national business-oriented ... wire service,' as required by the [PSLRA].")(citations omitted); cf. In re Party City Sec. Litig., 189 F.R.D. 91, 105 n.10 (D.N.J. 1999) ("ThePR Newswire appears to be a business-oriented wire service within the meaning of the PSLRA.")(citations omitted).5. Effect Of Failure To Give NoticeIn Carson, 1998 U.S. Dist. LEXIS 6903, where plaintiff brought a purported class actionon behalf of a class of persons who purchased warrants from a Merrill Lynch offering, plaintifffailed to comply with the disclosure and notice provisions of the PSLRA. Id. at *10. Grantingplaintiff's motion to amend his complaint, Judge Waters held that the failure to comply with theprovisions of the PSLRA is not fatal to the maintenance of a securities class action:The PSLRA does not direct a court to dismiss a complaint when a plaintiff fails tocomply with either the certification requirement or the notice provisions.... [I]fCongress had wanted the courts to dismiss a complaint when a plaintiff failed tofile a sworn certification or publish timely notice, then Congress could haveincluded such language in the PSLRA.Id. at *16. Accordingly, in Carson Judge Waters distinguished as dicta language to the contraryin Chief Judge Tauro's opinion in Greebel, 939 F. Supp. at 60, where the district court stated that"[f]ailure of the named plaintiff to file a certification with the complaint and to serve notice toclass members are fatal to maintenance of the putative class action." As Judge Waters explained:Defendants contend that Greebel stands for the proposition that the complaintmust be dismissed when the plaintiff fails to comply with either the certificationor the notice requirements of the PSLRA. We disagree. The court in Greebel wassimply stating in dicta that if a plaintiff never complies with the provisions of thePSLRA, then the class action cannot go forward. The court did not state that anamed plaintiff could not correct such a failure to comply by filing a certificationwith an amended complaint and serving such notice within 20 days of theamended complaint. Therefore, we conclude that nothing under the PSLRAprohibits the court from allowing a plaintiff to file a sworn certification with anamended complaint and to publish belated notice to the other purported classmembers.Carson, 1998 U.S. Dist. LEXIS 6903, at *16-17 (footnote omitted). In that decision, JudgeWaters also stated:15

Id. at *17 n.3.The facts in Greebel are also dissimilar to the facts in the present case. InGreebel, the parties had already reached the stage in the lawsuit where notice hadbeen published and other class members had come forward and moved the courtto be appointed lead plaintiff. Thus, the court was in the process of determiningwhich plaintiff should be appointed lead plaintiff. At that point, it is importantthat a plaintiff has properly complied with the certification and notice provisionsof the PSLRA, so that the court can determine the most adequate plaintiff torepresent the class.The PSLRA's notice requirement has, according to one commentary, providedunexpected benefits for plaintiffs' counsel:One clearly unintended effect [of the PSLRA's notice provision] has beenthat the notices issued by law firms announcing the filing of class actions andproviding notice of the opportunity to seek appointment as lead plaintiff haveserved as public relations material for the plaintiffs' bar in soliciting new business.Jacobson & Martin, Survey, 5 SECURITIES REFORM ACT LITIG. RPTR. at 176 n.8. One plaintiffs'lawyer has similarly observed that "the plaintiff's counsel publishing the notice may attract othershareholders who consult with and retain him, thus enhancing his position and enabling that lawfirm to become lead counsel." Savett, Observations, 39 ARIZ. L. REV. at 529.III.APPOINTMENT OF LEAD PLAINTIFFSA. Outline Of ProceduresThe PSLRA establishes new rules requiring (and governing) appointment of leadplaintiff(s). Professor Weiss has stated that the statute's lead plaintiff provisions "actuallycomprise four elements," the first of which – notice to class members – is discussed above:First, the Act requires any person filing a securities class action to provide earlynotice to members of the purported class of the filing of the action, the nature ofthe claims made, and the purported class period. Second, the Act instructs courts(a) to provide an opportunity for members of the purported class to seekappointment as lead plaintiff and (b) to appoint to that position the "most adequateplaintiff," which a court must presume is the aspiring plaintiff "with the largestfinancial interest in the relief sought by the class." Third, the Act directs courts toallow other members of the purported class to engage in discovery relating toappointment of the lead plaintiff only if they "first demonstrate[] a reasonablebasis for a finding that the presumptively most adequate plaintiff is incapable ofadequately representing the class." Finally, the Act authorizes the most adequateplaintiff, subject to court approval, to "select and retain counsel to represent theclass."16

Weiss, The Impact to Date, 39 ARIZ. L. REV. at 563-64 (emphasis added; footnotes omitted); seealso Pindus v. Fleming Cos., 146 F.3d 1224, 1225 n.1 (10th Cir. 1998) (under PSLRA, "within110 days of the date a class action is filed, the district court must resolve any outstandingmotions from putative class members who wish to be appointed as lead plaintiff); Sofran v.LaBranche & Co., 220 F.R.D. 398, 401 (S.D.N.Y. 2004) (outlining statutory procedures); Martin& Metcalf, Institutional Investors, 56 BUS. LAW. at 1385 (outlining PSLRA notice procedures).See also Ashe P. Puri, Comment, And the Winner Is … Interpreting the Lead Plaintiff and theLead Counsel Provisions of the Private Securities Litigation Reform Act of 1995, 47 VILL. L.REV. 491 (2002).As a result, Section 78u-4(a) of the Exchange Act effectively requires the district court toappoint a lead plaintiff and lead counsel at the very beginning of securities fraud class actionlitigation. See Christman v. Brauvin Realty Advisors, Inc., 185 F.R.D. 251, 254 (N.D. Ill. 1999)("The PSLRA contemplates that a lead plaintiff will be appointed early in the litigation. ThePSLRA requires that notice be filed within 20 days after the complaint is filed, that motions forappointment as lead plaintiffs be filed within 60 days after the notice is published, and that thecourt consider any such motions within 90 days after the notice is published."); see also Cendant,182 F.R.D. at 146-47 (outlining procedures for selection of lead plaintiff(s) and lead counsel);Chill v. Green Tree Fin. Corp., 181 F.R.D. 398, 407 (D. Minn. 1998) (same); see also Yousefi,70 F. Supp. 2d at 1066 (same); Winn v. Symons Int’l Group, 2001 U.S. Dist. LEXIS 3437, Fed.Sec. L. Rep. (CCH) 91,364 (S.D. Ind. Mar. 21, 2001) (same).B. Purpose Of Lead Plaintiff ProvisionsIn Greebel, Chief Judge Tauro stated that the "inspiration" for the PSLRA's lead plaintiffprovisions was a law review article that Professor Weiss co-authored with Professor John S.Beckerman. 939 F. Supp. at 58 n.2. Professor Weiss claimed in a subsequent law review articlethat "[o]ur goal in proposing a notice requirement was to provide institutional and other investorswith early notice of the pendency of a class action that had the potential to affect their rights."Weiss, The Impact to Date, 39 Ariz. L. Rev. at 564 (citing Elliott J. Weiss & John S. Beckerman,Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs inSecurities Class Actions, 104 YALE L.J. 2053, 2108-09 (1995)); see also Fisch, Class ActionReform, 39 ARIZ. L. REV. at 537-39. As Judge Green commented on the procedures for selectinglead plaintiffs under the PSLRA:The PSLRA envisions a mixed inquisitorial/ adversarial model fordeveloping a record to make the Lead Plaintiff decision. In a case where morethan one group vies for Lead Plaintiff status, the Court usually receives the benefitof the adversarial process to have the merits developed before rendering adecision ... [W]here no opposition has been noted, Congress envisioned that thecourts still would play an independent, gatekeeping role to implement thePSLRA. At the same time, Congress envisioned that the Court would do this withdispatch.In re The Baan Co. Sec. Litig., 186 F.R.D. 214, 215 (D.D.C. 1999) (footnote omitted).17

C. Time PeriodsIn several cases where the appointment of lead plaintiffs has been contested, the timeperiods prescribed by Congress have not been met. As Magistrate Judge Lefkow commented:Because the issue of appointment of lead plaintiffs has been contested, thestatutory requirement to appoint the lead plaintiff within 90 days after thepublication of early notice to class members of the litigation has not beenaccomplished. See SEC Report to President and Congress on the First Year ofPractice Under the [Reform Act] at 43 (Part VI, C. 3, "The Lead PlaintiffProvision Has Added Delay and Expense"). In light of the inevitable delaynecessitated by the motions, including an effort to launch discovery under § 78u-4(a)(3)(B)(iv), the court has appointed the Minnesota State Board of Investment(MSBI), the plaintiff which it has preliminarily concluded is the presumptivelymost adequate plaintiff to represent the class, to act as interim lead plaintiff. Thecourt has also approved MSBI's counsel, Heins, Mills & Olson, to serve asinterim lead counsel in order that this bottleneck not prevent the litigation frommoving forward.Raftery v. Mercury Fin. Co., 1997 U.S. Dist. LEXIS 12439, at *2-3, 1997 WL 529553 (N.D. Ill.Aug. 7, 1997). But see Skwortz v. Crayfish Co., Ltd., 2001 U.S. Dist. LEXIS 15532, 2001 WL1160745 (S.D.N.Y. Sept. 26, 2001) (rejecting the only entity moving for lead plaintiff statusbecause it filed its motion one day after expiration of 60-day deadline following notice of initialclass action filing). In a similar vein, one plaintiff's lawyer has asserted:The [PSLRA] produces great delay in getting the case moving to themerits. Under the [PSLRA], the early notice to potential class members must befiled twenty days after the first complaint is filed. The notice allows sixty daysfor applications to be made for lead plaintiff, and the lead plaintiff, once selected,hires lead counsel subject to court approval. The [PSLRA] provides that the courtshould select lead plaintiff and lead counsel by ninety days, providedconsolidation has occurred.It often takes even longer than ninety days for the court to select leadplaintiffs and lead counsel, especially if there are competing applications.Savett, Observations, 39 ARIZ. L. REV. at 531 (emphasis added; footnotes omitted).D. Statutory ProvisionsSection 21D of the Exchange Act establishes a rebuttable presumption that the "mostadequate plaintiff," for purposes of appointment as lead plaintiff, is "the person or group ofpersons" that(aa) has either filed the complaint or made a motion [seekingappointment as lead plaintiff];18

(bb) in the determination of the court, has the largest financial interestin the relief sought by the class; and(cc) otherwise satisfies the requirements of Rule 23 of the FederalRules of Civil Procedure.15 U.S.C. § 78u-4(a)(3)(B)(iii)(I). See Reiger v. Altris Software, 1998 U.S. Dist. LEXIS 14705,at *5-6, 1998 WL 1986953 (S.D. Cal. Sept. 11, 1998) (outlining lead plaintiff appointmentprocedure); Yousefi, 70 F. Supp. 2d at 1066 (same); Cendant, 182 F.R.D. at 146-47 (same);Martin & Metcalf, Institutional Investors, 56 BUS. LAW. at 1385-86 (offering analysis ofstatutory provisions and summarizing relevant case law).For example, in In re AOL Time Warner, Inc. Secs. & ERISA Litig., 2003 U.S. Dist.LEXIS 145, 2003 WL 144844 (S.D.N.Y. Jan. 8, 2003), Judge Kram appointed the MinnesotaState Board of Investment – an institutional investor with the greatest financial stake (allegedlosses of $249 million during the class period) – as the lead plaintiff.E. Rebutting The PresumptionAs Judge Buchmeyer has explained the applicable procedures governing appointment oflead plaintiffs and how the above-referenced presumption may be rebutted:The court is directed to consider all motions made by purported class membersseeking to be appointed Lead Plaintiff and to determine the "member or membersof the purported plaintiff class that the court determines to be most capable ofadequately representing the interests of class members." 15 U.S.C. § 78u-4(a)(3)(B)(i). In so determining the "most adequate plaintiff," the court isdirected to adopt a presumption that the most adequate plaintiff is the person orgroup of persons that filed a motion, that "has the largest financial interest in therelief sought by the class," and that "otherwise satisfies the requirements of Rule23 of the Federal Rules of Civil Procedure." 15 U.S.C. § 78u-4(a)(3)(B) (iii)(I).This presumption may be rebutted only by proof of another member of thepurported plaintiff class that the presumptively most adequate plaintiff "will notfairly and adequately protect the interests of the class" or "is subject to uniquedefenses that render such plaintiff incapable of adequately representing the class."15 U.S.C. § 78u-4(a)(3)(B) (iii)(II).Gluck, 976 F. Supp. at 544.Thus, a member of the purported plaintiff class who wishes to challenge the appointmentof a presumptively most adequate plaintiff must present proof that the presumptively mostadequate plaintiff "either (i) will not fairly and adequately protect the interests of the class or (ii)is subject to unique defenses that render that plaintiff incapable of adequately representing theclass." Id. at 547 (citing 15 U.S.C. § 78u-4(a)(3)(B)(iii)(II)); see also Sofran, 220 F.R.D. at 403(“That presumption can be rebuted only upon proof by a member of the purported plaintiff classthat the presumptive lead plaintiff will not fairly and adequately protect the interests of the classor is subject to unique defenses that prevent the plaintiff from adequately representing the19

class.”) (quoting In re WorldCom, Inc. Secs. Litig., 294 F. Supp. 2d 392, 421 (S.D.N.Y. 2003)(internal quotation marks omitted)); American Bus. Finan. Svcs., 2004 U.S. Dist. LEXIS 10200,at *4-6 (“The Engler Group is the presumptive lead plaintiff in this case. It has filed a motion tobe appointed lead plaintiff, has the largest financial interest of all those bringing actions, and hasmade a prima facie showing it can satisfy the typicality and adequacy requirements of Rule 23. . .. The Pension Funds have not rebutted the presumption that the Engler Group is the mostadequate plaintiff.”) (citations omitted); Martin & Metcalf, Institutional Investors, 56 BUS. LAW.at 1387-88 (“Rebutting the Presumption”).Under the PSLRA, some district courts have instituted competitive bidding (or“auctions”) governing the selection of lead plaintiffs’ counsel. See, e.g., In re Lucent Tech., Inc.Secs. Litig., 194 F.R.D. 137, 156-57 (D.N.J. 2000); In re Banc One Shareholders Class Actions,96 F. Supp. 2d 780, 784-85 (N.D. Ill. 2000). In two securities fraud class actions that wereconsolidated for motion practice – In re Quintus Secs. Litig. and In re Copper MountainNetworks Secs. Litig., 201 F.R.D. 475 (N.D. Cal. 2001) – Judge Walker issued a lengthy opinionexplaining his view of the respective lead plaintiffs’ “adequacy.” In one case, the court rejectedthe lead plaintiff candidates with the largest losses and instead appointed the plaintiff who, in thecourt’s opinion, had negotiated the best attorney’s fee arrangement with prospective classcounsel. In the companion case, Judge Walker found no plaintiff with the ability to negotiate afavorable arrangement with counsel, and so the court appointed a “nominal lead plaintiff” andinitiated a competitive bidding procedure to select class counsel. The Ninth Circuit reversedJudge Walker’s decision, holding that under the PSLRA, the district court is obligated to selectas lead plaintiff the candidate with the largest loss as long as he, she, or it meets the “typicality”and “adequacy” requirements of Rule 23. Hergott v. United States District Court (In reCavanaugh), 306 F.3d 726 (9 th Cir. 2002).However, in In re Cendant Corp. Litig., 264 F.3d 201 (3 rd Cir. 2001), the Third Circuitquestioned whether a district court may use an auction to select lead counsel. Cendant, asecurities fraud class action, involved the appeal of a $3.2 billion settlement of securities fraudclass action litigation; objectors to the settlement challenged the district court’s use of an auctionto choose lead counsel and establish the attorney’s fee compensation structure. The ThirdCircuit held that the PSLRA does not generally permit an auction to select lead counsel in asecurities class action. But an auction might be permissible under limited circumstances, whichthe court explained in the context of how to evaluate the lead plaintiff’s choice of counsel underthe statute. The import of the court’s decision was summarized by one recent commentary:The [Third] Circuit has struck a sharp blow against the increasing use of auctionsto select lead counsel in a class action, but only in the PSLRA context. It hasplaced control over counsel selection and retention under the PSLRA back intothe hands of the lead plaintiff, absent extraordinary circumstances. Other courtsand circuits will likely follow its lead in varying degrees.Carol V. Gilden, Courts grapple with lead-counsel auctions, NAT’L L.J., Oct. 8, 2001, at C6.F. Combinations Of Persons Or Entities20

The district courts remain divided as to whether members of the class or a group ofpersons (or entities) may combine to constitute the "largest financial interest" and thereby jointlyserve as the "most adequate plaintiff"; many reported cases hold that such combinations areproper. See Yousefi, 70 F. Supp. 2d at 1067 ("[T]he majority of courts addressing this issue havepermitted the aggregation of claims.") (citing In re Advanced Tissue Sciences Sec. Litig., 184F.R.D. 346, 353 (S.D. Cal. 1998) (allowing aggregation of six plaintiffs); In re Oxford HealthPlans, Inc. Sec. Litig., 182 F.R.D. 42, 45-48 (S.D.N.Y. 1998) (appointing three plaintiffs as leadplaintiffs); and Chill, 181 F.R.D. at 409 (aggregating six plaintiffs)).In an influential decision, Judge Cedarbaum rejected the appointment of six leadplaintiffs in a securities class action, asserting that it would defeat the purpose of the PSLRA:To allow an aggregation of unrelated plaintiffs to serve as lead plaintiffs defeatsthe purpose of choosing a lead plaintiff. One of the principal legislative purposesof the PSLRA was to prevent lawyer-driven litigation. Appointing lead plaintiffon the basis of financial interest, rather than on a "first come, first serve" basis,was intended to ensure that institutional plaintiffs with expertise in the securitiesmarket and real financial interests in the integrity of the market would control thelitigation, not lawyers. See H.R. Conf. Rep. No. 104-369, at 31-35 (1995),reprinted in 1995 U.S.C.C.A.N. 679, 730, 730-34. To allow lawyers to designateunrelated plaintiffs as a "group" and aggregate their financial stakes would allowand encourage lawyers to direct the litigation. Congress hoped that the leadplaintiff would seek the lawyers, rather than having the lawyers seek the leadplaintiff.... Counsel have not offered any reason for appointing an aggregation ofunrelated institutional and individual investors as lead plaintiffs other than theargument that the language of the statute does not expressly forbid such a result.In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156, 157-58 (S.D.N.Y. 1997).Following Judge Cedarbaum’s lead, the aggregation of plaintiffs has been disallowed byseveral district courts in securities fraud class actions. See, e.g., Banc One, 96 F. Supp. 2d at 783(choosing lead plaintiff “based on the number of shares held by such an assemblage of smallholders would really subvert the purposes of the [PSLRA] by maximizing the prospect that thelawsuit would truly be run by the lawyers and not by the client class members”); In re NetworkAssocs., Inc. Secs. Litig., 76 F. Supp. 2d 1017, 1024 (N.D. Cal. 1999) (based upon assumptionthat "[t]he whole point of the [PSLRA] was to install a lead plaintiff with substantive decisionmaking ability and authority," court held that aggregations of unrelated investors cannot satisfylead plaintiff provisions of PSLRA); Aronson v. McKesson HBOC, Inc., 79 F. Supp. 2d at 1153-54 ("The strictest approach forbids aggregation of unrelated plaintiffs.... *** The court adoptsthis narrow view...."); In re Telxon Corp. Secs. Litig., 67 F. Supp. 2d 803, 813 (N.D. Ohio 1999)("[T]he context and structure of the PSLRA evince an intent that a 'group' consist of more than amere assemblage of unrelated persons who share nothing in common other than the twinfortuities that (1) they suffered losses and (2) they entered into retainer agreements with the sameattorney or attorneys") (emphasis in original). See generally Nicholas Even, Group Dysfunction:Two Class Certification Denials Reinforce Rule 23 Adequacy Principles, While Exposing theFiction of “Lead Plaintiff Groups,” 15 SECURITIES REFORM ACT LITIG. RPTR. 230 (May 2003);Jonathan C. Dickey, et al., Defense Strategies in Securities Class Actions 5-6 (ALI-ABA 2001)21

(collecting and analyzing cases); W. Reece Bader, Further Developments in the LeadPlaintiff/Lead Counsel Wars, 8 SECURITIES REFORM ACT LITIG. RPTR. 802 (Mar. 2000) (same);R. Chris Heck, Comment, Conflict and Aggregation: Appointing Institutional Investors as SoleLead Plaintiffs Under the PSLRA, 66 U. CHI. L. REV. 1199, 1214-16 (1999) (same).In Oxford Health Plans, the Colorado Public Employees Retirement Association(ColPERA) sought appointment as sole lead plaintiff in a securities class action. In its motion,ColPERA alleged losses in excess of $20 million due to Oxford's allegedly fraudulent activities.A competitor for appointment as lead plaintiff – a group consisting of 35 individuals (the "VogelGroup") – alleged collective losses of $10 million. Another institutional holder, PHBG Funds("PHBG"), alleging an estimated $2.76 million in losses, also moved for appointment as leadplaintiff.The SEC filed an amicus curiae brief in support of ColPERA's motion, "urging the courtto reject the request for multiple lead plaintiffs because it would undercut Congress' intent tocurb lawyer-driven cases." Karen Donovan, Oxford Suits Raise Lead Counsel Issue, NAT'L L.J.,June 15, 1998 at B-1; see also Saparoff & Sisitsky, Two Years Later, SECURITIES NEWS at 9.Judge Brieant, however, overruled the SEC's argument, stating that "in the circumstances of thisparticular case, the interests of the proposed class will be best served by a group of three co-leadplaintiffs." Oxford Health Plans, 182 F.R.D. at 45. Accordingly, the court appointed ColPERA,the Vogel Group and PHBG as co-lead plaintiffs. Id. at 49. The court then appointed the threelaw firms proposed by each of the respective co-lead plaintiffs as co-lead counsel. Id. at 50. InOctober 1998, the Second Circuit held that it did not have subject matter jurisdiction to considerColPERA's appeal of the district court's denial of its motion for sole lead plaintiff status. MetroSvcs., Inc. v. Wiggins, 158 F.3d 162 (2 nd Cir. 1988).The position taken by Judge Brieant in Oxford Health Plans upholding the aggregation ofinvestors (both institutional and individual) to serve as co-lead plaintiffs represents the correctinterpretation of the PSLRA. See, e.g., Bell v. Ascendant Solutions, Inc., 2002 U.S. Dist. LEXIS6850, at *15, 2002 WL 638571 (N.D. Tex. Apr. 2002) (allowing three individual plaintiffs to beaggregated into one “lead plaintiff” to ensure better class representation); In re Bank OneShareholders Class Actions, 96 F. Supp. 2d 780, 783 (N.D. Ill. 2000) (“Pension Group” –consisting of six employee benefit funds whose aggregate purchases during Class Period totaled77,200 shares – chosen as “lead plaintiff”); Tarica, 2000 U.S. Dist. LEXIS 5031, at *15-16(court approves appointment of group of four to serve as “lead plaintiff”); In re The First UnionCorp. Sec. Litig., 157 F. Supp. 2d 638, 643 (W.D.N.C. 2000) (approving stipulation betweenplaintiffs' counsel appointing two groups of investors as co-lead plaintiffs); Baan, 186 F.R.D. at216 ("The text of the PSLRA does not limit the composition of a 'group of persons' to those onlywith a pre-litigation relationship, nor does the legislative history provide a sound enoughfoundation to support such a gloss"; rejecting appointment of 20-person group as too large tocontrol litigation, but appointing three individual members of 466-person shareholder group asco-lead plaintiffs); Reiger, 1998 U.S. Dist. LEXIS 14705, at *13 ("By using the phrase 'group ofpersons,' Congress made clear that a court can consider the aggregate group's losses indetermining which group has the largest financial interest."). Cf. Gluck, 976 F. Supp. at 546, 549(recognizing that "aggregating the shares of several plaintiffs for purposes of this calculation isproper under the statutory language," but finding that the financial interest of a group ofplaintiffs was "significantly smaller" than that of an institutional investor, which was appointed22

as lead plaintiff; declining to appoint co-lead plaintiffs "as it would inevitably delegate morecontrol and responsibility to the lawyers for the class and make the class representatives morereliant on the lawyers") (citing Donnkenny, 171 F.R.D. at 157-58). See generally Ashe P. Puri,Comment, And the Winner Is . . . Interpreting the Lead Plaintiff and the Lead CounselProvisions of the Private Securities Litigation Reform Act of 1995, 47 VILL. L. REV. 491 (2002).Echoing Judge Cedarbaum’s reasoning in Donnkenny, however, other district courts haveconcluded that a large group of co-lead plaintiffs would be unable to control the litigation,effectively negotiate retention agreements, and supervise the conduct of counsel. See, e.g., Rothv. Knight Trading Group, 228 F. Supp. 2d 524 (D.N.J. 2002) (appointing presumptive leadplaintiff to take sole charge of securities fraud litigation, even though that party had stipulated toa co-lead plaintiff arrangement with another plaintiff; the case was not complex and having twoco-lead plaintiffs would not benefit the class); Sakhrani v. Brightpoint, Inc., 78 F. Supp. 2d 845,849-54 (S.D. Ind. 1999) (appoints individual investor with greatest losses as lead plaintiff andapproves his selection of two law firms as co-lead counsel; court criticizes practice ofaggregating groups of unrelated investors as lead plaintiffs and concludes that absent aninstitutional investor stepping forward, the individual with the greatest losses should serve aslead plaintiff); Yousefi, 70 F. Supp. 2d at 1068 (refusing to appoint group consisting of threenamed plaintiffs and "134 unrelated class members"; court appointed as lead plaintiffs twoshareholders -- one institutional shareholder and one individual shareholder -- who had sustainedthe largest losses of the group); Baan, 186 F.R.D. at 217 (rejecting proposal that 466-membershareholder group or 20-person committee be appointed as co-lead plaintiffs and appointingthree shareholders, each with unrealized losses in excess of $300,000, as co-lead plaintiffs);Advanced Tissue Sciences, 184 F.R.D. at 352-53 ("The idea of appointing over 250 unrelatedindividual investors as lead plaintiffs runs afoul of Congress's intent in enacting the PSLRA";granting alternate motion to appoint six designated group members as co-lead plaintiffs); Chill,181 F.R.D. at 408-09 (winnowing 300-person plaintiffs group to six co-lead plaintiffs). Seegenerally William F. Alderman, Recent Developments in the Lead Plaintiff/Lead Counsel Wars,8 SECURITIES REFORM ACT LITIG. RPTR. 663 (Feb. 2000) (collecting and analyzing cases).The SEC has taken the position that "ordinarily this group should be no more than threeto five persons." Baan, 186 F.R.D. at 215 (citing amicus curiae brief submitted by SEC); seealso Yousefi, 70 F. Supp. 2d at 1068 ("In fact, when courts appoint multiple class members aslead plaintiffs, they typically appoint less than ten plaintiffs.") (citations omitted); Memorandumof SEC as Amicus Curiae at 8, LaPerriere v. Vesta Ins. Group, Inc., No. CV-98-AR-1407-S(N.D. Ala. 1998) ("[T]he Court should limit the proposed lead plaintiff 'group' to a small numbercapable of most effectively managing the litigation and exercising control over counsel."). See,e.g., In re Orthodontic Centers of America, Inc. Secs. Litig., 2001 U.S. Dist. LEXIS 21816, 2001WL 1636846, Fed. Sec. L. Rep. (CCH) 91,676 (E.D. La. Dec. 19, 2001) (court approvesunrelated small group of investors – four unrelated individuals and church – as lead plaintiffs).In those districts where the courts have allowed groups of investors to serve as leadplaintiffs, certain plaintiffs’ counsel have aggressively sought to enlist shareholders to join such agroup. These tactics have led, in turn, to ethical challenges brought by competing plaintiffs’counsel. For example, in Knisley v. Network Assocs., Inc., 77 F. Supp. 2d 1111 (N.D. Cal.1999), Judge Armstrong held that a law firm seeking to assemble a lead plaintiff group in asecurities fraud class action did not violate the PSLRA or the Model Rules of Professional23

Conduct when it paid broker-dealers to distribute a notice regarding the class action to thebroker-dealers' customers who had purchased the security in question.G. Discovery Regarding Most Adequate Plaintiff(s)The PSLRA directs that discovery regarding whether a member of the purported plaintiffclass is the most adequate plaintiff may be conducted by a competing plaintiff only if thatchallenger first demonstrates a reasonable basis for a finding that the presumptively mostadequate plaintiff is incapable of adequately representing the class. See 15 U.S.C. § 78u-4(a)(3)(B)(iv); Gluck, 976 F. Supp. at 547 ("If the challenging member of the purported class candemonstrate a reasonable basis for a finding that the presumptively most adequate plaintiff isincapable of adequately representing the class, then discovery on the issue may be conductedbefore the Court appoints a Lead Plaintiff."); see also Martin & Metcalf, Institutional Investors,56 BUS. LAW. at 1388 (discussing when such discovery of “most adequate” plaintiff(s) isappropriate).In In re Cephalon Secs. Litig., 1996 U.S. Dist. LEXIS 10546, at *1-2 (E.D. Pa. July 18,1996), Judge Green addressed the issue of discovery in the context of a leadership strugglebetween proposed lead plaintiffs and their counsel:Pursuant to Private Securities Litigation Reform Act of 1995 ... limited discoveryrelating to whether a member of the purported plaintiff class may be had wherethere is a reasonable basis for finding that the presumptively most adequateplaintiff is incapable of adequately representing the class. As Sands Point hasasserted that it is a uniquely situated institutional investor to which the Act affordspreference in appointing the lead plaintiff, and as the Hooshmand plaintiffs haveraised concerns challenging this position, this court finds that discovery on theissue of determining the most adequate plaintiff is appropriate.Id.; see also Party City, 189 F.R.D. at 106 (discussing propriety of discovery directed atproposed “most adequate” plaintiff).H. What Do Defendants Have To Say About “Lead Plaintiffs”?What is the position of defendants in the event of a contest between competing “mostadequate” plaintiffs? Most courts have held that defendants have no standing in this contest,with Magistrate Judge Erickson stating that "it is doubtful" that defendants "have standing toobject to the adequacy of the Lead Plaintiffs that have been proposed." D'Hondt, 1997 U.S. Dist.LEXIS 17700, at *11 n.6 (citing Greebel, 939 F. Supp. at 60). See also Bell, 2002 U.S. Dist.LEXIS 6850, at *7 (“[T]he majority of courts – and this court – have concluded that a defendantdoes not have standing to object” to a lead plaintiff application) (citations omitted); Nice Sys.,188 F.R.D. at 218 n.11 ("A defendant or defendants may not object to the adequacy or typicalityof the proposed lead plaintiff at this preliminary stage of the litigation.") (citations omitted);Baan, 186 F.R.D. at 215 n.1 ("Defendants generally have been held to lack standing to challengeappointment of lead plaintiffs.") (citations omitted); In re Waste Mgmt., Inc. Secs. Litig., 128 F.Supp. 2d 401, 409 (S.D. Tex. 2000) (same); Fischler, 1997 U.S. Dist. LEXIS 2875, at *6 ("Theplain language of the [PSLRA] dictates only members of the plaintiff class may offer evidence to24

Id. at *17. See Mayo v. Apropos Technology, Inc., 2002 U.S. Dist. LEXIS 1924, 2002 WL193393, Fed. Sec. L. Rep. (CCH) 91,717 (N.D. Ill. Feb. 6, 2002) (court selects as lead plaintiffinvestor with greatest financial loss); accord Albert Fadem Trust v. Citigroup, Inc., 239 F. Supp.2d 344 (S.D.N.Y. 2002) (Pompano Beach Police & Firefighters’ Retirement System waspresumptively the “most adequate” plaintiff where it had incurred the largest financial losses,was otherwise “adequate” and “typical,” and it had a significant interest in the outcome of thelitigation); Johnson v. Tellabs, Inc., 214 F.R.D. 225 (N.D. Ill. 2002) (appointed the party with thegreatest losses as the lead plaintiff and approved its choice of counsel as lead counsel);As noted above, any member of the purported class may rebut the presumption uponproof "that the presumptively most adequate plaintiff ... will not fairly and adequately protect theinterests of the class ... [or] is subject to unique defenses that render such plaintiff incapable ofadequately representing the class." 15 U.S.C. § 78u-4(a)(3)(B)(iii)(II)(aa), (bb). See In reNanophase Tech. Corp. Litig., No. 98 C 3450, 1999 U.S. Dist. LEXIS 16171, at *15, 1999 WL965468, Fed. Sec. L. Rep. (CCH) 90,686 (N.D. Ill. Sept. 30, 1999); Martin & Metcalf,Institutional Investors, 56 BUS. LAW. at 1385-86.In ruling on such challenges, the district court can and should take into account theindividual facts and circumstances of each proposed “lead plaintiff.” For example, in Ravens v.Iftikar, 174 F.R.D. 651 (N.D. Cal. 1997), Judge Walker held that the proposed plaintiffs did notmeet the statutory requirement of "most adequate plaintiff" because they did not purchase theirstock until the class period was one-half over and did so after the defendant company had issuedpartial disclosures. In In re Enron Corp. Secs. Litig., 2002 U.S. Dist. LEXIS 3688 (S.D. Tex.Feb. 15, 2002), the district court rejected a combination of two large institutional investors – theFlorida State Board of Administration (FSBA) and the New York City pension funds – asartificially created. The court found that FSBA was atypical because it had purchased Enronstock after the key disclosures on the advice of an investment adviser who was an Enron insider.It was also a participant in numerous other securities fraud actions. See generally Melanie M.Piech, Was the Selection of Lead Plaintiff and Lead Counsel in Enron Correct?, 13 SECURITIESREFORM ACT LITIG. RPTR. 6 (Apr. 2002).IV.APPOINTMENT OF LEAD COUNSELA. Statutory TextThe PSLRA requires the lead plaintiff, "subject to the approval of the court, [to] selectand retain counsel to represent the class." 15 U.S.C. § 78u-4(a)(3)(B)(v); see also Nanophase,1999 U.S. Dist. LEXIS 16171, at *15 n.3; Yousefi, 70 F. Supp. 2d at 1071; Gluck, 976 F. Supp.at 545; Donnkenny, 171 F.R.D. at 158. A court may disturb the lead plaintiffs' choice of counselonly if it appears necessary to "protect the interests of the class." Advanced Tissue, 184 F.R.D. at353; see also Milestone, 187 F.R.D. at 175-76 (detailing statutory provisions governingappointment of lead counsel). In Bank One, 2000 U.S. Dist. LEXIS 6254, relying upon thisstatutory exception, Senior Judge Shadur recently employed a “bidding process” to select leadcounsel in a securities fraud case, choosing a law firm that had not been selected by leadplaintiffs (an aggregation of six employee benefit funds). Id. at *15-33. See also Craig v. SearsRoebuck & Co., 253 F. Supp. 2d 1046 (N.D. Ill. 2003) (reserving judgment on appointment of26

lead plaintiff and approval of counsel; directing State of New Jersey to submit additionalinformation regarding the timing of its selection of counsel, as well as information that wouldallow the court to assess whether New Jersey had engaged in appropriate bargaining over theterms of the retainer or had other choices in counsel that were clearly more reasonable). Seegenerally Fred B. Burnside, “Go Pick a Client” – and Other Tales of Woe Resulting from theSelection of Lead Counsel by Court-Ordered Competitive Bidding, 8 FORDHAM J. CORP. & FIN.L. 363 (2003); AnaLisa Valie, Comment, To the Lowest Bidder? The Private SecuritiesLitigation Reform Act and Auctioning the Role of Lead Counsel, 74 U. COLO. L. REV. 359(2003); James L. Tuxbury, Note, A Case for Competitive Bidding for Lead Counsel in SecuritiesClass Actions, 2003 COLUM. BUS. L. REV. 285 (2003); Jill E. Fisch, Lawyers on the AuctionBlock: Evaluating the Selection of Class Counsel by Auction, 102 COLUM. L. REV. 650 (2002);Jill E. Fisch, Complex Litigation at the Millennium: Aggregation, Auctions, and OtherDevelopments in the Selection of Lead Counsel Under the PSLRA, 64 LAW & CONTEMP. PROB.53 (2001).B. Multiple Lead CounselIn Nager, 1997 U.S. Dist. LEXIS 19601, at *4-5, Judge O'Toole approved the selectionof three law firms to serve as an "executive committee" to manage the litigation, stating inpertinent part:Id.There is no question that any of the firms is qualified to represent the plaintiffclass. There is some question whether it is necessary to approve the selection of a"committee," when any one firm would be qualified to handle the matter.However, because this matter now involves five consolidated cases, each initiallybrought by particular plaintiffs represented by different law firms, it seemssensible to employ the "committee" approach to minimize the potential fordisputes about the direction of the litigation. There should be no concern thatduplicative legal efforts will result in higher legal costs to the class because thestatute limits total attorneys' fees to "a reasonable percentage of the amount of anydamages and prejudgment interest actually paid to the class." 15 U.S.C. § 78u-4(a)(6). That limit should make it a matter of indifference to the class whether areasonable fee is paid to one or divided among cooperating recipients.This ruling represents the majority rule adopted by the district courts under the PSLRA.See also American Bus. Finan. Svcs., 2004 U.S. Dist. LEXIS 10200, at *15-16 (appointing coleadcounsel for lead plaintiff); Funke v. Life Finan. Corp., 2003 U.S. Dist. LEXIS 1226, 2003WL 194204, Fed. Sec. L. Rep. (CCH) 92,275 (S.D.N.Y. Jan. 28, 2003) (approvingappointment of co-lead counsel, finding that the location of documents and witnesses in bothNew York and California justified the appointment of firms from both locales); Advanced Tissue,184 F.R.D. at 353 (approving appointment of three law firms to represent co-lead plaintiffs); Inre Sunbeam Secs. Litig., 89 F. Supp. 2d 1326 (S.D. Fla. 1998) (appointing four law firms as coleadcounsel and appointing two law firms as co-liaison counsel); Lax, 1997 U.S. Dist. LEXIS11866, at *26 (approving retention of two law firms to serve as co-lead counsel, "provided thatthere is no duplication of attorneys' services, and the use of co-lead counsel does not in any way27

increase attorneys' fees and expenses"); In re Cephalon Secs. Litig., No. 96-CV-0633, 1996 U.S.Dist. LEXIS 13492, at *2, 1996 WL 515203, Fed. Sec. L. Rep. (CCH) 99,313 (E.D. Pa. Aug.27, 1996) (appointing three law firms as co-lead counsel for plaintiffs).Some recent decisions observe that the appointment of co-lead counsel for lead plaintiffs,or appointment of lead counsel “executive committees” is inconsistent with the PSLRA’s goalsbecause they create a significant potential for inefficient management of the litigation and makeit more difficult for the lead plaintiff to monitor the conduct of lead counsel. See, e.g., In re NiceSys. Secs. Litig., 188 F.R.D. 206, 221-24 (D.N.J. 1999); see also In re IBP, Inc. Secs. Litig., 2001U.S. Dist. LEXIS 7898 (D.S.D. June 7, 2001) (court rejects lead counsel proposal for lack ofindication that lead plaintiff agreed to arrangement); Yousefi, 70 F. Supp. 2d at 1072 (refusing toappoint three law firms as co-lead counsel; "the Court will only permit one law firm to serve aslead counsel in this case on the basis that class interests are better served by a central law firm";in that case, Judge Baird of the Central District of California refused to appoint as co-leadcounsel the Philadelphia-based law firm whose client, a Pennsylvania-based municipalemployees retirement fund, was the institutional investor that had been selected as one of two coleadplaintiffs; on reconsideration, however, the court relented and appointed the disappointedlaw firm as co-lead counsel); Milestone, 187 F.R.D. at 180 (rejecting proposal that court appointseveral co-lead counsel, executive committee and liaison counsel); In re Orbital Sciences Corp.Secs. Litig., 188 F.R.D. 237, 240 (E.D. Va. 1999) ("[T]he purpose of the [PSLRA] favors thechoice of one law firm to act in this capacity absent a specific reason to use multiple firms")(citing Milestone). Cf. In re Party City Secs. Litig., 189 F.R.D. 91, 114-17 (D.N.J. 1999)(appointing co-lead counsel, but noting that this was a rare case that called for more than onelead counsel, due to the potential size of the class and the nature of the litigation).V. RULE 9(B) PLEADING REQUIREMENTSA. The Level Of Particularity RequiredRule 9(b) of the Federal Rules of Civil Procedure, which is applicable to securities fraudclaims, requires that allegations of fraud be specific enough to give defendants notice of theparticular misconduct so that they can defend against the charge(s) and not just deny that theyhave done anything wrong. Powers, 977 F. Supp. at 1036. Rule 9(b) requires plaintiff to pleadwith sufficient particularity attribution of the alleged misrepresentations or omissions to eachdefendant; the plaintiff is obligated to "'distinguish among those they sue and enlighten eachdefendant as to his or her part in the alleged fraud.'" Id. at 1036-37 (citation omitted); see also Inre Rockefeller Ctr. Props. Secs. Litig., 311 F.3d 198 (3 rd Cir. 2002); Silva Run Worldwide v.Gaming Lottery Corp., 1998 U.S. Dist. LEXIS 4699, at *27, 1998 WL 167330, Fed. Sec. L. Rep.(CCH) 90,196 (S.D.N.Y. Apr. 8, 1998). However, "the complaint need only provide areasonable delineation of the underlying acts and transactions allegedly constitut[ing] the fraud."Fischler v. AmSouth Bancorp, 1996 U.S. Dist. LEXIS 17670, at *7, 1996 WL 686565 (M.D. Fla.Nov. 14, 1996) (citation omitted).A sufficient level of factual support for a Rule 10b-5 claim may be found where thecircumstances of the fraud are pled "in detail." Rehm v. Eagle Fin. Corp., 954 F. Supp. 1246,1251 (N.D. Ill. 1997). Thus, plaintiff's complaint must set forth in detail such matters as the28

time, place and contents of the false representations and the identity of the person making eachrepresentation. For each statement alleged to be false or misleading, plaintiffs must identify whomade the statement, where and when the statement was made, and why the statement was falseor misleading. See Barrie v. Intervoice-Brite, Inc., 2005 WL 1118162 (5 th Cir. May 12, 2005)(securities fraud complaint’s attribution of false and misleading statement to two officers inconjunctive satisfied PSLRA’s heightened pleading requirements, even though complaint did notallege which officer made the statements); Novak v. Kasaks, 216 F.3d 300, 305-06 (2 nd Cir.2000); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3 rd Cir. 1999); In re Grand Casinos,Inc. Sec. Litig., 988 F. Supp. 1273, 1281 (D. Minn. 1997); In re Phycor Corp. Sec. Litig., 2000U.S. Dist. LEXIS 2218, at *8 (M.D. Tenn. Feb. 17, 2000); Cherednichenko v. QuarterdeckCorp., 1997 U.S. Dist. LEXIS 23107, at *5, 1997 WL 809750, Fed. Sec. L. Rep. (CCH) 90,108(C.D. Cal. Nov. 26, 1997); see also Bryant v. Apple South, 25 F. Supp. 2d 1372, 1379 (M.D. Ga.1998) (plaintiffs adequately pled that defendants' statements were false when made), vacated andremanded on other grounds, Bryant v. Avado Brands, Inc., 187 F.3d 1271 (11th Cir. 1999);Robertson v. Strassner, 32 F. Supp. 2d 443, 448 (S.D. Tex. 1998) (same).In the words of Judge Kimball, § 21(D)(b)(1) of the Exchange Act "imposes even morerigorous pleading requirements on plaintiffs alleging fraud in the securities context" because thecomplaint "must 'specify each statement alleged to have been misleading' as well as 'the reasonor reasons why the statement is misleading.'" Karacand v. Edwards, 53 F. Supp. 2d 1236, 1242(D. Utah 1999) (quoting 15 U.S.C. § 78u-4(b)(1)); see also SEC v. ICN Pharmaceuticals, Inc.,84 F. Supp. 2d 1097, 1098 (C.D. Cal. 2000) (PSLRA’s “more rigorous” pleading requirements“go beyond the Rule 9(b) [pleading] requirements”). Thus, plaintiff's complaint must set forthwith particularity facts that create a strong inference that defendants knew that their statementswere false or misleading at the time they were made. See Grand Casinos, 988 F. Supp. at 1281(allegations of fraud concerning construction of casino were adequately pled); Stratosphere, 1 F.Supp. 2d at 1110-12 (same). However, Rule 9(b)'s particularity requirement may be relaxedwhere factual information is peculiarly within defendant's knowledge or control. See Bell v.Fore Sys., Inc., 17 F. Supp. 2d 433, 437 (W.D. Pa. 1998); Tse v. Ventana Med. Sys., 1998 U.S.Dist. LEXIS 16760, at *18, 1998 WL 743668 (D. Del. Sept. 23, 1998); Queen Uno Ltd.Partnership v. Coeur D'Alene Mines Corp., 2 F. Supp. 2d 1345, 1354 (D. Colo. 1998); In reMobileMedia Secs. Litig., 28 F. Supp. 2d 901, 935 (D.N.J. 1998). It should be noted that thePSLRA’s heightened pleading requirement is expressly limited to securities fraud class actionsbrought under the Exchange Act; it is not applicable to claims brought under the Securities Actof 1933. See In re Adams Golf, Inc. Secs. Litig., 176 F. Supp. 2d 216 (D. Del. 2001). But seeRombach v. Chang, 355 F.3d 164, 171 (2 nd Cir. 2004) (“We hold that the heightened pleadingstandard of Rule 9(b) applies to Section 11 and Section 12(a)(2) claims insofar as the claims arepremised of allegations of fraud.”).B. Allegations Based Upon “Information And Belief”Under the PSLRA, a complaint must specify each statement alleged to have beenmisleading, the reason or reasons why the statement is misleading, and if the allegation is basedon information and belief, the complaint must state with particularity all facts on which thatbelief is formed. 15 U.S.C. § 78u-4(b)(1). See Carney v. Cambridge Tech. Partners, Inc., 135 F.Supp. 2d 235 (D. Mass. 2001) (dismissing nondisclosure claims for lack of particularity about29

defendants’ knowledge of falsity); Sabratek Corp. v. Keyser, 2000 U.S. Dist. LEXIS 4981, at*10, 2000 WL 423529, Fed. Sec. L. Rep. (CCH) 90,949 (S.D.N.Y. Apr. 19, 2000) (same). InChalverus v. Pegasystems, Inc., 59 F. Supp. 2d 226, 233 (D. Mass. 1999), the court held thatinvestors provided required factual support for allegations of revenue overstatement by companymade on "information and belief" by listing SEC filings and news stories containing optimisticstatements regarding company's earnings. See also Adams v. Kinder-Morgan, Inc., 340 F.3d1083, 1097-98 (10 th Cir. 2003) (collecting and analyzing cases); In re Theragenics Corp. Secs.Litig., 137 F. Supp. 2d 1339, 1351 (N.D. Ga. 2001) (permitting claims to proceed once plaintiffsidentified insider statement that contradicted contemporaneous public declarations; court detailedstandards for “information and belief” pleading under PSLRA).However, in Branca v. Paymentech, Inc., 2000 U.S. Dist. LEXIS 1704, 2000 WL145083, Fed. Sec. L. Rep. (CCH) 90,911 (N.D. Tex. Feb. 8, 2000), Judge Lindsay reached theopposite conclusion:Plaintiffs have not met their duty to plead "with particularity" the facts supportingtheir belief that these statements are actually [actionable] misrepresentations ...Plaintiffs' general statement that the allegations in the Complaint are based onpublic filings, news articles, press releases, analyst reports, and meetings withconsultants does not sufficiently identify the facts upon which Plaintiffs' beliefsare based. Plaintiffs have not identified the particular articles, releases, filings,documents, or other information, including the substance of the meetings withconsultants, that would support their allegations that Defendants made falserepresentations....Id. at *22-23 (citations omitted).In In re Cabletron Sys., Inc., 311 F.3d 11 (1 st Cir. 2002), the First Circuit reverseddismissal of securities fraud claims against a company charged with inflating revenues throughfalse bookkeeping, channel stuffing, and other measures. The complaint’s reliance onanonymous sources was sufficient because of the great detail of the allegations, the multiplicityof sources, and other corroborative evidence.Numerous plaintiffs have sought to "plead around" the statutory requirements by allegingthat their claims are based upon "an investigation of counsel" or "information obtained fromformer employees" of the defendant company, rather than "information and belief"; however, thecourts are divided on whether this strategy passes muster under the PSLRA. Indeed, the courtsare sharply divided on whether plaintiffs must divulge the sources of their information in orderto allege falsity with the requisite particularity. Compare In re Silicon Graphics, Inc. Secs.Litig., 970 F. Supp. 746, 763 (N.D. Cal. 1997) (rejecting plaintiffs' characterization of theircomplaint as "based upon the investigation of their counsel" and holding that "because thesources [cited] do not provide plaintiffs with personal knowledge, the complaint must be basedon information and belief "), aff’d, 183 F.3d 970, 985 (9 th Cir. 1999) (requiring plaintiffs todivulge sources of information in order to allege falsity with requisite particularity) with Novak,216 F.3d at 313 (finding that if sources must be revealed in order to provide an adequate basisfor believing that statements were false, plaintiffs generally may provide particularizedinformation about the source’s position rather than stating the source’s name). The Second30

Circuit’s holding in Novak that named identification of confidential sources was not required wasfollowed by the Third Circuit in California Public Employees’ Retirement Sys. v. Chubb Corp.,394 F.3d 126, 146-47 (3 rd Cir. 2004), and by district courts in In re ATI Technologies, Inc. Secs.Litig., 216 F. Supp. 2d 418, 432 (E.D. Pa. 2002) (“A complaint to be particularized need notnecessarily reveal the names of anonymous sources of fact.”); In re DaimlerChrysler AG Secs.Litig., 197 F. Supp. 2d 42, 77-79 (D. Del. 2002) (ruling plaintiffs need not identify anonymoussources, but must specify the factual information that comes from the sources and connect theinformation to the sources); In re Theragenics Corp. Secs. Litig., 105 F. Supp. 2d 1342 (N.D. Ga.2001), and Fitzer v. Security Dynamics Tech., 119 F. Supp. 2d 12 (D. Mass. 2000). The relevantcases were collected in analyzed in Miller v. Ventro Corp., 2004 U.S. Dist. LEXIS 6913, 2004WL 868202 (N.D. Cal. Apr. 21, 2004), in which Magistrate Judge LaPorte granted defendants’motion to compel discovery, thereby ordering plaintiffs to disclose the names of their 22confidential witnesses.One commentator sought to elucidate the applicable rules of pleading and procedure:Section 21D(b)(1) of the [PSLRA] imposes a tough standard for pleadingsecurities fraud which can provide the basis for attacking an "information andbelief" complaint that is distinct from that available under [Fed. R. Civ. P.] 9(b).In responding to a securities fraud complaint, defense counsel initially shoulddetermine whether the complaint, wholly or in part, is pled on information andbelief. Such a determination depends, significantly, on whether the factssupporting the allegations are within plaintiff's or a third-party's knowledge.Where the allegations are stated to be based on facts acquired through counsel'sinvestigation – and even when plaintiff denies that the allegations are based oninformation and belief – defense counsel may still be able to prevail on anargument that the complaint is based on information and belief and is required,but fails to meet the "particularity" requirements of [Section] 21D(b)(1) of the[PSLRA].By the same token, in preparing a complaint, counsel should give carefulconsideration to whether some or all of the allegations are based on informationand belief. Those which are should include a statement of the actual sourcesrelied upon. A boilerplate clause generally describing the types of documentsreviewed is inadequate. Where third party witnesses, such as consultants orformer employees, are referred to as having supplied information that forms thebasis of the complaint, they, too, should be identified in the complaint.Miranda S. Schiller & Haron W. Murage, "Information and Belief" Pleading Under the ReformAct, 8 SECURITIES REFORM ACT LITIG. RPTR. 8, 12-13 (Oct. 1999) (footnote omitted).VI.PLEADING SECURITIES FRAUD CLAIMSA. Primary Violators Only: No Aiding Or Abetting Liability31

Section 10(b) of the Exchange Act prohibits the “use or employ, in connection with thepurchase or sale of any security, … [of] any manipulative or deceptive device or contrivance incontravention of such rules and regulations as the Commission may prescribe. 15 U.S.C.§ 78j(b). Rule 10b-5, promulgated by the SEC under § 10(b), makes it unlawful for any person“to make any untrue statement of a material fact or to omit to state a material fact necessary tomake the statements made in the light of the circumstances under which they were made, notmisleading … in connection with the purchase or sale of any security.” 17 C.F.R. § 240.10b-5.To state a claim under Section 10(b)/Rule 10b-5, plaintiff must allege that the defendant (1)made a misstatement or an omission of a material fact; (2) with scienter; (3) in connection withthe purchase or the sale of a security; (4) upon which the plaintiff reasonably relied; and (5) thatthe plaintiff’s reliance was the proximate cause of his or her injury. See Semerenko v. CendantCorp., 223 F.3d 165 (3 rd Cir. 2000).Only primary participants in a violation of Section 10(b)/Rule 10b-5 may be held liable.The Supreme Court has held that § 10(b)/Rule 10b-5 did not create liability for aiding andabetting the securities violations of others; such secondary participation is beyond the scope ofthe statute. Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994); see alsoPowers v. Eichen, 977 F. Supp. 1031, 1040 (S.D. Cal. 1997) (dismissing claims againstdefendants who were not specifically alleged to have made false or misleading statements thatdid not fall within scope of group-published information).B. "Secondary" Actor's Misconduct May Lead To Primary LiabilityHowever, primary liability under Section 10(b)/SEC Rule 10b-5 may be imposed "'notonly on persons who made fraudulent misrepresentations but also on those who had knowledgeof the fraud and assisted in its perpetration.'" SEC v. First Jersey Secs., 101 F.3d 1450, 1471 (2 ndCir. 1996) (quoting Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2nd Cir. 1994)); see also Inre Health Management, Inc. Secs. Litig., 970 F. Supp. 192, 209 (E.D.N.Y. 1997). The SecondCircuit has held that more than significant participation by the "secondary" actor is needed toincur primary liability. Shapiro v. Cantor, 123 F.3d 717, 720 (2nd Cir. 1997). Themisrepresentation must be attributed to that specific actor at the time of publicationdissemination, that is, in advance of the investment decision. Wright v. Ernst & Young LLP, 152F.3d 169, 175 (2nd Cir. 1998). See, e.g., In re Livent, Inc. Noteholders Secs. Litig., 174 F. Supp.2d 144 (S.D.N.Y. 2001) (denying motion to dismiss claims that investment banker violated §10(b) of Exchange Act by first participating in client loan that was misleadingly characterized asinvestment and then selling client’s notes without correcting that mischaracterization). TheNinth Circuit has held that "secondary" parties may be primarily liable for statements made byothers in which the former significantly participated. In re Software Toolworks Secs. Litig., 50F.3d 615 (9 th Cir. 1995). See generally Jill E. Fisch, Symposium: The Scope of PrivateSecurities Litigation: In Search of Liability Standards for Secondary Defendants, 99 COLUM. L.REV. 1293 (1999).C. The Elements Plaintiff Must Allege To State A Claim1. Introduction32

To state a valid claim for violations of Section 10(b)/Rule 10b-5, plaintiff must allegethat defendant (1) made a misstatement or omission, (2) of material fact, (3) with scienter, (4) inconnection with the purchase or sale of securities, (5) upon which the plaintiff relied, and (6) thatreliance proximately caused the plaintiff's injury. In re Peritus Software Svcs., Inc., 52 F. Supp.2d 211, 219 (D. Mass. 1999); Bryant, 25 F. Supp. 2d at 1377; see also Powers, 977 F. Supp. at1037. Chief Judge Young elucidated the pleading requirements established by the PSLRA:[A] securities fraud plaintiff must allege with particularity the who, what, when,where, and why of each materially false or misleading misrepresentation oromission. This Court concludes that [plaintiff] has satisfied this requirement.The Complaint sets forth the content of each statement alleged to be false ormisleading, the name of the speaker, the date on which each statement was made,the document in which each statement was made public, and a detailedexplanation of why each statement was false.Chalverus, 59 F. Supp. 2d at 232-33 (citations omitted).2. FalsityPlaintiff's securities fraud complaint must set forth what is false and misleading about thestatement and why it is false. See Nolte v. Capital One Financial Corp., 390 F.3d 311, 315 (4 thCir. 2004); Chalverus, 59 F. Supp. 2d at 232-33 (quoted above); Marksman Partners, 927 F.Supp. at 1308 (complaint alleged in sufficient detail precise dates, manner, content and nature ofstatements alleged to be fraudulent); In re Olympic Finan. Ltd. Sec. Litig., 1998 U.S. Dist.LEXIS 14789, at *5-11 (D. Minn. Sept. 10, 1998) (refusing to dismiss claims allegingmisrepresentation of nature of loan portfolio and mischaracterization of loans as "prime");Warman v. Overland Data, Inc., 1998 U.S. Dist. LEXIS 2009, at *9-10, 1998 WL 110018, Fed.Sec. L. Rep. (CCH) 90,167 (S.D. Cal. Feb. 23, 1998) (same; failure to disclose problems withproducts). Plaintiffs may satisfy this requirement by alleging facts demonstrating "'that thestatements failed to reflect the company's true condition at the time the statements were made.'"Id. (citation omitted).A complaint must set forth precisely what statements or omissions were made in whatdocuments or oral presentations, who made the statements, the time and place of the statements,the contents of the statements or manner in which they misled the plaintiff, and what defendantsgained as a consequence. In re Valujet, Inc., Secs. Litig., 984 F. Supp. 1472, 1477 (N.D. Ga.1997); see also Summit Med., 10 F. Supp. 2d at 1071 (Rule 9(b) pleading requirements heldsatisfied).3. MaterialityA fact is material if it is substantially likely that the fact would be viewed by a reasonableinvestor as significantly altering the "total mix" of information available, and if there is asubstantial likelihood that a reasonable investor would consider it important to the investmentdecision. City of Monroe Employees Retirement Sys. v. Bridgestone Corp., 399 F.3d 651 (6 thCir. 2005); Kapps v. Touch Offshore, Inc., 379 F.3d 207 (5 th Cir. 2004); Cooperman v.Individual, Inc., 171 F.3d 43, 49 (1 st Cir. 1999); Marksman Partners, 927 F. Supp. at 1305; see33

also Bryant, 25 F. Supp. 2d at 1379; Cherednichenko, 1997 U.S. Dist. LEXIS 23107, at *12;Valujet, 984 F. Supp. at 1478; Varljen, 1998 U.S. Dist. LEXIS 10493, at *18. Ordinarily,whether a fact is material is a jury question requiring assessment of inferences that a reasonableinvestor would draw from a given set of facts. See, e.g., In re Adams Golf, Inc. Secs. Litig., 381F.3d 267, 274-77 (3 rd Cir. 2004) (in securities fraud action arising out of golf clubmanufacturer’s initial public offering, materiality of undisclosed “gray market” issue could notbe resolved at pleading stage); Marksman Partners, 927 F. Supp. at 1306; Cherednichenko, 1997U.S. Dist. LEXIS 23107, at *12-13 (refusing to dismiss complaint on materiality grounds; "[W]ecannot conclude that none of the alleged misrepresentations would have significantly altered the'total mix' of information available to the market"); Bridgestone, 399 F.3d at 670-677 (allegedlyfalse statement that recalled tires were high-quality and safe was actionable); Valujet, 984 F.Supp. at 1478 (same; airline's safety record was material).4. Duty to DiscloseIf defendant chooses to reveal relevant, material information even though it had no dutyto do so, there is a duty to make the disclosure complete and accurate. In re Boeing Secs. Litig.,40 F. Supp. 2d 1160, 1167 (W.D. Wash. 1998); see also Schaffer v. Evolving Sys., Inc., 29 F.Supp. 2d 1213, 1221 (D. Colo. 1998) (defendants released only positive financial informationbut should have revealed potentially negative information as well).Plaintiff must show that the defendant had a duty to disclose arising from a relationshipof trust and confidence between parties to a transaction. See, e.g., In re Ford Motor Co. Secs.Litig., 184 F. Supp. 2d 626 (E.D. Mich. 2001) (car maker’s failure to inform investors of possiblerecalls of tires, and possible lost profits due to possible litigation, did not constitute securitiesfraud because car maker was not required to disclose unforeseeable costs); Vento & Co. of NewYork, LLC v. Metromedia Fiber Network, Inc., 1999 U.S. Dist. LEXIS 3020, at *25, 1999 WL147732, Fed. Sec. L. Rep. (CCH) 90,460 (S.D.N.Y. Mar. 18, 1999). A duty to disclose ariseswhen there is (1) insider trading; (2) a statute or regulation requiring disclosure; (3) aninaccurate, incomplete or misleading prior disclosure; and/or (4) when one of two parties to asecurities transaction "'possess superior knowledge, not readily available to the other, and knowsthat the other is acting on the basis of mistaken knowledge.'" Id. at *26 (citation omitted).Insiders are defined as those who are in a special relationship with the corporation and arethereby privy to confidential information. Insiders assume an affirmative duty of disclosurewhen trading in shares of their own corporation. Tse v. Ventana Med. Sys., Inc., 1998 U.S. Dist.LEXIS 16760, at *28, *30 n.11, 1998 WL 743668 (D. Del. Sept. 23, 1998).Statements may be rendered false and misleading by the failure to fully discloseinformation. A "duty to speak the full truth arises when a defendant undertakes the duty to sayanything." Zuckerman, 4 F. Supp. 2d at 624 (defendants' statements held actionable asunfounded predictions) (citation omitted). Defendant has duty to disclose or abstain from insidertrading. See Bryant, 25 F. Supp. 2d at 1381 (plaintiffs satisfied pleading requirements for Rule10b-5 violation based upon insider trading); Voit, 977 F. Supp. at 368-69 (trading on non-publicinformation creates duty to disclose).D. Pleading Scienter Under The PSLRA34

1. Introduction: The Circuits Are DividedTo sufficiently allege scienter, the complaint must "state with particularity facts givingrise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C.§ 78u-4(b)(2) (emphasis added). "However, the [PSLRA] does not give a good definition of'strong inference,'" Schaffer, 29 F. Supp. 2d at 1225, and the circuit and district courts are clearlydivided as to the methods by which a plaintiff can plead scienter. Lawrence J. Zweifach et al.,Recent Developments in the Standard for Pleading Claims Under the Private SecuritiesLitigation Reform Act, 13 SECURITIES REFORM ACT. LITIG. RPTR. 213 (May 2002) (surveyingcase law). See, e.g., Phillips v. LCI Int'l, Inc., 190 F.3d 609, 621 (4 th Cir. 1999) ("We have notyet determined which pleading standard best effectuates Congress's intent. Nor need we do sohere because the stockholders have failed to allege facts sufficient to meet even the most lenientstandard possible under the PSLRA, the two-pronged Second Circuit test."; affirming dismissalof complaint alleging that company had falsely claimed that it was not for sale in order todepress its stock price and facilitate merger; there was no motive for scienter because contentionsthat corporate officer somehow benefited from depressing company's stock price were toospeculative); see also In re Ciena Corp. Secs. Litig., 99 F. Supp. 2d 650 (D. Md. 2000) (same);Harris v. Ivax Corp., 182 F.3d 799, 804 (11 th Cir. 1999) ("We do not address ... the question ofwhat exactly a 'strong inference' of the appropriate scienter is, an issue that has vexed the courtssince the PSLRA's enactment.") (citing circuit and district court opinions); In re Next Level Sys.,Inc. Sec. Litig., 2000 U.S. Dist. LEXIS 149, at *3-13, 2000 WL 15091, Fed. Sec. L. Rep. (CCH) 90,738 (N.D. Ill. Jan. 4, 2000) (refusing to reconsider prior denial of company's motion todismiss for failure to plead scienter, and reiterating that plaintiff had sufficiently pled scienterthrough circumstantial evidence of company's recklessness; surveying previous decisionsaddressing scienter pleading requirements under PSLRA); In re Orbital Sciences Corp. Secs.Litig., 58 F. Supp. 2d 682, 688 n.6 (E.D. Va. 1999) (after noting that the "[t]he Fourth Circuithas yet to determine the point at which a Complaint will suffice to meet this standard" and that"the other circuits are deeply divided in this regard," stating that "[t]he Court need not determinethe appropriate interpretation [of the PSLRA] to use, because whether applied to a test of motiveand opportunity or to a test of heightened recklessness, unusual insider trading is sufficient tocreate a strong inference of recklessness"; holding that insiders' sales of 15% and 72% ofstockholdings during class period created strong inference of scienter) (citation omitted).This split in the circuits, and the debate over the proper standard for pleading scienterunder the PSLRA has generated a great deal of legal commentary. See generally Ray J.Grzebielski & Brian O. O’Mara, Whether Alleging “Motive and Opportunity” Can Satisfy theHeightened Pleading Standards of the Private Securities Litigation Reform Act of 1995: MuchAdo About Nothing, 1 DEPAUL BUS. & COMM. L.J. 313 (2003);Joseph A. Grundfest & A.C.Pritchard, Statutes with Multiple Personality Disorders: The Value of Ambiguity in StatutoryDesign and Interpretation, 54 STAN. L. REV. 627 (2002); Laurae Rossi, Comment, Choosing theBest Standard of Pleading Under the 1995 Private Securities Litigation Reform Act, and Why theNinth Circuit’s Standard Under In re Silicon Graphics Conquers the Battle of the Circuits, 31SW. U. L. REV. 263 (2002); Elliott J. Weiss, Complex Litigation at the Millennium: PleadingSecurities Fraud, 64 LAW & CONTEMP. PROB. 5 (2001); Brian Murray & Donald J. Wallace, YouShouldn’t Be Required to Plead More Than You Have to Prove, 53 BAYLOR L. REV. 783 (2001);Daniel S. Boyce, Note, Pleading Scienter Under the Private Securities Litigation Reform Act of1995: A Legislative Attempt at Putting Teeth Into the Required State of Mind, 35 NEW ENG. L.35

REV. 761 (2001); Ann Morales Olazabal, The Search for “Middle Ground”: Towards aHarmonized Interpretation of the Private Securities Litigation Reform Act’s New PleadingStandard, 6 STAN. J.L. BUS. & FIN. 153 (2001); Michael R. Dube, Note, Motive and OpportunityTest Survives Congressional Death Knell in Private Securities Litigation Reform Act, 42 B.C. L.REV. 619 (2001); Christopher J. Hardy, Comment, The PSLRA’s Heightened Pleading Standard:Does Severe Recklessness Constitute Scienter?, 35 U.S.F.L. REV. 565 (2001); Joseph T.Phillips, A New Pleading Standard Under the Private Securities Litigation Reform Act?, 69 U.CIN. L. REV. 969 (2001); Chuan Li, Note, Gauging the Hurdle to Strike Suits: Reconciling theCircuit Split Over the Proper Interpretation of the Heightened Pleading Standard Under thePrivate Securities Litigation Reform Act of 1995, 26 IOWA J. CORP. L. 435 (2001); Terrence G.Stolly, Comment, Scienter Under the Private Securities Litigation Reform Act of 1995, 29 CAP.U. L. REV. 545 (2001); Laura R. Smith, Comment, The Battle Between Plain Meaning andLegislative History: Which Will Decide the Standard for Pleading Scienter After the PrivateSecurities Litigation Reform Act of 1995?, 39 SANTA CLARA L. REV. 577 (1999); Miranda S.Schiller & Haron W. Murage, The Circuit Courts Divide on Key Securities Litigation Reform ActIssue, 8 SECURITIES REFORM ACT LITIG. RPTR. 406 (Dec. 1999); Matthew Roskoski, Note, ACase-By-Case Approach to Pleading Scienter Under the Private Securities Litigation Reform Actof 1995, 97 MICH. L. REV. 2265 (1999); Richard H. Walker & J. Gordon Seymour, RecentJudicial and Legislative Developments Concerning the Private Securities Fraud Class Action, 40ARIZ. L. REV. 1003 (1998); Ryan G. Meist, Would the Real Scienter Please Stand Up: TheEffect of the Private Securities Litigation Reform Act of 1995 on Pleading Securities Fraud, 82MINN. L. REV. 1103, 1126 (1998).2. The Second Circuit Standarda. "Motive and Opportunity"Prior to the PSLRA's enactment, in the Second Circuit a strong inference of fraudulentintent could be established in a securities fraud case either (1) "by alleging facts that constitutestrong circumstantial evidence of conscious misbehavior or recklessness" or (2) "by allegingfacts to show that defendants had both motive and opportunity to commit fraud." The High ViewFund, L.P. v. Hall, 27 F. Supp. 2d 420, 426 (S.D.N.Y. 1998) (quoting Shields v. CitytrustBancorp, Inc., 25 F.3d 1124, 1128 (2 nd Cir. 1994); see also In re Oxford Health Plans, Inc., 187F.R.D. 133, 138 (S.D.N.Y. 1999).b. The Press Decision and Its ProgenyFollowing enactment of the PSLRA, there was some confusion among the district courtsas to the level of pleading scienter required by the statute. See High View Fund, 27 F. Supp. 2dat 426 n.2 (collecting cases and holding that allegations of officers' misuse of funds cannotsupport inference of scienter for earlier alleged misrepresentations); Holding v. Nu-Tech Bio-Med, Inc., 1998 U.S. Dist. LEXIS 20399, at *11, 1999 WL 4922, Fed. Sec. L. Rep. (CCH) 90,417 (S.D.N.Y. Dec. 31, 1998) ("The PSLRA raised the bar at the pleading stage andrequires the allegation of facts that give rise to a strong inference of reckless or consciousbehavior on behalf of the defendant.") (citation omitted).36

In one of the first appellate court opinions addressing the issue, however, the SecondCircuit held (albeit without much analysis) that the PSLRA "heightened the requirement forpleading scienter to the level used by the Second Circuit." Press v. Chemical Inv. Svcs. Corp.,166 F.3d 529, 537-38 (2nd Cir. 1999). In Press, the plaintiff purchased a $100,000 Treasury Billthrough a registered broker-dealer. After he had purchased it, he was told that he could not pickup a check for the proceeds in New York City on the date of maturity but, rather, would have towait for the proceeds to arrive via regular mail. (He could, however, have the proceeds sent viaexpress mail or wire transfer for an additional fee.)Press sued the broker-dealer and its clearing firm, alleging that they fraudulently failed todisclose that the funds would not be immediately available to him at maturity. He alleged thatthe yield should have been calculated over a longer period of time, thus making the advertisedyield fraudulently inaccurate. He also claimed that defendants had structured the transaction inthis manner to allow themselves more time to use the funds.Defendants sought dismissal of Press's complaint, contending that he had not pledscienter in accordance with the PSLRA's heightened pleading requirement. After citing thestatute's requirement that a plaintiff must "state with particularity facts giving rise to a stronginference that the defendant acted with the required state of mind," 15 U.S.C. § 78u-4(b)(2), theSecond Circuit stated without analysis that this requirement could be satisfied by its traditionaltwo-pronged standard. 166 F.3d at 538. Under this standard, fraud could be established byallegations of either (1) "both motive and opportunity to commit fraud" or (2) "strongcircumstantial evidence of conscious misbehavior or recklessness." Id. (citation omitted).The Press court also noted that it had "been lenient in allowing scienter issues towithstand summary judgment based on fairly tenuous inferences" because "we are not inclined tocreate a nearly impossible pleading standard when the 'intent' of a corporation is at issue." Id.The investor in Press alleged that defendants "had a motive to keep possession of his proceeds tohave the 'float' or use of the funds," and that they "had the opportunity to do this since theproceeds of the T-bill at maturity were in their control." Id. While characterizing the allegationsbefore it as "the barest of all pleading that would be acceptable," the Second Circuit neverthelessfound that they were sufficient to satisfy the PSLRA. Id.In Stevelman v. Atlas Research, Inc., 174 F.3d 79 (2 nd Cir. 1999), the Second Circuitfound that violations of generally accepted accounting principles (GAAP) or SEC accountingrules were not, in and of themselves, sufficient to support an inference of scienter. Id. at 84.However, the appellate court found that the "motive and opportunity" test could be satisfied bythe fact that the CEO, along with other officers, "sold off large portions of his stock holdingsduring the period of the misrepresentations." Id. at 85. As the court elaborated:Some of the sales occurred after the representations were made, several officersmade large sales, and a motive for inflation of the stock price can be inferred fromthese sales. Moreover, the statements that continued to be made after the salesthat followed the earlier statements could well be probative of an intent to keepthe stock price high in order to avoid detection of the alleged fraud.37

174 F.2d at 86. Thus, the court held that the insider trading, in combination with the timing ofthe misrepresentations, satisfied the pleading requirements of Rule 9(b) and the PSLRA. Id.More recently, in Novak v. Kasaks, 216 F.3d 300 (2 nd Cir. 2000), the Second Circuitreaffirmed that the PSLRA• Did not change the substantive standard of scienter and, therefore, continued to includerecklessness• Would permit facts raising a strong inference of state of mind or evidence includingmotive and opportunity to defraud to satisfy a scienter allegation• Would not require name identification of confidential informants who provide a basis for“information and belief” allegations• Would not require all information upon which “information and belief” pleadings werebasedSee also In re Scholastic Corp. Secs. Litig., 252 F.3d 63, 74-76 (2 nd Cir. 2001) (reversing districtcourt decision holding that securities fraud plaintiff’s complaint was not sufficiently particularand that it failed to allege facts showing a strong inference of scienter; investor relations officer’ssale of 80% of his stock within single week following material, negative event that wentunreported met “motive and opportunity” test for pleading scienter; court also followed Novak’srule on pleading on “information and belief”); In re Carter-Wallace Secs. Litig., 220 F.3d 36, 39(2 nd Cir. 2000).The Second Circuit has made clear, however, that a strong inference of scienter does notarise merely by pleading facts that are common to all corporate insiders. See Chill v. GeneralElec. Co., 101 F.3d 263, 268 (2 nd Cir. 1996). Instead, a plaintiff must allege facts showing that“defendants benefited in some concrete and personal way from the purported fraud,” Novak, 216F.3d at 307-08, and received “special benefit” not shared by all corporate insiders or allshareholders. Kalnit v. Eichler, 224 F.3d 131, 142 (2 nd Cir. 2001) (affirming dismissal ofshareholder’s complaint alleging that directors who had accepted an acquisition offer failed todisclose they had waived standstill agreement that subsequently enabled company to acceptbetter offer; court found that defendants had no motive to defraud beyond generalized incentivesthat were common to corporate directors).c. District Courts Apply The Second Circuit's "Motive andOpportunity" TestIn a variety of factual settings, district courts within the Second Circuit have applied the"motive and opportunity" formulation for pleading scienter. See, e.g., In re Initial PublicOffering Secs. Litig., 241 F. Supp. 2d 281 (S.D.N.Y. 2003) (denying motion to dismiss claimsthat underwriters, issuers and corporate officials engaged in an illegal scheme to artificiallyinflate the price of newly-issued shares); Burstyn v. Worldwide Xceed Group, Inc., 2002 U.S.Dist. LEXIS 18555, 2002 WL 31191741 (S.D.N.Y. Sept. 30, 2002) (scienter could be found incompany’s motive to use inflated share value to finance acquisitions and, circumstantially, by38

magnitude of accounting errors); RMED Int’l, Inc. v. Sloan’s Supermarkets, Inc., 185 F. Supp. 2d389 (S.D.N.Y. 2002) (refusing to dismiss claims that company failed to disclose it was indiscussions with FTC regarding investigation that could eventually require divestment ofacquisitions; scienter was established both by motive and opportunity and circumstantialevidence because defendant was primary shareholder and president of corporation); Cyber MediaGroup, Inc. v. Island Mortg. Network, Inc., 183 F. Supp. 2d 559 (E.D.N.Y. 2002) (refusing todismiss claims against company’s officers alleging that company inflated its stock price in stockfor-stockmerger; plaintiffs alleged that officers stood to personally benefit from increase incompany’s stock price because it was directly linked to compensation packages they wouldreceive from their prospective employer); Liberty Ridge LLC v. RealTech Sys. Corp., 173 F.Supp. 2d 129 (S.D.N.Y. 2001) (scienter requirement was satisfied because individual defendantswere positioned to know about situation inside company and they participated directly in allegedmisrepresentations); In re Xerox Corp. Secs. Litig., 165 F. Supp. 2d 208 (D. Conn. 2001)(refusing to dismiss claims that company falsely touted restructuring program that in fact wascausing negative consequences; scienter was supported by fact that individual defendants madevery large insider trades shortly after releasing positive information, in an amount exceeding thatof prior years); Manavazian v. ATEC Group, Inc., 160 F. Supp. 2d 468 (S.D.N.Y. 2001)(denying motion to dismiss claims that company made series of positive statements when it knewthat business was declining; scienter could be based upon circumstantial evidence and significantinsider trading by officer defendants during class period); In re Complete Mgmt. Secs. Litig., 153F. Supp. 2d 314 (S.D.N.Y. 2001) (company failed to disclose that its critical receivables weretainted by fraud and uncollectible; scienter alleged as to individual officers because collectibleswere huge proportion of business and defendants were members of top management; company’sneed to inflate share value to conduct acquisitions was evidence of motive to commit fraud); Inre Independent Energy Holdings PLC Secs. Litig., 154 F. Supp. 2d 741 (S.D.N.Y. 2001)(denying motion to dismiss claims against company, its officers, and underwriters whoconducted secondary offering; underwriters had “motive and opportunity” scienter becausesuccessful conduct of offering provided substantial financial benefits to its parent company); Inre Revlon, Inc. Secs. Litig., 2001 U.S. Dist. LEXIS 3265 (S.D.N.Y. Mar. 27, 2001) (denyingmotion to dismiss claims that defendants prematurely booked revenue, dumped inventory, andengaged in counterproductive cost-cutting measures in order to inflate revenue; scienter wassatisfied by allegations of defendants’ monitoring and awareness of challenged practices); Rizzov. MacManus Group, Inc., 158 F. Supp. 2d 297 (S.D.N.Y. 2001) (denying motion to dismissclaims by former CEO who negotiated a severance agreement and received payment for his stockafter receiving misleading representations about the prospect of an imminent merger; plaintiffalleged that defendants “knew but concealed” material information); Fellman v. Electro OpticalSys. Corp., 2000 U.S. Dist. LEXIS 5324, at *29-30, 2000 WL 489713 (S.D.N.Y. Apr. 25, 2000)(allegations that defendant corporate insiders were compensated via direct payment, stockownership, or through other “financial dealings” were insufficient to allege their motivation tocommit fraud); In re MCI Worldcom, Inc. Secs. Litig., 93 F. Supp. 2d 276 (E.D.N.Y. 2000)(denying motion to dismiss claims by former shareholders of acquired company who alleged thatacquirer had implied that it had no plans just days before completing takeover; plaintiffs assertedthat MCI was motivated to deflate SkyTel’s stock price in order to keep the acquisition pricelower and yet make terms of offer more attractive to SkyTel shareholders); In re American BankNote Holographics, Inc. Secs. Litig., 93 F. Supp. 2d 424 (S.D.N.Y. 2000) (denying motion todismiss securities fraud claims against officers and company that spun off subsidiary whose39

financial statements were seriously misstated and subsequently went bankrupt; alleged GAAPviolations were so large and perpetuated for such a long time that court found that they createdstrong circumstantial evidence of scienter, even though plaintiffs failed to alleged individualdefendants’ motive to commit fraud).In one case, In re Fine Host Corp. Secs. Litig., 25 F. Supp. 2d 61 (D. Conn. 1998), JudgeHall held that the language in the PSLRA relating to "information and belief" pleading appliesonly to pleading fraud, not scienter. Thus, there is no requirement that plaintiff plead the sourceof the information upon which the allegations regarding a particular defendant's scienter arebased. In that case, the court held that allegations of specific facts indicating that a defendantcorporate officer had falsified the company's financial statements were sufficient to pleadscienter, where plaintiffs alleged that he admitted in a telephone call that he had knowingly (andimproperly) capitalized current expenses to increase the company's earnings.d. Other District Courts Apply "Motive and Opportunity"Numerous district courts in other circuits "have concluded that Congress did not intendfor the [PSLRA] to abolish" the "motive and opportunity" formulation for pleading scienter. SeeIn re Hartmarx Secs. Litig., 2002 U.S. Dist. LEXIS 6983, 2002 WL 653892, Fed. Sec. L. Rep.(CCH) 91,783 (N.D. Ill. Apr. 19, 2002) (because the Seventh Circuit had not yet established astandard for pleading scienter under the PSLRA, district court would utilize Second Circuit“motive and opportunity” test); Chu v. Sabratek Corp., 100 F. Supp. 2d 815, 822-23 (N.D. Ill.2000) (same; collecting cases); Branca, 2000 U.S. Dist. LEXIS 1704, at *17 ("Because thePSLRA did not amend or alter existing pleading standards, the court joins those other courts whohave recognized the continuing validity of the motive and opportunity test for pleadingscienter.") (citations omitted); Tatz v. Nanophase Techs. Corp., 2002 U.S. Dist. LEXIS 19467,2002 WL 31269485 (N.D. Ill. Oct. 9, 2002) (same); In re Datastream Sys., Inc. Secs. Litig., 2000U.S. Dist. LEXIS 1468, at *8 n.3, *9, 2000 WL 33176025, Fed. Sec. L. Rep. (CCH) 90,907(D.S.C. Jan. 31, 2000) (noting that "the Fourth Circuit has not adopted a standard for pleadingscienter under the PSLRA" but asserting that "this Court believes the Second Circuit offers asufficient standard for determining whether a 'strong inference' exists"; upholding complaint'sallegations of defendants' motive and opportunity); McNamara v. Bre-X Minerals Ltd., 57 F.Supp. 2d 396, 408 (E.D. Tex. 1999) (citations omitted) (dismissing securities fraud action againstpotential business partner and underwriter, financial adviser, securities analysts and engineeringconsultant of company that allegedly misrepresented its gold reserves; complaint’s reliance on"must have known" scienter grounded in defendants' visits to site gold reserves held insufficientto plead scienter, even under "motive and opportunity" test); Next Level, 2000 U.S. Dist. LEXIS149, at *12 (asserting that "[t]he majority of courts agree with the Second Circuit, includingthose within this district [N.D. Ill.]") (citations omitted); In re BankAmerica Corp. Secs. Litig.,78 F. Supp. 2d 976, 990-91 (E.D. Mo. 1999) (permitting plaintiffs to proceed with claims thatmerger partner failed to disclose major investment losses and that merger was falsely portrayedas marriage of equals; expressly adopting Second Circuit "motive and opportunity" standard forpleading scienter); In re Transcrypt Int'l Secs. Litig., 57 F. Supp. 2d 836 (D. Neb. 1999) ("TheSecond Circuit has led the way in interpreting the PSLRA and specifically addressing thescienter requirement for claims under § 10(b) and Rule 10b-5.") (citing Press).40

3. The Third Circuit Follows Second Circuit Decisions On "Motive AndOpportunity"a. The Advanta DecisionIn In re Advanta Corp. Secs. Litig., 180 F.3d 525 (3 rd Cir. 1999), the Third Circuit statedthat the PSLRA's requirement for pleading scienter mirrors that previously adopted in the SecondCircuit, holding that it "remains sufficient" for plaintiffs to plead scienter by alleging facts"establishing a motive and an opportunity to commit fraud, or by setting forth facts thatconstitute circumstantial evidence of either reckless or conscious behavior." Id. at 534-35(citations omitted). "Motive and opportunity, like all other allegations of scienter (intentional,conscious, or reckless behavior) must now be supported by facts stated 'with particularity' andmust give rise to a 'strong inference' of scienter." Id. at 535 (quoting 15 U.S.C. § 78u-4(b)(2)).Accord GSC Partners CDO Fund v. Washington, 368 F.3d 228 (3 rd Cir. 2004) (discussing howsecurities fraud plaintiffs can satisfy “motive and opportunity” requirement); In re Digital Isl.Secs. Litig., 357 F.3d 322, 328 (3 rd Cir. 2004) (same).Advanta involved a class action against a credit card issuer that attracted new customerswith unusually low introductory interest ("teaser") rates that remained in effect for a limitedperiod of time, after which the interest rate would then return to a higher, permanent level.Advanta shareholders brought suit against the corporation and several of its officers, alleging thatthey had made false and misleading statements and material admissions regarding the company'searnings potential.The focus of the securities fraud litigation was a $20 million loss that Advanta announcedin the first quarter of 1997. In September 1996 -- about six months before this loss -- one ofAdvanta's officers had projected a "large increase in revenues" as Advanta converted more than$5 billion in accounts from teaser rates to its normal interest rate. 180 F.3d at 528. Nine monthslater -- and three months following Advanta's announcement of its first quarter 1997 loss --Advanta's chairman and former CEO explained that "[w]hat happened is that when theintroductory period ended, we were probably not as aggressive as we could have been" inrepricing the interest rates. Id. Plaintiffs alleged that the latter statement (Alter statement)demonstrated that the earlier statement (Point) statement was fraudulent when made. They alsoalleged that Advanta had made a series of false "positive portrayals" about its earnings andfuture. Id.The Third Circuit found that the "precise extent to which Congress intended to adopt theSecond Circuit standard is not clear," id. at 531, and that the PSLRA's legislative history on thispoint was "ambiguous and even contradictory." Id. Given the contradictory and inconclusivenature of the legislative history, the appellate court instead focused on the statute's plainlanguage "requir[ing] the plaintiff to allege facts supporting a 'strong inference' of ... the requiredstate of mind." Id. at 533-34. Because this language "closely mirrors" the language employedby the Second Circuit, id. at 533, the Third Circuit concluded thatCongress's use of the Second Circuit's language compels the conclusion that the[PSLRA] establishes a pleading standard approximately equal to that of theSecond Circuit. Because the Second Circuit standard was regarded as the most41

estrictive prior [to] the [PSLRA], this interpretation is consistent with Congress'sstated intent of strengthening pleading requirements and deterring frivoloussecurities litigation.Id. at 534. The court also held that recklessness was still sufficient to satisfy the scienterrequirement, and that the PSLRA "did not purport to alter the substantive contours of scienter."Id.Unlike the Second Circuit's opinion in Press, 166 F.3d at 538, in Advanta the ThirdCircuit conducted an in-depth analysis of the PSLRA's legislative history to arrive at a similarstandard. 180 F.3d at 530-33. Advanta sought to determine congressional intent by reviewingthe legislative debate surrounding the Securities Litigation Uniform Standards Act of 1998,which included a discussion regarding the pleading requirements necessary to allege scienterunder the PSLRA. Id. at 533.The Third Circuit found that the pleading at issue did not satisfy its standard. Id. at 539.First, the statement that Advanta "'will experience a large increase in revenues'" was found to bea "forward-looking" statement under the PSLRA. Id. Accordingly, it was protected under thePSLRA's safe harbor, unless it was made with "actual knowledge" that it was false andmisleading. Id.Plaintiffs argued that the falsity of the statement was proven by Advanta's CEO's laterstatement that "'we were probably not as aggressive as we could have been'" in repricing thecompany's interest rates. The Third Circuit found that this was not sufficient to support aninference that Advanta had actual knowledge that the forward-looking statement was false at thetime it was made:The complaint's only specific factual allegation regarding the falsity of the Pointstatement is the existence of the Alter statement some nine months later. But thePoint statement and the Alter statement are not inconsistent: Point stated inSeptember 1996 that Advanta planned to reprice its teaser rates to 17%; ninemonths later, Advanta expressed regret that Advanta did not reprice to that level.Id. Accordingly, the appellate court found that the statement was protected by the safe harborprovision for forward-looking statements under the PSLRA.The Third Circuit also found that the plaintiffs had not alleged facts sufficient to supportan inference that the positive portrayals of Advanta's business were made with scienter. Id. at539. The court found that these positive portrayals fell into two categories: "accurate reports ofpast earnings" and "non-actionable expressions of optimism for the future." Id. With respect tothe first category, the Third Circuit states that "[f]actual recitations of past earnings, so long asthey are accurate, do not create liability under Section 10(b)" of the Exchange Act. Id. at 538(citation omitted). The second category of statements, expressing optimism for the future, werefound to "'constitute no more than 'puffery' and are understood by reasonable investors as such.'"Id. (citation omitted).Even if these positive portrayals had been materially misleading, the Third Circuit foundthat the complaint should still be dismissed because it contained no more than conclusory42

allegations that the "defendants must have been aware of the impending losses by virtue of theirpositions within the company." Id. at 539. Such "[g]eneralized imputations of knowledge do notsuffice," the court held, "regardless of the defendants' positions within the company." Id. Seealso In re Alpharma, Inc. Secs. Litig., 372 F.3d 137 (2004) (affirming dismissal of plaintiffs’securities fraud claims and rejecting the “premise that the individual defendants are liable simplyby virtue of the positions they hold within the company”; “[W]e conclude that plaintiffsallegations as stated that (1) defendants violated GAAP and Alpharma’s revenue recognitionpolicy, and (2) that employees within the Brazil division reported these violations to thecompany’s headquarters in New Jersey do not amount to ‘an extreme departure from thestandards of ordinary care’”) (quoting Advanta, 180 F.3d at 535); GSC Partners CDO Fund v.Washington, 368 F.3d 228, 237 (3 rd Cir. 2004) (outlining applicable rules for pleading securitiesfraud scienter in Third Circuit).b. Third Circuit District Court OpinionsDistrict courts within the Third Circuit have applied the standard for alleging scienter in awide variety of securities fraud cases. See, e.g., In re Vibropharma, Inc. Secs. Litig., 2003 U.S.Dist. LEXIS 5623 (E.D. Pa. Apr. 7, 2003) (refusing to dismiss claims that drug companymisleadingly reported success of clinical trial for key product and failed to disclose negativematerial information); Nappier v. Pricewaterhousecoopers LLP, 227 F. Supp. 2d 263 (D.N.J.2002) (plaintiff failed to allege that auditor was aware of company’s fraudulent accounting forsales); In re Rent-Way Secs. Litig., 209 F. Supp. 2d 493 (W.D. Pa. 2002) (magnitude and natureof accounting fraud supported inference of scienter against corporate officers and outsideauditors); In re Cybershop.com Secs. Litig., 189 F. Supp. 214 (D.N.J. 2002) (dismissing claimsthat company failed to disclose composition of revenues; minimal sales of company stock by twoof three officer defendants was insufficient to establish scienter); Wilson v. Bernstock, 195 F.Supp. 2d 619 (D.N.J. 2002) (dismissing action alleging that executives failed to timely notifymarket of serious problems in new management information system, which caused company tofall under debt covenants; complaint did not sufficiently allege “motive” because existence ofincentive compensation systems and need to report positive results to lenders were too general);In re Honeywell Int’l Inc. Secs. Litig., 182 F. Supp. 2d 414 (D.N.J. 2002) (refusing to dismissclaims against CEO, COO and CFO of company that made misrepresentations following itsmerger, noting that misrepresentations were particularly flagrant and significant; fact thatdefendants were in positions to be fully informed of company’s affairs and transmittedmisrepresentations to analysts created inference of scienter; inference was supported bydefendants’ insider selling during class period); In re Providian Finan. Corp. Secs. Litig., 152 F.Supp. 2d 814 (E.D. Pa. 2001) (failure to disclose company’s illegal business practices statedsecurities fraud claim; scienter was sufficiently alleged because illegal practices were soextensive that individual defendants must have been aware of their nature); In re Reliance Secs.Litig., 91 F. Supp. 2d 706 (D. Del. 2000) (refusing to dismiss claims by shareholders whoobjected to failure of officers, directors and an outside accounting firm to disclose seriouslydeteriorating state of company’s loan portfolio; substantial inference of recklessness heldestablished by combination of GAAP violations, fact that loan losses were increasingsubstantially at same time that reserves were declining substantially, and fact that new chieffinancial officer identified problem quickly after taking office); In re Cendant Corp. Secs. Litig.,76 F. Supp. 2d 531, 536-38 (D.N.J. 1999) (permitting investment management firm to proceed43

with § 10(b) claims against company and two executives who assured plaintiff that originalannouncement of need for income restatement was accurate when, soon thereafter, company hadto substantially increase size of restatement; sufficient allegations of scienter found whereindividual defendants were aware of requests for very large transfers of money from mergerreserves into income statements, thereby exceeding the size of original restatement; court notedthat one of the insiders had sold all of his shares in the company before the original report wasissued); In re Tel-Save Secs. Litig., 1999 U.S. Dist. LEXIS 16800, at *16, 1999 WL 999427, Fed.Sec. L. Rep. (CCH) 90,693 (E.D. Pa. Oct. 19, 1999) ("After the [PSLRA], catch-all allegationsthat defendants stood to benefit from wrongdoing and had the opportunity to implement afraudulent scheme are no longer sufficient, because they do not state facts with particularity orgive rise to a strong inference of scienter ... a defendant's motive and opportunity to commitfraud must be clearly stated by the plaintiff"; denying securities fraud claims against officer ofcompany that disguised marketing expenses and artificially inflated financial statements;complaint alleged his direct participation in scheme and he had direct financial interest inpropping up stock price to better enable sale of his shares and use them as collateral for loan); Inre Cendant Corp. Secs. Litig., 60 F. Supp. 2d 354, 369 (D.N.J. 1999) (denying most of motion todismiss by defendants charged with omissions and misleading disclosures of accountingirregularities that later required substantial downward restatement of revenue; scienter heldsufficiently pled because individual defendants were company insiders privy to knowledge ofproblems and many of them engaged in substantial stock sales during class period; allegationsalso supported strong inference of reckless on part of accounting firm defendant); KenilworthPartners L.P. v. Cendant Corp., 59 F. Supp. 2d 417, 428 (D.N.J. 1999) (claims dismissedbecause complaint alleged little more than that corporate officer and director defendants "musthave known" of the true facts simply by virtue of their positions at company; "if the courtinferred scienter from mere fact of director's position, then 'executives of virtually everycorporation in the United States would be subject to fraud allegations'") (citation omitted).c. Other District Courts Follow AdvantaDistrict courts in other circuits have followed the Third Circuit’s formulation of thePSLRA’s scienter requirement. See, e.g., In re Engineering Animation Secs. Litig., 110 F. Supp.2d 1183 (S.D. Iowa 2000) (following Advanta); In re Spyglass, Inc. Secs. Litig., 1999 U.S. Dist.LEXIS 11382, at *20, 1999 WL 543197, Fed. Sec. L. Rep. (CCH) 90,607 (N.D. Ill. July 21,1999) ("[t]he scienter requirement can still be established by a motive and an opportunity tocommit fraud, or by establishing facts that constitute circumstantial evidence of reckless orconscious behavior"; "The change made by the PSLRA is that the complaint itself now mustallege particular facts supporting a strong inference of scienter as to each defendant."; holdingthat individual officer defendants' sale of 34% to 94% of their stockholdings during three-monthclass period was unusual enough to support inference of scienter) (citations omitted); Coates v.Heartland Wireless Comm., Inc., 55 F. Supp. 2d 628, 635 (N.D. Tex. 1999) (indicating that inthe absence of post-PSLRA guidance from the Fifth Circuit, it would follow Third Circuitapproach); Hartsell v. Source Media, Inc., 1999 U.S. Dist. LEXIS 13082, at *4, 1999 WL649645 (N.D. Tex. Aug. 24, 1999) (reiterating that "allegations of 'motive and opportunity' aresufficient to satisfy" scienter pleading requirement); RGB Eye Assocs., P.A. v. Physicians Res.Group, Inc., 1999 U.S. Dist. LEXIS 17665, at *25, 1999 WL 980801, Fed. Sec. L. Rep. (CCH) 90,711 (N.D. Tex. Oct. 28, 1999) (dismissing action brought by physicians against medical44

support company that misrepresented its abilities in order to win contract with plaintiffs;plaintiffs failed to allege "motive and opportunity" scienter because only motive asserted wasdefendants' general desire to preserve capital by offering stock to plaintiffs and this was toogeneral a motive to support scienter under PSLRA).4. Other Formulations Of The Scienter Pleading Requirementa. IntroductionSome courts hold that "motive facts can be considered in determining whether thecomplaint raises a strong inference of scienter, even though satisfaction of the motive test alonedoes not conclusively establish an inference of the required state of mind" under the PSLRA.McNamara v. Bre-X Minerals Ltd., 57 F. Supp. 2d 396, 411 (E.D. Tex. 1999) (collecting cases).b. Silicon Graphics: The Ninth Circuit's ApproachIn a district court opinion issued following enactment of the PSLRA, Judge Smith heldthat in order to state a private securities fraud claim, "plaintiffs must create a strong inference ofknowing or intentional misconduct," explaining that "[m]otive, opportunity, and non-deliberaterecklessness may provide some evidence of intentional wrongdoing, but are not alone sufficientto support scienter unless the totality of the circumstances creates a strong inference of fraud."Silicon Graphics, 970 F. Supp. at 757. Judge Zilly termed this the "Second Circuit plus" test fordetermining whether plaintiffs have adequately pled scienter. In re Boeing Secs. Litig., 40 F.Supp. 2d 1160, 1176 (W.D. Wash. 1998) (holding that knowing misstatements and defendants'motive to complete corporate merger were sufficient to establish a strong inference of scienter).Prior to the Ninth Circuit's Silicon Graphics decision, district courts within the circuitwere divided as to what allegations of scienter passed muster under the PSLRA. Compare In reAscend Comm. Sec. Litig., 1999 U.S. Dist. LEXIS 20716 (C.D. Cal. Feb. 2, 1999) (recognizingthat motive and opportunity method of pleading scienter is still appropriate, but finding plaintiffs'allegations that defendants wished to inflate company's stock prices too conclusory to suffice);Head v. Netmanage, Inc., 1998 U.S. Dist. LEXIS 20433, at *11-14, 1998 WL 917794, Fed. Sec.L. Rep. (CCH) 90,412 (N.D. Cal. Jan. 4, 1999) (allegations of insider trading held insufficientto establish scienter because they did not establish sales that were unusual or suspicious enough);Plevy v. Haggerty, 38 F. Supp. 2d 816, 834-35 (C.D. Cal. 1998) (shareholders failed toadequately allege scienter on part of corporate officers and directors; allegations that defendantswere motivated to issue misleading statements to cash in on artificially inflated stock pricesfailed to raise strong inference of scienter because plaintiffs failed to show that defendants' tradeswere unusual) with PETsMART, 61 F. Supp. 2d at 990 (recognizing that Second Circuit's "motiveand opportunity" test to plead scienter under PSLRA was still valid, but failing to determinewhether plaintiffs' allegations were sufficient because of other pleading deficiencies); Schlagal v.Learning Tree Int'l, Inc., 1998 U.S. Dist. LEXIS 20306, at *48-56, 1998 WL 1144581, Fed. Sec.L. Rep. (CCH) 90,403 (C.D. Cal. Dec. 23, 1998) (recognizing that Second Circuit standard forpleading scienter remained viable; allegations grounded on the boosting of executives' bonuscompensation and inflating corporation's stock price met "motive" test, and evidence of"conscious" or "reckless" behavior met by alleging stock sales shortly after positive45

announcements, violations of GAAP, and defendants' regular receipt of internal corporatereports); Marksman Partners, L.P. v. Chantal Pharmaceutical Corp., 1998 U.S. Dist. LEXIS12743, at *2-4 (C.D. Cal. Aug. 12, 1998) (refusing to dismiss § 10(b) claims brought againstcorporation alleged to have participated in ship-hold-and-return scheme aimed at fraudulentlyinflating stock price of related concern where it was alleged to have made knowingly falsestatements to securities analyst); In re Ancor Comms., Inc. Secs. Litig., 22 F. Supp. 2d 999, 1006(D. Minn. 1998) (failure to disclose product's incompatibility with another manufacturer'scomponent, combined with allegations of insider trading and GAAP violations, were sufficienteven under Silicon Graphics "conscious behavior" test).The Ninth Circuit adopted the most stringent pleading standard in In re Silicon Graphics,Inc. Secs. Litig., 183 F.3d 970 (9 th Cir.), rehearing denied, 195 F.3d 521 (9 th Cir. 1999) (enbanc), holding thata private securities plaintiff proceeding under the PSLRA must plead, in greatdetail, facts that constitute strong circumstantial evidence of deliberately recklessor conscious misconduct.... [A]lthough facts showing mere recklessness or amotive to commit fraud and opportunity to do so may provide some reasonableinference of intent, they are not sufficient to establish a strong inference ofdeliberate recklessness.183 F.3d at 974 (emphasis in original).The Silicon Graphics court's holding rested on the conclusion that Congress intended toelevate the pleading requirement above the Second Circuit standard requiring plaintiffs merely toprovide facts showing simple recklessness or a motive to commit fraud and opportunity to do so.Instead, as the Ninth Circuit held:In order to show a strong inference of deliberate recklessness, plaintiffs must statefacts that come closer to demonstrating intent, as opposed to mere motive andopportunity. Accordingly, we hold that particular facts giving rise to a stronginference of deliberate recklessness, at a minimum, is required to satisfy theheightened pleading standard under the PSLRA.Id. See also Livid Holdings, Ltd. v. Salomon Smith Barney, Inc., 403 F.3d 1050 (9 th Cir. 2005)(investor met heightened pleading standard for scienter by raising strong inference that promoteracted with requisite scienter); Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d1226 (9 th Cir. 2004) (investors’ allegations raised strong inference of scienter); In re Read-RiteCorp. Secs. Litig., 335 F.3d 832, 846 (9 th Cir. 2003) (same); Heliotrope Gen'l, Inc. v. Ford MotorCo., 189 F.3d 971, 980 (9 th Cir. 1999) (plaintiff's complaint did not "state facts that create astrong inference of the required degree of intent") (citing Silicon Graphics). See generally BrentWilson, Comment, Pleading Versus Proving Scienter Under the Private Securities LitigationReform Act of 1995 in the Ninth Circuit After In re Silicon Graphics and Howard v. Everex:Meet the Pleading Standard and the Fat Lady Has Already Sung, 38 WILLAMETTE L. REV. 321(2002); Erin Brady, Comment, Determining the Proper Pleading Standard Under the PrivateSecurities Litigation Reform Act of 1995 After In re Silicon Graphics, 28 PEPP. L. REV. 471(2001); Aron Hansen, Comment, The Aftermath of Silicon Graphics: Pleading Scienter in46

Securities Fraud Litigation, 34 U.C. DAVIS L. REV. 769 (2001); Bruce Cannon Gibney,Comment, The End of the Unbearable Lightness of Pleading: Scienter After Silicon Graphics,48 UCLA L. REV. 973 (2001); Symposium, Securities Fraud Litigation After Silicon Graphics, 7SECURITIES REFORM ACT LITIG. RPTR. 798 (Aug.-Sept. 1999).In Ronconi v. Larkin, 253 F.3d 423 (9 th Cir. 2001), the defendant officers and directors ofa corporation merged with another company which was losing money. Plaintiffs brought a classaction suit on behalf of shareholders, who alleged that defendants repeatedly lied to the market,through stock analysts and press releases, misleading the stock market into overvaluing theirstock based on a false impression that the merger was going well. Affirming the district court’sdismissal of the case, the Ninth Circuit found that plaintiffs' allegations simply did not state a setof facts raising a strong inference that any statements made by defendants were intentionallyfalse, misleading, or made with deliberate recklessness because the complaint did not containallegations of specific contemporaneous statements or conditions that demonstrated thedeliberately misleading nature of the statements when they were made. Further, none of theevidence presented by plaintiffs raised raise a strong inference of intentional or deliberatelyreckless falsity or deception on the part of defendants. In In re The Vantive Corp., 283 F.3d1079 (9 th Cir. 2002), the Ninth Circuit affirmed the dismissal with prejudice of a complaintalleging fraud over a 15-month open market class period, holding that plaintiffs failed to pleadeither falsity or scienter with the specificity demanded by the PSLRA, notwithstanding insidersales by the individual defendants of 38% of their Vantive stockholdings for proceeds totaling$38 million during the alleged class period. In Lipton v. PathoGenesis Corp., 284 F.3d 1027 (9 thCir. 2002), the court affirmed dismissal with prejudice of a complaint based on a stock dropcaused by an announcement of reduced sales expectations. The Ninth Circuit held that under theSilicon Graphics standard, plaintiffs failed to plead scienter with requisite specificity becausethey did not specify the exact contents of reports allegedly seen by defendants; the court refusedto infer scienter from allegations that the company’s CEO made his first-ever stock sales duringthe period of the alleged fraud, noting that the number of shares he sold was tiny both incomparison to the public float and his own shareholdings. In DSAM Global Fund v. AltrisSoftware, Inc., 288 F.3d 385 (9 th Cir. 2002), the Ninth Circuit agreed with the district court thatthe shareholders' allegations did not establish a strong circumstantial case of deliberaterecklessness or conscious misconduct as was required in a securities fraud case. The court foundthat the shareholders had failed to allege any facts to establish that the auditor knew or must havebeen aware of the improper revenue recognition, intentionally or knowingly falsified thefinancial statements, or that the audit was such an extreme departure from reasonable accountingpractice that the auditor knew or had to have known that its conclusions would mislead investors.In No. 84 Employer-Teamster Joint Council Pension Trust Fund v. America West Holding Corp.,320 F.3d 920 (9 th Cir. 2003), the Ninth Circuit reversed dismissal of a shareholder complaintalleging that airline officers made misleading statements while aware of impending costlyregulatory sanctions. Although the market did not react immediately to the imposition of thosesanctions, that did not disprove materiality, and the market did react when the full costimplications of the penalty was announced. Scienter was established in part by the defendants’insider trading. See also In re Copper Mtn. Secs. Litig., 311 F. Supp. 2d 857 (N.D. Cal. 2004);In re Nike, Inc. Secs. Litig., 181 F. Supp. 2d 1160 (D. Or. 2002) (dismissing complaint allegingthat corporate officers failed to report serious inventory management problems andsimultaneously projected growth in earnings per share; while complaint had sufficient detailabout the nature of the problems and the mid-level managers’ awareness, it lacked necessary47

detail about the officer defendants’ knowledge of the problems); In re NorthPoint Comm. Group,Inc., 184 F. Supp. 2d 991 (N.D. Cal. 2001) (dismissing claims that defendants made misleadingpositive statements and recognized revenue that proved uncollectible; while complaintreferenced numerous confidential witnesses, their accounts lacked details and none of themoffered evidence that defendants were aware that revenue was uncollectible at time of itsrecognition; insider trading was only small percentage of defendants’ shareholdings and couldnot support inference of scienter).Several district courts within the Ninth Circuit have applied this stringent standard andnevertheless found plaintiff's allegations to be sufficient. See In re Nat’l Golf Props. Secs. Litig.,2003 U.S. Dist. LEXIS 4321, 2003 WL 23018761 (C.D. Cal. Mar. 20, 2003) (holding thatcomplaint adequately alleged false statements and material omissions, and facts giving rise to astrong inference of scienter); In re Amylin Pharms., Inc. Secs. Litig., 2002 U.S. Dist. LEXIS19481, 2002 WL 31520051, Fed. Sec. L. Rep. (CCH) 92,007 (S.D. Cal. Oct. 9, 2002)(shareholders’ allegations of false and misleading statements concerning success of company’sclinical trials of potential diabetes treatment were made with sufficient particularity), vacated by,in part, amended by, reconsideration denied, 2003 U.S. Dist. LEXIS 7667, 2003 WL 21500525(S.D. Cal. May 1, 2003); Marks v. Simulation Sciences, 2000 U.S. Dist. LEXIS 4536, at *12,2000 WL 33115589, Fed. Sec. L. Rep. (CCH) 90,993 (C.D. Cal. Feb. 28, 2000) (plaintiffssufficiently pled specific facts regarding fraudulent accounting practices to survive defendantcompany’s motion to dismiss); In re Imperial Credit Indus., Inc. Secs. Litig., 2000 U.S. Dist.LEXIS 2340, at *5-9, 2000 WL 1049320, Fed. Sec. L. Rep. (CCH) 91,024 (C.D. Cal. Feb. 22,2000) (complaint pled defendants' scienter with sufficient particularity by "point[ing] tonumerous e-mails and internal reports that raise a strong inference that Defendants knew [theirpublic statements] were false or misleading at the time they were made"; "inference of scienter"was supported by plaintiffs' allegations of motive: "Defendants had a strong incentive to inflateSPF's financial status because they were shopping SPF for a buyer and sought to attract a largebid"; "[a]lthough evidence of motive is not sufficient to support an inference of scienter" underthe Ninth Circuit's decision in Silicon Graphics, "it is still probative to the inquiry"); In re SonusPharmaceuticals, Inc. Secs. Litig., 1999 U.S. Dist. LEXIS 11517, at *3-4, 1999 WL 1209500,Fed. Sec. L. Rep. (CCH) 90,637 (W.D. Wash. July 21, 1999) (sustaining plaintiffs' amendedcomplaint against defendants' motion to dismiss, holding that allegations that Sonus failed toreport FDA inspections revealing problems with pending approval of its drug showed stronginference that defendants acted with required state of mind).In In re Southern Pacific Funding Corp. Secs. Litig., 83 F. Supp. 2d 1172 (D. Or. 1999),Judge Marsh offered an extensive discussion of the Ninth Circuit's opinion in Silicon Graphics,explaining first the concept of "deliberate recklessness":I find that the Silicon court raised the substantive standard applicable to § 10(b)claims to that of deliberate recklessness and that "deliberate recklessness"constitutes a higher degree of recklessness than previously contemplated. Ifurther find that "deliberate recklessness," means that the defendants must haveacted with full knowledge of the risks of the consequences of their actions in amanner akin to that of a driver that attempts to speed across railroad tracks infront of a rapidly approaching and clearly visible oncoming train. This48

formulation takes into account the level of risk as measured against the severityof the consequences and the knowledge of the defendant of both factors.Id. at 1177. The court also found that "materiality" and "factual context" are "critical factors inexamining the adequacy of pleading scienter." Id. As Judge Marsh explained:If a corporate president receives a report that his largest factory has burned to theground and nevertheless attends a stock holder meeting and publicly claims thatthere will be no slow down in a production schedule, the degree of materiality ofthe omission must have a bearing upon just how wrong his public statement wasat the time. The greater the materiality, the greater inference of scienter. Thus,while motive and opportunity are insufficient to give rise to a strong inference ofscienter standing alone, motive and opportunity coupled with highly materialmisrepresentations or omissions may well satisfy the standard. It is one thing toignore reports of potential bad weather; it is quite another to set sail in the face ofa storm.Id. at 1177-78. Finding that plaintiffs had met the heightened particularity requirement of thePSLRA, Judge Marsh analyzed the allegations of the complaint:Overall, the complaint paints a picture of a group of corporate insiders who knewthat the entire mortgage lending industry was facing significant hardships due tothe drop in lending rates. The complaint further reveals that the defendantsattempted to distinguish SPF from others in the industry by assuring investors thatSPF was utilizing particularly conservative assumptions relative to pre-paymentrates and delinquencies such that the general industry downturn should not haveadversely affected SPF. In spite of these assurances, the complaint alleges thatdefendants were aware, over a lengthy period, of the fact that their pre-paymentand delinquency assumptions were grossly inaccurate and that these inaccuraciesthreatened the financial stability of the company. Board meeting minutes and e-mail reveal that defendants were aware of the seriousness of the situation SPFfaces. I find that these allegations satisfy the "deliberate recklessness" pleadingstandard set forth in Silicon [Graphics]. If proven, the facts alleged support afinding that the defendants knew that they were driving in front of a speedingfreight train and that there was a high likelihood of getting hit.Id. at 1178-79 (emphasis added).In SEC v. Dain Rauscher, Inc., 254 F.3d 852 (9 th Cir. 2001), where the Ninth Circuitreversed a dismissal of an SEC action brought against an investment banker that allegedlyparticipated as an underwriter in Orange County’s too-risky investment strategy, resulting in thecounty’s bankruptcy and its consequent defaults on bonds used to finance the strategy, the courtdefined scienter without reference to Silicon Graphics. The court stated that “[s]cienter issatisfied by recklessness.” Id. (citing Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69(9 th Cir. 1990) (en banc)). Whether this opinion signals an abandonment of the stringentpleading standard stated in Silicon Graphics remains to be seen.49

c. The Intermediate Standard Followed in the First, Fourth, Fifth,Sixth, Eighth, Tenth and Eleventh CircuitsIn contrast to the approach taken in the Second and Third Circuits, other appellate courtshave held that alleging defendants' "motive and opportunity" is no longer sufficient to pleadscienter, reasoning that the PSLRA was enacted to heighten pleading standards for securitiesfraud claims. In one case, In re Comshare, Inc. Secs. Litig., 183 F.3d 542, 549-51 (6th Cir.1999), the Sixth Circuit held that under the PSLRA, plaintiffs may plead scienter by allegingfacts giving rise to strong inference of recklessness, but not by alleging facts merely establishingthat defendant had motive and opportunity to commit securities fraud. Accord In re PrisonRealty Sec. Litig., 117 F. Supp. 2d 681 (M.D. Tenn. 2000) ("Defendants' alleged knowledge offacts that contradicted public statements, in combination with the proximity in time between thealleged misrepresentations and the disclosure ... are enough to create a strong inference ofscienter"). See also Phycor, 2000 U.S. Dist. LEXIS 2218, at *12 (amended complaint "allegessufficient circumstantial evidence of knowing or reckless misconduct to satisfy scienterrequirement ... Defendants' alleged knowledge of facts that contradict public statements, incombination with the alleged insider sales at pivotal times and in unusual amounts, are enough tocreate a strong inference of scienter"); Hines v. ESC Strategic Funds, Inc., 1999 U.S. Dist.LEXIS 15790, at *31-32, 1999 WL 1705503, Fed. Sec. L. Rep. (CCH) 90,684 (M.D. Tenn.Sept. 17, 1999) (applying Comshare standard). Other courts followed the approach taken by theSixth Circuit in Comshare. See In re Ceridian Corp. Secs. Litig., 1999 U.S. Dist. LEXIS 15611,at *38-39 (D. Minn. Mar. 29, 1999); cf. New England Health Care Employees Pension Fund v.Fruit of the Loom, Inc., 1999 U.S. Dist. LEXIS 12999, at *23-27, 1999 WL 33295037 (W.D. Ky.Aug. 18, 1999) (holding that plaintiffs' allegations regarding defendants' scienter satisfiedComshare test).In Helwig v. Vencor, Inc., 251 F.3d 540 (6 th Cir. 2001), however, by a 7-6 en bancdecision the Sixth Circuit rejected the Ninth Circuit’s holding in Silicon Graphics that“recklessness” is insufficient to establish scienter under Rule 10b-5. The Sixth Circuit adoptedthe Second Circuit’s view of the PSLRA’s pleading standard for scienter (as elucidated inNovak) thereby representing a shift from the prior perception that the Sixth Circuit had rejected“motive and opportunity” facts as inadequate. See generally Hugh Beck, Comment,Determining the Materiality of Earnings Forecasts Under the Private Securities LitigationReform Act in Helwig v. Vencor, 2002 B.Y.U.L. REV. 111 (2002). In Bovee v. Coopers &Lybrand C.P.A., 272 F.3d 356 (6 th Cir. 2001), the Sixth Circuit reversed a district court’sdismissal of securities fraud claims brought against an accounting firm because the lower courtfailed to consider the amended complaint that laid out additional allegations of recklessness. Theallegations included the fact that the accounting firm’s internal documents acknowledged therisks that later led to the client’s bankruptcy. See also PR Diamonds, Inc. v. Chandler, 364 F.3d671, 683-93 (6 th Cir. 2004) (affirming dismissal of securities fraud complaint for failure to allegethat individual defendants acted with scienter); Miller v. Champion Enterprises, Inc., 346 F.3d660, 676-79 (6 th Cir. 2003) (same).In City of Philadelphia v. Fleming Cos., 264 F.3d 1245 (10 th Cir. 2001), the TenthCircuit held that while allegations of defendants’ “motive” and “opportunity” to commitsecurities fraud are relevant to a finding of scienter, “they do not constitute a separate,alternative method of pleading scienter.” Id. at 1261. Rather, “courts must look to the totality of50

the pleadings to determine whether the plaintiffs’ allegations permit a strong inference offraudulent intent.” Id. at 1262. (emphasis added). The Tenth Circuit affirmed dismissal of ashareholder complaint arising out of the company’s failure to disclose a pending lawsuit thateventually resulted in a substantial damages award against the company. The court found thatthe complaint lacked allegations that the individual defendants were aware of the lawsuit or itspotential materiality during much of the class period, and the damages alleged in the underlyinglitigation did not exceed the threshold level at which the SEC directs disclosure. In fact, as soonas the requested damages were amended upward by a significant amount, the company disclosedthe litigation. Thus, in the Tenth Circuit, allegations of defendants’ “motive” and “opportunity”may bear on the trial courts’ scienter analysis, but such allegations cannot, by themselves, createa “strong inference” of scienter. Id.; see also Pirraglia v. Novell, Inc., 339 F.3d 1182, 1188-94(10 th Cir. 2003) (reversing dismissal of securities fraud claims where plaintiffs alleged withsufficient detail improper revenue recognition practices); In re Sun Healthcare Group, Inc. Secs.Litig., 181 F. Supp. 2d 1283, 1294 (D.N.M. 2002) (explicating Tenth Circuit test for pleadingscienter). See generally Charles F. Hart, Interpreting the Heightened Pleading of the ScienterRequirement in Private Securities Fraud Litigation: The Tenth Circuit Takes the MiddleGround, 80 DENV. U.L. REV. 577 (2003).In Nathenson v. Zonagen, Inc., 267 F.3d 400, 410-11 (5 th Cir. 2001), the Fifth Circuitheld that scienter can be alleged by pleading facts that give rise to a strong inference ofrecklessness or conscious misconduct, but that allegations of “motive and opportunity,” standingalone, fail to meet the pleading requirement. In that case, the Fifth Circuit reversed dismissal ofa securities fraud case regarding the company’s patent coverage. The company had a single drugthat was critical to its success and stated that it had a patent on the drug; in fact, the patentcovered only a method of use for the drug that was not even the same method to be marketed bythe company. Given the company’s small size and the significance of the drug, it was reasonableto infer scienter on the part of the CEO, though not the outside directors. See also Plotkin v.Ipaxess, 2005 WL 926974 (5 th Cir. Apr. 21, 2005) (investor adequately pled facts giving rise tostrong inference of company defendants’ fraudulent intent in issuing false or materiallymisleading press releases); R2 Investments LDC v. Phillips, 401 F.3d 638 (5 th Cir. 2005)(investor failed to state scienter element, given lack of motive and other factors); Rosenzweig v.Azurix Corp., 332 F.3d 854, 867-68 (5 th Cir. 2003) (affirming dismissal of securities fraud actionfor failure to allege defendants’ scienter); Berger v. Beletic, 248 F. Supp. 2d 597 (N.D. Tex.2003) (dismissing complaint that insufficiently alleged scienter on part of corporate CEO);Haack v. Max Internet Comm., Inc., 2002 U.S. Dist. LEXIS 5652, 2002 WL 511514, Fed. Sec.L. Rep. (CCH) 91,763 (N.D. Tex. Apr. 2, 2002) (allegations of scienter held sufficient in lightof restatement of revenues downward by 98%).In Abrams v. Baker Hughes, Inc., 292 F.2d 424, 432 (5 th Cir. 2002), the Fifth Circuitaffirmed the district court’s holding that the investors' complaint failed to adequately allegeparticularized facts to establish the necessary element of scienter. The appellate court held thatthe investors' complaint did not allege that defendants knew about the internal control problems,only that they should have known, or that their lack of knowledge based on the their corporatepositions demonstrated recklessness. The investors' pleading of scienter could not rest on theinference that defendants must have been aware of the misstatement based on their positionswithin the company. Further, the Fifth Circuit found that the investors' allegations regardingnon-specific internal reports were also inadequate, reasoning that unsupported general claims51

about the existence of confidential corporate reports that revealed information contrary toreported accounts were insufficient to survive the motion to dismiss. Moreover, the appellatecourt found that the investors had not pointed to any particular reports or information that wasavailable to defendants before the announced financial restatements that were contrary to therestatements. See also Goldstein v. MCI Worldcom, 340 F.3d 238, 249-54 (5 th Cir. 2003)(affirming dismissal for failure to adequately plead defendants’ scienter).In Bryant, 25 F. Supp. 2d at 1379-81, Judge Fitzpatrick of the Middle District of Georgiaadopted the Second Circuit's standard for pleading scienter, refusing to dismiss § 10(b) claimsagainst a restaurant company that was alleged to have fraudulently inflated the price of its stock.The court held that plaintiffs' allegations raised a sufficient inference of scienter where theycharged that the individual defendants' knowledge of the corporation's problems were at oddswith the company's public statements. Moreover, three of the individual defendants had soldsubstantial portions of their stockholdings. The district court, however, coupled its rulings infavor of plaintiffs with a recommendation that the Eleventh Circuit permit an immediateinterlocutory appeal of the decision. Accordingly, the Eleventh Circuit addressed the scienterissue in Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1283, 1285 (11th Cir. 1999). The courtstated that "we are in basic agreement with the Sixth Circuit," and it "reject[ed] the notion thatallegations of motive and opportunity to commit fraud, standing alone, are sufficient to establishscienter in this Circuit." See also Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015 (11 th Cir.2004) (factual allegations may be aggregated to infer scienter and must be inferred for eachdefendant with respect to each violation); Theoharous v. Fong, 256 F.3d 1219 (11 th Cir. 2001)(plaintiff must allege facts “giving rise to a strong inference that the defendant acted ‘in aseverely reckless manner’”) (quoting Bryant); Holmes v. Baker, 166 F. Supp. 2d 1362 (S.D. Fla.2001) (same). See also In re Hamilton Bankcorp, Inc. Secs. Litig., 194 F. Supp. 2d 1353 (S.D.Fla. 2002) (magnitude of banking fraud, among other factors, created sufficient inference ofscienter); In re World Access, Inc. Secs. Litig., 119 F. Supp. 2d 1348 (N.D. Ga. 2000) (plaintiffsmet pleading threshold by alleging eight identifiable problems associated with a switch identifiedin defendants’ press release, averring that defendants’ financial statements were false ormisleading because they did not make appropriate accounting entries to reflect non-paymentsarising from disputes about the switches, and by alleging that defendants routinely employed“bill and hold” practices); In re Physician Corp. of America Secs. Litig., 50 F. Supp. 2d 1304(S.D. Fla. 1999) ("We disagree ... that 'motive and opportunity' evidence alone will meet thepleading requirements in the Eleventh Circuit."); Malin v. Ivax Corp., 17 F. Supp. 2d 1345,1357-58 (S.D. Fla. 1998) (ruling that allegations regarding defendants' motive and opportunitydo not suffice to allege scienter under PSLRA).In Florida State Board of Admin. v. Green Tree Finan. Corp., 270 F.3d 645 (8 th Cir.2001), the Eighth Circuit implicitly joined the Fifth, Sixth, Tenth and Eleventh Circuits,reversing the grant of a motion to dismiss and finding that plaintiffs met the PSLRA’s scienterrequirement by alleging that the executives of the defendant financing company usedunreasonable assumptions in their gain-on-sale accounting that resulted in an overvaluation ofthe company’s assets and an overstatement of its earnings. The court’s decision seemingly turnedon the unusual compensation contract for Green Tree’s CEO, under which he was to be awardeda percentage of the company’s pre-tax income. This contract was set to expire in 1996 and, inthat same year, resulted in the CEO being the highest paid U.S. executive, receiving $102million. However, in Kushner v. Beverly Enterprises, 317 F.3d 820 (8 th Cir. 2003), the Eighth52

Circuit affirmed the dismissal of a securities fraud action brought against a health care companythat violated Medicare, due to the failure to plead scienter. The court found that there were nospecific allegations of the defendants’ awareness of the violations at the time when they madecontrary statements. The “sheer size” of the violations would not establish the necessary stronginference of scienter, and the court noted that the violations may have involved only a fewindividuals at a regional subsidiary. The Eighth Circuit held that allegations that defendants“designed and implemented” improper accounting policies failed to state a claim for securitiesfraud in the absence of “allegations of specific facts demonstrating how the defendants knew ofthe scheme at the time they made their statements of compliance, that they knew the financialstatements overrepresented the company’s true earnings, or that they were aware of a GAAPviolation and disregarded it. . . . Rote allegations that the defendants knowingly made falsestatements of material fact fail to satisfy the heightened pleading standard of the [PSLRA].” Id.at 827-28 (citation and internal quotations omitted). In re K-tel Int’l, Inc. Secs. Litig., 300 F.3d881 (8 th Cir. 2002) (affirming dismissal of complaint alleging that defendants waited one year todisclose a subsidiary’s known losses and failed to disclose letter threatening NASDAQ delisting,while selling a high percentage of their stockholdings in the company; complaint failed to allegeeither material misrepresentations or scienter with requisite particularity); In re Navarre Corp.Secs. Litig., 299 F.3d 735 (8 th Cir. 2002) (affirming dismissal of shareholder complaint forfailing to plead material misstatements sufficiently; while plaintiffs alleged improper recognitionand false hyping of an IPO for corporate subsidiary, complaint did not contain particularizedfacts about the transactions or reasons to conclude that the statements were false when made).Prior to the PSLRA, the First Circuit required securities fraud plaintiffs to allege"specific facts that make it reasonable to believe that defendant knew that a statement wasmaterially false or misleading." Greenstone v. Cambex Corp., 975 F.2d 22, 25 (1st Cir. 1992).Following the statute's enactment, the court asserted that "we do not interpret the [PSLRA]standard to differ from that which this court has historically applied." Maldonado v. Dominguez,137 F.3d 1, 9 n.5 (1st Cir. 1998) (citing Greenstone); see also Peritus, 52 F. Supp. 2d at 219. InGreebel v. FTP Software, Inc., 194 F.3d 185 (1st Cir. 1999), however, the First Circuit generallyfollowed the Sixth Circuit's approach, offering an extensive analysis of the PSLRA's statutorylanguage and legislative history, id. at 191-97, before adopting the following standard forpleading scienter:Our view of the [PSLRA] is thus close to that articulated by the SixthCircuit [in Comshare]....Without adopting any pleading litany of motive and opportunity, we rejectdefendants' argument that facts showing motive and opportunity can never beenough to permit the drawing of a strong inference of scienter. But ... merelypleading motive and opportunity, regardless of the strength of the inferences to bedrawn of scienter, is not enough. [The Second, Third and Fifth] [C]ircuits haveinterpreted the PSLRA as permitting use of motive and opportunity type pleadingif it raises a strong inference. Like the Third Circuit, we caution that "catch-allallegations that defendants stood to benefit from wrongdoing and had theopportunity to implement a fraudulent scheme are [not] sufficient."53

Similarly, the PSLRA neither prohibits nor endorses the pleading ofinsider trading as evidence of scienter, but requires that the evidence meet the"strong inference" standard. Unusual trading or trading at suspicious times or insuspicious amounts by corporate insiders has long been recognized as probativeof scienter. The vitality of the inference to be drawn depends on the facts, andcan range from marginal to strong. This continues to be true in litigation after theeffective date of the PSLRA. Indeed, ... we still think today, that allegations ofunusual insider trading by a defendant with access to material non-publicinformation can support a strong inference of scienter. We similarly caution thatmere pleading of insider trading, without regard to either context or the strengthof the inferences to be drawn, is not enough. At a minimum, the trading must bein a context where defendants have incentives to withhold material, non-publicinformation, and it must be unusual, well beyond the normal patterns of tradingby those defendants.194 F.3d at 197-98 (footnotes and citations omitted) (quoting Advanta, 180 F.3d at 535). Seealso Aldridge v. A.T. Cross Corp., 284 F.3d 72 (1 st Cir. 2002) (reversing dismissal of shareholderclass action charging that company misleadingly frontloaded sales of new product and failed todisclose associated marketing practices; scienter was established through circumstantialevidence, and because individual defendant corporate officers knew that their continuedemployment depended on success of product); In re Tyco Int’l, Ltd. Secs. Litig., 185 F. Supp. 2d102, 112-15 (D.N.H. 2002) (investors’ complaint lacked sufficient detail to satisfy PSLRA;plaintiffs failed to identify which accounting reserves were overstated, how much they wereoverstated, how those overstatements defrauded the market, and how defendants prompted theoverstatements); Gelfer v. Pegasystems, Inc., 2000 U.S. Dist. LEXIS 834, at *11-25, Fed. Sec. L.Rep. (CCH) 90,749 (D. Mass. Jan. 27, 2000) (denying motion to dismiss securities fraudclaims complaining of series of income and revenue overstatements that had to be correctedthrough substantial restatements; court found that continuance of similar problems, magnitudeand frequency of need for restatements, warnings that company received from its outsideauditors, and departure from internal accounting standards and GAAP combined to createnecessary inference of recklessness).Most recently, the Fourth Circuit followed the approach of the Eighth Circuit, SixthCircuit, and First Circuit, holding that “courts should not restrict their scienter inquiry byfocusing on specific categories of facts, such as those relating to motive and opportunity, butinstead should examine all of the allegations in each case to determine whether they collectivelyestablish a strong inference of scienter. And, while particular facts demonstrating a motive andopportunity to commit fraud (or lack of such facts) may be relevant to the scienter inquiry, theweight accorded to those facts should depend on the circumstances of each case.” Ottmann v.Hanger Orthopedic Group, 353 F.3d 338, 345-46 (4 th Cir. 2003).VII. ACCOUNTING FRAUD: PLEADING SCIENTER UNDER THEPSLRAA. The SEC’s Focus On “Accounting Fraud”54

In response to the erosion in the quality of financial reporting, several years ago the SECcommenced an intensive initiative to challenge what it deems "accounting hocus pocus." Suchpractices, which include the immediate write-off of a huge percentage of an acquired company'svalue as a charge to in-process research and development ("IPR&D"), and avoiding futureearnings degradation from the amortization of goodwill, manipulate earnings revenue anddiminish the integrity and reliability of financial reporting in the U.S. securities markets. SeeRemarks by SEC Chairman Arthur Levitt made at the Center for Law and Business at New YorkUniversity (Sept. 28, 1998), available at andcomment letter submitted by SEC Chief Accountant Lynn Turner to the American Institute ofCertified Public Accountants (Oct. 9, 1998).The SEC's expressed concern is understandable: During 1997-2001, at least $50 billionin market value was wiped out as a result of accounting errors (based upon the decline in stockprices following disclosures by more than a dozen companies, including:Oxford Health Plans: market value lost $4.25 billionSunbeam: market value lost $3.75 billionGreen Tree Financial: market value lost $1.62 billionPhilip Services: market value lost $1.42 billionAccording to a recent study published by accounting firm Arthur Andersen, over a recentfour-year period nearly one in five accounting restatements – red flags for potential misconduct –have been by companies in California. During the same four-year period, the total number ofrestatements has nearly doubled. According to the Arthur Andersen study of accountingrestatements from 1997 to 2001, 27% of the restatements nationwide were filed in the softwareand computer industries. See Karl Schoenberger, When the Numbers Just Don’t Add Up, N.Y.TIMES, Aug. 19, 2001.The most visible indicator of improper accounting – and source of new[SEC] investigations – is the growing number of restated financial reports.Restatements ballooned to 233 last year, twice the number in 1997, according to arecent study by Arthur Andersen LLP. Of those, only 9% resulted from newaccounting methods required by the SEC.Michael Schroeder, SEC List of Accounting-Fraud Probes Grows, WALL ST. J., July 6, 2001.See also Jonathan C. Dickey et al., SEC Investigations and Enforcement Actions: An Overviewand Discussion of Recent Trends in Accounting Fraud Investigations, 12 SECURITIES REFORMACT LITIG. RPTR. 701 (Feb. 2002) (analyzing SEC enforcement actions filed during 1999-2001).Financial Executives International (FEI), which studies accounting issues, reported in theSpring of 2001 that there had been 464 cases of financial statements being restated during theprevious three years. That’s more than all restatements during the previous seven years. MattKrantz & Greg Farrell, Fuzzy accounting raises flags, usatoday.com, June 22, 2001. FEI saysthat more than $31.2 billion in market value was wiped out following earnings restatements in2000 alone. Id.55

A recent study into financial restatements announced that the number of companieschanging prior year’s financial statements due to accounting errors increased to a record 330 in2002. See Huron Consulting Group, An Analysis of Restatement Matters: Rules, Errors, Ethics,For the Five Years Ended December 31, 2002 (Jan. 21, 2003). During the same period, thenumber of restated audited annual financial statements increased to 183 from just 43 auditedannual restatements in 2001. Id. The Huron Consulting Group identified three primary causesfor the accounting errors: Problems applying accounting rules; human and system errors; andfraudulent behavior. Id. The number of public companies that restated their previously releasedfinancial statements due to accounting errors totaled 323 in 2003, a slight decline compared tothe 330 restatement filings identified in 2002, and up from 270 in 2001 and 233 in 2000. SeeHuron Consulting Group, 2003 Annual Review of Financial Reporting Matters 4 (2004).Shareholder suits alleged significant accounting fraud in approximately 65% of the 224federal securities cases filed during 2002. Slightly less than one-half of these cases allege thatdefendants increased total sales either through the fictitious or artificial creation of revenue or themature recognition of revenue. Approximately 30% of the accounting fraud complaints allegeinsider trading by the companies’ officers and directors. 34% of the complaints alleged that theissuer restated at least one financial report previously filed with the SEC. See Paul R. Bessette etal., Accounting Fraud in 2002: Lessons Learned, 15 SECURITIES REFORM ACT LITIG. RPTR. 8, 8-9 (Apr. 2003).TEN NOTABLE ACCOUNTING RESTATEMENTS(1997-1998)Mercury Finance (April 1997)Auto finance companyRestated 1996 results: In Jan. 1997, initially reportedearnings of $120.7 million; Apr. 1997 "update" anticipated1996 loss of $48-$55 million1995 results changed from net income of 57 cents per share to43 cents per shareCentennial Technologies (June 1997)$2.64 billion market value lostMaker of computer memory cardsRestated results for 14 quarters through end of 1996$28.1 million loss for restated period, versus aggregate netincome of $12.1 reported for 42-month periodRestatement resulted from audit following dismissal andarrest of founder and ex-CEO on securities fraud chargesRestatement showed that company never had profitable56

quarter during period in which it often reported recordearnings growthStock was top-performing issue on NYSE for 1996Informix (Nov. 1997)Securities fraud claims settled for $24 millionDatabase software makerRestated 14 quarters of financial statements due to accountingirregularities1996 reported net income of $97.8 million restated to net lossof $73.6 millionCompany recognized revenue from software that was shippedto distributors, even though products were never sold throughto final customersDisclosed that federal regulators were examining itsbookkeeping practicesMedaphis (Nov. 1997)Securities fraud claims settled for $142 millionProvider of business management and software services todoctors and hospitalsRestated earnings for three and one-half fiscal yearsSecurities fraud claims settled for $75 millionSybase (Jan. 1998)Database software companyRestated results for first three quarters of 1997Reported profit of $5.2 million changed to loss of $25.5millionFine Host (Feb. 1998)Adjustments made for improper revenue-boosting tactics atJapanese subsidiaryFood concession operatorRestated financial results for four years, wiping out all of itsearnings during that time and posting losses due to"accounting irregularities"Wall Street Journal reported: "In revising its results57

downward, Fine Host cited a failure to properly recordexpenses and a tendency to prematurely record profit."Stock delisted by NASDAQWaste Management (Apr. 1998)$244 million market value lostTrash-hauling companyRestated four years of financial results (1992-1996)Restated earnings downward by $1.32 billionSEC reportedly investigating Arthur Andersen audit offinancial statements$4.76 billion market value lostVesta Insurance (Aug. 1998)Securities fraud claims settled for $677 millionProperty and casualty insurerEarnings were restated for four years due to improperaccounting practicesRestatement lowered net income by $72.4 millionLivent (Aug. 1998)$874 million market value lostTheatrical production companyAnnounced it would restate earnings because of "seriousirregularities" in its financial recordsCompany said it was "virtually" certain it would restatefinancial results back to 1996 due to "millions of dollars" inirregularitiesSubsequent bankruptcy filingCendant (Aug. 1998)$113 market value lostProduct of $14 billion merger in late 1997 between HFS(franchise operator) and CUC Int'l (membership cluboperator)Announced it had uncovered substantial accountingirregularities in former CUC business unit58

Revealed that CUC had been padding its results since 1995,creating more than $500 million of imaginary profits to meetWall Street "expectations"$100 million restatement of reported income caused stockprice to plummet by 46% -- more than $17 per share -- in oneday, vaporizing $15 billion of shareholder equity$3.525 billion settlement of securities fraud claimsIn 2000, Virginia-based MicroStrategy, Inc.'s common stock price fell $140 (to $86.75), adecline of 62%, after the company reported that its auditors had forced it to defer about onequarterof the $205.4 million in revenue it had reported for 1999. The plunge wiped out nearly$12 billion in market value for the company. See Floyd Norris, MicroStrategy Shares PlungeOn Restatement, N.Y. TIMES, Mar. 21, 2000, at C1; Greg Miller, Software Stock Falls 62% AfterSales Revision, L.A. TIMES, Mar. 21, 2000, at C1.We must also consider the ongoing revelations about Enron Corp., a pioneer of energytrading, a way of using financial techniques of trading forward commitments in natural gas andelectricity to establish future prices on long-term supply contracts. As the business boomed,Enron’s reported revenue soared, from $20 billion in 1997 to $100 billion in 2000. Through thefirst three quarters of 2001, the firm was on course to exceed $200 billion in revenue. But inOctober 2001, Enron announced that it had lost more than $600 million in the third quarter, andthat it needed to reduce shareholder equity by $1.2 billion due to certain undisclosed transactionswith one of its partnerships. Then, on November 8, 2001, Enron restated its accounts back to1997. The restatements resulted in a reduction of reported profit by more $586 million. JamesFlanigan, Enron’s Troubles Could Spur Securities Reform, L.A. TIMES, Nov. 25, 2001. InDecember 2001, Enron filed the largest corporate bankruptcy in U.S. history.Disclosures about the “culture” of fraud at Cendant Corp. (the successor to CUCInternational) made clear that for more than ten years (from approximately 1985 to 1998) its topexecutives directed a conspiracy to inflate profit so as to meet Wall Street analysts’ forecasts andto keep the stock price high. See Floyd Norris & Diana B. Hendriques, 3 Admit Guilt inFalsifying CUC’s Books, N.Y. TIMES, June 15, 2000, at C1 (“Three former executives of CUCInternational pleaded guilty today to federal charges in what the authorities said was the largestand longest accounting fraud in history, continuing at least 12 years and costing investors $19billion.”). One commentator wondered how the company’s auditors missed the fraud:For all those years, the books were audited by Ernst & Young or itspredecessor, Ernst & Whinney. In hindsight, they missed more than a few redflags. A report by Arthur Andersen, another accounting firm hired after the fraudwas exposed, described meetings in which Ernst & Young officials askedquestions and got odd answers. In one case, there was no explanation ordocumentation for $25 million in profits. The auditors decided that was not amaterial amount, and let it go. The Andersen report did not criticize Ernst &59

Young, but that was no surprise. Ernst & Young had refused to supplyinformation to Andersen until it was promised that the report would not commenton the quality of the Ernst & Young audits.The S.E.C. says that the fraud was easier to pull off because CUC officialsknew which subsidiaries would be audited, and therefore hid the most obviousfrauds in subsidiaries that they knew the auditors would not look at.As the fraud grew, CUC’s old tactics of inflating revenues and suppressingexpenses were no longer adequate. So it took to manipulating merger reserves,which are supposed to cover one-time costs related to takeovers and are oftenignored by investors. The reserves became a cookie jar in which operating lossescould be fraudulently concealed. Unfortunately for CUC, some of its acquisitionswere such dogs that the merger reserves were soon exhausted, making itnecessary to make more acquisitions.Did the auditors know what was going on? They deny it, and there is noproof that they did. But they didn’t show much suspicion when confronted withsome odd-looking transactions of funds between various accounts.Floyd Norris, Asleep at the Books: A Fraud That Went On and On and On, N.Y. TIMES, June16, 2000, at C1.In litigation arising out of Cendant’s cross-claims against its auditor, Ernst & Young(“E&Y”), for settlement payments made to defrauded investors, the district court held:• Contribution by E&Y was barred on both the Section 11 (Securities Act) and Rule 10b-5(Exchange Act) claims because § 21D of the Exchange Act bars contribution claimsagainst a settling defendant, and that rule applies where Securities Act (or other) claimsare “integrally related” to the Exchange Act claims.• Section 21D of the Exchange Act does not bar indemnity claims, although indemnity isnot ordinarily available for securities law violations.• State law claims for tort, breach of contract and/or breach of fiduciary duty may beactionable.• Under a standard audit engagement, an auditor contracts to report fraud to the nondefraudingmanagers or directors. Whether an account acting in any capacity is afiduciary presents a question of fact.In re Cendant Corp. Sec. Litig., 139 F. Supp. 2d 585 (D.N.J. 2001).B. Specific Allegations Of Accounting Fraud Supporting Strong Inference OfScienter Under The PSLRA1. Earnings/Revenue Misrepresentations60

"A defendant's failure to recognize revenue in accordance with GAAP does not, by itself,suffice to establish scienter." Chalverus, 59 F. Supp. 2d at 233 (citation omitted); see also In reStone & Webster, Inc. Secs. Litig., 253 F. Supp. 2d 102 (D. Mass. 2003) (without additionalallegations of particular facts, violations of GAAS and GAAP do not give rise to inference ofscienter); Umsted v. Andersen LLP, 2003 U.S. Dist. LEXIS 1250, 2003 WL 222621 (N.D. Tex.Jan. 29, 2003) (auditors’ mere publication of inaccurate accounting or failure to follow GAAPdid not establish scienter).. Rather, the court must determine "whether the alleged GAAPviolations, combined with other circumstances indicative of fraudulent intent, raise a stronginference that the defendants acted with scienter." Id. at 233 (emphasis added) (citing In reAncor Comms., 22 F. Supp. 2d at 1005 (noting that "violations of GAAP, in combination withother factors, may support a strong inference of scienter")); see also In re Daou Sys., Inc. Secs.Litig., 397 F.3d 704 (9 th Cir. 2005) (investors’ allegations regarding violations of GAAP weresufficiently particularized to state cause of action); Ferris, Baker Watts, Inc. v. Ernst & YoungLLP, 395 F.3d 851 (8 th Cir. 2005) (broker-dealer’s catch-all and blanket assertion that publicauditing firm acted recklessly or knowingly with regard to GAAP and GAAS was not evidenceof corresponding fraudulent intent sufficient to satisfy scienter requirement).A number of district courts have held that misrepresentations about the company'searnings or revenue, if pled with requisite particularity, satisfy the applicable standard forpleading scienter under the PSLRA. See In re Scientific-Atlanta, Inc. Secs. Litig., 239 F. Supp.2d 1351 (N.D. Ga. 2002) (denying motion to dismiss claims that company engaged in “channelstuffing” and accounting violations to temporarily inflate its stock price); Gelfer, 96 F. Supp. 2dat 16-20 (magnitude of revenue overstatements during class period tends to support stronginference of scienter); Phycor, 2000 U.S. Dist. LEXIS, at *16 ("Plaintiffs ... allege in theAmended Complaint that Defendants not only violated GAAP, but also made false andmisleading public statements as a result. This is sufficient to overcome a motion to dismiss.");Cendant, 60 F. Supp. 2d at 372-73 (allegations that public accounting firm failed to discover thatcorporation's operating income and earnings per share were overstated, that firm's audits werenot performed in accordance with GAAP, and that its unqualified audit reports filed with SECwere materially false and misleading adequately pled scienter); Chalverus, 59 F. Supp. 2d at234-36 (investors adequately pleaded scienter in suit involving overstatement of revenue;investors alleged overstatement of $5 million in single quarter, in violation of GAAP; violationof internal policies on income recognition; failure to disclose that cross-license agreement citedas source of $50 million of income over next few years required payment of $12.9 million tocross-licensee; and alleged that both CEO and CFO had motive and opportunity to commit fraud;significant financial restatements may support a conclusion that defendants acted with scienter);Gross, 977 F. Supp. at 1472 (allegation that insiders engaged in elaborate accounting fraudscheme designed to ensure that company met earnings and revenue projections); In re HealthMgmt., Inc. Sec. Litig., 970 F. Supp. 192, 203 (E.D.N.Y. 1997) (allegation that corporate insiderapproved of plans for accounting fraud and false revenue recognition evidence of scienter); In reWellcare Mgmt. Group, Inc. Sec. Litig., 964 F. Supp. 632, 640 (N.D.N.Y. 1997) (allegation thatcorporate executive "had knowledge of, condoned, and/or encouraged ... the deliberateoverstatement of earnings by a number of means"); Rehm, 954 F. Supp. at 1255-56(overstatement of earnings by persons responsible for calculating and releasing financialinformation shows scienter); Cherednichenko, 1997 U.S. Dist. LEXIS 23107, at *11-12 (courtfound strong circumstantial evidence of conscious behavior); Marksman Partners, L.P. v.Chantal Pharmaceutical Corp., 927 F. Supp. 1297, 1313-14 (C.D. Cal. 1996) (overstated61

evenues when method of recognition was inconsistent with SFAS 48); Varljen, 1998 U.S. Dist.LEXIS 10493, at *2, *15 (defendants falsely inflated earnings by including income fromfraudulent medical billings); In re Miller Indus., Inc. Sec. Litig., 12 F. Supp. 2d 1323, 1329 (N.D.Ga. 1998) (defendants understated acquired companies' pre-merger revenues which overstatedgrowth of company's post-merger revenues, overstated company's revenue growth in coremanufacturing business by combining it with revenue from non-manufacturing activities,reported income misrepresented size of one-time gain from litigation settlement, accounted fortrade-ins at cost which was substantially greater than market price, misrepresented other onetimegains, engaged in "channel stuffing" by artificially stimulating revenues by offeringextraordinary discounts and trade-ins and extended payment terms and other unusual financingarrangements to mask deterioration in revenues); Employee Solutions, 1998 U.S. Dist. LEXIS16444, at *3, *8 (setting aside low workers' compensation reserves enabled defendants to presentfalsely as a highly profitable company); Fine Host., 25 F. Supp. 2d at 70 (plaintiffs alleged thattop officer admitted in phone call that he knowingly capitalized certain expenses to increaseearnings); In re Olympic Finan. Ltd. Sec. Litig., Civil File No. 97-496 (MJD/AJB), 1998 U.S.Dist. LEXIS 14789, at *11 (D. Minn. Sept. 10, 1998) (defendants knowingly overstated qualityof loan portfolio); Hudson Venture Partners, L.P. v. Patriot Aviation Group, Inc., No. 98 Civ.4132 (DLC), 1999 U.S. Dist. LEXIS 1518, at *11, 1999 WL 76803, Fed. Sec. L. Rep. (CCH) 90,431 (S.D.N.Y. Feb. 17, 1999) (closely-held corporation under reported losses and accountspayable and over reported accounts receivable and overstated profits by 80% for first two monthsof fiscal year).2. Violations of GAAP Can Form Part Of The Basis Supporting StrongInference Of ScienterIt has long been recognized that accounting principles “tolerate a range of ‘reasonable’treatments, leaving the choice among alternatives to management.” Godchaux v. ConveyingTechniques, Inc., 846 F.2d 306, 315 (5 th Cir. 1988). For this reason, courts have held thatwithout a specific showing of conscious misbehavior or actual intent to defraud, allegations thata company violated GAAP or even restated its financial statements will not support a securitiesfraud claim. See, e.g., Chill v. General Elec. Co., 101 F.3d 263, 270 (2 nd Cir. 1996) (finding that“allegations of a violation of GAAP . . . without corresponding fraudulent intent, are notsufficient to state a securities fraud claim”); In re Worlds of Wonder Secs. Litig., 35 F.3d 1407,1426 (9 th Cir. 1994) (proclaiming that the “mere publication of inaccurate accounting figures, ora failure to follow GAAP, without more, are issues of corporate mismanagement and areinsufficient to constitute securities fraud”); Melder v. Morris, 27 F.3d 1097, 1103 (5 th Cir. 1994)(affirming dismissal of fraud allegations against accountants based on alleged GAAP violations);Coble v. Broadvision, Inc., 2002 U.S. Dist. LEXIS 17495, 2002 WL 31093589, Fed. Sec. L. Rep.(CCH) 92,238 (N.D. Cal. Sept. 11, 2002) (scienter should not be inferred due to a restatementof company expenses unaccompanied by significant insider stock sales); Peritus, 52 F. Supp. 2dat 223 ("A host of courts have held that a mere failure to recognize revenue in accordance withGAAP does not, by itself, suffice to establish scienter.") (citations omitted); Fine Host, 25 F.Supp. 2d at 69 (allegations that accounting practices violated GAAP held insufficient to raise“strong inference of conscious recklessness” and were, therefore, insufficient to allege scienter).62

When combined with other circumstances suggesting fraudulent intent, however, "suchviolation may be used to show scienter." Cherednichenko, 1997 U.S. Dist. LEXIS 23107, at *10(citing Marksman Partners, 927 F. Supp. at 1313) (premature recognition of earnings fromconsignment sales, combined with significant extent of alleged overstatement, as well as otherfactors, created strong inference that defendants acted with either specific or reckless intent todefraud), Wellcare Mgmt., 964 F. Supp. at 640 (finding that knowledge of deliberateoverstatement of earnings and other accounting improprieties, as well as other misconduct,tended to show scienter)). See also In re Oxford Health Plans, Inc. Secs. Litig., 51 F. Supp. 2d290, 294-95 (S.D.N.Y. 1999) (refusing to dismiss claims against auditors because allegations ofGAAP violations, defective computer system and state regulatory discovery of fraud heldsufficient to support strong inference of scienter); Gross, 977 F. Supp. at 1472 (allegations thatcorporate insiders "improperly recognized income that [d]efendants knew should not have beenrecognized under GAAP principles" is sufficient to establish scienter); Ancor Comm., 22 F.Supp. 2d at 1005-06 (overstating revenues by reporting consignment sales in violation of GAAP;defendants continually represented in SEC filings that financial results were prepared inaccordance with GAAP); Marksman Partners, 927 F. Supp. at 1313 (violating GAAP by earlyrecognition of consignment sales resulting in overstated revenues); Health Mgmt., 970 F. Supp.at 203 (holding sufficient allegations of GAAP and GAAS violations, the auditor's six-yearengagement, the magnitude of the misrepresentations, and the auditor's ignorance of "red flags");Miller Indus., 12 F. Supp. 2d at 1332 (overstatement of revenues and income in violation ofGAAP may constitute violation of Rule 10b-5).3. Improper Revenue Recognition Of A Significant Portion Of RevenuesIn the words of one district court, "[w]hile it is true that the mere fact that a company'sfinancial reporting was inaccurate does not establish scienter, the magnitude of reporting errorsmay lend weight to allegations of recklessness where defendants were in a position to detect theerrors. The more serious the error, the less believable are defendants protests that they werecompletely unaware of [the Company's] true financial status and the stronger is the inference thatdefendants must have known about the discrepancy." Rehm, 954 F. Supp. at 1256 (citationsomitted); see also Marksman Partners, 927 F. Supp. at 1314 (overstated revenues constitutedsignificant portion of company's total revenues); Cherednichenko, 1997 U.S. Dist. LEXIS23107, at *7 (substantial overstatement by reporting consignment sales as revenues); Varljen,1998 U.S. Dist. LEXIS 10493, at *15 (defendants falsely inflated earnings by including incomefrom fraudulent Medicare billings).C. The Standard Of "Recklessness" For Accountant's Liability1. Plaintiff's BurdenPlaintiffs must allege and prove "'highly unreasonable [omissions or acts], involving notmerely simple negligence, but an extreme departure from the standards of ordinary care, andwhich presents a danger of misleading buyers or sellers that is either known to the defendant oris so obvious that the actor must have been aware of it.'" Retsky, 1998 U.S. Dist. LEXIS 17459,at *26-27 (citation omitted); see also First Merchants, 1998 U.S. Dist. LEXIS 17760, at *29(same).63

"[Plaintiffs] must prove that the accounting practices were so deficient that the auditamounted to no audit at all, or "an egregious refusal to see the obvious or to investigate thedoubtful," or that the accounting judgments which were made were such that no reasonableaccountant would have made the same decisions if confronted with the same facts.'" Retsky,1998 U.S. Dist. LEXIS 17459, at *27 (citation omitted); see also Rehm, 954 F. Supp. at 1255;First Merchants, 1998 U.S. Dist. LEXIS 17760, at *29; Health Mgmt., 970 F. Supp. at 202; seealso Jacobs v. Coopers & Lybrand, L.L.P., 1999 U.S. Dist. LEXIS 2102, at *44, 1999 WL101772, Fed. Sec. L. Rep. (CCH) 90,443 (S.D.N.Y. Mar. 1, 1999) (finding sufficientallegations of GAAS violations, including a failure to confirm accounts receivable properly, tosupport strong inference of auditor scienter; "Failing to adhere to one or two AuditingInterpretations may be only negligence, but Coopers is alleged to have disregarded manydifferent Auditing Interpretations. Based on the facts as alleged, a trier of fact could findCooper's audit so reckless that Coopers should have had knowledge of the underlying fraud, andacted in blind disregard that there was a strong likelihood that Happiness was engaged in theunderlying fraud.") (citation omitted).2. Ignoring "Red Flags" Of Accounting FraudCircumstances suggesting fraudulent intent can include the presence of "red flags" orwarning signs. Compare Fidel v. Farley, 392 F.3d 220 (6 th Cir. 2004) (alleged “red flags”detailed in investors’ complaint against corporation outside auditor did not raise required stronginference of scienter on auditor’s part at time it issued unqualified audit report approvingfinancial statements that allegedly contained misleading information) with Great Neck CapitalAppreciation Investment P’ship, L.L.P. v. PricewaterhouseCoopers, 137 F. Supp. 2d 1114 (E.D.Wis. 2001) (accounting firm was potentially liable for GAAS violations in financial statementsin light of firm’s knowledge of “red flags”); Transcrypt Int'l, 1999 U.S. Dist. LEXIS 17540, at*29 (denying motions to dismiss claims against auditor for company that had to substantiallyrestate its financial statements; because the corrected accounts receivable were less than 30% ofthe original number, the magnitude of the discrepancy, along with alleged "red flags" and GAASviolations, was sufficient to create necessary strong inference of scienter); Rehm, 954 F. Supp. at1256 ("[T]he more serious the error, the less believable are defendants['] protests that they werecompletely unaware of [the company's] true financial status and the stronger the inference thatdefendants must have known about the discrepancy."); Health Mgmt., 970 F. Supp. at 199(outside auditor's ignorance of "red flags" present evidence of its fraudulent intent) (citationomitted); In re Leslie Fay Cos., Inc. Secs. Litig., 835 F. Supp. 167, 175 (S.D.N.Y. 1993)(rejecting independent auditor's motion to dismiss where allegations of large accounting errorsgave rise to inference of scienter).In Retsky, 1998 U.S. Dist. LEXIS 17459, at *29-32, plaintiffs satisfied the applicablepleading requirements by alleging that Price Waterhouse knew of "red flags" involved withcustomer contract because (1) Price Waterhouse reviewed and commented on a report preparedby the Company's internal audit department noting concerns of premature revenue booking; (2)Price Waterhouse noted that contract contingencies set forth in contract precluded certainrevenue recognition; and (3) Price Waterhouse noted that the MD&A discussion in the Form 10-K report concerning product risks failed to comply with Reg. S-K.64

In First Merchants, 1998 U.S. Dist. LEXIS 17760, at *17-20, Judge Coar of the NorthernDistrict of Illinois permitted a complaint to proceed against corporate auditors whoserecklessness was evidenced by GAAP violations, "red flags," and the magnitude of the fraud inthe company's false financial statements. The court held that plaintiffs satisfied the applicablepleading requirements by alleging that accountants should have known of "red flags" including(1) bad debt reserves were out of line with bad debt write-offs; (2) there were dramatic increasesin the rate of 60- and 90- day delinquencies; and (3) there was an increase in the average lengthof loans reflecting higher risk borrowers.VIII. PRIMARY AND SECONDARY LIABILITYA. Primary LiabilityIn Central Bank, the Supreme Court held that there can be no liability under Section10(b)/Rule 10b-5 for aiding and abetting securities fraud. Unless the defendant committed amanipulative or deceptive act within the meaning of Section 10(b), the defendant has notviolated the securities laws. Following Central Bank, however, the federal courts have splitover the threshold required to show that a "secondary" actor's conduct constitutes primaryliability. Compare In re Software Toolworks, Inc., 50 F.3d 615, 628 n.3 (9 th Cir. 1994)(secondary actors may be held primarily liable for statements made by others in which theformer significantly participated) with Wright v. Ernst & Young LLP, 152 F.3d 169, 175 (2 nd Cir.1998) ("[A] secondary actor cannot incur primary liability ... for a statement not attributed to thatactor at the time of its dissemination"). See also Ziemba v. Cascade Int’l, Inc., 256 F.3d 1194(11 th Cir. 2001) (affirming dismissal of claims against law firm and accounting firm forsubsidiaries that allegedly participated in parent company’s blatant fraud; because none ofalleged misrepresentations were directly attributed to law firm or accounting firm, plaintiffscould not have relied upon their fraud); Cooper v. Pickett, 137 F.3d 616, 624 (9 th Cir. 1998)(denying Deloitte & Touche's motion to dismiss securities fraud claims when complaint allegedthat accountants certified false revenues); In re Enron Corp. Secs. Litig., 258 F. Supp. 2d 576(S.D. Tex. 2003) (complaint did not establish that any outside director knew or recklesslydisregarded fraudulent acts taking place and approved them in order to further Ponzi scheme, orthat outside directors had participated in insider trading); In re Homestore.com, Inc., 252 F.Supp. 2d 1018 (C.D. Cal. 2003) (dismissing claims against business partners who allegedlyparticipated directly in transactions enabling the company to fraudulently report revenues; thepartners made no representations of their own and were only aiders and abettors of the fraudulentscheme); In re Lernout & Hauspie Secs. Litig., 230 F. Supp. 2d 152 (D. Mass. 2002) (anauditor’s willful drafting, signing, and publication of a “clean” audit report on corporate filingsthat were rife with false and misleading information was sufficient to trigger “primary” liabilityunder any of the competing constructions of the Supreme Court’s decision in Central Bank);Carley Capital Group v. Deloitte & Touche LLP, 27 F. Supp. 2d 1324, 1333-36 (N.D. Ga. 1998)(refusing to dismiss claims that accounting firm had primary liability for its client's materialmisrepresentations, including improper revenue recognition, in financial statements; theaccountants' direct involvement in the representations, the magnitude of the GAAP violations,and Deloitte's dual role as management consultant and auditor combined to create stronginference of scienter), certification for interlocutory appeal denied, 1999 U.S. Dist. LEXIS 1368,1999 WL 816963, Fed. Sec. L. Rep. (CCH) 90,429 (N.D. Ga. Jan. 20, 1999). See generally65

Aegis J. Frumento, Misrepresentation of Secondary Actors in the Sale of Securities: Does In reEnron Square with Central Bank?, 59 BUS. LAW. 975 (2004); Tarik J. Haskins, HoldingSecondary Actors Liable: Defining Primary Liability Under Section 10(b), 71 U. CIN. L. REV.1093 (2003); Andrew B. Weissman & Mark M. Oh, The Metaphysics of Primary and SecondaryLiability Under Section 10(b): “Substantial Assistance,” “Substantial Participation,” and theRedistribution of Wealth, 14 SECURITIES REFORM ACT LITIG. RPTR. 1044 (Mar. 2003).In In re Enron Corp. Secs., Derivative & ERISA Litigation, 235 F. Supp. 2d 549 (S.D.Tex. 2002), Judge Harmon ruled on motions to dismiss filed by various financial institutions,two law firms, and the Arthur Andersen accounting firm in the Enron shareholder lawsuit. Thedistrict court denied the majority of the motions, keeping most of Enron’s investment banks andVinson & Elkins, the company’s chief outside law firm, in the action. (The court dismissed onlyDeutsche Bank and Kirkland & Ellis, one of Enron’s other outside law firms.) In the 307-pageopinion, Judge Harmon addressed the distinction in the federal securities laws between “aidingand abetting” (or secondary) liability and primarily liability under Section 10(b) of the ExchangeAct and SEC Rule 10b-5. The court offered an extensive analysis of the tests adopted by thevarious lower federal courts following the Supreme Court’s decision in Central Bank of Denverv. First Interstate Bank of Denver, 511 U.S. 164 (1993), and took note of an alternative testproposed by the SEC in an amicus curiae brief. Under the SEC’s proposed test, a person can bea primary violator if he or she writes misrepresentations for inclusion in a document to be givento investors, even if the idea for those representations came from someone else. With herinterpretation of this “substantial participation” test in hand, Judge Harmon proceeded todetermine whether the shareholders’ complaint adequately pleaded Section 10(b)/Rule 10b-5claims. The court believed that plaintiffs’ allegations established that investment banks J.P.Morgan, Citigroup, Credit Suisse First Boston, CIBC and Barclays, law firm Vinson & Elkins,and accounting firm Andersen had knowledge of Enron’s precarious financial situation and/orfraudulent schemes. Despite such knowledge, these defendants made positive public statementsabout Enron or otherwise engaged in conduct that the district court found to be a primaryviolation of Section 10(b) and Rule 10b-5. On the other hand, Judge Harmon dismissed claimsagainst Bank of America because the complaint did not allege “how, when, and what it learned.”The court also dismissed claims against Kirkland & Ellis because, although that law firm wasalleged to be aware of Enron’s financial situation and/or fraudulent schemes, Kirkland did notmake positive public statements about Enron. For a detailed analysis of Judge Harmon’sopinion, see 14 SECURITIES REFORM ACT LITIG. RPTR. 697-700; see also Timothy E. Hoeffner &Ashish D. Gandhi, Enron Court Clarifies Pleading Standard for Individual Representatives of aProfessional Accounting Firm, 15 SECURITIES REFORM ACT LITIG. RPTR. 22 (Apr 2003)(analyzing Judge Harmon’s subsequent rulings on motions to dismiss brought by (a) 18 partnersof Arthur Andersen, see In re Enron Corp. Secs., Derivatives & ERISA Litig., 2003 U.S. Dist.LEXIS 1668, 2003 WL 230688, Fed. Sec. L. Rep. (CCH) 92,404 (S.D. Tex. Jan. 28, 2003),and (b) Enron’s outside directors, see In re Enron Corp. Secs., Derivatives & ERISA Litig., 258F. Supp. 2d 576 (S.D. Tex. 2003)).B. Secondary Actor's Conduct May Constitute Primary LiabilityHowever, primary liability under Rule 10b-5 may be imposed "'not only on persons whomade fraudulent misrepresentations but also on those who had knowledge of the fraud and66

assisted in its perpetration.'" SEC v. First Jersey Secs., Inc., 101 F.3d 1450, 1471 (2 nd Cir. 1996)(quoting Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2 nd Cir. 1994)); see also Health Mgmt.,970 F. Supp. at 209. More than significant participation by the secondary actor is needed toincur primary liability. Shapiro, 123 F.3d at 720. The misrepresentation must be attributed tothat specific actor at the time of publication dissemination, that is, in advance of the investmentdecision. Wright v. Ernst & Young LLP, 152 F.3d 169, 175 (2 nd Cir. 1998). Secondary partiesmay be primarily liable for statements made by others in which the secondary party significantlyparticipated. Software Toolworks, 50 F.3d 615.C. Fraudulent Scheme LiabilityAlthough in Central Bank the Supreme Court eliminated liability for aiders and abettorsof securities fraud, under § 10(b)/Rule 10b-5 primary liability may be imposed not only onpersons who made fraudulent misrepresentations but also on those who had knowledge of thefraud and assisted in its perpetration. See Health Mgmt., 970 F. Supp. at 203; Page, 1997 U.S.Dist. LEXIS 3673, at *11-15; Marksman Partners, 1998 U.S. Dist. LEXIS 12743, at *4(defendants' involvement in ship-hold-and-return scheme).D. "Group Published" DoctrineWhen alleging securities fraud based on false and misleading statements in prospectuses,registration statements, annual reports, press releases, or other "group published" information,there is a presumption that these statements are the collective work of those individuals whohave high level positions with the issuer; are involved in the day-to-day operations; directlyparticipate in management; and were involved in drafting, reviewing, and/or disseminating thefalse and misleading statements. Prospectuses, registration statements, annual reports, pressreleases, or other group published information are presumed to be collective actions. Schaffer,29 F. Supp. 2d at 1225.Whether the PSLRA abolished this doctrine has been a subject of considerable debate.See generally William O. Fisher, Don't Call Me a Securities Law Groupie: The Rise andPossible Demise of the "Group Pleading" Protocol in 10b-5 Cases, 56 BUS. LAW. 991 (2001).Defendants argue that the "group pleading" doctrine was abolished by the PSLRA, and a numberof courts have agreed. See, e.g., Southland Secs. Corp. v. Inspire Ins. Solutions, Inc., 365 F.3d353, 363-65 (5 th Cir. 2004) (offering extensive discussion of “group pleading” doctrine beforerejecting it; “the PSLRA requires the plaintiffs to ‘distinguish among those they sue andenlighten each defendant as to his or her particular role in the alleged fraud”) (emphasis inoriginal); In re Capstead Mortg. Corp. Secs. Litig., 258 F. Supp. 2d 533 (N.D. Tex. 2003)(“group pleading” doctrine is irreconcilable with PSLRA’s mandate that plaintiffs plead specificfacts as to each act or omission by defendants); In re Enron Corp. Secs. Litig., 2003 U.S. Dist.LEXIS 1668, 2003 WL 230688, Fed. Sec. L. Rep. (CCH) 92,404 (S.D. Tex. Jan. 28, 2003)(same); In re BMC Software, Inc. Secs. Litig., 183 F. Supp. 2d 860 (S.D. Tex. 2001); P.Schoenfeld Asset Mgmt. LLC v. Cendant Corp., 142 F. Supp. 2d 589, 618-21 (D.N.J. 2001);Lemmer v. NuKote Holding, Inc., 2001 U.S. Dist. LEXIS 13978, 2001 WL 1112577, Fed. Sec. L.Rep. (CCH) 91,604 (N.D. Tex. Sept. 6, 2001); Marra, 1999 U.S. Dist. LEXIS 7303, at *13("[T]he court concludes that the presumption inherent in group pleading is inconsistent with the67

PSLRA's purpose") (citing Coates, 26 F. Supp. 2d at 915-16, and Allison v. Brooktree Corp., 999F. Supp. 1342, 1350 (S.D. Cal. 1998)). See also Schiller v. Physicians Researce Group, 2002U.S. Dist. LEXIS 3240, 2002 WL 318441, Fed. Sec. L. Rep. (CCH) 91,722 (S.D. Tex. Feb. 27,2002) (collecting cases).In Coates, the court reasoned that because the PSLRA requires plaintiffs to set forth factsraising a strong inference that each defendant acted with the required state of mind, grouppleading is inconsistent with the statutory language and purpose: "[I]t is nonsensical to requirethat a plaintiff specifically allege facts regarding scienter as to each defendant, but to allow himto rely on group pleading in asserting that the defendant made the statement or omission." 26 F.Supp. 2d at 916. The Allison court reached the same conclusion for the same reasons, holdingthat group pleading was suspect because the "judicial presumption" of group pleading could not"be reconciled with the statutory mandate that plaintiffs must plead specific facts as to each actor omission by the defendant." 999 F. Supp. at 1350. Accord Branca, 2000 U.S. Dist. LEXIS1704, at *26 (adopting the reasoning in Coates and Allison that "bars the use of group pleadingtechniques in PSLRA cases"); Calliott v. HFS, Inc., 2000 U.S. Dist. LEXIS 4368, at *16 & n.3,2000 WL 351753, Fed. Sec. L. Rep. (CCH) 90,939 (N.D. Tex. Apr. 5, 2000) (same);Thompson v. Avondale Indus., Inc., 2000 U.S. Dist. LEXIS 4380, at *5, 2000 WL 310382 (E.D.La. Mar. 24, 2000) (“[T]he PSLRA codifies a ban on the group pleading doctrine”) (citingCoates and Branca).Nevertheless, many courts facing the issue have determined that the group pleadingdoctrine does in fact survive the passage of the PSLRA. See, e.g., Steinbeck v. SonicInnovations, Inc., 2003 U.S. Dist. LEXIS 2378 (D. Utah Feb. 11, 2003) (complaint alleged factsunder which corporate directors could be held liable as direct participants in fraudulent scheme,or under the “group published” presumption, or as control persons); In re Neopharm, Inc. Secs.Litig., 2003 U.S. Dist. LEXIS 1862, 2003 WL 262369 (N.D. Ill. Feb. 7, 2003); In re Emex Corp.Secs. Litig., 2002 U.S. Dist. LEXIS 17528, 2002 WL 31093612, Fed. Sec. L. Rep. (CCH) 91,980 (S.D.N.Y. Sept. 17, 2002) (individual high level corporate officers and directors could beheld liable under “group pleading” doctrine); In re U.S. Interactive, Inc. Class Action Secs.Litig., 2002 U.S. Dist. LEXIS 16009, 2002 WL 1971252, Fed. Sec. L. Rep. (CCH) 92,015(E.D. Pa. Aug. 23, 2002) (following a narrowly construed “group pleading” rule and finding itvalid when applied to corporate officers where it is almost certain that given the high-levelposition of the officer within the company and the nature of the published writing that he or shewould have been involved directly with writing the document or approving its content, and thatthe officer was privy to information concerning the accuracy of statements within the document);In re Raytheon Secs. Litig., 157 F. Supp. 2d 131, 152-53 (D. Mass. 2001) (collecting cases); In reSmarTalk Telesvcs., Inc. Secs. Litig., 124 F. Supp. 2d 527, 545 (S.D. Ohio 2000) (holdingPSLRA did not abolish “group published” information rule); In re Baan Co. Secs. Litig., 103 F.Supp. 2d 1, 17 (D.D.C. 2000); In re Oxford Health Plans, Inc. Secs. Litig., 187 F.R.D. 133, 142(S.D.N.Y. 1999); BankAmerica, 78 F. Supp. 2d at 988 ("[B]ecause the group pleading doctrine isa rebuttable presumption applicable only to a limited group of persons within the company, thecourt finds that the presumption is not inconsistent with the PSLRA"); In re PeopleSoft Secs.Litig., 2000 U.S. Dist. LEXIS 10953, 2000 WL 1737936, Fed. Sec. L. Rep. (CCH) 91,035(N.D. Cal. May 25, 2000) (same); Learning Tree, 1998 U.S. Dist. LEXIS 20306, at *18 ("Untilthe Ninth Circuit speaks otherwise, the Court finds the rationale behind the group-pleadingdoctrine sound and will not disturb it. Given that Plaintiffs have adequately alleged that68

Defendants ran LTI on a day-to-day basis, Defendants are not entitled to a dismissal on thisbasis.") (footnote omitted); Miller Indus., 12 F. Supp. 2d at 1329 (group pleading survivesenactment of PSLRA); Stratosphere, 1 F. Supp. 2d at 1108 (holding that the PSLRA did notabolish the "group pleading" doctrine); Powers v. Eichen, 977 F. Supp. 1031, 1040 (S.D. Cal.1997) (same), reconsideration denied, 1997 U.S. Dist. LEXIS 10881 (S.D. Cal. 1997) (same); Inre Health Mgmt. Secs. Litig., 970 F. Supp. 192, 208-09 (E.D.N.Y. 1997) (same); see alsoSouthland Secs., 365 F.3d at 364 (collecting cases holding that PSLRA did not abolish “grouppleading” doctrine).IX. THE PSLRA’S “SAFE HARBOR” FOR "FORWARD- LOOKING"STATEMENTS AND THE "BESPEAKS CAUTION" DOCTRINEA. When “Forward-Looking” Statements Are ProtectedFollowing long-standing efforts by the SEC to create a “safe harbor” for certain“forward-looking” statements made by corporate management, see SEC Securities Act ReleaseNo. 33-6084, 44 F.R. 33810 (June 25, 1979) (promulgating Rule 175 under Securities Act andRule 3b-6 under Exchange Act), and judicial attempts to immunize statements accompanied bysufficient warnings (the so-called “bespeaks caution” doctrine, see, e.g., In re Worlds of WonderSecs. Litig., 35 F.3d 1407, 1414 (9 th Cir. 1994), in the PSLRA Congress also attempted toencourage the quality and quantity of forward-looking information disseminated to investors byincluding a "safe harbor" from liability for certain "forward-looking statements." 15 U.S.C.§ 78u-5. Congress enacted the safe harbor provision "in order to loosen the 'muzzling effect' ofpotential liability for forward-looking statements, which often kept investors in the dark aboutwhat management foresaw for the company." Harris v. Ivax Corp., 182 F.3d 799, 806 (11 th Cir.1999) (quoting H.R. Conf. Rep. 104-369, at 42 (1995), reprinted in 1995 U.S. CODE CONG. &ADMIN. NEWS 730, 741)). See also Employers Teamsters Local v. The Clorox Co., 353 F.3d1125, 1132 (9 th Cir. 2004) (“The PSLRA created a statutory version of [the ‘bespeaks caution’]doctrine by providing a safe harbor for forward-looking statements identified as such, which areaccompanied by meaningful cautionary statements.”) (footnote and citations omitted); accord Inre Amdocs Ltd. Secs. Litig., 390 F.3d 542 (8 th Cir. 2004).Under the PSLRA, the court must determine, at the pleading stage, whether a “forwardlooking”statement falls within the "safe harbor." 15 U.S.C. § 78u-5(e); see Karacand, 53 F.Supp. 2d at 1243; MobileMedia, 28 F. Supp. 2d at 930 n.18 ("Before deciding whether the safeharbor is available, it must first be determined whether there is a 'forward looking statement,' asdefined in the [PSLRA]."). Because the statute "closes the universe of supposedly falsestatements under scrutiny to those 'specif[ied]' in the complaint," the legislative history "impliespiecemeal examination of the statements found in a company communication." Harris, 182 F.3dat 804 (quoting 15 U.S.C. § 78u-4(b)(1)).Whether under the statutory definitions or otherwise, to qualify for the protection offereda statement, either oral or written, must first be deemed to be “forward-looking.” See Helwig v.Vencor, Inc., 251 F.3d 540, 558 (6 th Cir. 2001) (noting that some SEC filings and press releaseslacked designation of “forward-looking,” as required by PSLRA); In re Sun Healthcare Group,Inc. Secs. Litig., 181 F. Supp. 2d 1283, 1288-89 (D.N.M. 2002) (although statements were69

forward-looking, they were not properly identified as “forward-looking” and thus did not qualifyfor PSLRA’s “safe harbor”); In re Secure Computing Corp. Secs. Litig., 120 F. Supp. 2d 810,818 (N.D. Cal. 2000) (notwithstanding statutory definitions, court may take more simplisticapproach and look to see whether statement is a prediction as to future events as opposed to astatement of current business conditions); Robertson v. Strassner, 32 F. Supp. 2d 443, 450 (S.D.Tex. 1998) (press release did not qualify for safe harbor because it was not identified as“forward-looking”).If a statement qualifies as “forward-looking,” it will fall within the safe harbor if it is“accompanied by meaningful cautionary statements identifying important factors that couldcause actual results to differ materially from those in the forward-looking statement." 15 U.S.C.§ 78u-5(c)(1)(A)(i). See, e.g., Baron v. Smith, 380 F.3d 49, 53-54 (1 st Cir. 2004) (press releaseannouncing bankruptcy filings by corporation and subsidiaries was protected by “safe harbor”).Oral statements, such as those made to securities analysts or the press, may also fall within thestatutory protection. See 15 U.S.C. § 78u-5(b)(2).Even if the “forward-looking” statement has no accompanying cautionary language, theplaintiff must prove that the defendant made the statement with "actual knowledge" that it was"false or misleading." 15 U.S.C. § 78u-5(c)(1)(B). See, e.g., Asher v. Baxter Int’l, Inc., 377 F.3d727, 734-35 (7 th Cir. 2004) (“safe harbor” was not necessarily applicable, without discovery as towhat corporate executives knew of risks at time when cautionary language was written); SunHealthcare Group, 181 F. Supp. 2d at 1289 (“the forward-looking statements at issue can alsoqualify for safe harbor if Plaintiffs fail to prove that statements were ‘made with actualknowledge’ of being false or misleading”) (quoting statute). These statutory provisions operateindependently, see Harris, 182 F.3d at 803; Fellman v. Electro Optical Sys. Corp., 2000 WL489713, at *4 (S.D.N.Y. Apr. 25, 2000), by which Congress intended to immunize statementswith meaningful warnings regardless of allegation of actual knowledge possessed by the speaker.See Greebel v. FTP Software, Inc., 194 F.3d 185, 201 (1 st Cir. 1999) (“The safe harbor has twoalternative inlets: the first shelters forward-looking statements that are accompanied bymeaningful cautionary statements.”); see also In re 2TheMart.com Secs. Litig., 114 F. Supp. 2d955, 961 (C.D. Cal. 2000) (“statements of expectation and belief are, however, actionable if ‘(1)the statement is not actually believed (2) there is no reasonable basis for the belief or (3) thespeaker is aware of undisclosed facts tending seriously to undermine the statement’s accuracy.’”)(citation omitted); In re MCI WorldCom, Inc. Secs. Litig., 191 F. Supp. 2d 778 (S.D. Miss. 2002)(absent any allegations that defendants’ statements were knowingly false when made, they wereprotected by “safe harbor”). “Actual knowledge” is a higher level of scienter than the“recklessness” required by the pleading standards of the PSLRA. See Sun Healthcare Group,181 F. Supp. 2d at 1289; Harold S. Bloomenthal & Samuel Wolff, SECURITIES AND FEDERALCORPORATE LAW § 15:15, at 15-43 (2 nd ed. 2000).Under the PSLRA, a “forward-looking” statement includes (a) statements containingprojections of revenues, income, earnings per share, or other financial items; (b) statements ofthe plans and objectives of management for future operations; and (c) statements of futureeconomic performance. See 15 U.S.C. § 77z-2(i) (Securities Act definition of “forward-lookingstatement”); 15 U.S.C. § 78u-5(i)(1)(A) (Exchange Act definition). Courts have recognized thatpredictions are often founded upon current facts or interlace present understanding with a beliefof possible outcomes. In Harris, 182 F.3d at 803-07, the Eleventh Circuit recognized that such70

mixed presentations should be viewed “as a whole” and “be either forward-looking or notforward-looking in its entirety”; thus, it held that a statement in a drug company's press releasethat challenges unique to period in its history were not behind it, when considered in context ofanticipated improvements in business, qualified as "forward-looking" statements). See alsoAdvanta, 180 F.3d at 536 (statements predicting that company “will experience a large increasein revenues” as a result of actions to be taken in future “clearly qualifies” as projection andconstituted “forward-looking” statements). Other courts have held that it is the overall nature ofan assertion that governs whether a statement will qualify, and not whether the statement ispredicated on current facts even if it is alleged that current facts have been omitted. See, e.g.,Eizenga v. Stewart Enters., Inc., 124 F. Supp. 2d 967, 978-79 (E.D. La. 2000) (projections wereforward-looking despite allegation that they failed to disclose then-existing decline in demandfor product); Fitzer v. Security Dymanics Tech., Inc., 119 F. Supp. 2d 12, 31 (D. Mass. 2000)(predictions as to release date of “complex technical product” are “forward-looking”); Bryant v.Avado Brands, Inc., 100 F. Supp. 2d 1368, 1378 (M.D. Ga. 2000) (earnings estimates, plans forexpansion and expected contribution of development project were “clearly” forward-lookingstatements), rev’d, 252 F.3d 1161 (11 th Cir. 2001); In re Ciena Corp. Secs. Litig., 99 F. Supp. 2d650, 661 (D. Md. 2000) (prediction of earnings and future performance were forward-lookingstatements despite allegation that they were based upon historical purchasing patterns ofconsumers); Stratosphere, 1 F. Supp. 2d at 1114 (statements regarding hotel-casino’s marketingplans were forward-looking).If a statement qualifies as forward-looking, the next task for the court is to determine (1)whether the statement is accompanied by “meaningful cautionary statements,” or (2) if it is not,whether plaintiff has alleged that the speaker had “actual knowledge” of the falsity of thestatement. As to the first test, the PSLRA requires that cautionary statements must warninvestors of “important factors that could cause actual results to differ materially from those inthe forward-looking statement.” 15 U.S.C. § 78u-5(c)(1)(A)(i). While courts uniformly holdthat mere “boilerplate” warnings are insufficient to invoke the protections of the safe harbor, seeIn re World Access, Inc. Secs. Litig., 119 F. Supp. 2d 1348, 1356 (N.D. Ga. 2000) (neither thestatutory safe harbor nor the bespeaks caution doctrine applies where a warning “contain[s] onlyminimal boilerplate language”), the courts differ on how precise warnings must be and to whatextent they must foreshadow the ultimate problem encountered. In Harris, 182 F.3d at 807,where the Eleventh Circuit posed the question as “must the cautionary language explicitlymention the factor that ultimately belies a forward-looking statement?,” id. (emphasis inoriginal), the court held that “when an investor has been warned of risks of a significance similarto that actually realized, she is sufficiently on notice of the danger of the investment to make anintelligent decision about it according to her own preferences for risk and reward.” Id. (emphasisadded). In Ehlert v. Singer, 245 F.3d 1313 (11 th Cir. 2001), the same court held that a warningthat cautioned that “[t]here can be no assurance that the Company will successfully complete thedevelopment of the market for practice management systems” was sufficient to put an investoron notice that important company software would not be upgraded to Year 2000 compliance.Articulating the test as one of “similar significance,” the court held that “the warnings actuallygiven were not only of a similar significance to the risks actually realized but were also closelyrelated to the specific warning which Plaintiffs assert should have been given.” Id. at 1319.Applying the standard elucidated by the Eleventh Circuit (or similar standards) othercourts have held that various warnings were adequate. See, e.g., In re USEC Secs. Litig., 190 F.71

Supp. 2d 808 (D. Md. 2002) (detailed cautionary language of prospectus prevents statementsfrom being misleading); Rosenzweig v. Azurix Corp., 198 F. Supp. 2d 862 (S.D. Tex. 2002) (allpost-IPO statements were labeled as “forward-looking” and contained meaningful cautionarylanguage); In re Republic Ser. Inc. Sec. Litig., 134 F. Supp. 2d 1355 (S.D. Fla. 2001) (difficultiesin assimilation of acquisitions were sufficiently forewarned by statement observing that thecompany faced “significant challenges” in that regard); Carney v. Cambridge Tech. Partners,Inc., 135 F. Supp. 2d 235 (D. Mass. 2001) (corporate officer who publicly disagreed withpessimistic analyst reviews held protected by safe harbor).B. When Forward-Looking Statements Are Not ProtectedA prediction may be actionable as a false statement of fact if (1) the speaker did notgenuinely believe the statement was true; (2) there was no reasonable basis for the speaker tobelieve the statement; and (3) the speaker was aware of an undisclosed fact tending to underminethe accuracy of the statement. Berti v. VideoLan Tech., 135 F. Supp. 2d 480 (W.D. Ky. 1998);see also In re Reliance Secs. Litig., 2001 WL 326870, at *21 (D. Del. Mar. 29, 2001) (holding nosafe harbor because statement of belief of adequacy of loss reserve was one of “then-presentstate” of company’s financial condition, not future event); In re Splash Tech. Holdings, Inc. Secs.Litig., 2000 WL 1727377, at *6, Fed. Sec. L. Rep. (CCH) 91,250 (N.D. Cal. Sept. 9, 2000)(statement regarding “planned investment” was a statement of past fact of planning rather thanforward-looking statement); Karacand, 53 F. Supp. 2d at 1243 ("The Safe Harbor does not applyto the extent a statement was made by a person or entity having actual knowledge that it wasfalse or misleading.") (citing 15 U.S.C. § 78u-5(c)(1)(B)).Thus, in Stratosphere, 1 F. Supp. 2d at 1111-12, the plaintiff shareholders alleged that thecompany’s officers and directors knew that their predications that a hotel-casino constructionproject would be on budget were false because the insiders had received construction estimatesshowing that the project would have cost overruns. On a motion to dismiss, Judge Pro held thatthose allegations were sufficient to withstand dismissal under the PSLRA's "actual knowledge"scienter standard for forward-looking statements. Following discovery, the court reached thesame conclusion once a complete factual record had been presented. See In re StratosphereCorp. Secs. Litig., 66 F. Supp. 2d 1182, 1191-93 (D. Nev. 1999) (material issues of factregarding defendants' knowledge of cost overruns on hotel-casino construction project andcompany’s generation of change orders and extra work orders without apparent regard forbudgetary constraints precluded summary judgment on defendants' claim that prospectusstatements regarding financial condition were not made with required scienter). Other courtshave reached similar conclusions. See, e.g., Weiss v. Mentor Graphics Corp., 1999 U.S. Dist.LEXIS 17026, at *45-46, 1999 WL 985141 (D. Or. Oct. 6, 1999) (interpreting “actualknowledge” standard to require that defendants knew -- not should have known -- of facts whichseriously undermined their prediction or knew -- not should have known -- there was noreasonable basis for their prediction"); Geffon v. Micrion Corp., 1998 U.S. Dist. LEXIS 15773,at *10-11, Fed. Sec. L. Rep. (CCH) 90,307 (D. Mass. Sept. 24, 1998) (denying summaryjudgment on claims that defendants had misrepresented to market that they had firmcommitments and an order backlog, when purchaser retained right to cancel significant portionof order; held that comments were not protected by safe harbor because such statements wereclearly not forward-looking and because cautionary language did not clearly express nature of72

cancellation right). See generally Edward Brodsky, Making the Safe Harbor Safer: GivingMeaning to "Meaningful Cautionary Statements," 7 SECURITIES REFORM ACT LITIG. RPTR. 7(Apr. 1999).A “forward-looking” statement is insulated from liability unless the defendant fails tomake accompanying cautionary statements or the plaintiff proves the defendant actually knewthe statements were false when made. See Schaffer, 29 F. Supp. 2d at 1224 (defendants knewtruth about future business based on company's financial statements which revealed downturn innew business); Kensington Capital, 1999 U.S. Dist. LEXIS 385, at *10-11 (plaintiffs pled factssufficient to create strong inference of defendants' knowledge of falsity of statements regardingintroduction of new sunglass line).The PSLRA’s safe harbor explicitly excludes from protection forward-looking statementsincluded in financial statements prepared in accordance with GAAP; statements contained inregistration statements; or statements made in connection with a tender offer or initial publicoffering. See Queen Uno, 2 F. Supp. 2d at 1360 (particular and detailed representationsregarding expected production levels of specific facilities may be actionable).C. The "Bespeaks Caution" Doctrine: When Cautionary Language ProtectsMisleading Statements"Proving that Defendant has provided enough cautionary language as a matter of law is ahigh standard." Lister, 1999 U.S. Dist. LEXIS 384, at *9; see also Kensington Capital, 1999U.S. Dist. LEXIS 385, at *8. "The 'bespeaks caution' doctrine is applied narrowly because anoverbroad interpretation would encourage management to conceal deliberate misrepresentationsbeneath the mantle of broad cautionary language." Boeing, 1998 U.S. Dist. LEXIS 14803, at*24. Whether a statement is misleading may be determined as a matter of law only whenreasonable minds could not disagree as to whether the mix of information is misleading.Powers, 977 F. Supp. at 1043; Grand Casinos, 988 F. Supp. at 1279; Boeing, 1998 U.S. Dist.LEXIS 14803, at *24-25 (reasonable minds could differ as to whether cautionary language wassufficient).Under the judicially created "bespeaks caution" doctrine, misstated "'forecasts, opinions,or projections' do not amount to 'material misrepresentations' if 'meaningful cautionarystatements' accompany the forward-looking statements." Valujet, 984 F. Supp. at 1479 (allegedmisrepresentation was not based on forward-looking statements but existing facts) (citationomitted).A claim can only be dismissed under the "bespeaks caution" doctrine if defendants'forward looking statements are accompanied by enough cautionary language or risk disclosurethat "'reasonable minds' could not disagree that the challenged statements were not misleading."Cherednichenko, 1997 U.S. Dist. LEXIS 23107, at *17 (citation omitted); Olympic Fin., 1998U.S. Dist. LEXIS 14789, at *12; Boeing, 1998 U.S. Dist. LEXIS 14803, at *17, *24; KensingtonCapital, 1999 U.S. Dist. LEXIS 385, at *8.The “bespeaks caution” doctrine provides a mechanism by which a court can rule as amatter of law that defendants' forward looking statements contained enough cautionary language73

or risk disclosure to protect the defendant against securities fraud. Hoffman v. Avant! Corp.,1997 U.S. Dist. LEXIS 21823, at *4 (N.D. Cal. Dec. 16, 1997) (citation omitted). The doctrinereflects nothing more than the unremarkable proposition that statements must be analyzed incontext. See Powers, 977 F. Supp. at 1043. Dismissing a securities action under the bespeakscaution doctrine represents a conclusion that, as a matter of law, a securities prospectus as awhole is not misleading due to the risks disclosed and the nature and extent of the othercautionary language employed. Hoffman, 1997 U.S. Dist. LEXIS 21823, at *5.D. Cases In Which Cautionary Disclosures Were Insufficient To “BespeakCaution”In a variety of cases, courts have held that defendants’ cautionary disclosures wereinsufficient to “bespeak” caution. See Bryant, 25 F. Supp. 2d at 1382 (no defense whencautionary statements regarding forward-looking information are separate statements ordocuments from those listed in complaint); Cherednichenko, 1997 U.S. Dist. LEXIS 23107, at*17-18 (warnings appeared in documents that did not accompany allegedly misleading oralrepresentations, thus diminishing their cautionary effect); Powers, 977 F. Supp. at 1043-44(information does not clearly preclude reasonable minds from differing); Fugman, 961 F. Supp.at 1199-98 (statements concerning marketability of medical diagnostic test); Voit, 977 F. Supp. at371 (cautionary warning itself was actionable as material misstatement); Hoffman, 1997 U.S.Dist. LEXIS 21823, at *5 (representations regarding merits of defendants' legal position may bemisleading and substantially minimize impact of company's risk disclosures); Olympic Finan.,1998 U.S. Dist. LEXIS 14789, at *13 (documents containing some cautionary language did notspecifically address heart of plaintiffs' claim); Schaffer, 29 F. Supp. 2d at 1224 (misleadingquarterly earnings are present factual conditions); Kensington Capital, 1999 U.S. Dist. LEXIS385, at *8 (same; statements concerning introduction of new sunglass line).E. Boilerplate Warnings Are Insufficient To “Bespeak Caution”To determine whether the doctrine immunizes defendants from liability, the court mustanalyze whether the cautionary statements are "precise" and directly addressed to the future riskat issue. Hoffman, 1997 U.S. Dist. LEXIS 21823, at *5; Olympic Fin., 1998 U.S. Dist. LEXIS14789, at *12. "To immunize the type of conduct alleged here would be to give companies alicense to issue groundless appraisals to investors so long as they include a modest footnote orappendix with a kernel of truth that might enable an analyst or accountant to spot theinconsistencies." Marksman Partners, 927 F. Supp. at 1307.To be meaningful, cautionary statements must identify important facts that could causeactual results to differ materially from the forward looking statement. See Boeing, 40 F. Supp.2d at 1169-71 (warnings did not speak to factors that could adversely affect company'sdevelopment of systems to improve efficiency).If a party is aware of an actual danger or cause for concern, the party may not rely on ageneric disclaimer in order to avoid liability under the bespeaks caution doctrine. See In reCredit Suisse First Boston Corp. Secs. Litig., 1998 U.S. Dist. LEXIS 16560, at *21, 1998 WL734365, Fed. Sec. L. Rep. (CCH) 90,306 (S.D.N.Y. Oct. 20, 1998) (blanket disclaimer that74

defendant/ market maker "may from time to time have long or short positions" not enough toprotect defendants); Feiner v. SS&C Tech., 11 F. Supp. 2d 204, 209 (D. Conn. 1998)("[W]arning is not so precise and obvious that it renders plaintiffs' allegations unactionable as amatter of law."); Warman, 1998 U.S. Dist. LEXIS 2009, at *15 (rejecting defendants' bespeakscaution defense because cautionary statements did not directly address defendants' projectionsand "even if the statements were forward looking, the language used by the defendants appearsto be merely a boilerplate disclaimer"); Cherednichenko, 1997 U.S. Dist. LEXIS 23107, at *17(rejecting bespeaks caution defense because "many of the disclosures appear to be merelyboilerplate disclaimers") (citation omitted); Stratosphere, 1 F. Supp. 2d at 1118 (plaintiffsalleged that because defendants knew of existing, specific construction cost overruns andconstruction delays which would necessarily affect operating revenues once hotel-casino opened,they cannot insulate these statements with general language in securities disclosures concerningrisks inherent in every construction enterprise).F. The "Bespeaks Caution" Doctrine Is Not Applicable WhenMisrepresentations Or Omissions Concern Historical Hard Or Current FactsPredictive statements contain the factual assertions that the speaker genuinely believesthe statement is accurate, that there is a reasonable basis for that belief, and that the speaker isunaware of any undisclosed facts that would tend to seriously undermine the accuracy of thestatement. It follows that statements of opinion are actionable if they are made in bad faith or arenot reasonably supported by evidence available to the person that issues the statements. SeeCredit Suisse, 1998 U.S. Dist. LEXIS 16560, at *14. See also Grand Casinos, 988 F. Supp. at1279-1280 (forward-looking cautionary language does not render immaterial presently knownfacts regarding cost overruns and other construction difficulties); Friedberg v. Discreet Logic,Inc., 959 F. Supp. 42, 47 (D. Mass. 1997) (while defendants disclosed "risk" that existingproducts may become obsolete by introduction of new products by partners, defendants' failureto disclose that such new product had already been created, was about to be introduced tomarket, and would render company's "current product line obsolete within the industry and, thus,materially lower [the company's] revenues and earnings for the second quarter of fiscal year1996" held actionable); Page v. Derrickson, 1997 U.S. Dist. LEXIS 3673, at *33-34, 1997 WL148558 (M.D. Fla. Mar. 25, 1997) ("bespeaks caution" doctrine inapplicable when plaintiffsallege misstatements of existing facts); Powers, 977 F. Supp. at 1043 (rejected defendants'bespeaks caution defense because cautionary language "does not directly address the delays thatPlaintiffs claim Proxima was then experiencing with its laser-projector development"); Valujet,984 F. Supp. at 1479 (plaintiffs alleged that defendants misrepresented and failed to disclosepoor safety record and fact that FAA approval was required before expansion could beconsummated); Voit v. Wonderware Corp., 977 F. Supp. 363, 372 (E.D. Pa. 1997) (allegationsthat defendants made omissions of present fact regarding CEO departure and that stockplummeted following announcement contradicted defendants' contention that omission was softinformation); Fugman, 961 F. Supp. at 1197 n.9 (cautionary statements cannot render immaterialcompany's factual representations regarding the adequacy of one component in a medicaldiagnostic testing system).X. LIABILITY OF SECURITIES ISSUERS AND THEIR OFFICERS ANDDIRECTORS FOR SECURITIES ANALYSTS' STATEMENTS75

A. The Fraud-On-The-Market DoctrineFederal regulation of securities began with the Securities Act of 1933 (the "SecuritiesAct") and the Securities Exchange Act of 1934 (the "Exchange Act"). The goal of both statutescan best be understood as the promotion of a more efficient securities market. See HouseCommittee on Interstate and Foreign Commerce, 95th Cong., Report of the Advisory Committeeon Corporate Disclosure to the Securities and Exchange Commission 560 (1977) ("1977REPORT"). To achieve this goal, the legislation mandates company disclosure of materialinformation and establishes liability for false and misleading statements. Id. at 564-65.Market efficiency has two components: informational efficiency and allocationalefficiency. James D. Cox, et al., SECURITIES REGULATION 36-38 (Aspen 2 nd ed. 1997). "Onclose inspection, there are really two distinct aspects of market efficiency: informationalefficiency and allocational efficiency. Informational efficiency describes the speed with whichmarket prices adjust to new information. Allocational efficiency concerns the allocation ofresources to their best or highest use." Id. at 38. "Prices in an efficient market more closelyreflect underlying value than in an inefficient market, and scarce resources are thereforeallocated more efficiently." Id. at 36. By mandating company disclosures, with the SecuritiesAct and the Exchange Act Congress sought to increase informational efficiency and thusincrease allocational efficiency." 1977 REPORT, at 562. "The Securities Act was founded on thetheory that informed investors seeking to maximize their own investment needs and objectivesresulted in the most efficient allocation of capital among innumerable alternative investmentopportunities." Id. at 563.In open market securities cases brought by defrauded investors under Section 10(b) of theExchange Act and SEC Rule 10b-5 plaintiffs often employ the "fraud-on-the-market" theoryendorsed by the Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 247 (1988): "[M]ostpublicly available information is reflected in market price, [and therefore] an investor's relianceon any public material misrepresentations ... may be presumed for purposes of a Rule 10b-5action."As the Basic Court recognized, the fraud-on-the-market theory presupposes that thesecurities market "'transmits information to the investor in the processed form of a marketprice.... The market is acting as the unpaid agent of the investor, informing him that given all theinformation available to it, the value of the stock is worth the market price.'" Id. at 244 (quotingIn re LTV Sec. Litig., 88 F.R.D. 134, 143 (N.D. Tex. 1980)); see also Unger v. Amedisys, Inc.,401 F.3d 316 (5 th Cir. 2005) (offering extensive analysis of “fraud-on-the-market” theory). Seegenerally Paul A. Ferillo et al., The “Less Than” Efficient Capital Markets Hypothesis:Requiring More Proof From Plaintiffs in Fraud-on-the-Market Cases, 78 ST. JOHN’S L. REV. 81(2004); Jeffrey L. Oldham, Comment, Taking “Efficient Markets’ Out of the Fraud-on-the-Market Doctrine After the Private Securities Litigation Reform Act, 97 NW. U.L. REV. 995(2003); Peter J. Dennin, Note, Which Came First, the Fraud or the Market: Is the Fraud-Created-the-Market Theory Valid Under Rule 10b-5?, 69 FORDHAM L. REV. 2611 (2001);Jonathan R. Macey & Geoffrey P. Miller, Good Finance, Bad Economics: An Analysis of theFraud-on-the-Market Theory, 42 STAN. L. REV. 1059 (1990).76

B. Causation In Securities Fraud CasesIn a Rule 10b-5 action brought by a private party, the plaintiff must prove that he, she, orit suffered an injury that was caused by the defendant’s misrepresentations. The causationrequirement encompasses both transaction causation – that the violations in question caused theplaintiff to engage in the transaction – and loss causation – that the misrepresentations oromissions caused the harm. See, e.g., Binder v. Gillespie, 184 F.3d 1059, 1065 (9 th Cir. 1999).Loss causation has long been a judicially inferred element of a Rule 10b-5 claim, see, e.g.,Bastian v. Petren Res. Corp., 892 F.2d 680, 683-85 (7 th Cir. 1990), and by virtue of the PSLRA,it has been a statutory element since 1995. As amended by the PSLRA, the Exchange Act, in aprovision entitled “Loss causation,” requires a plaintiff in a private action to prove that “the[challenged] act or omission of the defendant . . . caused the loss for which the plaintiff seeks torecover damages.” 15 U.S.C. § 78u-4(b)(4). See generally 2 Thomas Lee Hazen, SECURITIESLAW HANDBOOK § 27:77 (2004). See also Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161(2 nd Cir. 2005) (investors alleging securities fraud via research reports intending to artificiallyinflate prices of stocks of companies that were clients of investment brokerage firm/investmentbank’s investment banking business failed to state loss causation element, i.e., that allegedlyfalse research reports concealed particular circumstances that resulted in losses suffered).In the past few years, a split has developed among the circuit courts as to what plaintiffsmust do to plead loss causation. Under one view, the loss occurs when the plaintiff pays toomuch for her shares, while the alternative view is that the loss occurs when the stock pricedeclines. Currently, the Eighth and Ninth Circuits hold that plaintiffs do not have to allege thatthe fraud or its disclosure caused a stock price decline but have to plead only that there was adifference between the market price and the stock’s true value (what is called a “purchase pricedisparity.” See, e.g., Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9 th Cir. 2003)(holding that “loss causation” does not require pleading a stock price drop following a correctivedisclosure or otherwise; it merely requires pleading that the price at the time of purchase wasoverstated and sufficient identification of the cause), cert. granted, No. 03-932 (June 28, 2004);Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824, 831 (8 th Cir. 2003) (“Our finding of materialityallows the plaintiffs to invoke the fraud-on-the market theory and assume that themisrepresentations inflated the stock’s price. Paying more for something than it is worth isdamaging. Thus, the plaintiffs adequately pleaded their case for damages.”).On the other hand, in Emergent Capital Inv. Mgmt., LLC v. Stonepath Group, Inc., 343F.3d 189 (2 nd Cir. 2003), the Second Circuit held that “[s]imilar to loss causation, the proximatecause element of common law fraud requires that plaintiff adequately allege a causal connectionbetween defendants’ non-disclosures and the subsequent decline in the value of NETVsecurities.” It explicitly rejected the purchase-only pleading requirement, observing that“Plaintiff’s allegation of a purchase-time value disparity, standing alone, cannot satisfy the losscausation pleading requirment.” Id. at 198-99. In Semerenko v. Cendant Corp., 223 F.3d 165(3 rd Cir. 2000), and Robbins v. Koger Props., Inc., 116 F.3d 1441 (11 th Cir. 1997), two othercircuit courts held that plaintiffs must allege and prove that the fraud or its disclosure cause aprice decline. See generally David Tabak, Loss Causation and Damages in Shareholder ClassActions: When It Takes Two Steps to Tango (NERA May 2004).77

In Dura Pharmaceuticals, Inc. v. Broudo, 125 S. Ct. 1627 (2005), the Supreme Courtruled on the issue of loss causation in private securities open market-fraud actions. The issue asframed in Dura was a narrow one: Whether an allegation of price inflation alone due to amaterial misrepresentation or omission was sufficient to establish loss causation. Reversing aNinth Circuit panel that had held that an inflated purchase price alone “establishes” losscausation, the Supreme Court determined that defrauded investors need to prove that defendants’misrepresentation proximately caused investors economic loss. Having determined thatplaintiffs need to prove causation leading to economic loss, the Supreme Court held thatplaintiffs’ pleadings must provide defendants with fair notice of plaintiff’s claim.In rejecting the argument that Rule 9(b) particularity applied to the elements of causationand economic loss, or that the PSLRA had raised the pleading standards as to these elements asargued by the Solicitor General, the Supreme Court “conceded that the Federal Rules of CivilProcedure require only ‘a short and plain statement of the claims showing that the pleader isentitled to relief.’ Fed. R. Civ. P. 8(a)(2).’ That statement must provide fair notice of whatplaintiff’s claim is and the ground upon which it rests. Conley v. Gibson, 355 U.S. 41, 47(1957).” As a result, the Court found it should not prove burdensome for a plaintiff who hassuffered an economic loss to “provide a defendant with some indication of the loss and the causalconnection that the plaintiff has in mind.” The Supreme Court also failed to adopt Dura’srequest for a rule that required a stock drop directly tied to a corrective disclosure. Instead, theCourt seemed to recognize, as the Solicitor General argued, that a drop in the stock price may notbe a necessary condition for establishing loss causation in every fraud-on-the-market case.According to the Solicitor General, inflation attributable to a misrepresentation might be reducedor eliminated even if there were a net “increase in price” – a case the Supreme Court specificallydeclined to address – but a concept it did not reject.A careful reading of the Dura decision reveals that the opinion consists of two sections –(A) and (B) – dealing with matters of “proof” and “pleading” respectively. Section A of theopinion deals only with what securities-fraud plaintiffs must prove to establish loss causation andconcludes that “a plaintiff must prove that defendant’s misrepresentation (or other fraudulentconduct) proximately caused the plaintiff’s economic loss.” While this proof may take a varietyof forms, the Supreme Court declined to define their parameters, whether substantive ortemporal. It holds only that plaintiffs must ultimately prove the economic loss they suffered asthe “relevant truth begins to leak out,” or as “the truth makes its way into the market place.”Importantly, although the Dura defendants (and Dura’s numerous amici in the securities andbusiness arenas) had urged stringent loss causation/proximate cause rules that would haverequired proof of a direct tie between any subsequent stock decline and a previousmisrepresentation, the Supreme Court expressly declines to go that far. “We need not, and donot, consider other proximate cause or loss related questions.”The “pleading” section of the Dura opinion contains the core of the Court’s guidance, forthe underlying case is currently at the motion-to-dismiss stage and the Court knew that the NinthCircuit had already granted plaintiffs leave to amend their complaint. Dura confirms thatsecurities-fraud plaintiffs face no enhanced burdens in satisfactorily alleging loss causation.Rather, to successfully plead loss causation in a securities-fraud action, plaintiffs simply need toallege a “‘short and plain statement’” of the loss and how defendants caused it, sufficient to78

provide defendants with “‘fair notice.’” This should not be difficult because, as the Courtexplains, satisfactory loss-causation allegations need only “provide a defendant with someindication of the loss and the causal connection that the plaintiff has in mind.”Clearly, the Court means for this pleading exercise to be a fairly simple one, focusing onthe plaintiff’s subjective belief of how defendant caused his loss. Twice, in fact, the SupremeCourt explains that the plaintiff needs only to allege an “indication” of the economic loss andproximate cause that “the plaintiff has in mind.” This language, considered in conjunction withthe Court’s earlier acknowledgment that a “tangle of factors” related to price will have to besorted out at the proof stage, makes clear that the Court does not intend for the motion-to-dismissstage to become a mini-trial on loss causation scenarios.While the foregoing explains what the Supreme Court’s Dura opinion holds, the opinionis also notable for what it does not hold. Defendants and their amici had tried mightily toconvince the Supreme Court to raise both the proof and pleading bars of securities fraud actionswell out of reach of many defrauded investors. By any reasoned analysis of the Dura opinion,their efforts failed.Specifically, Dura (and commentators like Professor John Coffee) hoped the SupremeCourt might reconsider Basic v. Levinson, 485 U.S. 224 (1988). Basic’s rebuttable presumptionof plaintiffs’ reliance on the integrity of a security’s market price, according to Professor Coffee,could have been significantly curtailed. Their hopes were dashed, however, as the Court insteadrepeatedly cites Basic with approval. It uses Basic to lay out a securities fraud action’s basicelements, notes the unsurprising axiom that the securities laws were not intended to providebroad insurance against non-fraud-related market losses, and – importantly, given defendants’and Professor Coffee’s contrary urgings – repeats Basic’s rule concerning a rebuttablepresumption of investors’ reliance on stocks’ public market prices.Nor does the Court adopt the argument, urged by Dura and its amici, that loss causationrequires that there always exist a corrective disclosure – really, an admission by defendants –specifically linked to a final stock drop. (A more pernicious extension of that argument furtherurged the Court to hold that that final drop was the total measure of plaintiffs’ damages.)Instead, the Supreme Court explains in Dura’s “proof” discussion that plaintiffs’ economic lossmay occur as the “relevant truth begins to leak out,” or as “the truth makes its way into themarket place.” Importantly, the Court does not require that an explicit disclosure – whether bydefendants themselves, or sleuthing outsiders – be the mechanism by which the truth “leak[ed]”out. As this Article explains elsewhere, and as plaintiffs’ counsel explained at oral argument,there are myriad ways in which the truth involving defendants’ fraud can be communicated tothe market, thereby removing inflation from the stock price and harming investors. The SupremeCourt has now confirmed that plaintiffs need only provide defendants with “some indication” ofthe connection between that leakage and plaintiffs’ claimed economic loss.Finally, Dura and the United States urged the Supreme Court to hold that loss causationneeded to be pleaded, like falsity and scienter, with Rule 9(b) particularity. The Court reacted tothat argument with skepticism at oral argument, and its opinion did not adopt the SolicitorGeneral’s or Dura’s position that Rule 9(b) did apply in this context. Dura reaffirms the vitality79

of Conley v. Gibson and the requirement that, absent special pleading rules, a complaint needonly provide a “short and plain statement” of loss causation. “[I]t should not proveburdensome,” explained the Court, “for a plaintiff who has suffered an economic loss to providea defendant with some indication of the loss and the causal connection that the plaintiff has inmind.” That explanation is consistent with the Court’s earlier observation that the “tangle offactors affecting price” will be part of the proof of loss causation – a fact-intensive inquiryclearly reserved for trial.C. The Important Role Played By Securities AnalystsIn explaining how the securities market translates company-specific information into astock price, the Basic Court emphasized the importance of "market professionals":We need not determine by adjudication what economists and social scientistshave debated through the use of sophisticated statistical analysis and theapplication of economic theory. For purposes of accepting the presumption ofreliance in this case, we need only believe that market professionals generallyconsider most publicly announced material statements about companies, therebyaffecting stock market prices.485 U.S. at 247 n.24 (emphasis added). Prominent among these "market professionals" aresecurities analysts; indeed, district courts have frequently stated that the number of such analystsreporting on a particular security is one of the factors to be examined in determining whether thefraud-on-the-market theory is to be applied in a particular case. See, e.g., In re MDC HoldingsSec. Litig., 754 F. Supp. 785, 804-05 (S.D. Cal. 1990); Cammer v. Bloom, 711 F. Supp. 1264,1286 (D.N.J. 1989). See also Brad M. Barber, et al., The Fraud-on-the-Market Theory and theIndicators of Common Stocks' Efficiency, 19 J. CORP. L. 285, 305 (1994) (number of analystsfollowing stock and trading volume are only factors having independent statistical significance indetermining market efficiency); Donald C. Langevoort, Investment Analysts and the Law ofInsider Trading, 76 VA. L. REV. 1023, 1024 (1990) (academic commentary supports theproposition that "[i]nvestment analysts are crucial players in the mechanisms of marketplaceefficiency that lead to optimal allocations of capital resources").Courts have recognized that earnings forecasts disseminated by securities analysts are ofparticular importance because such analysts are theoretically independent of the companies theyfollow and, as a result, they can be expected to provide more objective projections than thecompanies themselves:[T]he corporation's own officers are not likely to be the most reliable source ofprojections of future corporate performance. Officers and internal analysts maybe biased by their personal goals in evaluating the corporation's prospects forshort- and long-term success. [So] long as the corporation provides accurate harddata to the market, professional analysts and investors are in at least as good andprobably a better position to make the predictions about a corporation's futurewhich are relevant to the valuation of corporate securities.80

This is true for a number of reasons. First, the professional analyst has moreinterest in making the most accurate prediction possible, because the analyst'sreputation and livelihood depend solely on the analyst's ability to be correct. Thecorporate officer's success does not depend primarily or even significantly on anability to predict stock prices. Second, the analyst has the benefit of objectivitybecause the analyst is removed from the daily operations of the corporation,whereas the corporate officer is in the thick of these developments. Finally, andmost importantly, the analyst is skilled in combining the specific data disclosedby the corporation with general knowledge about the industry and the national andinternational economies in which the corporation competes. Corporations call ontheir officers for other skills.In re Verifone Secs. Litig., 784 F. Supp. 1471, 1481-82 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9 thCir. 1993) (footnote omitted). See also In re Compaq Secs. Litig., 848 F. Supp. 1307, 1315 (S.D.Tex. 1993) ("market makers often use analysts' opinions rather than management's to form thebasis for their decisions about the appropriate market price for a company's stock") (footnoteomitted); William O. Fisher, The Analyst-Added Premium as a Defense in Open MarketSecurities Fraud Cases, 53 BUS. LAW. 35, 38-43 (Nov. 1997) (recognizing influence thatsecurities analysts have upon stock prices).D. Liability Of Securities Issuers For Statements And Projections DisseminatedBy Securities Analysts1. IntroductionSeveral legal theories impose liability upon securities issuers and their officers anddirectors for statements or projections made by securities analysts, as Judge Legge has cogentlyexplained:If defendants made misleading statements to securities analysts regardingexpected licensing revenues, they may be liable for securities fraud, even if thecompany did not adopt the analysts' subsequent reports. If a company chooses tospeak to the market on a subject, through an analyst or otherwise, it must make afull and fair disclosure to ensure that its statements are not materially misleading.A company may be liable under Rule 10b-5 for misrepresentations to analysts thatreach the market.Although a company is not generally responsible for the accuracy ofstatements made by securities analysts, a company may adopt or endorse ananalyst's report, causing the report to be attributed to the company. A defendantmay become sufficiently entangled by reviewing the analysts' reports and makingrepresentations that the information is true or in accordance with the company'sviews, or by exercising some measure of control over the content of the reports.For liability to attach, plaintiffs must demonstrate: 1) that a corporate insideradopted the analysts' forecasts; and 2) that the insider knew the analysts' forecastswere unreasonable when made, yet failed to disclose their unreasonableness to81

investors. Generally, a company is liable for analysts' forecasts that it fosteredand reviewed but failed to correct if the company expressly or impliedlyrepresented that the information in the forecasts was accurate or coincided withthe company's views.In re DSP Group Secs. Litig., 1997 U.S. Dist. LEXIS 11942, at *19-21, 1997 WL 678151, Fed.Sec. L. Rep. (CCH) 99,525 (N.D. Cal. Mar. 5, 1997) (citations omitted). See also NursingHome Pension Fund, 380 F.3d at 1235 (“[W]hen statements in analysts’ reports clearlyoriginated from the [corporate] defendants, and do not represent a third party’s projection,interpretation, or impression, the statements may be held to be actionable even if they are notexact quotations.”); In re Harmonic, Inc. Secs. Litig., 163 F. Supp. 2d 1079, 1094-95 (N.D. Cal.2001) (outlining theories of liability). See generally Shirli Fabbri Weiss, Securities Analysts inSecurities Class Actions: Theories of Liability and Defense After the Private SecuritiesLitigation Reform Act, 8 SECURITIES REFORM ACT LITIG. RPTR. 667 (Feb. 2000) ("Weiss,Securities Analysts"); Peter L. Cholakis, Comment, Company Disclosures of EarningsProjections: Should Individual Investors Be Allowed Into the "Ball Park"?, 39 SANTA CLARA L.REV. 819, 836 n.147 (1999) ("Cholakis, Company Disclosures") ("Corporations may also besubject to [Rule] 10b-5 liability stemming from relations with analysts where they: (1) providean analyst with false information, (2) entangle themselves with an analyst's report, or (3)disseminate an analyst's report.") (citations omitted).On December 22, 1997, the Securities and Exchange Commission ("SEC") issued anEnforcement Release defining the circumstances under which a securities issuer may be heldliable for statements, including earnings forecasts, contained in a securities analyst's report. SeeIn the Matter of Presstek, Inc., Administrative Proceeding File No. 3-9515, 1997 SEC LEXIS2645 (Dec. 22, 1997). In an accompanying civil action brought against Presstek's chairman,Robert Howard, and president, Robert Verrando, the SEC alleged that Howard and Verrandocaused Presstek to disseminate, through its own statements and its distribution of analysts'statement, materially misleading information concerning its sales and business prospects. SEC v.Robert Howard, No. 97 Civ. 9378 (SWK), Litigation Release No. 15599, 1997 SEC LEXIS 2623(Dec. 22, 1997). In 1994 and 1995, Howard directed Presstek to distribute several thousandcopies of several editions of the Cabot Market Letter, a financial newsletter that aggressivelytouted Presstek and which contained excessive earnings projections for the company. Howardknew, or was reckless in not knowing, that those earnings projections far exceeded Presstek'scontemporaneous internal projections. Presstek adopted those unrealistic projections bydistributing the Cabot Market Letters without disclaimer, and during a time when Presstekelected not to make public its own projections because management did not view them asreliable.In November 1995, Howard reviewed and edited the draft of a research analyst's reporton Presstek and had Presstek distribute the report, which in final form substantially overstatedPresstek's sales and earnings expectations. For example, the report projected 1996 sales of aPresstek laser imaging product of $26 million, when Presstek internally projected only $10million. It also projected 1996 sales of consumable printing plates of $33.2 million, contrastedwith Presstek's internal projection of $8.7 million. It projected 1997 earnings of $2.42 per share,80% more than Presstek's internal projection of $1.34 per share. Howard did not correct thoseerrors, and Presstek distributed the erroneous report for more than six months to investors82

without disclaimer. Verrando was aware that projections in the analyst's report weresignificantly greater than Presstek's contemporaneous projections, but failed to halt itsdistribution.In its release, the SEC recognized "entanglement" liability (see discussion below), statingthat "[a]n issuer is liable for inaccuracies in a research report published by someone else" if it"'sufficiently entangled itself' with such information to render them attributable to the issuer."Presstek, 1997 SEC LEXIS 2645, at *29 (citation omitted). The SEC also recognized "adoption"liability (see discussion below), stating that "[a]n issuer may also be liable for false statementscontained in a third-party report if it adopts, expressly or impliedly, the statements after they arepublished, even if management had no role in preparing the reports." Id. at *31. Analyzing thefacts of the case, the SEC held that Presstek was liable under both theories. Id. at *34-39.E. The "Entanglement" TheoryAs a general rule, securities issuers are not liable for statements or forecasts disseminatedby securities analysts; however, reference to reported cases demonstrates numerous exceptionsthat nearly swallow the rule. Thus, issuers can be held liable under § 10(b)/Rule 10b-5 if theyhave "sufficiently entangled [themselves] with the analysts' forecasts [so as] to render thosepredictions 'attributable to [the issuers].'" Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 163 (2 ndCir. 1980). In that case, the Second Circuit explained the rationale for its holding:We have no doubt that a company may so involve itself in the preparation ofreports and projections by outsiders as to assume a duty to correct material errorsin those projections. This may occur when officials of the company have, by theiractivity, made an implied representation that the information they have reviewedis true or at least in accordance with the company's views.Id.; accord Presstek, 1997 SEC LEXIS 2645, at *29-30 (explicating "entanglement" theory andcollecting cases). In order for the securities issuer to be held liable for the securities analysts'statements or projections under the so-called "entanglement" theory, the issuer must have placedits "imprimatur, expressly or impliedly, on the analysts' projections." Elkind, 635 F.2d at 163;see also Harmonic, 163 F. Supp. 2d at 1095; Presstek, 1997 SEC LEXIS 2645, at *30; In re StacElecs. Secs. Litig., 89 F.3d 1399, 1410 (9 th Cir. 1996) (same); In re Nokia Corp. Secs. Litig.,1998 U.S. Dist. LEXIS 4100, at *31, 1998 WL 150963, Fed. Sec. L. Rep. (CCH) 90,195(S.D.N.Y. Mar. 31, 1998); Verifone, 784 F. Supp. at 1486; Alfus v. Pyramid Tech. Corp., 764 F.Supp. 598, 603 (N.D. Cal. 1991). See also In re Polaroid Corp. Secs. Litig., 134 F. Supp. 2d 176(D. Mass. 2001) (company had no duty to correct inaccurate analysts’ reports circulating inmarket).At least one district court has observed that there are "sound reasons ... to construe theentanglement requirement strictly." In re Caere Corp. Secs. Litig., 837 F. Supp. 1054, 1059(N.D. Cal. 1993). As Judge Williams explained:In today's complex and highly competitive financial markets, countless analysts ...issue earnings and revenue forecasts on virtually every publicly-tradedcorporation. Forecasts may vary a great deal. If corporate insiders are held liable83

under Rule 10b-5 every time one of these forecasts proves to be incorrect, theywould likely spend more time in court than running their companies.Also, if a loose and capricious entanglement standard is allowed todevelop, it will be very difficult for corporate insiders to know how to regulatetheir behavior in such a way as to adopt only with those forecasts which they havecarefully examined and have determined to be reasonably accurate. Corporateinsiders should not be exposed to Rule 10b-5 liability for an analyst's forecastunless it is clear, based on the insider's conduct, that he could have reasonablyforeseen that he would be held liable if the forecast turned out to be unreasonablewhen made and materially misleading to the investing public.Id.; see also In re Syntex Corp. Secs. Litig., 95 F.3d 922, 934 (9 th Cir. 1996) (quoting Caerecourt's "strict construction" language with approval). Relying upon Caere, 837 F. Supp. at 1059,Judge Lasker posited the standard for liability under the "entanglement" theory in the followingterms:Courts concluding that an issuer may be liable under the statute for failureto correct an analyst statement have generally required that the plaintiff allegethat: (1) the issuer "entangled" itself in the making of a statement by the analyst;(2) the issuer knew that the statement (commonly a prediction) was false orlacked a reasonable factual basis when made; and (3) the issuer failed to disclosethe falsity or the unreasonableness to investors. The element of entanglementmay be satisfied by the issuer having either "fostered," "induced," or otherwisecaused the statement to be made in the first place, or having adopted, ratified, orotherwise "endorsed" the statement after it was made. In either instance, theissuer must have "sufficiently entangled itself with the analysts' [statements] torender [them] attributable to it."In re Boston Tech. Secs. Litig., 8 F. Supp. 2d 43, 55 (D. Mass. 1998) (citations omitted); accordHarmonic, 163 F. Supp. 2d at 1095; Carney v. Cambridge Technology Partners, 135 F. Supp. 2d235, 248 & n.7 (D. Mass. 2001) (in order for company to be held liable for statements about itsstock made by outside analysts, complaint must sufficiently plead “entanglement” between thecompany or its officers and the issuance of the report); Peritus Software, 52 F. Supp. 2d at 230;In re Number Nine Visual Tech. Corp. Secs. Litig., 51 F. Supp. 2d 1, 30 (D. Mass. 1999). Seealso In re Crown Am. Realty Trust Secs. Litig., 1997 U.S. Dist. LEXIS 14609, at *54, 1997 WL599299 (W.D. Pa. Sept. 15, 1997) (to plead "imputation" theory with sufficient particularity toavoid dismissal under Rule 9(b), plaintiffs "'must (1) identify specific analyst opinions and namethe insider who adopted them; (2) point to specific interactions between the insider and theanalyst which gave rise to the entanglement; and (3) state the dates on which the acts whichallegedly gave rise to the entanglement occurred'") (citation omitted); accord Sun HealthcareGroup, 181 F. Supp. 2d at 1292 (positing same test for “sufficient pleading of entanglement”).Thus, in Graff v. Prime Retail, Inc., 172 F. Supp. 2d 721 (D. Md. 2001), Judge Motz held thatplaintiffs had not pled “with specificity … which Prime Retail officials provided the informationto the analysts or how it was provided.” “Failing to plead the identity of the speakers of allegedmateial misstatements is a critical defect.” Id. at 730 (citation omitted).84

Under this line of authority, courts typically hold that a so-called "one-way flow ofinformation, from [issuer] representatives to analysts and from the analysts to their customers" isnot sufficient "entanglement" to render the issuer liable for the analysts' statements orprojections. Syntex, 95 F.3d at 934; accord Harmonic, 163 F. Supp. 2d at 1095 (“The complaintmust allege a two-way flow of information between the analyst and the insider, such as reviewand approval of the report by the insider.”) (citations omitted). Those courts which strictlyconstrue the requirements of the "entanglement" theory require plaintiffs to allege withparticularity the time, place, content, and speaker of the issuer's communications with thesecurities analysts, and explain why the communications were fraudulent. See Suna v. BaileyCorp., 107 F.3d 64, 73-74 (1st Cir. 1997) (declining to reach ultimate issue of whether actionagainst issuer could lie on basis of analyst statements, but dismissing case on grounds ofplaintiffs' failure to plead issuer's "entanglement" sufficiently, indicating that if squarely facedwith issue, it might well permit findings of liability for analyst statements); accord In re VisualNetworks, Inc. Secs. Litig., 217 F. Supp. 2d 662 (D. Md. 2003) (misstatements to analysts werenot pled with particularity because the shareholder plaintiffs were unable to identify anyone whoactual spoke with the analysts on June 14, 2000, referring only to “senior management,” not toany individual); Barrie v. InterVoice-Brite, Inc., 2002 U.S. Dist. LEXIS 14695, 2002 WL1841631 (N.D. Tex. Aug. 8, 2002) (plaintiffs could not rely on statements by analysts whichgenerally failed to mention particular individuals as a source and never identified specificcomments by a particular invividual); Harmonic, 163 F. Supp. 2d at 1095 (“The complaint‘should 1) identify the specific forecasts and name the insider who adopted them, 2) point tospecific interations between the insider and the analyst which allegedly gave rise to theentanglement, and 3) state the dates on which the acts which allegedly gave rise to theentanglement occurred.’”) (citation omitted); Peritus Software, 52 F. Supp. 2d at 230; NumberNine Visual, 51 F. Supp. 2d at 30-31. See also In re Health Mgmt. Sys., Inc. Secs. Litig., 1998U.S. Dist. LEXIS 8061, at *15 n.2, 1998 WL 283286, Fed. Sec. L. Rep. (CCH) 90,235(S.D.N.Y. May 27, 1998) ("The complaint alleges that a report published by the firm ofRobinson-Humphrey Co. is attributable to defendants because it was written by a former CFO ofHMS and because the information is of sufficient detail that it could only have come fromdefendants. I find that these allegations do not sufficiently plead with particularity thatdefendants so thoroughly 'entangled' themselves with such report as to render them liable forsuch reports."); DSP Group, 1997 U.S. Dist. LEXIS 11942, at *27 ("Plaintiffs have not alleged[with particularity] which securities analysts provided draft reports to DSP corporate insiders,when they provided those reports, or which corporate insiders reviewed and approved the draftreports."); Colby v. Hologic, Inc., 817 F. Supp. 204, 215 (D. Mass. 1993) (holding that plaintifffailed to adequately plead "entanglement" or misstatements of facts to analysts). But see HarveyM. Jasper Retirement Trust v. Ivax Corp., 920 F. Supp. 1260, 1267 (S.D. Fla. 1995) ("At thepleading stage, all plaintiffs need allege is that defendants provided the information to thesecurities analyst, upon which the reports were based.").Not surprisingly, with a liability standard phrased as "entanglement" or "imprimatur," thecourts have experienced difficulty in determining when an issuer may be held liable for asecurities analyst's statement or projection. Some cases addressing the question have held that anissuer who simply provides background information to a securities analyst will not be liable forstatements in the analyst's subsequent report. As Judge Patel explained in Padnes v. Scios NovaInc., 1996 WL 539711 (N.D. Cal. Sept. 18, 1996):85

Here, plaintiffs have pled only that the analysts' reports were based oninformation provided by the defendants. This, without more, in [sic] insufficientunder the great weight of authority in this district to attribute third-partystatements to a defendant company. Mere provision of information cannotamount to entanglement sufficient to sustain liability under Elkind.Id. at *10 (citations omitted). See also In re Rasterops Corp. Secs. Litig., 1994 U.S. Dist. LEXIS18245, at *9, 1994 WL 618970, Fed. Sec. L. Rep. (CCH) 98,231 (N.D. Cal. Oct. 31, 1994)("[I]t is not enough to simply allege that the reports were based on information provided by thecompany and that the company received and reviewed a draft of the report."); O'Sullivan v.Trident Microsystems, 1994 U.S. Dist. LEXIS 17065, at *46, 1994 WL 124453, Fed. Sec. L.Rep. (CCH) 98,116 (N.D. Cal. Jan. 31, 1994) ("While the company may have provided theinformation on which the reports were based, this does not mean the company is liable for thecontents of the reports.").On the other hand, in Presstek, 1997 SEC LEXIS 2645, the SEC held that the followingfacts constituted "entanglement":Presstek's management directly participated in preparing a report that it knew, orwas reckless in not knowing, included forecasts that were far more optimistic thanPresstek's contemporaneous internal projections. For example, the PMG Reportquoted management's projection of "a few 100" Pearlsetter sales for 1996.However, Howard and Verrando knew, or were reckless in not knowing, thatPresstek's internal forecasts projected only half as many Pearlsetter sales for 1996as were forecast in the PMG Report. Moreover, in an effort to give added weightto the inaccurate Pearlsetter forecast, Howard falsely attributed it to "industryexperts." Howard also failed to lower the PMG Reports 1996 or 1997 revenueforecasts to conform them to Presstek's contemporaneous internal projections.Although Howard edited the PMG Report's 1996 EPS projection, he did notcorrect its 1997 EPS projection ($2.42), which far exceeded Presstek's internalprojection ($1.34). By revising certain forecasts concerning Presstek's revenuesand earnings, Howard impliedly represented to PMG that those he did not revisewere accurate.Id. at *34-35. "Such involvement by management in the preparation, review, and editing of thePMG Report establishes Presstek's liability for the report's forecasts." Id. at *35-36.F. The "Conduit" TheoryThe "entanglement" analysis applies where the securities analyst's statement forecast isthe product of his own work on which the issuer has placed its imprimatur by entanglingconduct. When plaintiffs allege that the issuer consciously planted false information with ananalyst, so that the analyst acted as a conduit for introducing the false information into themarket, the company may be liable whether or not it entangled itself by review of draft reports.See, e.g., In re Sunbeam Sec. Litig., 89 F. Supp. 2d 1326 (S.D. Fla. 1999) (refusing to dismissclaim that "Defendants used private securities analysts to mislead the public about the financialcondition of Sunbeam and its operations" where plaintiffs alleged that it was "Sunbeam's practice86

to have officers communicate with analysts frequently, in conference calls, meetings and analystbriefs, in order to falsely present the operations and allegedly successful prospects of Sunbeam tothe marketplace and inflate artificially the price of Sunbeam common stock"). In the words ofone recent commentary:If an issuer intentionally or recklessly misleads securities analysts, thenthe analyst reports are relevant to determine securities fraud liability. Adoption orentanglement is not required in such circumstances and an issuer cannot avoidliability just because the fraud is perpetrated through third parties.Robert Norman Sobol, The Tangled Web of Issuer Liability for Analyst Statements: In re CirrusLogic Securities Litigation, 22 DEL. J. CORP. L. 1051, 1057-58 (1997) ("Sobol, Tangled Web")(footnotes omitted). (It should be noted that in Presstek, 1997 SEC LEXIS 2645, the SEC didnot address the "conduit" theory of liability.)Section 10(b) of the Exchange Act prohibits the use of "any manipulative or deceptivedevice or contrivance," whether practiced "directly or indirectly." 15 U.S.C. § 78j(b). Section20(b) of the Exchange Act specifies that it is unlawful for a person "to do any act or thing whichit would be unlawful for such person to do ... through or by means of any other person." 15U.S.C. § 78t(b). As a result,[m]anipulation of the prices of securities by the dissemination of false andmisleading information through analysts is exactly the type of conduct section10(b) prohibits. When an issuer communicates such misleading information toinvestment analysts there is an expectation that the false information will reachthe marketplace and influence prices.Sobol, Tangled Web, 22 DEL. J. CORP. L. at 1058 (footnote omitted). See also Kirby v. CullinetSoftware, Inc., 116 F.R.D. 303, 307 (D. Mass. 1987) (stating that reliance on the market alsoincludes reliance on third party statements that just relayed the misstated information fromsecurities issuers).In Warshaw v. Xoma Corp., 74 F.3d 955 (9 th Cir. 1996), the Ninth Circuit reverseddismissal of a securities fraud complaint which alleged that the securities issuer intentionallyused securities analysts and the press to disseminate false information to the investing public:[I]f defendants intentionally misled securities analysts and the press in order tostave off a Xoma stock sell off, then these third-party reports would be relevant todetermine Xoma's securities fraud liability. The Complaint asserts that Xomaintentionally used these third parties to disseminate false information to theinvesting public. If this is true, Xoma cannot escape liability simply because itcarried out its alleged fraud through the public statements of third parties. TheComplaint should not have been dismissed under 12(b)(6), without a contextual,"delicate assessment" of the facts presented by including the statements of thirdpartyanalysts.87

Id. at 959 (citing Fecht v. Price Co., 70 F.3d 1078, 1080-81 (9 th Cir. 1995)). Accord DSP Group,1997 U.S. Dist. LEXIS 11942, at *25 ("If defendants provided inflated or otherwise misleadinglicensing revenue projections to the analysts, that could qualify as misleading the analysts.").In another case, In re Cirrus Logic Secs. Litig., 946 F. Supp. 1446 (N.D. Cal. 1996), thedistrict court observed:Defendants also argue that they cannot be held liable for allegedlymisleading statements made to analysts, unless plaintiffs can prove Cirrus'sentanglement with, or adoption of, the analysts' reports. This is not the law....The Court finds that a company may be liable under Rule 10b-5 for its ownintentional or reckless misrepresentations to analysts that reach the market,whether or not the company adopts the resulting analysts' reports.Id. at 1466-67. Similarly, in Simon v. American Power Conversion Corp., 945 F. Supp. 416(D.R.I. 1996), the court denied a motion to dismiss that part of the complaint alleging liability forstatements made by analysts because[t]here are sufficient facts to support a finding that any misstatements in theanalysts' reports were caused by APC's management. The reports referencenumerous conversations with APC management on the question of APC's buildupof inventories, during which APC gave its explanation for the increase ininventories. From that, it would be reasonable for the fact-finder to infer that anymisrepresentations in the reports were based on or caused by false or misleadinginformation obtained directly from APC. Such causation, if proven, is sufficientto support APC's liability through the attribution of the statements.Id. at 429-30 (footnote omitted).In Schaffer v. Timberland Co., 924 F. Supp. 1298 (D.N.H. 1996), the court denieddefendant's motion to dismiss becauseId. at 1312.[s]ignificantly, the plaintiffs have identified specific analyst statements and theinsider information, sometimes directly quoted, upon which they allege thestatements were based.... Jeffrey Swartz is alleged to have made direct statements,excerpted verbatim, statements of approval of erroneous projections of outsideanalysts, and statements concerning the size and nature of Timberland's inventoryand the demand for its product. The plaintiffs next allege, again in detail, that thefollowing day Merrill Lynch directly relied on and incorporated Swartz's remarksinto its report.It is not unusual for plaintiffs to allege several alternative theories of issuer liability foranalyst statements. See Gross, 977 F. Supp. at 1474 ("Plaintiffs sufficiently allege that the[analysts'] reports were based on misleading information provided by Defendants. Finally,Plaintiffs allege that Defendants, without any reasonable basis, endorsed and adopted each of theanalysts' reports by, among other things, expressing comfort with the third and fourth quarter88

earnings estimates contained in one of the reports.") (citations omitted); In re Wall Data Secs.Litig., 1996 U.S. Dist. LEXIS 14052, at *14, 1996 WL 585596, Fed. Sec. L. Rep. (CCH) 99,292 (W.D. Wash. June 25, 1996) (granting motion to dismiss as to entanglement theory, butnot as to conduit theory; "Plaintiffs' allegations that the Company made false and misleadingstatements to analysts, however, are relevant to plaintiffs' claim under § 10(b) that the Companymade false and misleading statements about acceptance of Wall Data products and theCompany's potential for growth."). Judge Smith has agreed that[i]t is also possible for liability to attach if a corporate officer or employeemakes false and misleading statements to an analyst, who then in good faithincorporates them into his or her report. Because a company official spoke ... thisis a form of direct liability and does not involve the imputation of the analyst'sstatements back to the company. Under such a theory, the plaintiff must "pleadwith the requisite specificity precisely what misstatements were made by whichdefendants to which analysts, and precisely how that specific misinformationreached the market through a specific analyst report."Crown Am. Realty, 1997 U.S. Dist. LEXIS 14609, at *54 n.2 (citations omitted) (quoting Rubinv. Trimble, 1997 U.S. Dist. LEXIS 14011, at *55-57, 1997 WL 227956 (N.D. Cal. Apr. 28,1997)).The Ninth Circuit has held that the Supreme Court's decision in Central Bank, whichabolished aiding and abetting liability, does not foreclose such a theory, at least where thesecurities analysts act wittingly. In Cooper, 137 F.3d 616, where the court reversed dismissal ofsecurities fraud claims, the securities issuer argued that "it is not responsible for therecommendations of securities analysts, even if it provided information on which the analysts'assessments were based." Id. at 623-24. The Ninth Circuit rejected this argument, noting that ithad held in Warshaw, 74 F.3d at 959, that "corporate defendants may be directly liable under[Rule] 10b-5 for providing false or misleading information to third-party securities analysts."Cooper, 137 F.3d at 624. Further rejecting the issuer's argument that "Central Bank precludesholding it liable for the analysts' statements," id., Judge Fletcher stated:Merisel is alleged to have made misleading statements to the analysts with theintent that the analysts communicate those statements to the market. This is notaiding and abetting or secondary liability; the complaint alleges that Merisel is[responsible] for its own false statements to the analysts.Id. Judge Fletcher concluded her analysis of this issue by stating that[p]laintiffs' claims ... are not barred by Central Bank in that they are asserting thatMerisel, through false statements to analysts, and those analysts, by issuingreports based on statements they knew were false, together engaged in a schemeto defraud the shareholders.Cooper, 137 F.3d at 625. Accord In re Secure Computing Corp. Secs. Litig., 184 F. Supp. 2d980, 990 (N.D. Cal. 2001): “Plaintiffs sufficiently plead the conduit theory of liability. Plaintiffsallege a specific false and misleading statement by Defendants regarding the financial status of89

Secure, directly communicated to analysts at a specific time and place, followed on the very nextday by analysts’ recommendations to buy Secure stock. These allegations identify the dates ofDefendants’ false and misleading statements, their locations, the speakers, the content of thestatements, and the dates (in each case the following day), contents and speakers of the Analysts’statements. These allegations are sufficient to plead liability for the analysts’ statements.” Seealso Weiss, Securities Analysts, 8 SECURITIES REFORM ACT LITIG. RPTR. at 669 (discussingCooper). But see DeMarco v. DepoTech Corp., 2002 U.S. App. LEXIS 2993, at *6, 2002 WL461217 (9 th Cir. Feb. 21, 2002) (unpublished opinion) (affirming dismissal of securities fraudclaims against defendants accused of making false and misleading statements about clinical trialsfor drug; “[The complaint does not] allege that DepoTech ‘made false and misleading statementsto securities analysts with the intent that the analysts communicate those statements to themarket.’”) (emphasis in original) (quoting Cooper, 137 F.3d at 624); In re Pinnacle Sys. Secs.Litig., 2002 U.S. Dist. LEXIS 22555, 2002 WL 31655187 (N.D. Cal. Nov. 19, 2002) (dismissingclaims upon finding that plaintiffs’ complaint did not adequately allege that the quoted securitiesanalysts were repeating statements made by company officials).G. Securities Issuer's Review, Correction And/Or Dissemination Of SecuritiesAnalysts' ReportsIn Elkind, following a jury trial the Second Circuit affirmed that the securities issuer,Liggett & Myers, was not liable for securities analysts' projections. 635 F.2d at 163. In soholding, it noted that Liggett had hired a public relations firm in order to specifically encourage"closer contact between analysts and company management" because management "concludedthat the company's stock was underpriced, due in part to lack of appreciation in the financialcommunity for the breadth of its market activity." Id. at 159. While the Second Circuit notedthat Liggett's officers had received drafts of analysts' reports and corrected them, the courtstressed that the company's review and correction did not extend to forecasts:[W]e find no reason to reverse as clearly erroneous the district court's finding thatLiggett did not place its imprimatur, expressly or impliedly, on the analysts'projections. The company did examine and comment on a number of reports, butits policy was to refrain from comment on earnings forecasts. Testimony at trialindicated that the analysts knew the were not being made privy to the company'sinternal projections. While the evidence leaves little doubt that Liggett madesuggestions as to factual and descriptive matters in a number of the reports itreviewed, the record does not compel the conclusion that this conduct carried asuggestion that the analysts' projections were consistent with Liggett's internalestimates.... Thus, Liggett assumed no duty to disclose its own forecasts or towarn the analysts (and the public) that their optimistic view was not shared by thecompany.Id. at 163 (footnotes omitted).Subsequent decisions have reached varying results on the precise question of whetherreview and correction of draft securities analysts' reports by an officer or employer of thesecurities issuer constitutes sufficient "entanglement" to attribute the analysts' statements to theissuer. In SEC v. Wellshire Secs., Inc., 773 F. Supp. 569, 572 (S.D.N.Y. 1991), the court denied90

a permanent injunction as to two individual defendants and dissolved an injunction against acorporate defendant, finding that statements in a broker's market letter were not attributable tothose defendants. The district court so held even though the brokers sent a draft of a marketletter to the defendants, the defendants corrected the draft and sent it back to the broker, and thebroker then incorporated that corrected draft into its market letters. Contrasting the facts of thatcase with Elkind, the court wrote:Id. at 573.The facts of the case at bar indicate less entanglement that in Elkind,where the court was not inclined to find entanglement because the company'sgeneral policy was not to involve itself with forecasting. No evidence has beenpresented as to any meetings between the ... defendants and [the broker] inpreparing the drafts at bar or [the] Market Letters.On the other hand, there are a number of decisions holding on their particular facts thatreview and correction of analysts' draft reports by a securities issuer's officer or employee issufficient to constitute entanglement. For example, in In re ICN/Viratek Secs. Litig., 1996 U.S.Dist. LEXIS 4407, at *10, 1996 WL 164732, Fed. Sec. L. Rep. (CCH) 99,213 (S.D.N.Y.Apr. 4, 1996), where the court denied defendants' summary judgment motion, Judge Wood notedthat plaintiffs had "submitted evidence indicating not only that defendants reviewed thePaineWebber report, but also that defendants did fail to correct factual statements in the reportthat they knew were erroneous B while at the same time making other corrections and additionsto the report." (Emphasis in original.) The district court contrasted the facts before the SecondCircuit in Elkind, where the corporation reviewed and commented on an early draft of ananalyst's report but "did not review the actual text of the final report just prior to issuance," andnoted that in the case at bar, defendants' "review and amendment of the final draft of the reportjust before its issuance" made a difference. Id. at *16, *18 (emphasis in original). AccordPresstek, 1997 SEC LEXIS 2645, at *35-36 (citing ICN/Viratek with approval).In Stack v. Lobo, 903 F. Supp. 1361 (N.D. Cal. 1995), the court denied a motion todismiss, noting that plaintiffs alleged "that the analyst who wrote each of these reports sentcopies to three Quickturn insiders (Lobo, D'Amour and Ostby), and that all three of theseinsiders reviewed and approved of the report during the week prior to the report's publication."Id. at 1372. See also In re Gupta Corp. Secs. Litig., 900 F. Supp. 1217, 1237 (N.D. Cal. 1994)(denying motion to dismiss because plaintiffs made "detailed allegations that Gupta insidersprovided information and guidance to analysts to assist the analysts in creating forecasts for thecompany" and alleged, although generally, "that defendants reviewed and approved analysts'reports before publication"). Also relevant is Judge Lefkow’s recent analysis of this issue:Where, as here, the plaintiff has narrowed the possible sources of information toWestell’s CEO, Chief Financial Officer …, and the head of Investment Relations,the court finds that plaintiff has sufficiently pled who made the allegedmisrepresentations. Although the complaint does not specifically plead lack ofaccess to information, it is plain enough here that the statements to analysts thatwere not publicly attributed are not likely to be available to plaintiff withoutdiscovery.91

In re Westell Tech., Inc. Secs. Litig., 2001 U.S. Dist. LEXIS 17867, at *32-33, 2001 WL1313785, Fed. Sec. L. Rep. (CCH) 91,628 (N.D. Ill. Oct. 30, 2001) (footnote and citationomitted).H. "No Comment" PoliciesCases that follow Elkind and find defendants not liable for analysts' forecasts frequentlyemphasize that the issuer had a policy of refraining from comment on such forecasts, or point tostatements by the issuer's management distancing the company from the forecasts. See, e.g.,Syntex, 95 F.3d at 934 (affirming dismissal of securities fraud claims; "when Defendant Freiman(Syntex's CEO) was asked about the analysts' predictions related to future earnings per share,Mr. Freiman stated, 'We don't forecast earnings,' and emphasized that such estimates should notbe attributed to Syntex"). See also In re Cypress Semiconductor Secs. Litig., 891 F. Supp. 1369,1377 (N.D. Cal. 1995) (granting summary judgment for defendants as to all statements inanalysts' reports; "Rodgers and Allen both testified that Cypress does not give its forecasts toanalysts and has a policy of not commenting on analysts' forecasts. Plaintiffs have failed topresent any credible evidence that Cypress ever deviated from this policy during the classperiod.") aff'd sub nom. Eisenstadt v. Allen, 1997 U.S. App. LEXIS 9587 (9 th Cir. Apr. 28,1997); In re Seagate Tech. II Secs. Litig., 1995 U.S. Dist. LEXIS 2052, at *13-14, 1995 WL66841, Fed. Sec. L. Rep. (CCH) 98,530 (N.D. Cal. Feb. 8, 1995) (granting summary judgmentfor defendants because Seagate's president "testified that throughout fiscal 1988, the companyhad a strict policy not to comment upon analysts' financial projections. Analysts themselvesconfirm Seagate's adherence to this policy. Plaintiffs fail to present evidence that defendantsdeparted from their policy of not commenting on analysts' forecasts."), aff'd, 98 F.3d 1346 (9 thCir. 1996). As the district court noted in Caere:The only specific statements alleged in the Amended Complaint which suggest anentanglement are Caere's Chief Financial Officer's March 15, 1993, commentsregarding analysts' forecasts, indicating that Caere did not have "sufficientinformation" upon which to base a comment, that "the first quarter is typicallyslower, reflecting seasonality in Caere's business," and that "as a result, results forthe [first] quarter are always difficult to predict." It strains the intellect to imaginehow this statement could constitute an entanglement. Caere's Chief FinancialOfficer was not embracing the analysts' forecasts when she made this statement.To the contrary, she was suggesting that the analysts' forecasts might be overlyoptimistic.837 F. Supp. at 1060; see also Cirrus Logic, 946 F. Supp. at 1466 (granting summary judgmentfor company defendants for liability on opinions contained in 32 analyst reports; companypersonnel who were authorized by internal policy to talk with analysts stated that "they nevercommented on analysts' financial projections, and never provided to analysts internal earnings orrevenue forecasts or other specific financial guidance").As a result of plaintiffs' claims of issuer liability for statements or projections containedin securities analysts' reports, some issuers have reassessed their policies regarding corporatecommunications with analysts. See Dale E. Barnes, Jr. & Constance E. Bagley, GreatExpectations: Risk Management Through Risk Disclosures, 1 STAN. J. L. BUS. & FIN. 155, 18292

(1994) (citing to various articles indicating that companies such as Exabyte Corp., SoftwareToolworks and Oracle Systems Corp. now have stringent guidelines on the content and mannerof such communications as a result of securities litigation involving those companies).I. "Adoption" Or "Ratification" Of Analysts' ReportsWhile in Elkind the Second Circuit addressed pre-publication "entanglement," severalcases hold that an issuer can be held liable for post-publication adoption or ratification of asecurities analyst's statement or projection. See Sobol, Tangled Web, 22 DEL. J. CORP. L. at 1065(distinguishing "[p]republication entanglement" from post-publication "adoption" of analysts'statements or projections); Presstek, 1997 SEC LEXIS 2645, at *29-33 (same); In re BurlingtonCoat Factory Secs. Litig., 114 F.3d 1410, 1429 (3 rd Cir. 1997) (holding that use of word"comfortable" by corporate officer in regard to his views of certain analysts' estimates clearlyevidenced adoption).For example, a securities issuer might ratify, endorse, or adopt an analyst's report(including presumably any forecasts contained therein) by distributing copies of the report toshareholders or potential investors:The act of circulating the reports amounts to an implied representation that theinformation contained in the reports is accurate or reflects the company's views....By passing out the favorable analyst reports, Rasterops was clearly implying thatthe company agreed with the forecasts contained in the reports.Rasterops, 1994 U.S. Dist. LEXIS 18245, at *10, *11 (denying motion to dismiss and noting thatplaintiff alleged that "the company provided false information to the [securities] analysts andapproved drafts of the reports"). See also Strassman v. Fresh Choice, Inc., 1995 U.S. Dist.LEXIS 19343, at *31, 1995 WL 743728 (N.D. Cal. Dec. 7, 1995) (stating that "[i]n addition topre-publication entanglement ... this Court has held that a company may also be liable if itratifies an analysts' report after the report has been published," but granting motion to dismissbecause plaintiffs failed to alleged which reports were circulated by defendants, which defendantcirculated reports and to whom reports were circulated). As the SEC recently concurred:In the Commission's view, under certain circumstances an issuer thatdisseminates false third party reports may adopt the contents of those reports andbe fully liable for the misstatements contained in them, even if it had no rolewhatsoever in the preparation of the report. If an issuer knows, or is reckless innot knowing, that the information it distributes is false or misleading, it cannot beinsulated from liability because management was not actively involved in thepreparation of that information.Presstek, 1997 SEC LEXIS 2645, at *33-34; see also Id. at *38 (citing Rasterops opinion withapproval).In Stratosphere, 1 F. Supp. 2d at 1115, Judge Pro granted defendants' motions to dismissplaintiffs' claims based upon the "entanglement" theory, finding that the complaint "fail[s] toallege specific interactions between the insider and the analyst giving rise to the entanglement, or93

allege when these interactions occurred." Id. However, the court reached a different conclusionas to other allegations:Plaintiffs also point to two facsimile cover sheets from an analyst to[Stratosphere chief financial officer] Lettero for the proposition that Letteroendorsed or approved the reports, and allege that certain analysts testified indepositions that Lettero was sent drafts of letters and sent drafts of reports prior toissuance by the analysts. Plaintiffs also contend that Stratosphere and theIndividual Defendants distributed copies of analysts' reports and/or provided a listof analysts' coverage of Stratosphere in the packages that the company sent topotential investors. These allegations are sufficient to meet the pleadingrequirements for liability, and this Court does not dismiss liability based on theseclaims.Id. at 1115-16.In Stack v. Lobo, 1995 U.S. Dist. LEXIS 19966, at *24, 1995 WL 241448 (N.D. Cal.Apr. 19, 1995), Judge Williams observed that "[b]y reproducing and including these [securitiesanalysts'] reports in their own stockholder informational materials, Quickturn may haveimpliedly represented that the information contained in those reports was accurate or reflectedthe company'[s] own views"; however, the court granted defendants' motion to dismiss becauseplaintiffs did "not identify the particular 'investor relations package' or provide the date on whichit was sent out." In a later opinion in the same case, however, the district court seemed toreconsider its earlier ruling and found plaintiffs' allegations to be sufficient, thereby denyingdefendants' motion to dismiss as to securities analysts' reports that had been included in investorrelations packets:Plaintiffs here have pled sufficient facts with regard to the investor relationspackage to satisfy Rule 9(b). Plaintiffs allege that specific Quickturn insidersapproved the inclusion of specific analysts' reports and brochures in the package.Requiring Plaintiffs to identify each package that was sent out and the date onwhich it was sent would be unduly burdensome and unrealistic.J. Public Company Practices In Dealing With Securities AnalystsGiven the perils inherent in public companies' "entanglement" with securities analysts, itis surprising to see the frequency with which their officers (and directors) review drafts ofanalysts' reports, selectively disclose material information to analysts, and engage in similarpractices. See Cholakis, Company Disclosures, 39 SANTA CLARA L. REV. at 845-47. A studypublished in May 1998 revealed the following practices employed by public companies indealing with securities analysts:94

Does any officer of your company review drafts of securities analysts' reports on aregular basis?Does any officer of your company check analysts' earnings projections or modelsbefore they are published?Does any officer of your company challenge analysts' assumptions if they appear"out of line"?Does any officer of your company express a general level of comfort with analysts'earnings estimates?Does your company provide analysts with guidance and/or financial data relating tofuture trends?Does your company limit its comments on analysts' reports to correcting errors ofhistorical fact?If guidance has been given to analysts during the quarter but results are expected tobe well below expectations, would your company issue a press release to correctmisperceptions?Yes 86% (78% in 1995)No 14%Yes 79% (69% in 1995)No 21%Yes 77% (same in 1995)No 23%Yes 71% (same in 1995)No 29%Yes 46%No 54%Yes 45% (34% in 1995)No 55%Yes 70% (47% in 1995)No 30%Would an officer of your company follow up with investment professionals, eitherindividually or by conference call?Yes 70% (47% in 1995)No 30%Would an officer of your company inform analysts that results are expected to bewell below expectations without first issuing a press release?Does your company set aside a period of days in advance of an earningsannouncement during which corporate representatives do not provide analysts withearnings guidance?Yes 26% (40% in 1995)No 74%Yes 77% (56% in 1995)No 23%Does your company have a written disclosure policy for dealing with analysts? Yes 40% (50% in 1995)No 60%95

See National Investor Relations Institute, A STUDY OF CORPORATE DISCLOSURE PRACTICES (May1998).The following "rules of the road" have been recommended for companies when dealingwith securities analysts:Don't distribute analyst reportsDon't link to analyst reports on your Web siteDon't incorporate analyst projections into Web pagesDon't review or comment on reportsDon't express "comfort" with or comment on projectionsSteven E. Bochner & Ignacio E. Salceda, Over the Wall: Handling Analysts' Conference Calls,Earnings Forecasts, and Reports Effectively, 2 wallstreetlawyer.com 1, 7 (Apr. 1999); see alsoJohn V. Erskine, Comment, Don’t Believe the Hyperlink: Potential Liability of Issuers UnderAnti-Fraud Provisions of the Federal Securities Laws for Embedding Hyperlinks to Analysts’Reports on Their Web Sites, 32 SETON HALL L. REV. 190 (2001); Mason Miller, Note,TechnoLiability: Corporate Websites, Hyperlinks, and Rule 10(b)-5, 58 WASH. & LEE L. REV.367 (2001).96