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Combining '33 and '34 Securities Act Plaintiffs in the Same Class
Special to Law.com
September 08, 2009
David Saunders
Howard S. Suskin
In an opinion of interest to both plaintiff and defense counsel, the 2nd U.S. Circuit Court of Appeals recently ruled that plaintiffs suing under the Securities Act of 1933 and the Securities Exchange Act of 1934 may co-exist within the same plaintiff class even if the allegations of misrepresentation underlying the '33 act and '34 act claims differ.[FOOTNOTE 1] The 2nd Circuit's decision will likely have the effect of enlarging the size of plaintiff classes in securities class actions as well as increasing the number of claims that defendants will be subject to in class action suits. It bears close consideration by counsel involved in class actions in which both '33 act and '34 act claims may be asserted.
In In re Flag Telecom Holdings, Ltd. Securities Litigation (pdf), the 2nd Circuit affirmed the certification of a single class of plaintiffs that included some plaintiffs bringing '33 Act claims and others bringing '34 Act claims .[FOOTNOTE 2] The plaintiff class in Flag included investors who purchased the common stock of Flag Telecom Holdings Ltd between March 6, 2000 and Feb. 13, 2002, and investors who purchased FTH stock during the IPO and between Feb. 11, 2000 and May 10, 2000.[FOOTNOTE 3] The Flag plaintiffs alleged various misrepresentations by FTH related to its IPO and subsequent public statements regarding its financial health. Specifically, the plaintiff class alleged that the defendants -- FTH's former directors, officers and Citigroup Global Markets Inc., the lead underwriter for the IPO -- induced investors to purchase FTH securities pursuant to a registration statement and prospectus containing materially false and misleading information regarding the pre-sale of certain fiber optic cable capacity in violation of §§11, 12(a)(2) and 15 of the '33 act, and that defendants made materially false and misleading statements regarding FTH's financial condition, causing FTH securities to trade at artificially inflated prices in violation of §§10(b) and 20(a) of the '34 act and Rule 10b-5 promulgated thereunder.[FOOTNOTE 4]
Two years after its IPO, FTH publicly disclosed that approximately 14 percent of its GAAP revenues for the year ending Dec. 31, 2001 were associated with "reciprocal transactions" -- transactions in which fiber optic cable capacity on FTH's network was swapped for fiber optic cable capacity on a competitor's network.[FOOTNOTE 5] Innocent as reciprocal transactions may be, the district court recognized that such transactions can also "be utilized by a company seeking to defraud investors or its creditors to create the impression that the company is selling capacity when it is merely unloading useless dark fiber on one of its networks in exchange for useless dark fiber on a competitor's network."[FOOTNOTE 6] The day FTH reported its reciprocal transactions, its stock plunged 46 percent in value.[FOOTNOTE 7] Compounding the negative news in FTH's disclosure was its 10-K filing on April 1, 2002 that disclosed the asset value of one of FTH's main products -- a fiber optic cable from Paris, London and New York (the "FA-1") -- was impaired, and that FTH was forced to recognize an impairment charge of more than $350 million.[FOOTNOTE 8] On April 12, 2002, FTH filed for Chapter 11 bankruptcy protection.[FOOTNOTE 9]
The first of several securities class actions against FTH was filed in April 2002. Then, in October 2002, several of the securities class actions against FTH were consolidated into a single case by the district court.[FOOTNOTE 10] The district court subsequently dismissed the Flag plaintiffs' second amended complaint without prejudice, and in April 2004, the Flag plaintiffs filed a third amended complaint.[FOOTNOTE 11]
On Jan. 23, 2006, the district court denied the defendants' motion to dismiss the third amended complaint, and held that the defendants "had not satisfied their burden to establish negative causation with respect to the '33 act plaintiffs' claims."[FOOTNOTE 12] The district court also rejected the defendants' contention that because the '33 act plaintiffs did not learn of the allegedly misleading information regarding the pre-sale of FA-1 capacity until after the filing of an unrelated case in November 2003 -- at which time FTH's stock had been canceled -- none of the decline in FTH's stock value could be attributed to those misstatements. The district court instead found that defendants failed to "demonstrate that the decline was not due, at least in part, to the alleged misrepresentations concerning pre-sales in Flag's prospectus, which presumably inflated the price level attained in the IPO and thereby heightened the loss when the price fell virtually to zero."[FOOTNOTE 13]
In the third amended complaint, the Flag plaintiffs alleged that the defendants: (1) materially misstated the amount of pre-sales on the FA-1 cable; (2) inflated FTH's revenues by engaging in reciprocal transactions that had no business purpose; (3) violated GAAP by improperly recognizing revenue earlier than was permitted; and (4) failed to take an impairment on the value of the FA-1 cable at the appropriate time.[FOOTNOTE 14] The '33 act plaintiffs based their claims on FTH's statements in its prospectus and related registration statement regarding FTH's pre-sale of capacity on the FA-1 cable; by contrast, the '34 act plaintiffs based their claims on the allegedly false and misleading statements by the defendants subsequent to the IPO.[FOOTNOTE 15] There thus existed two independent sets of alleged misrepresentations that formed the bases for the Flag plaintiffs' claims.
