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A federal appeals court has put research analysts on the same footing as stock issuers for claims they should be held liable for misrepresentations under the fraud-on-the-market theory. The 2nd U.S. Circuit Court of Appeals ruled that no greater showing is required to warrant application of that presumption than is the case in lawsuits against securities issuers. But the court vacated a lower court’s certification of a class in a case alleging bogus research reports by Salomon Smith Barney analyst Jack Grubman. The appeal decided by Judges John M. Walker Jr., Guido Calabresi and Rosemary Pooler in In re: Salomon Analyst Metromedia Litigation, 06-3225-cv, called on the Circuit to decide the scope of the U.S. Supreme Court’s ruling in Basic Inc. v. Levinson, 485 U.S. 224 (1988). In Basic, the Court said that where a defendant has publicly made a material misrepresentation of information about stock traded on an efficient market, the reliance of individual investors on the information can be presumed. Here, plaintiffs alleged that Grubman, an influential analyst, issued favorable reports about a credit line that parent company Citigroup Inc. had arranged for the Metromedia Fiber Network Inc. to help the company build out a network. The plaintiffs alleged that, even though the credit line was not actually secured, Grubman reported it was secure in order to win Metromedia’s investment banking business. In 2005, Southern District of New York Judge Gerard Lynch certified a class with respect to certain research reports issued between March 8 and July 25, 2001. Anyone who purchased Metromedia stock between those dates was part of the class. Pooler, writing for the 2nd Circuit, said the court was refusing to adopt a bright-line rule barring application of the Basic presumption to suits alleging misrepresentation by analysts. “Defendants argue that the Basic presumption should be limited to suits involving misrepresentations by issuers, because misrepresentations by third parties are less likely to materially affect market prices,” she said. “But they cite no case, and we have found none, that supports such a rule.” The reason, she said, was that the Supreme Court said it was premising the Basic presumption on the belief that share prices “reflect all publicly available information, and hence, any material misrepresentations.” The defendants’ back-up argument was that Lynch erred by not requiring the plaintiffs to bear the burden of showing the misrepresentations “moved the market,” and had a measurable effect on price. But Pooler said, “This is a misreading of Basic” because the “ point of Basic is that an effect on market price is presumed based on the materiality of the information and a well-developed market’s ability to readily incorporate that information into the price of securities.” Importantly for a case involving research analysts, Pooler said, “The structure of this analysis does not vary according to the identity of the speaker.” “Defendants worry that if no heightened test is applied in suits against non-issuers, any person who posts material misstatements about a company on the Internet could end up a defendant in a Rule 10b-5 action,” Pooler said. “The worry is misplaced.” CERTIFICATION VACATED Nevertheless, the Circuit vacated the order of class certification and remanded the case for further proceedings. Lynch had held that the burden was on the defendants to show there was no price effect from the alleged misrepresentation when called upon to rebut the Basic presumption. The court commended the “valiant effort” of Lynch to “reconcile the conflicting message from our court on class certification standards.” But the Circuit said the judge had not had the benefit of critical case law when he ruled that he could not take or weigh any evidence on whether the Basic presumption can be rebutted prior to class certification, because he would have been required to “weigh merits-related evidence.” Under In re Initial Public Offering Sec. Litig., 471 F.3d 24 (2d. Cir 2006), which was decided after Lynch certified the class, the district court is “required to make a ‘definitive assessment’ that the Rule 23(b)(3) predominance requirement has been met,” Pooler said. Therefore, she said, a court has to give defendants a chance to rebut the Basic presumption before a class is certified. And the Circuit remanded the case to give the defendants a chance to do just that. Jeffrey J. Angelovich of Nix, Patterson & Roach in Daingerfield, Texas, is one of the attorneys who represented the plaintiff class. “We’re very pleased with the opinion and quite honestly not surprised,” Angelovich said. “What the court has said is that the Supreme Court opinion in Basic is alive and well. The decision to send it back is based on a new holding that occurred after certification. We thought all along that we would be going back given the holding” in In re Initial Public Offering Sec. Litig. Robert McCaw of Wilmer Cutler Pickering & Hale represented Citigroup Global Markets. He declined to comment.

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