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A Southern District of New York judge has raised the bar for class certification in securities fraud lawsuits that accuse stock analysts of tailoring their evaluations to curry favor with their firms’ institutional clients. In an area of law the 2nd U.S. Circuit Court of Appeals has described as being in flux, Judge Jed Rakoff rejected class action status for three consolidated suits against Lehman Brothers even though the allegations were sufficient to survive motions to dismiss. To qualify for class status when pursuing a “fraud on the market” claim, Judge Rakoff wrote in DeMarco v. Lehman Brothers, 03-3470, plaintiffs must demonstrate that large numbers of stock buyers relied upon the analysts’ allegedly ginned up recommendation. He rejected arguments mounted by plaintiffs lawyers that a market impact from an analyst’s report could be presumed. Instead, plaintiffs must make “a prima facie showing” that the analyst’s report moved the market price of the stock “in a reasonable quantifiable respect,” the judge said. That preliminary showing must be demonstrated by the production of “admissible evidence,” he added. The failure to make such a showing doomed the effort to secure class action status in the three cases against Lehman Brothers and its analyst, Michael Stanek, Rakoff ruled. The suits claimed that Stanek had issued public reports strongly recommending the purchase of stock in a computer software company called RealNetworks Inc. Simultaneously, however, the complaints alleged that he recommended to preferred clients that they sell the stock. Also, according to the complaints, Stanek told his preferred clients that he had touted RealNetworks’ stock because it was using Lehman Brothers as one of its investment bankers. Suits raising similar claims against investment houses have proliferated nationwide since spring 2002, when New York Attorney General Eliot Spitzer accused Merrill Lynch of skewing its stock assessments to help its investment banking clients. Rakoff rejected the plaintiffs’ argument that market impact could be presumed under a 1988 U.S. Supreme Court precedent from Basic v. Levinson that said misleading statements by a company operate as a fraud in “a developed market” even if investors do not rely on the statements. Basic v. Levinson, which applied to statements issued by a company, should not be extended to statements issued by analysts, Rakoff concluded. Because a statement of opinion issued by an analyst is “far more subjective and far less certain” than a statement of fact issued by a company, he wrote, “no automatic impact on the price of a security can be presumed.” Rakoff made it plain that a plaintiff’s proffer of “admissible evidence” of market impact should be rigorously examined.

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