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Suing public companies for shareholder losses arising from allegedly false registration statements accompanying public stock offerings will be more difficult under a recent ruling by the 5th U.S. Circuit Court of Appeals. On March 1, a three-judge panel of the 5th Circuit affirmed a 2003 decision by U.S. District Judge Sam Sparks of Austin to dismiss claims of shareholders who filed a class action under �11 of the Securities Act of 1933 against pcOrder.com and the company’s directors, majority shareholder, officers and lead underwriters. Sparks found that, with one exception, the lead plaintiffs were unable to show that the pcOrder.com shares they bought in the stock market could be traced to the company’s two public offerings in 1999 that the plaintiffs allege were accompanied by false or misleading registration statements. In a first-of-its-kind ruling by a federal court of appeals, the 5th Circuit panel unanimously held in Jerry Krim, et al. v. pcOrder.com Inc. that shareholders who purchase shares of company stock after the shares mix in the market with shares from other sources cannot use mere statistical probabilities to establish �11 standing to sue with regard to a public offering. In the opinion written by Judge Patrick Higginbotham, the panel provides a detailed examination of the requirement that shareholders complaining of offering registration statements under �11 must be able to trace their shares directly to the challenged offering shares. “The 5th Circuit defined who could have standing to bring an action under 11,” says Gary Ewell, attorney for pcOrder.com underwriters Goldman Sachs & Co., Credit Suisse/First Boston and SG Cowen & Co., and head of litigation in the Austin office of Vinson & Elkins. “The ruling forecloses a potential significant loophole for lawsuits that try to use this statute to create a large class action of those who did not buy shares directly from a public offering but instead simply bought in the open market,” says Noel M.B. Hensley, lead defense counsel in Krim and a partner in Dallas’ Haynes and Boone. Hensley represents Trilogy Software Inc., pcOrder.com’s controlling shareholder. Ewell says that pcOrder.com’s stock reached the market by means other than the public offerings when the company’s executives sold about 800,000 shares. James Baskin, the plaintiffs’ attorney and the principal in the Baskin Law Firm in Austin, did not return three telephone calls seeking comment before press deadline. NO ‘SOUND REASON’ The plaintiffs alleged in their brief to the 5th Circuit that there is no “sound reason” for prohibiting the use of circumstantial or statistical evidence to prove standing under �11. The greater than 99 percent probability that plaintiffs Gene Burke and Jean Schwartzburke acquired some of pcOrder.com’s initial public offering stock and the greater than 90 percent probability that plaintiff David Petrick acquired some stock from the two questioned offerings — as the plaintiffs’ expert witness testified before Sparks at a 2002 hearing on class certification — should be sufficient to meet the �11 requirement for standing, the plaintiffs argued in the brief. According to the plaintiffs’ brief, three shareholders filed separate class actions between December 2000 and February 2001, asserting claims against pcOrder.com. As noted in the brief, Sparks consolidated those suits in Krim. But Sparks denied class certification in October 2002, after conducting an evidentiary hearing. Acting on a motion from the defense, Sparks dismissed the suit in May 2003, prompting the plaintiffs’ appeal to the 5th Circuit. In 2003, the 5th Circuit held in Rozenzweig v. Azurix Corp. that aftermarket stock purchasers do not inevitably lack standing to sue under �11 but must demonstrate the ability to “trace” their shares to the prospectus they allege is defective. Left unanswered in Rozenzweig is the question of what is necessary to trace shares to the defective prospectus when shares enter the market by means other than the public offering. The 5th Circuit answered that question in Krim. Baker Botts’ James Maloney, who is representing pcOrder.com in the case, says the 5th Circuit’s Krim decision to strictly interpret the �11 requirement is important to companies that can be held liable even if they make an innocent mistake in a prospectus. The plaintiffs argued in their brief to the 5th Circuit that nothing in the text or legislative history of �11 prevents the use of statistical evidence to establish standing to file a suit and courts should not support such a limitation. An interpretation that standing can be established by mere probabilities “cannot be squared” with what Congress intended in �11, the 5th Circuit held. “We decline the invitation to reach further than the statute,” Higginbotham wrote in the opinion. Judges Eugene Davis and Emilio Garza joined Higginbotham in the decision. Maloney, who is chairman of Baker Botts’ securities litigation group, says Krim also is important because the 5th Circuit addressed the policy argument given the developments in the market since 1973. Before 1973, shareholders received paper certificates identifying their stock, while today stock is held in a fungible mass in a street name. In the opinion, the 5th Circuit recognized that present market realities may render 11 “ineffective as a practical matter” in some instances in which stock is purchased by means other than a public offering. That is an issue for Congress to address, according to the opinion. “It is not within our purview to rewrite the statute to take account of changed conditions,” Higginbotham wrote.

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