Opinion
Master File No. 02 Civ. 3288 (DLC).
February 17, 2005
Max W. Berger, John P. Coffey, Steven B. Singer, Chad Johnson, Beata Gocyk-Farber, John C. Browne, David R. Hassel, Bernstein Litowitz Berger Grossman LLP, New York, New York, for Lead Plaintiff in the Securities Litigation.
Leonard Barrack, Gerald J. Rodos, Jeffrey W. Golan, Mark R. Rosen, Jeffrey A. Barrack, Pearlette V. Toussant, Regina M. Calcaterra, Chad A. Carder, Barrack, Rodos Bacine, Philadelphia, Pennsylvania.
Geoffrey S. Harper, Beth Jaynes, Kelly R. Vickers, Autumn J.S. Hwang, Fish Richardson P.C., New York, New York, for Defendant Francesco Galesi.
George E. Ridge, Cooper Ridge Lantinberg, P.A., Jacksonville, FL, for Defendant Bert C. Roberts, Jr.
Eliot Lauer, Michael Moscato, Jonathan Walsh, Curtis, Mallet-Prevost, Colt Mosle LLP, New York, NY, for Defendant Arthur Andersen LLP.
Jay B. Kasner, Thomas J. Nolan, Jay S. Berke, Susan L. Saltzstein, Jason D. Russell, Cyrus Amir-Mokri, Steven J. Kolleeny, Skadden, Arps, Slate, Meagher Flom LLP, New York, New York, for Underwriter Defendants.
OPINION AND ORDER
This Opinion addresses the eleven motions in limine made by the Underwriter Defendants in this consolidated securities class action scheduled for trial on February 28, 2005. Familiarity with the Opinions issued in the securities litigation arising from the collapse of WorldCom, Inc. ("WorldCom") is assumed.
See, e.g., In re WorldCom, Inc. Sec. Litig., ___ F. Supp. 2d ___, No. 02 Civ. 3288 (DLC), 2005 WL 89395 (S.D.N.Y. Jan. 18, 2005) (Andersen's motion for summary judgment); In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004) (Underwriter Defendants' motion for summary judgment); In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 392 (S.D.N.Y. 2003) (deciding a number of defendants' motions to dismiss); In re WorldCom, Inc. Sec. Litig., 219 F.R.D. 267 (2003) (class certification).
1. Motion to exclude references to other WorldCom-related proceedings
The Underwriter Defendants have moved to preclude any reference to the Individual Actions or WorldCom's bankruptcy during the trial of the class action. They reserve the right, however, to introduce evidence relating to WorldCom's bankruptcy in addressing the Lead Plaintiff's request for damages.
Arthur Andersen LLP ("Andersen") has joined in this motion.
The Lead Plaintiff consents to the application to exclude references to the Individual Actions, but opposes the request to exclude references to WorldCom's bankruptcy. It also opposes the application to the extent that the Underwriter Defendants seek to exclude references of the congressional investigation of WorldCom and WorldCom's bankruptcy. The Lead Plaintiff points out that an Andersen witness, Melvin Dick, testified before Congress and will be testifying at trial, and that Jack Grubman's congressional testimony will be offered at trial. The Lead Plaintiff agrees that WorldCom's bankruptcy is relevant to the computation of damages, but adds that it is also relevant to the story of WorldCom's liquidity battle, which was waged for at least six months prior to the filing for bankruptcy and, therefore, is also relevant to liability issues.
The Lead Plaintiff reads the Underwriter Defendants' application to include a request to exclude references to any other private WorldCom lawsuit or arbitration, the many class actions that were filed and consolidated into the class action that is going to trial, the SEC action against WorldCom, and criminal complaints filed against WorldCom employees. It consents to barring evidence of each of these matters, unless the defendants open the door to evidence of these other proceedings — for instance, by placing the good faith of Lead Plaintiff in issue. This reading of the Underwriter Defendants' motion may be overbroad. In any event, the Court will assume that all parties agree that there shall be no reference at trial to any other private civil action or arbitration, and shall not seek to offer such evidence without raising the issue in the first instance with all other trial counsel. Whether references to SEC proceedings against WorldCom and the prosecutions of WorldCom employees are relevant and admissible, will depend on issues not addressed by the parties in the briefing of the Underwriter Defendants' first motion in limine. It seems inevitable, however, that the fact of the criminal prosecutions, albeit not the substance of the arrest complaints, will come before the jury.
It is not clear that the Underwriter Defendants' motion in limine sought to exclude references to the Congressional investigation.
The motion is denied to the extent it seeks to bar evidence of WorldCom's bankruptcy from the jury. WorldCom's bankruptcy filing is an integral and necessary part of the story of its financial history. The Underwriter Defendants make a brief and undeveloped allusion to Rule 403 concerns. They have not shown that the probative value of evidence of WorldCom's bankruptcy is substantially outweighed by the factors that are pertinent to a Rule 403 analysis.
2. Motion to preclude evidence of any settlement reached in the WorldCom litigation
The Underwriter Defendants move to preclude the Lead Plaintiff from introducing evidence of any settlement reached in the WorldCom litigation but reserve the right to offer evidence of such a settlement to show bias of a witness, particularly of any Director Defendant who was willing to enter into a settlement. The settlements to which they refer are the settlements of the Citigroup Defendants, see In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2004 WL 2591402 (S.D.N.Y. Nov. 12, 2004), the settlement of theErisa Litigation, see In re WorldCom, Inc. ERISA Litig., No. 02 Civ. 3288 (DLC), 2004 WL 2338151 (S.D.N.Y. Oct. 18, 2004), the abandoned settlement of the Director Defendants in the class action, see In re WorldCom Sec. Litig., No. 02 Civ. 3288 (DLC), 2005 WL 323719 (S.D.N.Y. Feb. 10, 2005), and the settlement of a state court action, Retirement Sys. of Alabama v. J.P. Morgan Chase Co., 386 F.3d 419 (2d Cir. 2004).
Andersen has joined in this motion.
Ten Director Defendants had executed a settlement agreement with the Lead Plaintiff in January 2005; that settlement was ultimately voided after it was found on February 2 to violate the PSLRA. See In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2005 WL 323719 (S.D.N.Y. Feb. 10, 2005).
The Lead Plaintiff agrees that evidence of settlements is not relevant or admissible and represents that it has no present intention to introduce evidence of the settlements. It notes, however, that the Andersen and Underwriter Defendants' experts have relied upon the Citigroup settlement of the class action in their damages calculations, that the Underwriter Defendants seek to offer press coverage of the Citigroup settlement and evidence of the attorneys fees awarded to Lead Counsel in that settlement, and that the Underwriter Defendants have reserved the right to cross-examine the ten Director Defendants who had negotiated a settlement with the Lead Plaintiff about that settlement.
Before any party may make reference to the settlements or settlement efforts in the WorldCom litigation, they must first discuss their intention with all other trial counsel and be prepared to support the admissibility of the evidence under Federal Rule of Evidence 408. This includes questions asked to impeach a witness and the damage calculations proffered by experts.
3. Motion to preclude references to insurance coverage
The Underwriter Defendants move for an order precluding references to any liability insurance policy belonging to any Underwriter Defendant. The Lead Plaintiff consents so long as the defendants do not suggest that any of the damage award will be borne by the Underwriter Defendants' shareholders or employees.
All references at trial to insurance and insurance coverage are barred. If any defendant intends to make an argument or offer evidence to permit an argument that an award of damages will be borne by their shareholders or employees, or intends to offer evidence in order to permit an argument that the jury should consider their financial circumstances in awarding damages, they shall notify the Lead Plaintiff of such an intention no later that February 25. In the absence of such notice, all such references and arguments are barred.
4. Motion to preclude evidence of the compensation of any present or former employee of an Underwriter Defendant
The Underwriter Defendants move to preclude any evidence or reference at trial to the compensation earned by present or former employees of the Underwriter Defendants, some of whom are "highly compensated." They argue that establishing the degree to which their income is dependent on their salary from their employer is sufficient to show bias and that public disclosure of the amount of compensation invades a person's privacy and runs the risk of appealing to class prejudice. The Lead Plaintiff consents to this application. The motion is granted.
5. Motion to preclude evidence of the fees earned by the Underwriter Defendants
The Underwriter Defendants move to preclude evidence of their fees earned generally as compensation for services in bond offerings and other transactions, and specifically the fees earned for the 2000 and 2001 Offerings. They particularly emphasize the inadmissibility of evidence of fees they earned for their work for entities other than WorldCom.
The fees earned by the Underwriter Defendants from WorldCom for their investment banking work are directly relevant to the issues to be tried, and evidence of those fees is admissible. See, e.g., In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 688-89 (S.D.N.Y. 2004). For example, the negotiations between the banks and WorldCom during the Spring of 2001, in which the banks' extension of a credit facility to WorldCom was tied to the size of their investment banking fee, are an important part of the Lead Plaintiff's proof at trial. Id. at 649-52. The motion is denied to the extent that it seeks to exclude evidence of fees paid by WorldCom to the Underwriter Defendants. These defendants have not shown that its relevance is substantially outweighed by any unfair prejudice.
Because the fees earned from WorldCom are directly relevant to the issues at trial, the jury may also need to learn about industry practice in this regard. Therefore, given this ruling, it is entirely possible that the defendants, as well as the Lead Plaintiff, will now seek to offer evidence of fees earned by the Underwriter Defendants from work for other clients. If the Underwriter Defendants still seek to exclude all evidence of fees earned from any client other than WorldCom or the size of their investment banking fees generally, they shall notify the Lead Plaintiff by February 25. If a dispute arises in this regard, they may renew their motion insofar as it concerns fees earned for their work for entities other than WorldCom.
6. Motion to preclude references to counsel's background or other characteristics
The Underwriter Defendants move to preclude all references to government service by counsel, the size of any law firm, the number of attorneys working on this matter, or the place of counsel's residence and practice. The Lead Plaintiff consents except to the extent that it reserves the right to comment on the size of Skadden, Arps. The Lead Plaintiff asserts that the size of the firm may be relevant to arguments that it has to make regarding the failure of the Underwriter Defendants to identify on a timely basis the individuals who participated in the underwriting process for the 2000 and 2001 Offerings.
Apparently, some of the Underwriter Defendants' trial counsel will be drawn from locations outside New York City. The principal trial counsel for the Lead Plaintiff was once an Assistant United States Attorney.
The motion is granted in its entirety. To the extent that problems arose during the discovery process, those issues are to be addressed to the Court, not the jury. Appropriate orders have been and will be issued to address any delinquency during discovery.
7. Motion to preclude evidence of corporate wrongdoing generally
The Underwriter Defendants seek to preclude reference to disclosures by companies other than WorldCom of corporate wrongdoing, civil or criminal investigations and litigation concerning those other companies, and investigations and litigation concerning business practices by financial institutions. In this regard, the Underwriter Defendants identify the scandals concerning Enron, Global Crossing, Adelphia, and Wall Street analyst research and reporting.
The Lead Plaintiff represents that it will offer testimony regarding other corporate misconduct only when it is directly relevant to the issues at this trial. It identifies three contexts in which this evidence is relevant and admissible. First, Andersen's role in the Enron scandal led the internal audit department of WorldCom to alter its audit schedule and thereby led to the discovery of the capital expenditure fraud at WorldCom. Second, to the extent that the Underwriter Defendants intend to argue at trial, as they did in connection with their summary judgment motion, that they were entitled to rely on Andersen's comfort letters, the Lead Plaintiff wants to offer evidence that the Underwriter Defendants were aware as of the 2001 Offering that Andersen had agreed on April 27, 2001, to pay $100 million to settle class action claims brought in 1998 for its work at the Sunbeam Corporation; that in January 2001, the Arizona Attorney General filed a lawsuit against Andersen arising from the bankruptcy of the Baptist Foundation of Arizona, in which it charged that Andersen had been a willing participant in a ponzi scheme that cost retired Baptists several hundred million dollars; and that in 1998, Waste Management and Andersen agreed to pay $220 million to settle a shareholder lawsuit. Finally, the Lead Plaintiff argues that to the extent that the Underwriter Defendants seek to offer evidence and argue at trial, as they did in their summary judgment motion, that their spinning of hot IPO stocks to WorldCom executives was widely known and endorsed by the SEC, then the Lead Plaintiff is entitled to cross-examine witnesses to show that the SEC and the NASD have condemned the practice as improper. Alternatively, the Lead Plaintiff argues that evidence of the SEC and NASD investigations is somehow admissible to prove the motive of the Underwriter Defendants in spinning shares to WorldCom executives.
On May 15, 2001, the SEC issued a press release announcing that it had commenced a lawsuit against Andersen over their work at Sunbeam.
An Andersen trial witness, Richard Howell, may have been a witness to events that led to the Arizona suit.
Before ruling on these issues, it is necessary to give all parties an opportunity to respond to the specific examples given by the Lead Plaintiff. Decision is reserved.
8. Motion to exclude evidence regarding Intermedia Communications, Inc. and Digex Inc.
The Underwriter Defendants move to exclude evidence and argument concerning WorldCom's acquisition of Intermedia Communications, Inc. and Digex Inc. (together, "Intermedia"). The Underwriter Defendants were awarded summary judgment on the alleged omissions relating to Intermedia because of the extensive disclosures made by WorldCom concerning them.WorldCom, 346 F. Supp. 2d at 638, 695 n. 61.
The Lead Plaintiff seeks to preserve its right to offer evidence and argument concerning Intermedia as relevant to the Underwriter Defendants' due diligence defense. The Lead Plaintiff points out that the expert for the Underwriter Defendants relies on the due diligence conducted on Intermedia in reaching his opinion that the Underwriter Defendants conducted a reasonable investigation.
The defendants' expert report was written before the summary judgment opinion was issued. It is assumed that, having made this motion, the Underwriter Defendants no longer intend to present evidence of their due diligence concerning Intermedia. If this assumption is in error, the Underwriter Defendants shall notify the Lead Plaintiff by February 25, 2005. Decision on this motion is reserved.
9. Motion to exclude certain damages-related opinion testimony of Dr. Blaine F. Nye
The Underwriter Defendants move to exclude three opinions from Lead Plaintiff's expert Dr. Blaine F. Nye ("Nye"), to wit, that had WorldCom's financial condition been correctly stated the 2000 and 2001 bonds would not have issued, and thus, negative causation is zero; that WorldCom would have been "bankrupt" prior to the 2000 and 2001 bond offerings (the "Offerings") had it reported its financials correctly; and that WorldCom would have been in violation of its debt covenants prior to the Offerings had it reported its financials correctly. They also seek to exclude Nye's aggregate damages calculation. The Underwriter Defendants contend that Nye's opinions are premised on a legal error and reflect assertions of fact that are flawed because Nye lacks a foundation for his opinions and has ignored relevant information.
Andersen joins in this motion.
Nye provides expert testimony for the Lead Plaintiff regarding damages. Damages for a violation of Section 11 are governed by Section 11(e) of the Securities Act. Section 11(e) provides three measures for recovery of damages. They are
such damages as shall represent the difference between the amount paid for the security . . . and (1) the value thereof as of the time such suit was brought, or (2) the price at which such security shall have been disposed of in the market before suit, or (3) the price at which such security shall have been disposed of after suit but before judgment if such damages shall be less than the damages representing the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and the value thereof as of the time such suit was brought. . . .15 U.S.C. § 77k(e). This language is exclusive and precludes recovery on other theories. See McMahan Co. v. Wherehouse Entertainment, Inc., 65 F.3d 1044, 1048 (2d Cir. 1995); Goldkrantz v. Griffin, No. 97 Civ. 9075 (DLC), 1999 WL 191540, at *3 (S.D.N.Y. Apr. 6, 1999).
Section 11(e), however, also provides a defendant with an opportunity to disprove causation and thereby reduce damages. See Akerman v. Oryx Communications, Inc., 810 F.2d 336, 341 (2d Cir. 1987). If a defendant can prove that the loss in the value of a security is due to something other than the alleged misrepresentation on which the Section 11 claim is premised, Section 11(e) will bar a recovery of damages. This proof is referred to as evidence of negative causation. Section 11(e) provides:
[T]hat if the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from such part of the registration statement, with respect to which his liability is asserted, not being true or omitting to state a material fact required to be stated therein or necessary to make the statements therein not misleading, such portion of or all such damages shall not be recoverable.15 U.S.C. § 77k(e) (emphasis supplied). The price of a security immediately before the disclosure that a prior statement was inaccurate is often the point from which to begin an analysis of causation. Goldkrantz, 1999 WL 191540, at *3.
In his October 1, 2004 report, Nye admits that defendants may limit their liability if they establish negative causation and proceeds to opine that defense experts disregarded the drop in the prices of the bonds during the first half of 2002. Nye refers to discussions in his prior reports where he explained that the misrepresentations of WorldCom's true financial condition caused the prices of the bonds to be inflated. Nye then adds, at paragraphs five and six, two passages which prompt this motion. Relying on another expert's opinion that WorldCom would not have been able to complete the 2000 Offering had its financial condition been accurately revealed, he opines that "[a]ccordingly, there is no offset for negative causation for the May 2000 Notes." Similarly, based on his opinion that WorldCom could not have proceeded with the 2001 Offering if its financial statements had been accurate, he opines that "there is no offset for negative causation for Section 11 and Section 12(a)(2) damages for the May 2001 Offering Notes."
Nye is relying on the opinion expressed by Lead Plaintiff's expert James Miller. As described in connection with the Underwriter Defendants' eleventh motion in limine, Miller's opinion regarding WorldCom's bankruptcy in 2000 does not survive.
The Underwriter Defendants' motion in limine is granted to the extent of striking Nye's opinions that there is "no offset for negative causation" because the Offerings could not have proceeded if accurate financial information had been disclosed. While testimony about what would have happened to WorldCom and to the Offerings if WorldCom had filed truthful financial statements will be relevant for various purposes, including proof of materiality, as a matter of law it does not rebut the affirmative defense of negative causation.
The Lead Plaintiff relies on the formulation of loss causation contained in Emergent Capital Investment Management, LLC v. Stonepath Group, Inc., 343 F.3d 189 (2d Cir. 2003). Proof of loss causation is an element of a Section 10(b) Exchange Act claim. The parties agree that the negative causation defense in Section 11 and the loss causation element in Section 10(b) are mirror images; in the former, the burden of proving negative causation is on the defendant, and in the latter, the burden of proving the existence of loss causation is on the plaintiff. Emergent described loss causation as "the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff."Id. at 197. It elaborated, "[w]e have often compared loss causation to the tort law concept of proximate cause, meaning that the damages suffered by plaintiff must be a foreseeable consequence of any misrepresentation or material omission." Id. (citation omitted). Proof of intervening events, "like a general fall in the price of Internet stocks," are a matter for proof at trial. Id.
Recently, the Second Circuit revisited the concept of loss causation in the context of lawsuits filed against Merrill Lynch Co. for its alleged intentionally misleading analyst reports. Lentell v. Merrill Lynch Co., No. 03 Civ. 7948, ___ F. 3d ___, 2005 WL 107044 (2d Cir. Jan. 20, 2005). The Merrill Lynch court reaffirmed the analogy to proximate cause, adding that "a misstatement or omission is the proximate cause of an investment loss if the risk that caused the loss was within the zone of risk concealed by the misrepresentations and omissions alleged by a disappointed investor."Id. at *9. Thus, a plaintiff must show that the "subject of the fraudulent statement or omission was the cause of the actual loss suffered, i.e., that the misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security." Id. (citation omitted) (emphasis in original). A concealed fact cannot cause a decrease in the value of a stock before the concealment is made public. Id. at *12 n. 4. As Merrill Lynch has formulated the test for loss causation, a plaintiff must show "both that the loss be foreseeable and that the loss be caused by the materialization of the concealed risk." Id. at *10 (emphasis in original).
Merrill Lynch, as is true of most of the loss causation cases, was a pleading case. It held that the complaint failed to plead loss causation because it contained no allegation that the market reacted negatively to a corrective disclosure regarding the alleged misstatement or omission, and no allegation that the misstatements or omissions led to the loss.Id. at *14. It distinguished allegations that misstatements "artificially inflated" the price of the securities as allegations that establish transaction causation, a separate element of a Section 10(b) claim. Id. at *12; see also In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 392, 413, 428 n. 27 (S.D.N.Y. 2003) (discussing the distinction between transaction and loss causation and the Lead Plaintiff's theory of loss causation).
Neither Emergent nor Merrill Lynch provide succor to the Lead Plaintiff. The Underwriter Defendants will be able to sustain their burden of showing negative causation to the extent that they can establish that the decline in the price of WorldCom bonds was due to factors other than misstatements and omissions that the jury finds to be a basis for liability. Showing that the Offerings would never have occurred if the financial statements had not been manipulated is not responsive to this analysis.
The Underwriter Defendants also argue that Nye's opinion about WorldCom's bankruptcy, which emerged in the course of Nye's deposition, and his opinion about WorldCom's violation of its debt covenants, which was contained in an expert report, are unreliable. They argue that Nye does not have sufficient expertise to render an opinion on bankruptcy since his field of expertise is financial economics. As for the debt covenants, they point to various scenarios that Nye failed to consider. The motion is denied to the extent it seeks to foreclose Nye testimony generally on the effect that accurately stated financials would have had on the timing of WorldCom's bankruptcy or the debt covenants. The Lead Plaintiff has shown that Nye has the expertise necessary to opine on these issues and that his opinion is sufficiently reliable to be presented to the jury.
Nye is apparently prepared to testify that WorldCom became bankrupt by at least the end of 2000, when it should have taken a non-cash asset impairment charge. The Underwriter Defendants have not provided each of the passages of the deposition from which their description of his testimony is drawn.
In his August 20, 2004 report, Nye states that "it is almost certain that WorldCom and the Underwriter Defendants would not have been able to proceed with the May 2001 Offering had they reported WorldCom's true financial condition."
With respect to Nye's aggregate damages calculation, the Underwriter Defendants argue that the calculation must be stricken since Nye failed to consider several variables. They contend that Nye's aggregate damage analysis does not "fit" the issues in this case because it fails to consider the magnitude of the opt-outs from the class, the various conclusions a jury may reach regarding liability on the various alleged omissions and misstatements, the receipt of money by class members through the bankruptcy settlement, and the success that the Underwriter Defendants may have in proving their affirmative defense that an individual class member actually knew of the alleged misrepresentations and omissions when she purchased the bonds.
As reflected above, the Underwriter Defendants have also moved to exclude presentation of evidence to the jury about the existence of the Individual Actions. That application has been granted. For a discussion of the Individual Actions and their role in the Securities Litigation, see In re WorldCom, Inc. Sec. Litig., 308 F. Supp. 2d 214 (S.D.N.Y. 2004).
The Underwriter Defendants have not shown that an aggregate damages award should not be made by a jury. Aggregate damages awards are a "standard practice" in securities cases. In re Oxford Health Plans, Inc. Sec. Litig., 244 F. Supp. 2d 247, 251 (S.D.N.Y. 2003). "Before and after the enactment of the PSLRA, absent class members in securities fraud cases have been awarded a common fund of damages computed by the trier of fact, based usually on expert testimony. . . ." Id.; see also In re Blech Sec. Litig., No. 94 Civ. 7696 (RWS), 2003 WL 1610775, at *26 (S.D.N.Y. Mar. 26, 2003) ("It is the common practice to award an aggregate verdict for the class as a whole."). Since the award from the common fund established by any damages award will be on a claims-made basis, there is no danger that monies will be distributed to opt-outs. See Blech, 2003 WL 1610775, at *26 (citing Boeing Co. v. Van Gemert, 444 U.S. 472, 482 (1980)). Because of judgment reduction credits and the claims process, any award will also be reduced by money already received from settlements, including the settlement with the Citigroup Defendants and the bankruptcy settlement.
The likelihood that the Underwriter Defendants will have any good faith basis to pursue a claim that an individual class member knew of the fraud is remote, particularly in light of the fact that they have taken the position that despite their direct access to WorldCom and due diligence duty they did not know of the fraud. See In re WorldCom Sec. Litig., 219 F.R.D. 267, 303 (S.D.N.Y. 2003).
To the extent that there is an affirmative defense of knowledge by the class, that of course will be tried at the plenary trial. To the extent that there is a basis to pursue this affirmative defense with respect to any class member individually, that will be pursued in the individual proceedings that will follow the plenary trial. Finally, if the Underwriter Defendants can show that an award of damages in the amount calculated by Nye is unsupported because the Lead Plaintiff has been unable to prove that a necessary predicate material misrepresentation or omission was made, then that is an appropriate line of cross examination and summation argument. The existence of that potential defense, however, does not eliminate the right of the Lead Plaintiff to calculate damages premised on the Lead Plaintiff's belief that it will succeed at trial in proving the material misstatements and omissions.
The Underwriter Defendants also contend that they will be significantly prejudiced by the testimony that supports an award of damages in the amount of approximately $17 billion. Testimony about the damages suffered by the class does not constitute unfair prejudice. "Because virtually all evidence is prejudicial to one party or the other, to justify exclusion under Rule 403 the prejudice must be unfair. The unfairness contemplated involves some adverse effect beyond tending to prove a fact or issue that justifies admission." Costantino v. Herzog, 203 F.3d 164, 174-75 (2d Cir. 2000) (citation omitted) (emphasis in original).
In a final set of arguments, the Underwriter Defendants contend that Nye erred in calculating damages by basing his calculation on the value of the bonds as of the date of suit instead of the date on which the bonds were disposed of in the WorldCom bankruptcy process or any intervening date. This argument is addressed in a companion Opinion in regard to Andersen's motion in limine regarding Nye.
They also argue that Nye's analysis of the Section 12(a)(2) damages is flawed because Nye included after-market purchasers who do not have standing to bring Section 12(a)(2) claims, and because his assumption that all Section 12 (a) (2) purchasers sold their bonds after March 2002 is no more plausible than the assumption that they all sold them before March 2002 (when the bonds traded at or near par value). The Underwriter Defendants may cross-examine Nye regarding the validity of his assumptions as to the date by which Section 12(a)(2) bondholders sold their bonds. The Lead Plaintiff requests permission for Nye to file a supplemental expert report that includes an aggregate Section 12 damage analysis that excludes after-market purchasers. The Underwriter Defendants will be given an opportunity at the final pre-trial conference to be heard on this request.
Bondholders who purchased in the after-market may recover through the Section 11 claim from the Underwriter Defendants, but not through the Section 12(a)(2) claim. See WorldCom, 294 F. Supp. 2d at 407-09.
10. Motion to exclude evidence regarding Grubman and SSB
The Underwriter Defendants move to exclude evidence or argument concerning the activities of Jack Grubman ("Grubman") of Salomon Smith Barney, Inc. ("SSB") — specifically, whether Grubman issued false analyst reports and assisted in the allocation of IPO shares to WorldCom executives. They contend that these issues are not relevant because all claims against the Citigroup Defendants, including Grubman and SSB, were severed following their settlement with the Lead Plaintiff, see WorldCom, 2004 WL 2591402, at *6, and that there is insufficient evidence that the Underwriter Defendants who are proceeding to trial, or the SSB due diligence team on the 2000 and 2001 Offerings, knew of these practices. They also argue that J.P. Morgan Securities, Inc. ("J.P. Morgan") conducted its own independent due diligence and considered SSB's due diligence as just one piece of the information that it had, and that junior underwriters relied on the due diligence conducted not only by SSB but also by J.P. Morgan. The Lead Plaintiff opposes this motion.
The Underwriter Defendants contend that the spinning was largely limited to the years 1996 and 1997, and that Ebbers realized less than $20,000 in profits from the allocation of IPO shares to him in 1999, and no profits in the year 2000.
The Underwriter Defendants who are proceeding to trial acknowledge that junior underwriters "certainly relied in part on SSB's due diligence." See also WorldCom, 346 F. Supp. 2d at 647. According to the Lead Plaintiff, in response to the Lead Plaintiff's first set of interrogatories, J.P. Morgan and each of the junior underwriters stated that it relied on SSB's due diligence.
This motion is essentially an untimely summary judgment motion. The allegations regarding Grubman and SSB have played a prominent role in this litigation since its inception. Were there a reasonable basis to argue that no disputed issues of fact exist regarding the truth of Lead Plaintiff's accusations concerning Grubman and SSB, then that argument should have been presented at the time scheduled for summary judgment motions. Similarly, a summary judgment motion could have been brought to show both that the Underwriter Defendants who are proceeding to trial were unaware and through due diligence would not have learned of those alleged conflicts of interest, and that they did not rely on SSB's due diligence.
In terms of relevance, the Lead Plaintiff has shown that the evidence regarding the accuracy of the Grubman analyst reports and SSB's "spinning" of shares to WorldCom executives is relevant. SSB was a lead underwriter for both the 2000 and 2001 Offerings. Information regarding a conflict of interest between an underwriter and issuer can constitute a material omission. See WorldCom, 346 F. Supp. 2d at 689. A jury will have to determine whether the registration statements for the 2000 and 2001 Offerings needed to disclose the quid pro quo relationship alleged by the Lead Plaintiff, in which SSB got valuable investment banking business from WorldCom in return for publishing analyst reports favorable to WorldCom and spinning IPO shares to WorldCom executives. As underwriters for the two Offerings, the Underwriter Defendants have liability for any material omission from a registration statement, including one that concerns SSB.
Moreover, SSB's performance of due diligence is relevant to the due diligence defense presented by the Underwriter Defendants who are proceeding to trial. To the extent that any underwriter proceeding to trial made SSB its agent for conducting due diligence, if SSB failed to insist on the proper disclosures in the registration statement or failed to conduct adequate due diligence, then the relying underwriter's defense will also fail. See Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 697 n. 26 (S.D.N.Y. 1968) (holding that those underwriters who relied on the lead underwriter were "bound" by the lead underwriter's failure to conduct adequate due diligence).
The Lead Plaintiff argues that evidence about Grubman's research reports will also be important at trial for an entirely different reason. It contends that it needs to explore the extent to which the Underwriter Defendants who are proceeding to trial relied upon Grubman's analyst reports, and what they understood his reports to indicate. Grubman was the premier telecommunications analyst and was widely known to have a close relationship to WorldCom. The Lead Plaintiff is correct that it is entitled to explore the extent to which those conducting due diligence considered Grubman's analyst reports concerning WorldCom.
Relying on Rule 403, the Underwriter Defendants argue that the evidence about Grubman's analyst reports should be excluded because there is no evidence that the other underwriters who participated in the Offerings published skewed analyst reports about WorldCom. Specifically, they contend that the jury will be confused and assume that SSB's conduct is chargeable to them. It is difficult to believe that the jury will be unable to distinguish between SSB and the Underwriter Defendants who are proceeding to trial. In any event, this argument rests on a fallacy. To the extent and in the ways just described, the Underwriter Defendants will be charged at trial with SSB's conduct. The Underwriter Defendants may propose a limiting instruction to address any impermissible inference they fear the jury may draw. The Underwriter Defendants have not, however, identified any issue of juror confusion that substantially outweighs the probative value of this evidence.
The Underwriter Defendants also make a Rule 403 argument concerning SSB's spinning of shares to WorldCom executives. They assert that there is no evidence that SSB's due diligence team knew of the practice and that the WorldCom executives received only modest profits from the practice in the years of the Offerings. They anticipate that evidence of spinning will consume too much of the trial time, confuse jurors, and prejudice them. When the parties have finally selected their trial witnesses, the Underwriter Defendants may renew this application if they continue to perceive that the Lead Plaintiff will be spending too much trial time on this issue. They have not shown that the jury is likely to be confused by this evidence. Nor have they identified the nature of any unfair prejudice to them. To the extent that they believe the jury needs to be given limiting instructions during the trial, they are invited to submit proposed charges. Their Rule 403 motion is denied.
The Underwriter Defendants' assertion that there is no evidence that the due diligence team knew of the spinning is in tension with their argument, made at other times in this litigation, that the practice was so widely known that no disclosure in the registration statements was necessary.
11. Motion to exclude certain testimony of Lead Plaintiff's due diligence expert
The Underwriter Defendants move to exclude the testimony of Lead Plaintiff's due diligence expert James F. Miller ("Miller") contained in his third report filed on October 1, 2004 ("October Report"). They specifically seek to exclude his testimony (1) that WorldCom would have been unable to sell bonds to the market in May 2000 had the world known that WorldCom's accounts were false because the bonds would not have been rated as investment grade bonds, and (2) that WorldCom would have been in bankruptcy by the end of 2000. The Underwriter Defendants contend that Miller lacks any qualification to opine on how a company's debt is rated or on accounting matters. Second, they argue that his opinion is couched in language reflecting that it is entirely speculative.
Federal Rule of Evidence 702 provides that expert testimony concerning technical or specialized knowledge is admissible to assist the trier of fact if "(1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case." Fed.R.Evid. 702. A court has an obligation to act as a gatekeeper to ensure the "reliability and relevancy of expert testimony" presented to a jury. Kumho Tire Co. v. Carmichael, 526 U.S. 137, 152 (1999); see also Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579, 594-95 (1993). Specifically, the court must determine that the expert "employs in the courtroom the same level of intellectual rigor that characterizes the practice of an expert in the relevant field." Kumho, 526 U.S. at 152;see also Amorgianos v. Nat'l R.R. Passenger Corp., 303 F.3d 256, 267 (2d Cir. 2002) ("The flexible Daubert inquiry gives the district court the discretion needed to ensure that the courtroom door remains closed to junk science while admitting reliable expert testimony that will assist the trier of fact.").
Miller has been offered as an expert regarding investment banking issues, and specifically the standards for conducting due diligence. The Underwriter Defendants do not challenge his expertise on those matters. The October Report responded to a request from Lead Plaintiff for his opinion as to whether WorldCom could have completed the 2000 Offering had the true facts about its financial condition been known to the market. He opined that it was "doubtful" that WorldCom could have successfully conducted the Offering.
Relying on the work of the Lead Plaintiff's accounting expert, Miller starts with the fact that with a proper accounting for line costs, WorldCom would have reported an E/R ratio of 46.2% instead of 41% for the first quarter of 2000. He opines that an E/R ratio of 46.2% would have revealed that WorldCom's gross profit margins were deteriorating and that WorldCom was not as good an operator as it claimed. In addition, to the extent that the market learned that WorldCom had manipulated its reporting of line costs by more than a half a billion dollars in the first quarter of 2000, the market would have understood that management was cooking the books to conceal the deterioration in WorldCom's business. He concludes that, had this information been known, "it is possible that WorldCom's debt would not have been rated investment grade." (Emphasis supplied.) Without an investment grade rating, "WorldCom wouldlikely not have been able to complete the 2000 Offering," or would have been able to do so only for a smaller amount than $5 billion and at the higher interest rates that normally accompany junk bonds. (Emphasis supplied.)
Line costs were WorldCom's single largest operating expense. For a discussion of the role that line costs played in the alleged manipulation of WorldCom's financial statements, see, inter alia, WorldCom, 346 F. Supp. 2d at 640.
See WorldCom, 346 F. Supp. 2d at 640-42, 678-80 (discussing E/R ratio).
Miller also refers to his discussion in a prior report of the requirement that WorldCom write off some of its overstated goodwill before the 2000 Offering. With such a write-off, he opines that "there is a reasonable probability" that WorldCom would not have been able to complete the Offering to raise the same amount of money and at the same interest rate. He then discusses the combined effect of the write-down and the accurate reporting of the line costs. "While it is possible that neither the writedown of good will nor the understatement of line costs would individually have caused WorldCom to be rated less than investment grade; when taken together, they most likely would have caused such a downgrade." (Emphasis supplied.)
Miller concludes with an analysis of what the disclosure of management's accounting manipulations would have done to the company. He states that he is "certain" that WorldCom could not have sold public market debt following such a disclosure without replacing Ebbers and Sullivan, the company's CEO and CFO. He concludes that given the deteriorating cash flow and time needed to replace Ebbers and Sullivan, "I doubt that WorldCom would have gotten through 2000 without filing for bankruptcy." (Emphasis supplied.)
The Underwriter Defendants' attack on Miller's qualifications to judge the investment grade rating of bonds must be rejected. To bring a bond offering to market, an investment banker must be able to judge accurately how a market will rate the bonds in light of the company's financial statements and related facts, such as an assessment of the competence and integrity of management and the health of the industry.
Similarly, their argument that Miller's opinions about the 2000 Offering are too speculative must be rejected. While Miller's initial opinions, particularly on the effect of the disclosure of the altered E/R ratio and management's dishonesty, are hedged in language that does not reflect sufficient certainty to merit presentation to a jury, those initial opinions serve as building blocks for the ultimate conclusion about the combined effect of the disclosures described in the October Report. When read in its entirety, the October Report does express with sufficient reliability an opinion about the likely impact of the disclosures on the success of the 2000 Offering. The opinion is supported by other admissible evidence on which Miller may properly rely and by his own established expertise. The opinion will be of assistance to the jury.
Miller's opinion about the likelihood that WorldCom would have entered bankruptcy at some point in 2000 stands on a different footing. The Lead Plaintiff contends that Miller is not opining on whether bankruptcy was WorldCom's only viable option, but on how WorldCom's inability to raise capital would have affected its ability to continue as a going concern. Despite this effort to reformulate the opinion, the October Report is not reasonably susceptible to such a construction. Miller's opinion that WorldCom would not have gotten through 2000 without filing for bankruptcy is stricken as too speculative. He does not express an opinion with sufficient certainty to make it reliable expert testimony that would be of assistance to the jury.
Conclusion
The Underwriter Defendants' motion to exclude references to WorldCom's bankruptcy is denied. Their motions to preclude evidence of the Individual Actions, any settlement reached in the WorldCom litigation, to preclude references to insurance coverage, and to preclude evidence of the compensation of any present or former employee of an Underwriter Defendant are granted, as is their motion to preclude references to counsel's background or other characteristics. Their motions to preclude evidence of the fees earned by the Underwriter Defendants from WorldCom and to exclude evidence regarding Grubman and SSB are denied. Their motion to exclude testimony of Lead Plaintiff's due diligence expert that WorldCom would have entered bankruptcy in 2000 is granted.
The motion to exclude certain damages-related opinion testimony of Dr. Blaine F. Nye concerning negative causation is granted. The remainder of their motion concerning Nye's testimony is either denied or subject to further briefing. Decision is reserved on the Underwriter Defendants' motion to preclude evidence of corporate wrongdoing generally, and to exclude evidence regarding Intermedia Communications, Inc. and Digex Inc.
SO ORDERED.