Opinion
Civil No. 3: 03-CV-2761-H.
April 15, 2005
MEMORANDUM OPINION AND ORDER
Before the Court are Lead Plaintiffs' Motion for Class Certification, filed October 4, 2004; Defendants' Opposition and Appendix, filed December 6, 2004; Defendants' Amended Opposition and Supplemental Appendix, filed December 20, 2004; Lead Plaintiffs' Reply, filed January 10, 2005; and Defendants' Surreply, filed January 27, 2005. Also before the Court are a variety of letters from both parties, including: Lead Plaintiffs' Letter, dated January 31, 2005; Defendants' Letter, dated February 18, 2005; Lead Plaintiffs' Letter, dated February 22, 2005; and Defendants' Letters, dated February 23 and 25, 2005. For the reasons stated below, Lead Plaintiffs' Motion is GRANTED.
The Court considered Defendants' Appendix filed with their Opposition, but did not consider the briefing in Defendants' Opposition, filed December 6, 2004, since such briefing was replaced by Defendants' Amended Opposition, filed December 20, 2004.
I. BACKGROUND
Plaintiff Oscar Private Equities ("Oscar") filed its original Class Action Complaint for Breach of Fiduciary Duty and Violations of Federal Securities Laws ("Original Complaint") on November 13, 2003. On January 27, 2004, Oscar and Plaintiffs Brett Messing and Marla Messing filed their motion for appointment as Lead Plaintiffs and for approval of Lead Plaintiffs' selection of counsel. The Court appointed Oscar and the Messings as Lead Plaintiffs and approved their selection of lead counsel by Order entered February 6, 2004.
Throughout this Memorandum Opinion and Order, Oscar and the Messings are collectively referred to as Lead Plaintiffs.
Allegiance Telecom ("Allegiance") was a publicly traded company that provided integrated telecommunications services to business, government, and other institutional users in major metropolitan areas across the United States during the putative Class Period, April 24, 2001, through February 19, 2002. (Am. Compl. at 41, 49.) Allegiance also offered local, long-distance, broadband/Internet access and Internet-related services, bundled and carrier-oriented wholesale services, as well as end-user equipment sales and maintenance services to individual customers and businesses. Defendant Royce J. Holland was the Chairman and Chief Executive Officer of Allegiance during the putative Class Period; Defendant Anthony Parella was the Executive Vice President for Sales.
Allegiance Telecom is not named as a defendant in this case because it filed Chapter 11 bankruptcy.
Lead Plaintiffs assert claims for securities fraud pursuant to § 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, for deceiving the investing public and causing Lead Plaintiffs and other class members to purchase securities of Allegiance at artificially inflated prices. Lead Plaintiffs also assert claims for violations of § 20(a) of the Securities Exchange Act. All of Lead Plaintiffs' claims result from a statement issued by Allegiance on February 19, 2002, informing the public that Allegiance had overstated its "installed line count" — the number of lines sold to customers that were being used to provide services. Lead Plaintiffs assert that these line counts were an important measure of Allegiance's performance and prospects, and were relied on by the market. (Am. Compl. at 7.) As a start-up company, Allegiance's success was measured by line count, not by its net income figures. ( See id.)
The Court, in its Order entered June 10, 2004, dismissed all of Lead Plaintiffs' claims against Defendants excepting those related to misrepresentations concerning Allegiance's line counts. Lead Plaintiffs now move pursuant to Federal Rule of Civil Procedure 23 to certify a class "consisting of all persons, without geographic limitation, who purchased Allegiance . . . common stock in the open market during the period from April 24, 2001 through February 19, 2002, inclusive . . . and who were damaged by Defendants' alleged violations of Section 10(b) and/or 20(a) of the Securities Exchange Act of 1934 . . . and Rule 10b-5 promulgated thereunder. Excluded from the Class are Defendants, their legal representatives, heirs, successors and predecessors in interest, affiliates, assigns, and any entities in which the Defendants (or any of them) had a controlling interest in during the Class Period." (Pls.' Mot. at 1.)
II. STANDARD
Class certification is proper where the Lead Plaintiffs have met their burden under Federal Rule of Civil Procedure 23 ("Rule 23"). Rule 23 requires Lead Plaintiffs to prove that (1) the class is so numerous that joinder of all members is impracticable ("numerosity"); (2) there are questions of law or fact which are common to the class ("commonality"); (3) claims or defenses of the representative parties are typical of the claims and defenses of the class ("typicality"); and (4) that the Lead Plaintiffs will fairly and adequately protect the interests of the class ("adequacy"). FED. R. CIV. P. 23(a). Lead Plaintiffs must also prove that common questions of law or fact predominate and that a class action is superior to other methods of adjudication. FED. R. CIV. P. 23(b)(3).
Defendants do not challenge the numerosity, typicality, or commonality requirements of Rule 23(a). (Defs.' Am. Opp. at 4.) Lead Plaintiffs carries the burden of proving the elements of Rule 23. See Stirman v. Exxon Corp., 280 F.3d 554, 562 (5th Cir. 2002). Therefore, the Court considers each factor of class certification to determine if Lead Plaintiffs have met their burden.
Defendants' conflict of interest challenge to the adequacy of Brett Messing might also be styled as a challenge to the typicality of Mr. Messing as a Lead Plaintiff. The Court addresses Defendants' conflict of interest arguments both as they relate to adequacy and typicality.
The Court must conduct a rigorous analysis to find the facts supporting class certification, not merely assume that such facts exist. Unger v. Amedisys Inc., 401 F.3d 316, 320 (5th Cir. 2005); see also General Tel. Co. v. Falcon, 457 U.S. 147, 161 (1982). This requires going beyond the pleadings to "understand the claims, defenses, relevant facts, and applicable substantive law in order to make a meaningful determination of the certification issues." Castano v. Am. Tobacco Co., 84 F.3d 734, 744 (5th Cir. 1996). However, "[c]lass certification hearings should not be mini-trials on the merits of the class or individual claims." Unger, 401 F.3d at 321. Determining whether or not a class should be certified is left to the sound discretion of the trial court as constrained by Federal Rule of Civil Procedure 23. Id. at 320 (citing Gulf Oil Co. v. Bernard, 452 U.S. 89, 100 (1981)).
III. ANALYSIS
1. Adequacy of Class Representatives
A. Rule 23(a) Requirements
"The Court must find that class representatives, their counsel, and the relationship between the two are adequate to protect the interests of absent class members." Unger, 401 F.3d at 321 (citing Stirman, 280 F.3d at 562). The Fifth Circuit has stressed that an adequate representative must be willing to take an active role in and exercise ultimate control of the litigation in order to protect the interests of the absent class members. Berger v. Compaq Comp. Corp., 257 F.3d 475, 479 (5th Cir. 2001), clarified on rehearing en banc, 279 F.3d 313 (5th Cir. 2002). "[C]lass representatives need not be legal scholars and are entitled to rely on counsel, [but] do need to know more than that they were involved in a bad business deal." Id. at 483.
With respect to counsel, Defendants acknowledged in oral argument that they do not oppose Lead Plaintiffs' choice of counsel. Similarly, Defendants have raised no challenge to the relationship between Lead Plaintiffs and their counsel. Defendants only dispute whether each of the Lead Plaintiffs are adequate to represent the class. Defendants challenges against each Lead Plaintiff are addressed below. Only one Lead Plaintiff is necessary in this class action, since no subclasses have been alleged as necessary for adequate representation of the putative class. See In re Enron Corp. Sec. Litig., 206 F.R.D. 427, 451 (S.D. Tex. 2002); Holley v. Kitty Hawk, Inc., 200 F.R.D. 275, 279-80 (N.D. Tex. 2001). See also Weinberg v. Atlas Air Worldwide Holdings, Inc., 216 F.R.D. 248, 254 (S.D.N.Y. 2003); Burke v. Ruttenberg, 102 F. Supp. 2d 1280, 1324-26 (N.D. Ala. 2000). Accordingly, the Court will consider the adequacy of Brett Messing ("Messing"), the main Lead Plaintiff actor in the litigation thus far.
Because the Court finds Messing adequate as Lead Plaintiff, the Court need not address the adequacy of Marla Messing or Oscar. See In re Enron Corp. Sec. Litig., 206 F.R.D. at 451; Holley, 200 F.R.D. at 279-80. Nevertheless, in an abundance of caution, the Court will consider the adequacy of Oscar and Marla Messing.
The Court finds that as an aggregated group of Lead Plaintiffs, Lead Plaintiffs are made adequate by Messing's involvement alone. The Court is not concerned that the addition of Oscar and Marla Messing as Lead Plaintiffs would create conflicts, disharmony, or otherwise jeopardize the representation of the class, especially when Marla Messing has committed to greater involvement in the case. (Pls.' Supp. App. at 174-78.) Rather, this group appears to be exactly the type of cohesive Lead Plaintiff group envisioned by the Private Securities Litigation Reform Act. 15 U.S.C. § 78u-4(a)(3)(B)(iii); see Richard NMI Bell v. Acendant Solutions, Inc., No. Civ.A. 3:01-CV-0166, 2002 WL 638571, at *1 n. 2 (N.D. Tex. April 17, 2002) (Solis, J.) (citations omitted); cf. Holley, 200 F.R.D. at 279 ("When there are no other parties seeking to be appointed lead plaintiff, the moving parties have the largest financial interest.").
Although Oscar is now defunct, Defendants, as stated in oral argument, do not dispute that the adequacy of Oscar to represent the class is contingent on the adequacy of Messing, who is acting on its behalf. Accordingly, Oscar is deemed adequate as a class representative, acting through Messing. The joining of Oscar as a Lead Plaintiff would not create problems for the cohesiveness of the group. The Court also notes that no such concerns are present by adding Marla Messing, Messing's wife.
Although Marla Messing has had considerably less involvement in the case until now, Marla Messing has indicated that she intends to take a more active approach in the litigation should she be selected as Lead Plaintiff. (Pls.' Supp. App. at 174-78.) Despite her minimal involvement, she has nevertheless demonstrated an understanding of the issues and an ability and willingness to take a more active role in and control over the litigation ( id.). See Berger, 257 F.3d at 479. Her commitment to the class action and her fiduciary duties to the class should she be selected as a Lead Plaintiff is deemed by the Court sufficient to support her appointment as joint Lead Plaintiff with Messing, who has been involved with the action from the beginning. See In re Baan Co. Sec. Litig., No. 1:98CV2465 (ESH), 2002 WL 32307825, at *4 (D.D.C. July 19, 2002).
a. Active Role Control
No challenge is made to Messing's qualifications to serve as a lead plaintiff in the instant action or his understanding of line count manipulation. (Pls.' Supp. App. at 134-35.) Instead, Defendants challenge Messing's understanding of the duties as a class representative and review of key pleadings. See Lehocky, 220 F.R.D. at 503.
The Court notes that Plaintiff appears qualified to serve as Lead Plaintiff, having attended Brown University and Harvard Law School and served on the boards of various telecommunications companies, as well as working for Goldman Sachs. (Pls.' App. at 128.)
Defendants argue that Messing is inadequate because he has turned over control of the litigation to lead counsel. (Defs.' Am. Opp. at 9.) Defendants say that because Messing's lawyers conducted an investigation and amended the original complaint, which added new defendants and dropped a fiduciary duty claim (Defs.' App. at 91), allegedly without guidance from Messing, that he is inadequate to serve as a representative of the class. (Defs.' Am. Opp. at 9-10.) Defendants state that Messing's conduct "indicates that his review and oversight of other pleadings has been haphazard at best." ( Id. at 10.) To this end, Defendants argue that Messing is inadequate as a class representative because he has not been involved in the motion for class certification and did not understand why the six individuals sought to intervene as Lead Plaintiffs. ( Id.; Defs.' App. at 91-94.)
As to the amended complaint, the crux of Defendants' arguments of inadequacy stem from Messing's reliance upon his lawyers to conduct investigations and amend the complaint. ( Id. at 9-10.) Defendants' arguments are insufficient to establish inadequacy. It is often the case that discovery yields additional parties that should be added or additional claims that should be brought based on scienter later adduced. In the class action context, Lead Plaintiffs should not be penalized for this process. That an investigation, conducted by Lead Plaintiffs' lawyers, happened is normal. Messing indicated that he directed the lawyers to information to assist them in the investigation. (Pls.' App. at 137.) That the complaint was amended as a result of findings of the investigation is also not unusual and Messing is not made inadequate by this process.
Messing's deposition indicates that he was unaware why the fiduciary duty claim was dropped. (Defs.' App. at 91.) The Court finds this insufficient to establish inadequacy, however, since the decision to drop the fiduciary duty claim is primarily for lawyers to decide and beyond the expertise required of a lead plaintiff.
Indeed, Messing initiated the complaint because it was clear to him "based on the conduct of the management [of Allegiance], that there was something actionable here." (Pls.' App. at 131.) Messing believed that management lied about their line counts among other things and that he believes line count information to be a primary metric of growth. ( Id. at 132, 134.) Lead Plaintiffs also produced evidence that Messing reviewed discovery materials and directed his attorneys in formulating the Amended Complaint, including reviewing and providing comments on multiple drafts of same. ( Id. at 138; Pls.' Supp. App. at 121-22, 137-38). Messing believes, based on the investigation done by his lawyers, that Defendant Holland "clearly knew at the time that they were playing with the numbers to make the line count" and that Defendant Parella knew at the time he made various statements that they were false. (Defs.' App. at 95, 98.)
Messing's statements indicate that he has taken an active role in the litigation and has taken control of the major aspects of the litigation, including reviewing pleadings. Messing's involvement in the instant case is substantial considering the complexity of the case. Messing suffers none of the defects in representation noted in Umsted v. Intelect Comms., Inc., No. Civ.A. 3:99-cv-2604, 2003 WL 79750 (N.D. Tex. Jan. 7, 2003) (Lynn, J.) and Defendants have not raised the specter of Messing's inadequacy regarding attorney-class conflicts noted in Griffin v. GK Intelligent Sys., Inc., 196 F.R.D. 298, 302 (S.D. Tex. 2000). Indeed, the evidence points to the contrary, since, unlike the case in Griffin, Messing selected counsel, rather than vice-versa. ( See Pls.' App. at 131.)
Defendants also argue that Messing should be named inadequate under In re Quarterdeck Office Sys., Inc. Sec. Litig., No. CV 92-3970-DWW(GHKx), 1993 WL 623310, at *5-6 (C.D. Cal. Sept. 30, 1993). However, Lead Plaintiffs in that case were far less active than Messing. They did not select lead counsel nor could they name counsel, were located in different cities from lead counsel, were not aware of any consideration afforded for dropped defendants, or whether the defendants had sufficient assets to cover the damages sought, and one of them stated that they would abdicate control to counsel. Id. at *6.
Messing does not recall whether he reviewed the motion for class certification before or after it was filed, but does recall reviewing the motion. (Pls.' App. at 139.) Messing also reviewed, prior to filing, the Motion for Appointment as Lead Plaintiff and the Motion to Intervene. (Defs.' App. at 87, 91.) That Messing did not understand the reasons behind the Motion to Intervene, despite having reviewed the motion (Defs.' App. at 92), does not establish inadequacy, especially since it does not relate to his fiduciary duties to represent the class.
The Court finds that Messing is active in the litigation, has not abdicated control to the lawyers, and is willing and able to direct the litigation. Accordingly, the Court finds Messing to be an adequate Lead Plaintiff.
b. Sworn Certificate of Plaintiff
Defendants also argue that Messing is inadequate because he did not personally execute a sworn certificate of plaintiff. (Defs.' Am. Opp. at 9-10.) However, this is only required by individuals filing a complaint. See 15 U.S.C. § 78u-4(a)(2)(A). Oscar filed the complaint and Messing executed a sworn certificate of plaintiff on behalf of Oscar. (Pls.' Supp. App. at 136.) Messing was added as a lead plaintiff on February 6, 2004, after the complaint was filed on November 13, 2003. Accordingly, Messing is not required to file a sworn certificate of plaintiff.
c. Conflict of Interest
Defendants further argue that Messing has a potential conflict of interest with absent class members because, as a portfolio manager and analyst, his published analyses of Allegiance stock do not mention the line count adjustment as a cause for the depressed stock value. (Defs.' Am. Opp. at 11.) Defendants claim that Messing's failure to address line count information in his publications both during and after the putative Class Period indicates that he did not rely upon such information in making his investment decisions. ( Id. at 11-12; Defs.' App. at 179-82, 184.) Messing's publications, however, do not create a conflict of interest. It is difficult to see how a conflict of interest is created when Messing filed the lawsuit alleging that misrepresentations regarding line counts caused investors to lose income. Certainly, Messing's interest in the case is not antagonistic to the interests of the putative class. See In re United Energy Corp. Solar Power Modules Tax Shelter Investments Sec. Litig., 122 F.R.D. 251, 257 (C.D. Cal. 1988). While Messing's publications may raise doubts as to his reliance on the representations forming the basis of the lawsuit, they only raise issues, if any, as to unique defenses against Messing.
In any event, Messing has provided statements that he did, in fact, rely upon line count information in his investment decisions and that he considers line count information to be a primary growth metric in making investment decisions. ( See Pls.' Supp. App. at 141-42; Pls.' App. at 132, 134.) Defendants' potential defenses as to Messing's reliance based upon those publications do not create a conflict of interest between Messing and the class, nor do they destroy Messing's typicality, since they form only a minor part in the overall litigation and will not dominate the litigation nor detract from the common questions of law and fact in the case. See Lehocky, 220 F.R.D. at 500-02 (internal citation omitted). Even if it is later proved that Messing did not rely on the line count information, this would be insufficient to rebut the presumption of fraud on the market applicable to the putative Class or to defeat Messing's typicality. See Cheney v. Cyberguard Corp., 213 F.R.D. 484, 492, 493 n. 13 (S.D. Fla. 2003) (internal citations omitted); In re Worldcom, Inc. Sec. Litig., 219 F.R.D. 267, 281 (S.D.N.Y. 2003). Since Messing asserts the same causes of action as the putative Class generally and has the same incentive as the putative Class to prove up the allegations in the Amended Complaint, no conflicts exist between Messing and the class. See In re NASDAQ Market-Makers Antitrust Litig., 172, F.R.D. 119, 128 (S.D.N.Y. 1997).
Defendants' conflict of interest argument might be styled as a challenge to Messing's typicality, so the Court addresses Defendants' argument as to both adequacy and typicality.
Messing's post-putative Class Period publications, if unrelated to the line count, are not necessarily relevant to the issue of whether he relied on line count information during the Class Period and do not affect typicality. See Lehocky, 220 F.R.D. at 501-02; In re Frontier Ins. Group, Inc. Sec. Litig., 172 F.R.D. 31, 42 (E.D.N.Y. 1997). "[S]peculative conflict should be disregarded at the class certification stage." In re Visa Check/MasterMoney Antitrust Litig., 280 F.3d 124, 145 (2d Cir. 2001) (internal quotation omitted).
2. Numerosity
Plaintiff provides evidence that over 116 million shares of Allegiance stock were outstanding during the putative Class Period. (Pls.' App. at 79.) There were 248 owners of record of said stock excluding shares held in nominee or street name by brokers. ( Id. at 80, 26-32.) The Court applies the presumption established in Zeidman v. J. Ray McDermott Co., 651 F.2d 1030, 1039 (5th Cir. 1981), that "any class composed of the sellers of a nationally traded security during a period in which hundreds of thousands or even millions of shares of the security were traded must necessarily be `so numerous that joinder of all members is impracticable.'" Accordingly, the Court finds the numerosity requirement met in the instant case. See Mullen v. Treasure Chest Casino, LLC, 186 F.3d 620, 624 (5th Cir. 1999) (finding numerosity requirement met with 100-150 putative members). Indeed, numerosity is conceded by Defendants. (Defs.' Am. Opp. at 4.)
3. Commonality
To meet the requirements of commonality, Lead Plaintiffs must demonstrate that there exist "questions of law or fact common to the class." FED. R. CIV. P. 23(A)(2); Mullen, 186 F.3d at 625. "The test for commonality is not demanding." Id. Indeed, one common question of law or fact is all that is required. James v. City of Dallas, Tex., 254 F.3d 551, 570 (5th Cir. 2001); Forbush v. J.C. Penney Co., 994 F.2d 1101, 1106 (5th Cir. 1993). In the instant case, the theory of recovery is the same: material misrepresentations regarding line count information made in an efficient market artificially inflated the stock price, causing the class to suffer losses. This is sufficient to meet Lead Plaintiffs' burden to establish commonality. Defendants concede that commonality exists. (Defs.' Am. Opp. at 4.)
4. Typicality
To prove typicality, Lead Plaintiffs must demonstrate that the claims or defenses of the Lead Plaintiffs are "typical of the claims or defenses of the class." FED. R. CIV. P. 23(a)(3); Mullen, 186 F.3d at 625. "Like commonality, the test for typicality is not demanding. It focuses on the similarity between the named Lead Plaintiffs' legal and remedial theories and the theories of those whom they purport to represent." Mullen, 186 F.3d at 625. Complete identity of claims and defenses is not required, nor is complete uniformity in fact; rather, the claims and defenses of the named Lead Plaintiffs must "arise from a similar course of conduct and share the same legal theory." James, 254 F.3d at 551, 571. As with commonality, Lead Plaintiffs' claims arise from, and are based upon, the same alleged misrepresentations upon which the class would base potential recovery. Therefore, Lead Plaintiffs' actions are typical of those of the class and the typicality requirement has been met. Defendants' arguments against Messing's typicality, if any, were framed as challenges to his adequacy. The Court considered Defendants' challenges both as to their impact on Messing's adequacy and typicality above and finds them insufficient to negate Messing's adequacy as representative or typicality of the putative Class.
B. Rule 23(b) Requirements
For class actions seeking money damages, the Court must make findings regarding the predominance of common issues of law or fact and the superiority of a class action as a means of adjudication. FED. R. CIV. P. 23(b).
1. Superiority
Defendants, as noted in oral argument, challenge the superiority of a class action based solely on their challenges to other certification requirements, primarily that of predominance. The Court is of the opinion that a class action is a superior method of adjudicating the action in the instant case because given the Court's ruling on the fraud-on-the-market presumption of class-wide reliance, see infra, the case would not present significant managerial difficulties as a class action and would save judicial and party resources. See Mullen, 186 F.3d at 627. The Court has been pointed to no evidence as to the remaining factors in Rule 23(b)(3) which would alter its determination. See FED. R. CIV. P. 23(b)(3).
2. Predominance
The predominance "requirement, although reminiscent of the commonality of Rule 23(a), is `far more demanding' because it `tests whether [a] proposed class[is] sufficiently cohesive to warrant adjudication by representation.'" Unger, 401 F.3d at 320 (quoting Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 623-24 (1997)).
In the instant case, Defendants challenge that the predominance requirement has been met. Defendants argue that Lead Plaintiffs have not demonstrated class-wide reliance on the alleged misrepresentations because Lead Plaintiffs have failed to establish the fraud-on-the-market presumption of reliance. "The key issue regarding predominance is whether plaintiffs are entitled to a presumption of reliance applicable to all class members." Lehocky, 220 F.R.D. at 504. "Absent an efficient market, individual reliance by each plaintiff must be proven, and the proposed class will fail the predominance requirement." Unger, 401 F.3d at 322 (citing Castano, 84 F.3d at 745). The Court discusses the factors supporting a determination of whether Lead Plaintiffs have met their burden to establish a fraud on the market theory below.
C. Predominance/Fraud on the Market Theory
Generally, individual reliance may be presumed "when a fraudulent misrepresentation or omission impairs the value of a security traded in an efficient market." Id. at 322 (internal quotation omitted). This presumption of reliance, allowing class actions to proceed, is based upon what is known as the "fraud on the market theory." See Basic, Inc. v. Levinson, 485 U.S. 224, 241-42 (1988). To establish a presumption of individual reliance under the "fraud on the market theory," a plaintiff must prove that: "(1) the defendant made public material misrepresentations, (2) the . . . shares were traded in an efficient market, and (3) the lead plaintiffs traded shares between the time the misrepresentations were made and the time the truth was revealed." Greenberg v. Crossroads Sys., Inc., 364 F.3d 657, 662 (5th Cir. 2004) (citing Basic, 485 U.S. at 248 n. 27). "[A] district court must perform sufficient analysis to determine that class members' fraud claims are not predicated on proving individual reliance." Unger, 401 F.3d at 321 (applying Castano, 84 F.3d at 745). This requires the Court to "engage in thorough analysis, weigh the relevant factors, require both parties to justify their allegations, and base its ruling on admissible evidence." Id. at 325.
1. Trading Shares
In the instant case, there is no dispute that Lead Plaintiffs traded shares between the time the alleged misrepresentations were made and the time of the corrective disclosure. (Pls.' App. ¶ 189.) The Court therefore finds that Lead Plaintiffs met their burden to prove trading during the period between the alleged misrepresentation and the corrective disclosure.
2. Falsity
The parties dispute that the public statements regarding line counts were false. (Pls.' App. ¶¶ 11, 123, 129, 137, 144; Defs.' Surreply at 7.) This dispute, however, goes to the merits of the action, rather than to whether the action may be certified as a class action. Lehocky, 220 F.R.D. at 505 n. 16 ("At this stage in the proceedings, the Court need only inquire whether the stock traded in an efficient market and not examine the merits of the case."). The Court, having considered the line count allegations and evidence provided and taking Lead Plaintiffs' allegations as true, Ogden v. AmeriCredit Corp., 225 F.R.D. 529, 531 (N.D. Tex. 2005), finds for the purposes of the instant Motion, that the class has established the existence of public misrepresentations to the extent necessary at this stage in the proceedings.
A number of Defendants' factual disputes presented in their Surreply go to the merits of the action and are not properly analyzed at this stage. ( See Defs.' Surreply at 8 ("What the [confidential] witnesses say in these interviews does not match the key allegations in the amended complaint.").)
For further discussion on this issue, see the Court's Memorandum Opinion and Order, entered June 10, 2004.
3. Materiality
The parties also dispute that such alleged misrepresentations were material. In the Fifth Circuit, materiality is established when it is shown that there is a "substantial likelihood that [the alleged misrepresentation] would have been viewed by the reasonable investor as having altered the `total mix' of information made available." Basic, 485 U.S. at 231-32; Nathenson, 267 F.3d at 418 (internal quotation omitted). Here, Defendants do not dispute the substantial likelihood that line count information would affect the information upon which a reasonable investor would rely, especially when such a company is a startup. Defendants only dispute what investors actually relied upon, not what might potentially cause reliance. See Nathenson, 267 F.3d at 419. Lead Plaintiffs' analyst reports and other evidence submitted establish that line counts are an important metric in determining the viability of and investment opportunities in a startup telecom such as Allegiance. Accordingly, the Court finds that materiality has been established.
Reliance and materiality have been used somewhat interchangeably in fraud on the market cases, since "[i]n the context of an `efficient' market, the concept of materiality translates into information that alters the price of the firm's stock." See Nathenson v. Zonagen, Inc., 267 F.3d 400, 415 (5th Cir. 2001) (internal quotation omitted); see also Basic, 485 U.S. at 248 n. 27 (collapsing materiality and reliance tests into single test). However, the Fifth Circuit considers the requirement that the stock price be affected by the release of related information to be more related to reliance than materiality. Nathenson, 267 F.3d at 415. Accordingly, because Defendants' challenges to the "materiality" of the alleged line count misrepresentations relate to their impact on Allegiance stock prices, Defendants' challenges are more properly considered challenges to the reliance element, discussed below.
4. Efficient Market
Defendants rely on Unger for the argument that "a lead plaintiff's burden of proof for market efficiency at the class certification stage is akin to the degree of proof necessary in preliminary injunction hearings or personal jurisdiction contests." ( See Letter, dated Feb. 25, 2005). See also Unger, 401 F.3d at 322-23. Unger, however, related to "small-cap stocks traded in less-organized markets." Id. at 322. The Fifth Circuit stated that "[i]n many cases, where heavily-traded or well known stocks are the target of suits, market efficiency will not even be an issue." Id.
Here, the issue of market efficiency is not at issue. (Defs.' Am. Opp. at 15 ("Lead Plaintiffs have arguably demonstrated that Allegiance traded on an efficient market.").) Nevertheless, in an abundance of caution, the Court analyzes and weighs the identified factors relevant to a determination of an efficient market:
(1) the average weekly trading volume expressed as a percentage of total outstanding shares;
(2) the number of securities analysts following and reporting on the stock;
(3) the extent to which market makers and arbitrageurs trade in the stock;
(4) the company's eligibility to file SEC registration Form S-3 (as opposed to Form S-1 or S-2);
(5) the existence of empirical facts "showing a cause and effect relationship between unexpected corporate events or financial releases and an immediate response in the stock price;
Defendants' oral argument acknowledged that they oppose Lead Plaintiffs' contention that Allegiance stock traded in an efficient market in only one respect: Defendants believe that Allegiance stock was too volatile to be traded in an efficient market. Volatility, however, does not directly correlate to market efficiency. Rather, volatility is an important factor in determining how responsive stock prices are to corporate and industry events. Accordingly, Defendants' volatility challenge is considered as it relates to the factor of stock responsiveness to corporate events. See infra.
(6) the company's market capitalization;
(7) the bid-ask spread for stock sales; and
(8) float, the stock's trading volume without counting insider-owned stock.Id. at 323 (internal citation omitted). The court must analyze and weigh these factors to determine whether an efficient market is present, not merely count the factors. Id. (noting also that the list is not exhaustive and each item may not be relevant in every action). To this end, the Court "must address and weigh factors both for and against market efficiency." Id. at 325.
(a) Average Weekly Trading Volume
"A high weekly stock trading volume suggests the presence of active, informed investors." Id. at 324. As noted in Cammer v. Bloom, 711 F. Supp. 1264, 1286 (D.N.J. 1989), the case which set forth the basis for the test used by the Fifth Circuit to determine whether an efficient market exists, "average weekly trading of two percent or more of the outstanding shares would justify a strong presumption that the market for the security is an efficient one; one percent would justify a substantial presumption." The Court must determine the actual weekly average of shares regularly being traded. See Unger, 401 F.3d at 324. In the instant case, there is no dispute that the number of shares traded weekly during the putative Class Period approximated 3.7% of the outstanding shares (after discounting the trading volumes reported by NASDAQ by half). (Pls.' App. at 9-10.) See Unger, 401 F.3d at 324 (noting that trade volumes can be exaggerated by up to and over fifty percent on some exchanges). After adjusting the reported trading volume for possible double-counting, the Court finds this trading volume, supported by reliable reporting and expert analysis, to establish a very strong presumption of an efficient market. See Cammer, 711 F. Supp. at 1286.
(b) Number of Securities Analysts
The number of securities analysts following the stock is an important factor in determining market efficiency. Unger, 401 F.3d at 325. Indeed, "the greater the number of securities analysts that cover a security, the more likely that investors rely on disseminated information." Lehocky v. Tidel Techs., Inc., 220 F.R.D. 491, 508 (S.D. Tex. 2004). In the instant case, significant reporting existed on Allegiance stock. Over 140 reports on Allegiance stock exist on Thomson One Analytics searchable database, 78 of which were reported during the putative Class Period of approximately 10 months. (Pls.' App. at 34-45.) The First Call and/or Investext searchable database yielded 123 reports during the putative Class Period. ( Id. at 46-57, 12.) Although the Court is not certain of the extent of the duplication in the results of searches within these two databases, the Court concludes that either database yields results which weigh significantly in favor of finding an efficient market and reliance on such analyst reporting.
(c) Market Makers
This factor has been heavily criticized by the courts. See Unger, 401 F.3d at 324 (citing cases). The Fifth Circuit has determined the factor to be an unreliable measure of market efficiency unless it is somehow correlated to the trading volume and price. See id. (citing Krogman v. Sterritt, 202 F.R.D. 467, 476 (N.D. Tex. 2001)). Even assuming such a correlation, the Court considers this factor to be of little relevance or weight in determining whether an efficient market exists. Nevertheless, approximately ten percent of the NASDAQ active market makers were involved in Allegiance stock during the putative Class Period, or approximately 50 of the 500 NASDAQ market makers active during that time. (Pls.' App. at 63-71, 13.) Fifty market makers are significantly more than has been held to support a finding of an efficient market in other cases. E.g., Lehocky, 220 F.R.D. at 509 (20-25 market makers, only 4-5 of which were active); Cammer, 711 F. Supp. at 1283 n. 30 (11 active market makers). The Court therefore concludes that this factor, although given little relevance or weight by the Court, weighs in favor of finding that an efficient market exists.
(d) Eligibility to File Form S-3
There is no dispute that Allegiance was eligible to, and did, file Form S-3 with the Securities Exchange Commission ("SEC"). (Pls.' App. at 58, 60, 61.) A company which filed monthly reports with the SEC for one year and which has common equity held by non-affiliates of the registrant in excess of $75 million is eligible to file Form S-3. 17 C.F.R. § 239.13. This factor is helpful in determining whether an efficient market exists because it implies a wide following of an actively traded stock. In re Empyrean Bioscience, Inc. Sec. Litig., 255 F. Supp. 2d 751, 763 (N.D. Ohio 2003).
(e) Stock Responsiveness
The responsiveness of stock to corporate events is "one of the most important marketefficiency factors." Unger, 401 F.3d at 324. "In an efficient market, where information is nearly perfect, material misstatements alter a stock's price almost immediately." Id. In determining how responsive stock prices are to corporate events, the courts must also consider other factors which may have caused the prices to fluctuate. See id. at 325. These factors may include, inter alia, the daily market average, national, local and industry-specific economic news, and actions of competitors. See id. Additionally, the "overall volatility of the stock price and the speed of its reaction to company news may also be significant." Id. (citing Krogman, 202 F.R.D. at 477-78). The Court may not presume that because the stock price moved on the same day as a corrective disclosure or misrepresentation that such movement is indicative of causation. See id. Given the complexity of the causation analysis, reliable expert testimony, though not required, may be helpful to determine whether stock price was responsive to corporate events, misrepresentations, or corrective disclosures. See id. at 323 n. 6, 325.
In the instant case, Lead Plaintiffs provided the report of an expert who conducted a regression analysis to determine statistically significant stock movements. ( See Pls.' App. at 16.) Although Defendants argue that the stock was highly volatile (Defs.' App. at 2, 22, 24, 27, 29, 30-31), Lead Plaintiffs' regression analysis incorporates an analysis of stock volatility with statistical support. Defendants' general qualitative assertions and minute-by-minute and general stock price trend analyses regarding the volatility of Allegiance stock do little to undermine Lead Plaintiffs' analysis, which identified statistically significant stock price movements, despite the volatility of Allegiance stock. For the purposes of the instant motion, the Court is satisfied with the confidence levels in the expert report and notes that despite a general decline of Allegiance stock prices during the putative Class Period, Allegiance stock may still have been artificially inflated by the alleged misrepresentations.
Lead Plaintiffs' expert noted a few instances where statistically significant stock movements occurred and on which a press release was made on the same day. ( Id. at 16-18.) Lead Plaintiffs' expert noted that trading volumes related to these events were significantly higher than weekly average trading volumes and that the stock moved significantly more than did the stock of its competitors, as reflected by the movement of the Bloomberg Telecommunication Services Index, or NASDAQ Composite index generally. ( Id.) Lead Plaintiffs' expert determined with statistically significant confidence levels, that the stock was responsive to the press releases and corporate events analyzed. ( Id.) Lead Plaintiffs' expert then cross-checked her findings by using a serial correlation test and found that Allegiance's stock was traded in an efficient manner. ( Id. at 18-19.) The Court finds that the evidence regarding stock responsiveness weighs in favor of finding an efficient market.
(f) Market Capitalization
Although Unger includes this as a factor to be analyzed, Unger, 401 F.3d at 323, the Court concludes that this factor is addressed by the corporation's eligibility to file Form S-3, trading volumes, and float, and has marginal, if any, independent value in determining the incentives of investors to purchase stock. But see Krogman v. Sterritt, 202 F.R.D. at 478 . In any event, the eligibility of the corporation to file a Form S-3 suggests a market capitalization which would attract investors and result in heavier trading, such trading was indeed heavy, and the float suggests that most trading was external to the corporation and its affiliates. As a result, although the Court ascribes little weight to this factor, the Court considers it to weigh in favor of finding an efficient market.
(g) Bid-Ask Spread
The Court has been directed to no evidence on this point. Although this factor may infer market efficiency, the Court finds this factor less compelling where stock, such as in the instant case, is particularly volatile, since rapid price fluctuations may result in a large bid-ask spread, even in an efficient market.
(h) Float
The float, or non-insider owned stock trading volume, also appears significant in the instant case. Although the Court does not have exact figures, it has been provided data on the ownership of Allegiance stock, including that 68% of the outstanding common shares, or 76 million of the 112 million common shares issued and outstanding, were held by 100 reporting institutional investors. (Pls.' App. at 9, 10, 26-32.) As of March 26, 2001, there were 224 owners of record. (Pls.' App. at 10.) It is likely that the number of actual owners are significantly greater than this figure, however, because the figure does not include owners whose stock is held in nominee or street name by brokers. The Court concludes that the float must be significant because were it not, Allegiance stock ownership, unless traded wholly internally, would have resulted in a significant dilution of the internal ownership of Allegiance stock. The amount of analyst reporting, number of market makers, and weekly trading volume suggest that trading was not wholly comprised of internal transfers. Defendants do not argue that all or even most trading volume was comprised of internal transfers. Accordingly, the Court finds that the float is significant and weighs in favor of finding that an efficient market exists.
(i) Weighing the Factors
The Court, in its analysis of the various factors related to a determination of market efficiency, finds the majority of those factors to weigh heavily in favor of finding that Allegiance's stock was traded in an efficient market. The majority of less relevant or important factors also weigh in favor of finding an efficient market. Indeed, only one factor — the bid-ask spread, which the Court concludes is of limited value in the context of volatile stock — does not weigh in favor of finding an efficient market because it is inconclusive, no evidence being presented on the issue. Considering that Defendants acknowledge that "[l]ead Lead Plaintiffs have arguably demonstrated that Allegiance [Telecom] traded on an efficient market" (Defs.' Am. Opp. at 15), the Court finds that the factors related to market efficiency weigh in favor of finding an efficient market. Therefore, for the purposes of the instant Motion, the Court concludes that Plaintiffs have met their burden to establish that Allegiance shares were traded in an efficient market.
Defendants argue that at this stage Lead Plaintiffs must establish transactional causation and loss causation, the two prongs of loss causation in a securities fraud claim. See, e.g., LHLC Corp. v. Cluett, Peabody Co., Inc., 842 F.2d 928, 931 (7th Cir. 1988); In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804, 884 n. 136 (S.D. Tex. 2004). Lead Plaintiffs allege that they and the putative Class relied on the line count misstatements to purchase Allegiance stock at artificially inflated prices which caused the stock prices to "plummet" when the corrective disclosure was issued. (Am. Compl. at 7, 9.) Transactional causation, or reliance, is presumed in fraud on the market cases where the factors supporting such reliance are established. See Binder v. Gillespie, 184 F.3d 1059, 1065 (9th Cir. 1999) ("The requirement of transaction causation is equivalent to the element of reliance."). Individual loss causation, on the other hand, is established by meeting the Greenberg test that a significant part of the stock price decline was more likely than not caused by the alleged misrepresentation. Greenberg, 364 F.3d at 666; see also Binder, 184 F.3d at 1065.
The presumption regarding class-wide reliance under fraud on the market theory, however, is not established with a finding of the factors in Unger when multiple items of negative news are released simultaneously. "To trigger the presumption [of reliance where multiple pieces of negative information are issued at the same time] Lead Plaintiffs must [also] demonstrate that there is a reasonable likelihood that the cause of the decline in price is due to the revelation of the truth and not the release of the unrelated negative information." Greenberg, 364 F.3d at 665. This requires the Lead Plaintiffs to demonstrate "(1) that the negative `truthful' information causing the decrease in price is related to an allegedly false, non-confirmatory positive statement made earlier and (2) that it is more probable than not that it was this negative statement, and not other unrelated negative statements, that caused a significant amount of the decline." Id. at 666.
The presumption of reliance afforded by the "fraud on the market theory" may be rebutted later by "[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price." Basic, 485 U.S. at 248; Lehocky, 220 F.R.D. at 505 n. 16 ("At [the class certification] stage in the proceedings, the Court need only inquire whether the stock traded in an efficient market and not examine the merits of the case. . . . Thus the Court will not address whether Defendants' can rebut the presumption of reliance.") (internal citation omitted). That Defendants retain the right of rebuttal does not preclude a finding of predominance of common questions of fact or law. See In re First RepublicBank Sec. Litig., Civ. A. Nos. 3-88-641-H, 3-88-1251-H, 1989 WL 108975, at *9 (N.D. Tex. Aug. 1, 1989).
Neither party argues that the alleged misrepresentation merely constituted confirmatory information. The Court therefore, based on the record before it, concludes, for the limited purpose of ruling on the instant Motion, that the alleged misrepresentation was not merely confirmatory. See id. at 665-66. Additionally, there is no dispute that the negative information released contained a corrective disclosure that related, at least in part, to the alleged misrepresentations which Lead Plaintiffs claim artificially inflated the stock price. See id. at 666.
Defendants dispute whether the stock price decline, if any, after the corrective disclosure, was in fact related to the line count adjustment and not the other negative information released concurrently. (Defs.' Surreply at 2.) Indeed, Defendants argue that "Lead Plaintiffs must rule out all announced negative information other than the alleged fraud as having caused the stock price to drop." (Defs.' Surreply at 2.) Defendants, however, misstate the rule in Greenberg. Lead Plaintiffs need not rule out other factors which may have contributed to a decline in stock price. Rather, Lead Plaintiffs must demonstrate that it is more likely than not that a significant part of the decline in stock value is attributable to the alleged fraud. See Greenberg, 364 F.3d at 666.
Defendants dispute various findings of Lead Plaintiffs' expert, including: (1) whether Lead Plaintiffs could show that the restatement of the line count caused the price of its common stock to fall (Defs.' Opp. at 13-14, 21); (2) whether the stock price decline on the day ending the putative Class Period was attributed to the disclosure of information unrelated to the line count corrective disclosure ( id. at 15-20); (3) whether the statements of other companies about Allegiance's ability to comply with its loan covenants resulted in the stock price decline ( id. at 16-17); (4) whether Allegiance's stock was too volatile during the putative Class Period to determine statistically significant stock movements or class-wide causation. ( Id. at 21.) Defendants do not present an expert report on the issue of market efficiency or Allegiance stock's responsiveness to corporate events, but instead rely upon Lead Plaintiffs' expert report, stock price data, analyst reports, press releases, and the deposition of and articles written by Messing. (Defs.' Surreply at 4.)
Defendants argue that because Lead Plaintiffs' expert combined some unrelated negative information in her calculation of the total price decline, that Lead Plaintiffs' expert has not established that the entire decline was caused by the corrective disclosure. ( See Defs.' Surreply at 3.) Indeed, Lead Plaintiffs' expert report indicated that "[t]he restatement of Allegiance [Telecom]'s previously reported line count was bad and was partially responsible for the price decline." (Pls.' Supp. App. at 10.) Defendants' arguments, however, miss the mark in that they focus solely on the total loss as opposed to the relative loss caused by each piece of negative information. Whether some loss was caused by the unrelated negative information is not dispositive. The question is how much of the loss was caused by the related negative information, i.e., whether it is more likely than not that a significant part of the stock's decline is attributable to the corrective disclosure.
None of the cases cited by Defendants support the proposition they seek to have the Court hold.
Nathenson stands merely for the proposition that in order for plaintiffs seeking to assert a fraud on the market theory of reliance to overcome a motion to dismiss, plaintiffs must allege that the stock price was affected by the alleged misrepresentations. Nathenson, 267 F.3d at 404 n. 1, 414. Nathenson does not establish that plaintiffs must allege that the entirety of the stock decline must be attributable to the alleged misrepresentation. Indeed, to do so would allow companies to avoid liability for earlier misrepresentations, even when made with scienter, merely by correcting such misrepresentations in tandem with other negative information which might impact the stock price. From a policy perspective, Defendants' position is clearly unreasonable and serves to negate the purpose of the Securities Exchange Act. See 15 U.S.C. § 78b (West 2005). Having already ruled on Defendants' Motion to Dismiss ( see Mem. Op. Order, entered June 10, 2004), the Court need not address this issue in great detail here. The Court merely notes that the Amended Complaint repeatedly indicates how line count information materially affected Allegiance's stock price. ( See Am. Compl. at 2, 9, 10, 21-22, 41-42, 44-45, 46-47, 50.) In ruling on a class certification motion, the Court accepts as true the substantive allegations in the Amended Complaint. See Ogden, 225 F.R.D. at 531.
Basic held that the presumption of reliance was rebuttable, but only as related to a summary judgment motion. See Basic, 485 U.S. at 248. Indeed, Greenberg, also decided on summary judgment, never determined at what stage in the proceedings the presumption of reliance may be rebutted. The Fifth Circuit in Greenberg found that the plaintiffs were not entitled to the presumption as to some of their claims and therefore summary judgment was appropriate as to those claims, and that they were entitled to the presumption as to some of their claims, to which the district court improperly granted summary judgment. Greenberg, 364 F.3d at 666-67, 670-71. The Court then remanded those claims back to the district court for further consideration. Id. at 671. As noted above, the Court is of the opinion that the class certification stage is not the proper time for Defendants to rebut Lead Plaintiffs' fraud on the market presumption. See supra note 16. What is proper at this stage is to ensure that Lead Plaintiffs have met their burden to establish the presumption.
Defendants dispute the expert's interpretation and selective inclusion of excerpts from various analyst reports. ( See Defs.' Surreply at 5-6.) Defendants point to Lead Plaintiffs' evidence to argue that the line count adjustment did not or only minimally affected revenues. ( Id. at 5-6 (citing Pls.'s Supp. App. at 51, 55, 56-57, 70).) Additionally, Lead Plaintiffs' expert reported that more analysts were concerned about the line count restatement than were surprised or concerned about other negative information released with the corrective disclosure. ( See Pls.' Supp. App. at 2-10.) Defendants' qualitative evidence is insufficient to dispel the statistical study and Lead Plaintiffs' expert report, for the purposes of the instant Motion, that a significant part of the stock decline was more likely than not caused by the line count adjustment.
Lead Plaintiffs provide evidence of analyst reports indicating that the unrelated negative information related to revenue and Earnings Before Interest Taxes Depreciation and Amortization ("EBITDA") was merely confirmatory. ( See Pls.' Supp. App. at 4-6.) Such confirmatory information is already incorporated into the price of stock in an efficient market. Greenberg, 364 F.3d at 665-66. Defendants provide no substantive evidence disputing Lead Plaintiffs' contention that such information was merely confirmatory. Accordingly, the Court concludes for the purposes of the instant motion that it is not likely that such unrelated negative information caused Allegiance's stock to decline.
Defendants also argue that Allegiance's unrelated negative disclosure related to its debt covenants was a significant factor in the decline in stock price. (Defs.' Surreply at 6 (citing Pls.' Supp. App. at 8).) Lead Plaintiffs counter this evidence with analyst and debt rating agency reports indicating that Allegiance's ability to satisfy loan covenants was not troubling to them. (Pls.' Supp. App. at 7, 9.) The Court finds this qualitative dispute insufficient to dispel Lead Plaintiffs' statistical analysis and expert report supporting a finding, for the purpose of the instant Motion, that a significant part of the decline was more likely than not caused by the line count adjustment.
Defendants also argue that aftermarket trading increases of Allegiance stock prices after the corrective disclosure negates any causation related to the line count adjustment. (Defs.' Am. Opp. at 22-24.) Lead Plaintiffs' expert report, however, indicates that such increases were not statistically significant and therefore do not support any conclusion regarding causation. ( See Pls.' Supp. App. at 11.)
In sum, Lead Plaintiffs have established, for the purposes of the instant Motion, that Allegiance shares were traded in an efficient market and that it is more likely than not that a significant part of the stock decline causing the putative Class's loss is attributable to the line count corrective disclosure. Accordingly, Lead Plaintiffs and the putative Class are entitled to the presumption of reliance afforded under the fraud on the market line of cases.
IV. CONCLUSION
For the foregoing reasons, Lead Plaintiffs' Motion for Class Certification is GRANTED. The following class is hereby certified as such: All persons, without geographic limitation, who purchased Allegiance common stock in the open market during the period from April 24, 2001 through February 19, 2002, inclusive, and who were damaged by Defendants' alleged violations of Section 10(b) and/or 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. Excluded from the Class are Defendants, their legal representatives, heirs, successors and predecessors in interest, affiliates, assigns, and any entities in which the Defendants (or any of them) had a controlling interest in during the Class Period.
SO ORDERED.