Opinion
No. 03 Civ. 177 (JFK).
March 24, 2005
Securities Exchange Commission, Russell D. Duncan, Esq., Stacey M. Narhwold, Esq., U.S. Securities Exchange Commission, Washington, D.C., for Plaintiff Securities and Exchange Commission.
Paul, Weiss, Rifkind, Wharton Garrison LLP, Mark F. Pomerantz, Esq., Eric S. Goldstein, Esq., Jonathan H. Hurwitz, Esq., Douglas M. Pravda, Esq., New York, NY, for Defendant Paul E. Johnson.
OPINION AND ORDER
Introduction
The Securities and Exchange Commission ("SEC") brings this action alleging violations of the Securities Exchange Act of 1934 ("Exchange Act") § 10(b), 15 U.S.C. § 78j(b) ("§ 10(b)"), Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 ("10b-5"), and the Securities Act of 1933 ("Securities Act") § 17(a), 15 U.S.C. § 77q(a) ("§ 17(a)"), against defendant Paul E. Johnson ("Johnson"). The SEC alleges that Johnson, while a research analyst at the registered broker-dealer company Robertson Stephens, Inc., ("Robertson Stephens"), issued false and misleading research reports and public statements.
Before the Court is Johnson's motion for summary judgment. For the reasons that follow, Johnson's motion is denied in its entirety.
Because this is a motion for summary judgment, the facts summarized here either are undisputed or conform to the facts alleged by the SEC. See Anderson v. Liberty Lobby, 477 U.S. 242, 255 (1986) ("The evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in his favor.").
From 1994 until 2002, Johnson worked as a managing director and senior equity analyst for the now-defunct Robertson Stephens. While an employee of Robertson Stephens, Johnson wrote reports rating various publicly-traded companies. All such reports contained the following boilerplate disclosure language:
Robertson Stephens, its managing directors, its affiliates, its employee investment funds, and/or its employees, may have an interest in the securities of the issue(s) described and may make purchases or sales while this report is accessible.
On March 30, 1999, Johnson invested $50,000 in Siara Systems Inc. ("Siara"), which was, at that time, a privately-held company. In June 1999, Johnson wrote the first of several reports on Redback Networks, Inc. ("Redback"), a publicly-traded company. Johnson rated Redback a "buy."
On November 29, 1999, Redback announced an agreement to merge with Siara. On that day and the next, Johnson rated Redback a "strong" buy in research reports and was quoted in Bloomberg as praising the merger. In none of these instances did Johnson disclose that, should the merger be completed, his Siara stock would be converted to Redback stock worth approximately $5 million.
When the merger finally closed in March 2000, Johnson's Siara stock was converted to Redback stock with a value of $10 million. At some point — it is in dispute when — Johnson disclosed his Siara investment to his superiors at Robertson Stephens. In December 2000, at the demand of Robertson Stephens, Johnson deposited his Redback shares into a blind trust account over which he had no control.
In November 1999, Johnson issued his first report on the public company Sycamore Networks, Inc. ("Sycamore"), rating it a "buy." Then, on February 1, 2000, Johnson invested $75,000 into the private company Sirocco Systems, Inc. ("Sirocco"). In June 2000, Sycamore announced that it would buy Sirocco, which merger Johnson praised in a published report and over Bloomberg and CNNfn. The report, like all others published by Robertson Stephens, included the boilerplate language of disclosure but neither the report nor the public statements included information regarding Johnson's anticipated gain from the merger. When the merger closed in September 2000, Johnson received shares of Sycamore worth $2.4 million. Again, in December 2000, Johnson put some of his Sycamore shares into a blind trust at the bidding of Robertson Stephens; the larger portion of those shares he sold for $600,000.
The third and final investment at issue is Johnson's investment in a private company known as Corvis Corporation ("Corvis"). Johnson recommended Corvis to the Bayview Partnerships, the Robertson Stephens employee investment fund (which included Bayview 99 I and II and Bayview Corvis, hereinafter collectively referred to as "Bayview"), beginning in November 1999. Bayview invested approximately $5 million in Corvis stock, of which amount approximately $90,000 represented Johnson's personal investment. Bayview also signed lockup agreements in June 2000, prohibiting Bayview from selling the Corvis shares until 180 days after Corvis's anticipated initial public offering ("IPO").
Beginning in August 2000, Johnson reported on Corvis, calling it a "buy." Johnson reiterated this view in October 2000, even though Corvis stock prices had been falling. Corvis stock continued to fall in price through January 2001, from a high of $90 to a low of $24 per share; however, Johnson continued to rate Corvis a "buy."
On January 23, 2001, Johnson participated via telephone in a meeting of Bayview members. The purpose of the meeting was to decide what Bayview should do with its Corvis stock when the lock-up period expired on January 24, 2001. According to the deposition testimony of Dana Welch, Robertson Stephen's General Counsel at the time, Johnson made a statement at this meeting to the effect that he would not buy Corvis stock at the then-current price of $24 per share; he would, however, buy it at $12-14 per share. Bayview voted to sell its Corvis shares.
On January 26, 2001, despite a 4th quarter loss, Johnson again gave Corvis a "buy" rating. Between January 24 and January 29, 2001, however, Johnson sold all his Corvis shares, purportedly because he needed cash liquidity. Johnson publicly disclosed his sale by filing a Form 144 statement with the SEC.
Procedural Posture
Johnson now brings this motion for summary judgment, seeking dismissal of the SEC's claim in its entirety. Johnson argues that his statements about Redback and Sycamore were not fraudulent or misleading, that the reports were lawful at the time he wrote them and any finding of liability would thus violate due process, and that no reasonable jury could find that Johnson committed securities fraud with respect to Corvis. The SEC opposes Johnson's motion, claiming that issues of material fact exist and that Johnson is not entitled to judgment as a matter of law.
Legal Standards
1. Summary judgment
A motion for summary judgment may be granted under Rule 56 of the Federal Rules of Civil Procedure if the entire record demonstrates that "there is no genuine issue as to any material fact and . . . the moving party is entitled to judgment as a matter of law." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250 (1986). When viewing the evidence, the Court must "assess the record in the light most favorable to the non-movant and . . . draw all reasonable inferences in its favor." Delaware Hudson Ry. Co. v. Consol. Rail Corp., 902 F.2d 174, 177 (2d Cir. 1990);see McLee v. Chrysler Corp., 109 F.3d 130, 134 (2d Cir. 1997); see also Anderson, 477 U.S. at 255. "[A]t the summary judgment stage the judge's function is not himself to weigh the evidence and determine the truth of the matter but to determine whether there is a genuine issue for trial." Anderson, 477 U.S. at 249. "[T]he plaintiff, to survive the defendant's motion, need only present evidence from which a jury might return a verdict in his favor. If he does so, there is a genuine issue of fact that requires a trial." Id. at 257.
2. § 10(b), Rule 10b-5, and § 17(a)
The Securities Exchange Act of 1934, of which § 10(b) is a part, has as its "fundamental purpose" the implementation of a "philosophy of full disclosure." Basic Inc. v. Levinson, 485 U.S. 224, 230 (1988) (quotations and citations omitted). To that end, § 10(b) proscribes,
in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.15 U.S.C. § 78j(b). Under Rule 10b-5, promulgated by the SEC, it is unlawful "[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading." 17 C.F.R. § 240.10b-5(b); see Podany v. Robertson Stephens, Inc., 318 F. Supp. 2d 146, 152-53 (S.D.N.Y. 2004). To establish a cause of action under 10(b) or 10b-5, a plaintiff must show "(1) in connection with the purchase or sale of a security; (2) defendant, acting with scienter; (3) made a material misrepresentation or (where there exists a duty to speak) a material omission." Press v. Quick Reilly, Inc., 218 F.3d 121, 129 (2d Cir. 2000); see Podany, 318 F. Supp. 2d at 153.
Scienter, which has been defined as "intent to deceive, manipulate, or defraud, or at least knowing misconduct," SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996) (citations omitted), may be shown by (a) motive and opportunity, or (b) strong circumstantial evidence of conscious misbehavior or recklessness. Podany, 318 F. Supp. 2d at 156 n. 4 (quotations and citations omitted). Scienter is considered to be subjective in nature, and "[w]hether or not a given intent existed is, of course, a question of fact." First Jersey, 101 F.3d at 1467. Indeed, "[t]he Second Circuit has been lenient in allowing scienter issues to withstand summary judgment based on fairly tenuous inferences." Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 538 (2d Cir. 1999); see Thomas Lee Hazen, Securities Regulation § 12.8[3] at 434 (4th ed. 2002) ("Due to . . . the subjective nature of scienter, courts have been reluctant to grant summary judgment in 10b-5 cases where scienter is a contested issue.").
Under TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), an omitted fact is material if "the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." See also Basic, 485 U.S. at 232 ("We now expressly adopt the TSC Industries standard of materiality for the § 10(b) and Rule 10b-5 context."). Materiality is a fact-intensive issue that is only rarely appropriate for summary judgment. Its determination "requires delicate assessments of the inferences a `reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him. . . ."Basic, 485 U.S. at 236; see Hazen § 12.9[2] at 451 ("Summary disposition of a materiality claim is appropriate only in those rare instances in which the alleged misrepresentations or omissions `would be so obviously unimportant to a reasonable investor that reasonable minds could not differ on their importance.'").
3. Organizational Rules
The parties do not dispute that, at the time of the events giving rise to this case, the following rules and guidelines were in effect.
New York Stock Exchange Rule 472.30 states, in pertinent part, "No member or member organization shall utilize any communication which contains (i) any untrue statement or omission of a material fact or is otherwise false or misleading. . . ."
New York Stock Exchange Rule 472.40 states,
When a communication (excluding extemporaneous interviews in and with the media) recommends the purchase or sale of a specific security, member organizations must disclose the following information: . . . if the member organization or its employees involved in the preparation or the issuance of the communication may have positions in any securities or options of the recommended issuer.
The New York Stock Exchange Interpretation Handbook, March 1992 Editorial Revision ("Handbook") section 472/08 notes that "[a]ll member organization communications are subject to the general standards set forth in 472.30," (emphasis in original), and that those general standards include, inter alia, radio and television broadcasts. Handbook section 472/09 observes that the specific standards outlined in Rule 472.40 are not exclusive, and that compliance with 472.40 "may not necessarily satisfy the provision of Rule 472.30(i) where additional facts would be material to the customer or reader."
Analysis
1. Corvis
The centerpiece of the SEC's case with respect to Johnson's investment in Corvis is the testimony of Ms. Welch, i.e., that Johnson said he would not buy Corvis stock at the then-market price of about $24, but would buy Corvis stock at $12-14. According to the SEC, this statement shows that Johnson's reports and "buy" ratings of Corvis did not reflect his true beliefs and, therefore, constituted misrepresentations.
Johnson, on the other hand, argues that all his statements at the January 23 meeting were "bullish," that Ms. Welch is the only witness who recalls the half-price statement, and that the SEC has taken Ms. Welch's testimony out of context. The half-price statement, Johnson also argues, was simply an expression of Johnson's personal investment goals which differed from the goals of Johnson's intended audience.
The facts presented to the Court are not so one-sided as to persuade the Court that Johnson is entitled to judgment as a matter of law with respect to the Corvis investments and reports. Indeed, disputed issues of material fact exist that require determination by a finder of fact. Whether Johnson told his colleagues that he would not buy Corvis stock at the then-existing price, what that statement, if indeed uttered by Johnson, meant, as well as the credibility of Ms. Welch's testimony and that of any other witnesses whom the parties might present, are all questions that a jury could reasonably resolve in favor of either party. While defendant may be correct that the testimony of Ms. Welch is overwhelmingly in favor of defendant's position, it is not for the Court to make that determination at this time. Defendant's motion for summary judgment with respect to Corvis is, therefore, denied.
2. Redback and Sycamore
Johnson argues that he was under no duty to disclose his interests in Redback and Sycamore and that, absent a duty to disclose, his statements were not fraudulent. Furthermore, Johnson contends that none of his statements were rendered misleading by the omission of information about his investments and that there is no evidence of the requisite scienter.
New York Stock Exchange Rule 472.30, which mirrors § 10(b) and Rule 10b-5, makes clear that the philosophy of full disclosure should pervade a member's communications with the public. Moreover, according to the Handbook, compliance with section 472.40 does not necessarily equal compliance with 472.30. Taken together, all the relevant rules in existence at the time of the transactions and reports at issue here only reinforce — and in no way lessen — the philosophy of full disclosure that § 10(b) and Rule 10b-5 embody.
With respect to Redback and Sycamore, Johnson is essentially asking the Court to declare NYSE Rule 472.40 a "safe harbor" that will protect those who comply with it from violations of § 10(b) and Rule 10b-5. This the Court will not do. As the Second Circuit stated in the context of a broker-dealer's disclosure of any remuneration received from third parties in connection with a customer transaction, "[The applicable rule] is not intended as a safe harbor from disclosure obligations imposed by the general antifraud provisions of the federal securities laws. . . . [T]he antifraud provisions of the federal securities law may impose, given the circumstances, greater than what may be required by a specific rule or regulation" Quick, 218 F.3d at 131.
Johnson's remaining arguments with respect to Redback and Sycamore — that the omission of additional information did not render the statements misleading and that evidence of scienter is lacking — raise questions of fact which, as previously discussed, are appropriately resolved by a finder of fact. Thus, Johnson's motion for summary judgment with respect to Redback and Sycamore is denied.
3. Due Process
Johnson argues that, because the applicable rules did not require disclosure of his investment interests, and because other analysts routinely withheld similar information, to sanction Johnson for his conduct would violate due process. However, as discussed above, the pervasive philosophy of full disclosure found in the then-applicable rules did proscribe Johnson's alleged conduct. Furthermore, "even where a defendant is successful in showing that it has followed a customary course in the industry, the first litigation of such a practice is a proper occasion for its outlawry if it is in fact in violation."Chasins v. Smith Barney Co., 438 F.2d 1167, 1171 (2d Cir. 1971). Thus, Johnson's due process claim is without merit.
Conclusion
In light of the many factual issues raised, the Court denies defendant's motion for summary judgment. The parties are to appear before the Court on April 21, 2005, at 10:00 a.m., for a conference at which a ready-for-trial date will be set and further proceedings will be discussed.
SO ORDERED.