Opinion
No. 5:91-cv-682 (EBB).
June 22, 2000.
Ruling on plaintiff's Motion for Class Certification
Plaintiff Paul Stevelman ("Stevelman") moves pursuant to Fed.R.Civ.P. 23(a) and (b)(3) to certify a class of investors who purchased stock in defendant Alias Research ("Alias") during the eleven-month period between May 28, 1991, and April 30, 1992, (the "proposed class period") while share value was allegedly not accurately reflected in the market price due to fraud. Stevelman is the sole plaintiff seeking to represent such a class. Because he meets all the prerequisites of Rule 23 during at least some portion of the proposed class period, a class will be certified. The temporal parameters of that class, however, will be limited to purchasers of Alias stock during the seven-month period between June 27, 1991, the earliest date on which an actionable fraud may be properly alleged, and January 27, 1992, the date on which the only named plaintiff completely divested his entire interest in Alias stock.
I. Background
Much of the factual context of this securities fraud class action has been addressed in rulings on the defendants' motion to dismiss. See Stevelman v. Alias Research Inc., 174 F.3d 79 (2d Cir. 1999) (reversing dismissal with prejudice of amended complaint for failure to plead fraud with particularity). Only the background germane to resolving this motion is reiterated here. In deciding whether to certify a class, the allegations in the complaint are presumed true. See Shelter Realty Corp. v. Allied Maintenance Corp., 574 F.2d 656, 661, n. 15 (2d Cir. 1978).
Alias was a photo-imaging software company started in 1983 by defendant Bingham, who was the chief executive officer. During the proposed class period, Alias was a publicly-held corporation whose approximately five-and-a-half million outstanding shares traded on NASDAQ. Stevelman bought 1000 shares of Alias common stock at $15.50/share on September 16, 1991, after reading about the company in the Wall Street Journal and consulting with his broker. Some eighteen weeks later on January 27, 1992, Stevelman sold these 1000 shares at $11/share for a loss of $4500. He alleges that this loss is due to defendants' fraud in violation of § 10(b) of the Securities Exchange Act, 15 U.S.C. § 78j(b), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5.
The confluence of three purported improprieties, which provide the requisite scienter to plead fraud in this case, is pertinent to determining when the class period may commence. First, defendants' allegedly made material misrepresentations by overstating Alias' revenues for the initial three quarters of 1991. The first such overly optimistic disclosure was a May 28, 1991, press release, which was issued in advance of Alias' filing with the SEC of its first quarter Form 10-Q on June 14th Each of Alias' next two quarterly earnings reports, filed in September and December, also painted an inordinately rosy picture of the company's growth potential.
Second, defendants' unduly sanguine revenue outlook during the first three quarters of 1991 was due, in part, to alleged accounting irregularities, by which sales were booked, and revenues recognized, prematurely. In 1991, Alias took three separate charges against its accounts receivable, setting aside a total of $13.2 million as uncollectible. In April 1992, on its Form 10-K for fiscal 1991, Alias announced a change in its accounting policy to conform to generally accepted accounting principles ("GAAP"), and restated its earnings for the three prior quarters.
Third, defendant Bingham also allegedly engaged in insider trading, dumping 175,000 shares (40% of his holdings) of Alias stock at $20/share on June 27, 1991, the same day on which Alias called off the planned registration of an additional 1.65 million shares of common stock. Two other insiders, the chief financial officer and a corporate vice president, also sold in excess of 5000 shares each in June at or above $25/share.
In a civil enforcement action related to this case, settlement of which is pending, the SEC brought insider trading charges against three Alias officers, including defendant Bingham. See Securities and Exchange Comm'n v. Bingham, No. 96-cv-10793 (D. Mass. 1996); Plf's. Reply Mem. at 12, n. 10 [Doc. No. 801 (March 28, 2000).
Together these allegations of inflated revenues, accounting anomalies and insider trading suffice to allege the requisite scienter to plead securities fraud. See Stevelman, 174 F.3d at 86 ("we hold the insider trading alleged here, in combination with the timing of the misrepresentations, satisfies the pleading requirements of [Fed.] Rule [Civ. P.] 9(b) for the purposes of the scienter element of section 10(b) and Rule 10b-5"). The first date on which all three of these factors coincided was June 27, 1991, when Bingham sold nearly half of his 8.4% stake in Alias. Two weeks earlier, on June 14th Alias had filed its inflated 10-Q for the first quarter of 1991. Although Alias did not begin to reserve funds for uncollectible accounts until the third quarter of 1991, the alleged accounting improprieties were reflected in that first quarter 10-Q, whose bloated figures were eventually restated.
II. Standards
District courts have broad discretion in deciding whether and when to certify a class. See Reiter v. Sonotone Corp., 442 U.S. 330, 345, 99 S.Ct. 2326, 60 L.Ed.2d 931 (1979); see also Fed.R.Civ.P. 23(c)(1) (certification orders may be "conditional, and may be altered or amended before the decision on the merits"). "Before certifying a class, a district court must be persuaded, `after a rigorous analysis, that the prerequisites of Rule 23 have been satisfied.'" Caridad v. Metro North Commuter R.R., 191 F.3d 283, 291 (2d Cir. 1999) (quotingGeneral Tel. Co. v. Falcon, 457 U.S. 147, 161, 102 S.Ct. 2364, 72 L.Ed.2d 740 (1982)). Although the court may not delve into the merits of the case at the class certification stage, see Eisen v. Carlisle Jacquelin, 417 U.S. 156, 177-78, 94 S.Ct. 2140, 40 L.Ed.2d 732 (1974), it may in its Rule 23 analysis "probe behind the pleadings before coming to rest on the certification question." Falcon, 457 U.S. at 160; see also Coopers Lybrand v. Livesay, 437 U.S. 463, 469, 98 S.Ct. 2454, 57 L.Ed.2d 351 (1978) ("class determination generally involves considerations that are enmeshed in the factual and legal issues comprising the plaintiff's cause of action"). The movant bears the burden of proving that certification is warranted. See,e.g., Caridad, 191 F.3d at 291.
Of the six prerequisites to certifying the type of class Stevelman proposes, only two are challenged by defendants: typicality and adequacy of representation. See Fed.R.Civ.P. 23(a)(3) (4). A putative plaintiff's claim is typical of the class he proposes to represent if it "arises from the same event or course of conduct that gives rise to claims of other class members and the claims are based on the same legal theory."Dura-bilt v. Chase Manhattan Corp., 89 F.R.D. 87, 99 (S.D.N Y 1981) ("Typicality refers to the nature of the claim of the class representative, and not to the specific facts from which the claim for relief arose or relief is sought.").
Subsections (a) and (b)(3) of Rule 23 together require plaintiff to show: numerosity, commonality, typicality, adequacy, predominance and superiority. See Fed.R.Civ. p. 23.
"(a) Prerequisites to a Class Action. One or more members of a class my sue or be sued as representative parties on behalf of all only if . . . (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class, and (4) the representative parties will fairly and adequately protect the interests of the class."
A named plaintiff may adequately represent a class if he has no potential conflict with absent class members, and his attorney is qualified to vigorously prosecute the action. See, e.g.,Garfinkel v. Memory Metals, Inc., 695 F. Supp. 1397, 1405 (D. Conn. 1988). As with the typicality requirement, "[t]he purpose of the adequacy requirement . . . is to protect the legal rights of absent class members who are bound by the resulting judgment."Id.
Proposed plaintiffs may not be named to represent the interests of absent class members where their claims are subject to unique defenses. See, e.g., Gary Plastic Packaging Corp. v. Merrill, Lynch, Inc., 903 F.2d 176, 180 (2d Cir. 1990) ("Regardless of whether the issue is framed in terms of the typicality of the representative's claims, or the adequacy of its representation, there is a danger that absent class members will suffer if their representation is preoccupied with defenses unique to it.") (internal citations omitted). Such defenses would render the named plaintiff atypical of the class he purports to represent and, hence, inadequate to serve in that representative capacity.
III. Discussion
Defendants mount two challenges to plaintiff's motion to certify, the first of which seeks to strike Stevelman as named plaintiff and the second of which seeks to curtail the class period. Each of these arguments is addressed in turn.
A. Dispositive Challenges to Appointment of Named Plaintiff
Defendants' dispositive challenges attack Stevelman as atypical because he is subject to a unique defense or inadequate because he lacks basic knowledge of this lawsuit. Neither of these arguments is persuasive.
1. Typicality
Defendants contend that Stevelman is atypical of the class he seeks to represent because he did not rely on any of the fourteen alleged misstatements issued by Alias, three of which were disclosed prior to his September 16, 1991, purchase of Alias stock. See Defs. Opp'n at 9 [Doc. No. 771 (March 14, 2000) Prior to that day, Alias had issued press releases (on May 28th and September 13th) and filed Forms 10-Q (on June 14th and September 16th) for the first two quarters of 1991. As previously indicated, the exaggerated revenue figures in these disclosures reflected ongoing accounting irregularities, which in combination with the June 1991 insider trading, allege actionable fraud starting on June 27th nearly three months before Stevelman bought his shares. Although additional misleading disclosures followed Stevelman's purchase, those that predated it suffice to allege fraud.
Defendants further argue that even if the pre-purchase misstatements, in combination with alleged insider trading, were material to plead fraud, Stevelman is still subject to a unique defense because he did not read or consider this information in making his investment decision. In his deposition, Stevelman apparently conceded as much. See Defs. Opp'n at 9 n. 7. Stevelman likely acquired much of the same information contained in the SEC filings when he read the Wall Street Journal piece and consulted with his broker. Among individual investors such as Stevelman, this means of gathering information is not atypical.See Garfinkel, 695 F. Supp. at 1404 ("Reliance on third parties such as investment counselors or knowledgeable family members is likely to be typical, rather than atypical, of the circumstances under which a substantial number of class members purchased their stock."). Even if Stevelman had not read or considered Alias' first two quarterly reports of 1991, he would not be atypical because plaintiff need not show he directly relied upon the false or misleading information in a Rule 10b-5 case. See, e.g., In re Ames Dep't Store Stock Litig., 991 F.2d 953, 967 (2d Cir. 1993).
Among the elements necessary to state a claim for securities fraud, plaintiff must allege that his trade was "in connection with" a materially false or misleading statement or omission. 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. In order to show that his purchase was in connection with Alias' false statements, Stevelman must demonstrate that he relied on that misleading information in deciding to invest in Alias. For stocks like Alias that trade on a listed exchange such as NASDAQ, this reliance element of a 10b-5 cause of action is presumed. See Basic, Inc. v. Levinson, 48S U.S. 224, 247, 108 S.Ct. 978, 99 L. Ed. 2d 194 (1988) ("An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentation, therefore, may be presumed for purposes of a Rule 10b-5 action."); see also In re Ames, 991 F.2d at 667 ("Because the fraud on the market may taint each purchase of the affected stock, each purchaser who is thereby defrauded . . . is defrauded by reason of the publicly disseminated statement.").
The rebuttable presumption created by this so-called fraud on-the-market theory presupposes that in an efficient capital market like NASDAQ, all information about a publicly-traded company such as Alias is accurately reflected in the stock's trading price. As such, material misstatements like those alleged here are presumed to artificially distort share price, obviating the need to show plaintiff's individual reliance on the fraudulent disclosure. Under the fraud-on-the-market presumption, the court must assume that if the information disclosed was not materially misleading, Stevelman would not have opted to invest at the prevailing share price.
Because Stevelman's purchase of Alias stock proximately followed materially misleading disclosures, he is typical of those class members he seeks to represent. Defendants do not suggest that Stevelman is subject to any particular unique defense, such as relying on non-public information. Cf.Kamerman v. Ockap Corp., 112 F.R.D. 195, 197-98 (S.D.N.Y. 1986) (denying certification where the sole proffered class representative did not rely on the market but learned of misleading statements prior to the merger vote that allegedly injured the shareholders); Grace v. Perception Tech. Corp., 128 F.R.D. 165, 169 (D. Mass. 1989) (finding atypical plaintiff who purchased immediately after conferring with corporate insiders).
Absent some evidence to rebut the presumption of reliance — none of which is offered here — Stevelman's claim does not hinge on whether or not he actually read and relied on the alleged misinformation in making his investment decision. Because Stevelman's reliance is not a critical issue in the case, he is therefore not atypical of the class of investors he seeks to represent. Cf. Gary Plastic, 903 F.2d at 180 ("class certification is inappropriate where a putative class representative is subject to unique defenses which threaten to become the focus of the litigation").
2. Adequacy
Even if Stevelman is typical of Alias investors and not subject to unique defenses, defendants assert that he is an inadequate representative because he is a reluctant litigant, unable to supervise counsel and lacks basic information about the case. See Defs. Opp'n at 17-18.
That Stevelman is the only plaintiff-investor who has come forward seeking to represent a class in an action against Alias "weighs in favor of certification." Gary Plastic, 903 F.2d at 180. Though he may not completely abdicate control of the case to his attorneys, plaintiff need not be a sophisticated institutional investor driving the litigation. Cf. Private Litigation Securities Reform Act of 1995 ("PLSPA"), Pub.L. 104-67, 109 Stat. 737-765 (codified as amended in the Securities Exchange Act of 1934 § 21D(a)(3)(B) (iii)), 15 U.S.C. § 78u-4 (a)(3)(B) (iii) (codifying presumption that the most adequate plaintiff is the investor, usually an institutional investor, who has the largest financial stake in the outcome of the case).
After reviewing excerpts of Stevelman's deposition testimony, the court finds that he has sufficient knowledge of the allegations and familiarity with the issues asserted in this case to adequately press the claims of absent class members. Despite the PLSRA's preference for institutional investors to serve as lead plaintiffs in securities fraud class actions, the court is not prepared to strike Stevelman — particularly where no others have come forward — just because he is not a sophisticated investor. His interests are not adverse to the rest of the class and his attorneys have demonstrated their zeal to pursue the case vigorously.
Defendants advance another inadequacy argument, positing that Stevelman, who sold during the proposed class period, is an inadequate representative because his interests are antagonistic to those members who retained their shares beyond the date Stevelman sold his Alias stock. See Defs. Opp'n at 13. Because the court holds that plaintiff lacks standing to represent would-be class members after Stevelman sold his shares, it need not address the novel argument that he is also inadequate to represent the interests of post-sale members. See section III.B.2, infra, at 13.
B. Class Period
Having determined that Stevelman satisfies the requisites of Rule 23 for at least part of the proposed class period, the court next considers when such a class should begin and end.
1. Start Date
No class period may commence prior to the earliest date on which plaintiff can properly allege all the elements of his prima facie case. Prior to that time, plaintiff as a matter of law has no cognizable cause of action. See Sirota v. Solitron Devices, Inc., 673 F.2d 566, 572 (2d Cir. 1982). In a securities fraud case such as this, stock purchased prior to the alleged fraud could not meet the requirement that it be purchased "in connection with" the fraud. Therefore, the class period may not commence until Alias shareholders relied, albeit unwittingly, on a stock price that was allegedly distorted by the materially misleading information disseminated in the market.
Here, it has already been determined that June 27, 1991, is the first date on which the combined allegations of revenue inflation, accounting irregularities and insider trading suffice to plead fraud under the federal securities laws. The class period, therefore, may not begin until that day, the earliest date on which a strong inference of fraudulent intent (the scienter element) arose based on the circumstantial evidence of defendants' conscious misbehavior or recklessness, or motive and opportunity to commit fraud. See Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996).
2. End Date
Plaintiff contends that the class period should extend until April 30, 1992, when, on its Form 10-K for fiscal 1991, Alias released curative information into the market by disclosing its accounting problems and revising its revenue figures for the first three quarters. Defendants, on the other hand, seek to truncate the class period to end on September 16, 1991, the date on which Stevelman purchased his shares. For the following reasons, the court finds that the correct termination date falls between these two.
Defendants argue that Stevelman lacks standing to pursue the claims of absent class members who purchased Alias shares after he bought his. See Defs. Opp'n at 5-7. As such, defendants would end the class on the day Stevelman bought his shares, September 16th. The court agrees that plaintiff Stevelman does indeed lack standing to represent the class during the latter part of the proposed class period, but concludes that this jurisdictional threshold was crossed when Stevelman sold his stock, not when he bought it.
Last term, the Supreme Court reiterated that "class certification issues are . . . `logically antecedent' to Article III concerns, and themselves pertain to statutory standing, which may properly be treated before Article III standing." Ortiz v. Fiberboard Corp., 527 U.S. 815, ___, 119 S.Ct. 2295, 2307, 144 L.Ed.2d 715 (1999) (citing Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 612, 117 S.Ct. 2231, 138 L.Ed.2d 689 (1997)). "Thus the issue about Rule 23 certification should be treated first, `mindful that the Rule's requirements must be interpreted in keeping with Article III constraints. . . .'" Ortiz, 119 S.Ct. at 2307 (citing Amchem, 521 U.S. at 612-13).
As a certification issue, plaintiff's capacity to represent a class is framed as a question of his typicality or adequacy. As noted above, the court has already determined Stevelman to be typical of, and an adequate representative for, the class he seeks to represent, at least for the duration of his ownership of Alias stock. Sufficient fraud had been alleged prior to Stevelman's purchase of Alias stock for his claim to be actionable. Having thus considered and resolved the Rule 23 certification issues, the court turns next to the question of whether a named plaintiff in a securities fraud class action has Article III standing to represent the class after he has sold all of his shares. Based on logic and long-standing precedent in this circuit, the court concludes that he does not.
Standing analysis in the context of a class action looks to the status of the, named plaintiff, not the standing of unidentified class members. A named plaintiff may only represent absent class members if he personally has standing to litigate his own claim. See, e.g., Simon v. Eastern Ky. Welfare Rights Org., 426 U.S. 26, 40 n. 20, 96 S.Ct. 1917, 48 L.Ed.2d 450 (1976) ("That a suit may be a class action . . . adds nothing to the question of standing, for even named plaintiffs who represent a class `must allege and show that they personally have been injured, not that injury has been suffered by other, unidentified members of the class to which they belong and which they purport to represent.'") (quoting Warth v. Seldin, 422 U.S. 490, 502, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975)). If, after divesting his interest in Alias, Stevelman lacks standing to press claims on his own behalf, how can he possibly be permitted to represent any other member of a class? Cf. Zucker v. Sasaki, 963 F. Supp. 301, 307 n. 7 (S.D.N.Y. 1997).
For the post-sale period, Stevelman fails to meet the "irreducible constitutional minimum" standing requirements.Lujan v. Defenders of Wildlife, 504 U.S. 555, 560-61, 112 S.Ct. 2130, 119 L.Ed.2d 351 (1992) (outlining three elements for standing: "[f]irst, the plaintiff must have suffered an injury in fact — an invasion of a legally protected interest which is concrete and particularized, and actual or imminent, not conjectural or hypothetical, [s]econd, there must be a causal connection between the injury and the conduct complained of — the injury has to be fairly traceable to the challenged action of the defendant, and not the result of the independent action of some third party not before the court, [and] [t]hird, it must be likely, as opposed to merely speculative, that the injury will be redressed by a favorable decision.") (internal citations and quotations omitted). of the three elements needed to have standing — injury, traceability and redressability — Stevelman lacked at least two after selling his Alias stock. Without owning any stock in Alias, Stevelman cannot show any injury, nor that any subsequent loss would have been fairly traceable to defendants' fraud. After divesting his interest in Alias, Stevelman no longer has standing to allege an actual loss due to fraud involving Alias securities for the post-sale period.
Circuit precedent lends further support to the intuitive appeal of this reasoning. See Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952). In Birnbaum, the Second Circuit held that courts may not speculate whether and how much an investor might have traded if the market in a given security had not been defrauded. Id. at 464. As such, only actual purchasers and sellers have standing in a 10b-5 case. See id.; see also Blue Chip Stamps v. Maynard Drug Stores, 421 U.S. 723, 737-38, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975). Therefore, the court may not conjecture whether Stevelman might have purchased additional shares of Alias after selling off his initial 1000 share investment. The possibility of reinvestment is too speculative to support a post-divestment claim of Article in standing.
Cases cited by defendants for the proposition that named plaintiffs lack standing to challenge alleged misrepresentations that post-date their purchase of stock are inapposite to the facts of this case. See Defs. Opp'n at 6-7. Plaintiffs in those cases lacked standing because there were no material misstatements to allege fraud prior to their purchase of stock. Here, by contrast, Stevelman's purchase on September 16th, was nearly three months after the alleged misstatements became material on June 27th. In the only case cited by defendants that is binding on this court, the Second Circuit affirmed the dismissal of a 10b-5 case for failure to plead fraud with particularity where plaintiff could not "share in any recovery because no fraudulent statements were issued before his purchase." Denny v. Barber, 576 F.2d 465, 468-69 (2d Cir. 1978) (Friendly, J.) (citing Blue Chip Stamps, 421 U.S. at 737-38).Denny, like the other cases cited by defendants, does not apply to this situation where the material misstatements occurred long before the named plaintiff purchased the stock.
IV. Conclusion
For the foregoing reasons, plaintiff's motion to certify [Doc. No. 66] is GRANTED as modified by the court's adjustment to the proposed class period. Accordingly, the class of investors who purchased Alias stock during the seven-month period between June 27, 1991, the date of the first alleged material fraud, and January 27, 1992, when Stevelman relinquished his ownership of Alias stock, is hereby certified. Stevelman is hereby designated as the sole named representative of that class and plaintiff's counsel is hereby designated as counsel for the class. In accordance with Fed.R.Civ. p. 23(c)(2), plaintiff shall submit to the court for approval a proposed notice to the class.
So ordered.
Dated at New Haven, Connecticut, this 22nd day of June, 2000.