Second Circuit Affirms Dismissal in Merrill Lynch Case

Under the shadow of the U.S. Supreme Court considering the same issue this spring, the Second Circuit affirmed the 2003 dismissal of In re Merrill Lynch Research Reports Securities Litigation, 273 F. Supp. 2d 351 (S.D.N.Y. 2003) on the basis that investors could not prove "loss causation." The appellate court opinion can be found at 2005 WL 107044. Even if analysts' biased and false reports (in this case, the reports of Henry Blodget) cause the share price to be artificially inflated when the investor bought the securities, so the argument goes, the investor must plead that something the analyst did eventually made the stock go down (cause the loss). The high court will take up this issue in Dura Pharmaceuticals v. Broudo, which was argued last Wednesday. The briefs are here.

The requirement to plead loss causation is an extraordinary hurdle in these types of cases where a false analyst report pumped up the price and the price naturally fell over time when predictions were not realized. This Merrill Lynch case involved analyst reports in connection with the IPOs of 24/7Real Media and Interliant. The same district court judge, now deceased, that threw out this case also threw out similar cases involving other IPOs. In this case, the opinion reflects the judge's assessment of plaintiff investors as equal to football players who hold on every play, but then cry "foul" when the other team holds them:

The record clearly reveals that plaintiffs were among the high-risk speculators who, knowing full well or being properly chargeable with appreciation of the unjustifiable risks they were undertaking in the extremely volatile and highly untested stocks at issue, now hope to twist the federal securities laws into a scheme of cost-free speculators' insurance. Seeking to lay the blame for the enormous Internet Bubble solely at the feet of a single actor, Merrill Lynch, plaintiffs would have this Court conclude that the federal securities laws were meant to underwrite, subsidize, and encourage their rash speculation in joining a freewheeling casino that lured thousands obsessed with the fantasy of Olympian riches, but which delivered such riches to only a scant handful of lucky winners. Those few lucky winners, who are not before the Court, now hold the monies that the unlucky plaintiffs have lost-fair and square-and they will never return those monies to plaintiffs. Had plaintiffs themselves won the game instead of losing, they would have owed not a single penny of their winnings to those they left to hold the bag (or to defendants).

The plaintiffs attempted in the court below to argue that the analysts were agents of the investors (who were not otherwise clients of ML). This argument did not fly with this judge, but an alternative argument of quasi-agency is made in an Iowa law review article by Jill Fisch and Hillary Sale, The Securities Analyst as Agent: Rethinking the Regulation of Analysts, 88 Iowa L. Rev. 1035 (2003).