Lentell v. Merrill Lynch & Co., Inc.

Brief Fact Summary. Publically traded stock investors (Plaintiff) claimed that Merrill Lynch & Co. (Merrill) (Defendant), via its analyst Blodget, released false information and misrepresentative reports endorsing buying specific Internet companies stock, claimed that these falsifications and omissions caused the investors’ losses, and argued that they adequately pleaded loss causation.

Synopsis of Rule of Law. In a securities fraud action, to sufficiently plead loss causation, where considerable indicia of the risk that appeared are decidedlyobvious on the face of the disclosures purported to hide that exact risk, a plaintiff must assert (i) facts able to support an implication that it was the defendant’s fraud, as opposed to other prominentinfluences,  that proximately caused the plaintiff ‘s loss; or (ii) facts satisfactory enough to allocate of the losses betwixt the disclosed and hidden sections of the risk that finally annihilated an investment.

Facts. Merrill Lynch & Co. (Merrill), an investment bank, employs analysts of publically traded companies to make investment recommendations. The Internet Group, one of Merrill’s analyst groups, researched and offered up investment recommendations on up and coming internet companies. The Internet Groups lead analyst, Blodget, recommended two companies, 24/7 Real Media, Inc. (24/7 Media) and Interliant, Inc. (Interliant). Once New York’s Attorney General (NYAG) investigated and requested to bring securities fraud actions against Merrill on the basis that Merrill participated in a strategy where its research departmentdistributedfalse analysis on internet companies, including 24/7 Media and Interliant, in an attempt to create investment banking business, 140 class-action complaints were filed, depending on the NYAG’s supporting affidavits.  The 24/7 Media and Interliant actions went first, after they consolidated all the actions. In the aforementioned actions, Merrill was accused of participating in a strategy that included five components: (1) knowingly, carelessly dishonest research reports maintained and published for the public; (2) 24/7 Media and Interliant publishing fake “BUY or ACCUMULATE recommendationsâ€; (3) setting outrageously unreal price goals for those stocks; (4) the presence of undisclosed arrangements betwixt Merrill, 24/7 Media and Interliant to “trade†promising, optimistic analyst reports for investment banking business lead to Merrill; and (5) the undisclosed sharing among Merrill and its internet analysts of investment banking fees. The purported reason behind this strategy was to make the price of the recommended stock falsely rise so that Merrill would attain and sustain investment banking business from the very companies whose stock the analysts recommended. The “BUY†and “ACCUMULATE†recommendations were deceiving due to the reports not disclosing that Merrill and Blodget had a policy of not issuing a rating or recommendation aside from “BUY†or “ACCUMULATE†seeing as to do so would risk Merrill’s capability to attain underwriting or investment advisory arrangements, according to the investors. During the class period, 24/7 Media’s stock went from around $45 to a high of $65 and falling to a low of $3, while Interliant’s stock went from about $16 to a high of $56 and dropped to a low of $4. During this time, Merrill’s investment-banking department helped Interliants attain 27 companies, and underwrote a multimilliondollar convertible-bond offering while Merrill’s analysts clearly specified that the companies referenced in their reports were in danger of price instability and were high risk companies. The reports also included specific financial information and complex analysis, the majority of signifying that the companies were unstable investments and were in jeopardy of “imploding.†The district court dismissed the actions for failure to plead loss causation. The court of appeals granted review.

Issue. During a securities fraud action, to sufficiently plead loss causation, where considerable indicia of the risk that appeared are decidedly obvious on the face of the disclosures purported to hide that exact risk, must a plaintiff assert (i) facts able to support an implication that it was the defendant’s fraud, as opposed to other prominent influences,  that proximately caused the plaintiff ‘s loss; or (ii) facts satisfactory enough to allocate of the losses betwixt the disclosed and hidden sections of the risk that finally annihilated an investment?

Held. (Jacobs, J.) Yes. During a securities fraud action, to sufficiently plead loss causation, where considerable indicia of the risk that appeared are decidedly obvious on the face of the disclosures purported to hide that exact risk, a plaintiff must assert (i) facts able to support an implication that it was the defendant’s fraud, as opposed to other prominent influences,  that proximately caused the plaintiff ‘s loss; or (ii) facts satisfactory enough to allocate of the losses betwixt the disclosed and hidden sections of the risk that finally annihilated an investment. It is long decided that a securities-fraud plaintiff must demonstrate both transaction and loss causation. Transaction causation is like reliance, and needs only an accusation that but for the alleged misrepresentation or omission, the plaintiff would not have engaged in detrimental securities transactions. Loss causation “is the casual link between the alleged misconduct and the economic harm ultimately suffered by a plaintiff.†In this case, only if the investors pleaded loss causation is of concern.  On this issue, the plaintiff carries the onus and needs to demonstrate that a misstatement or omission is the “proximate cause†of an investment loss if the risk could have been avoided if not hidden by the misstatements and omission. The misrepresentation or omission must have hidden something from the market that, once disclosed, had a negative impact on the value of the security, otherwise the loss was unexpected. These pleading principles necessitate that the loss be both predictable and triggered by the emergence of the hidden risk, so, loss causation has to do with the connection betwixt the plaintiff’s loss and the information misrepresented or hidden by the defendant. A fraud claim will not last if this connection is fragile.  It is not sufficient for a plaintiff to plead that a defendant’s misstatement and omissions induced a “purchase-time value disparity†betwixt the purchase price for a security and its “true investment quality.†An allegation like this is basically an assertion of transaction causation, but it fails to mention the association between the fraud and the loss of the investment. In this case, to plead loss causation, the investors must state facts that support an implication that Merrill’s misrepresentations and omissions hid the situations that brought about loss sustained by the investors in such a way that they would have been freed from all or a calculable section of that loss minus the fraud. No such accusations were made, in other words, the investors failed to make an accusation that the market had a negative reaction to a corrective disclosure about the deceptiveness of Merrill’s “buy†and “accumulate†recommendations and made no claims that Merrill misrepresented or omitted that led to the loss.  The investors failed to allege the reason behind the decline of their stock value as being a result of Merrill’s fake and deceitful recommendations.  They are also lacking an allegation that Merrill hid or misrepresented any dangers connected with investing in these companies, clearly stated in each report were the dangers of devaluation. So, the investors did not adequately claim loss causation; there are potentially allegations of transaction causation though. Affirmed.

Discussion. While the plaintiffs here failed to succeed on their claims, the case still inspired Merrill to settle other multiple actions against it. Merrill settled three class action lawsuits in early 2007 claiming it gave deceptive analyst research regarding Internet companies to buyers of mutual friends. Refer to In re Merrill Lynch & Co. Research Reports Sec. Litig., 2007 U.S. Dist LEXIS 9450 (S.D.N.Y. 2007).