strong sentiments which favor the use of class actions in securities fraud cases, see supra p 17, the court concludes that certain minimal levels of antagonism must be tolerated.
Turning first to the interests of in/out traders, a plaintiff class composed primarily of retention traders will clearly result in prejudice to the in/out plaintiffs' interests. Although this is troubling, it should not preclude class certification.
The in/out plaintiff presents a special situation. Because he necessarily bought and sold in the relevant period, he has one interest in shaping the evidence for the moment at which he bought, and the opposite interest for the moment at which he sold. Where a plaintiff class is comprised solely of retention plaintiffs except for one in/out trader, the latter's interests, of course, are likely to be substantially prejudiced. But even if a class were composed entirely of in/out plaintiffs, the seller-purchaser conflicts would still be pervasive.
In other words, the in/out plaintiff must deal with the inevitable fact that if he attempts to participate in a mass suit along with other injured traders (whether in/out or retention), his interests will be compromised.
For this reason, the court cannot concern itself with the prejudice that the in/out plaintiff may face in a class composed primarijy of retention plaintiffs, as the in/out plaintiff will always face such adverse interests when participating in a class action. The in/out trader's recourse, though not attractive, is to opt-out of the class and sue individually. Unfortunately, the in/out plaintiff's dilemma of either suing individually or facing adverse interests is one which this court can do little to alleviate, as it is a direct result of the out-of-pocket measure of damages.
Therefore, it is the potential for prejudice to retention plaintiffs which must guide the court in determining the point at which class certification is no longer proper. When the proportion of in/out plaintiffs in the class is relatively low, the retention plaintiffs in the class are not likely to be seriously prejudiced by the seller-purchaser conflict. This is true simply because of the relevant numbers -- a large number of retention plaintiffs will handily defeat a smaller number of in/out plaintiffs in shaping the evidence.
As the number of in/out traders in the class increases, so, too, does the severity of the seller-purchaser conflict. See supra part III.A. At some point, the interests of the retention plaintiffs become unduly impinged upon by the combination of the seller-purchaser conflicts with the lurking equity conflicts. Th court feels that this point is reached where the retention plaintiffs in the class no longer "predominate" over the in/out plaintiffs. So long as retention plaintiffs do predominate, their interests are adequately protected.
As discussed above, plaintiffs must provide evidence establishing that to the extent conflicts exist in the plaintiff class, they are not so serious as to preclude a finding of adequacy of representation. In order to provide plaintiffs an opportunity to meet this burden, the court will conduct an evidentiary hearing. The following suggestions are made to guide the parties in their presentations.
First, plaintiffs should provide proof regarding the extent and severity of both the seller-purchaser and equity conflicts. Although it is the seller-purchaser conflict which is exacerbated by partial curative disclosures, it is the cumulative effect of both types of conflict that is particularly troubling. Second, plaintiffs must establish both the level of price inflation and the trading volumes in Seagate common prevailing during the class period. From these data, plaintiffs should be able to ascertain the nature of the damages (in/out or retention) suffered by the various class members and, therefore, the proportion of the plaintiff class that is comprised of in/out traders, and the fraction composed of retention plaintiffs.
The court realizes that to request plaintiffs to provide such proof before the class certification. decision seems to depart from the rule set forth in Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177-78, 94 S. Ct. 2140, 40 L. Ed. 2d 732 (1974), which prohibits an examination of the merits of plaintiffs' case as part of the certification analysis. In Eisen, the district court had imposed upon the defendants 90% of the costs of sending notices to putative class members, reasoning that plaintiffs were "more than likely" to prevail on the merits. The Supreme Court held that:
nothing in either the language or history of Rule 23 * * * gives a court any authority to conduct a preliminary inquiry into the merits of a suit in order to determine whether it may be maintained as a class action.
Id. at 177. The Court reasoned that a contrary rule would provide the representative plaintiff with a determination of the merits of the class action even before the prerequisites to class certification had been satisfied. Id. at 177-78. The Court also noted that to allow such an examination of the merits could result in "substantial prejudice" to the defendant, because the usual procedures available in a full trial would be unavailable. Id. at 178.
The Eisen case was decided in 1974, before the Ninth Circuit's adoption of the fraud-on-the-market theory in Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975), and well before the Supreme Court's 1988 endorsement of the theory in Basic v. Levinson, 485 U.S. 224, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988). As discussed above, the advent of the fraud-on-the-market theory has magnified the severity of certain class conflicts, particularly in partial curative disclosure cases. In order to ensure that the FRCP 23 requirement of adequate representation is satisfied, the court is forced to examine evidence which prior to the fraud-on-the-market theory, would have been presented as part of the merits of the case.
Given the relative recency of the decision in Basic, the court concludes that the Eisen rule prohibiting examination of the merits during the class certification process must yield. By adopting the fraud-on-the-market theory, the Basic court implied, though perhaps unintentionally, that the district courts must examine some of the merits. Because of the potential for conflicts created by the fraud-on-the-market theory and the out-of-pocket measure of damages, the adequacy of the representation cannot be ascertained without examining the composition of the class. And there is simply no way to discover the makeup of the class without investigating the trading volumes and the amount of price inflation prevailing during the class period. Accordingly, this court has little choice but to resort to an evidentiary hearing on these issues.
The court next turns to defendants' motion for summary judgment on plaintiffs' fraud-on-the-market claim. The motion is based on three arguments. First, defendants present an "event analysis" which purports to establish that the market was never biased by any alleged misstatements by defendants. Second, defendants argue that they had no affirmative duty to disclose adverse financial information to the public any earlier than they did. Third, defendants assert that they are entitled to summary judgment on the issue of scienter. Plaintiffs have brought a cross-motion for partial summary judgment claiming that Seagate's stock was biased as a matter of undisputed fact.
Summary judgment is a method for the prompt disposition of an action in which there is no genuine issue of material fact. Federal Rule of Civil Procedure 56(c) provides for the granting of summary judgment where the moving party is entitled to judgment as a matter of law. The burden of establishing that there is no genuine issue of material fact lies with the moving party. Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986). Once the moving party has met that burden by presenting evidence which, if uncontradicted, would entitle it to a directed verdict at trial, FRCP 56(e) shifts to the nonmoving party the burden of presenting specific facts showing that such contradiction is possible. British Airways Board v. Boeing Co., 585 F.2d 946, 950-52 (9th Cir. 1978).
Earlier in this litigation, defendants had moved for summary judgment based on their assertion that the market was unaffected by defendants' misstatements and omissions. In rejecting this "truth on the market" defense, the court noted:
When * * * courts can with the level of confidence required by FRCP 56 find no reasonable possibility of systematic bias by examining certain news accounts, analyst reports or other such evidence, a truth on the market defense may be appropriate. Where such evidence is not so persuasive, as here, a defendant must attempt a more convincing demonstration that the misstatements or omissions alleged did not bias the market. Such demonstration may take the form of a time event or comparable index study, both of which are commonly used in securities fraud cases.
In re Seagate Technology II Securities Litigation, 802 F. Supp. 271, 277 (ND Cal 1992). Accordingly, defendants have performed such an "event analysis" and now again move the court for summary judgment.
Defendants' expert, Dr. Kleidon, conducted the econometric "event study" by noting the movement of the price of Seagate common for each day in the class period and comparing it with an industry index.
According to Dr. Kleidon, most of the variation in the price of Seagate stock during the class period can be attributed to movements in the industry index. Kleidon Dec P12. As for the dates on which the price of Seagate common deviated from the industry index in a statistically significant amount, Dr. Kleidon posited that the disclosures issued by the company on those dates were primarily responsible. Thus, Dr. Kleidon concluded that "none of the allegedly false and misleading statements cited in the complaint resulted in a significant increase in stock price, properly adjusting for general market and industry effects." Kleidon Dec P 3(b).
According to defendants, this event study "objectively establishes the market was not misled" by defendants' statements and that defendants cannot be liable for any fraud on the market. Defendants' Mem in Supp. at 4-8. The court disagrees with the sweeping conclusion that the study absolves defendants of all fraud-on-the-market liability. The expert analysis simply shows that plaintiffs' claims for liability based on affirmative misstatements cannot succeed; the study has no impact, however, on the viability of those claims based on the omission of material information.
Defendants' expert analysis in this case conclusively shows that none of Defendants' affirmative corporate disclosures caused a statistically significant variance in the relative price of Seagate stock. Because plaintiffs have failed to rebut this evidence, defendants' summary judgment motion as to all claims based on affirmative misstatements is hereby GRANTED.
But as to plaintiffs' allegations that the price of Seagate common was fraudulently inflated by the omissions of defendants, the expert analysis of Dr. Kleidon is of little import. After all, it is entirely plausible that while defendants made affirmative statements which failed to impact the trading price of Seagate common, they simultaneously withheld information from the market which rendered the statements misleading. Of course, one would not expect the withholding of such information to affect the trading price of Seagate stock: the market cannot react to what it does not know.
Defendants' attempt to obtain summary judgment on plaintiffs' omissions claims is in any event premature. In order to establish a "truth on the market" defense to an omissions claim, defendants must prove that despite the withholding of material information, the price line never diverged from the valu line;
in other words, defendants must establish that there was never any price inflation because the market already knew the withheld information. The existence and degree of price inflation are two of the issues the court has determined are to be developed at an evidentiary hearing on the propriety of class certification. See supra part IV. Therefore, defendants' summary judgment motion on the omissions claims would be more appropriately brought after that hearing. Because defendants have thus far failed to produce evidence which demonstrates the absence of price inflation, defendants' motion for summary judgment on the omissions claims is hereby DENIED without prejudice.
In considering fraud-on-the-market claims brought for omissions of material information, it is important to note that generally, the corporation has no affirmative duty of disclosure. In certain circumstances, however, the corporation does have a duty to disclose information unknown to the public. For example, it is beyond question that when an issuer of public stock makes a voluntary disclosure it must be true in its entirety and "not misleading" by omission of information "necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." SEC Rule 10b-5; Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 51 L. Ed. 2d 480, 97 S. Ct. 1292 (1977); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976); Dirks v. SEC, 463 U.S. 646, 77 L. Ed. 2d 911, 103 S. Ct. 3255 (1983).
Defendants have moved for summary judgment based on two contentions. The first is that defendants had no duty to disclose the alleged material information to the investing public. The second is that defendants are entitled to summary judgment on the issue of scienter. The court finds neither argument convincing.
In response to defendants' contention that they were under no duty to disclose information regarding Seagate, plaintiffs seek to impose such a duty under two different theories. First, plaintiffs attempt to rely on the duty to disclose which arises under insider trading law. Second, plaintiffs suggest that defendants made affirmative statements which were materially misleading due to the omission of critical information.
Plaintiffs first seek to establish a duty to disclose based on the alleged, insider trading of two of the individual defendants. Under the laws covering insider trading, a corporate insider with material, non-public information has a duty either to disclose the information to the person with whom he trades, or to abstain from trading. According to plaintiffs, this court should import this duty to disclose or abstain into this case involving fraud-on-the-market.
The court declines to adopt plaintiffs' rationale. Such a rule, when applied in fraud-on-the-market cases, would lead to enormous liability on insider traders -- liability that could not have been anticipated by Congress. See 15 USC § 78t-1 (limiting standing for insider trading claims to plaintiffs that "contemporaneously" bought or sold securities of the same class). Plaintiffs' rule could potentially subject a low level employee/insider, who traded in only a few shares of stock, to broad liability for fraud on the entire market. See Colby v. Hologic, 817 F. Supp. 204, 216 (D Mass 1993) (" * * * to extend liability 'well beyond the time of the insider's trading could make the insider liable to all the world"'). And as another court noted:
In contrast to a fraud-on-the market scheme, insider trading does not artificially boost or deflate the market price of a stock aside from typically negligible supply and demand adjustments. Accordingly, the remedy for wrongful insider trading is disgorgement of trading profits and is only available to actual or potential victims of the insider trades."
In re Aldus Securities Litigation, 1993 U.S. Dist. LEXIS 5008, CCH Fed Sec L Rep P97,376 (WD) Wash 1993). Because plaintiffs here were not contemporaneous traders during the alleged insider trading, they have no standing to assert the duty to disclose imposed upon insider traders.
Plaintiffs also argue that a duty to disclose arose here because defendants made statements which were materially misleading due to omitted information. According to plaintiffs, defendants withheld material information regarding Seagate's "severe excess capacity." Second Consol Amended Compl P 61 a-q at 34-36. Plaintiffs maintain that this excess capacity was caused by over-expansion of Seagate's manufacturing facilities, declinin market demand for the 5-1/4 inch rigid disk drives to which these facilities were geared, and a bloated inventory of such disk drives. Id. All of this allegedly contributed to Seagate's overall financial difficulties, which were also undisclosed until Seagate announced on October 5 that it would suffer a loss in the quarter ended on September 30.
Plaintiffs further allege that affirmative statements made during the class period were materially misleading due to the above omissions. For example, plaintiffs present evidence that on May 3, 1988, defendant Shugart reported to a group of securities professionals that because of the rising demand for disk drives, Seagate had to increase its manufacturing capacity to maintain marketshare. See Sidener Dec Exh 8. Also, on June 29, 1988, Seagate publicly confirmed that it was raising prices on some of its disk drives due in part to "very heavy demand." See Sidener Dec Exh 10. Both of these disclosures came only one or two months before Seagate's revelation on July 18 and August 1, 1988, that Seagate was suffering' severe financial losses. According to plaintiffs, these allegedly misleading disclosures gave rise to a duty to disclose in the defendants.
Defendants suggest that the statements identified by plaintiffs were not misleading because they were literally true. This argument misses the point. Even if the court assumes that the corporate disclosures were literally true, this does not mean that the statement did not give rise to a duty to disclose. As stated by the court in In re Convergent Technologies Securities Litigation, 948 F.2d 507, 516 (9th Cir. 1991):
Some statements, although literally accurate, can become, through their context and manner of presentation, devices which mislead investors. For that reason, the disclosure required by securities laws is measured not by literal truth, but by the ability of the material to accurately inform rather than mislead prospective buyers.