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June 28, 2001


The opinion of the court was delivered by: Orrick, District Judge.


In these thirty-two private plaintiff class actions ("these actions"), certain shareholders of Critical Path, Inc. ("Critical Path") have brought suits charging Critical Path and various of its officers and directors and its outside auditor, PricewaterhouseCoopers, with having disseminated materially misleading information concerning the company's future profitability during a period commencing July 2000 and continuing until February 2001, and with other acts all in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 of the Securities and Exchange Commission.

The complaints in these actions assert substantially the same claims arising under the Securities Exchange Act of 1934. Three parties*fn1 have sought to consolidate these actions for all purposes. The Court has so ordered. Copies of the orders of consolidation heretofore filed, are hereto annexed as Exhibits A and B, respectively.

Having made the decision on the motions to consolidate, the Court now considers motions made by purported class members to be appointed lead plaintiff. Preliminarily, it is appropriate to summarize the facts as they are alleged in Cohn v. Critical Path, No. C-01-0551 WHO, which is the first-filed action.

Critical Path is in the business of providing end-to-end Internet messaging and collaboration solutions for, among others, internet service providers, web portals, and web hosting companies. (Compl. ¶ 2.) It went public in March 1999, and its stock rose 174 percent on the first day of trading. (Id. ¶ 15.) Although the NASDAQ suffered a sharp decline in mid-April 2000, Critical Path's stock recovered by September 2000. (Id.) Critical Path's customers were in financial trouble by September 2000, and the company knew that many of its customers were cutting costs in a way that would negatively impact Critical Path's bottom line. (Id. ¶ 16.) Nevertheless, the officers of Critical Path allegedly disseminated materially misleading information, which generally consisted of optimistic predictions by Critical Path executives about the company's future profitability, during a period beginning in July 2000, and continuing until February 2001. (See, e.g., id. ¶¶ 20, 23-25, 34, 37, 46.)

Defendants David Hayden and David Thatcher sold thousands of shares of the company's stock. (See, e.g., id. ¶¶ 27-28, 32-33.) On October 19, 2001, Critical Path reported record financial results for the quarter ending September 30, 2000. (Id. ¶ 34.) Critical Path leadership subsequently continued to predict an increase in revenue for the fourth quarter of 2000, but on January 18, 2001, revealed that revenues had in fact declined. (Id. ¶¶ 39, 42.) In response to this disclosure, analysts downgraded their recommendations with respect to the stock, and the stock price sharply declined, trading at a record volume of more than 29 million shares. (Id. ¶¶ 43-44.) On February 2, 2001, Critical Path issued a press release stating that it had initiated an investigation into its revenue recognition practices, believed that the results for fourth quarter 2000 may have been materially misstated, and had placed its President, David Thatcher, and Vice-President of worldwide sales, William Rinehart, on administrative leave. (Id. ¶¶ 46-47.) Following the issue of this press release, Critical Path's stock price plummeted nearly 60 percent. (Id. ¶ 48.)

Based upon these facts and a review of the complaints filed in these actions, it is appropriate for the Court to determine the class period, for the purposes of these motions only.

The Court has three options. It may select only the class period alleged in the first-filed complaint, namely, June 15, 2000, through February 1, 2001, or it may select only the period of time between specific alleged misrepresentations, or it may and does select as inclusive a class period as the complaints on file suggest exists, namely, October 20, 2000, through February 1, 2001.

The Court now turns to a discussion of the main statutory requirements to be considered in connection with appointing a lead plaintiff, namely, the prospective lead plaintiffs financial interest in the recovery sought by the class, and the prospective lead plaintiff's ability to satisfy the requirements of typicality and adequacy set forth in Rule 23 of the Federal Rules of Civil Procedure.

The PSLRA requires each prospective lead plaintiff to submit a certification that he did not purchase the shares in Critical Path to participate in this action, that he is willing to serve as a representative party, and that he will not accept any payment beyond his pro rata share of the recovery. See 15 U.S.C. § 78u-4 (a)(2). The certification must also set forth all of [his] transactions in Critical Path shares during the class period, and identify any other private securities class action "filed during the three-year period preceding the date on which the certification is signed by [him]" in which he has sought to serve as lead plaintiff. See id. The Court finds that each prospective lead plaintiff here has filed a sworn certification that satisfies this requirement of the PSLRA.

The PSLRA sets forth a rebuttable presumption that the "most adequate plaintiff," i.e., the one who is to be selected as lead plaintiff, is the one who:

(aa) has either filed the complaint or made a motion in response to a notice under subparagraph (A)(i);
(bb) in the determination of the court, has the largest financial interest in the relief sought by the class; and
(cc) otherwise satisfies the requirements of Rule 23 of the Federal Rules of Civil Procedure.

15 U.S.C. § 78u-4 (a)(3)(B)(iii)(I).

This presumption

may be rebutted only by proof by a member of the purported plaintiff class that the presumptively most adequate plaintiff —
(aa) will not fairly and adequately protect the interests of the class; or
(bb) is subject to unique defenses that render such plaintiff incapable of inadequately representing the class.

15 U.S.C. § 78u-4 (a)(3)(B)(iii)(II).

There are two approaches to the determination of who has the "largest financial interest." The first looks to four factors:

(1) The number of shares purchased;

(2) the number of net shares purchased;

(3) the total net funds expended by the plaintiffs during the class period; and
(4) the approximate losses suffered by the plaintiffs.

In re Milestone Scientific Sec. Litig., 183 F.R.D. 404, 413 (D.N.J. 1998); see also In re Olsten Corp. Sec. Litig., 3 F. Supp.2d 286, 295 (E.D.N.Y. 1998).

Finally, although the statute limits the frequency with which one may serve as lead plaintiff, it gives the Court discretion to avoid the prohibition by appointing a person as a lead plaintiff who may have served as such in securities class actions more than five times in the last three years if, in the Court's opinion, the appointment is consistent with the purposes of the statute. The statute provides that except "as the Court may otherwise permit, consistent with the purposes of this section, a person may be a lead plaintiff, or an officer, director, or fiduciary of a lead plaintiff, in no more than 5 securities class actions brought as plaintiff class actions pursuant to the Federal Rules of Civil Procedure during any 3-year period." 15 U.S.C. § 78u-4 (a)(3)(B)(vi). As is clear from the text of the statute, the Court has discretion to permit a suitable lead plaintiff to serve as such in more than five securities class actions during a three-year period.

In these cases, six purported class members have made motions to be appointed lead plaintiff. The moving parties are the Florida State Group, the Thomson-CSF Group, the Hall Family, Columbus Capital Partners L.P. ("Columbus Capital"), Sambasiba Avirneni ("Avirneni"), and the Carly Plaintiffs.

The Florida State Group consists of the Florida State Board of Administration ("FSBA") and David Lewis ("Lewis"). The FSBA is "an entity with constitutional and statutory authority under Florida law for the investment and re-investment of the Florida Retirement System Trust Funds for the benefit of the employees of the State of Florida." (FSBA Mot. at 5:19-21.) It has over $100 billion under management. The FSBA avers, through its in-house counsel, Horace Schow II ("Schow"), that it is experienced in securities litigation and is committed to the vigorous prosecution of this action. (Pucillo Aff. in Supp. of FSBA Mot. Ex. A, Schow Aff. ¶ 5.) The FSBA purchased 64,000 shares on the open market, and sold none, during the class period. It alleges losses of $2,352,013.

Lewis moves on behalf of the Lewis Family as part of the Florida State Group. The Lewis Family claims that it lost over $1.9 million as a result of the alleged fraud. Lewis claims this comprised a "very substantial portion" of the family's net worth. He purchased 110,200 shares, and sold 81,800, during the class period, and alleges losses of $1,892,881.

Columbus Capital is an investment fund based in San Francisco. It purchased 410,000 shares (20,000 of which were purchased to cover a short position), and sold 140,000 shares (20,000 of which were sold short), during the class period. It alleges net losses in excess of $1.8 million.

The Hall Family is comprised of Ashley Jay Hall, and his parents, Lester Hall and Joyce Hall. The three members of the Hall Family acquired 253,407 shares of Critical Path in exchange for shares in PeerLogic on September 25, 2000, and did not sell any shares during the class period. The Hall Family alleges losses of $15,850,000.

The Carly Plaintiffs are comprised of Mr. and Mrs. Dan and Geraldine Carly (the "Carlys"), and Dennis Swing ("Swing").*fn2 The Carlys acquired 458 shares, and sold 104, during the class period, and allege losses of approximately $12,000. Swing acquired 3,400 shares, and sold none, during the class period. He alleges losses of slightly more than $200,000.

Avirneni acquired 150 shares of Critical Path on January 18, 2001, and sold none during the class period. He alleges losses of $2,400.

Two of these motions may be quickly resolved. Neither Avirneni nor the Carly Plaintiffs have the largest financial interest.

The Carly Plaintiffs allege more substantial losses, and Geraldine Carly alleges losses of nearly all of her net worth. Mrs. Carly contends that the fact that she lost a high percentage of her net worth supports a finding that she has the largest financial interest in the relief sought by the class. The Court rejects this proportional approach to financial interest for two reasons. First, such an approach would undercut the PSLRA's goal of increasing the appointment of institutional investors as lead plaintiffs. This is because a large numerical loss suffered by an institutional investor is likely to be a smaller percentage of the institution's assets under management than a smaller loss suffered by an individual investor would be of that investor's assets. Second, while it may be true that losing a high percentage of one's net worth due to an alleged fraud contributes to one's desire to prosecute a lawsuit against the wrongdoer, that desire is no substitute for the experience and resources of an institutional investor with, presumably, an in-house legal team and experience in the securities business.

Columbus Capital alleges losses that would make it an acceptable lead plaintiff if others with higher losses were found unsuitable under the Rule 23 inquiry conducted at this stage, but is not a suitable lead plaintiff for another reason. In January 2001, Columbus Capital sold short 20,000 shares of Critical Path. Short-selling is an investment strategy the success of which is premised on a drop in stock price. In In re Bank One Shareholders Class Actions, 96 F. Supp.2d 780 (N.D.Ill. 2000), the court rejected a hedge fund because of a similar trading pattern. See id. at 783. It is a poor choice to appoint a class representative who engaged in a trading practice premised on the belief the stock would fall. The fraud-on-the-market theory, the premise of which is that the market price accurately reflects publicly available information, is central to securities actions. See Basic, Inc. V. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). Short sales raise the question of whether the seller was actually relying on the market price, and the class is not served by its representative coming under such scrutiny. But cf. Danis v. USN Communications, Inc., 189 F.R.D. 391, 396 (N.D.Ill. 1999) (rejecting challenge to class representative's typicality based on short sales, because class representative also lost money on long positions; acknowledging that short selling may be inconsistent with fraud-on-the market theory).

This leaves the FSBA Group, the Thomson-CSF Group, and the Hall Family as possible lead plaintiffs.

Even assuming that the Hall Family has the largest financial interest (there is considerable disagreement between it and the Thomson-CSF Group as to the proper calculation of damages), the Hall Family is not adequate because of the manner in which it acquired its shares, which was the apparently privately negotiated acquisition of PeerLogic. The Hall Family, in an effort to demonstrate its suitability for the position of lead plaintiff, has submitted a declaration stating that it "did not rely on non-public information in making the decision to exchange [its] PeerLogic shares for Critical Path shares. Rather, [its] investment decision was based upon publicly available information that was known to the entire market." (Supp. Joint Decl. of Ashley Jay Hall, Joyce Hall, and Lester Hall in Supp. of Mot. at ¶ 8.) The Hall Family does not elaborate on the information upon which it relied. It claims it is a typical class member on the theory that a searching inquiry under Rule 23 is not appropriate at this stage in the litigation. It contends that its declaration is, therefore, sufficient to entitle it to the presumption that it is the "most adequate plaintiff," citing Gluck, v. CellStar Corp., 976 F. Supp. 542 (N.D.Tex. 1997), for the proposition that the possibility that a prospective lead plaintiff otherwise entitled to the presumption that it is "most adequate" may be subject to unique defenses later in the litigation does not rebut the presumption.

The Court declines to follow Gluck, and considers instead that the concerns raised by a private transaction are appropriately addressed at this stage. See, e.g., Network Assocs., 76 F. Supp.2d at 1030. The fact that a searching inquiry under Rule 23 is not required at this stage of the litigation does not mean that the Court must pay mere lip service to the requirement of the statute that a prospective lead plaintiff "satisfi[y] the requirements of Rule 23." See 15 U.S.C. ยง 78u-4 (a)(3)(b)(iii)(I)(cc). The doctrine against conducting a searching inquiry under Rule 23 at this stage is best understood as a means of speeding the litigation along, and thus encouraging efficiency, rather than a means of avoiding problems that may affect the class later on in the lawsuit. Refusing to conduct a thorough Rule 23 inquiry for the latter reason is contrary to the interests of the class. The Court, in determining whether a prospective lead plaintiff has made a prima facie showing of typicality and adequacy, must be mindful that it is protecting the interests of the class. The Hall Family's conclusory statement that it did not rely on nonpublic information, made without elaboration and buttressed by insistence that the Court conduct only a cursory Rule 23 examination, fails to satisfy the Court. Appointing as lead ...

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