Bricklayers & Trowel Trades Int'l Pension Fund v. Credit Suisse Sec. (Usa) LLC

• Decision Date: 14 May 2014
• Docket Number: No. 12–1750.,12–1750.
• Citation: 752 F.3d 82
• Parties: BRICKLAYERS AND TROWEL TRADES INTERNATIONAL PENSION FUND, Plaintiff, Appellant, James Uphoff; Goodman Family Trust; Malka Birnbaum, on behalf of herself and all others similarly situated; Neil McCarty; Rodney W. Narbesky, individually and on behalf of all others similarly situated, Plaintiffs, v. CREDIT SUISSE SECURITIES (USA) LLC; Credit Suisse (USA), Inc.; Jamie Kiggen; Frank P. Quattrone; Laura Martin; Elliot Rogers, Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

752 F.3d 82

BRICKLAYERS AND TROWEL TRADES INTERNATIONAL PENSION FUND, Plaintiff, Appellant,James Uphoff; Goodman Family Trust; Malka Birnbaum, on behalf of herself and all others similarly situated; Neil McCarty; Rodney W. Narbesky, individually and on behalf of all others similarly situated, Plaintiffs,

v.CREDIT SUISSE SECURITIES (USA) LLC; Credit Suisse (USA), Inc.; Jamie Kiggen; Frank P. Quattrone; Laura Martin; Elliot Rogers, Defendants, Appellees.

No. 12–1750.

United States Court of Appeals, First Circuit.

May 14, 2014.

Frederic S. Fox, with whom Kaplan Fox & Kilsheimer LLP and Shapiro Haber & Urmy LLP were on brief, for appellant.

Lawrence Portnoy, with whom Daniel J. Schwartz, Jonathan K. Chang, Dharma Betancourt Frederick, Davis Polk & Wardwell LLP, Robert Buhlman, Siobhan E. Mee, Amanda V. Muller, and Bingham McCutchen LLP were on brief, for appellees.

Before HOWARD, Circuit Judge, SOUTER,^* Associate Justice and TORRESEN,^** District Judge.

HOWARD, Circuit Judge.

Alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act and of SEC Rule 10b5, the appellant pension fund and other America Online (“AOL”) shareholders brought this class action against Credit Suisse First Boston (“CSFB”), former CSFB analysts Jamie Kiggen and Laura Martin, and other related defendants. The shareholders claim that CSFB fraudulently withheld relevant information from the market in its reporting on the AOL–Time Warner merger, and that the shareholders purchased stock in the new company at prices that were artificially inflated as a result of the defendants' purposeful omissions. This appeal concerns the admissibility of the opinion of the shareholders' expert Dr. Scott D. Hakala, whose testimony the district court precluded for lack of reliability. We find no abuse of discretion in that decision. We also agree with the district court that, without the expert's testimony, the shareholders are unable to establish loss causation. Summary judgment was therefore properly awarded to the defendants.

I. Background

A. Facts

On January 11, 2001, Time Warner Inc. and AOL merged into a single media and technology company (hereinafter referred to as “AOL”). This marriage of “old” and “new” media received extensive coverage from both the press and the financial industry. CSFB was among the many financial firms reporting on AOL's business and forecasting its outlook for the future. Kiggen and Martin headed CSFB's AOL coverage beginning the day after the merger and continuing for about a year, through January 2002, when CSFB ceased covering AOL (Kiggen retired in January 2002; Martin had left CSFB a few months earlier). During the coverage period, CSFB published the results of its research in regular reports. These contained, in addition to observations about AOL, a buy or sell recommendation and a price target, which was a prediction of AOL's stock price twelve months hence. CSFB issued thirty-five such reports during this period, and each such report recommended buying AOL stock. CSFB initially targeted AOL's future stock price at $80, but revised it downwardly to $75 one month later in February 2001, and then to $45 in September 2001. Nine months later, AOL's stock was trading at $11 per share.

The shareholders allege that Kiggen and Martin misrepresented their true opinions in these reports, in order to maintain a good relationship with AOL. The shareholders' theory is that AOL had the potential to generate significant investment banking revenue for CSFB, and Kiggen and Martin overstated AOL's financial strength in the hopes of winning this future business (CSFB did in fact assist AOL in managing a bond deal purportedly generating between $750,000 and $820,000 in fees for CSFB). In a series of internal emails among AOL team members, Kiggen and Martin expressed doubts about their projections for AOL, yet decided not to lower their estimates for AOL's future performance notwithstanding these concerns. Moreover, they regularly showed their projections to AOL and revised them based on AOL's reactions. Even as advertising revenue, a key factor in AOL's success, declined throughout the industry, CSFB reports continued to predict AOL's ability to rise above the general slowdown.

In addition, the shareholders allege two instances in which CSFB ¹ received non-public, material information about AOL that CSFB did not disclose in its coverage of the company. On July 10 and 11, 2001, Anthony Lorenzo, a junior CSFB analyst not assigned to cover AOL, emailed to Kiggen information about AOL layoffs. Citing an unnamed source, Lorenzo wrote that AOL “apparently ... had some layoffs” that “were medium in terms of severity and will not be announced publicly.” The parties disagree over the import of this tip. The shareholders claim that the information pertained to layoffs of “up to 1,000 employees” subsequently reported in The Wall Street Journal and The Washington Post on August 13 and 14, 2001. CSFB counters that this unnamed source (later identified as a low-level employee in AOL's Interactive Marketing Group) was referring only to a small number of layoffs that occurred within the Interactive Marketing Group on July 10, 2001, as reported in The Washington Post the next day.

Lorenzo's emails also mentioned “that AOL was under investigation and has suspended some employees for inappropriate accounting activities—some deals booked inappropriately inflated revenue.” CSFB did not disclose this information in any of its reports; it was eventually reported by The Washington Post in a July 2002 article disclosing that AOL had engaged in “unconventional” advertising deals that might have inflated revenue. On July 24, 2002, AOL acknowledged that the SEC was investigating its accounting practices, but denied any wrongdoing.

B. Procedural History

On the basis of these alleged material misstatements and omissions—overstating AOL's financial strength, not disclosing reports of medium-severity layoffs, and not disclosing reports of unconventional accounting—the shareholders brought suit in December 2005 against Kiggen, Martin, and CSFB under Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and under SEC Rule 10b–5. The complaint also alleged that CSFB, Credit Suisse First Boston (USA) Inc. (CSFB's parent company), and CSFB executives Frank Quattrone and Elliot Rogers violated Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), by failing to exercise control over their employees' alleged misstatements and omissions.

In due course, the defendants sought summary judgment. At the hearing occasioned by that motion, the shareholders and the defendants each presented expert testimony to show the effect, or lack thereof, of CSFB's omissions on AOL stock prices. The shareholders retained Dr. Hakala, while CSFB employed Dr. René M. Stulz. Each side subsequently moved to exclude the other's expert opinion under Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 597, 113 S.Ct. 2786, 125 L.Ed.2d 469 (1993) (“[T]he Rules of Evidence—especially Rule 702—[ ] assign to the trial judge the task of ensuring that an expert's testimony both rests on a reliable foundation and is relevant to the task at hand.”). In due course, the court held a Daubert hearing to determine the admissibility of the proffered expert testimony on loss causation.

C. Event Studies and Expert Testimony

Loss causation is among the six elements of a private cause of action for securities fraud; the other five are: a material misrepresentation or omission, scienter, a connection with the purchase or sale of a security, reliance, and economic loss. Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341–42, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). To prove loss causation, a plaintiff “must show ‘a sufficient connection between [the fraudulent conduct] and the losses suffered....’ ” In re Omnicom Grp., Inc. Sec. Litig., 597 F.3d 501, 510 (2d Cir.2010) (quoting Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 157 (2d Cir.2007)) (alterations in original). In other words, the stock market must have reacted to the subsequent disclosure of the misconduct and not to a “tangle of [other] factors.” Dura Pharm., 544 U.S. at 343, 125 S.Ct. 1627.

The usual—it is fair to say “preferred”—method of proving loss causation in a securities fraud case is through an event study, in which an expert determines the extent to which the changes in the price of a security result from events such as disclosure of negative information about a company, and the extent to which those changes result from other factors.² First, the expert selects the period in which the event could have affected the market price.³ The expert then attempts to determine the effect on the share price of general market conditions, as opposed to company-specific events, using a multiple regression analysis, a statistical means for explaining the relationship between two or more variables. 1 David L. Faigman et al., Modern Scientific Evidence; The Law and Science of Expert Testimony 430 (2012). Thus, for any given day, the expert predicts the company's share price based on the market trends on that particular day. The expert then compares this predicted return with the actual return in the event window in order to determine the probability that an abnormal return of that magnitude could have occurred by chance. If this probability is small enough, the expert can reject the hypothesisthat normal market fluctuations, as opposed to company-specific events, can explain the movement in the share price.

Central to multiple regression analyses are variables, which, as the term implies, can have two or more possible values. Id. n. 1. Multiple regression includes a variable to be explained (the dependent variable) and explanatory (or independent) variables that have the potential to be associated with changes to the dependent variable. Id. at 430. (“[A] multiple regression analysis might estimate the effect of the number of years of work on...