Desai v. Deutsche Bank Securities Ltd.

• Decision Date: 29 July 2009
• Docket Number: No. 08-55081.,08-55081.
• Citation: 573 F.3d 931
• Parties: Amish DESAI; Elizabeth Lamb; Therese Long; Christopher Long, Plaintiffs-Appellants, v. DEUTSCHE BANK SECURITIES LIMITED; Deutsche Bank Securities Inc.; Deutsche Bank AG, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

573 F.3d 931

Amish DESAI; Elizabeth Lamb; Therese Long; Christopher Long, Plaintiffs-Appellants, v. DEUTSCHE BANK SECURITIES LIMITED; Deutsche Bank Securities Inc.; Deutsche Bank AG, Defendants-Appellees.

No. 08-55081.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted May 7, 2009.

Filed July 29, 2009.

Joseph J. Tabacco, Jr., Berman, DeValerio, Pease, Tabacco Burt & Pucillo, San Francisco, CA, argued the cause for the appellants and was on the briefs. Nicole Lavallee, Berman, DeValerio, Pease, Tabacco, Burt & Pucillo, San Francisco, CA, filed briefs. James C. Magid, Berman, DeValerio, Pease, Tabacco, Burt & Pucillo, San Francisco, CA, and Ira M. Press, Kirby, McInerney LLP, New York, NY, were also on the briefs.

James H.R. Windels, Davis, Polk & Wardwell, New York, NY, argued the cause for the appellees and filed the brief.

Appeal from the United States District Court for the Central District of California, Stephen V. Wilson, District Judge, Presiding. D.C. No. CV-01-09024-SVW.

Before: JOHN T. NOONAN, DIARMUID F. O'SCANNLAIN, and SUSAN P. GRABER, Circuit Judges.

Per Curiam Opinion; Concurrence by Judge O'SCANNLAIN; Concurrence by Judge GRABER.

PER CURIAM:

We must decide whether a putative class can be certified in this securities fraud class action.

I

This appeal stages the last act of a long drama that followed the collapse of an elaborate stock manipulation scheme.

A

GenesisIntermedia, Inc. ("GENI") is a Delaware corporation with its registered address in California. Its stock once traded on the NASDAQ, but since late 2001 has traded over the counter but off the NASDAQ.¹ Turmoil in GENI's stock price began in the fall of 2001 and continued as the details emerged of what the plaintiffs allege was a sophisticated scheme to manipulate the price of the company's stock.

Appellants—Amish Desai, Christopher and Therese Long, and Elizabeth Lamb ("Investors")—allege that Deutsche Bank Securities Ltd. ("DBSL"), Deutsche Bank Securities, Inc., and Deutsche Bank AG (collectively, "Deutsche Bank"), through Wayne Breedon, a vice-president at DBSL, masterminded this stock price manipulation scheme.² Breedon and Deutsche Bank, however, played only one part in the plot that Investors allege. Some background, therefore, is necessary.

A common way to manipulate the market in a security is to cause its price to increase by creating the illusion of more investor interest than really exists. The manipulator acquires shares of the security before the price increase, then slowly sells them off and reaps the profit. The problem with this model, however, is that as the manipulator sells off his shares he depresses the price, which lessens his profit. Investors here allege a scheme that varied the theme in a way designed to cure this problem. It involved a commercial arrangement known as a securities loan.

In the typical securities loan, a brokerdealer lends securities to another brokerdealer, the loan being secured by cash collateral the borrower gives to the lender. See generally Stephenson v. Deutsche Bank AG, 282 F.Supp.2d 1032, 1044-45 (D.Minn.2003). The borrower of the security receives so-called rebate payments, which are like interest on the cash collateral he has transferred to the security lender.³ As the value of the security increases, the amount of cash collateral and the level of interest also increase. Adjustments— marking the securities to the market—are made daily.

According to Investors, a web of schemers (including several persons no longer defendants) used securities loans to profit contemporaneously with the inflation of GENI's stock price, rather than by selling the stock after the price rose (which would have depressed the price). It worked as follows.⁴

Officers of GENI first issued themselves unregistered shares of the company. Such shares may not be publicly traded, but the GENI officers loaned them to a brokerdealer called Native Nations Securities, Inc., receiving cash collateral in return. Richard Evangelista, an employee of Native Nations and apparently a longtime associate of Breedon, falsified the records of his employer to make it look like the GENI shares had come from other brokerdealers. Native Nations then lent the shares (cash collateral coming back) to Deutsche Bank. Breedon was in charge of this account, which continued to absorb unregistered shares of GENI stock. Eventually, Breedon and his associates at GENI developed a chain of broker-dealers that came between Native Nations and Deutsche Bank in order to increase the amount of capital for the scheme and to insulate Deutsche Bank from any fallout should the scheme collapse.

The GENI officers used the cash collateral to day-trade in GENI's publicly traded shares. This created the appearance of investor demand. That appearance inflated the stock price, which in turn required the borrowers of GENI stock, from Native Nations to Deutsche Bank, to provide more cash collateral to feed the cycle. It also increased the rebate payments to the borrowers, from Native Nations down the line to Deutsche Bank. It seems Deutsche Bank gained the most from the rebate payments, however, because the intermediary broker-dealers in the chain paid out a percentage of the rebates they received to the next party in the chain. Deutsche Bank, being the last in line, did not have to do that.

To ensure that GENI's price kept climbing, Breedon and his associates at GENI allegedly paid off two stock analysts to recommend GENI stock in order to drum up demand. One of the analysts was Courtney Smith, a one-time defendant in this litigation; the Longs claim that they purchased GENI stock in February of 2000 on the basis of Smith's bogus recommendations. The secret deal between GENI and Smith later came to light in the news media.

As the district court put it, this scheme solved the classic problem of market manipulators everywhere: it allowed them to profit from fraudulently inflating a stock's price without having to sell the shares.

By September 11, 2001, the scheme had driven GENI's stock price from $12 per share to over $52 per share. The terrorist attacks that day stopped all trading in the markets until September 17. When trading resumed, the share price fell dramatically for reasons that are unclear. By September 25, GENI stock was down to $9 per share, at which point trading in the stock was suspended. GENI delisted its stock from NASDAQ soon after; it now trades for pennies.

As the price collapsed in September of 2001, borrowers of the stock, starting with Deutsche Bank, demanded their cash collateral back. The cash calls went up the chain to Native Nations. Though Deutsche Bank was able to recover nearly all the collateral it had pledged, the intermediary broker-dealers were not so lucky. GENI had spent the cash collateral, so it could not return it to Native Nations, which left the broker-dealer, and many of the other broker-dealers between it and Deutsche Bank, insolvent. Thus, Deutsche Bank had profited through the rebate payments it received, but it had managed to recover almost of all the cash collateral it had advanced.

B

Investors seek to represent a class of people who bought GENI stock in the putative class period, which is December 21, 1999, to September 25, 2001. They sue under §§ 10(b) and 20(a) of the Securities Exchange Act of 1934 ("the 1934 Act"), codified at 15 U.S.C. §§ 78j(b) and 78t(a), respectively. Desai, the lead plaintiff, purchased 50,000 shares on the last day of the period. Lamb bought 100 shares on September 20, 2001. The Longs, as mentioned, bought their 100 shares in February of 2000 after seeing analyst Courtney Smith's recommendations on television.

This case began over seven years ago, but it remains at the class certification stage. In October of 2001, several parties, Desai apparently among them, filed putative class actions in United States District Court for the Central District of California, Judge Stephen V. Wilson presiding. Originally, they alleged that GENI, its officers, and their associates had made misrepresentations to the public or paid others to do so to inflate the price of GENI stock. Deutsche Bank was not named a defendant.

After some preliminary wrangling over who would be the lead plaintiff, the California district court appointed Horizon International LLC, an institutional investor, and Desai as lead plaintiffs. When the Third Amended Complaint, on which the two district court opinions relevant to this appeal are based, was filed, Desai and Horizon were the only representative plaintiffs.

In June of 2003, the California district court transferred the case to the United States District Court for the District of Minnesota, where related proceedings were pending in the bankruptcy of MJK Clearing Inc., one of the unfortunate broker-dealers in the chain between Deutsche Bank and GENI. See In re GenesisIntermedia, Inc. Sec. Litig., 232 F.R.D. 321 (D.Minn.2005). Investors' counsel added Lamb and the Longs as class representatives, and Horizon withdrew as lead plaintiff. Then Investors moved for certification of the class pursuant to Federal Rule of Civil Procedure 23(b)(3). In December of 2005, the Minnesota district court denied the motion. The Eighth Circuit denied Investors' petition for interlocutory appeal, and the Minnesota district court transferred the case back to Judge Wilson in California.

In March of 2006, the case was reopened in the Central District of California. A little more than two months later, the district court allowed Investors to renew their motion for class certification. Judge Wilson ultimately denied the motion one day after Investors filed a Fourth Amended Complaint. The district court's order denying the motion therefore assumes that the Third Amended Complaint is the operative complaint, although it was aware that the Longs and Lamb had been added as representative plaintiffs.⁵ After that, default judgment was entered against some of the...