In re Flag Telecom Holdings Securities Litigation

• Decision Date: 22 July 2009
• Docket Number: Docket No. 07-4025-cv (CON).,Docket No. 07-4017-cv (L).
• Citation: 574 F.3d 29
• Parties: In re FLAG TELECOM HOLDINGS, LTD. SECURITIES LITIGATION Peter T. Loftin, Norman H. Hunter, and Joseph Coughlin, individually and on behalf of all others similarly situated, Plaintiffs-Appellees, v. Andres Bande, Edward McCormack, Edward Mcquaid, Philip Seskin, Daniel Petri, Dr. Lim Lek Suan, Larry Bautista, and Citigroup Global Markets Inc., formerly known as Salomon Smith Barney Holdings Inc., Defendants-Appellants.
• Court: U.S. Court of Appeals — Second Circuit

574 F.3d 29

In re FLAG TELECOM HOLDINGS, LTD. SECURITIES LITIGATION Peter T. Loftin, Norman H. Hunter, and Joseph Coughlin, individually and on behalf of all others similarly situated, Plaintiffs-Appellees, v. Andres Bande, Edward McCormack, Edward Mcquaid, Philip Seskin, Daniel Petri, Dr. Lim Lek Suan, Larry Bautista, and Citigroup Global Markets Inc., formerly known as Salomon Smith Barney Holdings Inc., Defendants-Appellants.

Docket No. 07-4017-cv (L).

Docket No. 07-4025-cv (CON).

United States Court of Appeals, Second Circuit.

Argued: April 23, 2009.

Decided: July 22, 2009.

Arthur R. Miller, Milberg LLP, New York, NY, (Brad N. Friedman, Matthew A. Kupillas, and Arvind B. Khurana, on the brief) for Plaintiffs-Appellees.

Jerome S. Fortinsky, Sherman & Sterling LLP, New York, NY, (Daniel H.R. Laguardia and Jeffrey J. Resetarits, on

the brief) for Defendants-Appellants Andres Bande, Larry Bautista, Lim Lek Suan, Edward McCormack, Edward McQuaid, Daniel Petri, and Philip Seskin.

Douglas W. Henkin, Milbank Tweed Hadley & McCloy LLP, New York, NY, (James N. Benedict, C. Neil Gray, and Kevin M. Ashby, on the brief) for Defendant-Appellant Citigroup Global Markets, Inc.

Before: POOLER, HALL, Circuit Judges, and SWEET, District Judge.^*

SWEET, District Judge:

Defendants Andres Bande, Larry Bautista, Dr. Lim Lek Suan, Edward McCormack, Edward McQuaid, Daniel Petri, and Philip Seskin (the "Individual Defendants") and Citigroup Global Markets Inc. ("Citigroup") (collectively, the "Defendants") appeal from an order of the United States District Court for the Southern District of New York (Conner, J.) certifying the proposed class and appointing Peter T. Loftin, Norman H. Hunter and Joseph Coughlin ("Plaintiffs") to serve as class representatives and Milberg Weiss LLP to serve as class counsel.

This appeal raises issues implicating both the substance of the often overlapping requirements of typicality and adequacy laid out in Rule 23(a) of the Federal Rules of Civil Procedure and the correct standard of proof to be applied by courts in this context. We conclude that while the district court did not abuse its discretion in granting certification of a class encompassing members who allege claims under both the Securities Act of 1933 (the "'33 Act") and the Securities Exchange Act of 1934 (the "'34 Act"), it did err in certifying as members of the class those individuals who sold their stock prior to the February 13, 2002 close of the class period.

BACKGROUND

In February 2000, Flag Telecom Holdings, Ltd. ("Flag" or the "Company"), a self-described telecommunications "carriers' carrier" whose business involved the sale of access to its telecommunications network, offered its shares to the public in an initial public offering ("IPO"). See In re Flag Telecom Holdings, Ltd. Sec. Litig. ("In re Flag"), 245 F.R.D. 147, 151-52 (S.D.N.Y.2007). In the prospectus, which was incorporated into the registration statement filed with the U.S. Securities and Exchange Commission in connection with the IPO, Flag stated that it had obtained $600 million in bank financing and presales of $750 million to construct the Flag Atlantic-1 cable system (the "FA-1 system"), a fiber-optic submarine cable connecting Paris and London to New York.

According to Plaintiffs, despite an over-supply of fiber optic capacity in the market generally, Defendants made various misstatements and omissions in the prospectus and during the two years following the IPO, assuring investors that demand for Flag's cable remained strong. On February 13, 2002, the Company disclosed, inter alia, that approximately 14% of the Company's GAAP revenues for the year ending December 31, 2001, were associated with so-called "reciprocal transactions." Described by the lower court as "swaps of telecommunications capacity between competitors," reciprocal sales

may be entered into for legitimate reasons, i.e. to acquire access on networks in a market that a company wishes to enter in exchange for capacity that has yet to be sold and is not otherwise in use ("dark fiber") ... [or] can also be utilized by a company seeking to defraud investors or its creditors to create the impression that the company is selling capacity when it is merely unloading useless dark fiber on one of its networks in exchange for useless dark fiber on a competitor's network.

In re Flag Telecom Holdings, Ltd. Sec. Litig., 352 F.Supp.2d 429, 461 (S.D.N.Y. 2005). Following the announcement, Flag stock dropped 46% from its closing price on February 12, 2002, to $0.36 per share on February 13, 2002.

Shortly after, on April 1, 2002, Flag filed its 10-K report for fiscal year 2001, disclosing that the asset value of its FA-1 system was impaired and that it was forced to recognize an impairment charge of $359 million. On April 12, 2002, the Company filed its Chapter 11 bankruptcy petition. Before being canceled pursuant to Flag's court-approved Chapter 11 plan in September 2002, the Company's common stock was trading at $0.002 per share, having traded as low as $0.0001 per share during the bankruptcy.

The first of several securities class actions was filed against Defendants in connection with these events in April 2002. In October 2002, the Honorable William C. Conner consolidated several of the actions and appointed Loftin, who purchased approximately 1.7 million shares of Flag common stock between July 17, 2000, and September 22, 2000, Lead Plaintiff and Milberg Weiss Bershad Hynes & Lerach LLP Lead Counsel. Plaintiffs filed a Consolidated Amended Complaint on March 20, 2003, and a Second Consolidated Amended Complaint on December 1, 2003. Judge Conner dismissed the Second Consolidated Amended Complaint without prejudice, and a Third Consolidated Amended Complaint was filed on April 14, 2004, adding Hunter, who purchased 200 shares of Flag stock in the IPO, as a plaintiff.

Plaintiffs bring the instant action on behalf of those who purchased or otherwise acquired Flag common stock between February 11, 2000, and February 13, 2002 (the "Class Period") for violations of §§ 11, 12(a)(2), and 15 of the '33 Act (the "'33 Act Plaintiffs") and §§ 10(b) and 20(a) of the '34 Act and Rule 10b-5 promulgated thereunder (the "'34 Act Plaintiffs"). Plaintiffs allege that as a result of Defendants' materially false and misleading statements in the Company's registration statement, SEC filings, and press releases, the value of Flag stock was artificially inflated during the Class Period. Specifically, the '33 Act Plaintiffs allege that Defendants' statements in the prospectus regarding the FA-1 system and the $750 million in presales were misleading in that certain of the presales were entered into to ensure financing and did not accurately represent profit or demand.¹ The '34 Act Plaintiffs allege that the Individual Defendants made false and misleading statements regarding the Company's profitability, most notably by falsely reporting the types of reciprocal sales described above.

In an Amended Opinion and Order dated January 23, 2006, Judge Conner denied Defendants' motion to dismiss, holding that Defendants had not satisfied their burden to establish negative causation with respect to the '33 Act Plaintiffs' claims as required by 15 U.S.C. §§ 77k(e) and 77l(b). See In re Flag Telecom Holdings, Ltd. Sec. Litig., 411 F.Supp.2d 377, 383-84 (S.D.N.Y.2006). The district court rejected Defendants' argument that since the '33 Act Plaintiffs did not learn of the allegedly misleading pre-sale until after the November 2003 filing of a complaint in a related state court action,² at which time Flag common stock had been cancelled and was already worthless, none of the decline in the stock's value could be attributed to those misstatements. The court found that Defendants had not "demonstrate[d] that the decline was not due, at least in part, to the alleged misrepresentations concerning pre-sales in Flag's Prospectus, which presumably inflated the price level attained in the IPO and thereby heightened the loss when the price fell virtually to zero." Id. at 384. With the court's approval, Plaintiffs filed a Fourth Consolidated Amended Complaint on October 15, 2007.

In September 2007, the district court granted Plaintiffs' motion for certification pursuant to Fed.R.Civ.P. 23 and appointed Loftin, Hunter, and Coughlin³ class representatives and Milberg Weiss LLP class counsel. Judge Conner defined the certified class as follows:

All persons or entities who purchased common stock of Flag Telecom Holdings, Ltd. ("Flag" or the "Company") between March 6, 2000 and February 13, 2002, inclusive, as well as those who purchased Flag common stock pursuant to or traceable to the Company's initial public offering between February 11, 2000 and May 10, 2000, inclusive (collectively, the "Class Period"), but shall exclude: (1) defendants herein, members of each individual defendants' immediate family, any entity in which any defendant has a controlling interest, and the legal affiliates, representatives, heirs, controlling persons, successors and predecessors in interest or assigns of any such extended party; (2) Verizon Communications, Inc.; and (3) entities that had the right to appoint a director to Flag's Board of Directors and proceeded to make such an appointment (or, for reasons unique to them, chose not to exercise such right), such as Dallah Albaraka Holding Company, Telecom Asia Corporation Public Co. Ltd., Marubeni Corporation, the Asian Infrastructure Fund and Tyco International Ltd.

In re Flag, 245 F.R.D. at 174. In determining that Plaintiffs had established each of the Fed.R.Civ.P. Rule 23(a) and (b)(3) requirements, the lower court rejected several of Defendants' arguments now before us on appeal.

With respect to the typicality requirement of Rule 23(a)(3), Judge Conner concluded that "the typicality requirement is met because plaintiffs ... like the putative class members, will attempt to prove that they purchased Flag...