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        Max W. Berger, John P. Coffey, Bernstein Litowitz Berger & Grossman LLP, New York City, Leonard Barrack, Gerald J. Rodos, Jeffrey W. Golan, Barrack Rodos Bacine, Philadelphia, PA, for Lead Plaintiff in the Securities Litigation.

        David Wertheimer, Lyndon Tretter, Hogan & Hartson, New York City, for Defendant Bernard J. Ebbers.

        Juliet Rotenberg, Arnold & Porter, Washington, DC, for Defendant Scott Sullivan.

        N. Richard Janis, S. Robert Sutton, Janis Schuelke & Wechsler, Washington, DC, for Defendant David F. Myers.

        Lisa F. Fishberg, David Schertler, Coburn & Schertler, Washington, DC, for Defendant Buford Yates, Jr.

        Paul Curnin, Simpson Thacher & Bartlett, New York City, for Director Defendants.

        Jay B. Kasner, John Gardner, Skadden Arps Slate Meagher & Flom LLP, New York City, for Underwriter Defendants.

        Eliot Lauer, Curtis Mallot Prevost Colt & Mosley LLP, New York City, for Defendants Arthur Andersen LLP, Melvin Dick and Mark Schoppet.

        William R. Maguire, Derek J.T. Adler, Sarah K. Loomis, Hughes Hubbard & Reed LLP, New York City, for Defendant Andersen UK.

        James J. Sabella, Sidley Austin Brown & Wood, New York City, William F. Lloyd, Jeffrey R. Tone, David A. Gordon, Sidley Austin Brown & Wood, Chicago, IL, for Defendant Andersen Worldwide Societe Cooperative.

        Martin London, Richard A. Rosen, Paul Weiss Rifkind Wharton & Garrison, New York City, for Defendants Salomon Smith Barney, Inc., Citigroup Inc., and Jack Grubman.

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        COTE, District Judge.

        WorldCom, Inc. ("WorldCom"), once a giant of the telecommunications industry, is now the subject of colossal litigation. On July 21, 2002, WorldCom filed the largest bankruptcy in United States history. WorldCom executives have pleaded guilty to violating the securities laws; WorldCom's stock and bondholders, including numerous state and private pension funds, have lost hundreds of millions of dollars in investments; state and federal governments have conducted investigations into WorldCom's ascent and collapse; and those associated with the company have been sued in venues across the country. This Opinion addresses the motions to dismiss the consolidated class action complaint filed in the multi-district securities litigation.

        Plaintiffs contend that WorldCom officers, directors, auditors, underwriting syndicates, and its most influential outside analyst disseminated materially false and misleading information. The false information appeared in analyst reports, press releases, public statements, and filings with the Securities and Exchange Commission ("SEC") from April 1999 through May 2002, including registration statements issued in conjunction with WorldCom's May 2000 note offering ("2000 Offering") and May 2001 note offering ("2001 Offering," together the "Offerings"). Plaintiffs allege that as WorldCom faced growing pressure to satisfy increasingly unrealistic earnings expectations, the company engaged in a series of illegitimate accounting strategies in order to hide losses and inflate reported earnings. By concealing losses to exaggerate reported earnings, plaintiffs argue, WorldCom affected the price of its securities and misled investors regarding the true value of the company.¹

        On April 30, 2002, the first securities class action in connection with these events was filed in this district. At least twenty related class actions had been filed here by the end of the summer. By Order dated August 15, 2002, the actions were consolidated under the caption In re WorldCom, Inc. Securities Litigation ("Securities Litigation"). The New York State Common Retirement Fund ("NYSCRF") was appointed lead plaintiff, and filed a Consolidated Amended Complaint on October 11 ("Complaint") adding three more named plaintiffs. Plaintiffs filed suit on their own behalf and as a class action on behalf of all persons and entities who purchased or acquired publicly traded WorldCom securities between April 29, 1999 and June 25, 2002, including those who acquired shares of common stock in the secondary market or in exchange for shares of acquired companies pursuant to a registration statement,

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and those who acquired WorldCom debt securities in the secondary market or pursuant to a registration statement. Plaintiffs allege violations of Sections 11, 12 and 15 of the Securities Act of 1933 ("Securities Act") and of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 promulgated thereunder.

        Drawing from the allegations in the Complaint, Part I of this Opinion identifies the parties and Part II describes the alleged fraud. Part III describes the legal standards that apply to the motions to dismiss. Part IV addresses the merits of each defendant's motion.² The defendants' motions are addressed in the following order: (1) Bernard J. Ebbers; (2) directors; (3) underwriters; (4) Jack Grubman, Salomon Smith Barney, and Citigroup, Inc.

        The Complaint is lengthy and detailed. The descriptions that follow summarize the allegations that are most relevant to the motions addressed in this Opinion.

        I. The Parties

        A. Plaintiffs

        Lead Plaintiff

        NYSCRF invests the assets of the New York State and Local Employees' Retirement System and the New York State and Local Police and Fire Retirement System and is the second largest public pension fund in the United States. During the class period, NYSCRF purchased WorldCom stock and WorldCom MCI tracking stock, and lost over $300 million in its investments.

        Additional Named Plaintiffs

        Three entities have joined the action as named plaintiffs. The Fresno County Employees Retirement Association ("FCERA"), a California entity, purchased WorldCom stock and debt, including at least $3 million of notes offered in WorldCom's 2001 Offering. The County of Fresno, California ("Fresno") purchased over $6 million of notes in WorldCom's 2000 Offering. HGK Asset Management ("HGK") is a registered investment advisor and acts on the behalf of union-sponsored pension and benefit plan clients pursuant to ERISA, 29 U.S.C. § 1001 et seq. During the relevant period, HGK purchased nearly $130 million of WorldCom debt securities, including approximately $43 million of notes in the 2000 Offering and over $29 million of notes in the 2001 Offering.

        B. Defendants

        WorldCom Executives

        Four of WorldCom's former executive officers are named as defendants. Bernard J. Ebbers ("Ebbers") was the President, Chief Executive Officer and a WorldCom Director during the class period. He resigned from the company under pressure on April 29, 2002. Ebbers has not been indicted on criminal charges relating to WorldCom. The Complaint pleads claims under Sections 11, 15, 10(b), and 20(a) against Ebbers (Counts I, II, VI, and VII). Ebbers moves to dismiss all claims against him.

        Scott D. Sullivan ("Sullivan") was WorldCom's Chief Financial Officer and a Director during the class period. After Ebbers's resignation, Sullivan served as Executive Vice President from April 30, 2002 until June 25, 2002, when WorldCom terminated his employment. In a criminal complaint dated July 31, 2002, Sullivan was charged with felonies in connection with his activities at WorldCom, including

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securities fraud, conspiracy to commit securities fraud and making false filings with the SEC. He was arrested on August 1, and indicted on August 28, 2002. The Complaint pleads Section 11, 15, 10(b), and 20(a) claims against Sullivan.³

        David F. Myers ("Myers") was WorldCom's Controller and a Senior Vice President. He resigned from the company on June 25, 2002. On September 26, 2002, Myers pleaded guilty to charges of conspiracy, securities fraud, and the filing of false documents with the SEC. The Complaint pleads Sections 15, 10(b), and 20(a) claims against Myers.⁴

        Buford Yates, Jr. ("Yates") was WorldCom's Director of General Accounting. On October 7, 2002, Yates pleaded guilty to securities fraud and conspiracy to commit securities fraud. The Complaint pleads Sections 15, 10(b), and 20(a) claims against Yates.⁵

        WorldCom Directors

        The WorldCom Directors consist of Clifford Alexander, Jr., James C. Allen, Judith Areen, Carl J. Aycock, Max E. Bobbitt, Francesco Galesi, Stiles A. Kellett, Jr., Gordon S. Macklin, John A. Porter, Bert C. Roberts, Jr., John W. Sidgmore, and Lawrence C. Tucker ("Director Defendants").⁶ The Complaint pleads Section 11, 15, and 20(a) claims against all Director Defendants. All Director Defendants move to dismiss the Sections 15 and 20(a) claims (Counts II and VII); none have moved to dismiss the Section 11 claim (Count I).

        Director Defendants Allen, Areen, and Galesi were members of the Audit Committee of the Board, and Bobbitt its Chair, during the class period ("Audit Committee Defendants"). Count VI pleads a Section 10(b) claim against the Audit Committee Defendants. They move to dismiss the claim.

        Director Defendant Kellett was the Chairman of the Compensation Committee of WorldCom's Board. Count VI pleads a Section 10(b) claim against Kellett. He moves to dismiss this claim.

        Accountants and Auditors

        The Complaint pleads claims against WorldCom's outside auditors and accountants, Arthur Andersen LLP, Andersen UK, Andersen Worldwide SC, and Andersen partners Mark Schoppet and Melvin Dick ("Andersen Defendants"). Plaintiffs claim that the Andersen Defendants are liable for violations of Sections 11 and 10(b) (Counts III and XIII).

        Underwriters

        The Complaint pleads Sections 11 and 12(a)(2) claims against underwriters consisting of Salomon Smith Barney, Inc. ("SSB"), J.P. Morgan Chase & Co., Banc of America Securities LLC, Deutsche Bank Securities Inc., now known as Deutsche Bank Alex. Brown Inc., Chase Securities Inc., Lehman Brothers Inc., Blaylock & Partners L.P., Credit Suisse First Boston Corp., Goldman, Sachs & Co., UBS Warburg LLC, ABN/AMNRO Inc., Utendahl Capital, Tokyo-Mitsubishi International plc, Westdeutsche Landesbank Girozentrale, BNP Paribas Securities Corp., Caboto Holding SIM S.p.A., Fleet Securities, Inc., and Mizuho International

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plc ("Underwriter Defendants"). The Underwriter Defendants move to dismiss both claims against them (Counts IV and V).

        The allegations against the Underwriter Defendants arise from two bond offerings made by WorldCom: the 2000 and 2001 Offerings. SSB and J.P. Morgan served as lead managers of the 2000 Offering. Banc of America, Chase, Deutsche Bank, Lehman Brothers, Blaylock, Credit Suisse, Goldman Sachs, and UBS Warburg joined in underwriting the $5 billion 2000 Offering. The registration statements and prospectus documents filed in connection with the offering ("2000 Registration Statement") are alleged to have included WorldCom's materially false financial statements for 1999 and to have incorporated by reference other SEC filings for WorldCom that contained materially false information.

        SSB was the lead underwriter for the 2001 Offering. Together with J.P. Morgan, Banc of America, Deutsche Bank, Blaylock, Mitsubishi, Westdeutsche, BNP Paribas, Blaylock, Caboto, Mitzuho, ABN/AMNRO Inc., Utendahl and Fleet Securities, Inc. they underwrote the $11.8 billion 2001 Offering. The documents alleged to have constituted the May 2001 registration statement ("2001 Registration Statement," together with the 2000 Registration Statement, "Registration Statements") contained false and misleading financial information for WorldCom for the years 1999 and 2000, and incorporated by reference other SEC filings with false information about WorldCom's finances.

        Citigroup, Inc. SSB, and Jack Grubman

        The Complaint pleads claims against Citigroup, Inc. ("Citigroup"), a financial services company; SSB, a Citigroup subsidiary; and Jack Grubman ("Grubman"), the high-profile SSB telecommunications analyst (together "SSB Defendants"). In addition to the two claims in Counts IV and V against SSB as one of the Underwriter Defendants, the Complaint alleges that SSB and Grubman violated Section 10(b) in connection with the 2000 and 2001 Offerings (Count IX), and, in a separate Count, in connection with Grubman's analyst reports (Count X). The Complaint also pleads a controlling person claim pursuant to Section 20(a) against SSB and Citigroup for Grubman's analyst reports (Count XI). Citigroup, SSB and Grubman move to dismiss all counts against them.

        II. The Fraud

        For many years, WorldCom grew by acquisitions. By 1998, it had acquired more than sixty companies in transactions valued at over $70 billion. Its largest acquisition was of MCI on September 14, 1998, a transaction valued at $40 billion. In early 2000, however, its attempt to acquire Sprint collapsed. During this period of acquisition-driven expansion, WorldCom had used accounting devices to inflate its reported earnings. Senior WorldCom management instructed personnel in the company's controller's office on a quarterly basis to falsify WorldCom's books to reduce WorldCom's reported costs and thereby to increase its reported earnings. When the pace of acquisitions slowed, it added new strategies to disguise a decline in its revenues. In 2002, however, the scheme collapsed.

        On June 25, 2002, WorldCom announced that it had improperly treated more than $3.8 billion in ordinary costs as capital expenditures in violation of generally accepted accounting principles ("GAAP") and would have to restate its publicly-reported financial results for 2001 and the first quarter of 2002. WorldCom later announced that its reported earnings for 1999 through the first quarter of 2002 had been affected by manipulation of various reserves and had overstated earnings by

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$3.3 billion. WorldCom also announced that it would likely write off goodwill of $50 billion. The impact of those disclosures on the price of WorldCom shares and the value of its notes was catastrophic. Its common stock dropped from a high of $65 per share to pennies.

        A. Accounting Irregularities

        WorldCom manipulated its books in two main areas: (1) its charges to income and classification of assets in connection with acquisitions, and (2) its accounting for "line" costs. In each of these areas, WorldCom failed to follow GAAP, and instead freely reworked its numbers in order to meet marketplace earnings projections.

        1. Acquisitions

        Part of the acquisition process involves identifying costs incurred in connection with each merger and taking corresponding charges to income. WorldCom improperly recorded expenses at the time of the acquisition that should not have been included. The effect was to inflate earnings in later periods when the expenses were actually incurred and should have been recorded.

        In addition, at the time of acquisitions, WorldCom took overly large and unjustified charges to income, creating inflated merger reserves that it would later tap into when it needed to do so to boost reported earnings. Enormous charges were typical of the mergers and acquisitions in the 1990s and "WorldCom and its senior officers knew that Wall Street would not be concerned with the size of the charges."

        WorldCom used the acquisition of MCI in particular to manipulate its earnings statements by improperly classifying the assets it obtained. WorldCom understated the book value of MCI's property, plant and equipment assets and overstated the value of the goodwill acquired. By classifying MCI's value in terms of a slowly depreciating asset like goodwill rather than hard assets, which depreciate in one-tenth of the time, WorldCom improperly inflated its earnings during the years immediately following the MCI acquisition.

        2. Line Costs

        With a decline in its revenue, and further prompted by the failure of its attempt to acquire Sprint, WorldCom began a new accounting fraud, no later than 2000, in connection with its single largest operating expense: line costs. WorldCom had entered into long-term lease agreements with other telecommunications companies for the use of their networks. Pursuant to these leases, WorldCom was obligated to make fixed monthly payments for the use of the networks, or lines, regardless of whether WorldCom or its customers in fact used the leased lines. When demand did not grow as WorldCom had hoped, the company found itself with substantial fixed line costs for networks that were not generating any income.

        Under GAAP, line costs must be reported as an expense. In October 2000, and without any justification in fact or under GAAP, Sullivan instructed Yates, Myers and others in WorldCom's accounting department to make journal entries crediting WorldCom's line cost expense accounts, and instructed Myers and others to make corresponding reductions in various reserve accounts so that the general ledger would balance.

        In 2001, WorldCom changed its method for disguising the impact of line costs on its revenues. Sullivan directed that line costs simply be reclassified as capital expenditures that could be depreciated over time. The effect of the reclassification was to inflate WorldCom's reported earnings.

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        B. The Defendants

        Bernard J. Ebbers

        Ebbers's position in the company, his statements, his close relationship with Sullivan, his reputation for acting as a "hands on" manager, the size of the fraud, and certain decisions he made regarding WorldCom's internal audit department provide evidence that Ebbers was aware of WorldCom's fraudulent accounting practices. Key allegations include the following.

        WorldCom's General Counsel has admitted that Sullivan informed Ebbers that hundreds of millions of dollars had been transferred into capital expenditure accounts. In 2000, Ebbers assured the assembled senior staff that the company "won't have to worry about earnings for years" because it could use cash reserves to boost revenue if necessary. As reflected in e-mail correspondence, at a dinner attended by Ebbers, Sullivan, and WorldCom employees Ron Beaumont and Tom Bosley, Bosley agreed to do whatever was necessary to get WorldCom's "margins back in line" before the financial results for the fourth quarter of 2000 were disclosed. In March 2002, Ebbers sought to curtail the work of WorldCom's internal auditors by cutting the department's budget in half. Ebbers repeatedly represented to the public that he was familiar with WorldCom's accounting policies and practices, that they were reliable, and that they complied with SEC requirements. On February 7, 2002, only a month before the SEC began its investigation of WorldCom, Ebbers stated in an earnings conference call with analysts that "we stand by our accounting."

        Ebbers's personal financial situation provided a strong motive for materially misstating WorldCom's earnings. Ebbers had significant personal loans secured by WorldCom stock. In the fall of 2000, as WorldCom's stock price fell, Ebbers faced margin calls on those loans. That fall, after government regulators blocked WorldCom's proposed merger with Sprint, Ebbers sold about $70 million worth of WorldCom stock. The sale was structured as a forward sales contract in which Ebbers received a guaranteed price of approximately $70 million for stock that was to be exchanged in April 2002. By selling through the forward contract, Ebbers disguised the obvious implications of the sale of a substantial amount of WorldCom stock by its CEO, but received approximately $13 million less than he would have had he sold the stock at that time. Ebbers had planned to sell more of his WorldCom holdings earlier that fall in order to cover margin calls but, fearing that a stock sale by the CEO would adversely affect the company's share price, WorldCom loaned Ebbers sufficient funds to cover the calls. This pattern repeated itself in November and December 2000. WorldCom also loaned Ebbers funds to repay certain personal debt. Ultimately, over the course of 2000 and 2001, WorldCom loaned Ebbers approximately $400 million to cover margin calls on personal loans secured by WorldCom stock. During the class period, Ebbers had approximately $900 million in personal loans secured by WorldCom stock. WorldCom's board and senior management were aware that Ebbers faced continuous pressure from margin calls on loans secured by WorldCom stock. Further allegations regarding Ebbers are discussed below in connection with the SSB Defendants.

        Director Defendants

        All or most of the Director Defendants signed each of the following documents filed by WorldCom with the SEC: the 1999, 2000, and 2001 Forms 10-K, May 2000 and May 2001 Registration Statements, and the registration statements filed in connection with WorldCom's acquisition

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of SkyTel Communications, Inc. in 1999 and of Intermedia Communications, Inc. in 2001.⁷

        The Complaint alleges that the Director Defendants participated directly and indirectly in the preparation or issuance of public statements in violation of Section 10(b). By virtue of their positions on the WorldCom Board of Directors and, in some instances, its Audit and Compensation Committees, the Director Defendants were able to and did control the false public statements that constitute the substance of the allegations, are presumed to have had the power to control the transactions that gave rise to the violations, and did have the power to direct the management and activities of WorldCom and its employees, including the power to cause WorldCom to engage in the violations.

        Audit committees play a critical role in monitoring corporate management and a corporation's auditor.⁸ WorldCom's SEC filings represented that the WorldCom Audit Committee reviewed its financial statements, communicated with WorldCom's independent accountants, and reviewed internal accounting controls. Despite these representations, WorldCom's accounting controls were "virtually nonexistent." The size of WorldCom's restatement alone demonstrates that the Audit Committee Defendants either knew of the accounting irregularities, or recklessly disregarded information which would have led them to discover the fraud. The Audit Committee had direct notice that WorldCom's internal controls were deficient. Fraudulent billing practices discovered in a Pentagon City, Virginia WorldCom office in June 2001, resulted in the overpayment of almost $1 million in sales commissions.

        The Complaint includes allegations that are specific to individual Director Defendants. On January 30, 2002, two weeks before WorldCom took a massive write-off of goodwill, Galesi sold 63% of his WorldCom holdings in return for $27 million. As Chair of the Compensation Committee, Kellett played a key role in securing the Company's $400 million in loans for Ebbers. In exchange, the Complaint alleges that WorldCom leased a jet to Kellett for one dollar per month. Kellett also received from SSB 31,550 shares in "hot" initial public offerings ("IPOs"). In November 2000, Kellett entered a forward sale of sixty-seven percent of his WorldCom holdings in exchange for $53 million to be paid in November 2003. While this sale was for less than the shares were worth on the open market, this contract was a hedge against the impending collapse in the share price and avoided the negative market reaction to an insider's sale of this magnitude. Kellett sold fifty-percent of his remaining WorldCom holdings in December 2001, for $11.9 million.

        Underwriter Defendants

        As underwriters of the 2000 and 2001 Offerings the Underwriter Defendants

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were responsible for the contents and dissemination of the Registration Statements, which contained material misrepresentations and upon which plaintiffs relied in purchasing WorldCom securities. Although the Underwriter Defendants were aware that the value of the goodwill identified in WorldCom's books was impaired, they did not reflect that fact in the Registration Statements. In order to assess WorldCom's anticipated sources of revenue in preparation for the Offerings, the Underwriter Defendants should have examined WorldCom's infrastructure; had they done so, they would have discovered WorldCom's improper capitalization of line costs. By comparing WorldCom's budgeted capital expenditures to its actual capital expenditures or its revenues to its revenue producing capital assets, and by investigating the authorization or lack thereof for the capital accounting, the Underwriter Defendants also could have discovered the accounting fraud. Numerous other "red flags" should have alerted the Underwriter Defendants to WorldCom's fraudulent accounting practices and should have been investigated by them, including WorldCom's interest in using unusually aggressive accounting practices, commitment to aggressive and unrealistic forecasts, lack of effective Board oversight over WorldCom executives, inadequate monitoring of significant controls, failure to make certain corrections in a timely manner, market saturation and declining margins, and tendency to base material amounts of assets, liabilities, revenues, and expenses on estimates involving unusually subjective judgments or uncertainties. Given SSB's significant and unusual relationship with WorldCom and its executives, the remaining Underwriter Defendants should have been particularly alert in conducting their own due diligence prior to the Offerings.

        SSB, Grubman, and Citigroup

        In addition to WorldCom's own fraudulent representations, investors were misled by material misrepresentations and omissions by Jack Grubman and SSB in SSB's analyst reports and by SSB in WorldCom's Registration Statements. The SSB Defendants' analyst reports and the Registration Statements issued in connection with the 2000 and 2001 Offerings were false and misleading not only because they misrepresented WorldCom's financial condition, but also because they failed to disclose key information regarding the nature and extent of an illicit quid pro quo arrangement that existed between the SSB Defendants and WorldCom.⁹ Had that self-serving arrangement been adequately disclosed, it would have been apparent that Grubman's positive reports about WorldCom and recommendations to buy WorldCom were not reliable advice from an independent analyst and trustworthy brokerage house. The illegal quid pro quo arrangement was that the SSB Defendants would issue positive analyst reports about WorldCom, provide WorldCom senior executives with valuable IPO shares, and loan Ebbers hundreds of millions of dollars, in exchange for WorldCom's investment banking business and the substantial revenue and personal compensation that that business generated for the SSB Defendants.

        Throughout the class period, SSB issued analyst reports authored by Grubman that touted WorldCom's value and that vigorously encouraged investors to buy the purportedly undervalued stock. These reports were issued despite the knowledge of SSB's management that the integrity and objectivity of its research department was

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compromised by the department's decision to serve the needs of the firm's investment bankers at the expense of providing investors with independent analysis. In February 2001, the global head of SSB's retail stock selling division told the head of SSB's Global Equity Research Management that SSB's "research was basically worthless."

        Far from being an independent analyst, Grubman's compensation was directly tied to SSB's investment banking business. In 2001 alone, Grubman claimed compensation for his involvement in ninety-seven investment banking transactions which together generated $166 million in revenues. Grubman even attended two WorldCom board meetings, meetings concerning the acquisition of MCI and of Sprint. When he attended Ebbers's wedding, Grubman charged the trip to the investment banking department. Grubman's importance to SSB is reflected in his compensation. Between 1998 and 2002, Grubman made about $20 million each year. When Grubman resigned from SSB in August 2002, he received a severance package of $32 million plus forgiveness of a $19 million loan.

        There are several examples of how Grubman's research reports were compromised by his close ties to the investment banking department. Grubman has admitted that he had refrained from downgrading his ratings of certain stocks due to pressure from his firm's investment bankers, and gave several telecommunications companies higher ratings than he believed the companies deserved. Grubman's reports on WorldCom itself are evidence that he wrote them in bad faith. Grubman repeatedly issued positive reports and "buy" ratings in connection with announcements by WorldCom that were expected to cause its stock price to fall. Grubman maintained a "buy" rating until April 21, 2002, by which time WorldCom stock was trading at only $4 per share. Just before the 2000 Offering for which SSB served as the co-lead underwriter, Grubman began to use a new "cash earnings" model for evaluating WorldCom. Until early 2000, Grubman had assessed WorldCom and other telecommunications companies using a "discounted free cash flow" model. When use of that model threatened to expose WorldCom's financial deterioration, Grubman adopted a new model designed to omit the influence of capital expenditures a key element of WorldCom's accounting fraud. Over the next two years, Grubman did not apply the cash earnings model to any of the other telecommunications companies on which he reported.

        Grubman, Ebbers, SSB and WorldCom thrived through their symbiotic relationship. During this same time, Grubman was SSB's top telecommunications analyst and one of the most powerful men on Wall Street. It was said that he could make or break any telecommunications stock. Grubman's positive research reports played a significant role in assuring that the SSB Defendants would retain WorldCom's lucrative investment banking business. WorldCom was an extremely desirable client because it engaged in so many acquisitions, generating significant banking business. Since premier investment banks charge similar underwriting fees, Grubman's positive analyst reports succeeded in giving SSB's investment bankers an advantage over their competitors. WorldCom selected SSB to serve as its lead investment bank in every major acquisition and debt offering between 1997 and 2001, twenty-three deals in all. In compensation, SSB received $107 million. The deals included WorldCom's $40 billion merger with MCI, the failed $129 billion Sprint merger, and, as lead or co-lead underwriter, the 2000 and 2001 Offerings.

        On WorldCom's side, Ebbers, Sullivan and Kellett received valuable allocations of

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shares in various "hot" IPOs from SSB. SSB gave significant percentages of its total available retail allocation from "hot" IPOs to Ebbers on multiple occasions. Ebbers alone received allocations in at least twenty-one hot IPOs, from which he derived profits of $11.5 million. In a letter to the United States House of Representatives Committee on Financial Services, SSB admitted that "some allocations to corporate officers and directors . . . were sufficiently large as to raise questions about the appearance of conflicts."

        Ebbers also received hundreds of millions of dollars in loans from The Travelers Insurance Company ("Travelers"), a Citigroup subsidiary and a former parent of SSB. These loans were never publicly disclosed. They were effectively concealed because they were made to Joshua Timberlands LLC, an entity controlled by Ebbers, but held by another entity whose connection with Ebbers was also obscured. The loans were secured in part by WorldCom stock, a fact that gave Citigroup an additional incentive to prop up the price of WorldCom stock to protect its investment.

        III. Legal Standards

        Federal Rules of Civil Procedure

        The defendants move to dismiss the Complaint pursuant to Rules 9(b) and 12(b)(6), Fed.R.Civ.P., and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u4-b. Rule 8, Fed.R.Civ.P., is also relevant to portions of these motions.

        Rule 8

        The Federal Rules of Civil Procedure require that a complaint contain "a short and plain statement of the claim showing that the pleader is entitled to relief." Rule 8(a)(2), Fed.R.Civ.P. Pleadings are to give "fair notice" of a claim in order to enable the opposing party to answer and prepare for trial, and to identify the nature of the case. Simmons v. Abruzzo, 49 F.3d 83, 86 (2d Cir.1995); Salahuddin v. Cuomo, 861 F.2d 40, 42 (2d Cir.1988). "Rule 8(a)'s simplified pleading standard applies to all civil actions, with limited exceptions." Swierkiewicz v. Sorema, N.A., 534 U.S. 506, 513, 122 S.Ct. 992, 152 L.Ed.2d 1 (2002).

        Rule 12(b)(6)

        To dismiss an action pursuant to Rule 12(b)(6), a court must determine that "it appears beyond doubt, even when the complaint is liberally construed, that the plaintiff can prove no set of facts which would entitle him to relief." Jaghory v. New York State Dep't of Educ., 131 F.3d 326, 329 (2d Cir.1997) (citations omitted). In construing the complaint, the court must "accept all factual allegations in the complaint as true and draw inferences from those allegations in the light most favorable to the plaintiff." Id. "Given the Federal Rules' simplified standard for pleading, a court may dismiss a complaint only if it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations." Swierkiewicz, 534 U.S. at 514, 122 S.Ct. 992 (citation omitted).

        Although the court's focus should be on the pleadings, it may also consider

        any written instrument attached to [the complaint] as an exhibit or any statements or documents incorporated in it by reference, as well as public disclosure documents required by law to be, and that have been, filed with the SEC, and documents that the plaintiffs either possessed or knew about and upon which they relied in bringing the suit.

        Rothman v. Gregor, 220 F.3d 81, 88 (2d Cir.2000) (citations omitted); Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir.1991). The court need not credit general conclusory allegations that "are belied by more specific allegations

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of the complaint." Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1092 (2d Cir.1995).

        Rule 9(b)

        Rule 9(b) requires allegations of fraud, including securities fraud, to be stated with particularity. Ganino v. Citizens Utils. Co., 228 F.3d 154, 168 (2d Cir. 2000). Under Rule 9(b), "[m]alice, intent, knowledge and other conditions of mind of a person may be averred generally." Rule 9(b), Fed.R.Civ.P.; Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir.2001). To comply with the requirements of Rule 9(b), an allegation of fraud must specify: "(1) those statements the plaintiff thinks were fraudulent, (2) the speaker, (3) where and when they were made, and (4) why plaintiff believes the statements fraudulent." Koehler v. Bank of Bermuda (New York) Ltd., 209 F.3d 130, 136 (2d Cir.2000).

        The Securities Act of 1933

        Section 11

        "The Securities Act of 1933 was designed to provide investors with full disclosure of material information concerning public offerings of securities in commerce, to protect investors against fraud and, through the imposition of specified civil liabilities, to promote ethical standards of honesty and fair dealing." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (citation omitted). Section 11 of the Securities Act provides that any signer, director of the issuer, preparing or certifying accountant, or underwriter may be liable if "any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading. . . ." 15 U.S.C. § 77k(a) (emphasis supplied).¹⁰ "The section was designed to assure compliance with the disclosure provisions of the [Securities] Act by imposing a stringent standard of liability on the parties who play a direct role in a registered offering." Herman & MacLean v. Huddleston, 459 U.S. 375, 381-82, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983).

        "[A]ny person acquiring a security issued pursuant to a materially false registration statement" has a cause of action under Section 11 "unless the purchaser knew about the false statement at the time of acquisition." Demaria v. Andersen, 318 F.3d 170, 175 (2d Cir.2003) (citation omitted). Purchasers have standing to sue whether they purchased at the time of the initial public offering or in the aftermarket, and those who purchased within twelve months after the issuance of the registration statement need not prove reliance in order to recover. Id. at 176; 15 U.S.C. § 77k(a).

        Allegations that "material facts have been omitted" from a registration statement or "presented in such a way as to obscure or distort their significance" are sufficient to state a claim for violation of Section 11. I. Meyer Pincus & Assocs.,

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P.C. v. Oppenheimer & Co., 936 F.2d 759, 761 (2d Cir.1991) (citation omitted). Material facts may "include not only information disclosing the earnings and distributions of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell, or hold the company's securities." Kronfeld v. Trans World Airlines, Inc., 832 F.2d 726, 732 (2d Cir.1987) (citation omitted). The "central inquiry" in determining whether a statement is misleading under Section 11 is "whether defendants' representations, taken together and in context, would have misled a reasonable investor about the nature of the investment." I. Meyer Pincus, 936 F.2d at 761 (citation omitted); see also Demaria, 318 F.3d at 180.

        Section 11(e), 15 U.S.C. § 77k(e), provides an affirmative defense for defendants who can prove that the loss in the value of a security is due to something other than the alleged misrepresentation or omission on which the Section 11 claim is premised. It states:

        That if the defendant proves that any portion or all of such damages represents other than the depreciation in value of such security resulting from such part of the registration statement, with respect to which his liability is asserted, not being true or omitting to state a material fact required to be stated therein or necessary to make the statements therein not misleading, such portion of or all such damages shall not be recoverable.

        15 U.S.C. § 77k(e). Although "not insurmountable," defendants' burden in establishing this defense is heavy since "the risk of uncertainty" is allocated to defendants. Akerman v. Oryx Commun., Inc., 810 F.2d 336, 341 (2d Cir.1987).

        Section 12

        Section 12(a)(2) of the Securities Act, known prior to the 1995 PSLRA amendments as Section 12(2), allows a purchaser of a security to bring a private action against a seller that "offers or sells a security . . . by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements . . . not misleading." 15 U.S.C. § 771(a)(2). The section entitles the buyer

        to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he no longer owns the security.

        Id.; Commercial Union Assur. Co. v. Milken, 17 F.3d 608, 615 (2d Cir.1994); Randall v. Loftsgaarden, 478 U.S. 647, 655, 106 S.Ct. 3143, 92 L.Ed.2d 525 (1986) ("§ 12(2) prescribes the remedy of rescission except where the plaintiff no longer owns the security.").

        Section 12 turns on status, not scienter: it imposes liability without requiring "proof of either fraud or reliance." Gustafson v. Alloyd Co., 513 U.S. 561, 582, 115 S.Ct. 1061, 131 L.Ed.2d 1 (1995). Instead, plaintiff must show "only some causal connection between the alleged communication and the sale, even if not decisive." Metromedia Co. v. Fugazy, 983 F.2d 350, 361 (2d Cir.1992) (citation omitted).

        The PSLRA added an affirmative defense modeled after Section 11 of the Securities Act. Goldkrantz v. Griffin, No. 97 Civ. 9075(DLC), 1999 WL 191540, at *6 (S.D.N.Y. Apr. 6, 1999), aff'd, 201 F.3d 431 (2d Cir.1999). The statute prohibits recovery to the extent that

        the person who offered or sold such security proves that any portion or all of the amount recoverable . . . represents other than the depreciation in value of the subject security resulting from such part of the prospectus or oral communication,

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with respect to which the liability of that person is asserted. . . .

        15 U.S.C. § 771(b).

        Defendants may be liable under Section 12(a)(2) either for selling a security or for soliciting its purchase. First, Section 12 creates a cause of action against sellers who "passed title, or other interest in the security, to the buyer for value." Pinter v. Dahl, 486 U.S. 622, 642, 108 S.Ct. 2063, 100 L.Ed.2d 658 (1988); Wilson v. Saintine Exploration & Drilling Corp., 872 F.2d 1124, 1126 (2d Cir.1989) (applying Pinter's § 12(1) analysis to what is now § 12(a)(2)); Capri v. Murphy, 856 F.2d 473, 478 (2d Cir.1988) (same). To be liable as a seller, the defendant must be the "buyer's immediate seller; remote purchasers are precluded from bringing actions against remote sellers. Thus, a buyer cannot recover against his seller's seller." Pinter, 486 U.S. at 644 n. 21, 108 S.Ct. 2063.

        Second, persons who are not in privity with the plaintiff may be liable if they "successfully solicit[ed] the purchase, motivated at least in part by a desire to serve [their] own financial interests or those of the securities owner." Id. at 647, 108 S.Ct. 2063; see also Wilson, 872 F.2d at 1126; Commercial Union Assurance Co., 17 F.3d at 616. In finding that Section 12 included liability for solicitation, the Supreme Court observed that, "[t]he solicitation of a buyer is perhaps the most critical stage of the selling transaction . . . . [and] the stage at which an investor is most likely to be injured." Pinter, 486 U.S. at 646, 108 S.Ct. 2063.

        Underwriters may be liable as sellers under Section 12(a)(2). In a firm commitment underwriting, "the underwriter agrees to purchase an agreed upon percentage of the offering irrespective of whether the securities can be sold in the public market; therefore, the underwriter bears the risk if the offering is undersubscribed." Jackson 32 F.3d 697, 701 (2d Cir.1994)'>Nat'l Life Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 701 (2d Cir.1994). The underwriter is thus the owner of any unsold shares and can be liable as a "seller" for direct sales to the public for purposes of Section 12(a)(2). In re American Bank Note Holographics, Inc. Sec. Litig., 93 F.Supp.2d 424, 438-39 (S.D.N.Y.2000); cf. In re Deutsche Telekom AG Sec. Litig., No. 00 Civ. 9475(SHS), 2002 WL 244597, at *4-5 (S.D.N.Y. Feb. 20, 2002) (issuer not liable as seller under § 12(a)(2) because it had transferred title to underwriters in accordance with a firm commitment underwriting).

        Section 15

        Section 15 of the Securities Act attaches liability to "[e]very person who, by or through stock ownership, agency, or otherwise, . . . controls any person liable" under Sections 11 or 12 of the Securities Act. 15 U.S.C. § 77o. To state a violation of Section 15, a plaintiff must plead (1) an underlying primary violation of Sections 11 or 12 by the controlled person; and (2) the defendant's control over the primary violator. In re Deutsche Telekom, 2002 WL 244597, at *6 (noting intra-circuit split). Section 15 provides an affirmative defense. It exempts from liability a person who "had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist." 15 U.S.C. § 77o.

        The Securities Exchange Act of 1934

        Section 10(b) and Rule 10b-5

        The fundamental purpose of the federal securities laws "was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 11 L.Ed.2d 237

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(1963). Section 10(b) of the Exchange Act in particular is designed to protect investors by serving as a "catchall provision" which creates a cause of action for manipulative practices by defendants acting in bad faith. Hochfelder, 425 U.S. at 206, 96 S.Ct. 1375.

        Section 10(b) provides that:

        It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

        15 U.S.C. § 78j(b). Rule 10b-5, the parallel regulation, describes what constitutes a manipulative or deceptive device and provides that it is unlawful for any person, directly or indirectly:

        (a) To employ any device, scheme, or artifice to defraud,

        (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

        (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

        17 C.F.R. § 240.10b-5; Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 534 (2d Cir.1999). Plaintiffs' claims arise under Section 10(b) and Rule 10b-5 of the Exchange Act.

        To state a cause of action under Section 10(b) and Rule 10b-5 a plaintiff must allege that "the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that plaintiff's reliance on defendant's action caused injury to the plaintiff." Lawrence v. Cohn, 325 F.3d 141, 147 (2d Cir.2003) (quoting Ganino, 228 F.3d at 161); see also Kalnit, 264 F.3d at 138 (citation omitted). Section 10(b) claims sound in fraud, and must satisfy the pleading requirements of Rule 9(b) and the PSLRA. In re Scholastic Corp., 252 F.3d 63, 69-70 (2d Cir.2001).

        1. Statements and omissions

        A statement is material where there is a substantial likelihood that a reasonable person would consider it important when deciding whether to buy or sell securities. Halperin v. EBankerUsa.com, Inc., 295 F.3d 352, 357 (2d Cir.2002). Statements of opinion and projections are actionable if they are "worded as guarantees or are supported by specific statements of fact, or if the speaker does not genuinely or reasonably believe them." Int'l Bus. Mach. Corp. Sec. Litig., 163 F.3d 102, 107 (2d Cir.1998) (citation omitted). For each statement or omission, the court must determine whether "defendants' representations or omissions, considered together and in context, would affect the total mix of information and thereby mislead a reasonable investor regarding the nature of the securities offered." Halperin, 295 F.3d at 357; Basic v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988); In re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 267-68 (2d Cir.1993).

        The "bespeaks caution" doctrine instructs courts to consider the "total mix" of information available to a reasonable

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investor to determine whether cautionary language in a document would have prevented an investor from being misled. Halperin, 295 F.3d at 357. To be effective, the cautionary language must warn of or directly relate to the risk that brought about the plaintiff's loss. Id. at 359; Demaria, 318 F.3d at 181-82. Conversely, misrepresentations will be immaterial as a matter of law where "it cannot be said that any reasonable investor could consider them important in light of adequate cautionary language set out in the same" document. Halperin, 295 F.3d at 357. A complaint fails to state a claim only if "no reasonable investor could have been misled about the nature of the risk." Id. at 359 (emphasis in original).

        The PSLRA added a statutory "safe harbor" for forward-looking information. It applies only to statements accompanied by meaningful cautionary language or which are not proven to have been made with actual knowledge that they were false or misleading. In re Nortel Networks Corp. Sec. Litig., 238 F.Supp.2d 613, 629 (S.D.N.Y.2003); see 15 U.S.C. §§ 77z-2(c)(2)(A)(i) and 2(c)(1)(B)(1), 78u-5(c)(1)(A)(i) and 5(c)(1)(B)(2) (safe-harbor provisions).

        2. Scienter

        "The requisite state of mind, or scienter, in an action under section 10(b) and Rule 10b-5, that the plaintiff must allege is an intent to deceive, manipulate or defraud." Kalnit, 264 F.3d at 138 (citation omitted). In the Second Circuit, plaintiffs alleging securities fraud have long been required to state with particularity "facts that give rise to a strong inference of fraudulent intent." Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir.1995); San Leandro Emergency Med. Grp. Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 812 (2d Cir.1996).

        When Congress passed the PSLRA it required that

        [i]n any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.

        15 U.S.C. § 78u-4(b)(2) (emphasis supplied). The PSLRA raised the nationwide pleading standard for securities fraud but did not alter the level of pleading previously required by the Second Circuit. Kalnit, 264 F.3d at 138; Ganino, 228 F.3d at 170; Novak v. Kasaks, 216 F.3d 300, 310 (2d Cir.2000).

        The Second Circuit standard provides that "plaintiffs must allege facts that give rise to a strong inference of fraudulent intent. The requisite `strong inference' of fraud may be established either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Acito, 47 F.3d at 52 (citation omitted); see also Kalnit, 264 F.3d at 138; Rothman, 220 F.3d at 90.

        The Second Circuit also has noted, however, that because Congress did not mention the pleading of "motive and opportunity" as a means to establish the "strong inference" of scienter, courts "need not be wedded to these concepts in articulating the prevailing standard." Novak, 216 F.3d at 310. Nonetheless, the Second Circuit has continued to rely on facts demonstrating that a defendant had both the motive and the opportunity to commit fraud in evaluating the adequacy of scienter allegations. See, e.g., In re Scholastic Corp., 252

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F.3d at 74-76. It has identified four types of allegations that may support a strong inference of scienter:

        [W]here the complaint sufficiently alleges that the defendants: (1) benefitted in a concrete and personal way from the purported fraud; (2) engaged in deliberately illegal behavior; (3) knew facts or had access to information suggesting that their public statements were not accurate; or (4) failed to check information they had a duty to monitor.

        Novak, 216 F.3d at 311 (citation omitted).

        (a) Motive and opportunity

        "Motive would entail concrete benefits that could be realized by one or more of the false statements and wrongful nondisclosures alleged. Opportunity would entail the means and likely prospect of achieving concrete benefits by the means alleged."

        Novak, 216 F.3d at 307 (citation omitted).

        General allegations that identify the same motives "possessed by virtually all corporate insiders" are not sufficient to create a strong inference of fraudulent intent. Id. Plaintiffs cannot, for example, rest solely on allegations that defendants sought to prolong their employment at certain positions, Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1130 (2d Cir. 1994), that defendants owned stock, id. at 1131, or that defendants sought to retain a high bond or credit rating for the company, San Leandro, 75 F.3d at 814. See Novak, 216 F.3d at 307-08.

        Insider sales may serve as evidence of motive, but the plaintiff must allege that any such sales were unusual in some way. For example, the insider trading may be extensive. See Novak, 216 F.3d at 308. If one director engaged in insider sales, the court may consider whether other directors also sold or held their shares during the relevant period. Acito, 47 F.3d at 54. The amount of profit and the percentage of the defendant's holdings that were sold are also relevant. In re Scholastic Corp., 252 F.3d at 63, 74-75; Rothman, 220 F.3d at 94-95; Stevelman v. Alias Research, Inc., 174 F.3d 79, 85 (2d Cir.1999).

        (b) Conscious misbehavior or recklessness

        The pleading standard also will be satisfied if plaintiffs allege facts showing that the defendant's conduct was "highly unreasonable, representing an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it." Rothman, 220 F.3d at 90 (citation omitted); Kalnit, 264 F.3d at 142. Pleadings have been found sufficient when they have "specifically alleged defendants' knowledge of facts or access to information contradicting their public statements. Under such circumstances, defendants knew or, more importantly, should have known that they were misrepresenting material facts related to the corporation." Kalnit, 264 F.3d at 142 (citation omitted). If plaintiffs rely on allegations that the defendants had access to facts contradicting their public statements, plaintiffs must "specifically identify the reports or statements containing this information." Novak, 216 F.3d at 309 (citation omitted). Allegations of recklessness have also been sufficient where the allegations demonstrate that defendants "failed to review or check information that they had a duty to monitor, or ignored obvious signs of fraud." Id. at 308. A violation of GAAP, however, standing alone, is insufficient. Id. at 309.

        3. Causation

        Another element of a Section 10(b) claim is that "plaintiff's reliance on defendant's action caused plaintiff injury." Press, 166

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F.3d at 534 (citation omitted). "It is settled that causation under federal securities laws is two-pronged: a plaintiff must allege both transaction causation, i.e. that but for the fraudulent statement or omission, the plaintiff would not have entered into the transaction; and loss causation, i.e., that the subject of the fraudulent statement or omission was the cause of the actual loss suffered." Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95 (2d Cir.2001); Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 186-87 (2d Cir.2001); Grace v. Rosenstock, 228 F.3d 40, 46 (2d Cir.2000). Transaction and loss causation are alleged when plaintiffs aver "both that they would not have entered the transaction but for the misrepresentations and that the defendants' misrepresentations induced a disparity between the transaction price and the true `investment quality' of the securities at the time of transaction." Suez Equity, 250 F.3d at 97-98 (emphasis in original).

        Given the difficulty of proving direct reliance in the complex world of the modern securities markets, plaintiffs may rely on the "fraud-on-the-market" theory. Under the fraud-on-the-market theory, plaintiffs need not allege that they actually encountered the misrepresentation. Instead, they are presumed to have relied on the market to have "perform[ed] a substantial part of the valuation process performed by the investor in a face-to-face transaction. The market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price." Basic, 485 U.S. at 244, 108 S.Ct. 978 (citation omitted); DiRienzo v. Philip Services Corp., 294 F.3d 21, 33 (2d Cir.2002). Although the presumption is not absolute, at the pleading stage it satisfies plaintiffs' burden of alleging transaction causation. See Basic, 485 U.S. at 247, 108 S.Ct. 978; In re Ames Dept. Stores Inc. Stock Litig., 991 F.2d 953, 967 (2d Cir.1993).

        Loss causation is akin to the concept of "proximate cause" in tort law, "meaning that in order for the plaintiff to recover it must prove the damages it suffered were a foreseeable consequence of the misrepresentation." Suez Equity, 250 F.3d at 96 (citation omitted); Manufacturers Hanover Trust Co. v. Drysdale Sec. Corp., 801 F.2d 13, 21 (2d Cir.1986). The Second Circuit has noted that "[a] foreseeability finding turns on fairness, policy, and `a rough sense of justice.'" AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 217 (2d Cir.2000) (quoting Palsgraf v. Long Island R. Co., 248 N.Y. 339, 352, 162 N.E. 99 (1928)). Determining whether a loss was a foreseeable consequence of a particular defendant's actions is, ultimately, a public policy question, which asks how far back along the causal chain should liability for the plaintiffs' losses extend. Suez Equity, 250 F.3d at 96; AUSA Life Ins. Co., 206 F.3d at 210. In assessing loss causation allegations, courts ask "was the damage complained of a foreseeable result of the plaintiff's reliance on the fraudulent misrepresentation?" Weiss v. Wittcoff, 966 F.2d 109, 111 (2d Cir.1992) (citation omitted). If the allegations support an inference that a defendant could reasonably have foreseen that the misrepresentation pertained to an issue that would cause the eventual damage, loss causation will be considered adequately pleaded. Suez Equity, 250 F.3d at 98; Citibank, N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992).

        Section 20(a)

        Section 20(a) of the Exchange Act creates a cause of action against defendants alleged to have been "control persons" of

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those engaged in the primary securities fraud. The section provides:

        Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.

        15 U.S.C. § 78t(a). In construing a statute, the starting point must be "the words of the text." Saks v. Franklin Covey Co., 316 F.3d 337, 345 (2d Cir.2003). The statutory language identifies two components to a control person claim: (1) a primary violation by a controlled person; and (2) direct or indirect control of the primary violator by the defendant. It also provides for an affirmative defense of good faith.

        Other courts in this District have thoughtfully discussed the lack of clarity in the law concerning Section 20(a), and this Court will not replicate their careful efforts. See, e.g., Initial Public Offering Sec. Litig., 241 F.Supp.2d 281, 392-97 (S.D.N.Y.2003); In re Livent Sec. Litig., 148 F.Supp.2d 331, 351-55 (S.D.N.Y.2001); Mishkin v. Ageloff, No. 97 Civ. 2690(LAP), 1998 WL 651065, at *21-26 (S.D.N.Y. Sept. 23, 1998). Much of the confusion concerns the phrase "culpable participant," a phrase which appears to have first arisen in Second Circuit jurisprudence in a discussion of the congressional intent behind the passage of Section 20(a). See Lanza v. Drexel & Co., 479 F.2d 1277, 1299 (2d Cir.1973). The principle issues regarding this phrase concern its role at the pleading stage and its content. Specifically, lower courts have tried to discern (1) whether it is necessary to plead culpable participation in addition to the other two components of a Section 20(a) claim, and (2) even if there is no burden to plead culpable participation but only a burden on a plaintiff to present prima facie evidence of culpable participation at trial, whether proof of culpable participation entails proof that the control person acted with a particular state of mind. Under the PSLRA, the requirement that the plaintiff prove a culpable state of mind at any point in the proceedings requires compliance with the PSLRA's heightened pleading standard. Pursuant to the PSLRA, whenever recovery of damages requires "proof that the defendant acted with a particular state of mind, the complaint shall . . . state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2).

        A review of the Second Circuit's opinions in which the phrase "culpable participation" is used in a discussion of Section 20(a) indicates that the term is most frequently used in the context of describing the burden placed on the plaintiff at trial to present prima facie evidence of culpable participation, a burden which if met, operates to shift the burden to the defendant to present evidence of good faith.¹¹ See, e.g., SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1473 (2d Cir.1996). This is not, however, the sole context in which the phrase is used. In Suez Equity, 250 F.3d 87, for example, culpable participation appears as

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a pleading requirement. Id. at 101; In re Scholastic Corp., 252 F.3d at 77. In either context, however, it does not appear that there is any requirement that the plaintiff plead or prove a culpable state of mind to allege or establish culpable participation.

        A few examples will suffice to illustrate that there is no required state of mind for a defendant's culpable participation in a Section 20(a) offense. In Suez Equity, 250 F.3d 87, a complaint that alleged (1) that the person who had violated the securities laws was an officer of the defendant bank, and (2) that that person had primary responsibility for the dealings of the bank with the business whose securities were at the center of the lawsuit, was sufficient to allege a Section 20(a) claim against the bank. Id. at 101. Marbury Mgt. v. Kohn, 629 F.2d 705 (2d Cir.1980), the Court's detailed description of the evidence at trial that sufficed to establish Section 20(a) liability for the employer did not include any reference to evidence of scienter. Id. at 711-12. Specifically, the evidence "did not show that [the employer] intended to deceive plaintiffs, or knew of [the] violations, or provided substantial assistance to [the wrongdoer] in violating the securities law, but at most showed only negligence on [the employer's] part." Id. at 710. Despite the lack of evidence of knowledge or intent, the Court of Appeals reversed and remanded the Section 20(a) claim because the trial court had failed to consider the employer's liability under Section 20(a). Id. at 711, 716. Similarly, most other Circuit Courts of Appeals, including those that have a culpable participant test, have not required a plaintiff to plead, or, in establishing liability to prove, a defendant's culpable state of mind in connection with a Section 20(a) claim. See, e.g., Maher v. Durango Metals, Inc., 144 F.3d 1302, 1305 (10th Cir.1998); Brown v. Enstar Group, Inc., 84 F.3d 393, 396 (11th Cir.1996); Harrison v. Dean Witter Reynolds, Inc., 79 F.3d 609, 614 (7th Cir.1996); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1575 (9th Cir.1990). But see, e.g., Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 885 (3d Cir.1975).

        From this review it appears that a plaintiff must plead only the existence of a primary violation by a controlled person and the direct or indirect control of the primary violator by the defendant in order to state a claim under Section 20(a). In addition, this pleading requirement is governed by Rule 8, Fed.R.Civ.P. See Swierkiewicz, 534 U.S. at 513, 122 S.Ct. 992; In re IPO Sec. Litig., 241 F.Supp.2d at 396.

        The concept of culpable participation describes that degree of control which is sufficient to render a person liable under Section 20(a). At the pleading stage, the extent to which the control must be alleged will be governed by Rule 8's pleading standard. At trial, the degree of control will require the plaintiff to present prima facie evidence of sufficient control to support liability. Although previous opinions of this Court have imposed a greater burden on plaintiffs at the pleading stage, this Court now finds that plaintiffs need not meet the PSLRA's heightened pleading standard in alleging a violation of Section 20(a), or separately allege culpable participation. In re IPO Sec. Litig., 241 F.Supp.2d at 396 n. 186.

        If the plaintiff has adequately pleaded a Section 10(b) claim, the first or primary violation element of a Section 20(a) claim is sufficiently pled. In re Scholastic Corp., 252 F.3d at 77-78. Control is defined in 17 C.F.R. § 240.12b-2 as "the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." See also First Jersey, 101 F.3d at 1472-73 (adopting this standard for Section 20(a) claim). A short,

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plain statement that gives the defendant fair notice of the claim that the defendant was a control person and the ground on which it rests its assertion that a defendant was a control person is all that is required. See Swierkiewicz, 534 U.S. at 512, 122 S.Ct. 992; In re IPO Sec. Litig., 241 F.Supp.2d at 352.

        IV. Discussion

        Ebbers

        Ebbers moves to dismiss all claims against him (Counts I, II, VI and VII). Since his motion is principally addressed to Count VI, the Section 10(b) claim, that is the only claim addressed here.¹²

        The allegations in the Complaint are sufficient to create a strong inference that Ebbers acted with the requisite scienter. First, the Complaint describes strong circumstantial evidence that Ebbers knew that WorldCom was manipulating its books. The Complaint pleads with particularity information from a wealth of sources that support the inference that Ebbers was fully familiar with WorldCom's true financial state, was actively monitoring its financial condition, and was directly involved in decisions central to the accounting fraud. Although size alone does not necessarily create an inference of scienter, the enormous amounts at stake in the alleged fraud combined with the allegations regarding Ebbers's close relationship with Sullivan, his hands-on management style, and the Complaint's more detailed recitations, create a strong inference that Ebbers knew that his public statements lauding WorldCom's financial state and SEC filings were not just reckless, but false. In re Scholastic Corp., 252 F.3d at 73 (size of post-class period special charge supports inference of knowledge); Rothman, 220 F.3d at 92 (size of write-off supports claim of fraudulent intent).

        The Complaint also adequately alleges scienter in terms of Ebbers's motive and opportunity. Although the same motives "possessed by virtually all corporate insiders" such as protecting the appearance of corporate profits or increasing executive compensation by maintaining a high stock price are insufficient to plead scienter, Novak, 216 F.3d at 307, Ebbers's financial incentives were unique and substantial. Ebbers's WorldCom shares provided a crucial underpinning for his complicated personal finances, including stock transactions, the purchase of hundreds of thousands of acres of land for hundreds of millions of dollars, and his considerable personal loans from WorldCom and Citigroup. Ebbers had at least $900 million in loans secured by his WorldCom holdings, including a $400 million loan from WorldCom that was reported to be the largest amount ever loaned by a corporation to one of its officers. In order to avoid or mitigate margin calls from lenders, Ebbers faced substantial pressure to maintain the price of the WorldCom stock that was serving as his collateral. In addition, Ebbers's continued relationship with SSB, from which he derived not only "hot" IPO

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shares but also enormous Travelers loans, depended on sustaining WorldCom's acquisition strategy and its stock price. The benefit to Ebbers of maintaining a fraudulently inflated share price was enormous, unusual, personal and concrete enough to satisfy the pleading requirements for scienter.

        While Ebbers attempts to argue that each of the many allegations against him is unreliable or an insufficient basis for finding scienter, the attempt is fundamentally flawed.¹³ Time and again the sources of the information and the information itself are described in detail, and time and again the information implicates Ebbers in the securities fraud. The allegations in the Complaint are entitled to be taken together to determine if the facts "give rise to a strong inference of fraudulent intent." Acito, 47 F.3d at 52. The inference of Ebbers's scienter arises from the combined force of the allegations; the weighing of each piece of evidence and the impeachment of each source must await trial. Moreover, this pleading is not based principally on confidential sources, despite Ebbers's effort to cast it in that light. Even if it were, however, "there is nothing in the case law of this Circuit that requires plaintiffs to reveal confidential sources at the pleading stage." Novak, 216 F.3d at 313.

        Taken as a whole, the allegations against Ebbers create a strong inference of scienter. His motion to dismiss the Section 10(b) claim is denied.¹⁴

        Director Defendants

        The Audit Committee Defendants (Allen, Areen, Bobbitt and Galesi) as well as Kellett are the only Director Defendants charged with violations of Section 10(b) and each moves to dismiss those claims. All of the Director Defendants are named in and move to dismiss the Sections 15 and 20(a) control person claims.

        Section 10(b) Claim

        The Complaint adequately alleges that the Audit Committee Defendants and Kellett made material misrepresentations when they signed WorldCom's Forms 10-K for 1999, 2000, and 2001, as well as the note offering and acquisition registration statements identified above. SEC filings are the quintessential statement on which a reasonable investor may rely and thus are the type of statement that can give rise to a Section 10(b) and Rule 10b-5 action against a defendant who signed them. In re Ames Dept. Stores, 991 F.2d at 972; Thomson Kernaghan & Co. v. Global Intellicom, Inc., Nos. 99 Civ. 3005 & 99 Civ. 3015(DLC), 2000 WL 640653, at *5 (S.D.N.Y. May 17, 2000); In re JWP Sec. Litig., 928 F.Supp. 1239, 1256 (S.D.N.Y.1996). The defendants' novel contention that these documents can only be attributed to WorldCom itself and its management is wrong.

        The five Director Defendants who have been named in a Section 10(b) claim argue principally that the Section 10(b) claim must be dismissed because there are insufficient allegations of their individual scienter.

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The Complaint relies on allegations of conscious misbehavior or recklessness for each of the four members of the Audit Committee. The Complaint also relies on allegations of motive and opportunity for Defendants Kellett and Galesi.

        Audit Committee: conscious misbehavior or recklessness

        Plaintiffs contend that the Complaint alleges "strong circumstantial evidence" sufficient to establish that each of the Audit Committee Defendants either engaged in conscious misbehavior or acted recklessly. Plaintiffs argue that because the accounting fraud was so substantial, the Audit Committee members either knew or were reckless in not knowing that WorldCom's SEC filings materially misrepresented the company's financial situation. The magnitude of the alleged fraud is not sufficient, standing alone, to create liability. Plaintiffs also rely on the Audit Committee's general oversight responsibilities and the commitment in the SEC filings that it would review WorldCom's financial statements and internal accounting controls. With one exception, however, the Complaint does not identify what the Audit Committee members would have learned from exercising these responsibilities that would have put them on notice that the SEC filings that they signed were inaccurate. The one exception is that in June 2001 they learned that WorldCom employees in a Virginia office had manufactured phony sales by moving customer accounts from one billing system to another in order to generate almost $1 million in extra commissions. This manipulation is too far removed from the fraud underlying the false statements in the SEC filings to put those defendants on notice of those frauds. The inference that plaintiffs wish the Court to draw that this Virginia office's scheme revealed that WorldCom as a whole had no internal fraud controls is not sufficiently supported by the Complaint's allegations.

        Finally, plaintiffs also contend that at least four "red flags" put the Audit Committee on notice: (1) questions raised during an earnings conference call on February 7, 2002; (2) the SEC's March 7, 2002 request for documents; (3) the March 11, 2002 Dow Jones Newswire disclosure of the SEC inquiry; and (4) the internal audit in May 2002. Each of the events occurred after the last misrepresentation any of the Audit Committee Defendants is alleged to have made and within the last five months leading up to the restatement. The Complaint does not allege that Audit Committee Defendants made any material misstatements after they had received any of these warnings.

        The strongest allegations against the Audit Committee members rest on the descriptions of the duties imposed on and assumed by the Audit Committee. Nonetheless, the Complaint falls short of identifying the information which they had a duty to monitor as Audit Committee members and that would have disclosed the fraud had they done so. See Novak, 216 F.3d at 311.

        In support of its contention that a Section 10(b) claim can be pursued against Audit Committee members based on their failure to exercise strict oversight, plaintiffs direct the Court to three cases, none of which supports a holding that the claim is adequately pleaded. Filler v. Lernout, 286 B.R. 33 (D.Mass.2002), the audit committee consistently ignored the outside accountant's recommendations that the company implement a system of internal audit controls, failed to deliver on its own commitment to recommend an internal auditor, and had received reports identifying specific questionable transactions relating to the fraud. Id. at 37-38. Greenfield v. Prof. Care, Inc., 677 F.Supp. 110 (E.D.N.Y.1987), the audit committee members appeared to function as inside directors

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and either knew of the fraud or were reckless in disregarding it. Id. at 115. In re JWP, 928 F.Supp. 1239, addressed a summary judgment motion.

        Galesi and Kellett: motive and opportunity

        The Complaint alleges that Galesi and Kellett possessed the motive and opportunity necessary to establish scienter. The SEC Forms 4 reporting Galesi's sales disclose that the sales were by banks "pursuant to loan documents."¹⁵ Sales made by a bank to satisfy margin calls are insufficient allegations of motive.

        The allegations regarding Kellett stand on a different footing. According to the Complaint, he provided substantial assistance to and received substantial, irregular benefits from or through Ebbers. In addition, while his sales of stock did not occur at or near the peak price for WorldCom's stock, the sales guaranteed for him the receipt of tens of millions of dollars in a declining market, before the revelations of the fraud decimated the stock's price, and amounted to a significant percentage of his holdings. Taken together, these allegations are sufficient to create a strong inference of Kellett's fraudulent intent.¹⁶

        Since the Complaint does not allege facts supporting a strong inference that the Audit Committee Director Defendants acted with fraudulent intent, the Section 10(b) claim against them in Count VI is dismissed with leave to amend.¹⁷ The motion to dismiss the Section 10(b) claim against Kellett is denied.

        Section 20(a)

        The Complaint has adequately alleged a primary Section 10(b) violation by at least WorldCom, Ebbers and Sullivan, and control of them by the Director Defendants. The Complaint alleges that by reason of their board and committee membership, Director Defendants are liable as "control persons" in that these defendants did control false public statements that constitute the heart of the fraud, can be presumed to have controlled the fraud's underlying transactions, and had the power to direct WorldCom's management and activities.

        Where it is alleged that a defendant signed an SEC filing that contained the misrepresentations that are the subject of the Section 10(b) claim, this is sufficient to allege control of the authors of the filing, and the management and policies of the corporation behind the misrepresentations. See, e.g., 17 C.F.R. § 240.12b; Thomson Kernaghan, 2000 WL 640653, at *7; In re Livent, 78 F.Supp.2d at 222 (while signing was presumed to reflect control, the court dismissed for failure to plead culpable participation); Jacobs v. Coopers & Lybrand, LLP, No. 97 Civ. 3374(RPP), 1999 WL 101772, at *17 (S.D.N.Y. Mar. 1, 1999).

        The Director Defendants urge that the signatures on SEC filings should not be sufficient to allege control since they are required by virtue of their status to sign annual reports and registration statements. They protest that if a signature that is required by law is sufficient to plead control then "every director will automatically be deemed to have control based solely on his or her status."

        There are several responses to this protest. First, what is at issue here is the sufficiency of pleadings under Rule 8. In

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that regard, it is important to remember that Section 20(a) contains a good faith defense. Second, the allegation that a Director signed a Form 10-K or a registration statement may not be sufficient to allege control over the person who is alleged to have violated Section 10(b) when the misrepresentation or omission at issue in the Section 10(b) claim does not appear in those documents; that is an issue not presented by the motion. Third, the ruling here reflects the scheme established by Congress. It has imposed a heightened pleading standard for a Section 10(b) claim but not for a Section 20(a) claim.¹⁸ If a plaintiff succeeds in pleading a Section 10(b) violation, then Congress has determined that those who control that violator may be sued too. Finally, as a practical matter, just what is a signature on an SEC filed document meant to represent if it does not represent a degree of responsibility for the material contained in that document? The very fact that a director is required to sign these critical documents charges the director with power over the documents and represents to the corporation, its shareholders, and the public that the corporation's director has performed her role with sufficient diligence that she is willing and able to stand behind the information contained in those documents. As the SEC explained when it announced the requirement in 1980:

        With an expanded signature requirement, the Commission anticipates that directors will be encouraged to devote the needed attention to reviewing the Form 10-K and to seek the involvement of other professionals to the degree necessary to give themselves sufficient comfort. In the Commission's view, this added measure of discipline is vital to the disclosure objectives of the federal securities laws, and outweighs the potential impact, if any, of the signature on legal liability.

        Integration of Securities Act Disclosure Systems, Amendments to SEC Rules 17 C.F.R. Parts 229, 231, 239, 240, 241 & 249, Releases Nos. 33-6231, 34-17114; AS-279, 45 F.R. 63630 (Sept. 25, 1980).

        Each of the Director Defendants signed multiple disclosures filed with the SEC that are alleged to have contained actionable misrepresentations, including Forms 10-K and registration statements. These approvals through signing sufficiently allege control over those who have been alleged to have violated Section 10(b), at least in connection with the misrepresentations and omissions in those documents. The motion to dismiss Count VII is denied.

        Underwriter Defendants

        The Complaint pleads claims pursuant to Sections 11 and 12(a)(2) against the Underwriter Defendants arising from material misstatements or omissions in the 2000 and 2001 Registration Statements, including the prospectuses and oral communications, in connection with the 2000 and 2001 Offerings. The Underwriter Defendants seek to dismiss all of the claims against them on the ground that NYSCRF does not have standing to sue them since it has not alleged that it purchased any WorldCom bonds in either the 2000 or 2001 Offerings. These defendants assert that the inclusion of the other three named plaintiffs, who do allege that they bought bonds in those Offerings, does not cure the standing deficiency because (1) they were not appointed co-lead plaintiff under the process set forth in the PSLRA, 15 U.S.C. § 77z-1(a)(3)(B) (Securities Act); 15 U.S.C. § 78u-4(a)(3) (Exchange Act), and (2) the Complaint identifies only the NYSCRF as the party bringing this action

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"individually and on behalf of all other persons and entities who purchased or acquired publicly traded shares, bonds or notes of WorldCom." These related arguments confuse the inquiries to be made at three separate stages of this action: the appointment of lead plaintiff, the motion to dismiss, and the motion to certify a class.

        The first of these stages appointment of lead plaintiff was "intended to empower investors so that they, not their lawyers, control securities litigation."¹⁹ Private Securities Litigation Reform Act of 1995, S.Rep. No. 104-98, 104th Cong. 1st Sess. 1, 6 (1995), reprinted in 1995 U.S.S.C.A.N. 679, 685. If multiple plaintiffs file class actions asserting substantially the same claims, the PSLRA creates a presumption that the plaintiff with the largest financial interest and who otherwise satisfies the requirements of Rule 23, Fed.R.Civ.P., should serve as the lead plaintiff. 15 U.S.C. § 77z-1(a)(3)(B)(iii)(I). That presumption can be rebutted "only upon proof by a member of the purported plaintiff class" that the presumptive lead plaintiff "will not fairly and adequately protect the interests of the class" or is subject to "unique defenses" that prevent the plaintiff from adequately representing the class. 15 U.S.C. § 77z-1(a)(3)(B)(iii)(II) (emphasis supplie