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Corporate Finance
This playlist contains the judicial opinions that I assign in my Corporate Finance class.
  • 1 VFB LLC. v. Campbell Soup Company

    This case illustrates courts' reliance on public securities prices to answer difficult valuation questions. Here, the valuation question arises in the context of a fraudulent transfer claim.

    1

    482 F.3d 624

    2
    VFB LLC, a Delaware limited liability company, Appellant
    v.
    CAMPBELL SOUP COMPANY; Campbell Investment Company; Campbell Foodservice Company; Campbell Sales Company; Campbell Soup Company, Ltd. (Canada); Joseph Campbell Company; Campbell Soup Supply Company, L.L.C.; Pepperidge Farm, Incorporated.
    3

    No. 05-4879.

    4

    United States Court of Appeals, Third Circuit.

    5

    Argued January 18, 2007.

    6

    Filed March 30, 2007.

    7

    [482 F.3d 626] John A. Lee, Esquire, Robin Russel, Esquire, Andrews & Kurth LLP, Houston, TX, Barbara W. Mather, [Argued], Robert L. Hickok, Benjamin P. Cooper, Pepper Hamilton LLP, Philadelphia, PA, for Appellant.

    8

    Richard P. McElroy, Mary Ann Mullaney, Blank Rome LLP, Philadelphia, PA, Michael W. Schwartz, [Argued], Harold S. Novikoff, David C. Bryan, Wachtell, Lipton, Rosen & Katz, New York, NY, for Appellees.

    9

    Before SLOVITER, RENDELL, and CUDAHY,[*] Circuit Judges.

    10
    OPINION OF THE COURT
    11
    CUDAHY, Circuit Judge.
    12

    In 1998, Campbell Soup Co. incorporated a wholly-owned subsidiary, Vlasic Foods International, Inc., and sold it several food companies in exchange for borrowed cash. Then it issued the subsidiary's stock to Campbell shareholders as an in-kind dividend, making VFI an independent company. Within three years of this transaction, VFI filed for bankruptcy and sold the food companies for less than it had paid for them. VFI has since reorganized into the bankruptcy creature VFB, LLC, and acting on behalf of VFI's disappointed creditors claims that the transaction was a constructively fraudulent transfer and that Campbell aided a breach of fiduciary duty by VFI's directors. The district court, 2005 WL 2234606, entered judgment for Campbell after a bench trial. VFB appeals both from the judgment and from the district court's decision to strike a motion to amend the judgment. We affirm.

    13
    I. Background
    14

    In 1996, Campbell Soup Co. (Campbell) decided to improve its stock price by disposing of certain underperforming subsidiaries and product lines, the largest and most prominent of the lot being Vlasic, of pickle fame, and Swanson, the TV dinner manufacturer. (The companies in question were eventually organized into what Campbell called its "Specialty Foods Division"; we will refer to the companies by that name or as "the Division.") The Division companies were not highly regarded within Campbell. One consultant urged that all the relevant businesses other than Vlasic and Swanson had basically no growth potential and should be managed strictly for cash. (Op. at 13.) Vlasic and Swanson were both troubled, but they were historically strong brands that, it was thought, might be turned around under new management. (Op. at 14-15.)

    15

    Campbell decided the best way to dispose of the Division would be through a [482 F.3d 627] "leveraged spin" transaction. Campbell would incorporate a new wholly-owned subsidiary and the subsidiary would take on bank debt in order to purchase the Division.[1] Then Campbell would give the stock in the subsidiary to Campbell shareholders as an in-kind dividend. Campbell would remove underperforming businesses from its balance sheet and get cash; Campbell shareholders would own roughly the same assets as before, albeit in different corporate packages.[2]

    16

    The terms of the spin were negotiated between Campbell and a group of high-ranking Campbell employees who sought to manage the new subsidiary, named Vlasic Foods International, Inc. (VFI), after the spin. Campbell declared several basic terms of the agreement non-negotiable, among them the businesses to be transferred to VFI and VFI's initial debt level (that is, how much it would pay Campbell for the Division). The future VFI managers later testified that Campbell did not give them the resources they needed to properly research the transaction. The resulting bargain contained various additional terms unfavorable to VFI.

    17

    The deal closed on March 30, 1998. On VFI's end, the spin was approved by VFI's "pre-Spin directors," also major Campbell officers, who understood their sole task to be approving the spin and resigning. They did not investigate the deal and made no effort to protect VFI's interests as against Campbell's.

    18

    The district court called the bargain struck in the spin "particularly hard" for VFI, but further concluded that it was even harder than the public knew at the time. For two years before the spin, Campbell massaged the Specialty Foods Division's operating results, ostensibly misleading the public about its operating record and prospects. The spin took place midway through Campbell's 1998 fiscal year (FY1998); Division managers used a number of techniques in FY1997 and FY1998 to increase short term sales and earnings (and to secure salary bonuses tied to meeting operating targets). But none of the techniques changed the companies' longer-term prospects. For instance, VFB focuses on "product loading" as the chief tool used to prop up sales and earnings. This term refers to using bulk discounts and other promotional tools to encourage retailers to increase their inventory. While this technique increases sales in the short term, there is a corresponding decrease in sales in a later period as retailers allow their inventories to decline to normal levels. Product loading and similar tactics[3] in FY1997 and early FY1998 left VFI facing an imminent corrective decrease in its sales and earnings at the time of the spin.

    19

    VFB now urges (and Campbell does not argue the point) that because of these tactics, Campbell's SEC disclosures in the years leading up to the spin, and in particular the FY1997 and FY1998 earnings figures on the Form 10 SEC filing describing the spin transaction itself, were unreliable. (Op. at 16, 22-23.) The filings misled not only the public securities markets, but also [482 F.3d 628] the banks providing the leverage for the transaction, which did not independently investigate the performance of the Specialty Foods Division but instead "relied heavily on `pro forma' financial statements and projections supplied by Campbell." (Op. at 27.)

    20

    After the spin, the Specialty Foods Division's inflated sales and earnings figures quickly corrected themselves. By June, VFI had lowered its FY1998 earnings estimates from $143 million to $70 million. VFI feared that this would soon lead to a default of its loan agreement with the banks, so it sought to renegotiate the agreement. The banks, after thoroughly examining VFI's finances, agreed to a new loan agreement on September 30, 1998. Among other things, the agreement required VFI to reduce the banks' exposure by issuing new bonds contractually subordinated to the bank debt.

    21

    Despite these very public problems, VFI did not fold. The price of its shares on the New York Stock Exchange remained essentially steady. Indeed, VFI outperformed the S & P mid-cap food index from the time of the spin, March 30, 1998, through January 1, 1999. (Op. at 30.) More than a year after the spin, in June 1999, VFI successfully completed its required issue of $200 million in unsecured debt to institutional investors, despite disclosing discouraging financial data for the first nine months of FY1999, declining sales, limited advertising and product innovation, and other worrisome news. (Op. at 34-36.) VFI's market capitalization never dropped below $1.1 billion until January 1999.

    22

    While VFI did not suddenly collapse, it nonetheless slowly declined, presumably because of basic problems in its business (declining sales, for example, a problem shared by most food companies during the period in question). (Op. at 58.) VFI's managers had hoped to reinvigorate the Vlasic and Swanson brands with aggressive advertising and expansion campaigns, but they lacked the cash for such an ambitious project after renegotiating VFI's loan agreement with the banks. VFI needed all its available cash to service its debt. (Op. at 40.)

    23

    In January 2000, VFI discovered that it had underestimated its accrued trade spending in FY1999 and earlier—that is, its salesmen had granted discounts to various bulk purchasers throughout FY1999, but although FY1999 ended in September 1999, VFI did not accurately calculate the effect of those discounts until January 2000. The discovery drove down VFI's FY2000 earnings, triggered a default under the new loan agreement and sent the public price of VFI's unsecured debt below par value. (Op. at 40-41.) One year later, VFI filed for bankruptcy. (Op. at 42.)

    24

    VFI sold off the former Specialty Foods Division piecemeal both before and during bankruptcy, in a period from roughly January 1999 to May 2001. These sales brought in $504 million, which discounts back to $385 million at the time of the spin, $115 million less than VFI paid for the Division at that time.

    25

    VFI assigned all of its legal claims against Campbell to the plaintiff VFB, LLC, a Delaware limited liability company whose members are VFI's impaired creditors. (The banks are not members; they have already been made whole because of security interests and other protection granted by the renegotiated loan agreement. VFB's members are the holders of the unsecured bonds issued in 1999, the landlord of VFI's headquarters and certain of VFI's employees and trade creditors.) VFB then brought the present action against Campbell, seeking to set aside the spin as a constructively fraudulent transfer and claiming that Campbell aided and [482 F.3d 629] abetted a breach of VFI's pre-spin directors' duty of loyalty to VFI.

    26

    The district court held a lengthy bench trial. The chief factual dispute concerned the value of the Specialty Foods Division on March 30, 1998, and specifically whether it was worth the $500 million VFI paid for it. The parties offered three chief types of evidence on this point. First, there was the price of VFI's publicly traded stock and bonds. The 45 million outstanding shares of VFI stock traded at $25.31 on the New York Stock Exchange at the close of trading on March 30, 1998. This put VFI's equity market capitalization at $1.1 billion, which, considering VFI's $500 million debt obligation, put the value of the Specialty Foods Division at $1.6 billion. VFB argued that the market price reflected the misleadingly high pre-spin earnings figures in Campbell's SEC reports rather than the true value of the Division, but the district court noted that VFI's market capitalization did not even drop below $1.1 billion until 1999, despite the market's quickly learning the truth about VFI's earnings prospects in 1998.

    27

    Second, the parties submitted various valuations of the Specialty Foods Division and VFI, prepared before and after the spin for use by Campbell and VFI. The estimated values of the Division businesses were uniformly above $500 million.

    28

    Third and finally, the parties hired economic expert witnesses and had them estimate the value of the Division. Campbell presented Timothy Leuhrman, who estimated VFI's post-spin value by comparing it to that of six other companies he considered comparable to VFI; he guessed that the Division businesses were worth $1.5-1.8 billion at the time of the spin. VFB called three experts. Henry Owsley, comparing VFI to a different set of companies and performing a discounted cash flow analysis, estimated the Division's worth at $569 million and $270-360 million, respectively. Sheridan Titman and Greg Hallman performed a discounted cash flow analysis that produced a value for the Division of $377 million.

    29

    The district court concluded that the Specialty Foods Division was worth well in excess of the $500 million VFI paid for it on March 30, 1998. It relied primarily on the price of VFI's stock, reasoning that as private traders seek to pay no more for an asset (and sell an asset for no less) than it is worth, the market price was a rational valuation of VFI in light of all the information available to market participants. Although the price was infected by Campbell's manipulation of the Division's earnings at the time of the spin, VFI's stock price remained high even after the truth about VFI's prospects had been fully exposed. The district court concluded that the post-exposure market capitalization was based on an accurate picture of VFI's position as of March 30, 1998, indicating a value of well over $500 million at that time.

    30

    The district court also addressed the expert witnesses' valuations in some detail, finding Leuhrman's analysis convincing and Owsley, Titman and Hallman's analyses flawed, primarily due to hindsight bias, that is, their use of assumptions about VFI that were not shared by the informed public markets at the time of and after the spin. (Op. at 62-68.) But basically the district court regarded the hired expert valuations as a side-show to the disinterested evidence of VFI's capitalization in "one of the most efficient capital markets in the world."

    31

    VFB does not even attempt to show any market valuation of VFI contemporaneous with the Spin-off that is anywhere close to the figures urged by VFB's experts. There is simply no credible evidence to justify setting aside VFI's stock price and the other contemporaneous [482 F.3d 630] market evidence of VFI's worth. Even if, as VFB implies, the market was suffering from some "irrational exuberance" in establishing VFI's stock price, that gives me no basis for second-guessing the value that was fairly established in open and informed trading. (Op. at 58.)

    32

    In light of that conclusion, the court determined both that the spin was not a fraudulent transfer and that, because VFI had been solvent at the time of the spin, it owed no "fiduciary duty to future creditors of VFI."

    33

    In the district court, Campbell also brought certain bankruptcy claims against VFB (successor in interest to VFI). VFB asked the court to disallow the claims because Campbell did not offer any proof for them, but the court held that once Campbell had submitted a facially valid claim, the burden fell to VFB to offer some evidence to rebut it. VFB had offered no such evidence into the record, so the district court allowed the claim. VFB then moved to amend the judgment under Bankruptcy Rule 9023, which motion the district court struck as untimely.

    34
    II. Discussion
    35

    VFB appeals from the district court's judgment and the striking of its motion to amend the judgment. We review the district court's legal determinations de novo, Jean Alexander Cosmetics, Inc. v. L'Oreal, USA, Inc., 458 F.3d 244, 248 (3d Cir.2006), but its findings of fact "shall not be set aside unless clearly erroneous." Fed.R.Civ.P. 52(a); In re Fruehauf Trailer Corp., 444 F.3d 203, 209-10 (3d Cir.2006).

    36
    A. Constructive Fraudulent Transfer
    37

    VFB seeks to set aside the spin as a fraudulent transfer. The parties do not dispute whether VFB, as VFI's successor, has the right to "avoid any transfer of an interest of [VFI] in property or any obligation incurred by [VFI] that is avoidable under applicable law by a creditor holding an unsecured claim that is allowable." 11 U.S.C. § 544(b)(1).

    38

    Both parties agree that New Jersey law applies. Under New Jersey's version of the Uniform Fraudulent Transfer Act:

    39

    A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation. N.J. Stat. Ann. § 25:2-27(a).

    40

    Alternatively,

    41

    A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation . . . [w]ithout receiving reasonably equivalent value in exchange for the transfer or obligation, and the debtor:

    (1) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or

    (2) Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they become due.

    42

    Id. § 25:2-25(b)

    43

    To succeed under either of these provisions, VFB must at least show that the Specialty Foods Division was not "reasonably equivalent value" for the $500 million provided to Campbell. The district [482 F.3d 631] court concluded that it was reasonably equivalent. New Jersey law does not offer a universal definition of "reasonably equivalent value," cf. N.J. Stat. Ann. § 25:2-24(b) (addressing foreclosure sales), and neither does the case law, see, e.g., Flood v. Caro Corp., 272 N.J.Super. 398, 640 A.2d 306, 310 (App.Div.1994). This is probably as it should be, since reasonably equivalent value is not an esoteric concept: a party receives reasonably equivalent value for what it gives up if it gets "roughly the value it gave." In re Fruehauf Trailer Corp., 444 F.3d 203, 213 (3d Cir.2006); Mellon Bank, N.A. v. Metro Comms., Inc., 945 F.2d 635, 647 (3d Cir.1991). We think the New Jersey Supreme Court would agree with the "common sense" approach we have used to determine "reasonably equivalent value" under the bankruptcy code's similar fraudulent transfer provision, 11 U.S.C. § 548(a)(1)(B)(I). Fruehauf Trailer, 444 F.3d at 214; see also Highlands Ins. Co. v. Hobbs Group, LLC, 373 F.3d 347, 351 (3d Cir.2004) ("[W]here the state's highest court has not spoken definitively on a particular issue, the federal court must make an informed prediction as to how the highest state court would decide the issue.").

    44

    Clearly the Division and VFI's cash were both valuable assets, but was the Division worth roughly the $500 million that VFI paid for it? In a meticulous and well-considered opinion the district court concluded that it was, reasoning primarily that in light of VFI's $1.1 billion market capitalization nine months after the spin, the Division businesses were worth indeed far more than $500 million. Because the court focused on VFI's market capitalization as evidence of its value, VFB now concentrates on attacking this approach.

    45

    Some portions of VFB's brief seem to argue that courts should never measure the value of a business by its market capitalization because the market price of a corporation's stock "is based on expectations (projections) of future income," which may turn out to be inaccurate. (Reply Br. for Appellant at 11.) That contention is clearly wrong. Equity markets allow participants to voluntarily take on or transfer among themselves the risk that their projections will be inaccurate; fraudulent transfer law cannot rationally be invoked to undermine that function. In re R.M.L., Inc., 92 F.3d 139, 151 (3d Cir.1996) ("Presumably the creditors . . . want a debtor to take some risks that could generate value."). True, earnings projections "must be tested by an objective standard anchored in [a] company's actual performance," but such a test applies to information about a company's performance available "when [the projection is] made." Moody v. Security Pacific Bus. Credit, Inc., 971 F.2d 1056, 1073 (3d Cir.1992). Market capitalization is a classic example of such an anchored projection, as it reflects all the information that is publicly available about a company at the relevant time of valuation. Basic Inc. v. Levinson, 485 U.S. 224, 243, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (plurality); Peil v. Speiser, 806 F.2d 1154, 1160-61 (3d Cir.1986). A company's actual subsequent performance is something to consider when determining ex post the reasonableness of a valuation, see Moody, 971 F.2d at 1074, but it is not, by definition, the basis of a substitute benchmark, R.M.L., 92 F.3d at 155 (criticizing "[t]he use of hindsight to evaluate a debtor's financial condition").

    46

    We therefore move on to VFB's chief argument, that the district court erred in holding that VFI's market capitalization measured the value of its assets because Campbell manipulated the Specialty Foods Division's sales and earnings prior to the spin.[4] The value of a business [482 F.3d 632] is a mixed question of fact and law, with the underlying factual findings reviewed for clear error and the court's choice of legal precepts and application of those precepts to the facts reviewed de novo. In re Fruehauf Trailer Corp., 444 F.3d 203, 209-10 (3d Cir.2006); R.M.L., 92 F.3d at 147; Mellon Bank, N.A. v. Metro Communications, Inc., 945 F.2d 635, 641-42 (3d Cir. 1991).

    47

    VFB argues that whether VFI's market capitalization reflected its value is a purely legal question because it concerns the proper "method of valuation" of VFI's businesses, and should therefore be reviewed de novo, citing Amerada Hess Corp. v. Commissioner of Internal Revenue, 517 F.2d 75, 82 (3d Cir.1975). VFB misreads Amerada Hess. We held in that case that the proper method of valuation in a particular factual context is a legal question. Id. (citing Richardson v. Commr. of Internal Revenue, 151 F.2d 102, 103 (2d Cir.1945)); see also Moody v. Security Pacific Bus. Credit, Inc., 971 F.2d 1056, 1063 (3d Cir.1992). But the factual context is, naturally enough, a question of fact, and it is the context that the parties dispute in the present case. All agree that if the market capitalization was inflated by Campbell's manipulations it was not good evidence of value; the question is whether it was so inflated. We review the court's resolution of that question for clear error. See Moody, 971 F.2d at 1063; Amerada Hess, 517 F.2d at 83.

    48

    Were the market capitalization numbers on which the district court relied inflated? VFB often attempts to confuse the nature of the district court's reasoning on this point, for instance by stating that the court relied on "VFI's market capitalization at the time of the Spin" despite finding that investors were at that time misled by Campbell's manipulation. (Br. of Appellant at 46-47.) That is not what the court did. It explicitly chose not to rely on VFI's market capitalization at the time of the spin, precisely because of Campbell's manipulation, and instead looked at market capitalization several months later, when the truth of VFI's situation had become clear. (Op. at 54-56.) Nobody contends that VFI was worth more in September 1998 than at the end of March 1998. Consequently, if VFI's September 1998 market capitalization reflected a value for the Division businesses of at least $500 million, despite no longer being affected by Campbell's pre-spin operations, then the Division must have been worth more than $500 million at the time of the spin.

    49

    VFB's fraudulent conveyance claim therefore fails unless VFB can show that the district court clearly erred in concluding that the market price of VFI's stocks and bonds were no longer affected by Campbell's pre-spin manipulations as of September 1998, an issue that VFB seems reluctant to squarely address. Its only argument is to point out that in January 2000, during VFI's FY2000, VFI discovered a $15 million underestimation of FY1999 trade spending that, when figured into FY2000 earnings, triggered a default [482 F.3d 633] under VFI's new loan agreement and caused its unsecured debt to trade below par value. VFB urges that this demonstrates that VFI was in fact insolvent in FY1999, when the underestimated trade spending was actually occurring.

    50

    This argument shows that VFI was insolvent in FY2000; if the bondholders thought VFI solvent, they wouldn't have sold their debt so cheaply. This argument might also suggest that VFI was insolvent in FY1999, although that conclusion is speculative. Additional trade spending alone might not have been enough to render VFI unable to pay its debts; declining sales or some other worsening aspect of VFI's condition between FY1999 and FY2000 might have contributed.

    51

    But what the argument clearly does not show is that VFI was insolvent in FY1998, at the time of the spin. Even if the bondholders were unaware of the current state of VFI when trading bonds at par value in FY1999, they were still aware of everything Campbell reportedly concealed about the Specialty Foods Division prior to the spin. (VFB cites to testimony indicating that some of the underestimated trade spending may have occurred before FY1999 (App. at 1221), but it makes no effort to quantify how much, and both the evidence and the arguments suggest that the lion's share occurred in FY1999 (see, e.g., App. at 1662).) Again, nobody claims that VFI's fortunes were improving, so the market's valuation of VFI as solvent in FY1999 was strong evidence that VFI was solvent at the time of the spin, and therefore received reasonably equivalent value for its $500 million.

    52

    VFB makes additional arguments concerning its expert witnesses' valuations, urging that it was clear error to dismiss them in favor of the market figures, but we do not think that the district court erred in choosing to rely on the objective evidence from the public equity and debt markets. To the extent that the experts purport to measure actual post-spin performance, as by, for example, discounted cash flow analysis, they are measuring the wrong thing. To the extent they purport to reconstruct a reasonable valuation of the company in light of uncertain future performance, they are using inapt tools. Kool, Mann, Coffee & Co. v. Coffey, 300 F.3d 340, 362 (3d Cir.2002) (noting that discounted cash flow analyses are imprecise and have value only "in certain limited situations"). Absent some reason to distrust it, the market price is "a more reliable measure of the stock's value than the subjective estimates of one or two expert witnesses." In re Prince, 85 F.3d 314, 320 (7th Cir.1996); see also In re Hechinger Investment Co. of Del., 327 B.R. 537, 548 (D.Del.2005); Peltz v. Hatten, 279 B.R. 710, 738 (D.Del.2002); Metlyn Realty Corp. v. Esmark, Inc., 763 F.2d 826, 835 (7th Cir.1985) ("[T]he price of stock in a liquid market is presumptively the one to use in judicial proceedings.").

    53

    VFB has consequently not shown clear error in the district court's finding that the Specialty Foods Division was worth far more than its $500 million in debt acquired at the time of the spin. We stress that, given the arguments VFB has made, the question is not even close. Valuing an asset is a difficult task that depends upon detailed factual determinations, which may be overturned only if they are "completely devoid of a credible evidentiary basis or bear[ ] no rational relationship to the supporting data." In re Fruehauf Trailer Corp., 444 F.3d 203, 210 (3d Cir.2006) (quoting Citicorp Venture Capital, Ltd. v. Comm. of Creditors, 323 F.3d 228, 232 (3d Cir.2003)). Where the asset being valued is a speculative investment, a trial court's factual determinations will be "largely immune from attack on [482 F.3d 634] appeal." In re R.M.L., Inc., 92 F.3d 139, 154 (3d Cir.1996).

    54

    For its appeal to succeed, VFB must show that on March 30, 1998, the Specialty Foods Division was clearly worth less than $500 million. Yet it never engages with the relevant numbers in any detail, explaining by how much Campbell's various manipulation techniques affected its statistics, or by how much the statistical inflation affected VFI's market capitalization. Its approach is simply to note that Campbell played with its operations and suggest that the market capitalization numbers may have been wrong to some undetermined degree.

    55

    They may have been, but only to the extent that the market was in the dark about the Division's operational prospects. VFB's theory is that the potential for new management to turn around Vlasic's and Swanson's slow slide depended on ready access to sufficient capital to launch brand-expansion programs, and that in light of the early renegotiation of VFI's loan agreement Campbell never gave it a reasonable chance of having access to that capital, dooming it to eventual insolvency and bankruptcy. But the participants in the 1998 equity market were familiar with VFI's business plan, knew about the renegotiated loan agreement and the likely trouble VFI would have getting access to capital, and still nonetheless valued the company at well more than $500 million, apparently concluding that the company's chances of success were good. VFB's arguments may create some very meager doubt, but the district court's task is to resolve doubts by a preponderance of the evidence. VFB's arguments do not shake our belief that it performed this task meticulously and accurately; the district court carefully considered both the evolving facts and Campbell's duty not to constructively defraud VFI's present and future creditors.

    56

    Because the district court did not err in concluding that VFI received reasonably equivalent value in the spin, we need not discuss the fine distinctions between balance-sheet insolvency, equitable insolvency and unreasonable undercapitalization. Judgment against VFB on its fraudulent transfer claim must be affirmed.

    57
    B. Aiding and Abetting a Breach of Corporate Fiduciary Duty
    58

    VFB's second claim against Campbell is that Campbell aided and abetted a breach of the VFI directors' duty of loyalty to VFI when it entered into the spin transaction knowing that the VFI directors were simultaneously serving as officers of Campbell. New Jersey imposes civil liability for knowingly aiding and abetting an agent's breach of a duty of loyalty to its principal. Franklin Med. Assocs. v. Newark Public Schs., 362 N.J.Super. 494, 828 A.2d 966, 974-76 (App.Div.2003); Hirsch v. Schwartz, 87 N.J.Super. 382, 209 A.2d 635, 640 (App.Div.1965) (citing Restatement 2d of Agency § 312). To hold Campbell liable, VFI must of course show, among other things, that the VFI directors did in fact breach a duty of loyalty to VFI. Franklin Med. Assocs. 828 A.2d at 975; see also Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 172 (Del.2002) (setting forth the elements of aiding and abetting a breach of fiduciary duty). It is here that the district court rejected VFB's claim, holding that VFI's directors breached no fiduciary duty because VFI was solvent at the time of the spin.

    59

    Corporate directors must act in their shareholders' best interests and not enrich themselves at its expense. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993), modified, 636 A.2d 956 (Del. 1994); AYR Composition, Inc. v. Rosenberg, 261 N.J.Super. 495, 619 A.2d 592, 595 [482 F.3d 635] (App.Div.1993). The law enforces this duty of loyalty by subjecting certain actions to unusual scrutiny. Where a director acts while under an incentive to disregard the corporation's interests, she must show her "utmost good faith and the most scrupulous inherent fairness of the bargain." In re PSE & G Shareholder Litigation, 173 N.J. 258, 801 A.2d 295, 307-308 (2002) (quoting Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del.1983)); Brundage v. New Jersey Zinc Co., 48 N.J. 450, 226 A.2d 585, 598-99 (1967).

    60

    VFB urges that VFI's pre-spin directors had an incentive to and admittedly did disregard VFI's best interests in the context of the spin because they were simultaneously officers of Campbell. Normally, simultaneously serving two transacting companies will trigger heightened scrutiny. Summa Corp. v. Trans World Airlines, Inc., 540 A.2d 403, 406 (Del. 1988); Brundage, 226 A.2d at 598. However, scrutiny is unnecessary when the two companies are a parent and its wholly-owned, solvent corporate subsidiary. Anadarko Petroleum Corp. v. Panhandle Eastern Corp., 545 A.2d 1171, 1174 (Del.1988); Bresnick v. Franklin Capital Corp., 10 N.J.Super. 234, 77 A.2d 53, 56 (App.Div. 1951), aff'd, 7 N.J. 184, 81 A.2d 6 (1951) (per curiam). Directors must act in the best interests of a corporation's shareholders, but a wholly-owned subsidiary has only one shareholder: the parent. There is only one substantive interest to be protected, and hence "no divided loyalty" of the subsidiary's directors and no need for special scrutiny of their actions. Bresnick, 77 A.2d at 56; see also Anadarko Petroleum, 545 A.2d at 1174. The VFI directors looked out only for Campbell's interest because, substantively, that was their duty; whether they thought they were acting in the interest of VFI or Campbell "seems inconsequential." Bresnick, 77 A.2d at 57.

    61

    VFB argues that Bresnick and Anadarko have not been followed and are bad law, urging that they would deny a wholly-owned subsidiary standing to sue its directors for a breach of fiduciary duty. But the two cases do not address the subsidiary's distinct legal existence and standing to enforce its directors' duties, a bedrock principle of corporate law. Rather, they address the distinct question of what duties a director owes the subsidiary. See In re Scott Acquisition Corp., 344 B.R. 283, 287 (Bankr.D.Del.2006); First Am. Corp. v. Al-Nahyan, 17 F.Supp.2d 10, 26 (D.D.C.1998). Corporate duties should be as broad as their purpose requires, but it makes no sense to impose a duty on the director of a solvent, wholly-owned subsidiary to be loyal to the subsidiary as against the parent company. None of the cases VFB cites convinces us that the New Jersey Supreme Court would impose such a duty.

    62

    A duty of loyalty against the parent should arise whenever the subsidiary represents some minority interest in addition to the parent. That could happen if the subsidiary were not wholly-owned, see Summa Corp., 540 A.2d at 407, but VFB concedes that Campbell was VFI's sole stockholder at the time of the spin. It could also happen if the subsidiary were insolvent. Directors normally owe no duty to corporate creditors, but when the corporation becomes insolvent the creditors' investment is at risk, and the directors should manage the corporation in their interests as well as that of the shareholders. Bd. of Trustees of Teamsters Local 863 Pension Fund v. Foodtown, Inc., 296 F.3d 164, 173 (3d Cir.2002); AYR Composition, Inc. v. Rosenberg, 261 N.J.Super. 495, 619 A.2d 592, 597 (App.Div.1993); Francis v. United Jersey Bank, 87 N.J. 15, 432 A.2d 814, 824 (1981); Whitfield v. Kern, 122 N.J. Eq. 332, 192 A. 48, 54-55 [482 F.3d 636] (N.J.1937). In such a situation, the loyalties of the VFI directors would be divided between Campbell and the banks that loaned money to VFI as part of the spin transaction, and the spin would be subject to heightened scrutiny. See, e.g., Scott Acquisition, 344 B.R. at 288 ("There is no basis for the principle . . . that the directors of an insolvent subsidiary can, with impunity, permit it to be plundered for the benefit of its parent corporation"); In re Sabine, Inc., No. 05-1019-JNF, 2006 WL 1045712 (Bankr.D.Mass. Feb.27, 2006) (refusing to dismiss a complaint alleging that a company looted its insolvent, wholly-owned subsidiary of cash).

    63

    VFB contends that VFI was rendered insolvent by the spin, but this argument should sound familiar. VFI's pre-spin balance sheet contained nothing; its post-spin balance sheet contained $500 million in debt and the Specialty Foods Division. As noted above, the district court did not clearly err in valuing the division at well over $500 million, meaning that VFI's assets were easily greater than its debts. In Whitfield v. Kern, the New Jersey Supreme Court held that corporate duties to creditors arise in the context of equitable insolvency, "the general inability of the corporate debtor to meet its pecuniary liabilities as they mature, by means of either available assets or an honest use of credit." 192 A. at 55. The district court did not err under this test, either, given the market price of VFI's debt over time. In June 1999, well after the markets were aware of all information that might have been concealed about VFI's condition at the time of the spin, VFI was able to sell $200 million in unsecured debt. That debt continued to sell at par value until January of 2000, indicating that until that point VFI's creditors believed that VFI would pay its unsecured debt as it came due. The district court did not clearly err in concluding that VFI was solvent, and for that reason VFI's claim for aiding and abetting a breach of fiduciary duty must fall.

    64
    C. Campbell's Claims Against the VFI Estate
    65

    Finally, we reach VFB's appeal from the district court's allowance of Campbell's bankruptcy claims. Once a creditor alleges facts sufficient to support a claim, the claim is prima facie valid. 11 U.S.C. § 502(a); In re Allegheny Int'l, Inc., 954 F.2d 167, 173 (3d Cir.1992). Once such a claim is alleged, the burden shifts to the debtor to produce evidence sufficient to negate the prima facie valid claim, that is, "evidence equal in force to the prima facie case." Allegheny Int'l, 954 F.2d at 173. Here, VFB says that it objected to Campbell's claims in its complaint, but an unverified complaint is not evidence. VFB also claims that its own sworn answers to Campbell's interrogatories explain in detail why each of Campbell's claims is not allowable, but it admits that no one put these interrogatories into the record. The district court could not consider evidence that was not before it. Its decision to allow Campbell's claims was correct.

    66

    VFB's motion to amend the judgment included, in part, a request to reopen the record to permit it to introduce the verified interrogatory answers it had failed to submit before. Several potential problems prevented the relief VFB requested, but we need only discuss one: VFB filed its notice of appeal on November 1, 2005, depriving the district court of jurisdiction to grant its motion. Venen v. Sweet, 758 F.2d 117, 123 (3d Cir.1985) (holding that the filing of a notice of appeal deprives the district court of jurisdiction to grant a motion to amend the appealed judgment). The striking of the motion to amend the judgment was not in error.

    67
    [482 F.3d 637] III. Conclusion
    68

    For the foregoing reasons, we affirm both the district court's judgment and its decision to strike the motion to amend the judgment.

    69

    [*] Hon. Richard D. Cudahy, United States Senior Circuit Judge for the United States Court of Appeals for the Seventh Circuit, sitting by designation.

    70

    [1] Technically, what happened in the present case was that the banks extended Campbell credit under a loan agreement that provided that the rights and obligations under the agreement would be assumed by the subsidiary upon transfer of the Division. (Op. at 27.) This transaction is, for our purposes, functionally identical to the transaction described above.

    71

    [2] No one claims that the spin harmed Campbell shareholders.

    72

    [3] Among the other devices Campbell is said to have used are reducing inventory to create "last in first out" gains, delaying scheduled maintenance, using corporate reserves, changing its deduction assumptions and underestimating trade spending.

    73

    [4] We find it difficult to understand how Campbell's sales and earnings manipulation could have seriously misled the public markets about the Division's prospects, especially its "product loading." Product loading involves highly public sales campaigns using devices like sweepstakes and coupons to encourage retailers to take on a larger inventory than usual. (See, e.g., Op. at 17.) We suspect that it would be easy for interested observers to take the effect of this behavior into account when evaluating Campbell's reports and projections. We also find the banks' failure to independently investigate the Division to be somewhat unusual conduct for an institution lending half a billion dollars with a further quarter-billion credit line in reserve. But, in any event, the district court assumed, and took into account, some misleading of the public. (See, e.g., Op. at 16, 22-23, 27.) Our difficulties are irrelevant to the result of this appeal.

  • 2 Bricklayers & Trowel Trades Intern. v. CSFB

    This opinion first explains the basics of event studies, and their importance in securities litigation. The court then discusses problems with the particular study performed by plaintiffs' main expert witness. In this rare case, the court grants defendants' motion to exclude plaintiffs' expert testimony as misleading, which here further leads the court to grant summary judgment for the defendant sua sponte. For a different take on the analysis performed by the expert, see the plaintiffs' brief.

    1
    853 F.Supp.2d 181 (2012)
    2
    BRICKLAYERS AND TROWEL TRADES INTERNATIONAL PENSION FUND, Goodman Family Trust, James Uphoff, Malka Birnbaum, Neil McCarty, and Rodney Narbesky, Consolidated Plaintiffs,
    v.
    CREDIT SUISSE FIRST BOSTON, Jamie Kiggen, Frank Quattrone, Laura Martin, and Elliot Rogers, Defendants.
    3
    Civil Action No. 02-12146-NMG.
    4

    United States District Court, D. Massachusetts.

    5
    January 13, 2012.
    6
    Order Denying Reconsideration May 17, 2012.
    7

    [184] Daniel S. Sommers, Steven J. Toll, Cohen, Milstein, Hausfeld & Toll, Washington, DC, Donald R. Hall, Frederic S. Fox, Joel B. Strauss, Melinda D. Campbell, Gregory Michael Egleston, Egleston Law Firm, Menachem E. Lifshitz, New York, NY, Thomas G. Shapiro, Todd S. Heyman, Adam M. Stewart, Edward F. Haber, Boston, MA, for Plaintiffs.

    8

    Avi S. Gesser, Dharma B. Frederick, Jennifer Newstead, Lawrence Portnoy, Daniel J. Schwartz, Jonathan K. Chang, Lawrence Portnoy, Davis, Polk & Wardwell, Henry Putzell, III, Law Office of Henry Putzell, III, Michael W. Mitchell, Jeff E. Butler, Warren L. Feldman, Alejandra De Urioste, New York, NY, Robert A. Buhlman, Siobhan E. Mee, Jason D. Frank, Sarah G. Kim, Jeffrey B. Rudman, Stephen A. Jonas, Adam Hornstine, Timothy J. Perla, Wilmer, Cutler, Pickering, Hale and Dorr, LLP, Jonathan A. Shapiro, Eben P. Colby, James R. Carroll, Skadden, Arps, Slate, Meagher & Flom, Boston, MA, Barbara A. Winters, Kenneth G. Hausman, Mark A. Sheft, Howard, Rice, Nemerovski, Canady, Falk Rabkin, San Francisco, CA, for Defendants.

    9
    MEMORANDUM & ORDER
    10
    GORTON, District Judge.
    11

    This case is a consolidated securities class action in which the court-appointed lead plaintiff, the Bricklayers and Trowel Trades International Pension Fund, asserts claims on behalf of the class of individuals ("plaintiffs") who purchased common stock of AOL-Time Warner, Inc. ("AOL") from January 12, 2001, through July 24, 2002 ("the Class Period"). The defendants include Credit Suisse First Boston (USA), Inc. ("CSFB-USA"), Credit Suisse First Boston, LLC ("CSFB"), its wholly-owned subsidiary, and four individuals who were employed by CSFB during all or part of the Class Period (collectively, "defendants"). The individual defendants include James Kiggen and Laura Martin, former CSFB research analysts responsible for investment research coverage of AOL during the Class Period. Kiggen and Martin reported to defendants Frank Quattrone, the former Senior Managing Director and Global Head of CSFB's Technology Group, and Elliot Rogers, the former Managing Director and Global Director of Technology Research.

    12
    I. The Complaint
    13

    The Second Amended Consolidated Class Action Complaint ("the complaint") asserts two counts: 1) CSFB, Kiggen and Martin made material misstatements and omissions in violation of section 10(b) of the Securities Exchange Act ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5(b) promulgated thereunder, 17 C.F.R. § 240.10b-5 ("Count I"), and 2) CSFB-USA, CSFB, Quattrone and Rogers acted as "control persons" in violation of section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a) ("Count II").

    14

    To prove allegations of securities fraud under Rule 10b-5, a plaintiff must establish:

    15
    1) that the defendants made a material misrepresentation in connection with the purchase or sale of a security;
    16
    2) that the misrepresentation was made with scienter;
    17
    3) reliance, i.e., but for the misrepresentation, an investor would not have purchased or sold the security;
    18
    4) economic loss, i.e., the investor lost money as the result of said purchase or sale; and
    19
    5) loss causation, i.e., a causal connection between the misrepresentation and the economic loss.
    20

    [185] In re PolyMedica Corp. Sec. Litig., 432 F.3d 1, 6-7 (1st Cir.2005).

    21

    Plaintiffs' theory of recovery in this case is commonly referred to as the fraud-on-the-market scenario. Plaintiffs allege, under that theory, that 1) CSFB's overly optimistic and intentionally misleading reports, upon which class investors relied in purchasing the AOL stock, artificially inflated the stock price and 2) after the market learned of the deception, the price of the stock declined.

    22
    II. Procedural history
    23

    In 2003, various cases were consolidated to comprise this action. In September, 2006, former United States District Judge Nancy Gertner denied defendants' motions to dismiss and, two years later, certified the class. Most recently, on August 26, 2011, 2011 WL 3813204, Judge Gertner provisionally denied defendants' motions for summary judgment without ruling on defendants' objection to the testimony of plaintiffs' expert Dr. Scott Hakala. On that occasion she stated:

    24
    Summary judgment — without a full Daubert hearing — is an inappropriate way to decide [whether Dr. Hakala's event study and testimony will be admitted at trial.]. Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 113 S.Ct. 2786, 125 L.Ed.2d 469 (1993). The expert issues cannot be determined by precedent, pointing out that Plaintiffs' expert was accepted or rejected in this or that case so long as the Defendants are making, in effect, an as-applied challenge on these facts, in this context. It requires more than warring affidavits and strident briefs. It requires an evidentiary hearing. And in the hearing the threshold question is not just the reliability of the expert testimony under the Federal Rules of Evidence 702. It is also whether a jury would fully understand the attacks and counterattacks as they play out in the instant case.
    25

    Judge Gertner pointed out that reliance and loss causation, two central elements of plaintiffs' securities fraud case, "necessarily rely on [the] expert testimony" of Dr. Hakala, implying that if the Court were to exclude the testimony of Dr. Hakala after a Daubert hearing, it would necessarily have to revisit its summary judgment decision.

    26

    Upon Judge Gertner's retirement from the bench, the case was transferred to this Session. Pending before the Court are defendants' motion to preclude the expert opinions of Scott Hakala, M. Laurentius Marais, Bernard Black and Reinier Kraakman, which plaintiffs oppose, and plaintiffs' motion to preclude the expert opinions of Rene Stulz and John Deighton, which defendants oppose. On December 20, 2011, the Court convened a Daubert hearing at which Dr. Hakala and Dr. Marais testified and counsel were afforded an opportunity to expound at length on their respective motions. The Court took the motions under advisement and, upon further reflection and analysis, renders the following decision.

    27
    III. Defendants' motion to preclude the expert opinion of Dr. Scott Hakala
    28

    Dr. Hakala prepared an event study to measure the impact, if any, of defendants' allegedly fraudulent statements and omissions on the value of AOL stock during the Class Period.

    29
    A. Event studies
    30

    A conventional securities fraud event study is conducted as follows: an economist performs a regression to estimate the relationship between a stock's "actual return" (the difference between closing prices on two consecutive days) and the movement of one or more indices representing [186] an average of the stock prices for several companies which make up the market and/or industries in which the firm operates. This first step allows the economist to predict how the stock price should move on any given day based on the movement of the indices ("the expected return") and thereby provides a benchmark for all companies within a particular market. The estimated expected return is then used as the baseline against which the stock's actual return on pre-selected event days is measured. The expected return is thus a measured expectation of what the normal stock price movement would have been if the event had not occurred. If the difference between the expected return and the actual return on an event day is statistically significant, it may be attributed to the event occurring on that day, provided that the study controls for confounding factors. A. Craig MacKinlay, Event Studies in Economics and Finance. 35 J. Econ. Literature 13, 13-35 (1997); Jay W. Eisenhofer, Geoffrey C. Jarvis & James R. Banko, Securities Fraud, Stock Price Valuation, and Loss Causation: Toward a Corporate Finance-Based Theory of Loss Causation. 59 Bus. Law. 1419, 1425-26 (2004).

    31

    An event study is an accepted method of measuring the impact of alleged securities fraud on a stock price and often plays a "pivotal" role in proving loss causation and damages in a securities fraud case. In re Williams Sec. Litig., 496 F.Supp.2d 1195, 1272 (N.D.Okla.2007). Given the difficulty inherent in proving the effect, if any, of a single news item on the price of a stock, many courts require them in such cases. See Fener v. Operating Eng'rs Const. Indus. & Misc. Pension Fund (LOCAL 66), 579 F.3d 401, 409 (5th Cir.2009) ("[T]he testimony of an expert — along with some kind of analytical research or event study — is required to show loss causation."); In re Imperial Credit Indus., Inc. Sec. Litig., 252 F.Supp.2d 1005, 1015 (C.D.Cal.2003) ("[A] number of courts have rejected or refused to admit into evidence damages reports or testimony by damages experts in securities cases which fail to include event studies or something similar.") (internal citations and question marks omitted). While event study techniques have become more sophisticated over the years, their basic format and methodology have not materially changed. S.P. Kothari and Jerold B. Warner, Econometrics of event studies. Handbook of Corporate Finance: Empirical Corporate Finance (2004). In other words, there is no great dissension in the financial econometric community about how to conduct a proper event study.

    32
    B. Standard
    33

    The admission of expert evidence is governed by Federal Rule of Evidence 702, which codified the Supreme Court's holding in Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 113 S.Ct. 2786, 125 L.Ed.2d 469 (1993), and its progeny. United States v. Diaz, 300 F.3d 66, 73 (1st Cir.2002). Rule 702 charges a district court with determining whether: 1) "scientific, technical, or other specialized knowledge will assist the trier of fact," 2) the expert is qualified "by knowledge, skill, experience, training, or education" to testify on that subject, 3) the expert's proposed testimony is based upon "sufficient facts or data," 4) that testimony is the product of "reliable principles and methods" and 5) the expert "applies the principles and methods reliably to the facts of the case." Furthermore, a critical inquiry is whether the expert "employs in the courtroom the same level of intellectual rigor that characterizes the practice of an expert" on securities fraud event studies. Kumho Tire Co. v. Carmichael, 526 U.S. 137, 152, 119 S.Ct. 1167, 143 L.Ed.2d 238 (1999).

    34

    [187] The Court must be vigilant in exercising its gatekeeper role because of the latitude given to expert witnesses to express their opinions on matters about which they have no firsthand knowledge and because an expert's testimony may be given substantial weight by the jury due to the expert's status. See Daubert, 509 U.S. at 595, 113 S.Ct. 2786; Kumho Tire, 526 U.S. at 148, 119 S.Ct. 1167. This consideration looms large in securities fraud cases, where complex event studies are often the only evidence used to establish reliance and loss causation.

    35

    The Court must, nonetheless, keep in mind that

    36
    vigorous cross-examination, presentation of contrary evidence, and careful instruction on the burden of proof are the traditional and appropriate means of attacking shaky but admissible evidence.
    37

    Daubert, 509 U.S. at 596, 113 S.Ct. 2786. If an expert's testimony is within "the range where experts might reasonably differ," the jury, not the trial court, should be the one to decide among the conflicting views of different experts. Kumho Tire, 526 U.S. at 153, 119 S.Ct. 1167.

    38
    C. Analysis
    39

    Defendants contend that Dr. Hakala's event study is unreliable because it flouts established event study methodology and draws unreasonable conclusions from the data presented. Specifically, defendants argue that Dr. Hakala 1) studies the wrong days, 2) overuses so-called "dummy variables," 3) disregards prior disclosures and 4) fails to control for confounding factors. The Court addresses defendants' arguments seriatim.

    40
    1. Event day selection
    41

    Accepted event study methodology teaches that an economist should exclude from the regression the days the alleged fraudulent misrepresentations were made ("inflationary days"), the days the market learned the truth ("corrective days") (together, "event days") and any other days on which major company-specific news, such as a quarterly earnings statement, was reported ("material news days"). By removing those days from consideration, an economist can establish a baseline of normal stock price volatility against which the change in price on event days can be compared. If stock price volatility is abnormally high on event days, and the study properly controls for other industry- and company-specific information released to the marketplace unrelated to defendants' alleged fraud ("confounding factors"), the inflation or deflation may fairly be attributed to the defendants. MacKinlay, supra, at 13-35; Eisenhofer, supra, at 1425-26.

    42

    To summarize: an economist should select as the event days to be studied the days the allegedly fraudulent misrepresentations were made and the days the market learned the truth. Dr. Hakala admittedly did not proceed in this fashion. Instead of selecting as event days the 34 days on which, according to the complaint, CSFB issued misleading reports, Dr. Hakala selected only 12 of those days, deeming the remaining 22 irrelevant to his study. His approach, while unconventional, does not necessarily subvert his study. It is, after all, certainly possible that some misleading analyst statements impact the price of a stock while others do not. It does, however, compel this Court to scrutinize his selection of event days.

    43

    Of the 57 identified event days, Dr. Hakala labels 21 as inflationary (i.e., days defendants' alleged misrepresentations purportedly inflated the value of AOL stock) and 36 as corrective (i.e., days the value of AOL stock correspondingly deflated when the market purportedly learned the truth). A review of the information [188] released to the market on those days exposes the fallibility of his classifications.

    44

    Take, for example, February 1, March 7 and April 2, 2001, days on which CSFB issued reports allegedly misrepresenting AOL's earning potential and omitting material information that, if revealed, likely would have tempered investor expectations. Instead of treating those event days as inflationary, Dr. Hakala inexplicably deems them corrective disclosures. In so doing, his study not only contravenes established event study methodology, it belies the very allegations plaintiffs made in the complaint, i.e., that CSFB reports inflated AOL's stock price.

    45

    Nor were these isolated mistakes. Dr. Hakala's event study is replete with event days that appear to have been selected more for their volatility than for their actual relationship to defendants' alleged fraud. June 7, 2001 and February 5 and 26, 2002 are examples of days on which what little AOL news released to the market was positive and, yet, AOL's stock price declined. Instead of concluding that the news did not cause the price deflation and attributing it to any of the myriad other variables that affect stock prices, Dr. Hakala blamed the decline on defendants and labeled the days as corrective even though the news released was positive.

    46

    Rather than study the market's reaction to the misrepresentations alleged in the complaint, Dr. Hakala cherry-picked unusually volatile days and made them the focus of his study. If the stock price increased sharply, he attributed it to the defendants (even if no CSFB reports were released on that day). If the stock price decreased sharply, he called it a corrective disclosure (even if the news released was positive). The Court concludes, as did United States District Judge Rya Zobel in In re Xcelera.com Sec. Litig., No. 00-11649-RWZ, 2008 WL 7084626, at *2 (D.Mass. Apr. 25, 2008), that, "[q]uite simply, [Dr. Hakala's] theory does not match the facts."

    47
    2. Dummy variables
    48

    A dummy variable is a variable that takes the value of one or zero to indicate the presence or absence of some effect in an event study. Dummy variables allow financial economists to control for the effect of event days and material news days on the price of a stock. They are a common and accepted component of securities fraud event studies, although courts have cautioned against their overuse. See In re Northfield Labs., Inc. Sec. Litig., 267 F.R.D. 536, 548 (N.D.Ill.2010); Xcelera, 2008 WL 7084626, at *1.

    49

    Defendants assert that Dr. Hakala's event study uses a much higher percentage of dummy variables than is considered acceptable in the financial econometric community and that such overuse renders his study unreliable. Instead of dummying out the 34 event days on or after which defendants issued analyst reports and any other days significant AOL-related news appeared, as defendants suggest would have been proper, Dr. Hakala dummied out virtually every day any AOL-specific news was reported (211 of the 388 days in the study period, a breathtaking 54%). In so doing, Dr. Hakala assumed for the purpose of his study that AOL stock trades "normally" less than half the time.

    50

    Apparently, this is not the first time that Dr. Hakala has been criticized for overusing dummy variables. In the event studies he prepared for the Northfield and Xcelera cases, he dummied out 117 of 1,383 trading days (8%) and 130 of 343 trading days (38%), respectively. The Xcelera court explained that Dr. Hakala's use of dummy variables was not a reliable method supported by the academic literature. 2008 WL 7084626, at *1 ("Although the academic [189] literature supports the use of dummy variables for events in which significant company-specific news is released, no peer-reviewed journal supports the view that dummy variables may be used on all dates on which any company news appears."). The Northfield court explained why:

    51
    Dr. Hakala's excessive use of dummy variables understates the usual volatility of the stock [to 3.66% from 4.09%], which has the effect of making it appear that news had a greater affect [sic] on price than it actually had.
    52

    267 F.R.D. at 548. Both courts excluded Dr. Hakala's event studies after concluding that his overuse of dummy variables rendered them unreliable.

    53

    Exclusion is likewise warranted here. In this case, Dr. Hakala used dummy variables for a greater number of days and a higher percentage of the study period (211 days and 54%, respectively) than he did in his event studies in Northfield and Xcelera. If those courts were correct in excluding his event studies for the reasons articulated therein, as this Court believes they were, it follows a fortiori that his event study should be excluded here.

    54

    Looking beyond the numbers, Dr. Hakala's use of dummy variables in the event study he prepared for this case artificially deflated the baseline volatility of AOL's stock price during the Class Period, thereby making its volatility on days CSFB issued reports appear greater than it really was. Because the stock price of any company is likely to be more volatile on material news days, removing those days from the study creates a downward bias in the study's measure of price volatility. As a result, Dr. Hakala's study cannot establish that it was the reports of the CSFB analysts, rather than the tangle of factors that affect the price of a stock, that inflated AOL's share price during the Class Period.

    55
    3. Prior disclosures
    56

    At the class certification stage, plaintiffs established that AOL stock was traded on an efficient market (i.e., that the market price of AOL stock at any given time reflected all information publically available at that time). As a result, the Court ruled that they were entitled to the fraud-on-the-market presumption of reliance, which allows them to presume that investors relied on defendant's alleged misstatements, in order to prove the second element of Count I.

    57

    The fraud-on-the-market presumption is little more than legal recognition of an established economic principle. In an efficient market, a company's stock reacts immediately to new material information. PolyMedica, 432 F.3d at 14. If an executive or analyst makes a material misrepresentation, we can presume that investors relied upon it in purchasing the stock. As a corollary, a company's stock in an efficient market should generally not react to reiterations of previously released information. See Teachers' Ret. Sys. of La. v. Hunter, 477 F.3d 162, 187-88 (4th Cir. 2007). A possible exception to this principle might be when the information is later released by a more reputable source or to a larger market. Reframed, the principle might read: a company's stock in an efficient market should not, without good reason, react to reiterations of previously released information.

    58

    Dr. Hakala's event study is also unreliable because it repeatedly ignores the efficient market principle. The study attributes volatility in AOL's stock price to the reports of defendant analysts when, at the time of the inflation or deflation, an efficient market would have already priced in the reports. For example, Dr. Hakala labels April 18, 2002 as a corrective date, [190] and attributes stock price deflation to the defendants, even though the information released on that day, Deutsche Bank's lowered estimate and price target, was released nine days earlier without any corresponding impact.

    59

    Plaintiffs may not at the same time presume an efficient market to prove reliance and an inefficient market to prove loss causation. They may not have their cake and eat it too.

    60
    4. Confounding factors
    61

    To establish a causal link between stock price movement and misrepresentations or corrective disclosures, an economist must control for confounding factors, i.e., other industry- or company-specific information released to the market unrelated to the alleged fraud. In re Omnicom Grp., Inc. Sec. Litig., 541 F.Supp.2d 546, 554 (S.D.N.Y.2008). Financial economists have at their disposal a number of sophisticated methods to isolate the causal effect of different news items released on the same day.

    62

    One such method, intra-day trading analysis, charts the minute-by-minute stock price and the exact time each news item was released to the market and then compares the two to discern whether any causal relationship can be drawn. See Laura Starks, Discussion of Market Microstructure: An Examination of the Effects on Intraday Event Studies, 10 Contemp. Acct. Res. 355, 383-86 (1994). For example, if the price of a company's stock rose a staggering $10 per share on the same day that two positive reports about that company were released, one would examine the market's reaction to each report. If the stock price remained fairly level after the first report but rose dramatically after the second, the increase could fairly be attributed to the second report and the first report could be discounted as a causal factor. The converse could be inferred if the $10 spike occurred immediately after the first report. An intra-day trading analysis is not proof of a causal relationship but it provides a factfinder with a basis for determining whether and to what extent a single news release impacted the price of a stock on an otherwise confounded event day.

    63

    An event study that fails to disaggregate the effects of confounding factors must be excluded because it misleadingly suggests to the jury that a sophisticated statistical analysis proves the impact of defendants' alleged fraud on a stock's price when, in fact, the movement could very well have been caused by other information released to the market on the same date. In re Williams Sec. Litig., 558 F.3d 1130, 1143 (10th Cir.2009), aff'g, 496 F.Supp.2d 1195 (N.D.Okla. 2007); Xcelera, 2008 WL 7084626, at *4-5.

    64

    Given the extraordinary volume of AOL-related news in the marketplace during the Class Period, Dr. Hakala had a herculean task. His principal approach was to read all the AOL-related news released on a given day and to make subjective judgments about which news impacted the stock price. It would be just as scientific to submit to the jurors evidence of defendants' alleged fraud and AOL's stock fluctuations and let them speculate whether the former caused the latter. See Williams, 558 F.3d at 1143 (finding that expert's subjective intuitions about which news moved a stock price "would be no less speculative and unreliable if reached by jurors"). After all, Dr. Hakala is an expert in financial econometrics, not in securities trading; that is why plaintiffs hired Professors Black and Kraakman. Courts require rigorous event studies to avoid such fallacious post-hoc inferences.

    65

    [191] As a result, confounding factors pervade Dr. Hakala's event study. On many event days, information was released from a variety of different sources (e.g., stock analysts, news media and AOL itself) about different aspects of AOL's business (from acquisitions to advertising to subscriptions). Some of the information was positive, some negative. Instead of conducting an intra-day trading analysis for each event day with confounding information (which is, to say, nearly all of them) in order to provide the jury with some basis for discerning the cause of the stock price fluctuation, Dr. Hakala either attributed a rough proportion of the movement to each report or blamed it all on the defendants.

    66

    The problem is not just that many event days are hopelessly confounded and not readily attributable to the defendants' alleged misconduct; it is, more importantly, that Dr. Hakala made unreasonable judgments about which factors likely caused stock price movement on event days. For instance, Dr. Hakala attributes AOL's stock price increase on April 18, 2001 to a CSFB report even though AOL itself reported rising first-quarter earnings that morning and the CSFB report merely passed along that news.

    67

    There are at least three pitfalls associated with Dr. Hakala's theory. First, it makes little sense to conclude that investors relied upon the CSFB report and ignored the earnings numbers upon which it was based. Second, the academic literature on securities fraud event studies recommends excluding from an event study days with such firm-specific confounding announcements because of a) the difficulty of disentangling the response to the earnings announcement from the response to the analyst forecast revision and b) the typically minor impact of an analyst report issued immediately after an earnings announcement. See Zoran Ivkovic and Narasimhan Jegadeesh, The Timing and Value of Forecast and Recommendation Revisions, 73 J. Fin. Econ. 433, 448 (2004). Third and finally, an intra-day trading analysis conducted by Dr. Stulz suggests that the CSFB report did not cause the stock increase: AOL stock reached its end-of-the-day share price of $49 by 11 a.m., nearly five hours before CSFB issued its report.

    68

    In sum, Dr. Hakala's failure to isolate the effect of defendants' alleged fraud from other industry- and company-specific news reported on event days confounds his event study and renders it unreliable.

    69
    5. Conclusion
    70

    This judicial officer is inclined to let experts testify. The crucible of cross-examination is the usually the best way to assess the reliability of expert testimony. Juries are the hallmark of our legal system and they deserve far more credit than they are given to discern the truth through the fog of competing expert testimony.

    71

    Until now, no expert has been precluded on Daubert grounds from testifying in this Session of the United States District Court for the District of Massachusetts. Had Dr. Hakala's event study suffered from only one of the four methodological defects identified by this Court, or suffered from those flaws jointly but to a lesser degree, today's ruling might have been different. Given, however, the pervasiveness of Dr. Hakala's methodological errors and the lack of congruity between his theory and the data, the Court is compelled to exercise its role as gatekeeper and to exclude his event study as unreliable.

    72
    IV. Summary judgment
    73

    The same deficiencies that render Dr. Hakala's event study inadmissible also prevent the study, even if it were admitted, [192] from raising a triable issue of fact on loss causation.

    74
    A. Standard
    75

    The role of summary judgment is "to pierce the pleadings and to assess the proof in order to see whether there is a genuine need for trial." Garside v. Osco Drug, Inc., 895 F.2d 46, 50 (1st Cir.1990) (quoting Fed.R.Civ.P. 56 advisory committee's note). The burden is on the moving party to show, through the pleadings, discovery and affidavits, "that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(c).

    76

    A fact is material if it "might affect the outcome of the suit under the governing law." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). "Factual disputes that are irrelevant or unnecessary will not be counted." Id. A genuine issue of material fact exists where the evidence with respect to the material fact in dispute "is such that a reasonable jury could return a verdict for the nonmoving party." Id.

    77

    Once the moving party has satisfied its burden, the burden shifts to the non-moving party to set forth specific facts showing that there is a genuine, triable issue. Celotex Corp. v. Catrett, 477 U.S. 317, 324, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). The Court must view the entire record in the light most favorable to the non-moving party and indulge all reasonable inferences in that party's favor. O'Connor v. Steeves, 994 F.2d 905, 907 (1st Cir.1993). Summary judgment is appropriate if, after viewing the record in the non-moving party's favor, the Court determines that no genuine issue of material fact exists and that the moving party is entitled to judgment as a matter of law.

    78

    To survive summary judgment on loss causation in a fraud-on-the-market case, plaintiffs must show that their losses "are attributable to some form of revelation to the market of the wrongfully concealed information." In re Worldcom, Inc. Sec. Litig., No. 02 Civ. 3288(DLC), 2005 WL 2319118, at *23 (S.D.N.Y. Sept. 21, 2005). The revelation can occur through one or more discrete corrective disclosures or it can "leak out" more gradually. Williams, 558 F.3d at 1137-38. Either way, plaintiffs must establish the mechanism by which the truth was revealed. Id. at 1138. It is not enough simply to note that

    79
    the market had learned the truth by a certain date and, because the learning was a gradual process, attribute all prior losses to the revelation of the fraud. The inability to point to a single corrective disclosure does not relieve the plaintiff of showing how the truth was revealed; he cannot say, "Well, the market must have known."
    80

    Id.

    81

    Whether plaintiffs proceed under a corrective disclosure theory or a leakage theory, they must establish that the market reacted to the revelation of the alleged misrepresentation or the facts underlying it, not to other negative information about the company unrelated to the alleged fraud. In re Oracle Corp. Sec. Litig., 627 F.3d 376, 392 (9th Cir.2010). For that reason, an expert "must be careful not to connect each and every bit of negative information about a company to an initial misrepresentation," Williams, 558 F.3d at 1140, such that "every announcement of negative news [is labeled a] corrective disclosure," In re Motorola Sec. Litig., 505 F.Supp.2d 501, 546 (N.D.Ill.2007).

    82
    The market need not know at the time that the practices in question constitute a "fraud," nor label them "fraudulent", [193] but in order to establish loss causation, the market must learn of and react to those particular practices themselves.
    83

    Oracle, 627 F.3d at 392.

    84

    The corrective disclosure must also "present facts to the market that are new, that is, publicly revealed for the first time." Katyle v. Penn Nat'l Gaming, Inc., 637 F.3d 462, 473 (4th Cir.2011). Consistent with the efficient market principle, if investors already knew the truth, the drop in stock price could not be attributed to the disclosure. Id.; see also FindWhat Investor Grp. v. FindWhat.com, 658 F.3d 1282, 1312 n. 28 (11th Cir.2011) ("[B]ecause a corrective disclosure must reveal a previously concealed truth, it obviously must disclose new information, and cannot be merely confirmatory.").

    85

    Finally, to survive summary judgment, plaintiffs must isolate the extent to which the decrease in stock price was caused by the disclosure and not, as the Supreme Court has warned, "the tangle of [other] factors affecting [stock] price," such as

    86
    changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price.
    87

    Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 343, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005); see also In re Scientific Atlanta, Inc. Sec. Litig., 754 F.Supp.2d 1339, 1371-76 (N.D.Ga.2010) ("[I]n order to defeat summary judgment, plaintiffs in a securities fraud case must present evidence disaggregating the fraud and non-fraud-related causes of the plaintiff's loss."); Omnicom, 541 F.Supp.2d at 554 ("Because the law requires the disaggregation of confounding factors, disaggregating only some of them cannot suffice to establish that the alleged misrepresentations actually caused Plaintiffs' loss."); Williams, 558 F.3d at 1140 (affirming district court's grant of summary judgment on loss causation because plaintiffs' expert failed to disaggregate confounding factors).

    88
    B. Application
    89

    This brings us to the case at bar, where the "tangle of factors" affecting AOL's stock price during the Class Period was akin to the Gordian knot. AOL was covered extensively by over 40 investment firms, many if not most of which projected aggressive earnings estimates for AOL during the Class Period. As one of the first corporate entities to bring under one roof "old" and "new" media, and one of the major players in the burgeoning internet marketplace, AOL was abnormally susceptible to stock price volatility. With the merger also came exposure to different industries, yet another factor obscuring the true cause(s) of its stock price movement.

    90

    Dr. Hakala's event study purports to disentangle those factors and pinpoint with precision the effect of defendants' alleged fraud on AOL's stock price. To do so, Dr. Hakala identifies 36 corrective disclosure dates on which, he claims, defendants' alleged fraud was revealed to the market and caused a decline in AOL stock price. Careful review of the information disclosed to the market on those dates reveals three infirmities in Dr. Hakala's methodology that prevent plaintiffs from raising a triable issue of fact on loss causation.

    91

    First, Dr. Hakala fails to link many of the events he labels as corrective disclosures to the defendants' alleged fraud. Plaintiffs allege in the complaint that CSFB knew, yet failed to disclose, that

    92
    1) a substantial weakening in the advertising markets would likely prevent AOL from reaching its earning projections;
    93
    [194] 2) AOL engaged in inappropriate accounting activities which artificially inflated its revenue statements; and
    94
    3) layoffs had occurred which, if made public, would negatively impact AOL's stock price.
    95

    In a fraud-on-the-market case such as this one, in which defendant analysts are alleged to have fraudulently misstated a company's earning potential, plaintiffs must do more than show that "the market reacted to the purported `impact' of the alleged fraud — the earnings miss." Oracle, 627 F.3d at 392. To qualify as a corrective disclosure in this case, information released to the market must pertain to at least one of the foregoing topics about which defendants allegedly concealed information. See Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172-73 (2d Cir.2005).

    96

    Yet many of the corrective disclosures identified by Dr. Hakala do not contain any mention of weakening advertising markets, inappropriate accounting practices or stealth layoffs. Information released on many of the identified corrective disclosure dates pertained to subscription rates (January 31, 2001, and January 2 and 4, March 12 and April 11, 2002), unrelated acquisitions (January 31 and December 3, 2001), management changes (April 11, 2002), projection downgrades by other firms (December 7, 2001, and January 3 and 4, 2002) and AOL's quarterly earnings miss (October 17, 2001).

    97

    Second, as discussed in greater depth in Section II.C.3 supra, many of the so-called corrective disclosures did not include new information. Assuming an efficient market, as plaintiffs have, the information disclosed to the market on many of the identified corrective disclosure days was already incorporated into the AOL stock price. Dr. Hakala should not have attributed it to defendants' alleged fraud.

    98

    Third, as discussed in greater depth in Section II.C.4 supra, Dr. Hakala failed properly to isolate the extent to which the stock price deflation was caused by the disclosures and not by other confounding factors.

    99

    This is not the first time a court has premised, at least in part, its entry of summary judgment on Dr. Hakala's failure to disaggregate confounding factors. In Omnicom, the court held that Dr. Hakala's event study could not establish loss causation, and granted summary judgment for defendants as a result, because

    100
    to the extent that any corrective disclosures exist, the event study does not isolate their effect on Omnicom's stock price from that of [other] negative reporting [and] the effect of post-Enron changed investor expectations.
    101

    541 F.Supp.2d at 554. Affirming the district court's ruling on appeal, the Second Circuit reiterated that his event study "does not suffice to draw the requisite causal connection" between the corrective disclosure and the fraud alleged in the complaint. In re Omnicom Grp., Inc. Sec. Litig., 597 F.3d 501, 512 (2d Cir.2010).

    102

    The court reached the same result in Scientific Atlanta:

    103
    Dr. Hakala's analysis fails to disentangle the effect of the new information regarding customer inventory levels from SA's new, negative characterization of how industry-wide trends were affecting it specifically.
    104

    754 F.Supp.2d at 1379. It would be a mistake to submit the evidence to the jury, the court reasoned, because the jury would have no basis for determining how much, if any, of the plaintiffs' loss should be attributed to defendants' fraudulent conduct. Id.

    105

    This Court reaches the same conclusion. Nearly all of the 54 event days are confounded [195] in some way; many of the days, hopelessly so. It is not enough to divide each day's economic loss by the number of analyst reports on that day and attribute a corresponding proportion to the defendants, without demonstrating that the defendants' report was a substantial cause of the loss. See id. at 1376. Nor is it sufficient simply to speculate that one report caused the loss instead of another,

    106
    without providing the factfinder with a basis for evaluating the relative effects of [potential] competing causes, thereby determining which factors were substantial and which were relatively minor or inconsequential.
    107

    Id. As the Supreme Court has emphasized, "[t]o `touch upon' a loss is not to cause a loss, and it is the latter that the law requires." Dura, 544 U.S. at 343, 125 S.Ct. 1627. This Court finds, as did the Omnicom and Scientific Atlanta courts, that Dr. Hakala's "partial disaggregation of confounding factors is insufficient to establish that the alleged misrepresentations actually caused plaintiffs' loss." Scientific Atlanta, 754 F.Supp.2d at 1379.

    108
    C. Conclusion
    109

    Thus the Court concludes, as did the Fifth Circuit in Fener, that "once we disregard Hakala's flawed event study, the rest of his testimony is insufficient to prove loss causation." 579 F.3d at 410; see also Xcelera, No. 00-11649-RWZ (allowing defendants' renewed motion for summary judgment in light of Court's exclusion of Dr. Hakala's event study); Williams, 496 F.Supp.2d at 1290-95 (granting summary judgment for defendants on loss causation after excluding expert witness's testimony as unreliable). Because plaintiffs have failed to raise a triable issue of fact on the element of loss causation, defendants are entitled to summary judgment on Counts I and II.

    110
    V. Other experts
    111

    Finding that the exclusion of Dr. Hakala's event study and testimony entitles the defendants to summary judgment on Counts I and II, the Court declines to assess whether the remaining experts should be permitted to testify.

    112
    ORDER
    113

    In accordance with the foregoing, defendants' motion to preclude the expert opinions of Scott Hakala, M. Laurentius Marais, Bernard Black and Reinier Kraakman (Docket No. 303) is ALLOWED, in part, and DENIED, in part. The motion is allowed as it pertains to Dr. Scott Hakala and denied as moot as it pertains to Dr. Marais and Professors Black and Kraakman. Plaintiffs' motion to preclude the expert opinions of Rene Stulz and John Deighton (Docket No. 310) is DENIED as moot.

    114

    Having ruled that Dr. Hakala's event study is inadmissible and having concluded that, without it, plaintiffs cannot raise a triable issue of fact as to loss causation, the Court grants summary judgment sua sponte on Counts I and II in favor of the defendants.

    115

    So ordered.

    116
    MEMORANDUM & ORDER
    117

    In a Memorandum and Order entered on January 13, 2012 ("the January 2012 M & O"), this Court excluded the event study of Dr. Scott Hakala and granted summary judgment in favor of the defendants. Pending before the Court is plaintiffs' motion to reconsider that ruling.

    118
    I. Background
    119

    The background and procedural history of this case was recounted in detail in the January 2012 M & O and will be rehearsed [196] here only to the extent necessary. In 2003, various cases were consolidated to comprise this securities fraud class action over which United States District Judge Nancy Gertner was assigned to preside. In September 2006, Judge Gertner denied defendants' motions to dismiss and, two years later, certified the class.

    120

    In a Memorandum and Order entered on August 26, 2011, 2011 WL 3813204, Judge Gertner provisionally denied defendants' motions for summary judgment without ruling on the admissibility of expert testimony. She explained that "summary judgment — without a full Daubert hearing — is an inappropriate way" to decide the complicated expert issues presented. Because reliance and loss causation, two central elements of plaintiffs' case, "necessarily rely on expert testimony," Judge Gertner intimated that if Dr. Hakala's testimony were excluded, her conditional summary judgment decision would have to be revisited.

    121

    Upon Judge Gertner's retirement, the case was transferred to this Session. In December 2011, a Daubert hearing was held at which counsel were given an opportunity to be heard with respect to their expert preclusion motions and Drs. Hakala and Marais testified. On January 13, 2012, the Court rendered its opinion. After finding four critical methodological flaws in Dr. Hakala's event study, the Court excluded that study as unreliable and granted summary judgment sua sponte in favor of the defendants on the grounds that, without the event study, plaintiffs could not raise a triable issue of fact as to loss causation. Shortly thereafter, plaintiffs filed the instant motion for reconsideration.

    122
    II. Motion for Reconsideration
    123
    A. Standard
    124

    Ruling on a motion for reconsideration requires a court to "balance the need for finality against the duty to render just decisions." Davis v. Lehane, 89 F.Supp.2d 142, 147 (D.Mass.2000). Reconsideration is warranted only in a limited number of circumstances:

    125
    if the moving party presents newly discovered evidence, if there has been an intervening change in the law, or if the movant can demonstrate that the original decision was based on a manifest error of law or was clearly unjust.
    126

    United States v. Allen, 573 F.3d 42, 53 (1st Cir.2009). Such motions are not vehicles for pressing arguments which could have been asserted earlier or for "re-arguing theories previously advanced and rejected." Palmer v. Champion Mortg., 465 F.3d 24, 30 (1st Cir.2006). The granting of such a motion is "an extraordinary remedy which should be used sparingly." Id.

    127
    B. Application
    128

    Plaintiffs present procedural and substantive grounds for reconsideration. First, they contend that the Court misapplied the rules governing the admissibility of expert testimony. Second, they assert that the Court erred by granting summary judgment sua sponte without affording them notice and an opportunity to present curative evidence.

    129
    1. Expert Preclusion
    130

    The Court's ruling to preclude Dr. Hakala's testimony was rendered after a thorough examination of his expert report, multiple rounds of briefing and a full Daubert hearing which included live testimony from Dr. Hakala himself. Because plaintiffs do little more than advance arguments already considered and rejected by this Court, their motion to reconsider the Court's expert preclusion ruling will be denied.

    131
    [197] 2. Notice
    132

    A district court may enter summary judgment sua sponte as long as "discovery is sufficiently advanced that the parties have enjoyed a reasonable opportunity to glean the material facts," and the party against whom judgment is to be entered has been given "notice and a chance to present its evidence on the essential elements of the claim." Berkovitz v. Home Box Office, Inc., 89 F.3d 24, 29 (1st Cir.1996). Formal notice is not required. As then-Judge Breyer explained,

    133
    [B]eing "on notice" does not mean that [plaintiff] had to receive a formal document called "notice" or that the district court had to say the words "you are on notice" or even that the court had to explicitly tell [plaintiff], "I am thinking of ordering summary judgment for [defendants] sua sponte."
    134

    Nat'l Expositions, Inc. v. Crowley Maritime Corp., 824 F.2d 131, 133 (1st Cir. 1987). Rather, the issue is whether the party against whom judgment is to be entered has been given "a meaningful opportunity" to present the best evidence and legal arguments in support of its position. Id. at 31 (affirming sua sponte grant of summary judgment where the plaintiff had repeatedly addressed the relevant facts and legal issues); see also Young v. City of Providence, 404 F.3d 4, 13 n. 4 (1st Cir.2005) (finding that plaintiff had sufficient notice because the basis for the Court's ruling was raised in defendants' initial summary judgment motion, to which plaintiff had responded).

    135

    According to plaintiffs, defendants' motion for summary judgment was denied in full by Judge Gertner and, by entering summary judgment sua sponte, this Session effectively second-guessed her decision. Plaintiffs, however, gloss over the fact that Judge Gertner expressly declined to rule on whether triable issues of fact remained with respect to reliance and loss causation and indicated that if the Court were to preclude the testimony of Dr. Hakala after a Daubert hearing, her summary judgment decision would need to be reconsidered. Far from second-guessing Judge Gertner, this Session has followed her guidance.

    136

    Indeed, Judge Gertner specifically suggested that the best course of action would be "follow Judge Zobel's lead in In re Xcelera.com Securities Litigation." In that securities fraud case, summary judgment was provisionally denied until the Court had the chance to rule upon the admissibility of the expert testimony after a Daubert hearing, whereupon the Court precluded the expert (Dr. Hakala, coincidentally) from testifying and granted summary judgment in favor of defendants. This Session has done likewise.

    137

    By unambiguously deferring a ruling on loss causation until after the Daubert hearing, Judge Gertner's opinion put plaintiffs on notice that such issues remained pending before the Court. Plaintiffs were given ample opportunity to convince the Court that Dr. Hakala's report was sufficient to establish loss causation. Their inability to do so does not furnish a basis for reconsideration.

    138

    Plaintiffs also complain that the Court unfairly changed course after leading them to believe that the action would proceed to trial. As evidence, they point to statements made by the Court at the November 21, 2011 status conference indicating that the case would likely proceed to trial and the Daubert hearing would not be as comprehensive as counsel envisioned. Plaintiffs misconstrue the Court's comments. First, by stating that the chances were high that the case would go to trial, the Court was merely notifying the parties that its general inclination is to let expert witnesses [198] testify. Dr. Hakala is, in fact, the first expert witness precluded from testifying by this Session in many years. Second, the reference to the comprehensiveness of the Daubert hearing was, as the context makes clear, intended to inform the parties that the hearing would be limited in duration. The Court was not degrading its importance.

    139

    Finally, plaintiffs maintain that they were prejudiced by the Court's sua sponte grant of summary judgment because it prevented them from submitting curative evidence in the form of the Mulcahey Report, a 1,000-page expert report purporting to demonstrate that the methodological flaws pointed out by the Court are correctable. Plaintiffs fail to explain their untimely submission of this report more than three years after the close of fact and expert discovery. The same flaws of which the Court took notice were identified by the defendants as early as April, 2007. Plaintiffs had ample opportunity to respond to them and may not reopen expert discovery at this late stage of the case.

    140
    ORDER
    141

    In accordance with the foregoing, plaintiffs' motion for reconsideration (Docket No. 397) is DENIED.

    142

    So ordered.

  • 3 In re Credit Suisse – AOL Securities Litigation (Plaintiff's brief in Bricklayers v. CSFB))

    This is plaintiffs' brief in Bricklayers and Trowel Trades Intern. Pension Fund v. Credit Suisse First Boston, 853 F.Supp.2d 181 (D. Mass. 2012). Not surprisingly, plaintiffs have a very different take on their expert's study than the court.

    1
    In re CREDIT SUISSE – AOL SECURITIES LITIGATION
    2

    UNITED STATES DISTRICT COURT DISTRICT OF MASSACHUSETTS

    3

    This Document Relates To:

    4

    ALL ACTIONS

    5

    Case No. 1:02 CV 12146 (Judge Gertner)

    6

    PLAINTIFFS’ MEMORANDUM OF LAW IN OPPOSITION TO DEFENDANTS’ MOTION TO PRECLUDE THE EXPERT OPINIONS OF SCOTT D. HAKALA, M. LAURENTIUS MARAIS, REINIER KRAAKMAN AND BERNARD BLACK

    7

    TABLE OF CONTENTS

    8

     

    9

    PRELIMINARY STATEMENT .......... 1

    10

    ARGUMENT .......... 4

    11

    I. DR. HAKALA’S OPINIONS ARE ADMISSIBLE PURSUANT TO THE FEDERAL RULES, DAUBERT AND FIRST CIRCUIT LAW .......... 5

    12

    A. Dr. Hakala Implemented A Valid Peer-Reviewed Event Study Methodology .......... 8

    13

    B. Dr. Hakala Implemented the Methodology in a Reliable and Replicable Manner .......... 13

    14

    1. Dr. Hakala Properly Identified Days on Which Significant AOL-Specific News Entered the Market.......... 13

    15

    2. Defendants’ Other “Replication” Arguments Are Equally Unfounded.......... 18

    16

    C. Defendants’ Meritless Arguments Concerning Dr. Hakala’s Identification and Treatment of “Relevant” Events, “New” News, and Confounded Events Do Not Warrant Precluding His Opinions .......... 20

    17

    1. Dr. Hakala Applied An Accepted Damages Analysis Methodology And Properly Identified Relevant Disclosures .......... 21

    18

    2. Dr. Hakala Adequately Accounted for Any “Confounding” Events .......... 25

    19

    3. Dr. Hakala Only Identified “New” News as Material .......... 29

    20

    D. Dr. Hakala’s Calculation of an Analyst Proxy Results in a Reliable, Conservative Estimate of The Impact of Defendants’ Misrepresentations and Omissions .......... 31

    21

    II. MARAIS’S TESTIMONY IS ADMISSIBLE UNDER THE FEDERAL RULES AND DAUBERT.......... 35

    22

    III. PROFESSOR KRAAKMAN’S TESTIMONY IS ADMISSIBLE UNDER THE FEDERAL RULES AND DAUBERT .......... 37

    23

    A. Professor Kraakman is Amply Qualified to Serve as an Expert Concerning The Subjects of His Report.......... 37

    24

    B. Professor Kraakman’s Opinions are Relevant, Reliable and Will Assist the Jury In Making Important Factual Determinations In This Case.......... 39

    25

    C. Professor Kraakman’s Opinions Concern Issues Of Economic and Finance Theory and Do Not Constitute Legal Opinions .......... 40

    26

    D. Professor Kraakman’s Opinions Properly Rebut Professor Stulz’s Report and Testimony .......... 42

    27

    IV. PROFESSOR BLACK’S OPINIONS ARE ADMISSIBLE UNDER THE FEDERAL RULES AND DAUBERT .......... 43

    28

    A. Professor Black’s Extensive Corporate Finance Credentials And Experience Amply Qualify Him To Opine On The Significance Of Certain Statements To The Market .......... 44

    29

    B. Professor Black’s Report Properly Rebuts Opinions Offered By Professors Stulz And Deighton.......... 45

    30

    C. Professor Black’s Opinions Are The Product of Reliable Principles And Methods Which He Properly Applied To The Facts of This Case .......... 48

    31

    CONCLUSION.......... 50

    32

    TABLE OF AUTHORITIES

    33

    Basic Inc. v. Levinson, 485 U.S. 224 (1988).......... 3, 38

    34

    Bonner v. ISP Tech., Inc., 259 F.3d 924 (8th Cir. 2001) .......... 5

    35

    Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993).......... 1, 4, 21

    36

    DeMarco v. Lehman Bros., Inc., 222 F.R.D. 243 (S.D.N.Y. 2004) .......... 33

    37

    Elwood v. Pina, 815 F.2d 173 (1st Cir. 1987).......... 37

    38

    Freeland v. Iridium World Comm’n, Ltd., 545 F. Supp. 2d 59 (D.D.C. 2008) .......... 49

    39

    Freeland v. Iridium World Commc’n, Ltd., 233 F.R.D. 40 (D.D.C. 2006).......... 29

    40

    In re AOL Time Warner, Inc. Sec. and “ERISA” Litig., No. MDL-1500 (S.D.N.Y.) .......... 36

    41

    In re Clarent Sec. Litig., No. 01-3361 CRB (N.D. Cal. Feb. 9, 2005) .......... 7

    42

    In re Countrywide Financial Corp. Sec. Litig., 588 F. Supp. 2d 1132 (C.D. Cal. 2008) .......... 28, 29

    43

    In re Daou Sys., Inc., 411 F.3d 1006, 1025 (9th Cir. 2005) .......... 26

    44

    In re Enron Corp. Sec., Derivative and ERISA Litig., No. MDL-1446, 2005 WL 3504860 (S.D. Tex. Dec. 22, 2005).......... 25

    45

    In re Flag Telecom Holdings, Ltd. Sec. Litig., 245 F.R.D. 147 (S.D.N.Y. 2007) .......... 8

    46

    In re JDS Uniphase Sec. Litig., No. 02-01486 CW (N.D. Cal. Nov. 1-2, 2007).......... 7

    47

    In re Motorola Secs. Litig., 505 F. Supp. 2d 501 (N.D. Ill. 2007) .......... 29

    48

    In re Nature’s Sunshine Prods. Inc. Sec. Litig., 251 F.R.D. 656 (D. Utah 2008) .......... 7

    49

    In re Neurontin Mktg., Sales Practices, and Prods. Liab. Litig., MDL No. 1629, Civil Action No. 04-10981-PBS, 2009 WL 1212944 (D. Mass. May 5, 2009) .......... 5

    50

    In re Omnicom Group, Inc. Sec. Litig., 541 F. Supp. 2d 546 (S.D.N.Y 2008) .......... 25

    51

    In re Omnicom Group, Inc., Sec. Litig., No. 02 Civ. 4483 (S.D.N.Y.) (Hr’g Tr. Aug. 24, 2007) .......... 18, 25

    52

    In re Parmalat Sec. Litig., No. 04-MD-1653(LAK), 2008 WL 3895539 (S.D.N.Y. Aug. 21, 2008) .......... 6, 7

    53

    In re PolyMedica Corp. Sec. Litig., 432 F.3d 1 (1st Cir. 2005).......... 3, 38

    54

    In re Raytheon Co. Securities Litigation, Civil Action No. 99-12142 (Saris, J.) (Order Denying Mot. to Strike Hakala Reports, May 6, 2004).......... 7

    55

    In re Salomon Analyst Metromedia Litig., No. 06-3225-cv, 2008 WL 4426412 (2d Cir. Sept. 30, 2008) .......... 31

    56

    In re Viagra Prods. Liab. Litig., 572 F. Supp. 2d 1071 (D. Minn. 2008) .......... 5

    57

    In re Vivendi Universal, S.A. Sec. Litig., No. 02 Civ. 5571 (RJH), 2009 U.S. Dist. LEXIS 34563 (S.D.N.Y. Apr. 6, 2009) .......... 29, 31

    58

    In re Xcelera.com Sec. Litig., 430 F.3d 503 (1st Cir. 2005).......... 6

    59

    In re Xcelera.com Sec. Litig., Civ. Action No. 00-11649-RWZ, 2008 U.S. Dist. LEXIS 77807 (D. Mass. Apr. 25, 2008) .......... 6, 7

    60

    In re Xcelera.com Sec. Litigation, Civ. Action No. 00-11649-RWZ, 2004 U.S. Dist. LEXIS 29064 (D. Mass. Sept. 30, 2004) .......... 6

    61

    Int’l Adhesive Coating Co. v. Bolton Emerson Int’l, Inc., 851 F.2d 540 (1st Cir. 1988).......... 50

    62

    Interfaith Cmty. Org. v. Honeywell Int’l, Inc., 399 F.3d 248 (3rd Cir. 2005) .......... 41

    63

    Kumho Tire Co., Ltd. v. Carmichael, 526 U.S. 137 (1999).......... 1, 4, 5, 21

    64

    Lapin v. Goldman Sachs & Co., 254 F.R.D. 168 (S.D.N.Y. 2008) .......... 7

    65

    Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147 (2nd Cir. 2007) .......... 26, 27

    66

    Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005) .......... 25

    67

    Lormand v. US Unwired, Inc., No. 07-30106, 2009 WL 941505 (5th Cir. Apr. 9, 2009) .......... 25

    68

    McDonough v. City of Quincy, 452 F.3d 8 (1st Cir. 2006).......... 37

    69

    Nathenson v. Zonagen, 267 F.3d 400 (5th Cir. 2001) .......... 31

    70

    Nieves-Villanueva v. Soto-Rivera, 133 F.3d 92 (1st Cir. 1997).......... 41

    71

    Pelletier v. Main Street Textiles, LP, 470 F.3d 48 (1st Cir. 2006).......... 41

    72

    RMED Intern., Inc. v. Sloan's Supermarkets, Inc., No. 94 Civ. 5587 PKL RLE, 2000 WL 310352 (S.D.N.Y. Mar. 24, 2000) .......... 18

    73

    Robbins v. Koger Props., Inc., 116 F.3d 1441 (11th Cir.1997) .......... 26

    74

    Ruiz-Troche v. Pepsi Cola of Puerto Rico Bottling Co., 161 F.3d 77 (1st Cir. 1998).......... 4

    75

    Sappington v. Skyjack, Inc., 512 F.3d 440 (8th Cir. 2008) .......... 49

    76

    Shirk v. Fifth Third Bancorp, No. 05-cv-049, 2009 WL 692124 (S.D. Ohio Jan. 29, 2009) .......... 7

    77

    Tuli v. Brigham & Women’s Health Hospital, Inc., 592 F. Supp. 2d 208 (D. Mass 2009) .......... 40

    78

    U.S. v. Aviles-Colon, 536 F.3d 1 (1st Cir. 2008).......... 37

    79

    U.S. v. Buchanan, 964 F. Supp. 533 (D. Mass. 1997) .......... 41

    80

    U.S. v. Green, 405 F. Supp. 2d 104 (D. Mass. 2005) .......... 50

    81

    U.S. v. Hines, 55 F. Supp. 2d 62 (D. Mass 1999) .......... 39, 41

    82

    U.S. v. Vargas, 471 F.3d 255 (1st Cir. 2006).......... 49

    83

    Wagner v. Barrick Gold Corp., 251 F.R.D. 112 (S.D.N.Y. 2008) .......... 7, 8

    84

    Rules

    85

    Federal Rules of Evidence Rule 403 .......... 37

    86

    Rule 702 .......... 1, 4

    87

    Other Authorities

    88

    Bradford Cornell & R. Gregory Morgan, Using Finance Theory to Measure Damages in Fraud on the Market Cases, 37 UCLA L. Rev. 883, 894 (1990) .......... 21

    89

    Confronting the New Challenges of Scientific Evidence, 108 Harv. L. Rev. 1532, 1552 (May 1995).......... 9

    90

    Frank J. Fabozzi et al., Financial Modeling of the Equity Market: From CAPM to Cointegration, 431-32 (Wiley 2006) .......... 18

    91

    Henry J. Cassidy, Using Econometrics: a Beginners Guide, (1981).......... 23

    92

    Information Asymmetry, the Internet, and Securities Offerings, 2 J. Small & Emerging Bus. L. 91-99 (1998) .......... 44

    93

    Intriligator, Econometric Models, Techniques, and Applications, 1978, pp. 188-189 .......... 23

    94

    J. Applied Corp. Fin. xxx-yyy (2000) (http://ssrn.com/abstract=84489) .......... 44

    95

    Joel E. Thompson, More Methods that Make Little Difference in Event Studies, 15(1) J. Bus. Fin. & Acct., 77, 78 (1988) .......... 10

    96

    John D. Jackson et al., The Impact of Non-Normality and Misspecification on Merger Event Studies, 13:2 Int. J. of the Econ. of Bus. 247, 262 (2006) .......... 2, 9

    97

    John Finnerty & George Pushner, An Improved Two-Trader Model for Estimating Damages in Securities Fraud Class Actions, 8 Stan. J.L. Bus. & Fin. 213, 219 (2003).......... 21, 22

    98

    John Y. Campbell et al., The Econometrics of Financial Markets, 524 (Princeton Univ. Press 1997).......... 14, 18

    99

    Litigation Services Handbook: The Role of the Financial Expert, 2005 Cumulative Supplement, 3d ed., John Wiley & Sons .......... 35

    100

    Madge S. Thorsen, Richard A. Kaplan & Scott Hakala, Rediscovering the Economics of Loss Causation, 6 J. Bus. & Sec. L. 93 (2006).......... 22

    101

    Michael Barclay & Frank C. Torchio, A Comparison of Trading Models Used for Calculating Aggregate Damages in Securities Litigation, 64(2)-(3) L. & Contemporary Probs. 105, 106 (2001).......... 21

    102

    Nihat Aktas et al., Event studies with a contaminated estimation period, 13 J. Corp. Fin., 129 (2007) .......... 2, 8

    103

    Peter Kennedy, A Guide to Econometrics, 253-54 (MIT Press 5th ed. 2003) .......... 14

    104

    Philip Hans Franses, Time Series Models for Business and Economic Forecasting, (Cambridge Univ. Press 2002) (1998) .......... 2

    105

    Richard Roll, R2, 43 J. Fin. 541, 558-560 (1988) .......... 9, 13, 14

    106

    Robert B. Thompson II, Chris Olsen & J. Richard Dietrich, The Influence of Estimation Period News Events on Standardized Market Model Prediction Errors, 63(3) Acct. Rev., 448, 466-68 (Jul. 1988).......... 10, 13, 14

    107

    Robert S. Pindyck & Daniel L. Rubinfeld, Econometric Models and Economic Forecasts, 162-166 (3d ed., McGraw-Hill Inc. 1991) .......... 23

    108

    Ronald J. Gilson & Bernard Black, The Law and Finance of Corporate Acquisitions, 221 (2d ed. Foundation Press, Inc. 1995) .......... 26

    109

    Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Issuer Disclosure of Material Information, 67 Fed. Reg. 142 (Aug. 2, 2002) .......... 14

    110

    [1] Lead Plaintiff Bricklayers and Trowel Trades International Pension Fund, on behalf of the certified class (“Plaintiffs”), respectfully submit this Memorandum In Opposition To Defendants’ Motion to Preclude the Expert Opinions of Scott D. Hakala, M. Laurentius Marais, Reinier Kraakman and Bernard Black, together with the Declaration of Melinda D. Rodon (the “Rodon Decl.”). As shown below, Plaintiffs’ expert witnesses are eminently qualified experts under Federal Rule of Evidence 702 and the Supreme Court’s holdings in Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993) and Kumho Tire Co., Ltd. v. Carmichael, 526 U.S. 137 (1999), and should be allowed to offer their relevant and reliable opinions at trial.

    111
    PRELIMINARY STATEMENT
    112

    In moving to preclude the testimony of all four of Plaintiffs’ expert witnesses, Defendants lodge myriad attacks attempting to paint Plaintiffs’ expert testimony as either irrelevant or unreliable, but a common theme reverberates throughout: the utter dearth of support, whether in academic literature or through any independent testing, for their arguments. Unable to even colorably impugn Dr. Hakala’s qualifications as an expert in the field of econometrics[1] or the relevance of his opinions to factual issues in dispute, Defendants attempt to smear his credibility, applying factual determinations favorable to Defendants as a basis for arguing that Dr. Hakala’s methodology and professional judgments are unreliable, and claiming that Dr. Hakala must have employed a results-oriented approach to “manufacture” statistical significance for the disclosures at issue. Defendants’ unfounded and outrageous attacks grossly misconstrue Dr. Hakala’s proper [2] implementation of a valid methodology, and Defendants fail to submit to this Court any scientific study or regression analysis which demonstrates that an event study conforming to their criticisms would alter the results from Dr. Hakala’s study in any significant way. Indeed, as discussed in greater detail below, that is precisely what the Xcelera defendants did—they submitted an event study which they claimed corrected Dr. Hakala’s supposed errors and found an inefficient market with no statistically significant curative disclosures in that case. Here, to the contrary, Defendants and Professor Stulz concede market efficiency, and the only regression analysis Defendants have submitted confirms the statistical significance of the key disclosures in this case.

    113

    Thus, in contrast to Defendants’ baseless assertions and innuendo, the record before the Court amply supports the following facts which eviscerate Defendants’ arguments: (1) both Dr. Hakala’s proper event study and the biased event study[2] by Professor Stulz clearly identify statistically significant price declines at the 90% confidence level or better associated with the major disclosure dates in this action – July 18-19, 2001, August 14, 2001, February 20, 2002, and July 24-25, 2002; (2) Dr. Hakala’s event study was conducted in accordance with peer reviewed literature and constitutes a more accurate measure of statistical significance than Defendants’ event study;[3] and (3) all of Professor Stulz’s opinions regarding the supposed lack of causation and damages are not based on any scientific evidence but rather are circularly based on the assumptions and advice he received from defense counsel. (See Stulz Corrected Rpt. ¶ [3] 5(b) (“Dr. Hakala’s analysis and conclusions are severely flawed because they depend on several incorrect assumptions that counsel for CSFB has advised me are not supportable and contradicted by the facts developed in discovery and/or by reasonable economic analyses.”)) (Emphasis added.)

    114

    Finally, in Defendants’ desperation to eliminate Plaintiffs’ additional rebuttal experts, Defendants press such improbable arguments as claiming that Professor Reinier Kraakman, one of the foremost and oft-cited authorities on the efficient market hypothesis,[4] is somehow inadequately qualified to opine regarding the economic implications of applying the efficient market hypothesis to analysts’ statements. (Defs.’ Mem. 44-46.) Likewise, they dubiously suggest that the testimony of Dr. M. Laurentius Marais, a published expert regarding event study methodology, is “irrelevant” because he rebuts only one of their several attacks on Plaintiffs’ event studies. (Defs.’ Mem. 32-33.) Defendants also challenge Professor Bernard Black, ignoring the majority of the opinions and analysis in his report and myopically and hypocritically arguing that a single, corrected error which did not significantly alter his ultimate conclusions somehow renders all of his opinions unreliable, despite the fact that Defendants’ own expert, Professor Stulz, had to correct four separate portions of his own report, including very significant and telling compensation information.

    115

    Hence, as explained in detail below, Defendants’ contrived and meritless arguments that the expert testimony of Dr. Hakala and Plaintiffs’ other experts is inadmissible should be rejected in their entirety.

    116
    [4] ARGUMENT
    117

    Plaintiffs’ proffered expert testimony provides reliable specialized knowledge and information which is necessary to assist the jury with important factual determinations, and therefore is admissible under the Federal Rules of Evidence. Rule 702 of the Federal Rules of Evidence governs the admissibility of expert testimony.[5] As the Supreme Court has explained, under Rule 702 the district court must perform a critical “gatekeeping” role to ensure that the scientific evidence admitted is both relevant and reliable.[6] Daubert, 509 U.S. at 589. In performing this gatekeeping role, the district court enjoys “considerable leeway” in determining whether an expert’s testimony is reliable. Kumho Tire, 526 U.S. at 152. However, as the First Circuit has explained:

    118

    Daubert does not require that a party who proffers expert testimony carry the burden of proving to the judge that the expert's assessment of the situation is correct. As long as an expert's scientific testimony rests upon “good grounds, based on what is known,” Daubert, 509 U.S. at 590 (internal quotation marks omitted), it should be tested by the adversary process-competing expert testimony and active cross-examination-rather than excluded from jurors' scrutiny for fear that they will not grasp its complexities or satisfactorily weigh its inadequacies, see id. at 596.

    119

    Ruiz-Troche v. Pepsi Cola of Puerto Rico Bottling Co., 161 F.3d 77, 85 (1st Cir. 1998). Hence, “[i]f an expert’s testimony is within ‘the range where experts might reasonably differ,’ the jury, not the trial court, should be the one to ‘decide among the conflicting views of different experts.’” In re Neurontin Mktg., Sales Practices, and Prods. Liab. Litig., MDL No. 1629, Civil [5] Action No. 04-10981-PBS, 2009 WL 1212944, at *9 (D. Mass. May 5, 2009) (Saris, J.) (quoting Kumho Tire, 526 U.S. at 153). Indeed, “[o]nly if the expert's opinion is so fundamentally unsupported that it can offer no assistance to the jury must such testimony be excluded.” In re Viagra Prods. Liab. Litig., 572 F. Supp. 2d 1071, 1078 (D. Minn. 2008) (quoting Bonner v. ISP Tech., Inc., 259 F.3d 924, 929-30 (8th Cir. 2001)).

    120

    Defendants’ arguments fail to cast any doubt on the fact that Plaintiffs’ proffered expert testimony will assist the jury and is reliable and relevant. At best, Defendants’ arguments constitute disputes about which “experts might reasonably differ,” hence, Defendants’ motion to preclude Plaintiffs’ expert testimony should be denied in its entirety.

    121

    I. DR. HAKALA’S OPINIONS ARE ADMISSIBLE PURSUANT TO THE FEDERAL RULES, DAUBERT AND FIRST CIRCUIT LAW

    122

    Dr. Hakala performed his event studies in conformity with accepted practices, and his reports cite to numerous academic and peer-reviewed authorities that validate the methods he applied. (See Rodon Decl. Ex. A (Decl. of Scott Hakala Regarding Market Efficiency dated Feb. 28, 2007 (the “Market Efficiency Rpt.”)) ¶¶ 15-16 & nn.9-13; Rodon Decl. Ex. C (Expert Rpt. of Scott Hakala dated Mar. 4, 2008 (the “Damages Rpt.”)) ¶¶ 30-34.) Moreover, as discussed below, several peer-reviewed authorities published over the past two decades support the superiority of the event study performed by Dr. Hakala over the alternatives proposed by Defendants and Professor Stulz. Thus, using a proper methodology, Dr. Hakala’s event studies find statistical significance, evidencing loss causation and damages, associated with the materialization of the risks hidden by Defendants.

    123

    Despite the abundant support for Dr. Hakala’s analyses, Defendants attempt to label his methodology as unreliable, but fail to cite to any academic support or to submit any valid test or analysis girding their self-serving conclusions. Contrary to Defendants’ bald and counterfactual [6] assertions, Dr. Hakala’s approach was not outcome determinative, biased or otherwise unreliable. In attacking Dr. Hakala, Defendants substantially rely on In re Xcelera.com Sec. Litig., Civ. Action No. 00-11649-RWZ, 2008 U.S. Dist. LEXIS 77807 (D. Mass. Apr. 25, 2008) (Zobel, J.), which excluded an event study prepared by Dr. Hakala, notwithstanding the Xcelera court’s previous reliance on his event study at class certification and the First Circuit’s approving reference to that event study in upholding class certification.[7] However, in Xcelera, the record before Judge Zobel was far different from the record here. Defendants in that case proffered an event study which concluded that the market was inefficient and that there were no statistically significant declines associated with any of the alleged disclosures of the misrepresented risk.[8]

    124

    Thus while the plaintiffs in Xcelera may have disagreed with Judge Zobel’s finding in favor of defendants, that finding did have some basis in the record. Not so here. As set forth above, despite having had ample time to do so, Defendants simply have not and cannot produce a scientific study which finds no statistical significance associated with the major disclosures in this case. See In re Parmalat Sec. Litig., No. 04-MD-1653(LAK), 2008 WL 3895539, at *10 (S.D.N.Y. Aug. 21, 2008) (rejecting arguments against Dr. Hakala’s event study because opposing expert “did no event study to show how Dr. Hakala’s analysis would have differed had the claimed flaws in his work been corrected.”). Nor have Defendants presented a single academic test or paper that rejects or criticizes Dr. Hakala’s event study methodology. And indeed, Defendants have conceded that the market is efficient. Hence, at bottom, Defendants’ arguments against Dr. Hakala in this case are truly baseless, lacking any support in the record.

    125

    [7] Moreover, as discussed more fully in Plaintiffs’ memoranda submitted on May 9, 2008 and June 3, 2008, the Xcelera court’s exclusion of Dr. Hakala’s study was based primarily on the court’s disagreement with aspects of his loss causation analysis relating to delayed investor reaction to alleged leakage of corrective information, and Dr. Hakala’s heavy, but necessary, reliance in that case on internet bulletin board postings to identify disclosure events, due to the very limited news and analyst coverage of the subject company. These conditions are unique to that case, as were the rejected aspects of Dr. Hakala’s study there, compelling a different outcome here.[9]

    126

    Indeed, Dr. Hakala’s event studies have been admitted in nearly all of the cases in which they have been presented, including in this district in In re Raytheon Co. Securities Litigation, Civil Action No. 99-12142 (Saris, J.) (Order Denying Mot. to Strike Hakala Reports, May 6, 2004), and most recently, in: Shirk v. Fifth Third Bancorp, No. 05-cv-049, 2009 WL 692124, *7 (S.D. Ohio Jan. 29, 2009); In re Nature’s Sunshine Prods. Inc. Sec. Litig., 251 F.R.D. 656 (D. Utah 2008); Lapin v. Goldman Sachs & Co., 254 F.R.D. 168 (S.D.N.Y. 2008); In re Parmalat, 2008 WL 3895539, at *9-10; Wagner v. Barrick Gold Corp., 251 F.R.D. 112, 119-20 (S.D.N.Y. 2008); In re JDS Uniphase Sec. Litig., No. 02-01486 CW (N.D. Cal. Nov. 1-2, 2007) (testified at trial as damages expert); In re Clarent Sec. Litig., No. 01-3361 CRB (N.D. Cal. Feb. 9, 2005) (testified at trial as damages expert). Dr. Hakala brings this considerable expertise in real-world applications of event study methodology to bear on the complex issues of analyst statements and [8] impact here, which will be invaluable to the jury in determining issues of materiality, loss causation and damages.

    127

    A. Dr. Hakala Implemented A Valid Peer-Reviewed Event Study Methodology

    128

    The validity of the basic methodology applied by Dr. Hakala (and Defendants’ expert, Professor Stulz), the “intervention” or “event parameter” methodology, is not challenged by Defendants. Moreover, as a general matter, event studies are a commonly accepted way of demonstrating a significant correlation between stock price movements and events or disclosures as evidence relevant to market efficiency, loss causation, materiality and damages. See, e.g., In re Flag Telecom Holdings, Ltd. Sec. Litig., 245 F.R.D. 147, 170 (S.D.N.Y. 2007) (noting that “numerous courts have held that an event study is a reliable method for determining market efficiency and the market's responsiveness to certain events or information,” and crediting an event study by Dr. Hakala over the defendants’ abbreviated Daubert challenge); Wagner, 251 F.R.D. at 119-20 (same, and likewise crediting an event study by Dr. Hakala concerning market efficiency).

    129

    Defendants’ main attack on Dr. Hakala’s event study methodology is their utterly baseless claim that Dr. Hakala’s event study is “result driven, internally inconsistent and scientifically unsound.” (Defs.’ Mem. 4-5.) But these unsupported attacks do not gain any strength from mere repetition. As described at length in Dr. Hakala’s reports, each and every step of the event study methodology applied in both of Dr. Hakala’s event studies in this litigation is supported by peer-reviewed literature. (See, e.g., Market Efficiency Rpt. ¶¶ 15-16; Rodon Decl. Ex. E (Rebuttal Rpt. of Scott D. Hakala dated July 17, 2008, the “Damages Rebuttal Rpt.”)) ¶¶ 38, 41-44.) More particularly, Dr. Hakala’s use of dummy variables to control for significant news released during the study period is supported by academic studies. See, e.g., Nihat Aktas et al., Event studies with a contaminated estimation period, 13 J. Corp. Fin. 129 [9] (2007) (concluding that their study’s “results highlight the importance of explicitly controlling for unrelated events occurring during the estimation window, especially in the presence of event- induced increase in return volatility.”); John D. Jackson et al., The Impact of Non-Normality and Misspecification on Merger Event Studies, 13:2 Int. J. Econ. Bus. 247, 262 (2006) (recommending that researchers “document that they have included all relevant events, both related and [un]related, in their event study model” because failing to identify and control for significant events causes “the true significance level of the test [to be] misstated”). As Dr. Marais explained with regard to the Aktas study, “Aktas et al. state the problem that Dr. Hakala’s method aims to solve (that is, properly taking account of ‘unrelated [company-specific] events’ in the data used for estimation), and offer as a ‘natural solution’ to this problem essentially the method employed by Dr. Hakala (that is, selecting estimation data ‘free of such contaminating events’).” (Rodon Decl. Ex. F (the Rebuttal Decl. of M. Laurentius Marais, dated July 16, 2008, (the “Marais Rpt.”)) ¶ 17.)

    130

    Indeed, academic studies comparing event study methodologies that control for significant news releases, like Dr. Hakala’s, to methodologies that do not, like Professor Stulz’s, universally conclude that Dr. Hakala’s methodology results in a more powerful test, meaning that there is a greater “likelihood that [the] test will declare an association when there actually is an association.”[10] See, e.g., Richard Roll, R2, 43 J. Fin. 541, 558-60 (1988) (finding an increase in the explanatory power of event studies that control for all company-specific news listed in the Wall Street Journal and Dow Jones news service, with the biggest improvements involving companies that experienced major events such as takeovers or disasters); Robert B. Thompson II, Chris Olsen & J. Richard Dietrich, The Influence of Estimation Period News Events on [10] Standardized Market Model Prediction Errors, 63(3) Acct. Rev. 448, 466-68 (Jul. 1988) (concluding “that conventional market model parameter estimates are biased relative to those derived from the news-conditional market model,” and that there is an “increase in power [which] appears to be due primarily to the inclusion of a broad set of firm-specific news events (i.e., those reported in the Wall Street Journal Index) in the model specification.”); and Joel E. Thompson, More Methods that Make Little Difference in Event Studies, 15(1) J. Bus. Fin. & Acct. 77, 78 (1988) (finding that “extraneous events may increase the variance of a firm’s returns resulting in a larger estimated variance and thereby decrease the power of the test.”).[11]

    131

    Defendants do not challenge the conclusions of these studies, but they implicitly contradict them – without any academic foundation – in arguing that Dr. Hakala’s dummying out of returns for days with significant AOL-specific news artificially “inflates” Dr. Hakala’s results and renders them unreliable. Defendants cite to no literature, testing or other support in the record for their claim that controlling for significant events imparts any bias into the tests’ results, which is contrary to the academic literature cited above.[12] Instead, Defendants rely wholly on the ipse dixit of Professor Stulz, who claims that Dr. Hakala’s use of dummy variables “unfailingly inflates the statistical significance of abnormal stock returns of the subject company.” (Defs’ Mem. 20; Stulz Corrected Rpt. ¶ 100.) Indeed, as Dr. Marais noted in his report, “Dr. Stulz conspicuously fails to identify any violation by Dr. Hakala of any specific, generally accepted mathematical or statistical principle whose violation would logically impart [11] the purported ‘bias’ to the Hakala results.”[13] (Marais Rpt. ¶ 15.) Moreover, Professor Stulz apparently ignores the fact that Dr. Hakala’s second event study in this case, which employs more dummy variables than his first study, resulted in lower statistical significance findings for 23 days in the study, including 3 days when CSFB issued AOL reports. (Compare Market Efficiency Rpt. Ex. B and Damages Rpt. Ex. B-1.) Indeed, to demonstrate the invalidity of Professor Stulz’s criticism that Dr. Hakala’s supposed “overuse” of dummy variables “unfailingly inflates” his statistical significance findings, Dr. Hakala tested it by reducing the number of dummy variables used to include only statistically meaningful events, and found that the resulting statistical significance findings were not materially altered overall, with a minor increase in the statistical significance findings of most of the events of interest – the opposite of the expected result according to Professor Stulz. (Damages Rebuttal Rpt. ¶¶ 46, 49 & Exhibit B-1 Limited).) Thus, Defendants’ and Professor Stulz’s claims that Dr. Hakala’s methodology “unfailingly inflates” his results is not only unsupported, but provably wrong.

    132

    Similarly, Defendants and Professor Stulz offer no academic studies, independent testing or other support for their claim that any increased findings of statistical significance represent artificial inflation or bias as opposed to simply the more accurate findings of a more powerful study.[14] As Dr. Marais explains, “[i]t is true that any fraud-related price movement will likely stand out more prominently against Dr. Hakala’s material-news-free baseline than against a baseline tainted by other, irrelevant but potentially price-moving news events. Dr. Stulz is [12] mistaken, however, in claiming that this consequence is a “bias”; rather, this is precisely—and properly—the purpose of Dr. Hakala’s procedure.” (Marais Rpt. ¶ 13 (emphasis in original).) Indeed, Dr. Hakala directly demonstrated in his rebuttal report on market efficiency that controlling for significant news releases increased the power of his event study relative to Professor Stulz’s study. Dr. Hakala replicated Professor Stulz’s regression analyses, applying dummy variables to control for the same significant news events as in Dr. Hakala’s event study. (Rodon Decl. Ex. B (Rebuttal Decl. of Scott D. Hakala dated June 27, 2007, (the “Market Efficiency Rebuttal”)) ¶ 13.) This analysis revealed that if Professor Stulz had used dummy variables to control for the same significant AOL-specific news as Dr. Hakala did, it would have reduced the standard error in Professor Stulz’s regressions from 2.52% to approximately 1.80%, a 28.4% improvement in the power of Professor Stulz’s event study. (Id.) Defendants do not offer any testing or other refutation of these findings.

    133

    Further, Defendants do not and cannot point to a single academic study suggesting that there is some finite maximum number of days which may be excluded from a study period (whether by use of dummy variables or otherwise) before an event study is rendered unreliable.[15]Instead, Defendants cite to a handful of academic sources which do not discuss the use of dummy variables in the context of performing event studies to suggest that this evinces that dummy variables should not be used at all, and argue that the Aktas study cited by Dr. Hakala does not actually support his method because it only involved a small number of significant events that were dummied out. However, as Dr. Marais explains, “Aktas et al. state no explicit limitation of the scope of their comments to the case of only a small proportion of contaminating [13] events, and no such limitation is logically implied by their analysis of the issue.” (Marais Rpt. ¶ 18.) Indeed, the “contaminating news events” in the Aktas study were created by its authors and inserted into the study period to provide a hypothetical scenario for use in testing the effectiveness of various methods of controlling for contaminating news events: to read any significance into the number of fictional contaminating events the study’s authors created represents nothing more than a baseless effort to distinguish a plainly relevant and applicable academic precedent for Dr. Hakala’s methodology here.[16] Moreover, Defendants’ argument ignores the academic articles cited in the Aktas paper and other articles cited herein which control for a larger number of company-specific news events, similar to Dr. Hakala.[17] Hence, Defendants’ criticism of the number of dummy variables used by Dr. Hakala has no academic basis and is meritless.

    134

    B. Dr. Hakala Implemented the Methodology in a Reliable and Replicable Manner

    135

    1. Dr. Hakala Properly Identified Days on Which Significant AOL-Specific News Entered the Market

    136

    As described in considerable detail in Dr. Hakala’s reports, Dr. Hakala applied generally accepted protocols in identifying days when significant AOL-specific news was released, and tested to verify the significance of the news identified through this procedure. (See generally Market Efficiency Rpt. ¶¶ 12, 16-17; Damages Rpt. ¶¶ 30, 34-35.) As recommended by the [14] relevant academic literature, Dr. Hakala selected events on an a priori or “blind” basis, meaning that the events were selected based solely on the substance of the news conveyed and without knowledge of whether AOL’s stock price moved that day.[18] (Market Efficiency Rpt. ¶ 12; Damages Rpt. ¶ 30.) As a foundation for the identification of significant or “material” information, Dr. Hakala and his staff applied the categories of material information contained in the NASD guidelines, as recognized by the Securities and Exchange Commission,[19] together with third party news and analyst reports recognized as material in the academic literature.[20] (Id.) Additionally, in order to verify the results of this process for identifying significant news, Dr. Hakala performed an “F-test,” which is “a conservative test for the statistical significance of a group of events or explanatory variables.”[21] (Damages Rpt. ¶ 35.) “[T]he F-test for significance of the identified events suggested a confidence level in excess of 99.99%[.]” (Id.) Neither Professor Stulz nor Defendants have challenged Dr. Hakala’s F-test results, nor have they performed any tests contradicting these results.[22]

    137

    Nonetheless, Defendants argue that Dr. Hakala’s identification of significant events to include in his event study is unreliable because it involves some measure of professional judgment, which they claim is impossible to replicate. (Defs.’ Mem. 24-25.) The sole support Defendants offer for their claim that Dr. Hakala’s process of event identification is not replicable [15] is a comparison of three separate event studies which Dr. Hakala prepared for different purposes relating to AOL stock price movements: one preliminary study in the class action case against AOL (the “AOL Study”), and the two performed in connection with this litigation. Defendants argue that the different number of events identified in these studies, standing alone, demonstrates that Dr. Hakala’s method cannot be replicated and is therefore, unscientific. This argument not only vastly overstates the significance of the changes between the reports, but wholly ignores the logical reasons for the changes, and generally misconstrues the scientific issue of replication.

    138

    First, Defendants’ argument counterfactually presupposes that each of these event studies involved a review of precisely the same set of source documents, but that Dr. Hakala somehow identified substantially more documents fitting within the news categories described in the protocol of his reports for his Damages Study than for his AOL Study.[23] Dr. Hakala’s reports and testimony do not support this supposition. Although Dr. Hakala’s reports identified categories of news he sought to include in his studies (as discussed above) and listed several news sources he searched (i.e., Factiva, LexisNexis, Bloomberg, L.P., etc.), they did not specify his search terms or protocols for the first step of his process: gathering news for the subsequent manual review. As Dr. Hakala testified, the additional events identified in the later event studies were the result of three changes in this first step of his procedure: (i) more thorough database searches in gathering the documents to be reviewed, (ii) specific efforts to identify analyst disclosures which were relevant to the event studies in this case, but not the AOL Study and; (iii) access to additional news sources not previously available to Dr. Hakala. (Hakala 2008 Dep. [16] Tr. 194:10-195:17; see also Damages Rebuttal Rpt. ¶ 45.) Thus, the fact that additional events were included in the later studies based on a broader group of source documents reveals nothing about whether the application of the review protocols is replicable.

    139

    Second, Defendants do not show, through testing or otherwise, that any differences in the identification of events between the two reports in this case biased Dr. Hakala’s results or even impacted the results significantly. As Dr. Marais testified, whether there is a reasonable degree of replicability to a test in the field of statistics does not depend on “calculating percentages of dates that match between two implementations,” but rather, requires “tracing whatever range of variation happens to occur in the implementation of the event selection protocol . . . to its consequences for final opinions or . . . for ultimate conclusions[.]” (Rodon Decl. Ex. K (attaching transcript excerpts from the Aug. 13, 2008 deposition of M. Laurentius Marais, (“Marais Dep. Tr.”)) 87:2-89:23.) Indeed, if Defendants’ definition of replication were applied, most of the peer-reviewed papers on event study methods would be rejected since nearly all involve numerous judgments and assumptions as to the appropriate model and variables to employ. Hence, “replication,” as used by Defendants, does not and can not logically apply to the judgments and assumptions underlying the statistical model, but rather, as described by Dr. Marais, only applies to the ultimate conclusions obtained once those judgments and assumptions have been made.

    140

    Here, the results of Dr. Hakala’s Damages event study do not in any way undermine the conclusion of his Market Efficiency study, namely, that AOL stock trades in an efficient market. Moreover, the resulting statistical significance findings are substantially similar, and any [17] differences are inconsequential to the ultimate conclusions drawn from the studies.[24] Finally, as explained supra p. 11, any changes in the statistical significance findings – both increases and the 23 decreases which Defendants do not mention – are the proper result of a better specified test, and therefore, do not suggest any bias or otherwise unreliable methodology.

    141

    Additionally, Defendants ignore as though it were immaterial the fact that the present matter involves different issues than the AOL litigation, and that an event study pertaining to different issues may properly identify different relevant disclosures. As Dr. Hakala’s declaration in the AOL litigation stated, his study there was preliminary, and he was asked to merely “identify instances, if any, of loss causation associated with the allegations” in that matter.[25] Considering that the AOL litigation concerned AOL’s accounting fraud and misstatements and not issues regarding analyst statements,[26] clearly different disclosures constituted relevant events between the two cases.[27] Moreover, given that most of CSFB’s 35 AOL reports were reiterations, it is unlikely that Dr. Hakala would have identified many of them as otherwise significant news for which he would need to control.

    142

    Finally, Defendants’ argument that Dr. Hakala’s event study is rendered unreliable merely because some professional judgment was used in identifying material news ignores the fact that academic literature expressly recognizes that aspects of an event study, including the process of identifying events to include in the model, call for the exercise of informed [18] judgment.[28] Dr. Hakala’s exercise of his informed judgment thus adheres to academic protocols and does not impart any unscientific or unreliable element to his event studies.

    143

    Likewise, by extension, Dr. Hakala’s professional judgment calls do not render his event studies inadmissible, because Daubert “does not preclude an expert from relying upon his experience and judgment in coming to conclusions.” (Rodon Decl. Ex. J (In re Omnicom Group, Inc., Sec. Litig., No. 02 Civ. 4483 (S.D.N.Y. Hr’g Aug. 24, 2007)) (denying motion to preclude Dr. Hakala’s testimony and event study based, in part, on Dr. Hakala’s selection of event and relevant days).) See also RMED Intern., Inc. v. Sloan's Supermarkets, Inc., No. 94 Civ. 5587

    144

    PKL RLE, 2000 WL 310352, *8 (S.D.N.Y. Mar. 24, 2000) (noting that “a statistical event study involves subjective elements. A researcher performing an event study must identify which company-specific events to study, and in the process, categorize those events as fraud or non- fraud related. . . . Because [the expert’s] decision was informed by a detailed factual analysis and grounded on principles generally accepted within the relevant field, her testimony is sufficiently reliable to be admitted.”) Hence, Defendants’ arguments that Dr. Hakala’s event studies should be precluded because they involved some professional judgment should be rejected.

    145

    2. Defendants’ Other “Replication” Arguments Are Equally Unfounded

    146

    Defendants also argue that changes Dr. Hakala made in the study period and composite index from the AOL Study to the Damages Report Study further demonstrate that his methodology cannot be replicated and is therefore unreliable. Like their arguments about Dr. Hakala’s identification of significant events, Defendants’ arguments regarding changes to Dr. [19] Hakala’s study period and composite index are based on an erroneous understanding of the concept of replication in statistical studies, and ignore the legitimate reasons connected to the facts of this case for the changes made. Because Defendants fail to establish any bias or impact on the results traceable to the changes of which they complain, there can be no doubt as to the replicability and reliability of Dr. Hakala’s event studies.

    147

    Defendants claim that Dr. Hakala “inexplicably” shortened the event study window from a September 16, 2002 ending date in the AOL Study to a July 25, 2002 ending date in the CSFB Damages Report Study, despite a comment in his AOL Study about the “reliability and precision” of his estimates there. (Defs.’ Mem. 26.) Defendants’ argument that this demonstrates a shortcoming in the study window of Dr. Hakala’s Damages Report strains credulity. In the first instance, there is nothing “inexplicabl[e]” about this difference between the two reports: Dr. Hakala expressly stated in his AOL Study that “I extended the study period beyond the July 26, 2002 date . . . in order to analyze the events that occurred between July 26 and September 16, 2002.” (AOL Study ¶ 30.) Defendants ignore that the AOL Study included disclosures after July 25, 2002 which were relevant to the loss causation analysis in that case, but which are not relevant to loss causation or damages here.[29] Thus, Dr. Hakala’s use of a shorter event window here represents a proper limitation connected to the facts of this case.

    148

    Additionally, Defendants argue, without support of any kind, that changes in the composite index of Dr. Hakala’s AOL Study to the Damages Study were “arbitrary.” (Defs.’ Mem. 26.) However, as Dr. Hakala explained in his Damages Rebuttal report, the shorter study period here (January 12, 2001 through July 25, 2002) relative to the original study period in the AOL case (1999 through July 25, 2002) resulted in changes in the companies which constituted [20] significant competitors of AOL. (Damages Rebuttal ¶ 48 (regarding the rationale for the addition of Gannett and the removal of AT&T, Comcast and Ebay from the respective industry indices).) Moreover, Defendants do not explain why this change to fit the circumstances of the present matter should be considered “arbitrary” or how it might have harmed the results of Dr. Hakala’s Damages study. They do not explain this because they can not: the correction to the relevant competitors specified in Dr. Hakala’s market models produced a slight improvement in the explanatory power (meaning the percentage of the daily variance in AOL’s stock prices that was explained by the model), from 51.3% in the Market Efficiency study to 52.13% in the Damages Report study.[30] (Market Efficiency Rpt. ¶ 13; Damages Rpt. ¶ 31.) Thus, the changes from the AOL Study are clearly based on a valid rationale and have the effect of improving the reliability of Dr. Hakala’s Damages Study for the purposes of this litigation.

    149

    C. Defendants’ Meritless Arguments Concerning Dr. Hakala’s Identification and Treatment of “Relevant” Events, “New” News, and Confounded Events Do Not Warrant Precluding His Opinions

    150

    Defendants further argue that Dr. Hakala’s opinions should be precluded as unreliable because he supposedly used irrelevant disclosures in his Damages Study, identified “old” news as material, and failed to take into consideration confounding events. (Defs.’ Mem. 8-12.) Defendants have not proffered an event study to show how any individual event Dr. Hakala supposedly erroneously included in his Damages event study biased or otherwise affected his results, but rather, aim to taint the Court’s opinion of Dr. Hakala’s judgments in general, offering only Defendants’ own severely flawed and self-serving factual assumptions as a basis. As described more fully below, Dr. Hakala’s judgments regarding the events to include in his study were reasonable and supported by the record. To the extent that Defendants raise any genuine [21] factual dispute as to the inclusion of particular “relevant,” “new” or “confounded” events in the Damages Study, these arguments easily fall within “the range where experts might reasonably differ,” Kumho Tire, 526 U.S. at 153, and thus, the “traditional and appropriate means of attacking” Dr. Hakala’s opinions on these matters is through “[v]igorous cross-examination, presentation of contrary evidence, and careful instruction on the burden of proof[.]” Daubert, 509 U.S. at 596. Thus, Defendants’ arguments fall far short of establishing any unreliability in Dr. Hakala’s opinions or analysis, as required for excluding his testimony under the Federal Rules of Evidence.

    151

    1. Dr. Hakala Applied An Accepted Damages Analysis Methodology And Properly Identified Relevant Disclosures

    152

    For the purpose of calculating damages, in accordance with the peer-reviewed literature Dr. Hakala sought to identify “the portion of the loss in share price . . . that would not have occurred had the truth as alleged by Plaintiffs been disclosed in a timely manner.”[31] (Damages Rpt. ¶ 36.) To accomplish this, Dr. Hakala first established the total fraudulent inflation in the stock for each of the claimed misrepresentations and omissions, using the alleged curative disclosures for the accounting and layoff claims, and a calculation of the impact of comparable performance and ad-related analyst disclosures for the performance and ad-related claims,[32] and [22] attributed that percentage of inflation to AOL’s share price as of the first relevant date for each claim (i.e., July 12, 2001 and January 12, 2001, respectively).[33] (Id. at ¶¶ 9-11, Exs. C-1 & C-2. He next calculated AOL’s “true value” (i.e., its price per share excluding the fraudulent inflation) for each day from the beginning of the Class Period until all of the fraudulent inflation had dissipated from the stock through curative disclosures and other relevant disclosures concerning the misrepresented and omitted information.[34] (Damages Rpt. ¶¶ 44-46, Exs. C-1 & C-2.) From this analysis, individual plaintiff’s damages can be calculated as the difference between the fraudulent inflation in AOL’s share price upon purchase less the inflation at the time of sale. (Damages Rpt. ¶¶ 47-49.) However, Defendants challenge the curative and relevant disclosures identified in Dr. Hakala’s analysis, claiming that they were selected in an improper manner and that certain of them are unrelated to the alleged fraud.

    153

    First, Defendants falsely and disingenuously claim that Dr. Hakala somehow “manufactured” the relevance of the dates in his Damages study by identifying the relevant events after running his regression analysis. (Defs.’ Mem. 14-15.) This bald claim is meritless, Dep. Tr. 224:23-225:18.) Based on this calculation, Dr. Hakala attributed only a small proportion of the total impact of each individual relevant event to Defendants. (See Damages Rpt. Exs. C-1 & C-1a (attributing only 13.41% of the relevant, performance and ad-related disclosures to CSFB).) [23] and indeed, undermined by the record. As discussed supra p. 14, Dr. Hakala selected all of the events included in the Damages event study blindly, i.e., based on the news imparted, not on the corresponding return data. He likewise selected the relevant events based on the content of the news disclosed and not the statistical significance of the events – a fact not lost on Defendants, who criticized Dr. Hakala, essentially, for not data-mining and removing relevant events without statistically significant returns.[35] (Defs.’ Mem. 27.) Thus, Dr. Hakala plainly did not select relevant events in a manner that could even potentially impart any bias.

    154

    Moreover, Defendants do not demonstrate how any of Dr. Hakala’s determinations of relevant events supposedly impacted the results of his analysis, as they claim. As with their other claims of bias, they do not demonstrate it because they cannot. Given that Dr. Hakala only attributed a small proportion of the total impact of any relevant event to Defendants (based on his calibration calculation discussed, supra note 32), the impact of each individual relevant event is quite small on the amount of fraudulent inflation reflected in the damages analysis.[36] (Damages Rpt. Ex. C-1.) Moreover, if anything, Dr. Hakala’s identification of relevant leakage events benefited Defendants by dissipating the fraudulent inflation out of the stock price earlier in the Class Period and thereby reducing damages overall: indeed, 32 of the 50 relevant events [24] identified by Dr. Hakala reduced the amount of inflation for shares purchased after those events. (Id.) Hence, Defendants fail to identify how Dr. Hakala’s process might potentially have biased his results, much less demonstrate any actual bias.

    155

    Defendants further argue that Dr. Hakala’s definition of a “relevant event” is unclear[37] and that it is “impossible to discern how many of the ‘relevant events’ listed in Dr. Hakala’s exhibits have anything to do with this case.” (Defs.’ Mem. 18.) However, Defendants’ relevancy arguments are rooted in Defendants’ misguided belief that CSFB’s AOL reports are the only relevant disclosures in this litigation. For example, Defendants argue that Dr. Hakala’s failure to designate 22 of their 35 reports on AOL as relevant events, and his designation of February 1, 2001 and March 7, 2001 as relevant deflationary events due to disclosures other than the CSFB AOL reports issued on those days, renders his analysis in conflict with the allegation that CSFB’s AOL reports caused AOL’s share price to be artificially inflated.[38] (Defs.’ Mem. 17-18.) This is, in essence, simply a rehashing of Defendants’ perennial favorite (but legally unsound) argument, that they cannot be held liable for securities fraud under Plaintiffs’ theory, that Defendants’ reports maintained inflation in AOL’s stock by misrepresenting and omitting risks known to them that ultimately materialized, causing Plaintiffs’ losses.[39] It thus is Defendants, not Dr. Hakala, who ignore the facts and allegations in this matter, as well as a considerable body of cases providing that loss causation and damages may be established with [25] evidence of the materialization of risks or third party curative disclosures. See Lormand v. US Unwired, Inc., No. 07-30106, 2009 WL 941505 (5th Cir. Apr. 9, 2009) (acknowledging that “the great weight of federal courts . . . have held that Dura does not prevent a plaintiff from alleging or proving loss causation by showing partial or indirect disclosures of such truth by persons other than the defendants).[40]

    156

    2. Dr. Hakala Adequately Accounted for Any “Confounding” Events

    157

    Defendants argue that Dr. Hakala’s Damages event study failed to disaggregate the effects of supposedly confounding news, and therefore, is unreliable. (Defs.’ Mem. 8-10.) However, at best, these factual arguments do not render Dr. Hakala’s event study unreliable or inadmissible, but merely bear on the weight of the loss causation and damages evidence. (See, e.g., Rodon Decl. Ex. J (In re Omnicom Group, Inc., Sec. Litig., No. 02 Civ. 4483 (S.D.N.Y. Hr’g Aug. 24, 2007)) (“Defendants’ argument that Dr. Hakala failed adequately to disaggregate the effects of fraud-related and non-fraud-related information on each relevant day . . . does not require exclusion” because “Rule 702, a rule of threshold admissibility, should not be transformed into a rule for imposing a more exacting standard of causality . . . simply because scientific issues are involved.”).)[41]

    158

    [26] Moreover, considering that “[a] plaintiff is not required to show ‘that a misrepresentation was the sole reason for the investment's decline in value’ in order to establish loss causation,” In re Daou Sys., Inc., 411 F.3d 1006, 1025 (9th Cir. 2005) (emphasis in original), but need only calculate a “rough proportion of the whole loss” attributable to Defendants’ alleged misconduct, Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 158 (2nd Cir. 2007), it is clear that Dr. Hakala’s analysis, which reasonably identifies confounding news and roughly apportions the impact of the news accordingly, will assist the jury in its determinations of loss causation and damages.[42]

    159

    Defendants’ arguments that Dr. Hakala did not properly take into account any potentially confounding simultaneous news releases are undermined by peer-reviewed literature and the record in this case. The academic literature concerning event studies advises that “[a]n event study can tell us that something happened, but it can’t tell us why . . . . The event study technique does not eliminate the need to assess cause through deductive reasoning; it only – though this is substantial – helps delineate what needs to be explained.” Ronald J. Gilson & Bernard Black, The Law and Finance of Corporate Acquisitions, 221 (2d ed. Foundation Press, Inc. 1995).

    160

    Thus, Dr. Hakala reviewed the news on each day of his study to determine whether there were multiple pieces of significant news, and attributed only a proportion of the impact for particular days to account for other news. For example, Dr. Hakala determined that on September 19, 2001, there were similar significant, positive AOL comments issued by both CSFB and Bear Stearns, thus, Dr. Hakala attributed only 50% of the share price increase corresponding to this [27] news to Defendants. As Dr. Hakala explained, “we can draw an inference that when two analysts speak and speak contrary to market beliefs and expectations and give more than just a reiteration, that it does move the stock price[,] and CSFB was one of the two.” (Rodon Decl. Ex. K, (attaching transcript excerpts from the July 10, 2007 deposition of Scott D. Hakala, (“Hakala 2007 Dep. Tr.”)) 69:24-70:6.) Plainly, this analysis represents an exercise of deductive reasoning anticipated by the academic literature governing event studies. Moreover, it will assist the jury by delineating a “rough proportion of the whole loss” to Defendants’ alleged misconduct. Lattanzio, 476 F.3d at 158.

    161

    Additionally, the record establishes that for days when multiple analyst reports were issued, Dr. Hakala evaluated the reports and determined that certain of the days were not confounded (i.e., they did not contain different significant information) if: (i) one of the reports was clearly positive or negative and the other(s) was (or were) relatively neutral or (ii) both (or all) reports contained similarly positive or negative statements.”[43] (Damages Rebuttal Rpt. ¶ 20.) Such un-confounded analyst event days were thus properly included in Dr. Hakala’s study.[44] Additionally, as previously described, for damages purposes Dr. Hakala only ascribed a portion of the total impact of any such events to CSFB based on his calculation of the impact of CSFB’s misrepresentations concerning AOL’s performance and advertising revenues. Hence, Dr. Hakala [28] properly sought to identify any confounding news and ascribed only CSFB’s calculated proportion of the impact to Defendants.

    162

    Thus, contrary to Defendants’ claims that Dr. Hakala ignored the issuance of multiple “confounding” analyst reports, for example, in selecting February 1, 2001, July 19, 2001 and February 5, 2002 as relevant events for his study, Dr. Hakala in fact evaluated the reports to determine if they were confounded and discounted the impact of the news by 86.59% for each of these dates. (Id.) Defendants have provided no explanation of why this approach is unreasonable or how it renders Dr. Hakala’s analysis or results unreliable.

    163

    Finally, Defendants’ extreme position – that a plaintiff can never establish loss causation where there are multiple pieces of news or even just one piece of news which addresses multiple subjects – underestimates the jury’s capacity to review news and qualitatively weigh its significance with the assistance of expert testimony. Moreover, if the Court were to accept Defendants’ position, the result would be vast immunity against securities fraud liability for any company receiving adequate press or analyst coverage. Indeed, such a rule could even encourage companies to thwart liability by strategically releasing curative information coupled with other, unrelated information, as was recently acknowledged in In re Countrywide Financial Corp. Sec. Litig., 588 F. Supp. 2d 1132, 1200 (C.D. Cal. 2008) (observing that “corrective information often comes at the same time as good news (. . . either innocently or in order to minimize volatility or confound loss causation).”) Under the same reasoning with regard to claims under the Securities Act of 1933, the Countrywide court rejected defendants’ loss causation rule which “would perversely encourage slow information leaks and give management a strong incentive to correct market misperceptions as slowly and ambiguously as possible[,]” noting that “[i]f taken to its logical conclusion, Defendants’ rule would eliminate liability for [29] even the most egregious fraud where corrective disclosure comes in such minute increments that no plaintiff could locate a discrete point of ‘correction.’”[45] Id. at 1172 n.49.

    164

    Thus, given Dr. Hakala’s reasonable efforts to identify and respond to confounding news, and the jury’s ability to weigh this information, Defendants’ arguments substituting an unduly strict loss causation standard for the relevant Rule 702 admissibility standard should be rejected.

    165

    3. Dr. Hakala Only Identified “New” News as Material

    166

    Defendants claim that “numerous” relevant events included in Dr. Hakala’s Damages study were not “new” news, and that his study therefore contradicts market efficiency and is unreliable. (Defs.’ Mem. 11-12.) However, like Defendants’ other self-serving factual findings, Defendants’ determinations that certain news was not “new” are severely flawed and do not constitute grounds for precluding Dr. Hakala’s testimony.

    167

    Defendants claim that their AOL report on February 5, 2001 is an example of “old” news which Dr. Hakala erroneously concluded impacted AOL’s stock, supporting this claim with nothing more than a misleading excerpt of a statement Dr. Hakala made at his deposition.

    168

    (Defs.’ Mem. 12 (quoting Dr. Hakala as saying, “[S]ometimes a report that might not change anything . . . can sometimes have a positive effect. And that’s an example of what’s happening here.”).) The complete statement uttered by Dr. Hakala was: “[S]ometimes a report that might not change anything but is reacting after a negative event such as occurred on February 1st, even reiterating a report that's following a negative development can sometimes have a positive effect. And that’s an example of what’s happening here.” (Rodon Decl. Ex. K (attaching [30] transcript excerpts from the Aug. 11, 2008 deposition of Scott D. Hakala (“Hakala 2008 Dep. Tr.”)) 214:12-18) (emphasis added).) Moreover, this statement was an explanation of how the qualitative statements in the February 5, 2001 CSFB report can impact a stock’s price, even when there are no quantitative changes to earnings forecasts, price targets and buy/sell ratings. Indeed, as Plaintiffs explained in the summary judgment briefing, Defendants’ February 5, 2001 AOL report clearly contained a new, significantly expanded optimistic commentary by Jamie Kiggen regarding AOL’s advertising revenues. (Plts.’ S.J. Opp. 64 (Dkt. Entry 288).) Thus, it was CSFB’s affirmative decision to promote AOL’s shares and reaffirm its confidence in AOL after doubts had been raised on February 1, 2001 that made the February 5, 2001 CSFB report material and significant to this case.

    169

    Likewise, Plaintiffs have thoroughly refuted Defendants’ simplistic conclusion that there was no new, relevant news in the February 20, 2002 Lehman Brothers report, which Dr. Hakala has also disputed. (See Plts.’ S.J. Opp. 57-58 (detailing the new information contained in Lehman’s February 20 report); Damages Rebuttal Rpt. ¶ 18 (stating that “the assertion . . . that the Lehman Brothers report on February 20, 2002 did not contain new information but merely repeated statements from a prior report on January 31, 2001 is simply not true, as a review of both reports easily reveals, and is belied by the stock price impact of the report and the numerous published news articles that attributed the decline in AOL’s share price to the February 20, 2002 Lehman Brothers analyst report.”).) Hence, Defendants’ unfounded and self-serving conclusions regarding “new” news do not suggest any true flaw in Dr. Hakala’s analysis, and should remain issues for the jury to resolve.

    170

    [31] D. Dr. Hakala’s Calculation of an Analyst Proxy Results in a Reliable, Conservative Estimate of The Impact of Defendants’ Misrepresentations and Omissions

    171

    Defendants criticize Dr. Hakala’s estimation of fraudulent inflation based on an analyst proxy, claiming that “under established law and economic principles,” he should have only analyzed the impact of CSFB’s reports, not the impact of other analysts’ reports. (Defs.’ Mem. 28.) This argument, again, rests on Defendants’ misguided belief that there can be no liability for their misrepresentations without proof of statistically significant stock price increases in response to their AOL reports. See In re Scientific-Atlanta, 571 F. Supp. 2d at 1340-41 (“Contrary to Defendants’ argument, the mere absence of a statistically significant increase in share price in response to fraudulent information does not ‘sever the link’ between the material misstatements and the price of the stock. Rather, price stability may just as likely demonstrate the market consequence of fraud where the alleged fraudulent statement conveys that the company has met market expectations, when in fact it has not.”).[46] Considering that Defendants never issued anything even vaguely resembling a curative disclosure, Defendants’ argument that Dr. Hakala must rely solely on CSFB’s reports is nonsensical.[47] Moreover, as detailed below, Defendants’ criticisms misstate or miscomprehend Dr. Hakala’s analysis, and should be rejected.

    172

    [32] In order to conservatively estimate the impact of an “equivalent disclosure” for the fraudulent inflation attributable to Defendants’ misrepresented performance projections and ad revenue risk,[48] given that Defendants never timely or sufficiently lowered their AOL projections to match their internally discussed views, Dr. Hakala identified equivalent, significant negative analyst comments on AOL (i.e., significant ad revenue projection reductions, substantially reduced price targets or EBITDA estimates, downgrades, etc.),[49] on days which were relatively free of AOL news from non-analyst sources, and found an average negative impact of 2.71% associated with such negative analyst forecast revisions. (Damages Rpt. ¶¶ 7 & 27; Hakala 2008 Dep. Tr. 187:15-189:16.) Dr. Hakala also considered a combined set of positive and negative AOL analyst reports issued on relatively news-free days, and found an average absolute impact of 2.70%. (Damages Rpt. ¶ 27.) Finally, Dr. Hakala compared these results to the actual inflationary impact of two significant CSFB AOL reports to confirm the validity of his estimate: one on February 5, 2001, which had a relative price effect of 2.91%, and the other on September 19, 2001, which had a relative price effect attributable to CSFB of approximately 1.79%,[50] averaging out to 2.35%.[51] Thus, Dr. Hakala used the estimated impact of 2.70% to represent the inflation in AOL’s share price on January 12, 2001 attributable to Defendants’ misrepresentations concerning AOL’s expected performance and ad revenues. during the Class Period. (Corrected Rpt. ¶ 38.) Considering that Plaintiffs allege that all of these reports misrepresented and omitted Defendants’ true beliefs about AOL’s poor financial prospects, it is hard to imagine how the allegedly fraudulent reports could possibly serve as a basis for estimating the impact of curative disclosures.

    173

    [33] Incredibly, Defendants argue that this analysis “has absolutely nothing to do with AOL’s actual stock price movements,” (Defs.’ Mem. 29), when Dr. Hakala’s entire analysis is plainly and precisely that, an analysis of AOL’s stock price responses to significant analyst forecast and valuation revisions comparable to the disclosure(s) Defendants should have made, given their internally expressed beliefs about AOL’s financial prospects.

    174

    Moreover, contrary to Defendants’ suggestion, Dr. Hakala’s analyst proxy bears no resemblance to the expert analysis rejected in DeMarco v. Lehman Bros., Inc., 222 F.R.D. 243, 248 (S.D.N.Y. 2004). (Defs.’ Mem. 29-30.) There, the expert had assumed a “minimum” analyst impact of 5% based on his review of a general study of the impact of analysts statements on 200 companies during the period of 1989-1991, and had estimated a “maximum” analyst impact based on the returns data for three days in the class period when the price of the subject stock rebounded after publication of analysts’ positive statements, yielding an average 16% maximum impact. DeMarco, 222 F.R.D. at 248-49. The DeMarco court found that this study was unreliable and irrelevant because, inter alia, the estimate of the “minimum” analyst impact was based on a study of analysts in general from a much earlier, pre-Internet bubble period, and the maximum estimate involved a very small sample of only three dates.[52] Dr. Hakala’s study here is vastly different because, unlike the study in DeMarco, Dr. Hakala’s estimates: (1) are based on an event study which measured, rather than assumed, the impact of analyst statements; (2) used actual AOL return data from the Class Period, rather than return data for other companies from a different time period; (3) covered a much larger sample of 43 relatively news- free days, as opposed to the three days used in the DeMarco study; and (4) were confirmed by [34] comparison to two clean instances of inflationary CSFB reports on AOL. Thus, Defendants’ argument that Dr. Hakala’s study here is perilously similar to the DeMarco study is unfounded and should be rejected.

    175

    Finally, in response to the criticisms by Professor Stulz, including criticisms of a percentage-based damages calculation generally, Dr. Hakala has thoroughly explained the logical and economic underpinnings for his approach and provided extensive authority for his inflation per share methodology. (Damages Rpt. ¶¶ 33-48; Damages Rebuttal Rpt. ¶¶ 50-52.) Further, Dr. Hakala has submitted with his Damages Rebuttal an alternative analysis under a dollar-drop methodology which does not involve any analyst proxy analysis, and confirms the fact that there are substantial damages in this case under either methodology. (Damages Rebuttal Rpt. ¶ [53], Exs. C-1a (Limited Rebuttal) & C-2a (Limited Rebuttal).) Defendants have never offered any refutation of this analysis, and indeed, Professor Stulz argues that a dollar-drop method is the appropriate measure of damages in this case. (Corrected Rpt. ¶¶ 89-91 (arguing that a percentage approach is incorrect because, supposedly, “the same piece of information will affect the present value of the cash flows by the same dollar amount regardless of the current price of the stock at the time the market learns that piece of information[.]”).) Given Dr. Hakala’s presentation of both alternatives, which both find significant damages, and Defendants’ failure to offer any damages analysis, there simply is no basis in the record for Defendants’ claims that there is any flaw in Dr. Hakala’s damages analyses or that any such claimed flaw significantly undermines his results.

    176

    Thus, as described above, Dr. Hakala’s event studies and opinions are relevant, reliable, and will greatly assist the jury in resolving these complex issues, and therefore should be admitted under Federal Rule of Evidence 702.

    177

    [35] II. MARAIS’S TESTIMONY IS ADMISSIBLE UNDER THE FEDERAL RULES AND DAUBERT

    178

    Due to the numerous, complicated but technically meritless attacks lodged by Professor Stulz and Defendants against the event study methodology employed by Plaintiffs’ loss causation and damages expert, Dr. Hakala, Plaintiffs retained Dr. M. Laurentius Marais, a preeminent authority on event study methodology, to set the record straight on these significant issues. Dr. Marais is a coauthor of “Event study methods: detecting and measuring the security price effects of disclosures and interventions,”53 and has served on the editorial board of the Journal of Accounting Research and refereed for numerous professional journals, including the Journal of Accounting and Economics; the Journal of Business and Economic Statistics and the Journal of Financial Research. (Marais Rpt. Ex. A.) Dr. Marais reviewed Dr. Hakala’s event study methodology and opined unequivocally that it is consistent with peer-reviewed literature “is affirmatively and positively consistent with ideas that are in the peer reviewed literature.” (Marais Dep. Tr. 108:7-110:23.)

    179

    Defendants acknowledge that Dr. Marais answers Professor Stulz’s methodological criticisms, but claim that his testimony is irrelevant because Dr. Marais only opined on the validity of Dr. Hakala’s method and not various details of how the method was implemented. (Defs.’ Mem. 32-33.) This argument carries no practical import: clearly Dr. Hakala’s opinions may be excluded by the Court or discounted by the jury if they are determined to be based on an invalid methodology, irrespective of how that methodology was applied.[54] Moreover, because [36] Defendants’ attacks on Dr. Hakala’s methodology confuse or ignore significant principles of statistics and misrepresent the academic literature supporting Dr. Hakala’s event study – literature which is completely indecipherable to a lay person lacking high-level statistics training – Dr. Marais’s testimony will assist a jury in understanding the key concepts and foundation for Dr. Hakala’s work here, which provides substantial evidence of loss causation and damages.

    180

    Defendants also argue that Dr. Marais’s opinions are redundant of Dr. Hakala’s defense of his methodology, and are therefore excludable as “needlessly cumulative” evidence. To the contrary, Dr. Marais’s testimony is not a mere reiteration of Dr. Hakala’s: Dr. Marais brings his considerable knowledge of the peer-reviewed academic literature regarding event studies to bear on the question of whether and how Dr. Hakala’s methodology is supported in the literature, offering in particular, an expanded discussion of the primary article Dr. Hakala cites for support, the Aktas article. As previously noted, Dr. Marais also offers unique testimony from Dr. Hakala on the issue of “replicability” in statistical studies, and concludes from his own review of Dr. Hakala’s described methodology that there was “no reason to expect” any increase rate of “false positive” results based on Dr. Hakala’s use of dummy variables. (Marais Dep. Tr. 167:2-168:4.) Hence, Dr. Marais’s testimony regarding Dr. Hakala’s methodology plainly exceeds the scope of Dr. Hakala’s own defense. Indeed, similar testimony by Dr. Marais supporting Dr. Hakala’s methodology was admitted in In re AOL Time Warner, Inc. Sec. and “ERISA” Litig., No. MDL-1500 (S.D.N.Y.). (See Market Efficiency Rebuttal ¶ 11.)

    181

    Finally, even if Dr. Marais’s testimony were cumulative in some sense of portions of Dr. Hakala’s testimony, this alone would not render it unduly or prejudicially cumulative under [37] Federal Rule of Evidence 403. See U.S. v. Aviles-Colon, 536 F.3d 1, 22-23 (1st Cir. 2008) (rejecting claim that witness’s testimony and recorded conversation presented at trial “were cumulative or unfairly prejudicial under Federal Rule of Evidence 403 simply because [another witness] had previously testified” as to the same matters). Further, the cases cited by Defendants do not support precluding a witness from testifying altogether based solely on the purportedly “cumulative” nature of the testimony offered. (See Defs.’ Mem. 33 (citing McDonough v. City of Quincy, 452 F.3d 8, 20 (1st Cir. 2006) (ruling that the district court did not abuse its discretion in urging the City to “move on” at trial after counsel had asked the plaintiff several repetitive questions about the plaintiff’s sour relationship with the City); Elwood v. Pina, 815 F.2d 173, 178 (1st Cir. 1987) (ruling merely that the exclusion of certain cumulative documentary evidence, the substance of which had been presented through testimony, “[i]f an error at all . . . was harmless.”).) Hence, Dr. Marais’s proposed testimony is neither irrelevant nor needlessly cumulative and Defendants’ motion to preclude it should be denied.

    182

    III. PROFESSOR KRAAKMAN’S TESTIMONY IS ADMISSIBLE UNDER THE FEDERAL RULES AND DAUBERT

    183

    A. Professor Kraakman is Amply Qualified to Serve as an Expert Concerning The Subjects of His Report

    184

    Without question, Professor Kraakman is qualified to testify as an expert on the issues addressed in his report and deposition, namely, matters of corporate finance and economic theory. (See Rodon Decl. Ex. G (the Expert Rebuttal Report of Reinier Kraakman to the Expert Report of Professor Stulz, dated July 16, 2008 (the “Kraakman Rpt.”)) ¶ 1 & Ex. A.) He is a highly respected academic who authored certain of the seminal articles concerning the functioning of efficient markets and the efficient market hypothesis. In fact, his publications have been cited in at least fifty court opinions, including most notably here, the Supreme Court’s decision in Basic and the First Circuit’s opinion in PolyMedica. See Basic Inc. v. Levinson, 485 [38] U.S. 224, 253 (1988); In re PolyMedica Corp. Sec. Litig., 432 F.3d 1, 9 (1st Cir. 2005). Professor Kraakman has authored numerous textbooks and over forty articles on corporate finance and corporate governance, and currently teaches courses in corporations, corporate finance and corporate theory at Harvard Law. (Kraakman Rpt. Ex. A; Rodon Decl. Ex. K (attaching transcript excerpts from the Aug. 7, 2008 deposition of Reinier Kraakman, (“Kraakman Dep. Tr.”)) 14:14-24.)

    185

    Defendants nonetheless argue that Professor Kraakman lacks sufficient “‘knowledge, skill, experience training or education’ regarding the influence of analyst reports and other information on stock prices” based on Professor Kraakman’s testimony that he was “[p]robably not” more of an expert than defense counsel academic literature pertaining to analyst’s impact. (Defs.’ Mem. 42.) This argument strains credulity. Professor Kraakman’s modest self- assessment – or generous assessment of defense counsel’s knowledge – does not nullify the considerable expertise he has built in his field.[55] Moreover, the issue is whether he has specialized knowledge which will assist the jury, and as Professor Kraakman further testified, “I think I’m more qualified to discuss the content of that literature than someone who hasn’t read the articles I’ve read.” (Kraakman Dep. Tr. 51:15-20.) Professor Kraakman noted that he had researched the literature concerning the impact of analysts’ statements in connection with his 1984 article, Mechanisms of Market Efficiency, and that he reviewed additional literature on the issue in preparation for his testimony in this case. (Id. at 50:13-51:6.) Thus, there is no genuine issue concerning Professor Kraakman’s impressive qualifications to opine as an expert regarding the efficient market hypothesis and its application to analyst statements.

    186

    [39] B. Professor Kraakman’s Opinions are Relevant, Reliable and Will Assist the Jury In Making Important Factual Determinations In This Case

    187

    Professor Kraakman opines here on whether and under what circumstances stock prices in an efficient market respond to information, including statements issued by analysts and others.[56] These opinions will assist the jury in determining whether AOL’s stock was impacted by Defendants’ statements, and in sorting through the numerous arguments Defendants have asserted regarding whether certain news releases in Dr. Hakala’s event study are “new” news or are “confounded” by other simultaneous releases. Defendants’ assertions that Professor Kraakman opines on legal issues and that his opinions are unreliable are meritless and should be rejected.

    188

    Professor Kraakman’s guidance concerning the relevant criteria for the jury to consider in determining whether a statement impacted a stock’s price will assist jurors because the operation of efficient markets is a specialized topic which is “beyond the ken of the lay jury.” See U.S. v. Hines, 55 F. Supp. 2d 62, 64 (D. Mass. 1999) (Gertner, J.). Moreover, a basic understanding of how efficient markets operate is critical to determining key issues in this case, including whether Plaintiffs have established loss causation and how to calculate damages based on the curative disclosures identified in the complaint. Professor Kraakman’s report provides jurors with an explanation of the factors identified in the great body of academic literature dedicated to studying the types of disclosures that impact stock prices. Rather than evaluating all of the disclosures Professor Stulz opines on or Defendants’ raise in their arguments and instructing the jury on how they should resolve the disputes, Professor Kraakman explains how prominent [40] analysts’ statements and other news impact the price of widely-traded stocks, much like issuers impact stock prices when they make public disclosures. (Kraakman Rpt. ¶¶ 8-9.) Thus, Professor Kraakman provides the jury with “a context for considering the evidence before it, as opposed to a roadmap to a particular outcome.” See Tuli v. Brigham & Women’s Health Hospital, Inc., 592 F. Supp. 2d 208, 211 (D. Mass 2009) (Gertner, J.). His explanations as to how efficient markets operate will thus aid jurors in their understanding of the issues without “simply telling jurors what the outcome should be.” Id.

    189

    Moreover, Professor Kraakman’s opinions are based on reliable data, including the academic literature concerning the efficient market hypothesis, which contains peer-reviewed studies on the impact of different types of news and speakers on stock market prices. Additionally, to the extent he offered any opinions regarding discreet factual issues, he directly reviewed source documents, including documents produced in this case concerning Mr. Kiggen’s and Ms. Martin’s rankings and other indicia of elite analysts, and the January 31, 2002 and February 20, 2002 Lehman Brothers analyst reports, and applied the criteria discussed in academic literature to the documents and information he reviewed. (See Kraakman Rpt. ¶ 4.)

    190

    C. Professor Kraakman’s Opinions Concern Issues Of Economic and Finance Theory and Do Not Constitute Legal Opinions

    191

    Defendants argue that Professor Kraakman’s report amounts to little more than a legal opinion concerning whether the fraud-on-the-market presumption should apply in this case. (See Defs.’ Mem. 43.) However, the fact that Professor Kraakman is, among other things, a law professor does not convert every opinion he provides into a legal opinion. Although Professor Kraakman’s opinions here bear some significance to the resolution of legal issues in this case – and they would not be relevant if they did not – his opinions concern an economic and corporate finance issue, namely, the market impact of certain types of statements as discussed in academic [41] literature, not the case law. As described above, he is easily qualified as an expert in corporate finance literature and he acts in that capacity here, explaining relevant factors identified in the academic literature for determining whether certain disclosures economically impacted a stock’s price.

    192

    Indeed, Defendants’ unfounded assertion is belied by the contents of Professor Kraakman’s report. In his report, Professor Kraakman does not discuss any case law. (See id.) Moreover, the academic literature Professor Kraakman cites addresses economic issues, including: the content of financial analysts’ forecasts of earnings, the investment value of brokerage analysts’ recommendations, the performance of buy and sell recommendations, analysts’ predictive abilities, and investor reaction to celebrity analysts. (See Kraakman Rpt. nn.4-9). Professor Kraakman does not recite the holding of a single court case, draw legal conclusions,[57] interpret the meaning of statutes or regulations,[58] instruct the jury as to the applicable law, or usurp the role of the jury in applying the law to the facts before it. See Hines, 55 F. Supp. 2d at 72 (Expert testimony does not usurp the function of the jury where “[a]ll that the expert does is provide the jury with more information with which the jury can then make a more informed decision.”). Thus, Professor Kraakman clearly does not opine on an issue of law, and Defendants’ argument that his testimony should be excluded on this basis should be rejected.

    193

    [42]D. Professor Kraakman’s Opinions Properly Rebut Professor Stulz’s Report and Testimony

    194

    Professor Kraakman’s report broadly rebuts Professor Stulz’s opinions about whether certain news is “new” or confounded by providing guidance to the jury about relevant considerations in making these factual determinations. Additionally, as concrete and relevant applications of the principles set forth in the academic literature he discusses, Professor Kraakman directly rebuts Professor Stulz’s opinions concerning: (i) the elite status of Mr. Kiggen and Ms. Martin and; (ii) whether the ad-related information in the February 20, 2002 Lehman report constituted “new” news. As Professor Kraakman explains, by examining “press coverage, professional prominence and affiliation with a prominent investment bank,” one can infer whether an analyst belongs to the “influential professional elite.” (Kraakman Rpt. ¶ 6.) Based on these characteristics, Mr. Kiggen and Ms. Martin qualify as influential analysts who could impact the stock prices of the companies they covered. (Id. at ¶ 7.)

    195

    Defendants grossly misrepresent Professor Kraakman’s opinions regarding the February 20, 2002 Lehman report, claiming that he agreed with Professor Stulz that the “the negative information about online advertising at AOL in the February 20, 2002 report had already been disclosed in Lehman Brothers’ January 31, 2002 report.” (Defs’ Mem. 50.) As Professor Kraakman explained in his report, ”[t]he February 20th [Lehman Brothers’] report contained a distinctly bleaker and more detailed discussion of AOL’s advertising prospects” than the January 31st report and, more importantly, “the February 20th report cast AOL’s advertising difficulties as a principal basis for lowering Lehman’s rating of AOL Time Warner.” (Kraakman Rpt. ¶ 17.) The changed stock recommendation in the February 20th report, from “2 Buy” to “3 Market Perform,” represented new information concerning the impact of the ad market on AOL’s future [43] prospects. (See id.) Thus, to claim that Professor Kraakman agreed with Professor Stulz that this was not new ad-related news flatly misstates Professor Kraakman’s opinion.

    196

    For all of the reasons herein, Defendants’ arguments to preclude Professor Kraakman’s opinions should be rejected.

    197

    IV. PROFESSOR BLACK’S OPINIONS ARE ADMISSIBLE UNDER THE FEDERAL RULES AND DAUBERT

    198

    Professor Black opines in his rebuttal report that: 1) the market was not already aware in 2001 of the scope of the advertising decline and its impact on AOL; 2) Mr. Kiggen and Ms. Martin were highly respected analysts whose statements would have affected AOL’s share price; 3) disclosure of CSFB’s internal views regarding the impact on AOL of the advertising slowdown would have substantially affected investor views about AOL due to the significance of AOL’s advertising revenues to the enormous growth rate applied in valuing the company; 4) the mere fact of an additional investigation into AOL’s accounting could call into question the integrity of AOL’s financial reporting generally, and thus could affect the value of its shares; 5) substantial, undisclosed layoffs at AOL would be highly relevant to investors; and 6) certain CSFB reports were not plausible when written and were not appropriately revised when they turned out to be overly optimistic.

    199

    Of all of these opinions, Defendants only directly challenge the opinion that CSFB’s reports were highly optimistic, claiming that his entire opinion is rendered unreliable by a single error in only one of the underlying analyses, which Professor Black acknowledged and corrected at his deposition. Due to this correction, Professor Black moderated the language of his opinion, stating that CSFB’s AOL projections were “highly optimistic” instead of “absurd,” but did not withdraw his opinion. (See Rodon Decl. Ex. K, (attaching transcript excerpts from the Aug. 19, 2008 deposition of Bernard S. Black (“Black Dep. Tr.”)) 104:2-5.) Therefore, there simply is no [44] basis for Defendants’ argument that the corrected opinion or analysis is unreliable. (Black Dep. Ex. 1, p. 9.)

    200

    Defendants otherwise move to preclude Professor Black’s opinions based only generally on the claims that Professor Black is unqualified to opine concerning the types of information that are important to investors and that his opinions exceed the scope of the opinions by Professors Stulz and Deighton which he is rebutting. As discussed below, these arguments are meritless, and hence, Professor Black’s opinions should be admitted.

    201

    A. Professor Black’s Extensive Corporate Finance Credentials And Experience Amply Qualify Him To Opine On The Significance Of Certain Statements To The Market

    202

    Professor Black’s considerable experience and academic work in the field of corporate finance spanning over 25 years provides a more than sufficient basis for his opinions here. As described at length in his curriculum vitae, Professor Black has experience in a broad range of corporate finance matters as an author, advisor, counsel, board member and professor. (Rodon Decl. Ex. H (the Expert Rebuttal Report of Bernard S. Black, dated July 17, 2008 (the “Black Rpt.”)) App. A.) Professor Black has served as a policy advisor to foreign countries concerning securities markets and has advised the Securities and Exchange Commission on various topics including proxy reform and corporate governance issues. (Id.) Indeed, Professor Black served as counsel to Commissioner Joseph A. Grundfest at the Securities Exchange Commission. Further, Professor Black taught at Stanford and Columbia, and has published textbooks and scholarly articles on corporate finance.[59] (See id.) Currently, Professor Black holds a joint position as professor of finance at the McCombs School of Business and professor of law at the University of Texas Law School. (Id.; Black Dep. Tr. 16:4-7.)

    203

    [45] Defendants nonetheless seek to disqualify Professor Black, arguing that he may not have “any more expertise” than the jury in determining the information that would be significant to investors because Professor Black “has never been a securities analyst” and is “only” generally familiar with the academic literature concerning the impact of analyst statements. (Defs.’ Mem. 39.) This argument strains credulity. Professor Black testified that he is “knowledgeable in finance and in the valuation of companies” and that he has performed the types of calculations used in his report numerous times over the course of his career. (Black Dep. Tr. 15:12-16:10.) Moreover, Professor Black has expert “knowledge about what it is that investment banks do, that analysts do, [and] what kinds of information investors are looking for from analysts,” (Black Dep. Tr. 16:21-17:6), which he developed from his extensive research and writing about corporate acquisitions, experience on the boards of directors of various public companies, experience as an attorney in transactional mergers and acquisitions practice at a major law firm, and a experience as an expert witness in securities cases of various kinds. (Black Dep. Tr. 17:7-18:5.) Thus, there is no merit to Defendants’ argument that Professor Black is unqualified to opine on issues concerning company valuation and investors’ concerns merely because he has never worked as an equity research analyst.

    204

    B. Professor Black’s Report Properly Rebuts Opinions Offered By Professors Stulz And Deighton

    205

    Contrary to Defendants’ claims that Professor Black’s opinions fail to rebut the opinions of Professors Stulz and Deighton and should therefore be precluded, Professor Black’s entire analysis rebuts their opinions and criticizes their focus on irrelevant issues. As discussed above, Professor Black counters Professor Stulz’s analysis concerning the “reasonableness” of Defendants’ projections and criticizes Professor Stulz’s opinion that CSFB’s $75 price target could be justified. (See Black Rpt. 22.) Moreover, Professor Black rejects Professor Stulz’s [46] contentions, based on facts Professor Stulz was instructed by defense counsel to assume, that Defendants’ AOL reports were honest and reasonable, that Mr. Kiggen disagreed with Ms. Martin’s AOL projections and concerns, and that thisa supposed disagreement was based on reasonable differences in projections for the America Online business. (See id.; Rodon Decl. Ex. D (the Corrected Expert Report of Rene M. Stulz, dated July 8, 2008 (the “Stulz Corrected Rpt.”)) ¶ 28(b).) Professor Black notes that although AOL’s prospects deteriorated over the course of 2001, CSFB’s contemporaneous internal documents and Professor Black’s financial analyses suggest that both Ms. Martin and Mr. Kiggen did not believe CSFB’s public statements about AOL, but that they nonetheless failed to significantly revise their estimates or reduce CSFB’s $75 target price until September 25, 2001. (See Black Rpt. 22-23.) Professor Black disagrees with Professor Stulz’s justification for this target price, and he opines that a clear statement from CSFB to the effect that AOL’s performance would be substantially impacted by the advertising slowdown would have significantly affected investor views about AOL. (See id. at 24.)

    206

    Additionally, contrary to Defendants’ claim that Professor Black agreed with Professor Deighton regarding both of Professor Deighton’s opinions, (Defs.’ Mem. 40-41), Professor Black’s opinions also properly rebut Professor Deighton’s report. While Professor Black acknowledges that there was some general information about an advertising decline available to investors, he refutes Professor Deighton’s view that the market was already aware of the likely impact of the advertising decline on AOL. (See Black Rpt. 17-21; Deighton Rpt. ¶ 40.) Professor Black explains that the known information concerning an advertising decline was “soft” and uncertain early in the Class Period, particularly with regard to online advertising. (See Black Rpt. 18.) Moreover, Professor Black points out that in early 2001, AOL repeatedly [47] claimed that the advertising slowdown was not impacting AOL, and CSFB stood behind these statements despite their internally discussed concerns to the contrary. (See id. at 19 (noting a CSFB-hosted lunch with Robert Pittman, AOL’s chief operating officer, on May 22, 2001, and the subsequent, positive CSFB report on AOL).)

    207

    Professor Black also disputes Professor Deighton’s theory that despite the decline in the advertising markets, CSFB’s optimistic projections for AOL were reasonable. (See id.) More particularly, given that CSFB forecasted growth of the online advertising market overall at only 8%, Mr. Kiggen’s estimates that AOL would grow its own online ad revenue by 64% for the same time period were not plausible. (See id. at 20-21.) It was also implausible that in a maturing market AOL would capture 80% of the total worldwide growth in online advertising over the next five years, as CSFB projected. (Id. at 21.) Considering that advertising was the principal driver of growth and accounted for most of AOL’s profit, AOL’s subscription business, which was maturing and facing a competitive threat from broadband internet access, did not “justify anything close to a 60x EBITDA multiple.” (See id. at 19-20.) Thus, Professor Black concluded that Professor Deighton was wrong in opining that CSFB’s highly optimistic projections for AOL were reasonable.

    208

    In addition, Professor Black opines that since even Professor Deighton acknowledges that Mr. Kiggen lacked expertise regarding Time Warner, it was unreasonable for Mr. Kiggen to increase revenue projections for Time Warner businesses in the April 10, 2001 report in order to make up for a shortfall in the America Online business and maintain overall guidance. (See id. at 18.) Thus, even assuming Ms. Martin’s views were limited to Time Warner at the time, it was nonetheless unreasonable for CSFB’s published reports to be as optimistic as they were about AOL as a whole. (See id.)

    209

    [48] C. Professor Black’s Opinions Are The Product of Reliable Principles And Methods Which He Properly Applied To The Facts of This Case

    210

    Professor Black’s opinions are based primarily on his analysis of certain data contained in AOL’s financial releases compared to Defendants’ projections for AOL. (See Black Rpt. 7-16.) In particular, Professor Black focused on two detailed sets of CSFB projections, a Fidelity presentation on January 24, 2001 and a public report dated April 10, 2001. (Id. at 8.) Professor Black calculated Mr. Kiggen’s projected revenue growth rate for AOL’s fourth quarter of 2000, by subtracting Mr. Kiggen’s total revenue estimate for 2000 from the sum of AOL’s first three quarters, which were already known at the time of the January 24, 2001 presentation to Fidelity. Id. at 8-9. According to Professor Black’s calculations, Mr. Kiggen projected revenues of $2,208 for AOL’s fourth quarter of 2000. (Black Dep. Tr. 102:10-23.) By dividing Mr. Kiggen’s fourth quarter results by his projected third quarter results, Professor Black calculated Mr. Kiggen’s highly optimistic 11.8% quarter-over-quarter projected growth rate for AOL. (Black Dep. Tr. 102:16-23; 103:20-21.)

    211

    Moreover, Professor Black notes that by the time CSFB published its April 10, 2001 report, AOL had already failed to meet Mr. Kiggen’s revenue estimates for the fourth quarter of 2000. (Black Rpt. 11.) To account for this shortfall, Mr. Kiggen reduced his estimates for AOL revenue by $1.2 billion in this report; however, he increased Time Warner’s estimated revenue by $800 million at the same time, despite Ms. Martin’s insistence that Time Warner numbers should be brought down, in order to minimize the net reduction to AOL’s revenue overall to only $400 million. (Id.) Based on these analyses, Professor Black found that Defendants’ projections were overstated to a sufficient degree to suggest their falsity or bad faith, and that the overstatement was significant enough that it would likely have been important to investors.

    212

    [49]Defendants attack Professor Black’s analysis, significantly exaggerating the effect and implications of a single, isolated error in one of Professor Black’s charts – namely, the accidental use of a restated 10-K instead of the original 10-K he had intended to use[60] – on Professor Black’s results and the ultimate conclusions he drew from the chart. As his testimony and revised report show, Professor Black stood by his ultimate conclusions, he merely modified his language, changing his description of Mr. Kiggen’s projections from “absurd” to “highly optimistic.” (Black Dep. Tr. 104:2-10; 168:12:18.) As regrettable as any mistake is, this one error does not render his entire report unreliable. There is no reason to believe that any further inaccuracies exist in Professor Black’s data, considering that Defendants did not raise any at his deposition or in their brief.

    213

    At most, this error provides a basis for Defendants to argue to a jury that Professor Black’s opinions should be discounted, but it does not impact the admissibility of his testimony. See U.S. v. Vargas, 471 F.3d 255, 264 (1st Cir. 2006); see also Freeland v. Iridium World Comm’n, Ltd., 545 F. Supp. 2d 59, 88 (D.D.C. 2008) (“‘[T]he factual basis of an expert opinion goes to the credibility of the testimony, not the admissibility,’ making it a jury determination.”) (quoting Sappington v. Skyjack, Inc., 512 F.3d 440, 450 (8th Cir. 2008)). Indeed, for purposes of admissibility:

    214

    The issue is whether ‘(a) the opinions and conclusions of the expert are accompanied by information that enables the factfinder to evaluate the likely accuracy of the expert’s opinion, and (b) the information is presented in such a way that factfinders will not be fooled into excessively overvaluing the testimony’. . . Expert evidence should not be excluded merely because witnesses practicing in that field make errors with some frequency . . . but also because the factfinder has no information about the likelihood of error in the opinions, and thus cannot adjust the weight to be given to the evidence.

    215

    [50] U.S. v. Green, 405 F. Supp. 2d 104, 119 (D. Mass. 2005) (Gertner, J.) (internal citations omitted). Given the record of Professor Black’s deposition, Defendants can hardly claim that the jury might be “fooled in to excessively overvaluing” Professor Black’s testimony or that they will have “no information about the likelihood of error” in his opinions from which they may adjust the weight given his report. Hence, Defendants are free to “explore and expose any weaknesses” in the factual basis of Professor Black’s opinions during cross-examination, Int’l Adhesive Coating Co. v. Bolton Emerson Int’l, Inc., 851 F.2d 540, 545 (1st Cir. 1988), and their arguments to preclude his testimony based on this error should be rejected.

    216
    CONCLUSION
    217

    For all of the foregoing reasons, Defendants’ motion to preclude the expert testimony of Dr. Scott Hakala, Dr. M. Laurentius Marais, Professor Reinier Kraakman and Professor Bernard Black, should be denied in its entirety.

    218

    DATED: June 5, 2009 KAPLAN FOX & KILSHEIMER LLP

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    /s/ Frederic S. Fox

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    Frederic S. Fox (admitted pro hac vice)

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    Joel B. Strauss (admitted pro hac vice)

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    Donald R. Hall (admitted pro hac vice)

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    Melinda D. Rodon (admitted pro hac vice)

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    850 Third Avenue, 14th Floor

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    New York, NY 10022

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    Telephone: 212-687-1980

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    Facsimile: 212-687-7714

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    Lead Counsel for Class Plaintiffs

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    [51]nbsp;Edward F. Haber (BBO #215620) Todd Heyman (BBO #643804) SHAPIRO HABER & URMY LLP

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    53 State St. 37th Floor

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    Boston, MA 02109

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    Telephone: 617-439-3939

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    Facsimile: 617-439-0134

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    Liaison Counsel for Class Plaintiffs

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    Notes:

    239

    [1] Any challenge to Dr. Hakala’s impressive credentials would be futile. In 1989, Dr. Hakala received his Ph.D. in Economics from the University of Minnesota, where he wrote his dissertation under the direction of Edward Prescott, the recipient of the Nobel Prize in Economics in 2004. (Damages Rpt. Ex. A.) Dr. Hakala has published peer-reviewed articles on subjects including the economics of loss causation and the valuation of distressed equity securities, and has taught classes on asset pricing and market efficiency at the doctoral level. (Id.) Additionally, he is a director of CBIZ Valuation Group, LLC, one of the largest business valuation and consulting firms in the United States with offices in Dallas, Chicago, Atlanta, Milwaukee, St. Louis and Princeton, and has served as a consultant and expert witness on numerous occasions in litigations similar to this one. (Id.) Finally, having received the professional designation of Chartered Financial Analyst, Dr. Hakala is uniquely qualified to opine on numerous issues commonly confronted by equity research analysts.

    240

    [2] As explained more fully below, infra note 14, by Defendants’ own description of event study methodology, their study underestimates the impact of all news other than CSFB’s reports.

    241

    [3] (See, e.g., Damages Rebuttal Rpt. ¶¶ 41-42 & n.24); see also Nihat Aktas et al., Event studies with a contaminated estimation period, 13 J. Corp. Fin. 129 (2007) (highlighting “the importance of explicitly controlling for unrelated events occurring during the estimation window” of an event study”); John D. Jackson et al., The Impact of Non-Normality and Misspecification on Merger Event Studies, 13:2 Int. J. of the Econ. of Bus. 247, 262 (2006) (recommending controlling for all related and unrelated events because failing to do so causes “the true significance level of the test [to be] misstated”); see generally Philip Hans Franses, Time Series Models for Business and Economic Forecasting (Cambridge Univ. Press 2002) (1998).

    242

    [4] Professor Kraakman’s publications on the topics he opines on here have been cited in numerous court opinions, including the Supreme Court’s decision in Basic and the First Circuit’s opinion in PolyMedica. See Basic Inc. v. Levinson, 485 U.S. 224, 253 (1988); In re PolyMedica Corp. Sec. Litig., 432 F.3d 1, 9 (1st Cir. 2005).

    243

    [5] Rule 702 provides: “If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.”

    244

    [6] Additionally, the Supreme Court articulated five non-exclusive factors that bear on the question of the admissibility of scientific or technical testimony: 1) whether the expert's technique or theory can be or has been tested; 2) whether the expert's technique or theory has been subject to peer review and publication; 3) the known or potential error rate; 4) the existence and maintenance of standards and controls; and 5) whether the technique has gained general acceptance in the relevant scientific community. Daubert, 509 at 593-94; Kumho Tire, 526 U.S. 137.

    245

    [7] In re Xcelera.com Sec. Litigation, Civ. Action No. 00-11649-RWZ, 2004 U.S. Dist. LEXIS 29064 (D. Mass. Sept. 30, 2004) (rejecting attacks on Dr. Hakala’s qualifications and his event study analysis and granting class certification); In re Xcelera.com Sec. Litig., 430 F.3d 503, 512-514 (1st Cir. 2005) (describing Dr. Hakala’s “sophisticated event study” and upholding the district court’s grant of class certification based on the study, in part.)

    246

    [8] (See Affidavit of Professor Matthew Richardson, In re Xcelera.com Sec. Litig., Civ. Action No. 00-11649- RWZ (D. Mass. filed March 7, 2003) (Dkt. Entry 73).)

    247

    [9] Defendants claim that just as in Xcelera, Dr. Hakala dummied out all company-specific news in his event studies here. (Defs.’ Mem. 21.) This claim is demonstrably false: not only has Dr. Hakala described at length his protocol for selecting only significant company-specific news, there was, in fact, AOL-specific news on every trading day of the study period here, but Dr. Hakala did not dummy out 168 days of his Damages Study. (See also Hakala 2008 Dep. Tr. 379:16-380:12 (testifying that there was AOL-specific news on every single day of the study period and that he was “much more selective here” in identifying significant news).) This procedure is perfectly in accord with the event study procedure Judge Zobel acknowledged as proper, observing that “the academic literature supports the use of dummy variables for events in which significant company-specific news is released[.]” In re Xcelera.com Sec. Litig., 2008 U.S. Dist. LEXIS 77807, at *3.

    248

    [10] Confronting the New Challenges of Scientific Evidence, 108 Harv. L. Rev. 1532, 1552 (May 1995) (defining “power” in the context of statistical significance tests).

    249

    [11] Moreover, all three of these studies identified as “events” all firm-specific news from the cited sources and controlled for all such news. Although Dr. Hakala did not control for all AOL-specific news here, these studies nonetheless evidence that there would have been no error had he done so.

    250

    [12] In fact, as explained more fully in the memorandum submitted in support of Plaintiffs’ Motion to Preclude the Expert Opinions of René M. Stulz and John Deighton, it is Professor Stulz’s event study method that is biased precisely because it fails to control for known company-specific news events, while Dr. Hakala eliminates this bias by properly controlling for all predetermined “material” events. (See Plts.’ Mot. to Preclude Expert Opinions 7-9.)

    251

    [13] Further, Dr. Marais testified that he had “no reason to expect” that there was any effect on the rate of “false positive” results due to Dr. Hakala’s use of dummy variables for event dates other than those dates under analysis. (Marais Dep. Tr. 167:2-168:4.)

    252

    [14] By Defendants’ own admission, Professor Stulz’s event study is not a valid measure of the statistical significance of any news other than CSFB’s reports because his study did not control for the possible effects of any other news. As Defendants explained, “it is important for the economist to exclude the possible effects of the events for which he or she is testing; otherwise, the predicted return will already include such effects, if any[.]” (Defs.’ Xcelera Mem. 4 (Dkt. entry 232) (emphasis added).) Hence, Professor Stulz’s event study systematically underreports the significance of all news other than CSFB’s AOL reports and cannot serve as a test of the statistical significance for such news.

    253

    [15] As Dr. Marais testified, the criterion for determining whether Dr. Hakala’s use of dummy variables comports with the relevant academic literature “would not be the mechanistic and superficial percent of some universe of observations that he might have been able to use” but would instead “go to valid technical principles concerning the validity of the exercise[.]” (Marais Dep. Tr. 105:5-106:13.)

    254

    [16] Dr. Hakala’s method of substituting dummy variables for days when significant news is released is the same as the method used by Aktas and referred to as the “manual” or “brute force” method. Aktas used the brute force method as a measure of the effectiveness of various other mathematical models for accomplishing the same thing, namely, eliminating the effects of the contaminating news events from their study. While the brute force method is considered highly effective, it may be impractical in the typical academic event study context because, as Aktas noted, the process of identifying all significant events may be “unreasonable for large-sample analyses” involving multiple companies and hundreds or thousands of observations. Aktas, supra note 3, at 130.

    255

    [17] See, e.g., Richard Roll, R2, 43 J. Fin. 541, 558 (1988) (“On average over [the sample of] ninety-six stocks, 23.7 percent of the daily observations were excluded by being either the day of a news event or the preceding day[,]” based on company-specific news listed in the Wall Street Journal and Dow Jones news service); Robert B. Thompson II et al., The Influence of Estimation Period News Events of Standardized Market Model Prediction Errors, 63 Acct. Rev. 448 (1988) (identifying and controlling for all company-specific news found in the Wall Street Journal index on 12.3% of trading days for a set of 2,358 selected stocks).

    256

    [18] See, e.g., John Y. Campbell et al., The Econometrics of Financial Markets, 524 (Princeton Univ. Press 1997) (discussing “the need for an a priori framework or specification for the model before confronting the data. By proposing such a specification . . . the chance of coming upon a spuriously successful model is reduced.”); see also Roll, supra note 17, at 558 (applying the same a priori approach); Thompson, supra note 17 (same).

    257

    [19] See Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Issuer Disclosure of Material Information, 67 Fed. Reg. 142 (Aug. 2, 2002), at 51306-10.

    258

    [20] Paul Ryan & Richard J. Taffler, Are Economically Significant Stock Returns and Trading Volumes Driven by Firm-specific News Releases?, 31(1)-(2) J. Bus. Fin. & Acct. 49, 74-76 (2004) (appendix providing a description of the news categories driving price and trading volume activity).

    259

    [21] See also Peter Kennedy, A Guide to Econometrics, 253-54 (MIT Press 5th ed. 2003) (“An F test would be used to test if several observations could be considered consistent with the estimated equation.”)

    260

    [22] Dr. Hakala likewise performed an F-test with respect to the events identified in his event study concerning market efficiency, and similarly found that the events identified in that study were significant at a 99.99% confidence level. (Market Efficiency Rpt. ¶ 17.)

    261

    [23] This argument is not only counterfactual relative to Dr. Hakala’s description of his methodology, but also ignores Dr. Hakala’s testimony that in preparing his Damages Study, he tested the variation in applying this protocol to the same set of source documents and found a very insignificant degree of difference in the implementations, around 2-3%. Dr. Hakala arrived at this conclusion through a double-blind test in which he and two of his staff members independently reviewed the gathered documents and identified conforming news, then Dr. Hakala compared the results of the separate reviews. (Hakala 2008 Dep. Tr. 190:23-192:9.) By contrast, Defendants’ “replication” arguments compare implementation of the document identification protocols to different sets of source documents for different purposes.

    262

    [24] Defendants complain that an additional 5 days when CSFB issued reports are found to be statistically significant in Dr. Hakala’s Damages Study versus his Market Efficiency Study, but they fail to note that there are also 3 days when CSFB issued reports that show decreased statistical significance findings in his Damages Study.

    263

    [25] (See Rodon Decl. Ex. I (the Affidavit of Scott D. Hakala filed in In re AOL Time Warner, Inc. Sec. & “ERISA” Litig., MDL No. 1500 (S.D.N.Y. Nov. 2, 2004) (the “Hakala AOL Aff.”)).)

    264

    [26] As Dr. Hakala explained in his Damages Rebuttal Report, “the original event study in the AOL Time Warner case was preliminary in nature, performed prior to discovery, and did not focus specifically on the impact of analyst reports on AOL’s share price.” (Hakala AOL Aff. ¶ 35 (emphasis added).)

    265

    [27] Similarly, the Damages event study in this litigation was of considerably broader scope than the Market Efficiency event study, providing evidence not only that AOL traded in an efficient market, but evidence relevant to the issues of materiality, loss causation and damages. As Dr. Hakala testified, this broader scope required more thorough searches for relevant disclosures to include. (Hakala 2008 Dep. Tr. 194:10-195:17.)

    266

    [28] See, e.g., Frank J. Fabozzi et al., Financial Modeling of the Equity Market: From CAPM to Cointegration, 431-32 (Wiley 2006) (“[A]ny process of model selection must start with strong economic intuition. . . . Economic intuition clearly entails an element of human creativity. As in any other scientific and technological endeavor, it is inherently dependant on individual abilities.”); John Y. Campbell et al., The Econometrics of Financial Markets, 524 (Princeton Univ. Press 1997) (stating that in identifying events, it is important “to impose some discipline on the specification search by a priori theoretical considerations[,]” which “may be in the form of well-articulated mathematical models of economic behavior, or behavioral models motivated by psychological phenomena, or simply heuristic rules of thumb based on the judgment, intuition, and past experience.”).

    267

    [29] (See also Damages Rebuttal Rpt. ¶ 35 (stating that Defendants’ criticism of the change in event window “ignores the fact that the [c]lass [p]eriod and loss causation analysis in the original AOL Time Warner securities litigation ranged from 1999 through August 2002.”).)

    268

    [30] Furthermore, both of Dr. Hakala’s market models are more powerful that Professor Stulz’s, which only explained 45.9% of the daily variance in AOL stock prices. (Stulz Decl. 9 n.14.)

    269

    [31] Dr. Hakala calculated damages according to the “out-of-pocket” rule, which “is well recognized and has been consistently applied by experts in securities litigation.” (Damages Rpt. 34 n. 24 (citing references).) See also John Finnerty & George Pushner, An Improved Two-Trader Model for Estimating Damages in Securities Fraud Class Actions, 8 Stan. J.L. Bus. & Fin. 213, 219 (2003) (describing the steps of a damages analysis under this method); Bradford Cornell & R. Gregory Morgan, Using Finance Theory to Measure Damages in Fraud on the Market Cases, 37 UCLA L. Rev. 883, 894 (1990) (discussing damages calculations models and jurisprudence); Michael Barclay & Frank C. Torchio, A Comparison of Trading Models Used for Calculating Aggregate Damages in Securities Litigation, 64(2)-(3) L. & Contemporary Probs. 105, 106 (2001) (“In general, damages per share are calculated as the artificial inflation when the shares were purchased minus the artificial inflation when the shares were sold.”)

    270

    [32] The so-called “analyst proxy” analysis, as described in greater detail, infra pp. 31-33. In an abundance of conservatism, rather than relying on any one analyst or third party disclosure concerning AOL’s underperformance as a basis for estimating the related fraudulent inflation, Dr. Hakala considered a set of 43 relevant analyst disclosures within the Class Period and applied peer-reviewed calibration techniques to prepare “an exact calculation of what portion of all those [relevant] events should be attributable to CSFB by itself.” (Hakala 2008

    271

    [33] Defendants apparently take issue with this long-standing, bedrock method of estimating damages, which they describe as “nonsensical” because it supposedly attributes accounting investigation-related inflation to AOL’s share price on January 12, 2001, long before Defendants learned of AOL’s accounting investigation on July 11, 2001. (Defs.’ Mem. 17 n.13.) This claim is simply false, as made clear from the Damages Report and accompanying exhibits: Dr. Hakala did not attribute any fraudulent inflation related to Defendants’ failure to disclose or adjust their estimates based on their knowledge of AOL’s accounting investigation until July 12, 2001, the day after Defendants actually gained knowledge of the accounting issues. (Damages Rpt. Exs. C-2 & C-2a.)

    272

    [34] As discussed in an article co-authored by Dr. Hakala, a variety of market, industry and other forces including “leakage” events or other relevant disclosures, act on the amount of fraudulent inflation in a stock on any given day in the class period. See Madge S. Thorsen, Richard A. Kaplan & Scott Hakala, Rediscovering the Economics of Loss Causation, 6 J. Bus. & Sec. L. 93 (2006) (discussing various ways that fraudulent inflation and dissipation occur, as well as how to model this inflation/dissipation with event studies); see also John Finnerty & George Pushner, An Improved Two-Trader Model for Estimating Damages in Securities Fraud Class Actions, 8 Stan. J.L. Bus. & Fin. 213, 219 (2003) (discussing adjusting the corrective events over time for a “comparable-stock index that recognizes both industry and market-wide influences” and adjusting for “firm-specific factors that can be directly attributed to company announcements that are not related to the fraud” using the “backwardization” approach based on percentage returns). Thus, the “relevant events” are not necessarily “corrective disclosures,” as Defendants appear to assume, but they may nevertheless effectively dissipate fraudulent inflation from the stock.

    273

    [35] See Henry J. Cassidy, Using Econometrics: a Beginners Guide 246-48 & 250-53 (1981) (stating, “to exclude some of the seasonal dummies because their estimated coefficients have low t-statistics is not recommended[,]” and discussing the related problems); Intriligator, Econometric Models, Techniques, and Applications 188-89 (1978) (“[E]xcluding relevant variables yields biased and inconsistent estimators, while including irrelevant variables yields unbiased and consistent estimators. Thus, in terms of bias and consistency, it is better to include too many than to include too few explanatory variables. . . . Considerable judgment, in fact, is called for in the specification of the model, balancing between including ‘too few’ and ‘too many’ variables[.]”); and Robert S. Pindyck & Daniel L. Rubinfeld, Econometric Models and Economic Forecasts, 162-66 (3d ed., McGraw- Hill Inc. 1991) (1976) (“If we are unsure of which explanatory variables ought to appear in a model, we face several trade-offs. The analysis shows that the cost of excluding a variable which should appear in the model is bias and inconsistency. The cost of adding one or more irrelevant variables is loss of efficiency. . . . In general, the choice of model form must be made in terms of the bias-efficiency trade-off, with the result dependent on the objective. If accurate forecasting is the goal, minimizing mean square error is one reasonable objective, since it accounts for both bias and efficiency.”).

    274

    [36] The only exceptions are: (1) the disclosure by AOL of an ad revenue shortfall with its earnings release on July 18, 2001; and (2) the subsequent analyst commentary on the earnings release on July 19, 2001. Each of those events was significant in the damages analysis.

    275

    [37] As Dr. Hakala described in his Damages Report, relevant disclosures are disclosures relating to AOL’s underperformance and advertising revenue weakness, and, after July 11, 2001, to AOL’s undisclosed layoffs and accounting improprieties. (Damages Rpt. ¶ 9.) Additionally, in Exhibits B-1, C-1a and C-2a, Dr. Hakala denoted the category of relevant event as ad-related, analyst-related, layoff-related or accounting-related, and provided a corresponding description of the relevant news. Thus, any failure on Defendants’ part to comprehend why particular dates were identified as relevant by Dr. Hakala does not signify any shortcoming in Dr. Hakala’s report or analysis.

    276

    [38] Defendants’ assertion that Dr. Hakala “ignored” CSFB’s AOL reports is incorrect. Dr. Hakala “specifically considered each CSFB report in the context of when it was issued and what it said (such as whether there was a material change in revenue or EBITDA forecasts not already factored in by the news, whether the opinions significantly altered CSFB’s prior opinions, and whether and to what extent there was confounding information).” (Damages Rebuttal Rpt. ¶ 16.)

    277

    [39] See cases cited infra note 46 and accompanying text.

    278

    [40] See also Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173 (2d Cir. 2005) (ruling that loss causation may be proven through “materialization of the risk”); In re Enron Corp. Sec., Derivative and ERISA Litig., No. MDL-1446, 2005 WL 3504860, at *16 (S.D. Tex. Dec. 22, 2005) (“[B]esides a formal corrective disclosure by a defendant . . . the market may learn of possible fraud from a number of sources [such as] whistleblowers, analysts’ questioning financial results, resignations of CFOs or auditors, announcements by the company of changes in accounting treatment going forward, newspapers and journals, etc.”).

    279

    [41] In support of their argument that Dr. Hakala’s treatment of confounding events renders his analysis unreliable, Defendants cite to the Omnicom court’s ultimate grant of summary judgment based, in part, on the fact that Dr. Hakala’s analysis in that case did not disaggregate any impact attributable to the “negative tone” of certain articles from the impact of the partial revelations of the truth contained in those same articles. In re Omnicom Group, Inc. Sec. Litig., 541 F. Supp. 2d 546, 553 (S.D.N.Y 2008). That decision is currently on appeal to the Second Circuit but in any event, is distinct from the present matter because unlike in Omnicom, here Dr. Hakala has disaggregated the impact of potentially confounding events by applying weights to reflect the impact of multiple news items and/or CSFB’s impact as distinct from that of all other speakers. See id. at 553 (“While plaintiffs need not quantify the fraud-related loss, they must ‘ascribe some rough proportion of the whole loss to [the alleged] misstatements.’”) Hence, Dr. Hakala’s anlysis here satisfies the standard articulated in Omnicom.

    280

    [42] As the Ninth Circuit has explained, “as long as the misrepresentation is one substantial cause of the investment’s decline in value, other contributing forces will not bar recovery under the loss causation requirement but will play a role in determining recoverable damages.” In re Daou Sys., Inc., 411 F.3d at 1025; see also Robbins v. Koger Props., Inc., 116 F.3d 1441, 1447 (11th Cir. 1997) (“Because market responses, such as stock downturns, are often the result of many different, complex, and often unknowable factors, the plaintiff need not show that the defendant's act was the sole and exclusive cause of the injury he has suffered; he need only show that it was ‘substantial’, i.e., a significant contributing cause.”)

    281

    [43] Dr. Hakala determined whether analyst reports were positive, negative or neutral based on the objective criteria of whether they contained material changes in the price targets, buy/sell recommendations or earnings forecasts. (Hakala 2008 Dep. Tr. 202:18-204:3.)

    282

    [44] Defendants suggest that Dr. Hakala’s determinations of whether particular events were confounded by multiple pieces of news or analyst reports are too subjective, pointing to his inclusion in his damages analysis of October 17, 2001, which he testified was “partially confounded,” as a supposed example of this flaw. (Defs.’ Mem. 10.) On October 17, 2001, AOL released third quarter 2001 earnings, and Merrill Lynch downgraded AOL from “buy” to “neutral” based on AOL’s disappointing ad revenue performance. Dr. Hakala explained that he included the date as a relevant analyst disclosure because the “news reports clearly attributed the decline in AOL’s share price to the Merrill Lynch report and not the earlier earnings release, (which was viewed as expected and neutral in its impact)[.]” Thus, Dr. Hakala’s inclusion of October 17, 2001 was clearly not based on any supposedly “subjective” beliefs about confounding events, but rather, on what the press reported as being the more significant item.

    283

    Moreover, as with other such events, Dr. Hakala only included a small proportion, 13.41%, of the total impact of the day’s news in his damages analysis.

    284

    [45] See also In re Motorola Sec. Litig., 505 F. Supp. 2d 501, 544 (N.D. Ill. 2007) (rejecting defendants’ arguments that the alleged curative disclosures were too vague because “[d]efendants’ proposed rule would provide an expedient mechanism for wrongdoers to avoid securities fraud liability.”); Freeland v. Iridium World Commc’n, Ltd., 233 F.R.D. 40, 47 (D.D.C. 2006) (following precedents rejecting an interpretation of Dura which “would allow wrongdoers to immunize themselves with a protracted series of partial disclosures.”); In re Vivendi Universal, S.A. Sec. Litig., No. 02 Civ. 5571 (RJH), 2009 U.S. Dist. LEXIS 34563, *43 (S.D.N.Y. Apr. 6, 2009) (observing that loss causation “determinations may often rest in part on legal policy considerations[.]”) (internal citations omitted).

    285

    [46] See also Vivendi, 2009 U.S. Dist. LEXIS 34563, at *43 (stating that “stock prices decline in reaction to information released into the market rather than in reaction to the fraudulent statements themselves. When that information was previously concealed from the market by the fraud, we can properly conclude that whatever decline in the stock price was caused by the release of that information was also caused by the fraud.”); Nathenson v. Zonagen, 267 F.3d 400, 419 (5th Cir. 2001) (“We also realize that in certain special circumstances public statements falsely stating information which is important to the value of a company’s stock traded on an efficient market may affect the price of the stock even though the stock’s market price does not soon thereafter change. For example, if the market believes the company will earn $1.00 per share and this belief is reflected in the share price, then the share price may well not change when the company reports that it has indeed earned $1.00 a share even though the report is false in that the company has actually lost money (presumably when that loss is disclosed the share price will fall”). To the extent Defendants’ argument rests on the premise that a different legal standard should be applied to analysts, that position has been discredited. In re Salomon Analyst Metromedia Litig., No. 06-3225-cv, 2008 WL 4426412, at *7 & *9 (2d Cir. Sept. 30, 2008) (ruling that “no heightened test is needed in the case of research analysts” for application of the fraud-on-the-market presumption).

    286

    [47] Indeed, in attacking Dr. Hakala’s analyst proxy analysis, Professor Stulz incredibly suggests that a more accurate damages estimate could be derived using the impact of ten “negative” AOL reports issued by Defendants

    287

    [48] The analyst proxy analysis does not apply to the accounting or layoff claims, for which damages were calculated based solely on the curative disclosures identified in the complaint. (See Damages Rpt. ¶¶ 10-11.)

    288

    [49] Dr. Hakala confirmed his identification of significant analyst statements using a joint t-test, which demonstrated that the identified statements were extremely significant, with a joint t-statistic of 12.28 for all statements and 9.12 for negative analyst statements. (Damages Rpt. ¶¶ 27-28.)

    289

    [50] As discussed supra pp. 26-27, two substantially similar analyst reports were issued by highly respected analysts on September 19, 2001: one by Bear Stearns and the other by CSFB. Thus, Dr. Hakala divided the AOL impact of the positive analyst commentary for that day evenly between the two firms.

    290

    [51] Professor Stulz’s regression analysis measured a significantly higher one-day impact on February 5, 2001 of 3.37%, but a somewhat lower one-day impact on September 19, 2001, of which 1.55% is attributable to CSFB, yielding a slightly higher average CSFB inflationary impact of 2.46%, relative to the 2.35% Dr. Hakala found. (See Rodon Decl. Ex. L, (attaching Exhibit 2 from the June 21, 2007 deposition of Rene M. Stulz).)

    291

    [52] Defendants misrepresent this aspect of the DeMarco ruling, suggesting that the DeMarco court was critical of the sample size of the study of 200 companies, when in fact, the sample size criticism applied to the estimation of maximum inflation, which was limited to three events. DeMarco, 222 F.R.D. at 249; (Defs.’ Mem. 30). Moreover, Defendants erroneously state that the study referenced in DeMarco was of 200 companies over three years, when in fact, it was over two years (1989-1991). DeMarco, 222 F.R.D. at 248.

    292

    [53] Published in Litigation Services Handbook: The Role of the Financial Expert, 2005 Cumulative Supplement, 3d ed., John Wiley & Sons.

    293

    [54] Further, Dr. Marais could hardly be as “expert” in the factual application of Dr. Hakala’s event study as Dr. Hakala is himself. Instead of improperly offering “me too” testimony to bolster the various professional judgments by Dr. Hakala that Defendants’ challenge, Dr. Marais guides the jury concerning the key principles in making their own evaluation of Dr. Hakala’s event study. For example, Defendants criticize Dr. Marais for not opining on whether one step the event study is “replicable” based on a purported percentage of variance in implementation, however, Dr. Marais testified that no artificial percentage of variance can answer the question because the relevant issue is whether that variance translates into a different ultimate outcome for the event study as a whole. (Marais Dep. Tr. 87:2-89:23.) Thus, Dr. Marais appropriately provides the jury with guidance concerning the technically important factors for evaluating Dr. Hakala’s event study, rather than instructing the jury on what its opinion should be, as Defendants implicitly suggest he should have done.

    294

    [55] Although Professor Kraakman testified that he is “[p]robably not” more of an expert than defense counsel on the academic literature pertaining to analysts, he did qualify the statement, adding, “I don't know what your background is and how used you are to reading finance articles[.]” (Kraakman Dep. Tr. 52:5-7.)

    295

    [56] Formally, Professor Kraakman’s report examines four key issues: (i) whether the reports of prominent securities analysts can have a material effect on share prices in an efficient market; (ii) whether, assuming such an effect, there is justification for treating analyst statements differently than issuer statements for purposes of fraud- on-the-market theory; (iii) whether prices in an efficient market react only to new information bearing on share value; and, if so, (iv) whether prices in an efficient market necessarily react to statements by analysts who merely repeat information that is already fully disclosed to the market. (Kraakman Rpt. ¶ 3.)

    296

    [57] In Nieves-Villanueva, cited by Defendants, the expert at issue testified as to “the holdings of various opinions of the Supreme Court of Puerto Rico” and drew legal conclusions that the First Circuit described as “misleading at best.” Nieves-Villanueva v. Soto-Rivera, 133 F.3d 92, 99 (1st Cir. 1997).

    297

    [58] The remaining cases cited by Defendants in support of their argument that Professor Kraakman opines on issues of law are also inapposite. See Pelletier v. Main Street Textiles, LP, 470 F.3d 48, 55 (1st Cir. 2006) (Expert testimony interpreting the meaning of OSHA regulations excluded.); U.S. v. Buchanan, 964 F. Supp. 533, 537 (D. Mass. 1997) (Expert testimony excluded to the extent that it “recounts . . . the standards of conduct that plainly derive directly from the statutes and regulations[.]”); Interfaith Cmty. Org. v. Honeywell Int’l, Inc., 399 F.3d 248, 253-54 (3rd Cir. 2005) (The majority held that determinations under the Resource Conservation Recovery Act are a question of fact, but Defendants cited the concurrence, which argues that these determinations should be reviewed as a mixed question of fact and law. Id. at 268-69.).

    298

    [59] See, e.g., Information Asymmetry, the Internet, and Securities Offerings, 2 J. Small & Emerging Bus. L. 91-99 (1998) (http://ssrn.com/abstract=84489).

    299

    [60] As Professor Black testified, he had intended to use the original financials because he was attempting to show that Defendants’ projections were highly optimistic based on the information they had at the time. (See Black Dep. Tr. 93:4-9, 97:4-7.)

  • 4 In re Exide Technologies

    To understand this case and the importance of valuation in bankruptcy, you need to know 11 U.S.C. 1129(a)(8)/(b)(1).

    This provision contains the key condition under which a judge can accept a bankruptcy plan without the consent of a class of impaired claimants. First, no junior claim can be paid unless all senior claims are paid in full (“absolute priority”). Second, however, senior claims cannot be paid more than in full. The only way to ensure both of these is to value the business and hence the equity of the reorganized business exactly. If it is valued too high, senior claims will get too little. If it is valued too low, junior claims will get too little.

    Not surprisingly, senior claimants always argue for a low valuation of the business, while junior claimants including shareholders argue for a high valuation

    A numerical example

    For example, imagine that the bankrupt company has $50 of senior debt and $50 of junior debt. For simplicity, consider an all-equity reorganization, i.e., a reorganization in which all of the claims to be allocated are equity (the reorganized company will not have any debt).

    If the judge values the business at $50, section 1129 requires that she allocate all the new equity to senior claimants and wipe out juniors and old equity. By contrast, if the judge values the business at $125, section 1129 requires that she allocate $50/$125=40% of the equity to each of the senior and junior groups, and the remaining 20% to the old shareholders.

    1

    303 B.R. 48

    2
    In re EXIDE TECHNOLOGIES, et al.[1], Debtors.
    3

    No. 02-11125 (KJC).

    4

    United States District Court, D. Delaware.

    5

    December 30, 2003. 

    6

    [52] Christopher James Lhulier, James E. O'Neill, Kathleen Marshall DePhillips, Laura Davis Jones, Pachulski, Stang, Ziehl, Young & Jones, PC, Wilmington, DE, Matthew N. Kleiman, Yosef Riemer, Craig Primis, and Tim Elliott, Kirkland & Ellis, LLP, Chicago, IL, for Debtors.

    7

    Frederick B. Rosner, Jaspen Schlesinger Hoffman, Wilmington, DE, Itai David Tsur, Dechert LLP, New York City, for Trustee.

    8
    OPINION ON CONFIRMATION[2]
    9
    KEVIN J. CAREY, Bankruptcy Judge.
    10

    The Debtor asks that this Court confirm its Fourth Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the "Plan").[3] Objections to the Plan have been filed by various parties, including, the Official Committee of Unsecured Creditors, Smith Management, LLC, HSBC Bank USA as Indenture Trustee, Enersys, Inc., and others. The hearing to consider confirmation of the Debtor's Plan was held on October 21, 22, 25, 27, and November 1, 6, and 12, 2003. For the reasons set forth below, I conclude that the Debtor's Plan cannot be confirmed in its present form.

    11
    BACKGROUND
    12
    1. The Bankruptcy Filing.
    13

    On April 15, 2002 (the "Petition Date"), Exide Technologies, f/k/a Exide Corporation, Exide Delaware, L.L.C., Exide Illinois and RBD Liquidation, L.L.C. (the "Original Debtors") filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code. On November 21, 2002, Dixie Metals Company and Refined Metals Corporation (the "Additional Debtors") also filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code. An order consolidating the cases for the Original Debtors and the Additional Debtors (collectively, the "Chapter 11 Cases") was entered by the Court on November 29, 2002. The Debtor continues in possession of its properties and is operating and managing its businesses as a debtor and debtor in possession pursuant to §§ 1107(a) and 1108 of the Bankruptcy Code.

    14

    On April 29, 2002, the United States Trustee appointed the Official Committee of Unsecured Creditors (the "Creditors Committee"). On September 23, 2002, the [53] Court entered an order appointing the Official Committee of Equity Security Holders of Exide Technologies (the "Equity Committee").[4]

    15
    2. Summary of the Debtor's Business.[5]
    16

    The Debtor manufactures and supplies lead acid batteries for transportation and industrial applications worldwide, with operations in Europe, North America and Asia. The Debtor's operations outside the United States are not included in the chapter 11 proceedings. The Debtor's transportation segment represented approximately 63% of its business in fiscal year 2003. Transportation batteries include starting, lighting and ignition batteries for cars, trucks, off-road vehicles, agricultural and construction vehicles, motorcycles, recreational vehicles, boats, and other applications. In North America, Exide is the second largest manufacturer of transportation batteries. In Europe, Exide is the largest manufacturer of transportation batteries.

    17

    The Debtor's industrial business consists of two segments: motive power and network power. Sales of motive power batteries represented approximately 20% of the company's net sales for fiscal year 2003. Exide is a market leader in this segment of the worldwide industrial battery market. The largest application for motive power batteries is the materials handling industry, including forklifts, electric counter balance trucks, pedestrian pallet trucks, low level order pickers, turret trucks, tow tractors, reach trucks and very narrow aisle trucks.

    18

    Sales of network power batteries represented approximately 17% of the company's net sales for fiscal year 2003. Network power (also known as standby or stationary) batteries are used for back-up power application to ensure continuous power supply in case of main (primary) power failure.

    19

    On September 29, 2000, the Debtor acquired GNB Technologies, Inc. ("GNB"), a U.S. and Pacific Rim manufacturer of both industrial and transportation batteries, from Pacific Dunlop Limited.

    20
    3. Prepetition and DIP Lending.
    21

    On the Petition Date, the Debtor and certain lenders (the "DIP Lenders") entered into the Secured Super Priority Debtor in Possession Credit Agreement (the "DIP Agreement"). Also on the Petition Date, the Debtor, its foreign non-debtor affiliates and the Prepetition Lenders[6] executed the Standstill Agreement and Fifth Amendment to the Credit Agreement (the "Standstill Agreement"), in which the Prepetition Lenders agreed to forbear from exercising any of their rights and remedies relating to defaults under the prepetition credit agreement against [54] the Debtor's non-debtor affiliates until December 18, 2003.[7] The Standstill Agreement contains a cross-default provision, which provides that a default under the DIP Agreement also constitutes a default under the Standstill Agreement. On April 17, 2002, the Court approved the DIP Agreement on an interim basis, and by Order dated May 10, 2002, the DIP Agreement was approved on a final basis (the "Final DIP Order").[8]

    22
    4. The Creditors Committee's Adversary Proceeding.
    23

    In the Final DIP Order, the Debtor agreed with the Prepetition Lenders not to investigate the conduct or claims of the Prepetition Lenders and waived any claims it might have against the Prepetition Lenders. Thereafter, the Creditors Committee negotiated for and obtained the right to pursue investigations of and causes of action against the Prepetition Lenders as part of the Final DIP Order. After conducting its own investigation and analysis, the Creditors Committee took the position that the estate had significant causes of action against the Prepetition Lenders and, on January 16, 2003, the Creditors Committee commenced a suit against the Prepetition Lenders in the adversary proceeding styled Official Committee of Unsecured Creditors, et al v. Credit Suisse First Boston et al. (No. 03-50134-KJC)(the "Adversary Proceeding").[9] The Adversary Proceeding alleges that, in financing the Debtor's purchase of GNB in 2000, the Prepetition Lenders were able to obtain significant control over the Debtor, enabling the Prepetition Lenders to force the Debtor to provide them with additional collateral and to control the Debtor's bankruptcy filing. The Adversary Proceeding complaint included counts to recharacterize part of the Prepetition Credit Facility as an equity contribution, to equitably subordinate the Prepetition Credit Facility Claims to the payment of general unsecured claims, to avoid certain transfers from the Debtor to the Prepetition Lenders as insider preference payments and/or as fraudulent transfers, to find that the Prepetition Lenders aided and abetted the Debtor's breach of its fiduciary duties to the Debtor's unsecured creditors, and for deepening insolvency.

    24

    On February 27, 2003, the Prepetition Lenders filed a motion to dismiss the Adversary Proceeding. By this Court's Order and Memorandum dated August 21, 2003, the motion to dismiss was granted, in part, and denied, in part, so that R2 was dismissed as a party plaintiff and Count I (Recharacterization) and Count XVIII (objection to the Prepetition Lenders' claims under § 502) were dismissed.[10] Other [55] Counts were dismissed with leave to amend and the Creditors Committee filed an amended complaint on September 4, 2003 (the "Amended Complaint").[11] Discovery was limited during the pendency of the Prepetition Lenders' motion to dismiss and, although intense discovery activity took place prior to the confirmation hearing, the Creditors Committee argues that yet more discovery is necessary in connection with claims raised in the Adversary Proceeding.

    25
    5. The Debtor's Plan.
    26

    On September 8, 2003, the Debtor filed the Second Amended Disclosure Statement for the Debtor's Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the "Disclosure Statement") and the Third Amended Plan. On September 10, 2003, this Court entered the Order (A) Approving the Debtor's Disclosure Statement; (B) Scheduling a Hearing to Confirm the Plan; (C) Establishing A Deadline for Objecting to the Debtor's Plan; (D) Approving Form of Ballots, Voting Deadline and Solicitation Procedures; and (E) Approving Form and Manner of Notices (the "Disclosure Statement Order"). The Disclosure Statement Order, among other things, approved the Disclosure Statement and authorized the Debtor to solicit acceptances of the Plan.

    27

    The Plan summarized its classification and treatment of claims and equity interests as follows:

    28

    Summary of Classification and Treatment of Claims and Equity Interests: Exide[12]

    29
     
    30
    Class
    Claim
    Status
    Voting Right
    P1
    Other Priority Claims       
    Unimpaired
    Deemed to Accept
    P2
    Other Secured Claims
    Unimpaired
    Deemed to Accept
    P3
    Prepetition Credit Facility Claims
    Impaired
    Entitled to vote
    P4  
    General Unsecured Claims
    Impaired
    Entitled to vote
    P5   
    2.9% Convertible Note Claims
    Impaired
    Deemed to reject
    P6
    Equity Interests
    Impaired
    Deemed to reject
    31

     

    32

    Summary of Classification and Treatment [56] of Claims and Equity Interests: Subsidiary Debtor[13]

    33
     
    34
    Class
    Claim
    Status
    Voting Right
    S1
    Other Priority Claims
    Unimpaired
    Deemed to Accept
    S2
    Other Secured Claims
    Unimpaired
    Deemed to Accept
    S3
    Prepetition Credit Facility Claims
    Impaired
    Entitled to vote
    S4
    General Unsecured Claims
    Impaired
    Deemed to Reject
    P5
    Equity Interests
    Impaired
    Deemed to reject
    35

    See Plan, Section III.A.1.

    36

    The Plan provides holders of Prepetition Credit Facility Claims with two options for treatment. Prepetition Lenders who select "Election A" receive a combination of a Pro Rata share of New Exide Preferred Stock and a Pro Rata distribution in cash, all calculated as described more in Section III.B.3 of the Plan. Prepetition Lenders who select "Election B" receive a Pro Rata share of the "Class P3 Election B Distribution," which includes New Exide Preferred Stock as calculated and as described more fully in Section III.B.3 of the Plan. Each election provides for different treatment of the Prepetition Lenders' Prepetition Foreign Secured Claims (i.e., prepetition credit facility claims as to which any of the "Foreign Subsidiary Borrowers" are obligors).

    37

    The Plan also splits Exide's General Unsecured Claims (Class P-4) into two subclasses for purposes of distribution.[14] Class P4-A consists of Non-Noteholder General Unsecured Claims and Class P4-B consists of 10% Senior Note Claims.[15] The Plan provides that Class P4-A, the General Unsecured Claims, will receive a Pro Rata distribution of the Class P4-A Cash Pool. The Class P4-A Cash Pool consists of cash in the amount of $4.4 million. The Debtor projects claims in this class to be in the approximate amount of $322.5 million, resulting in a projected recovery of 1.4%.[16] See Disclosure Statement, p. 4. The Plan provides that Class P4-B, the 10% Senior Noteholders, will receive, in part, a Pro Rata distribution of New Exide Common Stock. There are approximately $300 million in claims in Class P4-B, and the Debtor values the common stock distribution in the amount of $4.1 million, so that the subclasses of Class P-4 are to receive an equivalent recovery of 1.4% of their claims. See Disclosure Statement, pp. 4-6.

    38
    6. Objections to the Plan.
    39

    The Debtor received more than twenty-five responses and objections to the Plan. [57] At the hearing on November 6, 2003, the Debtor presented the Court with a report describing which objections were withdrawn, resolved or still pending. At this time, the objections that remain are those filed by the United States Trustee, Enersys, Inc., Bank of New York, the Official Committee of Unsecured Creditors, Smith Management, LLC, HSBC Bank USA as Indenture Trustee, the Official Committee of Equity Security Holders, and the United States Environmental Protection Agency (to the extent it supports the Creditors Committee's position arguing that the proposed "settlement" payment being offered to unsecured creditors is unfair).[17]

    40
    7. Plan Voting.
    41

    On November 20, 2003, the Amended Declaration Of Voting Agent Regarding Tabulation of Votes In Connection with Debtor's Third Amended Joint Plan Of Reorganization Under Chapter 11 of the Bankruptcy Code (the "Plan Voting Report") was filed. The Plan Voting Report showed that more than 90% in number and amount of the votes received by the Prepetition Credit Facility Claims (Class P3/S3) voted in favor of the Plan, while 71.82% in number and 96.14% in claim amount of the aggregate General Unsecured Claims (Class P4) voted against the Plan. The voting is summarized as follows:

    42
     
    43
    Impaired Class and Description     
    # votes 
    counted
    # and % 
    accept
    # and % 
    reject 
    amount and 
    % accepting
    amount and 
    % rejecting
    Class P3/S3 Prepetition Credit Facility Claims
    54
    51  
    (94.44%)   
     3 
    (5.56%)
    $602,549,235 
    (97.70%) 
    $14,189,921.11
    (2.30%)
    Class P4 General Unsecured Claims, Aggregate
    [18]
    2179
    614
    (28.18%)
    1565
    (71.82%)
    $18,744,534.77
    (3.86%)   
    $466,759.34
    (96.14%)
    [19]
    Class P4-A General Unsecured Claims
    [20]
    1612
    467
    (28.97%)   
    1145
    (71.03%)
    $9,822,205.77
    (2.26%)
    $424,636,302.34
    (97.74%)
    Class P4-B General Unsecured Claims
    [21]
    567
    147
    (25.93%)
    420
    (74.07%)
    $8,922,329.00
    (17.48%)
    $42,123,000.00
    (82.52%)
    44

    The Voting Report clearly shows that Class P3 (Prepetition Credit Facility Claims) voted overwhelmingly in favor of the Plan, while Class P4 (General Unsecured [58] Claims) voted overwhelmingly against the Plan (regardless of how General Unsecured Claims are grouped).

    45
    DISCUSSION
    46
    1. Plan Confirmation Requirements and Remaining Objections.
    47

    The requirements for confirmation are set forth in § 1129 of the Bankruptcy Code. The plan proponent bears the burden of establishing the plan's compliance with each of the requirements set forth in § 1129(a), while the objecting parties bear the burden of producing evidence to support their objections. Matter of Genesis Health Ventures, Inc., 266 B.R. 591, 598-99 (Bankr.D.Del.2001); Matter of Greate Bay Hotel & Casino, Inc., 251 B.R. 213, 221 (Bankr.D.N.J.2000) (citations omitted). In a case such as this one, in which an impaired class does not vote to accept the plan, the plan proponent must also show that the plan meets the additional requirements of § 1129(b), including the requirements that the plan does not unfairly discriminate against dissenting classes and the treatment of the dissenting classes is fair and equitable. Id.

    48

    The chief issues raised in the remaining objections to the Debtor's Plan include the following:

    49

    (i) whether the Plan was proposed by self-interested management for the purpose of maximizing value and benefits to the Prepetition Lenders, who, it is alleged, will receive in excess of the full value of their claims, at the expense of the unsecured creditors, thereby violating § 1129(a)(3), (b)(1) and (b)(2);

    (ii) whether the Plan's proposed settlement of the Creditors Committee's Adversary Proceeding fails to comply with the applicable provisions of the Bankruptcy Code and was not proposed in good faith, thereby violating § 1129(a)(1), (a)(3), (b)(1) and (b)(2);

    (iii) whether the proposed post-confirmation release and injunction provisions in the Plan violate applicable bankruptcy law, thereby violating § 1129(a)(2); and

    (iv) whether the Plan discriminates unfairly in its treatment of unsecured creditors, thereby violating § 1129(a)(2) and 1129(b)(1) and (b)(2).

    50

    Because the parties' competing views of Exide's enterprise value permeate all of these issues, I first consider valuation.

    51
    2. The Debtor's Enterprise Valuation.
    52

    The Debtor and the Creditors Committee each offered their own expert to testify about the Debtor's enterprise value. The Debtor presented the expert testimony and valuation analysis of Arthur B. Newman ("Newman"), a senior managing director and founding partner of the Restructuring and Reorganization Group of The Blackstone Group, L.P. ("Blackstone"), who has over 38 years of experience in the merger and acquisitions market for restructuring companies. The Creditors Committee presented the expert testimony and analysis of William Q. Derrough ("Derrough"), a managing director and co-head of the Recapitalization and Restructuring Group of Jefferies & Company, Inc. ("Jefferies"), who also was qualified as an expert based upon his experience in numerous restructuring, financings, and merger and acquisition transactions.[22]

    53

    [59] Both experts used the same three methods to determine the Debtor's value: (i) comparable company analysis; (ii) comparable transaction analysis; and (iii) discounted cash flow. However, the end results of their valuations were far from similar. Newman, the Debtor's expert, set the Debtor's value in a range between $950 million and $1.050 billion, while Derrough, the Creditors Committee's expert, set the value in a range between $1.478 billion and $1.711 billion.[23] It becomes necessary, therefore, to delve deeper in the parties' respective approaches to valuation, so that the court may make its own determination.

    54

    The Debtor argues that its expert used a "market-based approach" to valuation that determines value on a going concern basis by analyzing the price that could be realized for a debtor's assets in a realistic framework, assuming a willing seller and a willing buyer. Travellers Int'l AG v. Trans World Airlines, Inc. (In re Trans World Airlines, Inc.), 134 F.3d 188, 193-94 (3d Cir.1998). The Debtor claims that Newman's application of the valuation methods in this case "reflects the manner in which he believes real world purchasers will view the Company." Debtor's Post-Trial Brief in Support of Confirmation (Docket # 3092), p. 3-4. The Debtor also argues that Newman's value is confirmed by the "private equity process" conducted by the Debtor during the chapter 11 case, during which offers were solicited from potential purchasers, including private equity firms and one strategic buyer. The Debtor claims that the process fixed the total enterprise value of the Debtor in a range of $782 million and $950 million. See The Newman Report, pp. 6, 17-18.[24]

    55

    [60] The Creditors Committee, on the other hand, argues that the most accurate way to determine the enterprise value of a debtor corporation is by the straight-forward application of the three standard valuation methodologies. To support its position, the Creditors Committee presented expert testimony of Professor Edith Hotchkiss ("Hotchkiss"), a professor of finance at Boston College who, in addition to teaching the topic of how to value companies, has performed research and written articles specifically related to valuation of companies in bankruptcy.[25] Hotchkiss agreed with the Creditors Committee's argument in favor of objective application of the valuation methods, and opined that although determining the "inputs" for the methods of valuation tends to involve some subjectivity (e.g., choosing the comparable companies or transactions), the mechanics of the calculating value based upon standard methods should not. Tr. 10/25/03, pp. 120-21. Hotchkiss noted that, in this case, the input information chosen by the experts was not significantly different; what caused the variance was that Newman made a subjective determination to reduce further the multiples determined from the input information prior to applying the valuation formula. Tr. 10/25/03, pp. 121-25.

    56

    The Creditors Committee argues, too, that Hotchkiss' research also supports its argument that the Debtor has undervalued the company. In her research, Hotchkiss compared the value of chapter 11 debtor companies prior to confirmation, which she determined by applying the valuation methods to the cash flows in the Debtor's disclosure statements, to the market price of the debtor companies after exiting chapter 11. Tr. 10/25/03, p. 113. Her research showed that, in some cases, the debtors' disclosure statement cash flows were significantly overvaluing or undervaluing the debtors and, from those findings, she extrapolated certain factors that tended to predict when debtors were being overvalued or undervalued. Tr. 10/25/03, pp. 115-16. She noted that plans providing management and/or senior creditors with the majority of stock or options in the reorganized company (as in the Debtor's Plan) is a strong indicator that the company is being undervalued, resulting in a windfall for management and the senior creditors.[26] Tr. 10/25/03, p. 116-17.

    57

    A determination of the Debtor's value directly impacts the issues of whether the [61] proposed plan is "fair and equitable," as required by 11 U.S.C. § 1129(b). Section 1129(b)(2) sets forth the "absolute priority rule," applicable to unsecured creditors, which provides that a plan may be confirmed despite rejection by a class of unsecured creditors if the plan does not offer a junior claimant any property before each unsecured claims receives full satisfaction of its allowed claim. 11 U.S.C. § 1129(b)(2)(B)(ii); Genesis Health Ventures, 266 B.R. at 612. Courts have decided that "a corollary of the absolute priority rule is that a senior class cannot receive more than full compensation for its claims." Id. citing In re MCorp Financial, Inc., 137 B.R. 219, 225 (Bankr.S.D.Tex.1992). The Creditors Committee argues that the Debtor's expert has undervalued the company and that the Plan will result in paying the Prepetition Lenders more than 100% of their claims to the detriment of the unsecured creditors. The Debtor, on the other hand, argues that the Creditors Committee's expert has overvalued the company and that the Plan is fair and equitable in its treatment of unsecured creditors. The following is a detailed review of the competing experts' valuation reports, keeping in mind each side's incentive to either overvalue or undervalue the Debtor.

    58
    A. Comparable Company Analysis.
    59

    The key components of a comparable company analysis are the Debtor's EBITDA (i.e., earnings before interest, taxes, depreciation and amortization) and the selection of an appropriate multiple to apply to the EBITDA to arrive at enterprise value. The appropriate multiple is determined by comparing the enterprise value of comparable publicly traded companies to their trailing twelve months EBITDA.[27] A subjective assessment is required to select the comparable companies and, here, the parties argue about which comparable companies are more appropriate to use.

    60

    However, as pointed out by the Creditors Committee, regardless of the comparables used, both experts arrived at similar EBITDA multiples, with Newman at 7.2x and Derrough at 7.7x. However, Newman then reduced his multiple to a range between 5.0x and 6.0x, because he determined that his comparable for the Debtor's industrial division (C & D Technologies) should be given less weight. The Debtor also argues that Newman's reduced multiple is more in line with the implied EBITDA multiples that can be derived from the Debtor's private equity process. See, Newman Report, p. 18.

    61

    The experts significantly differed on their choice of the data to use for the Debtor's EBITDAR.[28] Newman used the EBITDAR for the twelve months ending June 30, 2003, ($179.4 million) as set forth in the Debtor's revised five-year plan prepared in October 2003 (Ex. D-18) Newman explained that using the "historical" EBITDAR is appropriate in this case since it is the latest date for which actual EBITDAR is available for both the Debtor and the comparable companies. Derrough, however, used the EBITDAR based on projected earnings for the trailing twelve months ending December 31, 2003 ($196 million). Derrough's figure is based upon the Debtor's business plan that was prepared in December 2002 because he did not have access to the revised October 2003 business plan.

    62

    [62] Hotchkiss testified that a comparable company analysis for companies emerging from chapter 11 should use the first year's projected EBITDAR because the historical EBITDAR does not reflect any of the benefits from the debtor's restructuring. (Tr. 10/25/03, p. 125), which results in understating value. Id. Derrough's use of the December 31, 2003 figure uses half historical and half projected EBITDAR, so it is an arguably more conservative approach than that suggested by Hotchkiss. Tr. 10/25/03, p. 128.

    63

    In determining the Debtor's value for purposes of deciding whether the Debtor's Plan is fair and equitable, it is appropriate to include the benefit of the Debtor's restructuring. Part of the purpose of this exercise is to determine whether the Debtor's intent to give common stock to the Prepetition Lenders results in paying the Prepetition Lender more than 100% of the value of their claims. This requires a forward-looking valuation and I conclude that it is appropriate to use projected, rather than historic, EBITDAR.[29] Because the Debtor has revised its projections, the most appropriate EBITDAR to use would be for the trailing twelve months ending December 31, 2003 as set forth in the October 2003 business plan ($188.2 million).

    64

    Based on the foregoing comparable company analyses, Newman determined that the Debtor's enterprise value was a range between $897 million to $1.076 billion, while Derrough determined that the Debtor's enterprise value was $1.515 billion.[30] However, because I find that it is appropriate to calculate value based upon the EBITDAR for the trailing twelve months ending December 31, 2003 ($188.2 million), and the appropriate multiple is between 7.2 (the multiple calculated by Newman before subjectively reducing it) and 7.7x (Derrough's multiple), the comparable company value should be in the range between $1.355 billion (using 7.2x) and $1.449 billion (using 7.7x).

    65
    B. Comparable Transaction Analysis.
    66

    The comparable transaction analysis is similar to the comparable company analysis in that an EBITDA multiple is determined from recent merger and acquisition transactions in the automotive and industrial battery industries and that multiple is then applied to the appropriate trailing twelve months of the Debtor. Newman calculated multiples for two transactions that took place in 2002 (6.0x and 7.2x) and set his multiple in a range of 5.5x to 6.0x, after adjusting the comparable transaction [63] multiples due to his knowledge of the companies involved in the 2002 transactions and his opinion that a similar strategic acquisition was not likely for the Debtor because of antitrust concerns. See The Newman Report, pp. 11, 26. Derrough, on the other hand, looked at more than a dozen merger and acquisition transactions occurring between May 1998 and November 2002 to derive an EBITDA multiple of 7.0x. However, Derrough's "comparable transactions" for 1998 and 1999 probably are not useful in this matter since the experts agreed that the market had changed considerably since 2000. (See Tr. 10/22/03, pp. 234-35 (Newman); Tr. 10/25/03, pp. 138-39 (Hotchkiss); Tr. 10/25/03, pp. 308-09 (Derrough)).

    67

    Therefore, for the reasons discussed above regarding the comparable company analysis, a straightforward application of the multiple derived from Newman's comparable transactions before his adjustment should be applied here. The Committee argues that a proper weighting of the multiples derived from Newman's 2002 transactions would result in a multiple of approximately 6.4x. See Creditors Committee Post-trial Brief, p. 15.

    68

    As in the comparable company analysis, Newman then applied his multiple to the Debtor's revised latest twelve months ending June 30, 2003 ($179.4 million), while Derrough applied his multiple to the Debtor's trailing twelve months ending December 31, 2003 ($196 million) as set forth in the December 2002 five-year plan. Also, for the reasons discussed in the comparable company analysis above, I have concluded that the trailing twelve months ending December 31, 2003, as updated in October 2003 plan, should be used ($188.2 million). Applying the 6.4x EBITDA multiple to the trailing twelve months ending December 31, 2003 results in a valuation of $1.204 billion.

    69
    C. Discounted Cash Flow.
    70

    The experts' valuations based on a discounted cash flow analysis differed greatly, with Newman calculating value in a range between $1.023 and $1.254 billion and Derrough calculating value in a range between $1.583 and 1.837 billion. Derrough applied the discounted cash flow analysis in a straight-forward manner (see Tr. 10/25/03, pp. 135-36 (Hotchkiss)), while Newman adjusted his formula based upon his "market-based approach" to valuation to account for the manner in which he believed prospective purchasers would view the Debtor.

    71

    The discounted cash flow ("DCF") analysis has been described as a "forward-looking" method that "measure[s] value by forecasting a firms' ability to generate cash." Pantaleo, supra. n. 29, at 427. DCF is calculated by adding together (i) the present value of the company's projected distributable cash flows (i.e., cash flows available to all investors) during the forecast period, and (ii) the present value of the company's terminal value (i.e., value of the firm at the end of the forecast period). In this case, the experts relied on the Debtor's projected cash flows for the fiscal years ending March 31, 2004 through March 31, 2008, as set forth in the Debtor's five-year business plans.[31] The DCF factors which the parties dispute are (1) the discount rate; and (2) the multiple used to calculate terminal value. See, generally, 7 COLLIER ON BANKRUPTCY ¶ 1129.06[2][a][ii] (15th ed. rev.2003).

    72

    Newman used a discount rate in the range of 15% to 17%, while Derrough used [64] a discount rate in the range of 10.5% and 11.5%. Both experts relied on a weighted average cost of capital (the "WACC") to determine the discount rate, which is based upon a combined rate of the cost of debt capital and the cost of equity capital. In determining the cost of equity, Derrough used the generally accepted method known as the capital asset pricing model or "CAPM."[32] Newman, however, chose not to use CAPM because he noted that CAPM can be inaccurate when applied to company that is not publicly traded. Tr. 10/22/03, pp. 236-38. See also Tr. 10/27/03, pp. 86-87 (Pfieffer agreeing). However, in such cases, comparable companies are used to determine the "beta" for a CAPM valuation (see Tr. 10/25/03, pp. 212-13 (Derrough)), but Newman felt that comparable companies are inappropriate in this instance because the Debtor is emerging from chapter 11 and will face substantial risk in executing its five-year projected business plan. See Tr. 10/22/03, pp. 238-39.

    73

    Therefore, Newman determined cost of equity based upon information showing the rate of return on equity that a prospective purchase would demand. Based upon the private equity process (and, the Debtor argues, supported by the testimony of John Craig of Enersys, Inc), Newman used a cost of equity between 20% and 30%; while the standard CAPM method employed by Derrough resulted in a cost of equity between 13.6% and 14.6%.[33]

    74

    Furthermore, in calculating WACC, Newman determined the cost of debt at 7.5%, while Derrough's calculation resulted in a cost of debt at 5.9%. The Debtor's own five-year plan assumes a cost of debt at 6.2%. (Tr. 10/22/03, pp. 322-23).

    75

    Discounted cash flow analysis has been used to determine valuation in many chapter 11 cases. See, e.g., In re Zenith Elecs. Corp., 241 B.R. 92, 103-05 (Bankr.D.Del.1999); and In re Cellular Information Systems, Inc., 171 B.R. 926, 930-37 (Bankr.S.D.N.Y.1994). Newman's numerous subjective adjustments to the analysis stray too far from the generally accepted method of determining the discount rate. Therefore, I will rely on Derrough's more straight forward determination of the discount rate.

    76

    Newman determined the terminal value in his discounted cash flow analysis by [65] using the same adjusted EBITDA multiple as used in his comparable company analysis (i.e., 5.0x to 6.0x). Derrough, however, used the actual multiple which he derived from his comparable company analysis. Again, Newman's terminal value multiple was adjusted, causing his calculation to depart from the standard discounted cash flow methodology.

    77

    The Debtor argues that in the final determination of enterprise value, Derrough accorded too much weight to his DCF analysis. Derrough elected to attribute 60% of his total valuation to his DCF analysis. The Debtor argues that a DCF analysis is dependent on a company's ability to meet long-range projections, in this case the Debtor's FY 2008 projections. Because the long-range projections are the most speculative and uncertain, and because testimony of the Debtor's officers showed that the Debtor's past and current performance has not met the projections in its business plans (see Tr. 10/21/03, pp. 218-19 (Donahue); Tr. 11/1/03, p. 126 (Muhlhauser)), the Debtor argues that Derrough's strong reliance on his DCF is misplaced.

    78

    Courts often rely upon DCF analyses in valuing reorganizing debtors. I conclude that it is appropriate to consider DCF when determining such value and no less weight should be accorded to DCF because it relies upon projections. When other helpful valuation analyses are available, as in this case, each method should be weighed and then all methods should be considered together.

    79
    D. Valuation Summary.
    80

    There are many approaches to valuation, but value "gathers its meaning in a particular situation from the purpose for which a valuation is being made." 7 COLLIER ON BANKRUPTCY § 1129.06[2], at 1129-154 (15th ed. rev.2003) quoting Group of Institutional Investors v. Chicago, Milwaukee, St. Paul & Pacific R.R. Co., 318 U.S. 523, 540, 63 S.Ct. 727, 738, 87 L.Ed. 959, 994 (1943). The Supreme Court has held that a reorganized debtor's value should be based upon earning capacity. Consolidated Rock Products Co. v. Du Bois, 312 U.S. 510, 526, 61 S.Ct. 675, 685, 85 L.Ed. 982 (1941)("The criterion of earning capacity is the essential one if the enterprise is to be freed from the heavy hand of past errors, miscalculations or disaster, and if the allocation of securities among the various claimants is to be fair and equitable.") As discussed in a leading treatise, this view was "not a rejection of the market; rather, this reflected a notion that markets undervalued entities in bankruptcy, and that the taint of the proceeding would adversely affect what someone would pay." 7 COLLIER ON BANKRUPTCY § 1129.06[2][a], at 129-155 (15th ed. rev.2003). The Third Circuit Court of Appeals also agreed with this approach, writing:

    81

    That argument [that market value should not be used] has considerable force when the securities in issue represent equity in, or long term interest bearing obligations of, a reorganized debtor. In such cases, the market value of the security will depend upon the investing public's perception of the future prospects of the enterprise. That perception may well be unduly distorted by the recently concluded reorganization and the prospect of lean years for the enterprise in the immediate future. Use of a substitute "reorganization value" may under the circumstances be the only fair means of determining the value of the securities distributed.

    82

    Matter of Penn Central Transportation Co., 596 F.2d 1102, 1115-16 (3d Cir.1979). Collier's notes that "modern finance has caught up with" the Supreme Court's directions in Consolidated Rock by providing [66] courts with valuation methodologies that focus upon earning capacity, such as the comparable company analysis and the discounted cash flow analysis used in this case. 7 COLLIER ON BANKRUPTCY § 1129.06[2][a], at 1129-156 (15th ed. rev.2003); Pantaleo, supra. n. 29, at 420-21.

    83

    The stated purpose for Newman's numerous adjustments to the valuation methodologies were to bring value calculations in line with current market value. This is not appropriate when seeking to value securities of a reorganized debtor since the "taint" of bankruptcy will cause the market to undervalue the securities and future earning capacity of the Debtor. See Penn Central, 596 F.2d at 1115-16. The more appropriate method, in this instance, is a straight forward application of the valuation methodologies to arrive at a better understanding of whether the Debtor's Plan treats creditors fairly and equitably.

    84
    E. Valuation Conclusion.
    85

    The Debtor advocates an enterprise value in the range of $950 million to $1.050 billion; the Creditors Committee advocates a range of $1.5 billion to $1.7 billion. After considering the various methods employed by the experts and their resultant valuations, the competing incentives of the parties to either overvalue or undervalue the company, and the extensive, divergent evidence offered in support of valuation, and consistent with the above analysis of all of these, I determine the Debtor's enterprise value to be in the range of $1.4 billion to $1.6 billion.

    86
    3. Proposed Settlement of the Adversary Proceeding.
    87

    The Creditors Committee and other objecting parties argue that the Debtor's Plan cannot be confirmed because a key element of the Plan is the settlement of the Creditors Committee's Adversary Proceeding by including a broad release of claims related to the Prepetition Credit Facility (see Article X of the Debtor's Plan) in exchange for a distribution to the General Unsecured Creditors in the maximum amount of $8.5 million. The Creditors Committee and Smith Management argue that the proposed settlement (i) was made by the Debtor, who is not a party to the litigation and has no standing or right to settle the litigation; and (ii) falls far below the "range of reasonableness" for settlement of the Adversary Proceeding.

    88

    A plan may include a provision that settles or adjusts any claim belonging to the debtor or the estate. 11 U.S.C. § 1123(b)(3)(A). See also Protective Comm. For Independent Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414, 424, 88 S.Ct. 1157, 1163, 20 L.Ed.2d 1 (1968)("Compromises are `a normal part of the process of reorganization.'") (citations omitted). The unsecured creditors, however, argue that the Debtor does not have standing or authority to control and settle the Adversary Proceeding. The unsecured creditors draw attention to the Stipulation and Consent Order signed by the Debtor, in which it waived all claims against the Prepetition Lenders in exchange for debtor-in-possession financing, and ceded authority to the Creditors Committee and the investors to pursue claims against the Prepetition Lenders. Order (Consent) Approving Stipulation, Docket # 1174 (November 29, 2002). Because the Debtor did not reserve any rights with respect to the claims, the unsecured creditors argue that the Debtor gave up any right to settle, dismiss or participate in the litigation.

    89

    The unsecured creditors also argue that allowing the Debtor to control and settle the Adversary Proceeding directly contravenes the purpose and ruling of the Third [67] Circuit's recent decision Official Comm. of Unsecured Creditors v. Chinery (In re Cybergenics Corp.), 330 F.3d 548 (3d Cir.2003), in which the Court determined that the Bankruptcy Code allowed a creditors committee to bring a derivative avoidance action on behalf of the Debtor's estate.

    90

    The Debtor argues that other courts have determined that a plan may include a proposed settlement that is not the result of arms-length negotiations with the opposing party as long as the proposed settlement is fair and equitable. See Matter of Texas Extrusion, 844 F.2d 1142 (5th Cir.1988)(The Fifth Circuit Court of Appeals decided that the Bankruptcy Court did not abuse its discretion in approving a joint plan filed by a secured creditor and the creditors committee that included a settlement of the debtor's action against the secured creditor); In re BBL Group, Inc., 205 B.R. 625 (Bankr.N.D.Ala.1996)(The court held that the proposed settlement of a state court action between the debtor and secured creditor included in the secured creditor's proposed plan was fair and equitable); Cellular Info. Sys., 171 B.R. 926 (The court held that the secured creditor's plan could include settlement of the debtor's lender liability lawsuit against the secured creditor that was negotiated with the creditors committee and not the debtor); and In re Allegheny Int'l, Inc., 118 B.R. 282 (Bankr.W.D.Pa.1990)(The court determined that the debtor's proposed settlement of an adversary proceeding brought by the creditors committee and equity committee against the secured lenders was fair and equitable and could be approved as part of the debtor's proposed plan; this settlement was the result of negotiations among the debtor, banks, and creditors committee, although objected to by the equity committee).

    91

    After examination of the plain language of § 1123(b)(3)(A) and upon review of the relevant decisional law on the issue, I conclude that § 1123(b)(3)(A) authorizes the Debtor to propose a settlement of the Creditors Committee's Adversary Proceeding in its plan. However, it is the "duty of the Bankruptcy Court to determine that a proposed compromise forming part of a reorganization plan is fair and equitable." Cellular Info. Sys., 171 B.R. at 947-48 quoting TMT Trailer Ferry, 390 U.S. at 424, 88 S.Ct. at 1163. Further, "the Court must reach an `informed, independent judgment' supported by the factual background underlying the litigation and bankruptcy." Allegheny, 118 B.R. at 309 quoting In re Texaco, Inc., 84 B.R. 893, 901 (Bankr.S.D.N.Y.1988).

    92

    The Third Circuit has instructed that the Court should consider four factors in deciding whether to approve a settlement: (1) the probability of success in litigation, (2) the likely difficulties in collection, (3) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; and (4) the paramount interest of the creditors. In re RFE Industries, Inc., 283 F.3d 159, 165 (3d Cir.2002). When considering a settlement in the context of a plan of reorganization, other bankruptcy courts have also applied the following criteria:

    93

    (1) The balance between the likelihood of plaintiff's or defendant's success should the case go to trial vis a vis the concrete present and future benefits held forth by the settlement without the expense and delay of a trial and subsequent appellate procedures.

    (2) The prospect of complex and protracted litigation if the settlement is not approved.

    (3) The proportion of the class members who do not object or who affirmatively support the proposed settlement.

    [68] (4) The competency and experience of counsel who support the settlement.

    (5) The relative benefits to be received by individuals or groups within the class.

    (6) The nature and breadth of releases to be obtained by the directors and officers as a result of a settlement.

    (7) The extent to which the settlement is truly the product of "arms-length" bargaining, and not of fraud or collusion.

    94

    Texaco, 84 B.R. at 902. See also Allegheny, 118 B.R. at 310 (adopting the foregoing Texaco criteria). Upon consideration of the foregoing factors, and for the reasons set forth below, I conclude that the Plan's proposed settlement of the Adversary Proceeding is not fair and equitable to the general unsecured creditors.

    95
    (1) Probability of success on the merits.
    96

    In evaluating this aspect of the proposed settlement, the Court's task is not to "decide the numerous questions of law and fact raised by [objections] but rather to canvass the issues to see whether the settlement fall[s] below the lowest point in the range of reasonableness." In re Neshaminy Office Bldg. Assoc., 62 B.R. 798, 803 (E.D.Pa.1986) quoting In re W.T. Grant Co., 699 F.2d 599, 608 (2d Cir.1983). See also Cellular Info. Sys., 171 B.R. at 950.

    97

    Briefly, the challenged transactions involve the following: In 1997, the Prepetition Lenders established a $650 million credit facility for Exide and its borrowing subsidiaries (the "Exide Group"). In 2000, a further loan of $250 million was used to finance the acquisition of a competitor — GNB. In exchange for the financing, the members of the Exide Group granted additional collateral and guarantees. The effect of the transaction, the plaintiffs allege, was to increase significantly the Prepetition Lenders' control over the Exide Group. After the GNB transaction closed, Exide's financial condition deteriorated rapidly. On or about October 26, 2001, at the direction of the Prepetition Lenders, Exide replaced its chief financial officer with a principal of J.A. & A. Services, LLL, an affiliate of Alix Partners, LLC. Shortly thereafter, the parties amended the loan documents to suspend, temporarily, compliance with certain financial covenants in return for the granting of liens on all of the Exide foreign subsidiaries' assets and capital stock (the "Second Amendment").

    98

    On December 28, 2001, the parties entered into a third amendment to the loan agreement pursuant to which the Prepetition Lenders agreed to forbear for a period of time just days longer than the 90-day preference period (the "Third Amendment"). Additional collateral and guarantees were given by Exide and certain subsidiaries to the Prepetition Lenders just outside of the 90-day non-insider preference period. During the period in which these amendments were being negotiated and executed, it is alleged that the Debtor suffered massive losses and became more insolvent.

    99

    Part of the basic premise of the Amended Complaint is that the Second and Third Amendments were a series of "asset-grabbing" transactions by the Prepetition Lenders on the eve of the Debtor's bankruptcy filing, without providing anything of real value in return, to the detriment of the unsecured creditors. The unsecured creditors allege that these transactions were undertaken at a time when the Debtor was insolvent and planning its inevitable bankruptcy under the insider control of the Prepetition Lenders' agents, Credit Suisse First Boston ("CSFB") and Solomon Smith Barney ("SSB"). The Amended Complaint avers a series of claims that [69] seek to have these transfers avoided and equitably subordinated as preferential and/or fraudulent, under both intentional and constructive fraud theories, and that the conduct constitutes aiding and abetting the breaches of fiduciary duties of Exide's management, and asserts a claim of deepening insolvency.

    100

    I am familiar with the background and the alleged facts underlying the Adversary Proceeding by virtue of my decision on the Prepetition Lenders' motion to dismiss the complaint which I decided by Memorandum and Order dated August 21, 2003. See Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Technologies, Inc.), 299 B.R. 732 (Bankr.D.Del.2003). Prior to that decision, I permitted limited discovery. Since that decision, the parties have resumed discovery. In addition, the Court approved a separate discovery schedule in connection with the Confirmation Hearing. The Creditors Committee argues that the Debtor and Prepetition Lenders have engaged in efforts to delay or preclude the Committee from engaging in any meaningful discovery, such as (i) by "dumping" no fewer than 147 boxes of documents on the Committee between October 1, 2003 (the scheduled date for conclusion of document productions) and October 16, 2003 (more than a week after depositions had begun and less than one week before the start of the Confirmation Hearing), thereby preventing the Committee from any meaningful evaluation of the contents of the boxes; (ii) by withholding important documents under "suspicious claims of privilege;" (iii) by precluding meaningful deposition discovery with witnesses who were unprepared or the wrong designees.

    101

    The Debtor and CSFB presented evidence at the Confirmation Hearing that the Debtor was solvent at the time of the GNB transaction in 2000. (See Expert Report of Keith Bockus, Ex. D-84, and Expert Report of Alan M. Pfeiffer, Ex. B-81). This fact alone, even if true, will not extinguish other claims in the Adversary Proceeding, particularly with respect to the allegations regarding the transfers of collateral pursuant to the Second and Third Amendments. The Debtor also presented the testimony of Lisa Donahue, the Debtor's Chief Restructuring Officer and former Chief Financial Officer at the time of the Second and Third Amendments, to support their position that the Prepetition Lenders did not unduly influence the granting of additional collateral and timing of the Debtor's bankruptcy filing. However, the Creditors Committee challenges Ms. Donahue's testimony regarding the timing of the bankruptcy filing. Even if the Debtor's and the Prepetition Lenders' pre-bankruptcy machinations were not driven entirely by events, the timing of which were beyond their control, the Creditors Committee clearly continues to face numerous hurdles toward proving its allegations. Overall, I conclude that the evidence presented is inconclusive as to the likelihood of the plaintiff's or the defendants' success on the merits of the Adversary Proceeding should it go to trial. Because the Debtor has failed to demonstrate that the Creditors Committee is not likely to succeed at trial, this factor weighs against approval of the settlement.

    102
    (2) The likely difficulties in collection.
    103

    Despite the arguments of the Debtor to the contrary, this factor does not weigh in favor of approving the settlement.[34] First, [70] there was no evidence that any monetary award would be uncollectible; moreover, any money judgment in favor of the Creditors Committee might be setoff against the Prepetition Lenders' secured claim, which is asserted to be in an amount in excess of $700 million. If the Creditors Committee succeeds in its equitable subordination claim, and the relief awarded involved readjusting the priority of the Prepetition Lenders' liens, no collection efforts may be necessary.

    104
    (3) The complexity of the litigation involved and the expense, inconvenience and delay necessarily attending it.
    105

    This factor clearly weights in favor in settlement. There is no doubt that this litigation involves complex issues on a variety of topics that will require costly and time-consuming discovery in addition to a potentially lengthy trial, possibly delaying the Debtor's exit from chapter 11.

    106
    (4) The paramount interest of the creditors.
    107

    The unsecured creditors voted overwhelmingly to reject the Debtor's Plan; this evidences a resounding rejection of the proposed settlement, a key component of the Plan.[35] An important element in many of the cases in which courts approved plan settlements that had not been negotiated with the opposing party is that the settlements were negotiated with and/or supported by the Creditors Committee, while the party opposing settlement was typically the debtor or an equity holder. See Texas Extrusion, 844 F.2d at 1149 (Plan which included proposed settlement was filed jointly by the secured creditor and the Creditors Committee); BBL Group, 205 B.R. at 630 (All creditors voted in favor of the plan); Cellular Info. Sys., 171 B.R. at 947 (Proposed settlement was negotiated with Creditors Committee); and Allegheny Int'l, 118 B.R. at 309 (Proposed settlement had the support of the Creditors Committee). Unsecured creditors are not voluntary investors in the Debtor and their position on the settlement, under these circumstances, is entitled to substantial weight.

    108

    The Creditors Committee argues that its lawsuit potentially could offset the Prepetition Lenders' secured claim in an amount between the high end of $500 million, if it is successful on its argument that the pledge of Exide Holding Europe SA ("EHE") stock was defective, to a minimum amount of $78.6 million, if its success is limited to avoiding the grants of collateral made in connection with the Second and Third Amendments. (See Creditors Committee Post-trial Brief Regarding Settlement of the Adversary Proceeding, Docket # 3098, at 39-41). Even assuming, without deciding, that the Creditors Committee's "high end" projections are overly optimistic, the offer of no more than $8.5 million by the Prepetition Lenders to the unsecured creditors in settlement of this matter is below the lowest range of reasonableness, particularly in light of the enterprise value of the Debtor.[36] Accordingly, [71] this factor weighs heavily against approval of the settlement.

    109

    The only factor that weighs in favor of approving the settlement is the complexity of issues and cost and delay that will likely result from the continuation of the lawsuit. These elements are present in most litigation, do not outweigh the other factors under these circumstances, and do not form a sufficient basis for approval of the settlement proposed in the Debtor's Plan.

    110
    (5) The Texaco Factors.
    111

    Similarly, viewing the Adversary Proceeding in light of the seven factors set forth in Texaco, supra., also supports the conclusion that the proposed settlement should not be approved. Again, the only factor that weighs in favor of settlement is # 2 (the prospect of complex and protracted litigation if the settlement is not approved). With respect to factor # 4 (the competency and experience of counsel who support the settlement), competent and experienced counsel are present on both sides of the issue.

    112

    The remaining Texaco factors weigh against approval. First, the minimal amount offered in settlement does not provide any benefit that outweighs the cost and delay of going forward, especially since it is too early to judge the likelihood of success on the merits. As discussed above, over 71% in number and over 96% in amount of general unsecured claims voted against the Debtor's Plan. The individual general unsecured creditors would not receive much benefit from the proposed settlement since it provides only 1.4% recovery for unsecured creditors. (See Disclosure Statement, pp. 4-6). The nature and breadth of the Plan's releases of the Debtor, its management, and the Prepetition Lenders is not permissible, as discussed infra. Finally, the proposed settlement was not the result of arms-length bargaining with the unsecured creditors, who are the plaintiffs in the action and are directly affected by it. Instead, it is the result of discussions between the Prepetition Lenders and the Debtor only.

    113

    For all of the foregoing reasons, I conclude that the proposed settlement of the Adversary Proceeding is not fair and equitable, not in the paramount interest of creditors, and should not be approved.

    114
    4. The Proposed Release and Injunction Provisions.
    115

    The Creditors Committee, Smith Management and others object to the provisions in Article X of the Debtor's Plan ("Release, Injunctive and Related Provisions"), which release and enjoin various claims and causes of action against the "Releasees," arguing that the provisions (i) violate § 524(e) of the Bankruptcy Code; (ii) include releases of third parties (i.e., the Prepetition Lenders and the Debtor's officers and directors) who have not provided value for the releases, and (iii) are not consensual. The term "Releasees" is defined in Section I.B.131 of the Plan as meaning "the Debtor and their Affiliates, the Reorganized Debtor and each of their Affiliates, the Creditors Committee, the Equity Committee, the Agent, the Option A Electors and all officers, directors, members, employees, attorneys, financial advisors, accountants, investment bankers, agents and representatives of each of the foregoing, whether current or former, in each case in their capacity as such, and only if serving in such capacity on the Initial Petition Date or thereafter."

    116

    In Zenith, Judge Walrath held that, notwithstanding § 524(e), a plan may provide [72] for releases by a Debtor of non-debtor third parties under certain limited circumstances, after consideration of five factors:

    117

    (1) the identity of interest between the debtor and the third party, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete assets of the estate;

    (2) substantial contribution by the non-debtor of assets to the reorganization;

    (3) the essential nature of the injunction to the reorganization to the extent that, without the injunction, there is little likelihood of success;

    (4) an agreement by a substantial majority of creditors to support the injunction, specifically if the impacted class or classes "overwhelmingly" votes to accept the plan; and

    (5) provision in the plan for payment of all or substantially all of the claims of the class or classes affected by the injunction.

    118

    Zenith, 241 B.R. at 110 citing Master Mortgage Inv. Fund, Inc., 168 B.R. 930, 937 (Bankr.W.D.Mo.1994). The Master Mortgage Court recognized that these factors are neither exclusive nor are they a list of conjunctive requirements. Master Mortgage, 168 B.R. at 935. Instead, they are helpful in weighing the equities of the particular case after a fact-specific review. Id.

    119

    On the other hand, non-consensual releases by a non-debtor of other non-debtor third parties are to be granted only in "extraordinary cases." Genesis Health Ventures, 266 B.R. at 608 citing Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 212 (3d Cir.2000). In Continental, the Third Circuit did "not establish a rule regarding conditions under which non-debtor releases and permanent injunctions are appropriate or permissible" (203 F.3d at 214), but determined that the non-consensual release of a non-debtor party in Continental's plan did "not pass muster under even the most flexible tests for the validity of non-debtor releases. The hallmarks of permissible non-consensual releases — fairness, necessity to the reorganization, and specific factual finding to support these conclusion — are all absent here." Id.

    120
    (1) The Release Provisions.
    121

    Article X contains two "release" provisions. First, Article X.B. entitled "Releases by the Debtors," provides for a broad release by the Debtor and the Reorganized Debtor of the Releasees from all claims, causes of action, etc. arising before or after the Effective Date of the Plan relating to or arising from:

    122

    (a) the Prepetition Credit Facility, including but not limited to the negotiation, formulation, preparation, administration, execution, and enforcement thereof, and any payment received by the lenders thereunder, (b) any guaranty arising under the Prepetition Credit Facility, (c) any liens, pledges, or collateral of any kind and (d) any of the other loan documents referred to in the Prepetition Credit Facility or any other documents contemplated thereby or therein or the transactions contemplated thereby or therein or any action taken or omitted to be taken by the Agent under or in connection with any of the foregoing;....

    123

    Debtor's Fourth Amended Joint Plan Of Reorganization, Section X.B.

    124

    Second, Article X.C., entitled "Releases by Holders of Claims" provides for a release by any Holder of a Claim who has accepted the Plan of each "Releasee" from pre-confirmation claims (including derivative claims asserted on behalf of Exide) relating to:

    125

    [73] (t) the purchase or sale...of any security of any Debtor, (u) the Chapter 11 Cases, (v) the negotiation, formulation and preparation of the Plan or any related agreements, instruments or other documents, (w) the Prepetition Credit Facility, including, but not limited to the negotiation, formulation, preparation, administration, execution, and enforcement thereof, and any payments received by such Lenders, (x) any guaranty arising under the Prepetition Credit Facility, (y) any liens, pledges, or collateral of any kind and (z) any of the other loan documents referred to in the Prepetition Credit Facility or any other documents contemplated thereby or therein or the transactions contemplated thereby or therein or any action taken or omitted by the Agent under or in connection with any of the foregoing.

    126

    Debtor's Fourth Amended Joint Plan Of Reorganization, Section X.C.

    127

    The effect of the "Release by Debtors" provision (Section X.B.) would, among other things, bar continuation of the Creditors Committee's Adversary Proceeding, since the majority of those claims are derivative. To determine whether the release is fair, it is appropriate to consider the Zenith factors to determine whether the equities weigh in favor of approval.

    128

    The Debtor, relying on its enterprise valuation, argues that the "Option A Electors" have provided significant value to the reorganization by voluntarily waiving their rights and agreeing to convert their claims — whether secured by domestic or foreign assets — to equity in the Reorganized Debtor. The Debtor's position is that these lenders will receive only a partial recovery of their claims, yet at the same time the lenders have agreed to reallocate assets to establish the fund for general unsecured creditors. Because the Debtor believes that their Plan could not be implemented absent such agreement, they argue that the Option A Electors have satisfied factors (1), (2) and (3) of the Zenith test. The unsecured creditors, however, argue that the Option A Electors have not provided any significant value in exchange for the Release Provision because they will recover more than 100% of their claims and, therefore, factors (2), (4) and (5) weigh against approval of the Release.

    129

    As discussed supra., I have determined that the enterprise value is greater than the amount of the Prepetition Lenders claims. Therefore, the fund set aside for the general unsecured creditors should not be considered a "substantial contribution" of assets by the lenders to unsecured creditors in exchange for the Release. I cannot conclude, therefore, that the Option A Electors' agreement constitutes fair consideration to the unsecured creditors in exchange for the broad Release. The equities do not weigh in favor of approving the inclusion of the Option A Electors in the "Release by Debtors" provision.

    130

    Neither do the equities weigh in favor of including the Debtor's officers, directors, and professionals as part of the Debtor's release. The Zenith Court decided that the officers and directors provided a substantial contribution to the reorganization "by designing and implementing the operational restructuring and negotiating the financial restructuring." Zenith, 241 B.R. at 111. Here, the Debtor cited to testimony of Craig Mulhauser, its CEO, and Lisa Donahue, its Chief Restructuring Officer, to evidence the efforts by the officers and directors to preserve the value of the Debtor and design the restructuring and exit financing. See Debtor's Post-hearing Brief, pp. 109-110. The Release of the officers, directors and others in this case is not limited to post-petition actions, [74] but also includes a release of prepetition conduct.

    131

    In Genesis Health Ventures, the court considered a release of officers and directors that included prepetition conduct. Using the five-part test in Zenith, the Genesis Health Ventures Court rejected the release, finding that (i) the officers' and directors' restructuring efforts, for which they were otherwise compensated, did not satisfy the requirement that they contribute "assets" to the reorganization; and (ii) although the Court understood that the debtor desired to retain current management, there was no evidence that the release was necessary for the success of the reorganization. Genesis Health Ventures, 266 B.R. at 606-07. The Court wrote that "the rationale offered does not support a release of Debtor's management for prepetition conduct." Id. at 607.

    132

    Applying the five-part Zenith test to the Release of the officers, directors and others for prepetition conduct in this case, I conclude that the equities do not weigh in favor of approving a release of their prepetition conduct. While the contributions of the officers, directors and others may be meaningful, especially in a chapter 11 as contentious as this, the majority of unsecured creditors do not support the injunction and the Debtor's Plan provides only for a minimal payment of claims of the class affected by the injunction.[37]

    133

    The "Releases by Holders of Claims" provision applies release both pre- and post-petition claims against the Releasees, but it binds only those creditors and equity holders who accept the terms of the Plan. Because it is consensual, there is no need to consider the Zenith factors.

    134
    (2) The Exculpation Provision.
    135

    Article X contains an "Exculpation" provision that provides as follows:

    136

    The Releasees shall neither have nor incur any liability to any Person or Entity for any pre or post-petition act taken or omitted to be taken in connection with, or related to the formulation, negotiation, preparation, dissemination, implementation, administration, Confirmation or Consummation of the Plan, the Disclosure Statement or any contract, instrument, release or other agreement or document created or entered into in connection with the Plan or any other pre or post-petition act taken or omitted to be taken in connection with or in contemplation of the restructuring of the Debtor, provided, however, that the foregoing provision of this Article X.E shall have no effect on the liability of any Person or Entity that results from any such act or omission that is determined in a Final Order to have constituted gross negligence or willful misconduct.

    137

    Debtor's Fourth Amended Joint Plan of Reorganization, Section X.E. (the "Exculpation Provision").

    138

    Although the Debtor argues that the Exculpation Provision is similar to that approved by the Third Circuit Court of Appeals in PWS Holding Corp., 228 F.3d [75] 224 (3d Cir.2000), the Exculpation Provision included in the Debtor's Plan is far more broad. The PWS Court wrote that the release provision in issue there "releases Committee members and professionals who provided services after the petition date from certain liability for their work in the reorganization...it does not eliminate liability but rather limits it to willful misconduct or gross negligence." PWS, 228 F.3d at 235. The PWS Court held that the release could be included in the Debtor's confirmation order because it was outside the scope of § 524(e) and correctly set forth the applicable standard of liability for under § 1103(c).[38] Id. at 246-47.

    139

    The Exculpation Provision in the Debtor's Plan, however, goes beyond the applicable standard of liability that could be read into § 1103. It provides, in part, that the Releasees (which includes parties other than the Debtor, including the Committees, and their officers, directors, professionals, or members, such as the Prepetition Lenders) shall not have any liability for prepetition acts "taken or omitted to be taken in connection with or in contemplation of the restructuring of the Debtor." Thus, the Exculpation Provision can be read to include a release of any claims by third parties against the Prepetition Lenders for their prepetition acts, yet it is not limited to those creditors who have accepted the Plan.[39]

    140

    The Genesis Health Ventures Court suggests that non-consensual releases may be approved only in an "extraordinary" case if all of the following four factors are present: (i) the non-consensual release is necessary to the success of the reorganization; (ii) the releasees have provided a critical financial contribution to the Debtor's plan; (iii) the releasees' financial contribution is necessary to make the plan feasible; and (iv) the release is fair to the non-consenting creditors, i.e., whether the non-consenting creditors received reasonable compensation in exchange for the release. See Genesis Health Ventures, 266 B.R. at 607-08.[40]

    141

    As previously discussed in the context of the release provisions, and based upon my conclusion as to the enterprise value of the Debtor, the Option A Electors have not made a substantial contribution to the unsecured creditors in return for Release; consequently, their alleged contribution also cannot be found to be fair consideration for a non-consensual release. Further, the Exculpation Provision also binds, without their consent, unsecured creditors in Class P5 (the Convertible 2.9% Notes) and equity holders in Class P6 (Equity Interests), who will not receive any distribution under the Plan. The Exculpation Provision also fails for lack of consideration to these parties.

    142
    (3) The Subordination Injunction and Injunction Provisions.
    143

    Finally, there are also two injunction sections in Article X. Section X.A. regarding "Subordination" provides:

    144

    [76] The classification and manner of satisfying all Claims and Equity Interests and the respective distributions and treatments hereunder take into account and/or conform to the relative priority and rights of the Claims and Equity Interests in each Class in connection with any contractual, legal and equitable subordination rights relating thereto whether arising under general principles of equitable subordination, section 510(b) of the Bankruptcy Code or otherwise, and any and all such rights are settled, compromised and released pursuant hereto. The Confirmation Order shall permanently enjoin, effective as of the Effective Date, all Persons and Entities from enforcing or attempting to enforce any such contractual, legal and equitable subordination rights satisfied, compromised and settled in this manner.

    145

    See The Debtor's Fourth Amended Joint Plan Of Reorganization, Section X.A. (the "Subordination Injunction").[41]

    146

    Section X.H., entitled "Injunction," sets forth the following:

    147

    Except as otherwise provided herein, from and after the Effective Date, all Holders of Claims or Equity Interests shall be permanently enjoined from commencing or continuing in any manner, any suit, action or other proceeding, on account of or respecting any Claim, Equity Interest, obligation, debt, right, Cause of Action, remedy or liability or any other claim or cause of action released or to be released pursuant hereto.

    148

    Debtor's Fourth Amended Joint Plan of Reorganization, Section X.H. (the "General Injunction").

    149

    Similar to the Exculpation Provision, the Subordination Injunction furthers the non-consensual release of claims against non-debtor third-parties. It cannot be approved for the same reason that the Exculpation Provision fails: there is no evidence that any value has been given to creditors or equity holders in exchange for the Subordination Injunction or that the Subordination. Injunction is necessary for the Plan's success. The creditors have rejected this Plan and, as stated above, there has not, as yet, been any demonstration that there exist circumstances to justify approval over such rejection. Therefore, the Subordination Injunction cannot be approved.

    150

    The General Injunction prevents creditors and equity holders from bringing an action against a Releasee on any claims "released or to be released" in the Debtor's Plan. Because the General Injunction incorporates all claims released in the Release and the Exculpation Provision, which I have determined cannot be approved, the General Injunction, likewise, cannot be approved.[42]

    151
    [77] 5. Unfair Discrimination.
    152

    The Creditors Committee argues that the Debtor's Plan unfairly discriminates in its treatment of unsecured creditors and violates Bankruptcy Code §§ 1123(a)(4), 1129(a)(1) and 1129(b)(1). Similarly, Smith Management and HSBC Bank argue that any settlement or reallocation must be distributed equally among all unsecured creditors.

    153

    The Plan provides for different treatment among three categories of unsecured claims: the general unsecured creditors (Class P4-A), who will share a "cash pool" in the amount of $4.4 million, the 10% Senior Noteholders (Class P4-B), who will receive equivalent payment in the form of restricted common stock in New Exide, and the 2.9% Convertible Note Claims (Class P5), who will not receive any distribution.

    154

    The Debtor claims that the disparate treatment of unsecured creditors is permissible because the payments result from the Prepetition Lenders' agreement to redistribute $8.5 million of their recovery to pay the general unsecured creditors and 10% Senior Noteholders. This theory stems from the Debtor's position throughout this process that the Debtor's enterprise value is not sufficient to pay the Prepetition Lenders' claims in full. Therefore, the Debtor argues, the only way in which unsecured creditors can receive any recovery is through the Prepetition Lenders' voluntary agreement to allocate a portion of their recovery to the unsecured creditors as part of the consideration for settlement of the Adversary Proceeding. Further, the Debtor argues that other courts have permitted senior creditors to allocate part of their recovery to certain creditors while excluding others. See Official Unsecured Creditors' Committee v. Stern (In re SPM Mfg. Corp.), 984 F.2d 1305 (1st Cir.1993); In re MCorp Fin., Inc., 160 B.R. 941 (S.D.Tex.1993); Genesis Health Ventures, 266 B.R. at 612.

    155

    The Debtor correctly indicates that the SPM Court decided that a senior creditor could agree to reallocate the net proceeds from the sale of assets subject to its lien to a junior creditor without regard to the Bankruptcy Code's priority provisions. SPM, 984 F.2d at 1313 ("The Code does not govern the rights of creditors to transfer or receive nonestate property. While the debtor and the trustee are not allowed to pay nonpriority creditors ahead of priority creditors, ... creditors are generally free to do whatever they wish with the bankruptcy dividends they receive, including to share them with other creditors.") Although SPM was not decided in the context of a chapter 11 plan, courts subsequently have approved chapter 11 plans that included such reallocations. See MCorp, 160 B.R. at 960 (approving a plan in which senior creditors agreed to fund a settlement with a specific junior creditor by reallocating a portion of their recovery); Genesis Health Ventures, (approving a plan in which senior lenders agreed to reallocate a portion of their distribution to certain classes of unsecured creditors). But see Sentry Operating Co. of Texas, Inc., 264 B.R. 850 (Bankr.S.D.Tex.2001).

    156

    I have already concluded that the Plan undervalues the Debtor; therefore, there may be sufficient value to pay the Prepetition Lenders' claims in full. Accordingly, the distribution to unsecured creditors is not, in fact, a reallocation of the Prepetition Lenders' recovery, and the Debtor and Prepetition Lenders do not [78] enjoy the unfettered freedom, under the present proposal, to choose which unsecured creditors they wish to pay. Consequently, the Debtor must meet the requirements of § 1129(b) to confirm the Plan over the dissenting creditors — including meeting the requirements that the Plan "does not discriminate unfairly, and is fair and equitable" with respect to each impaired class that has not accepted the plan. § 1129(b)(1). As discussed in Genesis Health Ventures:

    157

    The concept of unfair discrimination is not defined under the Bankruptcy Code. Various standards have been developed by the courts to test whether or not a plan unfairly discriminates. In re Dow Corning Corp., 244 B.R. 705, 710 (Bankr.E.D.Mich.1999), aff'd 255 B.R. 445 (E.D.Mich.2000). The hallmarks of the various tests have been whether there is a reasonable basis for the discrimination, and whether the debtor can confirm and consummate a plan without the proposed discrimination. See, e.g., In re Ambanc La Mesa L.P., 115 F.3d 650, 656 (9th Cir.1997) cert. denied, 522 U.S. 1110, 118 S.Ct. 1039, 140 L.Ed.2d 105 (1998).

    158

    Genesis Health Ventures, 266 B.R. at 611. Therefore, in order to confirm the Plan, the Debtor must show that (i) there is a reasonable basis for the Debtor's separate classification of the general unsecured creditors, the 10% Senior Noteholders, and the 2.9% Convertible Note Claims; and (ii) that the Debtor cannot confirm a plan absent the separate classification of unsecured claims.

    159

    The 2.9% Convertible Note claimants argue that there is no basis for separate classification and disparate treatment of two types of investor claims. Lisa Donahue testified that the Debtor classified the 2.9% Convertible Note Claims separately from the 10% Senior Noteholders because of the subordination provisions contained in the 2.9% Convertible Senior Subordinated Notes (the "2.9% Convertible Notes"). Tr. 10/21/03, pp. 227-28. The 2.9% Convertible Notes contain a provision prohibiting payment while any default exists in the "Senior Indebtedness" (which is defined in Section 1.01 of the Indenture for the 2.9% Convertible Notes as including the 10% Senior Noteholders). See Ex. D-69, Section 4.02.

    160

    Although some commentators have argued in favor of limiting a debtor's ability to discriminate among creditors of the same priority level, they have agreed that discrimination based upon subordination rights is viewed as fair. See Steven M. Abromowitz, et al., Making The Test For Unfair Discrimination More "Fair": A Proposal, 58 Bus.Law. 83, 107 (Nov.2002)(Arguing that the case law regarding unjust discrimination is too unpredictable and inconsistent, and proposing an approach postulated by Professor Bruce A. Markell[43] which "would prohibit discrimination in amount of recovery subject to two exceptions, enforcing subordination rights and rewarding a reasonable equivalent contribution in money or money's worth.")[44] This view would permit the [79] Debtor to discriminate between the 10% Senior Noteholders and the 2.9% Convertible Note Claims.

    161

    However, Smith Management and HSBC Bank argue that the subordination provisions in the 2.9% Convertible Notes are not triggered by the Plan's proposed distribution to unsecured creditors in settlement of the Adversary Proceeding. They rely upon the definition of "Senior Subordinated Obligations" in the Indenture Agreement and argue that a payment made in settlement of litigation does not fall within that definition, which states:

    162

    The term "Senior Subordinated Obligations" means any principal of, premium, if any, or interest on the Notes payable pursuant to the terms of the Notes or upon acceleration, including amounts received upon the exercise of rights of rescission or other rights of action (including claims for damages) or otherwise, to the extent relating to the purchase price of the Notes or amounts corresponding to such principal, premium, if any, or interest on the Notes.

    163

    Ex. D-69, Section 1.01, p. 29.

    164

    Section 4.02(a) of the 2.9% Convertible Notes, however, provides:

    165

    No direct or indirect payment by or on behalf of the Company of Senior Subordinated Obligations, whether pursuant to the terms of the Notes or upon acceleration or otherwise, shall be made if, at the time of such payment, there exists a default in the payment of all or any portion of the obligations on any Senior Indebtedness, and such default shall not have been cured or waived or the benefits of this sentence waived by or on behalf of the holders of such Senior Indebtedness.

    166

    Ex. D-69, Section 4.02(a), p. 51.

    167

    Smith Management and the other holders of the 2.9% Convertible Notes are involved in the bankruptcy case, due to the fact that they are owed payment of the Senior Subordinated Obligations. Any settlement payment, whether made by the Debtor directly or by the Prepetition Lenders as part of the "reallocation" proposed by this Plan, would be paid based on the existence and amount of their Senior Subordinated Obligations claim and would fall within the prohibited payments of Section 4.02(a).[45]

    168

    Because the subordination provisions apply here, it appears that the Debtor's classification of unsecured claims may, [80] in concept, pass the two-part test of Genesis Health Ventures. However, the Debtor focused its arguments in response to the unfair discrimination objections on the case law allowing secured creditors to reallocate their distribution among any class or classes they may choose. As a result, the current record is insufficient for me to conclude that the separate classification of the general unsecured claims and the investor claims is both reasonable and necessary and does not discriminate unfairly as required by § 1129(b)(1).

    169

    For all of the reasons set forth above, I conclude that the Debtor's Plan cannot be confirmed.[46]

    170
    ORDER
    171

    AND NOW, this 30th day of December, 2003, for the reasons given in the accompanying Opinion On Confirmation, it is ORDERED and DECREED that confirmation of the Debtor's proposed Fourth Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code is DENIED.

    172

    It is FURTHER ORDERED that a status hearing in the Adversary Proceeding (Adv. No. 03-50134 KJC) will be held on the next omnibus hearing date, January 22, 2004 at 2:00 p.m.

    173

    [1] The debtors in these proceedings are: Exide Technologies, f/k/a Exide Corporation; Exide Delaware, L.L.C.; Exide Illinois, Inc.; RBD Liquidation, L.L.C.; Dixie Metals Company; and Refined Metals Corporation (For ease of reference, the debtors shall be referred to herein as the "Debtor").

    174

    [2] This Opinion constitutes the findings of fact and conclusions of law required by Fed.R.Bankr.P 7052. This Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1334 and 157(a). This is a core proceeding pursuant to 28 U.S.C. 157(b)(1) and (b)(2)(L).

    175

    [3] The plan voting and confirmation took place with respect to the Debtor's Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the "Third Amended Plan") filed on September 8, 2003 (Docket # 2312). In response to some of the objections received, the Debtor filed the Debtor's Fourth Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the "Fourth Amended Plan") on October 25, 2003 (Docket # 2935), along with the Motion For Approval of Technical Modifications to the Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (Docket # 2938). See 11 U.S.C. § 1127(a)(A plan proponent may modify its plan before confirmation; the plan as modified becomes the plan).

    176

    The Debtor has also filed the following documents to supplement the Plan: (i) Revised Exhibit D to the Plan (Personal Injury and Wrongful Death Procedures) filed 11/12/03 (Docket # 3084); (ii) Plan Supplement filed between October and December 2003 (Docket # s 2588 — 2698); (iii) First Amended Plan Supplement filed 10/25/03 (Docket # 2934); (iv) Second Amended Plan Supplement filed 11/18/03 (Docket # 3146); and (v) Third Amended Plan Supplement filed 12/22/03 (Docket # 3369).

    177

    [4] These Orders were entered by my predecessor, the Honorable John C. Akard. My involvement in these proceedings began in October, 2002.

    178

    [5] The information in this subsection is taken largely from the Second Amended Disclosure Statement For Debtors' Third Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (the "Disclosure Statement"), pp. 10-15.

    179

    [6] The term "Prepetition Lenders" is defined in the Plan as "those Persons party to the Prepetition Credit Facility as lenders thereunder." The "Prepetition Credit Facility" is defined in the Plan as "that certain amended and restated credit and guarantee agreement dated September 29, 2000, as amended from time to time, among Exide and certain borrowing subsidiaries and certain guarantors and the Agent and certain other parties thereto." Further, the term "Agent" is defined in the Plan as "Credit Suisse First Boston in its capacity as administrative agent under the Prepetition Credit Facility."

    180

    [7] By letter dated December 1, 2003, the Debtor's counsel informed this Court that the December 18, 2003 deadline had been extended to March 18, 2004.

    181

    [8] The "Final DIP Order" is defined in the Plan as "the `Final Order Authorizing the Debtor In Possession to Enter into Post-Petition Credit Agreement and Obtain Post-Petition Financing Pursuant to Sections 363 and 364 of the Bankruptcy Code, Providing Adequate Protection, and Granting Liens, Security Interests and Super-Priority Claims' entered by the Bankruptcy Court on May 10, 2002."

    182

    [9] Defendant, Credit Suisse First Boston, is sued individually and as administrative agent, joint lead arranger, sole book manager and class representative for a syndicate of banks and other institutions identified in the lawsuit as the Prepetition Banks. Defendant Salomon Smith Barney, Inc. is sued as the syndication agent, joint lead arranger and class representative for the Prepetition Banks.

    183

    [10] Count XVIII was dismissed due to the fact that the Prepetition Lenders had not yet filed any proof of claim. The Prepetition Lenders have since filed a proof of claim and the Amended Complaint contains a count objecting to this claim.

    184

    On the eve of confirmation, the Prepetition Lenders filed a Bankruptcy Rule 3018 Motion, requesting temporary allowance of their claim for purposes of plan voting (Docket # 2840)(the "3018 Motion"), which was opposed by various parties, including the Creditors Committee. Ultimately, the 3018 Motion was granted and the Prepetition Lenders were permitted to vote their claim in favor of the Plan (Docket # 3169). This was the only impaired class that voted affirmatively to accept the Debtor's Plan. See 11 U.S.C. §§ 1129(a)(10), (b)(1).

    185

    [11] The Court's decision is reported at Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide Technologies, Inc.), 299 B.R. 732 (Bankr.D.Del.2003). Subsequently, the parties to the Adversary Proceeding submitted a certification and proposed order in the adversary case (Docket # 104), reflecting their agreement that the August 21, 2003 Memorandum incorrectly stated that Amalgamated Gadget, L.P. (an R2 affiliate) sits on the Equity Committee and requesting, pursuant to Fed.R.Civ.P. 60(a) and Fed.R.Bankr.P. 9024, modification of the Memorandum to reflect this. The assertion by the Creditors Committee of this "fact" in its papers responding to the defendants' motion to dismiss was not contested by the defendants. I decline to amend formally the August 21, 2003 Memorandum, but wish to note here the parties' agreement on the subject. Even assuming that what the parties now agree is true, it had no bearing on the outcome of the motion to dismiss.

    186

    [12] "Exide" is defined in the Plan as Exide Technologies, f/k/a Exide Corporation, a Delaware corporation.

    187

    [13] "Subsidiary Debtor" is defined in the Plan as "Exide Delaware, Exide Illinois, RBD Liquidation, Dixie Metals and Refined Metals."

    188

    [14] The holders of the 2.9% Convertible Notes are unsecured creditors, but the Debtor classified those creditors separately and provided for no distribution to that class (Class P5) because the 2.9% Convertible Notes are subordinated to the 10% Senior Notes. Various holders of the 2.9% Convertible Notes have objected to confirmation of the Plan based, in part, upon the separate classification. These objections are discussed later in this Opinion.

    189

    [15] There is no similar split of Class S4 claims, which are all in one group known as General Unsecured Claims.

    190

    [16] The Plan provides that the amount of the cash pool may decrease if the aggregate amount of Allowed Class P4-A claims is less than the amount estimated in the Disclosure Statement, to keep equivalent the Pro Rata recovery for the Class P4 subclasses.

    191

    [17] The Debtor's November 6, 2003 report of outstanding Plan objections notes that the Debtor has resolved the objection filed by Antoine Dodd and Certain Other Lead Contaminated Child Claimants by the insertion of certain language in the proposed confirmation order. The Debtor nonetheless offers argument in its brief that all personal injury/wrongful death claimants should be denied any right to punitive damages. In light of the disposition of the Debtor's present proposed Plan, I do not address this issue.

    192

    [19] The Voting Agent did not tabulate 223 deficient ballots according to tabulation procedures set forth in the Solicitation Order.

    193

    [18] This percentage does not exclude claims to which objections were raised. When those claims are removed, 82.57% of Class P4 voted to reject the Plan.

    194

    [20] P4-A represents ballots cast by unsecured creditors whose claims are not derived from publicly traded securities.

    195

    [21] P4-B represents Beneficial Holder ballots cast in connection with publicly traded securities.

    196

    [22] Initially, the Creditors Committee also designated as an expert in valuation Masroor Siddiqui of Jefferies. Mr. Siddiqui was deposed, but was not called to testify at trial, the expert designation having been "withdrawn" by the Creditors Committee. The Debtor, largely through its cross-examination of Derrough, highlighted conflicts between the views of the Jefferies brethren, to which I give little weight, the exercise having proved primarily that the Creditors' Committee was perhaps mistaken in its initial designation of Mr. Siddiqui.

    197

    [23] The parties also disagree about the "hurdle" amount, i.e., the amount that the Debtor must be worth to enable it to pay all secured, administrative and priority claims and have some value left to distribute to the unsecured creditors. The Creditors Committee used a hurdle amount of $1.190 billion based upon Exhibit C to the Debtor's Disclosure Statement See Ex. C-152, Expert Valuation Report by Jefferies & Company, Inc. (the "Derrough Report"), p. 13. At the confirmation hearing, the Debtor argued that its expert had "updated" the hurdle amount and set it at $1.285 billion. See Ex. D-64, Expert Report of Arthur B. Newman (the "Newman Report"), p. 29.

    198

    [24] The "private equity process" was conducted by Newman's employer, Blackstone, for the purpose of raising $2 to $3 million in cash in exchange for some percentage investment in the reorganized Exide. (Tr. 10/22/03, p. 212). Blackstone approached approximately 75 equity firms, 35 of which signed confidentiality agreements and received the offering memorandum and financial information, and seven of which submitted expressions of interest in March 2003. (Tr. 10/22/03, pp. 214-15). Three participants then performed extensive due diligence and submitted second round bids in late June 2003. (Tr. 10/22/03, pp. 215-16). Blackstone informed the participating parties the Debtor was unlikely to consider seriously offers in which the enterprise value of the Debtor was considered to be under $900 million. (Tr. 10/22/03, p. 215) However, the enterprise value was set by the highest second round bid at approximately $950 million, with the other two bids under $900 million. (Tr. 10/22/03, p. 216). A subsequent round of telephone calls to the lower bidders did not generate any interest in continuing the process to attempt to increase the bids. (Tr. 10/22/03, pp. 218-19). At this point, the private equity process was terminated, partially due to the fact that only one party seemed interested in bidding more than $900 million, and partially due to the fact that the Prepetition Lenders' Steering Committee had expressed a willingness to convert the entire bank debt, including the domestic and European debt, to equity. (Id.) Newman testified that he did not believe that a subsequent auction would have generated a higher offer. (Tr. 10/22/03 at pp. 203, 219).

    199

    [25] See Stuart C. Gilson, Edith S. Hotchkiss & Richard S. Ruback, Valuation of Bankruptcy Firms, 13-1 REV. OF FIN. STUD. 43 (2000).

    200

    [26] The Creditors Committee also relies upon the testimony of John Craig, President and CEO of Enersys, Inc. ("Enersys"), to support its argument that the Debtor's enterprise value has been significantly undervalued. Mr. Craig testified that he sent a letter to Craig Mulhauser of Exide on August 28, 2003 expressing his interest on behalf of Enersys to acquire Exide's transportation division for $950 million. Tr. 10/22/03, pp. 146, 154; See Ex. D-57 (Ex. A thereto). However, I can afford little weight to this. First, the August 28, 2003 letter itself states that it is a "nonbinding" "expression of interest." See Ex. D-57 (Ex. "A" thereto). Second, Mr. Craig admitted that he had not determined whether Enersys's interest included taking on the environmental liabilities, pension liabilities and an allocation of shared services with the industrial division. Tr. 10/22/03, pp. 198-200. Third, the Debtor and Enersys are embroiled in a vigorously contested dispute about whether the Debtor may reject a valuable intellectual property license now used by Enersys. While Enersys's interest in acquiring Exide's transportation business may be genuine, the timing of the "expression of interest" — after the Debtor filed its Disclosure Statement and Enersys was aware that the Debtor's valuation was in dispute — may be considered suspect. Tr. 10/22/03, p. 181.

    201

    [27] Exide is held publicly, but was delisted by the New York Stock Exchange sometime around February 2002. (Tr. 10/21/03, p. 187).

    202

    [28] For the Debtor, EBITDAR is used to add "restructuring charges" to the metric.

    203

    [29] See also Peter V. Pantaleo and Barry W. Ridings, Reorganization Value, 51 BUS.LAW. 419, 437 (1996)("[V]aluations based on comparable company analysis are `backward looking' in that they generally rely on historical information about earnings or cash flow in order to determine value. If history is not a reliable guide to future performance — and, arguably, in many reorganizations, it is not — then relying on past earnings to determine value is problematic as a matter of economic theory"). While applying a current market multiple against several years of forecasted EBITDA can result in overvaluation (See Id. at 426), use of the trailing twelve months ending December 31, 2003 in the revised projections does not reach so far into the future so as to detract from its reliability.

    204

    [30] Derrough's comparable company analysis provided a range between $1.427 billion and 1.537 billion. However, his valuation range was based upon analysis of the Debtor's EBITDAR (7.7x), EBITR (earnings before interest, taxes and restructuring charges)(12.8x), and FCF (free cash flow, which was defined as EBITDAR minus capital expenditures)(11.6x). Because Newman's report used only EBITDAR and because Derrough's EBITDAR value falls in the middle of his comparable company analysis, I have compared only the experts' EBITDAR analysis.

    205

    [31] Again, it appears that Newman used the Debtor's most recent business plan prepared in October 2003, while Derrough used the older business plan provided by the Debtor in its Disclosure Statement.

    206

    [32] CAPM is a formula that was developed to calculate the cost of equity capital. Pantaleo, supra n. 29, at 433 n. 52. "While there are other models to determine equity, CAPM is probably the most widely used." Id. The CAPM formula is:

    207
           Cost of Equity = R(f) + (Beta × [R(m) — R(f)])
    208
           Where: R(f) =  risk free rate
    209
           Beta  =  beta of the target's equity security
    210
           R(m) =  expected return on a market portfolio consisting of a large number of diversified stocks
    211

    Id. "This formula, in essence, provides that a firm's cost of equity is equal to the sum of the risk-free rate of return plus a risk premium (i.e., a return above the risk free rate). The risk premium for the firm is calculated by multiplying the risk premium that the equity market generally must pay to attract investors by the firm's `beta,' which...reflects the risk associated with an equity investment in the firm relative to the risk of an investment in the equity market as a whole." Id. at 433-34. "For companies that are not publicly traded — including most Chapter 11 debtors — the only way to measure beta is by reference to comparable companies." Id. at 435.

    212

    [33] The Creditors Committee points out that the Derrough's only departure from the "textbook" CAPM calculation was to include a risk premium of 1-2% to increase the cost of equity. This actually reduced his opinion of the Debtor's enterprise value.

    213

    [34] The Debtor's argument on this factor, in part, asserted that difficulty in collection was tied to the likelihood of success factor. The Debtor argues that, because there is no evidence to substantiate the claims in the Adversary Proceeding, the Creditors Committee's likely recovery, if any, would be minimal and, further, there would be no funds available to pay the unsecured creditors' minimal judgment after payment of the large amount of secured and priority claims against the Debtor. I reject this approach.

    214

    [35] As shown by the Plan Voting Report, 71.82% in number and 96.14% in amount of the general unsecured creditors voted against the Plan.

    215

    [36] Indeed, at the confirmation hearing, the proposed settlement was described as a "tip, a simple token or gesture for people to come on board with a plan to make it consensual" (Tr. 11/1/03, pp. 215-16) in the deposition testimony of Todd Arden, Director of Angelo Gordon & Company, L.P., that was read into the record. Angelo Gordon & Company, L.P. is an investment firm which purchased part of the Prepetition Lender debt.

    216

    [37] I do not hold here that the price of a release of officers, directors and others must always involve the contribution of tangible "assets" or that efforts alone of officers and directors are never sufficient to warrant such a release. In this matter, the unsecured creditors' overwhelming opposition to the proposed settlement, combined with the Debtors' undervaluation of its worth and the minimal distribution to unsecured creditors, all make the proposed releases inappropriate. I note also that upon presentation of a consensual plan, in the absence of objection to the release/injunction provisions, or upon a more meaningful distribution to unsecured creditors, the Court may, appropriately, view such provisions in a different light.

    217

    [38] The PWS Court determined that other cases had interpreted § 1103(c) to grant a limited immunity to committee members. PWS, 228 F.3d at 246 (citing cases).

    218

    [39] Smith Management commenced its own lawsuit against the Prepetition Banks on October 14, 2003, seeking declaratory and equitable relief arising out of the Prepetition Banks' alleged inequitable and bad faith conduct, improper control of the Debtor and breach of the 2.9% Convertible Note Indenture.

    219

    [40] The Zenith Court flatly rejected inclusion of a non-consensual release in a chapter 11 plan. Zenith, 241 B.R. at 111. However, Zenith was decided prior to the Third Circuit Court of Appeal's decision in Continental.

    220

    [41] On December 1, 2003, the Creditors Committee filed a motion seeking permission to commence an adversary action on behalf of the Debtor's estate against R2 Investments LDC and R2 Top Hat, Ltd. and affiliated entities (collectively, R2)(Docket # 3261)(the "R2 Motion"), to which the Debtor, R2 and the Prepetition Lenders all objected on various grounds. After preliminary consideration of the R2 Motion at the scheduled omnibus hearing on December 18, 2003, I decided to defer further consideration of the R2 Motion until the January 22, 2004 omnibus hearing date. As the objectors point out in their opposition to the R2 Motion, the Creditors Committee challenged R2's conduct in its Supplemental Objection to Confirmation (Docket # 3017). Any equitable subordination claim against R2 (as well as against the Prepetition Lenders) would be foreclosed by confirmation of this Plan.

    221

    [42] Furthermore, Section V.H of the Debtor's Plan, entitled "Dismissal of Creditors Committee Adversary Proceeding and Other Plan Settlements" provides "In addition to the general injunction set forth in Article X.H. hereof, from and after the Effective Date, the Creditors Committee, R2 Investments, LDC and each Holder of General Unsecured Claims and 2.9% Convertible Note Claims shall be permanently enjoined from continuing in any manner the Creditors Committee Adversary Proceeding." For the same reasons set forth above, this non-consensual injunction is also rejected.

    222

    [43] Bruce A. Markell, A New Perspective on Unfair Discrimination in Chapter 11, 72 Am. Bankr.L.J. 227 (1998). Markell's proposal was adopted by the Sentry Court. Sentry, 264 B.R. at 863-64.

    223

    [44] The argument to limit discrimination to cases involving subordination or contribution was not accepted by all members of the "Committee on Bankruptcy and Corporate Reorganization of the Association of the Bar of the City of New York," which authored the Abramowitz article. Some members dissented from the proposal, stating

    224

    The Supreme Court has emphasized that "policies of flexibility and equity [are] built into Chapter 11 of the Bankruptcy Code" because the "fundamental purpose" of Chapter 11 is "to prevent a debtor from going into liquidation, with an attendant loss of jobs and possible misuse of economic resources." NLRB v. Bildisco & Bildisco, 465 U.S. 513, 525, 528, 104 S.Ct. 1188, 79 L.Ed.2d 482 (1984). The Committee's view overemphasize the need for commercial predictability in Chapter 11, where courts must often be given "great latitude" in determining "how the equities relate to the success of the reorganization." Id. at 527, 104 S.Ct. 1188. Congress provided bankruptcy courts with such flexibility in reviewing Chapter 11 plans under the standard at issue by permitting a plan to "discriminate" between classes as long as it does not "discriminate unfairly," without any further statutory delineation of how that requirement must be met.

    225

    Abramowitz, at 106 n. 163.

    226

    [45] Smith Management also argues that the Debtor has no right to enforce the subordination provisions, citing to Krafsur v. Scurlock Permian Corp. (In re El Paso Refinery, L.P.), 171 F.3d 249, 257 (5th cir.1999) and In re Chicago, South Shore & South Bend R.R., 146 B.R. 421, 427 (Bankr.N.D.Ill.1992). In those cases, the subordination agreements in issue were inter-creditor agreements regarding lien priorities to which neither the debtor nor the trustee standing in the shoes of the debtor were a party. In contrast, the Indenture Agreement regarding the 2.9% Convertible Notes was issued by Exide so the Debtor is clearly a party to the agreement. These cases are not applicable here.

    227

    [46] Obviously, this case has been a contentious one among the major constituents, in which the parties have chosen, as is their right, to assert vigorously their own economic and strategic interests. On August 1, 2003, the Creditors Committee moved to stay the disclosure and confirmation process (Docket # 2118)(the "Stay Motion"), in part, because it maintained that the Debtor had not engaged in any meaningful plan negotiations. At the conclusion of the hearing on the Stay Motion, I denied the Stay Motion, but cautioned the Debtor that if its plan were not confirmed, it was unlikely that I would permit further extension of the exclusive period (without prejudicing any further request in light of other circumstances which might develop).

    228

    In an on-the-record conference call with interested counsel on December 16, 2003, the Court was advised that negotiations for a consensual plan were ongoing. No further report to the Court has since been made. Fortunately, the Debtor has managed to obtain extensions of its DIP financing and of the Standstill Agreement deadline, which should afford sufficient time for the parties to reach accord on the terms of a consensual plan.

    229

    The initial chapter 11 filing was on April 15, 2002, more than 20 months ago. The record made at the confirmation hearing convinces me that the Debtor is a viable company with a positive outlook for the future, provided it completes the contemplated restructuring of its European business and can achieve the necessary global financial restructuring. It is now time for the parties to develop an agreed exit strategy, failing which, it may become appropriate to consider other alternatives. See, e.g., In re Marvel Entertainment Group, Inc., 140 F.3d 463 (1998).

    230

    Unless the Debtor and other interested parties request an earlier hearing or teleconference, the Debtor and other interested parties should be prepared to report to the Court on the status of further plan negotiations at the next omnibus hearing, now set for January 22, 2004.

  • 5 Kamin v. American Express Co.

    hiding represents corporate finance version (law light)

    1
    86 Misc.2d 809 (1976)
    2
    Howard P. Kamin et al., Plaintiffs,
    v.
    American Express Company et al., Defendants.
    3

    Supreme Court, Special Term, New York County.
    March 17, 1976

    4

    Carter, Ledyard & Milburn for American Express Company, defendant. Winthrop, Stimson, Putnam & Roberts for Hoyt Ammidon and others, defendants. Cowan, Liebowitz & Latman, P.C., for plaintiffs.

    5
    [810] EDWARD J. GREENFIELD, J.
    6

    In this stockholders' derivative action, the individual defendants, who are the directors of the American Express Company, move for an order dismissing the complaint for failure to state a cause of action pursuant to CPLR 3211 (subd [a], par 7), and alternatively, for summary judgment pursuant to CPLR 3211 (subd [c]).

    7

    The complaint is brought derivatively by two minority stockholders of the American Express Company, asking for a declaration that a certain dividend in kind is a waste of [811] corporate assets, directing the defendants not to proceed with the distribution, or, in the alternative, for monetary damages. The motion to dismiss the complaint requires the court to presuppose the truth of the allegations. It is the defendants' contention that, conceding everything in the complaint, no viable cause of action is made out.

    8

    After establishing the identity of the parties, the complaint alleges that in 1972 American Express acquired for investment 1,954,418 shares of common stock of Donaldson, Lufken and Jenrette, Inc. (hereafter DLJ), a publicly traded corporation, at a cost of $29,900,000. It is further alleged that the current market value of those shares is approximately $4,000,000. On July 28, 1975, it is alleged, the board of directors of American Express declared a special dividend to all stockholders of record pursuant to which the shares of DLJ would be distributed in kind. Plaintiffs contend further that if American Express were to sell the DLJ shares on the market, it would sustain a capital loss of $25,000,000 which could be offset against taxable capital gains on other investments. Such a sale, they allege, would result in tax savings to the company of approximately $8,000,000, which would not be available in the case of the distribution of DLJ shares to stockholders. It is alleged that on October 8, 1975 and October 16, 1975, plaintiffs demanded that the directors rescind the previously declared dividend in DLJ shares and take steps to preserve the capital loss which would result from selling the shares. This demand was rejected by the board of directors on October 17, 1975.

    9

    It is apparent that all the previously-mentioned allegations of the complaint go to the question of the exercise by the board of directors of business judgment in deciding how to deal with the DLJ shares. The crucial allegation which must be scrutinized to determine the legal sufficiency of the complaint is paragraph 19, which alleges: "19. All of the defendant Directors engaged in or acquiesced in or negligently permitted the declaration and payment of the Dividend in violation of the fiduciary duty owed by them to Amex to care for and preserve Amex's assets in the same manner as a man of average prudence would care for his own property."

    10

    Plaintiffs never moved for temporary injunctive relief, and did nothing to bar the actual distribution of the DLJ shares. The dividend was in fact paid on October 31, 1975. Accordingly, that portion of the complaint seeking a direction not to [812] distribute the shares is deemed to be moot, and the court will deal only with the request for declaratory judgment or for damages.

    11

    Examination of the complaint reveals that there is no claim of fraud or self-dealing, and no contention that there was any bad faith or oppressive conduct. The law is quite clear as to what is necessary to ground a claim for actionable wrongdoing. "In actions by stockholders, which assail the acts of their directors or trustees, courts will not interfere unless the powers have been illegally or unconscientiously executed, or unless it be made to appear that the acts were fraudulent or collusive and destructive of the rights of the stockholders. Mere errors of judgment are not sufficient as grounds for equity interference; for the powers of those entrusted with corporate management are largely discretionary." (Leslie v Lorillard, 110 N.Y. 519, 532; see, also, Winter v Anderson, 242 App Div 430, 432; Rous v Carlisle, 261 App Div 432, 434, affd 290 N.Y. 869; 11 NY Jur, Corporations, § 378.)

    12

    More specifically, the question of whether or not a dividend is to be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the board of directors. "Courts will not interfere with such discretion unless it be first made to appear that the directors have acted or are about to act in bad faith and for a dishonest purpose. It is for the directors to say, acting in good faith of course, when and to what extent dividends shall be declared * * * The statute confers upon the directors this power, and the minority stockholders are not in a position to question this right, so long as the directors are acting in good faith" (Liebman v Auto Strop Co., 241 N.Y. 427, 433-434; accord: City Bank Farmers Trust Co. v Hewitt Realty Co., 257 N.Y. 62; Venner v Southern Pacific Co., 279 F 832, cert den 258 US 628).

    13

    Thus, a complaint must be dismissed if all that is presented is a decision to pay dividends rather than pursuing some other course of conduct. (Weinberger v Quinn, 264 App Div 405, affd 290 N.Y. 635.) A complaint which alleges merely that some course of action other than that pursued by the board of directors would have been more advantageous gives rise to no cognizable cause of action. Courts have more than enough to do in adjudicating legal rights and devising remedies for wrongs. The directors' room rather than the courtroom is the appropriate forum for thrashing out purely business questions [813] which will have an impact on profits, market prices, competitive situations, or tax advantages. As stated by CARDOZO, J., when sitting at Special Term, the substitution of someone else's business judgment for that of the directors "`is no business for any court to follow.'" (Holmes v Saint Joseph Lead Co., 84 Misc 278, 283, quoting from Gamble v Queens County Water Co., 123 N.Y. 91, 99.)

    14

    It is not enough to allege, as plaintiffs do here, that the directors made an imprudent decision, which did not capitalize on the possibility of using a potential capital loss to offset capital gains. More than imprudence or mistaken judgment must be shown. "Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient." (Pollitz v Wabash R.R. Co., 207 N.Y. 113, 124.)

    15

    Section 720 (subd [a], par [1], cl [A]) of the Business Corporation Law permits an action against directors for "[t]he neglect of, or failure to perform, or other violation of his duties in the management and disposition of corporate assets committed to his charge." This does not mean that a director is chargeable with ordinary negligence for having made an improper decision, or having acted imprudently. The "neglect" referred to in the statute is neglect of duties (i.e., malfeasance or nonfeasance) and not misjudgment. To allege that a director "negligently permitted the declaration and payment" of a dividend without alleging fraud, dishonesty or nonfeasance, is to state merely that a decision was taken with which one disagrees.

    16

    Nor does this appear to be a case in which a potentially valid cause of action is inartfully stated. The defendants have moved alternatively for summary judgment and have submitted affidavits under CPLR 3211 (subd [c]), and plaintiffs likewise have submitted papers enlarging upon the allegations of the complaint. The affidavits of the defendants and the exhibits annexed thereto demonstrate that the objections raised by the plaintiffs to the proposed dividend action were carefully considered and unanimously rejected by the board at a special meeting called precisely for that purpose at the plaintiffs' request. The minutes of the special meeting indicate that the [814] defendants were fully aware that a sale rather than a distribution of the DLJ shares might result in the realization of a substantial income tax saving. Nevertheless, they concluded that there were countervailing considerations primarily with respect to the adverse effect such a sale, realizing a loss of $25,000,000, would have on the net income figures in the American Express financial statement. Such a reduction of net income would have a serious effect on the market value of the publicly traded American Express stock. This was not a situation in which the defendant directors totally overlooked facts called to their attention. They gave them consideration, and attempted to view the total picture in arriving at their decision. While plaintiffs contend that according to their accounting consultants the loss on the DLJ stock would still have to be charged against current earnings even if the stock were distributed, the defendants' accounting experts assert that the loss would be a charge against earnings only in the event of a sale, whereas in the event of distribution of the stock as a dividend, the proper accounting treatment would be to charge the loss only against surplus. While the chief accountant for the SEC raised some question as to the appropriate accounting treatment of this transaction, there was no basis for any action to be taken by the SEC with respect to the American Express financial statement.

    17

    The only hint of self-interest which is raised, not in the complaint but in the papers on the motion, is that 4 of the 20 directors were officers and employees of American Express and members of its executive incentive compensation plan. Hence, it is suggested, by virtue of the action taken earnings may have been overstated and their compensation affected thereby. Such a claim is highly speculative and standing alone can hardly be regarded as sufficient to support an inference of self-dealing. There is no claim or showing that the four company directors dominated and controlled the 16 outside members of the board. Certainly, every action taken by the board has some impact on earnings and may therefore affect the compensation of those whose earnings are keyed to profits. That does not disqualify the inside directors, nor does it put every policy adopted by the board in question. All directors have an obligation, using sound business judgment, to maximize income for the benefit of all persons having a stake in the welfare of the corporate entity. (See Amdur v Meyer, 15 AD2d 425, app dsmd 14 N.Y.2d 541.) What we have here as revealed [815] both by the complaint and by the affidavits and exhibits, is that a disagreement exists between two minority stockholders and a unanimous board of directors as to the best way to handle a loss already incurred on an investment. The directors are entitled to exercise their honest business judgment on the information before them, and to act within their corporate powers. That they may be mistaken, that other courses of action might have differing consequences, or that their action might benefit some shareholders more than others present no basis for the superimposition of judicial judgment, so long as it appears that the directors have been acting in good faith. The question of to what extent a dividend shall be declared and the manner in which it shall be paid is ordinarily subject only to the qualification that the dividend be paid out of surplus (Business Corporation Law, § 510, subd [b]). The court will not interfere unless a clear case is made out of fraud, oppression, arbitrary action, or breach of trust.

    18

    Courts should not shrink from the responsibility of dismissing complaints or granting summary judgment when no legal wrongdoing is set forth. As stated in Greenbaum v American Metal Climax (27 AD2d 225, 231-232): "It is well known that derivative actions by stockholders generally involve extensive pretrial procedures, including lengthy examinations before trial, and then, finally, prolonged trials; and that they also entail large litigation costs, including the probability of a considerable liability upon the corporation for the defense costs of defendant offices. Such actions are a heavy burden upon the courts and litigants. Consequently, the summary judgment remedy should be fully utilized and given due effect to challenge such an action which appears to be in the nature of a strike suit or otherwise lacks apparent merit * * * [plaintiffs] are bound to bear in mind that matters depending on business judgment are not actionable. (Cf. Steinberg v Carey, 285 App Div 1131.) They are required to set forth something more than vague general charges of wrongdoing; their charges must be supported by factual assertions of specific wrongdoing; conclusory allegations of breaches of fiduciary duty are not enough."

    19

    In this case it clearly appears that the plaintiffs have failed as a matter of law to make out an actionable claim. Accordingly, the motion by the defendants for summary judgment and dismissal of the complaint is granted.

  • 6 Unocal Corp. v. Mesa Petroleum Co.

    1
    493 A.2d 946 (1985)
    2
    UNOCAL CORPORATION, a Delaware corporation, Defendant Below, Appellant,
    v.
    MESA PETROLEUM CO., a Delaware corporation, Mesa Asset Co., a Delaware corporation, Mesa Eastern, Inc., a Delaware corporation and Mesa Partners II, a Texas partnership, Plaintiffs Below, Appellees.
    3

    Supreme Court of Delaware.
    Submitted: May 16, 1985.
    Oral Decision: May 17, 1985.
    Written Decision: June 10, 1985.\

    4

    A. Gilchrist Sparks, III (argued), and Kenneth J. Nachbar of Morris, Nichols, Arsht & Tunnell, Wilmington, James R. Martin and Mitchell A. Karlan of Gibson, Dunn & Crutcher and Paul, Hastings, Janofsky & Walker, Los Angeles, Cal., of counsel, for appellant.

    5

    Charles F. Richards, Jr. (argued), Samuel A. Nolen, and Gregory P. Williams of Richards, Layton & Finger, Wilmington, for appellees.

    6

    Before McNEILLY and MOORE, JJ., and TAYLOR, Judge (Sitting by designation pursuant to Del. Const., Art. 4, § 12.)

    7
    [949] MOORE, Justice.
    8

    We confront an issue of first impression in Delaware — the validity of a corporation's self-tender for its own shares which excludes from participation a stockholder making a hostile tender offer for the company's stock.

    9

    The Court of Chancery granted a preliminary injunction to the plaintiffs, Mesa Petroleum Co., Mesa Asset Co., Mesa Partners II, and Mesa Eastern, Inc. (collectively "Mesa")[1], enjoining an exchange offer of the defendant, Unocal Corporation (Unocal) for its own stock. The trial court concluded that a selective exchange offer, excluding Mesa, was legally impermissible. We cannot agree with such a blanket rule. The factual findings of the Vice Chancellor, fully supported by the record, establish that Unocal's board, consisting of a majority of independent directors, acted in good faith, and after reasonable investigation found that Mesa's tender offer was both inadequate and coercive. Under the circumstances the board had both the power and duty to oppose a bid it perceived to be harmful to the corporate enterprise. On this record we are satisfied that the device Unocal adopted is reasonable in relation to the threat posed, and that the board acted in the proper exercise of sound business judgment. We will not substitute our views for those of the board if the latter's decision can be "attributed to any rational business purpose." Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 720 (1971). Accordingly, we reverse the decision of the Court of Chancery and order the preliminary injunction vacated.[2]

    10
    I.
    11

    The factual background of this matter bears a significant relationship to its ultimate outcome.

    12

    On April 8, 1985, Mesa, the owner of approximately 13% of Unocal's stock, commenced a two-tier "front loaded" cash tender offer for 64 million shares, or approximately 37%, of Unocal's outstanding stock at a price of $54 per share. The "back-end" was designed to eliminate the remaining publicly held shares by an exchange of securities purportedly worth $54 per share. However, pursuant to an order entered by the United States District Court for the Central District of California on April 26, 1985, Mesa issued a supplemental proxy statement to Unocal's stockholders disclosing that the securities offered in the second-step merger would be highly subordinated, and that Unocal's capitalization would differ significantly from its present [950] structure. Unocal has rather aptly termed such securities "junk bonds".[3]

    13

    Unocal's board consists of eight independent outside directors and six insiders. It met on April 13, 1985, to consider the Mesa tender offer. Thirteen directors were present, and the meeting lasted nine and one-half hours. The directors were given no agenda or written materials prior to the session. However, detailed presentations were made by legal counsel regarding the board's obligations under both Delaware corporate law and the federal securities laws. The board then received a presentation from Peter Sachs on behalf of Goldman Sachs & Co. (Goldman Sachs) and Dillon, Read & Co. (Dillon Read) discussing the bases for their opinions that the Mesa proposal was wholly inadequate. Mr. Sachs opined that the minimum cash value that could be expected from a sale or orderly liquidation for 100% of Unocal's stock was in excess of $60 per share. In making his presentation, Mr. Sachs showed slides outlining the valuation techniques used by the financial advisors, and others, depicting recent business combinations in the oil and gas industry. The Court of Chancery found that the Sachs presentation was designed to apprise the directors of the scope of the analyses performed rather than the facts and numbers used in reaching the conclusion that Mesa's tender offer price was inadequate.

    14

    Mr. Sachs also presented various defensive strategies available to the board if it concluded that Mesa's two-step tender offer was inadequate and should be opposed. One of the devices outlined was a self-tender by Unocal for its own stock with a reasonable price range of $70 to $75 per share. The cost of such a proposal would cause the company to incur $6.1-6.5 billion of additional debt, and a presentation was made informing the board of Unocal's ability to handle it. The directors were told that the primary effect of this obligation would be to reduce exploratory drilling, but that the company would nonetheless remain a viable entity.

    15

    The eight outside directors, comprising a clear majority of the thirteen members present, then met separately with Unocal's financial advisors and attorneys. Thereafter, they unanimously agreed to advise the board that it should reject Mesa's tender offer as inadequate, and that Unocal should pursue a self-tender to provide the stockholders with a fairly priced alternative to the Mesa proposal. The board then reconvened and unanimously adopted a resolution rejecting as grossly inadequate Mesa's tender offer. Despite the nine and one-half hour length of the meeting, no formal decision was made on the proposed defensive self-tender.

    16

    On April 15, the board met again with four of the directors present by telephone [951] and one member still absent.[4] This session lasted two hours. Unocal's Vice President of Finance and its Assistant General Counsel made a detailed presentation of the proposed terms of the exchange offer. A price range between $70 and $80 per share was considered, and ultimately the directors agreed upon $72. The board was also advised about the debt securities that would be issued, and the necessity of placing restrictive covenants upon certain corporate activities until the obligations were paid. The board's decisions were made in reliance on the advice of its investment bankers, including the terms and conditions upon which the securities were to be issued. Based upon this advice, and the board's own deliberations, the directors unanimously approved the exchange offer. Their resolution provided that if Mesa acquired 64 million shares of Unocal stock through its own offer (the Mesa Purchase Condition), Unocal would buy the remaining 49% outstanding for an exchange of debt securities having an aggregate par value of $72 per share. The board resolution also stated that the offer would be subject to other conditions that had been described to the board at the meeting, or which were deemed necessary by Unocal's officers, including the exclusion of Mesa from the proposal (the Mesa exclusion). Any such conditions were required to be in accordance with the "purport and intent" of the offer.

    17

    Unocal's exchange offer was commenced on April 17, 1985, and Mesa promptly challenged it by filing this suit in the Court of Chancery. On April 22, the Unocal board met again and was advised by Goldman Sachs and Dillon Read to waive the Mesa Purchase Condition as to 50 million shares. This recommendation was in response to a perceived concern of the shareholders that, if shares were tendered to Unocal, no shares would be purchased by either offeror. The directors were also advised that they should tender their own Unocal stock into the exchange offer as a mark of their confidence in it.

    18

    Another focus of the board was the Mesa exclusion. Legal counsel advised that under Delaware law Mesa could only be excluded for what the directors reasonably believed to be a valid corporate purpose. The directors' discussion centered on the objective of adequately compensating shareholders at the "back-end" of Mesa's proposal, which the latter would finance with "junk bonds". To include Mesa would defeat that goal, because under the proration aspect of the exchange offer (49%) every Mesa share accepted by Unocal would displace one held by another stockholder. Further, if Mesa were permitted to tender to Unocal, the latter would in effect be financing Mesa's own inadequate proposal.

    19

    On April 24, 1985 Unocal issued a supplement to the exchange offer describing the partial waiver of the Mesa Purchase Condition. On May 1, 1985, in another supplement, Unocal extended the withdrawal, proration and expiration dates of its exchange offer to May 17, 1985.

    20

    Meanwhile, on April 22, 1985, Mesa amended its complaint in this action to challenge the Mesa exclusion. A preliminary injunction hearing was scheduled for May 8, 1985. However, on April 23, 1985, Mesa moved for a temporary restraining order in response to Unocal's announcement that it was partially waiving the Mesa Purchase Condition. After expedited briefing, the Court of Chancery heard Mesa's motion on April 26.

    21

    [952] On April 29, 1985, the Vice Chancellor temporarily restrained Unocal from proceeding with the exchange offer unless it included Mesa. The trial court recognized that directors could oppose, and attempt to defeat, a hostile takeover which they considered adverse to the best interests of the corporation. However, the Vice Chancellor decided that in a selective purchase of the company's stock, the corporation bears the burden of showing: (1) a valid corporate purpose, and (2) that the transaction was fair to all of the stockholders, including those excluded.

    22

    Unocal immediately sought certification of an interlocutory appeal to this Court pursuant to Supreme Court Rule 42(b). On May 1, 1985, the Vice Chancellor declined to certify the appeal on the grounds that the decision granting a temporary restraining order did not decide a legal issue of first impression, and was not a matter to which the decisions of the Court of Chancery were in conflict.

    23

    However, in an Order dated May 2, 1985, this Court ruled that the Chancery decision was clearly determinative of substantive rights of the parties, and in fact decided the main question of law before the Vice Chancellor, which was indeed a question of first impression. We therefore concluded that the temporary restraining order was an appealable decision. However, because the Court of Chancery was scheduled to hold a preliminary injunction hearing on May 8 at which there would be an enlarged record on the various issues, action on the interlocutory appeal was deferred pending an outcome of those proceedings.

    24

    In deferring action on the interlocutory appeal, we noted that on the record before us we could not determine whether the parties had articulated certain issues which the Vice Chancellor should have an opportunity to consider in the first instance. These included the following:

    25
    a) Does the directors' duty of care to the corporation extend to protecting the corporate enterprise in good faith from perceived depredations of others, including persons who may own stock in the company?
    26
    b) Have one or more of the plaintiffs, their affiliates, or persons acting in concert with them, either in dealing with Unocal or others, demonstrated a pattern of conduct sufficient to justify a reasonable inference by defendants that a principle objective of the plaintiffs is to achieve selective treatment for themselves by the repurchase of their Unocal shares at a substantial premium?
    27
    c) If so, may the directors of Unocal in the proper exercise of business judgment employ the exchange offer to protect the corporation and its shareholders from such tactics? See Pogostin v. Rice, Del. Supr., 480 A.2d 619 (1984).
    28
    d) If it is determined that the purpose of the exchange offer was not illegal as a matter of law, have the directors of Unocal carried their burden of showing that they acted in good faith? See Martin v. American Potash & Chemical Corp., 33 Del.Ch. 234, 92 A.2d 295 at 302.
    29

    After the May 8 hearing the Vice Chancellor issued an unreported opinion on May 13, 1985 granting Mesa a preliminary injunction. Specifically, the trial court noted that "[t]he parties basically agree that the directors' duty of care extends to protecting the corporation from perceived harm whether it be from third parties or shareholders." The trial court also concluded in response to the second inquiry in the Supreme Court's May 2 order, that "[a]lthough the facts, ... do not appear to be sufficient to prove that Mesa's principle objective is to be bought off at a substantial premium, they do justify a reasonable inference to the same effect."

    30

    As to the third and fourth questions posed by this Court, the Vice Chancellor stated that they "appear to raise the more fundamental issue of whether directors owe fiduciary duties to shareholders who they perceive to be acting contrary to the best interests of the corporation as a whole." While determining that the directors' decision to oppose Mesa's tender [953] offer was made in a good faith belief that the Mesa proposal was inadequate, the court stated that the business judgment rule does not apply to a selective exchange offer such as this.

    31

    On May 13, 1985 the Court of Chancery certified this interlocutory appeal to us as a question of first impression, and we accepted it on May 14. The entire matter was scheduled on an expedited basis.[5]

    32
    II.
    33

    The issues we address involve these fundamental questions: Did the Unocal board have the power and duty to oppose a takeover threat it reasonably perceived to be harmful to the corporate enterprise, and if so, is its action here entitled to the protection of the business judgment rule?

    34

    Mesa contends that the discriminatory exchange offer violates the fiduciary duties Unocal owes it. Mesa argues that because of the Mesa exclusion the business judgment rule is inapplicable, because the directors by tendering their own shares will derive a financial benefit that is not available to all Unocal stockholders. Thus, it is Mesa's ultimate contention that Unocal cannot establish that the exchange offer is fair to all shareholders, and argues that the Court of Chancery was correct in concluding that Unocal was unable to meet this burden.

    35

    Unocal answers that it does not owe a duty of "fairness" to Mesa, given the facts here. Specifically, Unocal contends that its board of directors reasonably and in good faith concluded that Mesa's $54 two-tier tender offer was coercive and inadequate, and that Mesa sought selective treatment for itself. Furthermore, Unocal argues that the board's approval of the exchange offer was made in good faith, on an informed basis, and in the exercise of due care. Under these circumstances, Unocal contends that its directors properly employed this device to protect the company and its stockholders from Mesa's harmful tactics.

    36
    III.
    37

    We begin with the basic issue of the power of a board of directors of a Delaware corporation to adopt a defensive measure of this type. Absent such authority, all other questions are moot. Neither issues of fairness nor business judgment are pertinent without the basic underpinning of a board's legal power to act.

    38

    The board has a large reservoir of authority upon which to draw. Its duties and responsibilities proceed from the inherent powers conferred by 8 Del.C. § 141(a), respecting management of the corporation's "business and affairs".[6] Additionally, the powers here being exercised derive from 8 Del.C. § 160(a), conferring broad authority upon a corporation to deal in its own stock.[7] From this it is now well established that in the acquisition of its shares a [954] Delaware corporation may deal selectively with its stockholders, provided the directors have not acted out of a sole or primary purpose to entrench themselves in office. Cheff v. Mathes, Del.Supr., 199 A.2d 548, 554 (1964); Bennett v. Propp, Del.Supr., 187 A.2d 405, 408 (1962); Martin v. American Potash & Chemical Corporation, Del.Supr., 92 A.2d 295, 302 (1952); Kaplan v. Goldsamt, Del.Ch., 380 A.2d 556, 568-569 (1977); Kors v. Carey, Del. Ch., 158 A.2d 136, 140-141 (1960).

    39

    Finally, the board's power to act derives from its fundamental duty and obligation to protect the corporate enterprise, which includes stockholders, from harm reasonably perceived, irrespective of its source. See e.g. Panter v. Marshall Field & Co., 646 F.2d 271, 297 (7th Cir.1981); Crouse-Hinds Co. v. Internorth, Inc., 634 F.2d 690, 704 (2d Cir.1980); Heit v. Baird, 567 F.2d 1157, 1161 (1st Cir.1977); Cheff v. Mathes, 199 A.2d at 556; Martin v. American Potash & Chemical Corp., 92 A.2d at 302; Kaplan v. Goldsamt, 380 A.2d at 568-69; Kors v. Carey, 158 A.2d at 141; Northwest Industries, Inc. v. B.F. Goodrich Co., 301 F.Supp. 706, 712 (M.D.Ill. 1969). Thus, we are satisfied that in the broad context of corporate governance, including issues of fundamental corporate change, a board of directors is not a passive instrumentality.[8]

    40

    Given the foregoing principles, we turn to the standards by which director action is to be measured. In Pogostin v. Rice, Del.Supr., 480 A.2d 619 (1984), we held that the business judgment rule, including the standards by which director conduct is judged, is applicable in the context of a takeover. Id. at 627. The business judgment rule is a "presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, Del.Supr., 473 A.2d 805, 812 (1984) (citations omitted). A hallmark of the business judgment rule is that a court will not substitute its judgment for that of the board if the latter's decision can be "attributed to any rational business purpose." Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 720 (1971).

    41

    When a board addresses a pending takeover bid it has an obligation to determine whether the offer is in the best interests of the corporation and its shareholders. In that respect a board's duty is no different from any other responsibility it shoulders, and its decisions should be no less entitled to the respect they otherwise would be accorded in the realm of business judgment.[9] See also Johnson v. Trueblood, 629 F.2d 287, 292-293 (3d Cir.1980). There are, however, certain caveats to a proper exercise of this function. Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.

    42

    This Court has long recognized that:

    43
    [955] We must bear in mind the inherent danger in the purchase of shares with corporate funds to remove a threat to corporate policy when a threat to control is involved. The directors are of necessity confronted with a conflict of interest, and an objective decision is difficult.
    44

    Bennett v. Propp, Del.Supr., 187 A.2d 405, 409 (1962). In the face of this inherent conflict directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person's stock ownership. Cheff v. Mathes, 199 A.2d at 554-55. However, they satisfy that burden "by showing good faith and reasonable investigation...." Id. at 555. Furthermore, such proof is materially enhanced, as here, by the approval of a board comprised of a majority of outside independent directors who have acted in accordance with the foregoing standards. See Aronson v. Lewis, 473 A.2d at 812, 815; Puma v. Marriott, Del.Ch., 283 A.2d 693, 695 (1971); Panter v. Marshall Field & Co., 646 F.2d 271, 295 (7th Cir.1981).

    45
    IV.
    46
    A.
    47

    In the board's exercise of corporate power to forestall a takeover bid our analysis begins with the basic principle that corporate directors have a fiduciary duty to act in the best interests of the corporation's stockholders. Guth v. Loft, Inc., Del. Supr., 5 A.2d 503, 510 (1939). As we have noted, their duty of care extends to protecting the corporation and its owners from perceived harm whether a threat originates from third parties or other shareholders.[10] But such powers are not absolute. A corporation does not have unbridled discretion to defeat any perceived threat by any Draconian means available.

    48

    The restriction placed upon a selective stock repurchase is that the directors may not have acted solely or primarily out of a desire to perpetuate themselves in office. See Cheff v. Mathes, 199 A.2d at 556; Kors v. Carey, 158 A.2d at 140. Of course, to this is added the further caveat that inequitable action may not be taken under the guise of law. Schnell v. Chris-Craft Industries, Inc., Del.Supr., 285 A.2d 437, 439 (1971). The standard of proof established in Cheff v. Mathes and discussed supra at page 16, is designed to ensure that a defensive measure to thwart or impede a takeover is indeed motivated by a good faith concern for the welfare of the corporation and its stockholders, which in all circumstances must be free of any fraud or other misconduct. Cheff v. Mathes, 199 A.2d at 554-55. However, this does not end the inquiry.

    49
    B.
    50

    A further aspect is the element of balance. If a defensive measure is to come within the ambit of the business judgment rule, it must be reasonable in relation to the threat posed. This entails an analysis by the directors of the nature of the takeover bid and its effect on the corporate enterprise. Examples of such concerns may include: inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on "constituencies" other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally), the risk of nonconsummation, and the quality of securities being offered in the exchange. See Lipton and Brownstein, Takeover Responses and Directors' Responsibilities: An Update, p. 7, ABA National Institute on the Dynamics of Corporate Control (December 8, 1983). While not a controlling factor, it also seems to us that a board may reasonably consider the basic stockholder [956] interests at stake, including those of short term speculators, whose actions may have fueled the coercive aspect of the offer at the expense of the long term investor.[11] Here, the threat posed was viewed by the Unocal board as a grossly inadequate two-tier coercive tender offer coupled with the threat of greenmail.

    51

    Specifically, the Unocal directors had concluded that the value of Unocal was substantially above the $54 per share offered in cash at the front end. Furthermore, they determined that the subordinated securities to be exchanged in Mesa's announced squeeze out of the remaining shareholders in the "back-end" merger were "junk bonds" worth far less than $54. It is now well recognized that such offers are a classic coercive measure designed to stampede shareholders into tendering at the first tier, even if the price is inadequate, out of fear of what they will receive at the back end of the transaction.[12] Wholly beyond the coercive aspect of an inadequate two-tier tender offer, the threat was posed by a corporate raider with a national reputation as a "greenmailer".[13]

    52

    In adopting the selective exchange offer, the board stated that its objective was either to defeat the inadequate Mesa offer or, should the offer still succeed, provide the 49% of its stockholders, who would otherwise be forced to accept "junk bonds", with $72 worth of senior debt. We find that both purposes are valid.

    53

    However, such efforts would have been thwarted by Mesa's participation in the exchange offer. First, if Mesa could tender its shares, Unocal would effectively be subsidizing the former's continuing effort to buy Unocal stock at $54 per share. Second, Mesa could not, by definition, fit within the class of shareholders being protected from its own coercive and inadequate tender offer.

    54

    Thus, we are satisfied that the selective exchange offer is reasonably related to the threats posed. It is consistent with the principle that "the minority stockholder shall receive the substantial equivalent in value of what he had before." Sterling v. Mayflower Hotel Corp., Del.Supr., 93 A.2d 107, 114 (1952). See also Rosenblatt v. Getty Oil Co., Del.Supr., 493 A.2d 929, 940 (1985). This concept of fairness, while stated in the merger context, is also relevant [957] in the area of tender offer law. Thus, the board's decision to offer what it determined to be the fair value of the corporation to the 49% of its shareholders, who would otherwise be forced to accept highly subordinated "junk bonds", is reasonable and consistent with the directors' duty to ensure that the minority stockholders receive equal value for their shares.

    55
    V.
    56

    Mesa contends that it is unlawful, and the trial court agreed, for a corporation to discriminate in this fashion against one shareholder. It argues correctly that no case has ever sanctioned a device that precludes a raider from sharing in a benefit available to all other stockholders. However, as we have noted earlier, the principle of selective stock repurchases by a Delaware corporation is neither unknown nor unauthorized. Cheff v. Mathes, 199 A.2d at 554; Bennett v. Propp, 187 A.2d at 408; Martin v. American Potash & Chemical Corporation, 92 A.2d at 302; Kaplan v. Goldsamt, 380 A.2d at 568-569; Kors v. Carey, 158 A.2d at 140-141; 8 Del. C. § 160. The only difference is that heretofore the approved transaction was the payment of "greenmail" to a raider or dissident posing a threat to the corporate enterprise. All other stockholders were denied such favored treatment, and given Mesa's past history of greenmail, its claims here are rather ironic.

    57

    However, our corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs. Merely because the General Corporation Law is silent as to a specific matter does not mean that it is prohibited. See Providence and Worcester Co. v. Baker, Del.Supr., 378 A.2d 121, 123-124 (1977). In the days when Cheff, Bennett, Martin and Kors were decided, the tender offer, while not an unknown device, was virtually unused, and little was known of such methods as two-tier "front-end" loaded offers with their coercive effects. Then, the favored attack of a raider was stock acquisition followed by a proxy contest. Various defensive tactics, which provided no benefit whatever to the raider, evolved. Thus, the use of corporate funds by management to counter a proxy battle was approved. Hall v. Trans-Lux Daylight Picture Screen Corp., Del.Supr., 171 A. 226 (1934); Hibbert v. Hollywood Park, Inc., Del.Supr., 457 A.2d 339 (1983). Litigation, supported by corporate funds, aimed at the raider has long been a popular device.

    58

    More recently, as the sophistication of both raiders and targets has developed, a host of other defensive measures to counter such ever mounting threats has evolved and received judicial sanction. These include defensive charter amendments and other devices bearing some rather exotic, but apt, names: Crown Jewel, White Knight, Pac Man, and Golden Parachute. Each has highly selective features, the object of which is to deter or defeat the raider.

    59

    Thus, while the exchange offer is a form of selective treatment, given the nature of the threat posed here the response is neither unlawful nor unreasonable. If the board of directors is disinterested, has acted in good faith and with due care, its decision in the absence of an abuse of discretion will be upheld as a proper exercise of business judgment.

    60

    To this Mesa responds that the board is not disinterested, because the directors are receiving a benefit from the tender of their own shares, which because of the Mesa exclusion, does not devolve upon all stockholders equally. See Aronson v. Lewis, Del.Supr., 473 A.2d 805, 812 (1984). However, Mesa concedes that if the exclusion is valid, then the directors and all other stockholders share the same benefit. The answer of course is that the exclusion is valid, and the directors' participation in the exchange offer does not rise to the level of a disqualifying interest. The excellent discussion in Johnson v. Trueblood, 629 F.2d at 292-293, of the use of the business judgment rule in takeover contests also seems pertinent here.

    61

    [958] Nor does this become an "interested" director transaction merely because certain board members are large stockholders. As this Court has previously noted, that fact alone does not create a disqualifying "personal pecuniary interest" to defeat the operation of the business judgment rule. Cheff v. Mathes, 199 A.2d at 554.

    62

    Mesa also argues that the exclusion permits the directors to abdicate the fiduciary duties they owe it. However, that is not so. The board continues to owe Mesa the duties of due care and loyalty. But in the face of the destructive threat Mesa's tender offer was perceived to pose, the board had a supervening duty to protect the corporate enterprise, which includes the other shareholders, from threatened harm.

    63

    Mesa contends that the basis of this action is punitive, and solely in response to the exercise of its rights of corporate democracy.[14] Nothing precludes Mesa, as a stockholder, from acting in its own self-interest. See e.g., DuPont v. DuPont, 251 Fed. 937 (D.Del.1918), aff'd 256 Fed. 129 (3d Cir.1918); Ringling Bros.-Barnum & Bailey Combined Shows, Inc. v. Ringling, Del.Supr., 53 A.2d 441, 447 (1947); Heil v. Standard Gas & Electric Co., Del.Ch., 151 A. 303, 304 (1930). But see, Allied Chemical & Dye Corp. v. Steel & Tube Co. of America, Del.Ch., 120 A. 486, 491 (1923) (majority shareholder owes a fiduciary duty to the minority shareholders). However, Mesa, while pursuing its own interests, has acted in a manner which a board consisting of a majority of independent directors has reasonably determined to be contrary to the best interests of Unocal and its other shareholders. In this situation, there is no support in Delaware law for the proposition that, when responding to a perceived harm, a corporation must guarantee a benefit to a stockholder who is deliberately provoking the danger being addressed. There is no obligation of self-sacrifice by a corporation and its shareholders in the face of such a challenge.

    64

    Here, the Court of Chancery specifically found that the "directors' decision [to oppose the Mesa tender offer] was made in the good faith belief that the Mesa tender offer is inadequate." Given our standard of review under Levitt v. Bouvier, Del. Supr., 287 A.2d 671, 673 (1972), and Application of Delaware Racing Association, Del.Supr., 213 A.2d 203, 207 (1965), we are satisfied that Unocal's board has met its burden of proof. Cheff v. Mathes, 199 A.2d at 555.

    65
    VI.
    66

    In conclusion, there was directorial power to oppose the Mesa tender offer, and to undertake a selective stock exchange made in good faith and upon a reasonable investigation pursuant to a clear duty to protect the corporate enterprise. Further, the selective stock repurchase plan chosen by Unocal is reasonable in relation to the threat that the board rationally and reasonably believed was posed by Mesa's inadequate and coercive two-tier tender offer. Under those circumstances the board's action is entitled to be measured by the standards of the business judgment rule. Thus, unless it is shown by a preponderance of the evidence that the directors' decisions were primarily based on perpetuating themselves in office, or some other breach of fiduciary duty such as fraud, overreaching, lack of good faith, or being uninformed, a Court will not substitute its judgment for that of the board.

    67

    In this case that protection is not lost merely because Unocal's directors have [959] tendered their shares in the exchange offer. Given the validity of the Mesa exclusion, they are receiving a benefit shared generally by all other stockholders except Mesa. In this circumstance the test of Aronson v. Lewis, 473 A.2d at 812, is satisfied. See also Cheff v. Mathes, 199 A.2d at 554. If the stockholders are displeased with the action of their elected representatives, the powers of corporate democracy are at their disposal to turn the board out. Aronson v. Lewis, Del.Supr., 473 A.2d 805, 811 (1984). See also 8 Del.C. §§ 141(k) and 211(b).

    68

    With the Court of Chancery's findings that the exchange offer was based on the board's good faith belief that the Mesa offer was inadequate, that the board's action was informed and taken with due care, that Mesa's prior activities justify a reasonable inference that its principle objective was greenmail, and implicitly, that the substance of the offer itself was reasonable and fair to the corporation and its stockholders if Mesa were included, we cannot say that the Unocal directors have acted in such a manner as to have passed an "unintelligent and unadvised judgment". Mitchell v. Highland-Western Glass Co., Del. Ch., 167 A. 831, 833 (1933). The decision of the Court of Chancery is therefore REVERSED, and the preliminary injunction is VACATED.

    69

    [1] T. Boone Pickens, Jr., is President and Chairman of the Board of Mesa Petroleum and President of Mesa Asset and controls the related Mesa entities.

    70

    [2] This appeal was heard on an expedited basis in light of the pending Mesa tender offer and Unocal exchange offer. We announced our decision to reverse in an oral ruling in open court on May 17, 1985 with the further statement that this opinion would follow shortly thereafter. See infra n. 5.

    71

    [3] Mesa's May 3, 1985 supplement to its proxy statement states:

    72

    (i) following the Offer, the Purchasers would seek to effect a merger of Unocal and Mesa Eastern or an affiliate of Mesa Eastern (the "Merger") in which the remaining Shares would be acquired for a combination of subordinated debt securities and preferred stock; (ii) the securities to be received by Unocal shareholders in the Merger would be subordinated to $2,400 million of debt securities of Mesa Eastern, indebtedness incurred to refinance up to $1,000 million of bank debt which was incurred by affiliates of Mesa Partners II to purchase Shares and to pay related interest and expenses and all then-existing debt of Unocal; (iii) the corporation surviving the Merger would be responsible for the payment of all securities of Mesa Eastern (including any such securities issued pursuant to the Merger) and the indebtedness referred to in item (ii) above, and such securities and indebtedness would be repaid out of funds generated by the operations of Unocal; (iv) the indebtedness incurred in the Offer and the Merger would result in Unocal being much more highly leveraged, and the capitalization of the corporation surviving the Merger would differ significantly from that of Unocal at present; and (v) in their analyses of cash flows provided by operations of Unocal which would be available to service and repay securities and other obligations of the corporation surviving the Merger, the Purchasers assumed that the capital expenditures and expenditures for exploration of such corporation would be significantly reduced.

    73

    [4] Under Delaware law directors may participate in a board meeting by telephone. Thus, 8 Del.C. § 141(i) provides:

    74

    Unless otherwise restricted by the certificate of incorporation or by-laws, members of the board of directors of any corporation, or any committee designated by the board, may participate in a meeting of such board or committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this subsection shall constitute presence in person at such meeting.

    75

    [5] Such expedition was required by the fact that if Unocal's exchange offer was permitted to proceed, the proration date for the shares entitled to be exchanged was May 17, 1985, while Mesa's tender offer expired on May 23. After acceptance of this appeal on May 14, we received excellent briefs from the parties, heard argument on May 16 and announced our oral ruling in open court at 9:00 a.m. on May 17. See supra n. 2.

    76

    [6] The general grant of power to a board of directors is conferred by 8 Del.C. § 141(a), which provides:

    77

    (a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation. (Emphasis added)

    78

    [7] This power under 8 Del.C. § 160(a), with certain exceptions not pertinent here, is as follows:

    79

    (a) Every corporation may purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use and otherwise deal in and with its own shares; ...

    80

    [8] Even in the traditional areas of fundamental corporate change, i.e., charter, amendments [8 Del.C. § 242(b)], mergers [8 Del.C. §§ 251(b), 252(c), 253(a), and 254(d)], sale of assets [8 Del.C. § 271(a)], and dissolution [8 Del.C. § 275(a)], director action is a prerequisite to the ultimate disposition of such matters. See also, Smith v. Van Gorkom, Del.Supr., 488 A.2d 858, 888 (1985).

    81

    [9] This is a subject of intense debate among practicing members of the bar and legal scholars. Excellent examples of these contending views are: Block & Miller, The Responsibilities and Obligations of Corporate Directors in Takeover Contests, 11 Sec.Reg. L.J. 44 (1983); Easterbrook & Fischel, Takeover Bids, Defensive Tactics, and Shareholders' Welfare, 36 Bus.Law. 1733 (1981); Easterbrook & Fischel, The Proper Role of a Target's Management In Responding to a Tender Offer, 94 Harv.L.Rev. 1161 (1981). Herzel, Schmidt & Davis, Why Corporate Directors Have a Right To Resist Tender Offers, 3 Corp.L.Rev. 107 (1980); Lipton, Takeover Bids in the Target's Boardroom, 35 Bus.Law. 101 (1979).

    82

    [10] It has been suggested that a board's response to a takeover threat should be a passive one. Easterbrook & Fischel, supra, 36 Bus.Law. at 1750. However, that clearly is not the law of Delaware, and as the proponents of this rule of passivity readily concede, it has not been adopted either by courts or state legislatures. Easterbrook & Fischel, supra, 94 Harv.L.Rev. at 1194.

    83

    [11] There has been much debate respecting such stockholder interests. One rather impressive study indicates that the stock of over 50 percent of target companies, who resisted hostile takeovers, later traded at higher market prices than the rejected offer price, or were acquired after the tender offer was defeated by another company at a price higher than the offer price. See Lipton, supra 35 Bus.Law. at 106-109, 132-133. Moreover, an update by Kidder Peabody & Company of this study, involving the stock prices of target companies that have defeated hostile tender offers during the period from 1973 to 1982 demonstrates that in a majority of cases the target's shareholders benefited from the defeat. The stock of 81% of the targets studied has, since the tender offer, sold at prices higher than the tender offer price. When adjusted for the time value of money, the figure is 64%. See Lipton & Brownstein, supra ABA Institute at 10. The thesis being that this strongly supports application of the business judgment rule in response to takeover threats. There is, however, a rather vehement contrary view. See Easterbrook & Fischel, supra 36 Bus.Law. at 1739-1745.

    84

    [12] For a discussion of the coercive nature of a two-tier tender offer see e.g., Brudney & Chirelstein, Fair Shares in Corporate Mergers and Takeovers, 88 Harv.L.Rev. 297, 337 (1974); Finkelstein, Antitakeover Protection Against Two-Tier and Partial Tender Offers: The Validity of Fair Price, Mandatory Bid, and Flip-Over Provisions Under Delaware Law, 11 Sec.Reg. L.J. 291, 293 (1984); Lipton, supra, 35 Bus.Law at 113-14; Note, Protecting Shareholders Against Partial and Two-Tiered Takeovers: The Poison Pill Preferred, 97 Harv.L.Rev. 1964, 1966 (1984).

    85

    [13] The term "greenmail" refers to the practice of buying out a takeover bidder's stock at a premium that is not available to other shareholders in order to prevent the takeover. The Chancery Court noted that "Mesa has made tremendous profits from its takeover activities although in the past few years it has not been successful in acquiring any of the target companies on an unfriendly basis." Moreover, the trial court specifically found that the actions of the Unocal board were taken in good faith to eliminate both the inadequacies of the tender offer and to forestall the payment of "greenmail".

    86

    [14] This seems to be the underlying basis of the trial court's principal reliance on the unreported Chancery decision of Fisher v. Moltz, Del.Ch. No. 6068 (1979), published in 5 Del.J.Corp.L. 530 (1980). However, the facts in Fisher are thoroughly distinguishable. There, a corporation offered to repurchase the shares of its former employees, except those of the plaintiffs, merely because the latter were then engaged in lawful competition with the company. No threat to the enterprise was posed, and at best it can be said that the exclusion was motivated by pique instead of a rational corporate purpose.

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