In re Sterling Foster and Co., Inc. Securities Litigation

Sterling Foster and Co., Inc. (SFC) (defendant) and Patterson Travis, Inc., underwrote public offerings for six companies (the issuers) (defendants). Purchasers of the issuers’ securities (the purchasers) (plaintiffs) sued SFC, the issuers, and others, alleging securities-law violations. The actions were consolidated, and a class-action complaint was filed, alleging that (1) before each issuer’s public offering, company insiders and principal stockholders (insiders) purchased shares for up to $1 per share, while shares were being offered to the public for five times that price; (2) most insiders entered into lock-up agreements, agreeing not to sell their shares for at least one year without SFC’s permission; (3) the issuers’ prospectuses failed to disclose that SFC had secretly agreed to release the insiders from their lock-up agreements after the registration statements became effective and purchase their shares at per-share prices from $1.50 to about $3 to cover a short position SFC intended to take in the aftermarket; (4) SFC’s sales force engaged in boiler-room sales practices designed to artificially inflate the demand for, and price of, the issuers’ stocks; (5) when the share prices and demand reached certain levels, SFC sold shares to the public at the artificially inflated prices, often selling many more shares than it owned; (6) SFC failed to provide the purchasers with copies of the issuers’ prospectuses and led the purchasers to believe they were buying shares in initial public offerings rather than the aftermarket; (7) SFC covered its short positions by releasing the insiders from their lock-up agreements and purchasing the shares at the agreed-upon discounted prices; and (8) the flood of shares on the market caused share prices to drop, and the purchasers lost the value of their investments. SFC and other defendants moved to dismiss the purchasers’ claims under § 12(a)(2) of the Securities Act of 1933 (Securities Act), arguing that the purchasers lacked standing to bring the claims because they purchased their shares in secondary-market transactions and not in the public offerings. Section 12(a)(2) gave purchasers a cause of action for rescission against issuers who made material misstatements or omissions in a prospectus.