## Facts

- Investors brought a consolidated putative class action arising from public offerings of securities of six small issuers underwritten and sold by a broker-dealer.
- Plaintiffs alleged a coordinated scheme involving underwriting defendants, issuers, and insiders to inflate aftermarket prices and then profit as prices later collapsed.
- Insiders allegedly acquired shares at very low prices before the offerings, while the public was sold shares at significantly higher offering prices.
- Insiders allegedly entered lock-up agreements restricting resale, but the offering materials allegedly failed to disclose a secret understanding that insiders would be released early and their shares repurchased at prearranged prices.
- Plaintiffs alleged the underwriter used high-pressure sales tactics to create artificial demand and sold large volumes into the aftermarket at inflated prices, including sales in excess of its inventory (short selling).
- Plaintiffs alleged they were not provided prospectuses and were led to believe they were purchasing in the initial offerings when they were actually purchasing in the aftermarket.
- The underwriter allegedly covered short positions by releasing insiders from lock-ups and buying their low-cost shares, which increased supply and contributed to price collapses and investor losses.
- Plaintiffs asserted, among other claims, Securities Act § 12(a)(2) claims based on material misstatements and omissions in prospectuses concerning the undisclosed lock-up and short-covering arrangements.

## Issues

1. Whether investors who purchased in aftermarket transactions, rather than directly in the registered offerings, have standing to sue under Securities Act § 12(a)(2).
2. Whether a § 12(a)(2) claim can be pleaded where plaintiffs allege they did not receive the prospectus, but contend the securities were sold “by means of” a prospectus containing material omissions.
3. Whether the alleged undisclosed lock-up release and short-covering arrangements were sufficiently connected to the challenged sales and plausibly material at the motion-to-dismiss stage.

## Decision

- The court denied defendants’ motion to dismiss the § 12(a)(2) claims for lack of standing.
- Accepting the allegations as true, the court held plaintiffs plausibly alleged that their purchases, though in the aftermarket, occurred as part of a distribution-like scheme carried out by means of materially misleading prospectuses and related selling efforts.
- The court rejected the argument that failure to deliver a prospectus to each purchaser necessarily defeats § 12(a)(2) pleading where the prospectus allegedly functioned as part of the mechanism enabling the sales.
- The court held the allegations were sufficient at the pleading stage to proceed on a theory that the omitted agreements affected supply, demand, and price and were material to investors.

## Legal Principles

- Section 12(a)(2) may reach sales to aftermarket purchasers when the complaint plausibly alleges an integrated distribution-like scheme in which a materially misleading prospectus (or related oral communications) was used as a means of effecting the sales.
- Actual physical delivery of the prospectus to the particular purchaser is not categorically required at the pleading stage if the prospectus is plausibly alleged to have been part of the sales mechanism.
- On a Rule 12(b)(6) motion, the court accepts well-pleaded factual allegations as true and draws reasonable inferences in plaintiffs’ favor when assessing standing and plausibility of the statutory nexus (“by means of”) and materiality.

## Conclusion

The court allowed § 12(a)(2) claims to proceed where plaintiffs alleged that aftermarket purchases were part of a continuous offering-related manipulation scheme and that misleading prospectuses, despite not being delivered to each purchaser, plausibly operated as a means by which the challenged sales were made.


In re Sterling Foster & Co., Inc. Securities Litig., 222 F. Supp. 2d 216 (E.D.N.Y. 2002)