Shearman & Sterling obtained a significant victory in In re FLAG Telecom Holdings, Ltd. Securities Litigation, a securities class action that the firm has been litigating for the past seven years, when the United States Court of Appeals for the Second Circuit excluded "in-and-out" purchasers—investors who sold their shares before the disclosure to the market of the putative fraud—from the certified class. The decision, which came on an interlocutory appeal pursuant to Rule 23(f) of the Federal Rules, is the first appeals court ruling in the country to address the issue. The Second Circuit's ruling also had the indirect effect of wiping out the bulk of the damages claimed by the plaintiffs.

In the complaint, the plaintiffs alleged that FLAG, which was in the business of providing telecommunications capacity on its fiber optic network to other telecoms, failed to tell the market prior to February 13, 2002, that a percentage of its revenues stemmed from "swaps" of capacity with other providers. In the two days after the February 2002 disclosure, FLAG's stock price dropped from 67 cents to 30 cents a share -- more than half, but still only 37 cents. In order to claim greater damages, the plaintiffs asserted that some of the information about FLAG's purportedly inflated revenues began to "leak" into the market earlier in the class period, and that accordingly the disclosure of the truth caused a much greater skid in the share price than the 37 cent drop in February 2002 would suggest (in February 2001, for example, FLAG's stock was trading at $13 per share).

When the district court certified the class in September 2007, it permitted the in-and-out traders to remain in the class because, the court said, it was "conceivable" that they "may be able" to prove that the "truth" leaked into the market during the class period and that their losses were caused by the purported fraud. Shearman & Sterling argued that, under the "preponderance of the evidence" standard set forth by the Second Circuit in its decision in In re Initial Pub. Offerings Sec. Litig., 471 F.3d 24 (2d Cir. 2006), it was not enough to show that it was conceivable, and that, in any event, none of the evidence put forward by the plaintiffs met even that test. The Second Circuit agreed, and thereby pulled the rug out from under the plaintiffs' theory of damages. Shearman & Sterling’s clients opposed class certification on several other grounds at the district court level, one of which was also included in their brief at the appellate level, but those arguments were rejected.

Shearman & Sterling’s clients in the litigation are seven former FLAG officers and directors. The plaintiffs have asserted claims against each of them, and Citigroup Global Markets Inc., pursuant to sections 11, 12 (a)(2) and 15 of the Securities Act of 1933 for an alleged misstatement in the prospectus for FLAG’s initial public offering in 2000. The plaintiffs also brought claims against the three former FLAG officers for alleged violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934. FLAG itself (which was also represented by Shearman & Sterling) is no longer a defendant because the district court granted its motion to dismiss in 2005.

Professor Arthur Miller, a leading scholar in the field of American civil procedure, argued the appeal for the plaintiffs in the Second Circuit. New York litigation partner Jerome S. Fortinsky argued for the individual defendants. The Shearman & Sterling team on the FLAG litigation included: counsel Daniel Laguardia (New York-Litigation) and associates Miriam Farber (New York-Litigation), Richard Kelly (London-Litigation), Jeffrey Resetarits (New York-Litigation), Grace Lee (New York-Litigation), Robert Whitener (New York-Litigation), Melissa Godwin (New York-Litigation), Michael Mitchell (New York-Litigation), Colleen Meringolo (New York-Litigation), Nicholas Menasche (New York-Litigation), Brian McElroy (New York-Litigation), Navid Mehrjou (New York-Litigation), and Andrew Stephens (New York-Litigation); and legal assistants Laurel Bernick (New York-Litigation) and Mariusz Jedrzejewski (New York-Litigation).