Summary
finding a detailed chart of the sales alleged to underlie the death spiral scheme to be sufficient
Summary of this case from Pet Quarters, Inc. v. BadianOpinion
02 Civ. 0767 (LBS)
October 10, 2002
OPINION AND ORDER
Plaintiff Nanopierce ("NPCT" or "Plaintiff") brings nine claims in various combinations against Defendants Southridge Capital Management LLC ("Southridge"), Dan Pickett ("Pickett"), Patricia Singer ("Singer"), Thomson Kernaghan Co. ("TK"), and Harvest Court LLC ("Harvest Court") (collectively "Defendants"). The claims allege (1) misrepresentation under § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"). 15 U.S.C. § 78j(b), and Securities and Exchange Commission ("SEC") Rule 10b-5, C.F.R. § 240.10b-5, promulgated thereunder; (2) stock manipulation under § 10(b) and Rule 10b-5; (3) control person liability on the basis of the aforementioned § 10(b) claims under § 20(a) of the Exchange Act; (4) securities fraud under Colorado law; (5) control person liability on the basis of the Colorado securities violation; (6) aiding and abetting the Colorado securities violation; (7) common law fraud; (8) civil conspiracy; and (9) breach of contract. Claims 2, 4, 6, and 8 are asserted against all Defendants; claims 1 and 7 are asserted against Southridge, Pickett, and Singer; claims 3 and 5 are asserted against Southridge, Pickett, and TK; and claim 9 is asserted solely against Harvest Court. (First Amended Complaint ("Complaint") at 21-27.) Defendants move to dismiss all claims pursuant to Fed.R.Civ.P. 12(b)(6) for failure to state a claim, and to dismiss the fraud claims pursuant to Fed.R.Civ.P. 9(b) and the Private Securities Litigation Reform Act of 1995 ("PSLRA") for failure to plead with the requisite particularity.
I. Allegations
On a motion to dismiss, the Court must accept as true all allegations in the Complaint, and draw all inferences therefrom in favor of the plaintiff. Grandon v. Merrill Lynch Co., 147 F.3d 184, 188 (2d Cir. 1998). The following facts are therefore drawn from the Complaint.
At the end of 1999, NPCT obtained financing from a company called Equinox Investors, LLC ("Equinox"), not a party in this action. Under the financing agreement, Equinox received what are known as convertible debentures, which means that Equinox could convert its notes into a certain number of shares of NPCT stock depending on the stock's current trading price. NPCT alleges that, heeding its economic self-interest, Equinox proceeded artificially to depress the price of NPCT stock through short sales and other methods, and thereafter to convert its notes into a large number of NPCT shares. (Complaint at 7.)
Due in part to the fallout from the Equinox affair, NPCT sought additional financing from Defendant Southridge. In a September 26, 2000, meeting at Southridge's Connecticut office, NPCT's president Paul Metzinger ("Metzinger") negotiated an agreement with Southridge employees Defendants Singer and Pickett. Metzinger informed Singer of NPCT's problems with Equinox, in response to which "Singer assured Nanopierce that Southridge would not engage in these practices" or "behave as . . . Equinox had." (Complaint at 8.) Defendant Pickett affirmed as well that "Southridge was no Equinox" and that "Southridge did not make its money that way." (Complaint at 9.) Nonetheless, Pickett insisted that the financing agreement between NPCT and Southridge contain so-called reset rights. Reset rights entitle the lender to additional shares of common stock in the event the stock price declines; they function similarly to convertible debentures in that the number of additional shares issued depends on the stock's current trading price. Pickett asserted that Southridge sought reset rights "only to `protect its investors'" in case the stock declined due to "normal market forces," and that Nanopierce "`did not have to worry' about Southridge exhibiting behavior like that of Equinox." (Complaint at 9-10.)
NPCT and Southridge closed the new financing agreement (Annex A to Affirmation of Caryn G. Mazin in Support of Motion to Dismiss First Amended Complaint ("the Agreement")) on October 20, 2000. The Agreement called for $7.5 million in initial financing in exchange for 4,531,613 shares of NPCT stock. (Complaint at 13.) The reset clause included three reset dates (65, 130, and 195 days after the closing) at which times additional shares would be issued (without additional consideration) if the stock was trading below the initial purchase price. The number of shares to be issued was determined by a formula taking into account the lowest bid prices over the 65 days preceding each reset date. (Agreement at 7.) The Agreement also provided for an additional $7.5 million in financing at a future date, on the condition that NPCT's stock met certain price and volume thresholds. (Agreement at 9.) Additiondlly. just before the closing Defendants substituted as signatory a Cayman Islands entity, Defendant Harvest Court, which NPCT alleges was merely a "straw man" for Southridge. (Complaint at 13.)
The portion of the contract setting forth the terms of the reset warrant was not included in any of the documents submitted to the Court. But NPCT asserts that the shares were issued without additional consideration (Transcript of Oral Argument, September 12, 2002 ("Oral Argument"), at 20), and Defendants do not dispute this assertion.
At this point, according to the Complaint, Defendants began to execute a scheme to enrich themselves by driving down the price of NPCT stock and exploiting the reset rights. On October 23, 2000, the first trading day after the closing, Defendant TK, "purportedly acting on behalf of Harvest Court," commenced a sequence of large sales of NPCT stock. For approximately six months, until May 9, 2001 (when Defendants allegedly liquidated their position in NPCT), TK sold NPCT stock nearly every day, accounting for an average of 36.5% of the daily traded volume and 22.7% of the traded volume over the entire period. On 47 trading days within this period, TK accounted for over half of the volume of NPCT trades. The stock price, which had closed at $2.63 on October 23, 2000, dropped steadily, reaching a low of $0.32 in April 2001, and closing at $0.51 on May 9, 2001. (Complaint at 14-18.) NPCT asserts that "[n]o material adverse information had been disclosed about Nanopierce that would . . . account for the decline." (Complaint at 20.) After the first reset date, TK requested, and NPCT issued, 2,143,975 reset shares pursuant to the formula. (Complaint at 21.)
Beyond this unusual timing and pattern of sales, NPCT also alleges that TK acted suspiciously by conducting a large amount of its trading through non-party Jeffries Co. Jeffries Co. is apparently not a market maker in NPCT stock, which Plaintiff suggests means that TK was interested in something other than receiving the best price for its stock. (Complaint at 20.) Finally, NPCT alleges that Defendants' manipulation of NPCT stock was only one example of an extensive "unlawful scheme," by which Defendants insert conversion and reset provisions into financing agreements with other companies, and then proceed to drive down the stock price via dumping, short sales, and other means. The Complaint includes a list of 27 other companies alleged to be victims of Defendants' scheme. (Complaint at 4-6.)
II. Standard of Review
"Dismissal of the complaint is proper only where it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Automated Salvage Transp., Inc. v. Wheelabrator Envtl. Sys., Inc., 155 F.3d 59, 67 (2d Cir. 1998) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)) (footnote, citation, and quotation marks omitted). The Court may take into account documents incorporated by reference in the Complaint, or documents of which Plaintiff had notice or on which Plaintiff relied in bringing suit. Cortec Indus. v. Sum Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991).
III. Claim 1 — Misrepresentation in violation of § 10(b) and Rule 10b-5 (Pickett, Singer, and Southridge)
NPCT alleges that during the negotiations Defendants made misrepresentations and omissions that amounted to securities fraud in violation of § 10(b) and Rule 10b-5. Specifically, NPCT charges both Pickett and Singer with their statements assuring Metzinger that the Southridge Agreement would not be a repeat of the Equinox experience, and that the reset rights were intended merely to protect Southridge against "normal market forces." NPCT also charges Pickett with misrepresenting that a total of $15 million in financing would be available, when in fact only $7.5 million was provided. Additionally, NPCT labels omissions the failure of Pickett and Singer to disclose (1) their intention to manipulate NPCT stock; (2) their intention to avoid the second $7.5 million in financing; (3) their intention to "attempt to take control over Nanopierce"; (4) their "pattern and practice" of manipulating the stock of other companies; (5) a jury verdict against a company allegedly associated with Defendants for manipulating the stock of a company called DG Jewellery [sic]; and (6) testimony by Pickett that Southridge clients tend to "liquidate their stock positions before the expiration of the initial reset period." (Complaint at 8-12.) Southridge is alleged to be liable on the basis of these statements and omissions by its employees.
NPCT also labels a misrepresentation assertions by Pickett and Singer that "Southridge had been in business since 1993, managed over four hundred million dollars in assets, and owned the building in which they were meeting."
To allege a misrepresentation claim under § 10(b) and Rule 10b-5, "a plaintiff must plead that the defendant made a false statement or omitted a material fact, with scienter, and that plaintiff's reliance on defendant's action caused plaintiff injury." Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir. 2001). In addition, the misrepresentation or omission underlying the claim must be made "in connection with the purchase or sale of any security." 15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b-5. Claims alleging fraud must be pleaded with particularity, Fed.R.Civ.P. 9(b), and "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were made." Shields v. Citytrust Bancorp, 25 F.3d 1124, 1128 (2d Cir. 1994).
Defendants object to these allegations on a variety of grounds. First, Defendants argue that NPCT has failed to allege facts demonstrating that the alleged misrepresentations were false. (Memorandum of Law in Support of Motion To Dismiss First Amended Complaint ("Def. Mem.") at 9-10.) Although the Court agrees that Plaintiff has erred on the side of alleging more misrepresentations than facts demonstrating falsehood, it nonetheless finds that the description of the manipulative scheme alleged in this case amply supports the crux of Plaintiff's misrepresentation claim, which is that Defendants represented that they would not manipulate NPCT's stock. See Internet Law Library v. Southridge Capital Mgmt., 2002 U.S. Dist. LEXIS 13172, *16-*17 (S.D.N.Y. July 18, 2002) (Carter, J.).
For example, NPCT's charge that Defendants omitted to mention the jury verdict finding manipulation of D.G. Jewellery's stock comes despite the fact that, as Defendants note, the trial court in that case immediately set the jury's verdict aside. See Haymarket LLC v. D.G. Jewellery [sic] of Canada Ltd., 290 A.D.2d 318, 319, 736 N.Y.S.2d 356 (1st Dept. 2002) (affirming the trial court's vacatur of the jury verdict). Nor does the Court find that Plaintiff has alleged any facts supporting an inference that Defendants schemed to take control over NPCT, or that any of the representations about Southridge's business history, see fn.2, supra were false.
Next, Defendants argue that because the written terms of the Agreement fully explain the operation of the reset rights without restricting Harvest Court's right to sell its shares of NPCT stock, Plaintiff could not reasonably rely upon any prior oral statements to the contrary. (Def. Mem. at 9; Reply to Opposition to Motion To Dismiss First Amended Complaint ("Def. Reply Mem.") at 7.) The Court is mindful that a written agreement can preclude reliance on contrary oral representations. See, e.g., Global Intellicom v. Thomson Kernaghan Co., 1999 U.S. Dist. LEXIS 11378, *31-*34 (S.D.N.Y. July 27, 1999) (Cote, J.) (finding it unreasonable to rely on an oral representation that defendants would not engage in short selling when defendants specifically refused to insert such language in the written contract and the contract expressly permitted all legal sales). Nonetheless, the Court finds that in this case the substance of the alleged misrepresentations — that Defendants would not engage in a manipulative scheme to depress the price of NPCT stock — was not explicitly addressed in the Agreement here. See Internet Law Library, 2002 U.S. Dist. LEXIS 13172, at *25-*28.
Defendants next attack NPCT's pleading of scienter. Under the PSLRA, which "raised pleading requirements to a level commensurate with those long in place in the Second Circuit," see id. at *20, Plaintiff must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," 15 U.S.C. § 78u-4(b)(2). The required state of mind is "an intent to deceive, manipulate, or defraud," Kalnit, 264 F.3d at 138, and Plaintiff may carry this burden "either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness," id. at 138-39 (quoting Acito v. Imcera Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995). In the Complaint, NPCT takes the first road, alleging that the economic structure of the Agreement gave Defendants "both the motive and the opportunity to defraud Nanopierce." (Complaint at 21-22.)
NPCT subsequently argues that it has sufficiently alleged scienter via the "conscious misbehavior or recklessness" avenue as well (Plaintiff's Memorandum of Law in Support of its Opposition to Defendants Motion To Dismiss ("Pl. Mem.") at 3-4), but because the Court is satisfied with the pleading of scienter on the basis of "motive and opportunity," it does not address this argument.
Defendants' major scienter argument is that they lacked any motive to manipulate downward the price of NPCT stock, because as stockholders (and holders of warrants to purchase additional shares) they stood to profit if the stock price went up. (Def. Mem. at 7-8; Def. Reply Mem. at 5-6.) This argument has been urged on this Court without success on more than one occasion in the past. See, e.g., Internet Law Library, 2002 U.S. Dist. LEXIS 13172, at *22-*24 ("[D]efendants' contention that they stood to profit from an increase in the stock price of ITIS shares . . . does not foreclose the possibility that they stood to gain even more from a decline in the price of ITIS stock."), Global Intellicom, 1999 U.S. Dist. LEXIS 11378, at *28; SEC v. Parnes, 2001 U.S. Dist. LEXIS 21722, *17-*18 (S.D.N.Y. Dec. 26, 2001) (Stanton, J.). Defendants correctly point out that this case is somewhat more complicated than the cases cited above because Plaintiff here does not allege that Defendants engaged in short sales as the stock price declined. (Def. Reply Mem. at 6.) The import of this distinction is that as a stockholder Harvest Court stood to lose money from the stock decline at the same time as it made money through the additional (but devalued) reset shares. A financial loss for Harvest Court was therefore one possible outcome of declining stock prices; but it was not the only possible outcome, and it is not the outcome that NPCT alleges. Under the Agreement, the net economic effect on Defendants of a drop in NPCT stock price depended on a complex interaction of the rate of the price drop, the rate of liquidation by Harvest Court, and any potential upturn in stock price while Harvest Court still owned, or was owed, shares. Indeed, according to Plaintiff, after the delivery of the first reset at 2,143,975 shares, the second reset (which was never honored) "purportedly entitled the defendants to 7,247,871 shares; and the third [also never honored] would have entitled the defendants to 4,552,455 shares of stock. The total value of these reset shares would have been $11,510,514." (Plaintiff's Memorandum of Law in Support of its Opposition to Defendants' Motion To Dismiss ("Pl. Mem.") at 6.) Any remaining questions are for discovery and trial: even in the absence of short selling, the allegations of motive here are more than sufficient to survive a motion to dismiss.
Although the cases cited above involved convertible debentures rather than reset rights, the Court is not persuaded that there is any difference between the two for these purposes. The function of the reset provision, just like the function of a convertible debenture, is to provide the lender with a greater number of shares, each of lesser value, as the stock price declines.
The Complaint suggests that manipulation occurred via "pre-arranged sales, covering short positions, and painting the tape," but NPCT appears to have dropped any allegations of painting the tape, as well as any allegations of short-selling beyond the first three days of sales. (Oral Argument at 17.)
Even if it turns out that Defendants ultimately lost money on their investment, that fact might not be dispositive to a finding of scienter.Cf. Markowski v. SEC, 274 F.3d 525, 529 (D.C. Cir. 2001) ("Just because a manipulator loses money doesn't mean he wasn't trying.").
NPCT suggests that Defendants also stood to gain from depressing the stock price by avoiding their obligation to provide the additional $7.5 million in financing. (Pl. Mem. at 5.) The Court is not persuaded by this argument: if the additional financing were required it would have been a consequence of the shares held by Defendant having appreciated in value.
Finally, Defendants argue that any misrepresentations and omissions were not made "in connection with the purchase and sale of any security" within the definition of § 10(b) because they did not "go to the value of the securities or the value of the consideration for the securities." (Def. Mem. at 12-13.) This interpretation is too restrictive. See SEC v. Zandford, 122 S.Ct. 1899, 1903 (2002) ("[N]either the SEC nor this Court has ever held that there must be a misrepresentation about the value of a particular security in order to run afoul of the Act."); id. at 1904 ("It is enough that the scheme to defraud and the sale of securities coincide.").
IV. Claim 2 — Manipulation in violation of § 10(b) and Rule 10b-5 (all Defendants)
Defendants next attack NPCT's manipulation claim on two fronts. Defendants argue first that the Complaint lacks the specificity requisite under Rule 9(b) because it does not distinguish which of the various defendants performed which manipulative acts, and because it does not allege specific examples of pre-arranged sales or "painting the tape." (Def. Mem. at 14-15.) This argument is rejected. "In market manipulation claims, courts have more relaxed pleading requirements, since market manipulation claims present circumstances in which the mechanism of the scheme is likely to be unknown to the plaintiffs. In such situations, courts have only required the plaintiff to lay out the nature, purpose, and effect of the fraudulent conduct and the roles of the defendant without requiring specific instances of the conduct." Global Intellicom, 1999 U.S. Dist. LEXIS 11378, at *23-*24. The Complaint amply lays out the nature and purpose of the manipulation alleged here, and provides a detailed chart of the sales by TK alleged to underlie the scheme (Complaint at 14-18).
"Painting the tape" signifies creating an appearance of trading activity without an actual change in beneficial ownership.
More cogently, Defendants argue that their alleged behavior, essentially just selling NPCT stock, does not amount to impermissible manipulation:
[S]imply because sales affect the price of stock does not mean that the sales are manipulative . . . NPCT included no restrictions on the sale of these shares . . . NPCT fails to allege that any specific inaccurate information was injected into the market, the litmus test for a market manipulation claim. NPCT thus fails to allege any cognizable claim of stock manipulation. (Def. Mem. at 16.)
Defendants contend that a rule holding traders liable for mere "intent to depress the price of a stock" would have the consequence that "any person who sells large quantities of stock on the open market would have to fear being hailed [sic] into court to face a manipulation claim" (Def. Reply Mem. at 5.) NPCT, for its part, responds that "[t]he law forbids all techniques, both old and new, of artificially affecting the price of securities." (Pl. Mem. at 11.)
According to the Supreme Court, the word "manipulative" "was virtually a term of art when used in connection with securities markets. It connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities." Ernst Ernst v. Hochfelder, 425 U.S. 185, 198 (1976). Stock manipulation is proscribed by, inter alia, § 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), which prohibits the use "in connection with the purchase or sale of any security" of "any manipulative or deceptive device or contrivance" as defined by the SEC. Rule 10b-5. C.F.R. § 240.10b-5, promulgated pursuant to § 10(b), makes it unlawful:
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
Additionally, § 9(a)(1) of the Exchange Act prohibits two specific species of manipulation known as matched orders and wash orders. 15 U.S.C. § 78i(a)(1)(A-C). § 9(a)(2) generally prohibits "creating actual or apparent active trading" in, or "raising or depressing the price" of a security listed on a national exchange, "for the purpose of inducing the purchase or sale of such security by others." 15 U.S.C. § 78i(a)(2).
A plaintiff claiming market manipulation under Rule 10b-5 must plead the following elements: "(1) damage, (2) caused by reliance on defendants' misrepresentations or omissions of material fact, or on a scheme by the defendants to defraud, (3) scienter, (4) in connection with the purchase or sale of securities, (5) furthered by the defendants' use of the mails or any facility of a national securities exchange." Schnell v. Conseco, Inc., 43 F. Supp.2d 438, 448 (S.D.N.Y. 1999) (Parker, J.).
The Court acknowledges that the law of the Second Circuit on so-called open-market manipulation — where the alleged manipulator has made otherwise legitimate trades, yet with the subjective intent to affect the stock price thereby — is not yet fully settled. The analysis must begin with United States v. Mulheren, 938 F.2d 364 (2d Cir. 1991). Mulheren was an acquaintance of Ivan Boesky and was convicted of Rule 10b-5 manipulation for trading in Gulf Western stock with the purpose of driving its price up to $45, which had the effect of triggering a prior agreement under which Boesky stood to make a significant amount of money. According to the government's theory, the Court of Appeals explained,
when an investor, who is neither a fiduciary nor an insider, engages in securities transactions in the open market with the sole intent to affect the price of the security, the transaction is manipulative and violates Rule 10b-5. . . . When the transaction is effected for an investment purpose, the theory continues, there is no manipulation, even if an increase or diminution in price was a foreseeable consequence of the investment. . . . Although we have misgivings about the government's view of the law, we will assume, without deciding on this appeal, that an investor may lawfully be convicted under Rule 10b-5 where the purpose of his transaction is solely to affect the price of a security.Id. at 368.
The court proceeded to overturn the conviction on the ground that the evidence adduced at trial did not support a finding of manipulative intent. Among the relevant factors were (1) the paucity of evidence as to intent (essentially one cryptic phone conversation), id. at 367-69; (2) that Mulheren himself lost money on the deal, id. at 370; and (3) Mulheren's domination of the market for only a brief portion of one day,id. at 371. The court added, however, that "[w]hen domination is sustained over . . . an extended period of time, evidence of manipulation is strong." Id. at 371.
See also In re College Bound Consolidated Litigation, 1995 U.S. Dist. LEXIS 10684 (S.D.N.Y. July 31, 1995) (Mukasey, J.). The College Bound court similarly declined to decide the issue left open byMulheren, finding that plaintiffs had not pleaded the necessary elements of a manipulation scheme to inflate a stock price by making large purchases at the end of the day. The court identified the "elements of an open-market manipulation claim outlined in Mulheren" as: "1) profit or personal gain to the alleged manipulator; 2) deceptive intent; 3) market domination; and 4) economic reasonableness of the alleged manipulation."College Bound, 1995 U.S. Dist. LEXIS 10684, at *15 (quotation marks omitted).
In a Second Circuit case decided two weeks prior to Mulheren, but which the Mulheren court did not discuss, the court affirmed the manipulation conviction of a Drexel Burnham Lambert trader. See United States v. Regan, 937 F.2d 823, 829 (2d Cir. 1991). The trader had arranged with another firm to sell a security short, without disclosing either the true seller or Drexel's involvement in the deal, in order to reduce the price of the security. The court found that this behavior "artificially depressed" the market price, and fit "comfortably within this full range of wrongful acts" proscribed by § 10(b). Id. (quotation marks omitted).
Plaintiff also invokes the Second Circuit's decision in Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374 (2d Cir. 1974), as evidence that liability for open-market manipulation is in fact not as open a question as Mulheren represents. It is true that the Schlick court reversed the dismissal under Rule 12(b)(6) of a manipulation claim which alleged that the defendants had arranged the purchase of common stock "in order to create a higher price for the shares." Id. at 379. But the scheme as pleaded also involved a host of other deceptive actions including the looting of another company's assets and various accounting irregularities. Schlick does not stand for the proposition that open-market purchases alone can support a manipulation claim under § 10(b).
An earlier Second Circuit case, Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 795 (2d Cir. 1969), found the possibility of manipulation, and therefore reversed the dismissal of a 10b-5 claim, where a company sought to inflate a stock price and thereby influence a tender offer, by purchasing a large volume of shares on the open market while secretly selling them at a significant loss at the same time. Cf. Crane Co. v. American Standard, Inc., 603 F.2d 244, 249 (2d Cir. 1979) (finding on the basis of an intervening Supreme Court case that, contrary to its earlier holding, the plaintiff in Crane lacked standing to assert the manipulation claim).
In addition to invoking Regan, NPCT points to Markowski v. SEC, 274 F.3d 525 (D.C. Cir. 2001). Markowski involved an underwriter and a trader who were disciplined by the National Association of Securities Dealers for manipulating the price of a security by "(1) maintain[ing] high bid prices . . ., and (2) absorb[ing] all unwanted securities into inventory, thereby preventing sales from depressing market prices." Id. at 527. The defendants argued that because their "bids and trades in this case were `real' — they involved real customers, real transactions, and real money — the trades cannot be classified as an unlawful manipulation." Id. at 528. The Court of Appeals considered the issue:
Liability for manipulation wholly independent of fictitious transactions in fact raises interesting questions. Without such transactions, the core of the offense can be obscure. It may be hard to separate a `manipulative' investor from one who is simply overenthusiastic, a true believer in the object of investment. . . . Legality would thus depend entirely on whether the investor's intent was an investment purpose or solely to affect the price of the security. Id. (punctuation omitted).
The court acknowledged these "practical concerns," but nonetheless deferred to the SEC's interpretation of Rule 10b-5, holding that "we cannot find the Commission's interpretation to be unreasonable in light of what appears to be Congress's determination that `manipulation' can be illegal solely because of the actor's purpose." Id. at 529. In Markowski's case, admissions of manipulative intent by firm personnel were sufficient to sustain liability.
The court reasoned that because § 9(a)(2) of the Exchange Act prohibits some stock manipulation on the basis of intent, it was reasonable for the SEC to interpret § 10(b)'s prohibition on manipulation as doing so as well.
The Third Circuit, in examining a similar 10b-5 claim involving convertible debentures and short sales, agreed with the Markowski court that it might be difficult to "distinguish between legitimate trading strategies intended to anticipate and respond to prevailing market forces and those designed to manipulate prices and deceive purchasers and sellers." GFL Advantage Fund Ltd. v. Colkitt, 272 F.3d 189, 205 (3d Cir. 2001). The Colkitt court therefore supplemented Markowski's subjective intent requirement with an additional prong asking whether the alleged manipulator "engaged in deceptive or manipulative conduct by injecting inaccurate information into the marketplace or creating a false impression of supply and demand for the security." Id. at 207. The court further found that short sales alone could not meet this conduct threshold, but that "some other deceptive practice" was necessary to comprise manipulation. Id. at 207-8 (listing examples such as "unauthorized placements and parking of stock"; secret sales without disclosing the real party in interest; encouraging others to sell short by guaranteeing profits; fraudulently low appraisals; painting the tape; and matched sales); see also id. at 209 (noting that large volume alone would not qualify short selling as manipulation).
See also Pagel v. SEC, 803 F.2d 942, 946 (8th Cir. 1986) (affirming a finding of manipulation on the basis of stock purchases, market domination, use of nominee accounts, and the timing of bulk trades); Alabama Farm Bureau Mut. Cas. Co. v. American Fid. Life Ins. Co., 606 F.2d 602, 611-12 (5th Cir. 1979) (finding issues of material fact as to whether a stock repurchase scheme was manipulative where it was alleged to be undertaken with the purpose of artificially inflating the market price).
Several other manipulative schemes similar to that alleged here, some involving similar defendants, have come before this Court with differing results. The most similar case is Internet Law Library, which involved a sale of convertible preferred stock, after which the defendant purchasers allegedly engaged in immediate and large-scale short sales, as well as "hitting the bids," dumping, and painting the tape in order to drive down the stock price. The defendants subsequently converted over three million shares to cover their short position. Id. at *7. The court rejected the defendants' motion to dismiss, finding that the plaintiffs had "adequately detailed what manipulative acts the defendants have undertaken against them" and "described the effect that such activity has had on the market for ITIS stock, namely that it has artificially depressed the price of ITIS stock." Id. at *30 (citations and quotation marks omitted). See also Parnes, 2001 U.S. Dist. LEXIS 21722, *18-*19 (declining to dismiss a claim involving a similar scheme featuring convertible debentures and short sales as well as allegations of multiple regulatory violations); Log On America, Inc. v. Promethean Asset Mgmt. L.L.C., 2001 U.S. Dist. LEXIS 20374, *29-*30 (S.D.N.Y. Dec. 10, 2001) (Berman, J.) (dismissing a claim involving a similar scheme featuring convertible preferred stock and short sales because "Defendants' alleged and conclusory scheme to `manipulate downward the stock price' is insufficient"); Global Intellicom, 1999 U.S. Dist. LEXIS 11378, *25-*26 (dismissing on standing grounds a claim involving a similar scheme featuring convertible preferred stock and debentures and "massive" short sales).
Defendants also invoke a state court case involving some of the same parties as this action (and the subject of one of the misrepresentations alleged in this action). Haymarket LLC v. D.G. Jewellery [sic] of Canada Ltd., 290 A.D.2d 318, 736 N.Y.S.2d 356 (1st Dept. 2002), involved a stock purchase agreement with reset rights and the alleged manipulation by Haymarket of D.C. Jewellery's stock price. D.G. Jewellery refused to honor a reset request, Haymarket sued for breach of contract, and D.G. Jewellery interposed the manipulative scheme as an affirmative defense. The jury agreed that there had been manipulation, but the trial judge set aside the verdict as unsupported by the evidence, and the Appellate Division affirmed. 290 A.D.2d at 318-19.Haymarket presents two difficulties for Defendants: First, neither the Appellate Division's published opinion nor the excerpts from the trial court's oral decision (reprinted in Southridge Capital Mgmt., LLC v. Lowry, 188 F. Supp.2d 388 (S.D.N.Y. 2002)) reveal what legal standard either court employed in its definition of stock manipulation. Second, both courts were largely elliptical as to whether their rulings were based on legal concepts or, like those in Mulheren and College Bound, merely evidentiary. See, e.g., Lowry, 188 F. Supp.2d at 392-93;Haymarket, 290 A.D.2d at 318-19.
In applying the principles gleaned from the cases discussed above to the facts at had, this Court is drawn ineluctably to the opinion that NPCT has adequately alleged that Defendants have "engaged in deceptive or manipulative conduct by . . . creating a false impression of supply and demand for the security." Although NPCT does not currently allege significant short sales, it does allege 1) subjective intent to depress the value of NPCT stock, based on a financing agreement that provides a motive for manipulation; 2) timing of sales beginning the first trading day after closing and continuing until liquidation; 3) dominant or near-dominant trading volume throughout a six month period; 4) significant amounts of trading conducted through a non-market maker; and 5) an extensive pattern of similar investments and subsequent stock price drops in other companies.
Recognizing the closeness of the issue, the Court finds that this combination of subjective intent and deceptive conduct is sufficient to state a claim for market manipulation in violation of § 10(b) and Rule 10b-5. First, Defendants are unable to distinguish Markowski, and eventually rest on the argument that it is not binding precedent on courts within the Second Circuit. (Def. Mem. at 14 n. 7.) Second, the behavior alleged here is of a different character than that found wanting in Mulheren, in which the court expressed "misgivings" about whether intent alone could establish manipulation but also remarked that market dominance over an extended period of time was "strong evidence" thereof. Moreover, the Court finds that both Mulheren and Regan are consistent with the Third Circuit's framework requiring "some other deceptive practice" beyond mere sales — a framework satisfied in this case via timing, volume, selling through a non-market maker, and a pattern of prior manipulation. Finally, the Court notes that a similar conclusion was reached by the Internet Law Library court on a similar fact pattern (with the addition of short sales). But see Log On America, 2001 U.S. Dist. LEXIS 20374, at *29-*30.
Defendants suggest, inter alia, that unlike in Markowski, "NPCT does not allege any sales at anything other than the market price." (Def. Reply Mem. at 4 n. 1.) This distinction is specious; once they were accepted the high bid prices in Markowski became the "market price" in the same manner that the allegedly low sale prices of NPCT stock became the market price here. Defendants also note that the SEC is not a party to this case, but it is not clear why that should affect our interpretation of Rule 10b-5. In their first brief, Defendants argued that Markowski involved § 9(a)(2) of the Exchange Act rather than § 10(b), which was simply incorrect. (Def. Mem. at 14 n. 7.)
Mulheren itself, as noted above, involved domination for only 6 minutes on one day. The Mulheren court cited two cases for the proposition that "[w]hen domination is sustained over such an extended period of time, evidence of manipulation is strong": one case in which the manipulator's trading constituted more than 50% of the overall trading over a year, and one case in which the manipulator accounted for 28.8% of the "daily exchange volume" over four months. Mulheren, 938 F.2d at 371. Defendants accounted for an average of 36.5% of the daily traded volume and 22.7% of the total traded volume over six months, and therefore fall much closer to the manipulative range than to the Mulheren range.
The Court also finds that the allegations here satisfy the "elements of an open-market manipulation claim" as distilled by College Bound, namely 1) profit to the manipulator; 2) deceptive intent; 3) market domination; and 4) economic reasonableness of the scheme. See fn. 10, supra.
V. Third Claim — Control Person Liability Under § 20(a) (Pickett, Southridge, and TK)
NPCT alleges further that Pickett is liable under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), for controlling Southridge and Harvest Court in their securities violations, and that Southridge and TK are liable for controlling Harvest Court. (Complaint at 23-24.) "In order to establish a prima facie case of liability under § 20(a), a plaintiff must show: (i) a primary violation by a controlled person; (ii) control of the primary violator by the defendant; and (iii) that the controlling person was in some meaningful sense a culpable participant in the primary violation." Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir. 1998) (citing SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1472 (2d Cir. 1996)) (internal quotation marks omitted). Because the Court has already found sufficient allegations of primary violations by those alleged to be controlled, and sufficient allegations of culpable conduct by those alleged to be controllers, its focus rests on the second (control) prong. "[C]ontrol of the primary violator may be established by showing that the defendant possessed the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise. At the motion to dismiss stage. plaintiffs need only plead facts supporting a reasonable inference of control." In re Emex Securities Litigation, 2002 U.S. Dist. LEXIS 17528, *27-*28 (S.D.N.Y. Sept. 18, 2002) (Kram, J.) (citations and internal quotation marks omitted).
Defendants object that the allegations in the Complaint are "vague and conclusory," and that they fail to allege facts "demonstrating that that [sic] Pickett is liable for the conduct of Southridge and Harvest Court or that Southridge is liable for the conduct of Harvest Court." (Def. Mem. at 17.) The Court finds that the Complaint contains sufficient allegations of the facts surrounding the negotiation and closing of the Agreement, as described above, to infer that Southridge had the power to control Harvest Court, and that Pickett had the power to control Southridge (and by extension Harvest Court as well). The Court finds, however, that there are insufficient allegations in the Complaint to support a reasonable inference that TK controlled Harvest Court. The only allegations on that point are that the funding for the Agreement came from Southridge or from two employees of TK, and that TK executed the sales at issue.
Defendants object in their brief that Plaintiff failed to incorporate by reference the other paragraphs in the Complaint, leaving the allegations in their control person claim purely conclusory. The court in Internet Law Library dismissed a similar § 20(a) claim on that basis, with leave to amend. Internet Law Library, 2002 U.S. Dist. LEXIS 13172, at *10. Here, however, Defendants appeared to abandon at oral argument any objections based on lack of incorporation by reference, the objection being readily curable in an amended complaint. (Oral Argument at 9.)
NPCT argues that "[b]ecause a control person claim is not one of the claims listed in Rule 9(b)," any requirement of fact pleading is improper. (Pl. Mem. at 17 (citing Swierkiewicz v. Sorema N.A., 534 U.S. 506 (2002).) This Court joins Internet Law Library, 2002 U.S. Dist. LEXIS 13172, at *10, in finding that this argument stretches Swierkiewicz (which dealt with an employment discrimination claim) too far. The control person claim is therefore dismissed to the extent that it is directed at Defendant TK.
VI. Fourth, Fifth, and Sixth Claims — Colorado Securities Fraud (all Defendants), Colorado Control Person Liability (Southridge, Pickett, and TK), and Colorado Aiding and Abetting (all Defendants)
Next, NPCT alleges that the acts and omissions constituting securities fraud under § 10(b) constitute violations of multiple provisions of Colorado law. (Complaint at 24-26.) Defendants counter that all of the Colorado claims should be dismissed pursuant to the following term in the Agreement:
(e) Governing Law. The corporate laws of the State of Nevada shall govern all issues concerning the relative rights of the Company and its stockholders. All other questions concerning the construction, validity, enforcement and interpretation of this Agreement shall be governed by and construed and enforced in accordance with the internal laws of the State of New York, without regard to the principles of conflicts of law thereof. Each party hereby irrevocably submits to the exclusive jurisdiction of the state and federal courts sitting in the City of New York, borough of Manhattan, for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein." (Def. Mem. at 17 (citing Agreement at § 6(e)).)
Plaintiff responds that although this provision mandates the application of New York law to disputes under the contract, it does not mandate the application of New York law to causes of action, such as fraud, that sound in tort. (Pl. Mem. at 18-19.)
It is true that the express terms of the provision invoke New York law for "questions concerning the construction, validity, enforcement and interpretation" of the Agreement, and only New York courts for "any dispute hereunder or in connection herewith." Nonetheless, courts in the Second Circuit have interpreted the broad language of similar choice-of-law-cum-forum-selection clauses to mandate application of New York law to all claims, including fraud claims, arising out of a transaction. See, e.g., Turtur v. Rothschild Registry Int'l Inc., 26 F.3d 304, 309-10 (2d Cir. 1994) (holding that "this language is sufficiently broad to cover tort claims as well as contract claims `arising out of or relating to' the subscription"); About.com, Inc. v. Targetfirst, Inc., 2002 U.S. Dist. LEXIS 7770, *4-*6 (S.D.N.Y. Apr. 30, 2002) (Daniels, J.) (finding dispositive the presence of a forum selection clause); Internet Law Library, 2002 U.S. Dist. LEXIS 13172, *36-*38 (same). By contrast, the choice of law clause in the case cited by NPCT did not include a similar forum selection clause. Krock v. Lipsay, 97 F.3d 640, 643-45 (2d Cir. 1996).
VII. Seventh Claim — Common law Fraud (Pickett, Singer, and Southridge)
Defendants object to NPCT's allegations of common law fraud on many of the same grounds that they object to the federal securities fraud claims. The Court therefore declines to dismiss this count for many of the same reasons it declined to dismiss the federal claims. "Since plaintiffs have satisfied the elements for pleading a § 10(b) and Rule 10b-5 violation, they have also fulfilled the requirements for pleading common law fraud, as they are basically identical." Internet Law Library, 2002 U.S. Dist. LEXIS 13172, *39 Defendants also object that the fraud claim is essentially duplicative of the contract claim, but the Court finds that the alleged misrepresentations were "collateral" to the Agreement rather than subsumed by it. Deerfield Communications Corp. v. Chesebrough-Ponds, Inc., 68 N.Y.2d 954, 956, 502 N.E.2d 1003, 510 N.Y.S.2d 88 (1986). Cf. Global Intellicom, 1999 U.S. Dist. LEXIS 11378, *53 (finding a fraud claim duplicative because it rested on breach of a contractual term); Log On America, 2001 U.S. Dist. LEXIS 20374, *41-*42 (same).
VIII. Eighth Claim — Civil Conspiracy
Defendants move to dismiss NPCT's eighth claim, for "civil conspiracy," on the wholly reasonable ground that "there is no substantive tort of civil conspiracy under New York law." (Def. Mem. at 23.) Defendants' statement of the law is correct, and the claim is dismissed. See Internet Law Library, 2002 U.S. Dist. LEXIS 13172, *40; Global Intellicom, 1999 U.S. Dist. LEXIS 11378, *54-*55; Briarpatch Ltd. v. Pate, 81 F. Supp.2d 509, 516 (S.D.N.Y. 2000) (Sweet, J.).
IX. Ninth Claim — Breach of Contract (Harvest Court)
Finally, NPCT claims that by "failing and refusing to honor its financing obligations and by violating the securities laws," Harvest Court breached the Agreement. (Complaint at 27.) Defendants object that not honoring the financing agreement could not constitute breach given that the conditions giving rise to the obligation were never met (Def. Mem. at 23-24), but NPCT pleads that it has "performed its obligations under [the] agreement, or is excused from performing because of Harvest Court's breach" (Complaint at 27), and no more is required at the pleading stage. See Internet Law Library, 2002 U.S. Dist. LEXIS 13172, *41-*42; ICD Holdings S.A v. Frankel, 976 F. Supp. 234, 243 (S.D.N.Y. 1997). Accordingly, the Court need not address NPCT's contract claim insofar as it relies on the violation of securities laws. See Internet Law Library, 2002 U.S. Dist. LEXIS 13172, *43.
X. Conclusion
The Motion To Dismiss is GRANTED on claims 4, 5, 6, and 8; GRANTED on claim 3 insofar as that claim is directed against Defendant TK and otherwise DENIED; and DENIED on claims 1, 2, 7, and 9.
The Court will hold a telephone conference to address scheduling in this matter at 10:00 a.m. on October 31, 2002.