WOLFSON, District Judge.
Presently before the Court is the motion of defendants, Intelli-Check, Inc. ("Intelli-Check" or "IDN" or the "Company"), Frank Mandelbaum, Paul Cohen, Edwin Winiarz, and W. Robert Holloway, to dismiss plaintiffs' Second Amended Complaint alleging violations of Sections 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1331 and 1337. For the reasons set forth below, defendants' motion to dismiss is granted, though plaintiffs are given leave to file an amended complaint on certain of the claims as set forth herein.
I. FACTUAL BACKGROUND
Plaintiffs, Keith Jones, Daniel Borislow, and the D & K Charitable Foundation,
Zlotnick v. TIE Communications, 836 F.2d 818, 820 (3d Cir.1988). In other words, a short seller borrows shares from a broker and immediately sells them to a buyer; this transaction is the "short sale." The short seller is obligated to purchase the same number of shares to return to the broker at any later date in the future; this transaction is the "covering purchase." If the stock price drops in the time between the short sale and the covering purchase, the short seller profits. If instead the stock price rises, the short seller suffers a loss.
Defendant IDN manufactures and markets a product known as ID-Check, which enables a retailer to verify driver licenses and other forms of government-issued identification. Second Amended Complaint at ¶¶ 17-18. Believing the price of IDN stock was overvalued, plaintiffs short sold a total of 215,300 shares from February 23, 2001 through September 20, 2001. Id. at ¶ 1. The stock price, however, did not drop as plaintiffs had expected. Rather, the price rose substantially, so much so that plaintiffs lost a total of $2,000,000 when they made their covering purchases from October 18, 2001 through January 3, 2002. Id Plaintiffs allege that defendants engaged in securities fraud through a series of actions designed to artificially inflate the price of IDN's stock, thereby causing plaintiffs' losses. Id. The individual defendants are sued in their following capacities with the Company: Frank Mandelbaum as Chairman of the Board and Chief Executive Officer; Edwin Winiarz as Chief Financial Officer, Senior Executive Vice President, Treasurer and director; W. Robert Holloway as Senior Executive Vice President; and Paul Cohen as director. Id. at ¶¶ 12-15.
A. Plaintiffs' Decision to Short Sell IDN's Stock
Plaintiffs allege that the reason they decided to short sell IDN's stock was because they noticed in IDN's filings with the SEC that for the first and second quarters of 2001, the Company's reported revenues came largely from previous sales instead of new sales. Second Amended Complaint at ¶¶ 28-41. Under IDN's new policy of "deferred revenue recognition," revenues from sales in the fourth quarter of 2000 would be recognized ratably over the following year. Id. at ¶ 29. This was possible because after IDN's sale of its product to a customer, it provided the customer with post-contract service and support. See id. Up until the start of the fourth quarter 2000, IDN recognized all of
Plaintiffs believed IDN's newly-adopted revenue recognition policy gave the false impression that IDN's sales were increasing when in fact they were, at some points, decreasing. For example, as described in more detail below, IDN reported in a press release that its first quarter 2001 revenues were $204,635, compared with $30,218 for the first quarter 2000. Second Amended Complaint at 133. Plaintiffs considered this misleading because (as IDN disclosed in its 10-QSB for the first quarter 2001) $180,984 of that revenue included revenue that was deferred from previous sales. Id. at ¶ 31. Thus, sales had actually decreased $23,651 from the first quarter of 2000 to the first quarter of 2001. See id. Plaintiffs considered this a misleading accounting technique that artificially inflated the price of IDN's stock. Id. at ¶ 40. They "believ[ed] that eventually IDN would not be able to rely on the use [of] deferred revenues" to overstate the Company's growth, and that the stock price would in time drop as other investors realized it was overvalued. See id. at ¶ 41. According to plaintiffs, this was the reason they decided to short sell IDN's stock. Id.
Plaintiffs allege that they came to the conclusion that IDN was using a misleading accounting technique by analyzing the following three filings with the Securities and Exchange Commission ("SEC") and two press releases: Form 10-KSB for the period ended December 31, 2000 (filed March 31, 2001 and amended October 9, 2001); the May 9, 2001 press release; Form 10-QSB for the period ended March 31, 2001 (filed May 14, 2001 and amended on August 23, 2001); Form 10-QSB for the period ended June 30, 2001 (filed August 13, 2001); and the August 13, 2001 press release. These documents are discussed in turn below.
1. Form 10-KSB for the Period Ended December 31, 2000
IDN filed its Form 10-KSB for the period ended December 31, 2000 on March 31, 2001, and amended it on October 9, 2001. As plaintiffs allege, this filing announced IDN's new revenue recognition policy:
Second Amended Complaint at ¶ 29. Plaintiffs do not allege that this filing contained any misleading information.
2. May 9, 2001 Press Release
On May 9, 2001, five days before IDN filed its 10-QSB for the first quarter of 2001, it issued a press release highlighting the results of the quarter. The press release stated:
Id. at ¶ 33. In the release, Defendant Frank Mandelbaum, Chairman and CEO of IDN, was quoted as saying:
Id. Plaintiffs allege these statements were misleading because sales actually decreased from the first quarter of 2000 to the first quarter of 2001.
3. Form 10-QSB for the Period Ended March 31, 2001
IDN filed its Form 10-QSB for the period ended March 31, 2001 on May 14, 2001, and amended it on August 23, 2001. This filing listed the same figures announced in the May 9, 2001 press release. See id. at ¶ 31. It stated, in relevant part: "[revenues increased substantially from $30,218 for the first three months ended March 31, 2000 to $204,638 recorded for the three months ended March 31, 2001." Declaration of Francis P. Karam in Support of Defendants' Motion to Dismiss ("Karam Dec") at Ex. D, p. 5.
Id. In the same filing, IDN again reported its revenue recognition policy, using substantially the same language as in its 10-KSB for the period ended December 31, 2000. Compare id. at p. 3 with Second Amended Complaint at ¶ 29. Plaintiffs allege that this filing materially misrepresented IDN's performance during the first quarter of 2001. See Second Amended Complaint at ¶ 31.
4. Form 10-QSB for the Period Ended June 30, 2001
On or about August 13, 2001, IDN filed its Form 10-QSB for the period ended June 30, 2001. In relevant part, it stated:
Second Amended Complaint at ¶ 36. This filing also described IDN's revenue recognition policy. Karan Dec. at Ex. F, p. 3. Plaintiffs allege that this filing materially misrepresented IDN's performance during the second quarter of 2001. Second Amended Complaint at ¶ 34.
5. The August 31, 2001 Press Release
On the same day IDN filed its second quarter 2001 10-QSB, it issued a press release announcing the results. The release stated, in relevant part:
Second Amended Complaint at ¶ 37. Defendant Mandelbaum was quoted as saying:
Id. at ¶ 38. Plaintiffs allege that this press release materially misstated IDN's growth during the second quarter of 2001. Id. at ¶ 39.
B. IDN's "Squeeze" of Plaintiffs and the Resultant "Bubble Period"
Plaintiffs allege that in the summer of 2001, IDN became aware that plaintiffs had taken significant short positions in its stock. Id. at ¶ 42. Because substantial short sales in a stock can have the effect of lowering the stock price, defendants allegedly set out on a plan to punish or "squeeze" plaintiffs by:
Id. According to plaintiffs, "the effect of these two strategies was to balloon the overvaluation into a huge, artificial bubble" stretching from late September 2001 until the filing of the Second Amended Complaint on May 31, 2002. Id. The allegedly improper acts of defendants are discussed in turn below.
1. Comparison of Prior Period "Sales" with Current Period "Revenues": Form 10-QSB for the Period Ended September 30, 2001
On November 13, 2001, IDN filed its Form 10-QSB for the period ended September 30, 2001. Id. at ¶ 53. As in the first and second quarter 2001 reports, the third quarter 2001 report announced an increase in revenue as compared to the same period in 2000: "[r]evenues increased $170,590 from $109,676 recorded for the three months ended September 30, 2000 to $280,266 recorded for the three months ended September 30, 2001." IDN's Third Quarter 2001 10-QSB, p. 7.
2. Failure to Disclose Competition
Plaintiffs allege that IDN has never disclosed the existence of competition by VeriFone, a company that markets an identification verification product substantially similar to IDN's. Id. at ¶¶ 43-46. Plaintiffs contend that VeriFone has a unique advantage in the identification verification market because its technology can coexist on terminals that it has already provided
VeriFone first publicized its Easy ID product in a press release June 20, 2001. Id. at ¶44. Since then, IDN has not named VeriFone as a competitor in any of its public filings or statements. Id. at ¶ 46.
3. Untimely and Misleading Disclosure of the Messina Lawsuit
Kevin Messina, a former officer and director of IDN,
IDN's Third Quarter 2001 10-QSB, p. 9.
While plaintiffs' complaint is not a model of clarity with respect to the claims of improper disclosure of the Messina suit, the Court can discern four distinct allegations of impropriety:
The patent suit was filed against IDN in August 1999 by IdentiScan, a rival company which markets a product similar to IDN's. Karam Dec. at Ex. C, p. 10. As reported in IDN's Year 2000 10-KSB, the suit involved a dispute over which company
4. IDN's Block of Messina's Sales of His Company Stock
In addition to alleging that IDN improperly disclosed the details of the Messina suit, plaintiffs claim that IDN's actions that precipitated the suit—namely, the Company's refusal to allow Messina to sell his shares on October 12, 15, and 16, 2001—amount to securities fraud. Id at ¶¶ 56-58. Plaintiffs contend IDN blocked Messina's sales in order to create a "false shortage" of IDN's shares, which in turn would artificially inflate the stock price. Id at ¶ 58. Plaintiffs argue this effect on the market is shown by the fact that "IDN's share price has consistently dropped following Messina's sales on January 10, 2002, April 19, 2002, and May 7, 2002." Id.
5. Rights Offering
On September 21, 2001, IDN filed a Registration Statement with the SEC announcing a rights offering for 970,076 of its shares, whereby its stockholders were to receive one non-transferable right to purchase one share of IDN's common stock at $8.50 a share for every ten outstanding shares of common stock held on March 30, 2001. Id. at ¶ 60. On October 5, 2001, IDN issued a press release publicizing the rights offering, which expired on October 4, 2002. Id. at ¶ 62. Plaintiffs allege that the rights offering harmed them because it had "the effect of increasing the cost to cover their short positions." Id. at ¶ 63. In addition, plaintiffs contend that IDN's Prospectus filed in connection with the rights offering incorporated by reference its Year 2000 10-KSB, and its first and second quarter 2001 10-QSBs, which included material misrepresentations concerning the overstatement of revenue and the failure to properly disclose the existence of VeriFone and the details of the Messina suit, as discussed above.
6. Interference with Borislow's Trading Activities
Plaintiffs dedicate only one paragraph in their Second Amended Complaint to this claim. The paragraph, in its entirety, is as follows:
Id. at ¶ 59.
II. PROCEDURAL HISTORY
Plaintiff Keith Jones originally filed this suit as a class action on October 18, 2001. On November 30, 2001, plaintiff Daniel Borislow joined Jones in filing an amended complaint, which abandoned the class action. Defendant Kevin Messina and the remaining defendants filed, pursuant to Appendix N of the Local Rules of Civil Procedure, two separate Notices of Intent to submit a motion to dismiss the amended complaint on March 11, 2002. Before the Appendix N packages were submitted to the Court, plaintiffs obtained new counsel, and the parties stipulated that defendants would withdraw their motions to dismiss and plaintiffs would file a Second Amended Complaint. On May 31, 2002, plaintiffs Jones and Borislow, along with a new plaintiff, D & K Charitable Foundation, filed their Second Amended Complaint. Plaintiffs voluntarily dismissed their claims against Messina on September 25, 2002, and on October 2, 2002, the remaining defendants filed the present motion to dismiss the Second Amended Complaint pursuant to Fed.R.Civ.P. 12(b)(6) and Fed. R.Civ.P. 9(b). This matter was reassigned from the Honorable Jerome B. Simandle to me on January 8, 2003.
III. APPLICABLE STANDARDS
A. Federal Rule of Civil Procedure 12(b)(6)
Federal Rule of Civil Procedure 12(b)(6) provides that a court may dismiss a complaint "for failure to state a claim upon which relief can be granted." A claim should be dismissed only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." In re: Rockefeller Center Properties, Inc. Securities Litig., 311 F.3d 198, 215 (3d Cir.2002) (citing Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). The inquiry is not whether plaintiff will ultimately prevail, but whether he is entitled to offer evidence to support his claims. Id. (citing Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d 90 (1974)). In deciding a 12(b)(6) motion, courts must accept all well-pleaded factual allegations in the complaint as true and draw all reasonable inferences in favor of the plaintiff. Id. (citing Scheuer, 416 U.S. at 236, 94 S.Ct. 1683). Nevertheless, courts are not required to credit bald assertions or legal conclusions alleged in the complaint. Id. (citing In re Burlington Coat Factory Securities Litig., 114 F.3d 1410, 1429 (3d Cir.1997)). Similarly, legal conclusions draped in the guise of factual allegations do not benefit from the presumption of truthfulness. Id. (citing In re: Nice Systems, Ltd. Securities Litig., 135 F.Supp.2d 551, 565 (D.N.J.2001)).
As a general matter, courts ruling on a motion to dismiss may not consider matters extraneous to the complaint. Burlington Coat Factory, 114 F.3d at 1426. However, an exception to the general rule is that a "document integral to or explicitly relied upon in the complaint" may be considered "without converting the motion [to dismiss] into one for summary judgment." Id. (quoting Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1220 (1st Cir.1996) and citing Trump Casino, 7 F.3d at 368 n. 9 ("a court may consider an undisputedly authentic document that a defendant attaches as an exhibit to a motion to dismiss if the plaintiffs claims are based on the document.")). The rationale underlying this exception is that the primary problem raised by considering documents outside the complaint— lack of notice to the plaintiff—is dissipated where plaintiff has actual notice and has
B. Section 10(b) of the Exchange Act and Rule 10b-5
Section 10(b) of the Exchange Act and Rule 10b-6 create liability for securities fraud, i.e. for false or misleading statements or omissions of material fact, Burlington Coat Factory, 114 F.3d at 1417, or for deceptive or manipulative acts, GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 207 (3d Cir.2001), that affect the trading of securities on the secondary market. Section 10(b) provides in pertinent part:
15 U.S.C. § 78j(b). To implement this section, the SEC enacted Rule 10b-5, violation of which gives rise to a private cause of action. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975). Rule 10b-5 makes it unlawful:
17 C.F.R. § 240.10b-5.
There are two types of claims available under Section 10(b) and Rule 10b-5: misrepresentation or omission of material facts, Burlington Coat Factory, 114 F.3d at 1417, and market manipulation, Colkitt, 272 F.3d at 207. Plaintiffs in this case allege both.
1. Misrepresentation or Omission of Material Facts
To state a securities fraud claim for misrepresentation or omission of material facts, a plaintiff must plead:
See Semerenko v. Cendant Corp., 223 F.3d 165, 174 (3d Cir.2000). A defendant cannot be held liable for failure to disclose unless plaintiff first establishes a duty to disclose, since "[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5." Basic Inc. v. Levinson, 485 U.S. 224, 239 n. 17, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). Except for specific periodic reporting requirements, primarily the quarterly and annual reports, there is no general
A fact is material if there is a substantial likelihood that a reasonable investor would have viewed it as having significantly altered the total mix of information available to the public. Shapiro v. UJB Financial Corp., 964 F.2d 272, 280 n. 11 (3d Cir.1992) (quotations omitted). "Materiality is a mixed question of law and fact, and the delicate assessments of the inferences a reasonable shareholder would draw from a given set of facts are peculiarly for the trier of fact." Id. (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 450, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976)). However, the Third Circuit has fashioned a special rule for deciding materiality as a matter of law in the context of an efficient securities market. Oran, 226 F.3d at 282 (3d Cir.2000) (citing Burlington Coat Factory, 114 F.3d at 1425). The rule is based on the fundamental economic insight that in an open and developed market, the price of a company's stock is determined by all available material information regarding the company and its business. Id. In an efficient market, "information important to reasonable investors ... is immediately incorporated into the stock price." Id. As a result, when a stock is traded in such a market, the materiality of disclosed information may be measured by looking to the movement of the stock's price in the period immediately following disclosure. Id. If a company's disclosure has no effect on the stock price, "it follows that the information disclosed ... was immaterial as a matter of law." Id,
2. Market Manipulation
Third Circuit case law on market manipulation is sparse. In 2001, the Third Circuit noted that "we seem not to have addressed squarely what elements are required to establish a claim of market manipulation." Colkitt, 272 F.3d at 203. Section 10(b) provides in relevant part that "[i]t shall be unlawful for any person... [t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations" promulgated by the SEC. Id. The SEC's Rule 10b-5 states in pertinent part that "[i]t shall be unlawful for any person ... [t]o employ any device, scheme, or artifice to defraud." Id.
Colkitt, read in conjunction with the well-established law on pleading a Section 10(b)/Rule 10b-5 claim, instructs that in order to state a claim of market manipulation, a plaintiff must plead that:
See Colkitt, 272 F.3d at 206 n. 6; see also Semerenko, 223 F.3d at 174.
The issue of market manipulation in Colkitt arose in the context of an affirmative defense under Section 29(b) of the Exchange Act. Section 29(b) provides that a contract made or performed in violation of any other section of the Exchange Act or in violation of any rule or regulation promulgated thereunder is void. Colkitt, 272 F.3d at 199. As an affirmative defense to a breach of contract claim, Colkitt argued that because plaintiff had violated Section 10(b) and Rule 10b-5 by engaging in market manipulation, the contract at issue was void pursuant to Section 29(b). Id. The Third Circuit held that in order for an affirmative defense of market manipulation to survive summary judgment, a party must prove steps (1) through (3), noted above. Id. at 207. The court also noted that in order to maintain any private cause of action under Section 10(b), a plaintiff must also prove reliance and damages. Id. at 206 n. 6 (clarifying that "Section 29(b) only requires a violation of Section 10(b), not the maintenance of a private suit under Section 10(b)," which "requires a plaintiff to prove reliance and damages."). Though procedurally Colkitt involved summary judgment, the Third Circuit has made clear on other occasions that in order for a Section 10(b)/Rule 10b-5 claim to survive a motion to dismiss, a plaintiff must plead reliance, causation of damages, and also scienter (i.e. steps (4) through (6), noted above). E.g., Semerenko, 223 F.3d at 174.
C. Federal Rule of Civil Procedure 9(b)
Since claims brought under Section 10(b) and Rule 10b-5 are fraud claims, plaintiffs must comply with the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure. Rockefeller, 311 F.3d at 216. Rule 9(b) provides: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Id. This requirement has been rigorously applied in securities fraud cases. Id. (citing Burlington Coat Factory, 114 F.3d at 1417). Rule 9(b) requires, at a minimum, that plaintiffs support their allegations of securities fraud with all of the necessary factual background that would accompany "the first paragraph of any newspaper story," that is, the "who, what, when, where and how" of the relevant events. Id. at 217 (citing Burlington Coat Factory, 114 F.3d at 1422). Rule 9(b)'s heightened pleading standard serves important objectives: it "gives defendants notice of the claims against them, provides an increased measure of protection for their reputations, and reduces the number of frivolous suits brought solely to extract settlements." Id at 216 (quoting Burlington Coat Factory, 114 F.3d at 1418).
Nevertheless, the Third Circuit has also warned that courts should be "sensitive" to situations in which "sophisticated defrauders" may "successfully conceal the details of their fraud." Id. If plaintiffs can show that the requisite factual information is "peculiarly within the defendant's knowledge or control," the strict requirements of Rule 9(b) may be relaxed. Id. In order to
Citing case law from the Southern District of New York, plaintiffs argue that market manipulation claims are entitled to the benefit of a less exacting pleading standard. PI. Br. at 19. In that district, plaintiffs bringing a market manipulation claim are entitled to a somewhat relaxed pleading standard
D. The Private Securities Litigation Reform Act
In addition to Rule 9(b), plaintiffs alleging securities fraud must also comply with the heightened pleading standards of the Private Securities Litigation Reform Act ("PSLRA"). 15 U.S.C. § 78u-4(b)(1), (b)(2); Rockefeller, 311 F.3d at 217. The PSLRA was designed to establish a "uniform and stringent pleading" standard and to provide companies added protection against what Congress perceived as a growing number of frivolous "strike suits" aimed at achieving quick settlements. Nappier v. Pricewaterhouse Coopers LLP, 227 F.Supp.2d 263, 273 (D.N.J.2002) (citing In re Advanta Corp. Securities Litig., 180 F.3d 525, 531 (3d Cir.1999)). Section 78u-4(b)(1) requires specificity in pleading a claim of misrepresentation or omission of material fact. It provides:
Advanta, 180 F.3d at 530. Section 78u-4(b)(2) requires a showing of scienter, or knowledge, in any securities fraud claim:
Advanta, 180 F.3d at 530-31. Failure to meet the pleading requirements of the PSLRA results in mandatory dismissal of the complaint. See 15 U.S.C. § 78u-4(b)(3)(A); see also Nappier, 227 F.Supp.2d at 274.
Scienter is adequately plead by "setting forth facts that constitute circumstantial evidence of either reckless or conscious behavior" or by alleging facts "establishing a motive and an opportunity to commit fraud." Advanta, 180 F.3d at 534-35 (quoting Weiner v. Quaker Oats Co., 129 F.3d 310, 318 n. 8 (3d Cir.1997)). Pursuant to the PSLRA, allegations of scienter must be supported by facts stated "with particularity" and must give rise to a "strong inference" of scienter. Id at 535. This requirement of scienter supercedes Rule 9(b) to the extent that the Rule would otherwise allow state of mind to be averred generally. Id at 531 n. 5. A reckless act is one "involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Id. (quotations omitted). "The definition of `reckless behavior' should not be a liberal one lest any discernable distinction between `scienter' and `negligence' be obliterated." In re: Digital Island Securities Litig., 223 F.Supp.2d 546, 555 (D.De.2002) (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir.1977)). Conscious wrongdoing can be shown through specific allegations of such acts as "intentional fraud or other deliberate illegal behavior." Advanta, 180 F.3d at 535.
Since passage of the PSLRA in 1995, "catch-all allegations that defendants stood to benefit from wrongdoing and had the opportunity to implement a fraudulent scheme are no longer sufficient, because they do not state facts with particularity or give rise to a strong inference of scienter." Id. Courts "will not infer fraudulent intent from the mere fact that some officers sold stock." Burlington Coat Factory, 114 F.3d at 1424 (citing Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir.1994) (noting in a similar context that if "incentive compensation" could be the basis for an allegation of fraud, "the executives of virtually every corporation in the United States would be subject to fraud allegations.")). "Instead, plaintiffs must allege that [a defendant's stock] trades were made at times and in quantities that were suspicious enough to support the necessary strong inference of scienter." Id.
Each of plaintiffs' three claims is premised on alleged violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. One claim is for misrepresentation and non-disclosure of material facts, specifically: the misleading comparison of current revenues to prior sales contained in IDN's Third Quarter 2001 10-QSB; faillure
I will analyze each of the allegations that comprise these claims individually. Plaintiffs argue that I should instead read the complaint as a whole. PI. Br. at 20. Under plaintiffs' theory, if I find that one of the fraud allegations lacks merit, I should nonetheless allow it to remain in the complaint because it is "part of a larger scheme" of market manipulation. Id. However, the Third Circuit rejected a similar argument in the securities fraud context:
In re: Westinghouse Securities Litig., 90 F.3d 696, 712 (3d Cir.1996). Thus, I will "compartmentalize" plaintiffs' various allegations and analyze whether each has merit standing on its own.
As an additional preliminary note, the full caption of the market manipulation claim is "For violations of Section 10(b) and Rule 10b-5 thereunder against defendants based upon deceptive and manipulative practices in connection with the IPO" (caption preceding ¶ 71 of the Second Amended Complaint) (emphasis added). However, plaintiffs have not alleged any type of deceptive or manipulative practices by defendants whatsoever in connection with the IPO. The IPO was completed in November of 1999, id. at ¶ 11, though plaintiffs do not allege any impropriety on the part of defendants until May 9, 2001, when defendants issued a press release announcing the allegedly misleading comparison of current revenues with prior sales, id. at ¶ 33. While plaintiffs allege that the May 9 press release "continued to mislead the market place," id., the press release is indeed plaintiffs' earliest plead example of anything that can possibly be construed as misleading. Even IDN's announcement of its new revenue recognition policy, which is not alleged to have contained any misleading information, was not publicized until the filing of its Year 2000 10-KSB, on March 29, 2001, almost a year and a half after the IPO. See id, at ¶¶ 28-30. Plaintiffs' brief is devoid of any reference to the IPO, and of any allegation of impropriety even remotely concerning the IPO. To the extent plaintiffs claim any type of securities fraud "in connection with the IPO," such claim is dismissed.
Before examining plaintiffs' six allegations of impropriety
To state a claim for securities fraud under Section 10(b) and Rule 10b-5 thereunder, a complaint must show that plaintiffs reasonably relied on defendants' allegedly fraudulent misrepresentations, omissions, or conduct. Zlotnick v. TIE Communications, 836 F.2d 818, 821 (3d Cir.1988). In Zlotnick, plaintiff believed Technicom's stock was overvalued because his analysis of the company's earnings and prospectus suggested to him that the company was not earning nearly enough to justify its stock price, and because he expected Technicom to face future competition that would diminish its profits and decrease further earnings. Id. at 819. He therefore sold short 1,000 shares of its stock on January 6, 1983, and another 1,000 shares five days later. Id At the time of his short sales he was unaware of any wrongdoing or misrepresentations by defendants; he did not base his decision to sell short on a belief that the company was deceiving investors. Id In early 1983, subsequent to plaintiffs short sales and 4unbeknownst to him, defendants—TIE, the parent company of Technicom, and Kifer, Technicom's Chairman and CEO— allegedly took action to artificially inflate the price of Technicom's stock. Id. Specifically, they caused the company to issue several press releases which misrepresented the company's sales agreements and earnings prospects, and caused the company to engage in illusory sales to TIE. Id. These actions had the desired effect of falsely inflating Technicom's stock price. Id. On March 14, 1983, plaintiff, unaware of these deceptive practices, decided to cut his losses by making the purchases necessary to cover his short positions, for a loss of approximately $35,000. Id. After Technicom issued more realistic statements, its stock price dropped sharply. Id. By the summer of 1983, its stock price was significantly lower than it had been the previous January when plaintiff acquired his short positions. Id
The sole issue before the Third Circuit was whether plaintiff adequately plead reliance. Id. at 821.
Zlotnick classified reliance on the market price of a stock as indirect reliance. Id. at 822, 823-24. It is so called because the misrepresentation or fraudulent act is not perpetrated directly on plaintiff. Id, Rather, the fraud is incorporated into the stock's price. Id. at 822. Thus, when plaintiff relies on the stock's price in making a purchase, he indirectly relies on defendants' fraud. Id. The court stressed that plaintiffs reliance must be actual; that is, plaintiff must be the one who actually relies on the stock's price. Id. at 823-24. The court squarely rejected an alternative theory of reliance whereby a short seller who is aware of defendants' fraud at the time he covers may nonetheless state a claim by arguing that the market was unaware of the fraud, and thus the stock's price remained artificially high despite his knowledge of the fraud. Id. The court reasoned that a plaintiff cannot recover for the reliance of other investors: "to the extent Zlotnick argues he is entitled to recover for the reliance of third parties, we reject his claim." Id. at 824.
For purposes of this case, the important lesson from Zlotnick is that if plaintiffs' complaint shows that at the time they covered, they were unaware of any fraudulent activity by defendants, they have adequately plead reliance. Id. at 822, 824. However, if plaintiffs were aware of defendants' fraud when they covered, then as a matter of law they are unable to show reasonable reliance, and their claims necessarily fail. See id. at 822 n. 6 ("if Zlotnick had known of the misrepresentation [when he covered], it would not have been reasonable for him to rely on the price of the stock as an accurate indication of the stock's value when he made his [covering] purchase.")
1. Plaintiffs Cannot Show Reasonable Reliance on IDN's Allegedly Misleading Accounting.
The rule announced in Zlotnick requires dismissal of many portions of plaintiffs' Second Amended Complaint. Most glaring is plaintiffs' attempt to recover for IDN's allegedly misleading comparison of current revenues to prior sales in its Third Quarter 2001 10-QSB.
Plaintiffs try to dodge this obvious defect in their pleading by alleging that when they were "forced to cover," they "relied on the integrity of the market for IDN stock in light of IDN's steadfast position that its accounting was proper," id. at ¶ 66, in an apparent attempt to parrot the legal standard of Zlotnick, Their assertion, however, runs afoul of Zlotnick in three respects. Firstly, as Zlotnick notes, there is no time limit on when a short seller may choose to cover. 836 F.2d at 820. Thus, it is disingenuous for plaintiffs to claim—as they do throughout the Second Amended Complaint and their brief—that they were "forced" to cover. See id. at 824 n. 8. Secondly, plaintiffs' assertion that they "relied on the integrity of the market" is also misplaced. Zlotnick carefully explained the difference between reliance on the integrity of the market and reliance on the integrity of the market price of a
Further support for dismissal of plaintiffs' allegations of accounting impropriety is found in Moelis v. ICH Corp., 1987 WL 9709, * 4 (S.D.N.Y.1987).
Id. at *4. The exact situation is presented in this case. Believing IDN's accounting was misleading, plaintiffs sold short, hoping that other investors would catch on and the stock price would fall. Second Amended Complaint at 1141. Now that the stock price has not fallen, plaintiffs have brought a fraud claim against IDN for those same allegedly misleading accounting methods of which they were plainly aware at all relevant times. Such a claim clearly fails.
Accordingly, to the extent plaintiffs' claims seek recovery for IDN's allegedly misleading accounting methods, the claims are dismissed pursuant to Fed.R.Civ.P. 12(b)(6).
2. Plaintiffs' Limited Ability to Show Reasonable Reliance on Their Remaining Allegations of Fraud
The first complaint in this case was filed with only Jones as a named plaintiff, on October 18, 2001—before Jones made any covering purchases. Class Action Complaint at ¶ 10 ("Plaintiff has not, to
On November 30, 2001, Borislow joined Jones in filing the First Amended Complaint. This complaint contained the same six allegations
The Second Amended Complaint therefore lacks critical particulars. This inadequacy is discussed more fully in the succeeding section regarding the specificity of losses plead. At this juncture it is enough to say that, as a matter of law, plaintiffs cannot base their claims on any alleged fraud known to them when they covered. To the extent plaintiffs seek to do so, their claims are dismissed pursuant to Fed. R.Civ.P. 12(b)(6).
B. Causation/Specificity of Losses Plead
Plaintiffs in a securities fraud case must show that their reliance on the fraud proximately caused their losses. Semerenko, 223 F.3d at 174. To survive a motion to dismiss, plaintiffs must allege facts sufficient to show that they suffered a monetary loss by purchasing shares whose prices were artificially inflated by defendants' fraudulent actions, misrepresentations or omissions. See id. at 185-86. Plaintiffs in this case have alleged:
Second Amended Complaint at ¶¶ 78, 89. Assuming the truth of those allegations, and taking all reasonable inferences in the light most favorable to plaintiffs, they have adequately plead causation. See Semerenko, 223 F.3d at 186.
Defendants insist that the aftermath of September 11, 2001, specifically the market's newfound interest in security-related products such as IDN's identification verification system, was the true cause of the spike in IDN's stock price and plaintiffs' resultant losses. Def. Br. at 1. While a factfinder may very well agree with defendants, their argument is irrelevant to this motion to dismiss. Semerenko, 223 F.3d at 186-87.
In a related issue, defendants contend that plaintiffs have not plead their losses with sufficient particularity, pursuant to Fed.R.Civ.P. 9(b). Def. Br. at 15-17. According to the Second Amended Complaint:
Second Amended Complaint at 18. Defendants argue, inter alia, that Rule 9(b) requires plaintiffs to plead the specific details of their transactions and resultant losses.
In Brickman v. Tyco Toys, Inc., 722 F.Supp. 1054, 1059-60 (S.D.N.Y.1989), plaintiffs claimed, in part, that a company's fraudulent misrepresentations caused harm to a class of investors who purchased the company's stocks. Id. at 1058. The court made clear that in order to recover, plaintiffs had to show that they relied on those misrepresentations. Id. at 1060. In this connection, the only relevant stock purchases were those that took place after the alleged misrepresentations. Id. Thus, plaintiffs were required to plead the dates of their purchases made after the alleged fraud. Id. at 1060-61.
Similarly, in this case, the dates of plaintiffs' transactions are relevant to the issue of reliance. Specifically, as discussed in the preceding section, plaintiffs cannot base their claims on any alleged fraud known to them when they covered. Thus, in addition to the dates Jones and Borislow first became aware of each allegation of fraud, it is necessary to know, for each individual plaintiff, including D & K Charitable Foundation, and for each short sale: the date the short position was acquired, the number of shares acquired, the sale price of those shares, the date the covering purchase was made, and the price of the covering purchase. That information is crucial to an understanding of which plaintiff may be entitled to recover for losses on which covering transaction, and in what amount. Plaintiffs' failure to plead these particulars is a basis for dismissing the Second Amended Complaint in its entirety, pursuant to Fed.R.Civ.P. 9(b).
C. Failure to Disclose the Existence of VeriFone
Plaintiffs allege that IDN failed to inform the market of the existence of a major new competitor in its field, Veri-Fone.
Defendants' amended Year 2000 10-KSB reported in the "Competition" section:
IDN's Form 10-KSB/A, p. 7.
Plaintiffs allege that VeriFone markets the same type of product as IDN, and
An equally viable theory of recovery for IDN's failure to disclose the existence of VeriFone is that IDN was subject to a duty to update the description of its competition in its SEC filings once IDN learned of the emergence of VeriFone. A company is under a duty to update a prior disclosure if it "[b]ecomes misleading when viewed in the context of subsequent events." Oran, 226 F.3d at 286 (quoting Burlington Coat Factory, 114 F.3d at 1431). As noted above, in IDN's Year 2000 10-KSB, filed March 29, 2001 and amended October 9, 2001, IDN disclosed the existence of various competitors whose products are portrayed as substandard to IDN's. In contrast, plaintiffs suggest that VeriFone's product is superior to IDN's. See Second Amended Complaint at ¶ 45. Hence, I find that a question of fact exists as to whether the arrival of VeriFone rendered IDN's previous disclosures of its competitors misleading, and thus whether IDN was under a duty to update its Year 2000 10-KSB, both as originally filed and as amended, to reflect the existence of VeriFone.
Defendants argue that they had no such duty because the market was already aware of VeriFone. Def. Br. at 20. As stated in the Second Amended Complaint ¶¶ 44-45, VeriFone announced its product through a press release on June 20, 2001, and its website contained a detailed description of its product. Id, Defendants also contend that plaintiffs themselves informed the market of VeriFone when they issued two press releases, on October 18 and October 25, 2001, announcing the basis of the class action suit to potential class members. Id. at 2, 20.
Defendants' arguments are unavailing. In re Campbell Soup Company Securities Litig., 145 F.Supp.2d 574 (D.N.J.2001), dealt with a similar issue. In that case, plaintiffs alleged that Campbell was aggressively supplying its customers with far more cans of its soup than they required, without informing the market, and all the while reporting in SEC filings that its sales and earnings were steadily increasing. Id. at 580-82. When Campbell finally revealed the extent of its sales tactics, its stock price fell significantly, to the detriment of the class of investors. Id. at 582. Plaintiffs contended that Campbell's earlier failure to disclose its sales practices rendered their reported earnings misleading and artificially inflated its stock price. See id, at 585. Campbell responded that the market knew of its sales tactics by way of various analyst reports which defendants included in their filings. Id. at 588 n. 1. The court found that it could not consider the reports for the pending motion to dismiss because plaintiffs did not
Defendants further argue that any failure to disclose the existence of VeriFone is immaterial as a matter of law because when plaintiffs issued the press releases announcing VeriFone's existence as a previously undisclosed competitor, IDN's stock prices rose instead of fell. Def. Br. at 20. This method of determining materiality is valid in the Third Circuit in the context of an efficient market, see Oran, 226 F.3d at 282 (discussed above in section III.B.l). IDN's stock is traded on the American Stock Exchange, "a market which has always been found efficient." RMED International, Inc. v. Sloan's Supermarkets, Inc., 185 F.Supp.2d 389, 405 (S.D.N.Y.2002); Second Amended Complaint at ¶ 11. However, for the reasons explained above, this Court cannot consider plaintiffs' press releases and therefore cannot consider their effect on the stock price. See Campbell, 145 F.Supp.2d at 588 n. 1; see also Burlington Coat Factory, 114 F.3d at 1424-25 (district court's reliance on information based solely on an affidavit attached to defendant's motion to dismiss was improper). Hence, I find that the question of the materiality of IDN's failure to disclose the existence of VeriFone cannot be decided on this motion to dismiss. Shapiro, 964 F.2d at 280 n. 11.
Thus, this claim will not be dismissed pursuant to Fed.R.Civ.P. 12(b)(6). However, to survive a motion to dismiss, plaintiffs must also comply with the PSLRA's requirement of raising a strong inference of scienter by "setting forth facts that constitute circumstantial evidence of either reckless or conscious behavior."
The Second Amended Complaint contains no allegations that would support any inference, much less a strong inference, that IDN intended to commit fraud by failing to disclose the existence of VeriFone in its amended Year 2000 10-KSB. Nor have plaintiffs alleged any support for the inference that IDN's failure to disclose VeriFone was "an extreme departure from the standards of ordinary care." At best, plaintiffs have alleged that IDN was negligent in submitting an incomplete or misleading filing with the SEC. This is not scienter. Thus, plaintiffs' claim of failure to disclose competition is dismissed for failure to comply with the PSLRA.
D. Failure to Timely and Adequately Disclose Details of the Messina Lawsuit
Kevin Messina, a former officer and director of IDN, filed a lawsuit on October 19, 2001, against the Company seeking a preliminary injunction enjoining it from restricting sales of his shares of company stock. Regulation S-B governs the requirements for a small business issuer's disclosure of legal proceedings. In the Company's annual and quarterly reports, it must do the following:
17 C.F.R. § 228.103; Form 10-KSB, Exchange Act, Fed. Sec. L. Rep. (CCH) ¶ 31,133 (Item 3) at 22,094 (Oct. 9, 2002) (referring the small business issuer to 17 C.F.R. § 228.103); Form 10-QSB, Exchange Act, Fed. Sec. L. Rep. (CCH) ¶ 31,041 (Item 1) at 22,034 (Oct. 9, 2002) (referring the small business issuer to 17 C.F.R. § 228.103). "A legal proceeding need only be reported in the Form 10-QSB filed for the quarter in which it first became a reportable event and in subsequent quarters in which there have been material developments." Form 10-QSB, Exchange Act, Fed. Sec. L. Rep. (CCH) ¶ 31,041 (Item 1) at 22,034 (Oct. 9, 2002).
On November 13, 2001, approximately three weeks after Messina filed suit, IDN reported in its Third Quarter 2001 10-QSB that:
IDN's Third Quarter 2001 10-QSB, p. 9. Plaintiffs claim this disclosure was deficient in several respects:
Plaintiffs first allegation of impropriety, that the disclosure was late, fails as a matter of law. Regulation S-B clearly states that a "legal proceeding need only be reported in the Form 10-QSB filed for the quarter in which it first became a reportable event." Form 10-QSB, Exchange Act, Fed. Sec. L. Rep. (CCH) ¶ 31,041 (Item 1) at 22,034 (Oct. 9, 2002). The suit was filed on October 19, which is in
Plaintiffs' remaining allegations are that IDN's disclosure of the Messina suit was misleading in various ways. These claims are therefore subject not only to Rule 9(b)'s requirement of stating fraud with particularity and the PSLRA's requirement of scienter, but are also subject to the PSLRA's mandate that:
Advanta, 180 F.3d at 530-31; 15 U.S.C. § 78u-4(b)(1).
Plaintiffs' contention that the disclosure was misleading because it was "inaccurate" is entirely unsupported by particulars. Plaintiffs allege nothing in support of this claim, and have therefore failed to comply with Rule 9(b). In addition, their failure to plead "the reason or reasons why" the disclosure was inaccurate is a violation of § 78u-4(b)(1) of the PSLRA. Without so much as an explanation as to why the disclosure was inaccurate, plaintiffs have likewise neglected to raise a strong inference of scienter, as required by § 78u-4(b)(2) of the PSLRA.
Plaintiffs third claim, that IDN's disclosure of the Messina suit was misleading because it failed to specify the allegations of the dispute, suffers from the same deficiencies. The disclosure in IDN's Third Quarter 2001 10-QSB reports that Messina sued the Company because it was not allowing him to sell restricted shares, on account of the Company's belief that he was an "insider." If plaintiffs are privy to other relevant details that IDN failed to disclose, they certainly have not plead those details, as required by Rule 9(b). Similarly, plaintiffs have not plead "the reason or reasons why" IDN's failure to disclose these (unspecified) details was misleading, as mandated by § 78u-4(b)(1) of the PSLRA. Without this information, the Court is unable to determine any basis of scienter on the part of the Company. If, for example, plaintiffs had plead, with particularized allegations in support thereof, that IDN purposefully withheld details of the suit that would have been damaging to the Company if publicized, perhaps they would have made the requisite showing of scienter. However, as it stands, the Second Amended Complaint falls far short of raising a strong inference that IDN intentionally or recklessly committed fraud by inadequately describing the Messina suit in its Third Quarter 2001 10-QSB.
Plaintiffs' fourth allegation pertains to the correlation between the Messina suit and IDN's patent suit against Identi-Scan that was pending at the time. As reported in IDN's Year 2000 10-KSB, the patent suit involved a dispute over which company held patent rights to the identification verification technology. Karam Dec. at Ex. C, p. 10. IDN's counsel in that suit identified Messina's "input on both our defensive case and affirmative claims against Identi-Scan as critical." Second Amended Complaint at II53. Yet on July 10, 2001, IDN's patent counsel informed the Company in writing that he had "endeavored unsuccessfully to obtain
However, plaintiffs have not plead enough to state a valid cause of action. Once a small business issuer has reported a legal proceeding in a SEC filing, Regulation S-B requires the company to report "material developments" in the case in subsequent quarterly reports. Form 10-QSB, Exchange Act, Fed. Sec. L. Rep. (CCH) ¶ 31,041 (Item 1) at 22,034 (Oct. 9, 2002). It is not clear from the Second Amended Complaint whether Messina's refusal to cooperate in the patent suit constituted a material development in that suit. What type of "input" could Messina have offered to the patent case? Why was the input "critical"? Could no one else at IDN offer such input? The Second Amended Complaint alleges none of these particulars, as required by Rule 9(b). Without these details, plaintiffs have also failed to raise a strong inference of scienter, as they must under § 78u-4(b)(2) of the PSLRA. If, for example, plaintiffs had plead allegations in support of a showing that Messina's cooperation was material to the patent suit, that his non-cooperation seriously hindered IDN's chances of success in the suit, and that IDN sought to conceal this development from the market, perhaps plaintiffs would have made a showing of scienter. However, the Second Amended Complaint contains no such allegations, and therefore fails to raise a strong inference that IDN intentionally or recklessly committed fraud by not revealing Messina's refusal to cooperate in the patent suit.
In sum: plaintiffs' claim of untimely disclosure of the Messina suit is dismissed pursuant to Fed.R.Civ.P. 12(b)(6). Plaintiffs' second and third allegations with respect to the Messina suit are dismissed for failure to comply with: (1) Fed.R.Civ.P. 9(b); (2) the PSLRA's instruction to allege the "reason or reasons why the statement is misleading," 15 U.S.C. § 78u-4(b)(1); and (3) the PSLRA's requirement of pleading scienter, 15 U.S.C. § 78u-4(b)(2). The fourth allegation, that IDN should have reported Messina's refusal to cooperate in the patent suit, is dismissed because it fails to comply with Rule 9(b), and fails to raise a strong inference of scienter.
E. IDN's Block of Messina's Sales of His Company Stock
As the "chief component of their market manipulation claim, plaintiffs allege that IDN's improper refusal to allow Messina to sell his shares on October 12, 15, and 16, 2001, artificially affected the supply of IDN's stock on the market and constituted securities fraud. Second Amended Complaint at ¶¶ 56-58; PI. Br. at 5. Plaintiffs contend that IDN blocked Messina's sales for the purpose of creating a "false shortage" of IDN's shares, which had the desired effect of artificially inflating the stock price. Id. at 158. Plaintiffs allege this effect on the market is shown by the fact that "IDN's share price has consistently dropped following Messina's sales on January 10, 2002, April 19, 2002, and May 7, 2002." Id.
Defendants argue that any claim based on the Messina suit lacks merit because the court in that case denied him injunctive relief and the case settled favorably for IDN. Def. Br. at 21. However, a review of the opinion in Messina v. Intelli-Check, Inc., (N.Y.Sup.Ct.2001), Index No.
Defendants' arguments that the Messina suit was baseless, and that the Company settled the case favorably, are improper on a motion to dismiss. At this stage, the Court must accept well-pleaded facts as true. See Burlington Coat Factory, 114 F.3d at 1426. Thus, the Court must assume that IDN improperly interfered with Messina's right to sell his stock, thereby creating a false impression of the supply and demand for the security, and that IDN did so for the purpose of artificially inflating the price of the stock. Defendants' protestations to the contrary are better suited for summary judgment.
Thus, this claim will not be dismissed pursuant to Fed.R.Civ.P. 12(b)(6). However, plaintiffs have again failed to show scienter, as required by the PSLRA. They have not plead allegations sufficient to support a strong inference that IDN intentionally or recklessly committed fraud by blocking Messina's sale of his shares. In IDN's Third Quarter 2001 10-QSB, the Company reported that it was acting within its rights by refusing to allow an insider to sell his restricted shares. IDN's Third Quarter 2001 10-QSB, p. 9. As the court noted in Messina v. Intelli-Check, Inc., the SEC has held that ownership of more than 10% of a company's shares supports a finding that the shareholder is an "affiliate" whose shares may only be sold pursuant to certain SEC rules. Messina at *2. IDN claimed that Messina, a former officer and director of the Company, by holding more than 14% of IDN's outstanding voting stock, so qualified as an "affiliate," and that his attempted sales did not comport with the SEC requirements. See id. While the court did not consider whether IDN's position was meritorious, plaintiffs have plead nothing to the contrary. Plaintiffs have not, for example, alleged that IDN blocked Messina's attempted sales despite knowing that the sales would have been in compliance with SEC rules. Accordingly, plaintiffs have failed to raise a strong inference that IDN intentionally or recklessly committed fraud by blocking Messina's sales. This claim is therefore dismissed for failure to show scienter, as required by the PSLRA.
F. Rights Offering
On September 21, 2001, IDN filed a Registration Statement with the SEC announcing a rights offering for 970,076 of its shares, whereby its stockholders were to receive one non-transferable right to purchase one share of IDN's common stock at $8.50 a share for every ten outstanding shares of common stock held on March 30, 2001. Second Amended Complaint at ¶ 60. Plaintiffs allege that the rights offering harmed them because it had "the effect of increasing the cost to cover their short positions." Id. at ¶ 63.
Defendants correctly argue that a rights offering is perfectly legal. Plaintiffs do not allege that defendants in any way violated the SEC's rules and regulations governing rights offerings. In an effort to cast some taint on the matter, plaintiffs contend that IDN's Prospectus filed in connection with the rights offering incorporated by reference its prior SEC filings which contained the misleading comparisons of current revenues with prior sales, and in which IDN also failed to properly disclose the existence of VeriFone and the details of the Messina suit. Id. at ¶ 61. This Court declines plaintiffs' invitation to consider these claims as inextricably intertwined
Accordingly, this claim is dismissed pursuant to Fed.R.Civ.P. 12(b)(6).
G. Interference with Borislow's Trading
Plaintiffs plead only one sentence in support of this allegation:
Id. at ¶ 59.
This claim is woefully inadequate. It does not come close to passing Rule 9(b)'s requirement that fraud allegations must be plead with particularity. Rule 9(b), rigorously applied in securities fraud cases, requires at a minimum that plaintiffs support their allegations with all of the necessary factual background that would accompany "the first paragraph of any newspaper story," that is, the "who, what, when, where and how" of the relevant events. Rockefeller, 311 F.3d at 217 (citations omitted).
The vagueness of this claim begs a host of unanswered questions: Who interfered with Borislow's relationship with his stock broker? How was this done? When and where did this happen? Who is Borislow's stock broker? What is wrong with "causfing] an investigation by the SEC into plaintiffs trading activities"? Who "attempted to interfere with efforts by plaintiffs [sic] to cover their short positions?" What does that mean? Who "otherwise targeted plaintiffs"? What does that mean? Who is bringing this claim— Borislow or all three plaintiffs? How is any of this a violation of Section 10(b) and Rule 10b-5? Where is the strong inference of scienter?
This claim is dismissed for failure to comply with Fed.R.Civ.P. 9(b) and the PSLRA.
H. Claims Against Individual Defendants
I. Section 20(a)
Plaintiffs bring a claim against each of the individual defendants—Frank Mandelbaum, Paul Cohen, Edwin Winiarz, and W. Robert Holloway—based on Section 20(a) of the Exchange Act. Section 20(a) creates a cause of action against individual defendants alleged to have been "control persons" of companies guilty of securities fraud. The section provides:
15 U.S.C. § 78t(a). One can be liable under this section for controlling a company that committed securities fraud. See In re: MobileMedia Securities Litig., 28 F.Supp.2d 901, 940 (D.N.J.1998). Plaintiffs
In MobileMedia, plaintiffs alleged that defendant was a director of the company who had, and exercised, power to influence and control the company. Id. Defendant argued that he did not have sufficient control over the company for purposes of a Section 20(a) violation. See id. Rejecting that argument as a question of fact improperly raised at the motion to dismiss stage, the court held that plaintiffs sufficiently plead control person status. Id.
Only defendants W. Robert Holloway and Paul Cohen contest that they are control persons. Def. Br. at 27-28. They claim that they are low-level officers or outside directors. Plaintiffs have alleged that Holloway was a Senior Executive Vice President of IDN, Cohen was a director of IDN, and that:
Plaintiffs further allege that the individual defendants:
Second Amended Complaint ¶¶ 13,15, 92. Plaintiffs have sufficiently alleged that Holloway and Cohen "had actual power or influence" over IDN's public filings and press releases. See MobileMedia, 28 F.Supp.2d at 940. As the MobileMedia court found, defendants' arguments to the contrary are questions of fact which are improper at the motion to dismiss stage. Id.
The Court notes that both defendants and plaintiffs in their briefing on Section 20(a) present arguments that are without sufficient legal support. Defendants argue that a cause of action for control person liability must include facte showing defendants' "culpable participation" in the company's wrongdoing. Def. Br. at 28. While plaintiffs will have to prove culpable participation at trial, Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880, 889-90, the "overwhelming trend in this circuit" is that culpable participation does not have to be plead in order to survive a motion to dismiss. Derensis v. Coopers & Lybrand Chartered Accountants, 930 F.Supp. 1003, 1013 (D.N.J.1996) ("plaintiff need only plead circumstances establishing control because: (1) the facts establishing culpable participation can only be expected to emerge after discovery; and (2) virtually all of the remaining evidence, should it exist, is usually within the defendants' control.") (quotations omitted); accord Campbell, 145 F.Supp.2d at 600 (collecting cases).
In any event, plaintiffs have adequately plead control person status under Section 20(a) for the individual defendants.
2. The Individual Defendants' Scienter
In addition to pleading control person status for purposes of Section 20(a), plaintiffs must also raise a strong inference that each individual defendant acted with scienter, as required by the PSLRA. Scienter is adequately plead by "setting forth facts that constitute circumstantial evidence of either reckless or conscious behavior" or by alleging facts "establishing a motive and an opportunity to commit fraud." Advanta, 180 F.3d at 534-35. A showing of scienter with respect to a company does not amount to a showing of scienter with respect to any officer or director of the company, since "[generalized imputations of knowledge do not suffice regardless of the defendant's position within the company." Oran, 226 F.3d at 290 (quoting Advanta, 180 F.3d at 539). Blanket allegations that defendants stood to benefit from wrongdoing and had the opportunity to commit fraud are not sufficiently plead under the PSLRA because they do not state facts with particularity or give rise to a strong inference of scienter. Burlington Coat Factory, 114 F.3d at 1424. Similarly, conclusory assertions that defendants acted "knowingly," or that, because of a defendant's position in a company, he or she "must have known" of alleged fraud are insufficient to establish scienter. Advanta, 180 F.3d at 539 (citation omitted).
Plaintiffs allege the following as evidence of scienter for the individual defendants:
Second Amended Complaint at ¶¶ 68, 70, 93.
Paragraphs 70 and 93 allege that defendants committed fraud in order to "maintain the value of their holdings" in the Company and to profit by selling their stocks at an inflated price. The Third Circuit has found that in order to successfully plead scienter in this fashion, plaintiffs must allege that defendants sold shares, "at times and in quantities that were suspicious enough to support the necessary strong inference of scienter." Burlington Coat Factory, 114 F.3d at 1424. Plaintiffs cannot successfully use this method of showing scienter with respect to a defendant who sold no shares during the relevant time period. Oran, 226 F.3d at 289. Plaintiffs have alleged the following regarding defendants' stock sales:
Second Amended Complaint at ¶¶ 12-15. Plaintiffs have failed to show that Winiarz and Holloway had a motive to commit fraud. See Oran, 226 F.3d at 289. Plaintiffs' allegations of Mandelbaum and Cohen's sales are not nearly specific enough to support a strong inference of scienter. There is no indication whether these sales were uncommon for the two; perhaps they normally trade this quantity of stock. More importantly, it is impossible to tell whether any of these sales occurred during plaintiffs' alleged "bubble period," which lasted from September 2001 through May 29, 2002. Plaintiffs have therefore failed to raise a strong inference of scienter with respect to Mandelbaum and Cohen as well. Id. at 290.
In sum, plaintiffs have not shown scienter with respect to any of the individual defendants. The claims against them are therefore dismissed pursuant to the PSLRA.
In conclusion, the following claims are dismissed pursuant to Fed.R.Civ.P. 12(b)(6):
These claims cannot be replead.
The following claims are dismissed for failure to comply with Fed.R.Civ.P. 9(b) and/or the PSLRA:
In addition, plaintiffs have failed to plead the dates on which they each became aware of each allegedly fraudulent misrepresentation or act, see supra section IV. A.2, and the dates and details of their short sale transactions, see supra section IV.B, as is in this case required by Fed. R.Civ.P. 9(b). Plaintiffs will be given the opportunity to move for leave to amend their complaint to account for the Rule 9(b) and PSLRA deficiencies within thirty days of the entry of the accompanying Order. See Nappier, 227 F.Supp.2d at 282 (granting motion to dismiss for failure to adequately plead scienter, but allowing plaintiffs to move to amend complaint through submission of proposed amended complaint containing more factual support for scienter). If plaintiffs choose to timely move for leave to file a Third Amended Complaint, the Court will then consider whether the amendments would be futile.
Though neither party submitted IDN's amended Year 2000 annual report to the Court, I will consider it for purposes of this motion to dismiss because plaintiffs' claims are in part based upon it. Trump Casino, 7 F.3d at 368 n. 9.