Opinion
09 CV 08862 (GBD).
December 22, 2010
MEMORANDUM DECISION AND ORDER
This action involves an alleged pump-and-dump scheme in which Defendants caused Plaintiffs, a group of Cayman Island based hedge funds, to purchase shares of "Penny Stock Companies" not traded on a U.S. domestic exchange at artificially inflated prices. Pending before the Court are Defendants' motions to dismiss the amended complaint. This case is dismissed for lack of subject matter jurisdiction.
According to the Securities Exchange Commission ("SEC"), a pump-and-dump scheme is "the touting of a company's stock (typically microcap companies) through false and misleading statements to the marketplace. After pumping the stock, fraudsters make huge profits by selling their cheap stock into the market." See http://www.sec.gov/answers/pumpdump.htm According to the SEC, "[t]he term `penny stock' generally refers to low-priced (below $5), speculative securities of very small companies. While penny stocks generally are quoted over-the-counter, such as on the OTC Bulletin Board or in the Pink Sheets) they may also trade on securities exchanges, including foreign securities exchanges." See http://www.sec.gov/answers/penny.htm.
The Amended Complaint includes claims against each Defendant for (I) misstatement and omissions pursuant to Section 10(b) and Rule 10b-5; claims against Homm, Hunter, Ficeto, Colin Heatherington, Craig Heatherington, CIC, the John and Jane Doe(s) and Doe Entities for (2) market manipulation under Section 10(b) and Rule 10b-5; (3) churning under Section 10(b) and Rule 10b-5; claims against each defendant for (4) fraud and fraud conspiracy; and claims against Homm and Ewing on behalf of ACM for (5) breach of fiduciary duty.
Following the filing of the pending motions to dismiss, the Supreme Court released its decision in Morrison v. National Australia Bank, 130 S. Ct. 2869, 2884 (2010), which limited the application of Section 10(b), and by extension, Rule 10b-5, in affirming a ruling that certain claims were not properly brought in the United States pursuant to federal securities laws for lack of subject matter jurisdiction. Defendants in the instant case also move for dismissal for lack of personal jurisdiction pursuant to Fed.R.Civ.P. 12(b)(2), failure to state a claim upon which relief can be granted pursuant to Fed.R.Civ.P. 12(b)(6), improper venue pursuant to Fed.R.Civ.P. 12(b)(3), or in the alternative, to transfer this case to the Northern District of California pursuant to 28 U.S.C. § 1404(a) and the expiration of the statute of limitations under the PSLRA. As the Court has determined that it lacks subject matter jurisdiction over Plaintiffs' claims, it does not consider those issues in this Memorandum Order.
Factual Background
The Parties
Plaintiffs are a group of Cayman Island companies registered as mutual (hedge) funds (the "Funds" or "Plaintiffs") that invested on behalf of investors located around the world, including the United States. (Amd. Compl. ¶ 2.) Defendants are individuals and entities who allegedly caused Plaintiffs to purchase nearly valueless penny stocks issued by companies that were registered with the United States Securities and Exchange Commission (the "SEC"). (Id. ¶¶ 1, 3.)
Defendant Florian Homm ("Homm") is a German national who also holds a Liberian passport. (Id. ¶ 9.) Homm maintains several residences throughout Europe. (Id.) Homm was a founder of Absolute Capital Management Holdings Limited ("ACM"), the investment manager for the Funds. (Id.) He served as ACM's Chief Investment Officer, and was responsible for the Funds investments for at least the middle of 2004 until or about September 18, 2007, when he resigned from his position. (Id.) Homm invested on behalf of the funds pursuant to a power of attorney. (Id. ¶ 25.) At all relevant times, Homm owned more than 40% of the outstanding shares of ACM through the investment vehicle he controlled and was also a 50% owner of Defendant Hunter World Markets, Inc. ("Hunter"). (Id. ¶ 9.) Homm has previously been fined or otherwise subject to discipline by German financial industry regulators. (Id.) Homm has gone "into hiding" and has not responded to the amended complaint. (Id.)
Defendant Hunter World Markets, Inc. is a California corporation. (Id. ¶ 11.) Hunter is registered with the Securities Exchange Commission ("SEC") and FINRA as a broker dealer. (Id.) At relevant times, Hunter held state registrations as a brokerdealer in California, Florida, Hawaii, Illinois, Massachusetts, Nevada, New Jersey, New York, Ohio, Texas and Washington. (Id.) On or about October 1, 2009, Hunter requested a termination of its registrations. (Id.) Hunter was an underwriter for or was otherwise involved in the offerings of the Penny Stock Companies whose shares Defendants caused the Funds to purchase. (Id.) Hunter was also affiliated with Defendant CIC Global Capital Ltd. ("CIC"), which sold the Funds millions of shares of the Penny Stock Companies. Defendants Todd M. Ficeto and Homm each owned 50% of Hunter. (Id.)
Defendant Todd M. Ficeto ("Ficeto") is a resident of Malibu, California. (Id. ¶ 10.) Ficeto served as President and Director of Hunter. (Id.) At all relevant times, Ficeto held Series 7, 24, 55 and 63 securities licenses issued by the Financial Industry Regulatory Authority ("FINRA") and was a registered securities agent in California, Florida, Illinois, Massachusetts, New Jersey, New York, Texas and Washington. (Id.) Ficeto has been previously fined and suspended by securities regulators. He is sued individually and as Guardian for Natalia C. Ficeto and Hunter M. Ficeto, his minor children. (Id.) At all relevant times. Ficeto was the control person of shares in the Penny Stock Companies held by Natalia C. Ficeto and Hunter M. Ficeto.
Defendant Colin Heatherington is a Canadian national, and a resident of Australia. (Id. ¶ 12.) Colin Heatherington was an ACM employee who assisted Defendant Homm. (Id.) His final day as an ACM employee was September 17, 2007, the day before Homm resigned. Colin Heatherington was also a principal of defendant CIC Global Capital Ltd. (Id.)
Defendant Craig Heatherington is a Canadian national, and a resident of Australia. (Id. ¶ 13.) He is Colin's brother, and also worked at ACM and was a principal of CIC. (Id.)
Defendant CIC Global Capital Ltd. is a company that was incorporated in the British Virgin Islands in January 2005. (Id. ¶ 14.) "CIC" is allegedly an acronym consisting of the initials of the first names of Colin Heatherington, Ida Manly (his wife), and Craig Heatherington. (Id.) In SEC filings, CIC is sometimes referred to as an affiliate or client of Hunter. (Id.)
Defendant Sean Ewing ("Ewing") is an Irish national who resides in Spain. (Id. ¶ 15.) Along with Homm, he was a founder of ACM and served as its Chief Executive Officer and Chairman of the Board from in or around the middle of 2005 until he resigned in August 2007. (Id.) At relevant times, Ewing owned a substantial percentage of the outstanding shares of ACM through the investment vehicle he controlled. (Id.) Ewing oversaw compliance and risk management in ACM's activities as the investment manager for the Funds. (Id.)
Defendant Ulrich Angersbach ("Angersbach") is a German national. (Id. ¶ 16.) Angersbach was a founder of ACM, a Director of ACM until January of 2006, and served as ACM's Head of Investor Relations and Marketing from in or about the middle of 2005 until December 2007. (Id.) Prior to the middle of 2005, Angersbach worked closely with Homm and was a founder of FM Fund Management Limited, the hedge fund management company that preceded ACM. (Id.) At various times, Angersbach owned a substantial percentage of the outstanding shares of ACM through the investment vehicle he controlled. Angersbach raised approximately $2 billion from approximately 400 professional investors. (Id.)
Defendants John Does, Jane Does and Doe Entities are persons or entities who participated in the alleged scheme to defraud and whose identities are not presently known to Plaintiffs. (Id. ¶ 17.) Homm, Ficeto, Hunter and Colin Heatherington are referred to in the collectively as the "Trading Defendants." (Id. ¶ 18.) Defendants Homm, Ficeto and Colin Heatherington maintained a close personal relationship that included traveling together and collectively purchasing a boat they named "No Remorse" after a Metallica song of the same name. (Id. ¶¶ 124-130.)
The Alleged Scheme
Exercising lawful control over the Funds, Defendants caused the Funds to purchase billions of shares of virtually worthless companies (the "Penny Stock Companies") that were incorporated in the United States and whose shares were quoted on the Over the Counter Bulletin Board or by Pink OTC Markets Inc. directly from those companies. (Id. ¶¶ 3, 5(a).) The securities at issue were not sold on an exchange, but were rather purchased directly from the companies pursuant to private placements known as PIPE (public investment in private equity) transactions. (Id. ¶ 31) The Penny Stock companies were thinly capitalized, and their securities (the "Penny Stocks") were essentially illiquid. (Id. ¶ 27.) Over a three year period, Defendants caused Plaintiffs to purchase shares in at least eight Penny Stock Companies. (Id. ¶ 28).
These companies include, but are not limited to, ProElite, Inc., MicroMed Cardiovascular, Inc., Berman Center, Inc., InterMetro Communications, Inc. (f/k/a "Lucy's Cafe, Inc."), NuRx Pharmaceuticals, Inc. (f/k/a "Quest Group International, Inc."), Java Detour, Inc., Logistical Support, Inc., and Duravest, Inc.
At the times of each purchase, Defendants either (1) already held in their own names, or otherwise controlled, substantial amounts of shares and/or warrants of the Penny Stock Companies, or (2) received shares and/or warrants from the Penny Stock Companies in exchange for causing the Funds to purchase shares from those Companies. (Id. ¶ 5(b).) Typically, Defendants paid nothing or almost nothing to acquire these shares and warrants. (Id.)
The alleged scheme was premised on manipulating and artificially inflating the prices of the Penny Stocks. (Id. ¶ 5(c).) This was accomplished, in part, by trading and re-trading the stocks many times over, sometimes on the same day, between and among the Funds. (Id. ¶ 34.) The alleged fraudulent purposes were twofold: (1) to generate bogus commissions for Homm, Hunter and Ficeto, and (2) to artificially inflate the stock price to the point at which Defendants were free to sell previously untradable shares and exercise certain warrants, which Defendants then sold to the Funds at a profit. (Id.) In order to successfully manage the alleged scheme and conceal its existence from ACM and the Funds, Defendants maintained control over each aspect from making trades to brokering the trades, to matching the trades on the back end. (Id. ¶¶ 40-44, 53-56, 66-68.) Numerous trades are detailed in the amended complaint, and Plaintiffs allege that they suffered losses on each trade, to the tune of at least $195 million. (Id. ¶¶ 36-123.)
The Role of Each Defendant
Hunter served as an underwriter and broker in the alleged scheme. (Id. ¶ 10.) Its only investors were certain of the Funds, which invested a total of $34 million with Hunter. (Id. ¶ 131.) Ficeto was the President, Director and 50% owner of Hunter. (Id. ¶ 11.) He managed all aspects of Hunter's business. (Id. ¶ 10.) Through his co-ownership of Hunter with Homm and his close personal relationship with Colin Heatherington, Ficeto was able to ensure that the Funds invested in the Penny Stocks he suggested. (Id. ¶¶ 10, 21(ii), 128, 130.) Ficeto gained personal benefits by (1) selling the Penny Stock shares he owned personally (and acquired for little of no consideration) to the Funds at artificially inflated prices; (2) paying himself commissions from the trades; and (3) paying himself fees for arranging financing for the transactions. (Id. ¶ 142.)
Colin Heatherington was Homm's "point man" on trading and his "right hand man". (Id. ¶¶ 12, 30.) He also had a close personal relationship with Ficeto and played a key role in the alleged scheme by purchasing the Penny Stocks on behalf of the Funds by placing the trades with Ficeto. (Id. ¶¶ 21(ii), 30, 128.) Colin Heatherington allegedly gained enormous personal benefits, perhaps as high as $25 million. (Id. ¶ 129.) He purchased a home for CAD 7.74 million as well as a yacht despite earning a salary of only 65,600 Euros (approx. $80,000). (Id.) The primary vehicle through with Colin Heatherington gained these benefits was CIC, a company in which he was a principal and shareholder that sold the Funds millions of shares of the Penny Stock Companies. (Id. ¶¶ 14, 126.) Some of these sales occurred as a result of fraudulent exercises of warrants which CIC was issued as part of the Penny Stock transaction. (Id. ¶¶ 32, 33.)
Craig Heatherington, Colin's brother, worked in ACM's back office. (Id. ¶ 13.) He was responsible for matching Penny Stock transactions. (Id. ¶ 30.). He obtained most of the benefits from the alleged fraudulent scheme through his role as a principal and shareholder of CIC, which fraudulently sold Penny Stocks at artificially inflated prices to the Funds. (Id. ¶ 134.) Craig Heatherington was involved in approving and signing for various transactions related to CIC. (Id. ¶ 124.) He is listed in certain SEC filings as a director of CIC. (Id. ¶ 33.)
Defendant Ewing, an officer of ACM, and Defendant Angersbach allegedly knew of the fraud, yet did not report it to ACM or the Funds. (Id. ¶¶ 140.) Furthermore, Ewing allegedly made misrepresentations about the funds, and specifically the actions of Homm, to investors in the United States and elsewhere. (Id. ¶¶ 135-136). Defendant Angersbach also assisted with marketing the funds in the United States and elsewhere. (Id. ¶ 141.)
Jurisdiction
Moving Defendants, with the exception of Ficeto and Hunter, assert that this Court lacks personal jurisdiction over them and seek dismissal pursuant to Fed.R.Civ.P. 12(b)(2). That said, subject matter jurisdiction is a threshold determination that the Court is obligated to consider sua sponte. Joseph v. Leavitt, 465 F.3d 87, 89 (2d Cir. 2006). "The validity of an order of a federal court depends upon the court's having jurisdiction over . . . the subject matter" of the dispute. In re European Aeronautic Defence Space Co. Sec. Litig., 2010 U.S. Dist. LEXIS 29742 at *13 (S.D.N.Y. Mar. 26, 2010) (quoting Ins. Com. of Ireland v. Compagnie des Bauxites de Guinee, 456 U.S. 694, 701 (1982)).
On June 24, 2010, the day after oral arguments were heard in the instant case, the Supreme Court issued its decision inMorrison v. National Australia Bank, 130 S. Ct. 2869 (2010). Morrison involved an "F-Cubed" claim, foreign investors suing foreign (and American) defendants for misconduct relating to securities purchased on a foreign exchange. Id. at 2873. The Supreme Court held that § 10(b) of the Exchange Act (and by extension, Rule 10b-5) applies to "only . . . [1] the purchase or sale of a security listed on an American stock exchange, and [2] the purchase or sale of any other security in the United States."Id. at 2884. The Supreme Court stated that the jurisdictional provision of the Act, 15 U.S.C. § 78aa, vested the district court with jurisdiction sufficient to adjudicate the question as to whether § 10(b) applied to the defendants' conduct. However, it does not relate at all to subject matter jurisdiction, which refers to a tribunal's power to hear a case. Id. at 2877 (internal quotations and citations omitted). The decision, which was highly critical of then prevailing Second Circuit precedent, limited the scope of § 10(b) by stating that "[w] hen a statute gives no clear indication of an extraterritorial application, it has none." Id. at 2869.
Given the facts in the instant case, it is worth noting that the defendant in Morrison was an Australian bank that was publicly traded on the Australian and other stock exchanges, however it was not listed on any American stock exchange. American investors were able to purchase shares of the bank via American Depositary Receipts (ADRs), which permit American investors to purchase shares of foreign corporations on domestic exchanges. See Law Debenture Trust Co. v. Maverick Tube Corp., 595 F.3d 458, 463-464 (2d Cir. 2010). The defendant bank owned an American mortgage servicing company based in Florida. Plaintiffs alleged that misstatements and omissions attributed to the mortgage servicing company caused the bank's shares to loose value and sought redress under US securities laws despite the bank not listing its shares on any American exchange.
The Supreme Court declined to remand on the issue because "a remand would only require a new Rule 12(b)(6) label for the same Rule 12(b)(1) conclusion." Morrison, 130 S. Ct. at 2877. Each defendant in the instant matter seeks dismissal pursuant to Rule 12(b)(6). In light of the foregoing, the Court has determined that dismissal is properly granted under Rule 12(b)(6) as well as 12(b)(1).
The practical effect of Morrison is the elimination of the "conduct or effect" test previously employed by the Second Circuit. That test sought to determine whether the allegedly offending transaction (1) had a substantial effect on United States markets or upon American citizens, or (2) occurred in the United States. See, e.g., SEC v. Berger, 322 F.3d 187, 192-93 (2d Cir. 2003). Under Morrison's "transactional test," "F-Cubed" cases may now be swiftly dispatched with for lack of subject matter jurisdiction, even where there is some connection to the United States. Morrison, 130 S. Ct. at 2884-2886.
Courts in the Southern District have had the opportunity to apply the new "transactional test." For instance, in Cornwell v. Credit Suisse Group, the court determined that sales of securities listed on a foreign exchange, even if purchased by United States residents, were not actionable under § 10(b). 2010 U.S. Dist. LEXIS 76543, at *7-8 (S.D.N.Y. July 26, 2010). In In re Alstom SA Sec. Litig., the court declined to undertake a "selective and overly-technical reading of Morrison" in ruling that the mere fact that a stock is listed on a domestic exchange does not give rise to a claim under domestic securities laws when the shares were purchased elsewhere. 2010 U.S. Dist. LEXIS 98242 (S.D.N.Y. Sept. 13, 2010) (citing Morrison, 130 S. Ct. at 2884 for the proposition that the focus of the court's inquiry should be on where the transaction occurs, not the exchange where ministerial pre-purchase activities were directed).
The instant case presents an interesting twist. Plaintiffs are based in the Cayman Islands. Defendants, with the exception of Ficeto and Hunter, are foreign nationals. The corporations that issued the Penny Stocks were registered with the SEC, however, their shares were not traded on a domestic exchange. Instead, the fraudulent scheme alleged involved private offerings (i.e. the "PIPE" transactions) in which the Funds were caused to purchase the illiquid shares directly from the companies through private placements. At no point were the shares released to the general market. In fact, the entire "market" alleged was the trading by and between the Funds. The Funds were based in the Cayman Islands and managed in Europe.
The plain language of the "transaction test" established inMorrison precludes this action from moving forward. Simply put, accepting the allegations of the amended complaint as true: (1) there was no sale of a security listed on an American Exchange as the PIPE (i.e. private placement) transactions involved "Penny Stocks" that were purchased "directly from the company;" and (2) no transaction occurred in the United States.
Morrison's treatment of ADRs lends to the conclusion that its holding applies even where companies are registered with the SEC.
The instant case involves foreign investors suing foreign and domestic defendants regarding private transactions in securities that were not listed on a United States domestic exchange. This appears to be precisely the type of case the Supreme Court had in mind when it issued Morrison. Permitting this case to move forward on the theory that any trade routed through the United States meets the Morrison standard would be the functional antithesis of Morrison's directive. By all accounts, Plaintiffs took great pains to avoid the regulations imposed by federal securities laws that apply to domestic market transactions. It would be illogical, and inconsistent with Morrison, to allow them to seek redress in this Court. Accordingly, Plaintiffs' claims must be dismissed on the grounds that the Court lacks subject matter jurisdiction.
CONCLUSION
This Court lacks federal subject matter jurisdiction over the claims asserted by Plaintiffs. As such, the Court has refrained from opining on the various other substantive grounds upon which Defendants have moved to dismiss. Plaintiffs' Complaint is dismissed in its entirety.
Dated: New York, New York December 22, 2010