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holding that plaintiff must plead with particularity that the controlling person "knew or should have known that the primary violator, over whom that person had control, was engaging in fraudulent conduct"
Summary of this case from Lapin v. Goldman Sachs Group, Inc.Opinion
01 Civ. 1125 (GEL)
September 30, 2002
Howard T. Longman, Stull Stull Brody, New York, N.Y. (Jules Brody and William W. Wickersham, Stull Stull Brody; Joseph H. Weiss and Moshe Balsam, Weiss and Yourman, New York, NY; Gary S. Graifman, Kantrowitz Goldhamer Graifman: Mel E. Lifshitz, Bernstein, Libhard Lifshitz; on the brief) for plaintiffs Adam Burstyn, Robert James Kennedy, Joseph Rosenbaum, Waterview Partners, and Eli Mann, on behalf of themselves and all others similarly situated.
Jeanne M Luboja, Willkie Farr Gallagher, New York, N.Y. (Michale R. Young, Ian K. Hochman, on the brief) for defendants Scott A. Mednick, Werner G. Haase, Nurit K. Haase, William Zabit, and John P. Gandolfo.
Edward J. Johnsen, Katten Muchin Zavis Rosenman, New York, N.Y. (David H. Kistenbroker, Leah J. Domitrovic, Matthew J. Cannon, Liat Riff Meisler, on the brief) for defendant Howard A. Tullman.
OPINION AND ORDER
In this securities class action brought by persons who purchased common stock of Worldwide Xceed Group, Inc. ("Xceed") between November 29, 1999, and November 15, 2000, (the "Class Period") against Scott A. Mednick, Werner G. Haase, Nurit K. Haase, William Zabit, John P. Gandolfo (collectively the "Individual Defendants"), Howard A. Tullman ("Tullman"), and Xceed, plaintiffs allege in the Amended Class Action Complaint ("Complaint" or "Compl.") that defendants violated section 10(b) of the Securities and Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 promulgated thereunder, and section 20(a) of the Exchange Act. The Individual Defendants and Tullman now move to dismiss pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b) ("PSLRA"). For the reasons stated below, the Individual Defendants' motion is denied, but Tullman's motion is granted.
BACKGROUND
Accepting the facts alleged by plaintiffs as true and drawing inferences in their favor, during the Class Period, defendants made false statements in Xceed's Securities Exchange Commission ("SEC") filings and in press releases, portraying Xceed "as a strong and viable company when, in fact, it was not." (Pl. Opp. at 1.) Xceed was a Delaware corporation that, prior to filing for bankruptcy on April 30, 2001, and selling its operating assets to another company on July 19, 2001, "provide[d] consulting services and digital solutions to corporations and businesses to compete more effectively in the network economy and to accelerate the development of eBusiness solutions." (Compl. ¶ 9.) Like many other so called "dot com" companies, Xceed's success was short-lived, and according to plaintiffs, was largely a mirage created by `defendants' multi-faceted accounting scheme" consisting of "sleight-of-hand accounting, violating one section after the other of Generally Accepted Accounting Principles ("GAAP")." (Pl. Opp. at 1.) During the Class Period, Xceed's stock rose to $48.00 per share, but by the end, fell as low as 50.75 per share. (Id.)
Xceed's Chapter 11 filing triggered an automatic stay of plaintiffs' claims against the company.
The Complaint identifies six individual defendants. Five (Mednick. W. Haase, N. Haase, Zabit, and Gandolfo) jointly move to dismiss; Tullman has submitted his own motion papers. Mednick is the only defendant affiliated with Xceed during the entire Class Period. He was the co-Chairman of the Board of Directors until his resignation effective December 15, 2000. (Id. ¶ 10.) Two others worked for Xceed during most of the Class Period: N. Haase served as Senior Vice President until resigning on July 31, 2000, (id. ¶ 12), and Gandolfo was Senior Vice President and Chief Financial Officer until resigning on September 29, 2000, (id. ¶ 13). The remaining three defendants acted as Xceed's President in quick succession. Zabit was President until March 2000. (Id. ¶ 14.) W. Haase replaced him and served as co-Chairman, Chief Executive Officer ("CEO"), and President for just six months, resigning in August 2000 with an alleged debt to the company exceeding $1.5 million. (id. ¶ 11.) Tullman took over for W. Haase as CEO pursuant to an agreement dated August 4, 2000 (id. ¶ 15), joining Xceed in September 2000 (Pl. Opp. at 31). He served as CEO and as a director until the end of the Class Period.
During the Class Period, according to the Complaint, these defendants knowingly and recklessly understated Xceed's losses in seven filings: the Form 10-Ks for the fiscal years ending August 31, 1999 ("99K"), and August 31, 2000 ("2000K"); the Form 10-K/A for the fiscal year ended August 31, 1999 ("99KA"); the Form 10-Qs for the quarters ending November 30, 1999 ("NovQ"), February 20, 2000 ("FebQ"), and May 31, 2000 ("MayQ"); and the Form 10-Q/A for the quarter ended November 30, 1999 ("NovQA") — described collectively as "Xceed's filings." (Compl. ¶ 35.) According to the Complaint, Mednick signed the 99K, 99KA, and 2000K. W. Haase signed the 99K, NovQ, 99KA, NovQA, FebQ, and 2000K. Zabit signed the 99K and 99KA. Gandolfo signed the 99KA and MayQ. Tullman (although not charged in the Complaint as having signed any fraudulent filings) signed the 2000K. N. Haase did not sign any of the filings at issue.
Tullman claims that "[p]laintiffs do not allege the 2000K was false." (Tullman Mem. at 1.) In the Complaint, however, plaintiffs allege that Xceed's Revenue Recognition Policy in the 2000K violated GAAP. (See Compl. ¶¶ 66-76.) Tullman argues that plaintiffs cannot plead fraud merely by alleging a GAAP violation. (Tullman Mem. at 18.)
Plaintiffs cite four types of accounting violations in the relevant filings. First, Xceed allegedly made inadequate allowances for doubtful accounts. For quarters ending November 30, 1999, and February 29, 2000, Xceed allowed for $1.8 million in uncollectible receivables. Although for the quarter ending May 31, 2000, the company reduced that number to approximately $1.6 million, representing a mere 6.3% of receivables, for the immediately following quarter, it allowed nearly 45% of its receivables, close to $9.4 million. (Id. ¶¶ 37-42.) Xceed acknowledged this adjustment and claimed it was required given sudden "cash flow difficulties [of customers] as a result of a decline in the economic marketplace for start up and dot-coin companies that began to occur during the fourth quarter [of fiscal year 2000]." (Id. ¶ 38.) Plaintiffs describe this extraordinary increase in allowance for uncollectible accounts as proof that the understatement in prior quarters was "intentional or in reckless disregard of Xceed's own stated accounting policy and the principles of GAAP." (Id. ¶¶ 42-43.)
Second, Xceed's 2000K sets forth its policy for amortization, stating that goodwill (the excess of purchase price over the fair value of net assets acquired) would be amortized over a seven-to twelve-year period, while other identifiable intangible assets associated with customer base, workforce, and industry contacts would be amortized over a seven-year period. (Id. ¶ 50.) After fiscal year ending August 31, 2000, Xceed amortized all remaining goodwill over a seven-year period. (Id. ¶ 54.) Plaintiffs allege that Xceed, contrary to its stated policy, amortized other identifiable intangible assets obtained in the September 1998 acquisition of Zabit Associates, Inc., over a twelve-year period. (Id. ¶ 52.) They also allege that amortizing goodwill associated with that acquisition over twelve years instead of seven was excessive. According to the Complaint, these maneuvers understated net losses by approximately 81.8 million on an annualized basis, and that defendants knew that use of the twelve-year period was excessive and would result in false and material understatement. (Id. ¶¶ 47-56.)
Third, Xceed wrote off approximately $87 million in unamortized goodwill in the fourth quarter of fiscal 2000 (id. ¶ 59) to account for a significant decrease in workforce and customer base (id. ¶ 62). Plaintiffs allege that defendants knew or should have known that impairment of these intangible assets began prior to the fourth quarter and should have been reflected in the NovQ, FebQ, and MayQ statements. (Id. ¶¶ 60, 64-65.) Failure to review these long-lived assets when "events of changes in circumstances indicate that the carrying amounts of the asset may not be recoverable" violates GAAP and Xceed's own stated policy. (Id. ¶ 61.)
Finally, GAAP limits the use of the percentage of completion method of accounting to contracts where, among other things, reasonably dependable estimates of progress, revenue, and cost are possible, and performance is expected. (Id. ¶ 70.) Although allegedly not such contracts, Xceed used the percentage of completion method for its fixed price contracts from the company's Internet Professional Services and Performance Enhancement Business (id. ¶ 68), which plaintiffs claim led to material understatement of net losses (id. ¶ 69).
In addition to the above allegations of fraud in Xceed's filings, plaintiffs also point to six press releases between April 11, 2000, and September 18, 2000, which contain optimistic characterizations of Xceed's performance. On April 11, 2000, a Business Wire release included a Mednick's statement that, "[t]he Company has continued its growth strategy both on a global and national scale. During the second quarter we saw significant growth both organically and through major acquisitions, increasing our strength in the U.K. and European markets," and W. Haase's statement that "we are proud of our continued growth." (Id. ¶¶ 76-77.) W. Haase described Xceed's growth as "explosive" in an April 27, 2000, Business Wire release (Id. ¶ 79), and soon after on June 15, 2000, Mednick predicted that Xceed "will be profitable before the end of the year" (id. ¶ 84). On July 11, 2000, Mednick described Xceed's revenue for the nine months ending May 31, 2000, and happily reported "rapid revenue growth" (id. ¶ 81). Mednick's statements were repeated on July 17, 2000, in a Work Group Computing Group press release. (Id. ¶ 82.) Finally, on September 18, 2000, Tullman noted in a Business Wire release that Xceed expect[s] to report strong growth for this recently completed quarter, which ended August 31, 2000," due to an increase in Interactive and Strategic Consulting revenues "by over 200% over the fiscal fourth quarter of 1999." (Id. ¶ 86.) Contrary to these statements, the 2000K eventually reported a loss of approximately $140 million for the fiscal year ending August 31, 2000. (Id. ¶ 88.)
In their opposition brief, plaintiffs claim that the "motive" for the deception described was Xceed's successful effort to acquire seven internet-related companies in fiscal year 2000 using inflated stock. (Pl. Opp. at 2; 2000K, Luboja Aff., Ex. C at F-13.) Although plaintiffs did not specifically mention the acquisition of these companies in the Complaint, the Court will take judicial notice of these facts since they are contained in Xceed's 2000K. a public document that is incorporated by reference in the Complaint and moreover, submitted by the Individual Defendants as part of their motion to dismiss. The Individual Defendants argue that "it is wholly improper for plaintiffs to use their opposition brief to assert new allegations that were never pleaded in the Complaint in the first instance," and quote district court opinions with language suggesting the same. (Defs. Reply at 3.) Although the quoted language read in isolation sounds persuasive, those cases do not bar consideration of facts that (although not highlighted in the pleadings) are subject to "thorough review" on a motion to dismiss either because they are contained in "documents incorporated in the complaint by reference" or because "the court can take judicial notice" of them. See e.g., Mathias v. Daily News, L.P., 152 F. Supp.2d 465, 480 (S.D.N.Y. 2001) (describing the "limited universe of factual allegations" as including incorporated documents and judicially noticeable facts).
DISCUSSION
On a motion to dismiss under Fed.R.Civ.P. 12(b)(6), the Court must accept "as true the facts alleged in the complaint," Jackson Nat'l Life Ins., 32 F.3d at 699-700, and may grant the motion 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." Thomas v. City of New York, 143 F.3d 31, 36 (2d Cir. 1998) (citations omitted); see also Bernheim v. Litt, 79 F.3d 318, 321 (2d Cir. 1996) (when adjudicating motion to dismiss under Fed.R.Civ.P. 12(b)(6), the "issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims" (internal quotation marks and citations omitted)). When deciding a motion to dismiss pursuant to Rule 12(b)(6), the Court may consider documents attached to the complaint as exhibits or incorporated in it by reference. Brass v. American Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993) ("the complaint is deemed to include any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference"). In addition to facts alleged in the complaint, the Court may take judicial notice of public disclosure documents filed with the SEC. Kramer v. Time Warner Inc., 937 F.2d 767, 774 (2d Cir. 1991). All reasonable inferences are to be drawn in the plaintiffs' favor, which often makes it "difficult to resolve [certain questions] as a matter of law." In re Independent Energy Holdings PLC, 154 F. Supp.2d 741, 747 (S.D.N.Y. 2001).
I. Section 10(b) Claims
A. Legal Standard
Section 10(b) protects investors by making it unlawful "[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 as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j(b). Pursuant to Rule 10b-5, making "any untrue statement of a material fact or omit[ting] 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" is unlawful. 17 C.F.R. § 240.10b-5.
In order to prevail on their claims under section 10(b), plaintiffs must plead that defendants, "in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiff[s'] reliance on the defendant's action caused injury to the plaintiff[s]." Ganino v. Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000) (emphasis added). These claims are subject to the heightened pleading requirements of Rule 9(b) that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b).
Although Rule 9(b) allows the pleading party to aver scienter generally, the Second Circuit warns that "the relaxation of Rule 9(b)'s specificity requirement regarding condition of mind [must not be mistaken] for a license to base claims of fraud on speculation and conclusory allegations." Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996) (internal quotation and citations omitted). Rather, plaintiffs must allege facts that "give rise to a strong inference of fraudulent intent."Id. (internal quotation and citations omitted; emphasis in original). This requirement is reinforced by the PSLRA which requires plaintiffs to "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). Passed by Congress in 1995, the PSLRA "raised the nationwide pleading standard" in securities cases. Novak v. Kasaks, 216 F.3d 300, 310 (2d Cir. 2000). However, since the Second Circuit already required heightened pleading, the PSLRA merely "adopted [the Circuit's] "strong inference' standard." Id. at 311. Plaintiffs may establish the requisite "strong inference" 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 307 (internal quotation and citations omitted); see also id. at 311 (directing district courts applying the strong inference standard to look to pre-PSLRA cases and the factors developed therein).
B. Application to the Individual Defendants
(1) Scienter
While the "strong inference" standard for scienter may be clear, "complexity and uncertainty . . . often surround its application" because of the "`inevitable tension' between the interests in deterring securities fraud and deterring strike suits." Id. at 307 (citation omitted). Despite noting some disparities in outcomes of securities cases, the Second Circuit in Novak noted some basic patterns, for identifying adequate claims. These general, guiding principles are applied below.(a) Motive and Opportunity
Motives "entail concrete benefit that could be realized by one or more of the false statements and wrongful nondisclosures alleged." Id. (internal quotation and citation omitted). Those "motives possessed by virtually all corporate insiders" do not suffice, and plaintiffs must allege "that defendants benefitted in some concrete and personal way" by, for example, selling shares while stock prices were artificially high. Id. at 307-308.
Construing the facts in plaintiffs' favor as required on a motion to dismiss, plaintiffs offer two motives: first, sales of inflated shares by N. Haase (Compl. ¶ 12) and Zabit (id. ¶ 14), and second, acquisition of companies with inflated stock (2000K, Luboja Aff., Ex. C, F-13-F-16). The first motive is unpersuasive. As noted by the Individual Defendants, N. Haase and Zabit, plaintiffs do not adequately plead — as they must — that the trades were somehow unusual. See, e.g., Acito v. Imcera Group, Inc., 47 F.3d 47, 54 (2d Cir. 1995) (noting that "unusual insider trading activity . . . may permit an inference of bad faith and scienter"). Moreover, N. Haase retained a large percentage of her shares (Defs. Mem. at 8), and Zabit actually increased his ownership (id. at 9).
The second, however, is sufficient. "[A]rtificial inflation of a stock price in order to achieve some more specific goal may satisfy the pleading requirement." In re Complete Mgmt. Inc. Sec. Litig., 153 F. Supp.2d 314, 328 (S.D.N.Y. 2001). Plaintiffs allege that defendants' specific goal" was to acquire companies. This motive is sufficiently concrete to support a strong inference of scienter.
(b) Conscious Misbehavior or Recklessness
Alternatively, plaintiffs can plead scienter by showing strong circumstantial evidence of conscious misbehavior or recklessness. Allegations of recklessness generally are sufficient when plaintiffs "have specifically alleged defendants' knowledge of facts or access to information contradicting their public statements" or have "alleged facts demonstrating that defendants failed to review or check information that they had a duty to monitor." Novak, 216 F.3d at 308. Liability for recklessness, however, does not include "fraud by hindsight," meaning that defendants cannot be held liable for failing to anticipate future events and make disclosures earlier than they did. Id. at 309. Violations of GAAP "standing alone, are insufficient to state a securities fraud claim." Id. Instead, plaintiffs much link such allegations with fraudulent intent. Id.
Defendants claim that plaintiffs' arguments as to recklessness amount to mere "fraud by hindsight." Although plaintiffs plead with specificity alleged violations of GAAP, these violations alone are not sufficient to make out a securities fraud claim nor are optimistic statements made in press releases. Stevelman v. Alias Research Inc., 174 F.3d 79, 84-85 (2d Cir. 1999). Here, however, the magnitude of the adjustments raises questions about defendants' credibility, makes the press statements increasingly suspect, and by doing such, further supports a strong inference of scienter. In re Complete Mgmt. Inc., 153 F. Supp.2d at 327.
(2) Materiality
Although the Individual Defendants argue otherwise, there is no question about the materiality of the misstatements alleged in the pleadings. Plaintiffs state with specificity four kinds of accounting violations that allegedly allowed Xceed to understate losses. Information is material "if there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available." Acito, 47 F.3d at 52 (internal quotation and citation omitted). The true amount of losses — regardless of how well or poorly quantified in the Complaint — is exactly that kind of information.
(3) Causation
Causation is two-pronged. Plaintiffs must allege both transaction and loss causation. Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95 (2d Cir. 2001). The Individual Defendants claim that plaintiffs have failed to allege loss causation, or in other words, that the alleged misrepresentations are not, as they must be to establish causation, "related to the stock's value." Id. at 97. Misrepresentations must "induce a disparity between the transaction price and the true "investment quality' of the securities." Id. at 98. In this action, the misrepresentations, and not the market forces behind the dot com collapse, must be the proximate cause of plaintiffs' injuries. See, e.g., Emergent Capital Investment Mgmt, LLC v. Stonepath Group, Inc., 165 F. Supp.2d 615, 618 (S.D.N.Y. 2001) (noting the difficulty of finding that misrepresentations rather than market forces behind "the E-commerce bubble" caused alleged injury).
Loss causation has been compared to "the tort concept of proximate cause." Emergent Capital Investment Mgmt., LLC v. Stonepath Group, Inc., 195 F. Supp.2d 551, 559 (S.D.N.Y. 2002). Courts consider, for example, "whether the resulting loss was a foreseeable outcome of the fraudulent statement and [whether] other factors such as intervening causes and the lapse of time between the fraudulent statement and the loss [existed]."Id. Here, the fraudulent statements all portrayed Xceed as healthy and viable, while the company was allegedly failing, thereby encouraging investors to purchase stock and creating a disparity between the transaction price and the true value of the securities. These alleged accounting violations were ultimately revealed to the market with the foreseeable consequence that share price would decline. While a trier of fact might blame market forces rather than accounting violations for that decline, the allegations in the Complaint are sufficient to carry plaintiffs' claims through this motion to dismiss.
C. Application to Tullman
Plaintiffs fail to plead facts supporting a strong inference of scienter as to Tullman. The only false statement attributed to Tullman, who joined Xceed in September 2000, is the September 18 press release. As to motive and opportunity, Tullman arrived well after the last acquisition listed on the 2000K form, and plaintiffs fail to plead any unusual sale of stock or other transaction that would satisfy the strong inference of scienter. As to conscious misbehavior or recklessness, Tullman made optimistic statements about what he expected for performance in the prior quarter. (2000K, Luboja Aff, Ex. C at 45; Tullman Ex. C at 2.) However, unlike the Individual Defendants, the magnitude of the adjustments in the fourth quarter do not support an inference of fraudulent intent as to Tullman, who joined Xceed after the various allegedly improper accounting activities had taken place. Moreover, given the proximity between Tullman's arrival at Xceed and his statement to the press, the inference that he must have known these statements were false is extremely weak, suggesting at most that Tullman was negligent. Tullman's motion to dismiss the section 10(b) claims against him is granted.
II. Section 20(a) Claims
Section 20(a) provides for control person liability for underlying securities law violations. The relevant provision states that:
[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.15 U.S.C. § 78t(a).
The district courts in this Circuit have divided as to the prima facie requirements of a section 20(a) claim, or more specifically as to whether plaintiffs must plead culpable participation. See e.g., In re Livent, Inc., Noteholders Sec. Litig., 151 F. Supp.2d 371, 413-17 (S.D.N.Y. 2001) (describing the intra-circuit split and holding that plaintiffs must plead culpable participation). While courts (and the parties here) agree that plaintiffs must show (1) a primary, securities law violation by the controlled person and (2) control over the primary violator by the targeted defendant, courts (and the parties here) disagree as to whether the prima facie case includes (3) culpable participation "in some meaningful sense" by the controlling person in the fraud.
Without citing any cases, plaintiffs claim that to survive the motion to dismiss on their section 20(a) claims, "[n]othing more is required" than pleading facts supporting a reasonable inference of control. (Pls. Opp. at 28.) Neglecting to brief the intra-circuit split, plaintiffs simply rely on Jacobs v. Coopers Lybrand, 97 Civ. 3374 (RPP), 1999 WL 101772 (S.D.N.Y. Mar. 1, 1999), which concludes fromMarbury Mgmt., Inc. v. Kohn, 692 F.2d 705, 716 (2d Cir. 1980), that only allegations of control are necessary.
This debate continues even though several recent Second Circuit opinions appear to treat culpable participation as an element of the prima facie case, see Ganino v. Citizens Utils. Co., 228 F.3d 154, 156 (2d Cir. 2000); Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir. 1998); SEC v. First Jersey, 101 F.3d 1450, 1472 (2d Cir. 1996), since the pleading standard of section 20(a) was not at stake in any of those cases and the split was not explicitly addressed. See, e.g., In re Livent, 151 F. Supp.2d at 415-16 (noting that procedural postures and burden-shifting elements of the relevant Second Circuit cases "leave some doubt as to [their] binding effect" but concluding that the "statement of the rule cannot be overlooked"); Mishkin v. Ageloff, 97 Civ. 2690 (LAP), 1998 WL 651065, at *22-*23 (S.D.N.Y. Sept. 23, 1998) (concluding that although "standard to be applied to a motion to dismiss" is not "well-established," "the PSLRA requires a plaintiff, at the pleading stage, to allege particular facts that give rise to a "strong inference' of the requisite state of mind"). This Court agrees with In re Livent andMishkin that plaintiffs must plead culpable participation.
Since culpable participation is an element, the PSLRA's heightened pleading requirements apply, and "plaintiffs must plead with particularity `facts giving rise to a strong inference that the controlling person knew or should have known that the primary violator, over whom that person had control, was engaging in fraudulent conduct.'" In re Independent Energy Holdings PLC Sec. Litig., 154 F. Supp.2d 741, 771 (S.D.N.Y. 2001) (citation omitted). "[D]etermination of § 20(a) liability requires an individualized determination of a defendant's control of the primary violator as well as a defendant's particular culpability." Boguslavsky, 159 F.3d at 720.
All defendants claim that plaintiffs have failed to plead adequately culpable participation. This failure is hardly surprising since plaintiffs appear to have assumed that culpable participation was not an element of their section 20(a) claims. While plaintiffs have not requested leave to amend the Complaint, the Court may in its discretion grant such leave to amend "when justice so requires." Fed.R.Civ.P. 15(a). Since the plaintiffs' section 10(b) claims survive against the Individual Defendants, plaintiffs may amend their control person claims as to those defendants. Since no primary violation of section 10(b) occurred during Tullman's tenure, a claim under section 20(a) could not run against himsee, e.g., Shields v. Citytrust Bancorp Inc., 25 F.3d 1124, 1132 (2d Cir. 1994), and leave to amend as to Tullman is denied.
CONCLUSION
Tullman's motion is granted in its entirety, and all claims against him are dismissed. The Individual Defendants' motion to dismiss is denied as to the section 10(b) claims. Plaintiffs may amend their section 20(a) claims as against the Individual Defendants in order to plead culpable participation.