Opinion
00 Civ. 8431 (LAP).
March 29, 2002
MEMORANDUM AND ORDER
Defendants Chandra Sekar, Naren Desai, North Cascade Limited, Collingwood Investments Limited, The Mayflower Trust, Marimutu Sinivasan, Ponnuswony Manohar, and Kishor Kumar Kantilal Naik (the "North Cascade Defendants") move to dismiss plaintiffs' Third Amended Complaint as to them pursuant to Fed.R.Civ.P. 12(b)(1), (2) and (6) for lack of subject matter and personal jurisdiction and failure to state a claim upon which relief can be granted; and Fed.R.Civ.P. 9(b) for failure to plead fraud with particularity. Defendant John W. Duffell and defendants Clarion Investment and Mortgage and Clifftown Holdings International, Inc. (the "Duffell Defendants") also move to dismiss plaintiffs' Third Amended Complaint as to them pursuant to Fed.R.Civ.P. 12(b)(1), (2), (3) and (6) for lack of subject matter and personal jurisdiction, improper venue and failure to state a claim upon which relief can be granted; and Fed.R.Civ.P. 9(b) for failure to plead fraud with particularity. For the reasons set forth below, the defendants' motion to dismiss is granted as to the first cause of action. As to the second and third causes of action, the defendants' motion is denied without prejudice to renewal upon adequate briefing. The defendants' motion to dismiss the fourth, fifth, and sixth causes of action is also denied without prejudice to renewal following resolution of renewed motions as to the second and third causes of action.
The parties were directed to consolidate their briefing of common legal issues. The Duffell Defendants adopted the North Cascade Defendants' Memorandum of Law in Support of their Motion to Dismiss ("NC Defs.' Moving Mem."), dated April 13, 2001, in its entirety. (Mem. of Def. John W. Duffell in Supp. of Mot. to Dismiss the Third Am. Compl. ("Duffell's Moving Mem."), dated April 27, 2001, at 1 n. 1; Notice of Mot. of Defs. Clarion and Clifftown to Dismiss the Third Am. Compl., dated April 27, 2001, at 1-2). As such, any reference to the "defendants" herein includes both the North Cascade Defendants and the Duffell Defendants, unless otherwise noted.
I. BACKGROUND
A. The Parties
The following facts are taken from allegations in the Third Amended Complaint, filed February 20, 2001, which I must accept as true for purposes of the motions to dismiss. Plaintiffs Euro Trade Forfaiting, Inc. ("Euro US"), Euro Trade Forfaiting Company Limited ("Euro U.K.") and MFC Merchant Bank S.A. ("MFC Merchant Bank") allege "a wide-ranging fraudulent scheme by defendant the Texmaco Group ("Texmaco") and affiliated individuals and entities to profit from the artificial inflation of Euro U.S.'s stock in violation of the United States securities laws." (Third Am. Compl. ¶ 1). Euro U.S. is a corporation organized under the laws of the State of Utah. During the time period at issue in this case its principal place of business was in London, England. (Id. ¶ 7). Euro U.K. is a United Kingdom corporation with its principal place of business in London, England. (Id. ¶ 6). MFC Merchant Bank, a Swiss corporation, has its principal place of business in Geneva, Switzerland and is owned by MFC Bancorp, a Canadian company that is not a party to this litigation. (Id. ¶ 8).
According to the plaintiffs, defendant Texmaco is an "industrial conglomerate" in the business of, inter alia, textiles, engineering, banking, manufacturing and natural resources, which was organized under the laws of Indonesia and has its head office in Jakarta. (Id. ¶ 9). Defendant Marimutu Sinivasan ("Sinivasan") is the founder and Chairman of Texmaco and a citizen and resident of Indonesia. (Id. ¶ 10). Ponnuswony Manohar ("Manohar"), a citizen of India and resident of Indonesia, is Sinivasan's personal assistant and chief lieutenant and is Group Director and Chief Financial Officer of Texmaco. (Id. ¶ 11). Chandra Sekar ("Sekar"), Sinivasan's son-in-law, is the former Chairman of Euro U.S. and Euro U.K. and is a resident of London, England. (Id. ¶ 12). By nature of their positions, Manohar and Sekar allegedly represented Sinivasan and Texmaco' s interests during the time period in dispute and had authority to act their behalf. (Id. ¶¶ 11, 12). Naren Desai ("Desai"), who resides in West Sussex, England, was a former director of Euro U.S. and Euro U.K., was the former chief financial officer, financial advisor and auditor of Euro U.K., and allegedly took directions from Manohar and Sekar with regard to Euro U.S. and Euro U.K. (Id. ¶ 13). Defendant Kishor Kimar Kantilal Naik ("Naik") was an accountant for Sekar and Texmaco and resides in London, England. (Id. ¶ 14).
The North Cascade defendants have not accepted service on behalf of the "Texmaco Group" because they "do not believe" such an entity exists. It is therefore not named as a moving party here. (NC Defs.' Moving Mem. at 1 n. 1). The docket sheet discloses no indication of service on Texmaco.
Defendants North Cascade Limited ("North Cascade") Collingwood Investments Limited ("Collingwood") and the Mayflower Trust ("Mayflower") were organized by the Sinivasan family to cold Euro U.S. shares. (Id. ¶ 15). North Cascade was organized under the laws of the British Virgin Islands, and Collingwood under the laws of the Bahamas. Mayflower, the sole shareholder of Collingwood and North Cascade, was organized under the laws of the Isle of Man. (Id.) All three defendants are allegedly alter egos of Texmaco and/or Sinivasan, with no separate corporate identity. (Id.).
Plaintiffs assert that Texmaco hired defendant John W. Duffell, III ("Duffell"), a citizen of the United States and a resident of France, to "inflate the value of [Texmaco's] assets, including Euro U.S." (Id. ¶ 17). Duffell has a history of securities fraud violations in the United States. (Id.). Both Clarion Investment and Mortgage ("Clarion") and Clifftown Holdings International ("Clifftown") are corporations "controlled by, or affiliated with, Mr. Duffell." (Id. ¶¶ 18-19). Clarion was organized under the laws of the State of Nevada and Clifftown under the laws of the British Virgin Islands.
Pursuant to a stipulation of settlement, defendant John Vowell was dismissed from the case on May 3, 2001. Therefore, the allegations against him are not discussed here.
Defendants John Does 1-10 are "individuals and/or entities who participated in or were aware of the wrongful activities described herein and/or who worked with, conspired with, controlled, assisted and/or directed the named defendants in connection with the wrongful activity described herein." (Id. ¶ 20)
B. The Alleged Scheme to Inflate Texmaco's Assets
According to plaintiffs, Texmaco's desperate financial position in the early 1990s led the defendants to devise a scheme to inflate Texmaco' s assets in 1998, 1999 and early 2000. (Id. ¶¶ 22-23). Specifically, plaintiffs allege that Sinivasan, Manohar and Sekar hired Duffell to increase the value of certain Texmaco assets, which Duffell did by obtaining a public listing for Euro U.K., engaging in a series of sham trades to inflate artificially the share price, and "us[ing] the inflated shares to generate cash by realizing trading profits and by pledging the inflated shares as collateral for loans." (Id. ¶ 25). Sinivasan and/or Sekar, acting on behalf of Texmaco, provided $1.25 million to Duffell to obtain U.S. public shell companies into which Texmaco would be merged. (Id. ¶ 26)
Duffell and Texmaco first obtained a public listing for Euro U.S. through a reverse merger with a publicly-traded shell corporation, Rotunda, whose name then changed to Euro U.S. (Id. ¶¶ 25, 27). In November 1998, Euro U.S.'s stock began trading on the over-the-counter ("OTC") market in the United States, with most of the market makers for Euro U.S. stock located in or around New York City. (Id. ¶ 27). Sekar and Naik then established trading accounts with securities firms in Vancouver, British Columbia, which were funded by Texmaco, Sekar and/or Sinivasan. (Id. ¶ 28). Sekar gave Duffell the authority to trade these accounts, and Naik maintained the records. (Id.) Sekar and Duffell then allegedly manipulated the market by making sham or "wash" trades by trading shares at a higher price than Euro U.S.'s true market value, which also "created the false impression of legitimate trading activity in the market for the thinly-traded Euro U.S. stock." (Id. ¶ 29). Duffell used Clifftown and Clarion to trade Euro U.S. shares, and the trades were made through, inter alia, the accounts in Vancouver and nominee companies controlled by Duffell. (Id.). According to the plaintiffs, Desai and Naik helped plan and were aware of the wash trading activity, and Naik kept the accounts of the trading activity on behalf of Texmaco, Sekar and Sinivasan. (Id.)
Transactions in securities outside the organized securities exchanges take place in the OTC market, which is "a group of markets in which broker-dealers transact business with the public as principals or agents, dealing for the most part in securities not listed on any exchanges." 3 Harold S. Bloomenthal Samuel Wolff, Sec. Fed, Corp. Law § 1:142 (2d ed. 2001).
Because of the wash trading, Euro U.S.'s shares remained at "artificially high market prices from November 1998 until at least February 2000." (Id. ¶ 30). Plaintiffs allege that the defendants engaged in several fraudulent acts during this time.
Most generally, the defendants sold Euro U.S. shares to "unsuspecting investors." (Id.). More specifically, the defendants used the shares as collateral for loans that have not been repaid. Acting through North Cascade and Collingwood, Texmaco and Euro U.S. entered into a series of agreements with MFC Bancorp and MFC Merchant Bank in January of 2000, which were negotiated by Sekar and Desai under Manohar's direction. (Id. ¶ 42). Under the agreements, North Cascade and Collingwood pledged their Euro U.S. shares as security for a $12 million loan from MFC Merchant Bank (Id. ¶¶ 31, 42-43, 45), and MFC Bancorp provided management services to Euro U.S. (Id. ¶ 43). The pledged shares are now worth approximately $2.75 million, and the loan has not been repaid. (Id. ¶ 45). Furthermore, MFC Merchant Bank received 214,313 of the allegedly inflated Euro U.S. shares in June of 1999 as compensation for management services rendered. (Id. ¶ 46)
When two senior executives of MED Bancorp became directors of Euro Trade pursuant to this "Services Agreement," they undertook a full scale review of Euro U.S.'s business and uncovered the defendants' alleged wrongdoing. (Id. ¶ 44)
In addition, plaintiffs allege that the defendants, as insiders, stole from Euro U.S. Sekar approved the issuance of 4,000,000 Euro U.S. shares in an offshore private placement at a subscription price of $.05 per share in December 1998. (Id. ¶ 34). These shares were issued to Sinivasan, Sekar, Manohar and Duffell, who did not pay for the shares at the time of issue and used nominee accounts or companies, including Clifftown, to conceal the extent of their holdings in Euro U.S. Plaintiffs allege that many of these shares were "traded and/or disposed of" through the wash trading scheme and as a result, the defendants effectively stole 4,000,000 shares from Euro U.S. (Id.). The transaction was effected pursuant to a November 20, 1998 subscription agreement, and Duffell executed the documents required for the transaction. (Id.). Plaintiffs also allege that, as compensation for obtaining the Euro U.S. listing, Duffell received 2% of the authorized capital of Euro U.S. in the form of common stock options and private placement shares. (Id. ¶ 35).
Plaintiffs also assert that the insiders looted Euro U.S. and U.K. through several transactions. In the first, Euro U.K. paid $500,000 to Irvingstone Investments, Ltd. ("Irvingstone"), an affiliate of Duffell, in return for a loan "of various securities of companies connected to Mr. Duffell," which were to be traded through one of Duffell's market makers, Legacy Capital, Inc. ("Legacy"). (Id. ¶ 39). Euro U.S. was to share in the trading profits. Sekar authorized the $500,000 payment and the transaction, but the securities were never delivered to Euro U.K. (Id.). In another transaction, at Sekar's direction, Euro U.K. made a $1,000,000 purchase of shares of a company promoted by Duffell, Valence 9, Inc. ("Valence"), which proved to be worthless. (Id. ¶ 40). The seller, Feron, Inc. ("Feron"), purchased an unrecoverable loan from Euro U.K. for $400,000, but "the net effect of the transaction was that Euro U.K. was cheated out of $600,000 by Mr. Duffell." (Id.). Feron was another company affiliated with Duffell. (Id. ¶ 39) Sekar and Desai arranged for an advance of $2.4 million from Euro U.K. to two companies affiliated with Texmaco in a third transaction which was disguised as a purchase of $24 million of defaulted promissory notes at 10% of their face value. (Id. ¶ 41). Euro U.K. was to earn a handling fee of $240,000 and gain $720,000 when one of the companies exercised its option to repurchase the promissory notes at 13% of their face value. (Id.). Euro U.K., however, never received the handling fee or the promissory notes that it supposedly purchased. Sekar and Desai also failed to obtain the fee and the notes, as well as the securities, a signed loan agreement or additional security for the loan. (Id.)
Finally, plaintiffs allege that Texmaco used the shares to finance a business agreement to purchase a group of South African companies and has since defaulted on the transaction. (Id. ¶¶ 31-32).
C. The Instant Action
Based on these allegations, the Third Amended Complaint asserts six causes of action, three for violating the federal securities laws and three pendent common law claims.
MFC Merchant Bank brings the first cause of action against all of the defendants for planning and carrying out "a scheme to fraudulently inflate the price of Euro U.S. shares by engaging in a series of sham trades" in violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, Section 18 of the Exchange Act and Section 11 of the Securities Act (the "Securities Fraud Claim"). (Id. ¶¶ 47-53).
Plaintiff Euro U.S. brings the second cause of action against defendants Duffell, Sinivasan, Sekar and Texmaco for "dispos[ing] of or otherwise alienat[ing] themselves from Euro U.S. shares at a profit within less than six months of receipt while each was an officer and director of Euro U.S." and while they were "beneficial owner[s] of more than 10% of the shares of Euro Trade common stock" in violation of Section 16(b) of the Exchange Act (the "16(b) Claim"). (Id. ¶ ¶ 54-59).
Plaintiff Euro U.S. brings the third cause of action against defendants Duffell, Sinivasan, Sekar and Texmaco for acquiring additional shares of Euro Trade during the time that they were the beneficial owners of more than five percent of the outstanding shares of Euro Trade without filing a Schedule 13D disclosing their ownership interests in violation of Section 13D of the Exchange Act (the "13D Claim"). (Id. ¶¶ 60-63).
Plaintiffs Euro U.S. and Euro U.K. bring the fourth cause of action against defendants Sekar and Desai for breach of fiduciary duty, for "participating in and concealing the wash trading scheme and causing Euro U.S. and Euro U.K. to enter into transactions . . . intended solely for the benefit of themselves or Texmaco." (Id. ¶¶ 64-68).
Plaintiffs Euro U.S. and Euro U.K. bring the fifth cause of action for misappropriation against defendants Duffell, Texmaco, Sinivasan, Manohar and Sekar for "wrongfully issu[ing] 4,000,000 shares of Euro U.S. while paying nothing to Euro U.S." and, in the case of Duffell, for misappropriating $1.1 million from Euro U.K. through the Irvingstone and Valence 9 transactions. (Id. ¶¶ 69-73).
All of the plaintiffs bring the sixth cause of action against all of the defendants for common law fraud. (Id. ¶¶ 74-77).
The North Cascade Defendants now move to dismiss the Third Amended Complaint for lack of subject matter and personal jurisdiction, failure to state a claim upon which relief can be granted, and failure to plead fraud with particularity. The Duffell Defendants move to dismiss on the same grounds, including improper venue.
II. THE FIRST CAUSE OF ACTION
A. Applicable Legal Standards
1. Rule 12(b)(1)
In considering a motion to dismiss under Rule 12(b)(1), I must view the complaint in the light most favorable to the plaintiff. See Yoder v. Orthomolecular Nutrition Inst., Inc., 751 F.2d 555, 562 (2d Cir. 1985). A court considering a Rule 12(b)(1) motion to dismiss must "accept as true all material factual allegations in the complaint." Atlantic Mut. Ins. Co. v. Balfour Maclaine Int'l Ltd., 968 F.2d 196, 198 (2d Cir. 1992) (citing Scheuer v. Rhodes, 416 U.S. 232, 236 (1974)). "However, argumentative inferences favorable to the party asserting jurisdiction should not be drawn." Id. at 198 (citing Norton v. Larney, 266 U.S. 511, 515 (1925)). Further, a "court may resolve disputed jurisdictional fact issues by reference to evidence outside the pleadings, such as affidavits." Antares Aircraft, L.P. v. Fed. Republic of Nigeria, 948 F.2d 90, 96 (2d Cir. 1991), vacated for reconsideration on other grounds, 505 U.S. 1215 (1992), reaff'd on remand, 999 F.2d 33 (2d Cir. 1993).
2. Rule 12(b)(6)
When deciding a motion to dismiss under Rule 12(b)(6), I must accept as true all well-pleaded factual allegations of the complaint and draw all inferences in favor of the pleader. See City of Los Angeles v. Preferred Communications, Inc., 476 U.S. 488, 493 (1986); Miree v. DeKalb County, 433 U.S. 25, 27 n. 2 (1977) (referring to "well-pleaded allegations"); Mills v. Polar Molecular Corp., 12 F.3d 1170, 1174 (2d Cir. 1993). "`[T]he complaint is deemed to include any written instrument attached to it as an exhibit or any statements or documents incorporated in it by reference.'" Int'l Audiotext Network, Inc. v. Am. Tel. Tel. Co., 62 F.3d 69, 72 (2d Cir. 1995) (quoting Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991)). In order to avoid dismissal, plaintiffs must do more than plead mere "[c]onclusory allegations or legal conclusions masquerading as factual conclusions."Gebhardt v. Allspect, Inc., 96 F. Supp.2d 331, 333 (S.D.N.Y. 2000) (quoting 2 James Wm. Moore, Moore's Federal Practice ¶ 12.34[a] [b] (3d ed. 1997)). Dismissal is proper only when "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); accord Cohen v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994).
B. Plaintiffs' Securities Fraud Claims
In their Third Amended Complaint, plaintiffs assert federal question jurisdiction over their first three causes of action pursuant to 28 U.S.C. § 1331, diversity jurisdiction under Section 1332 and supplemental jurisdiction over the last three causes of action pursuant to Section 1367. (Third Am. Compl. ¶ 21). Defendants, however, argue that this court may not exercise federal question jurisdiction over the first cause of action for securities fraud because the facts alleged here do not satisfy the "conduct" and "effects" tests applied when foreign plaintiffs bring securities fraud claims. (NC Defs.' Moving Mem. at 4). The defendants' subject matter jurisdiction challenge must be considered first to determine whether this court has jurisdiction over the action. See Steel Co. v. Citizens for a Better Environment, 523 U.S. 83, 94-95 (1998); W.G. v. Senatore, 18 F.3d 60, 64 (2d Cir. 1994) (citations omitted).
Plaintiffs appear to have abandoned any argument related to diversity jurisdiction because there is no discussion of Section 1332 in plaintiffs' opposition papers. Plaintiffs cite only to Sections 1331 and 1367 for the proposition that "[e]ach of the other two federal causes of action provides an independent basis for subject matter and supplemental jurisdiction." (Pls.' Mem. in Opp'n to Defs.' Motions to Dismiss ("Pls.' Mem. in Opp'n") at 3).
Defendants appear to concede that there is automatic subject matter jurisdiction over the second and third causes of action. (NC Defs.' Moving Mem. at 4 n. 3; Reply Mem. of the North Cascade Defs. in Supp. of Mot. to Dismiss ("NC Defs.' Reply Mem.") at 1 n. 1).
1. Standards for Determining Subject Matter Jurisdiction
As many courts have noted, the Securities Exchange Act is silent as to its extraterritorial application. Itoba Ltd. v. Lep Group PLC, 54 F.3d 118, 121 (2d Cir. 1995); Alfadda v. Fenn, 935 F.2d 475, 478 (2d Cir. 1991);Interbrew S.A. v. Edperbrascan Corp., 23 F. Supp.2d 425, 428 (S.D.N.Y. 1998). Because the case at bar involves "transactions that on any view are predominantly foreign," I must "seek to determine whether Congress would have wished the precious resources of United States courts and law enforcement agencies to be devoted to them rather than leave the problem to foreign countries." Bersch v. Drexel Firestone, Inc., 519 F.2d 974, 985 (2d Cir. 1975). In this Circuit, two tests are applied to determine whether a federal court has subject matter jurisdiction over a foreign plaintiff's securities fraud claim: the "conduct test" and the "effects test." Alfadda, 935 F.2d at 478.
Under the conduct test, which was first applied in Leaseco Data Processing Equip. Corp. v. Maxwell, 468 F.2d 1326, 1336-37 (2d Cir. 1972), a federal court has subject matter jurisdiction if two circumstances exist. First, the defendant's activities in the United States must be more than "merely preparatory" to a securities fraud conducted elsewhere. Itoba, 54 F.3d at 122 (quoting Bersch, 519 F.2d at 987). Second, the "activities or culpable failures to act within the United States" must have "`directly caused' the claimed losses." Id. (quoting Alfadda, 935 F.2d at 478).
The effects test first emerged in Schoenbaum v. Firstbrook, 405 F.2d 200, 206-09 (2d Cir.), rev'd with respect to holding on merits, 405 F.2d 215 (2d Cir. 1968) (en banc). A federal court has jurisdiction under the effects test "where illegal activity abroad causes a `substantial effect' within the United States." Alfadda, 935 F.2d at 478 (citing Consol. Gold Fields PLC v. Minorco, S.A., 871 F.2d 252, 261-62 (2d Cir. 1989)). When the transactions at issue "involve stock registered and listed on a national securities exchange, and are detrimental to the interests of American investors," Schoenbaum, 405 F.2d at 208, they create a substantial impact in the United States. Itoba, 54 F.3d at 124.
These two tests need not be applied separately, for "an admixture or combination of the two often gives a better picture of whether there is sufficient United States involvement to justify the exercise of jurisdiction by an American court." Itoba, 54 F.3d at 122.
2. Application to the Instant Dispute
Plaintiff MFC Merchant Bank alone brings the first cause of action against all of the defendants for securities fraud, alleging that the defendants fraudulently inflated the price of Euro U.S. shares by "engaging in a series of sham trades . . . selling the inflated shares to unsuspecting investors and pledging the inflated shares as collateral for loans granted by unsuspecting lenders, including the pledge of shares to MFC Merchant Bank." (Third Am. Compl. ¶ 48). These actions caused MFC Merchant Bank injury because it "suffer[ed] losses on the loan to North Cascade and Collingwood secured by Euro U.S. shares and through the decline in value of [the 214,313] Euro U.S. shares that it received for services rendered." (Id. ¶ 52).
(i) The Conduct Test
Citing Psimenos v. E.F. Hutton Co., plaintiffs argue that the conduct test is satisfied here because several activities "material to the completion of the fraud occurred in the United States." 722 F.2d 1041, 1046 (2d Cir. 1983) Specifically, the defendants obtained a public listing for Euro U.S., a Utah corporation, and carried out the trades on the NASD OTC market, a United States securities market. (Third Am. Compl. ¶¶ 2, 7, 25-30, 47-52). Because every fraudulent trade was made exclusively on a United States securities market, plaintiffs argue, the conduct test is met, and federal jurisdiction is warranted. (Pls.' Mem. in Opp'n at 4).
Plaintiffs' argument is unpersuasive. As noted above, the conduct test requires that the defendant's activities in the United States be more than "merely preparatory" to the alleged fraud and that they "directly caused" plaintiff's losses. Interbrew, 23 F. Supp.2d at 430. MFC Merchant Bank allegedly suffered financial losses because the value of the shares pledged as collateral and paid for services rendered was artificially inflated as a result of defendants' fraudulent scheme. The conduct that directly caused these losses, however, occurred outside of the United States. During the time period in question, Euro U.S. had its principal place of business in London. (Third Am. Compl. ¶ 7). North Cascade and Collingwood, both foreign corporations, pledged Euro U.S. shares as security for a man from MFC Merchant Bank, a foreign corporation. (Id. ¶¶ 8, 15). There is no allegation that the pledge transaction or the payment of Euro U.S. snares for MFC Merchant Bank's management services occurred in the United States, and there is no allegation that defendant Duffell, a U.S. citizen and French resident, pledged Euro U.S. shares or took any action with regard to the pledge. In contrast, the few activities that took place in the United States — securing a public listing for Euro U.S. and the trading activity on the OTC market — were merely preparation for the actual fraud, namely, the pledge and payment of shares to MFC Merchant Bank. Compare Cromer Fin. Ltd. v. Berger, 137 F. Supp.2d 452, 480 (S.D.N.Y. 2001) (finding federal jurisdiction over foreign defendants in an action brought by foreign investors in off-shore fund for fraudulent mismanagement scheme because "[a]lthough the named plaintiffs are foreign citizens, and the Fund operated as an offshore-fund, the fraud was run from the United States and it was the decisions made in the United States that led directly to the investors' losses.")
Specifically, the court pointed to the plaintiffs' allegations that: an American defendant conceived and executed the fraudulent scheme in New York to short-sell U.S. securities on American exchanges and implemented it through a New York-based company; an American investment bank and registered broker-dealer cleared the fund's securities transactions and held the fund's assets in New York; fictitious financial statements disseminated to investors abroad were prepared in New York; substantive business meetings were held in New York; and there was regular correspondence with one of the defendants in New York. Id. at 480-81.
Furthermore, Psimenos is distinguishable. There, Psimenos, a foreign plaintiff, brought an action under the anti-fraud provisions of the Commodities Exchange Act against E.F. Hutton, a United States corporation, for fraudulently procuring and managing his commodities trading account. Psimenos, 722 F.2d at 1042-43. When Psimenos initially became interested in opening a commodities trading account with Hutton, he contacted one of Hutton's agents in Greece. Id. at 1043. Psimenos ultimately opened an account in Athens, based in part on an informational flyer describing the experience and qualifications of Hutton's managers, which contained a postcard to send to Hutton's New York office for more information. Id. Thereafter, Hutton's agents engaged in high risk commodities transactions even though Psimenos had requested conservative investments, one agent was represented as a Hutton employee and registered broker when in fact he was neither, and trades were made on Psimenos' account solely to generate commissions, all of which resulted in large losses to Psimenos. Id. at 1043-44. While "most of the fraudulent misrepresentations alleged in the complaint occurred outside the United States, the trading contracts that consummated the transactions were often executed in New York." Id. at 1044.
The Court of Appeals, applying the conduct test, found that subject matter jurisdiction existed because "[t]he trades Hutton executed on American markets constituted the final act in Hutton's alleged fraud on Psimenos," were "the culminating acts of the fraudulent scheme" and, as such, could not be described as "merely preparatory." Id. The court specifically noted that the flyer emanating from New York that contained statements on which Psimenos relied could be considered substantial conduct in the United States if it induced Psimenos to open an account with Hutton, but that the flyer, by itself, would not be enough to sustain jurisdiction. Id. at 1046. "[T]he fact that Hutton's agents completed the alleged fraud by trading domestic futures contracts on American commodities exchanges" was "far weightier." Id. With respect to such commodities trading, the court noted:
[t]he commodity futures contracts involved are domestic: they are created by domestic exchanges and may lawfully be traded only on those exchanges. Whereas securities often "can be moved from place to place, bought, sold, traded or borrowed outside a central market, a commodity futures contract has no lawful existence or being independent of the designated contract market upon which it is traded." The commodities futures contracts at issue here present at least as strong a factor in favor of finding jurisdiction as do securities of a United States corporation traded in the United States.Id. at 1047 (citations omitted). The court found that these trading activities on a United States market were "the essential conduct needed to complete the fraudulent scheme" because without the trades, Psimenos would not have suffered any losses. Id. at 1047-48. Accordingly, the court found jurisdiction to be present.
Here, securities, not domestic futures contracts, were traded on a U.S. market. Based on the Court of Appeals' commentary in Psimenos on the non-portability of futures contracts compared to securities, I find the trading here to be a slightly less "eighty factor than the commodities trading in Psimenos. More importantly, however, the culminating act in defendants' allegedly fraudulent scheme here was the pledge of Euro U.S. shares as collateral for MFC Merchant Bank's loan and payment of Euro U.S. shares for their management services, acts that did not occur in the United States. Without the pledge and the payment of shares, MFC Merchant Bank would not have suffered any losses. The trades on an OTC market in the United States, while preparatory to the scheme, were not the final act in consummating the fraud complained of by MFC Merchant Bank. As stated in Psimenos, "[m]ere preparatory activities, and conduct far removed from the consummation of the fraud, will not suffice to establish jurisdiction." Id. at 1046; see also IIT v. Cornfeld, 619 F.2d 909, 920-21 (2d Cir. 1980), overruled on other grounds by Central Bank v. First Interstate Bank, 511 U.S. 164 (1994) (holding that private plaintiff may not maintain aiding and abetting suit under Section 10(b) of the Exchange Act) ("Determination whether American activities `directly' caused losses to foreigners depends not only on how much was done in the United States but also on how much . . . was done abroad.") Accordingly, the allegations here do not pass the conduct test.
Although not dispositive, I note that those trades were initiated through the securities firms in British Columbia where the defendants allegedly set up trading accounts.
(ii) The Effects Test
Plaintiffs also allege that the effects test is satisfied in this case because the defendants' conduct overseas had a "substantial effect" in the United States. Alfadda, 935 F.2d at 478 (citation omitted). Once again, plaintiffs emphasize that the NASD OTC market "is the only place in which the trades in support of the fraud were made, and where the effects of the artificial inflation necessarily were manifested." (Pls.' Mem. in Opp'n at 5). Relying on Schoenbaum and Itoba, plaintiffs flatly assert that the effects test is satisfied when fraud, even if it takes place abroad, involves stock traded on an American securities exchange and is detrimental to American investors' interests. Itoba, 54 F.3d at 124 (citing Schoenbaum, 405 F.2d at 208). While this case clearly involves stock traded on an American market, unlike Schoenbaum and Itoba, no specific harm to American investors' interests is specified.
In Schoenbaum, the plaintiff was an American shareholder of a Canadian corporation the shares of which traded on both the American Stock Exchange and the Toronto Stock Exchange. 405 F.2d at 204. The alleged damages resulted from sales made in Canada to the wholly-owned subsidiary of a French corporation and to an American corporation. Id. In the instant case, however, plaintiff MFC Merchant Bank is not an American shareholder, and plaintiffs have failed to allege any specific harm American investors suffered as a result of the defendants' alleged fraudulent scheme and therefore any "substantial effect" felt in the United States. In the Third Amended Complaint, plaintiffs charge that defendants allegedly profited from selling Euro U.S. shares to "unsuspecting investors," (Third Am. Compl. ¶¶ 1, 30, 48-50), and that defendants sold or pledged shares to unsuspecting buyers and lenders," (id. ¶¶ 3, 48), yet the only specific victim allegedly injured by the transactions in Euro U.S. shares is MFC Merchant Bank, a foreign corporation.
Itoba is instructive on this point. There, Itoba, a wholly-owned subsidiary of the transnational company ADT, sued a British issuer and its United States-based officers, alleging failure to disclose in SEC filings certain high risk investments and speculative business ventures undertaken by the corporation. 54 F.3d at 118-21. The Court of Appeals inItoba reversed the district court's dismissal of Itoba's action for lack of subject matter jurisdiction, finding that the "fraud occurring on an American exchange and persisting abroad . . . impacted detrimentally upon thousands of United States shareholders in the defrauded company, i.e., over $100 million lost in the shareholders' corporate equity." 54 F.3d at 124. Specifically, the court relied on the fact that approximately fifty percent of ADT's shares were held in the United States. Id. As such, those shareholders ultimately bore the loss when the plaintiff's stock prices plummeted. Id. Here, other than referring to "unsuspecting investors and lenders," plaintiffs fail to specify any American shareholders or investors who suffered losses. Unlike Itoba, the instant case is, at most, one where the defendant's acts "simply [had] an adverse affect [sic] on the American economy or American investors generally," an effect that does not warrant subject matter jurisdiction. Bersch, 519 F.2d at 989.
In Interbrew, the court granted defendant's Rule 12(b)(1) motion to dismiss when the plaintiff failed to allege an effect on a U.S.-affiliated company. 23 F. Supp.2d at 429. A Belgian plaintiff sued a Canadian defendant, alleging that it relied on defendant's misrepresentations and, as a result, purchased shares of a Canadian corporation whose stock traded on a Canadian stock exchange at an inflated price. Id. at 427-28. United States investors participated in the purchase "as owners of the approximately 25% of [the Canadian's corporation's] shares tendered by U.S. investors," but the court found that "these investors were neither the intended nor the actual `victims' of [the defendant's] purported scheme to defraud." Id. at 430. The court reasoned,
[t]he only justification for considering their participation as a basis for the exercise of jurisdiction would be to use the securities laws to "insure the maintenance of fair and honest markets" as [plaintiff] urges. The anti-fraud provisions of the U.S. securities laws would then be used to address general market conditions rather than redress specific harms suffered by some U.S.-interested party, a goal specifically foreclosed by numerous interpretations of the securities laws.Id. (citing Koal Indus. Corp. v. Asland, S.A., 808 F. Supp. 1143, 1155 (S.D.N.Y. 1992) (quotation omitted); Itoba, 54 F.3d at 124) Here also, there is no suggestion that the intended and/or actual victims of the defendants' alleged fraudulent scheme are American investors. To the contrary, the intended victim appears to be MFC Merchant Bank, which made a $12 million loan secured by the allegedly inflated stock. As inInterbrew, `the parties, events, and harm (if any) due to the alleged fraud are overwhelmingly foreign.'" Id. at 430.
Plaintiffs correctly point out that Interbrew, Bersch, and Koal involve securities that were not traded on a United States securities market. (Pls.' Mem. in Opp'n at 5-6 n. 3). I am not persuaded, however, that trading on a U.S. securities market automatically confers subject matter jurisdiction, particularly in the absence of any other U.S. connections.Cornfeld, 619 F.2d at 918 ("It should be evident by now that `the presence or absence of any single factor which was considered significant in other cases dealing with the question of federal jurisdiction in transnational securities cases is not necessarily dispositive' in future cases.") (quoting Continental Grain (Australia) Pty. Ltd. v. Pacific Oilseeds, Inc., 592 F.2d 409, 414 (8th Cir. 1979)). As the Interbrew court pointed out, the Court of Appeals in Europe and Overseas Commodity Traders, S.A. v. Bangue Paribas London, 147 F.3d 118 (2d Cir. 1998), found that it lacked subject matter jurisdiction "despite applying a combination of the `conduct' test and the `effects' test, and despite acknowledging that at least some critical events occurred in the United States. 23 F. Supp. at 429. The Europe and Overseas court stated, "[i]n this case, there is no U.S. party to protect or punish, despite the fact that the most important piece of the alleged fraud — reliance on a misrepresentation — may have taken place in this country." 147 F.3d at 130-31. In the instant case, plaintiffs similarly have failed to identify a U.S. party who requires protection or punishment. Mr. Duffell, as a U.S. citizen, comes the closest, but as previously noted, plaintiffs fail to allege how he directly caused MFC Merchant Bank's losses. Thus, the allegations here do not pass the effects test either. Accordingly, MFC Merchant Bank's first cause of action for securities fraud is dismissed for lack of subject matter jurisdiction.
B. Plaintiffs' Section 11 18 Claims
As part of the first cause of action, MFC Merchant Bank also alleges violations of Section 18 of the Exchange Act and Section 11 of the Securities Act. (Third Am. Compl. ¶¶ 47-53) Defendants characterize the Section 11 and 18 claims as "frivolous" and move to dismiss under Rule 12(b)(6), arguing that the Third Amended Complaint fails to state a claim under those provisions of the federal securities laws. (NC Defs.' Moving Mem. at 8).
Section 18 "creates a private remedy for `false or misleading' statements contained in `any application, report or document' filed with the S.E.C. pursuant to the 1934 Act in favor of any person `who, in reliance upon such a statement, shall have purchased or sold a security at a price which was affected by such statement.'" Ross v. A.H. Robins Co., 607 F.2d 545, 551-52 (2d Cir. 1979) (citations omitted); 15 U.S.C. § 78r(a). Section 11 "creates a cause of action in favor of any person acquiring stock where the relevant registration statement contains a material factual misrepresentation." Ross, 607 F.2d at 555; 15 U.S.C. § 77k. While reliance is "an essential prerequisite for a Section 18 action," Heit v. Weitzen, 402 F.2d 909, 916 (2d Cir. 1968), a "suit under § 11 of the 1933 Act requires no proof of fraud of deceit." Fischman v. Raytheon Mfg. Co., 188 F.2d 783, 786 (2d Cir. 1951). A Section 11 suit "may be maintained only by one who comes within a narrow class of persons[,] i.e.[,] those who purchase securities that are the direct subject of the prospectus and registration statement."Id.
Plaintiffs, without more, argue that because "the Complaint explicitly bases its allegation of securities fraud on the pledge of Euro U.S. shares to MFC Merchant Bank by North Cascade and Collingwood," MFC Merchant Bank may bring its Section 11 and 18 claims (Pls.' Mem. in Opp'n at 8 n. 8; Third Am. Compl. ¶¶ 31, 43, 51). As defendants correctly point out, however, the Third Amended Complaint fails to allege that plaintiff MFC Merchant Bank purchased or sold any security in reliance upon a document filed with the SEC. that any of the defendants made a misrepresentation in a filed document, or even that MFC Merchant Bank purchased stock that was the subject of a registration statement or other filing. (NC Defs.' Moving Mem. at 8 n. 4). Plaintiffs' response that "a pledge of stock is equivalent to a sale for the purposes of the federal securities laws," Marine Bank v. Weaver, 455 U.S. 551, 554 n. 2 (1982) (citing Rubin v. United States, 449 U.S. 424 (1981)), while accurate, is no substitute for the required allegations that the securities at issue were the subject of documents filed with the SEC. Accordingly, plaintiffs' Section 18 and 11 claims are dismissed, and the first cause of action is dismissed in its entirety.
II. THE SECOND AND THIRD CAUSES OF ACTION
As to the second and third causes of action, the North Cascade defendants argued for the first time in their reply brief that the Third Amended Complaint does not state a claim for relief because the securities at issue were not registered at the relevant times. This argument was then the subject of less than a page of argument in plaintiffs' sur-reply and the North Cascade defendants' sur-sur-reply. Because of the inadequacy of the briefing on this issue, apparently considered by the parties to be the pivotal issue on these two claims, the North Cascade defendants' motion as to these two counts is denied without prejudice to renewal upon adequate briefing.
III. THE COMMON LAW CLAIMS
Because defendants' motions to dismiss the second and third causes of action are denied without prejudice to renewal, I cannot at this point determine whether the exercise of supplemental jurisdiction over the common law claims is proper. Accordingly, the defendants' motion to dismiss the fourth, fifth, and sixth causes of action is denied without prejudice to renewal if the second and third causes of action proceed.
IV. CONCLUSION
Defendants' motions to dismiss are granted as to the first cause of action, denied without prejudice to renewal as to the second and third causes of action, and denied without prejudice to renewal (after resolution of renewed motions as to the second and third causes of action) as to the remaining causes of action.
Counsel shall appear for a conference in courtroom 12A at 500 Pearl Street on April 30, 2002 at 10:00 a.m.
SO ORDERED