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concluding that "Plaintiff's section 20 claim is an allegation of fraud."
Summary of this case from In re Bofl Holding, Inc. Sec. Litig.Opinion
No. C 92-3742 CRB
September 24, 2001
MEMORANDUM AND ORDER CLASS ACTION
In this securities fraud class action, plaintiffs allege that defendants participated in a scheme with Everex Systems, Inc. ("Everex") to artificially inflate the price of Everex stock by releasing false and misleading information to the public and to engage in insider trading. After a series of motions, amended complaints, a jury trial, and a reversal by the Ninth Circuit, plaintiffs filed their Third Amended Complaint ("TAC") against defendants Steven L.W. Hui ("Hui"), Wong's International (Holdings) Ltd. ("WIH"), and Gatcombe Corporation ("Gatcombe"). Plaintiffs seek to hold WIH and Gatcombe — outside shareholders — liable for statements made by Hui and Everex.
Now before the Court is the motion to dismiss filed by defendants WIH and Gatcombe. After carefully reviewing the papers filed by both parties and having had the benefit of oral argument on September 7, 2001, the Court GRANTS the motion to dismiss for the reasons set forth below.
BACKGROUND
Everex was a designer, manufacturer, and retailer of computers and computer products, and defendant Hui served as Everex's Chief Executive Officer ("CEO") and Chairman of the Board. WIH and Gatcombe, a wholly owned subsidiary of WIH, formed and funded Everex and were major shareholders of Everex stock. Michael Wong ("Wong") served as an outside director of Everex and indirectly owned a large amount of Everex stock through his holdings in WIH.
Plaintiff Joan Howard ("Howard") filed this class action lawsuit in September 1992, pursuant to sections 10(b) and 20(a) of the Securities Exchange Act of 1934, alleging that Everex, Hui, and Wong engaged in a scheme to artificially inflate the price of Everex stock by releasing false and misleading information to the public from November 21, 1991 to December 10, 1992.
"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j.
"Every 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).
Shortly thereafter, Everex filed for bankruptcy and all actions against it were stayed. In May 1993, Howard amended her complaint to add defendants WIH and Gatcombe. In November 1994, the Court, the Honorable Char1es Legge, dismissed WIH and Gatcombe, who reside overseas, for lack of personal jurisdiction and dismissed the section 10(b) claim against Wong on the ground that the claim was not pled with sufficient particularity. The Court subsequently held that Wong was not a control person for purposes of plaintiffs' section 20(a) claim, and granted summary judgment in Wong's favor. Howard's remaining claims were limited to Hui and proceeded to trial in August 1998. At the conclusion of Howard's case, the court dismissed all the claims against Hui, and plaintiff appealed.
This case was later reassigned to this Court in June of 2001.
The Ninth Circuit reversed in part, holding that the district court erred in dismissing WIH and Gatcombe for lack of personal jurisdiction and in dismissing the claims against Hui. Howard v. Everex Systems, Inc., 228 F.3d 1057, 1069 (9th Cir. 2000). In particular, the court held that the evidence was sufficient to support a verdict in plaintiff's favor. Id. However, the Ninth Circuit affirmed the entry of summary judgment in favor of Wong on the section 20(a) control person liability claim. Id. at 1067.
On February 9, 2001, Howard filed a Second Amended Complaint ("SAC") which added Charles Anderson as a plaintiff. Anderson was added as a plaintiff because, unlike Howard, he traded contemporaneously with defendants and has standing to bring insider trading claims. The SAC asserted three causes of action against WIH and Gatcombe: violations of section 10(b), section 20(a), and an insider trading claim under section 20(A).
"Any person who violates any provision of this chapter or the rules or regulations thereunder by purchasing or selling a security while in possession of material, nonpublic information shall be liable in an action in any court of competent jurisdiction to any person who, contemporaneously with the purchase or sale of securities that is the subject of such violation, has purchased (where such violation is based on a sale of securities) or sold (where such violation is based on a purchase of securities) securities of the same class." 15 U.S.C. § 78t-1(a).
WIH and Gatcombe subsequently moved to dismiss the SAC, and plaintiffs filed an opposition with an errata including an allegation that Gatcombe violated section 10(b) by filing a rule 144 notice when selling Everex stock. The Court struck plaintiffs' errata, and granted defendants' motion to dismiss with leave to amend. First, the Court held that the allegations were insufficient to show that WIH and Gatcombe were control persons for purposes of the financial statements at issue. Second, the Court held that plaintiffs failed to plead their section 10(b) and rule 10b-5 claims with sufficient particularity. The Court also determined that plaintiffs had not sufficiently pled scienter. Lastly, the Court held that there could be no liability under section 20(A) because plaintiffs had not properly pled the requisite underlying violation.
On June 8, 2001, plaintiffs filed their Third Amended Comuplaint ("TAC") and the case was subsequently reassigned to this Court. WIH and Gatcombe now move to dismiss the TAC on the grounds that: (1) plaintiffs fail to plead that WIH and Gatcombe were control persons for purposes of the section 20(a) claim: (2) plaintiffs fail to plead that defendants made material misrepresentations under rule 10b-5 or section 10(b); (3) Anderson's insider trading claims are time-barred, lack particularity, fail to allege scienter; and (4) Anderson's section 20(A) claim is otherwise defective due to the absence of a requisite underlying violation of federal securities law.
DISCUSSION
I. Legal Standard
A rule 12(b)(6) motion to dismiss for failure to state a claim is viewed with disfavor. See Gilligan v. Jamco Dev. Corp., 108 F.3d 246, 249 (9th Cir. 1997). Under rule 12(b)(6), a complaint should not be dismissed unless a plaintiff can prove "no set of facts in support of his claim that would entitle him to relief." Parks Sch. of Bus., Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir. 1995). The court must take the non-moving party's factual allegations as true and must construe those allegations in the light most favorable to the non-moving party. See id. The court must also draw all reasonable inferences in favor of the non-moving party. See Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987). However, "conclusory allegations of law and unwarranted inferences are insufficient to defeat a motion to dismiss for failure to state a claim." Epstein v. Washington Energy Co., 83 F.3d 1136, 1139 (9th Cir. 1996).
II. Control Person Claims
Plaintiffs' section 20(a) claim against WIH and Gatcombe is based on the theory that WIH and/or Gatcombe were "control persons." "In order to prove a prima facie case under § 20(a), plaintiff must prove: (1) a primary violation of federal securities laws . . . and (2) that the defendant exercised actual power or control over the primary violator." Howard, 228 F.3d at 1065. Plaintiff's allege that defendants were control persons with respect to Everex and/or Hui, the primary violators, based on the following: (1) WIH and Gatcombe owned the largest Everex stock percentage: 19.6%; (2) WIH and Gatcombe approved each director of the Everex board of directors; (3) the vice chairman of WIH represented WIH and Gatcombe on the Everex board; (4) WIH convinced the Everex board of directors to rescind Hui's resignation; (5) Hui was indebted to WIH and Gatcombe as a result of loans, and Hui had control over Everex; (5) Everex prohibited its officers from trading stock concurrently with WIH and Gatcombe at defendants' request; (6) WIH and Gatcombe arranged for Everex financing through Far East lenders; (7) WIH and Gatcombe caused Everex to defer filing for bankruptcy; (8) Gatcombe and Everex used the same law firm; (9) friends and family of WIH and Gatcombe benefitted from less than arms length transactions with Everex; (10) WIH and Gatcombe received material non-public information from Everex; and (11) WIH and Gatcombe convinced Everex to prevent its officers from trading stock at the same time as Gatcombe. Plaintiffs asserted all but the last two of the allegations in their dismissed SAC.
Plaintiffs' TAC also contains allegations that WIH and Gatcombe "had control over Everex's financial reporting" as demonstrated by the fact that: (1) WIH and Gatcombe's "representative on Everex's board of directors reviewed and approved [Everex's] financial statements for its first quarter fiscal 1992"; and (2) WIH and Gatcombe "retained the power to review and approve [Everex's] financial statements for its second quarter fiscal 1992." TAC ¶¶ 77, 194.
There is no concrete test for establishing whether a defendant is a control person. See Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1441 (9th Cir. 1987) ("[T]he concept of control, in the context of the securities law, is an elusive notion for which no clear-cut rule or standard can be devised."). The decision "is an intensely factual question" and "involves scrutiny of the defendant's participation in the day-to-day affairs of the corporation and the defendant's power to control corporate actions." Howard, 228 F.3d at 1065 (quoting Kaplan v. Rose, 49 F.3d 1363, 1382 (9th Cir. 1994)). General control over a company is not enough: plaintiffs must allege that the defendants were active in the day-to-day affairs of Everex or Hui or that they exercised specific control over the preparation and release of the financial statements. See id. at 1067 n. 13.
Defendants base their motion on two alleged deficiencies in plaintiffs' complaint. First, defendants assert that plaintiffs have not pled defendants' control liability with enough particularity to satisfy rule 9(b). In particular, they contend that plaintiffs' control theory allegations do not establish anything more than general control. In addition, defendants argue that plaintiffs' allegations concerning defendants' alleged control over Everex's financial reporting are dependent on Michael Wong, whose dismissal by the Ninth Circuit severs the link for WIH and Gatcombe's control liability.
A. Control Over Financial Reporting
The TAC alleges that defendants, through Michael Wong, "reviewed and affirmatively approved the public dissemination of the first quarter fiscal 1992 financial statements." TAC § 77; see also Plaintiff's Opposition p. 16. Wong was a director of WIH and also served as an outside director of Everex during a portion of the class period. He therefore serves as a potential link between WIH and Gatcombe and Everex for purposes of control liability. However, the Ninth Circuit held as a matter of law that Wong was not a control person. Howard, 228 F.3d at 1065-67. Therefore, plaintiffs' claim must fail to the extent that it relies on Wong to establish defendants' control over the financial statements at issue. Plaintiffs also claim, however, that WIH and Gatcombe had control over Everex and Hui independent of any control they may have had through Wong. The Court must therefore decide if the TAC, unlike the SAC, sufficiently alleges control liability independent of any of the allegations which are dependent on Wong.
B. Sufficiency of the Allegations
The new allegations in the TAC — that WIH and Gatcombe received material non-public information from Everex and also convinced Everex to prevent its officers from trading stock at the same time as Gatcombe — are insufficient to establish defendants' control person liability. As with the allegations of the SAC, plaintiffs' TAC allegations, assuming they are true as the Court must, do not establish that defendants were active in the day-to-day affairs of Everex, through HUi or otherwise, or that they exercised any specific control over the financial statements. See Howard, 228 F.3d at 1067 n. 13. Plaintiffs' section 20(a) claim therefore fails as a matter of law.
Plaintiffs respond that the Court is erroneously applying a heightened pleading standard; that is, a summary judgment standard or the more stringent pleading requirements of the PSLRA. The Court disagrees. Plaintiff's section 20(a) claim is an allegation of fraud. Allegations of fraud must be pled with particularity. See Fed.R.Civ.P. 9(b). While a plaintiff need not plead (or ultimately establish) the control person's scienter distinct from the controlled corporation's scienter, see Howard, 228 F.3d at 165, a plaintiff must plead the circumstances of the control relationship with sufficient particularity to satisfy rule 9(b). See In re Oak Tech. Sec. Litig., No. 96-20552 SW, 1997 WL 446168, at *14 (N.D. Cal. Aug. 1, 1997); see also In re Glenfed, Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995) (affirming dismissal of section 20(a) claim for failing to plead that the control person "participated in the day-to-day corporate activities, or had a special relationship with the corporation, such as a participation in preparing or communicating group information at particular times."). Accordingly, on a motion to dismiss, the Court is required to review plaintiffs' allegations as to the circumstances of the control relationship and determine whether they are sufficient to establish control person liability. See Oak Tech., 1997 WL 446168, at *14 (dismissing plaintiffs' section 20(a) claim for failure to plead the circumstances of the control relationship with sufficient particularity); see also Berry v. Valence Tech., Inc., 175 F.3d 699, 706-07 (9th Cir.), cert. denied, 538 U.S. 1019 (1999) (affirming 12(b)(6) dismissal of the defendant for failure to sufficiently allege how the defendant controlled or otherwise influenced the alleged misstatements).
III. Fraudulent Misrepresentation
Plaintiffs' section 10(b) and rule 10b-5 claims against defendants are based on the rule 144 notice defendants filed in connection with a sale of Everex stock. See Rule 144(h) (requiring the notice to be filed by any seller of more than 500 shares, or any amount of stock with an aggregate sale price in excess of $10,000 within a three month period). Defendants were required to file the rule 144 Notice with the Securities Exchange Commission upon the sale of their Everex shares. The Notice contains boilerplate language asserting that the person selling the securities does not know "any material adverse information in regard to the current and prospective operations of the Issuer [Everex] of the securities to be sold which has not been publicly disclosed." TAC §§ 118, 122, 130. Plaintiffs allege that WIH and Gatcombe were aware of adverse undisclosed information at the time they submitted the rule 144 Notice, and therefore the notice was false and misleading.
In order to establish a section 10(b) violation, plaintiffs must prove that the statements were material. Materiality exists when "`there is substantial likelihood that a reasonable investor would consider the information important in making an investment decision'" Caravan Mobile Home Sales, Inc. v. Lehman Brothers Kuhn Loeb, Inc., 769 F.2d 561, 565 (9th Cir. 1985) (quoting Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980)). Materiality is a fact-specific inquiry that is generally left for the jury unless the materiality is "so obvious that reasonable minds cannot differ." Durning v. First Boston Corp., 815 F.2d 1265, 1268 (9th Cir. 1987). Nonetheless, courts may, and do, dismiss section 10(b) claims for lack of materiality on rule 12(b)(6) motions. See e.g., In re Syntex Corp. Sec. Litig., 95 F.3d 922, 932 (9th Cir. 1996) (affirming dismissal for failure to state a claim regarding materiality of statements); In re Stac Elects. Sec. Litig., 89 F.3d 1399, 1405 (9th Cir. 1996) (affirming the dismissal of plaintiffs' complaint for failure to establish that statements were materially misleading); In re VeriFone Sec. Litig., 11 F.3d 865, 870 (9th Cir. 1994) (dismissal on 12(b)(6) grounds proper where omissions are not material).
The question here is whether an investor would consider the rule 144 statement to be important. Plaintiffs do not cite a single case to support their assertion that rule 144 statements can give rise to section 10(b) liability. As defendants point out, it is the sale of stock by a major shareholder that is a material event. The TAC does not include any allegations that suggest that the statement signed in conjunction with the sale is information that a reasonable investor would consider important. Accordingly, plaintiffs' section 10(b) claim fails as a matter of law.
IV. Insider Trading Claims
Anderson's insider trading claims are brought under section 10(b), rule 10b-5 and section 20(A). Defendants move to dismiss Anderson's insider trading claims on three independent grounds: (1) the claims are barred by the statute of limitations; (2) they fail to satisfy rule 9(b); and (3) they fail to sufficiently allege scienter. As the Court concludes that Anderson's claims are barred by the statute of limitations, it need not address defendants' additional arguments.
The statute of limitations for a section 20(A) violation is five years from the date of the last transaction that is the subject of the violation. 15 U.S.C. § 78t-1(b)(4). The statute of limitations for a section 10(b) claim is three years. 15 U.S.C. § 78i(e). The section 20(A) claim is based on Anderson's March 20, 1992 transaction, and therefore Anderson's section 20(A) claim should have been brought by March 20, 1997 and the section 10(b) claim by March 20, 1995. However, as is set forth above, Anderson did not bring his insider trading claims until February 2000. Therefore, Anderson's claims can proceed only if either "relation back" or equitable tolling applies.
A. Relation Back Doctrine
The relation back doctrine preserves a plaintiff's ability to add a new plaintiff only when "(1) the original complaint gave the defendant adequate notice of the claims of the newly proposed plaintiff; (2) the relation back does not unfairly prejudice the defendant; and (3) there is an identity of interests between the original and newly proposed plaintiffs." In re Syntex Corp. Sec. Litig., 95 F.3d 922, 935 (9th Cir. 1996) (citing Besig v. Dolphin Boating Swimming Club, 683 F.2d 1271, 1278-79 (9th Cir. 1982)).
"An amendment equitably may relate back when the prior complaint has given adequate notice of time facts supporting a claim." Besig v. Dolphin Boating Swimming Club, 683 F.2d 1271, 1278 (9th Cir. 1982). In order to relate back, the new claim must arise from the same core of operative facts pled prior to time expiration of the statute of limitations. If the focus of the litigation changes distinctly upon the amendment of a complaint, relation back is not justified. See id. at 1279. Where a new plaintiff within a new claim is sought to be added, the adversary must have notice about the operational facts as well as "fair notice that a legal claim existed in and was in effect being asserted by, the party belatedly brought in." Leachman v. Beech Aircraft Corp., 694 F.2d 1301, 1308-09 (D.C. Cir. 1982) (citing Williams v. United States, 405 F.2d 234, 238 (5th Cir. 1968)).
Howard's original complaint was limited to claims under section 10(b) and 20(a). Although the original complaint made reference to stock sales for the purpose of establishing scienter, it did not notify defendants that an insider trading claim may be asserted against them. Furthermore, Anderson's insider trading claims involve an independent core of operative facts. Insider trading claims require a predicate violation of a securities law, contemporaneous trading of defendant and plaintiff, and a profit gain or loss. 15 U.S.C. § 78t-1(a)-(b). The additional facts necessary to plead a section 20(A) claim therefore involve proof of time contemporaneous trading as well as evidence of profit or loss in addition to time underlying offense. Because the only notice defendants received regarding insider trading consisted of references to stock sales for the purposes of establishing scienter, plaintiffs have not met their burden of establishing adequate notice.
Plaintiffs' argument regarding identity of interest is equally unavailing. In Syntex, the Ninth Circuit held that two groups of plaintiffs had different interests for purposes of the relation-back doctrine because they bought stock at different values and after different statements were made by defendants. Syntex, 95 F.3d at 935. Although Anderson was a member of the class when the original complaint was filed, line asserts an entirely new claim that Howard did not and could not allege due to lack of standing. Thus, within respect to the new insider trading claim, Anderson has different interests from Howard. Accordingly, time relation-back doctrine does not rescue Anderson's insider trading claims.
B. Tolling
As an alternative to relation back, plaintiffs argue that the insider trading claims were equitably tolled. Plaintiffs allege that Anderson could not have brought suit prior to the Ninth Circuit's reversal because time district court had previously determined that WIH and Gatcombe were not subject to personal jurisdiction. Plaintiffs rely on Seattle Audubon Society v. Robertson, 931 F.2d 590 (9th Cir. 1991), to argue that the doctrine of impossibility should toll the statute of limitations until time Ninth Circuit held that WIH and Gatcombe were subject to time Court's jurisdiction.
Plaintiffs' "impossibility" argument is unpersuasive. In Seattle Audubon, the court tolled time statute of limitations because of a district court's erroneous determination that a statute was constitutional. Id. at 598. The plaintiffs appealed the district court's ruling, but in the meantime did not bring time action which on its face was barred by the statute which the district court had upheld. Seattle Audubon is limited to the "particular circumstances of [its] unusual case." Id. at 597. As the D.C. Circuit observed, Seattle-Audubon "was expressly limited to its peculiar circumstances, in particular the unusually short limitations period [15 days], and the diligence of the plaintiff in pursuing its case," and therefore the case "does not support the broad proposition" that "the presence of adverse precedent automatically leads to equitable tolling." Boling v. United States, 220 F.3d 1365 (D.C. Cir. 2000).
Here, there was no legal impediment to Anderson bringing his insider trading claims. The class was not certified at the time the Court dismissed WIH and Gatcombe for lack of personal jurisdiction, and thus Anderson was not bound by that determination. Accordingly, Anderson's insider trading claims are time-barred.
V. Section 20(A) Claim
Liability under section 20(A) is dependent on an underlying violation of the Securities Act. 15 U.S.C. § 78t-1(a). If plaintiffs have failed to allege "an actionable independent underlying violation of the `34 Act," they cannot maintain a claim under section 20(A). In re VerFone Sec. Litig., 11 F.3d 865, 872 (9th Cir. 1993). As the Court has concluded that plaintiffs cannot maintain a claim under section 10(b), section 20(a) or rule 10b-5, Anderson's section 20(A) claim must be dismissed for failure to establish a predicate violation of time Securities Exchange Act.
CONCLUSION
For the foregoing reasons, defendants WIH and Gatcombe's motion to dismiss is GRANTED in its entirety. As plaintiffs have already been granted leave to amend once, and as they have not come forward within any additional allegations not included in the TAC, the dismissal is without leave to amend.
IT IS SO ORDERED.