Opinion
No. 03 Civ. 4371 (JFK).
December 8, 2004
Daniel W. Krasner, Esq., Thomas H. Burt, Esq., Kate McGuire, Esq., Wolf Haldenstein Adler Freeman Herz LLP, New York, New York, Attorneys for Plaintiffs.
Jay Cohen, Esq., Robyn Tarnofsky, Esq., Paul, Weiss, Rifkind, Wharton Garrison LLP, New York, New York, Attorneys for Defendants.
OPINION and ORDER
INTRODUCTION
This case arises out of a merger transaction (the "Acquisition") between plaintiff NM IQ LLC ("NM IQ") and the now-bankrupt OmniSky Corporation ("OmniSky"). NM IQ commenced an action in New York State Court against OmniSky and three of its officers, alleging fraud, fraudulent inducement and mutual mistake. The court dismissed these claims for lack of standing and failure to state a cause of action. Upon leave of the court, seven members of NM IQ were added as plaintiffs. These plaintiffs then filed an amended complaint alleging the same claims against OmniSky and two of the officers. Again, the court dismissed for failure to state a cause of action.
Prior to filing their amended complaint in the state court, the same plaintiffs commenced an action in this Court against the original three OmniSky officers. This action added claims under Sections 10(b) and 20(a) of the Securities Exchange Act ("1934 Act") to the common law fraud, fraudulent inducement and mutual mistake claims before the state court. Defendants have moved to dismiss under Fed.R.Civ.P. 12(b)(6) and 9(b) on grounds ofres judicata, statute of limitations, failure to state claims and failure to plead fraud with sufficient particularity. For the reasons that follow, the Court finds the State Court dismissals preclusive of Plaintiffs' claims before this Court. Defendants' motion is therefore granted.
FACTUAL BACKGROUND
The Complaint alleges the following facts. OmniSky Corporation ("OmniSky") was a wireless technology company that offered service for use on handheld mobile devices. (Compl. ¶ 20). These services permitted subscribers to access the Internet, send and receive e-mail, and conduct e-commerce transactions. (Id.). At the time of the events giving rise to the Complaint, Defendant Patrick S. McVeigh ("McVeigh") was OmniSky's chairman and chief executive officer; defendant Lawrence S. Winkler ("Winkler") was chief financial officer; and defendant Ray Cleeman ("Cleeman") was vice president of finance and treasurer. (Id.).In October 2000, one month after OmniSky's initial public offering, OmniSky representatives commenced discussions with representatives of technology companies Nomad, Inc. and Nomad LTD (collectively "Nomad") concerning a possible acquisition. (Id. ¶¶ 22-25). Defendants McVeigh and Cleeman, along with then-president Barak Berkowitz ("Berkowitz"), were the primary negotiators for OmniSky. (Id. ¶ 25). Jacob Davidson ("Davidson"), a founder of Nomad and beneficial interest-holder in plaintiffs 2bVentures LLC ("2b") and Back Bay Capital Partners LLC ("Back Bay"), was the primary spokesman for Nomad. (Id. ¶ 25). In anticipation of the Acquisition, the seven non-NM IQ plaintiffs, who collectively owned 94% of Nomad, created NM IQ and transferred their interests to the new entity. (Id. ¶ 12). NM IQ was formed for the sole purpose of effecting the merger transaction with OmniSky. (Id.).
Three representations by Defendants during the merger negotiations form the basis of Plaintiffs' claims. The first involved OmniSky's ability to fund itself going forward. In October and November 2000, Cleeman provided Davidson with eight reports by Wall Street analysts. (Id. ¶ 30). The analysts' consensus was that OmniSky had sufficient on-hand cash, would not need additional funding until late in 2001 and would achieve profitability by 2003. (Id. ¶ 31). Plaintiffs also allege that McVeigh represented to Davidson during a November 16, 2000 meeting that OmniSky had sufficient capital under its current business model to continue funding its own and Nomad's operations into 2002. (Id. ¶ 26(a)). While Plaintiffs made allegations concerning OmniSky's ability to fund itself in the state action, their Memorandum of Law states that these allegations are not before this Court. (Pl. Mem. of Law at 32-33).
The second representation also involves the Wall Street analysts' reports. Four of the reports estimated that OmniSky would generate between 220,000 and 225,000 subscribers by the end of 2001. (Id. ¶ 43). Plaintiffs allege that Cleeman represented that he and OmniSky adopted the reports and that they accurately represented OmniSky's financial condition. (Id. ¶ 34). Plaintiffs claim that they relied on these reports in their determination to enter into the merger with OmniSky. (Id. ¶ 37).
The third representation involved a statement by McVeigh to Davidson at the November 16, 2000 meeting that OmniSky "had secured a commitment from Verizon to invest an additional $20 million in funding." (Id. ¶ 26(b)). Plaintiffs allege that they relied on this commitment because they assumed that Verizon, a well-capitalized investor in technology ventures, had conducted extensive independent due diligence. (Id. ¶ 28). Plaintiffs also believed, and Defendants allegedly represented, that Verizon's name recognition would attract other investors to OmniSky. (Id. ¶¶ 27, 28(c)).
During the second week of November 2000, Defendants attended an offsite meeting of OmniSky's senior executives. (Id. ¶ 29). Plaintiffs allege that they knew nothing of this meeting at the time. (Id.). At this meeting, an OmniSky vice president gave a presentation (the "Presentation") that included an agenda and timetable for revising the budget downward. (Id. ¶ 29, 39). This Presentation scheduled revised budget figures for a subsequent presentation on December 11, 2000. (Id. ¶ 42). The Presentation also stated subscriber projections of 158, 688 by the end of 2001, a 30% decrease from the estimates in the Wall Street reports. (Id. ¶¶ 41, 44).
After the November Presentation, Plaintiffs allege that OmniSky prepared documents containing the revised subscriber projection and planning budget cuts. (Id. ¶ 45). According to spreadsheets allegedly prepared for a December 11 presentation, OmniSky planned budget cuts of $3.5 million at the end of 2000 and $32 million from 2001 operating expenses to compensate for lower-than-expected subscriber totals. (Id. ¶ 50).
On November 21, 2000, after one month of negotiations, Plaintiffs and OmniSky executed an agreement in principle (the "Letter of Intent") setting forth the terms for OmniSky's acquisition of Nomad. (Id. ¶¶ 6, 51). Plaintiffs allege that Defendants did not disclose the reduction in subscriber projections or the proposed budget cuts at this time. (Id. ¶ 51). The Letter of Intent provided that OmniSky would pay Nomad's shareholders 2.5 million shares of unregistered OmniSky common stock, followed by payments of 600,000 and 400,000 shares approximately six months and one year after the acquisition. (Id. ¶ 52).
Cleeman faxed documents for the closing of the acquisition to Davidson on December 30, 2000. (Id. ¶ 55). Davidson asked Cleeman whether OmniSky would meet the subscriber targets in the Wall Street reports. (Id. ¶ 56). To Davidson's surprise, Cleeman responded — deceitfully, Plaintiffs allege — that he did not know the status of those projections. (Id. ¶ 57). Davidson then contacted Berkowitz, who allegedly gave assurances that OmniSky "was on track to meet its projections." (Id. ¶ 58). Davidson signed the acquisition documents on December 30. (Id.). The remaining plaintiffs executed a Share Exchange Agreement on January 3, 2001, and OmniSky announced the acquisition on the following day. (Id.). Defendants provided another report by Wall Street analyst Morgan Stanley Dean Witter on the date of the announcement. (Id. ¶ 61). This report supported earlier representations as to OmniSky's financial condition and subscriber estimates in excess of 220,000 for the end of 2001. (Id.).
At an offsite meeting with OmniSky management on January 15-16, 2001, before the acquisition closed, Davidson was "shocked" to learn that OmniSky had not met its subscriber targets and was setting much lower goals. (Id. ¶ 62). Nevertheless, Plaintiffs claim that the "financial entanglement" of OmniSky and Nomad "made it virtually impossible" to cancel the deal prior to closing. (Id.). Plaintiffs explain that "[i]n November 2000, the Nomad Businesses had a ready source of investment to continue their operations, but had instead taken an infusion of capital from OmniSky as part of the Acquisition upon signing the [Letter of Intent]." (Id.). Plaintiffs also note that all sides had already signed the Share Exchange Agreement prior to the closing. (Id.).
On January 18, 2001, Plaintiffs closed the sale of Nomad to OmniSky on the terms of the Share Exchange Agreement, which followed the terms of the Letter of Intent. (Id. ¶ 67). At the closing, Plaintiffs executed lock-up agreements that incorporated terms in the Share Exchange Agreement. (Id. ¶ 70). Under these agreements, Plaintiffs were permitted to sell their shares of OmniSky stock after time periods ranging from 180 to 330 days. (Id. ¶ 70).
In March 2001, McVeigh allegedly advised Davidson that OmniSky was in a liquidity crisis. (Id. ¶ 73). On July 15, 2001, a meeting was held to discuss Project Northstar, a reevaluation of OmniSky's business in light of its financial difficulties. (Id. ¶ 82). This meeting included discussions of various scenarios along with the amount of additional funding required and the date through which OmniSky could operate under the given scenario. (Id. ¶ 87). Possibilities included the closing of OmniSky's European operations, receipt of the promised $20 million from Verizon or both. (Id. ¶ 88-91). Plaintiffs allege that during this meeting, Cleeman made a presentation not distributed in hard copy to the participants. (Id. ¶ 93). Cleeman allegedly stated that if Verizon invested the $20 million, OmniSky would survive, and if Verizon did not invest, OmniSky would file for bankruptcy protection. (Id.).
During the week of September 11, 2001, Davidson attended a meeting at which he was advised that OmniSky had failed to secure the $20 million from Verizon, to cut sufficient costs and to raise sufficient revenue. (Id. ¶ 95). On September 21, 2001, Winkler reported to the OmniSky Board of Directors that OmniSky had failed to raise additional capital and would run out of cash by December. (Id. ¶ 96). Trading in OmniSky common stock was suspended in late 2001, and OmniSky filed for bankruptcy in December 2001. (Id. ¶ 97)
PROCEEDINGS IN STATE COURT
On December 5, 2001, Plaintiff NM IQ filed a complaint ("Initial Complaint") in New York State Supreme Court, New York County, against OmniSky, McVeigh, Winkler and Cleeman. (Tarnofsky Affd., Exh. O). The Initial Complaint asserted fraud, fraudulent inducement and mutual mistake claims in connection with the Acquisition. This Complaint, inter alia, alleged misrepresentations as to OmniSky's ability to fund itself and the Verizon investment, but did not address the subscriber projections. The defendants moved to dismiss. On January 3, 2003, Justice Karla Moskowitz (the "State Court") issued a non-final order granting the motion. NM IQ LLC v. OmniSky Corp., Index No. 605806/01 (N.Y.Sup.Ct. N.Y. Co. Jan. 3, 2003) ("January 2003 Order") (Tarnofsky Affid., Exh. P). At the threshold, the State Court determined that NM IQ lacked standing because (i) NM IQ was not in existence at the time of the alleged misrepresentations and (ii) NM IQ presented no proof that it was the successor-in-interest to its members' claims. (Id. at 6).The State Court also ruled that NM IQ's fraud, fraudulent inducement and mutual mistake claims failed to state causes of action against defendants McVeigh, Winkler and Cleeman. (Id. at 7). The court held that future projections concerning OmniSky's ability to fund itself were not actionable because they relied on estimates of future performance that carried no guarantee of success. (Id. at 8). The court rejected NM IQ's argument that the defendants knew their predictions would not come true, citing NM IQ's failure to identify any facts in support of this allegation. (Id. at 9). The court also determined that NM IQ's unreasonably relied on oral misrepresentations of OmniSky's financial status that contradicted risk factors and warnings in OmniSky's IPO Prospectus and SEC 10-Q report. (Id. at 10-11).
The State Court also ruled that NM IQ unreasonably relied on the alleged misrepresentations concerning the $20 million Verizon investment because the Wall Street analysts had reported that OmniSky required more than $20 million of additional capital for 2001. (Id. at 11). Finally, the court dismissed the mutual mistake claim. (Id. at 12).
At a June 5, 2003 hearing, the State Court granted leave for NM IQ to file an Amended Complaint (Tarnofsky Affid., Exh. R at 26-31). The court permitted NM IQ to allege standing and approved the addition of seven NM IQ members as plaintiffs. (Id. at 8). The court allowed allegations against OmniSky, McVeigh and Cleeman (but not Winkler) concerning the subscriber projections, but refused to permit allegations concerning OmniSky's ability to fund itself or the Verizon investment. (Id. at 25, 28-29). On June 18, 2003, Plaintiffs filed their Amended Complaint, which again alleged claims of fraud, fraudulent inducement and mutual mistake. (Tarnofsky Affid., Exh. T).
On March 22, 2004, the State Court granted the defendants' motion for dismissal of the claims in the Amended Complaint for failure to state a cause of action. NM IQ LLC v. OmniSky Corp., Index No. 605806/01 (Mar. 22, 2004) ("March 2004 Order"). The court noted that the plaintiffs received notice of the inaccuracy of the subscriber projections prior to the closing of the Acquisition. (Id. at 7-8). This disclosure, combined with plaintiffs proceeding with the closing without securing protective language in the closing agreements, negated any assertion of reasonable reliance. (Id. at 8). The court rejected the plaintiffs' contentions that they could not back out of the deal because it had been announced and the plaintiffs had already taken capital from OmniSky. (Id.). Once again, the court dismissed the mutual mistake claim. (Id. at 7). This March 2004 Order was marked "Final Disposition."
PROCEEDINGS IN FEDERAL COURT
On June 16, 2003, two days before filing of their Amended Complaint in New York State Supreme Court, Plaintiffs filed their Complaint in this Court. The Complaint alleges violations of Section 10(b) of the 1934 Act and Rule 10b-5, Section 20(a) of the 1934 Act, fraud, fraudulent inducement and mutual mistake. These claims arise out of the same transactions as those giving rise to the Initial and Amended Complaints in the state court. As before, the claims rely on Defendants' alleged misrepresentations and omissions concerning the $20 million Verizon commitment and the subscriber projections. To reiterate, Plaintiffs represent that Defendants' false representations concerning OmniSky's ability to fund itself are not before the Court. (Pl. Mem. of Law at 32-33).
Defendants have moved for dismissal of the claims pursuant to Fed.R.Civ.P. 12(b) (6) and 9(b). Plaintiffs have waived the mutual mistake claim (Pl. Mem. of Law at 31 n. 15), but otherwise oppose the motion in its entirety. It should be noted that the State Court issued the March 2004 Order after briefing of Defendants' motion in the instant matter was completed. In a letter to the Court dated April 6, 2004 ("April 6 Letter"), Defendants contended that the March order, together with the previous State Court orders, precludes all of Plaintiffs' claims before this Court. Plaintiffs responded in a letter dated April 15, 2004, that the Appellate Division, First Department, will consolidate an appeal of the March 2004 Order with Plaintiffs' other appeals pending before that court.
DISCUSSION
I. STANDARDS OF REVIEW
In deciding a motion to dismiss a complaint for failure to state a claim on which relief can be granted pursuant to Rule 12(b) (6), the Court is obligated to view the complaint in the light most favorable to the plaintiff. See H.J. Inc. v. Northwestern Bell Tel. Co., 492 U.S. 229, 249, 109 S. Ct. 2893, 2906, 106 L. Ed. 2d 195, 214 (1989). The Court accepts plaintiff's factual allegations as true, Haddle v. Garrison, 525 U.S. 121, 125, 119 S. Ct. 489, 491, 142 L. Ed. 2d 502, 508 (1998), and draws all reasonable inferences in the plaintiff's favor. Freedom Holdings Inc. v. Spitzer, 357 F.3d 205, 216 (2d Cir. 2004). The complaint will not be dismissed "unless 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, 78 S. Ct. 99, 102, 2 L.Ed. 2d 80, 84 (1957).
Rule 9(b) of the Federal Rules of Civil Procedure provides that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." According to the Second Circuit, Rule 9(b) requires that the complaint "(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent." Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993).
II. FRAUD STANDARDS
To state a claim for securities fraud under Section 10(b) of the 1934 Act ( 15 U.S.C. § 78j(b)) and its well-known remedy provision, Rule 10b-5, "a plaintiff must plead that the defendant, 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." Ganino v. Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000).
Section 20(a) of the 1934 Act is a liability provision aimed at control persons. See 15 U.S.C. § 78t(a). A plaintiff establishes a prima facie case under Section 20(a) by showing "(1) a primary violation by a controlled person; (2) control of the primary violator by the defendant; and (3) that the controlling person was in some meaningful sense a culpable participant in the primary violation." Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir. 1998) (internal quotes omitted).
III. RES JUDICATA
The Second Circuit has characterized the doctrine of res judicata as a river divided into two branches: claim preclusion (often confusingly known as res judicata) and issue preclusion (or collateral estoppel). Murphy v. Gallagher, 761 F.2d 878, 879 (2d Cir. 1985). A motion to dismiss pursuant to Rule 12(b)(6) may raise res judicata challenges. Thompson v. County of Franklin, 15 F.3d 245, 253 (2d Cir. 1994).
A. Claim Preclusion
The Full Faith and Credit Clause requires a federal court to "give to a state-court judgment the same preclusive effect as would be given that judgment under the law of the State in which the judgment was rendered." Migra v. Warren City School Dist. Bd. of Educ., 465 U.S. 75, 81, 104 S. Ct. 892, 896, 79 L. Ed. 2d 56, 61 (1984); see 28 U.S.C. § 1738. The federal court determines the preclusive effect of the state judgment by looking to the state's claim preclusion rules. AmBase Corp. v. City Investing Co. Liquidating Trust, 326 F.3d 63, 72 (2d Cir. 2003).
There is no discernable difference between New York and federal claim preclusion law. Marvel Characters, Inc. v. Simon, 310 F.3d 280, 286 (2d Cir. 2002). Under both, "the doctrine of res judicata, or claim preclusion, provides that [a] final judgment on the merits of an action precludes the parties or their privies from relitigating issues that were or could have been raised in that action." Maharaj v. BankAmerica Corp., 128 F.3d 94, 97 (2d Cir. 1997) (internal quotes omitted); see O'Brien v. City of Syracuse, 54 N.Y.2d 353, 357, 429 N.E.2d 1158, 1159, 445 N.Y.S.2d 687, 688 (1981) ("[O]nce a claim is brought to a final conclusion, all other claims arising out of the same transaction or series of transactions are barred, even if based upon different theories or if seeking a different remedy.").
Defendants assert that claim preclusion applies to Plaintiffs' common law fraud claims that were rejected by the State Court. (Def. Mem. of Law at 3; Def. April 6 Letter). Plaintiffs contend that the fraud claims are governed by federal law and thus not precluded by the State Court dismissals. (Pl. Mem. of Law at 31 n. 15). The Court rejects Plaintiffs' argument. "Where a case involves a common law fraud claim, state substantive law is controlling." Pal v. Sinclair, 90 F. Supp. 2d 393, 397 (S.D.N.Y. 2000) (citations omitted); see Texas Indus., Inc. v. Radcliff Materials, Inc., 451 U.S. 630, 640, 101 S. Ct. 2061, 2067, 68 L. Ed. 2d 500, 509 (1981) (holding that "federal common law" governs only in "few and restricted" instances). New York law, not federal law, applies to Plaintiffs' common law fraudulent and fraudulent inducement claims.
Plaintiffs do not challenge the existence of privity between NM IQ in the Initial Complaint and the seven additional plaintiffs added to the Amended Complaint and the federal Complaint. These additional plaintiffs were NM IQ members with the same interests throughout the litigation, even though they were not named in the Initial Complaint. See Melwani v. Jain, No. 02 Civ. 1224, 2004 WL 1900356 (S.D.N.Y. Aug. 24, 2004). The only issue, therefore, is whether the New York dismissals for failure to state a claim were final judgments on the merits. The March 2004 Order is marked "Final Disposition." Although none of the orders contain the precise words "on the merits," the New York Court of Appeals has held that "it suffices that itappears from the judgment that the dismissal was on the merits." Strange v. Montefiore Hosp. Med. Ctr., 59 N.Y.2d 737, 739, 450 N.E.2d 235, 236, 463 N.Y.S.2d 429, 430 (1983) (emphasis added). The State Court decided that Plaintiffs could not plead a necessary element of their claims because they unreasonably relied on OmniSky's projections concerning its ability to fund itself (January 2003 Order), the Verizon investment (January 2003 Order) and the subscriber projections (March 2004 Order). These dismissals were clearly on the merits.
Under New York law, the pendency of an appeal has no bearing on the finality of a judgment for the purposes of res judicata. Brown v. Manufacturers Hanover Trust Co., 602 F. Supp. 549, 551 (S.D.N.Y. 1984); see Parkhurst v. Berdell, 110 N.Y. 386, 392, 18 N.E. 123, 125-26 (1888).
A fair reading of both state complaints demonstrates that the allegations therein sought to comply with the heightened fraud pleading requirements of New York CPLR 3016(b), which is New York's version of Rule 9(b). While the State Court did not specifically address New York CPLR 3016(b), the court's overall rulings pointed out that the fraud allegations in the state complaints were insufficient. The common law fraud allegations in the federal Complaint are the same. Plaintiffs do not make an argument that application of Rule 9(b) requires a different result in federal court. Claim preclusion therefore applies relative to Rule 9(b).
In summary, the Court finds that Plaintiffs' common law fraud and fraudulent inducement claims are precluded under New York law. Plaintiffs' third and fourth causes of action are dismissed. As Plaintiffs have waived their mutual mistake claim (Pl. Mem. of Law at 31 n. 15), their fifth cause of action is dismissed as well.
B. Issue Preclusion
Plaintiffs' first and second causes of action allege violations of Sections 10(b) and 20(a) of the 1934 Act, respectively. These claims must navigate the other branch of the River res judicata: issue preclusion. This doctrine "refers to the preclusive effect of a judgment that prevents a party from litigating a second time an issue of fact or law that has once been decided." Murphy v. Gallagher, 761 F.2d 878, 879 (2d Cir. 1985). As in the case of claim preclusion, the federal court must accord full faith and credit to state court decisions by looking to the state's issue preclusion rules. Town of Deerfield, N.Y. v. FCC, 992 F.2d 420, 429 (2d Cir. 1993).
Under New York law, issue preclusion applies "if the issue in the second action is identical to an issue which was raised, necessarily decided and material in the first action, and the [party opposing preclusion] had a full and fair opportunity to litigate the issue in the earlier action." Parker v. Blauvelt Volunteer Fire Co., 93 N.Y.2d 343, 349, 712 N.E.2d 647, 651, 690 N.Y.S.2d 478, 482 (1999). The proponent of issue preclusion has the burden of demonstrating the identity and decisiveness of the issue, while the opponent must establish the absence of a full and fair opportunity to litigate that issue in the prior proceeding. Id.
The Second Circuit has taken the following position concerning the identity of issues involved in federal and common law fraud claims:
Although federal courts have developed legal principles that govern the application of § 10(b) and Rule 10b-5, the components of securities fraud cases — such as intent, scienter, fraud, deceit — involve issues regularly adjudicated in the state courts. Issue preclusion is fully applicable when a party has litigated these narrow issues in a state court, and later attempts to re-litigate them in a federal court. There generally will be a fairly precise overlap between the state and federal claims when the focus is on these narrow issues. This is a strong reason for giving a state-court decision full preclusive effect as [28 U.S.C.] § 1738 requires. New York judges regularly deal with these issues in the context of corporate and securities law cases in a competent and experienced fashion.Murphy, 761 F.2d at 885. The Murphy Court further held that state issue preclusion rules apply, "even though use of that doctrine disposes of the entire federal action." Id. at 886.
Defendants contend that the State Court's rejection of Plaintiffs' allegations concerning OmniSky's ability to fund itself and the Verizon investment precludes Plaintiffs from litigating these same issues before this Court. (Def. Mem. of Law at 17). Needless to say, the State Court's rejection of the subscriber projection allegations, after briefing of the instant motion, is swept into this contention. (See Def. Ltr. to Court, dated Apr. 6, 2004). Defendants clear the identity of issues hurdle. The issues before the State Court involved the reasonableness of Plaintiffs' reliance on alleged misrepresentations concerning OmniSky's ability to fund itself, the Verizon investment and the subscriber projections. According to Plaintiffs, the allegations involving OmniSky's ability to fund itself are not before this Court. (Pl. Mem. of Law at 32-33). The allegations concerning Verizon and the subscriber projections have not changed in the federal action despite assertion of the 1934 Act claims.
The next question is whether the Verizon and subscriber projection issues were necessary and materially decided in the state action. There is no issue concerning the subscriber projections, which were the exclusive focus of the March 2004 Order. In contrast, the January 2004 Order granted Defendants' motion to dismiss on the basis of lack of standing and failure to state a cause of action. (Tarnofksy Affd., Exh. P at 6). Despite the State Court's explicit finding of unreasonable reliance on the Verizon representations, this Order alone might not be enough for issue preclusion. It could be argued — despite Plaintiffs' failure to do so — that the State Court's reliance determination was not necessary and material to the January 2003 Order. Nevertheless, the State Court refused to permit repleading of the Verizon allegations at the June 5, 2003 hearing despite allowing Plaintiffs to remedy the standing problem. This decision makes clear that the necessary and material component of the Verizon portion of the January 2003 Order was reliance, not standing.
One issue involving the June hearing requires further discussion. At the hearing, the State Court refused to allow further allegations concerning the Verizon investment because, in the court's words, "I already struck that." (Tarnofsky Affd., Exh. R at 28). Earlier, however, the court had referred to the Verizon statements as "a representation of something in the future." (Id. at 25). This statement contradicts the January 2003 Order, which referred to the Verizon statement as "[t]he only alleged misrepresentation involving an existing fact." (Id., Exh. P at 9). Plaintiffs urge that this ambiguity defeats issue preclusion because it is impossible to know the basis of the State Court's rejection of the Verizon allegations. (Pl. Mem. of Law at 34). Defendants respond that the rejection was on reliance grounds, and the Court refused to permit repleading because the allegation had already been struck. (Def. Rep. Mem. of Law at 3-4).
The Court finds no uncertainty in the basis for the State Court's January 2003 rejection of the Verizon allegations. This Order clearly identified these allegations as involving existing facts (Tarnofsky Affd., Exh. P at 9), and Plaintiffs themselves concede that their Complaint "underscores the statements' present fact character." (Pl. Mem. of Law at 34;see Cmplt. ¶ 26(b); Initial Complaint (Tarnofsky Affd., Exh. O) ¶ 14(b)). Despite the characterization of the Verizon statements as future representations at the hearing, the State Court informed counsel:
Counsel, this is what I am saying. I don't see that, I know with your amendment here, I don't see anything different about what your [sic] pleading here about Verizon. I mean it's the same.
(Tarnofsky Affd., Exh. R at 25). As with claim preclusion, a dismissal for failure to state a claim gives rise to issue preclusion when the subsequent complaint is "virtually identical" to the first. Siegel, New York Practice § 462 (3d ed. 1999);see McKinney v. City of New York, 78 A.D.2d 884, 886, 433 N.Y.S.2d 193, 196 (2d Dep't 1980). The State Court informed counsel that its allegations concerning Verizon had not changed from the Initial Complaint. Therefore, the State Court refused to allow the same allegations in the Amended Complaint. Plaintiffs' federal Complaint has not cured the deficiencies with respect to Verizon. This Court therefore finds that the misstatement in the June 2003 hearing does not detract from the finding that the State Court's reliance determination, and not the standing problem, was the necessary and material reason that the court rejected the Verizon allegations in the January 2003 Order.
None of Plaintiffs' other arguments establish the absence of a full and fair opportunity to litigate the Verizon and subscriber projection issues. First, Plaintiffs contend that Defendants' issue preclusion arguments address claims that Plaintiffs do not pursue in this Court. (Pl. Mem. of Law at 32). The Court rejects this argument at the outset. The only difference in claims here involves the two 1934 Act claims, and the issues giving rise to these claims are the same. Second, Plaintiffs argue that the State Court's determination of unreasonable reliance on the Verizon statements was really a "materiality" finding, and state and federal law on materiality greatly differ. (Id. at 35-36). Third, to the extent that the State Court believed that the Verizon statements were future representations, Plaintiffs argue that federal and state standards of scienter are different. (Id. at 37-38). Fourth, Plaintiffs argue that the State Court's analysis of OmniSky's prospectus and SEC filing failed to consider limitations on the Private Securities Litigation Reform Act (PSLRA) "safe harbor" and the related "bespeaks caution" doctrine. (Id. at 38-41).
The Court rejects Plaintiffs' contention that the State Court made a "reliance" ruling based on what the federal courts call "materiality." Materiality" and "reliance" are separate and distinct elements of fraud claims. See Ganino v. Citizens Util. Co., 288 F.3d 154, 161 (2d Cir. 2000). The State Court made explicit findings in both the January 2003 and March 2004 Orders that Plaintiffs unreasonably relied on Defendants' representations. Despite Plaintiffs' argument, the reliance standards are similar for 1934 Act and common law securities fraud claims. In fact, federal courts have assessed the reliance element for both in the same analysis. See Harsco Corp. v. Segui, 91 F.3d 337, 342-46 (2d Cir. 1996); Pail v. Precise Imps. Corp., No. 99 Civ. 1624 (DLC), 1999 WL 681384 at *2 (S.D.N.Y. Aug. 31, 1999). If Plaintiffs believe that the State Court erroneously mixed reliance and materiality, they must obtain relief from the New York Appellate Division, not this Court.
Plaintiffs also contend that federal standards, particularly with respect to materiality and scienter, are so different from state standards that preclusion is inappropriate. But Plaintiffs fail to demonstrate how the standards are different. As before, there is precedent to support the opposite conclusion. See State v. Rachmani Corp., 71 N.Y.2d 718, 727, 525 N.E.2d 704, 709, 709, 530 N.Y.S.2d 58, 63 (1988) (adopting federal materiality standard to decide fraud claim under New York law); 2 Fifth Ave Tenants Ass'n v. Abrams, 183 A.D.2d 577, 578, 583 N.Y.S.2d 466, 467 (1st Dep't 1992) (following Rachmani). Plaintiffs' only support for differing scienter standards is its contention that the State Court's January 2003 Order required "actual knowledge" instead of recklessness. Plaintiffs are correct that the element of scienter may be satisfied by allegations of facts constituting strong circumstantial evidence of recklessness. See Rombach v. Chang, 355 F.3d 164, 176 (2d Cir. 2004). The State Court's dismissal, however, was based on the reliance element, not scienter. Plaintiffs' belief that the State Court incorrectly applied a particular standard does require the conclusion that federal and state fraud standards are so different that preclusion is inappropriate. This argument flies in the face of the Second Circuit's Murphy holding.
Finally, Plaintiffs argue that application of the PSLRA safe harbor and "bespeaks caution" doctrine to the Verizon statements and subscriber projections compels a result different from that reached by the State Court. The Second Circuit has recently held, in accordance with its sister circuits, that the "bespeaks caution" doctrine applies only to forward-looking representations, not to the misrepresentation of present or historical facts. P. Stolz Family P'ship L.P. v. Daum, 355 F.3d 92, 96-97 (2d Cir. 2004). The PSLRA safe harbor, by its terms, also applies solely to forward-looking statements. 15 U.S.C. § 78u-5(a), (c). The State Court determined, in accordance with Plaintiffs' Initial Complaint, that the Verizon representations involved an existing fact. (January 2003 Order, Tarnofsky Affd., Exh. P at 9). The court made the same finding with respect to the subscriber projections during the June 5, 2003 hearing. (Tarnofsky Affd., Exh. R at 28-29). The safe harbor and "bespeaks caution" doctrine therefore do not apply to the alleged misrepresentations involving the Verizon investment or subscriber projections.
Plaintiffs make a last attempt to save the claims against Winkler by arguing that the State Court predicated its dismissal against him on an "actual knowledge" standard, which is different from the standard of control person liability pursuant to Section 20(a) of the 1934 Act. (Pl. Mem. of Law at 41-42). This argument is unavailing. A prerequisite of a Section 20(a) claim is a primary violation by the control person. If Plaintiffs are precluded from alleging their Section 10(b) and Rule 10b-5 claim against Winkler, they have no Section 20(a) claim.
The State Court did not allow Plaintiffs to assert subscriber-related claims against Winkler in the Amended Complaint. Nevertheless, it is well-settled under New York law that a non-party to a prior action may assert issue preclusion in a subsequent action. See B.R. DeWitt, Inc. v. Hall, 19 N.Y.2d 141, 147, 225 N.E.2d 195, 198, 278 N.Y.S.2d 596, 601 (1967) (declaring the doctrine of mutuality of estoppel a "dead letter"). Plaintiffs have made no showing that they lacked the full and fair opportunity to litigate the issue of their reasonable reliance on the subscriber projections. Given that Plaintiffs' allegations concerning the projections have not changed from the state complaints to the federal Complaint, the State Court's dismissal precludes assertion of the subscriber projection issue with respect to all three federal defendants.
In light of the foregoing, the Court finds that Plaintiffs' 1934 Act claims involve the identical issues that were necessarily decided in state court. The Court also finds that Plaintiffs have not demonstrated the lack of a full and fair opportunity to litigate those issues in the state forum. The doctrine of issue preclusion applies, leaving Plaintiffs unable to establish reliance, an essential element of their Section 10(b) and Rule 10b-5 claim. Preclusion also means that Plaintiffs cannot establish the underlying violation necessary to sustain a Section 20(a) claim against Defendants as control persons. See Marcus v. Frome, 275 F. Supp. 2d 496, 503 (S.D.N.Y. 2003). Plaintiffs' first and second causes of action are therefore dismissed.
IV. LEAVE TO REPLEAD
The Federal Rules mandate that leave to amend a pleading be "freely given when justice so requires." Fed.R.Civ.P. 15(a). Nevertheless, the Court may deny leave to amend on grounds of futility. Ellis v. Chao, 336 F.3d 114, 127 (2d Cir. 2003). Plaintiffs have filed three complaints arising out of the OmniSky-Nomad acquisition. All three have been dismissed at the pleading stage. The Court determines that a fourth bite at the apple would be a waste of judicial resources. Leave to replead is denied.
CONCLUSION
For the foregoing reasons, Defendants' motion to dismiss Plaintiffs' claims is granted with prejudice. The Court orders the case closed and removed from the active docket.SO ORDERED.