Opinion
99 Civ. 4770 (RWS).
March 20, 2000
SECURITIES AND EXCHANGE COMMISSION, Attorney for Plaintiff, 7 World Trade Center, 13th Floor, New York, N Y 10048, By: CARMEN J. LAWRENCE, ESQ., WAYNE M. CARLIN, ESQ., KAY LACKEY, ESQ., ANTHONY J. BOSCO, ESQ., KATHLEEN FENNIMAN, ESQ., DORIA G. STETCH, ESQ., Of Counsel.
STROOCK STROOCK LAVAN, Attorney for Defendant Richard Silverman, 180 Maiden Lane, New York, N Y 10038, By: MELVIN A. BROSTERMAN, ESQ., JAMES A. SHIFREN, ESQ., JESSICA B. COPER, ESQ., Of Counsel.
OPINION
Defendant Richard Silverman ("Silverman") has moved, pursuant to Rules 9(b) and 12(b)(6), Fed.R.Civ.P., to dismiss this action for failure to plead fraud with particularity. For the reasons set forth below, the motion is denied.
The Parties
The Securities and Exchange Commission ("SEC") is a federal agency partially responsible for monitoring securities markets and enforcing the federal securities laws.
Silverman is a New York resident and, during the time period relevant to this action, was the head trader at D. Blech Co., Inc. ("DB Co."), a broker-dealer.
Prior Proceedings
Numerous lawsuits have been commenced in connection with the alleged wrongdoing at the heart of this case. See, e.g., In re Blech Sec. Litig., 928 F. Supp. 1279 (S.D.N.Y. 1996). The complaint in the instant SEC enforcement action was filed on July 1, 1999. On August 24, 1999, Silverman filed a motion to dismiss the complaint for failure to state fraud with particularity and for failure to state a claim. Rather than contest the motion, the SEC filed an amended complaint (the "Amended Complaint") on September 13, 1999. On October 14, 1999, Silverman filed a motion to dismiss the Amended Complaint. The Court received written submissions pertaining to the motion through December 8, 1999, at which point oral argument was heard.
The Allegations of the Amended Complaint
DB Co. was formerly a leading market-maker in a number of biotechnology securities. In 1994, the biotech industry experienced a cyclical downturn and the price of a number of the biotech securities in which DB Co. made a market declined. Because DB Co. held large inventory positions in these securities, and the equity value of the securities decreased, DB Co. experienced a net capital crisis.
Additionally, DB Co. had secured a line of credit from its clearing broker, Bear Stearns Co. ("Bear Stearns"), which was at least in part secured by the securities DB Co. held in its inventory. When market forces reduced the prices of biotech securities during 1994, it resulted in an increase in DB Co.'s debit balance with Bear Stearns, which DB Co. then had to reduce.
David Blech ("Blech"), the owner of DB Co., then implemented a market manipulation scheme to sell biotech stocks from DB Co.'s inventory account to customer accounts controlled by Blech, in order to withhold these securities from the market, conceal DB Co.'s ownership of the securities, and give the appearance of market interest, which had the effect of maintaining or increasing the price of these securities.
From at least June 1, 1994 through September 19, 1994, Blech, assisted by Silverman and Alefheim Prodani ("Prodani"), a trader at Baird Patrick Co. ("Baird Patrick"), manipulated the market of seven biotech securities: BioSepra Inc. common stock ("BioSepra"), Intelligent Surgical Lasers, Inc. (now known as Escalon Medical Corp.) Class A Warrants ("Intelligent Surgical"), HemaSure Inc. common stock ("HemaSure"), Ariad Pharmaceuticals, Inc. units ("Ariad"), Ecogen, Inc. common stock ("Ecogen"), Microprobe Corp. (now known as Epoch Pharmaceuticals, Inc.) common stock ("MicroProbe"), and MicroProbe warrants (collectively the "Blech Stocks").
Various deceptive devices were employed to effectuate the manipulation. For example, Blech Stocks held in DB Co.'s inventory account were "parked" in customer accounts controlled by Blech (the "Controlled Accounts"). Transactions were made between Controlled Accounts that involved no change in beneficial ownership of the Blech Stocks. Most of the transactions were unauthorized by the account holders.
By August 1994, DB Co. was struggling to survive, and Blech directed hundreds of manipulative trades, the details of which are described in the Amended Complaint for each of the Blech Stocks.
Silverman headed DB Co.'s trading desk, which also included two traders under Silverman, Alexander Pomper and Patrick Boyle. Silverman insured that the trades made at DB Co. were executed, and personally executed manipulative trades. (Blech was not a trader and thus could not execute trades himself.)
Silverman was also allegedly fully aware of the improper nature of the trades he was executing. On May 12, 1994, he is alleged to have stated, "These accounts of [Blech's] buying things and not paying for them, it's illegal." He is also alleged to have stated that "all Blech's accounts should be shipped out — it stinks what goes on in these accounts, that's why I get the tickets signed, because it stinks and I want to get out of the loop." And again: "It just stinks to me — we'll get a slap on the wrist for the time stamps, you live with that but this other stuff stinks like parking or something."
On July 25, 1994, Silverman resigned as head trader of DB Co., because he did not want his "license to be on the line." Nevertheless, he stayed on as a "senior trader." He eventually resigned on September 19, 1994, just a few days before the collapse of the firm.
Discussion
On a motion to dismiss under Rule 9(b) or Rule 12(b)(6), the facts alleged in the complaint are presumed to be true, and all factual inferences are drawn in the plaintiff's favor. See Mills v. Polar Molecular Corp., 12 F.3d 1170, 1174 (2d Cir. 1993). Dismissal is warranted only when "the plaintiff cannot recover on the facts he has alleged." Id.
The SEC has alleged that Silverman violated § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), and § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, by participating in the market manipulation scheme described above.
"Manipulation is `virtually a term of art when used in connection with securities markets.'" Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 476-77 (1977) (quoting Ernst Ernst v. Hochfelder, 425 U.S. 185, 199 (1976)). A claim premised on market manipulation, as alleged here, focuses on the "engaged in a scheme to defraud" aspect of Section 10(b) and Rule 10b-5, described by the Supreme Court in Hochfelder as conduct "designed to deceive or defraud investors by controlling or artificially affecting the price of securities." Hochfelder, 425 U.S. at 199. In order to survive a Rule 12(b)(6) motion, a plaintiff asserting a market manipulation claim must allege direct participation in a scheme to manipulate the market for securities. See In re Blech Sec. Litig., 961 F. Supp. 569, 580 (S.D.N.Y. 1997); see also Green, 430 U.S. at 476.
Rule 9(b) requires that in all allegations of fraud the circumstances constituting the fraud must be "stated with particularity." Fed.R.Civ.P. 9(b); see Shields v. Citytrust Bancorp., Inc., 25 F.3d 1124, 1127 (2d Cir. 1994). The concerns animating Rule 9(b) are (1) to provide a defendant with fair notice of the claims against it; (2) to protect a defendant from harm to its reputation or goodwill by unfounded allegations of fraud; and (3) to reduce the number of strike suits. See DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987). "Where the complaint gives fair and reasonable notice to a defendant of the claim and the grounds upon which it is based, it satisfies one of the main purposes of Rule 9(b), specifically, providing defendant with fair notice of the claim to enable preparation of a reasonable defense." SEC v. Feminella, 947 F. Supp. 722, 733 (S.D.N.Y. 1996).
Silverman maintains that the pleading standard for a market manipulation claim is equivalent to the standard for a claim alleging affirmative misrepresentations. This, however, is not the case. While the Second Circuit has not ruled on the question, this Court and other courts in this District have agreed that "[t]o satisfy Rule 9(b), a market manipulation claim must specify `what manipulative acts were performed, which defendants performed them, when the manipulative acts were performed, and what effect the scheme had on the market for the securities at issue.'" SEC v. U.S. Environmental, Inc., No. 94 Civ. 6608 (PKL), 2000 WL 150857, at *2 (S.D.N.Y. Feb. 9, 2000) (quoting T.H.C., Inc. v. Fortune Petroleum Corp., No. 96 Civ. 2690 (DAB), 1999 WL 182593, at *3 (S.D.N.Y. Mar. 31, 1999) (quoting Baxter v. A.R. Baron Co., No. 94 Civ. 3913, 1995 WL 600720, at *6 (S.D.N.Y. Oct. 12, 1995))); see also S.E.C. v. Schiffer, No. 97 Civ. 5853 (RO), 1998 WL 226101 (S.D.N.Y. May 5, 1998); In re Blech Sec. Litig., 961 F. Supp. 569, 585 (S.D.N Y 1997). In a market manipulation claim, then, as opposed to an affirmative misrepresentation claim, "the level of specificity required by Rule 9(b) is somewhat relaxed." Dietrich v. Bauer, 76 F. Supp.2d 312, 339 (S.D.N.Y. 1999); see Blech, 961 F. Supp. at 585. "More generalized allegations of the nature, purpose, and effect of the fraudulent conduct and the roles of the defendants are sufficient for alleging participation." Id.
As recounted above, the Amended Complaint easily satisfies this pleading standard. The specific stocks, the methods of manipulation, the time frame in which the manipulations were performed, and the effect on the market are all set forth with specificity in the Amended Complaint, as are the direct participants in the manipulation: Blech, Prodani, and Silverman. Contrary to Silverman's assertions, the SEC is simply not required at the pleading stage to list each and every specific trade which Silverman executed as part of the manipulative scheme. As the Amended Complaint now stands, Silverman has been given fair notice of the claims against him.
Silverman also claims that the Amended Complaint fails to allege facts giving rise to a strong inference of fraudulent intent, which "may be established either (a) by alleging facts to show that defendants had both the motive and opportunity to commit fraud, or (b) alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Shields, 25 F.3d at 1128. This claim is likewise meritless. As related above, the Amended Complaint attributes numerous statements to Silverman which constitute strong circumstantial evidence of conscious misbehavior. The statements, and the intent to resign, indicate that Silverman was well aware of the illegal practices that were being carried on at DB Co., and in which he is alleged to have directly participated.
Conclusion
For the reasons set forth above, Silverman's motion to dismiss is denied.
It is so ordered.