Filed: Jul. 11, 2007
Latest Update: Mar. 02, 2020
Summary: 05-5132-cv, 05-2593-cv ATSI Commc’ns v. Shaar Fund; ATSI Commc’ns v. Wolfson 1 UNITED STATES COURT OF APPEALS 2 FOR THE SECOND CIRCUIT 3 4 August Term 2006 5 (Argued: November 29, 2006 Decided: July 11, 2007) 6 Docket No. 05-5132-cv 7 -x 8 ATSI COMMUNICATIONS, INC., a Delaware Corporation, 9 10 Plaintiff-Appellant, 11 12 - v. - 13 14 THE SHAAR FUND, LTD., SHAAR ADVISORY SERVICES, N.V., RGC 15 INTERNATIONAL INVESTORS, LDC, ROSE GLEN CAPITAL MANAGEMENT, L.P., 16 CORPORATE CAPITAL MANAGEMENT, INTER
Summary: 05-5132-cv, 05-2593-cv ATSI Commc’ns v. Shaar Fund; ATSI Commc’ns v. Wolfson 1 UNITED STATES COURT OF APPEALS 2 FOR THE SECOND CIRCUIT 3 4 August Term 2006 5 (Argued: November 29, 2006 Decided: July 11, 2007) 6 Docket No. 05-5132-cv 7 -x 8 ATSI COMMUNICATIONS, INC., a Delaware Corporation, 9 10 Plaintiff-Appellant, 11 12 - v. - 13 14 THE SHAAR FUND, LTD., SHAAR ADVISORY SERVICES, N.V., RGC 15 INTERNATIONAL INVESTORS, LDC, ROSE GLEN CAPITAL MANAGEMENT, L.P., 16 CORPORATE CAPITAL MANAGEMENT, INTERC..
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05-5132-cv, 05-2593-cv
ATSI Commc’ns v. Shaar Fund; ATSI Commc’ns v. Wolfson
1 UNITED STATES COURT OF APPEALS
2 FOR THE SECOND CIRCUIT
3
4 August Term 2006
5 (Argued: November 29, 2006 Decided: July 11, 2007)
6 Docket No. 05-5132-cv
7 -------------------------------------------------------x
8 ATSI COMMUNICATIONS, INC., a Delaware Corporation,
9
10 Plaintiff-Appellant,
11
12 - v. -
13
14 THE SHAAR FUND, LTD., SHAAR ADVISORY SERVICES, N.V., RGC
15 INTERNATIONAL INVESTORS, LDC, ROSE GLEN CAPITAL MANAGEMENT, L.P.,
16 CORPORATE CAPITAL MANAGEMENT, INTERCARIBBEAN SERVICES LTD., CITCO
17 FUND SVCS., LUC HOLLMAN, SAM LEVINSON, HUGO VAN NEUTEGEM, DECLAN
18 QUILLIGAN, WAYNE BLOCH, GARY KAMINSKY, STEVE KATZNELSON, TRIMARK
19 SECURITIES, INC., LEVINSON CAPITAL MANAGEMENT, and W.J.
20 LANGEVELD,
21
22 Defendants-Appellees,
23
24 MARSHALL CAPITAL SERVICES, LLC., JESUP & LAMONT STRUCTURED
25 FINANCE GROUP, MG SECURITY GROUP, INC., CROWN CAPITAL
26 CORPORATION, JOHN DOES 1-50, KENNETH E. GARDINER, NATHAN LIHON,
27 and SEI INVESTMENT CO.,
28
29 Defendants.
30
31 -------------------------------------------------------x
32
33 Docket No. 05-2593-cv
34
35 -------------------------------------------------------x
36
37 ATSI COMMUNICATIONS, INC., a Nevada Corporation,
38
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1 Plaintiff-Appellant,
2
3 - v. -
4
5 URI WOLFSON,
6
7 Defendant-Appellee,
8
9 SAM LEVINSON,
10
11 Defendant.
12
13 -------------------------------------------------------x
14 B e f o r e : JACOBS, Chief Judge, WALKER and RAGGI, Circuit
15 Judges.
16
17 Appeals from judgments of the United States District Court
18 for the Southern District of New York (Lewis A. Kaplan, Judge),
19 dismissing plaintiff ATSI Communications, Inc.’s complaints
20 alleging, inter alia, securities fraud in violation of § 10(b) of
21 the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
22 thereunder. ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 357 F.
23 Supp. 2d 712 (S.D.N.Y. 2005).
24 AFFIRMED.
25 THOMAS I. SHERIDAN III (Andrea
26 Bierstein, Melissa C. Welch, on the
27 brief), Hanly Conroy Bierstein &
28 Sheridan LLP, New York, New York,
29 for ATSI Communications, Inc.
30 JONATHAN M. SPERLING (Amanda J.
31 Gourdine, on the brief), Covington
32 & Burling, New York, New York, for
33 The Shaar Fund, Ltd., Shaar
34 Advisory Services, N.V., Levinson
35 Capital Management, Sam Levinson,
36 and Uri Wolfson.
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1 J. KEVIN MCCARTHY (Joanne L.
2 Monteavaro, on the brief), Wilmer
3 Cutler Pickering Hale and Door LLP,
4 New York, New York, for Rose Glen
5 Capital Management, L.P., RGC
6 International Investors, LDC, Wayne
7 Bloch, Gary Kaminsky, and Steven
8 Katznelson.
9 DAVID G. CABRALES (W. Scott
10 Hastings, Jeffrey A. Logan, on the
11 brief), Locke Liddell & Sapp LLP,
12 Dallas, Texas; Cahill Gordon &
13 Reindel LLP (Thorn Rosenthal, Janet
14 A. Beer, on the brief), New York,
15 New York, for Trimark Securities,
16 Inc.
17 MICHAEL J. DELL (Elaine Golin, on
18 the brief), Kramer Levin Naftalis &
19 Frankel LLP, New York, New York,
20 for Citco Fund Services (Curaçao)
21 N.V., InterCaribbean Services,
22 Ltd., Hugo van Neutegem, Wim
23 Langeveld, Luc Hollman, and Declan
24 Quilligan.
25 Berkman, Henoch, Peterson & Peddy,
26 P.C. (Ronald M. Terenzi, on the
27 brief), Garden City, New York, for
28 Corporate Capital Management.
29
30 JOHN M. WALKER, JR., Circuit Judge:
31 These appeals arise from judgments of the United States
32 District Court for the Southern District of New York (Lewis A.
33 Kaplan, Judge), dismissing plaintiff ATSI Communications, Inc.’s
34 (“ATSI”) complaints under Fed. R. Civ. P. 12(b)(6) in two
35 separate actions arising from the same events. ATSI Commc’ns,
36 Inc. v. Shaar Fund, Ltd., 357 F. Supp. 2d 712 (S.D.N.Y. 2005).
37 ATSI alleges that the defendants made misrepresentations in
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1 connection with securities transactions and engaged in market
2 manipulation in violation of § 10(b) of the Securities Exchange
3 Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Rule 10b-5
4 promulgated thereunder, 17 C.F.R. § 240.10b-5, or were liable as
5 control persons under § 20(a) of the Exchange Act, 15 U.S.C. §
6 78t(a). ATSI claims that the defendants fraudulently induced it
7 to sell to them its convertible preferred stock. The defendants
8 then aggressively short sold ATSI’s common stock and converted
9 the preferred stock to cover their short positions. The alleged
10 consequence was a “death spiral” in the price of ATSI’s stock and
11 enormous profit for the defendants.
12 We affirm the judgments of the district court.
13 BACKGROUND
14 The following facts are taken from ATSI’s complaints and
15 supporting documents, which we must assume to be true in
16 reviewing a Fed. R. Civ. P. 12(b)(6) dismissal. See Rothman v.
17 Gregor, 220 F.3d 81, 88 (2d Cir. 2000).
18 A. ATSI and Its Efforts to Raise Money
19 ATSI was founded in December 1993 and hoped to become a
20 leading provider of retail communications services in Mexico in
21 the wake of the deregulation and privatization in Latin America’s
22 telecommunications markets. It never turned a profit. By 1999,
23 ATSI needed an infusion of capital to expand its U.S. customer
24 base and further develop its telephone network in Mexico.
-4-
1 To raise money, ATSI issued four series of cumulative
2 convertible preferred stock (“Preferred Stock”): Series B, C, D,
3 and E. Each transaction included a Securities Purchase
4 Agreement, a Certificate of Designation, and a Registration
5 Rights Agreement. Each series included a risk-mitigating
6 conversion feature that worked as follows. Upon conversion, a
7 “Market Price” was calculated as the average of the lowest five
8 closing bid prices during the ten-day period preceding the
9 conversion date. The “Conversion Price” was calculated as the
10 lesser of (1) the closing bid price on a trading day fixed by the
11 Certificate of Designation and (2) the Market Price discounted by
12 17% to 22% depending upon the series. ATSI would then issue a
13 number of shares of common stock equal to (1) the number of
14 shares of Preferred Stock to be converted (2) multiplied by the
15 Preferred Stock’s stated value of $1,000 per share (3) divided by
16 the Conversion Price. Because there is no limit on the number of
17 common shares into which the Preferred Stock could convert,
18 securities such as these are called “floorless” convertibles.
19 The obvious inference from ATSI’s sale of these securities is
20 that these unfavorable terms were necessary to attract investors
21 because ATSI was continuously losing money. In fact, ATSI
22 acknowledged that in light of its financial condition, it might
23 “not be able to raise money on any acceptable terms.” American
24 Telesource International, Inc., Annual Report (Form 10-K), at 16
25 (July 31, 2000).
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1 1. Sales to the Levinson Defendants
2 On a “road show” in Dallas, Texas in March 1999, defendant
3 Corporate Capital Management (“CCM”) introduced ATSI executives
4 to defendant Sam Levinson, the managing director of Levinson
5 Capital and the Shaar Fund. Shaar Advisory Services, N.V.
6 (“Shaar Advisory”) served as executive officer and general
7 partner of the Shaar Fund. Defendant Uri Wolfson controls the
8 Shaar Fund. Collectively, Levinson, Levinson Capital, the Shaar
9 Fund, and Shaar Advisory constitute the “Levinson Defendants.”
10 During a May 1999 telephone conversation, CCM told ATSI that
11 the Shaar Fund had invested in several strong, successful
12 companies and that the Levinson Defendants were interested in
13 ATSI’s long-term growth. During a June meeting, Levinson told
14 ATSI, inter alia, that the Levinson Defendants sought a long-term
15 investment in ATSI and would not engage in any activity to
16 depress its stock. ATSI claims that all of these representations
17 were false and misleading because CCM and Levinson knew otherwise
18 and the Levinson Defendants were actually market manipulators
19 that profited at the expense of the companies in which they
20 invested.
21 Over the next six months, ATSI entered into the following
22 securities transactions with the Shaar Fund.
23 Transaction # of Preferred # of Warrants Total Purchase
24 Date Shares Purchased Price
Purchased
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1 July 2, 1999 2,000 Series B 50,000 $2,000,000
2 Sept. 24, 1999 500 Series C 20,000 $500,000
3 Feb. 22, 2000 3,000 Series D 150,000 $3,000,000
4 The Securities Purchase Agreement for each transaction
5 included written representations that:
6 1. The Shaar Fund was an “accredited investor” within the
7 meaning of Rule 501 of Regulation D under the
8 Securities Act of 1933; and
9 2. “Neither [the Shaar Fund] nor its affiliates nor any
10 person acting on its or their behalf has the intention
11 of entering, or will enter into, prior to the closing,
12 any put option, short position, or other similar
13 instrument or position with respect to the Common Stock
14 [of ATSI] and neither [the Shaar Fund] nor any of its
15 affiliates nor any person acting on its or their behalf
16 will use at any time shares of Common Stock acquired
17 pursuant to this Agreement to settle any put option,
18 short position or other similar instrument or position
19 that may have been entered into prior to the execution
20 of this Agreement.”
21 ATSI claims that these representations were false because
22 (1) the Shaar Fund’s net worth was not high enough to meet the
23 requirements for being an accredited investor and (2) the Shaar
24 Fund intended to engage, and did engage, in short selling and
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1 manipulation of ATSI’s stock before, during, and after entering
2 into these agreements.
3 The Registration Rights Agreement in each transaction
4 contained a merger clause stating that:
5 There are no restrictions, promises, warranties, or
6 undertakings, other than those set forth or referred to
7 herein. This Agreement, the Securities Purchase
8 Agreement, the Escrow Instructions, the Preferred
9 Shares and the Warrants supersede all prior agreements
10 and undertakings among the parties hereto with respect
11 to the subject matter hereof.
12
13 The Registration Rights Agreements contemplated that the
14 Shaar Fund would soon sell its converted common stock into the
15 public markets. They required ATSI to use its “best efforts” to
16 register the common stock to be issued upon conversion of the
17 Preferred Stock within 90 days of closing and to take all
18 reasonable steps to help the Shaar Fund sell the common stock.
19 They also imposed, at most, a 90-day holding period before the
20 Shaar Fund could convert its Preferred Stock. The only
21 restriction upon the Shaar Fund’s ability to sell the common
22 stock was if ATSI notified it of a material misstatement in the
23 stock’s prospectus.
24 2. Sales to Rose Glen
25 In September 1999, ATSI decided to issue $15 million in its
26 equity to fund an acquisition. Defendant Crown Capital
27 Corporation (“Crown Capital”), acting as placement agent,
28 recommended defendants RGC International Investors, LDC, and Rose
29 Glen Capital Management, L.P. Defendants Wayne Bloch, Gary
-8-
1 Kaminsky, and Steve Katznelson were employees of Rose Glen
2 Capital Management. We refer collectively to all of these
3 defendants as “Rose Glen.”
4 During negotiations, Rose Glen allegedly made false verbal
5 representations similar to those made by the Levinson Defendants.
6 On September 27, 2000, Rose Glen submitted a draft term
7 sheet to ATSI offering a $10 million investment. ATSI claims
8 that it then fell victim to a bait-and-switch when, on October
9 16, 2000, Rose Glen submitted closing documents providing for
10 only a $2.5 million investment in Series E Preferred Stock, with
11 a promise of further investment of up to $10 million if certain
12 conditions were met. ATSI says it was forced to accept these
13 terms because it was required to pay $2 million to vendors in
14 Mexico the next day. ATSI sold Rose Glen additional Series E
15 Preferred Stock in March and July of 2001.
16 The Purchase Agreement pursuant to which these securities
17 were sold included two representations by Rose Glen that ATSI
18 claims to be false on the same basis as the Levinson
19 representations:
20 1. Rose Glen was an accredited investor; and
21 2. Rose Glen was purchasing the Preferred Stock and common
22 stock issuable upon conversion:
23 for its own account and not with a present view
24 towards the public sale or distribution thereof
25 except pursuant to sales registered or exempted
26 from registration under the 1933 Act; provided,
27 however that by making the representation herein,
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1 the Buyer does not agree to hold any of the
2 Securities for any minimum or other specific term
3 and reserves the right to dispose of the
4 Securities at any time in accordance with or
5 pursuant to a registration statement or exemption
6 under the 1933 Act.
7
8 The Registration Rights Agreements also contained a merger clause
9 similar to the one in the Shaar Fund transaction documents.
10 B. The “Death Spiral” Financing Manipulation Scheme
11 In addition to these misrepresentations, ATSI claims that
12 all of the defendants manipulated the market in ATSI’s common
13 stock by bringing about a “death spiral” in the price of ATSI’s
14 common stock. The scheme, as alleged, worked as follows. The
15 shareholder would short sell the victim’s common stock to drive
16 down its price.1 He then converts his convertible securities
17 into common stock and uses that common stock to cover his short
18 position. The convertible securities allow a manipulator to
19 increase his profits by allowing him to cover with discounted
20 common shares not obtained on the open market, to rely on the
21 convertible securities as a hedge against the risk of loss, and
22 to dilute existing common shares, resulting in a further decline
1
An investor sells short when he sells a security that he does
not own by borrowing the security, typically from a broker. See
Levitin v. PaineWebber, Inc., 159 F.3d 698, 700 (2d Cir. 1998).
At a later date, he “covers” his short position by purchasing the
security and returning it to the lender. Id. A short seller
speculates that the price of the security will drop. Id. If the
price drops, the investor profits by covering for less than the
short sale price. Id. If, on the other hand, the price
increases, the investor takes a loss. A short seller’s potential
losses are limitless because there is no ceiling on how high the
stock price may rise.
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1 in stock price. ATSI was aware of the risk of dilution; for
2 example, it disclosed in the registration statement on its Form
3 S-3 that it expected the Shaar Fund to convert shortly after the
4 registration became effective and that future issuances of
5 Preferred Stock would put downward pressure on and dilute its
6 common stock.
7 ATSI accuses the Levinson Defendants, Wolfson, and Rose Glen
8 of deliberately causing a “death spiral” in its common stock.
9 The Shaar Fund began converting its Preferred Stock shortly after
10 it was contractually permitted to do so. During the first two
11 quarters of fiscal year 2000, it had converted all of its Series
12 B shares into approximately 2.6 million common shares. Although
13 ATSI’s April 14, 2000 Form S-3 states that the Shaar Fund sold
14 the common stock, the complaints do not allege any such sales.
15 Between December 12, 2000 and January 23, 2002, the Shaar Fund
16 converted its Series D shares into 8,331,454 shares of ATSI
17 common stock. Between March 8, 2001 and August 14, 2002, Rose
18 Glen converted its Preferred Stock into over nineteen million
19 shares of common stock.
20 ATSI does not allege any specific acts of short selling by
21 the Levinson Defendants, but it includes circumstantial
22 allegations. It alleges that searches in the SEC’s Edgar
23 database reveal that of the 38 companies that reported the
24 Levinson Defendants as investors, 30 experienced stock price
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1 declines indicative of a “death spiral” financing scheme. Its
2 allegations against Rose Glen are of like kind.
3 ATSI also relies on the magnitude and timing of changes in
4 its stock price and trading volume. At the time of the Series B
5 transaction in July 1999, its stock traded at $1.50 per share.
6 Two months later, it traded at $1.08 per share. In February
7 2000, the Series D Preferred Stock purchase was preceded by a
8 significant increase in the daily trading volume of ATSI’s shares
9 and a dramatic rise in ATSI’s share price to $9 per share
10 (perhaps not coincidentally as ATSI listed its stock on the
11 American Stock Exchange (“AMEX”) during that period). April 2000
12 saw massive stock sales and large price declines in ATSI’s stock.
13 For example, between April 13, 2000 and April 18, 2000 – during
14 which time ATSI filed a registration statement for the common
15 stock into which the Series C and D Preferred Stock would convert
16 – the price fell from $6.50 per share to $3.62 per share on heavy
17 volume. ATSI claims that these price movements could only have
18 resulted from sales by the Levinson Defendants, despite
19 Levinson’s claim that the Shaar Fund was not selling.
20 ATSI’s stock price climbed up to $6 per share by early-June
21 2000. On September 8, 2000, ATSI’s registration of common stock
22 for the Series C and D Preferred Stock became effective and, by
23 November 28, 2000, its price had fallen to $0.75 per share, and
24 plummeted to $0.09 per share on August 16, 2002.
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1 In addition to these price fluctuations, ATSI relies more
2 specifically on price movements and trading volume around the
3 time that the Shaar Fund and Rose Glen converted their Series D
4 and E Preferred Stock, which worked to their benefit. ATSI
5 further points to instances where its stock price reacted
6 negatively to positive news. ATSI also points to a 10-trading-
7 day period between December 31, 2002 and January 14, 2003 in
8 which Depository Trust Company records show that over eight
9 million shares were traded in excess of settlement, which it
10 claims could only result from sham trading.
11 C. Other Defendants
12 ATSI alleges that any manipulation had to involve defendant
13 Trimark Securities, Inc. (“Trimark”), which served as the
14 principal market maker in ATSI’s stock.
15 ATSI also alleges that several defendants, hereinafter
16 referred to as the “Citco Defendants,” caused the Shaar Fund to
17 engage in the charged misconduct. Defendant Citco Fund Services
18 (Curaçao) N.V. is the parent of defendant InterCaribbean
19 Services, Ltd., the Shaar Fund’s sole director. Declan Quilligan
20 is a director of InterCaribbean. W.J. Langeveld, Hugo Van
21 Neutegem, and Luc Hollman served as Managing Directors of Shaar
22 Advisory.
23 D. ATSI’s Demise
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1 Telecom stocks were generally hard-hit during the period in
2 which ATSI alleges manipulation. Between February 22, 2000 (the
3 date on which ATSI issued the Series D Preferred Stock) and
4 October 31, 2002 (the date on which ATSI filed its first suit),
5 the AMEX North American Telecom Index (of which ATSI’s stock was
6 not a component) dropped by 73%. When ATSI filed its complaint,
7 its stock traded at $0.02 per share. Its financial impairment
8 has rendered it unable to raise capital to maintain or expand its
9 business.
10 E. ATSI’s Claims and Procedural History
11 ATSI claims that the Levinson Defendants, Wolfson,
12 Langeveld, Rose Glen, CCM, and Crown Capital are liable for
13 misrepresentations under § 10(b) and Rule 10b-5; that these same
14 defendants and Trimark are also liable for market manipulation in
15 violation of Rule 10b-5; and that the Citco Defendants and others
16 not relevant to this appeal are liable as control persons under §
17 20(a). ATSI also asserts various state law claims.
18 ATSI filed its complaint in the first suit in October 2002
19 against all defendants except Wolfson (“ATSI I”). In March 2004,
20 the district court dismissed ATSI’s first amended complaint
21 against the Levinson Defendants and Rose Glen for failing to
22 satisfy the pleading requirements of Fed. R. Civ. P. 9(b) and the
23 Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. §
24 78u-4(b). It dismissed as to the other defendants for improper
25 service and lack of personal jurisdiction. Second and third
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1 amended complaints followed and, in July 2004, ATSI filed a
2 largely identical complaint against Levinson and Wolfson in a
3 separate suit (“ATSI II”). In February 2005, the district court
4 dismissed the third amended complaint in ATSI I under Fed. R.
5 Civ. P. 12(b)(6) with prejudice for again failing to satisfy Rule
6 9(b) and the PSLRA’s pleading requirements. See ATSI Commc’ns,
7 357 F. Supp. 2d at 720. Because subject matter jurisdiction was
8 based solely on ATSI’s federal claims, the district court did not
9 separately consider the state law causes of action. The district
10 court entered judgment under Fed. R. Civ. P. 54(b), and the
11 parties in ATSI II stipulated to dismissal based on the district
12 court’s order in ATSI I.
13 ATSI’s timely appeals followed.
14 DISCUSSION
15 I. Legal Standards
16 We review a district court’s dismissal of a complaint
17 pursuant to Fed. R. Civ. P. 12(b)(6) de novo, accepting all
18 factual allegations in the complaint and drawing all reasonable
19 inferences in the plaintiff’s favor. Ganino v. Citizens Utils.
20 Co.,
228 F.3d 154, 161 (2d Cir. 2000). In addition, we may
21 consider any written instrument attached to the complaint,
22 statements or documents incorporated into the complaint by
23 reference, legally required public disclosure documents filed
24 with the SEC, and documents possessed by or known to the
-15-
1 plaintiff and upon which it relied in bringing the suit.
2 Rothman, 220 F.3d at 88. To survive dismissal, the plaintiff
3 must provide the grounds upon which his claim rests through
4 factual allegations sufficient “to raise a right to relief above
5 the speculative level.”2 Bell Atl. Corp. v. Twombly,
127 S. Ct.
6 1955, 1965 (2007). Once a claim has been adequately stated, it
7 may be supported by showing any set of facts consistent with the
8 allegations in the complaint.
Id. at 1969.
9 Securities fraud claims are subject to heightened pleading
10 requirements that the plaintiff must meet to survive a motion to
11 dismiss. First, a complaint alleging securities fraud must
12 satisfy Rule 9(b),
Ganino, 228 F.3d at 168, which requires that
13 “the circumstances constituting fraud . . . shall be stated with
14 particularity,” Fed. R. Civ. P. 9(b). This pleading constraint
15 serves to provide a defendant with fair notice of a plaintiff’s
16 claim, safeguard his reputation from improvident charges of
17 wrongdoing, and protect him against strike suits. Rombach v.
18 Chang,
355 F.3d 164, 171 (2d Cir. 2004). A securities fraud
19 complaint based on misstatements must (1) specify the statements
20 that the plaintiff contends were fraudulent, (2) identify the
2
We have declined to read Twombly’s flexible “plausibility
standard” as relating only to antitrust cases. See Iqbal v.
Hasty, - F.3d -, 2007 WL 1717803, at *11 (2d Cir. June 14, 2007).
“Some of [Twombly’s] language relating generally to Rule 8
pleading standards seems to be so integral to the rationale of
the Court’s parallel conduct holding as to constitute a necessary
part of that holding.” Id.
-16-
1 speaker, (3) state where and when the statements were made, and
2 (4) explain why the statements were fraudulent. Novak v. Kasaks,
3
216 F.3d 300, 306 (2d Cir. 2000). Allegations that are
4 conclusory or unsupported by factual assertions are insufficient.
5 See Luce v. Edelstein,
802 F.2d 49, 54 (2d Cir. 1986).
6 Second, private securities fraud actions must also meet the
7 PSLRA’s pleading requirements or face dismissal. See 15 U.S.C. §
8 78u-4(b)(3)(A). In pleading scienter in an action for money
9 damages requiring proof of a particular state of mind, “the
10 complaint shall, with respect to each act or omission alleged to
11 violate this chapter, state with particularity facts giving rise
12 to a strong inference that the defendant acted with the required
13 state of mind.”3
Id. § 78u-4(b)(2). The plaintiff may satisfy
14 this requirement by alleging facts (1) showing that the
15 defendants had both motive and opportunity to commit the fraud or
16 (2) constituting strong circumstantial evidence of conscious
17 misbehavior or recklessness.
Ganino, 228 F.3d at 168-69.
18 Moreover, “in determining whether the pleaded facts give rise to
19 a ‘strong’ inference of scienter, the court must take into
20 account plausible opposing inferences.” Tellabs, Inc. v. Makor
21 Issues & Rights, Ltd., – S. Ct. –,
2007 WL 1773208, at *10 (June
3
In a Rule 10b-5 action, scienter requires a showing of “intent
to deceive, manipulate, or defraud,” Ernst & Ernst v. Hochfelder,
425 U.S. 185, 194 n.12 (1976), or reckless conduct, In re Carter-
Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir. 2000); SEC v.
U.S. Envtl., Inc., 155 F.3d 107, 111 (2d Cir. 1998) (stating in
dicta that reckless behavior is sufficient to plead scienter).
-17-
1 21, 2007). For an inference of scienter to be strong, “a
2 reasonable person [must] deem [it] cogent and at least as
3 compelling as any opposing inference one could draw from the
4 facts alleged.” Id. (emphasis added).
5 If the plaintiff alleges a false statement or omission, the
6 PSLRA also requires that “the complaint shall specify each
7 statement alleged to have been misleading, the reason or reasons
8 why the statement is misleading, and, if an allegation regarding
9 the statement or omission is made on information and belief, the
10 complaint shall state with particularity all facts on which that
11 belief is formed.” 15 U.S.C. § 78u-4(b)(1).
12 II. ATSI’s Market Manipulation Claims
13 A. Market Manipulation and Short Selling
14 Section 10(b), in proscribing the use of a “manipulative or
15 deceptive device or contrivance,”
id. § 78j(b), prohibits not
16 only material misstatements but also manipulative acts. Cent.
17 Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,
18
511 U.S. 164, 177 (1994). Under the statute:
19 “Manipulation” is “virtually a term of art when used in
20 connection with securities markets.” The term refers
21 generally to practices, such as wash sales, matched
22 orders, or rigged prices, that are intended to mislead
23 investors by artificially affecting market activity.
24 Section 10(b)’s general prohibition of practices deemed
25 by the SEC to be “manipulative” – in this technical
26 sense of artificially affecting market activity in
27 order to mislead investors – is fully consistent with
28 the fundamental purpose of the [Exchange] Act “to
29 substitute a philosophy of full disclosure for the
30 philosophy of caveat emptor . . . .”
31
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1 Sante Fe Indus. v. Green, 430 U.S. 462, 476-77 (1977) (alteration
2 in original) (citations omitted). Thus, manipulation “connotes
3 intentional or willful conduct designed to deceive or defraud
4 investors by controlling or artificially affecting the price of
5 securities.” Ernst &
Ernst, 425 U.S. at 199. The critical
6 question then becomes what activity “artificially” affects a
7 security’s price in a deceptive manner.
8 Although not explicitly described as such, case law in this
9 circuit and elsewhere has required a showing that an alleged
10 manipulator engaged in market activity aimed at deceiving
11 investors as to how other market participants have valued a
12 security. The deception arises from the fact that investors are
13 misled to believe “that prices at which they purchase and sell
14 securities are determined by the natural interplay of supply and
15 demand, not rigged by manipulators.” Gurary v. Winehouse, 190
16 F.3d 37, 45 (2d Cir. 1999); see also Mobil Corp. v. Marathon Oil
17 Co.,
669 F.2d 366, 374 (6th Cir. 1981) (stating that the Supreme
18 Court has indicated that manipulation under § 10(b) refers to
19 “means unrelated to the natural forces of supply and demand”);
20 cf. Pagel, Inc. v. SEC,
803 F.2d 942, 946 (8th Cir. 1986)
21 (agreeing with the SEC that “[w]hen individuals occupying a
22 dominant market position engage in a scheme to distort the price
23 of a security for their own benefit, they violate the securities
24 laws by perpetrating a fraud on all public investors”); Crane Co.
25 v. Westinghouse Air Brake Co.,
419 F.2d 787, 796 (2d Cir. 1969)
-19-
1 (holding that nondisclosure of large open market purchases
2 combined with large secret sales to deter stockholders from
3 participating in a competing tender offer violated Rule 10b-5 by
4 “distort[ing] the market picture and deceiv[ing] the [issuer’s]
5 stockholders”).
6 In identifying activity that is outside the “natural
7 interplay of supply and demand,” courts generally ask whether a
8 transaction sends a false pricing signal to the market. For
9 example, the Seventh Circuit recognizes that one of the
10 fundamental goals of the federal securities laws is “to prevent
11 practices that impair the function of stock markets in enabling
12 people to buy and sell securities at prices that reflect
13 undistorted (though not necessarily accurate) estimates of the
14 underlying economic value of the securities traded,” and thus
15 looks to the charged activity’s effect on capital market
16 efficiency.4 See Sullivan & Long, Inc. v. Scattered Corp., 47
17 F.3d 857, 861 (7th Cir. 1995). The Seventh Circuit’s focus on
18 disruptions to the efficient pricing of a security is consistent
19 with our view that in preventing market rigging, § 10(b) seeks a
20 market where “competing judgments of buyers and sellers as to the
21 fair price of the security brings about a situation where the
4
The efficient capital market hypothesis, as adopted by the
Supreme Court, posits that “the market price of shares traded on
well-developed markets reflects all publicly available
information.” See Basic Inc. v. Levinson, 485 U.S. 224, 246 &
n.24 (1988).
-20-
1 market price reflects as nearly as possible a just price.” SEC
2 v. First Jersey Sec., Inc., 101 F.3d 1450, 1466 (2d Cir. 1996)
3 (quoting H.R. Rep. No. 73-1383, at 11 (1934)). In an efficient
4 market, trading engineered to stimulate demand can mislead
5 investors into believing that the market has discovered some
6 positive news and seeks to exploit it, see In re Initial Pub.
7 Offering Sec. Litig.,
383 F. Supp. 2d 566, 579 (S.D.N.Y. 2005),
8 aff’d Tenney v. Credit Suisse First Boston Corp., No. 05-3450-cv,
9
2006 WL 1423785 (2d Cir. May 19, 2006); the duped investors then
10 transact accordingly. To prevent this deleterious effect on the
11 capital markets, the Third Circuit distinguishes manipulative
12 from legal conduct by asking whether the manipulator “inject[ed]
13 inaccurate information into the marketplace or creat[ed] a false
14 impression of supply and demand for the security . . . for the
15 purpose of artificially depressing or inflating the price of the
16 security.” GFL Advantage Fund, Ltd. v. Colkitt,
272 F.3d 189,
17 207 (3d Cir. 2001); see also Jones v. Intelli-Check, Inc.,
274 F.
18 Supp. 2d 615, 627-28 (D.N.J. 2003).
19 Market manipulation is forbidden regardless of whether there
20 is a fiduciary relationship between the transaction participants.
21 See United States v. Russo,
74 F.3d 1383, 1391-92 (2d Cir. 1996);
22 United States v. Regan,
937 F.2d 823, 829 (2d Cir. 1991). A
23 market manipulation claim, however, cannot be based solely upon
24 misrepresentations or omissions. Lentell v. Merrill Lynch & Co.,
25
396 F.3d 161, 177 (2d Cir. 2005). There must be some market
-21-
1 activity, such as “wash sales, matched orders, or rigged prices.”
2 See Sante Fe, 430 U.S. at 476.
3 Furthermore, short selling – even in high volumes – is not,
4 by itself, manipulative.
GFL, 272 F.3d at 209. Aside from
5 providing market liquidity, short selling enhances pricing
6 efficiency by helping to move the prices of overvalued securities
7 toward their intrinsic values. See
id. at 208; Sullivan & Long,
8 47 F.3d at 861-62 (discussing the defendants’ short sales as
9 arbitrage that eliminates disparities between price and value);
10 In re Scattered Corp. Sec. Litig.,
844 F. Supp. 416, 420 (N.D.
11 Ill. 1994); John D. Finnerty, Short Selling, Death Spiral
12 Convertibles, and the Profitability of Stock Manipulation 2-3
13 (Mar. 2005), available at http://www.sec.gov/rules/petitions/4-
14 500/jdfinnerty050505.pdf; Ralph S. Janvey, Short Selling, 20 Sec.
15 Reg. L.J. 270, 272 (1992). In essence, taking a short position
16 is no different than taking a long position. To be actionable as
17 a manipulative act, short selling must be willfully combined with
18 something more to create a false impression of how market
19 participants value a security. Similarly, purchasing a floorless
20 convertible security is not, by itself or when coupled with short
21 selling, inherently manipulative. Such securities provide
22 distressed companies with access to much-needed capital and, so
23 long as their terms are fully disclosed, can provide a
24 transparent hedge against a short sale.
25 B. Pleading Market Manipulation
-22-
1 Market manipulation requires a plaintiff to allege (1)
2 manipulative acts; (2) damage (3) caused by reliance on an
3 assumption of an efficient market free of manipulation; (4)
4 scienter; (5) in connection with the purchase or sale of
5 securities; (6) furthered by the defendant’s use of the mails or
6 any facility of a national securities exchange. See Schnell v.
7 Conseco, Inc., 43 F. Supp. 2d 438, 448 (S.D.N.Y. 1999); Cowen &
8 Co. v. Merriam,
745 F. Supp. 925, 929 (S.D.N.Y. 1990).
9 Because a claim for market manipulation is a claim for
10 fraud, it must be pled with particularity under Rule 9(b). See
11 Internet Law Library, Inc. v. Southridge Capital Mgmt.,
223 F.
12 Supp. 2d 474, 486 (S.D.N.Y. 2002); U.S.
Envtl., 82 F. Supp. 2d at
13 239; see also Rooney Pace, Inc. v. Reid,
605 F. Supp. 158, 162-63
14 (S.D.N.Y. 1985) (applying Rule 9(b) to a market manipulation
15 claim). A claim of manipulation, however, can involve facts
16 solely within the defendant’s knowledge; therefore, at the early
17 stages of litigation, the plaintiff need not plead manipulation
18 to the same degree of specificity as a plain misrepresentation
19 claim. See Internet Law
Library, 223 F. Supp. 2d at 486; U.S.
20
Envtl., 82 F. Supp. 2d at 240; cf.
Romach, 355 F.3d at 175 n.10
21 (relaxing the standard where information was likely to be in the
22 exclusive control of the defendants and analysts).
23 Accordingly, a manipulation complaint must plead with
24 particularity the nature, purpose, and effect of the fraudulent
25 conduct and the roles of the defendants. See In re Blech Sec.
-23-
1 Litig., 928 F. Supp. 1279, 1291 (S.D.N.Y. 1996) (adopting this
2 test as set forth in the unpublished decision Baxter v. A.R.
3 Baron & Co., No. 94 Civ. 3913,
1995 WL 600720 (S.D.N.Y. Oct. 12,
4 1995)); see also Compudyne Corp. v. Shane,
453 F. Supp. 2d 807,
5 821 (S.D.N.Y. 2006); U.S. Commodity Futures Trading Comm’n v.
6 Bradley,
408 F. Supp. 2d 1214, 1222 (N.D. Okla. 2005) (market
7 manipulation under the Commodity Exchange Act); Fezzani v. Bear,
8 Stearns & Co.,
384 F. Supp. 2d 618, 642 (S.D.N.Y. 2004); In re
9 Royal Ahold N.V. Sec. & ERISA Litig.,
351 F. Supp. 2d 334, 372
10 (D. Md. 2004); Log On Am., Inc. v. Promethean Asset Mgmt.,
223 F.
11 Supp. 2d 435, 445 (S.D.N.Y. 2001); U.S.
Envtl., 82 F. Supp. 2d at
12 240; In re Blech Sec. Litig.,
961 F. Supp. 569, 580 (S.D.N.Y.
13 1997). But see
Intelli-Check, 274 F. Supp. 2d at 629
14 (articulating requirements for a less stringent pleading standard
15 in the Third Circuit). General allegations not tied to the
16 defendants or resting upon speculation are insufficient. This
17 test will be satisfied if the complaint sets forth, to the extent
18 possible, “what manipulative acts were performed, which
19 defendants performed them, when the manipulative acts were
20 performed, and what effect the scheme had on the market for the
21 securities at issue.” Baxter,
1995 WL 600720, at *6; see
22 also Miller v. Lazard Ltd.,
473 F. Supp. 2d 571, 587 (S.D.N.Y.
23 2007); In re Sterling Foster & Co. Sec. Litig.,
222 F. Supp. 2d
24 216, 270 (E.D.N.Y. 2002);
Blech, 961 F. Supp. at 580. This
25 standard meets the goals of Rule 9(b) while also considering
-24-
1 which specific facts a plaintiff alleging manipulation can
2 realistically plead at this stage of the litigation.
3 Because a claim for market manipulation requires a showing
4 of scienter, the PSLRA’s heightened standards for pleading
5 scienter also apply. Therefore, the complaint must plead with
6 particularly facts giving rise to a strong inference that the
7 defendant intended to deceive investors by artificially affecting
8 the market price of securities. See 15 U.S.C. § 78u-4(b)(2);
9 Section II.A, supra. This pleading requirement is particularly
10 important in manipulation claims because in some cases scienter
11 is the only factor that distinguishes legitimate trading from
12 improper manipulation.
13 C. Manipulation by the Levinson Defendants, Wolfson,
14 and Rose Glen
15 ATSI’s allegations that the Levinson Defendants, Wolfson,
16 and Rose Glen manipulated the market are based on (1) high-volume
17 selling of ATSI’s stock with coinciding drops in the stock price,
18 (2) trading patterns around conversion time, (3) the stock’s
19 negative reaction to positive news, and (4) the volume of trades
20 in excess of settlement during a 10-day period in 2003. We agree
21 with the district court that these allegations are inadequate
22 under Rule 9(b). In sum, ATSI has offered no specific
23 allegations that the defendants did anything to manipulate the
24 market; it relies, at best, on speculative inferences. Moreover,
25 ATSI has failed to adequately plead scienter.
-25-
1 ATSI’s complaint alleges high-volume selling between April
2 13, 2000 and April 18, 2000, resulting in a 44% decline in stock
3 price. ATSI narrows the list of potential culprits to these
4 defendants because ATSI’s major shareholders said that they were
5 not selling stock, leaving only the defendants with large enough
6 blocks of shares to trade at the observed volumes. These
7 allegations fail to state even roughly how many shares the
8 defendants sold, when they sold them, and why those sales caused
9 the precipitous drop in stock price. And the complaint is devoid
10 of facts supporting ATSI’s belief that these defendants had
11 sufficient shares to engage in the high-volume trading alleged.
12 Even though the complaint alleges trading volumes of up to 1.5
13 million shares per day, ATSI reported in its April 14, 2000 Form
14 S-3 that the Shaar Fund held only 492,308 shares of its common
15 stock. The complaint and relevant documents do not reveal how
16 many shares Wolfson and Rose Glen held. ATSI argues that the
17 Shaar Fund’s 3,000 shares of Series D Preferred Stock were
18 eventually converted into 8.3 million common shares – sufficient
19 to support the observed trading volumes. This allegation does
20 not help ATSI, however, because the complaint states that the
21 Shaar Fund did not begin converting those preferred shares until
22 December 12, 2000, many months after the high-volume selling.
23 The complaint then alleges that there was a drop in ATSI’s
24 stock price in the days leading up to the defendants’ conversion
25 of the Preferred Stock. It alleges that in the absence of
-26-
1 manipulation, (1) the Reference Price for conversion should
2 approximate the average price during the 30 days prior to the
3 look-back period and (2) that trading volumes during the look-
4 back periods should have been equal to the average for the
5 previous quarter. We agree with the district court’s view that
6 ATSI’s “position is ludicrous.” ATSI Commc’ns, 357 F. Supp. 2d
7 at 719. One does not observe constant prices or trading volumes
8 in the stock markets. Cf. Cent. Nat’l Bank of Mattoon v. U.S.
9 Dep’t of Treasury,
912 F.2d 897, 902 (7th Cir. 1990) (“[T]he
10 value of a company is rarely constant over an entire year . . .
11 .”).
12 The complaint next alleges that manipulation may be inferred
13 from the stock’s negative reaction to positive news. The
14 district court was mistaken in dismissing this circumstance on
15 the grounds that “the announcement concerns events with no
16 apparent connection to the defendants or this case.” ATSI
17
Commc’ns, 357 F. Supp. 2d at 719. The premise of ATSI’s theory
18 is that an issuer’s stock price, in the absence of manipulation,
19 should increase when good news is announced.5 Under such a
5
The strength of this broad proposition is questionable. Cf.
United States v. Bilzerian, 926 F.2d 1285, 1298 (2d Cir. 1991)
(“[W]hether a public company’s stock price moves up or down or
stays the same after the filing of a Schedule 13D does not
establish the materiality of the statements made, though stock
movement is a factor the jury may consider relevant.”). For
example, the stock price may not move if the market already knew
about the good news, or if the market believes the news is
overblown or false, or if adverse developments in the company or
industry are anticipated or rumored.
-27-
1 theory, the subject of the news and the defendants do not need to
2 be connected.
3 Nevertheless, this allegation cannot save the complaint
4 because ATSI pleads no particular connection between the negative
5 reaction of the stock price and anything the defendants did.
6 Adopting ATSI’s reasoning would subject large holders of
7 convertible preferred stock to the risk of suit under § 10(b)
8 whenever the stock price does not react to news as the issuer
9 expects. See Rombach, 355 F.3d at 171 (stating that Rule 9(b)
10 serves, inter alia, to safeguard a defendant’s reputation from
11 improvident charges of wrongdoing and protect him against strike
12 suits).
13 Finally, the complaint rests on an inference of manipulation
14 based upon Depository Trust Company records showing that
15 8,256,493 shares were traded in excess of settlements during the
16 10-day period before the AMEX suspended trading of ATSI’s stock.
17 Trading volume increased over this period, yet the percentage of
18 trading volume that settled decreased. ATSI claims that the only
19 plausible explanation is that the trades did not result in any
20 change in beneficial ownership, indicating “wash trades, matched
21 trades, phantom shares, and other manipulative trading.”
22 The inference ATSI asks us to draw is too speculative even
23 on a motion to dismiss. See Segal v. Gordon,
467 F.2d 602, 606,
24 608 (2d Cir. 1972) (holding that “distorted inferences and
25 speculations” could not meet Rule 9(b)’s requirements). Nowhere
-28-
1 does ATSI particularly allege what the defendants did - beyond
2 simply mentioning common types of manipulative activity - or
3 state how this activity affected the market in ATSI’s stock.
4 This data could easily be the result of internal settlements
5 within broker-dealers that do not involve the Depository Trust
6 Company. Manipulation is also unlikely given that ATSI’s closing
7 share price during this period started at $0.08 per share and
8 ended at $0.08 per share.
9 For similar reasons, none of these allegations, nor anything
10 else in the complaint, meets the PSLRA’s requirements for
11 pleading scienter. See 15 U.S.C. § 78u-4(b)(2). A strong
12 inference of scienter is not raised by alleging that a legitimate
13 investment vehicle, such as the convertible preferred stock at
14 issue here, creates an opportunity for profit through
15 manipulation. See Ganino, 228 F.3d at 168-69. These
16 circumstances are present for any investor in floorless
17 convertibles. Cf. Chill v. Gen. Elec. Co.,
101 F.3d 263, 267 &
18 n.5 (2d Cir. 1996) (holding that a generalized motive that an
19 issuer wishes to appear profitable, which could be imputed to any
20 public for-profit enterprise, was insufficiently concrete to
21 infer scienter); In re Alstom SA Sec. Litig.,
454 F. Supp. 2d
22 187, 197 (S.D.N.Y. 2006) (stating a similar proposition for
23 corporate insiders). Accordingly, there is a “plausible
24 nonculpable explanation[]” for the defendants’ actions that is
25 more likely than any inference that the defendants intended to
-29-
1 manipulate the market, see Tellabs, 2007 WL 1773208, at *10: ATSI
2 and the defendants simply entered into mutually beneficial
3 financing transactions. Further, because ATSI has not adequately
4 pled that the defendants engaged in any short sales or other
5 potentially manipulative activity, there is no circumstantial
6 evidence of manipulative intent. See
Ganino, 228 F.3d at 168-69.
7 Accordingly, more specific allegations are required.
8 D. Manipulation Claims Against Trimark
9 The complaint is plainly insufficient in alleging that
10 Trimark engaged in market manipulation.6 It only alleges that
11 Trimark was the principal market maker in ATSI’s stock, that
12 Trimark knew or should have known of the manipulation, and that
13 ATSI “believes” that Trimark was a cooperating broker-dealer.
14 Wholly absent are particular facts giving rise to a strong
15 inference that Trimark acted with scienter in manipulating the
16 market in ATSI’s common stock and any allegations of specific
6
Rose Glen and Trimark also argue that ATSI lacks standing to
bring a Rule 10b-5 claim against them because ATSI sold its
Preferred Stock and warrants to the defendants in primary market
transactions and did not transact in the allegedly manipulated
secondary market. Because ATSI’s complaints do not meet the
pleading requirements, we choose not to reach this statutory
standing question. See Coan v. Kaufman, 457 F.3d 250, 256 (2d
Cir. 2006) (“Unlike Article III standing, which ordinarily should
be determined before reaching the merits, statutory standing may
be assumed for the purposes of deciding whether the plaintiff
otherwise has a viable cause of action.” (citations omitted));
see also Official Comm. Of Unsecured Creditors of Worldcom, Inc.
v. SEC, 467 F.3d 73, 80-81 (2d Cir. 2006); cf. Steel Co. v.
Citizens for a Better Env’t, 523 U.S. 83, 97 n.2 (1998).
-30-
1 acts by Trimark to manipulate the market, much less how those
2 actions might have affected the market.
3 III. ATSI’s Misrepresentation Claims
4 To state a claim under Rule 10b-5 for misrepresentations, a
5 plaintiff must allege that the defendant (1) made misstatements
6 or omissions of material fact, (2) with scienter, (3) in
7 connection with the purchase or sale of securities, (4) upon
8 which the plaintiff relied, and (5) that the plaintiff’s reliance
9 was the proximate cause of its injury. Lentell, 396 F.3d at 172.
10 The district court properly dismissed the misrepresentations
11 claims.
12 A. Levinson Defendants and Wolfson
13 Of the misrepresentations that ATSI claims, we can quickly
14 dispose of all except the two alleged in the transaction
15 agreements. The Registration Rights agreement between ATSI and
16 the Shaar Fund plainly states that the only promises,
17 restrictions, and warranties to the transaction were those set
18 forth in the transaction documents. Where the plaintiff is a
19 sophisticated investor and an integrated agreement between the
20 parties does not include the misrepresentation at issue, the
21 plaintiff cannot establish reasonable reliance on that
22 misrepresentation. See Emergent Capital Inv. Mgmt. v. Stonepath
23 Group, Inc.,
343 F.3d 189, 196 (2d Cir. 2003); Dresner v.
24 Utility.com, Inc.,
371 F. Supp. 2d 476, 491-93 (S.D.N.Y. 2005).
25 By engaging in these private placements of complex securities,
-31-
1 ATSI is clearly a sophisticated investor. Accordingly, to the
2 extent ATSI’s causes of action are based on alleged
3 misrepresentations made during negotiations preceding the
4 defendants’ investment, those claims are barred by the merger
5 clauses.
6 1. Promise Not to Short Sell
7 The complaint alleges, on information and belief, a
8 fraudulent misrepresentation by the Shaar Fund in promising, in
9 the Securities Purchase Agreement, not to enter a short position
10 prior to closing or cover a short position entered into prior to
11 execution of the agreement using converted common stock. The
12 complaint fails to sufficiently allege that this representation
13 was false when made. While the failure to carry out a promise in
14 connection with a securities transaction might constitute breach
15 of contract, it “does not constitute fraud unless, when the
16 promise was made, the defendant secretly intended not to perform
17 or knew that he could not perform.” Gurary, 190 F.3d at 44
18 (internal quotation marks omitted). The speculative allegations
19 that the Levinson Defendants and Wolfson engaged in short selling
20 are deficient for the same reasons that they did not establish
21 manipulation.
22 ATSI asks us to infer that the Levinson Defendants never
23 intended to honor this promise because they had previously
24 engaged in “death spiral” financing schemes, as evidenced by the
25 declining stock prices of unspecified companies in which they
-32-
1 invested. These allegations fail Rule 9(b)’s requirement of
2 stating with particularity why the statement was fraudulent and
3 the PSLRA’s requirement of stating the facts on which a belief is
4 based. The complaint does not specify which companies
5 experienced a decline in share price or when they experienced the
6 decline (other than that they occurred within 1 year of an
7 unspecified time of investment). It also fails to allege with
8 particularity what, if anything, the defendants did to cause the
9 decline; it simply offers a generalized allegation that the
10 defendants engaged in death spiral financing combined with a
11 detailed definition of how death spiral financing works. Cf.
12 United States ex rel. Walsh v. Eastman Kodak Co., 98 F. Supp. 2d
13 141, 147 (D. Mass. 2000) (holding that fraud was not adequately
14 pled under Rule 9(b) where the plaintiff only alleged a method by
15 which the defendants could produce false invoices without
16 specifying instances of false claims arising from false
17 invoices). Holding otherwise would expose investors in start-ups
18 and risky, distressed companies to fraud claims based solely on
19 the (unsurprisingly) poor performance of their portfolios. See
20
Rombach, 355 F.3d at 171.
21 In response, ATSI argues that it adequately identified the
22 defendants’ victims by detailing how the companies could be found
23 by searching the SEC’s publicly-available Edgar database. It
24 also contends that the defendants have personal knowledge of what
-33-
1 investments they made and when the stock prices of those
2 investments declined.
3 ATSI cannot sufficiently plead fraud by simply providing a
4 method for the defendant to discover the underlying details. If
5 ATSI had access to the details necessary to make these
6 allegations, it must plead them and not just tell the defendants
7 to go find them.
8 We also reject ATSI’s argument that it adequately pled fraud
9 by pointing to the drop in the stock prices of the defendants’
10 other investments because that information is relevant under Fed.
11 R. Evid. 404(b) and 406 and supports “a reasonable inference of
12 fraud.” No inference of sabotage is available from the
13 circumstance that some (or many) risky investments come to
14 nothing. Moreover, the allegations fail to point to any specific
15 actions by the defendants with respect to those investments and
16 thus fail to establish that the defendants’ promise was
17 fraudulent. To the extent the Southern District of New York’s
18 decision in Internet Law Library, 223 F. Supp. 2d 474, is to the
19 contrary, we reject it.
20 2. Investor Profile Representation
21 ATSI also claims that the representation in the Securities
22 Purchase Agreement that the Shaar Fund was an accredited investor
23 was fraudulent. The complaint does not sufficiently allege loss
24 causation with respect to this misrepresentation. A plaintiff is
25 required to prove both transaction causation (also known as
-34-
1 reliance) and loss causation. Lentell, 396 F.3d at 172; see also
2 15 U.S.C. § 78u-4(b)(4). Transaction causation only requires
3 allegations that “but for the claimed misrepresentations or
4 omissions, the plaintiff would not have entered into the
5 detrimental securities transaction.”
Lentell, 396 F.3d at 172
6 (quoting Emergent
Capital, 343 F.3d at 197). Loss causation, by
7 contrast, is the proximate causal link between the alleged
8 misconduct and the plaintiff’s economic harm. See Dura Pharm.,
9 Inc. v. Broudo,
544 U.S. 336, 346 (2005);
Lentell, 396 F.3d at
10 172. To that end, the plaintiff’s complaint must plead that the
11 loss was foreseeable and caused by the materialization of the
12 risk concealed by the fraudulent statement. See Lentell,
396
13 F.3d at 173.
14 The complaint alleges losses (1) through the tremendous
15 decline in ATSI’s share price, impairing its access to capital
16 and its viability as a business; and (2) by ATSI’s sale of its
17 own stock at depressed prices. It fails, however, to establish
18 any causal connection between those losses and the
19 misrepresentation that the Shaar Fund was an accredited investor.
20 In what appears to be an attempt to meet Lentell’s requirements,
21 ATSI contends that it adequately pled loss causation because the
22 Levinson Defendants made this misrepresentation to induce ATSI to
23 enter into the transaction under the pretense that they were
24 “trustworthy, reputable and long-term investor[s],” and that when
25 the true risk of their plans materialized through their
-35-
1 manipulative acts, ATSI suffered losses. This allegation might
2 support transaction causation; it fails, however, to show how the
3 fact that the Shaar Fund was not an accredited investor caused
4 any loss. See id. at 174 (“Such an allegation - which is nothing
5 more than a paraphrased allegation of transaction causation -
6 explains why a particular investment was made, but does not speak
7 to the relationship between the fraud and the loss of the
8 investment.” (internal quotation marks omitted)).
9 ATSI is wrong in claiming that these allegations are
10 sufficient to establish loss causation under our decision in
11 Weiss v. Wittcoff,
966 F.2d 109 (2d Cir. 1992) (per curiam). In
12 Weiss, the plaintiff agreed to merge his business with the
13 defendant’s on the latter’s representation that his other company
14 would supply goods and services.
Id. at 110. When the defendant
15 sold his other company a year after the transaction,
id. at 110,
16 112, the plaintiff’s business suffered subsequent losses from
17 higher costs,
id. at 110-11. We held that the complaint
18 adequately pled loss causation because the plaintiff’s losses
19 were “clearly a proximate result of his reliance on defendants’
20 promises, since defendants’ failure to fulfill those promises
21 foreseeably caused [the business’s] financial condition to
22 deteriorate.”
Id. at 111.
23 Weiss is easily distinguishable. There, the complaint
24 established a causal connection between (1) the promise to
25 provide for the business’s needs and (2) the business’s increased
-36-
1 costs when the promise turned out to be false. See id. ATSI, by
2 contrast, fails to show that the subject of the fraudulent
3 statement proximately caused any loss. See
Lentell, 396 F.3d at
4 173 (“Thus to establish loss causation, ‘a plaintiff must allege
5 . . . that the subject of the fraudulent statement or omission
6 was the cause of the actual loss suffered . . . .’” (alteration
7 in original)).
8 B. Misrepresentations by Rose Glen
9 The misrepresentations attributed to Rose Glen suffer from
10 largely the same defects as those against the Levinson
11 Defendants. ATSI cannot claim reliance on Rose Glen’s pre-
12 contractual, verbal representations because of the merger clause
13 in the Registration Rights Agreement.
14 The only representation in the Securities Purchase Agreement
15 that merits discussion is the one in which Rose Glen represented
16 that it was purchasing the Preferred Stock:
17 for its own account and not with a present view towards
18 the public sale or distribution thereof except pursuant
19 to sales registered or exempted from registration under
20 the 1933 Act; provided, however that by making the
21 representation herein, the Buyer does not agree to hold
22 any of the Securities for any minimum or other specific
23 term and reserves the right to dispose of the
24 Securities at any time in accordance with or pursuant
25 to a registration statement or an exemption under the
26 1933 Act.
27
28 In addition to failing to plead falsity under Gurary, ATSI’s
29 complaint fails to plead that Rose Glen even broke this promise,
30 much less that it secretly intended to break it.
-37-
1 ATSI also alleges that Rose Glen engaged in a bait-and-
2 switch scheme by first promising in its draft term sheet to
3 invest $10 million, then offering only $2.5 million at closing.
4 The district court properly dismissed this claim. First, it is
5 time-barred. Prior to the passage of the Sarbanes-Oxley Act of
6 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002), the statute of
7 limitations required that a Rule 10b-5 claim be brought within
8 one year of discovery of the facts constituting the violation and
9 within three years of the violation. Lampf, Pleva, Lipkind,
10 Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364 (1991). ATSI
11 learned of the alleged falsity of this representation when it
12 signed the closing documents on October 16, 2000, but did not
13 commence its action against Rose Glen until October 31, 2002 –
14 more than two years later. See LC Capital Partners, LP v.
15 Frontier Ins. Group, Inc.,
318 F.3d 148, 154 (2d Cir. 2003)
16 (stating that the limitations period begins to run, inter alia,
17 after the plaintiff receives actual knowledge of the facts giving
18 rise to the action). Second, ATSI has not pled falsity or
19 reliance because the term sheet expressly stated that Rose Glen’s
20 “obligation to fund is subject to satisfactory due diligence, in
21 RGC’s sole discretion.”
22 C. Misrepresentations by CCM
23 ATSI claims that CCM made misrepresentations very similar to
24 those alleged against Rose Glen. Largely for the same reasons as
25 above, the district court properly dismissed those claims.
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1 IV. Control Person Liability
2 ATSI alleges control person liability under § 20(a) against
3 the Levinson Defendants, Wolfson, Rose Glen, and the Citco
4 Defendants. To establish a prima facie case of control person
5 liability, a plaintiff must show (1) a primary violation by the
6 controlled person, (2) control of the primary violator by the
7 defendant, and (3) that the defendant was, in some meaningful
8 sense, a culpable participant in the controlled person’s fraud.
9 First Jersey, 101 F.3d at 1472. ATSI fails to allege any primary
10 violation; thus, it cannot establish control person liability.
11 V. Leave to Amend
12 ATSI argues that even if the district court properly
13 dismissed its complaints under Fed. R. Civ. P. 12(b)(6), it
14 should have granted leave to amend. We review a district court’s
15 denial of leave to amend for abuse of discretion. Grace v.
16 Rosenstock,
228 F.3d 40, 54 (2d Cir. 2000). In ATSI I, ATSI
17 submitted three amended complaints; in ATSI II, it submitted a
18 complaint largely identical to ATSI I’s third amended complaint.
19 The district court had already dismissed ATSI I’s first amended
20 complaint for failure to meet Rule 9(b) and the PSLRA’s pleading
21 requirements on many grounds similar to its final dismissal.
22 District courts typically grant plaintiffs at least one
23 opportunity to plead fraud with greater specificity when they
24 dismiss under Rule 9(b). See
Luce, 802 F.2d at 56. ATSI was
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1 given that opportunity. The district court did not abuse its
2 discretion in declining to grant further leave to amend.
3 CONCLUSION
4 For the foregoing reasons, the judgments of the district
5 court are AFFIRMED.
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