NATHANIEL M. GORTON, District Judge.
Because of the coincidence and uncommonness of the names of one of the plaintiffs and the presiding judicial officer, the parties are advised that said judicial officer is neither related to nor acquainted with that plaintiff. After consideration of plaintiffs' objections thereto (Docket No. 48), Report and Recommendation is accepted and adopted.
DEIN, United States Magistrate Judge.
These consolidated actions arise out of Warrants to Purchase Securities (the
By their First Amended Complaints, the plaintiffs have asserted claims against ACT for securities fraud pursuant to section 10(b) of the Securities and Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, as well as for breach of contract. Additionally, the plaintiffs have asserted securities claims against the defendant, Wilmington Trust, N.A. ("Wilmington Trust"), as Special Administrator of the Estate of William MacKay Caldwell. By those claims, the plaintiffs are seeking to hold Wilmington Trust liable, pursuant to section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), based on Caldwell's former status as an alleged control person of ACT.
The matter is presently before the court on the defendants' motions to dismiss (Docket Nos. 13, 19, 37 and 38)
"In considering a motion to dismiss, a court must take the allegations in the complaint as true and must make all reasonable inferences in favor of the plaintiffs." Watterson v. Page, 987 F.2d 1, 3 (1st Cir.1993). In doing so, the court may consider documents attached to or expressly incorporated into the Complaint, as well as "documents the authenticity of which are not disputed by the parties," "official public records," "documents central to the plaintiffs' claim," and "documents sufficiently referred to in the complaint" without converting the motion into one for summary judgment. Id. at 3-4 and cases cited.
In 1995, Congress enacted the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. § 78u-4, which marked an effort to curb abuse in private securities lawsuits. See Greebel v. FTP Software, Inc., 194 F.3d 185, 191 (1st Cir. 1999). The PSLRA established strict pleading standards for such lawsuits, which are consistent with the First Circuit's preexisting standards for pleading securities fraud under Fed.R.Civ.P. 9(b). See id. at 193. The statute requires that a complaint claiming securities fraud based on misstatements or omissions set forth "each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C.
Although the pleading requirements in private securities fraud cases are strict, "they do not change the standard of review for a motion to dismiss." Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78 (1st Cir.2002). Accordingly, the following facts are viewed in the light most favorable to the plaintiffs.
Defendant ACT is an early-stage biotechnology company that is incorporated in Delaware and has a principal place of business in Marlborough, Massachusetts. (Compl. ¶ 5).
Plaintiff Aronson is a citizen of Nevada, and an investor in early stage start-up biotechnology companies. (Id. ¶ 4). He has owned shares of ACT common stock for over six years. (Id.). Plaintiff Gorton is a citizen of California. (G. Compl. ¶ 4). Like Aronson, Gorton is a shareholder of ACT. (Id.).
The Warrant Agreements at the center of this case arose out of a legal dispute that began in 2004, when Aronson and Gorton brought a collection action against ACT's predecessors and two of their officers in the Worcester Superior Court. (See Compl. ¶ 12). Following a year of litigation, during which time ACT's predecessors allegedly violated or sought to avoid the state court's orders, the parties reached a settlement, which was memorialized in a Settlement Agreement dated September 14, 2005. (Id. ¶¶ 12-24). Aronson, Gorton, ACT and Caldwell all were parties to the Settlement Agreement. (See Compl., Ex. A at p. 1). Pursuant to the terms of that Agreement, ACT was required to issue a Warrant to Purchase Shares ("Warrant Agreement") to each of
Pursuant to Aronson's Warrant Agreement, Aronson had the initial right to purchase, at any time through January 15, 2009, 375,756 shares of ACT common stock at a price of $2.20 per share (the "Warrant Purchase Price"). (Compl. ¶ 26; Compl., Ex. B at pp. 1-2). Similarly, under his Warrant Agreement, Gorton was granted the initial right to purchase, at any time through January 15, 2009, 46,970 shares of ACT common stock at the Warrant Purchase Price of $2.20 per share. (G. Compl. ¶ 26; G. Compl., Ex. B at pp. 1-2). Additionally, the plaintiffs were entitled to automatic adjustments in the number and purchase price of their shares in the event ACT issued or agreed to issue lower priced shares to a third party during the time period between May 1, 2005 and January 15, 2009 (the "Pricing Period"). (See Compl., Ex. B at p. 2 and ¶¶ 3, 3.1). As detailed below, the plaintiffs allege that during the Pricing Period, ACT issued lower priced shares to two different individuals, but took steps to conceal those transactions from the plaintiffs in order to avoid making the necessary adjustments.
Section 3 of the Warrant Agreements governed the circumstances under which adjustments were to be made before the plaintiffs exercised their purchase rights. Specifically, the relevant portions of Section 3 provide:
(Compl. ¶ 27; Compl., Ex. B ¶¶ 3, 3.1). Accordingly, if before the plaintiffs exercised their warrants ACT issued or agreed to issue any Equity Units or other securities at a price below $2.20 per share during the Pricing Period, the price at which the plaintiffs could exercise their stock purchase rights would decrease, and the number of purchasable shares would increase.
The Warrant Agreements also provided for adjustments to be made after the plaintiffs exercised some or all of their purchase rights:
(Compl. ¶ 30; Compl., Ex. B at p. 2). Thus, even after the plaintiffs exercised their rights to purchase shares, ACT was required to give them the best terms that it made available to other investors who received ACT stock during the Pricing Period. (See Compl. ¶¶ 31-32).
Other relevant provisions of the Warrant Agreements required ACT to notify Aronson and Gorton whenever it issued any Equity Units or other securities to third parties upon terms that triggered the plaintiffs' right to an adjustment, and provided for equitable relief in the form a decree for specific performance or an injunction prohibiting violations of the Warrant Agreements in the event ACT failed to comply with any of its obligations thereunder. (Id. ¶¶ 29, 33). Moreover, under the parties' Settlement Agreement, ACT agreed to pay any attorney's fees and costs incurred by the plaintiffs in connection with the enforcement of the Warrant Agreements. (Id. ¶ 34). By its claims in this action, Aronson and Gorton are seeking injunctive relief and attorney's fees, in addition to damages, as a result of ACT's alleged failure to comply with the terms of the Warrant Agreements. (Id. ¶¶ 100-03).
The plaintiffs challenge a warrant issued to the company's former Chief Financial Officer, Gunnar Engstrom (the "Engstrom Warrant"). (Id. ¶ 52). Pursuant to the Warrant, Engstrom was entitled to purchase, at any time during the period from April 1, 2005 through April 1, 2010, 100,000 shares of ACT common stock at a price of $0.25 per share. (Id. ¶¶ 52, 60; Compl.,
The record reveals that the Engstrom Warrant was issued in connection with a January 30, 2005 settlement agreement between ACT and Engstrom, under which ACT was required to grant Engstrom options to purchase ACT stock. (See Compl., Ex. L). As the relevant language of the settlement agreement provided:
(ACT Ex. 1 at Exhibit 10.53 ¶ 1) (emphasis added). Accordingly, the parties to the settlement contemplated that the Engstrom Warrant would be released from escrow and go into effect by April 1, 2005, one month prior to the start of the Pricing Period.
In fact, the evidence demonstrates that the Engstrom Warrant memorializing Engstrom's option to purchase ACT shares was executed on April 1, 2005, but was not delivered to Engstrom until April 29, 2005, still before the Pricing Period. (See Compl., Ex. L; Compl., Ex. M at pp. 1, 7). Nevertheless, because the Warrant was exercisable beginning on April 1, 2005, the record indicates that Engstrom could have exercised his purchase rights thereunder before the Pricing Period began on May 1, 2005. (See Compl. ¶ 60 (SEC Annual Report for Fiscal Year ended December 31, 2005 reports that these "warrants are exercisable on or after April 1, 2005 and lapse if unexercised on April 1, 2010.")).
As alleged by the plaintiffs, ACT subsequently "backdated" the Engstrom Warrant to November 30, 2004 and sent a revised copy of it to Engstrom on May 9, 2005.
On or about May 9, 2005, Attorney Howard sent Engstrom a letter enclosing a copy of the Warrant with the original execution date of April 1, 2005 crossed out and the new date of November 30, 2004 inserted above the parties' signature lines. (Compl., Ex. M at p. 7). In his cover letter accompanying the Warrant, Attorney Howard provided the following instructions:
(Compl., Ex. M at p. 1). Based on these facts, the plaintiffs contend that the warrant was issued on May 9, 2005.
The record reveals that ACT disclosed the Engstrom Warrant in its publicly filed Form 10-QSB for the period ended March 31, 2005.
ACT disclosed the Engstrom Warrant again in its Form 10-KSB for the fiscal year ended December 31, 2005. (Compl. ¶¶ 59-60). Although ACT did not identify Engstrom by name, it revealed that on November 30, 2004, it had granted warrants to a former executive of the company which entitled the former executive to purchase 100,000 shares of common stock at a price of $0.25 per share. (Id. ¶ 60). It further disclosed that the warrants were exercisable on April 1, 2005, and would lapse if not exercised by April 1, 2010. (Id.). The plaintiffs claim that ACT's public disclosures regarding the details of the Engstrom Warrant were misleading because they concealed the fact that the Warrant was issued on May 9, 2005, during the plaintiffs' Pricing Period, and not on November 30, 2004. (Id. ¶ 61).
The plaintiffs claim that ACT engaged in a second transaction that should have triggered the notice and adjustment requirements of their Warrant Agreements, and that the company intentionally concealed the existence of the transaction in order to avoid its obligations under those Agreements. Specifically, the plaintiffs allege that, unbeknownst to the plaintiffs, on or about September 15, 2005, during the Pricing Period, ACT executed and delivered a warrant to William Woodward (the "Woodward Warrant"), which entitled Woodward to purchase ACT stock at a price of $0.10 per share. (Id. ¶¶ 64-66, 72). According to the defendants, however, the Warrant issued to Woodward on September 15, 2005 was for $2.20 per share, and, therefore, did not have to be disclosed. The defendants contend further that sometime after the Pricing Period, ACT amended the Warrant to reduce the stock price to $0.10 per share, and to extend the period in which it could be exercised. The relevant allegations are as follows.
Plaintiffs allege in their First Amended Complaint that ACT first disclosed the existence of the Woodward Warrant on November 19, 2009, when ACT filed its Form S-1 Registration Statement with the SEC. (Id. ¶¶ 65-66). Therein, ACT revealed that it had engaged in a transaction involving "33,000 shares of common stock issuable upon exercise of warrants with an exercise price of $0.10, issued to William Woodward, on September 15, 2005, for consulting services[,]" and that the warrants were to "terminate on December 31, 2012." (Id. ¶ 66; Compl., Ex. S at 2). In response to this allegation, the defendants point to the Form 10-QSB issued by ACT for the period ended September 30, 2005. Therein ACT disclosed that "[o]n September 14, 2005, we issued a warrant to purchase 33,000 shares of common stock at an exercise price of $2.20 per share to William Woodward in connection with consulting services provided to us." (ACT Ex. 2 at p. 3). This disclosure was substantially consistent with the terms of the actual Woodward Warrant, as submitted by the defendants, which is dated September 15, 2005 (not September 14th) and purports to provide for the purchase of 33,000 shares of ACT common stock "at a purchase price of $2.20 per share." (ACT Ex. 3 at p. 1).
The plaintiffs, who were apparently unaware of the Form 10-QSB issued in 2005 when they filed their First Amended Complaints, argue that the only inference the court can draw is that the Warrant issued in September 2005 was for $0.10 per share, as reported in 2009, and, therefore, it should have been disclosed during the Pricing Period. The defendants argue that the only rational explanation is that
On or about August 25, 2006, each of the plaintiffs submitted a Subscription Agreement to ACT pursuant to which he "irrevocably elect[ed] to exercise the purchase rights represented by such Warrant," and to purchase all shares of common stock covered by the Warrant Agreement. (Compl., Ex. C). The Subscription Agreements were accompanied by letters to Caldwell in which the plaintiffs confirmed their intent to immediately exercise their rights under the Warrant Agreements. (Compl. ¶ 37). Additionally, in their letters, the plaintiffs notified Caldwell that based on information they had obtained from the company's public filings, they believed that ACT had failed to notify them of transactions which entitled them to adjustments under their Warrant Agreements. (Id.). Accordingly, the plaintiffs calculated the adjustments themselves, arrived at a price of $0.4174 per share, and demanded that ACT issue them the appropriate number of additional shares necessary to account for the adjusted share price. (Id. ¶¶ 37-40; Compl. Ex. D at pp. 1-5). Significantly, however, those adjustments were unrelated to either the Engstrom Warrant or the Woodward Warrant, and the plaintiffs allege that if ACT or Caldwell had provided them with accurate information about those Warrants, they would have demanded additional adjustments to their shares. (Compl. ¶ 89).
Shortly thereafter, on August 29, 2006, Caldwell notified Aronson and Gorton that appropriate adjustments would be made to the exercise price of their Warrants, and that ACT would forward them a notice setting forth the necessary calculations. (Id. ¶ 42). However, on or about September 12, 2006, before the plaintiffs had received the promised notice or obtained any of the shares owed to them by ACT, Aronson and Gorton learned of a more recent transaction, involving the issuance of common stock at a price of $0.288 per share, which entitled them to further adjustments under the post-exercise provisions of their Warrant Agreements. (Id. ¶ 45). Consequently, each of the plaintiffs sent Caldwell a letter demanding that ACT make the additional adjustments, and immediately send him the increased number of shares owed as a result of those adjustments. (Id. ¶ 47). Because the plaintiffs still had no knowledge of the Engstrom and Woodward Warrants, their demands did not include adjustments resulting from those transactions. (See id. ¶ 89).
On about September 27, 2006, Aronson sent a letter to ACT's Senior Vice President and General Counsel, Jon Atzen, and to ACT's outside counsel, Chris Howard, reiterating his demand for immediate delivery of the shares owed to him since the exercise of rights under his Warrant Agreement. (Id. ¶ 48). Additionally, Aronson requested that ACT provide a schedule detailing any transactions that ACT had entered into during the Pricing Period which would have entitled him to an adjustment. (Id.). Later that day, Attorney Howard sent an email to Aronson, which was copied to Gorton, in which Attorney Howard responded to Aronson's request for information. (Id.; Compl., Ex. K). Therein, Attorney Howard stated in relevant part as follows:
(Compl. ¶ 49, emphasis added). According to the plaintiffs, this critical representation was misleading because it omitted the fact that ACT had issued securities to Engstrom and Woodward during the Pricing Period at prices below $0.288 per share. (See id. ¶¶ 50, 52, 64-65).
The plaintiffs claim that in reliance on ACT's representation, and after further review of the company's public filings, Aronson accepted a transfer of 2,870,362 shares from ACT, and Gorton accepted a transfer of 358,799 shares from ACT, on October 4, 2006. (Compl. ¶ 51; G. Compl. ¶ 51). However, on October 16, 2006, less than two weeks after the plaintiffs received their stock, ACT's General Counsel notified Aronson and Gorton by email that there had been a mistake in the calculations, that the plaintiffs were entitled to fewer shares than they had received from the company, and that ACT intended to cancel the excess shares. (Compl. ¶ 68). A document attached to the email shows that ACT continued to base its calculations on a share price of $0.288 per share. (Compl., Ex. T at p. 2). ACT ultimately abandoned its effort to cancel a portion of the plaintiffs' shares. Nevertheless, the plaintiffs claim that the statements contained in the October 16, 2006 correspondence also were false and misleading because they failed to disclose the lower share prices reflected in the Engstrom and Woodward Warrants. (See Compl. ¶¶ 69-71).
Aronson commenced the present action on August 23, 2011 by filing a complaint in which he asserted claims against ACT and Wilmington Trust for violations of the Exchange Act based solely on ACT's and Caldwell's alleged misrepresentations and omissions with respect to the Engstrom Warrant. (See Docket No. 1 ¶¶ 47-58, 63-84). Aronson did not mention the Woodward Warrant in his original complaint, and did not include any allegations regarding the Woodward Warrant.
On August 25, 2011, Gorton filed his original complaint against ACT and Wilmington Trust. (Docket No. 1 in C.A. No. 11-11515-NMG). As in the case of Aronson, Gorton asserted claims against the defendants under the Exchange Act based on alleged misrepresentations and omissions relating to the Engstrom Warrant. (See id. ¶¶ 49-60, 65-86). Gorton's original complaint did not mention the Woodward Warrant. Nor did it contain any allegations concerning the facts of the Woodward Warrant.
Aronson filed his First Amended Complaint on October 13, 2011, and Gorton filed his First Amended Complaint on November 2, 2011. (Docket No. 4; Docket No. 4 in C.A. No. 11-11515-NMG). As described above, the plaintiffs, by their Amended Complaints, are asserting claims against the defendants under the Exchange Act based on alleged misrepresentations and omissions as to the Engstrom Warrant and the Woodward Warrant. Additionally, the plaintiffs are asserting claims for relief against ACT based on its alleged breach of the Warrant Agreements.
Additional factual details relevant to this court's analysis are described below where appropriate.
The plaintiffs have asserted claims against each of the defendants for alleged violations of the Exchange Act. Specifically, by their First Claims for Relief, the plaintiffs allege that ACT engaged in securities fraud, in violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder,
The defendants argue that the securities fraud claims must fail at the threshold level because Aronson and Gorton have failed to allege facts showing that ACT made any misrepresentations or omissions with respect to either the Engstrom Warrant or the Woodward Warrant. Specifically, the defendants argue that the plaintiffs have not alleged a plausible claim that either of those Warrants was "issued" during the Pricing Period at a price that should have triggered adjustments under the plaintiffs' Warrant Agreements. (ACT Mem. (Docket No. 20 in C.A. No. 11-11515-NMG) at 8). Therefore, the defendants contend that the plaintiffs cannot base their Exchange Act claims on these Warrants. For the reasons that follow, this court finds that the plaintiffs have
The relevant provisions of the Warrant Agreements required ACT to notify the plaintiffs and make adjustments to their shares "[i]f and whenever during the Pricing Period, [ACT] shall issue or agree to issue any Equity Units or other securities... for a consideration per share or providing for ... an exercise price per share which is less than the Warrant Purchase Price in effect immediately prior to such issue[.]" (Compl. ¶ 27; Compl., Ex. B ¶ 3.1). The defendants argue that the Engstrom Warrant did not trigger the notice and adjustment requirements of the Warrant Agreements because ACT issued the Warrant before the Pricing Period began on May 1, 2005. (ACT Mem. at 8-9). The plaintiffs contend that the Engstrom Warrant was issued on May 9, 2005, when ACT's counsel sent Engstrom the revised Warrant. (Pl. Opp. Mem. at 3-4). For the reasons detailed herein, this court finds that ACT "issued" the Engstrom Warrant before the Pricing Period.
"[T]he interpretation of a contract is a question of law for the courts."
The Warrant Agreements do not define the word "issue," and they contain nothing to suggest that the word was intended to carry any unusual meaning.
This court's conclusion that the Engstrom Warrant was issued prior to the start of the Pricing Period is consistent with evidence regarding the intent of the parties to the Engstrom Warrant. As described above, the settlement agreement between ACT and Engstrom called for the Engstrom Warrant to become effective on April 1, 2005. (ACT Ex. 1 at Exhibit 10.53 ¶ 1). Moreover, under the Warrant, Engstrom was authorized to exercise his stock purchase rights beginning on April 1, 2005. (Compl., Ex. M at p. 2). Thus, the parties to the transaction contemplated that the Warrant would become effective before the Pricing Period began on May 1, 2005.
In their complaints, the plaintiffs allege that "[t]he original issuance date" of the Engstrom Warrant was April 1, 2005, the date of its original execution by ACT. (See Compl. ¶ 57; Compl., Ex. M at p. 7). However, they argue, based on Attorney Howard's May 9, 2005 letter to Engstrom enclosing the revised Warrant, that "the warrant was `issued' to Mr. Engstrom as of May 9, 2005, to be effective afterwards when he signed and returned the warrant." (Aronson Opp. Mem. (Docket No. 25) at 3-4). This court finds that the circumstances surrounding the delivery of the revised Engstrom Warrant support no such conclusion. As Attorney Howard explained in his letter, the revised Warrant was "the same in all respects as the Warrant which [Engstrom] previously executed, with the exception of the date." (Compl., Ex. M at p. 1). As alleged, it did nothing more than replace the pre-existing Warrant with an identical version re-dated to reflect Engstrom's termination from employment. (See id.). It did not alter any of Engstrom's rights under the Warrant, including his right to purchase stock beginning on April 1, 2005, and there are no allegations indicating that it otherwise impacted the effectiveness of the original Warrant. Because there is nothing in the record to suggest that the re-dating interfered with Engstrom's ability to exercise his purchase rights in April 2005, the plaintiffs have not alleged a plausible claim that the Engstrom Warrant was issued during the Pricing Period.
The plaintiffs nevertheless argue, based on the language of the May 3, 2005 email from Mr. Stewart to Attorney Howard in which Mr. Stewart stated that ACT was "still holding the warrant agreement related to our settlement with Gunnar [Engstrom,]" that the original Engstrom Warrant could not be deemed to have been issued while it was still being "held" in escrow. (Aronson Opp. Mem. at 4). According to the plaintiffs, ACT's decision to hold the Warrant was consistent with the terms of its settlement agreement with Engstrom, which provided that ACT would hold the Warrant Agreement in escrow until Engstrom had complied with certain obligations. They contend that the Engstrom Warrant could not have been issued while it was being held by the company, and that "Mr. Engstrom could not exercise the option to purchase contained in the warrant until it was released from escrow either." (Id.).
Again the plaintiffs' argument is unpersuasive. As an initial matter, the settlement agreement between Engstrom and ACT called for the Engstrom Warrant to be released from escrow on April 1, 2005, after Engstrom had provided assistance and documents to the company. (See note
Finally, concluding that the Engstrom Warrant had been issued prior to the Pricing Period is consistent with the plaintiffs' own Warrant Agreements. The clear intent in the provisions of the Agreements allowing for a price modification was to insure that the company did not offer others the right to buy stock at a lower price during the Pricing Period. In the case of Engstrom, ACT clearly had obligated itself to issue his Warrants at the price of $0.25 per share before the Pricing Period and well before the plaintiffs even entered into their own agreements. Regardless of the date of Engstrom's Warrant, or the date it was released from escrow, the purchase rate had been set, and Engstrom's exercise period had commenced, before May 1, 2005. The Engstrom Warrant did not have to be disclosed during the Pricing Period.
The requirement that the court "take all well-pled allegations as true and make all reasonable inferences in favor of the plaintiff" does not mean that the court must make unreasonable inferences. Landy v. D'Alessandro, 316 F.Supp.2d 49, 60 (D.Mass.2004). Because the only reasonable inference to be drawn from the record is that the Engstrom Warrant was issued in April 2005, this court concludes that the plaintiffs have failed to state a claim for securities fraud under Section 10(b) and Rule 10b-5 based on misrepresentations and omissions relating to the Engstrom Warrant.
The defendants also argue that the plaintiffs' allegations fail to allege any misrepresentation or omission with respect to the Woodward Warrant because they have failed to state a plausible claim that ACT issued the Warrant during the Pricing Period at a price that would have triggered the notice and adjustment provisions of the plaintiffs' Warrant Agreements. This court disagrees. In light of the two differing descriptions of the Warrant in the two SEC filings, this court cannot find as a matter of undisputable fact that the Woodward Warrant at $0.10 per share was not issued during the Pricing Period.
As detailed above, there is evidence based on the Woodward Warrant dated September 15, 2005 and the Form 10-QSB for the period ended September 30, 2005 that in September 2005 Woodward was granted the right to purchase stock until September 14, 2010 at a price of $2.20 per share, a price which would not have had to have been reported to the plaintiffs. (ACT Ex. 2 at p. 3, ACT Ex. 3 at p. 1). However, ACT's Form S-1 Registration Statement, which was filed with the SEC in November 2009, reported that ACT had issued warrants to Woodward on September 15, 2005 which entitled him to purchase stock until December 31, 2012 at an exercise price of $0.10 per share, a price which should have been reported to Aronson
The defendants argue that the only plausible explanation for the discrepancy in the share prices reported is that the Registration Statement reflected an amendment to the Woodward Warrant. (ACT Mem. at 10, ACT Reply Mem. (Docket No. 29) at 6-7). Thus, they contend that the plaintiffs' "failure to allege the date of the Woodward warrant amendments, combined with the allegation that the amendments were disclosed in November 2009, plainly gives rise to the reasonable inference that the amendments were made after the Pricing Period ended on January 15, 2009, and shortly before the November 2009 disclosure." (ACT Mem. at 11). At this stage, however, the defendants' explanation is pure conjecture. There are no allegations, and the parties have not submitted any documents, substantiating the defendants' theory that an amendment took place. Furthermore, even if the defendants were correct in their assumption that an amendment occurred, neither the Form S-1 Registration Statement nor any of the other materials in the record support an inference that any such amendment occurred after the Pricing Period had ended. The conflicting information contained in the Woodward Warrant and in ACT's Form 10-QSB merely raises a factual issue which cannot be resolved at this stage in the litigation. Therefore, the securities' claims based on the Woodward Warrant should not be dismissed due to the alleged failure of the plaintiffs to establish misrepresentations and omissions with respect to that Warrant.
The defendants contend that even if the plaintiffs have asserted misrepresentations and omissions which may be actionable under the PSLRA, their securities' claims are nevertheless barred by the applicable statutes of limitations and/or repose. This court agrees that the claims are time-barred.
"Pursuant to 28 U.S.C. § 1658(b), a claim under Section 10(b) and Rule 10b-5 [of the Exchange Act] must `be brought not later than the earlier of — (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation.'" FirstBank Puerto Rico, Inc. v. La Vida Merger Sub, Inc., 638 F.3d 37, 38 (1st Cir.2011) (quoting 28 U.S.C. § 1658(b)). While the defendants have failed to show that any of the securities law claims are untimely under the 2-year statute of limitations, the record establishes that all of those claims are barred by the 5-year statute of repose.
For the reasons detailed above, this court has concluded that the Engstrom Warrant was not issued during the Pricing Period and, therefore, cannot form the basis of the plaintiffs' claims. The timeliness of the plaintiffs' claims vis-a-vis this Warrant, therefore, is only being addressed for purposes of completeness.
The defendants contend that the plaintiffs' claims relating to the Engstrom Warrant are barred by the 2-year statute of limitations set forth in the first prong of 28 U.S.C. § 1658(b) because their securities causes of action accrued more than two years before they filed their original complaints on August 23 and August 25, 2011. (ACT Mem. at 15-17; ACT Mem. (Docket No. 20 in C.A. No. 11-11515) at 16-18). In Merck & Co., Inc. v. Reynolds, 559 U.S. 633, 130 S.Ct. 1784, 176 L.Ed.2d
In support of their contention that the plaintiffs knew or should have known about the date change more than two years prior to filing the instant suit, the defendants rely on the plaintiffs' answers to interrogatories in another lawsuit Aronson and Gorton had filed against ACT in the Superior Court of California on October 1, 2007. In that suit, the plaintiffs alleged that ACT had breached their Warrant Agreements by failing to notify them of instances in which the company had issued stock during the Pricing Period at a price below $2.20 per share.
The defendants argue, based on these interrogatory responses, that more than two years prior to filing this litigation, Aronson and Gorton knew, or with a reasonably diligent investigation would have discovered, all of the facts necessary to assert their present securities claims based on the Engstrom Warrant, including the fact that the Warrant had been re-dated.
Furthermore, the record does not establish that a reasonably diligent plaintiff would have discovered facts regarding the alleged backdating more than two years before the plaintiffs filed their complaints in this case. As described above, the plaintiffs' claims in the California matter were based on Engstrom's exercise of his Warrant on October 3, 2005, during the course of the Pricing Period. Nothing in the plaintiffs' interrogatory responses indicates that Aronson and Gorton were pursuing other possible theories of liability or that discovery relating to the date of the issuance of the Engstrom Warrant would have been relevant to their claims. Furthermore, as alleged in this litigation, ACT repeatedly stated in its public disclosures that the Engstrom Warrant had been issued on November 30, 2004. (See ACT Ex. 1 at p. 12; Compl. ¶¶ 59-60). The defendants have not pointed to anything in the material from the California action, or elsewhere in the record, showing that the plaintiffs had reason to question the veracity of those statements at any time prior to two years before filing suit in this court. Accordingly, the defendants have not shown that the 2-year statute of limitations bars the securities claims based on the Engstrom Warrant.
The defendants also argue that the 5-year statute of repose set forth in the second prong of 28 U.S.C. § 1658(b) bars all of the plaintiffs' securities law claims. Unlike the 2-year statute of limitations, "[t]he five-year period of repose serves `as a cutoff' and `tolling principles do not apply.'" Goldenson v. Steffens, 802 F.Supp.2d 240, 257-58 (D.Me.2011) (quoting Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 363, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991)). This court concludes that the repose period began to run more than five years before the plaintiffs filed their original complaints in this action. Therefore, their securities law claims based on the Engstrom Warrant should be dismissed as untimely.
As described above, under 28 U.S.C. § 1658(b)(2), a claim under Section 10(b) and Rule 10b-5 must be brought within 5 years of a violation. "A `violation' of section 10(b) occurs ... on the date that the alleged fraudulent misrepresentation is made or, in the case of an omission, on the date a duty to disclose the withheld information arises." Nw. Human Servs., Inc. v. Panaccio, No. Civ. A. 03-157, 2004 WL 2166293, at *18 (E.D.Pa. Sept. 24, 2004). Accordingly, where, as here, the plaintiff claims that the defendant violated the securities laws by concealing material information, the 5-year period of repose begins to run "upon the date a duty to disclose the withheld information arises." In re Prudential Ins. Co. of Am. Sales Practice Litig., 975 F.Supp. 584, 605 (D.N.J.1997).
In the instant case, the plaintiffs allege that under the Warrant Agreements, ACT was obligated to notify Aronson and Gorton whenever securities were issued to third parties with terms that
The plaintiffs also contend that the defendants violated the securities laws by making an affirmative misrepresentation on September 27, 2006, when ACT represented that it had not issued shares during the Pricing Period below the price of $0.288 per share. (Id. ¶ 49; see also Aronson Opp. Mem. (Docket No. 26 in C.A. No. 11-11492-NMG) at 2 (asserting that ACT's representation in September 2006 constituted an actionable misrepresentation)). Where securities fraud claims are based on affirmative misrepresentations, "the repose period begins when the last alleged misrepresentation was made by any of the participants." Winters v. Stemberg, 529 F.Supp.2d 237, 246 (D.Mass. 2008) (quoting Cont'l Bank, Nat'l Ass'n v. Ludlow, 777 F.Supp. 92, 102 (D.Mass. 1991)) (punctuation omitted). However, in order to be actionable, the alleged misrepresentation on which the plaintiff relies must have occurred before the purchase and sale of the securities. See Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1487 (9th Cir.1991) ("conduct actionable under Rule 10b-5 must occur before investors purchase the securities, if — as here — they allege fraud induced them to make the purchase"); In re Exxon Mobil Corp. Sec. Litig., 387 F.Supp.2d 407, 422 (D.N.J.2005) ("it is a matter of simple logic that any such misrepresentation or omission must have occurred prior to the `purchase or sale' of securities"); Haft v. Eastland Fin. Corp., 772 F.Supp. 1315, 1318 (D.R.I.1991) (in order for plaintiff to maintain a claim under Section 10(b), alleged misrepresentations "must have occurred prior to [plaintiff's] purchase or sale of securities"). In this case, the purchase of securities occurred prior to September 27, 2006. Therefore, the alleged misrepresentation is not actionable under the securities laws.
"The purchase or sale of securities occurs when the parties involved in the securities sale are irrevocably committed to one another." Romani v. Shearson Lehman Hutton, Inc., Civ. A. No. 89-1675-MC, 1990 WL 150011, at *1 (D.Mass. Sept. 25, 1990). However, this does not mean that the transfer of securities must be completed at that time. "The `purchase or sale of securities within the meaning of Rule 10b-5 is to be determined as the time when the parties to the transaction are committed to one another,' even if the exchange of money and shares happens at a later time." Vacold LLC v. Cerami, 545 F.3d 114, 122 (2d Cir.2008) (quoting Radiation Dynamics v. Goldmuntz, 464 F.2d 876, 891 (2d Cir.1972)) (internal quotations omitted). See also Jordan v. McDonald, 803 F.Supp. 493, 495 (D.Mass.1992) (finding that sale occurs for purposes of claims under § 12(2) of the Securities Act of 1933 "when the parties obligate themselves to perform what they had agreed to perform even if the formal performance of their agreement is to be after a lapse of time") (quotations, punctuation and citations omitted). In the instant case, such a commitment occurred on August 25, 2006, when the plaintiffs submitted Subscription Agreements to ACT by which they irrevocably elected to exercise their purchase rights under their Warrant Agreements.
As detailed above, the plaintiffs have asserted a claim that ACT made fraudulent misrepresentations and wrongfully failed to disclose that the Woodward Warrant was issued at the purchase price of $0.10 per share on September 15, 2005. However, this claim is also barred by the statute of repose.
To the extent that the plaintiffs are claiming that ACT should have disclosed the Woodward Warrant when the Warrant was issued on September 15, 2005, those claims are barred by the 5 year statute of repose for the same reasons that the claims regarding the Engstrom Warrant are time barred. Similarly, the plaintiffs cannot rely on any representations made on September 27, 2006 relating to the lowest share price outstanding, since that representation was made after the plaintiffs irrevocably committed to purchasing the stock under their Warrant Agreements, as explained above.
Even assuming, however, that the September 27, 2006 representation is actionable, it is still time-barred in connection with the Woodward Warrant. The plaintiffs did not assert any claims arising out of the Woodward Warrant until they filed their Amended Complaints on October 13, 2011 and November 2, 2011, more than five years after the alleged misrepresentation on September 27, 2006. Under Fed.R.Civ.P. 15(c), "a new claim or set of allegations that would otherwise be time-barred [may] `relate back' to the date of filing the initial complaint." In re Stone & Webster, Inc. Sec. Litig., Civil Action No. 00-10874-RWZ, 2006 WL 1738348, at *3 (D. Mass. June 23, 2006). However, that rule applies only where "the amendment asserts a claim or defense that arose out of the conduct, transaction, or occurrence set out — or attempted to be set out — in the original pleading[.]" Fed.R.Civ.P. 15(c)(1)(B). It does not apply when the amendment "assert[s] a claim which was not even suggested in the original complaint." O'Loughlin v. Nat'l R.R. Passenger Corp., 928 F.2d 24, 26 (1st Cir.1991). Because the allegations in the original complaints contained no hint of the Woodward Warrant, there can be no relation back under Fed.R.Civ.P. 15(c) with respect to claims arising out of the Woodward Warrant. See In re Stone & Webster, Inc. Sec. Litig., 2006 WL 1738348, at *3 ("courts are more likely to allow amendment under [Rule 15(c)] where the plaintiff seeks to assert a new legal theory based upon the same facts, than to allow assertion of entirely new facts"). Accordingly, those claims would remain time-barred even if the September 27, 2006 statement were actionable.
For all these reasons, the plaintiffs' securities claims are barred by the statute of repose and should be dismissed.
The defendants also assert that the plaintiffs have failed to state a claim for securities fraud because they have failed to plead facts supporting a strong inference of scienter on the part of ACT. While this issue does not need to be reached in light of this court's conclusions above, this court will address scienter for the sake of completeness. As detailed herein, this court agrees that the allegations are not sufficient.
"To win a section 10(b) case, the plaintiff must show either that the defendants consciously intended to defraud, or that they acted with a high degree of recklessness." Aldridge, 284 F.3d at 82. "[T]he plaintiff may combine various facts and circumstances indicating fraudulent intent to show a strong inference of scienter." Id. Accordingly, "[s]cienter may be demonstrated by indirect evidence, and may extend to a form of extreme recklessness that `is closer to a lesser form of intent.'" In re Cabletron Sys., Inc., 311 F.3d at 38 (citations omitted). However, "[a] showing of negligence or `mere recklessness' does not suffice." In re Segue Software, Inc. Sec. Litig., 106 F.Supp.2d 161, 166 (D.Mass.2000) (quoting In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970, 976 (9th Cir.1999)). The Plaintiffs must set forth "specific facts that make it reasonable to believe that defendant[s] knew that a statement was materially false or misleading." Id. (quoting Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 361 (1st Cir.1994)).
The First Circuit "has rejected any rigid formula for pleading scienter, preferring to rely on a `fact-specific approach' that proceeds case by case." In re Cabletron Sys., Inc., 311 F.3d at 38. In evaluating whether a "strong inference" of scienter has been pled in a particular case, the court must consider "the complaint as a whole." N.J. Carpenters Pension & Annuity Funds v. Biogen Idec Inc., 537 F.3d 35, 45 (1st Cir.2008). Moreover, "[a] court must weigh not only inferences urged by the plaintiff ... but also competing inferences rationally drawn from the facts alleged." Id. (quotations and citations omitted). "An inference of fraudulent intent may be plausible, yet less cogent than other, nonculpable explanations for the defendant's conduct. To qualify as `strong'... an inference of scienter must be more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314, 127 S.Ct. 2499, 2504-05, 168 L.Ed.2d 179 (2007).
This court finds that when the Amended Complaint is viewed as a whole, the plaintiffs have failed to allege facts supporting a strong inference that ACT acted with extreme recklessness or an intent to defraud with respect to the Engstrom Warrant that is more compelling than the competing inference that the defendants acted with a nonfraudulent intent. Notably, any conclusion that ACT was acting with a fraudulent state of mind when it engaged in the process of backdating the Engstrom Warrant is undermined by the fact that the backdating process occurred months prior to ACT's issuance of the Warrant Agreements to the plaintiffs. As described above, the alleged backdating took place on or about May 9, 2005, but the Warrant Agreements were not issued until September 14, 2005. (Compl. ¶ 54; Compl., Ex. B at pp. 8-9; G. Compl., Ex. B at pp. 7-8). Because the Warrant Agreements did not exist at the time of the alleged backdating, there is no logical basis for concluding that ACT engaged in the re-dating process in order to avoid its obligations under those Agreements.
The plaintiffs concede that "[t]he back-dating of the Engstrom warrant in May 2005 alone may not have been motivated by an intent to de-fraud," but they argue that ACT's later representation that it had not issued shares during the Pricing Period at a price of less than $0.288 per share, and its failure to disclose the Engstrom Warrant after the plaintiffs exercised their purchase rights, are actionable and were done with scienter. (Aronson Opp. Mem. at 12). This argument is not persuasive.
In support of their claim that ACT was acting with a fraudulent intent with respect to the Engstrom Warrant, the plaintiffs allege that the company's "fraudulent misrepresentation enabled ACT to avoid its contractual obligations to Aronson [and Gorton]." (Compl. ¶ 63a). Such conclusory allegations are insufficient to support a strong inference of scienter. See Suna v. Bailey Corp., 107 F.3d 64, 68 (1st Cir.1997) (explaining that plaintiffs may not base claims of fraud on conclusory allegations). In addition, the plaintiffs have put forth unsubstantiated and very confusing theories to the effect that by changing the date on the Engstrom Warrant to a date before ACT became a publicly traded company, ACT could engage in accounting irregularities, violate GAAP, mislead the SEC and other warrant holders, and benefit Engstrom to the tune of approximately $124,000.00. (See Aronson Opp. Mem. at 13-14; Compl. ¶¶ 63a-c,63g, 63i). "Merely stating in conclusory fashion that a company's books are out of compliance with GAAP [does] not in itself demonstrate liability under section 10(b) or Rule 10b-5." In re Cabletron Sys., Inc., 311 F.3d at 34. Moreover, "`catch-all allegations' which merely assert motive and opportunity, without something more, fail to satisfy the PSLRA." Ezra Charitable Trust, 466 F.3d at 10 (quoting Cabletron Sys., Inc., 311 F.3d at 39). In short, the plaintiffs have failed to address the undisputed facts which indicate that the date change was done for a legitimate business reason, have failed to establish how any accounting irregularities or attempts to mislead third parties or the SEC demonstrate an intent to perpetrate a fraud upon Aronson and Gorton, and have otherwise failed to allege facts to support the conclusion that the defendants acted with scienter. Therefore, the securities claims related to the Engstrom Warrant should be dismissed for this reason as well.
The plaintiffs' allegations regarding the Woodward Warrant are similarly insufficient to support a strong inference of scienter. As in the case with the Engstrom Warrant, the only allegation of intent which specifically pertains to Aronson and Gorton is that ACT's misrepresentations and omissions with respect to the Woodward Warrant "enabled ACT to avoid its contractual obligations to [the plaintiffs]." (Compl. ¶ 67a). For the reasons discussed above, such allegations are inadequate to show that the defendant had a conscious intent to defraud or acted with a high degree of recklessness. Therefore, they do not support a claim for securities fraud.
In addition, the plaintiffs do not address the glaring fact that the Woodward Warrant was reported to have an exercise price of $2.20 per share in 2005, at the time the Warrant apparently was issued, or that the Woodward Warrant itself set forth a price of $2.20 per share. The fact that a later SEC filing was inconsistent could easily be explained by poor wording or negligence. Therefore, it is insufficient to establish either that the defendants knew that their statements to the plaintiffs were false or misleading or that they acted with a wrongful intent by failing to disclose the Woodward Warrant.
The remaining allegations of intent relating to the Woodward Warrant show, at most, that ACT had the motive and opportunity to commit fraud on other shareholders or to benefit from its alleged wrongdoing. Reading the confusing allegations most generously, the plaintiffs allege that (1) the Woodward Warrant reflected a sharp discount from the market value of ACT's stock; (2) disclosure of the Woodward Warrant would have raised objections from other investors who had received convertible debentures and warrants to purchase ACT common stock at an initial exercise price of $2.53 per share; (3) Caldwell had an incentive to reward Woodward for Woodward's alleged assistance in helping Caldwell to obtain employment at ACT; and (4) ACT's concealment of the Woodward Warrant enabled the company and Caldwell to escape scrutiny and avoid unspecified administrative and/or litigation proceedings against them for potential violations of the securities laws.
By their Third, Fourth and Fifth Claims for Relief, the plaintiffs are seeking relief against ACT based on its alleged
Among the relief that the plaintiffs are seeking in connection with their breach of contract claims is an order
(Compl. at Prayer for Relief ¶ C). The plaintiffs allege that such relief is appropriate because they have no adequate remedy at law and because the Settlement Agreement provides for specific performance at the plaintiffs' option. (Compl. ¶¶ 100-01).
The defendants have moved to dismiss this claim on the grounds that no such relief is contemplated under the plaintiffs' Warrant Agreements, and the plaintiffs have not met the requirements necessary to justify such relief. (Aronson Mem. at 19-20). The plaintiffs did not address this issue in their written submissions. However, at oral argument, the plaintiffs confirmed that they are not pursuing injunctive relief at this time, and that the relief that they will be seeking at the conclusion of trial will be consistent with their rights under their Warrant Agreements. In this
Finally, the plaintiffs have requested that they have an opportunity to amend their complaints in the event the court finds that any of their claims are deficient. To the extent that the plaintiffs are seeking leave to replead Exchange Act claims arising out of Engstrom and Woodward Warrants, this court recommends that leave to amend be denied. In light of this court's conclusion that the plaintiffs' securities claims are time-barred, any attempt to amend those claims would be futile. See Transwitch Corp. v. Galazar Networks, Inc., 377 F.Supp.2d 284, 290 (D.Mass.2005) (listing futility as a basis for denying leave to amend).
To the extent that the plaintiffs believe that they have other claims against the defendants, the viability of any such claims should await the filing of a motion to amend. That way the court will be presented with specific proposed amendments and the defendants will have an opportunity to present their positions.
For all of the reasons described above, this court finds that the plaintiffs have failed to state a claim against the defendants for violations of the federal securities laws, and recommends that Counts I and II of the plaintiffs' First Amended Complaints be dismissed with prejudice. This court also concludes that the plaintiffs' allegations are sufficient at this stage in the litigation to state a claim against ACT for breach of contract relating to the Woodward Warrant. Therefore, this court recommends to the District Judge to whom this case is assigned that Wilmington Trust's motions to dismiss (Docket Nos. 13, 37) be ALLOWED and that ACT's motions to dismiss be ALLOWED IN PART and DENIED IN PART, in accordance with this decision.