Opinion
02 Civ. 8726 (LAK)
April 9, 2003
ORDER
Three defendants in this securities fraud action seek an order requiring plaintiff and its counsel to disclose discovery obtained by plaintiff without notice to defendants and allegedly in violation of the automatic stay of disclosure contained in the Private Securities Litigation Reform Act of 1995 ("PSLRA") and to enjoin plaintiff and its counsel against further discovery violations.
Facts
The Internet Law Library Case Background concerning another case before this Court is necessary to put defendants' motion in context.
Internet Law Library, Inc., and others, all represented by a group of attorneys including Gary M. Jewell of Houston, Texas, commenced a securities fraud action in the Southern District of Texas against Southbridge Capital Management LLC and others (the "ILL Case"). The ILL Case was transferred to this Court by order dated July 20, 2001. The essence of the action is a claim that the defendants in the ILL action engaged in a scheme to defraud plaintiffs and to manipulate ILL's stock downward. At some point, Maryann Peronti, Esq., a member of the Bar of this Court, appeared on behalf of the plaintiffs in the ILL Case along with Mr. Jewell. The Commencement of this Action On October 31, 2002, ATSI Communications, Inc. ("ATSI"), also represented by Ms. Peronti and, at least at some later point, by Mr. Jewell brought this action against The Shaar Fund, Ltd. ("Shaar") and other defendants. The gravamen of the original complaint was an alleged scheme by defendants to defraud ATSI into selling multiple series of convertible preferred stock and to manipulate the price of its stock downward in order to take advantage of increased conversion rates resulting from the price decline. Significantly, no party to this case is a party to the ILL Case and vice versa.
Internet Law Library, Inc. v. Southbridge Capital Mgmt. LLC, 01 Civ. 6600 (RLC).
Id., 223 F. Supp.2d 474, 477-78 (S.D.N.Y. 2002).
Cpt. ¶ 28.
On December 13, 2002, the Court issued an order (1) setting a scheduling conference for February 3, 2003 absent prior agreement by the parties on an acceptable schedule, and (2) directing plaintiffs' counsel to send a copy of the order to the defendants' counsel or, if no appearance had been filed, to the defendants themselves. On February 3, 2003, Ms. Peronti appeared and advised the Court that plaintiffs had not served any defendants. Another conference was set for February 24, 2003.
The Disputed Subpoenas
Promptly after the February 3 conference, plaintiffs' counsel issued subpoenas to the National Association of Securities Dealers ("NASD") and the National Securities Clearinghouse Corporation ("NSCC") under the ILL Case caption. Both subpoenas seek exclusively documents relating to trading and market making in securities of ATSI. Defendants in this case were not notified of the service of those subpoenas.
Sperling Decl. ¶¶ 4-5 Exs. 1, 2.
On February 21, 2003, counsel for one of the individual defendants in this case learned of the NASD and NSCC subpoenas. At the conference on February 24, 2003, which was attended by counsel for defendants as well as Ms. Peronti, Ms. Peronti first indicated that she intended to amend the complaint. The Court gave her until March 17 to do so and deferred defendants' time to move until after service of the amended pleading. Defendants advised the Court of the issuance of the subpoenas in the ILL Case. Ms. Peronti responded that they had been issued with the permission of Judge Carter, to whom the ILL Case is assigned. When the Court inquired as to whether Ms. Peronti had advised Judge Carter that she planned to use the subpoenaed information in this case, in which discovery was stayed as a matter of law by the PSLRA, she admitted that she had not done so.
Id. ¶ 9.
Id. ¶¶ 9-10.
It might be noted also that Ms. Peronti failed to disclose that Judge Carter's order, upon which plaintiff evidently relies, states in part as follows:
"There is no need for citing in the scheduling order the constraints under which the parties are in the use of data gained in discovery. There is no need for a protective order relative to that issue. While the court may not have specifically placed limitations on use of such testimony, it was made clear that it was not to be used while this case is pending before me to locate new clients or to initiate new litigation. It could be used, however, in this case to locate additional witnesses or even to join new parties on a showing of good cause. Moreover, the use of such information in pending cases before other judges will be based on the judges' decisions in those cases. The plaintiff's response to defendants' observations does leave room for doubt that the above was clearly understood." Sperling Decl. Ex. 16.
Thus, to whatever extent Judge Carter approved the issuance of subpoenas for trading records, his contemplation was that such subpoenas were to be used to gather evidence exclusively for use in the case before him.
Defendants then sought plaintiff's voluntary withdrawal of the subpoenas. When that was not forthcoming, they moved to intervene in the ILL Case and to quash them. Judge Stein, sitting in Part I, promptly stayed the subpoenas. The motion remains sub judice.
Id. ¶¶ 15-17 Ex. 8.
Discussion
Two things are reasonably plain.
First, the PSLRA provides in relevant part:
"In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party."
In view of Congress' manifest intention to protect defendants in actions such as this from the burden and expense of premature discovery, the statute precludes discovery, whether from parties or nonparties, until the court sustains the sufficiency of the complaint. As this action arises under the relevant chapter of the securities laws, the subpoenas, if and to the extent they properly are regarded as seeking discovery in this action, were issued and served in violation of law.
E.g., In re Advanta Corp. Secs. Litig., 180 F.3d 525, 530-31 (3d Cir. 1999); Vacold LLC v. Cerami, No. 00 Civ. 4024 (AGS), 2001 WL 167704, at *6 (S.D.N.Y. Feb. 16, 2001); Faulkner v. Verizon Communications, Inc., 156 F. Supp.2d 384, 402-04 (S.D.N.Y. 2001); In re Carnegie Int'l Corp. Secs. Litig., 107 F. Supp.2d 676, 684 (D.Md. 2000); Novak v. Kasaks, No. 96 Civ. 3073 (AGS), 1996 WL 467534, at *1 (S.D.N.Y. Aug. 16, 1996).
Second, Federal Rule of Civil Procedure 45(b)(1) provides in relevant part that "[p]rior notice of any commanded production of documents and things . . . before trial shall be served on each party in the manner prescribed by Rule 5(b)." As defendants were not notified of the subpoenas, their issuance and service violated Rule 45(b)(1) if and to the extent they properly are regarded as seeking discovery in this action.
Plaintiff contends that the subpoenas were issued in the ILL Case and, in consequence, that neither it nor its counsel violated either the PSLRA or Rule 45(b)(1). As a matter of form, of course, it is correct. The Federal Rules of Civil Procedure, however, must be "construed and administered to secure the just, speedy, and inexpensive determination of every action." In consequence, the Court must concern itself with substance as well as form.
FED. R. CIV. P. 1 (emphasis added).
Plaintiff's counsel defend their actions by contending that the object of the subpoenas was to obtain trading data "to demonstrate patterns of manipulative trading activity by the [ILL Case] defendants" and their affiliates. They go on to say that their investigations in that action suggest that there are "factual alliances" between some of the defendants in the two cases, thus allegedly making trading in ATSI securities by defendants in this case relevant to the "pattern and practice" allegations in the ILL Case.
Peronti Decl. ¶ 4.
Id. ¶ 5.
Perhaps. Certainly Judge Carter's opinion in the ILL Case indicates that the plaintiffs there contend that the defendants "are seasoned practitioners of 'death spiral' funding schemes in which they provide financing to a target company and proceed to aggressively short-sell its stock in the hope that such short sales will drive down its price . . . [and] enable the defendants to obtain more shares of common stock upon conversion by virtue of an arrangement known as a 'toxic convertible' that allows the company's preferred stock to be converted at a discount to the present market value of the common stock issuable upon conversion." Evidence that the defendants in the ILL Case or their affiliates engaged in a similar pattern of activity with respect to other companies conceivably might be admissible.
Internet Law Library, Inc., 223 F. Supp.2d at 479; see generally Gurary v. Winehouse, 190 F.3d 37, 41 (2d Cir. 1999).
See FED. R. EVID. 404(b).
On the other hand, there are circumstances suggestive of a motive less benign than plaintiff's counsel claims. The fact that the NASD and NSCC subpoenas seek documents only with regard to trading in ATSI is suspicious, as it tends to undercut the notion that the subpoenas were intended to gain evidence of repeated use of "death spiral" schemes by the ILL Case defendants in connection with a number of different companies. Suspicious too is the long delay in serving the summons in this case, which might have been intended to facilitate an end-run around the PSLRA and Rule 45(b)(1). Finally, a review of the original complaint reveals sufficient doubt as to its ability to withstand attack under Rule 9(b) and the relevant provisions of the PSLRA as to indicate that plaintiff's counsel may have been motivated, at least in part, by a desire to seek discovery for the purpose of attempting to file an amended complaint.
In the last analysis, it is unnecessary for me, in deciding this application, to resolve the question whether plaintiff's counsel were using the ILL Case as a vehicle to conduct discovery for use in this action. As Mr. Justice Brandeis once said, "Sunshine is the best disinfectant." In view of the possibility that defendants' rights were violated, plaintiff and their counsel shall be required to disclose the entirety of what they have done, a disclosure to which they have no legitimate objection. This in all likelihood will remedy any violation that may have occurred. And plaintiff and its counsel will be foreclosed from conducting any further discovery with respect to defendants or trading or market making in the securities of ATSI except on notice to the defendants in this case. The question whether they will be permitted to use anything they have obtained by discovery nominally conducted in the ILL Case but arguably for use in this case will be decided for the ILL Case by Judge Carter and by the undersigned at such time as they seek to use such materials here.
Conclusion
Defendants' motion for an order requiring plaintiff's counsel to disclose certain discovery and for other relief is granted to the following, and only the following, extent:
1. Plaintiff and its counsel shall make complete disclosure to defendants, on or before April 16, 2003, of all materials obtained by them through the service of subpoenas and discovery requests in cases other than this one that relate in any way to any of the allegations in this case or to trading in the securities of ATSI. Such disclosure shall include copies of all subpoenas and discovery requests and all correspondence relating thereto, as well as copies of all materials produced pursuant thereto, including transcripts of depositions.
2. Plaintiff and its counsel shall not conduct any discovery, whether in this or any other action, relating to defendants named in this action or to trading or market making in the securities of ATSI except on prior notice to those defendants.
SO ORDERED.