Opinion
EP-03-CA-0004-DB
February 23, 2004
MEMORANDUM OPINION AND ORDER
On this day, the Court considered a "Motion By El Paso Electric Company, Terry D. Bassham, Julius F. Bates, James Haines, Jr., Gary R. Hedrick, and Eduardo A. Rodriguez to Dismiss" ("Motion to Dismiss"), filed in the above-captioned cause on August 20, 2003. Plaintiffs Jordan Roth, James Richards, and Kevmar Holdings Limited Partnership, ("Plaintiffs") filed a "Memorandum in Opposition To Motion To Dismiss" ("Response") on September 15, 2003. On October 2, 2003, Defendants filed a "Reply Memorandum In Support Of Motion To Dismiss" ("Reply"). Pursuant to the Order entered by the Court on November 26, 2003, it now enters this Memorandum Opinion and Order. After reviewing the factual recitations and the arguments in the Motion, Response, and Reply, the Court is of the opinion that the Motion to Dismiss should be denied in part and granted in part. The Motion to Dismiss is denied as pertaining to Defendants El Paso Electric Company, Terry D. Bassham, James Haines, Jr., and Gary R. Hedrick. However, the Motion to Dismiss is granted as pertaining to Defendants Julius F. Bates and Eduardo A. Rodriguez.
BACKGROUND
Defendant El Paso Electric Company ("EPE") is a public utility engaged in the generation, transmission and distribution of electricity throughout an area of approximately 10,000 square miles in western Texas and southern New Mexico. EPE is incorporated in Texas and its principle place of business is in El Paso, Texas.In 1997, EPE entered into a Power Consulting Services Agreement (the "PCSA") with Enron Corporation ("Enron"). Pursuant to the agreement, EPE permitted Enron to staff its energy trading desk and control and direct EPE's transmission and generation assets 75% of the time. EPE also provided Enron with parking and lending services. Under the PCSA, Enron staffed EPE's real-time marketing desk for sixteen hours each regular business day and for twenty-four hours a day on weekends and holidays. In its function as a real-time marketer on behalf of EPE, Enron monitored EPE's electrical system on an hourly basis, arranged power purchase transactions necessary to balance the system, and identified opportunities to sell power at rates in excess of EPE's production costs.
Black's Law Dictionary defines parking as the sale of securities subject to an agreement that the seller will buy them back at a later time for a similar price, and lending as allowing the temporary use of (something), sometimes in exchange for compensation, on condition that the thing or its equivalent be returned. Black's Law Dictionary 1139, 912-913 (7th ed. 1999).
In May 2002, the Federal Energy Regulatory Commission ("FERC") began an investigation into the manipulation of the power markets in the western United States. The FERC issued information requests to a number of energy trading companies, including EPE and Enron. On June 4, 2002, the FERC announced that EPE did not fully comply with its information requests and issued a "show cause" order to EPE that directed the Company to show why its market-based rate authority should not be revoked. On June 14, 2002, EPE responded that it sold over $200 million worth of Enron's electricity since early 2000. On August 13, 2002, the FERC announced that it was formally pursuing the matter against EPE in connection with its alleged manipulation of energy prices in California with Enron. During the FERC's investigation of EPE, EPE maintained that it had done nothing wrong, and that it was fully complying with the FERC's investigation.
As the disclosures to the FERC were made, EPE's stock dropped. On June 5, 2002, EPE's stock price dropped 7.9%. From August 12, 2002 to August 14, 2002, EPE's stock price dropped 13% as the market digested FERC's report of EPE's connection to Enron's alleged manipulation of California's energy prices. On October 21, 2002, at the close of the period at issue (between February 14, 2000 and October 21, 2002), when EPE finally announced accurate and dismal financial results, the market responded negatively once more and EPE's stock price dropped by another 10%. As a result of the losses, this cause of action ensued.
On December 5, 2002, EPE announced that it had reached a settlement with the FERC. Under the terms of the settlement, EPE agreed to refund $14 million, and to refrain from making sales pursuant to its market-based rate authority between December 1, 2002 and December 31, 2004. As part of the settlement, EPE admitted, inter alia, the following: (a) during the course of the PCSA, EPE allowed Enron to dispose of the output of certain EPE generation assets while Enron operated EPE's real-time trading desk; (b) documents provided by Enron state that its "Fatboy" trading strategy included parking energy on EPE's system; (c) Enron would sometimes purchase power from EPE while it was operating EPE's real-time desk; (d) Enron informed EPE that it kept track of its supplemental sales on "Fatboy" spreadsheets; and, (e) EPE identified thirty-six (36) transactions which may have been used by Enron as part of its "Richochet" strategy.
Both "Fatboy" and "Ricochet" are terms used to describe trading tactics.
Plaintiffs bring this class action lawsuit pursuant to Fed.R.Civ.P. 23(a) and (b)(3) on behalf of a potential class consisting of all persons who purchased or otherwise acquired the securities of EPE between February 14, 2000 and October 21, 2002, inclusive, and who were allegedly damaged thereby.
A "Motion For Class Certification" is currently pending before the Court.
Plaintiffs' amended class complaint is brought under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. § 78j(b) and 78t(a), and Securities Exchange Commission ("SEC") Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Plaintiffs allege that EPE's provision of these services violated the Federal Power Act, 16 U.S.C. § 824(a), as (i) EPE failed to file a tariff with the FERC to collect monies with respect to the parking and lending services that it provided to Enron; and (ii) EPE failed to provide these services on an open access and non-discriminatory basis.
The aforementioned scheme allegedly led to increased reported revenue and income for EPE, and this was reflected in an increase of EPE's stock price. EPE traded at $8.30 per share in February 2000; by the market's close on June 4, 2002, just before knowledge that an investigation by the FERC was looming, it was trading at $14.45 per share. According to Plaintiffs, these results were the product of a scheme to manipulate energy prices. The instant Motion to Dismiss followed. Defendants base their failure-to-state-a-claim-argument, pursuant to Fed.R.Civ.P. 12(b)(6), in part on the assertion that Plaintiffs did not adequately plead each element of Section 10(b) and Rule 1 Ob-5, as required by the Private Securities Act of 1995 and Federal Rule of Civil Procedure 9(b).
STANDARDS
A. Federal Rule of Civil Procedure 12(b)(6)
Rule 12(b)(6) allows a defendant to move for dismissal of a case because the plaintiff has failed to state a claim upon which relief can be granted. FED. R. Civ. P. 12(b)(6). Under Rule 12(b)(6), the Court must decide whether the facts alleged, if true, would entitle the plaintiff to some legal remedy. Conley v. Gibson, 355 U.S. 41, 45-46, 78 So. Ct. 99, 102, 2 L.Ed.2d 80 (1957). Dismissal for failure to state a claim is highly disfavored and is not granted routinely because of the liberal "notice pleading" requirements of the Federal Rules. FED. R. Civ. P. 8(a); Shipp v. McMahon, 199 F.3d 256, 260 (5th Cir. 2000). In short, a court should not dismiss a claim under Rule 12(b)(6) "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley, 355 U.S. at 45-46, 78 S.Ct. at 102.
When considering a motion under Rule 12(b)(6), the court must limit its inquiry to facts stated in the plaintiff's complaint and the documents either attached to or incorporated therein. Lovelace v. Software Spectrum, Inc., 78 F.3d 1015, 1017 (5th Cir. 1996). Further, the court must accept as true all material allegations in the complaint, as well as any reasonable inferences to be drawn from them, Kaiser Aluminum Chem. Sales, Inc., v. Avondale Shipyards, Inc., 677 F.2d 1045, 1050 (5th Cir. 1982), and must review those facts in a light most favorable to the plaintiff. Piotrowski v. City of Houston, 51 F.3d 512, 514 (5th Cir. 1995).
B. Private Securities Litigation Reform Act of 1995 ("PSLRA") and Fed.R.Civ.P. 9(b)
The PSLRA provides:
In any private action arising under this chapter in which plaintiff alleges that the defendant —
(A) made an untrue statement of a material fact; or
(B) omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading; the complaint shall specify each statement alleged that 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. § 78u-4(b)(1) (West 1997). "Pleading fraud with particularity in this circuit requires 'time, place and contents of the false representations, as well as the identity of the person making the misrepresentation' and what [that person] obtained thereby.'" ABC Arbitrage Plaintiffs Group; et. al. v. Tchuruk, 291 F.3d 336, 349 (5th Cir. 2002). Federal Rule of Civil Procedure Rule 9(b), which applies to securities fraud claims, states that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). The purpose of Rule 9(b) is to "provide defendants with fair notice of the plaintiffs' claims, protect defendants from harm to their reputation and goodwill, reduce the number of strike suits, and prevent plaintiffs from filing baseless claims and then attempting to discover unknown wrongs." In Re BankAmerica Corp. Securities Litigation, 78 F. Supp.2d 976, 986 (E.D. Mo., E. D. 1999).
The PSLRA "was not enacted to raise the pleading burdens under Rule 9(b) and section 78u-4(b)(1) to such a level that facially valid claims, which are not brought for nuisance value or as leverage to obtain a favorable or inflated settlement, must be routinely dismissed on Rule 9(b) and 12(b)(6)." ABC Arbitrage Plaintiffs Group, 291 F.3d at 354. The plaintiffs need not allege "all" the facts that are related to their claim, because that requirement is not possible to determine at the pleading stage of the litigation in nearly every securities fraud case, only the defendants know "all" the facts. Id. The court in ABC Arbitrage Plaintiffs Group, opined that "even with the heightened pleading standard under Rule 9(b) and the Securities Reform Act, we do not require the pleading of detailed evidentiary matter in securities litigation." Id. at 356.
"Rule 9(b) [is] part of the entire set of [Civil Procedure] rules, including Rule 8(a)'s insistence upon simple, concise, and direct allegations. Relatedly, while 9(b) stands as an exception to an overarching policy of immediate access to discovery, it [does] not reflect a subscription to fact pleading." Williams v. WMX Technologies, Inc., 112 F.3d 175, 178 (5th Cir. 1997). "The who, what, when, and where must be laid out before access to the discovery process is granted." Id. (emphasis contained). "We must not dim the beacon of Rule 8(f) that 'all pleadings shall be construed as to do substantial justice.'" Id.
DISCUSSION
Defendants' claim that Plaintiffs' reliance on rote allegations of fraud to explain why EPE's statements were allegedly misleading fails the PSLRA's and Rule 9(b)'s particularity requirements. In doing so, Defendants repeatedly refer to paragraph numbers in Plaintiffs' amended class complaint, but make an unconvincing attempt, by failing to pose plausible arguments to demonstrate to the Court how Plaintiffs have not satisfied the requirements of the PSLRA and Rule 9(b). Moreover, Defendants adamantly argue that Plaintiffs failed to adhere to the rudimentary requirements of answering the questions "who, what, when, and where" in their complaint.The Court finds that Plaintiffs' recitation of the facts and allegations, taken to be true and reviewed in a light most favorable to Plaintiffs, do in fact state claims upon which relief may be granted. The Court is of the opinion that the Moving Defendants' Motion to Dismiss based on Rule 12(b)(6) should be denied in part and granted in part for the reasons stated below.
A. Section 10(b) and Rule 10b-5
"To state a cause of action under Section 10(b) and Rule 10b-5, a plaintiff must allege (1) misstatement or omission (2) material fact (3) in connection with the purchase or sale of a security, which was made (4) with scienter, and upon which (5) plaintiff justifiably relied, (6) proximately causing injury to the plaintiff." Rosenzweig v. Azurix Corp., 332 F.3d 854, 865 (5th Cir. 2003). Since the parties do not dispute elements three, five, and six the Court construes the parties' silence as an implicit concession that these elements are adequately pled.
i. Misstatement or Omission
Plaintiffs accuse Defendants of not making a proper disclosure to EPE's shareholders regarding the EPE/Enron relationship. In Rubenstein v. Collins, as in this case, the defendants were accused of "knowingly concealing adverse, material information," that it did not disclose to shareholders. Rubinstein v. Collins, et. al., 20 F.3d 160, 169-170 (5th Cir. 1994). In that case, the court determined: "we have long held under Rule 10b-5, 'a duty to speak the full truth arises when a defendant undertakes a duty to say anything'. . . . Although such a defendant is under no duty to disclose every fact or assumption underlying a prediction [in a forecast statement], he must disclose material, firm-specific adverse facts that affect the validity or plausibility of that prediction." Id. (emphasis added).
Defendants, for their part, argue that EPE did not have a duty under securities laws to publicly accuse itself of wrongdoing, especially when it was not aware of such wrongdoing. To buttress this position, they offer that EPE complied with all SEC regulations governing the disclosure of alleged uncharged and unlawful conduct. Defendants claim that "everybody knew about the 'secret' PCS A" because press releases were disseminated, articles were published, and annual reports included the agreement between EPE/Enron. Moreover, Defendants contend that Plaintiffs failed to explain why the statements listed were misleading. In response, Plaintiffs specifically point to a press release that purportedly discloses EPE's arrangement with Enron. Plaintiffs claim, and the Court agrees, that the press release discloses very little about the relationship. Defendants' contention that the press release disclosed meaningful details is an ambitious leap. Since the Defendants "disclosed" the existence of the PCSA, they were required to make a full and truthful disclosure of all the aspects of that agreement and their actions in connection therewith. Defendants' earnest struggle to "split hairs" on this issue leads the Court to believe that Defendants do not have an adequate explanation for the subterfuge created to justify the EPE/Enron relationship.
The press release does not disclose the terms of the agreement. It does not even disclose the official name of the agreement. This press release in no way represents the "full truth" on the subject of the PCS A. Defendants also cite to EPE's 1996 annual report, which purportedly discloses the details of its relationship with Enron. Once again, the referenced document did not disclose any information of substance about the PCSA to the point of labeling its contents as the full truth about the EPE/Enron relationship. In fact, none of the exhibits that Defendants refer to shed proper light on the EPE/Enron relationship.
Finally, Plaintiffs identified with particularity that EPE failed to disclose its role in the Enron scheme because of the potential disgorgement of profits, substantial penalties, and suspension of EPE's market rate authority that would likely follow — all less than six months before EPE settled with the FERC and California parties for over $14 million and made certain admissions. In the final analysis, once EPE undertook the task of speaking about the PCSA in the aforementioned documents, it bore the onus of disclosing the full truth of the dealings between EPE and Enron. The Plaintiffs sufficiently plead the misstatement/omission element of the applicable Section 10(b) and Rule 10b-5 analysis.
ii. Material Fact
A misstatement or omission is material if "there [is] substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." Id. (quoting Basic, Inc. v. Levinson, 485 U.S. 224, 231, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988)). "Materiality is not judged in the abstract, but in the light of the surrounding circumstances." Id. at 866 (quoting Krim v. Banc Texas Group, Inc., 989 F.2d 1435, 1448 (5th Cir. 1993)). The determination of materiality "requires delicate assessments of the inferences a 'reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact." SEC v. Fox, 855 F.2d 247, 253 (5th Cir. 1988) (quoting Chiarella v. United States, 445 U.S. 222, 235, 100 S.Ct. 1108, 1118, 63 L.Ed.2d 348 (1980).
Here, Defendants stretch to deflect charges that the information it failed to provide to investors was not material, by claiming that EPE did not violate any of the FERC's rules or regulations. That explanation misses the mark completely, irrespective of the FERC's rules or regulations because a reasonably prudent investor might refrain from investing their money in a company that is involved in a potentially illegal relationship. EPE was in such a situation because the PCSA gave Enron significant inroads to the daily control of EPE's operations; information that might be important to an investor.
The aforementioned conditions preclude Defendants from remaining silent while in possession of material information. Defendants had access to, and were responsible to keeping investors apprized of the details surrounding EPE's relationship with Enron, especially once it endeavored to disseminate press releases, annual reports, and made statements in articles surrounding the relationship. Here, the facts in the amended class complaint support a finding of materiality because the investors' decisions regarding EPE would be substantially impacted, if they were made privy to the close dealings between EPE and Enron. Thus, the Court is of the opinion that Plaintiffs adequately plead the materiality element of the applicable Section 10(b) and Rule 10b-5 analysis.
iii. Scienter
Under the PSLRA, the district court on a motion to dismiss, must draw all reasonable inferences from the particular allegations in the plaintiff's favor, while at the same time requiring the plaintiff to show a strong inference of scienter. Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78 (1st Cir. 2002) accord Helwig v. Vencor, Inc., 251 F.3d 540, 553 (6th Cir. 2001) (en banc), petition for cert. filed, 70 U.S.L.W. 3269 (Sept.27, 2001) (No. 01-538).
"The plaintiff must also plead 'with particularity facts giving rise to a strong inference,' 15 U.S.C. § 78u-4(b)(2), that defendants acted with 'scienter', which is a 'mental state embracing intent to deceive, manipulate, or defraud." Rosenzweig, 332 F.3d at 866 (quoting Ernst Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 96 S.Ct.1375, 47 L.Ed.2d 668 (1976)). Circumstantial evidence may be strong enough to substantiate the requisite amount of scienter. Id. at 867.
"Scienter also embraces 'reckless indifference,' which we have defined as: limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and that presents a danger of misleading buyers or sellers which [are] either known to the defendant or is so obvious that the defendant must have been aware of it. . . . Insider trading in suspicious amounts or at suspicious times is, of course, presumptively probative of bad faith and scienter." Rubinstein, 20 F.3d at 169-170.
Here, Defendants postulate that Plaintiffs do not allege particularized facts that give rise to strong inference of scienter. To support this position, they declare ignorance about knowing that Enron was manipulating energy prices. Furthermore, they submit that Plaintiffs failed to allege Defendants had a bona fide motive to inflate stock prices. Defendants also assert that facts do not support the allegations that the stock sales were unusual or suspicious.
Plaintiffs retort that ignorance of Enron's activities is not a plausible shield coming from a major energy provider, which should not escape the probing discovery. Plaintiff adds that EPE was reckless, at the very least, because it failed to properly supervise Enron's use of EPE assets. As a result, the facts create a strong inference that EPE knew or recklessly disregarded the alleged fraud perpetuated at its trading desk, which in turn, allegedly resulted in misleading financial and other statements.
Moreover, Plaintiff alleges that EPE officials engaged in significant stock sales during the time in question. For example, Defendant Hopper sold more than 1.6 million shares of his EPE common stock for more than $21 million during the same time. Defendant Bassham sold approximately 51,000 shares for more that $700,000, and Defendant Haines sold more than 32,000 shares of his EPE common stock for nearly $950,000. The Court agrees with Plaintiffs when they claim that these allegations enhance the allegations of scienter against Defendants, especially when read in conjunction with other scienter allegations.
In the final analysis, EPE entered into an express agreement with Enron to provide exclusive and undisclosed parking and lending services, to allow Enron to operate its trading desk and control its assets 75% of the time, and to provide Enron with competitive market information. Plaintiffs contend, and the Court agrees, that these actions give rise to a strong inference of scienter because the actions are not possible without either actual knowledge or extremely reckless business dealings. Therefore, the Plaintiffs adequately plead the scienter element of the applicable Section 10(b) and Rule 10b-5 analysis.
B. Securities Exchange Act of 1934 Section 20(a)
Plaintiffs also allege defendants violated Section 20(a) of the Securities Exchange Act. Section 20(a) imposes joint and several liability upon persons who "control" defendants that violate the Exchange Act. Rosenzweig, 332 F.3d at 862. "Control person" liability is, however, derivative, i.e., such liability is predicated on the existence of an independent violation of the securities laws. Rubinstein, 20 F.3d at 166 (quoting Thomas Lee Hazen, The Law of Securities Regulation § 13.15 (1990)). At this point in time of the litigation, the solitary issue presented is whether Plaintiffs have pleaded an independent violation under 10b-5. In order to state a claim under Section 20, a plaintiff must allege a predicate securities fraud offense under Section 10(b). ABC Arbitrage Plaintiffs Group, 291 F.3d at 361.
Defendant's sole argument for dismissal is predicated on purported failure of the amended class complaint to "allege [the] predicate securities fraud offense under Section 10(b)" because Plaintiffs' Section 10(b) and Rule 10b-5 claims are allegedly not stated with particularity. Defendants do not otherwise challenge Plaintiffs' Section 20(a) claim, and collectively, the parties spend minimal time arguing their positions regarding this topic. Nevertheless, as discussed above, the Court is of the opinion that Plaintiffs have alleged a sufficient predicate securities fraud offense under Section 10(b) and, thus, the cause of action alleged under Section 20(a) will not be dismissed at this stage of the litigation.
C. Group Pleading Doctrine
Defendants also launch an assault against Plaintiffs' use of the "group pleading" doctrine. The group pleading doctrine allows Plaintiffs to attribute to officers and directors the actions of other officers in the group. In Re Bank America Corp., 78 F. Supp.2d at 988. Defendants claim that Plaintiffs' attempt to rely on non-particularized group pleading to lump the Defendants together, violates the PSLRA's requirement that fraud be pled with particularity. Because the group pleading doctrine is a rebuttable presumption applicable only to a limited group of persons within a company, it is not inconsistent with the PSLRA. Id. Even if the group pleading doctrine would be inconsistent with the PSLRA, individual defendants may still be held liable where they participated in the preparation of false and misleading public statements. See In re NetSolve, Inc. Sec. Litig., 185 F. Supp.2d 684, 699 (W.D. Tex. 2001) (holding that although the group pleading doctrine does not survive passage of the PSLRA, "individual defendants will remain . . . because the plaintiffs allege . . . that [they] helped prepare, directly participated in, and/or were quoted in the allegedly misleading public statements and documents").
Here, Plaintiffs allege that Defendants Hedrick, Haines and Bassham signed or personally made false and misleading statements in the Forms 10K for 1999, 2000 and 2001, the Forms 10Q for all four quarters of fiscal years 2000 and 2001, as well as for the first quarter of fiscal 2002, which they showed to financial analysts and to reporters. Thus, the Court agrees with Plaintiffs that regardless of the status of the group pleading doctrine in the wake of the PSLRA, the amended class complaint explicitly alleges violations by Defendants Hedrick, Haines, and Bassham in order to reap corporeal economic gain from their actions.
However, with regards to Defendants Bates and Rodriguez, Plaintiffs fail to explicitly cite an instance where EPE's misstatements were attributable to them. Therefore, Defendants Motion to Dismiss is granted as to Bates and Rodriguez.
CONCLUSION
For the reasons stated in this opinion, the Court concludes that Plaintiffs have sufficiently pleaded their claims under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. § 78j(b) and 78t(a), and SEC Rule 10b-5 with regards to Defendants Hedrick, Haines, and Bassham. However, the Court is further of the opinion that Plaintiffs have failed to specifically allege violations against Defendants Bates and Rodriguez. As a result, the Court is of the opinion that the Motion to Dismiss should be denied in part and granted in part. The Motion to Dismiss is denied as pertaining to Defendants El Paso Electric Company, Terry D. Bassham, James Haines, Jr., and Gary R. Hedrick. However, the Motion to Dismiss is granted as pertaining to Defendants Julius F. Bates and Eduardo A. Rodriguez.
Accordingly, IT IS HEREBY ORDERED that the "Motion to Dismiss" is DENIED IN PART AND GRANTED IN PART as set forth herein.