Summary
applying strong inference standard to decide motion for summary judgment
Summary of this case from In re Bristol-Myers Squibb Securities LitigationOpinion
Civil Action No. 00-10966-DPW
August 26, 2002
MEMORANDUM AND ORDER
Plaintiff KA Investments LDC ("KA Investments") seeks damages as a result of its purchase of 300 shares of preferred stock from Defendant Number Nine Visual Technology Corporation ("Number Nine") for $3 million, alleging violation of Section 10(b) of the Securities Exchange Act of 1934 (the "SEA"), 15 U.S.C. § 78j(b), as well as negligent misrepresentation. Following my grant of summary judgment to Defendant Argus Management Corporation ("Argus"), for lack of vicarious liability, the remaining defendants now move for summary judgment on both claims.
I. BACKGROUND A. The Parties
KA Investments is an investment firm wholly owned and managed by Deephaven Capital Management, LLC ("Deephaven"). Both entities have their principal place of business in Minnesota. At times relevant to this case, Deephaven channeled its private placement investments through KA Investments.
Number Nine, which filed for bankruptcy on December 20, 1999, was a Massachusetts corporation engaged in the design and manufacture of graphics accelerator cards for personal computers. Individual Defendants Andrew Najda, Timothy Burns, and William Ralph all are former Number Nine officers. Najda was Number Nine's founder, and served as its CEO and Chairman until his resignation in May 1999. Burns served as Number Nine's acting CFO from February 1998. Ralph served as Number Nine's General Manager from June 1998 until April 1999, and then as its COO.
The defendants note that the plaintiff's complaint misspells Najda's name as "Nadja."
B. Transactional History
After going public in 1995, Number Nine began to suffer a series of business setbacks, including the loss of a major account, and by late 1997 was in active pursuit of additional financing. In early 1998, Number Nine secured a $9 million investment from Silicon Graphics, Inc. ("Silicon Graphics") in the form of a loan convertible into preferred stock. By late 1998, Number Nine also was negotiating a $2 million sale of technology licensing rights to S3, Inc. ("S3").
In early 1999, Bruce Lieberman of Deephaven was contacted by a placement agent inquiring as to whether KA Investments would consider investing in Number Nine. Lieberman proceeded to contact Number Nine, and after a series of negotiations — in which Najda, Burns and Ralph all participated — KA Investments and Number Nine entered into an agreement on March 31, 1999 (the "Agreement") pursuant to which KA Investments purchased 300 shares of Number Nine's Series B convertible preferred stock for $3 million.
Among other things, the Agreement set forth the conditions under which KA Investments could convert its shares of Number Nine's preferred stock into common stock, and made provision for the payment of dividends in the form of common stock. KA Investments' strategy was predicated on its ability to then trade Number Nine's common stock on the NASDAQ National Market, where the stock was listed as of March 31, 1999, or on some other comparable market.
At his deposition, Lieberman testified that KA Investment's standard practice in relation to its private placement investments has been to "short sell" the purchased stock, as a means of hedging KA Investments' risk. The defendants attempt to portray this testimony as somehow damaging to the plaintiff's case, especially in light of the fact that the Agreement provided for a conversion ratio that was inversely proportional to the price of Number Nine's stock. However, I find Lieberman's cited testimony relevant only to the extent that it helps to confirm KA Investments' interest in trading Number Nine's common stock.
Two clauses of the Agreement designed to protect KA Investment's ability to trade Number Nine's common stock lie at the core of this case.
First, at Section 2(p) of the Agreement, Number Nine represented that:
Except as set forth in Schedule 2(p), [Number Nine] has not, in the two years preceding hereof, received notice (written or oral) from the NASDAQ or any other stock exchange, market or trading facility on which the Common Stock is or has been listed (or on which it has been quoted) to the effect that the Company is not in compliance with the listing or maintenance requirements of such exchange or market. The Company is, and has no reason to believe that it will not in the foreseeable future continue to be, in compliance with all such maintenance requirements.
(Emphasis added.)
Second, at Section 2(u), Number Nine confirmed that:
[Number Nine] has not provided [KA Investments] or its agents or counsel with any information that constitutes or might constitute material non-public information.
At Section 2(u), Number Nine further acknowledged its understanding that KA Investments would be relying on these and other listed representations in trading Number Nine's stock.
C. Number Nine's Compliance with NASDAQ's Net Tangible Asset Requirement
For listing on its National Market, NASDAQ requires a company to maintain at least $4 million in net tangible assets. Under NASDAQ standards, net tangible assets equal total assets minus total liabilities and goodwill. Number Nine's representation at Section 2(p) of the Agreement speaks directly to its compliance with this listing requirement. The issue also was the subject of discussions between KA Investments and Number Nine leading up to the Agreement.
In those discussions, Number Nine disclosed that in May 1998, it had received notice that NASDAQ had determined, upon review of Number Nine's results for the first quarter of 1998 — which disclosed $2.933 million in net tangible assets as of March 28, 1998 — that Number Nine no longer met NASDAQ's net tangible assets listing requirement. In response, Number Nine had persuaded Silicon Graphics to accelerate the conversion of its $9 million investment from a loan into shares of Number Nine's Series A convertible preferred stock, thereby removing the investment as a liability on Number Nine's balance sheet, and in Number Nine's view, adding it to the balance sheet as equity. In a letter dated August 5, 1998, NASDAQ recognized this accelerated conversion, as well as financial projections based on Number Nine's introduction of a new line of products, as grounds for concluding that Number Nine had "taken steps to achieve compliance with the net tangible assets requirement and [to] ensure that it will remain in compliance over the long term."
Ralph has testified that Number Nine never asked its auditors, in connection with Silicon Graphics' investment, whether (or to what extent) an investment received in exchange for convertible securities was properly characterized as equity.
The foregoing history was the subject of Schedule 2(p) of the Agreement, referred to at Section 2(p) as setting forth an exception to Number Nine's representations regarding its compliance with NASDAQ's listing requirements generally. Lieberman has testified that Number Nine officials informed him, prior to closing, that Number Nine had faced no other delisting threats in the past, and "didn't foresee any problems" in the future. Although the Agreement contained a complete integration clause at Section 4.2, I note that these were precisely the representations that were recorded at Section 2(p). In his testimony, Lieberman acknowledged that he understood that Number Nine's contractual representation that, as of the March 31, 1999 closing, the company was and had "no reason to believe that it will not in the foreseeable future continue to be" in compliance with NASDAQ listing requirements was premised on Number Nine's receipt of $3 million from KA Investments and $2 million from the sale to S3, which also closed on or about March 31, 1999. Lieberman added that he and KA Investments' counsel, Eric Cohen, had been informed by Number Nine officials that their expectation of Number Nine's continued compliance with NASDAQ listing requirements was further premised on the view that the $3 million from KA Investments would not appear as a liability on Number Nine's balance sheet, and in significant part would appear as equity. The defendants confirm that this was Number Nine's view, although there is some conflict within their deposition testimony as to its basis, and as to whether it was in fact communicated to KA Investments prior to closing.
At his deposition, Burns testified that Number Nine's view of the accounting treatment of the $3 million from KA Investments was not based on any discussions with Number Nine's auditors, Price Waterhouse Coopers, prior to March 31, 1999, and that he could not remember having conveyed this view to KA Investments. Ralph, on the other hand, has testified that Number Nine's view that the $3 million at least would not in any portion appear as liability on Number Nine's balance sheet was supported by an informal opinion obtained from Price Waterhouse Coopers, and was conveyed to Lieberman, both prior to closing. For his part, the Price Waterhouse Coopers partner responsible for the Number Nine account, Paul Joubert, has testified that he cannot recall discussing the classification of the $3 million with Number Nine officials prior to March 31, 1999, and that at any rate, Price Waterhouse Coopers only determined the proper classification sometime between that date and the filing of Number Nine's 10Q for the first quarter of 1999 on May 18, 1999. The Price Waterhouse Coopers manager who worked on the Number Nine account, John Crowley, did testify at his deposition to having discussed "possible accounting treatments" for the $3 million with Number Nine officials prior to closing, but maintains that he did not give any type of assurances regarding Price Waterhouse Coopers' final determination.
On April 2, 1999, Number Nine filed its 10K for the year ending January 2, 1999. Number Nine's 10K filing reported net tangible assets of $1.027 million. In a letter dated April 6, 1999, NASDAQ informed Number Nine that it had reviewed the 10K, and because Number Nine's net tangible assets had fallen well below the NASDAQ National Market's required minimum of $4 million, it would be "necessary to review [Number Nine's] eligibility for continued listing[.]" To that end, NASDAQ required Number Nine to submit by April 20, 1999 a "definitive plan" for achieving compliance, on which basis NASDAQ would make its determination as to Number Nine's eligibility. The letter concluded by noting that "no delisting action will be taken at this time."
In a letter dated April 13, 1999, Number Nine responded to NASDAQ's notice by reporting the investment from KA Investments, as well as a new contract with IBM, Inc. ("IBM") expected to commence in May 1999 and eventually generate approximately $150 million in revenue. Number Nine also claimed that it was "actively discussing a second round of equity financing with a venture capital firm," to close sometime during the second quarter of 1999. On these bases, Number Nine asserted that it would attain the required net tangible asset level for continued listing on NASDAQ's National Market in the second quarter of 1999. As for the first quarter of 1999, which ended on April 3, 1999, Number Nine projected, on attached pro forma quarterly balance sheets, only $3.469 million in net tangible assets. Ralph has testified that he counted the entire $3 million from KA Investments as equity in making this calculation. On the other hand, Burns has testified that the pro forma balance sheets were prepared sometime in mid to late February, when the sale to S3 was expected to net between $1 and $1.5 million, and thus understated the final ($2 million) sale amount. In his testimony, Burns does not explain why the figure was not updated in mid April 1999 for purposes of the correspondence with NASDAQ regarding potential delisting.
At any rate, Number Nine eventually reported $3.293 million in net tangible assets on its 10Q for the first quarter of 1999, which Number Nine filed on May 18, 1999. Ralph has testified that the entire $3 million from KA Investments was counted as a positive asset for purposes of this calculation, and none of it as a liability. According to Number Nine's controller, Barbara Cimitile, Number Nine's balance sheet reflected approximately $1.8 million of the investment as "mezzanine capital" and approximately $1.2 million as "additional paid in capital." "Mezzanine capital" refers to money that contains characteristics of both equity and liability, and hence is classified somewhere in between. According to both Ralph and Cimitile, Number Nine treated "additional paid in capital" as equity.
The accounting treatment of the $3 million from KA Investments on Number Nine's balance sheet as divided between mezzanine capital and additional paid in capital appears consistent with Price Waterhouse Coopers' formal advice to Number Nine. In an undated workpaper filed under seal, Price Waterhouse Coopers referenced $1.822 million of the investment as mezzanine capital, and $1.178 million as additional paid in capital. The Price Waterhouse Coopers workpaper divided the $1.178 million classified as additional paid in capital into two categories, labeling $348,000 under the heading of "warrants" and $830,000 under the heading of "beneficial conversion feature." This particular division also is noted on Number Nine's 10Q for the first quarter of 1999. In his testimony, Ralph admitted that Price Waterhouse Coopers did not advise Number Nine that the approximately $1.8 million of the investment classified as mezzanine capital would count as a positive asset for purposes of NASDAQ's net tangible assets test, but because this $1.8 million was not classified as a liability, he concluded that it counted as a positive amount for purposes of NASDAQ's test (which he did not view as being an "equity test").
At his deposition, Burns testified that Number Nine was advised by Price Waterhouse Coopers, and in fact reported on its 10Q for the first quarter of 1999, that the $830,000 of the investment from KA Investments labeled as the "beneficial conversion feature" was a liability. I note that Burns testimony in this regard is contradicted by the testimony of both Ralph and Cimitile, by Price Waterhouse Coopers' cited workpaper, and by the filed 10Q itself.
Two days following Number Nine's filing of its 10Q for the first quarter of 1999, NASDAQ informed Number Nine, in a letter dated May 20, 1999, that it would be delisted from NASDAQ's National Market effective May 28, 1999. In its letter, NASDAQ did not specifically reference Number Nine's recently filed 10Q. Rather, NASDAQ relied upon Number Nine's April 13, 1999 submission in determining that Number Nine had not "provided a definitive plan evidencing its ability" to achieve and then sustain compliance with the net tangible assets listing requirement. In particular, the letter noted, first, that Number Nine had not specified the amount expected to be raised from, or a definitive closing date for, additional equity financing, and second, that NASDAQ could not continue to "rely upon [Number Nine's] ability to generate positive net income given its history of recurring losses." Number Nine's appeal, in a letter dated May 26, 1999, was unsuccessful, and the company was delisted from NASDAQ's National Market.
Notably, Number Nine's May 26 letter of appeal, signed by Burns, referred to the transaction with KA Investments as having raised "$3 million of equity capital."
In its April 6, 1999 letter, NASDAQ had given Number Nine the option of transferring its listing to NASDAQ's Small Cap Market, which has a smaller net tangible assets listing requirement than the National Market. Although it appears that listing on NASDAQ's Small Cap Market would have sufficed for purposes of the Agreement, Number Nine apparently chose not to pursue this option.
D. Procedural Posture
In its complaint, KA Investments alleges that it has suffered money damages as a consequence of Number Nine's delisting, for which the defendants are liable under Section 10(b) of the SEA, 15 U.S.C. § 78j(b) (Count I), as well as under the common law tort of negligent misrepresentation (Count II). In Count III, KA Investments had sought to extend vicarious liability to Argus, on the basis of its relationship with Burns. By order dated November 20, 2001, I granted Argus' motion for summary judgment, on the ground that Burns was neither an employee nor an agent of Argus during the relevant time period. The remaining defendants collectively now move for summary judgment on the following grounds: First, as to the plaintiff's Section 10(b) claim, the defendants contend that (i) the claim is time-barred by the applicable statute of limitations, and (ii) that the plaintiff has failed to introduce sufficient evidence of the requisite scienter on the part of the defendants. Second, as to the plaintiff's negligent misrepresentation claim, the defendants contend that it is barred by controlling New York law.In the same motion, defendants Najda and Burns also request dismissal of both claims as to them, on the ground that neither signed the Agreement, and thus cannot be held liable for Number Nine's representations therein regarding its compliance with NASDAQ's listing requirements.
II. SUMMARY JUDGMENT STANDARD
Summary judgment is appropriate when "the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits . . . show that there is no genuine issue of material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). Consistent with this standard, I must accept the opposing party's version of genuinely disputed facts, drawing all reasonable inferences in their favor. See, e.g., Mullin v. Raytheon Co., 164 F.3d 696, 697 (1st Cir. 1999). It nevertheless remains for the party opposing summary judgment to demonstrate a genuine dispute with specific, provable evidence — mere assertions will not suffice. See, e.g., Brennan v. Hendrigan, 888 F.2d 189, 191 (1st Cir. 1989).
III. LIABILITY OF NAJDA AND BURNS
I first address the defendants' contention that Najda and Burns cannot be held liable for Number Nine's representations at Section 2(p) of the Agreement regarding its compliance with NASDAQ's listing requirements because neither signed the Agreement. The defendants argue that Najda and Burns may only be considered to have aided and abetted these contractual representations, and call attention to the Supreme Court's holding that there is no "aiding and abetting" liability under Section 10(b) of the SEA. See Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 175-78 (1994). The defendants do not similarly explain their claim that Najda and Burns also cannot be held liable, simply because neither signed the Agreement, for negligent misrepresentation.
Under Central Bank of Denver, the plaintiff's Section 10(b) claims against Najda and Burns do turn on whether they were primary actors in Number Nine's contractual representations to KA Investments. It was apparent from oral argument in this matter that the plaintiff's attempt to characterize Najda and Burns as primary actors rests simply on the fact that they both participated in the negotiations leading up to the Agreement and, by virtue of their executive positions, had some measure of control over the decision to execute it.
I note that the Agreement's integration clause, at Section 4.2, bars the plaintiff from alleging that any Number Nine official made an actionable misrepresentation during the course of those negotiations.
The narrow reading of primary liability under Central Bank makes clear that Section 10(b) cannot serve as the basis for the supervisory liability alleged with respect to Najda and Burns. Imputed liability of controlling officers is, however, a matter covered by Section 20(a) of the SEA, 15 U.S.C. § 78t(a). Inexplicably, the plaintiff did not assert a Section 20(a) claim, and has not sought to do so even in the face of the Central Bank defense raised by the defendants with respect to Najda and Burns. There being no proper Section 10(b) claim against Najda and Burns and because I will not entertain a modification of the pleadings at this point — I will allow summary judgment as to Najda and Burns' liability under Count I of the plaintiff's complaint.
Because in Section V infra I grant summary judgment on broad substantive grounds as to the plaintiff's claim of negligent misrepresentation, I need not determine whether the roles played by Najda and Burns in the execution of the Agreement would otherwise be sufficient to render them proper defendants under a negligent misrepresentation theory.
IV. PLAINTIFF'S SECTION 10(b) CLAIM (COUNT I)
To prove securities fraud in violation of Section 10(b) of the SEA and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, KA Investments must establish (i) that the defendants made materially false or misleading statements, (ii) that they did so with the requisite scienter, and (iii) that reliance thereupon caused injury. Shaw v. Digital Equipment Corp., 82 F.3d 1194, 1217 (1st Cir. 1996). Scienter refers to "a mental state embracing intent to deceive, manipulate, or defraud." Ernst Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976). In this circuit, the concept embraces both conscious intent and a high degree of recklessness (such as would be "closer to being a lesser form of intent than merely a greater degree of ordinary negligence"). Greebel v. FTP Software, 194 F.3d 185, 198-201 (1st Cir. 1999).
The plaintiff's Section 10(b) claim is premised on the allegation that Number Nine was not in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999, even taking into account the $3 million received from KA Investments and the $2 million received from S3, and that Number Nine officials knew this to be the case (or at least were highly reckless in believing otherwise).
The Supreme Court has held that Section 10(b) actions must be brought within one year from when the fraud was or ought to have been discovered, and cannot be subject to equitable tolling. See Lampf, Pleva, Lipkind, Prupis Petigrow v. Gilberston, 501 U.S. 350, 361-64 (1991); see also Cooperativa De Ahorro Y Credito Aguada v. Kidder, Peabody Co., 993 F.2d 269, 271 (1st Cir. 1993). KA Investments filed its complaint on May 17, 2000. The defendants contend that discovery has revealed that KA Investments had concluded in early April 1999 that Number Nine could not have been in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999. Thus, the defendants posit that the plaintiff's Section 10(b) claim was not timely brought, and seek to amend their answers to affirmatively raise this defense. I begin my analysis of the plaintiff's Section 10(b) claim with consideration of this issue.
A. Was Plaintiff's Section 10(b) Claim Timely Brought?
As a preliminary matter, I note that Number Nine's filing for bankruptcy on December 20, 1999 clearly tolled the one-year statute of limitations with respect to the company under relevant bankruptcy law Under 11 U.S.C. § 362(a)(1), the filing of a bankruptcy petition operates as a stay over "the commencement or continuation . . . of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before" the filing of the petition. 11 U.S.C. § 362(a)(1). 11 U.S.C. § 108(c) further provides that:
The Court's opinion in Lampf does not suggest that statutory tolling is inapplicable to Section 10(b) actions. See Lampf, 501 U.S. at 363.
[I]f applicable nonbankruptcy law . . . fixes a period for commencing or continuing a civil action in a court other than a bankruptcy court on a claim against the debtor, . . . and such period has not expired before the date of the filing of the petition, then such period does not expire until the later of —
(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or
(2) 30 days after notice of the termination or expiration of the stay . . . with respect to such claim.11 U.S.C. § 108(c). The plaintiff's motion for relief from the automatic stay was granted on May 11, 2000, and its complaint filed six days later. The defendants concede that there accordingly is no statute of limitations problem with respect to the plaintiff's Section 10(b) claim against Number Nine, and focus their argument instead on the plaintiff's Section 10(b) claims against the individual defendants, the only remaining one of whom is Ralph. The bankruptcy stay provisions do not provide a basis for any stay or consequent tolling with respect to the officers of a company that has filed for bankruptcy, and the plaintiff does not contend otherwise.
1. Lieberman's Deposition Testimony
The defendants' contention that KA Investments had concluded in early April 1999 that Number Nine could not have been in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999 is premised on (i) Lieberman's testimony that he reviewed Number Nine's 10K for 1998, which disclosed $1.027 million in net tangible assets as of January 2, 1999, shortly after it was filed on April 2, 1999, and (ii) the defendants' view that Lieberman then admitted that he considered this disclosure to reveal that Number Nine could not have had $4 million in net tangible assets (the NASDAQ National Market's minimum listing requirement) as of March 31, 1999.
Because of the importance of Lieberman's testimony to the defendants' statute of limitations argument, I reproduce a substantial segment I find relevant:
Q: There's two clauses there. There's one that "the Company is, and has no reason to believe it will not in the foreseeable future." Are you contending that the statement that the company is in compliance is incorrect as of March 31, 1999?
A: I believe it is.
Q: And I'm asking you for the basis for that belief.
A: Having looked at the financials from when they were filed, their K-1 from the end of 1998.
Q: K-1 or 10-K?
A: I'm sorry, 10-K from the end of 1998. And later on the Q from the first quarter that was filed, from the first quarter of 1999.
Q: You testified earlier that it was your practice to pull off 10-Ks when they're filed and see them on Bloomberg?
A: It was my practice to print out the latest — when I was doing the due diligence, the latest 10-K that was filed and the latest 10-K that was filed [sic].
Q: But I think you also, correct me if I'm wrong, you testified to the fact that while you monitored companies on almost a daily basis, when it comes up that there has been a filing of a company that you've invested in, you also pull that off?
A: I look at it.
Q: Did you look at the 10-K here when it was filed in April 1999?
A: Yes, I did.
Q: When you looked at that 10-K, did you make any — is that the basis for your assertion today that this statement that the company is in compliance with all such maintenance requirements was incorrect?
A: Yes.
Q: And you made that determination in April of 1999?
A: Along with the Q that was subsequently filed.
Q: But you made — to be in compliance you said the 10-K —
A: And the Q. I said and the first quarter from both of them.
Q: But as of the 10-K, that's for the period of time as of up to the end of 1998, correct?
A: That's when the K is through, yes.
Q: And the Q was for the period of first quarter?
A: Of '99, from both those together.
Q: Okay. What in the Q indicated that the statement that "the Company is, and has no reason to believe it will not in the foreseeable future be in compliance with all such maintenance requirements"?
A: I started going through the financials, all of them, after that, and started looking how poorly they had done in the first quarter.
To counter the defendants' contention that his testimony suggests that he considered Number Nine's 10K alone to reveal that the company could not have been in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999, Lieberman has filed an affidavit in which he testifies to the state of his knowledge as of reviewing Number Nine's 10K for 1998:
While I recognized that the 10-K revealed net tangible assets below the minimum NASDAQ requirement, I also recognized that Number Nine's representation that "The Company is and has no reason to believe that it will not in the foreseeable future continue to be in compliance with all [NASDAQ] maintenance requirements" was being made as of March 31, 1999, almost a full fiscal quarter after the period reported on the 10-K.
In his affidavit, Lieberman adds that he had no knowledge of Number Nine's performance during the first quarter of 1999 — on which basis he might conclude that Number Nine was not in compliance with the net tangible assets listing requirement as of March 31, 1999 — until Number Nine filed its 10Q for that quarter on May 18, 1999. If KA Investments in fact did not discover the state of Number Nine's compliance with the net tangible assets listing requirement — as of March 31, 1999 — until May 18, 1999, and cannot be faulted for its failure to do so, then its complaint must be deemed timely filed.
The defendants contend that Lieberman's affidavit testimony should not be deemed to support that legal conclusion, in light of the First Circuit's settled view that "[w]hen an interested witness has given clear answers to unambiguous questions, he cannot create a conflict and resist summary judgment with an affidavit that is clearly contradictory, but does not give a satisfactory explanation of why the testimony is changed." Torres v. E.I. DuPont de Nemours Co., 219 F.3d 13, 20 (1st Cir. 2000) (quoting Colantuoni v. Alfred Calcagni Sons, Inc., 44 F.3d 1, 4-5 (1st Cir. 1994). The defendants' argument presumes, however, that a factfinder must find Lieberman's deposition testimony to have expressed clearly that, in April 1999, he considered Number Nine's 10K alone to reveal that the company could not have been in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999. On the contrary, a factfinder would not be required to read Lieberman's deposition testimony in this way. Lieberman's deposition testimony can fairly be read to cite both Number Nine's 10K for 1998 and its 10Q for the first quarter of 1999 as joint bases for his eventual view that the company was not in compliance with the listing requirement as of March 31, 1999.
The defendants place great emphasis on the following exchange:
Q: When you looked at that 10-K, did you make any — is that the basis for your assertion today that this statement that the company is in compliance with all such maintenance requirements was incorrect?
A: Yes.
The defendants ignore, however, the exchange immediately following:
Q: And you made that determination in April of 1999?
A: Along with the Q that was subsequently filed.
A similar conjunction of the 10Q for the first quarter of 1999 with the 10K for 1998 appears throughout the portion of Lieberman's deposition testimony set forth above. Number Nine's 10K for 1998 is not sufficiently disaggregated — in Lieberman's deposition testimony — from Number Nine's 10Q for the first quarter of 1999 to establish for purposes of summary judgment that Lieberman actually concluded on the basis of the 10K alone that Number Nine was not in compliance with the net tangible assets listing requirement as of March 31, 1999.
2. Inquiry Notice
Notwithstanding my analysis above, there remains an alternative basis for concluding that KA Investments did not timely file its complaint for purposes of its Section 10(b) claims against the individual defendants. In particular, it may be the case that Lieberman's review of Number Nine's 10K for 1998, more than one year prior to the filing of the complaint, exposed him to "sufficient facts . . . to put a reasonable investor in [his] position on inquiry notice of the possibility of fraud." Maggio v. Gerard Freezer Ice Co., 824 F.2d 123, 128 (1st Cir. 1987). If that proves the case, then I must view the plaintiff's Section 10(b) claims against the individual defendants as time-barred unless the plaintiff thereafter exercised due diligence in attempting to determine, in particular, whether Number Nine was in compliance with the net tangible assets listing requirement as of March 31, 1999. Id.
I find that Lieberman's review of Number Nine's 10K reasonably ought to have alerted him to the possibility that Number Nine was not in compliance with the listing requirement as of March 31, 1999. Lieberman knew that Number Nine had been threatened with delisting after reporting $2.933 million in net tangible assets as of March 28, 1998, and had only managed to avoid that result by converting the $9 million from Silicon Graphics from a liability into an asset on its balance sheet. The disclosure in Number Nine's 10K for 1998 that the company's net tangible assets had fallen to $1.027 million as of January 2, 1999 at least constituted a "storm warning" that, even with the cumulative $5 million it received from KA Investments and S3 by March 31, 1999, Number Nine may still have fallen below the $4 million threshold as of that date.
Of course, it remains for me to determine whether the plaintiff exercised reasonable diligence in response to this warning, an inquiry of a more subjective nature which is not often easily resolved on summary judgment. Salois v. Dime Savings Bank of New York, 128 F.3d 20, 26 (1st Cir. 1997). The record before me contains no suggestion, however, that the plaintiff took any steps to ascertain the company's true financial condition as of March 31, 1999 after reviewing the dire financial information contained in the 10K for 1998 filed shortly thereafter.
At oral argument, the plaintiff contended that it could not make such inquiry given that it was trading Number Nine's stock. I consider this argument to be specious. It would have been no securities violation to inquire into what may have been material non-public information; any violation could only arise if the plaintiff were to have traded on such information. In short, the plaintiff could not ignore "storm warnings" simply on the ground that one method of acting on knowledge gained after further inquiry would be illegal. The plaintiff may well have desired to trade Number Nine's stock, but that is no excuse for neglecting its duty of inquiry.
Furthermore, the plaintiff cannot hope to prevail on the argument that, even in the exercise of reasonable diligence, it could not possibly have discovered whether Number Nine was in compliance with the listing requirement as of March 31, 1999, given that its Section 10(b) claim is founded on the premise that Number Nine officials knew that the company would not be in compliance well before that date.
Accordingly, the only obstacle to granting summary judgment to the defendants with respect to the plaintiff's Section 10(b) claims against the individual defendants is the fact that the defendants did not raise a statute of limitations defense in their original answers, which they have now moved to amend. In this regard, the Supreme Court has instructed that leave to amend should be freely given "[i]n the absence of any apparent or declared reason — such as undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, [or] futility of amendment[.]" Foman v. Davis, 371 U.S. 178, 182 (1962).
The plaintiff's most compelling argument in opposition to the defendants' motion to amend their answers has disappeared as a result of my effective determination above that such an amendment would not be futile. Accordingly, I will grant the defendants' motion to amend their answers, and following that, will grant the defendants' motion for summary judgment with respect to the plaintiff's Section 10(b) claims against the individual defendants, on the ground that these claims are time-barred. I note that this decision only will have practical effect with respect to the plaintiff's Section 10(b) claim against Ralph, and merely provides an alternative ground for awarding summary judgment with respect to the plaintiff's Section 10(b) claims against Najda and Burns.
B. The Merits of Plaintiff's Section 10(b) Claim
Having determined that KA Investments may proceed only with respect to Number Nine itself, I turn now to the merits of the plaintiff's Section 10(b) claim. As an initial matter, I note that the defendants do not seriously contest that the evidence — including Number Nine's own April 13, 1999 letter to NASDAQ — tends to suggest that Number Nine's contractual representation, at Section 2(p) of the Agreement, that the company was in compliance with the NASDAQ National Market's listing requirements as of March 31, 1999 was a false one. Neither do the defendants seriously dispute that this misrepresentation concerned a matter of material interest to KA Investments, given its express plan to trade Number Nine's common stock. The defendants do contend, however, that the plaintiff has failed to introduce sufficient evidence of the requisite scienter. Moreover, although not raised in their original motion for summary judgment, the defendants' subsequent briefing offers an additional argument against the plaintiff's Section 10(b) claim, namely that the plaintiff cannot demonstrate its alleged losses to have been caused by anything other than Number Nine's 10K filing for 1998. I will address each of these posited grounds for summary judgment in turn.
1. Scienter
The First Circuit has explained that to prove scienter, a plaintiff must not only show that a defendant made a particular false or misleading statement, but also the defendant knew, or was highly reckless as to the facts (i) "that the statement was false or misleading," and (ii) "that it was made in reference to a matter of material interest to investors." Geffon v. Micrion Corp., 249 F.3d 29, 35 (1st Cir. 2001). In keeping with the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4, the First Circuit has further emphasized that, even at the pleading stage, the inference of scienter must be not only reasonable, but "strong." Greebel v. FTP Software, Inc., 194 F.3d 185, 194-98 (1st Cir. 1999). Although the First Circuit has tended to articulate this standard in the context of motions to dismiss, there is no reason to suppose that it is any less rigorous in the context of a motion for summary judgment.
Unlike some of its sister circuits, the First Circuit has declined to identify any "characteristic pattern" of evidence that would support such an inference, preferring instead "a more fact-specific inquiry." Id. at 196-97.
In contending that the plaintiff has failed to adduce evidence supporting a strong inference of scienter, the defendants initially contend that their good faith belief that the company would be in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999 was based on their preliminary judgment that none of the $3 million from KA Investments would later appear as a liability on Number Nine's balance sheet, and that they learned from Price Waterhouse Coopers only in mid May 1999 that $830,000 of the investment labeled as the "beneficial conversion feature" in fact would be classified as a liability for purposes of the company's 10Q for the first quarter of 1999. Under this premise, even if the defendants had originally thought that the $830,000 would appear as neither a liability nor an asset on Number Nine's balance sheet, merely adding $830,000 to the $3.293 million in net tangible assets that Number Nine reported on its 10Q for the first quarter of 1999 — in order to assess the defendants' putative good faith belief as of March 31, 1999 — results in a number in excess of $4 million.
The defendants' argument rests entirely on the testimony of Burns. As noted earlier, note 5 supra, Burns' testimony is effectively rebutted by overwhelming evidence that no portion of the $3 million from KA Investments — including the $830,000 beneficial conversion feature — was treated as a liability for purposes of Number Nine's 10Q. That evidence includes the testimony of both Ralph and Cimitile, Price Waterhouse Coopers' formal advice to Number Nine, and the company's 10Q itself. Indeed, Ralph has admitted not only that Number Nine's 10Q did not count any portion of the $3 million investment as a liability for purposes of NASDAQ's net tangible assets test, but also that it counted the entire amount as a positive asset. It bears adding that in its May 26, 1999 appeal of NASDAQ's delisting decision, signed by Burns, Number Nine referred to the transaction with KA Investments as having raised "$3 million of equity capital."
In the face of this evidence, the defendants ultimately appear to drop their initial contention that the $830,000 "beneficial conversion feature" of the investment played any role in rendering their "good faith" belief later false. Rather, they correctly note that it remains the plaintiff's burden to adduce evidence that supports a strong inference of scienter, and contend that this burden has not been met.
The defendants also do not pursue the suggestion in their opening brief that their "good faith" belief Number Nine would be in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999 was based on the expected revenue from the contract with IBM. This appears a wise choice, given Cimitile's testimony that Number Nine knew at least as of March 24, 1999 that shipments for the IBM contract would not commence until sometime after the first quarter of 1999.
The plaintiff's best evidence in this affirmative regard consists, first, of a document dated May 24, 1999 that reports Number Nine to have had a deficit of $1.053 million in net tangible assets as of February 27, 1999. The plaintiff additionally submits a document dated December 29, 1998 that reports Number Nine to have lost $990,438 in the month of October 1998; a document dated December 30, 1998 reporting a loss of $907,031 in the month of November 1998; and a document dated May 24, 1999 reporting a loss of $1.052 million in the month of January 1999. Adding that the document reporting results for the month of February 1999 shows a loss of $1.028 million, the plaintiff concludes that by mid March 1999, the defendants knew that Number Nine was losing about $1 million a month, and ought to have expected that, absent new developments, it would lose another $1 million or so in the month of March. In fact, a document dated May 17, 1999 reporting results for the month of March, in which Number Nine closed its $2 million sale to S3, shows net income in the amount of $1.141 million, which appears consistent with the prior trend. Altogether, the plaintiff contends that the foregoing evidence demonstrates that, by mid March 1999, Number Nine knew that the best it could hope for — even with the $3 million from KA Investments and the $2 million from S3 — was to have net tangible assets in the vicinity of $3 million by the end of the month. And in fact, Number Nine's 10Q for the first quarter of 1999, ending on April 3, 1999, reported $3.293 million in net tangible assets.
Adding the cumulative $5 million from KA Investments and S3 to Number Nine's deficit of $1.053 million in net tangible assets as of February 27, 1999, and subtracting $1 million in light of prior monthly losses.
The defendants seek to counter this evidence by contending that the plaintiff has failed to establish that the foregoing documents demonstrate the defendants had access to all of the reported information anytime before the Agreement was executed. However, testimony from both Ralph and Cimitile confirms the accuracy of the cited documents, and testimony from both Ralph and Najda provides a basis for finding that such financial information would have been available to them within two weeks of the end of the month in question.
I find in the cited documents support for a strong inference that the defendants knew that Number Nine would not be in compliance with the NASDAQ National Market's net tangible assets listing requirement as of March 31, 1999 (or at least were highly reckless in believing otherwise). The plaintiff's evidence might not be irrefutable, but for present purposes it need not be. Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir. 2002). All that is necessary is for the plaintiff to demonstrate "that [its] characterization of the events and circumstances as showing scienter is highly likely." Id. This the plaintiff has successfully accomplished. Accordingly, I decline to grant Number Nine summary judgment on its contention that the plaintiff has failed to make an adequate showing of scienter.
2. Loss Causation
The defendants finally contend, with respect to the plaintiff's Section 10(b) claim, that summary judgment should enter in Number Nine's favor because the plaintiff cannot demonstrate its alleged losses to have been caused by anything other than Number Nine's 10K filing for 1998.
This argument rests entirely on the fact that NASDAQ's April 6, 1999 letter informing Number Nine that it would be necessary for NASDAQ to review the company's eligibility for continued listing on NASDAQ's National Market was prompted by NASDAQ's examination of Number Nine's 10K for 1998, which reported $1.027 million in net tangible assets. Thus, the defendants contend, Number Nine's eventual delisting was caused by its 10K filing and nothing subsequent.
To be sure, NASDAQ's May 20, 1999 letter informing Number Nine that it would be delisted was sent only two days after Number Nine filed its 10Q for the first quarter of 1999, and does not reference that filing. Nevertheless, NASDAQ's decision cannot be characterized as based solely on Number Nine's 10K filing for 1998. Indeed, NASDAQ's April 6 correspondence can only be read as initiating a process with no predetermined result in which Number Nine was given ample opportunity to demonstrate its ability to achieve compliance. Faced with a similar situation in May 1998, Number Nine had managed to persuade NASDAQ — in part on the basis of the accelerated conversion of Silicon Graphics' $9 million investment from a loan to preferred stock — that, in the words of NASDAQ's August 5, 1998 letter, the company had "taken steps to achieve compliance with the net tangible assets requirement and [to] ensure that it will remain in compliance over the long term." Number Nine similarly sought to persuade NASDAQ of its future compliance with the National Market's net tangible assets listing requirement in its letter of April 13, 1999, in which among other things it reported the investment from KA Investments. As described in NASDAQ's May 20, 1999 response, the final determination to delist Number Nine was based on the view that Number Nine's April 13 submission only forecast compliance with the net tangible assets listing requirement in the second quarter of 1999, and did not "provide a definitive plan evidencing [the company's] ability" to achieve compliance even then.
Somewhat open to question might be the extent to which NASDAQ's determination was founded specifically on Number Nine's admission that it did not forecast compliance with the net assets listing requirement in the first quarter of 1999, notwithstanding the company's representation to KA Investments at Section 2(p) of the Agreement, and this might prove a fruitful avenue for the defendants to develop at trial. But NASDAQ's determination clearly was not based solely on Number Nine's 10K filing for 1998. Accordingly, I also decline to grant Number Nine summary judgment on its contention that the plaintiff cannot demonstrate its alleged losses to have been caused by anything other than Number Nine's 10K filing for 1998.
V. PLAINTIFF'S NEGLIGENT MISREPRESENTATION CLAIM (COUNT II)
I finally address the plaintiff's claim of negligent misrepresentation. By virtue of Section 4.8 of the Agreement, New York law governs "questions concerning the construction, validity, enforcement and interpretation of this Agreement . . ., without regard to the principles of conflicts of law thereof." Under New York law, claims involving fraud and deception in the sale of securities are governed by the Martin Act, N.Y.Gen.Bus. Law, art. 23-A. §§ 352 et seq., which vests New York's attorney general with exclusive authority to bring such claims. Granite Partners, L.P. v. Bear, Stearns Co. Inc., 17 F. Supp.2d 275, 291 (S.D.N.Y. 1998); see also, Castellano v. Young Rubicam, Inc., 257 F.3d 171, 190 (2nd Cir. 2001). Thus, it would appear that the plaintiff's common law claim is barred.
The principal obstacle to this conclusion, according to the plaintiff, is the treatment under Massachusetts law of allegations of fraud as falling outside of a contract's choice-of-law provision, given that these concern "the validity of the formation of the contract." Northeast Data Systems, Inc. v. McDonnell Douglas Computer Systems Company, 986 F.2d 607, 611 (1st Cir. 1993) (emphasis in original). What the plaintiff does not take into account, however, is the concurrent recognition under Massachusetts law that claims of negligent misrepresentation are not similarly exempt from contractual integration provisions, at least in situations involving commercial actors in rough bargaining parity with one another. See generally Sound Techniques, Inc. v. Hoffman, 50 Mass. App. Ct. 425, 429-434 (2000). In particular, Sound Techniques teaches that under such circumstances, it is only "intentional misconduct that justifies judicial intrusion upon contractual relationships[.]" Id. at 433.
Given the Agreement's inclusion of a complete integration clause as well as the sophistication of the parties, I cannot permit the plaintiff to escape the terms of the contract on the basis of a theory premised solely on a failure of due care. Accordingly, I will grant the defendants' motion for summary judgment with respect to the plaintiff's negligent misrepresentation claim.
VI. CONCLUSION
For the reasons set forth more fully above:
I GRANT the defendants' motion to amend their answers to assert affirmatively a statute of limitations defense to the plaintiff's Section 10(b) claim, and GRANT the defendants' motion for summary judgment with respect to the plaintiff's Section 10(b) claims against the individual defendants Najda, Burns and Ralph. I also GRANT the defendants' motion for summary judgment with respect to the plaintiff's negligent misrepresentation claim generally. I DENY the defendants' motion for summary judgment with respect to the plaintiff's Section 10(b) claim against Number Nine.