Opinion
Civil Action Nos. 2:99-0992, 2:99-1115, 1:02-0344.
April 3, 2006
MEMORANDUM OPINION AND ORDER
By Order entered March 31, 2006, the court GRANTED in part and DENIED in part the motions for summary judgment filed by defendant Thomas Dooley (doc. # 1116) and Nancy Vargo (doc. # 1136). The reasons for that decision follow.
I. The Claims Against Dooley and Vargo
A. Procedural BackgroundPlaintiffs filed their consolidated amended complaint on August 16, 2000. The complaint names some thirty defendants, among them Dooley and Vargo. A review of the complaint reveals the following pertinent allegations regarding Dooley and Vargo:
The claims against the majority of these defendants have been settled and/or dismissed.
• That defendant Quantum Capital Corporation, a registered broker-dealer based in Columbus, Ohio, who sold its business to Michael Patterson, Inc., knowingly and/or recklessly participated in the fraudulent dumping of Keystone stock, directly selling 6,000 shares of Keystone stock in July 1999 (Complaint, ¶ 45);
• That Vargo was, at all relevant times, the president and controlling shareholder of Defendant Quantum Capital Corporation (Complaint, ¶ 47);
• That Dooley was, at all relevant times, an officer and controlling shareholder of Defendant Quantum Capital Corporation (Complaint, ¶ 48);
• That the broker defendants, including Dooley and Vargo, concealed from plaintiffs the fact that "they were manipulating the public market for Keystone stock by agreeing to promote Keystone stock as a `must' buy and to conceal from Class members that the Broker Defendants, in reality, [knew that] the Keystone stock had little, if any, value" (Complaint, ¶ 146);
• That the broker defendants, including Dooley and Vargo, failed to disclose to the plaintiffs other material facts impacting Keystone stock's true value (i.e., "red flags") (Complaint, ¶¶ 147, 161); and
• That the broker defendants, including Dooley and Vargo, acted in concert with E.E. Powell, Wagner, and the Patterson defendants in "dumping" Keystone stock upon the plaintiffs, disregarding various "red flags" as to Keystone's actual financial condition (Complaint, ¶ 163).
Plaintiffs group Dooley and Vargo with other defendants, including them in allegations collectively referring to the "Broker Defendants" (Complaint, ¶ 52).
Plaintiffs initially argued that these factual allegations support the following claims against Dooley and Vargo:
1. Counts I and II: Violation of Rule 10b-5 promulgated under Section 10(b) of the Securities Exchange Act ( 15 U.S.C. § 78j(b));
2. Count III: Violation of Section 20(a) of the Exchange Act and Section 15 of the Securities Act ( 15 U.S.C. § 78t(a) and 15 U.S.C. § 77(o)),
3. Count V: Violation of the West Virginia Uniform Securities Act (W.Va. Code § 32-4-410(a)(2)), Ohio Rev. Code § 1707, and/or the Pennsylvania Securities Act ( 70 P.S. § 1-501),
4. Count VI: Violation of W. Va. Code § 32-4-410(b),
5. Count VII: Breach of Fiduciary Duty (aiding and abetting),
6. Count VIII: Fraud,
7. Count IX: Constructive Fraud,
8. Count X: Negligent Misrepresentation,
9. Count XI: Aiding and Abetting Tortious Conduct, and
10. Count XII: Civil Conspiracy.
By Order dated September 28, 2001, the court dismissed Counts I, II, V, VIII, IX, XI, and XII as to Dooley. In her motion for summary judgment, Vargo asks that the court dismiss these claims as to her for the same reasons they were dismissed as to Dooley. Plaintiffs contend that "the record in discovery demonstrates more than sufficient evidence to require denial of Vargo's motion to dismiss these claims as well." Plaintiffs' Memo at 2, n. 1. Notwithstanding this assertion, plaintiffs fail to demonstrate how the deficiencies noted in the court's earlier Order have been remedied. Accordingly, for the reasons expressed in the court's Order of September 28, 2001, Counts I, II, V, VIII, IX, XI, and XII of the Consolidated Amended Complaint are dismissed as to Vargo.
B. Factual Background
In or about 1996, Dooley, Vargo, defendant Michael Patterson, and another person purchased Diversified Capital, and formed a new broker/dealer called Quantum Capital Corp. In 1998, Patterson, Dooley, and Vargo entered into an "Agreement for Separation of Business Interests" (the "Separation Agreement"), pursuant to which Patterson purchased Diversified Capital (the retail trading division of Quantum) from Dooley and Vargo. The Separation Agreement included an "Exclusive Trading Agreement and Covenant Not to Compete" providing that Quantum would execute all of Diversified Capital's retail trades.
During the months of May, June and July of 1999, Dooley purchased approximately 6,500 shares of Keystone stock from the brokerage firms of Fahn Stock and E.E. Powell. Dooley sold all his shares of stock to Michael Patterson, Inc ("MPI"). In connection with his sales of stock to Keystone, Dooley sent information regarding Keystone, as published in the Walker's Manual of Unlisted Stocks, to some of the brokers employed by MPI. There is some inconsistency as to whether Dooley sent out any other information to the MPI brokers. According to Dooley (and there is no evidence in the record to contradict his assertion), at the time he provided Patterson and his brokers with the Walker's Manual information, he was not aware Keystone was being investigated by federal regulators. Vargo never bought or sold Keystone stock and, in fact, was not even aware that Dooley had been doing so until after the fact.
During his deposition, Patterson testified that "[b]efore we did work with the bank and took a look at a bank, we would get either the Sheshunoff and the Walker's Manual Report from Tom Dooley and anything else he could get online or, you know, from Edgar or anywhere else." Patterson Depo. at 38. Patterson's testimony does not necessarily create an inconsistency as he testified "we could get either" Sheshunoff or Walker's; i.e., it is possible Dooley sent only the Walker's Report as he testified. Dooley even testified there was a strong possibility he sent Sheshunoff; he couldn't specifically recall. Dooley Depo. at 92. In any event, whether he sent one or both is of no legal moment to the disposition of these claims.
MPI, Michael Patterson, and/or Diversified Capital (collectively "Patterson Defendants") sold the Keystone stock purchased from Dooley to approximately 142 of its retail customers. When Keystone was declared insolvent and the stocks declined, those customers sustained losses of nearly $5,000,000.00. The Patterson defendants told many of those customers that the bank was sound and that its stock was a safe investment. There is no evidence that Dooley or Vargo had any contact with these customers.
II. Legal Framework and Analysis
Summary Judgment StandardRule 56 of the Federal Rules of Civil Procedure provides:
The judgment sought shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.
The moving party has the burden of establishing that there is no genuine issue as to any material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). This burden can be met by showing that the nonmoving party has failed to prove an essential element of the nonmoving party's case for which the nonmoving party will bear the burden of proof at trial. Id. at 322. If the moving party meets this burden, according to the United States Supreme Court, "there can be `no genuine issue as to any material fact,' since a complete failure of proof concerning an essential element of the nonmoving party's case necessarily renders all other facts immaterial." Id. at 323.
Once the moving party has met this burden, the burden shifts to the nonmoving party to produce sufficient evidence for a jury to return a verdict for that party.
The mere existence of a scintilla of evidence in support of the plaintiff's position will be insufficient; there must be evidence on which the jury could reasonably find for the plaintiff. The judge's inquiry, therefore, unavoidably asks whether reasonable jurors could find, by a preponderance of the evidence, that the plaintiff is entitled to a verdict. . . .Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 252 (1986). "If the evidence is merely colorable, or is not significantly probative, summary judgment may be granted." Id. at 250-51. The opposing party must demonstrate that a triable issue of fact exists and may not rest upon mere allegations or denials. Id. at 252.
Defendants herein contend that there are no genuine issues of material fact in dispute and, therefore, summary judgment in their favor is warranted. Plaintiff, however, argues that there are genuine issues of material fact for the jury to decide.
III. Analysis
A. Counts III and VI
Count III of the complaint alleges that defendants violated Section 20(a) of the Exchange Act and Section 15 of the Securities Act, codified at 15 U.S.C. § 78t(a) and 15 U.S.C. § 77o, respectively. Section 78t(a) provides that "[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." Section 77o provides that "[e]very person who, by or through stock ownership, agency or otherwise, . . . controls any person liable under sections 77k or 77l of [Title 15], shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist." These provisions establish what is called "controlling person" liability.
Count VI alleges that defendants violated West Virginia Code § 32-4-410(b) which provides that:
Every person who directly or indirectly controls a seller liable under subsection (a), every partner, officer or director of such a seller, every person occupying a similar status or performing similar functions, every employee of such a seller who materially aids in the sale, and every broker-dealer or agent who materially aids in the sale are also liable jointly and severally with and to the same extent as the seller, unless the nonseller who is so liable sustains the burden of proof that he did not know, and in exercise of reasonable care could not have known, of the existence of the facts by reason of which the liability is alleged to exist.
W. Va. Code § 32-4-410(b). Although the federal and state statutes are not identical, the parties have agreed that the control person liability provision of the West Virginia securities fraud statute is sufficiently analogous to the federal securities fraud laws such that the analysis used by the court to determine control person liability should be the same. See Baker v. First Wheat Securities, 643 F. Supp. 1420, 1434 n. 1 (S.D.W. Va. 1986) (holding that Rule 10b-5 and West Virginia Code § 32-4-410(b) were sufficiently analogous for statute of limitations purposes).
To establish a prima facie case of controlling-person liability, a plaintiff must show the following: (1) a primary violation by the controlled person; (2) control of the primary violator by the targeted defendant; and (3) the controlling person's culpable participation in the primary violator's actions. See S.E.C. v. First Jersey Securities, Inc., 101 F.3d 1450, 1472 (2d Cir. 1996), cert. denied, 522 U.S. 812 (1997). Control over a primary violator can be established by showing that the defendant possessed "the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise." Id. at 1472-73 (quoting 17 C.F.R. § 240.12b-2). The Seventh Circuit has viewed the statute as "remedial, to be construed liberally, and requiring only some indirect means of discipline or influence short of actual direction to hold a control person liable." Harrison v. Dean Witter Reynolds, Inc., 974 F.2d 873, 880-81 (7th Cir. 1992) (quotations and citations omitted), cert. denied, 509 U.S. 904 (1993).
In order to prevail on a securities fraud claim under Section 10(b) and Rule 10b-5, the plaintiff carries the burden of proving "(1) the defendant made a false statement or omission of material fact (2) with scienter (3) upon which the plaintiff justifiably relied (4) that proximately caused the plaintiff's damages."Phillips v. LCI Int'l, Inc., 190 F.3d 609, 613 (4th Cir. 1999) (citing Hillson Partners Ltd. Partnership v. Adage, Inc. 42 F.3d 204, 208 (4th Cir. 1994)).
In its attempt to defeat defendants' motions for summary judgment, plaintiffs' brief contains much in the way of speculation, conjecture, and argument but very little in the way of evidence. In any event, one thing is clear: no one alleges that Dooley or Vargo were control persons of the Patterson entities. Accordingly, for them to be found liable on Counts III and VI, plaintiffs would have to show: (1) a primary violation of the securities laws by Quantum; (2) control of Quantum by Dooley and Vargo; and (3) Dooley and Vargo's culpable participation in Quantum's actions.
It is clear that plaintiffs' claims against defendants on these two counts must fail because they cannot demonstrate a primary violation of the securities laws by Quantum. In order to withstand summary judgment, plaintiffs are required to show that they relied upon a misrepresentation attributable to Quantum, its officers or agents. See Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 511 U.S. 164, 180 (1994). Elaborating on this requirement, the United States Court of Appeals for the Fourth Circuit has stated in this very case:
[defendant] properly notes that in order to rely on presumed reliance flowing from an application of the fraud-on-the-market theory, the plaintiffs must demonstrate, among other things, that the defendant made a public misrepresentation. It also notes that such a misrepresentation must be directly attributable to [defendant] and
because liability under § 10(b) of the Securities Exchange Act and Rule 10b-5 does not include aiding and abetting liability. InCentral Bank, the Supreme Court observed that aiding and abetting liability would, if recognized, permit plaintiffs to circumvent the reliance requirement because a defendant could be liable without any showing that the plaintiff relied upon the aider and abettor's statements or actions. Gariety v. Grant Thornton, LLP, 368 F.3d 356, 369 (4th Cir. 2004) (internal citations and quotations omitted); see also Glaser v. Enzo Biochem, Inc., 126 Fed. Appx. 593, 598-99 (4th Cir. 2005) ("Following Central Bank, we have stated that a misrepresentation must be directly attributable to [the defendant] and not to some other person.") (internal citations and quotations omitted) (unpublished).
Even viewing the evidence in the light most favorable to plaintiffs, it appears that, at best, plaintiffs could show that Quantum, Dooley, and/or Vargo aided and abetted the Patterson defendants in a primary violation of the securities acts. However, aiding and abetting liability is precluded by Central Bank. Central Bank of Denver, 511 U.S. at 177. There is no evidence that Dooley or Vargo had any direct communication with the plaintiffs herein concerning Keystone stock and the plaintiffs have stated that they did not rely on Dooley in making their decision to purchase stock. While there is no requirement of direct communication in order to establish a primary violation of the securities laws, see Benedict v. Cooperstock, 23 F. Supp. 2d 754, 758 (E.D. Mich. 1998), reliance directly attributable to the defendants must be proven. See, e.g., Wright v. Ernst Young L.L.P., 152 F.3d 169, 175 (2d Cir. 1998) ("[A] secondary actor cannot incur primary liability under the [Exchange] Act for a statement not attributed to that actor at the time of its dissemination. Such a holding would circumvent the reliance requirements of the Act, as reliance only on representations made by others cannot itself form the basis of liability. Thus, the misrepresentation must be attributed to that specific actor at the time of public dissemination, that is, in advance of the investment decision."), cert. denied, 525 U.S. 1104 (1999); see also Great Neck Capital Appreciation Investment Partnership, L.P. v. Price water house Coopers, L.L.P., 137 F. Supp. 2d 1114, 1120 (E.D. Wisc. 2001) ("[A] secondary actor must actually make, author, publicly adopt or allow its name to be associated with a misleading statement in order for it to be held liable as a primary violation of § 10(b) and Rule 10b-5.").
Finally, that plaintiffs argue Dooley and Vargo violated the Exchange Act in that they "employed devices, schemes and artifices to defraud; made untrue statements of material facts or omitted to state material facts necessary in order to make statements made, in light of the circumstances under which they were made, not misleading, or engaged in acts, practices and a course of business that operated as a fraud or deceit upon the purchasers of Keystone stock," does not defeat defendants' summary judgment motions. The facts plaintiffs offer in support of this argument are largely irrelevant, including such things as: 1) the Patterson defendants and Quantum were housed in the same building; 2) Dooley had been the subject of regulatory investigations and fines (not related to Keystone); 3) Dooley knew that the Patterson defendants' customer base consisted largely of elderly or retired individuals; and 4) Patterson had engaged in misconduct such that he was forced to surrender his broker's license.
Market manipulation comprises a class of conduct prohibited by Section 10(b), which typically involves `practices such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting the market activity. A plaintiff asserting a market manipulation claim must allege direct participation in a scheme to manipulate the market for securities.Fezzani v. Bear, Stearns Co., Inc., 384 F. Supp. 2d 618, 641 (S.D.N.Y. 2004) (internal citations and quotations omitted). Furthermore, a complaint alleging market manipulation must state what manipulative acts were performed, which defendants performed them, when the manipulative acts were performed, what effect the scheme had on the market for the securities at issue, and how plaintiffs were harmed by the manipulation. See id. at 642-43. As discussed above, under a regime where aiding and abetting liability exists, plaintiffs' market manipulation claims against Dooley and Vargo might survive. However, because they have not stated a cause of action against Dooley and Vargo for a primary violation, the court will grant defendants' motion for summary judgment as to the market manipulation claims.
B. Breach of Fiduciary Duty
Count VII of the complaint alleges various bad acts by the Patterson defendants in connection with the sale of Keystone stock to plaintiffs. According to plaintiffs, as a result of these bad acts, the Patterson defendants violated their fiduciary duty to the plaintiffs. Plaintiffs allege that Dooley and Vargo, among others, knowingly provided substantial assistance to the Patterson defendants' breach of fiduciary duty, and, therefore, aided and abetted the Patterson defendants' breach of fiduciary duty, making them jointly liable.
In Price v. Halstead, 177 W. Va. 592, 598 (1987), West Virginia's highest court recognized the rule found in Section 876(b) of the Restatement (Second) of Torts (1979): "`For harm resulting to a third person from the tortious conduct of another, one is subject to liability if he . . . (b) knows that the other's conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other so to conduct himself.'"
Comment d. to Section 876(b) of the Restatement identifies six criteria to use when determining whether a person shall be liable for assisting or encouraging a tort. They include: 1) the nature of the act encouraged; 2) the amount of assistance given by the defendant; 3) the defendant's presence or absence at the time of the tort; 4) the defendant's relation to the other tortfeasor; 5) the defendant's state of mind; and 6) the foreseeability of the harm that occurred. In adopting the Restatement factors, the court went on to state they are not necessarily exhaustive. Courtney v. Courtney, 186 W. Va. 597, 605 (1991).
There are disputed issues of material fact that preclude summary judgment on this count, including but not limited to: 1) whether the Patterson defendants breached their fiduciary duty; and 2) if they did breach that duty, did Dooley and Vargo aid and abet them in doing so. There is no dispute that a relationship existed between Vargo, Dooley and the Patterson defendants for executing sales of Keystone stock. However, what remains in dispute is whether Vargo and Dooley knew the Patterson defendants were in breach of their fiduciary duty (if they were) and, if so, did they aid and abet that breach. The record is not sufficiently developed on this point and, accordingly, the motion for summary judgment as to Count VII is DENIED.
C. Negligent Misrepresentation
Count X of the complaint alleges that Dooley and Vargo negligently misrepresented the financial condition of Keystone Bank, knowing that the information would be relied upon by purchasers of Keystone stock. In discussing the elements of a negligent misrepresentation claim, both parties have relied on the Restatement (Second) of Torts § 552. That section provides:
One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.
Defendants argue that plaintiffs cannot prevail on a negligent misrepresentation claim as to them because plaintiffs cannot show that Dooley or Vargo made representations of any kind to plaintiffs. Defendants also contend that plaintiffs cannot show that the plaintiffs relied on any information provided by Dooley.
There is no evidence in the record to suggest that Dooley or Vargo made any representations directly to plaintiffs. That being the case, in their depositions, plaintiffs indicated that they did not rely on any information received from Dooley in making the decision to purchase Keystone stock. Indeed, most if not all of the plaintiffs stated that they didn't even know who Dooley was until after they purchased the stock.
However, there is evidence in the record that Dooley made representations regarding the soundness of Keystone stock to the Patterson defendants. Furthermore, there is evidence that the plaintiffs relied upon information received from the Patterson defendants in deciding to purchase the stock.
Section 552 of the Restatement goes on to state that liability "is limited to loss suffered (a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it. . . ." Comment g. to the Restatement also provides that "direct communication of the information to the person acting in reliance upon it is not necessary." In defining the contours of a negligent misrepresentation claim, Comment h. states that
it is not required that the person who is to become the plaintiff be identified or known to the defendant as an individual when the information is supplied. . . . It is sufficient . . . that the maker supplies the information for repetition to a certain group or class of persons and that the plaintiff proves to be one of them, even though the maker never had heard of him by name when the information was given.
Restatement 2d of Torts § 552, comment h.
Based on the foregoing, courts have determined that a person making a representation may be liable to a third party who relies on the representation to his or her detriment. See, e.g., Eastern Steel Constructors, Inc. v. City of Salem, 209 W. Va. 392, 399-401 (2001) (design professional, such as an architect or engineer, owes a duty of care to a contractor, who has been employed by the same project owner as the design professional and who has relied upon the design professional's work product in carrying out his or her obligations to the owner, notwithstanding the absence of privity of contract between the contractor and the design professional, due to the special relationship that exists between the two); First National Bank of Bluefield v. Crawford, 182 W. Va. 107, 110 (1989) (accountant is liable for negligent preparation of financial report to not only person for whom report was prepared but also to those he knows will be receiving and relying on report); see also Crawford, 182 W. Va. at 110, n. 6 and numerous cases cited therein.
In the instant case, there is no dispute that Dooley sold Keystone stock to the Patterson defendants and made some sort of representation regarding the soundness of the stock. Furthermore, there is evidence that Dooley knew Patterson was going to resell the stock to investors such as plaintiffs. One could infer that Dooley should have known that the Patterson entities would relay the information he provided to potential buyers of the stock. While the evidence is certainly thin, there are material questions of fact regarding the negligent misrepresentation claims and, accordingly, defendants' motions as to this claim must be DENIED.
IV. Conclusion
For the reasons articulated above, the motions for summary judgment of Thomas Dooley and Nancy Vargo were GRANTED in part and DENIED in part as follows:
1. Defendants' motions for summary judgment as to Counts IV and VI are GRANTED.
2. The motions for summary judgment as to Counts VII and X are DENIED.
3. As to Vargo, Counts I, II, V, VIII, IX, XI, and XII of the Consolidated Amended Complaint are dismissed.
The Clerk is directed to send copies of this Memorandum Opinion and Order to all counsel of record.