Summary
holding that scienter must exist at the time the allegedly fraudulent statement occurred
Summary of this case from In re Pilgrim's Pride Corporation Securities LitigOpinion
Civil Action No. 3:00-CV-2553-P
July 3, 2002
MEMORANDUM OPINION AND ORDER
Now before the Court for its consideration are:
1. Defendants Zero.Net, Inc. and Andrew L. Evans' Motion to Dismiss the Second Amended Complaint, filed October 12, 2001;
2. The Weinstock Defendants' Motion to Dismiss Second Amended Complaint, filed October 19, 2001;
3. Defendant Dominion Income Management Corp.'s Motion to Dismiss the Second Amended Complaint, filed October 23, 2001; and
4. Plaintiff's Motion for Leave to File Supplemental Response to Zero.Net Defendants' Motion to Dismiss, filed February 7, 2002.
All references and citations herein to "Complaint" refer to Plaintiff's Second Amended Complaint.
Plaintiff filed his response brief on November 1, 2001 and Evans and Zero.Net filed their reply brief on November 16, 2001.
Plaintiff filed his response brief on November 8, 2001 and the Weinstock Defendants filed their reply brief on November 26, 2001.
Plaintiff filed his response brief on November 13, 2001 and Dominion Income Management Corp. filed its reply brief on November 29.
Defendants Evans and Zero.Net filed their response brief on February 26, 2002. Plaintiff did not file a reply brief.
After careful consideration of the Parties' briefing and the applicable law, the Court hereby GRANTS IN PART and DENIES IN PART Defendants Zero.Net, Inc. and Andrew L. Evans' Motion to Dismiss the Second Amended Complaint, GRANTS IN PART and DENIES IN PART the Weinstock Defendants' Motion to Dismiss Second Amended Complaint, GRANTS IN PART and DENIES IN PART Defendant Dominion Income Management Corp.'s Motion to Dismiss the Second Amended Complaint, and DENIES Plaintiff's Motion for Leave to File Supplemental Response to Zero.Net Defendants' Motion to Dismiss. Plaintiff is given fifteen (15) days to replead his Complaint in compliance with this Order, Rule 9(b), the PSLRA, and all other applicable law.
PROCEDURAL HISTORY
This securities fraud case was originally filed in this Court in November of 2000. On December 21, 2000, Plaintiff William Kunzweiler ("Plaintiff") filed his First Amended Complaint and shortly thereafter, all of the named defendants filed motions to dismiss the First Amended Complaint. On July 16, 2001, the Court granted the motions of defendants Communicade, Inc., John D. Wren, and Dean M. Willard. The Court denied the motions of Defendants Dominion Income Management Corp. ("Dominion"), James B. Weinstock ("J. Weinstock"), Davis Weinstock ("D. Weinstock"), Andrew Evans ("Evans"), and Zero.Net, Inc. ("Zero.Net").
On September 24, 2001, Plaintiff filed his Second Amended Complaint. The remaining Defendants — Zero.Net, Evans, J. Weinstock, D. Weinstock, and Dominion — filed motions to dismiss the federal securities claims alleged against them for failure to plead scienter with the requisite particularity, in light of the Fifth Circuit's recent ruling in Natheson v. Zonagen Inc., 267 F.3d 400 (5th Cir. 2001). The Court hereby determines whether Plaintiff's Second Amended Complaint satisfies the pleading requirements of Rule 9(b), the PSLRA, and the Fifth Circuit's rulings in Natheson and ABC Arbitrate Plaintiffs Group v. Tchuruk, — F.3d —, 2002 WL 975299 (5th Cir. 2002) and whether Plaintiff's state law claims can survive dismissal.
The movants also sought dismissal of the state claims alleged against them.
FACTS
According to the Second Amended Complaint, on April 19, 2000, Plaintiff invested nearly $1,000,000.00 in Zero.Net. (Compl. ¶¶ 8, 16.) After losing a significant portion of his investment, Plaintiff filed this lawsuit accusing Defendants of disseminating false, misleading, and deceptive information about the company with the intention of inducing potential investors, including Plaintiff; to invest in Zero.Net. Zero.Net allegedly made these misrepresentations and omissions in its Private Placement Memorandum ("PPM") and in oral statements made by certain Defendants.
According to the Complaint, Zero.Net was formed in April 1999 as an "`emerging Internet holding company"' that takes "`strategic equity positions"' in internet companies. (Compl. ¶ 9.) At the time the PPM was issued, Defendant Evans was Zero.Net's Chairman and Chief Executive Officer, J. Weinstock served as its President and Chief Operating Officer, and D. Weinstock served as a Director of Zero.Net. (Compl. ¶ 9.)
Defendant Dominion allegedly is an investment firm controlled by Evans. (Compl. ¶ 10.) According to the PPM, beginning in August 1999, Dominion agreed to loan Zero.Net up to $20,000,000.00 (the "Dominion Loan"). (Compl. ¶ 10.) As of January 31, 2000, the principal and interest outstanding on the Dominion Loan was approximately $3,859,000.00. (Compl. ¶ 10.)
The PPM solicited a private offering of up to 5,000,000 shares in the stock of Zero.Net. The PPM purportedly touted the qualifications of Zero.Net's employees and the services they provided as well as Zero.Net's investment in a company known as Envision Development Corporation. (Compl. ¶ 12.)
The thrust of Plaintiff's argument is that Evans and Zero.Net induced Plaintiff to invest in Zero.Net with the intention of using his investment, not to further the purported business plan, but to pay off debt owed to Dominion, a company controlled by Evans. (See Compl. ¶ 14, 18.) Plaintiff contends that Evans made certain false representations (or omissions) to Plaintiff to induce him to make the investment. Plaintiff allegedly made his $1 million stock purchase in reliance on statements made in the PPM and on oral statements and omissions made by Defendants.
DISCUSSION
To the extent the issues and arguments addressed herein were raised by movants in their motions to dismiss the First Amended Complaint, the Court's Order of July 16, 2001 did not specifically address these issues.
A. SECURITIES FRAUD PLEADING STANDARDS UNDER THE PSLRA.
Section 10(b) provides in relevant part: "It shall be unlawful for any person, directly or indirectly . . . (b) To use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j(b). Rule 10b-5, which was promulgated by the SEC pursuant to § 10(b) states as follows:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.17 C.F.R. § 240.10b-5. In order to state a claim under section 10(b) of the 1934 Act and Rule 10b-5, a plaintiff must allege, in connection with the purchase or sale of securities, "(1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which plaintiff relied (5) that proximately caused [the plaintiffs] injury." Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994).
In 1995, in response to what was perceived as the rampant abuse of federal securities litigation, Congress passed the Private Securities Litigation Reform Act ("PSLRA"). See ABC Arbitrage Plainitffs Group v. Tchuruk, F.3d —, 2002 WL 975299, at *12 (5th Cir. May 13, 2002); see S. Rep. No. 104-98 (1995), reprinted in 1995 U.S.C.C.A.N. 679. The purpose of the PSLRA was to restrict abusive practices such as: (1) filing lawsuits against issuers of securities in response to any significant change in stock price, independent of the defendant's culpability; (2) targeting "deep pocket" defendants; and (3) abusing the discovery process to induce settlements. See S. Rep. No. 104-98 (1995), reprinted in 1995 U.S.C.C.A.N. 679.
1. Pleading Fraud with Particularity
The PSLRA requires plaintiffs to specify in their complaint "each statement or omission alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief; the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1). The effect of the PSLRA in this respect is to incorporate the standard for pleading fraud under Rule 9(b). See Natheson, 267 F.3d at 412. To satisfy the Rule 9(b) pleading requirement, a plaintiff must specify (1) the statement alleged to be misleading/fraudulent; (2) the speaker of the alleged fraudulent statement; (3) when and where the alleged fraudulent statement was made; (4) with particularity the contents of the false representations; (5) with particularity what the person making the misrepresentation obtained thereby; and (6) the reason(s) why the statement is misleading/fraudulent. ABC, 2002 WL 975299, at *9 The PSLRA mandates that the court shall dismiss a complaint on motion of any defendant if the complaint does not meet this pleading requirement. See 15 U.S.C. § 78u-4(b)(3)(A).
"In any private action arising under this chapter, the court shall, on the motion of any defendant, dismiss the complaint if the requirements of paragraphs (1) and (2) are not met." 15 U.S.C. § 78u-4(b)(3)(A).
2. Pleading Scienter with the Requisite Particularity.
With respect to the Rule 10(b) requirement that a defendant must have made its misrepresentation with scienter, the PSLRA heightened the Rule 9(b) pleading standard by requiring a stronger showing of fraudulent intent. The PSLRA provides in relevant part: "the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2) (emphasis added). The PSLRA also provides that if a plaintiff does not meet this requirement, the district court "shall," on defendant's motion, "dismiss the complaint." 15 U.S.C. § 78u-4(b)(3),
Prior to the Natheson holding, the Fifth Circuit had not definitively addressed the PSLRA's intended scienter pleading standard, that is, the "required state of mind" necessary to properly plead a securities fraud case. In Natheson, the Fifth Circuit joined the First, Third, Sixth, and Eleventh Circuits to find that a plaintiff must plead facts giving rise to a strong inference that the defendant acted with "severe recklessness" in making a misrepresentation. See Natheson, 267 F.3d at 408-09.
The Natheson court continued its analysis by outlining the types of facts that must be alleged to satisfactorily plead "severe recklessness." The court held that a plaintiff must plead specific facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness, however, allegations of motive and opportunity, standing alone, are insufficient to meet the pleading requirement. See Natheson, 267 F.3d at 410.
The Natheson court adopted the reasoning of the Sixth Circuit in Comshare, when it held that "`evidence of a defendant's motive and opportunity to commit securities fraud does not constitute `scienter' for the purposes of [section] 10(b) or Rule 10b-5 liability' . . . instead . . . motive and opportunity [can] be `relevant' to pleading scienter and "may, on occasion, give rise to the level of creating a strong inference of reckless or knowing conduct."' Natheson, 267 F.3d at 410-11 (citing In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 551 (6th Cir. 1999)). The Natheson court concluded its analysis by stating that "what must be alleged is not motive and opportunity as such but particularized facts giving rise to a strong inference of scienter . . . We conclude that simply because motive and opportunity is alleged does not of itself automatically and categorically mean that the necessary strong inference of scienter is present." Id. at 412.
B. EVANS AND ZERO.NET'S MOTION TO DISMISS.
1. Federal Securities Claims.
The Second Amended Complaint identifies a series of misrepresentations and omissions purportedly made by certain Defendants, both in the PPM or orally. We now consider each of the alleged misstatements and omissions in turn.
a. Misrepresentations Allegedly Made in the PPM
(1) Zero.Net's Investment in Envision. Plaintiff contends that the PPM valued Zero.Net's investment in Envision Development Corporation at $121 million, which was overstated, and thus the PPM misrepresented the value of Zero.Net's internet portfolio. (Compl. ¶ 15(j).) Plaintiff maintains that although Envision Development Corporation was purportedly publicly traded, Evans, Dominion, Zero.Net and others within their control owned substantially all of Envision Development Corporation's stock. (Compl. ¶ 12.) Plaintiff contends that Evans and Zero.Net failed to disclose Evans' and Dominion's control of Envision Development Corporation. (Compl. ¶ 15(j).) Because of their alleged control, Plaintiff contends that Envision Development Corporation's stock value of $121 million was materially overstated in the PPM, "which likewise materially overvalued Zero.Net." (Compl. ¶ 12.)
The alleged misrepresentations (i.e. the falsely stated values of the investment and the company) are premised solely on Plaintiff's allegation that Evans, Zero.Net, and Dominion had control of Envision Development Corporation. However, Plaintiff has pled this allegation on information and belief; and has failed to state with particularity any facts on which that belief is formed, as required by the PSLRA. See 15 U.S.C. § 78u-4(b)(1)(B).
The PSLRA specifies that when making an allegation regarding a misrepresentation or omission based on information and belief; a plaintiff must state with particularity all facts on which that belief is formed. See 15 U.S.C. § 78u-4(b)(1)(B). Plaintiff has failed to allege a single fact to support its allegation that Evans, Zero.Net, and Dominion had control of Envision Development Corporation. Because this information-and-belief allegation is not properly pled, Plaintiff cannot rely on it to make the inferential leap that Zero.Net's investment in Envision Development Corporation was overvalued.
The Fifth Circuit in ABC Arbitrage Plaintiffs Group v. Tchuruk, — F.3d —, 2002 WL 975299 (5th Cir. 2002) recently outlined in detail the requirements for pleading on information and belief.
The PSLRA also requires a plaintiff to specify in his complaint "the reason or reasons why [a] statement is misleading." 15 U.S.C. § 78u-4(b)(1)(B); see Natheson, 267 F.3d at 412. Yet Plaintiff has failed to specify how the stated investment values are untrue; in other words, he has failed to provide specific facts explaining why the values, as represented, were false. Rather, he relies on conclusory assertions, without any factual support, that the investment amount was overvalued and the amount of Zero.Net's investment portfolio was overstated. (See Compl. ¶¶ 12, 15(j).)
Plaintiff is also required by the PSLRA to plead with particularity facts giving rise to a strong inference that Evans made this alleged misrepresentation intentionally or with severe recklessness. In other words, Plaintiff is required to plead specific facts that constitute strong circumstantial evidence that Evans made this alleged misrepresentation consciously or with severe recklessness.
With respect to this representation, Plaintiff has not pled any facts in the Complaint that indicate that Evans and Zero.Net knew the stated values of the Envision Development Corporation investment and Zero.Net were not true or that they were severely reckless in not knowing of their falsity. As stated supra, the information-and-belief allegation that Evans, Zero.Net, and Dominion had control of Envision Development Corporation is not pled properly and is not considered a fact giving rise to a strong inference that Evans and Zero.Net made these representations with scienter. Therefore, Plaintiff has failed to meet the pleading requirements of the PSLRA and § 10(b).
Accordingly, the allegation(s) that Defendants misrepresented the value of Zero.Net's investment in Envision Development Corporation and the value of Zero.Net's internet portfolio is dismissed from the Complaint without prejudice.
(2) Zero.Net's Alleged Sham Business Plan. Plaintiff alleges that Zero.Net falsely represented that its business plan was to work as a partner with its internet companies to provide them with strategic guidance, mentoring, marketing, and branding services. (See Compl. ¶¶ 12, 25(a), (c).) Plaintiff contends that Zero.Net's officers, directors, and management had no intention of following through with the stated business plan. (Compl. ¶ 25(a).)
Plaintiff bases this conclusion on an information-and-belief allegation that the Dominion Loan was repaid. This single fact leads Plaintiff to the conclusion that the stock offering was used as a vehicle to pay off the money owed by Zero.Net to Dominion, not to fund the continuing operations and fulfill the business plan of Zero.Net. See Compl. ¶¶ 14, 18, 25(c).)
The only "fact" that is pled in support of Plaintiff's conclusion that the stated business plan was false, is an information-and-belief allegation that the Dominion Loan was repaid. (See Compl. ¶ 14.) Because Plaintiff has pled this allegation on information and belief; he is required under the PSLRA to state with particularity all facts on which that belief is formed. See 15 U.S.C. § 78u-4(b)(1)(B). Plaintiff has failed to allege a single fact to support his allegation that Zero.Net paid off the Dominion Loan. Because this information-and-belief allegation is not properly pled, Plaintiff cannot rely on it to make the inferential leap that the stock offering was used as a vehicle to pay off the debt, rather than to further Zero.Net's stated business plan.
At most, this allegation is a "motive and opportunity" allegation that does not meet the PSLRA's scienter pleading requirements, as set forth in Natheson v. Zonagen, Inc., 267 F.3d 400, 409 (5th Cir. 2001). The Complaint alleges that Evans stood to gain financially by using Plaintiff's investment in Zero.Net to "rid himself of debt owing from Zero.Net to Dominion," an entity that Evans allegedly owned, and by "direct[ing] Zero.Net's cash into EDC, a company in which Evans and Dominion allegedly had a significant investment and over which they allegedly had control." (Compl. ¶ 14.) This allegation, at most, is a motive-and-opportunity allegation suggesting that Evans had a financial motive and, as an officer of the company, had the opportunity to engage in the alleged conduct and make the alleged misrepresentation. The Natheson court explicitly held that "simply because motive and opportunity is alleged does not of itself automatically and categorically mean that the necessary strong inference of scienter is present." Natheson, 267 F.3d at 412. Because Plaintiff has failed to plead any other particularized facts that would, when combined with these motive-and-opportunity allegations, give rise to a strong inference of scienter, the Court finds that these allegations have not been properly pled.
Accordingly, the allegation that Defendants misrepresented Zero.Net's business plan is dismissed from the Complaint without prejudice.
b. Alleged Oral Misrepresentations.
Plaintiff also lists in his Complaint a series of alleged oral misrepresentations that were made to him to induce him to invest in Zero.Net.
(1) Evans' Management Role. Plaintiff contends that "Evans [mis]represented that he would personally continue to manage and operate Zero.Net on an ongoing basis." (Compl. ¶ 15(a).) In support of this conclusion, Plaintiff maintains that "Evans promptly left Zero.Net" even though the PPM stated that officers would be "elected annually." (Compl. ¶ 14.)
Elsewhere in the Complaint, Plaintiff attempts to convert this alleged misrepresentation into an omission when he alleges that Evans and ZeroNet failed to disclose that Evans planned to resign immediately from serving as officer or director of Zero.Net. (Compl. ¶ 15(f).)
Plaintiff is required by the PSLRA to plead with particularity facts giving rise to a strong inference that Evans made this alleged misrepresentation intentionally or with severe recklessness. Plaintiff alleges that during the period of March — April 2000, Evans told Plaintiff that he would "personally continue to manage and operate Zero.Net on an ongoing basis." (Compl. ¶ 15(a).) Plaintiff also has pled that Evans was the CEO of Zero.Net as of the date of issuance of the PPM, which was March 6, 2000. (Compl. ¶¶ 8, 9.) Then he alleges that J. Weinstock was the CEO of Zero.Net "by March 2000." (Compl. ¶ 15.) The Court presumes that Plaintiff intended to plead that J. Weinstock became CEO after March 6, but in any event, no later than April 26, 2000. (Compl. ¶ 17.)
The fact that Evans resigned or was terminated as CEO of Zero.Net so soon after the time Evans allegedly told Plaintiff he would be managing and operating Zero.Net on an ongoing basis gives rise to a strong inference that Evans knew or was reckless in not knowing that this representation was untrue. This brief time period between the representation and Evans' termination or resignation as CEO indicates that at the time Evans told Plaintiff that he "would personally continue to manage and operate Zero.Net on an ongoing basis," he knew the statement was not true or was severely reckless in not knowing of its falsity. Plaintiff has sufficiently pled that Evans made this representation with scienter and therefore, Plaintiff has met the pleading requirements of the PSLRA and § 10(b) with regard to this statement.
Therefore, this ground for dismissal is denied.
(2) Zero.Net's Investment in Plaintiff's Business. Plaintiff contends that "Evans and Zero.Net represented that Evans, Zero.Net, and/or Dominion would engage in a reciprocal $1,000,000-plus investment in a business partially owned by Kunzweiler." (Compl. ¶ 15(b).) The PSLRA requires a plaintiff to specify in his complaint "the reason or reasons why [a] statement is misleading." 15 U.S.C. § 78u-4(b)(1)(B); see Natheson, 267 F.3d at 412. Plaintiff has failed to specify how this statement is untrue. There is no allegation that Evans, Zero.Net, and/or Dominion failed to invest in the business partially-owned by Kunzweiler. Furthermore, Plaintiff has not pled any specific facts that constitute strong circumstantial evidence that Evans and Zero.Net made this alleged misrepresentation consciously or with severe recklessness. Plaintiff has failed to properly plead scienter because he has failed to allege specific facts indicating that Evans and Zero.Net knew at the time the representation was made that they were not going to invest in the business or that they were reckless in not knowing they were not going to invest. See Hayley v. Parker, NO. CIV.01-0069, 2002 WL 925322, at *3 (C.D. Cal. Mar 15, 2002) (plaintiff must establish "the defendant's scienter at the time of the misrepresentation or omission"(emphasis added)); In re 2TheMart.com, Inc. Sec. Litig., 114 F. Supp.2d 955, 959 (C.D. Cal. 2000) (same).
In order to state a claim under § 10(b), a plaintiff must also allege that he relied on the alleged misrepresentation when making his investment decision. See Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994). Nowhere in the Complaint does Plaintiff claim that he relied on this representation when making his decision to invest in Zero.Net. Because this representation is unrelated to the alleged fraudulent scheme that was being perpetrated by Evans and Zero.Net, Plaintiff must demonstrate that he relied on this representation in particular in making his investment decision. Plaintiff has failed to do so.
Accordingly, the allegation that Evans and Zero.Net misrepresented that Evans, Zero.Net, and/or Dominion would engage in a $1,000,000-plus investment in a business partially owned by Kunzweiler is dismissed from the Complaint without prejudice.
(3) Employment of Plaintiff's Employees. Plaintiff alleges that Evans and Zero.Net misrepresented that they would employ two of Kunzweiler's employees. (Compl. ¶ 15(c).) Again, the PSLRA requires a plaintiff to specify in his complaint "the reason or reasons why [a] statement is misleading." 15 U.S.C. § 78u-4(b)(1)(B); Natheson, 267 F.3d at 412. Plaintiff has failed to specify how this statement is untrue. There is no allegation that Evans, and/or Zero.Net failed to employ or offer employment to those employees. Furthermore, Plaintiff has not pled any specific facts that constitute strong circumstantial evidence that Evans and Zero.Net made this alleged misrepresentation consciously or with severe recklessness. Plaintiff has failed to properly plead scienter because he has failed to allege specific facts indicating that Evans and Zero.Net knew at the time the representation was made that they knew they were not going to employ Kunzweiler's employees or were reckless in not knowing they were not going to employ Kunzweiler's employees.
In order to state a claim under § 10(b), a plaintiff must also allege that he relied on the alleged misrepresentation when making his investment decision. See Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994); Shores v. Sklar, 647 F.2d 462, 467 (5th Cir. 1981). Nowhere in the Complaint does Plaintiff claim that he relied on this representation when making his decision to invest in Zero.Net. Because this representation is unrelated to the alleged fraudulent scheme that was being perpetrated by Evans and Zero.Net, Plaintiff must demonstrate that he relied on this representation in particular in making his investment decision. Plaintiff has failed to do so.
Accordingly, the allegation that Evans and Zero.Net misrepresented that they would employ two of Kunzweiler's employees is dismissed from the Complaint without prejudice.
(4) Zero.Net's Investors. Plaintiff contends that Evans and Zero.Net stated that Omnicom was making a large investment in Zero.Net in connection with the private placement that would assure success of the offering. (Compl. ¶ 15(d).) Plaintiff pleads on information and belief that Omnicom/Communicade entered into a subscription agreement for $20,000,000 in connection with this private placement. (Compl. ¶ 17.) Plaintiff further alleges on information and belief that Omnicom/Communicade obtained a refund for some or all of its $20,000,000, which resulted in Zero.Net's insolvency. (Compl. ¶ 19.) Plaintiff contends that Evans failed to disclose "that Omnicom might have any special terms or conditions to its investment under the PPM, including any potential right to rescind." (Compl. ¶ 15(d) (emphasis added).)
First, Plaintiff has pled his subscription and refund allegations on information and belief, yet he has failed to state with particularity any facts on which those beliefs are formed. See 15 U.S.C. § 78u-4(b)(1)(B). Plaintiff has failed to allege a single fact to support his allegations that Omnicom/Communicade entered into a $20 million subscription and obtained a refund for some or all of its money. Because these information-and-belief allegations are not properly pled, Plaintiff cannot rely on them to make the inferential leap that the alleged refund caused Zero.Net's financial ruin.
Second, Plaintiff has failed to plead any specific facts that constitute strong circumstantial evidence that Evans and Zero.Net made this alleged misrepresentation consciously or with severe recklessness. Plaintiff has failed to properly plead scienter because he has failed to allege specific facts indicating that at the time the representation was made, Evans and Zero.Net knew or were reckless in not knowing that Omnicom/Communicade would seek and receive a refund.
Moreover, the allegation that Evans and Zero.Net failed to disclose that "Omnicom might have any special terms or conditions to its investment" is not sufficiently pled because Plaintiff has not specified why this omission is fraudulent. (Compl. ¶ 15(c).) Plaintiff has not affirmatively pled that there were, in fact, special terms or conditions to Omnicom/Communicade's investment that should have been disclosed; he has only pled that there "might have" been special terms or conditions to Omnicom/Communicade's investment. Speculation will not suffice — the PSLRA requires plaintiffs to plead facts. See ABC Arbitrage Plaintiffs Group v. Tchuruk, — F.3d —, 2002 WL 975299, at *19 n. 67 (5th Cir. May 13, 2002); Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068 (5th Cir. 1994).
Accordingly, the allegation that Evans and Zero.Net failed to disclose "that Omnicom might have any special terms or conditions to its investment under the PPM, including any potential right to rescind is dismissed from the Complaint without prejudice.
(5) Evans' Wife's Implied Message. Plaintiff avers that Evans' wife implied during several telephone conversations with Plaintiff that Plaintiff must make his investment decision quickly or the opportunity would be lost. (Compl. ¶ 15(e).) Specifically, Plaintiff contends that Evans' wife "repeatedly contacted [Plaintiff] by telephone, insisting that time was of the essence in wrapping up [Plaintiff's] subscription under the PPM. [Evans' wife's] urgency and vague assertions of `needing' to get [Plaintiff's] subscription `wrapped up' were intended to leave [Plaintiff] with the impression that, absent his immediate subscription and investment, the opportunity would be lost." (Compl. ¶ 15(e).)
First, this misrepresentation is not properly pled because Plaintiff has failed to specify why the alleged representation is false. See Natheson, 267 F.3d at 412. Plaintiff has failed to plead facts establishing that time was not of the essence in securing Plaintiff's subscription. Plaintiff has also failed to plead any specific facts that constitute strong circumstantial evidence that Evans' wife made this alleged misrepresentation consciously or with severe recklessness. Plaintiff has failed to properly plead scienter because he has failed to allege any specific facts indicating that at the time the representation was made, Evans' wife knew or was reckless in not knowing that there was no rush in obtaining Plaintiff's subscription.
Accordingly, the allegation that Evans' wife implied during several telephone conversations with Plaintiff that Plaintiff must make his investment decision quickly or the opportunity would be lost is dismissed from the Complaint without prejudice.
(6) Evans' Relatives' Investment in Zero.Net. Plaintiff further alleges that "Evans represented that the investment in Zero.Net was so good that several of Evans' relatives invested" in the company and that therefore, the investment was suitable for a naive investor with limited funds available for investment. (Compl. ¶ 15(i).) Again, Plaintiff has failed to properly plead facts establishing the statement's falsity and Evans' culpable state of mind. Plaintiff has not pled a single fact to establish that Evans' relatives did not, in fact, invest in Zero.Net. Nor has Plaintiff pled a single fact giving rise to a strong inference that Evans knew or was reckless in not knowing that his relatives invested in Zero.Net. Moreover, the statement that the investment was "so good" is merely an "optimistic generalization" and an opinion that is not actionable under the PSLRA. See Natheson, 267 F.3d at 419.
Accordingly, the allegation that Evans misrepresented that the investment in Zero.Net was so good that several of Evans' relatives invested is dismissed from the Complaint without prejudice.
c. Omissions Pled in Complaint.
When analyzing a Rule 12(b)(6) motion to dismiss, a court determines whether an alleged material omission could render any identified affirmative statement or statements made by the defendants misleading under any set of facts. The court shall not render a decision as to whether a particular statement is actually rendered misleading by a particular omission. See Kas v. Caterpillar, Inc., 815 F. Supp. 1158, 1171-72 (C.D. Ill. 1992)
(1) Evans' Criminal and SEC Civil Proceedings. Plaintiff contends that the PPM, while touting the resume of CEO Evans, failed to disclose that Evans had a significant civil litigation and criminal history. (Compl. ¶¶ 13, 15(g).) Plaintiff also contends that Evans failed to disclose that he had a prior felony conviction concerning securities trading and had been involved in civil litigation and the subject of censure by the SEC. (Compl. ¶ 25(d).)
It is well established that there is no general duty for a company to speak whenever a material development occurs. Chiarella v. United States, 445 U.S. 222, 226 (1980). Absent a specific duty to disclose material information, silence is not a basis for Rule 10b-5 liability. See Basic, Inc. v. Levinson, 485 U.S. 224, 239 n. 17 (1988) ("[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5"). Where a complaint alleges a material omission, "[t]he materiality of the information claimed not to have been disclosed . . . is not enough to make out a sustainable claim of securities fraud. Even if the information is material, there is no liability under Rule 10b-5 unless there was a duty to disclose it." Bachman v. Polaroid Corp., 910 F.2d 10, 13 (1st Cir. 1990); see Glazer v. Formica Corp., 964 F.2d 149, 156-57 (2d Cir. 1992); Scarman v. Marathon Oil Co., 772 F.2d 231, 238 (6th Cir. 1985). One court has even found that absent a duty to disclose, the mere failure to report or disclose criminal conduct by an employee of an issuer does not constitute a violation of § 10(b), even if such information is material. See In re Salomon Inc. Sec. Litig., NO. 91 CIV. 5442 (RAP), 1994 WL 265917, at *9 (S.D.N.Y. Jun 16, 1994).
However, courts have held that an affirmative duty to disclose does arise when (1) a corporate insider trades on confidential information see United States v. O'Hagan, 521 U.S. 642, 652 (1997); In re BMC Software, Inc. Sec. Litig., 183 F. Supp.2d 860, 869 (S.D. Tex. 2001); (2) a corporation has made inaccurate, incomplete or misleading prior disclosures, see Sailors v. Northern States Power Co., 4 F.3d 610, 611 (8th Cir. 1993); Glazer v. Formica Corp., 964 F.2d 149, 157 (2d Cir. 1992); Roeder v. Alpha Indus., Inc., 814 F.2d 22, 26 (1st Cir. 1987); or (3) a statute or regulation requires disclosure. See Roeder, 814 F.2d at 26-27; Rand v. M/A-Com, Inc., 824 F. Supp. 242, 257 n. 36 (D. Mass. 1992); Greenberg v. Howtek, Inc., 790 F. Supp. 1181, 1187 (D.N.H. 1992); see also Dennis J. Block et al., Recent Developments in Securities Class Actions, 1023 PLI/Corp 701, 706 (1997).
In this case, a duty to disclose may have arisen for two interrelated reasons. First, Evans and Zero.Net's disclosure of Evans' positive experience in securities trading may be considered "incomplete." The Court must determine whether Evans and Zero.Net failed to state material facts that were necessary in order to make the statement made, in light of the circumstances under which it was made, not misleading. Second, Rule 10b-5 creates a statutory duty to speak the full truth when a defendant undertakes to say anything in the first place. See 17 C.F.R. § 240.10b-5; Rubinstein v. Collins, 20 F.3d 160, 170 (5th Cir. 1994); First Virginia Bankshares v. Benson, 559 F.2d 1307, 1317 (5th Cir. 1977); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp.2d 618, 625 (N.D. Tex. 1998); MeNamara v. Bre-X Minerals Ltd., 57 F. Supp.2d 396, 416 (E.D. Tex. 1999). The duty to disclose under both of these elements arises from the same conduct — failing to provide material facts that would make an earlier statement not misleading.
A statement is misleading if a reasonable investor, in the exercise of due care, would have received a false impression from the statement. See Securities and Exchange Comm'n v. Tex. Gulf Sulphur Co., 401 F.2d 833, 862 (2nd Cir. 1968); In re Par Pharmaceutical, Inc. Sec. Litig., 733 F. Supp. 668, 677 (S.D.N.Y. 1990); Levine v. NL Industries, Inc., 717 F. Supp. 252, 256 (S.D.N.Y. 1989). Because this determination requires "delicate assessments of the inferences a `reasonable shareholder' would draw from a given set of facts," TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 450 (1976), it is generally a question of fact for the jury. See Texas Gulf Sulphur, 401 F.2d at 863 (remanding to the district court for the trier of fact to apply "the standard of whether the reasonable investor, in the exercise of due care, would have been misled by [the press release]."); see also TSC Industries, Inc, 426 U.S. at 450 (issue of materiality is a mixed question of law and fact that is generally for the jury). Thus, the matter must go to the jury unless the Court, drawing all reasonable inferences in favor of the plaintiff, determines that reasonable minds could not differ on the question of whether the statements alleged in the complaint were misleading in light of the circumstances under which they were made. See TSC Industries, 426 U.S. at 450; Goldman v. Belden, 754 F.2d 1059, 1067-68 (2d Cir. 1985). If the Court so decides, then the statements are not misleading as a matter of law.
The Court concludes that a reasonable jury could find these statements to have been misleading to a reasonable investor in light of the circumstances under which they were made. When Evans and Zero.Net chose to provide information about Evans' business experience in the PPM, they had a duty to tell the whole truth about his business experience — the good and the bad. The PPM touted CEO Evans' positive business experience, presumably in an attempt to make Zero.Net appear an attractive investment opportunity to potential investors. (Compl. ¶ 13.) The PPM described Evans as a "professional investor for over 20 years" who had "participated in most phases of the securities business as trader, broker, investor, and director in both public and private offerings." (Compl. ¶ 13.) By limiting the description of Evans to this language, and by failing to provide potential investors with information concerning Evans' criminal conviction(s), the SEC investigation(s)/enforcement action(s), and Evans' implication in ongoing civil securities fraud litigation, Evans and Zero.Net failed to provide a complete picture of Evans' business experience. It is possible that a reasonable person reading the PPM may have been left with the misleading impression that Evans is an untainted securities trader.
Therefore, this ground for dismissal is denied.
(2) Control of Zero.Net. Plaintiff also alleges that "Evans, J. Weinstock, Llewellyn (Evans' wife), and Zero.Net failed to tell Plaintiff that Evans effectively controlled Zero.Net by using Dominion's controller to hold Zero.Net's purse strings, releasing no funds unless approved by Evans and/or Llewellyn and using Zero.Net to fund Evans' personal interests." (Compl. ¶ 15(h).) As stated supra, it is well established that there is no general duty for a company to speak whenever a material development occurs. See Chiarella v. United States, 445 U.S. 222, 226 (1980). A duty to speak does arise, however, when a defendant makes a misleading statement, yet fails to state material facts that would render the statement not misleading. A defendant must speak the full truth when he undertakes to say anything in the first place.
In this case, the Court must determine whether the alleged material omissions could have rendered any identified affirmative statement or statements made by the defendants misleading under any set of facts. Plaintiff has not identified any statement made by any of the defendants that would be rendered not misleading if the above-statements were disclosed. Therefore, these alleged omissions are not properly pled because there was no duty to disclose the information.
Moreover, the PSLRA requires that scienter be pleaded with regard to "each act or omission" sufficient to give "rise to a strong inference that the defendant acted with the required state of mind" 15 U.S.C. § 78u-4(b)(2). (emphasis added). Plaintiff has not pled any specific facts that constitute strong circumstantial evidence that Evans and Zero.Net made these alleged omissions consciously or with severe recklessness. Plaintiff has failed to properly plead scienter because he has failed to allege specific facts indicating that Evans and Zero.Net knew that the failure to disclose the above information rendered other statement(s), if any, misleading.
Accordingly, the conclusory allegation that Evans, J. Weinstock, and Zero.Net failed to tell Plaintiff that Evans effectively controlled Zero.Net by engaging in certain activities is dismissed from the Complaint without prejudice.
d. Pleading Based on Information and Belief.
Throughout the Complaint, Plaintiff pleads allegations based on information and belief. When an allegation regarding a misstatement or omission is made on information and belief, the PSLRA requires plaintiffs to "state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1)(B) (emphasis added). Plaintiff has not stated any facts on which his beliefs are formed. Therefore, Plaintiff's information-and-belief allegations regarding misrepresentations or omissions (specifically, those contained in paragraphs 4, 12, 14, 17, 18, and 19) are not sufficiently pled and dismissal is appropriate as to those allegations.
See, supra, note 10.
It is therefore ORDERED that Evans and Zero.Net's Motion to Dismiss is GRANTED IN PART and DENIED IN PART, as described in this Order. IT IS FURTHER ORDERED that Plaintiff shall have fifteen (15) days from the date of this Order to amend any portion of his Complaint dismissed by this Order.
C. THE WEINSTOCKS' AND DOMINION INCOME MANAGEMENT'S MOTIONS TO DISMISS.
1. Primary Liability.
To satisfy the Rule 9(b) pleading requirement, a plaintiff must specify (1) the statement alleged to be fraudulent; (2) the speaker of the alleged fraudulent statement; (3) when and where the alleged fraudulent statement was made; (4) and why the statements are fraudulent. See Natheson, 267 F.3d at 412. Plaintiff's conclusory allegation in his Complaint that "Defendants" (which presumably includes D. Weinstock and J. Weinstock) made certain misrepresentations is not supported by specific facts. (Compl. ¶ 25.) There is only one specific allegation of a representation made by J. Weinstock. Plaintiff pleads that "J. Weinstock echoed Evans' offer [of employing Plaintiff's employees] with the intent of wooing [Plaintiff] into investing in Zero.Net." (Compl. ¶ 15(c).) For the reasons stated supra, the alleged representation by Evans (and J. Weinstock) that Plaintiff was promised employment of his two employees is not actionable as pled. With respect to J. Weinstock in particular, this allegation is further deficient because Plaintiff has failed to plead when and where the alleged fraudulent statement was made. See Natheson, 267 F.3d at 412.
Plaintiff has not alleged any affirmative misrepresentation(s) or omissions made by D. Weinstock or Dominion.
Furthermore, absent a specific duty to disclose material information, silence is not a basis for Rule 10b-5 liability. See Basic, Inc. v. Levinson, 485 U.S. 224, 239 n. 17 (1988) ("[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5"). However, courts have held that an affirmative duty to disclose does arise when (1) a corporate insider trades on confidential information, see United States v. O'Hagan, 521 U.S. 642, 652 (1997); In re BMC Software, Inc. Sec. Litig., 183 F. Supp.2d 860, 869 (S.D. Tex. 2001); (2) a corporation has made inaccurate, incomplete or misleading prior disclosures, see Sailors v. Northern States Power Co., 4 F.3d 610, 611 (8th Cir. 1993); Glazer v. Formica Corp., 964 F.2d 149, 157 (2d Cir. 1992); Roeder v. Alpha Indus., Inc., 814 F.2d 22, 26 (1st Cir. 1987); or (3) a statute or regulation requires disclosure. See Roeder, 814 F.2d at 26-27; Rand v. M/A-Com, Inc., 824 F. Supp. 242, 257 n. 36 (D. Mass. 1992); Greenberg v. Howtek, Inc., 790 F. Supp. 1181, 1187 (D.N.H. 1992); see also Dennis J. Block et al., Recent Developments in Securities Class Actions, 1023 PLI/Corp 701, 706 (1997).
With respect to the omissions J. Weinstock is accused of making, the Court must determine whether J. Weinstock failed to state material facts that were necessary in order to make statements made by J. Weinstock, in light of the circumstances under which they were made, not misleading. (See Compl. ¶¶ 15(h), 27.) In addition, Rule 10b-5 creates a statutory duty to speak the full truth when a defendant undertakes to say anything in the first place. After reviewing the Complaint's scant allegations against J. Weinstock, the Court concludes that Plaintiff's omissions against J. Weinstock are not actionable because he is not alleged to have made any affirmative representations that may have been misleading.
Plaintiff cannot rely on the "group pleading" doctrine to plead and impose § 10(b) liability on the individual Defendants for misrepresentations allegedly made in the PPM. Prior to passage of the PSLRA, plaintiffs could satisfy Rule 9(b) by relying on the presumption that allegedly false and misleading "group published information", such as private placement memoranda, prospectuses, and press releases, were the collective action of officers and directors of a corporation. However, this district has repeatedly held that the doctrine did not survive passage of the PSLRA. See Coates v. Heartland Wireless Communications, Inc., 26 F. Supp.2d 910, 916 (N.D. Tex. Nov 02, 1998) ("The PSLRA codifies a ban on group pleading.") (Fitzwater, J.); Zishka v. American Pad Paper Co., No. 3:98-CV-0660-M, 2000 WL 1310529, at *1 (N.D. Tex. Sept. 13, 2000) ("[T]his Court rejects the notion of `group pleading' and `group publication' and concludes that such concepts . . . did not survive the adoption of the PSLRA.") (Lynn, J.); Lemmer v. Nu-Kote Holding, Inc., No. 3:98-CV-0161-L, 2001 WL 1112577, at *7 (ND. Tex. Sept. 6, 2001) ("The group pleading doctrine is inconsistent with the particularity requirements of the PSLRA . . .") (Lindsay, J.); Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., No. 4:00-CV-355-Y, slip op. at 6 (ND. Tex. March 12, 2001) ("The Court initially finds that Plaintiffs' complaint fails because of its reliance on group pleading.") (Means, J.); Calliot v. HFS, Inc., No. 3:97-CV-09241-L, 2000 WL 351753, at * 5 (N.D. Tex. March 31, 2000) (dismissing complaint based, in part, on plaintiffs' use of group pleading) (Lindsay, J.); Branca v. Paymentech, Inc, No. 3:97-CV-2507-L, 2000 WL 145083, at *8 (N.D. Tex. Feb. 8, 2000) (same) (Lindsay, J.). Therefore, the PSLRA requires plaintiffs to "distinguish among those they sue and enlighten each defendant as to his or her particular part in the alleged fraud." Schiller v. Physicians Resource Group, Inc., No. 3:97-CV-3158-L 2002 wL 318441, at *5 (N.D. Tex. Feb 26, 2002) (Lindsay, J.)
2. Control Person Liability — Section 20
Section 20(a) of the 1934 Act imposes joint and several liability on persons who are in "control" of those who violate federal securities laws, including § 10(b). Section 20(a) provides in relevant part: "Every person who, directly or indirectly, controls any person liable under any provision of this chapter . . . shall also be liable jointly and severally with and to the same extent as such controlled person." 15 U.S.C. § 78t(a). While there is no statutory definition of "control," the SEC has defined "control" as "the possession, directly or indirectly, of 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." 17 C.F.R. § 240.12(b)-2(f); see G.A. Thompson Co. v. Partridge, 636 F.2d 945, 957 (5th Cir. 1981).
Since § 20 is a secondary liability provision, it is necessary that a primary violation be established before liability under § 20 arises. Sec Maher v. Durango Metals, Inc., 144 F.3d 1302, 1304-05 (10th Cir. 1998); S.E.C. v. First Jersey Securities, Inc., 101 F.3d 1450, 1472 (2d Cir. 1996); Jaffe v. Bosco, NO. 3:93-CV-2064-X, 1996 WL 727981, at *6 (N.D. Tex. Sep 26, 1996); Liabilities under Sections 11, 12, 15 and 17 of the Securities Act of 1933 and Sections 10, 18 and 20 of the Securities Exchange Act of 1934, 1266 PLI/Corp 875, 1000 (2001).
In considering whether Plaintiff has stated a claim under § 20, the Court must determine whether Plaintiff has pled facts sufficient to establish that a defendant was in control of Evans or Zero.Net, the primary violators. Paragraph 26 of Plaintiff's Complaint sets forth the facts alleged by Plaintiff in support of his § 20(a) claim.
a. J. Weinstock
Plaintiff's "control person" allegations against J. Weinstock boil down to four items: First, J. Weinstock was a director, COO, and "CEO of Zero.Net by March [or April] 2000." (Compl. ¶¶ 15, 26(g).) Second, J. Weinstock's influence was substantial enough to cause him to rise from part-time employee at Zero.Net in 1999 to CEO by April 2000. Third, J. Weinstock's family connection could have enabled him to bring in Zero.Net's largest investor, Omnicom. Fourth, J. Weinstock used his control and influence over Zero.Net to obtain a refund of Omnicom's investment. (Compl. ¶ 26(h).)
In determining whether a plaintiff has made a prima facie showing of "control," it is well-established that a plaintiff must plead facts indicating that the defendant "had the requisite power to directly or indirectly control or influence corporate policy." G.A. Thompson Co. v. Partridge, 636 F.2d 945, 958 (5th Cir. 1981); McNamara v. Bre-X Minerals, Ltd., 46 F. Supp.2d 628, 637 (E.D. Tex. 1999). A plaintiff need not demonstrate "actual participation" in the underlying fraudulent transaction. Id. Nor does it appear that a plaintiff must establish that the defendant "`actually participated in the general, day-to-day control [of the general affairs of the company],"' though this requirement has not been explicitly addressed by the Fifth Circuit. See Bre-X, 46 F. Supp.2d at 638; Abbott, 2 F.3d at 620; Thompson, 636 F.2d at 958 n. 24.
The issue of control person liability cannot hinge solely upon a defendant's position or title. See Dennis v. General Imaging, Inc., 918 F.2d 496, 509-10 (5th Cir. 1990). Yet Plaintiff has alleged some additional facts in his Complaint concerning J. Weinstock's relationship with Zero.Net, from which it can be inferred that J. Weinstock had actual power or influence over Zero.Net.
Plaintiff contends that J. Weinstock "could" have been the person responsible for bringing Zero.Net its largest investor, Omnicom, because his father had ties with the company. (Compl. ¶ 26(f).) He was also a director of EDV, Zero.Net's largest holding. (Compl. ¶ 26(d).) Plaintiff also alleges that J. Weinstock assisted Omnicom in obtaining a refund from Zero.Net of its investment. Based on these facts, it is reasonable to infer that J. Weinstock may have had some influence in causing Omnicom to invest in Zero.Net and in causing Zero.Net to invest in EDV. Further, Plaintiff's refund allegation indicates that Plaintiff may have had the power to direct some of the policies of Zero.Net. Giving Plaintiff the benefit of all reasonable inferences, as a court must on a motion to dismiss, Plaintiff has sufficiently stated control status under § 20.
b. D. Weinstock.
The "control" allegations against D. Weinstock are as follows: D. Weinstock was a Director of ZeroNet and is J. Weinstock's father. (Compl. ¶ 26(a), (b).) D. Weinstock had influence over Omnicom sufficient to bring it in as an investor in Zero.Net and had influence over Zero.Net sufficient to obtain a refund of Omnicom's investment. (Compl. ¶ 26(e). Plaintiff has sufficiently pled his "control person" allegations against D. Weinstock for the same reasons his allegations against J. Weinstock pass muster.
c. Dominion.
Plaintiff contends that Dominion is a private investment company controlled by Evans that focuses on the technology and internet sectors. (Compl. ¶ 4.) Dominion is alleged to have exerted control over Zero.Net, used Zero.Net as its alter ego, and extended a substantial loan to Zero.Net. (Compl. ¶ 4.) Plaintiff alleges on information and belief that Dominion exercised its influence to have its loan preferentially repaid in whole or in part from the stock offering at issue. (Compl. ¶ 4.) The Court may infer from these allegations that Dominion, through Evans, had the requisite power to directly or indirectly control or influence Zero.Net's policies regarding use of the monies raised through the private placement. Therefore, the Court concludes that Plaintiff has stated a § 20(a) claim against Dominion.
D. STATE LAW CLAIMS.
1. Negligent Misrepresentation Claims.
Courts in this jurisdiction are split on whether the particularity requirements of Rule 9(b) apply to claims of negligent misrepresentation. See In re Compaq Sec. Litig., 848 F. Supp. 1307, 1310 (S.D. Tex. 1993) (requirement that fraud be pleaded with particularity did not extend to negligent misrepresentation claims); Federal Deposit Ins. Corp. v. Williams, 779 F. Supp. 63, 64 (N.D. Tex. 1991) (rule that requires that fraud be pled with particularity does not apply to allegations of gross negligence); but see Frith v. Guardian Life Ins. Co., 9 F. Supp.2d 734, 742 (S.D. Tex. 1998) (particularity requirement for pleading fraud applied to claims for violation of the Texas Insurance Code and the Texas Deceptive Trade, fraudulent inducement, fraudulent concealment, and negligent misrepresentation). The Fifth Circuit shed some light on this dilemma when it held that "[w]hen 1933 Securities Act claims are grounded in fraud rather than negligence . . . Rule 9(b) applies." See Lone Star Ladies Inv. Club v. Schlotzsky's Inc., 238 F.3d 363, 368 (5th Cir. 2001); Melder v. Morris, 27 F.3d 1097, 1100 n. 6 (5th Cir. 1994). Based on its reading of these cases, the Court concludes that the inverse must also be true — where a claim is grounded in negligence rather than fraud, Rule 9(b) does not apply.
Plaintiff has not pled any misrepresentation with respect to D. Weinstock and Dominion. Therefore, the negligent misrepresentation claims against them must be DISMISSED. With respect to J. Weinstock, Plaintiff has stated a claim for negligent misrepresentation. As an officer and director of Zero.Net, J. Weinstock may be held liable for the alleged misrepresentations appearing in the PPM. Specifically, J. Weinstock may be liable for the alleged misstatements concerning Evans' business experience and the purported business plan contained in the PPM.
Therefore, the Court concludes that Plaintiff has stated a claim against J. Weinstock for negligent misrepresentation and his motion to dismiss is DENIED with respect to this claim. Plaintiff has also pled a negligent misrepresentation claim against Evans and Zero.Net and therefore, their motion to dismiss is DENIED with respect to this claim.
2. Common-Law Fraud Claims and State Statutory Fraud Claims.
Plaintiff's common-law fraud claims against "Defendants" and his state statutory fraud claims are governed by the same Rule 9(b) pleading requirements that govern Plaintiff's federal statutory securities fraud allegations. As stated earlier, to plead fraud with particularity under Rule 9(b), a plaintiff must, at a minimum, include the time, place, and contents of the false representations, as well as identify the speaker who made the misrepresentation and what that person obtained thereby. Shushany v. Allwaste, Inc., 992 F.2d 517, 521 (5th Cir. 1993).
General allegations, which lump all defendants together failing to segregate the alleged wrongdoing of one from those of another, do not meet the requirements of Rule 9(b). Patel v. Holiday Hospitality Franchising, Inc., 172 F. Supp.2d 821, 824 (N.D. Tex. 2001). Plaintiff's common-law fraud allegations lump all defendants together when it states that "Defendants have, jointly and severally, made material misrepresentations and/or failed to disclose the material facts described above [in the Complaint] to [Plaintiff]." (Compl. ¶ 23.) Despite this pleading error, the Court will assume Plaintiff's common-law fraud allegations rest on the same allegations as his statutory securities fraud allegations.
Plaintiff does not specify in his Complaint under which state law securities fraud statute(s) he is suing. (See Compl. ¶ 25.) When claims are statutory in nature and require some showing of fraud, Rule 9(b) requires the plaintiff to identify in the complaint the specific statute upon which relief is sought. See Chrysler Capital Corp. v. Century Power Corp., 778 F. Supp. 1260, 1270 (S.D.N.Y. 1991). However, Plaintiff did refer to Article 581.33(A)(2) of Texas Revised Civil Statutes in his response to the motion to dismiss the first complaint. (See Pl.'s Collective Resp. to the Non-Communicade Defs.' Mot. to Dismiss at 34.) Therefore, Defendant is on notice of the specific statutory provisions on which Plaintiff is relying. See Chrysler, 778 F. Supp. at 1270 n. 12.
Because these claims must be pled in compliance with Rule 9(b) of the Federal Rules of Civil Procedure, they fail for the same reasons Plaintiff's federal statutory fraud allegations did not survive dismissal under Rule 9(b). To plead fraud with particularity in this circuit, a plaintiff must allege the "`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."' Williams v. WMX Technologies, Inc., 112 F.3d 175, 177 (5th Cir. 1997). As the Williams court noted, "articulating the elements of fraud with particularity requires a plaintiff to specify the statements contended to be fraudulent, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent."
Plaintiff's allegations that Evans/Zero.Net misrepresented Zero.Net's investment amount in EDC and the value of Zero.Net's investment portfolio are not properly pled because Plaintiff failed to explain the reason why the statements were misleading. Further, Plaintiff's allegations concerning Zero.Net's alleged promises to invest in Plaintiff's business and to employ Plaintiff's employees are not properly pled because Plaintiff has failed to allege that he relied on these representations when making his investment decision. Moreover, Plaintiff's allegation that Evans' wife falsely implied that "time was of the essence" in making his investment is not pled in compliance with Rule 9(b) because Plaintiff has failed to specify why this implied message was false. Lastly, Plaintiff's allegation that Evans falsely represented that his relatives invested in Zero.Net because it was a good investment is not properly pled because Plaintiff has failed to specify why this representation was false and because the quality-of-the-investment allegation is based on a non-actionable opinion. Because Plaintiff has pled some of the alleged misrepresentations against Evans and Zero.Net with the requisite specificity (e.g. Zero.Net's sham business allegations, Evans' management role, Evans' civil litigation and criminal history), Evans and Zero.Net's motion to dismiss is hereby DENIED with respect to the common-law fraud claim and the statutory fraud claim.
The Court is not persuaded by Evans and Zero.Net's argument that Plaintiff expressly disclaimed reliance on the non-PPM representations. (See Evans and Zero.Net's Mot. to Dismiss First Compl. at 20-21.) The unsigned "form" subscription agreement containing a reliance disclaimer is neither persuasive nor appropriate evidence at this motion-to-dismiss stage.
With respect to D. Weinstock and Dominion, Plaintiff has not pled any actionable misrepresentation or omission. Therefore D. Weinstock and Dominion's motions to dismiss the common-law fraud claims and the statutory fraud claims are hereby DISMISSED.
With respect to J. Weinstock, Plaintiff has stated a claim for common-law fraud and statutory fraud. As an officer and director of Zero.Net, J. Weinstock may be found liable for the alleged misrepresentations appearing in the PPM. Specifically, J. Weinstock may be liable for the alleged misstatements concerning Evans' business experience and the purported business plan contained in the PPM. Therefore, the Court concludes that Plaintiff has stated a claim against J. Weinstock for common-law fraud and statutory fraud and his motion to dismiss is DENIED with respect to this claim.
3. Negligence and Breach of Fiduciary Duty Claims.
Defendants argue that Plaintiff's claims of negligence, breach of fiduciary duty, and unjust enrichment belong only to the corporation, not to Plaintiff individually. (Evans and Zero.Net's Mot. to Dismiss at 22.) Under Delaware law, a shareholder may sue on his own behalf or derivatively, on behalf of the corporation. See Kramer v. Western Pacific Indus., 546 A.2d 348, 352 (Del. 1988). The distinction between derivative and individual actions rests upon the party being directly injured by the alleged wrongdoing. Id. Shareholders may bring direct actions for injuries done to them in their individual capacities by corporate fiduciaries. Id. Recovery in these individual actions goes to the suing shareholders. Id. Thus, to have standing to sue individually, rather than derivatively on behalf of the corporation, the plaintiff must allege "an injury [that] is separate and distinct from that suffered by other shareholders." Id. In other words, for a plaintiff to have standing to bring an individual action, he must be injured directly or independently of the corporation. Id.
Because all Parties cite to Delaware law in their briefing, the Court assumes there is no dispute that Delaware law governs the substantive state law claims in this case, and will analyze the issues under Delaware law as well.
Whether a cause of action is individual or derivative must be determined from the "nature of the wrong alleged" and the relief, if any, that could result if the plaintiff were to prevail. Id. In determining the nature of the wrong alleged, a court must look to "the body of the complaint, not to the plaintiffs designation or stated intention." Id.
In the Complaint, Plaintiff contends that Evans, J. Weinstock, and D. Weinstock breached their fiduciary duties to Plaintiff and were negligent by (1) failing to disclose material information (alleged as breach-of-fiduciary-duty claim only); (2) allowing a convicted felon to manage and control Zero.Net; (3) failing to follow through with the business plans of Zero.Net; (4) allowing preferential and imprudent distributions of cash to Dominion, Communicade and others; (5) "abandoning ship" to advance their own personal business interests; and (6) rendering Zero.Net insolvent (alleged as breach-of-fiduciary-duty claim only). (Compl. ¶¶ 24, 30.) All but one of the acts allegedly engaged in by Defendants were directed toward and suffered by Zero.Net. However, Plaintiff's allegation that Evans, J. Weinstock, and D. Weinstock breached their fiduciary duties to Plaintiff by failing to disclose material information to Plaintiff is an allegation directed specifically toward Plaintiff. Therefore, Plaintiff has failed to state a negligence claim, a breach of fiduciary claim, and an unjust enrichment claim against Evans, J. Weinstock and/or D. Weinstock with respect to allegations (2) through (5), and those allegations are hereby DISMISSED. Plaintiff's "failure to disclose" allegation, which is pled only as a breach-of-fiduciary-duty claim, not as a negligence claim, will be analyzed separately below.
a. Breach of Fiduciary Duty.
Plaintiff complains that Evans, J. Weinstock, and D. Weinstock breached their fiduciary duties to Plaintiff by failing to disclose certain "material" information to Plaintiff prior to making his investment. The gravamen of his Complaint is that had these Defendants disclosed the information to Plaintiff, he would not have made the investment and would not have suffered these financial losses.
Under Delaware law, directors of corporations "are fiduciaries who owe duties of due care, good faith and loyalty to the company and its stockholders." See Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170, 1172 (Del.Supr. 2000). However, Plaintiff was not a stockholder during the relevant time period. Plaintiff was a potential investor, to whom no fiduciary duties are owed. See Montgomery v. Aetna Plywood, Inc., 231 F.3d 399 (7th Cir. 2000) (applying Delaware law and citing Anadarko Petroleum Co. v. Panhandle Eastern Co., 545 A.2d 1171, 1174-77 (Del. 1988)).
b. Negligence.
As stated above, Plaintiff's negligence claims are DISMISSED WITHOUT PREJUDICE because all of the alleged negligent conduct was directed toward and suffered by Zero.Net, not Plaintiff individually. (See Compl. ¶ 30.)
c. Unjust Enrichment and Imposition of a Constructive Trust.
Unjust enrichment is the "unjust retention of a benefit to the loss of another, or the retention of money or property of another against the fundamental principles of justice or equity or good conscience." LaSalle Nat. Bank v. Perelman, 82 F. Supp.2d 279, 294 (D. Del. 2000). Under Delaware law, the elements of unjust enrichment are: (1) enrichment, (2) an impoverishment, (3) relation between enrichment and impoverishment, (4) absence of justification and (5) absence of remedy provided by law. Id. at 294-95. A constructive trust is proper when "a defendant's fraudulent, unfair or unconscionable conduct causes him to be unjustly enriched at the expense of another to whom he owed some duty." Jackson Nat. Life Ins. Co. v. Kennedy, 741 A.2d 377, 393-94 (Del.Ch. 1999).
Having pleaded sufficiently certain of his allegations for securities fraud and/or negligent misrepresentation to defeat this motion, as stated herein, it is axiomatic that Plaintiff has likewise pleaded sufficiently the allegations that Defendants were enriched by their actions, to the impoverishment of Plaintiff. Furthermore, a clear relation exists between the enrichment and the impoverishment. If Plaintiff succeeds on the merits of his remaining securities fraud claims or his remaining negligent misrepresentation claims, it is likely that he will also be able to prove that the liable Defendants should not retain any benefit resulting from the disputed transaction "justifiably" or in accordance with "`the fundamental principles of justice or equity and good conscience."' See Jackson, 741 A.2d at 393-94. Plaintiffs have properly stated an actionable claim for unjust enrichment and imposition of a constructive trust. Therefore, Defendants' motions to dismiss this claim is hereby DENIED.
4. Fraudulent Conveyance Claim.
Plaintiff asserts a fraudulent conveyance claim against Defendants for certain alleged payments made by Zero.Net to Dominion in connection with the Dominion Loan. (Compl. 6 32.) Texas' Uniform Fraudulent Transfer Act provides remedies under this act for creditors only. See Tex. Bus. Comm. Act. § 24.008. Nowhere in Plaintiff's Complaint does he allege he is a creditor in accordance with this section, and therefore, his fraudulent conveyance claim must be DISMISSED.
E. PLAINTIFF'S MOTION FOR LEAVE TO FILE SUPPLEMENTAL RESPONSE TO ZERO.NET DEFENDANTS' MOTIONS TO DISMISS.
Plaintiff's Supplemental Response will not be considered by the Court because it seeks to add new facts to the Complaint rather than provide new analysis to facts already pled in the Complaint. Factual allegations in a brief are not to be considered on a motion to dismiss for failure to state a claim pursuant to Rule 12(b)(6). See Shapiro. Lifschitz, Schram, P.C. v. R.E. Hazard, Jr., 24 F. Supp.2d 66, 73 (D.D.C. 1998); Allison v. Brooktree Corp., 999 F. Supp. 1342, 1347 (S.D. Cal. 1998) (considering face of complaint, documents referred to by complaint, and matters subject to judicial notice; not considering facts presented in briefs, affidavits, or discovery materials); Town of Ogden Dunes v. Bethlehem Steel Corp., 996 F. Supp. 850, 855 (N.D. Ind. 1998) (complaint cannot be amended by briefs filed by plaintiff in opposition to motion to dismiss). Therefore, Plaintiff's Motion for Leave to File Supplemental Response to Zero.Net Defendants' Motions to Dismiss is hereby DENIED.
CONCLUSION
For the reasons stated herein, the Court hereby GRANTS IN PART and DENIES IN PART Defendants Zero.Net, Inc. and Andrew L. Evans' Motion to Dismiss the Second Amended Complaint, GRANTS IN PART and DENIES IN PART the Weinstock Defendants' Motion to Dismiss Second Amended Complaint, GRANTS IN PART and DENIES IN PART Defendant Dominion Income Management Corp.'s Motion to Dismiss the Second Amended Complaint, and DENIES Plaintiff's Motion for Leave to File Supplemental Response to Zero.Net Defendants' Motion to Dismiss. Plaintiff is given fifteen (15) days to replead his Complaint in compliance with this Order, Rule 9(b), the PSLRA, and all other applicable law.