Opinion
Civil Action No. 3:05-CV-1747 (JCH).
July 28, 2006
AMENDED RULING ON DEFENDANTS' MOTIONS TO DISMISS AND MOTION TO STRIKE [DKT. NOS. 44, 45, 50, 53 and 97]
The court is issuing this Amended Ruling to correct clerical errors and make it clear that the scope of its opinion extends both to the Motion to Dismiss and the Motion to Strike filed by defendant Robert H. Jaffe.
The plaintiff Securities and Exchange Commission ("SEC"), brings this action against defendants PacketPort.com, Inc. ("PacketPort.com"), Ronald Durando ("Durando"), PacketPort, Inc., Microphase Corp. ("Microphase"), Robert H. Jaffe ("Jaffe"), Gustave Dotoli ("Dotoli"), IP Equity, Inc. ("IP Equity"), M. Christopher Agarwal ("Agarwal"), and Theodore Kunzog ("Kunzog") pursuant to sections 20(b) and 20(e) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§ 77t(b) and 77t(e), and Sections 21(d) and 21(e) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C §§ 78u(d) and 78u(e). The SEC alleges that, between December 14, 1999 and February of 2000, PacketPort.com, Durando, Microphase, Jaffe, Dotoli, IP Equity, Agarwal, and Kunzog engaged in a fraudulent market manipulation scheme to "pump" up the stock prices of PacketPort.com and "dump" the artificially inflated stock on the public. The complaint further alleges that defendant Coons knowingly aided and abetted the scheme by selling the manipulated stocks to the public. Jurisdiction is based upon Section 22(a) of the Securities Act, 15 U.S.C. § 77v (a), and Sections 21 (e) and 27 of the Exchange Act, 15 U.S.C. §§ 78u (e) and 78aa.
All the defendants have moved to dismiss the complaint in its entirety for failure to state a claim upon which relief can be granted pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. Durando, Dotoli, and Jaffe have moved to strike portions of the complaint as immaterial and impertinent pursuant to Rule 12(f) of the Federal Rules of Civil Procedure.
For the reasons set out below, the defendants' motions are denied.
The court takes the facts alleged in the SEC's Complaint as true, as it must, and draws all inferences in the SEC's favor.See Scheuer v. Rhodes, 416 U.S. 232, 236 (1974), overruled on other grounds by Davis v. Scherer, 468 U.S. 183 (1984).
PacketPort.com, formerly known as Linkon Corporation ("Linkon"), is a publicly owned Nevada corporation with its principal place of business in Connecticut. It purports to develop and sell Internet telephony products. PacketPort.com's common stock is registered with the SEC pursuant to Section 12(g) of the Exchange Act and traded in the over-the-counter bulletin board market. Ronald Durando is a resident of New Jersey, who is now, and at all times relevant to this action, Packeport.com's chairman, president, chief executive officer ("CEO") and majority stockholder. He is also the sole shareholder and president of PacketPort, Inc and the chief operating officer of Microphase Corporation. PacketPort, Inc. is a private Delaware corporation that serves solely as an investment vehicle for Durando. Microphase is a private Connecticut corporation that purports to design and manufacture electronics for commercial and defense applications. Microphase is affiliated with PacketPort.com through Durando and leases office space to PacketPort.com. Robert H. Jaffe is a New Jersey resident who served as a director of PacketPort.com from approximately November 26, 1999 until late 2000. Jaffe, an attorney and principal with the New Jersey law firm of Robert H. Jaffe Associates, represented Durando in his acquisition of PacketPort and served as PacketPort.com's special securities counsel. Gustave Dotoli is a New Jersey resident who has been a director of PacketPort.com since approximately November 26, 1999. William Coons III, a Connecticut resident and former stockbroker with New York's Investec Ernst Company, was Durando's stockbroker and sold shares of PacketPort.com to the public. IP Equity is a private California corporation that, at all times relevant to this action, owned and operated Internet Stock News, an Internet-based investment newsletter with URLhttp://www.internetstocknews.com. IP Equity entered an agreement with Durando and others to promote PacketPort.com.'s stock. At all times relevant to this action, M. Christopher Agarwal, last known to reside in California, was a director, a shareholder, and the president of IP Equity. Theodore Kunzog, last known to reside in California, was a director, the chief financial officer, the securities analyst, and a shareholder of IP Equity.
The SEC alleges that PacketPort.com, Durando, Dotoli, IP Equity, Agarwal, and Kunzog engaged in a so-called "pump and dump" scheme that Coons facilitated. The scheme involved the illegal sale of the common stock of PacketPort.com. Durando, Jaffe, Dotoli, Agarwal, and Kunzog allegedly collaborated to acquire majority control of Linkon (an insolvent public company); changed Linkon's name to PacketPort.com; laundered restrictive legends from stock certificates representing restricted and affiliate-owned stock; used IP Equity to "pump" the price of PacketPort.com's stock through false publicity; and employed Coons to sell about ninety-percent of the restricted shares to the public. The SEC further alleges that Durando, Jaffe, Dotoli, Agarwal, and Kunzog, assisted by Coons, publicly sold PacketPort.com shares after acquiring material, non-public information about the company. They allegedly obtained this information by breaching fiduciary duties. PacketPort.com, Durando, PackePort, Inc., Jaffe, and Dotoli also failed to disclose private sales of PacketPort.com stock during the illicit operation. The complaint further claims that PacketPort.com, in conjunction with Durando, Jaffe, and Dotoli, filed reports with the SEC that contained false and misleading information. Durando, Jaffe, and Dotoli then circumvented accounting controls and/or falsified PacketPort.com's records to conceal their activities. All told, the defendants made over nine million dollars in proceeds from the sale of low-value PacketPort.com shares. Compl. at ¶ 2.
The SEC brought the present action to permanently enjoin the defendants from violating, causing violations of, or aiding and abetting violations of the Exchange Act and the Securities Act. The SEC's request for injunctive relief is based on Section 20(b) of the Securities Act, 15 U.S.C § 77t (b), and Section 21(d) of the Exchange Act, 15 U.S.C. § 78u (d). The SEC also seeks an order for the defendants to provide complete and accurate accounting of certain business activities conducted and assets obtained from September 1, 1999 through the present. Lastly, the SEC requests that the defendants jointly and severely disgorge all enrichment gained from their alleged illegal conduct, along with prejudgment interest.
All defendants have moved pursuant to Fed.R.Civ.P. 12(b) (6) to dismiss the SEC's complaint for failing to state claims upon which relief can be granted. They argue collectively that the SEC is not entitled to an injunction under Section 20(b) or Section 21(d) of the Exchange Act because it does not allege that, at the time of the complaint, the defendants were engaged, were about to be engaged, or would in the future engage in violations of the securities law. Coons moved separately to dismiss on the grounds that the SEC did not allege the necessary scienter to sustain an aiding and abetting claim under Section 10(b) (5) of the Exchange Act and Rule 10b-5 promulgated thereunder. Dotoli, Durando, and Jaffe moved to strike references to their invocation of the Fifth Amendment during the SEC's pre-complaint investigation.
II. STANDARD OF REVIEW
A motion to dismiss filed pursuant to Rule 12(b)(6) can be granted only if "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957);see also Harris v. City of New York, 186 F.3d 243, 250 (2d Cir. 1994). In considering such a motion, the court accepts the factual allegations alleged in the complaint as true and draws all inferences in the plaintiff's favor. Scheuer v. Rhodes, 416 U.S. 232, 236 (1974), overruled on other grounds by Davis v. Scherer, 468 U.S. 183 (1984). In addition, Rule 8 of the Federal Rules of Civil Procedure requires only that a complaint "contain . . . a short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8(a)(2); see also Swierkiewicz v. Sorema N.A., 534 U.S. 506, 512 (2002).
"In considering a motion to dismiss . . . a district court must limit itself to facts stated in the complaint or in documents attached to the complaint as exhibits or incorporated in the complaint by reference . . . [and review all allegations] in the light most favorable to the non-moving party." Newman Schwartz v. Asplundh Tree Expert Co., Inc., 102 F.3d 660, 662 (2d Cir. 1996). "While the pleading standard is a liberal one, bald assertions and conclusions of law will not suffice." Leeds v. Meltz, 85 F.3d 51, 53 (2d Cir. 1996).
III. DISCUSSION
A. The SEC Claims for Injunctive Relief
The securities violations alleged in this case occurred approximately between December 14, 1999 through February of 2000. The SEC filed this complaint against the defendants on November 11, 2005. Because of this nearly six-year gap between the suspected activity and the SEC's present suit, the defendants argue that the SEC cannot satisfy the burdens for injunctive relief under the Securities Act and the Exchange Act.
Section 20(b) of the Securities Act states, in relevant part, that an action for injunction may be brought in a District Court:
[w]henever it shall appear to the Commission that any person is engaged or about to engage in any acts or practices which constitute or will constitute a violations of the provisions of this subchapter . . . the Commission may, in its discretion, bring an action in any district court of the United States . . . to enjoin such acts or practices, and upon proper showing, a permanent or temporary injunction or restraining order shall be granted.15 U.S.C. § 77t (b). Section 21(d) of the Exchange Act contains substantially the same language as that quoted above from the Securities Act. Compare id. with 15 U.S.C. § 78u (d) (1). Relying on this language, the defendants assert that the SEC does not allege that any of the defendants was engaged or was about to engage in securities violations at the time of the complaint. They contend that the six-year delay between their alleged securities violations and the filing of the SEC complaint forecloses the SEC from making the necessary showing that "there is a reasonable likelihood that the wrong[s] will be repeated." See, e.g. S.E.C. v. Management Dynamics, Inc., 515 F.2d 801, 807 (2d Cir. 1975) (quotingS.E.C. v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1100 (2d Cir. 1972) (internal citations omitted).
Regardless of the timing of the SEC complaint, this Circuit has long recognized that, even at a trial on the meritsl, the "mere cessation of illegal activity does not ipso factor justify the denial of an injunction." S.E.C. v. Universal Major Industries Corp., 546 F.2d 1044, 1048 (2d Cir. 1976) (citing S.E.C. v. Management Dynamics, supra, 515 F.2d at 807) (internal citations omitted). What will ultimately be at stake in considering the injunction "is whether the defendant's past conduct indicates . . . that there is a reasonable likelihood of further violations in the future." S.E.C. v. Commonwealth Chemical Securities, 574 F.2d 90, 99 (2d Cir. 1978) (quoting Louis Loss, 3 Securities Regulation 1976 (1961)) (internal citations omitted); see also S.E.C v. Materia, 745 F.2d 197, 200 (2d Cir. 1984) (holding that the SEC needs to establish a reasonable likelihood of future misconduct for temporary and permanent injunctive relief). Though the SEC must eventually go beyond allegations of past misconduct to establish a reasonable likelihood of future violations, see id. at 100, this court cannot conclude as a matter of law that it will be unable to do so based on the allegations in the complaint.
B. Aiding and Abetting Scienter Requirements
Coons argues that the complaint does not allege the requisite scienter to sustain the claim against him for aiding and abetting violations of Section 10(b)(5) of the Exchange Act, 15 U.S.C. § 17j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. Essentially, Coons asserts that this court should dismiss the complaint against him because the SEC does not allege that he knew about the other defendants or his own involvement in the supposed pump and dump scheme.
Because the SEC is proceeding against Coons under Section 21(d) of the Exchange Act, Section 78t (e) of the Exchange Act governs Coons' liability as an aider and abettor of securities law. See 15 U.S.C. 78t (e). This latter section establishes liability for aiding and abetting for anyone who "knowingly provides substantial assistance to another person in violation of this chapter, or of any rule or regulation issued under this chapter."Id.; accord S.E.C. v. Competitive Technologies, Inc., 2005 WL 1719725 at *7 (D.Conn. July 21, 2005) (holding that "knowledge of the violation by the aider and abettor" is an essential element of an aiding and abetting claim). Because aiding and abetting violations of section 10(b) (5) of the Exchange act and Rule 10(b)-5 promulgated thereunder are allegations of fraud, Rule 9(b) of the Federal Rules of Civil Procedure requires that the facts underlying the claims be plead with particularity.Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000). The scienter allegations must "give rise to a strong inference of fraudulent intent." Kalnit v. Eichler, 264 F.2d 131, 138 (2d Cir. 2001). However, the plaintiff can satisfy this requirement "by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." Id.
In its Complaint, the SEC alleges that Coons served as "the primary outlet for the illegal sales of restricted PacketPort.com shares," illegally selling about ninety percent of the shares the defendants sold to the public during the alleged scheme. Compl. at ¶ 100. In paragraphs 100 through 114 of the complaint, the SEC outlines a serious of factual allegations against Coons to establish that he knowingly and substantially assisted in violating securities law. See id. at ¶¶ 100-114. For example, the complaint alleges that Coons continued to sell shares of PacketPort.com on behalf of IP Equity despite his belief that Agarwal was a "scumbag" for authorizing the sales after his company IP Equity recommended the stock to the public. Id. at ¶¶ 104-05. The complaint also alleges that Coons, despite having ten years experience as a stockbroker, opened accounts for PacketPort.Inc, IP Equity, or Microphase without ever inquiring as to whether they obtained and sold their stock in PacketPort.com legally. Id. at ¶¶ 101, 103, 107, and 111. Given such allegations, this Court finds that the SEC adequately pled the facts constituting knowledge with sufficient particularity and cannot say, as a matter of law, that the SEC will be unable to prevail on its aiding and abetting claim at trial. Therefore, the motion to dismiss is denied.
C. Motions to Strike Fifth Amendment Invocations
Durando, Dotoli and Jaffe moved pursuant to Rule 12(f) of the Federal Rules of Civil Procedure to strike all references in the complaint to their invocations of the Fifth Amendment privilege against self-incrimination. All three defendants invoked the privilege in response to investigative subpoenas from the SEC. They claim that the references are "immaterial" and "impertinent" under the Federal Rules because the Fifth Amendment prohibits the fact-finder in their civil cases from drawing any adverse inferences against them based on their silence during the SEC investigation. It is axiomatic in this district that motions to strike are disfavored and will not be granted routinely. SEC v. DiBella, 409 F.Supp.2d 122, 126 (D.Conn. 2006). Here, the motions to strike fail as a matter of law.
The SEC accompanied its investigative subpoenas to Durando, Dotoli and Jaffe with copies of Form 1662, entitled, "Supplemental Information for Persons Requested to Supply Information Voluntarily or Directed to Supply Information Pursuant to a Commission Subpoena." SEC Form 1662 (7-98). Form 1662 informs those who provide testimony in SEC investigations that "[i]nformation you give may be used against you in any federal, state, local or foreign administrative, civil or criminal proceedings brought by the Commission or any other agency." Id. The heart of Durando, Dotoli and Jaffe's arguments is that, because their testimony could have been used in a criminal proceeding, the SEC investigation and any future criminal action were inseparable. As a result, the SEC investigation should be considered a criminal proceeding for Fifth Amendment purposes. Treating the SEC investigation as a criminal proceeding under the Fifth Amendment would prevent any adverse inferences against Durando, Dotoli and Jaffe for invoking their right to silence. This court does not accept the premise that SEC's actions here should be considered criminal proceedings.
The Fifth Amendment states that "no person . . . shall be compelled in any criminal case to be a witness against himself." U.S. Const. amend. V. In civil actions, however, "the Fifth Amendment does not forbid adverse inferences against parties . . . where the privilege is claimed by a party to a civil cause." Baxter v. Palmigiano, 425 U.S. 308, 318 (1976) (quoting 8 J. Wigmore, Evidence 439 (McNaughton rev. 1961). To the extent that being the target of an SEC investigation would give them "reasonable cause to apprehend danger" from answering questions, Durando, Dotoli and Jaffe had every right to assert their right to silence during the SEC's pre-complaint inquiry. Ohio v. Reiner, 532 U.S. 17, 21 (2001). However, the Fifth Amendment can only protect their silence from adverse inferences in criminal proceedings. The Supreme Court has held that SEC investigations are not criminal proceedings. See S.E.C. v. O'Brien, Inc., 467 U.S. 735, 742 (1984) (holding that the SEC did not have to notify target of investigation that it served third parties with subpoenas because "the Confrontation Clause does not come into play until the initiation of criminal proceedings.").
Also, courts in this District have allowed fact finders to draw adverse inferences when the target of an SEC investigation invokes the right to silence. See, S.E.C. v. Prater, 289 F.Supp.2d 39, 50 (D. Conn 2003) (holding in reference to defendant who invoked Fifth Amendment at deposition that "the Court is entitled to, and does, draw adverse inferences from Mr. Prater's invocation of the Fifth Amendment."); see also;S.E.C. v. Global Telecom Services, L.L.C., 325 F.Supp.2d 94, 109 (D. Conn 2004). A major justification for this rule in civil cases is to create strong incentives for defendants to supply evidence by which the fact finder can determine their liability. Global Telecom Services, 325 F.Supp.2d at 109 (quoting United States v. 4003-4005 5th Ave., 55 F.3d 78, 82 (2d Cir. 1995) (stating invocation of silence will "always disadvantage opposing parties . . . since it keeps them from obtaining information they could otherwise get"). The primary incentive is that "silence is often evidence of the most persuasive character," United States ex rel. Bilokumsky v. Tod, 263 U.S. 149, 153-54 (1923), so defendants in civil cases must decide whether to counter-act any potential negative inferences through their own proofs.
Because in this case silence alone cannot establish guilt and there is no reason to believe it will be given undue evidentiary value at trial, there is little reason to believe at this point that Dotoli, Durando and Jaffe will be unduly prejudiced by admission of their silence. See Baxter, 425 U.S. at 317, 318. This court sees no reason to depart from the plain text of the Fifth Amendment, the Supreme Court's view of SEC proceedings, and the prevailing precedent of this District. The motions to strike references to the Durando, Dotoli and Jaffe's invocation of their Fifth Amendment rights is therefore denied.
IV. CONCLUSION
For the foregoing reasons, the defendants' Motions to Dismiss (Doc. No. 44), Coons' Motion to Dismiss (Doc. No. 53), Jaffe's Motion to Dismiss (Doc. No. 97), Durando and Dotoli's Motion to Strike (Doc. No. 45), and Jaffe's Motion to Strike (Doc. No. 50) are DENIED.
SO ORDERED.