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THREE CROWN L.P. v. CAXTON CORP.

February 18, 1993

THREE CROWN LIMITED PARTNERSHIP, THREE CROWN CAPITAL PARTNERS, MEADOWLANDS FUND, L.P. and H. BARNDT HAUPTFUHRER, Plaintiffs,
v.
CAXTON CORPORATION, BRUCE KOVNER, D. SCOTT LUTTRELL, LUTTRELL CAPITAL MANAGEMENT, STEINHARDT PARTNERS, STEINHARDT MANAGEMENT CORPORATION, MICHAEL STEINHARDT, SOROS FUND MANAGEMENT, GEORGE SOROS, SALOMON BROTHERS, INC., JOHN DOE, JANE DOE, XYZ CORPORATION, XYZ PARTNERSHIP, XYZ INSURANCE COMPANY, XYZ BANKING COMPANY, XYZ BANKING CORPORATION and XYZ FUND, Defendants.


Carter


The opinion of the court was delivered by: ROBERT L. CARTER

ROBERT L. CARTER, District Judge

 Three Crown alleges that, in or about March 1991, defendant Kovner, chairman of the board of Caxton, convened a meeting at which Luttrell, Caxton's chief bond trader; Soros, the president and chairman of the board of SFM; and Steinhardt, the president of Steinhardt Partners; a representative of Salomon and others were present. Luttrell allegedly highlighted the attractiveness of the Treasury's two year notes, particularly the imminent April issue. Steinhardt Partners subsequently acquired $ 4 billion and Caxton $ 2.5 billion of the April 1993 Two-Years (the "April Two Years" or "April Treasury Notes") in the When-Issued Market. *fn2" By the early stages of the Secondary Market, *fn3" Steinhardt Partners and Caxton had each acquired substantial "long" positions of $ 8 billion of the April 1993 Two-Years, the equivalent of 133% of the issue. Plaintiffs took a substantial "short" position.

 Plaintiff further avers that some or all of the defendants, acting together, thereafter "squeezed" the Secondary and Financing Markets *fn4" for the April Two-Years by restricting the supply and circulation of these securities through "anti-competitive conduct," including "anti-competitive financing." Specifically, Salomon's finance department allegedly conspired in the manipulation of the Secondary and Financing Markets for the April Two-Years by financing positions of the April notes for some or all of the other defendants, and Steinhardt and others financed a portion of their position in a manner allegedly designed to ensure that the securities could only be relent at great expense to the borrower. Moreover, on or about May 24, 1991, Luttrell informed Three Crown that Caxton was a large holder of April 1993 Two-Years, and would continue to hold the notes and acquire more rather than swapping out into other issues. As a result of this conduct, plaintiffs claim that the availability of April Two-Years in the Secondary and Financing Markets was severely restricted until mid-September, 1991, when the "squeeze" ended, and Three Crown was "forced to pay artificially inflated prices to purchase and premium rates to borrow the [April Treasury Notes] they required to cover their position." Complaint P 69.

 Shortly after the next Two-Year Treasury Note auction was announced, a Salomon employee allegedly informed representatives of Tiger Investments, a non-party in this action, that he believed Salomon's finance department would be in a position to dictate a "special rate" *fn5" in the Financing Market for May 1993 Two-Years (the "May Two-Years" or the "May Treasury Notes"). Salomon thereafter acquired for its own account and for the accounts of certain customers, $ 10.6 billion of the $ 11.3 billion in May 1993 Two-Years auctioned. Salomon was allegedly aware that Steinhardt had acquired at least $ 6 billion in the May Two-Years. Plaintiff's aver that Soros, acting in concert with Salomon and allegedly financed at premium rates by Salomon, also took a substantial position of over 35% in the When-Issued Market, so that Salomon, Steinhardt and Soros together allegedly controlled more than 140% of the May Treasury Notes. Moreover, plaintiffs allege that the defendants entered into financing agreements that were designed to reduce the number of May 1993 Two-Years circulating in the Financing Market. *fn6"

 Securities Exchange Act Claim

 Rule 12(b)(6), F.R.Civ.P., Motion

 Alone among the moving defendants, the Caxton defendants contend that a defect in the complaint precludes plaintiffs from satisfying several elements of a § 10(b) and Rule 10b-5 claim, and requires that the claim be dismissed pursuant to Rule 12(b)(6), F.R.Civ.P.. *fn7"

 Specifically, the Caxton defendants assert that the complaint alleges an incomprehensible scenario: On the one hand, contend the defendants, the complaint alleges that the plaintiffs strongly believed that the When-Issued, Secondary and Financing Markets in April and May Treasury Notes (hereafter, the "Relevant Markets") were being manipulated, and, in particular, that by late May of 1991 plaintiffs "knew everything" about the Caxton defendants role in the purported "squeeze." On the other hand, contend the defendants, the complaint reveals that after learning of the manipulation in late May of 1991, the plaintiffs nonetheless substantially increased their aggregate short position, a move which escalated any exposure plaintiffs had to the alleged "squeeze." According to the defendants, the plaintiffs' behavior as alleged in the complaint constitutes an attempt by the plaintiffs to "have their cake and eat it too" by using the securities laws as an insurance policy against losses in the securities markets.

 Based on their interpretation of the complaint, the Caxton defendants contend that the plaintiffs have not sufficiently pled the materiality, reliance, transaction causation and loss causation elements of their § 10(b) and Rule 10b-5 claim. However, the defendants' attack with respect to each of these elements hinges on the court's acceptance of their interpretation of the complaint as described above. *fn8" Therefore, if the Caxton defendants' reading of the complaint is rejected, all of their attacks as to the sufficiency of plaintiffs' § 10(b) claim must necessarily fail.

 Although the defendants' reading of the complaint is interesting and may constitute a potent attack on plaintiffs' claim at a later stage of this litigation, it must be rejected at this stage based upon the well-known rule for deciding a motion to dismiss for failure to state a claim. The rule provides that for purposes of a Rule 12(b)(6), F.R.Civ.P., motion, plaintiffs' well-pleaded allegations must be accepted as true, together with such reasonable inferences as may be drawn in the plaintiffs' favor. See e.g. Allen v. Westpoint-Pepperell, Inc., 945 F.2d 40, 44 (2d Cir. 1991); Qantel Corp. v. Niemuller, 771 F. Supp. 1361, 1370 (S.D.N.Y. 1991) (Leisure, J.).

 While the Caxton defendants are correct that Appendix A of the complaint *fn9" appears to indicate that plaintiffs increased their aggregate short position in the April Treasury Notes after the end of May, see Appendix A at 28-33, the defendants' assertion that the plaintiffs "knew everything" about the alleged manipulation by the end of May must be rejected. In particular, the defendants rely on Paragraph 65 which states that "between May 24 and June 28, 1991" plaintiffs and other market participants advised the Federal Reserve Bank of New York and the United States Treasury "of the manipulation" in the Relevant Markets. Complaint P 65. However, a favorable inference for plaintiffs which may be drawn from this paragraph is that plaintiffs' initial phone calls to state and federal regulators in late May were query and concern oriented, and they did not fully understand that a "squeeze" had occurred in the relevant markets until late June. This inference is further supported by allegations in the complaint that it was not until the "last week of June" that plaintiffs "became aware" that the notes were "no longer freely trading in the Secondary Market," and that alleviation of the squeeze was not going to happen. Complaint P 65-66. *fn10"

 Accepting plaintiffs' contention, as the court must at this stage of the proceedings, that they were not fully aware of the manipulation until late June, rather than the late May date asserted by defendants, the Caxton defendants' Rule 12(b)(6) attack on the sufficiency of the Section 10(b) and Rule 10b-5 pleadings must be rejected.

 Rule 9(b), F.R.Civ.P., Motion

 The moving defendants all take issue with plaintiffs' "information and belief" pleading. Despite Rule 9(b)'s generally rigid requirement that the "circumstances constituting fraud [be] stated with particularity," allegations may be based on "information and belief when facts are peculiarly within the opposing party's knowledge." Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990); see also, DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1247-1248 (2d Cir. 1987); Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). In this case where manipulation is alleged, as opposed to affirmative misrepresentation, some or all of the facts will be in the control of the defendants and inaccessible to the plaintiffs without discovery. See Brickman v. Tyco Toys, Inc., 722 F. Supp. 1054, 1060 (S.D.N.Y. 1989) (Carter, J.). Therefore, the plaintiffs must be allowed some information and belief pleading.

 However, this exception allowing information and belief pleading is not free license to base claims of fraud on "speculation and conclusory allegations," rather the complaint must "adduce specific facts supporting a strong inference of fraud." Wexner, 902 F.2d at 172 (emphasis added). In particular, allegations based on information and belief must be accompanied by a statement of facts upon which the belief is founded. Segal v. Gordon, 467 F.2d 602, 608 (2d Cir. 1972). Despite this requirement, plaintiffs' complaint is based almost entirely on information and belief without accompanying statements of the facts upon which the allegations are founded. This is impermissible. *fn11"

 In addition, the defendants contend that the complaint does not adequately specify their respective roles in the manipulation. Under Rule 9(b), F.R.Civ.P., where multiple defendants are charged with fraud, the complaint must be specific as to the nature of each defendant's alleged participation in the fraud. DiVittorio, 822 F.2d at 1247. Despite this requirement, most all of the allegations in plaintiffs' complaint as to each defendant's role in the manipulation are alleged on information and belief without a statement of the source of information and the reasons upon which the belief is founded. Throughout the complaint defendants are clumped together in vague allegations regarding "some or all of the defendants." Such wide-scale clumping is unacceptable. See, The Limited, Inc. v. McCrory Corp., 645 F. Supp. 1038, 1043-45 (S.D.N.Y. 1986) (Carter, J.). For example, although plaintiffs provide some factual support for their allegation that a squeeze of the May Treasury Notes occurred, Complaint P 47, they provide no particularized facts as to why the Caxton, Steinhardt and Soros defendants are necessarily implicated in that squeeze.

 The moving defendants third attack with respect to Rule 9(b), F.R.Civ.P., is that plaintiffs have failed to plead scienter with the requisite specificity. A valid § 10(b) claim must allege scienter. See, Ochs v. Shearson Lehman Hutton, Inc., 768 F. Supp. 418, 427 (S.D.N.Y. 1991) (Haight, J.). While Rule 9(b), F.R.Civ.P., allows scienter to be averred generally, such allegations must be supported by facts giving rise to a "strong inference" of fraudulent intent. Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2d Cir. 1987), cert. den., 484 U.S. 1005, 98 L. Ed. 2d 650, 108 S. Ct. 698 (1988), overruled on other grounds, United States v. Indelicato, 865 F.2d 1370 (2d Cir. 1989) (en banc), cert. den., 493 U.S. 811, 110 S. Ct. 56, 107 L. Ed. 2d 24 (1989). To satisfy the scienter requirement, a plaintiff may allege facts showing a motive, or where motive is not apparent, a plaintiff may plead scienter by identifying circumstances indicating conscious behavior by the defendant, though the strength of the circumstantial allegations must be correspondingly greater. Id. at 50; see also, Rooney Pace, Inc. v. Reid, 605 F. Supp. 158, 162 (S.D.N.Y. 1985) (Weinfeld, J.) (where alleged fraudulent conduct is market manipulation proof of knowledge likely to be in defendants' exclusive control, evidence of intent must await discovery).

 The plaintiffs argue that the following six points constitute the "requisite factual predicates to support a strong inference of defendants' fraud": (1) defendants met in March 1991, (2) defendants thereafter took massive positions in the April and May Two-Years, (3) at least one defendant (D. Scott Luttrell) admitted to holding enormous positions, (4) a Salomon Brother representative said that the May 1993 Two-Years were going to trade "on special," (5) defendants engaged in restrictive financing, and (6) defendants made enormous profits. Plaintiffs Brief at 16.

 There are a host of problems with plaintiffs' list of "factual predicates." First, although the complaint describes a May 1991 meeting, it contains no allegations that defendants made any plans to manipulate the when-issued, Secondary and Financing markets for April and May two-year Treasury Notes at that meeting; rather, the complaint indicates the meeting was convened for the harmless purpose of discussing "various investment alternatives." Complaint P 50. Second, examination of the complaint reveals that plaintiffs' second, third and fifth alleged factual predicates, are not facts but allegations pled on information and belief without accompanying statements of fact. Complaint P 53-56, 73-74, 58-62, 64, 77-78. In addition, while plaintiffs characterize their third and fourth alleged factual predicates as admissions of fraudulent activity, their complaint does not provide any context for such an assumption. *fn12"

 While the fourth predicate provides some weak allegations of scienter with respect to defendant Salomon Brothers, Inc., who is not a moving defendant, the allegation is irrelevant to the moving defendants. Complaint P 72. The sixth predicate provides a conclusory allegation in support of motive with respect to the ...


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