narrowly defined group of highly ranked officers or directors who participated in the preparation and dissemination of a prospectus, plaintiffs are not expected to bear the burden of having to identify the role of each defendant in the fraud without the benefit of any discovery.
Defendants cite cases which hold that a director's actions may not be imputed to a company unless they were performed within the scope of his duties to that company; however, those cases were decided not on a motion to dismiss, but at subsequent stages of the proceedings, where plaintiffs had, as they have not here, a chance to offer evidence. See Scientific Holding Co., Ltd. v. Plessey Inc., 510 F.2d 15, 20 (2d Cir. 1974) (appeal from jury decision dismissing the action); Etshokin v. Texasgulf, Inc., 612 F. Supp. 1220 (N.D.Ill. 1985) (summary judgment); Gerling Int'l Ins. Co. v. C.I.R., 839 F.2d 131 (3d Cir. 1988) (summary judgment); Weintraub v. Texasgulf, Inc., 564 F. Supp. 1466 (S.D.N.Y. 1983) (summary judgment); Fidelity Bank Nat'l. Ass'n v. Avrutick, 740 F. Supp. 222 (S.D.N.Y. 1990) (summary judgment). Whether or not knowledge can be imputed in this fashion is a matter of fact that cannot be determined on a motion to dismiss.
2. Scienter is Adeguately Alleged
Not all elements of a fraud claim need be pled with equal particularity. Rule 9(b) provides that "malice, intent, knowledge, and other condition of mind of a person may be averred generally." See Shields, 25 F.3d at 1128. The Court of Appeals has held that "allegations of scienter . . . are not subjected to the more exacting consideration applied to the other components of fraud." Breard v. Sachnoff & Weaver, Ltd., 941 F.2d 142, 143 (2d Cir. 1991) (quoting Ouaknine, 897 F.2d at 81). All that is required under Rule 9(b) is that there exist a "minimal factual basis for . . . conclusory allegations of scienter." Cohen v. Koenig, 25 F.3d 1168, 1173 (2d Cir. 1994) (quoting Connecticut Nat'l Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir. 1987)). "In fact, conclusory allegations of scienter are sufficient 'if supported by facts giving rise to a "strong inference" of fraudulent intent.'" IUE AFL-CIO Pension Fund v. Herrmann, 9 F.3d 1049, 1057 (2d Cir. 1993), cert. denied, 130 L. Ed. 2d 38, 115 S. Ct. 86 (1994) (quoting Ouaknine, 897 F.2d at 80). There are two independent ways to give rise to such an inference. A plaintiff may either (1) identify circumstances indicating conscious or reckless behavior by the defendants, or (2) allege facts showing both a motive for committing fraud and a clear opportunity for doing so. Shields, 25 F.3d at 1128; Cosmas v. Hassett, 886 F.2d 8, 13 (2d Cir. 1989). The Complaints meet the first of these criteria, and scienter is, therefore, adequately alleged.
The Moving Defendants assert that plaintiffs fail to allege any facts indicating the requisite scienter. They contend that the Complaints lack facts evidencing their reckless or conscious misbehavior -- that the allegations of knowledge and recklessness are merely conclusions. They note too that Plaintiffs must "supply a factual basis for their conclusory allegations" of knowledge, see Ross, 607 F.2d at 558, or recklessness. See Chemical Bank v. Shearson Lehman Bros., Inc., 1992 U.S. Dist. LEXIS 10751, 91 Civ. 4915 (LLM), 1992 WL 183760 at *2 (S.D.N.Y. July 21, 1992).
Yet given that all inferences must be drawn here in plaintiffs' favor, Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990), and that, as noted above, only a minimal factual basis need exist for the conclusory allegations of scienter, the Complaints adequately allege scienter by alleging circumstances indicating conscious or reckless behavior by the defendants. Each of the Individual Defendants occupied a position with or had a relationship with his or her Company, and it could thus be inferred that each was privy to confidential, proprietary information concerning the Company. As senior officers, directors and shareholders, it could be inferred that the individual Defendants were aware of market manipulation by a controlling person, and the financial position of the controlling person. Although the inference of scienter presented by these facts is not terribly strong, it is sufficient to permit Plaintiffs, who have not yet had the benefit of discovery, to offer evidence to prove it.
Shields, 25 F.3d at 1128, is not to the contrary. In that case, the plaintiff alleged that the company's optimistic financial predictions had been fraudulently made. The Court noted that the plaintiff had failed to allege that the company's disclosures were incompatible with the most current company reports. Under these particular circumstances, allegations of knowledge failed to show any fraudulent intent because "misguided optimism is not a cause of action and does not support an inference of fraud." Shields, 25 F.3d at 1129. In contrast, Plaintiffs here allege that the Defendants were aware of actual facts, not merely predictions. See also Sperber Adams Assocs. v. JEM Management Assocs. Corp., 1992 U.S. Dist. LEXIS 8301, 90 Civ. 7405 (JSM), 1992 WL 138344 (S.D.N.Y. June 4, 1992) (allegations of knowledge or recklessness combined with allegations that defendants prepared false and misleading offering materials satisfy pleading requirements); In re Gas Reclamation, Inc. Sec. Litig., 659 F. Supp. 493, 503 (S.D.N.Y. 1987) (allegations of knowledge combined with factual allegations of misrepresentations and omissions give rise to an inference of knowledge or recklessness).
Because the Complaints allege fraud with sufficient particularity, the motions to dismiss pursuant to Rule 9(b) will be denied.
III. The Motions to Dismiss for Failure to State a Claim Will Be Denied
A. The Ouestion of Materiality Cannot Be Resolved at This Juncture
Section 11 imposes liability "in case any part of [a] registration statement . . . contains an untrue statement of material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a). Similarly, Section 12(2) imposes liability for using a prospectus "which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading." 15 U.S.C. § 771(2).
Defendants seek dismissal for failure to state a claim on the grounds that none of the nondisclosures alleged by Plaintiffs is material: that there is no substantial likelihood that a reasonable investor would have viewed disclosure of the omitted facts as significantly altering the "total mix" of information made available. TSC Indus. Inc. v. Northway, Inc., 426 U.S. 438, 449, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976). This argument consists of two related prongs: first, that the alleged omissions in the complaint amount merely to inferences that might be drawn from material facts, and that inferences, unlike facts, need not be disclosed; second, that the alleged omissions amount merely to forecasts concerning Blech and Blech & Co., and that the securities laws do not require forecasts at all, much less those concerning third parties.
Certainly, as our Court of Appeals has noted, "The disclosure requirements of the securities law require 'nothing more than the disclosure of basic facts so that outsiders may draw upon their own evaluative experience in reaching their own investment decisions with knowledge equal to that of the insiders.'" Gulf & Western Indus. v. Great Atl. & Pac. Tea Co., 476 F.2d 687, 697 (2d Cir. 1973) (quoting Securities & Exch. Comm'n v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976, 22 L. Ed. 2d 756, 89 S. Ct. 1454 (1969)). Nor need a defendant disclose plaintiffs' "pejorative characterizations" of facts set out in its offering materials. See, e.g., Hecco Ventures v. Avalon Energy Corp., 606 F. Supp. 512, 519 (S.D.N.Y. 1985). And the securities laws do not require an issuer to forecast unforeseeable consequences. See, e.g., Acito v. IMCERA Group, Inc., 47 F.3d 47, 53 (2d Cir. 1995).
Yet these arguments essentially beg the question of whether the alleged omissions meet the materiality element of Sections 11, 12 and 10(b). The issue of whether particular misrepresentations and omissions are material -- whether consequences were foreseeable, whether inferences could be drawn, and whether certain facts were basic -- are issues of fact inappropriate on a motion to dismiss. See Joyce v. Joyce Beverages, Inc., 571 F.2d 703, 707 (2d Cir.), cert. denied, 437 U.S. 905, 57 L. Ed. 2d 1135, 98 S. Ct. 3092 (1978).
Defendants contend further that they disclosed all information required by Regulation S-K, 17 C.F.R. § 229.500 et seq., concerning their underwriters, noting that there is no allegation that they failed to meet those obligations. That regulation requires an issuer to identify each underwriter with a material relationship with the issuer and the nature of the relationship, the underwriter's obligation to take securities, the underwriter's compensation, the existence of any underwriter's representatives on the issuer's board of directors, and any indemnity provided to the underwriter. A new issuer must also disclose the nature of the underwriter's experience, and, in large, bold-face type, whether the underwriter will effect transactions to stabilize the price of the security and facilitate the offering and that such stabilization may be discontinued at any time. Each of the companies, the Moving Defendants argue, made all of these disclosures, thus belying Plaintiffs' assertions that the Registrations and Prospectuses were misleading for failing to identify Blech & Co.'s role in the market for their stock. Yet although there is no authority that Defendants were required to go beyond the Regulation S-K disclosures and investigated the financial health of Blech and Co. and David Blech, no authority suggests that Regulation S-K is preemptive of the materiality requirement.
Certain of the Moving Defendants argue that no Section 11 or Section 12 claims are stated, because those claims do not contain allegations of knowledge. Yet knowledge is not an element of a Section 11 or 12(2) claim. As noted above in discussing the applicability of Rule 9(b) to such claims, Sections 11 and 12(2) provide for strict liability, and only a material misstatement or omission need be shown to establish a prima facie case. See 15 U.S.C. §§ 77k(a), 771(2); Herman & MacLean, 459 U.S. 375 at 381-82, 103 S. Ct. 683, 74 L. Ed. 2d 548; Wilson, 872 F.2d at 1126; Capri, 856 F.2d at 478.
B. The Complaint States a Section 11 Claim
In arguing for dismissal of the Section 11 claims, the Moving Defendants assert that the issuers and the individual Defendants bore no obligation to investigate Blech, their underwriter, and that, indeed, imposing a duty on an issuer to investigate its underwriter would stand the securities law regime on its head.
An issuer of securities is strictly liable for material misrepresentation and omissions in its registration statement and prospectus under Section 11. In re Ames Dept. Stores Inc. Stock Litig., 991 F.2d 953, 961 (2d Cir. 1993). Unlike certain other Section 11 defendants, the issuer has no "due diligence" defense available. Kronfeld v. Trans World Airlines, Inc., 832 F.2d 726, 730 (2d Cir. 1987), cert. denied, 485 U.S. 1007, 99 L. Ed. 2d 700, 108 S. Ct. 1470 (1988). The Moving Defendants do not cite, nor can this Court find, any authority setting out an exception to this rule with respect to underwriters for the securities in question.
C. The Complaint States a Section 12(2) Claim
Certain of the Moving Defendants seek dismissal of the Section 12(2) claim by alleging that they were not statutory "sellers" for the purposes of the section. See 15 U.S.C. § 771(2). Section 12(2) provides that:
Any person who . . . offers or sells a security . . . by means of a prospectus or oral communication, which includes an untrue statement of material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading . . ., shall be liable to the person purchasing such security from him . . . .
Although the Securities Act does not define the term "seller", the Supreme Court clarified its meaning in Pinter v. Dahl, 486 U.S. 622, 100 L. Ed. 2d 658, 108 S. Ct. 2063 (1988). Under Pinter and its progeny, a person is a "seller" under Section 12(2) if it either: (1) transferred title to the securities at issue; or (2) actively solicited the sale of the securities with a motivation to serve his own financial interests or those of the securities owner. See Commercial Union Assur. Co. v. Milken, 17 F.3d 608, 616 (2d Cir. 1994), cert. denied, 130 L. Ed. 2d 130, 115 S. Ct. 198 (1994), extending Pinter analysis from Section 12(1) to 12(2)); Cortec Indus. Inc. v. Sum Holding L.P., 949 F.2d 42, 49 (2d Cir. 1991), cert. denied, 503 U.S. 960 (1992).
Although certain Moving Defendants did not directly transfer the shares at issue, having sold them to Blech & Co. first, the Complaints allege facts sufficient to present the possibility that the Moving Defendants "actively solicited" the sale of the securities. Although signing the registration statement need not constitute active solicitation, see Mabon, Nugent & Co. v. Borey, 127 Bankr. 727, it is, at this stage of the proceedings, a sufficient allegation to permit Plaintiffs to present evidence that, alone or in tandem with other acts, the signatures constituted active solicitation, given that other courts have held involvement in preparation and circulation of the prospectus sufficient to show solicitation. See, e.g., Capri, 856 F.2d at 478. And although scienter must be pleaded when a plaintiff seeks to hold collateral participants liable under Section 12(2), see, e.g., Akerman v. Oryx Communications, Inc., 810 F.2d 336, 344 (2d Cir. 1987), whether or not the Moving Defendants were collateral participants is more appropriately a question for summary judgment.
D. The Complaint States a Controlling Person Claim
Defendants seek to dismiss the controlling person claims, noting that it has been held that "status as an officer, director, or shareholder, absent more, is not enough to trigger [control person] liability." Hemming v. Alfin Fragrances, Inc., 690 F. Supp. 239, 245 (S.D.N.Y. 1988). Moreover, they note, this court has required a plaintiff to plead not only that the defendant had actual authority, but also that he "possessed actual control over the transactions in question." Katz v. Katz, 82 Civ. 6383 (LBS), Fed. Sec. L. Rep. (CCH) P99,669, 1984 WL 2385, (S.D.N.Y. Feb. 14, 1984).
Plaintiffs have, however, met the prevailing standard for establishing a prima facie showing of control person liability by pleading that the Individual Defendants each controlled a primary violator of the securities laws: the Companies. Any defense must be raised in their responsive pleadings. Terra Resources I v. Burgin, 664 F. Supp. 82, 88 (S.D.N.Y. 1987). The Plaintiffs have gone beyond averring control by mere status, detailing each of the Individual Defendants' positions of control and authority as directors or executive officers of their respective companies, the terms of their public offerings, their underwriters, and the value and market for its securities; their ability to control the acts of their respective issuers; their control over the contents of the respective offering documents; their signatures thereon, and their failure to disclose material facts therein. Such allegations have been held to meet the standards for pleading control person liability. See In re Par pharmaceuticals, Inc. Secs. Litig., 733 F. Supp. 668, 679-680 (S.D.N.Y. 1990); Hemming, 690 F. Supp. at 245; Food & Allied Servs. Trades Dep't v. Millfeld Trading Co., 841 F. Supp. 1386, 1391 (S.D.N.Y. 1994); Morse v. Weingarten, 777 F. Supp. 312, 317-18 (S.D.N.Y. 1984). Although the Moving Defendants present a viable case that certain of them, particularly Haber, an outside director who owned just 1.2 percent of the company's outstanding stock, cannot be deemed a control person, this is a matter of fact more appropriately decided on a motion for summary judgment than on a motion to dismiss.
All arguments not explicitly addressed here have been considered and dismissed as unconvincing or irrelevant. For the reasons set forth above, the motion of the TBC Defendants for reconsideration of the Texas Order is granted. Its motion to dismiss and those of the other Moving Defendants are denied.
It is so ordered.
New York, N.Y.
June 6, 1996,
ROBERT W. SWEET
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