set of facts in support of plaintiff's claim which would entitle plaintiff to relief." Harsco Corp. v. Segui, 91 F.3d 337, 341 (2d Cir. 1996). In receiving such a motion, the court must take the plaintiff's allegations as true. Id.
B. Violation of 10(b) of the 1934 Act and Rule 10b-5
1. Scienter Under the Private Securities Litigation Reform Act
Defendants argue that plaintiff's securities fraud claim must be dismissed because plaintiff does not sufficiently plead scienter under the heightened pleading standard requirements of the Private Securities Litigation Reform Act ("PSLRA"). Plaintiff argues that the PSLRA adopted the Second Circuit's scienter pleading standard, and that plaintiff has adequately plead scienter because it has alleged circumstantial evidence of defendants' conscious or reckless behavior, and that defendants had the motive and opportunity to defraud it.
It appears that the standard for pleading scienter in private securities cases in light of the Private Securities Litigation Reform Act of 1995 ("PSLRA") is an issue of first impression in this circuit. Prior to the passage of the PSLRA, a plaintiff in the Second Circuit was required to allege specific facts that either (1) constituted circumstantial evidence of either reckless or conscious behavior on the part of the defendant or (2) established defendant's motive to commit fraud and an opportunity to do so. See In re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 269 (2d Cir. 1993). However, in passing the PSLRA, Congress sought to "strengthen existing pleading requirements," and stated that "it [did] not intend to codify the Second Circuit's case law interpreting this pleading standard."
H.R. Conf. Rep. 104-369, 104th Cong. 1st Sess. 41 (1995). Moreover, when he vetoed the PSLRA bill, a veto that Congress overrode, President Clinton stated that it was "crystal clear" that Congress intended the PSLRA "to raise the [pleading] standard even beyond the [high pleading standard of the Second Circuit]." 141 Cong. Rec. H15215-06 (1995). Therefore, under the PSLRA a plaintiff in a private securities litigation action must now plead specific facts that "create a strong inference of knowing misrepresentation on the part of the defendants." In re Silicon Graphics, Inc. Securities Litigation, 1996 U.S. Dist. LEXIS 16989, 1996 WL 664639, *7 (Sept. 25, 1996); see also Friedberg v. Discreet Logic Inc., 959 F. Supp. 42, 1997 U.S. Dist. LEXIS 2893, 1997 WL 109228 (D. Mass. March 7, 1997) (holding that the PSLRA pleading standard was intended to be stronger than the existing Second Circuit standard). But see Rehm v. Eagle Finance Corp., 954 F. Supp. 1246, 1997 U.S. Dist. LEXIS 767, 1997 WL 43037 (N.D. Ill. Jan. 28, 1997) (holding that although the PSLRA does not bind the courts to the Second Circuit's pleading standard, the court would still apply it); Marksman Partners L.P. v. Chantal Pharmaceutical Corp., 927 F. Supp. 1297, 1310 (C.D. Ca. 1996) (holding that the "motive and opportunity" test of the Second Circuit was not discarded by the passage of the PSLRA); Sloane Overseas Fund, Ltd v. Sapiens Internat'l Corp., N.V., 941 F. Supp. 1369, 1377 (S.D.N.Y. 1996) (citing PSLRA and parenthetically noting it codified the Second Circuit standard for pleading scienter).
While there is precious little guidance with respect to what will satisfy the PSLRA knowing misrepresentation standard, it is instructive to look at the first prong of the Second Circuit's standard noted above.
See Friedberg, 959 F. Supp. 42, 1997 U.S. Dist. LEXIS 2893, 1997 WL 109228 at *9 (finding that the PSLRA did not codify the Second Circuit's motive, opportunity and recklessness standard, but did not specifically reject the application of the Second Circuit's "conscious misbehavior" standard). Under this standard, the scienter requirement requires a plaintiff to allege "circumstances indicating conscious behavior by defendants." Cosmas v. Hassett 886 F.2d 8, 13 (2d Cir. 1989). A plaintiff cannot simply couple a factual statement with a conclusory allegation of fraudulent intent to adequately plead scienter. Acito v. Imcera Group, 47 F.3d 47, 53 (2d Cir. 1995); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1129 (2d Cir. 1994). Nor is it sufficient to simply allege statements of a prosperous future compared to a bleaker reality. Acito, 47 F.3d at 53. "Misguided optimism is not a cause of action, and does not support an inference of fraud." Id.
Defendants argue that plaintiff's federal securities fraud claim must be dismissed for failure to state a claim since the complaint is devoid of any facts that give rise to a strong inference that when defendants promised to fund Apex on an immediate and ongoing basis the promise was false. Defendants argue that Norwood does not allege that defendants ever represented that Apex would be funded from Apollo's or Converse's cash reserves, nor does Norwood allege that defendants knew that the bond offering would not be able to proceed at the time they made the promise of funding.
I find that Plaintiff, while a close question due to the paucity of precedent, has sufficiently alleged specific facts which create a strong inference of knowing misrepresentation on the part of the defendants. For example, plaintiff alleges that defendants repeatedly represented that they would provide Apex with adequate funding on an immediate and ongoing basis. Comp. PP 57, 64. Plaintiff alleges that not later than the closing of the transaction, defendants knew they planned to float a bond issue in late June, had retained BT Securities to assist them and that the funding of Apex was contingent on the success of the issue, and yet failed to disclose these facts to plaintiff. Comp. PP 83-84. Lastly, plaintiff alleges that even if the June bond issue had been successfully floated, the funds produced in July and August would have been too late to finance plaintiff's fall 1995 trade cycle. Comp. P 84. These allegations create a strong inference that, before and at the time of closing, defendants promised immediate funding knowing that such funding would not occur until at least one month after the transaction closed. These statements are more than factual allegations coupled with a conclusion of fraudulent intent. Therefore, plaintiff has sufficiently plead scienter under Section 10(b) and Rule 10b-5 interpreted in light of the PSLRA.
2. Loss Causation
The Court's inquiry, however, cannot end there. Defendants argue that even if Norwood sufficiently plead scienter, its federal securities fraud claim fails because it cannot sufficiently allege loss causation. In an action for federal securities laws violations, a plaintiff must adequately plead loss causation. See 15 U.S.C. § 78u-4(b)(4) (West Supp. 1996). To establish loss causation, a plaintiff must allege both "that the misrepresentation induced it to enter into the transaction and that the misrepresentation was the cause of the actual loss suffered." Citibank, N.A. v. K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992). The latter requires a plaintiff to show that the economic harm it suffered occurred as a result of the alleged misrepresentation. Id.
As noted above, Norwood received only Converse debt instruments in connection with its sale of Apex securities. Defendants argue that Converse's obligation to pay the notes could not be affected by the alleged fraud or subsequent bankruptcy of Apex or decline of Converse's stock, and therefore Norwood can allege no economic loss suffered. Plaintiff alleges it was damaged because, had it known about defendants fraud, it would have pursued other options, such as selling Apex to another interested company or putting Apex into bankruptcy sooner. Comp. PP 65-66.
Norwood has failed to adequately allege the causation requirements of the statute. While, plaintiff alleges that the defendants' misrepresentations induced them to enter into the transaction, it fails to allege how it suffered a loss as a result of the alleged misrepresentation. The complaint states that Converse's stock price has dropped and that as a "security holder of Converse, the [plaintiff was] directly damaged by [defendants'] fraudulent acts." Comp. P 14. However, Norwood is not an equity security holder, but simply a holder of Converse debt. In fact, as defendants point out, absent a threat to Converse's solvency (which was not alleged), a decrease in Converse's stock price cannot render Norwood's debt less likely to be paid. Faced with this fact, plaintiff merely claims with respect to damages it is "reasonable to assume" that because Converse's stock price had dropped, which parenthetically hasn't happened either,
the value of the notes has also declined. Pl. Memorandum p. 10. This allegation, however, falls short of showing actual loss suffered. Id. Therefore, because Norwood cannot prove actual loss causation, defendants' motion to dismiss Norwood's federal securities fraud claim is granted.
For the reasons stated above, defendant's motion to dismiss plaintiff's federal securities fraud claim is GRANTED, supplemental jurisdiction is declined, and plaintiff's state law claims are dismissed. The Clerk of the Court is directed to close this case.
New York, New York
April 3, 1997
Harold Baer, Jr.