The opinion of the court was delivered by: Barrington D. Parker, Jr., District Judge.
MEMORANDUM DECISION AND ORDER
Plaintiff David Schnell brings this action against Conseco, Inc.
("Conseco") and Sands Brothers & Co., Ltd. ("Sands"), on behalf of a
purported class of public investors in NAL Financial Group, Inc. ("NALF")
for injuries suffered as a result of Conseco's alleged fraud in violation
of the Racketeer Influenced and Corrupt Organizations Act ("RICO"),
18 U.S.C. § 1961, et seq., (Count I), and the manipulation of the
market for NALF securities allegedly committed by Sands, in violation of
Section 10(b) of the Securities Exchange Act of 1934,
15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder by the
Securities Exchange Commission ("SEC") (Count II). Essentially, Schnell
alleges that Conseco, with the assistance of Sands, unlawfully effected a
series of transactions — principally the sale of convertible
debentures in NALF — to gain control of NALF by acquiring its
common stock at artificially low prices to the detriment of its remaining
Defendants now move to dismiss plaintiffs claims against them pursuant
to Fed. R.Civ.P. 12(b)(6) and 9(b). For the reasons stated below,
defendants' motions are granted.
In deciding a motion pursuant to Rule 12(b), the court is, of course,
obligated to construe the pleadings in the plaintiff's favor. Cooper v.
Parsky, 140 F.3d 433, 440 (2d Cir. 1998); Mills v. Polar Molecular
Corp., 12 F.3d 1170, 1174 (2d Cir. 1993); Bankers Trust Co. v. Rhoades,
859 F.2d 1096, 1098 (2d Cir. 1988). The following facts are accordingly
Conseco is a financial services holding company incorporated under the
laws of the state of Indiana and engaged in the development, marketing,
and administration of annuity, supplemental health, and individual life
insurance products. Sands is an investment banking firm that is also a
broker and dealer in securities.
NALF is a Delaware corporation, engaged in the purchase,
securitization, and servicing of automobile finance contracts to
consumers with high credit risks. Through an insurance subsidiary, NALF
provides insurance and insurance-related products to automobile dealers
and their customers, and, through a remarketing subsidiary, NALF disposes
of some of its repossessed and off-lease vehicles. On March 23, 1998,
NALF filed a Chapter 11 petition for bankruptcy. No claims are asserted
in this action against NALF.
On April 23, 1996, Beneficial Standard Life Insurance Co. ("BSLIC") and
Great American Reserve Insurance Co. ("GARCO"), two Conseco
subsidiaries, each acquired $5,000,000 worth of 9% Subordinated
Convertible Debentures of NALF. The debentures had a life span of
eighteen months, expiring in October 1997, and were convertible at any
time into NALF common stock at the lesser of $12.00 per share or 80% of
the market price of the stock on the date of conversion. NALF also issued
to the subsidiaries warrants to purchase 500,000 restricted shares of
NALF common stock at an exercise price of $12.65 per share.
By late 1996, approximately $11 million in NALF debentures with
conversion features similar to the Conseco debentures were owned by other
investors, including Merrill Lynch, Westminster Capital, and Michael
Karp. Millions of dollars in warrants similar to those granted to the
Conseco subsidiaries in April 1996 were also issued by NALF to other
Plaintiff contends that the debentures gave Conseco an incentive to
artificially depress the price of NALF's stock at the end of the eighteen
month conversion period so that Conseco could acquire the shares at the
depressed price. In connection with Conseco's purchase of the
debentures, Conseco was also allowed to designate one director to NALF's
Board of Directors. Plaintiff claims that NALF's May 2, 1996 mailing of a
proxy statement to its public stockholders and its electronic filing with
the SEC was a result of Conseco's designation of a director to NALF's
Board and was in furtherance of Conseco's scheme to defraud.
Plaintiff alleges that through phone calls to investors and
dissemination of false opinions on the value of NALF stock, Sands, who
has acted as Conseco's investment banker, artificially inflated the price
of NALF stock through an illegal "pump and dump" scheme to enable Sands
to make increased profits on sales of NALF stock.*fn1 Plaintiff also
contends that Sands, which acted as Conseco's financial advisor and
received a placement fee in connection with the private placement of
Conseco debentures, failed to inform public investors that Conseco itself
derived substantial benefits from the Conseco debentures and was
positioning itself to acquire NALF at 80% of the market price of NALF
stock, which Conseco allegedly expected to be severely depressed at the
end of the conversion period.
After Conseco's purchase of NALF shares, plaintiff alleges that
defendants began to position NALF to be acquired at a sharp discount by
Conseco. Plaintiff contends that after selling NALF stock to the public
at artificially inflated prices, Sands took NALF stock off its
recommended list and stopped its aggressive efforts to market NALF
shares, resulting in a precipitous decline in the stock's value.
On June 23, 1997, when NALF common stock was trading below $2 per
Conseco, pursuant to a Credit Agreement, loaned an additional $5,000,000
to NALF secured by a note maturing on December 31, 1997. In connection
with this note, NALF issued to Conseco warrants to purchase 275,000
shares of NALF common stock at an exercise price of $.15 per share and
agreed to amend the exercise price of the Conseco warrants to $.15 per
share from $12.625 and $14.25 per share.
On August 21, 1997, NALF and Conseco entered into an Investment
Agreement, and a first amendment to the June 23, 1997 Credit Agreement.
In the Investment Agreement, Conseco acquired 5,000,000 shares of NALF
stock for $5 million, and purchased all of NALF's outstanding convertible
debentures held by third parties other than Conseco. The Investment
Agreement also provided that Conseco would not "initiate or cooperate in
the initiation of any reorganization or liquidation proceeding with
respect to the Company under the Bankruptcy Act" until the date of
Closing, which was October 1, 1997.
On October 1, 1997, Conseco converted many of the debentures it owned
into NALF common stock, which resulted in Conseco's ownership of 73.6% of
the company, and agreed to convert its remaining debentures into NALF
common stock once the company had sufficient authorized shares available
for issuance upon conversion. In addition, NALF's Board of Directors was
increased from four to six members and the number of Conseco designees on
the Board was raised from one to four. Conseco also agreed that it would
not pursue a cash-out merger of NALF's public shareholders prior to March
23, 1998 without the approval of a majority of the company's minority
stockholders, and that it would not pursue a cash-out merger prior to
December 23, 1998 without the approval of a majority of disinterested
Plaintiff alleges that on November 29, 1997, Conseco caused NALF to
mail to its shareholders and file electronically with the SEC its
November 1997 Proxy.*fn2 The proxy disclosed that NALF was continuing to
experience serious difficulties, and was mailed with an amendment to the
Company's Certificate of Incorporation that increased the number of
authorized NALF shares from 50,000,000 to 100,000,000, allegedly to allow
Conseco to convert its remaining debentures and increase its control to
On March 23, 1998, NALF filed a Chapter 11 petition for bankruptcy.
Plaintiff alleges that Conseco caused the filing of this petition, and
that the filing was improperly intended to enable Conseco to acquire NALF
without adequate consideration to its public shareholders.
Plaintiff alleges two claims. First, plaintiff asserts a claim against
Conseco for violation of RICO on behalf of himself and a purported class
of all other persons and their successors in interest who purchased NALF
common stock on or after April 25, 1996, and who still own such stock.
Second, plaintiff asserts a claim against Sands, for violation of Section
10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, on
behalf of himself and a purported class consisting of purchasers of NALF
common stock between April 25, 1996 and August 21, 1997. Both ...