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GABRIEL CAPITAL, L.P. v. NATWEST FINANCE

May 8, 2000

GABRIEL CAPITAL, L.P., A DELAWARE LIMITED PARTNERSHIP, AND ARIEL FUND LTD., A CAYMAN ISLANDS CORPORATION, PLAINTIFFS,
V.
NATWEST FINANCE, INC., F/K/A GLEACHER NATWEST INC., D/B/A NATWEST CAPITAL MARKETS LIMITED, AND MCDONALD INVESTMENTS INC, F/K/A MCDONALD & COMPANY SECURITIES, INC.; AND STEEL DYNAMICS INC., DEFENDANTS.



The opinion of the court was delivered by: Shira A. Scheindlin, U.S.D.J.:

    OPINION AND ORDER

Plaintiffs Gabriel Capital, L.P. ("Gabriel Capital") and Ariel Fund Ltd. ("Ariel Fund") have sued defendants NatWest Finance, Inc. ("NatWest"), McDonald Investments Inc. ("McDonald"), and Steel Dynamics Inc. ("SDI") for securities fraud arising from plaintiffs' purchase of certain debt securities (the "Note" or "Notes"). Plaintiffs allege that defendants violated section 10(b) of the Securities and Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, by making or participating in the making of untrue statements and by omitting material facts in order to induce plaintiffs to purchase the Notes. Plaintiffs also allege that, through the same conduct, defendants committed common law fraud, conspired to commit fraud, and aided and abetted fraud, all in violation of New York law.

All three defendants have moved to dismiss plaintiffs' Amended Complaint, pursuant to Fed.R.Civ.P. 12(b)(6), Fed. R. Civ. P. 9(b), and the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4(b)(2). Natwest and McDonald, both financial institutions, filed a joint motion to dismiss. SDI, a steel company, filed its own motion to dismiss. All three defendants argue that plaintiffs have failed to meet the various requirements for stating a claim of securities fraud.

I. BACKGROUND

A. Facts

The facts set forth below are taken from the Amended Complaint and are assumed to be true for purposes of this motion. See Harris v. City of New York, 186 F.3d 243, 247 (2d Cir. 1999) ("On a motion to dismiss under Rule 12(b)(6), the court must accept as true the factual allegations in the complaint, and draw all reasonable inferences in favor of the plaintiff."). In 1995, Nakornthai Strip Mill Public Company Limited ("NSM") decided to construct an experimental mini-mill (the "Mini-Mill") near Chonburi, Thailand. See Amended Complaint ¶ 9. The Mini-Mill was to consist of: (1) a compact strip production thin-slab hot mill (the "Hot Mill") for steel melting, refining, casting, and hot rolling; (2) a facility (the "DRI facility") for the production of direct reduced iron ("DRI"), which would be used along with steel scrap as the raw material for making steel; and (3) downstream processing facilities for the production of high-quality pickled and oiled, cold-rolled, galvanized, and other value-added steel products (the "Finishing Facilities"). See id. The design of the Mini-Mill was experimental, incorporating new and unproven technology. See id. The person who persuaded NSM to construct the Mini-Mill — John W. Schultes (then an employee of U.S. Steel) — had never built or operated a mini-mill and only had participated in a feasibility study of the mini-mill concept. See id.

NSM initially obtained financing for the Mini-Mill from the Chairman of its Board of Directors, Sawasdi Horrungruang, and a group of Thai banks. See id. ¶¶ 9, 10. When those sources of financing dried up, due in part to an economic downturn in Thailand in 1997, Schultes approached defendant McDonald, an investment bank with particular expertise in the steel industry; McDonald agreed to help NSM raise funds in the United States. See id. ¶ 10.*fn1 McDonald then approached NatWest to become the lead underwriter. See id. ¶ 11.*fn2

NatWest and McDonald were two of the four initial purchasers of the Notes, which were distributed in a private placement offering pursuant to Rule 144A, 17 C.F.R. § 230.144A. See id. ¶ 1. NatWest and McDonald worked together to market the Notes to institutional investors, including plaintiffs. See id. ¶ 11. As part of this marketing effort, NatWest and McDonald prepared an Offering Memorandum. See id. McDonald prepared detailed slides that were shown during "road shows." See id. Employees of defendants, including a McDonald employee named Gary Heasley, actively participated in these road shows. See id.

McDonald recognized that it needed to have a well-regarded mini-mill operator serve as a technical advisor to NSM, in order to induce investors to purchase the Notes. See id. ¶ 12. McDonald originally enlisted the help of Nucor Corporation ("Nucor"), which withdrew from the project in October 1997. See id. McDonald then turned to SDI, the only other mini-mill operator with the required experience. See id. Rather than limiting its role to technical advisor, SDI agreed to become a managing owner of NSM. See id. In exchange for its participation and promised services, SDI was given shares representing 10% of the equity in NSM, an annual fee of $2,000,000 (with the first payment made on March 12, 1998), a one-time incentive fee of $1,300,000 (to be paid no later than March 12, 1999), and a license to use the NSM technology. See id.

Keith Busse, the CEO of SDI, attended and actively participated in the road shows. See id. Busse endorsed NSM management, especially Schultes, and touted the design of the NSM mill as "A." Id. In addition, Busse affirmed and reiterated the following representations made by NatWest and McDonald employees: (1) SDI had verified NSM's concept and operating assumptions; (2) SDI would be a "managing owner" of NSM; (3) SDI was in "complete control" of all of NSM's operations (along with McDonald and other strategic equity investors); and (4) NSM was using technology that had proven successful at SDI's facilities. See id.

In mid-to-late February 1998, Robert Sherman, an agent and employee of NatWest, contacted Thomas Mullen, an agent and employee of plaintiffs, seeking an opportunity to pitch the Notes. See id. ¶ 13. Mullen referred Sherman to Jack Mayer and Selin Cebeci, representatives of plaintiffs; Mayer and Cebeci agreed to meet with Sherman and other representatives of NatWest, McDonald, and NSM. See id.

On February 26, 1998, Mayer and Cebeci met with Schultes, representatives of NatWest, including Sherman, and representatives of McDonald, including Gary Heasley and David Stickler.*fn3 See id. ¶ 14. At this meeting, defendants displayed a series of slides used at other road shows, describing, discussing, and elaborating on the information contained therein. See id. ¶ 16. In particular, defendants emphasized the following points:

The Hot Mill, already fully constructed and through start-up, was producing high quality steel. The proceeds from the bond offering would be used only to provide working capital for the facility to begin commercial operations, and to construct the Finishing Facilities and DRI Facility. See id. ¶ 16(a).
Under the terms of two "Off-Take Agreements" already in place, two major German trading companies were obligated to take 100% of NSM's production for the first three years of operation and 25% for each of five additional years. See id. ¶ 16(b).
Technology used at NSM was state-of-the-art, proven technology already employed by SDI. "Defendants emphasized and reiterated the representations made by SDI at other road shows throughout the country that SDI was a `managing owner' of NSM, that SDI had verified the NSM concept and operating assumptions, that SDI had analyzed and reviewed NSM's design and confirmed that it was viable, state-of-the-art, and proven, and that SDI, as a `strategic equity investor' along with defendant McDonald and other non-Thai entities, was in complete control of operations, including purchasing, sales, and finance." Id. ¶ 16(c).
NSM's Thai owners and management would not control the funds, which would be controlled by an independent management company consisting of representatives of defendants and other non-Thai entities. "In particular, Gary Heasley, an employee of defendant McDonald who defendants represented would become NSM's chief financial officer following the completion of the Offering, assured plaintiffs that he would be moving to Thailand and that he would have complete control over NSM's funds, thus obviating any concerns plaintiffs had concerning mismanagement, theft, graft, self-dealing or other issues relating to NSM's existing management." Id. ¶ 16(d).
Scrap metal was available in sufficient quantities in Thailand at highly advantageous rates. See id. ¶ 16(e).
The NSM mill had an advantageous location relative to the harbor and a nearby Ford Motor Company plant, which NSM purportedly would supply with high quality finished steel. See id. ¶ 16(f).

Plaintiffs were given several other documents as part of the sales pitch. Both prior to and at the February 26 meeting, NatWest gave plaintiffs several NatWest documents, with the notation "for internal use only," that purported to be NatWest's internal analysis of the valuation of the Notes. See id. ¶ 15. Shortly after the February 26 meeting, and prior to plaintiffs' investment decision, defendants gave them the final Offering Memorandum, dated March 2, 1998. See id. Finally, defendants gave plaintiffs a magazine published in the Fall of 1997 by the Indiana University-Purdue University Fort Wayne Alumni Association. The magazine's cover story was titled "Hot Metal Man — Keith Busse of Steel Dynamics." See id. ¶ 17. The article discusses Busse's career in the steel industry, focusing specifically on his expertise in the mini-mill industry. See id. SDI provided copies of this magazine to defendants, who then passed the magazine along to prospective purchasers.*fn4 See id.

After reviewing and relying upon the written materials provided to them, as well as the oral representations made by defendants, "plaintiffs together purchased $15.5 million in principal value of 12% NSM Senior Steel Mortgage Notes due 2006." Id. ¶ 18. This purchase took place on or about March 2, 1998. See id.

On August 24, 1998, SDI's counsel, Robert S. Walters, sent a memorandum to NSM regarding serious problems with the Mini-Mill (the "Walters memo"). See id. ¶ 19. The Walters memo "concluded, among other things, that `the management and operational problems at the Mill are so pervasive and fundamental that, coupled with the further deterioration of the steel markets in Asia and the enormous debt load that NSM is now carrying, it is doubtful that NSM can survive under the present circumstances.'" Id. (quoting Walters memo). In addition, the Walters memo "asserted that the representations in certain documents to be filed with the SEC, which included the representations made in the Offering Memorandum, were `fundamentally incorrect and misleading,' and `convey the impression of a Mill that, although facing substantial debt and start-up uncertainties, is basically sound, with reasonable prospects for success.' [The Walters memo] stated that this `does not appear to be justified under the circumstances.'" Id. (quoting Walters memo).

The Walters memo also detailed a number of problems at the Mini-Mill, "the majority of which were problems known to the defendants at the time of the offering and fundamentally inconsistent with the representations made by the defendants concerning various aspects of the project." Id. ¶ 20. These included:

"`The management team is not credible, . . . and . . . requires a major overhaul." Id. ¶ 20(a) (quoting Walters memo).
"`Financial controls are woefully inadequate; poor accounting practices abound; checks get written and invoices get paid without appropriate justification, documentation or signatures; industry intelligent financial statements cannot be realistically produced; assets and inventories are valued above market; and accurate forecasting tools are not available.'" Id. ¶ 20(b) (quoting Walters memo).
"`Scrap controls are non-existent to poor; quality scrap in the region is non-existent; and the prices charged by scrap vendors are outrageous relative to the purported grade. . . . There is also an enormous dollar value of useless scrap tied up on the ground.'" Id. ¶ 20(c) (quoting Walters memo).
"`It would appear that the scrap bay cranes cannot adequately support the volume of raw materials required for the ConSteel process. Additionally, the scrap bay crane scales do not correctly reflect the weight of material delivered to the ConSteel feeding system. Consequently, the proper operation of the electric arc furnace cannot be maintained.'" Id. ¶ 20(d) (quoting Walters memo).
"`The single EAF melting battery [electric arc furnace], with the ConSteel feeding system, is inadequate and will not deliver the projected tonnages that are represented. Assuming the correction of certain design deficiencies, and given the limitation that the furnace cannot be conventionally charged, it would appear that, even under optimal operating circumstances, an annual output tonnage of perhaps 800,000-900,000 tons is more realistic. . . . [I]t may eventually be necessary to add a second, conventional, furnace battery in order to provide the necessary tonnage to properly support the caster and to better spread the tremendous fixed costs and carrying charge of the overall Mill.'" Id. ¶ 20(e) (quoting Walters memo).
"`Theft, graft, and corruption need to be seriously investigated. . . . SDI suspects, but does not have the mandate or the resources to try to establish, that "sweetheart" deals, "commissions," and other serious contracting and payment practices have resulted or continue to result in a material amount of waste.'" Id. ¶ 20(f) (quoting Walters memo).
"`NSM Management Co. is not operating the way it was envisioned and still does not have its full complement of members,' resulting in an authority vacuum." Id. ¶ 20(g) (quoting Walters memo).

SDI did not send the Walters memo to plaintiffs or other purchasers. See id.

On September 24, 1998, Enron Corp., which had purportedly agreed to develop an electric power plant in connection with the DRI facility, presented a report to the NSM Management Company and the NSM Board (the "Enron Report"). See id. ¶ 21. The Enron Report "documented the substantial use of proceeds [from the offering] in ways not disclosed in the Offering Memorandum and a substantial shortage of funds necessary to complete the DRI and Finishing Facilities." Id. The Enron Report was not provided to plaintiffs or other investors. See id.

Soon after the Enron Report, NSM's Board asked for and received Schultes' resignation. See id. NSM bondholders were subsequently notified of this resignation in a conference call. See id. ¶ 22. SDI then invited bondholders to attend a meeting at its headquarters on October 13, 1998. See id. Selin Cebeci and Burton Weinstein participated by telephone on behalf of plaintiffs. See id. At that meeting, Keith Busse, the CEO of SDI, "provided information to the investors which revealed that the defendants' representations made prior to the offering were false and misleading, including the fact that the mill had never produced high quality steel." Id.

In a letter dated December 30, 1998, Busse notified NSM and NSM Management Company that SDI was terminating its licensing and advisory agreements with NSM (the "Busse Letter"). See id. ¶ 23. In his letter, Busse "noted that SDI had found a `far less complete mill, with serious design flaws, without the wherewithal to complete the project as represented and, even if completed as represented, without the capacity to produce the output upon which the financial projections were predicated.'" Id. (quoting Busse Letter). Busse did not circulate his letter to plaintiffs or other NSM bondholders. See id.

"Since December 1998, the mill has been shut down; efforts to construct the DRI facilities have been abandoned; there are insufficient funds remaining to complete construction of the DRI and Finishing Facilities; a default has been declared by the bondholders; and there are no present restructuring plans or any realistic prospects for restructuring." Id. ¶ 24.

B. Procedural History

Gabriel Capital and Ariel Fund sued NatWest, McDonald, and SDI, filing their initial Complaint on October 12, 1999, and serving their Amended Complaint on November 5, 1999. In their Amended Complaint, plaintiffs allege that defendants made a number of false and misleading statements concerning: (1) the status of the Hot Mill; (2) the design of the Mini-Mill; (3) the ability of NSM to secure an adequate supply of scrap; (4) the "Off-Take Agreements; " (5) the management of NSM; and (6) the use of the proceeds of the offering. See Amended Complaint ¶¶ 25-37. Plaintiffs also pled justifiable reliance, see id. ¶¶ 38-40, scienter, see id. ¶¶ 41-46, and causation, see id. ¶ 47.

All three defendants have moved to dismiss the Amended Complaint pursuant to Rules 9(b) and 12(b)(6). NatWest and McDonald filed a joint motion to dismiss, while SDI filed its own motion.

II. DISCUSSION

A. Applicable Legal Standards

Dismissal of a complaint for failure to state a claim pursuant to Rule 12(b)(6) is proper only where "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Harris v. City of New York, 186 F.3d 243, 247 (2d Cir. 1999); see also Cooper v. Parsky, 140 F.3d 433, 440 (2d Cir. 1998) ("The task of the court in ruling on a Rule 12(b)(6) motion is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof.") (quotation marks and citation omitted). Thus, to properly rule on such a motion, the court must accept as true all material facts alleged in the complaint and draw all reasonable inferences therefrom in the nonmovant's favor. See Harris, 186 F.3d at 247. Nevertheless, "[a] complaint which consists of ...


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