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DORCHESTER INVESTORS v. PEAK INTERN. LTD.

March 27, 2001

DORCHESTER INVESTORS, INDIVIDUALLY AND ON BEHALF OF ALL OTHERS SIMILARLY SITUATED, PLAINTIFF,
v.
PEAK INTERNATIONAL LIMITED, PEAK TRENDS TRUST, LUCKYGOLD 18A LIMITED, JERRY MO, T.L. LI AND DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION, DEFENDANTS.



The opinion of the court was delivered by: McKENNA, District Judge.

MEMORANDUM AND ORDER

The present case is a class action lawsuit arising out of the initial public offering and sale of Trust Enhanced Dividend Securities ("TrENDS") by Peak TrENDS Trust. According to Plaintiffs, the TrENDS offering violated the federal securities laws because the accompanying registration statement and prospectus were materially false or misleading. Defendants move to dismiss the First Amended Complaint ("Complaint") on the grounds that Plaintiffs fail to state a cause of action under the securities laws. For the reasons stated below, Defendants' motion is denied in part and granted in part.

PARTIES*fn1

Plaintiffs are a certified class of investors that purchased TrENDS pursuant to the allegedly false and misleading registration statement and prospectus issued in connection with the TrENDS offering.*fn2

Peak TrENDS Trust ("Trust") is registered under the Investment Company Act of 1940 as a non-diversified, closed-end management investment company. Pursuant to the TrENDS Prospectus, the Trust offered 5.3 million TrENDS at a purchase price of $15.75 per unit. Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") was the lead underwriter for the TrENDS offering.

Luckygold 18A Limited ("Luckygold") is a British Virgin Islands corporation that owns 7,888,038 shares of Peak International Limited ("Peak")common stock.*fn3 T.L. Li ("Li") was the Chairman of the Board and Chief Executive Officer of Peak, Chairman of the Board of QPL Holdings Group and the sole shareholder of Luckygold.

FACTS

On June 3, 1998 Peak TrENDS Trust, Luckygold and Peak, though DLJ, "participated in, conducted and completed the sale of" 5,300,000 TrENDS exchangeable for an equal amount of the common stock of Peak. (Compl. ¶ 13.) In connection with the sale of TrENDS, on May 29, 1998, the Trust filed with the SEC the Peak TrENDS Registration Statement and Prospectus (collectively referred to herein as the "TrENDS Prospectus"). Attached to the TrENDS Prospectus was the Peak Share Offering Registration Statement and Prospectus (collectively referred to herein as the "Peak Share Offering Prospectus") (Compl. ¶ 13.).

Peak TrENDS are debt securities linked to Peak common stock. (Compl. ¶ 14.) The TrENDS are the "functional equivalent" of convertible securities because on May 15, 2001 the TrENDS are to be exchanged for shares of Peak common stock or cash, depending on the performance of Peak common stock. (Id. ¶¶ 14-15.) Thus, the performance of Peak common stock directly impacts the value of the TrENDS.

Plaintiffs allege that the TrENDS were sold pursuant to a materially false and misleading prospectus. Plaintiffs assert that the TrENDS Prospectus either failed to disclose, or affirmatively misstated facts surrounding the true structure of the TrENDS offering, and contained misrepresentations regarding who was bearing the costs associated with the transaction.*fn4

According to the Complaint, DLJ "discovered, immediately prior to the Peak TrENDS Offering when it first attempted to market Peak TrENDS, the only investors who were willing to purchase Peak TrENDS were hedge fund investors who had the cash to arbitrage their positions, i.e., buy Peak TrENDS and simultaneously sell short the underlying Peak common stock." (Compl. ¶ 17(i).) Moreover, it is asserted that the DLJ investors in the TrENDS "were willing to purchase Peak TrENDS provided only that they were afforded the opportunity to sell shares of Peak stock short in amounts equal to their Peak TrENDS purchases." Id. (emphasis in original).

In order to accommodate the hedge investors, Defendant Li loaned 1.7 million shares of Peak common stock to DLJ ("Borrowed Shares") pursuant to a Share Loan Agreement. (Compl. ¶ 17(ii).) The Borrowed Shares were required because there was an insufficient amount of Peak common stock in the market to satisfy the short-selling requirements of the large number of hedge investors necessary to initiate a market for the TrENDS. (Id.) Plaintiffs argue that Defendants violated the federal securities laws by failing to adequately disclose that the 1.7 million shares of Peak common stock would be immediately loaned to DLJ investors to facilitate the hedge strategy. (Id. ¶¶ 17(ii)-17(iv).) Further, Plaintiffs claim that Defendants wrongfully failed to disclose the risks associated with the hedge strategy. (Id. ¶ 20.)

The TrENDS Prospectus stated:

In connection with the offering of the TrENDS, Luckygold and Donaldson, Lufkin & Jenrette Securities Corporation intend to enter into a securities loan agreement (the "Securities Loan Agreement") on or prior to the closing of the offering of the TrENDS, which is anticipated to provide that, subject to certain restrictions, Donaldson, Lufkin & Jenrette Securities Corporation may from time to time borrow, return and reborrow Shares (the "Borrowed Shares") from Luckygold. The number of Borrowed Shares borrowed under the Securities Loan Agreement at any time is not expected to exceed 1,793,038 Borrowed Shares. In addition, in the course of ordinary trading or market-making activities, Donaldson, Lufkin & Jenrette Securities Corporation intends to lend to third parties Borrowed Shares borrowed from Luckygold. It is anticipated that such third parties may offer for sale such Borrowed Shares directly to one or more purchasers at negotiated prices, at market prices prevailing at the time of sale or at prices related to such market prices.
  (Kreissman Aff. Ex. A at 31.) The TrENDS Prospectus also disclosed that:
The trading prices of the TrENDS in the secondary market will be directly affected by the trading prices of the Common Stock in the secondary market. Trading prices of Common Stock will be influenced by the Company's operating results and prospects and by economic, financial and other factors and market conditions.

(Id. at 7.) With respect to these two paragraphs of the TrENDS Prospectus, Plaintiffs find fault with the phrase "in the course of ordinary trading or market-making activities," the use of the word "may" and the failure to disclose the risk of market destabilization caused by the influx of a large number of short sales. (Compl. ¶¶ 26-29.)

Plaintiffs contend that because a large number of shares would need to be hedged against the TrENDS, such activity cannot reasonably be considered as taking place in the course of "ordinary trading or market-making activities." (Id. ¶ 26(i).) Moreover, the use of the word "may" suggests that the borrowing of shares was a mere possibility, "when, in fact, defendants had always intended to make the Borrowed Shares available to selected purchasers of the TrENDS so that these selected investors could hedge their TrENDS positions with the sale of Peak stock." (Id. ¶ 26(ii).) More specifically, Plaintiffs argue that Defendants were required to disclose that the short sales were a "foregone conclusion" because DLJ would not have been able to initiate a market for TrENDS without them. (Id.) Plaintiffs also contend that pursuant to Item 303 of Regulation S-K of the Securities Act of 1933, "defendants were required to disclose the existence of known trends, events or uncertainties that they reasonably expected would have a material unfavorable impact on net revenues or income or that were reasonably likely to result in the Company's liquidity decreasing in a material way." (Id. (citing 17 C.F.R. § 229.303)).

Plaintiffs also allege securities laws violations under the Peak Share Offering Prospectus. Many of the same disclosure statements, or lack thereof, were also contained in the Peak Share Offering Prospectus which was attached to the TrENDS Prospectus sent to investors. Despite the physical attachment to the TrENDS Prospectus when sent to investors, the Peak Share Offering Prospectus was not filed with the SEC as part of the TrENDS offering, and the TrENDS Prospectus explicitly did not incorporate the Peak Share Offering Prospectus by reference.

Plaintiffs make the same allegations as described above regarding the inadequate disclosure of the hedge strategy, as well as alleging that the Peak Share Offering Prospectus was "materially false and misleading because it contained false financial statements which reflected artificially inflated sales and revenues figures." (Compl. ¶ 22.) In addition, Plaintiffs allege that the Peak Share Offering Prospectus was false and or misleading because it included "extraordinary sales in the quarter immediately preceding the Peak TrENDS offering but failed to disclose that these sales were made in non-arms length transactions to affiliated third-parties owned and controlled by defendant Li, especially to QPL Holdings Group ("QPL") which was, and is, 40% owned by defendant Li." (Compl. ¶ 41.)

After the TrENDS offering and the hedge strategy commenced, the common stock of Peak declined substantially. Similarly, the price of the TrENDS, which were offered for approximately $15.75, declined to less than $4.00 within one year of the TrENDS offering. (Compl. ¶ 19.) The present litigation ensued.

LEGAL STANDARD

Under Rule 12(b)(6) a complaint will be dismissed if there is a "failure to state a claim upon which relief can be granted." Fed.R.Civ.P. 12(b)(6). The Court must read the complaint generously accepting the truth of and drawing all reasonable inferences from well-pleaded factual allegations. Mills v. Polar Molecular Corp., 12 F.3d 1170, 1174 (2d Cir. 1993). A court should dismiss a complaint only "if `it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Valmonte v. Bane, 18 F.3d 992, 998 (2d Cir. 1994) (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)).

DISCUSSION

Plaintiffs' Complaint seeks relief pursuant to three sections of the Securities Act of 1933 ("Securities Act"), and one claim for relief under the Investment Company Act of 1940. Defendants have asserted multiple arguments in support of their motion to dismiss the Complaint in its ...


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