The opinion of the court was delivered by: Motley, District Judge.
The November 18, 1991 letter advised Coates of Harley's
decision to discontinue testing of the engines equipped with the
Coates System in favor of other projects. See Pl.'s R. 56.1
Stmt. ¶ 53; see also Harley Letter. The letter did not
terminate the relationship with Coates; rather, it stated that
Harley would contact Coates "regarding possible ways to proceed
with the development of your system for our engines." See
Def.'s R. 56.1 Stmt. ¶ 56G; see also Harley Letter. Harley
sent a subsequent letter to Coates dated December 3, 1991 in
which it reiterated its continued interest in the Coates System.
See Def.'s R. 56.1 Stmt. ¶ 56G; see also Pl.'s Ex. 11,
Tuttle Dec. Ex. C, Harley December 3, 1991 Letter to Coates. As
of November 1, 1995, CIL had never developed a retrofitted
Harley motorcycle engine using the Coates System that was
acceptable to Harley. See Pl.'s R. 56.1 Stmt. ¶ 58.
CIL's December 1991 Confidential Information Memorandum stated
that engine prototypes were sent to a "major motorcycle
manufacturer." Id. ¶ 59. However, the memorandum did not
disclose any of the problems detailed in the November 18, 1991
Harley letter to Coates. See id. ¶ 61. In a letter to CIL
stockholders and potential purchasers of CIL stock dated July 6,
1992, Coates wrote: "Harley-Davidson's Motorcycle Engine is now
complete, and has been returned to them for final testing. We
are awaiting their response." Pl.'s Ex. 8, Carter Decl. Ex. B,
July 6, 1992 Harley Letter. The letter also contained a
solicitation to purchase additional CIL stock. See id.; see
also Pl.'s R. 56.1 Stmt. ¶ 65. The July 6, 1992 letter does not
disclose any of the problems detailed in the November 18, 1991
Harley letter to Coates. See Pl.'s R. 56.1 Stmt. ¶ 66.
4. Orders for the Coates System
In order to continue the development and testing of the Coates
System, CIL required substantial amounts of additional funding.
See id. ¶¶ 79-80. Prior to July 1994, CIL did not obtain the
necessary additional financing to complete the development and
testing of the Coates System nor did it have the manufacturing
capability to mass produce or sell the Coates System engines.
See id. ¶¶ 81, 87. Prior to November 1, 1995, CIL had neither
the manufacturing capacity nor the financing to manufacture or
sell engines on a commercial scale. See id. ¶ 88. Furthermore,
CIL had no binding sales orders for the Coates System engines as
of November 1, 1995. See Reg. St. at 22-24.
The March 24, 1992 and March 26, 1992 stockholder letters both
state that CIL had firm orders for 5000 four-cylinder Coates
Spherical Rotary Valve Systems per year. See Pl.'s R. 56.1
Stmt. ¶¶ 91, 92. The July 6, 1992 stockholder letter states: "We
have just received five engines from Italy for which the actual
order has gone up to 15,000 yearly." Pl.'s Ex. 8, Carter Decl.
Ex. B, July 6, 1992 letter. Additionally, a potential purchaser
of CIL stock received from CIL a letter, dated October 7, 1992,
that states: "We have orders for literally hundreds of thousands
of engines for different types of applications." See Pl.'s R.
56.1 Stmt. ¶ 94; see also Pl.'s Ex. 14, Hervert Decl. Ex. B,
October 7, 1992 letter. All of these letters included
solicitations to purchase CIL stock; however, these letters did
not disclose CIL's inability to manufacture or sell engines on a
commercial scale nor the fact that none of the orders taken by
CIL were firm orders. See Pl.'s R. 56.1 Stmt. ¶¶ 95-97; see
also Reg. St. at 22-24. In his sworn testimony before the
Commission on July 14, 1994, Coates explained that because final
testing and other prerequisites to "mass production" had yet to
be completed, "it is going to take at least twelve months or
maybe two years" before CIL can "have a product to sell to the
public." Pl.'s Ex. 4, Coates Tr. at 396-98.
Five patents for the Coates System were issued to Coates
before February 5, 1991.
See Pl.'s R. 56.1 Stmt. ¶ 99. Coates assigned these patents to
CIL on December 5, 1991, one day before the beginning of the
December 1991 Offering. See id. ¶ 100. These assignments were
disclosed in the appendix to the Confidential Information
Memorandum. See id. ¶ 101. On January 1, 1992, CIL's Board of
Directors authorized the transfer of these patents back to
Coates in return for an exclusive right to negotiate licenses
and transfers of technology associated with the patents, and on
June 29, 1992, CIL reassigned the patents to Coates. See id. ¶¶
102, 103. These authorizations and reassignments were not
disclosed by Coates or CIL prior to July 1994. See id. ¶ 104.
C. The Arrest and Incarceration of Coates in Connection
with this Action
On July 22, 1994, the same day that the Commission obtained
the initial injunction from the court, Coates was arrested by
members of the United States Postal Inspection Service pursuant
to a warrant for his arrest issued that same day by the court on
the basis of a mail fraud complaint sworn to by a Postal
Inspector and approved by an Assistant United States Attorney.
See Pl.'s R. 56.1 Reply Stmt. ¶ 3A. The complaint was based in
part on evidence obtained by the Commission through its inquiry
and investigation. See id. Because Coates was arrested late on
a Friday, he was incarcerated in the Mercer County jail until he
could be moved to the federal jail in Manhattan. See Def.'s R.
56.1 Stmt. ¶ 3B. Upon application by counsel, Coates was
released from jail by a federal magistrate in the Southern
District of New York on July 26, 1994, without the posting of
cash or a bail bond. See id. ¶ 3C. Coates was incarcerated for
five days. See id. ¶ 3D. The Office of the United States
Attorney for the Southern District of New York dismissed the
criminal charges. See id. ¶ 3F.
A. Summary Judgment Standard
Summary judgment should be granted where "[t]he pleadings,
depositions, answers to interrogatories, and admissions on file,
together with the affidavits, if any, show that there is no
genuine issue of any material fact and that the moving party is
entitled to a judgment as a matter of law." Fed.R.Civ.P.
56(c). To defeat a summary judgment motion, the opposing party
must "[c]ome forward with `specific facts showing that there is
a genuine issue for trial.';" Matsushita Elec. Indus. Co. v.
Zenith Radio, 475 U.S. 574, 587, 106 S.Ct. 1348, 89 L.Ed.2d 538
(1986). A genuine issue is present when the record would enable
a reasonable trier of fact to return a verdict for the
non-moving party. See Anderson v. Liberty Lobby, Inc.,
477 U.S. 242, 247-48, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). "Only
disputes over facts that might affect the outcome of the suit
under the governing law will properly preclude the entry of
summary judgment. Factual disputes that are irrelevant or
unnecessary will not be counted." Anderson, 477 U.S. at 248,
106 S.Ct. 2505.
B. Coates' Violations of the Exchange Act
The Exchange Act and its promulgating regulations prohibit
fraud in connection with the purchase and sale of securities.
See 15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b-5. With respect to
fraud, the Exchange Act provides:
It shall be unlawful for any person, directly or
indirectly, by the use of any means or
instrumentality of interstate commerce or of the
mails, or of any facility of any national securities
exchange . . . (b) To use or employ, in
connection with the purchase or sale of any security
registered on a national securities exchange or any
security not so registered, any manipulative or
deceptive device or contrivance in contravention of
such rules and regulations as the Commission may
prescribe as necessary or appropriate in the public
interest or for the protection of investors.
15 U.S.C. § 78j(b). Pursuant to the Exchange Act, Rule 10b-5 was
promulgated to prohibit fraud in connection with the purchase
and sale of securities, providing that:
It shall be unlawful for any person, directly or
indirectly, by the use of any means or
instrumentality of interstate commerce, or of the
mails or of any facility of any national securities
(a) To employ any device, scheme, or artifice to
(b) To make any untrue statement of a material
fact or to omit to state a material fact necessary
in order to make the statements made, in the light
of the circumstances under which they were made,
not misleading, or
(c) To engage in any act, practice, or course of
business which operates or would operate as a
fraud or deceit upon any person, in connection
with the purchase or sale of any security.
17 C.F.R. § 240.10b-5.
To have violated Section 10(b) and Rule 10b-5, defendant must
have: (1) made a material misrepresentation or a material
omission as to which he had a duty to speak, or used a
fraudulent device; (2) with scienter; (3) in connection with the
purchase or sale of securities. See SEC v. Monarch Funding
Corp., 192 F.3d 295, 308 (2d Cir. 1999).
To be material, misrepresented or omitted information must be
relevant to the investor's decision of whether to purchase,
hold, or sell the relevant security. See, e.g., Basic, Inc. v.
Levinson, 485 U.S. 224, 231-232, 108 S.Ct. 978, 99 L.Ed.2d 194
(1988). An omission of information is material if there is "a
substantial likelihood that the disclosure of the omitted fact
would have been viewed by the reasonable investor as having
significantly altered the `total mix' of information made
available." TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438,
449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976).
"The scienter needed in connection with securities fraud is
intent `to deceive, manipulate, or defraud,' or knowing
misconduct." Press v. Chemical Inv. Servs. Corp.,
166 F.3d 529, 538 (2d Cir. 1999) (quoting SEC v. First Jersey Sec.,
101 F.3d 1450, 1467 (2d Cir. 1996)). As a threshold matter, the
complaint must allege that Coates acted with sufficient
scienter. See SEC v. U.S. Environmental, Inc., 155 F.3d 107,
111 (2d Cir. 1998). The complaint in this case alleges that
Coates acted knowingly or recklessly. "Knowing misconduct" is
sufficient to establish liability under securities fraud
statutes. See First Jersey Sec., 101 F.3d at 1467.
Furthermore, "[i]n order to establish scienter . . ., [it is
sufficient that] the plaintiffs . . . identify circumstances
indicating conscious or reckless behavior by the defendants."
Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996).
Although determining issues of materiality and scienter on
summary judgment requires caution, this court nonetheless has
the authority to determine these issues on motion. See FED. R.
CIV. P. 56. As to the issue of materiality, the Supreme Court
has articulated the following standard:
The determination [of materiality] requires delicate
assessments of the inferences a "reasonable
shareholder" would draw from a given set of facts and
the significance of those inferences to him, and
these assessments are peculiarly one for the trier of
fact. Only if the established omissions are "so
obviously important to an investor, that reasonable
minds cannot differ on the question of materiality"
is the ultimate issue of materiality appropriate for
TSC Indus., 426 U.S. at 450, 96 S.Ct. 2126. As to the issue of
scienter, this court notes that determining a person's
subjective state of mind is peculiarly inappropriate for
resolution by summary judgment. Here, however, as discussed
below, various representations were clearly material and
knowingly false and various omissions were obviously material
and were known to Coates.
This court notes that the Commission's motion for summary
judgment was supported by extensive documentation of Coates'
fraud violation. The documentation included a transcript of
Coates' testimony taken during the Commission's
investigation*fn2 and documents drafted by the defendant
himself, including the registration statement Coates submitted
to the Commission. In response to the Commission's
well-documented motion, Coates' Revised Local
Rule 56.1 Statement of Material Facts admits the truth of the majority of
material facts set forth in the Commission's Local
Rule 56.1 Statement of Material Facts.
After considering the parties' voluminous submissions, this
court finds that Coates has violated the anti-fraud provisions
of the Exchange Act by knowingly making misrepresentations and
omissions of material facts in connection with the sale of CIL
securities. Coates violated the Exchange Act with respect to his
statements regarding (1) the EPA emissions testing, (2) CIL's
interactions with Harley-Davidson, (3) the orders for the Coates
System, and (4) the reassignment of the patents from CIL to
Coates. This court also finds that Coates statements regarding
Chrysler did not violate the Exchange Act.
1. Misrepresentations and Omissions Regarding EPA
Coates' statements concerning the EPA emissions testing
violated the Exchange Act's anti-fraud provisions. In the
Confidential Information Memorandum, which was disseminated to
potential investors regarding a private offering of CIL stock,
Coates stated that the Coates System engine "under an internally
supervised test, far surpassed the emissions standards imposed
by the [EPA]." In addition to this, the memorandum included a
chart listing comparisons between the federal emissions
standards and the Coates System engine emissions.
The "internally supervised test" was not performed at an
EPA-approved laboratory, and was not performed with a
dynamometer. Thus, the statements in the memorandum and the
comparisons in the chart give a false impression that the Coates
System engine's emissions levels would satisfy EPA requirements.
Coates states that the statement in the memorandum is accurate
because the tests referred to were conducted internally.
However, Coates does not address CIL's inability to
determine through its in-house tests whether its engines could
comply with EPA or federal requirements without the use of a
dynamometer. "A recklessly inaccurate and incomplete placement
memorandum cannot be used to gull and lull an investor." Spatz
v. Borenstein, 513 F. Supp. 571, 585 (N.D.Ill. 1981).
Furthermore, Coates represented in the March 24, 1992 and
March 26, 1992 stockholder letters that the Coates System
engines were either being testing by the EPA or were undergoing
some sort of EPA testing. Coates also referred to an independent
emissions test which indicated that the Coates System engines
had the lowest emissions in the world. On the whole, the letters
indicate that the independent emissions test is related to
official EPA testing or EPA testing requirements. In fact, the
EPA never conducted any testing of the Coates engines and the
only EPA testing facility that did conduct tests on the Coates
System engines found emissions levels higher than those
required by the EPA.
Coates states that EPA emissions standards are irrelevant
because Coates was designing racing engines which do not require
EPA approval. Although it is true that one of CIL's targeted
industries was the racing industry, the December 1991 Offering
memoranda and the Second Amended Registration Statement do not
limit the applications of Coates System engines to racing. In
addition, Coates himself made the EPA standards relevant by
promoting their importance in his correspondence with
stockholders and potential stockholders. This court therefore
finds that Coates statements in the December 1991 memorandum and
in the two March 1992 stockholder letters were material
misrepresentations. See, e.g., Hoffman v. Estabrook & Co.,
Inc., 587 F.2d 509, 514-15 (1st Cir. 1978) (representation that
company had working prototype of computer system violated the
anti-fraud provisions where company at most had developed
laboratory and engineering prototypes). Furthermore, Coates knew
at the time that he made the statements in the December 1991
memorandum and the March 1992 stockholder letters that the EPA
was not involved in any testing of the Coates System and that
the independent testing to which he referred was not conducted
by an EPA-approved facility.
Coates also omitted information in the December 1991
memorandum and in the March 1992 stockholder letters concerning
the results of the Compliance tests which revealed emission
levels that were substantially higher than the EPA maximums.
Coates states that the Compliance test results are immaterial
because (1) the purpose of the testing was not to access
emissions levels; (2) the vehicle tested was not equipped with
an air pump, EGR valve, or catalytic converter which are
pollution reduction devices; and (3) following the Compliance
tests but prior to the December 1991 memorandum, Coates made
improvements to the Coates System. See Def.'s R. 56.1 Stmt. ¶¶
27C, 32A; see also Pl.'s Ex. 4, Coates Tr. at 278-282. Given
the lapse of time between the Compliance tests and the December
1991 Offering, the possible improvements made to the Coates
System between those times, and the lack of pollution reduction
features on the vehicle tested, this court cannot determine
whether a reasonable investor would have found the Compliance
test results "so obviously important" as to make their omission
material. See TSC Indus., 426 U.S. at 450, 96 S.Ct. 2126.
2. Misrepresentations and Omissions Regarding
Coates' omissions regarding Harley's test results do not
violate the Exchange