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IN RE INDEPENDENT ENERGY HOLDINGS
July 26, 2001
IN RE: INDEPENDENT ENERGY HOLDINGS, PLC SECURITIES LITIGATION, MASTER FILE
The opinion of the court was delivered by: Shira A. Scheindlin, U.S.D.J.:
This is a securities class action*fn1 brought on behalf of all
persons, other than defendants, who purchased or otherwise acquired
American Depository Shares ("ADSs") and Ordinary Shares of Independent
Energy Holdings PLC ("Independent Energy" or "Company") in a March 28,
2000 secondary offering ("Secondary Offering") of 4.07 million ADSs and
on the open market during the class period which extends from February
14, 2000 until September 8, 2000 ("Class Period"). Plaintiffs have sued
the Company, the underwriters of its Secondary Offering ("Underwriter
Defendants"), two companies related to one of the Underwriter Defendants
(the "Related Defendants"), and several officers and directors of the
Company ("Individual Defendants"), asserting claims arising under
sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the
"Securities Act"), 15 U.S.C. § 77k, 771(a)(2), and 77o, and sections
10(b)(5) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange
Act"), 15 U.S.C. § 78j(b) and 78t(a), and Rule 10b-5 promulgated
thereunder, 17 C.F.R. § 240.10b-5. Now pending are two separate
motions to dismiss, pursuant to Rules 12(b)(6) and 9(b) of the Federal
Rules of Civil Procedure, filed by the Individual Defendants, and the
Underwriter and Related Defendants.*fn2
This case illustrates that motions to dismiss in securities fraud cases
have become all too common where the procedural posture of the case
renders most of the defendants' arguments futile. Many motions to dismiss
ask the court to engage in judgment calls which are better made by the
trier of fact. Cf. Gallagher v. Delaney, 139 F.3d 338, 342 (2d Cir.
1998)(stating that the determination of whether "borderline situations"
should be characterized as sexual harassment and retaliation is best left
to a jury, not the court). While Congress has acted to discourage the
filing of strike
suits, nothing Congress has done suggests that the
general principles of a motion to dismiss are no longer applicable in
securities fraud cases. In affirming dismissals in securities fraud
cases, the decisions of our Court of Appeals must not be mistaken for
license to draw inferences which a district court is not permitted to
draw on a motion to dismiss. Rather, in deciding a motion to dismiss, a
court must be mindful that all reasonable inferences are to be drawn in
the plaintiffs' favor. This general principle of law makes certain
questions — such as whether alleged misstatements and omissions in
a prospectus were material to a reasonable investor — difficult to
resolve as a matter of law. See Klein v. PDG Remediation, Inc.,
937 F. Supp. 323, 327 (S.D.N.Y. 1996) ("[I]t is unlikely, as a matter of
law, that a cause of action can be dismissed which requires a
determination of materiality.").
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). Nevertheless, "[a] complaint which consists of
conclusory allegations unsupported by factual assertions fails even the
liberal standard of Rule 12(b)(6)." De Jesus v. Sears, Roebuck & Co.,
87 F.3d 65, 70 (2d Cir. 1996)(quotation marks and citation omitted).
To properly rule on a 12(b)(6) 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. The Court must limit itself to facts stated in the complaint,
documents attached to the complaint as exhibits, and documents
incorporated by reference. See Dangler v. New York City Off Track Betting
Corp., 193 F.3d 130, 138 (2d Cir. 1999). However, the Court may also
consider documents, while not explicitly incorporated into the
complaint, that "plaintiffs either possessed or knew about and upon which
they relied in bringing the suit." Rothman v. Gregor, 220 F.3d 81, 88 (2d
Cir. 2000) (citing Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42,
44 (2d Cir. 1991)).
Independent Energy is the holding company for Independent Energy UK, its
wholly owned subsidiary.*fn3 See Second Consolidated Amended Class Action
Complaint ("SAC") ¶ 22.
Independent Energy was an electric company that had the right to supply
electricity in the United Kingdom ("U.K.") pursuant to a license granted it
under the Electricity Act of 1989. See id. ¶ 23.
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ
Securities"), one of the Underwriter Defendants, is a national investment
and merchant bank. See id. ¶ 35. DLJ Securities sold and distributed
to the investing public Independent Energy ADSs pursuant to the Secondary
Offering. See id.
DLJ Securities is a wholly owned subsidiary of Donaldson, Lufkin &
Jenrette, Inc. ("DLJ Inc."), one of the Related Defendants. See id. DLJ
Inc. is an integrated investment and merchant bank serving clients both
in the United States and internationally. See id. ¶ 34.
Another of DLJ Inc.'s wholly owned subsidiaries is Donaldson, Lufkin &
Jenrette International ("DLJ International"), also a Related Defendant in
this action. DLJ International frequently served as a financial advisor
to the Company. See id. ¶ 36.
The other two Underwriter Defendants are Prudential Securities
Incorporated ("Prudential") and Johnson Rice & Company L.L.C., Inc.
("Johnson Rice"). Prudential is a fully-diversified securities firm which
provides, among other things, underwriting services. See id. ¶ 37.
Johnson Rice is a securities boutique specializing in energy and oil
service companies. See id. ¶ 38.
Both Prudential and Johnson sold and distributed to the investing
public Independent Energy ADSs in connection with the Secondary Offering.
The Individual Defendants are John L. Sulley, Burt H. Keenan, Herbert
L. Oakes, Ian Stewart, Jerry W. Jarrell, Robert E. Jones, and David O.
May.*fn4 Each Individual Defendant was a Director of the Company's Board
of Directors ("Board") and each signed the Company's March 28, 2000
registration statement and prospectus ("Prospectus"). See id. ¶¶
26-32. In addition, Sulley was the Company's Chief Executive Officer
("CEO"); Jones was its Operations Executive; Stewart was Independent
Energy's Finance Executive; and Oakes was a Non-Executive Chairman of the
Board. See id. ¶¶ 26, 28-30. Most of the Individual Defendants also
owned Ordinary Shares of Independent Energy. Sulley owned 420,000
Ordinary Shares, approximately 1.1% of the Company's Ordinary Shares
issued and outstanding; Keenan, a founder of the Company, owned 1,164,125
Ordinary Shares (approximately 3.1%); Jones owned over 354,200 Ordinary
Shares; Jarrell owned 235,100 Ordinary Shares; and May owned 130,000
Ordinary Shares. See id. ¶¶ 26-28, 31, 32.
B. The Company's Background
Founded in 1996, Independent Energy was formed to capitalize on the
market opportunities created by the deregulation of the U.K. energy
markets.*fn5 See id. ¶ 77. The Company quickly grew to become the
largest independent supplier of electricity in the U.K. See id. It
operated primarily as a marketer of energy, purchasing electricity from
the "Electricity Pool", which serves as a market place for buying and
selling electricity in England and Wales, and then reselling electricity
to its own customers. See id. ¶¶ 54, 79. In order to participate in
the Electricity Pool as a purchaser of electricity, Independent Energy
was required to post a letter of credit good for twenty-eight days of
electricity trading. See id. ¶¶ 54, 55.
1. The Company's Billing Problems
In 1999, Independent Energy entered the market for small business and
residential customers, generally known as the sub-100 kilowatt ("kW")
market. See Prospectus at 6, 7.*fn6 In October 1999, the Company began
billing their customers in the sub-100 kW market.
See SAC ¶ 92. The Company and Vertex Data Science Limited
("Vertex"), a third party service provider to which the Company had
outsourced a large part of its billing and customer service operations,
could not process and produce timely and accurate bills to the Company's
customers. See id. ¶ 3. The seriousness of the Company's billing
problems and the corresponding growing number of customers lodging
complaints against the Company drew the attention of the Office of Gas &
Electricity Markets ("OFGEM"), U.K.'s energy regulator. See id. ¶¶
4, 97. From December 1999 through March 2000, OFGEM held weekly meetings
with Sulley and other Company officials expressing serious concerns over
the Company's billing and customer service problems. See id. ¶ 97.
During those meetings, OFGEM also informed the Company that if it did not
adequately remedy these problems, regulatory action against the Company
would be taken. See id. ¶¶ 5, 97-99. Furthermore, at a meeting in
February 2000, OFGEM informed the Company that its billing problems were
not an "industry problem", as Independent Energy had contended, but
rather, were distinct to the Company and its inadequate systems and
procedures. See id. ¶ 104.
2. The Company's Attempt to Solve Its Billing
Problems Fail In January 2000, the Company attempted to modify the
software employed by Vertex to improve its billing operations. See id.
¶ 100. However, these modifications were not improving the
situation. See id. Indeed, notwithstanding these modifications, OFGEM
informed the Company in mid-February 2000 that its investigation was now
a "formal investigation", the highest level of investigation possible.
See id. ¶¶ 6, 102. Plaintiffs contend that by this date, the
Company, Sulley, and other senior officials of the company "knew the
highly likely consequences of OFGEM's investigation based upon a similar
investigation OFGEM had conducted three months earlier against Northern
Electric, another licensed electricity provider in the U.K., and the
resulting sanction OFGEM had imposed against Northern Electric based upon
its billing system failures and customer complaint levels." Id. ¶
In a meeting in early March 2000, OFGEM informed the Company of its
concerns that the new software modifications were not working and that
the Company's billing problems were intensifying. See id. ¶ 111.
Indeed, during February and early March 2000, the situation deteriorated
to the point where 50% of the Company's customer complaints were not
being answered. See id. ¶ 109. Then, in mid-March 2000, shortly
prior to the Secondary Offering, OFGEM, in response to its increasing
concerns, instituted a formal reporting process which required the
Company to send OFGEM weekly written reports regarding billing and
complaints. See id. ¶ 112.
3. The Company's Liquidity Problems
The Company's problems in the sub-100 kW market began to impact its
liquidity. See id. ¶ 113. Toward the end of February 2000, the
Company was forced to seek additional credit and to post a ninety-day 60
million letter of credit in order to continue purchasing wholesale
electricity. See id. ¶ 114. In connection with the issuance of the
letter of credit, the Company and the Company's banker — Barclays
Bank PLC — entered into agreements with DLJ Inc. "to reimburse
Barclays for amounts drawn down under the letter of credit." Id. ¶
115. Pursuant to this agreement, DLJ Inc., among other things,
received the Company's agreement that, if the Secondary Offering was not
completed by April 30, 2000, the Company would issue DLJ Inc. warrants to
purchase 5 million of its Ordinary Shares, or approximately 12% of the
Company's equity, for 1 pence per share. See id. ¶ 116.
The Company also agreed to pay DLJ Inc. $2.90 million in fees in
connection with this line of credit guarantee. See id. ¶ 117.
B. Independent Energy's Secondary Offering and Continuing Problems
On March 28, 2000, Independent Energy's Prospectus for its Secondary
Offering became effective. See id. ¶ 118. The following day, the
Company announced that the ADSs would be priced at $49.25 per ADS. See
id. Following the completion of the Secondary Offering, the Company
raised approximately $157.6 million. See id. In connection with the
Secondary Offering, three of the Individual Defendants — Sulley,
Keenan, and Jones — sold their Ordinary Shares of Independent
Energy as ADSs and realized over $30 million dollars in proceeds.*fn7
See id. ¶¶ 26-28. DLJ International sold 250,000 Ordinary Shares of
Independent Energy, which constituted 100% of its securities investment
in the Company. See id. ¶¶ 36, 220. By this transaction, DLJ
International realized proceeds of $12.31 million. See id. ¶ 36. The
Underwriter Defendants received $8.90 million in fees for their
underwriting services.*fn8 See id. ¶¶ 35, 37, 38, 118.
Even following the Secondary Offering, the software modifications were
still not functioning properly and the Company's billing problems were
not improving. See id. ¶ 129. As a result, by April or May 2000, the
Company attempted to transfer a substantial part of its billing
operations to an in-house facility dubbed "Garret's Green." Id.
On May 3, 2000, OFGEM met with senior officials of the Company,
including Sulley and Oakes, to discuss the Company's continued billing
and customer service problems. See id. ¶ 119. At that meeting, the
Company agreed to an OFGEM-imposed license condition. See id. That
license condition, announced on May 10, 2000, prohibited the Company from
taking on any new business in the sub-100 kW market. See id. ¶ 121.
In the two days following the announcement, Independent Energy ADSs fell
34%, from $39 per ADS to $25.62 per ADS. See id. ¶ 124.
The Company's continuing billing and cash collection problems created
even greater cash flow pressures. See id. ¶ 144. Consequently, on
September 8, 2000, the Company announced that receivers had stepped in on
behalf of the Company's lenders and had begun to liquidate the Company.
See id. ¶¶ 14, 144. Independent Energy ADSs were halted at $7.56 per
ADS. When the Company started trading again on the NASDAQ on October 19,
2000, its ADSs opened at $0.125 per share. See id. ¶ 14. As of March
20, 2001, Independent Energy ADSs were trading at $0.005 per share on the
over-the-counter market. See id. ¶ 146.
C. Defendants' Misrepresentations and Omissions
1. Alleged Misrepresentations and Omissions in the
Prospectus The SAC sets forth the following five misstatements or
omissions in the Prospectus which plaintiffs allege violate the
a. The Prospectus falsely assured investors that the
Company had developed system modifications which were
likely to correct the Company's billing problems;
b. The Prospectus falsely attributed its billing
delays to poor information flow from the regional
electricity companies ("RECs"), responsible for
reading customer's meters within a particular
c. The Prospectus failed to disclose the scope of
the Company's collection problems;
d. The Prospectus failed to disclose the high volume
of complaints lodged against the Company by customers
and the inability of either the Company or Vertex to
handle customer inquiries;
e. The Prospectus failed to disclose that the
Company was under investigation by OFGEM, and
that it faced a serious risk of sanctions.
2. Alleged Misrepresentations and Omissions in Other Publicly-Made
Plaintiffs also allege that throughout the Class Period, the Company
and the Individual Defendants issued press releases and made statements
that misrepresented and omitted material facts. Specifically, the SAC
alleges that the following thirteen statements misrepresented or omitted
material facts then known to the Company:
a. The Company's February 14, 2000 press release
stating that it "wishes to make clear that successful
action is being taken to resolve the billing issue,
which relates to only one part of the business. The
problem is only one of timing of billing and does not
reflect any problem in collection." SAC ¶ 191.
b. A February 14, 2000 report issued by Brean Murray &
Co., Inc. ("Brean Murray") which, based upon
conversations with Company management and the
Company's February 14, 2000 press release, maintained
its BUY rating on the Company and stated that the
billing problem "is an industry wide problem caused by
the RECs." Id. ¶ 192.
c. On February 15, 2000, Sulley was quoted in an
article stating that the billing problem would have
only a "minimal" effect on profits, that "it's an
industry problem", and that "[m]ost of the backlog has
been cleared up." Id. ¶ 193.
d. On February 16, 2000, the Company's press release
assured investors that "substantial progress on
billing issues" was being made, and that the Company
"has put in place procedures to overcome the data
problems which continue to affect the industry in
general." Id. ¶ 195.
e. On February 17, 2000, DLJ Securities issued a
report that rated the Company as a BUY and stated that
the Company "has resolved the billing problems
surrounding its small business/domestic market", and
that "the billing problems arose because of the poor
transfer of data from the [RECs]". Id. ¶ 196.
Even following the announcement of OFGEM-imposed license condition, the
Company and its officers issued allegedly misleading statements:
g. On May 10, 2000, Sulley falsely stated in a press
release that "[w]e anticipate substantially completing
the backlog by the end of June" and that the Company
was "confident" that it would "resolve its customer
service problems to provide an improved and superior
service" "within a short space of time". Id. ¶¶
h. On May 10, 2000, a Brean Murray report based upon a
conversation with Sulley stated that there "is
unlikely to be any real negative fallout [from the
license condition] as many of [the Company's] problems
are industry wide. . . ." Id. ¶ 200.
i. On May 17, 2000, Sulley stated that he expects
the billing problems "will be largely resolved
within a short period". Id. ¶¶ 131, 201.
j. On May 17, 2000, the Company also stated that it
"believes that it now has in place a specific
strategy, which includes the new system of validating
the front end data and cleaning the backlog of data,
to ensure that future bills are dealt with efficiently
and effectively." Id. ¶ 201.
k. On May 17, 2000, defendant Sulley stated: "[T]he
worst was now behind the company with measures in
place that would resolve the situation `within a short
period.'" Id. ¶¶ 133, 202.
1. On May 18, 2000, Sulley was quoted saying: "[W]e
are solving the billing problems" and that the license
condition "doesn't have an impact on ongoing profit or
turnover." Id. ¶¶ 135, 203.
m. On May 18, 2000, Johnson Rice issued an analyst
report, based upon a conference call with the
Company's management, which stated that "[t]here are
no `collection' problems, only ...