v. Statements and Omissions Concerning the OFGEM Investigation Finally,
plaintiffs allege that the Prospectus was misleading because "by the
time of the Secondary Offering, the Company was aware that its worsening
billing and customer service problems had subjected it to a formal
investigation by OFGEM — the highest level of government
investigation . . . [and] that OFGEM had barred Northern Electric from
taking on new customers for similar problems, and that it would likely
be sanctioned by OFGEM." SAC ¶ 150(a); see also Pl. Mem. at 22-25.
Rather than inform investors of these facts, the Prospectus disclosed
that the Company's "activities are subject to extensive laws and
regulations . . . primarily by . . . OFGEM" and that "[a]ny change in
the laws or regulations governing our business could adversely affect
our operations and profitability." Prospectus at 9.
Drawing every reasonable inference in plaintiffs' favor, these
allegations are material. See SAC ¶ 150(a); see also Pl. Mem. at
22-25. OFGEM's investigation involved the Company's sub-100 kW business,
which represented 40% of the Company's customer base and was attractive
to the Company because of its potential growth and high profit margins.
See SAC ¶ 3.
While defendants correctly note that the securities laws may not
require disclosure of possible future sanctions, see Underwriter Def.
Mem. at 12; see also Individual Def. Mem. at 12, they certainly require
disclosure of information that would permit an investor to appreciate the
risk that the future sanction may arise.*fn15 See Milman, 72 F. Supp.2d
at 231. Therefore, a reasonable juror could find that an investigation of
such an important aspect of the Company's business would have been
material to a reasonable investor's decision to invest in the Company.
See Klein, 937 F. Supp. at 327 (nondisclosure of governmental action that
could affect funding for a large source of the company's operations was a
Nevertheless, defendants argue that while "OFGEM's regulatory
activities were not disclosed in the Prospectus, the possible outcome of
those activities was disclosed." Individual Def. Mem. at 13. See also
Prospectus at 10 ("If we are unable to correct our billing problems with
our existing customers and if we continue to experience billing problems
with our new customers, we will significantly limit our ability to grow
our customer base."). This disclosure, however, was not complete because
it did not indicate that the
Company's inability to take on new customers might result from an
investigation by a government regulatory body.
Moreover, the disclosure did not permit a reasonable investor to
appreciate the risk that the Company would ultimately have to agree to the
OFGEM-imposed license because it did not inform investors that the
Company was under "formal investigation" by OFGEM. Accordingly, the
failure to disclose that the Company was subject to an OFGEM
investigation and its possible consequences is actionable.
2. Plaintiffs' Standing to Sue Under Section 12(a)(2)
The Individual Defendants also seek to dismiss the section 12(a)(2)
claim because they contend that plaintiffs lack standing to sue them. See
Individual Def. Mem. at 14. The Individual Defendants argue that because
the sale of Independent Energy ADSs was effectuated through the
underwriters in a "firm commitment" offering,*fn17 Prospectus at 54-56,
plaintiffs cannot qualify as statutory "sellers" under section 12. See
Individual Def. Mem. at 14. Section 12(a)(2), as noted above, imposes
liability on "any person who . . . offers or sells a security."
15 U.S.C. § 771(a)(2). The term "seller" was defined by the Supreme
Court in Pinter v. Dahl, 486 U.S. 622 (1988), as the "owner who passed
title, or other interest in the security, to the buyer for value," or a
"person who successfully solicits the purchase, motivated at least in part
by a desire to serve his own financial interests or those of the
securities owner." Id. at 642, 647.
Thus, even in a firm commitment offering, Sulley, Keenan, and Jones
could be held liable as statutory sellers if plaintiffs demonstrate that
they (1) solicited sales of the Company's stock; and (2) did so motivated
by financial gain. See Milman, 72 F. Supp.2d at 229-30. The allegation of
financial gain in the SAC — that these Individual Defendants stood
to gain more than $30 million in capital from the Secondary Offering
— is sufficient to meet the second prong. See id. at 230 (stating
that financial gain prong is satisfied where defendants "received
millions of dollars in profits from the Offering").
The central question, therefore, is whether Sulley, Keenan, and Jones
"solicited" sales of their stock. Plaintiffs have alleged that these
defendants made or participated in the decision to hire the Underwriter
Defendants, drafted, disseminated and signed the Prospectus, and were
control persons of the Company by virtue of their positions and equity
ownership. See Pl. Mem. at 42; see also SAC ¶ 176. Furthermore, the
SAC alleges that Sulley directly promoted the Company stock to analysts
in a number of conference calls and press releases prior to the Secondary
Offering. See SAC ¶¶ 193, 195. Such allegations are sufficient to
constitute solicitation.*fn18 See, e.g., APAC Teleservices, 1999
WL 1052004, at *11 ("Courts have concluded that because the prospectus
itself is a document that solicits the purchase of securities, those who
sign the registration statement should be deemed persons who solicited
the purchase of the offered securities."); see also Capri v. Murphy,
856 F.2d 473, 478 (2d Cir. 1988); In re Twinlab Corp. Sec. Litig.,
103 F. Supp.2d 193, 204-05 (E.D.N.Y. 2000); Degulis v. LXR
Biotechnology, Inc., 928 F. Supp. 1301, 1315 (S.D.N.Y. 1996).
Accordingly, plaintiffs have alleged sufficient facts to assert a section
12(a)(2) claim against Sulley, Keenan, and Jones.
B. Section 10(b) Claims
Plaintiffs also allege violations of section 10(b) and Rule 10b-5
promulgated thereunder against the Company, DLJ Securities, Sulley, and
Keenan (Count IV). See SAC ¶¶ 187-227.
1. General Principles
To state a claim under section 10(b) and Rule 10b-5,*fn19 plaintiffs
must allege that in connection with the purchase or sale of securities:
(1) defendants made a false material misrepresentation or omitted to
disclose material information; (2) defendants acted with scienter; and
(3) plaintiffs detrimentally relied upon defendants' fraudulent acts. See
Ganino, 228 F.3d at 161; Press v. Chemical Inv. Servs. Corp., 166 F.3d 529,
534 (2d Cir. 1999). In addition, claims arising under section 10(b) are
subject to the heightened pleading requirements of Rule 9(b):
In all averments of fraud or mistake, the
circumstances constituting fraud or mistake shall be
stated with particularity. Malice, intent, knowledge,
and other condition of mind of a person may be averred
Fed.R.Civ.P. 9(b); see also Chill v. General Elec. Co., 101 F.3d 263, 267
(2d Cir. 1996) ("[T]he actual fraudulent statements or conduct and the
fraud alleged must be stated with particularity."). However, the Court of
Appeals has made clear that "the relaxation of Rule 9(b)'s specificity
requirement for scienter must not be mistaken for license to base claims
of fraud on speculation and conclusory allegations." Shields v. Citytrust
Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994) (quotation marks and
citations omitted); see also Acito, 47 F.3d at 52. "Plaintiffs still have
the `burden of pleading circumstances that provide at least a minimal
factual basis for their conclusory allegations of scienter.'" Chill, 101
F.3d at 267 (quoting Cohen v. Koenig, 25 F.3d 1168, 1173 (2d Cir.
Motivated by a perceived need to curtail the filing of meritless
lawsuits, Congress amended the Exchange Act through passage of the
PSLRA. See Novak, 216 F.3d at 306. The PSLRA raised the nationwide
pleading standard to that previously employed in the Second Circuit. See
id. at 310. With respect to scienter, the PSLRA requires that
[i]n any private action arising under this chapter in
which the plaintiff may recover money damages only on
proof that the defendant acted with a particular state
of mind, the complaint shall, with respect to each act
or omission alleged to violate this chapter, state
with particularity facts giving rise to a strong
inference that the defendant acted with the required
state of mind.
15 U.S.C. § 78u-4(b)(2).
Although speculative and conclusory allegations will not suffice to
plead scienter, the Second Circuit has made clear that "great specificity"
is not required, so long as plaintiffs allege "enough facts to support `a
strong inference of fraudulent intent.'" Ganino, 228 F.3d at 169 (citing
Stevelman v. Alias Research Inc., 174 F.3d 79, 84 (2d Cir. 1999)). See
also Novak, 216 F.3d at 311 (PSLRA adopted Second Circuit's strong
inference standard). Such an inference arises where plaintiffs allege
either (1) facts showing that defendants had both motive and opportunity
to commit fraud, or (2) facts constituting strong circumstantial evidence
of conscious misbehavior or recklessness. See Rothman, 220 F.3d at 90.
2. The Section 10(b) Claim Against DLJ Securities
a. Actionable Misrepresentations
The section 10(b) claim against DLJ Securities arises solely out of the
misrepresentations in the Prospectus. See SAC ¶ 210. Four of those
misrepresentations are actionable under sections 11 and 12(a) of the
Securities Act. See supra Part III.A.2. Similarly, only those
misrepresentations listed supra Part II.C.1.a, b, d, and e are actionable
under section 10(b) of the Exchange Act.
DLJ Securities moves to dismiss the section 10(b) claim against it for
failure to adequately plead scienter. See Underwriter Def. Mem. at
21-24. Plaintiffs contend that a strong inference of scienter has been
adequately pled under both the recklessness or conscious misbehavior
prong and the motive and opportunity prong.
i. Recklessness or Conscious Misbehavior
Plaintiffs maintain that the SAC adequately pleads recklessness or
conscious misbehavior by DLJ Securities. See Pl. Mem. at 38-41. The
essence of their claim is that because DLJ Securities was "intimately
familiar" with the Company, SAC ¶ 200, its "failure to disclose what
would have been obvious to anyone conducting due diligence" must have
been reckless. Pl. Mem. at 38.
The standard for pleading recklessness or conscious misbehavior is
high. Indeed, "the strength of the circumstantial allegations must be
correspondingly greater" when a plaintiff relies on allegations of
recklessness, as opposed to allegations of motive and opportunity. In re
WRT Energy Sec. Litig., Nos. 96 Civ. 3610, 96 Civ. 3611, 1999 WL 178749,
at *8 (S.D.N.Y. Mar. 31, 1999) (citing Beck v. Manufacturers Hanover
Trust Co., 820 F.2d 46, 50 (2d Cir. 1987)).
The high standard for pleading recklessness was first announced in Rolf
v. Blyth, Eastman Dillon & Co., 570 F.2d 38 (2d Cir. 1978), where the
Second Circuit stated:
Reckless conduct is, at the least, conduct which is
highly unreasonable and which represents an extreme
departure from the standards of ordinary care . . .
to the extent that the danger was either known to
the defendant or so obvious that the defendant must
have been aware of it.
Id. at 47 (quotation marks and citation omitted, and emphasis added). The
allegations of recklessness must be strong enough to give rise to a "strong
inference of fraudulent intent". Shields, 25 F.3d at 1128.