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December 10, 2001


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


On or about August 18, 2000, Plaintiff Log On America, Inc. ("Plaintiff" or "LOA") filed this action against defendants Promethean Asset Management L.L.C. ("Promethean") `and HFTP Investment L.L.C. ("HFTP" and, together with Promethean, the "Promethean Defendants"); Fisher Capital Ltd. ("Fisher"), Wingate Capital Ltd. ("Wingate") and Citadel Limited Partnership ("Citadel" and, together with Fisher and Wingate, the "Citadel Defendants"); and Marshall Capital Management, Inc. ("Marshall") (the Promethean Defendants, the Citadel Defendants and Marshall are collectively, the "Defendants"), asserting claims under the Securities Exchange Act of 1934, as amended (the "1934 Act"), specifically Section 10(b), 15 U.S.C. § 78j(b), Section 13(d), 15 U.S.C. § 78m(d), and Section 16(b), 15 U.S.C. § 78p(b); and claims for common law fraud, breach of contract, and breach of the covenants of good faith and fair dealing under New York law. Plaintiff seeks damages, injunctive relief, declaratory relief, rescission, disgorgement, and costs. Defendants*fn1 now move to dismiss Plaintiffs claims pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure ("Fed.R. Civ.P."). For the reasons stated below, Defendants' motion to dismiss is granted.*fn2

I. Background

Plaintiff is a Delaware corporation with its principal place of business in Providence, Rhode Island. (Complaint ("Compl.") ¶ 7). Plaintiff provides telephone service, high-speed Internet access, and cable programming to homes and businesses throughout the Northeast of the United States. (Id.).

Defendant HFTP is a limited liability company, organized and doing business in New York, engaged principally in the business of investments and financial services. (Id. at ¶ 8). Defendant Promethean, a New York company, is an affiliate of HFTP and also its investment advisor. (Id. at ¶ 9). Defendants Fisher and Wingate are limited partnerships organized under the laws of the Cayman Islands and have offices in Chicago, Illinois. (Id. at ¶¶ 10, 11). Fisher and Wingate are venture capital lenders. Defendant Citadel, a limited partnership, is a registered broker-dealer and is the trading manager of both Fisher and Wingate. (Id. at ¶ 12). Defendant Marshall, an Illinois (venture capital) investor corporation doing business in New York, is a wholly-owned subsidiary of Credit Suisse Group and an affiliate of Credit Suisse First Boston Corporation. (Id. at ¶ 13).

On February 23, 2000, LOA entered into the following financial agreements with HFTP, Fisher, Wingate, and Marshall: (i) Securities Purchase Agreement (the "Agreement"); (ii) Registration Rights Agreement ("Registration Agreement"); and (iii) Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock of Log On America, Inc. (the "Certificate of Designations") (collectively, the "Transaction Documents"). Under the Transaction Documents, HFTP, Fisher, Wingate, and Marshall (cumulatively) paid to LOA $15 million in exchange for: (i) 15,000 shares of LOA's Series A Convertible Preferred Stock ("Preferred Stock");*fn3 and (ii) 594,204 warrants (the "Warrants") for the purchase of LOA common shares ("Common Stock"). (Id. at ¶ 28).*fn4

Plaintiff acknowledged that "its obligation to issue Conversion Shares upon conversion of the Preferred Shares . . . is . . . absolute and unconditional regardless of the dilutive effect that such issuance may have on the ownership interests of other stockholders of [LOA]." (Agreement § 3(m)). The Certificate of Designations contains a "conversion cap" (or "blocker") limiting the beneficial ownership by any holder of Preferred Stock and its affiliates to 4.99% of the total outstanding shares of Plaintiffs common stock.*fn5 The Promethean Defendants and Citadel Defendants entered into separate letter agreements with LOA, each incorporated into the Agreement, precluding them from converting Preferred Stock if doing so would cause the number of shares of Common Stock owned by any one of them during any 60-day period to exceed 10% of LOA's Common Stock. (See Affidavit of Adrienne M. Ward, dated October 3, 2000 ("Ward Aff."), Exs. 8 and 9).*fn6

The Agreement provided that Defendants were acquiring the Preferred Stock and Warrants "for investment only". It did not by its terms constrain Defendants to hold the securities for any minimum period of time:

Investment Purpose. Such Buyer (i) is acquiring the Preferred Shares and the Warrants, (ii) upon conversion of the Preferred Shares, will acquire the Conversion Shares issuable upon conversion thereof and (iii) upon exercise of the Warrants, will acquire the Warrant Shares issuable upon exercise thereof . . . for its own account for investment only and not with a view towards, or for resale in connection with, the public sale or distribution thereof, except pursuant to sales registered or exempted under the 1933 Act; provided, however, that by making the representations herein, such Buyer does not agree to hold any of the securities for any minimum or other specific term and reserves the right to dispose of the securities at any time in accordance with or pursuant to a registration statement or an exemption under the 1933 Act.

Agreement § 2(a) (emphasis added).

Defendants were granted the right to sell short LOA Common Stock.*fn7 However, they agreed not to sell short more than 594,204 shares of Common Stock for a certain period of time:

Restriction on Short Sales. Each buyer agrees that, subject to the exceptions described below, during the period beginning on the Initial Closing Date and ending on but excluding the earlier of (i) the first date on which such Buyer no longer holds any Preferred Shares and (ii) the date which is 180 Days after the Initial Closing Date, neither such Buyer nor any of its affiliates shall engage in any transaction constituting a "short sale" (as defined in Rule 3b-3 of the 1934 Act) of the Common Stock (collectively, "Short Sale"); provided, however, that each Buyer and its Affiliates are entitled to engage in transactions which constitute Short Sales to the extent that following such transaction the aggregate net short position of such Buyer and its Affiliates does not exceed . . . the number of shares of Common Stock equal to the aggregate number of Warrant Shares which such Buyer and its Affiliates have the right to acquire upon exercise of the Warrants held by such Buyer and its Affiliates. . . .

Agreement § 4(0) (emphasis added).

Pursuant to the Agreement, Plaintiff was required to file a Registration Statement covering resale of the common stock underlying the Preferred Stock and Warrants and to request the Securities and Exchange Commission ("SEC") to declare the Registration Statement effective "as soon as practicable, but in no event later than 180 days after [February 23, 2000]." (Registration Agreement § 2(a)(i)). Plaintiff filed a Registration Statement with the SEC on or about April 26, 2000 to register shares of Common Stock on behalf of the holders of Preferred Stock, but the Registration Statement was not declared effective before the 180 day period expired on August 21, 2000.*fn8

Plaintiff alleges in the instant Complaint that Defendants "wrongfully utilized `floorless' convertible stocks . . . to launch an unlawful scheme to `short sell' Plaintiffs stock in sufficient volume to drive down its price knowing that they would be in a position to cover the short sales by converting their preferred stock at depressed market prices." (Compl. ¶ 2). Plaintiff maintains that Defendants violated the Federal Securities Laws and breached the terms of the Transaction Documents by "artificially manipulating the market prices of LOA's common stock through massive and unlawful short sales while in possession of material non-public information concerning LOA's business."*fn9 (Id. at ¶ 4). Plaintiff also alleges that Defendants constituted a "group" for purposes of Sections 13(d) and 16(b) of the 1934 Act analysis and violated both of these Sections because, among other things: (i) Defendants collectively acquired more than 5% of LOA's common stock but have not filed a 13(D) Registration Statement; (id. at ¶¶ 73-81); (ii) Defendants collectively own more than 10% of LOA's common stock; and (iii) that any conversions of the Preferred Stock to "cover" a short sale would constitute a "matching" purchase in violation of Section 16(h); (id. ¶¶ 82-86).*fn10

Defendants state that "[t]he fundamental problem with Plaintiffs claims is that short selling was expressly contemplated and authorized under the Agreement" and that "what Plaintiff is really complaining of here is not fraud or breach of contract, but of having to live up to its obligations under the Agreement." (Memorandum Of Law In Support Of Defendants' Joint Motion To Dismiss The Complaint With Prejudice ("Def.Mem.") at 5, 6). "Indeed, Plaintiff admitted in its Registration Statement that the holders of Preferred Stock could engage in short sales as a legitimate hedging strategy." (Id. at 10). Defendants' instant motion contends, inter alia: (i) Plaintiff has not alleged any actionable misrepresentation or breach; (id. at 8-11, 22-23); (ii) Plaintiff has no standing to assert a market manipulation claim, and, alternatively, Plaintiff does not plead manipulation with specificity; (id. at 1516); (iii) Plaintiffs insider trading claim is insufficient; (id. at 17); and (iv) Plaintiffs Section 13(d) claim fails because Defendants are not subject to that statute's reporting requirements; (id. at 18-20); and (v) Plaintiff fails to adequately plead a claim under Section 16(b) of the 1934 Act; (id. at 20-21).

II. Standard of Review

"In reviewing a [Fed.R.Civ.P.] 12(b)(6) motion, this Court must accept the factual allegations of the complaint as true and must draw all reasonable inferences in favor of the plaintiff." Bernheim v. Litt, 79 F.3d 318, 321 (2d Cir. 1996) (citing Hernandez v. Coughlin, 18 F.3d 133, 136 (2d Cir.), cert. denied, 513 U.S. 836, 115 S.Ct. 117, 130 L.Ed.2d 63 (1994)). The movant's burden is very substantial, as "[t]he issue is not whether a plaintiff is likely to prevail ultimately, `but whether the claimant is entitled to offer evidence to support the claims.'" Gant v. Wallingford Bd. of Educ., 69 F.3d 669 (2d Cir. 1995) (quoting Weisman v,. LeLandais, 532 F.2d 308, 311 (2d Cir. 1976) (per curiam)). In sum, "[t]he motion to dismiss for failure to state a claim is disfavored and is seldom granted." Bower v. Weisman, 639 F. Supp. 532, 539 (S.D.N.Y. 1986) (citing Arfons v. E.I. du Pont De Nemollurs & Co., 261 F.2d 434, 435 (2d Cir. 1958)).

In addition, a Rule 10b-5 plaintiff must comply with Fed.R.Civ.P. 9(b) and plead fraud with particularity, so thatd defendants have "a reasonable opportunity to answer the complaint and . . . adequate information to frame a response." Ryan v. Hunton & Williams, 99 Civ. 5938(JG), 2000 WL 1375265, at *6 (E.D.N.Y. Sept. 20, 2000) (quoting Ross v. A.H. Robins Co., 607 F.2d 545, 557-58 (2d Cir. 1979)). The Private Securities Litigation Reform Act of 1995 ("PLSRA") requires that in a fraud action, "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u4(b)(1) (1997).

III. Analysis

A. Section 10(b) and Rule 10b-5

Plaintiff alleges that Defendants engaged in three violations of § 10(b) of the 1934 Act and Rule 10b-5 promulgated thereunder: "(i) a pattern of misrepresentations and omissions intended to and having the effect of inducing LOA to sell Convertible Preferred Stock to Defendants; (ii) conduct to manipulate downward the market price of LOA's common stock; and (iii) trading on inside information." (Compl. ¶ 65).

Defendants contend that: (i) Plaintiff's misrepresentation claims fail because Plaintiff fails to plead sufficiently each of the (four) necessary elements, i.e. because Plaintiffs allegations "are not stated with the particularity required by Fed.R. Civ. Rule 9(b). . . ."; (Def. Mem. at 7); (ii) the market manipulation claim fails because Plaintiff lacks standing*fn11 and because Plaintiff fails adequately to plead the elements of manipulation; (id. at 16-17); and (iii) the insider trading claim fails because Plaintiff does not meet the pleading requirements ...

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