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
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 ¶
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 ¶
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,
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
"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).
"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).
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 ...