interest of 745,000 shares — more than 17% of shares.
The stock of Aviation Group was trading at more than $5.00 per share in
1999. It was trading at $0.01 at the time Emergent filed its amended
g. NAL Financial Group, Inc.
In November 1994, Panzo was the president and a director of NAL
Financial Group, Inc. ("NAL"), an operating private company.
On November 30, 1994, NAL consummated a reverse merger with Corporate
Financial Ventures, Inc. ("COFVI"), an inactive public company, whereby
the shareholders of NAL exchanged all of their shares of NAL stock in
exchange for approximately 56% of the shares of COFVI. COFVI then changed
its name to NAL.
In October 1994, in contemplation of the merger, Panzo arranged for
COFVI to sell him 333,333 common shares for a price of $19,000, which was
far below their anticipated value after the merger. Panzo also received
warrants, through AML, to purchase 33,000 shares for unspecified advisory
Panzo resigned from the board of COFVI at the time the merger was
consummated on November 30, 1994. He was reappointed to the board of NAL
in August 1995 and remained on the board through March 1996. In exchange
for unspecified advisory services, Appel's company FAC received warrants
to purchase 75,000 shares of NAL in August and September 1995 and
warrants to purchase 34,000 shares of NAL in May 1995.
Appel, through FAC and HMA, also purchased convertible debenture units
of NAL for approximately $1.35 million.
Panzo and Appel sold all or substantially all of their NAL shares for a
substantial profit at a price of at least $8 per share. The stock of NAL
is currently worthless. It was trading at less than $0.01 per share at
the time Emergent filed its amended complaint.
NETV filed no public documents that disclosed Panzo's prior affiliation
with Appel or any companies owned or controlled by Appel.
2. Appel's Relationship with NETV
Emergent claims that Appel is the founder and a controlling shareholder
NETV was originally a Florida corporation known as SUNCL. Prior to
August 1998, SUNCL was a public shell and had no operations of its own.
In or about August 1998, SUNCL signed a letter of intent to merge with
Net Value, Inc. In contemplation of the merger, SUNCL changed its name to
Net Value Holdings, Inc., or NETV, and reincorporated in Delaware.
Between October and December 1998, NETV acquired most of the common
stock and all of the preferred stock of Net Value Inc. The merger was
completed in November 2000. As part of the merger, the shareholders of
Net Value Inc. received shares of NETV.
Emergent claims that a number of shareholders of Net Value Inc. stock
had ties with Appel. These shareholders are Millworth, Steven Rosner, SPH
Investments, Inc., and SPH Equities. According to a Form 10-K filed with
the SEC on April 12, 2000, Appel is the President of Millworth. Rosner
worked for HMA in the early 1990's and was also a substantial shareholder
in a number of Appel's companies. SPH Investments and SPH Equities are
owned by Stephen P. Harrington, an affiliate of Appel. SPH owned a
substantial number of shares in a number of Appel's corporations.
In addition, Rozel International Holdings ("Rozel") has at all relevant
times been the largest shareholder of NETV, owning three million shares
at one time. Emergent alleges that Appel and Panzo control Rozel,
although nominal control vests with an individual named Harold
Chaffee.*fn1 During the past fifteen months, Rozel has sold more
than one million shares of NETV, and it has filed Forms 133 for the
proposed sale of an additional 300,000 shares.
C. The Amended Complaint
Emergent filed the second amended complaint on October 19, 2001,
alleging three claims for relief. First, it alleged that the statements
regarding Brightstreet and the omission of details concerning NETV's
association with Appel violated section 10(b) of the Exchange Act,
15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder. Second,
Emergent alleged that Hansen and Panzo are "controlling persons" of NETV
under Section 20 of the Exchange Act, 15 U.S.C. § 78t, and are
personally liable to Emergent for NETV's violations of Section 10(b) and
Rule 10b-5. Finally, Emergent claimed common law fraud.
Stonepath filed its motion to dismiss the instant amended complaint on
November 20, 2001. Emergent filed a response on January 2, 2002, and
Stonepath responded on January 23, 2002. The motion was argued and
considered fully submitted on February 13, 2002.
I. Rule 12(b)(6) Standard of Review
In reviewing a motion to dismiss under Rule 12(b)(6), courts must
"accept as true the factual allegations of the complaint, and draw all
inferences in favor of the pleader." Mills v. Polar Molecular Corp.,
12 F.3d 1170, 1174 (2d Cir. 1993) (citing IUE AFL-CIO Pension Fund v.
Herrmann, 9 F.3d 1049, 1052 (2d Cir. 1993)). Review must be limited to
the complaint and documents attached or incorporated by reference
thereto. Kramer v. Time Warner, Inc., 937 F.2d 767, 773 (2d Cir. 1991).
In this context, the Second Circuit has held that a complaint is deemed
to "include . . . documents that the 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). However, "legal conclusions,
deductions, or opinions couched as factual allegations are not given a
presumption of truthfulness." L'Eureopeenne de Bangue v. La Republica de
Venezuela, 700 F. Supp. 114, 122 (S.D.N Y 1988). "The issue is not
whether a plaintiff will ultimately prevail but whether the claimant is
entitled to offer evidence to support the claims." Villager Pond, Inc.
v. Town of Darien, 56 F.3d 375, 378 (2d Cir. 1995) (guoting Schener v.
Rhodes, 416 U.S. 232, 236 (1974)). A complaint may only be dismissed when
"it appears beyond doubt that the plaintiff can prove no set of facts in
support of his claim which would entitled him to relief."
Gibson, 355 U.S. 41, 45-46 (1957). See also Allen v. WestPoint-Pepperell
Inc., 945 F.2d 40, 44 (2d Cir. 1991); Berheim v. Litt, 79 F.3d 318, 321
(2d Cir. 1996).
II. Whether Deficiencies in Previous Complaint Have Been Corrected
This Court previously held that Emergent's complaint must be dismissed
because it failed to allege loss causation or reasonable reliance. Each
will be addressed in turn.
A. Loss Causation
Emergent's first and second claims allege violations of Rule 10b-5. To
sustain such allegations, a plaintiff must show that "`in connection with
the purchase or sale of securities, the defendant, acting with scienter,
made a false material misrepresentation or omitted to disclose material
information and that plaintiff's reliance on defendant's action caused
[plaintiff] injury.'" Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 534
(2d Cir. 1999) (quoting Time Warner Inc. Secs. Litig., 9 F.3d 2S9, 264
(2d Cir. 1993)).
Causation under federal securities laws requires both (1) transaction
causation (but for the fraudulent statement or omission the plaintiff
would not have entered into the transaction); and (2) loss causation (the
subject of the fraudulent statement or omission was the cause of the
actual loss suffered). Suez Equity Investors v. Toronto-Dominion Bank,
250 F.3d 87, 95 (2d Cir. 2001) (citing Mfrs. Hanover Trust Co. v.
Drysdale Secs. Corp., 801 F.2d 13, 20 (2d Cir. 1986) ("The standard for
liability in a civil action under section 10(b) is causation not merely
in inducing the plaintiff to enter into a transaction or series of
transactions, but causation of the actual loss suffered."). The
Litigation Reform Act similarly requires the plaintiff to demonstrate
that the act complained of "caused the loss for which the plaintiff seeks
to recover damages." 15 U.S.C. § 78u-4 (b)(4).
At issue here is loss causation, which is similar to the tort concept
of proximate cause. Thus, "in order for the plaintiff to recover it must
prove the damages it suffered were a foreseeable consequence of the
misrepresentation." Suez Equity, 250 F.3d at 96 (citing Citibank N.A. v.
K-H Corp., 968 F.2d 1489, 1495 (2d Cir. 1992)). The loss causation
inquiry typically examines how directly the subject of the fraudulent
statement caused the loss, whether the resulting loss was a foreseeable
outcome of the fraudulent statement and other factors such as intervening
causes and the lapse of time between the fraudulent statement and the
loss. Id. "In the end, whether loss causation has been demonstrated
presents a public policy question, the resolution of which is predicated
upon notions of equity because it establishes who, if anyone, along the
causal chain should be liable for the plaintiffs' losses." Id. (citing
AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 217 (2d Cir. 2000)).
Such finding must conform to "a rough sense of justice." Id. (citing
Palsraf v. L.I.R.R. Co., 248 N.Y. 339, 352 (1928) (Andrews, J.,
1. Brightstreet investment
Emergent has sufficiently alleged loss causation for the first alleged
misrepresentation regarding Brightstreet, and Stonepath does not appear
to contest this point. Emergent alleges that the fact that NETV's
investment in Brightstreet was $4 million and not $14 million "caused a
great disparity between the real value of the NETV shares and the price
that defendants induced plaintiff to pay for them." The actual aggregate
value of all of NETV's investments was less than 40% of the amount
represented by Stonepath. Moreover, the shares that Emergent purchased
were restricted and thus could not be sold without registration. By the
time Emergent was able to sell the shares, the market price was far less
than what Emergent had paid. That market price likely reflected the fact
that NETV did not have as great an amount invested as they represented.
Therefore, Emergent has sufficiently alleged loss causation with respect
to the alleged misrepresentation concerning the Brightstreet investment.
2. Appel's Relations with Panzo and NETV
Emergent claims that it alleges a kind of loss found sufficient in Suez
Equity as a result of Appel's relations with Panzo and NETV. The Suez
Equity court identified two losses: (1) the plaintiff's loss at the time
of purchase, due to the decreased "investment quality" of the stock, and
(2) the eventual loss due to the group's financial failure.
There is no question that Emergent has failed to allege facts
sufficient to prove the latter loss. Stonepath is correct that to do so,
Emergent would have to allege a causal connection between Appel's
purported connections with Panzo and NETV and the eventual decline in
stock price. Emergent has not done so.
Whether Emergent has alleged the first type of loss, loss of investment
quality, presents a closer question. Emergent claims in its amended
complaint that "the defendants allegedly concealed a lack of skills and
expertise on the part of the company's principal that, if revealed, would
directly affect the plaintiff's valuation of their investment in the
company." Emergent's amended complaint has alleged, unlike its earlier
complaint, that Emergent relied on Panzo's "experience, judgment,
management, business skill, character and honesty" in assessing the
merits of its investment in Stonepath, and that Panzo's alleged
relationship with Appell was not disclosed. Further, Emergent alleges
that the failure to disclose Panzo's prior investment history "induced a
disparity between the purchased price and real value" of Stonepath's
stock and caused Emergent to evaluate incorrectly Panzo's competency to
lead the company. These allegations are sufficient to state a claim for
loss of investment quality.
Stonepath reads Suez Equity to require that the securities be deemed
"worthless" at the time of acquisition in order to establish a claim of
loss of investment quality, and that Emergent failed to so aver.
However, in discussing prior case law on the topic, the Court defined
loss of investment quality to be that which occurs when "a reasonable
investor would presumably accord less deference to a trainee than it
would to a broker when valuating a recommended stock." 250 F.3d at 98.
Similarly, a loss of investment quality occurred when the concealment of
a lack of skills and expertise on the part of the company's principal, if
revealed, "would directly affect the plaintiffs' valuation of their
investment in the company." Id. The Court did not require the plaintiffs
to have valued the investment as worthless.
If Emergent had known about Panzo's long history of involvement in what
they allege to be "pump and dump" schemes with Appel, a person barred for
life from the securities industry, and that Appel was involved in NETV,
it is reasonable to assume that they would have valuated their investment
in the company much differently. That is sufficient to survive this
motion to dismiss. However, Emergent is limited to damages for its loss
of "investment quality" if this claim survives.
B. Reasonable Reliance
Under both New York and the federal securities laws, reasonable
reliance is a necessary element for establishing a fraud
Corp. v. Segui, 91 F.3d 337, 342 (2d Cir. 1996) (citing, inter alia,
Azrielli v. Cohen Law Offices, 21 F.3d 512, 517 (2d Cir. 1994) and
Channel Master Corp. v. Aluminium Ltd. Sales, Inc., 4 N.Y.2d 403, 407
(1958)). Thus, in order to succeed on any of its three claims, Emergent
must allege reasonable reliance.
This Court previously held that Emergent could not as a matter of law
reasonably rely on any statement that was not incorporated into the fully
integrated Stock Purchase Agreement. Emergent, 165 F. Supp.2d at 625.
Emergent's sophistication, the unambiguous terms of the Stock Purchase
Agreement including the integration clause, and Emergent's access to
financial information and other information concerning Stonepath were
used in reaching this conclusion.
Emergent has not amended its complaint so as to avoid this problem
— and indeed, it is difficult to see how it could amend its
complaint to do so in light of the earlier holding. Thus the second
amended complaint must be dismissed unless the holding that the
unambiguous terms of the Stock Purchase Agreement bars a claim of fraud
based on oral or written representations is reversed or otherwise
Under New York law, "where a party specifically disclaims reliance upon
a particular representation in a contract, that party cannot, in a
subsequent action for common law fraud, claim it was fraudulently induced
to enter into the contract by the very representation it has disclaimed
reliance upon." Harsco, 91 F.3d at 345 (citing Danann Realty Corp. v.
Harris, 5 N.Y.2d 317 (1959)); accord Manufacturers Hanover Trust Co. v.
Yanakas, 7 F.3d 310, 315 (2d Cir. 1993). This rule, enunciated by the New
York Court of Appeals in Danann Realty, applies also in the securities
fraud context. Harsco, 91 F.3d at 345 (citing Brown v. E.F. Hutton
Group, Inc., 991 F.2d 1020, 1033 (2d Cir. 1993)).
In order to invoke the rule from Danann Realty, however, the clause at
issue must contain an adequately specific, as opposed to general,
disclaimer. Chavin v. McKelvey, 25 F. Supp.2d 231, 235 (S.D.N.Y. 1998);
In re Tempo Shain Corp., 120 F.3d 16, 21 (2d Cir. 1997) ("A general
merger clause does not preclude parol testimony where a claim is based on
fraud in the inducement."); Yanakas, 7 F.3d at 316 ("[T]he touchstone is
specificity."). To be adequately specific, a clause "must contain specific
disclaimers of the particular representations that form the basis of the
fraud-in-the-inducement claim." Yanakas, 7 F.3d at 316; O'Hearn v.
Bodyonics, Ltd., 22 F. Supp.2d 7, 13 (E.D.N.Y. 1998) ("A specific
disclaimer typically consists of a clause stipulating that the parties
are not `relying' upon specified, extra-contractual representations.").
Even in the absence of a specific disclaimer, a fraudulent inducement
claim will be barred whenever "an express provision in a written contract
contradicts the claimed oral representations in a meaningful fashion."
Bango v. Naughton, 584 N.Y.S.2d 942, 944 (N.Y. App. Div. 1992); accord
Manufacturers Hanover Trust Co. v. Yanakas, 7 F.3d 310, 317-18 (2d Cir.
1993); M.H. Segan Ltd. Partnership v. Hasbro, Inc., 924 F. Supp. 512, 527
The rationale behind this well-settled rule is that it is unfair to
permit a party to claim fraudulent inducement after it plainly and
deliberately announces that it is not relying on these representations
when signing the contract. Citibank v. Plapinger, 66 N.Y.2d 90, 95
(1985). A contrary rule would allow the party claiming fraud to benefit
from its own deliberate misrepresentation when placing its signature on a
merger clause. Id.; Stanley v. Bray Terminals Inc.,
197 F.R.D. 224, 228 (N.D.N Y 2000).
Thus, a general merger clause "stating that the signatories acknowledge
the written document supersedes all prior agreements and constitutes the
sole embodiment of their obligations" does not bar an action for fraud.
O'Hearn, 22 F. Supp.2d at 13; Yanakas, 7 F.3d at 316-17 (collecting
cases); Citibank v. Plapinger, 66 N.Y.2d 90, 94-95 (1985). By contrast,
when a signatory explicitly disclaims reliance on the subject of the
allegedly fraudulent statement, or when the contract states that the
defendant makes no representations other than those contained in another
more exhaustive clause of the contract, a fraud claim may be precluded.
Harsco, 91 F.3d at 345-47; Yanakas, 7 F.3d at 317.
In order to determine whether Emergent can claim to have reasonably
relied on the alleged misrepresentations, it is necessary to determine if
the merger clause is specific or general. The merger clause provides the
usual boilerplate language:
This Agreement, together with the exhibits and schedules
hereto and ancillary Agreements, contains the entire
understanding and agreement between or among any of them,
and supersedes all prior understandings or agreements
between or among any of them with respect to the subject
If this merger clause stood alone, there would be no question that
it would not by itself preclude reasonable reliance as a matter of
law. In addition to the merger clause, however, the Stock Purchase
Agreement makes 29 separate representations and warranties and 16
separate covenants in favor of the series C purchasers, including
Emergent. Further, one of the representations states:
No representation or warranty by the Company in this
Agreement, in any schedule to this Agreement, or in the
Ancillary Agreements, contains or will contain any untrue
statement of a material fact or omits or will omit to
state a material fact required to be stated herein or
therein or necessary to make the statements contained
herein or therein not false or misleading. There is no
fact or circumstance relating specifically to the current
business operations or condition of the Company that
could reasonably be expected to result in a Material
Adverse Effect*fn2 that is not disclosed in a Schedule
Stock Purchase Agreement, § 2.29. Most of the cases cited by Emergent
do not involve contracts containing such comprehensive representations,
warranties, and covenants.