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United States District Court, Southern District of New York

July 7, 2003


The opinion of the court was delivered by: Robert Carter, United States District Senior Judge


Defendants Southridge Capital Management LLC, Stephen Hicks, Daniel Pickett, Christy Constabile, David Sims, Navigator Management Ltd., The Citco Group Limited and Citco Trustees Limited move to dismiss the complaint brought by plaintiffs, ITIS Holdings Inc. ("ITIS") (f/k/a ITIS Inc. and Internet Law Library), Hunter Carr, Kerwin Drouet, and Jack Tompkins pursuant to Rule 37(b)(2), F.R.Civ.P., due to plaintiffs' abuse of the discovery process and persistent refusal to abide by the court's discovery orders.


The underlying action originally brought by plaintiffs alleges fraud, misrepresentation of material facts, manipulation of ITIS' stock in violation of federal and state laws, control person liability claims, tortious interference with contract, and breach of contract, all in connection with defendants' investment in ITIS by means of a Convertible Stock Purchase Agreement entered into on or about May 11, 2000. Plaintiffs request relief that includes amongst other remedies: rescission of all agreements between the parties, declaratory relief excusing ITIS from performance of its duties under the Convertible Stock Purchase Agreement, and damages and costs that total more than $300 million. In the two years the parties have litigated this action the court has dealt with various issues, see, e.g., Internet Law Library v. Southridge Capital Mgmt. LLC, 208 F.R.D. 59 (S.D.N.Y. 2002); Internet Law Library v. Southridge Capital Mgmt. LLC, 223 F. Supp.2d 474 (S.D.N.Y. 2002), with which familiarity is assumed.

This request for dismissal follows several attempts by plaintiffs to override and misconstrue the authority of this court. Plaintiffs' pattern of disrespect for the court's rulings began with a conference held in chambers on September 26, 2002. The purpose of this conference was to set a timeframe for discovery and the filing of dispositive motions as well as resolve any open disputes between the parties. During the conference, defendants alleged that plaintiffs were using discovery to shop for new parties and requested a protective order for all document productions. In response, plaintiffs acknowledged they were inquiring with nonparties about defendants' actions but denied the allegations they were shopping for more plaintiffs. Plaintiffs claimed that defendants employed a financing scheme, similar to the one used with ITIS, to defraud many other companies and as a result these nonparty companies may have information relevant to the allegations of market manipulation and fraud in plaintiffs' complaint.

Taking into account plaintiffs' and defendants' arguments, the court placed its trust in plaintiffs' sense of restraint and denied the protective order. The court indicated that any information gained in discovery was not to be used to identify new clients or initiate new litigation but that it could be used to "locate additional witnesses or join new parties on a showing of good cause." (Endorsement Oct. 3, 2002). In addition, the court indicated that in the event plaintiffs wanted to use any information gained in discovery before another judge in a different litigation, the use of such information would be subject to the ruling of the presiding judge. This was in sum and substance the court's ruling on the scope of discovery made in the September conference.

Judging from their subsequent actions, plaintiffs interpreted the court's ruling to entitle plaintiffs to request every manner of discovery from defendants and nonparties with regard to all companies that bore a resemblance to the way in which ITIS was financed or its stock was sold. Using this interpretation, plaintiffs served subpoenas on February 3, 2003, under the ITIS caption, to the National Association of Securities Dealers ("NASD") and the National Securities Clearinghouse Corporation ("NSCC") in which they requested the records of trading in ATSI Communications ("ATSI") securities by the following companies: The Shaar Fund, Ltd., Levinson Capital Management, Shaar Advisory Services, N.V., Marshall Capital Services, LLC, Jessup & Lamont Structured Finance Group, RGC International Investors, LDC, Rose Glen Capital Management, L.P., MG Security Group, Inc., Corporate Capital Management, and Crown Capital Corporation. Every company referred to in the subpoenas is a party before Judge Lewis Kaplan in the ATSI Communications v. The Shaar Fund, No. 02 Civ. 8726 (S.D.N.Y.), action. None of them, however, are parties to the action before this court. The only common thread between the ATSI case and the ITIS case is that plaintiffs in both cases are represented by the same counsel, Maryann Peronti of Koerner Silberberg & Wiener, LLP and Gary Jewell of Christian Smith & Jewell.

In a February 24, 2003 conference before Judge Kaplan in the ATSI matter, the ATSI defendants, only recently informed of the subpoenas, brought them to the attention of Judge Kaplan. In defending the subpoenas, Ms. Peronti failed to produce the October 3, 2002 Endorsement upon which she was relying for her alleged authorization and misrepresented to Judge Kaplan that they were issued with the permission of this court. She further defended the subpoenas as a permissible search for pattern and practice evidence, alleging that there were factual alliances between defendants in the ATSI and ITIS cases such as to make the actions of the ATSI defendants in trading ATSI's stock relevant to allegedly similar manipulations of ITIS' stock by the ITIS defendants. When Judge Kaplan inquired into whether Ms. Peronti had advised this court that she planned to use the subpoenaed information in the ATSI action, in which discovery was stayed by the Private Securities Litigation Reform Act ("PSLRA"), she admitted she had not done so. Judge Kaplan effectively barred plaintiffs from using the subpoenaed information in the ATSI case and left the relevance of the subpoenas in the ITIS case for this court to decide. ATSI Communications, Inc., v. The Shaar Fund, Ltd., No. 02 Civ. 8726, 2003 WL 1877227, at *3 (S.D.N.Y. April 9, 2003).

On June 9, 2003, the court held a conference in chambers in which the validity of the ATSI subpoenas as well as plaintiffs' attempts to secure discovery of defendants' trading records with regard to nonparties were considered. After hearing arguments from both parties, including plaintiffs' claim that the ATSI subpoenas were issued simply in an attempt to find pattern and practice evidence of defendants' manipulative investment schemes, the court made it very clear that the substance of the October 3, 2003 Endorsement was that plaintiffs were to seek witnesses and not trading records with regard to nonparties. (Tr. of June 9, 2003 Conference, p. 6.) The court quashed the subpoenas and barred plaintiffs from making "any other efforts in this regard." (Id. at p. 9.) In addition the court warned plaintiffs that "any further violation of my order in any way, [and] I'm going to dismiss your case." (Id. at p. 10.)

On June 10, 2003, the day after this ruling, plaintiffs served defendants with notice that plaintiffs would be serving a subpoena on the NASD seeking every short sale made since March 30, 1999, irrespective of the identity of the stock or the trader. On June 11, 2003, defendants, by letter, moved to quash the subpoenas and also brought the present motion to dismiss in light of plaintiffs' clear violation of the court's order. The subpoenas were quashed immediately and the court requested that plaintiffs justify their actions promptly so that the court could rule on defendants' motion. Plaintiffs' response by letter on June 18, 2003, in essence indicates that its justification lies in the court's lack of clarity when it barred plaintiffs from making "any other efforts in this regard." (emphasis added) (Id. at p. 9.) Without knowing whether `this' referred specifically to the ATSI subpoenas or to discovery in trading records of nonparties in general, plaintiffs argue that they could not have violated any order as the order the court gave was so unclear as to not exist for all practical purposes.


Rule 37(b)(2)(C), F.R.Civ.P., authorizes dismissal of a plaintiff's complaint along with other sanctions by the district court if a party "fails to obey an order to provide or permit discovery." Dismissal is the harshest sanction available to a district court, and should thus "be imposed only in extreme circumstances." Jones v. Niagara Frontier Transp. Auth., 836 F.2d 731, 734-35 (2d Cir. 1987). Accordingly, dismissal is appropriate only where a party who has disobeyed an order has done so willfully, in bad faith, or is in some way at fault. Gilpin v. Philip Morris Int'l, Inc., No. 01 Civ. 5960, 2002 WL 1461433 (S.D.N.Y. July 8, 2002) (Carter, J.).

It is clear that the court never gave any permission in the September conference, explicit or otherwise, to plaintiffs to issue the ATSI subpoenas in the manner that they represented to Judge Kaplan. In issuing its order, the court intended that plaintiffs could use defendants' discovery to seek witnesses, be they parties or nonparties, that plaintiffs reasonably believed to have information supporting the allegations in their complaint. This is the only reference to nonparties in the order, and there was no more expansive discussion regarding nonparties in the conference that went unreflected in the order. The issue of nonparty trading records was never raised and in making such an unsupported claim to this court as well as to Judge Kaplan, plaintiffs all but fatally jeopardize their credibility.

In issuing the ATSI subpoenas, plaintiffs not only violated and misrepresented the court's ruling to Judge Kaplan, but they also attempted to violate the discovery stay mandated by the PSLRA in the ATSI case. The PSLRA provides in relevant part:

In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.
See 15 U.S.C. § 78u-4(b)(3)(B).

Plaintiffs' claim that the ATSI subpoenas were not intended for use in the ATSI case but rather could lead to the discovery of relevant evidence in this case is not supported by facts. The only alleged factual connection between the subpoenas and the ITIS case is the presence of one of defendant Citco Group Limited's hundreds of subsidiaries in filings that one of the subpoenaed broker/dealers made with the SEC. This connection, however, is so tenuous in comparison to the obvious utility the subpoenaed information had in assisting counsel to amend the ATSI complaint to defeat the ATSI defendants' motion to dismiss, as to make clear that plaintiffs intended to abuse this court's subpoena power to circumvent the PSLRA's constraints in the ATSI case. See ATSI, 2003 WL 1877227, at *3.

On its own, plaintiffs' abuse of the subpoena power would justify severe sanctions. In combination with plaintiffs' subsequent disregard for the court's order in the June 9, 2003 conference, plaintiffs' conduct warrants dismissal of their complaint. Plaintiffs defend their actions by claiming that they did not understand the court's order to include all nonparty discovery when it barred plaintiffs from making any more efforts "in this regard." In light of plaintiffs' vigorous defense of the ATSI subpoenas in the conference as part of their effort to find a pattern and practice of manipulative investments in nonparties, this alleged misunderstanding seems impossible. Furthermore, even if the court's order was unclear in some respects, it was absolutely clear with regard to ATSI, and the issuance of the second NASD subpoena does not reflect even the understanding that ATSI records were off limits.

Plaintiffs seem to believe that by playing innocent they can escape their duty to be a responsible litigant. The inexplicably self destructive nature of plaintiffs' action in serving the second NASD subpoena on defendants, considering the court's ruling and warning, can only be understood by the court as a willful attempt to try this case as they see fit, and not in the way the court has ordered or that law requires. Were plaintiffs proceeding pro se, the court would be more apt to believe plaintiffs misunderstood the court's order or made careless errors by failing to omit ATSI from the second NASD subpoena. These plaintiffs, however, are represented by experienced counsel. Based on their disregard for the court's orders and discovery rules in the past, the court can only conclude that their behavior with regard to the latest subpoena was willful and in bad faith, just as it was with the ATSI subpoenas.

Due to the harshness of dismissal, the court has considered other sanctions but does not find them to be as effective considering the circumstances of plaintiffs' transgressions. For example, an adverse inference instruction is not applicable as the subject matter of plaintiffs' actions, defendants trading in nonparties, is actually not relevant to plaintiffs' burden of proof and thus would be no punishment at all. The court also believes that monetary sanctions would not effectively deter future misconduct were this litigation to continue due to plaintiffs' failure to heed the court's explicit warning that any further violations would result in dismissal. Plaintiffs' conduct has diverted the court's attention from the efficient adjudication of this case and its case docket, despite clear warnings and orders to adhere to plaintiffs' obligations as litigants. This failure to respect the court and its orders justifies dismissal of plaintiffs' complaint as both a remedy and a deterrent to future misconduct. See United States Freight Co., v. Penn Central Transp. Co., 716 F.2d 954, 955 (2d Cir. 1983).


Plaintiffs' complaint is dismissed pursuant to Rule 37(b)(2), F.R.Civ.P., as to all defendants with prejudice due to plaintiffs' repeated and flagrant disregard for the court's orders.



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