The opinion of the court was delivered by: WILLIAM CONNER, Senior District Judge
Plaintiff Peter T. Loftin brings this putative class action against
defendants Flag Telecom Holding Group, Ltd. ("Flag"),*fn1 Salomon Smith
Barney, Inc. n/k/a Citigroup Global Markets, Inc. ("Citigroup" or the
"underwriter") and Verizon Communications, Inc. ("Verizon"). Plaintiff
also names eight individual defendants: Andres Bande, Larry Bautista,
Andrew Evans, Dr. Lim Lek Suan, Edward McCormack, Edward McQuaid, Daniel
Petri and Philip Seskin (collectively referred to as the "individual
defendants").*fn2 On October 18, 2002, this Court consolidated several
similar suits; Loftin was named lead plaintiff and Milberg Weiss Bershad
Hynes & Lerach was appointed lead counsel.
Plaintiff alleges that all defendants are liable under §§
11, 12(a)(2) and 15 of the Securities Act of 1933 (the "Securities Act").
Additionally, plaintiff claims that Flag and the individual defendants
violated § 10(b) of the Securities and Exchange Act of 1934 (the
"Exchange Act") and Rule 10b-5 promulgated thereunder. Flag, Verizon,
Citigroup and the individual defendants move to dismiss pursuant to
Rules 12(b)(6) and 9(b) and the Private Securities Litigation Reform Act
("PSLRA") for failure to state a claim. For the reasons stated herein,
defendants' motions are granted. Plaintiff, however, is granted leave to
replead all claims. Accordingly, plaintiff has thirty
days from the entry of this Opinion and Order to file a Second
Consolidated Amended Complaint.
Prior to filing its Chapter 11 bankruptcy petition,*fn3 Flag was a
telecommunications company, co-founded by Verizon's predecessor, (Complt.
¶ 52),*fn4 that marketed itself as a "carrier's carrier" i.e. a
company that owns its own telecommunications infrastructure and sells
access to it on a wholesale basis. (Id. ¶ 2.) Each of the
individual defendants served as officers or directors of Flag during the
class period. Specifically, Bande was the Chairman and Chief Executive
Officer ("CEO"), McCormack was the Chief Operating Officer ("COO"), Evans
was the Chief Technology Officer, Bautista was the Chief Financial
Officer ("CFO") and Petri, McQuaid, Seskin and Suan were directors.
In early 2000, Flag made an initial public offering ("IPO") as part of
an effort to expand its fiberoptic network. (Id. at ¶¶ 3-4;
Prospectus at 15.) One of the largest projects disclosed in the
Prospectus was a joint venture with GTS TransAtlantic ("GTS"). The
companies were constructing a fiberoptic connection between London and
Paris called the Flag Atlantic-1 system ("FA-1 system"). (Complt. at
¶ 4.) Flag also intended to develop its network by acquiring access
to cables owned by other carriers where rapid expansion was necessary or
where it was not economically
feasible to expand Flag's own infrastructure. (Prospectus at 1, 38.)
In industry jargon, such unused cables are called "dark fiber."
On January 18, 2000, Flag filed a Registration Statement that
incorporated the company's Prospectus. (Complt. ¶ 70.) The effective
date of the Registration Statement was February 11, 2000. (Id.
¶ 74.) Flag's IPO took place on February 16, 2000, and the company
raised approximately $634.6 million from the sale of its common stock.
(Id.) Citigroup served as lead underwriter. (Id. ¶
52.) Plaintiff alleges that the Prospectus contained actionable
misstatements because it created "the false and misleading impression
that strong demand existed for Flag's capacity, and that demand was
growing." (Id. ¶ 70.) Plaintiff also claims that the
Prospectus contained actionable omissions. (Id. ¶¶ 70-72.)
Sometime after the EPO, the telecommunications industry experienced a
decline and in late 2000 and early 2001, some of Flag's competitors began
to reduce forecasts and announce liquidity problems. (Id. ¶
64.) Plaintiff claims that rather than disclose the fact that Flag was
also experiencing difficulties, Flag relied on improper "swap"
transactions with competitors to inflate its financial results and made
misleading, or incomplete, public statements to create the sense that
Flag was not suffering the same fate as some of its competitors.
(Id. at ¶ 2.) The alleged misleading statements continued
until Flag's announcement on February 13, 2002 that the company was
"reviewing [its] business in light of deteriorating market conditions"
and that 14% of its revenues for 2001 were the result of reciprocal
transactions entered into with competitors. (Id. ¶ 153.)
Plaintiff proposes a Class Period from February 16, 2000, the date of
Flag's IPO, until February 13, 2002, the date of Flag's announcement that
it was "reviewing its business."
On a motion to dismiss pursuant to Rule 12(b)(6), the court must accept
as true all of the well pleaded facts and consider those facts in the
light most favorable to the plaintiff. See Scheuer v. Rhodes,
416 U.S. 232, 236 (1974), overruled on other grounds by Davis v.
Scherer, 468 U.S. 183 (1984); Harris v. City of New York,
186 F.3d 243, 247 (2d Cir. 1999); Faulkner v. Verizon Communications,
Inc., 156 F. Supp.2d 384, 390 (S.D.N.Y. 2001) (Conner, J.). On such
a motion, the issue is "whether the claimant is entitled to offer
evidence to support the claims." Scheuer, 416 U.S. at 236. A
complaint should not be dismissed for failure to state a claim "unless it
appears beyond doubt that the plaintiff can prove no set of facts in
support of his claim which would entitle him. to relief." Padavan v.
United States, 82 F.3d 23, 26 (2d Cir. 1996) (quoting Hughes v.
Rowe, 449 U.S. 5, 10 (1980)). Generally, "[c]onclusory allegations
or legal conclusions masquerading as factual conclusions will not suffice
to prevent a motion to dismiss." 2 JAMES WM. MOORE ET. AL., MOORE'S
FEDERAL PRACTICE § 12.34[b] (3d ed. 1997); see also Hirsch v.
Arthur Andersen & Co., 72 F.3d 1085, 1088 (2d Cir. 1995).
Allegations that are so conclusory that they fail to give notice of the
basic events and circumstances of which the plaintiff complains, are
insufficient as a matter of law. See Martin v. New York State Dep't
of Mental Hygiene, 588 F.2d 371, 372 (2d Cir. 1978).
In assessing the legal sufficiency of a claim, the court may consider
those facts alleged in the complaint, documents attached as an exhibit
thereto or incorporated by reference, see FED. R. Civ. P. 10(c);
De Jesus v. Sears, Roebuck & Co., Inc., 87 F.3d 65, 69 (2d
Cir. 1996), and documents that are "integral" to plaintiff's claims, even
if not explicitly incorporated by reference. Cortec Indus., Inc.
v. Sum Holding L.P., 949 F.2d 42, 46-48 (2d Cir. 1991). A
company's prospectus is integral to a plaintiff's § 11 and §
10(b) claims and can be considered in its entirety even where plaintiff
has quoted from it sparingly. I. Meyer Pincus &
Assocs. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d. Cir. 1991).
Indeed, when considering a motion to dismiss § 11 claims, the court
must consider the prospectus as a whole. Olkey v. Hyperion,
98 F.3d 2, 5 (2d Cir. 1996).
II. plaintiff's Securities Act Claims
Plaintiff has asserted a claim under § 11 of the Securities Act
against all named defendants. (Complt. ¶¶ 198-206.) In order to state
a claim under § 11, a plaintiff must allege that "the registration
statement . . . contained an untrue statement of a material fact or
omitted to state a material fact required to be stated therein or
necessary to make the statements therein not misleading. . . ."
15 U.S.C. § 77k(a). The truth of a statement made in the prospectus is
adjudged by the facts as they existed when the registration statement became
effective. In re MobileMedia Sec. Litig., 28 F. Supp.2d 901, 923
(D.N.J. 1998). A claim under this section may be asserted against every
person who signed the registration statement, the directors of the issuer
and the underwriter of the security. 15 U.S.C. § 77k(a). The test for
determining whether the prospectus contained material misstatements or
omissions is "whether the defendants' representations [made in the
prospectus], taken together and in context, would have misled a
reasonable investor. . . ." Olkey, 98 F.3d at 5. Plaintiff
attempts to plead a § 11 claim by alleging the following:
The Prospectus touted Flag's supposedly
"state-of-the-art technology" and the vast
capacity of its largest project, the FA-1 system.
In particular, the Prospectus went to great
lengths to create the false and misleading
impression that strong demand
existed for Flag's capacity, and that demand
was growing. . . . [Flag also] promoted the fact
that the FA-1 system had "pre-sales in excess of
$750 million," but failed to disclose that every
customer who was likely to purchase capacity on
the FA-1 had already done so.
(Complt. ¶¶ 70-71.) Plaintiff argues that these statements were
misleading because "a glut of supply existed that was overwhelming demand
and driving down prices" and the statements created the "misleading
impression that strong demand existed for Flag's capacity." (Id.
¶¶ 70-74.) Plaintiff further claims that the Prospectus was misleading
because it "touted" Flag's customer base without disclosing that "Flag
performed absolutely no due diligence on its customers to determine their
ability to pay." (Id., ¶ 72.)
None of the statements in the Prospectus constitutes an affirmative
representation by Flag that "strong demand existed for Flag's capacity,
and that demand was growing. . . ." (Id. ¶ 70.) For
instance, Flag stated that a particular feature of its FA-1 system was
"designed to meet the needs of major global carriers that require
substantial amounts of bandwidth." (Prospectus at 38.) This statement
merely indicates that Flag sought to attract major global carriers that
required facilities Flag offered, not that demand for Flag's capacity was
strong. While Flag announced that the FA-1 system had pre-sales of $750
million, it did not, as plaintiff claims, present this fact in an effort
to exaggerate the demand for Flag's products. In fact, the statement
appeared in a section of the Prospectus explaining how the project would
be financed. (Prospectus at 34.) Similarly, plaintiff points to Flag's
contention that "carriers have responded positively to our ability to
offer" certain facilites and services. (Id. at 40.) This
statement is far too vague to lead a reasonable investor to conclude that
at the time of the offering Flag claimed that demand was strong for its
Plaintiff has established that Flag represented that there was a
general demand for capacity
in the telecom industry and that Flag expected to "participate in
. . . important growth and strategic shifts in the international
telecommunications markets." (Prospectus at 39.) Most of these
representations consist of statements made by Flag concerning general
market conditions and trends. (Pl. Mem. Opp. Citigroup Mot. Dismiss at
3-4.) Plaintiff has not, however, pleaded any facts that indicate any of
these statements were untrue as of the effective date. In fact, the
Complaint tends to establish that the decline in the telecom industry did
not begin until late 2000 and early 2001. (Complt. ¶¶ 64-65.) The
Prospectus also contained meaningful cautionary language explaining that
the telecom industry faced significant challenges. Flag disclosed that it
faced "competition and pricing pressure from existing cables, planned
cables, and satellite providers." (Prospectus at 11.) Flag even predicted
that prices would decline going forward. (Id. at 31.) The
company explained that many of its competitors had greater resources and
that advances in technology could lead to an increase in its competitors'
capacity. (Id. at 11.) Furthermore, Flag frankly stated that
ventures, such as its FA-1 system, that employed "state of the art
technology" were subject to deployment problems that could have a
material adverse effect. (Id. at 6-14.) Far from brashly
"touting" its "state of the art technology" as plaintiff claims, Flag was
singling out its "state of the art technology" a significant risk factor.
When a prospectus contains detailed disclosures of the relevant risks
involved, general statements concerning the state of the industry, such
as the ones made here, are immaterial as a matter of law. See
Olkey, 98 F.3d at 6.
Plaintiff has also failed to plead an omission that will support
liability under § 11. When a plaintiff claims that the defendant
failed to disclose information in a prospectus, the plaintiff must plead
facts demonstrating the defendant possessed the omitted information when
the registration statement became effective and that the defendant had a
duty to disclose that information. See, e.g.,
Scibelli v. Roth, No. 98 Civ. 7228, 2000 WL 122193, at *3
(S.D.N.Y. Jan. 31, 2000) (dismissing a § 11 claim when it was alleged
that the defendant failed to disclose demand was weak because the
plaintiff did not plead facts demonstrating that the defendant possessed
information indicating that demand was weak on the effective date);
Fisher v. Ross, No. 93 Civ. 0275, 1996 WL 586345, at *3
(S.D.N.Y. Oct. 11, 1996).
In the present case, plaintiff alleges that Flag had a duty to disclose
that "a glut of supply existed that was overwhelming demand and driving
down prices." (Complt. ¶¶ 70-74.) This allegation fails because
plaintiff does not claim that this was true as of the effective date much
less allege that Flag possessed information indicating that demand was
weak on the effective date. In fact, the Complaint tends to show that
demand for telecom products did not weaken until long after the EPO,
(Id. ¶¶ 64-65), and the Prospectus disclosed in detail the
competitive challenges facing Flag. Plaintiff also alleges that Flag's
claim that it had "pre-sales in excess of $750 million" on its FA-1
system gave rise to a duty to disclose that all the customers who were
likely to purchase capacity on that network had already done so.
(Id. ¶ 71.) Even if this were the case, plaintiff has not
pleaded facts indicating that on the effective date Flag had information
that would lead to this conclusion.
The Prospectus also contained statements concerning Flag's customer
base. For example, Flag stated, "We have an established customer base of
approximately 90 customers." (Prospectus at 44.) Plaintiff does not
allege that Flag misrepresented its customer base. Instead, he claims
that Flag had a duty to disclose that it performed no due diligence on
its customers because Flag "touted" its customer base in the Prospectus.
The only allegation that plaintiff provides to support this claim is that
an unnamed former Finance Manager said that "when selling capacity, Flag
`just wanted to
record the sale.'" (Complt. ¶ 72 (quoting former Finance
Manager).) This vague statement does not indicate that Flag failed to
conduct due diligence; it merely states the Manager's interpretation of
Flag's desire. Indeed, the Complaint tends to establish that Flag did in
fact conduct due diligence. First, it notes that Barclays Bank agreed to
provide financing for the FA-1 system project (Id. ¶ 112);
if a bank was willing to provide substantial funding, it is unlikely that
Flag had no idea whether its customers had the ability to pay. Second,
the Prospectus states that 95% of Flag's reported revenues came from its
top fifty customers. (Prospectus at 52.) This suggests that Flag had
dealt with its customers in the past and was therefore assured of their
ability to pay. Therefore, this allegation fails because plaintiff has
not alleged any facts to indicate that Flag failed to adequately
investigate its customers' ability to pay. Accordingly, we conclude that
plaintiff has failed to plead an actionable omission under § 11.
Because plaintiff has failed to plead facts showing that "the
registration statement . . . contained an untrue statement of a material
fact or omitted to state a material fact required to be stated therein or
necessary to make the statements therein not misleading," his § 11
claims must be dismissed. 15 U.S.C. § 77k(a). The individual
defendants argue that these claims should also be dismissed because they
are time barred. (Indiv. Defs. Corr. Mem. Supp. Mot. Dismiss at 32.)
However, accepting the allegations in the Complaint as true, it is not
clear at this point that plaintiff should have discovered the allegedly
misleading statements prior to the end of the Class Period. Therefore, we
cannot say, as a matter of law, that plaintiff was put on inquiry notice
so as to trigger the one-year statute of limitations prior to that time.
See 15 U.S.C. § 77m.
B. Section 12(a)(2) and Section 15
Plaintiff has asserted a claim under § 12(a)(2) of the Securities
Act against Flag, the individual defendants and Citigroup. (Complt. ¶¶
207-14.) Section 12(a)(2) allows a plaintiff to proceed against "[a]ny
person who . . . offers or sells a security . . . by means of a
prospectus or oral communication, which includes an untrue statement of
material fact or omits to state a material fact necessary in order to
make the statements . . . not misleading. . . ." 15 U.S.C. § 771(a).
The Supreme Court has held that a private contract for sale is not a
"prospectus" under this provision, Gustafson v. Alloyd Co.,
513 U.S. 561, 571 (1995). The predominant view is that under this precedent
§ 12(a)(2) applies only to public offerings and therefore aftermarket
purchasers lack standing to bring a claim under § 12(a)(2). See,
e.g., Laser Mortgage Mgmt., Inc. v. Asset Securitization Corp., No.
00 Civ. 8100, 2001 WL 1029407, at *7-8 (S.D.N.Y. Aug. 17, 2001);
Waltree Ltd. v. ING Furman Selz LLC, 97 F. Supp.2d 464, 469
(S.D.N.Y. 2000). However, a party named "lead plaintiff under the PSLRA
need not have standing to sue on each individual claim asserted in the
complaint so long as other named plaintiff's have standing to pursue the
claims at issue. In re Initial Public Offerings Sec. Litig.,
214 F.R.D. 117, 123 (S.D.N.Y. 2002); In re Enron Corp. Sec.
Litig., 206 F.R.D. 427, 451 (S.D. Tex. 2002); In re American
Bank Note Holographics Sec. Litig., 93 F. Supp.2d 424, 436
(S.D.N.Y. 2000) ("Holographics"). Nevertheless, plaintiff's
§ 12(a)(2) claims must be dismissed for two other reasons: first, as
discussed supra in Part II.A., the Complaint fails to plead that
the Prospectus contained any actionable misstatements or omissions.
Second, plaintiff has not alleged that any of the named plaintiff's
purchased securities in the IPO and has thus failed to allege that any of
them has standing to pursue this claim.
Finally, plaintiff asserts a claim under § 15 of the Exchange Act
against Verizon and the
individual defendants. (Complt. ¶¶ 215-18.) Section 15 of the
Securities Act allows a plaintiff to proceed against "[e]very person who,
by or through stock ownership, agency or otherwise . . . controls any
persons liable under section 11 or 12" of the Securities Act.
15 U.S.C. § 77o. These claims must be ...