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United States District Court, S.D. New York

March 30, 2004.

ATSI COMMUNICATIONS, INC., Plaintiff, -against- THE SHAAR FUND, LTD., et al., Defendants

The opinion of the court was delivered by: LEWIS KAPLAN, District Judge


This case involves claims by plaintiff ATSI Communications, Inc. ("ATSI") that defendants violated federal securities laws and various state laws in connection with defendants' purchase of convertible preferred securities. Now pending before the Court are two motions to dismiss the amended complaint (the "Complaint") on behalf of (1) defendants Levinson Capital Management and Samuel Levinson (collectively, the "Levinson defendants"), and (2) defendants RGC International Investors, LDC and Rose Glen Capital Management, L.P. (collectively, the "Rose Glen defendants").

The Complaint centers around certain defendants' purchases of multiple series of ATSI convertible preferred stock. It alleges that defendants defrauded plaintiff into selling the preferred by promising, inter alia, not to put downward pressure on the price of ATSI common stock. ¶¶ 44-45, 48, 60, 67. Defendants allegedly had an incentive to manipulate the price of the common stock downward because a lower stock price would enable the defendants to obtain more shares of common stock upon conversion. Id. ¶ 35. The Complaint alleges that defendants secretly used short sales and other devices to manipulate the price of ATSI common stock. Id. ¶ 69. Defendants allegedly profited from the scheme by covering their short positions using the common stock issued upon conversion. Id. ¶ 35.

  The Levinson and Rose Glen defendants now move to dismiss on various grounds, including, primarily, that the Complaint fails to satisfy Fed. R. Civ. P. 9(b) and/or the Private Securities Litigation Reform Act, 15 U.S.C. § 78u-4(b). They argue that the Complaint does not adequately plead facts showing (1) why each alleged misstatement was false or misleading, or (2) manipulation. Page 2

 Misstatements and Omissions

  The Complaint alleges that the Levinson defendants misrepresented that they intended to be long-term investors in ATSI and that they would not put pressure on the stock by, for example, short selling. Cpt. ¶¶ 44-45, 48. ATSI allegedly relied on these misrepresentations in deciding to sell the convertible preferred securities to The Shaar Fund (an entity allegedly controlled by the Levinson defendants). Id. ¶¶ 85, 105.

  Failure to carry out a promise made in connection with a securities transaction "does not constitute fraud unless, when the promise was made, the defendant secretly intended not to perform or knew [that] he could not perform." Gurary v. Winehouse, 190 F.3d 37, 44 (2d Cir. 1999) (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1176 (2d Cir. 1993)). Here, plaintiff contends that its allegation that defendants secretly intended not to perform is supported adequately by allegations that the defendants previously engaged in similar manipulative schemes. ATSI Mem. in Opp. to Levinson Motion 8-9. The Complaint appears to base these allegations on information and belief, but it does not identify the basis for that belief. These allegations therefore are inadequate under both Rule 9(b)*fn1 and the PSRLA, the latter of which requires that, where an allegation regarding a misstatement or omission is based on information and belief, the plaintiff "state with particularity all facts upon which that belief is formed," 15 U.S.C. § 78u-4(b)(1).*fn2

  Even if plaintiff had pled adequately the basis for its belief that the defendants did not intend to perform at the time they made the alleged representations, the Complaint does not allege with particularity that the defendants acted inconsistently with the representations — i.e., that the defendants did not invest for the long-term and that the defendants put pressure on the stock. For example, the Complaint alleges, in conclusory terms, that the defendants drove down the price of common stock by "painting the tape, hitting the bids, failing to obtain the best price, naked short-selling and dumping stock in large numbers on the market." ¶ 69. But such conclusory allegations do not satisfy either Rule 9(b) or the PSLRA. Page 3

  Moreover, plaintiff's allegation that the Levinson defendants misrepresented their long-term investment plans is fatally undercut by the parties' agreement. The transaction documents expressly permitted the holder of the preferred securities to convert those securities and to resell the common shares.*fn3 In these circumstances, i.e., where the agreement itself permits the conduct that allegedly constituted the violation, it is questionable whether reliance on the prior representations would have been reasonable. Cf. Harsco. Corp. v. Segui, 91 F.3d 337, 345 (2d Cir. 1906) (disclaimer in agreement precluded justifiable reliance on oral representations made prior to agreement); Log On America, Inc. v. Promethean Asset Mgmt. LLC, 223 F. Supp.2d 435, 445 (S.D.N.Y. 2001) ("[I]t is difficult to find a `misrepresentation' where, as here, the accused party is not alleged to have done what he agreed (presumably intended) not to do and where, even if he did, he was contractually permitted to do so.").

  The allegations of misstatements by the Rose Glen defendants are equally deficient. The Complaint alleges that two individuals, Kevin Gale and Keith Marlow, misrepresented that Rose Glen intended to be a long-term investor in ATSI, that Rose Glen would not sell more than ten percent of the volume traded on any given day, and that Rose Glen was an accredited investor. ¶ 60. As a preliminary matter, the Complaint does not allege that these two individuals worked for Rose Glen, nor does it allege any other basis on which these statements are attributable to Rose Glen. But even assuming that the statements are attributable to Rose Glen, the allegations fail for the same reasons that the allegations against the Levinson defendants fail — the Complaint does not set forth any factual support to show the falsity of these statements, and any reliance on defendants' misrepresentations about their long-term investment plans appears to have been unreasonable in light of the parties' agreement.*fn4

  Plaintiff's reliance on the Rose Glen defendants' supposed misrepresentations was unreasonable for another reason as well. Plaintiff alleges that these misrepresentations occurred during the period leading up to plaintiff's October 2000 sale of convertible preferred securities to Page 4 Rose Glen. Cpt. ¶¶ 60-62. The securities purchase agreement, dated October 11, 2000, contained an integration clause which stated that the agreement contained the entire understanding of the parties unless otherwise provided.*fn5 Here, plaintiff docs not allege that the misrepresentations were contained in the agreement. Any reliance by plaintiff on any misrepresentations made prior to and outside the agreement would have been unjustifiable as a matter of law. Cf. Harsco. Corp., 91 F.3d at 345 (affirming dismissal of securities fraud claim where disclaimer In agreement precluded justifiable reliance on oral representations made prior to agreement).

  The Complaint alleges also that the Rose Glen defendants misrepresented the amount that they intended to invest in the company. According to the Complaint, the Rose Glen defendants initially promised to invest $15 million, but entered into an agreement for only $2.5 million. Cpt. ¶ 32. Plaintiff appears to raise this on both misrepresentation and breach of contract theories. See Id. ¶¶ 63, 99; ATSI Mem. in Opp. to Rose Glen Motion 10. Defendants seek dismissal of the misrepresentation claim on statute of limitations grounds. Rose Glen Mem. 25. Assuming arguendo that plaintiff has stated a claim for misrepresentation, as to which the Court expresses no view, plaintiff obviously would have been aware, and therefore received notice, of the change in the amount of defendants' investment at the time of the closing, on October 16, 2000. However, plaintiff did not file the original complaint until October 31, 2002, more than two years later. The misrepresentation claim therefore is time-barred.*fn6


  According to the Complaint, defendants' ownership of their convertible preferred securities gave them an incentive to drive down the market price of ATSI common stock in order to obtain more shares at the time of conversion. It alleges that the defendants not only defrauded ATSI into selling convertible preferred securities, but manipulated the price of the common downward using short sales and other devices. Defendants allegedly then profited by covering their short positions with the common stock that they obtained upon conversion of the preferred.

  Manipulation claims under Rule 10b-5 must meet the requirements of Rule 9(b), which applies to "all averments of fraud," Fed.R.Civ.P. 9(b). Two requirements of Rule 9(b) are Page 5 relevant to this motion. First, Rule 9(b) requires that plaintiffs alleging fraud state "the circumstances constituting fraud . . . with particularity," Fed.R.Civ.P. 9(b). Allegations that are "conclusory" or "unsupported by assertions of fact" are insufficient. Luce, 802 F.2d at 54; accord Segal, 467 F.2d at 608. Second, allegations of fraud generally cannot be based on "information and belief" absent allegations of sufficient fact to warrant the alleged belief. Luce, 802 F.2d at 54 n.1 (citing Schlick, 507 F.2d at 379). For matters that arc "peculiarly within the opposing party's knowledge," Rule 9(b) permits "information and belief" allegations so long as they arc "accompanied by a statement of facts upon which the belief is founded." Luce, 802 F.2d at 54 n.1 (citing Segal, 467 F.2d at 608).

  The allegations of the Complaint are conclusory and thus fail to pass muster under Rule 9(b). For example, the Complaint alleges on information and belief that defendants "employed a variety of manipulative devices and techniques, including, without limitation, painting the tape, hitting the bids, failing to obtain the best price, naked short-selling and dumping stock in large numbers on the market." ¶ 69. Not only is it unclear how certain of these "devices" were manipulative, but the Complaint offers no particulars to support this allegation, such as which defendants committed which acts, the timing of the alleged devices, and the effect of the devices on the stock's trading volume and price. Nor does the Complaint allege the facts upon which the plaintiff's belief is based. This type of conclusory allegation characterizes the remainder of the Complaint. Indeed, the primary factual allegation in support of plaintiff's theory is that the defendants purchased convertible preferred securities, but this conduct in no way violates any securities laws. Allowing this complaint to survive when the principal factual allegation is that defendants purchased convertible preferred would make any purchaser of such securities vulnerable to a federal securities fraud lawsuit.*fn7

  As the Complaint fails to comply with either the PSLRA or Rule 9(b), the Court need not address defendants' remaining arguments for dismissal of the federal securities law claims. The motions of the Levinson and Rose Glen defendants to dismiss the federal securities law claims [docket items 40 and 48] are granted, albeit with leave to replead no later than April 11, 2004. As there is no independent basis of federal jurisdiction over the state law claims, they are dismissed as well subject to plaintiffs' right to include pendent state claims in any amended complaint. There Page 6 being no proof of service on defendant Samuel Levinson, and more than 120 days having elapsed, the action is dismissed without prejudice as against him pursuant to Fed.R.Civ.P. 4(m).


  It is ORDERED that counsel to whom this Order is sent is responsible for faxing a copy to all counsel and retaining verification of such in the case file. Do not fax such verification to Chambers

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