United States District Court, S.D. New York
December 8, 2004.
NM IQ LLC, ARI GOTTESMAN, GAL KAPLAN, 2b VENTURES LLC, BACK BAY CAPITAL PARTNERS LLC, MICHAEL KAGAN, ISRAEL SEED LIMITED PARTNERS III ISRAEL, and ISRAEL SEED LIMITED PARTNERS III CAYMAN Plaintiffs,
PATRICK S. McVEIGH, LAWRENCE S. WINKLER, and RAY CLEEMAN, Defendants.
The opinion of the court was delivered by: JOHN KEENAN, Senior District Judge
OPINION and ORDER
This case arises out of a merger transaction (the
"Acquisition") between plaintiff NM IQ LLC ("NM IQ") and the
now-bankrupt OmniSky Corporation ("OmniSky"). NM IQ commenced an
action in New York State Court against OmniSky and three of its
officers, alleging fraud, fraudulent inducement and mutual
mistake. The court dismissed these claims for lack of standing
and failure to state a cause of action. Upon leave of the court,
seven members of NM IQ were added as plaintiffs. These plaintiffs
then filed an amended complaint alleging the same claims against
OmniSky and two of the officers. Again, the court dismissed for
failure to state a cause of action.
Prior to filing their amended complaint in the state court, the
same plaintiffs commenced an action in this Court against the
original three OmniSky officers. This action added claims under
Sections 10(b) and 20(a) of the Securities Exchange Act ("1934
Act") to the common law fraud, fraudulent inducement and mutual
mistake claims before the state court. Defendants have moved to
dismiss under Fed.R.Civ.P. 12(b)(6) and 9(b) on grounds of
res judicata, statute of limitations, failure to state claims
and failure to plead fraud with sufficient particularity. For the
reasons that follow, the Court finds the State Court dismissals
preclusive of Plaintiffs' claims before this Court. Defendants'
motion is therefore granted. FACTUAL BACKGROUND
The Complaint alleges the following facts. OmniSky Corporation
("OmniSky") was a wireless technology company that offered
service for use on handheld mobile devices. (Compl. ¶ 20). These
services permitted subscribers to access the Internet, send and
receive e-mail, and conduct e-commerce transactions. (Id.). At
the time of the events giving rise to the Complaint, Defendant
Patrick S. McVeigh ("McVeigh") was OmniSky's chairman and chief
executive officer; defendant Lawrence S. Winkler ("Winkler") was
chief financial officer; and defendant Ray Cleeman ("Cleeman")
was vice president of finance and treasurer. (Id.).
In October 2000, one month after OmniSky's initial public
offering, OmniSky representatives commenced discussions with
representatives of technology companies Nomad, Inc. and Nomad LTD
(collectively "Nomad") concerning a possible acquisition. (Id.
¶¶ 22-25). Defendants McVeigh and Cleeman, along with
then-president Barak Berkowitz ("Berkowitz"), were the primary
negotiators for OmniSky. (Id. ¶ 25). Jacob Davidson
("Davidson"), a founder of Nomad and beneficial interest-holder
in plaintiffs 2bVentures LLC ("2b") and Back Bay Capital Partners
LLC ("Back Bay"), was the primary spokesman for Nomad. (Id. ¶
25). In anticipation of the Acquisition, the seven non-NM IQ
plaintiffs, who collectively owned 94% of Nomad, created NM IQ
and transferred their interests to the new entity. (Id. ¶ 12). NM IQ was formed for the sole purpose of effecting the merger
transaction with OmniSky. (Id.).
Three representations by Defendants during the merger
negotiations form the basis of Plaintiffs' claims. The first
involved OmniSky's ability to fund itself going forward. In
October and November 2000, Cleeman provided Davidson with eight
reports by Wall Street analysts. (Id. ¶ 30). The analysts'
consensus was that OmniSky had sufficient on-hand cash, would not
need additional funding until late in 2001 and would achieve
profitability by 2003. (Id. ¶ 31). Plaintiffs also allege that
McVeigh represented to Davidson during a November 16, 2000
meeting that OmniSky had sufficient capital under its current
business model to continue funding its own and Nomad's operations
into 2002. (Id. ¶ 26(a)). While Plaintiffs made allegations
concerning OmniSky's ability to fund itself in the state action,
their Memorandum of Law states that these allegations are not
before this Court. (Pl. Mem. of Law at 32-33).
The second representation also involves the Wall Street
analysts' reports. Four of the reports estimated that OmniSky
would generate between 220,000 and 225,000 subscribers by the end
of 2001. (Id. ¶ 43). Plaintiffs allege that Cleeman represented
that he and OmniSky adopted the reports and that they accurately
represented OmniSky's financial condition. (Id. ¶ 34).
Plaintiffs claim that they relied on these reports in their
determination to enter into the merger with OmniSky. (Id. ¶
37). The third representation involved a statement by McVeigh to
Davidson at the November 16, 2000 meeting that OmniSky "had
secured a commitment from Verizon to invest an additional $20
million in funding." (Id. ¶ 26(b)). Plaintiffs allege that they
relied on this commitment because they assumed that Verizon, a
well-capitalized investor in technology ventures, had conducted
extensive independent due diligence. (Id. ¶ 28). Plaintiffs
also believed, and Defendants allegedly represented, that
Verizon's name recognition would attract other investors to
OmniSky. (Id. ¶¶ 27, 28(c)).
During the second week of November 2000, Defendants attended an
offsite meeting of OmniSky's senior executives. (Id. ¶ 29).
Plaintiffs allege that they knew nothing of this meeting at the
time. (Id.). At this meeting, an OmniSky vice president gave a
presentation (the "Presentation") that included an agenda and
timetable for revising the budget downward. (Id. ¶ 29, 39).
This Presentation scheduled revised budget figures for a
subsequent presentation on December 11, 2000. (Id. ¶ 42). The
Presentation also stated subscriber projections of 158, 688 by
the end of 2001, a 30% decrease from the estimates in the Wall
Street reports. (Id. ¶¶ 41, 44).
After the November Presentation, Plaintiffs allege that OmniSky
prepared documents containing the revised subscriber projection
and planning budget cuts. (Id. ¶ 45). According to spreadsheets
allegedly prepared for a December 11 presentation, OmniSky
planned budget cuts of $3.5 million at the end of 2000 and $32 million from 2001 operating expenses to compensate for
lower-than-expected subscriber totals. (Id. ¶ 50).
On November 21, 2000, after one month of negotiations,
Plaintiffs and OmniSky executed an agreement in principle (the
"Letter of Intent") setting forth the terms for OmniSky's
acquisition of Nomad. (Id. ¶¶ 6, 51). Plaintiffs allege that
Defendants did not disclose the reduction in subscriber
projections or the proposed budget cuts at this time. (Id. ¶
51). The Letter of Intent provided that OmniSky would pay Nomad's
shareholders 2.5 million shares of unregistered OmniSky common
stock, followed by payments of 600,000 and 400,000 shares
approximately six months and one year after the acquisition.
(Id. ¶ 52).
Cleeman faxed documents for the closing of the acquisition to
Davidson on December 30, 2000. (Id. ¶ 55). Davidson asked
Cleeman whether OmniSky would meet the subscriber targets in the
Wall Street reports. (Id. ¶ 56). To Davidson's surprise,
Cleeman responded deceitfully, Plaintiffs allege that he did
not know the status of those projections. (Id. ¶ 57). Davidson
then contacted Berkowitz, who allegedly gave assurances that
OmniSky "was on track to meet its projections." (Id. ¶ 58).
Davidson signed the acquisition documents on December 30.
(Id.). The remaining plaintiffs executed a Share Exchange
Agreement on January 3, 2001, and OmniSky announced the
acquisition on the following day. (Id.). Defendants provided
another report by Wall Street analyst Morgan Stanley Dean Witter on the date of the announcement. (Id. ¶ 61). This report
supported earlier representations as to OmniSky's financial
condition and subscriber estimates in excess of 220,000 for the
end of 2001. (Id.).
At an offsite meeting with OmniSky management on January 15-16,
2001, before the acquisition closed, Davidson was "shocked" to
learn that OmniSky had not met its subscriber targets and was
setting much lower goals. (Id. ¶ 62). Nevertheless, Plaintiffs
claim that the "financial entanglement" of OmniSky and Nomad
"made it virtually impossible" to cancel the deal prior to
closing. (Id.). Plaintiffs explain that "[i]n November 2000,
the Nomad Businesses had a ready source of investment to continue
their operations, but had instead taken an infusion of capital
from OmniSky as part of the Acquisition upon signing the [Letter
of Intent]." (Id.). Plaintiffs also note that all sides had
already signed the Share Exchange Agreement prior to the closing.
On January 18, 2001, Plaintiffs closed the sale of Nomad to
OmniSky on the terms of the Share Exchange Agreement, which
followed the terms of the Letter of Intent. (Id. ¶ 67). At the
closing, Plaintiffs executed lock-up agreements that incorporated
terms in the Share Exchange Agreement. (Id. ¶ 70). Under these
agreements, Plaintiffs were permitted to sell their shares of
OmniSky stock after time periods ranging from 180 to 330 days.
(Id. ¶ 70). In March 2001, McVeigh allegedly advised Davidson that OmniSky
was in a liquidity crisis. (Id. ¶ 73). On July 15, 2001, a
meeting was held to discuss Project Northstar, a reevaluation of
OmniSky's business in light of its financial difficulties. (Id.
¶ 82). This meeting included discussions of various scenarios
along with the amount of additional funding required and the date
through which OmniSky could operate under the given scenario.
(Id. ¶ 87). Possibilities included the closing of OmniSky's
European operations, receipt of the promised $20 million from
Verizon or both. (Id. ¶ 88-91). Plaintiffs allege that during
this meeting, Cleeman made a presentation not distributed in hard
copy to the participants. (Id. ¶ 93). Cleeman allegedly stated
that if Verizon invested the $20 million, OmniSky would survive,
and if Verizon did not invest, OmniSky would file for bankruptcy
During the week of September 11, 2001, Davidson attended a
meeting at which he was advised that OmniSky had failed to secure
the $20 million from Verizon, to cut sufficient costs and to
raise sufficient revenue. (Id. ¶ 95). On September 21, 2001,
Winkler reported to the OmniSky Board of Directors that OmniSky
had failed to raise additional capital and would run out of cash
by December. (Id. ¶ 96). Trading in OmniSky common stock was
suspended in late 2001, and OmniSky filed for bankruptcy in
December 2001. (Id. ¶ 97) PROCEEDINGS IN STATE COURT
On December 5, 2001, Plaintiff NM IQ filed a complaint
("Initial Complaint") in New York State Supreme Court, New York
County, against OmniSky, McVeigh, Winkler and Cleeman. (Tarnofsky
Affd., Exh. O). The Initial Complaint asserted fraud, fraudulent
inducement and mutual mistake claims in connection with the
Acquisition. This Complaint, inter alia, alleged
misrepresentations as to OmniSky's ability to fund itself and the
Verizon investment, but did not address the subscriber
projections. The defendants moved to dismiss. On January 3, 2003,
Justice Karla Moskowitz (the "State Court") issued a non-final
order granting the motion. NM IQ LLC v. OmniSky Corp., Index
No. 605806/01 (N.Y. Sup. Ct. N.Y. Co. Jan. 3, 2003) ("January
2003 Order") (Tarnofsky Affid., Exh. P). At the threshold, the
State Court determined that NM IQ lacked standing because (i) NM
IQ was not in existence at the time of the alleged
misrepresentations and (ii) NM IQ presented no proof that it was
the successor-in-interest to its members' claims. (Id. at 6).
The State Court also ruled that NM IQ's fraud, fraudulent
inducement and mutual mistake claims failed to state causes of
action against defendants McVeigh, Winkler and Cleeman. (Id. at
7). The court held that future projections concerning OmniSky's
ability to fund itself were not actionable because they relied on
estimates of future performance that carried no guarantee of
success. (Id. at 8). The court rejected NM IQ's argument that
the defendants knew their predictions would not come true, citing NM IQ's failure to identify any facts in
support of this allegation. (Id. at 9). The court also
determined that NM IQ's unreasonably relied on oral
misrepresentations of OmniSky's financial status that
contradicted risk factors and warnings in OmniSky's IPO
Prospectus and SEC 10-Q report. (Id. at 10-11).
The State Court also ruled that NM IQ unreasonably relied on
the alleged misrepresentations concerning the $20 million Verizon
investment because the Wall Street analysts had reported that
OmniSky required more than $20 million of additional capital for
2001. (Id. at 11). Finally, the court dismissed the mutual
mistake claim. (Id. at 12).
At a June 5, 2003 hearing, the State Court granted leave for NM
IQ to file an Amended Complaint (Tarnofsky Affid., Exh. R at
26-31). The court permitted NM IQ to allege standing and approved
the addition of seven NM IQ members as plaintiffs. (Id. at 8).
The court allowed allegations against OmniSky, McVeigh and
Cleeman (but not Winkler) concerning the subscriber projections,
but refused to permit allegations concerning OmniSky's ability to
fund itself or the Verizon investment. (Id. at 25, 28-29). On
June 18, 2003, Plaintiffs filed their Amended Complaint, which
again alleged claims of fraud, fraudulent inducement and mutual
mistake. (Tarnofsky Affid., Exh. T).
On March 22, 2004, the State Court granted the defendants'
motion for dismissal of the claims in the Amended Complaint for
failure to state a cause of action. NM IQ LLC v. OmniSky Corp., Index No. 605806/01 (Mar. 22, 2004) ("March 2004
Order"). The court noted that the plaintiffs received notice of
the inaccuracy of the subscriber projections prior to the closing
of the Acquisition. (Id. at 7-8). This disclosure, combined
with plaintiffs proceeding with the closing without securing
protective language in the closing agreements, negated any
assertion of reasonable reliance. (Id. at 8). The court
rejected the plaintiffs' contentions that they could not back out
of the deal because it had been announced and the plaintiffs had
already taken capital from OmniSky. (Id.). Once again, the
court dismissed the mutual mistake claim. (Id. at 7). This
March 2004 Order was marked "Final Disposition."
PROCEEDINGS IN FEDERAL COURT
On June 16, 2003, two days before filing of their Amended
Complaint in New York State Supreme Court, Plaintiffs filed their
Complaint in this Court. The Complaint alleges violations of
Section 10(b) of the 1934 Act and Rule 10b-5, Section 20(a) of
the 1934 Act, fraud, fraudulent inducement and mutual mistake.
These claims arise out of the same transactions as those giving
rise to the Initial and Amended Complaints in the state court. As
before, the claims rely on Defendants' alleged misrepresentations
and omissions concerning the $20 million Verizon commitment and
the subscriber projections. To reiterate, Plaintiffs represent
that Defendants' false representations concerning OmniSky's
ability to fund itself are not before the Court. (Pl. Mem. of Law
at 32-33). Defendants have moved for dismissal of the claims pursuant to
Fed.R.Civ.P. 12(b) (6) and 9(b). Plaintiffs have waived the
mutual mistake claim (Pl. Mem. of Law at 31 n. 15), but otherwise
oppose the motion in its entirety. It should be noted that the
State Court issued the March 2004 Order after briefing of
Defendants' motion in the instant matter was completed. In a
letter to the Court dated April 6, 2004 ("April 6 Letter"),
Defendants contended that the March order, together with the
previous State Court orders, precludes all of Plaintiffs' claims
before this Court. Plaintiffs responded in a letter dated April
15, 2004, that the Appellate Division, First Department, will
consolidate an appeal of the March 2004 Order with Plaintiffs'
other appeals pending before that court.
I. STANDARDS OF REVIEW
In deciding a motion to dismiss a complaint for failure to
state a claim on which relief can be granted pursuant to Rule
12(b) (6), the Court is obligated to view the complaint in the
light most favorable to the plaintiff. See H.J. Inc. v.
Northwestern Bell Tel. Co., 492 U.S. 229, 249, 109 S. Ct. 2893,
2906, 106 L. Ed. 2d 195, 214 (1989). The Court accepts
plaintiff's factual allegations as true, Haddle v. Garrison,
525 U.S. 121, 125, 119 S. Ct. 489, 491, 142 L. Ed. 2d 502, 508
(1998), and draws all reasonable inferences in the plaintiff's
favor. Freedom Holdings Inc. v. Spitzer, 357 F.3d 205, 216 (2d
Cir. 2004). The complaint will not be dismissed "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."
Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99, 102,
2 L.Ed. 2d 80, 84 (1957).
Rule 9(b) of the Federal Rules of Civil Procedure provides that
"[i]n all averments of fraud or mistake, the circumstances
constituting fraud or mistake shall be stated with
particularity." According to the Second Circuit, Rule 9(b)
requires that the complaint "(1) specify the statements that the
plaintiff contends were fraudulent, (2) identify the speaker, (3)
state where and when the statements were made, and (4) explain
why the statements were fraudulent." Mills v. Polar Molecular
Corp., 12 F.3d 1170, 1175 (2d Cir. 1993).
II. FRAUD STANDARDS
To state a claim for securities fraud under Section 10(b) of
the 1934 Act (15 U.S.C. § 78j(b)) and its well-known remedy
provision, Rule 10b-5, "a plaintiff must plead that the
defendant, in connection with the purchase or sale of securities,
made a materially false statement or omitted a material fact,
with scienter, and that the plaintiff's reliance on the
defendant's action caused injury to the plaintiff." Ganino v.
Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000).
Section 20(a) of the 1934 Act is a liability provision aimed at
control persons. See 15 U.S.C. § 78t(a). A plaintiff
establishes a prima facie case under Section 20(a) by showing
"(1) a primary violation by a controlled person; (2) control of the primary violator by the defendant; and (3) that the
controlling person was in some meaningful sense a culpable
participant in the primary violation." Boguslavsky v. Kaplan,
159 F.3d 715, 720 (2d Cir. 1998) (internal quotes omitted).
III. RES JUDICATA
The Second Circuit has characterized the doctrine of res
judicata as a river divided into two branches: claim preclusion
(often confusingly known as res judicata) and issue preclusion
(or collateral estoppel). Murphy v. Gallagher, 761 F.2d 878,
879 (2d Cir. 1985). A motion to dismiss pursuant to Rule 12(b)(6)
may raise res judicata challenges. Thompson v. County of
Franklin, 15 F.3d 245, 253 (2d Cir. 1994).
A. Claim Preclusion
The Full Faith and Credit Clause requires a federal court to
"give to a state-court judgment the same preclusive effect as
would be given that judgment under the law of the State in which
the judgment was rendered." Migra v. Warren City School Dist.
Bd. of Educ., 465 U.S. 75, 81, 104 S. Ct. 892, 896,
79 L. Ed. 2d 56, 61 (1984); see 28 U.S.C. § 1738. The federal court
determines the preclusive effect of the state judgment by looking
to the state's claim preclusion rules. AmBase Corp. v. City
Investing Co. Liquidating Trust, 326 F.3d 63, 72 (2d Cir. 2003).
There is no discernable difference between New York and federal
claim preclusion law. Marvel Characters, Inc. v. Simon,
310 F.3d 280, 286 (2d Cir. 2002). Under both, "the doctrine of res
judicata, or claim preclusion, provides that [a] final judgment on the merits of an action precludes the parties or
their privies from relitigating issues that were or could have
been raised in that action." Maharaj v. BankAmerica Corp.,
128 F.3d 94, 97 (2d Cir. 1997) (internal quotes omitted); see
O'Brien v. City of Syracuse, 54 N.Y.2d 353, 357,
429 N.E.2d 1158, 1159, 445 N.Y.S.2d 687, 688 (1981) ("[O]nce a claim is
brought to a final conclusion, all other claims arising out of
the same transaction or series of transactions are barred, even
if based upon different theories or if seeking a different
Defendants assert that claim preclusion applies to Plaintiffs'
common law fraud claims that were rejected by the State Court.
(Def. Mem. of Law at 3; Def. April 6 Letter). Plaintiffs contend
that the fraud claims are governed by federal law and thus not
precluded by the State Court dismissals. (Pl. Mem. of Law at 31
n. 15). The Court rejects Plaintiffs' argument. "Where a case
involves a common law fraud claim, state substantive law is
controlling." Pal v. Sinclair, 90 F. Supp. 2d 393, 397
(S.D.N.Y. 2000) (citations omitted); see Texas Indus., Inc. v.
Radcliff Materials, Inc., 451 U.S. 630, 640, 101 S. Ct. 2061,
2067, 68 L. Ed. 2d 500, 509 (1981) (holding that "federal common
law" governs only in "few and restricted" instances). New York
law, not federal law, applies to Plaintiffs' common law
fraudulent and fraudulent inducement claims.
Plaintiffs do not challenge the existence of privity between NM
IQ in the Initial Complaint and the seven additional plaintiffs
added to the Amended Complaint and the federal Complaint. These additional plaintiffs were NM IQ members with
the same interests throughout the litigation, even though they
were not named in the Initial Complaint. See Melwani v. Jain,
No. 02 Civ. 1224, 2004 WL 1900356 (S.D.N.Y. Aug. 24, 2004). The
only issue, therefore, is whether the New York dismissals for
failure to state a claim were final judgments on the merits. The
March 2004 Order is marked "Final Disposition."*fn1 Although
none of the orders contain the precise words "on the merits," the
New York Court of Appeals has held that "it suffices that it
appears from the judgment that the dismissal was on the
merits." Strange v. Montefiore Hosp. & Med. Ctr.,
59 N.Y.2d 737, 739, 450 N.E.2d 235, 236, 463 N.Y.S.2d 429, 430 (1983)
(emphasis added). The State Court decided that Plaintiffs could
not plead a necessary element of their claims because they
unreasonably relied on OmniSky's projections concerning its
ability to fund itself (January 2003 Order), the Verizon
investment (January 2003 Order) and the subscriber projections
(March 2004 Order). These dismissals were clearly on the merits.
A fair reading of both state complaints demonstrates that the
allegations therein sought to comply with the heightened fraud
pleading requirements of New York CPLR 3016(b), which is New
York's version of Rule 9(b). While the State Court did not
specifically address New York CPLR 3016(b), the court's overall rulings pointed out that the fraud allegations in the state
complaints were insufficient. The common law fraud allegations in
the federal Complaint are the same. Plaintiffs do not make an
argument that application of Rule 9(b) requires a different
result in federal court. Claim preclusion therefore applies
relative to Rule 9(b).
In summary, the Court finds that Plaintiffs' common law fraud
and fraudulent inducement claims are precluded under New York
law. Plaintiffs' third and fourth causes of action are dismissed.
As Plaintiffs have waived their mutual mistake claim (Pl. Mem. of
Law at 31 n. 15), their fifth cause of action is dismissed as
B. Issue Preclusion
Plaintiffs' first and second causes of action allege violations
of Sections 10(b) and 20(a) of the 1934 Act, respectively. These
claims must navigate the other branch of the River res
judicata: issue preclusion. This doctrine "refers to the
preclusive effect of a judgment that prevents a party from
litigating a second time an issue of fact or law that has once
been decided." Murphy v. Gallagher, 761 F.2d 878, 879 (2d Cir.
1985). As in the case of claim preclusion, the federal court must
accord full faith and credit to state court decisions by looking
to the state's issue preclusion rules. Town of Deerfield, N.Y.
v. FCC, 992 F.2d 420, 429 (2d Cir. 1993).
Under New York law, issue preclusion applies "if the issue in
the second action is identical to an issue which was raised, necessarily decided and material in the first action, and
the [party opposing preclusion] had a full and fair opportunity
to litigate the issue in the earlier action." Parker v. Blauvelt
Volunteer Fire Co., 93 N.Y.2d 343, 349, 712 N.E.2d 647, 651,
690 N.Y.S.2d 478, 482 (1999). The proponent of issue preclusion has
the burden of demonstrating the identity and decisiveness of the
issue, while the opponent must establish the absence of a full
and fair opportunity to litigate that issue in the prior
The Second Circuit has taken the following position concerning
the identity of issues involved in federal and common law fraud
Although federal courts have developed legal
principles that govern the application of § 10(b) and
Rule 10b-5, the components of securities fraud cases
such as intent, scienter, fraud, deceit involve
issues regularly adjudicated in the state courts.
Issue preclusion is fully applicable when a party has
litigated these narrow issues in a state court, and
later attempts to re-litigate them in a federal
court. There generally will be a fairly precise
overlap between the state and federal claims when the
focus is on these narrow issues. This is a strong
reason for giving a state-court decision full
preclusive effect as [28 U.S.C.] § 1738 requires. New
York judges regularly deal with these issues in the
context of corporate and securities law cases in a
competent and experienced fashion.
Murphy, 761 F.2d at 885. The Murphy Court further held that
state issue preclusion rules apply, "even though use of that
doctrine disposes of the entire federal action." Id. at 886.
Defendants contend that the State Court's rejection of
Plaintiffs' allegations concerning OmniSky's ability to fund itself and the Verizon investment precludes Plaintiffs from
litigating these same issues before this Court. (Def. Mem. of Law
at 17). Needless to say, the State Court's rejection of the
subscriber projection allegations, after briefing of the instant
motion, is swept into this contention. (See Def. Ltr. to Court,
dated Apr. 6, 2004). Defendants clear the identity of issues
hurdle. The issues before the State Court involved the
reasonableness of Plaintiffs' reliance on alleged
misrepresentations concerning OmniSky's ability to fund itself,
the Verizon investment and the subscriber projections. According
to Plaintiffs, the allegations involving OmniSky's ability to
fund itself are not before this Court. (Pl. Mem. of Law at
32-33). The allegations concerning Verizon and the subscriber
projections have not changed in the federal action despite
assertion of the 1934 Act claims.
The next question is whether the Verizon and subscriber
projection issues were necessary and materially decided in the
state action. There is no issue concerning the subscriber
projections, which were the exclusive focus of the March 2004
Order. In contrast, the January 2004 Order granted Defendants'
motion to dismiss on the basis of lack of standing and failure
to state a cause of action. (Tarnofksy Affd., Exh. P at 6).
Despite the State Court's explicit finding of unreasonable
reliance on the Verizon representations, this Order alone might
not be enough for issue preclusion. It could be argued despite
Plaintiffs' failure to do so that the State Court's reliance determination was not necessary and material to the
January 2003 Order. Nevertheless, the State Court refused to
permit repleading of the Verizon allegations at the June 5, 2003
hearing despite allowing Plaintiffs to remedy the standing
problem. This decision makes clear that the necessary and
material component of the Verizon portion of the January 2003
Order was reliance, not standing.
One issue involving the June hearing requires further
discussion. At the hearing, the State Court refused to allow
further allegations concerning the Verizon investment because, in
the court's words, "I already struck that." (Tarnofsky Affd.,
Exh. R at 28). Earlier, however, the court had referred to the
Verizon statements as "a representation of something in the
future." (Id. at 25). This statement contradicts the January
2003 Order, which referred to the Verizon statement as "[t]he
only alleged misrepresentation involving an existing fact."
(Id., Exh. P at 9). Plaintiffs urge that this ambiguity defeats
issue preclusion because it is impossible to know the basis of
the State Court's rejection of the Verizon allegations. (Pl. Mem.
of Law at 34). Defendants respond that the rejection was on
reliance grounds, and the Court refused to permit repleading
because the allegation had already been struck. (Def. Rep. Mem.
of Law at 3-4).
The Court finds no uncertainty in the basis for the State
Court's January 2003 rejection of the Verizon allegations. This
Order clearly identified these allegations as involving existing facts (Tarnofsky Affd., Exh. P at 9), and Plaintiffs
themselves concede that their Complaint "underscores the
statements' present fact character." (Pl. Mem. of Law at 34;
see Cmplt. ¶ 26(b); Initial Complaint (Tarnofsky Affd., Exh. O)
¶ 14(b)). Despite the characterization of the Verizon statements
as future representations at the hearing, the State Court
Counsel, this is what I am saying. I don't see that,
I know with your amendment here, I don't see anything
different about what your [sic] pleading here about
Verizon. I mean it's the same.
(Tarnofsky Affd., Exh. R at 25). As with claim preclusion, a
dismissal for failure to state a claim gives rise to issue
preclusion when the subsequent complaint is "virtually identical"
to the first. Siegel, New York Practice § 462 (3d ed. 1999);
see McKinney v. City of New York, 78 A.D.2d 884, 886,
433 N.Y.S.2d 193, 196 (2d Dep't 1980). The State Court informed
counsel that its allegations concerning Verizon had not changed
from the Initial Complaint. Therefore, the State Court refused to
allow the same allegations in the Amended Complaint. Plaintiffs'
federal Complaint has not cured the deficiencies with respect to
Verizon. This Court therefore finds that the misstatement in the
June 2003 hearing does not detract from the finding that the
State Court's reliance determination, and not the standing
problem, was the necessary and material reason that the court
rejected the Verizon allegations in the January 2003 Order. None of Plaintiffs' other arguments establish the absence of a
full and fair opportunity to litigate the Verizon and subscriber
projection issues. First, Plaintiffs contend that Defendants'
issue preclusion arguments address claims that Plaintiffs do not
pursue in this Court. (Pl. Mem. of Law at 32). The Court rejects
this argument at the outset. The only difference in claims here
involves the two 1934 Act claims, and the issues giving rise to
these claims are the same. Second, Plaintiffs argue that the
State Court's determination of unreasonable reliance on the
Verizon statements was really a "materiality" finding, and state
and federal law on materiality greatly differ. (Id. at 35-36).
Third, to the extent that the State Court believed that the
Verizon statements were future representations, Plaintiffs argue
that federal and state standards of scienter are different.
(Id. at 37-38). Fourth, Plaintiffs argue that the State Court's
analysis of OmniSky's prospectus and SEC filing failed to
consider limitations on the Private Securities Litigation Reform
Act (PSLRA) "safe harbor" and the related "bespeaks caution"
doctrine. (Id. at 38-41).
The Court rejects Plaintiffs' contention that the State Court
made a "reliance" ruling based on what the federal courts call
"materiality." Materiality" and "reliance" are separate and
distinct elements of fraud claims. See Ganino v. Citizens
Util. Co., 288 F.3d 154, 161 (2d Cir. 2000). The State Court
made explicit findings in both the January 2003 and March 2004
Orders that Plaintiffs unreasonably relied on Defendants' representations. Despite Plaintiffs' argument, the reliance
standards are similar for 1934 Act and common law securities
fraud claims. In fact, federal courts have assessed the reliance
element for both in the same analysis. See Harsco Corp. v.
Segui, 91 F.3d 337, 342-46 (2d Cir. 1996); Pail v. Precise
Imps. Corp., No. 99 Civ. 1624 (DLC), 1999 WL 681384 at *2
(S.D.N.Y. Aug. 31, 1999). If Plaintiffs believe that the State
Court erroneously mixed reliance and materiality, they must
obtain relief from the New York Appellate Division, not this
Plaintiffs also contend that federal standards, particularly
with respect to materiality and scienter, are so different from
state standards that preclusion is inappropriate. But Plaintiffs
fail to demonstrate how the standards are different. As before,
there is precedent to support the opposite conclusion. See State
v. Rachmani Corp., 71 N.Y.2d 718, 727, 525 N.E.2d 704, 709, 709,
530 N.Y.S.2d 58, 63 (1988) (adopting federal materiality standard
to decide fraud claim under New York law); 2 Fifth Ave Tenants
Ass'n v. Abrams, 183 A.D.2d 577, 578, 583 N.Y.S.2d 466, 467 (1st
Dep't 1992) (following Rachmani). Plaintiffs' only support for
differing scienter standards is its contention that the State
Court's January 2003 Order required "actual knowledge" instead of
recklessness. Plaintiffs are correct that the element of scienter
may be satisfied by allegations of facts constituting strong
circumstantial evidence of recklessness. See Rombach v.
Chang, 355 F.3d 164, 176 (2d Cir. 2004). The State Court's
dismissal, however, was based on the reliance element, not scienter. Plaintiffs' belief that the
State Court incorrectly applied a particular standard does
require the conclusion that federal and state fraud standards are
so different that preclusion is inappropriate. This argument
flies in the face of the Second Circuit's Murphy holding.
Finally, Plaintiffs argue that application of the PSLRA safe
harbor and "bespeaks caution" doctrine to the Verizon statements
and subscriber projections compels a result different from that
reached by the State Court. The Second Circuit has recently held,
in accordance with its sister circuits, that the "bespeaks
caution" doctrine applies only to forward-looking
representations, not to the misrepresentation of present or
historical facts. P. Stolz Family P'ship L.P. v. Daum,
355 F.3d 92, 96-97 (2d Cir. 2004). The PSLRA safe harbor, by its terms,
also applies solely to forward-looking statements.
15 U.S.C. § 78u-5(a), (c). The State Court determined, in accordance with
Plaintiffs' Initial Complaint, that the Verizon representations
involved an existing fact. (January 2003 Order, Tarnofsky Affd.,
Exh. P at 9). The court made the same finding with respect to the
subscriber projections during the June 5, 2003 hearing.
(Tarnofsky Affd., Exh. R at 28-29). The safe harbor and "bespeaks
caution" doctrine therefore do not apply to the alleged
misrepresentations involving the Verizon investment or subscriber
Plaintiffs make a last attempt to save the claims against
Winkler by arguing that the State Court predicated its dismissal against him on an "actual knowledge" standard, which is
different from the standard of control person liability pursuant
to Section 20(a) of the 1934 Act. (Pl. Mem. of Law at 41-42).
This argument is unavailing. A prerequisite of a Section 20(a)
claim is a primary violation by the control person. If Plaintiffs
are precluded from alleging their Section 10(b) and Rule 10b-5
claim against Winkler, they have no Section 20(a) claim.
The State Court did not allow Plaintiffs to assert
subscriber-related claims against Winkler in the Amended
Complaint. Nevertheless, it is well-settled under New York law
that a non-party to a prior action may assert issue preclusion in
a subsequent action. See B.R. DeWitt, Inc. v. Hall,
19 N.Y.2d 141, 147, 225 N.E.2d 195, 198, 278 N.Y.S.2d 596, 601 (1967)
(declaring the doctrine of mutuality of estoppel a "dead
letter"). Plaintiffs have made no showing that they lacked the
full and fair opportunity to litigate the issue of their
reasonable reliance on the subscriber projections. Given that
Plaintiffs' allegations concerning the projections have not
changed from the state complaints to the federal Complaint, the
State Court's dismissal precludes assertion of the subscriber
projection issue with respect to all three federal defendants.
In light of the foregoing, the Court finds that Plaintiffs'
1934 Act claims involve the identical issues that were
necessarily decided in state court. The Court also finds that
Plaintiffs have not demonstrated the lack of a full and fair opportunity to litigate those issues in the state forum. The
doctrine of issue preclusion applies, leaving Plaintiffs unable
to establish reliance, an essential element of their Section
10(b) and Rule 10b-5 claim. Preclusion also means that Plaintiffs
cannot establish the underlying violation necessary to sustain a
Section 20(a) claim against Defendants as control persons. See
Marcus v. Frome, 275 F. Supp. 2d 496, 503 (S.D.N.Y. 2003).
Plaintiffs' first and second causes of action are therefore
IV. LEAVE TO REPLEAD
The Federal Rules mandate that leave to amend a pleading be
"freely given when justice so requires." Fed.R.Civ.P. 15(a).
Nevertheless, the Court may deny leave to amend on grounds of
futility. Ellis v. Chao, 336 F.3d 114, 127 (2d Cir. 2003).
Plaintiffs have filed three complaints arising out of the
OmniSky-Nomad acquisition. All three have been dismissed at the
pleading stage. The Court determines that a fourth bite at the
apple would be a waste of judicial resources. Leave to replead is
For the foregoing reasons, Defendants' motion to dismiss
Plaintiffs' claims is granted with prejudice. The Court orders
the case closed and removed from the active docket.