The opinion of the court was delivered by: SIDNEY STEIN, District Judge
This suit arises from a dot com deal turned sour. Plaintiffs
sold their communications software company VCOM.COM to an
internet utility provider Utility.com and received most of
the consideration for their VCOM.COM shares in the form of
Utility.com shares. Within seven months of acquiring VCOM.COM,
Utility.com was liquidated, rendering its stock essentially
worthless. Plaintiffs claim they were fraudulently lured into the
transaction and seek damages for alleged violations of Sections
10(b), 15 U.S.C. § 78j(b), and 20(a), 15 U.S.C. § 77o, of the
Securities Exchange Act of 1934 and Rule 10b-5,
17 C.F.R. § 240.10b-5, promulgated under Section 10(b). Plaintiffs also
assert state law claims for fraud, fraudulent inducement, and
negligent misrepresentation. Defendants now move to dismiss the
complaint pursuant to Fed.R.Civ.P. 12(b)(6) for failure to
state a claim and failure to plead fraud with sufficient
particularity, as Fed.R.Civ.P. 9(b) and the Private Securities
Litigation Reform Act of 1995 ("PSLRA"), Pub.L. No. 104-67, 109
Stat. 737 (codified in pertinent part at 15 U.S.C. § 78u-4),
require. Because plaintiffs have failed to plead their securities fraud claims with the requisite particularity,
defendants' motions to dismiss the complaint are granted.
The relevant facts set forth in the First Amended Complaint
("FAC") are recounted below.
Before the transaction at issue in this action, plaintiffs
Steven Dresner and Robert Stark were the principle shareholders
of VCOM.COM ("VCOM"), a telecommunications software company that
was unprofitable, but "actively engaged in obtaining additional
financing for its operations." (FAC ¶¶ 1-2, 21, 22). Both
plaintiffs have studied business, and have an extensive practical
business background. (See Information Statement dated August 3,
2000 ("IS") at 22). During the process of negotiating and
effectuating the merger at issue in this litigation, the law firm
Paul, Hastings, Janofsky and Walker represented plaintiffs. (FAC
¶ 33; IS at 52).
Utility.com sold utility services, such as electricity, via the
Internet. (FAC ¶ 23). Prior to acquiring VCOM, Utility.com posted
substantial losses, but had secured over $30 million in private
equity investment. (Id. ¶ 25). At the time of the merger,
Utility.com anticipated obtaining another $22 million in what it
dubbed its "Series E financing," which closed in November of
2000, within a few months of the August 25 closing of the VCOM
acquisition. (Id. ¶¶ 2, 25). In March of 2001, within five
months of the completion of the Series E financing and seven
months of the closing of the VCOM acquisition, Utility.com was
being liquidated. (Id. ¶¶ 71-74).*fn1
3. idealab! Defendants Defendant William Gross was the co-founder of Utility.com and
served as chairman of the company. (Id. ¶¶ 6, 17). Defendant
Gross also co-founded idealab!, an incubator for internet
start-up companies. (Id. ¶¶ 6, 18). Allegedly, Gross controlled
idealab! and idealab! controlled Utility.com. (Id. ¶ 17(a)).
Defendant Clearstone Venture Partners, formerly known as
idealab! Capital Partners, is the venture capital arm of
idealab!. (Id. ¶ 17(b)). Gross co-founded Clearstone and
allegedly controlled it at the time of the merger at issue in
this litigation. (Id.). Gross and Clearstone Venture Partners
are referred to as the "idealab! Defendants."
Defendant Primedia Ventures Inc. ("Primedia") is the venture
capital affiliate of Primedia, Inc., a media company that owns
and operates websites. (Id. ¶ 18). Primedia owned approximately
5% of Utility.com. (Id.). Defendant Larry Phillips was a
managing director of Primedia before the merger. (Id.). In his
capacity as a member of Utility.com's Board of Directors,
Phillips on behalf of Primedia allegedly exercised
significant control over Utility.com.
Among the defendants are three former officers of Utility.com
who are referred to collectively as the "Insider Defendants."
They are Chris King, Co-Founder, Chief Executive Officer, and a
director of Utility.com; Paul Falchi, President and Chief
Operating Officer of Utility.com; and Timothy Morris, Chief
Financial Officer of Utility.com.*fn2 All defendants other
than the Insider Defendants are collectively referred to as the
"Non Insider Defendants."
Plaintiffs have also brought their claims against several
directors of Utility.com who are not alleged to have been
corporate officers. These defendants are Howard Morgan, Chairman
of the Board of Directors of Utility.com and Vice Chairman of idealab!; Joel
Hayatt, a director of Utility.com and Managing Director of
idealab's Silicon Valley office; Larry Phillips, a director of
Utility.com and a Managing Director of Primedia; and Todd
Springer, a director of Utility.com and Managing Director of
Trident Capital Partners, a venture capital firm that owned 11.4%
of Utility.com stock.*fn3 (Id. ¶¶ 19(a)-(i)). These
defendants and the "Insider Defendants" are collectively referred
to as the "Individual Defendants."
The idealab! defendants, Primedia and the Individual Defendants
(collectively, "the Moving Defendants") have all moved to dismiss
the complaint for failure to state a claim and for failure to
comply with the pleading particularity requirements of
Fed.R.Civ.P. 9(b) and the PSLRA, 15 U.S.C. § 78u-4.
B. The Alleged Misrepresentations and Omissions
Plaintiffs allege that in early 2000, Gross and the other
venture capitalists who had provided funding to Utility.com "were
anxious to cash out" through an initial public offering ("IPO").
(Id. ¶ 4). To do that successfully, they had to create the
appearance that Utility.com was expanding and diversifying into
new markets, such as telecommunications. (Id.). Around that
time, plaintiffs were negotiating for Series E financing to
sustain their money-losing operations until the contemplated IPO.
(Id. ¶ 6). Plaintiffs made representations to potential Series
E investors regarding VCOM. (Id.). In furtherance of the
objectives of securing the Series E financing and "cashing out"
at the IPO, defendants began negotiating with plaintiffs in
February of 2000. (Id. ¶¶ 6-7). In April, the parties signed a
mutual non-disclosure agreement. (Id. ¶ 31). In April, May and
June, plaintiffs engaged in discussions and had a series of
meetings with various defendants. (Id. ¶¶ 31-42). On May 30,
2000 after extensive negotiations, the parties executed a term sheet
and began due diligence. (Id. ¶ 36). On June 30, the parties
signed their Agreement and Plan of Reorganization ("Merger
Agreement" or "MA"). The transaction closed on August 25, 2000,
when Utility.com acquired VCOM for 2,362,794 shares of
Utility.com common stock, as well as $500,000 in cash. (Id. ¶
2). Plaintiffs claim that a series of misrepresentations made by
defendants in the Merger Agreement, as well as in statements made
before and after the Merger Agreement was signed, rise to the
level of fraud under the securities laws.
Plaintiffs have set forth the following specific incidents in
which fraudulent misrepresentations were allegedly made to
plaintiffs in advance of the Merger Agreement:
On April 13, 2000, in Emeryville, CA, plaintiffs
met with Falchi, King, Morris and Andersen, who
allegedly "made numerous positive representations
regarding the financial condition of Utility.com, the
strength of its operations and organization, its
ability to integrate VCOM and the early success the
Company was having with UtilityOne[, Utility.com's
software platform]." (Id. ¶ 32).
On April 17, 2000, plaintiffs met with Morris and
Phillips at the New York City offices of plaintiffs'
counsel, Paul Hastings. At that meeting Morris and
Phillips allegedly made representations about the
positive financial condition of Utility.com and its
ability to integrate VCOM into Utility.com. Phillips
also allegedly represented that his business
relationship with Primedia and idealab! would benefit
the combined company, and that he was interested in
investing in VCOM. (Id. ¶ 33). On May 16, 2000, plaintiffs met with Chris King in
Newark, New Jersey. Plaintiffs claim that King made
"numerous positive statements regarding Utility.com's
technology, financial condition and operations and
the experience of Utility.com's management." (Id. ¶
On May 23, 2000, in New York City, plaintiffs met
with Tim Morris "to discuss the organizational
structure of the combined company, compensation for
VCOM management, Utility.com's financial stability
and its fund raising efforts." (Id. ¶ 35).
During the week of June 5, 2000, plaintiffs met
several times with Andersen Consulting
representatives in the Utility.com offices in
Emeryville, CA. The consultants "repeatedly assured
plaintiffs that UtilityOne was operating effectively
and could continue to serve Utility.com's customers."
(Id. ¶ 37).
Plaintiffs claim that each of these representations was made with
the purpose of inducing plaintiffs to sell their VCOM stock, and
that each was materially false and misleading. Specifically,
plaintiffs contend that defendants obscured the following adverse
facts about Utility.com. First, Utility.com allegedly suffered
from significant business problems, including an absence of
capable managers, an unsuccessful business plan and the need to
spend excessively to attract new clients. (Id ¶ 10). Second,
UtilityOne, Utility.com's "core technology and platform for
conducting its business" allegedly did not function adequately
and suffered from bugs and glitches. (Id.). According to
plaintiffs, the system could not bill customers properly and
caused "persistent customer service problems." (Id.). Third, as
a result of its ineffective billing, Utility.com allegedly had
uncollectible accounts of more than $1 million. (Id.). Fourth,
Utility.com allegedly had an undisclosed liability stemming from
its pledge to provide discounted power to residents of the state
of Pennsylvania for twelve months. (Id.) Fifth, Utility.com
allegedly intended to shut down VCOM's New York offices after the
2. The Merger Agreement and the Information Statement On June 30, 2000 the parties signed the Merger Agreement,
which, according to plaintiffs, contained numerous false and
misleading statements. (Id. ¶ 38). The agreement provided that
Utility.com had no undisclosed liabilities and that subsequent to
its then-existing balance sheet, there had been no changes
expected to have an adverse effect on the company, no undisclosed
capital expenditure exceeding $10,000 and no revaluation of any
of the company's assets. (Id. ¶ 44(a)).
The Merger Agreement included a clause stating that other
documents provided to the plaintiffs in connection with the
Merger Agreement, which included the Information Statement, did
not contain any untrue statements. (Id. ¶ 46). Plaintiffs
maintain that this statement was misleading, because the
Information Statement did contain misrepresentations and
omissions. (Id.). Specifically, the Information Statement
characterized Utility.com's business in positive terms, expressed
the company's intentions to expand in the future, extolled the
company's "superior customer service" and referred to the
company's list of financial sponsors. (Id. ¶¶ 47-53). The
Information Statement praised UtilityOne, commenting that the
software delivered "superior e-commerce functionality" and that
it "is scalable to 25 million customers." (Id. ¶¶ 55-57). The
Information Statement also contained financial statements that
PriceWaterhouseCoopers ("PWC") prepared, which plaintiffs allege,
violated Generally Accepted Accounting Principles ("GAAP") by
failing to disclose contingent liabilities stemming from
Utility.com's commitment to provide discounted electricity to
Pennsylvania residents and Utility.com's inability to collect
accounts receivable. (Id. ¶¶ 60-64). In addition, the
Information Statement allegedly failed to disclose plans to close
the New York office of VCOM when discussing the integration of
the companies. (Id. ¶ 59).
Plaintiffs urge that the multitude of warnings contained in the
risk disclosures of the Information Statement violated securities
laws by representing as contingent eventualities certain events
that had already transpired. The warnings included that if
customers did not accept the Utility.com business model, "Utility.com's business results of
operations and financial condition will be materially and
adversely affected." (Id. ¶ 65). Utility.com cautioned that it
believed the success of the business depended on its ability to
develop technology and that if it failed to do so, the business
would be harmed. (Id.). Specifically, Utility.com stated that
"[a]lthough Utility.com has not suffered significant harm from
any errors or defects [in its software] to date, Utility.com may
discover significant errors or defects in the future that it may
or may not be able to correct." (Id.). Utility.com also
conveyed that it could not guarantee its ability to meet
financial projections in the Information Statement. (Id.).
According to plaintiffs, these cautionary statements were false,
because they warned of problems that had already materialized.
(Id. ¶ 65(a)).
Plaintiffs claim that the statements in the Merger Agreement
and Information Statement (the "Merger Documents") were
misleading, because they failed to disclose the following alleged
facts: the true state of the business, including poor management,
an inability to implement the business plan and excessive outlays
to obtain clients; the expenditure of over $4 million to Imagitas
for advertising; software and customer service problems stemming
from glitches in UtilityOne software; an intention to close
VCOM's New York office; a contingent liability in connection with
a pledge to the State of Pennsylvania to provide discounted power
to its residents; and the existence of substantial uncollectible
accounts. (Id. ¶ 45). Each of these categories is discussed
Plaintiffs claim that at the time of the Merger Documents,
defendants already knew that Utility.com could not provide
services to its customers in a cost-effective manner, that its
business model was failing, that it lacked a sufficiently
skillful managerial team to implement its business plan and that
it had no possibility of meeting its financial projections.
(Id. ¶¶ 45 (d), 65(b), (c), (h), 54(d), (g)). Plaintiffs allege
that although the Information Statement contained risk
disclosures addressing each of these financial difficulties as potential challenges, it
should have disclosed them as existing problems. (Id. ¶¶
The Merger Documents allegedly omitted "numerous capital
expenditures that exceeded $10,000 including but not limited to a
$4,075,000 payment to Imagitas for advertisements in National
Mover's Guide[.]" (Id. ¶ 45(g)).
c. Alleged Software and Customer Service Problems
Plaintiffs allege that the Merger Documents failed to convey
the problems Utility.com had been experiencing with UtilityOne,
the software "[a]t the center of Utility.com's business." (Id.
¶¶ 26, 45(a), 54(a), 55-58). Although Utility.com represented
that the software was effective, functional and "scalable to 25
million customers," it was, in actuality, according to
plaintiffs, "an unmitigated disaster." (Id.). UtilityOne
depended on its billing engine, 2.0 Billing Engine, which was
allegedly "inoperable at all times it was in use." (Id. ¶ 27).
On November 3, 1999, approximately eight months before the
merger, Michael Anderson allegedly received a memorandum
informing him that the 2.0 Billing Engine was inoperable.
(Id.). Moreover, plaintiffs allege that a former Utility.com
employee who left the company in January of 2000, reported that
the 2.0 Billing Engine was not functional as of January of 2000,
and that as a result the company was unable to process customers
in a particular market, San Diego California. (Id.).
At some point "[s]hortly after January 2000," Utility.com
attempted to improve UtilityOne by switching to a new billing
engine using software from providers including Portal and Vitria
("the Portal billing engine"). (Id. ¶ 28). Plaintiffs allege a
series of problems with the Portal billing engine:
The billing problems created by Portal were as
follows: (i) bills were not being sent to customers.
According to a former employee of the Company, who
was employed at the Company since its inception,
several Utility.com executives, including Chris King
and Tim Morris were customers of Utility.com but were
not receiving bills; (ii) the billing engine was not able to do "time of use"
billing; (iii) the billing engine could not handle
"balanced billing" where a customer pays a budgeted
amount and then at the end of the term there is a
"true-up" where budget payments are compared to
actual usage and the difference is either paid by the
customer or refunded to the customer; (iv) the
billing engine could not produce an accurate bill;
and (v) UtilityOne did not have the ability to
service commercial customers.
(Id. ¶ 29). Although plaintiffs claim that a former employee
stated broadly that "the UtilityOne platform `never worked?'"
(Id. ¶ 28), they do not designate any time frame for the
alleged problems with the Portal billing engine.
Plaintiffs maintain that at some point billing glitches in
UtilityOne led to customer service problems. (Id. ¶¶ 45(b),
54(b)). Specifically, thousands of customers were allegedly
emailing complaints that did not receive responses for months.
(Id. ¶ 30). Plaintiffs specify neither when these problems
occurred nor whether they were caused by the 2.0 Billing Engine
or the Portal billing engine. They do acknowledge, however, that
at some point ...