United States District Court, S.D. New York
May 18, 2005.
STEVEN DRESNER and ROBERT STARK, Plaintiffs,
UTILITY.COM, INC., CLEARSTONE VENTURE PARTNERS, WILLIAM T. GROSS, PRIMEDIA VENTURES, INC. HOWARD MORGAN, CHRIS KING, PAUL FALCHI, MICHAEL ANDERSON, TIMOTHY MORRIS, ELLA CONRAD, JOEL HAYATT, LARRY PHILLPS and TODD SPRINGER, Defendants.
The opinion of the court was delivered by: SIDNEY STEIN, District Judge
OPINION & ORDER
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.
A. The Parties
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."
4. Primedia 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.
5. Individual Defendants
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.
1. Pre-Merger Agreement
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
a. Financial Condition
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. ¶¶
b. Imagitas Expenditure
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 after these problems arose, "the Company had all
employees help respond to the emails to eliminate the backlog."
d. Closing the VCOM Office
The Merger Documents discussed the substantial efforts that
would be required to integrate Utility.com and VCOM successfully.
It noted potential problems that might arise due to the
geographic separation of the entities and the possibility that
certain employees might have to be terminated following the
merger. (Id. ¶ 59). Plaintiffs claim that these disclosures
misstated Utility.com's intentions, because the company had
already made plans to close VCOM's New York offices and move the
combined entity's operations to the west coast. (Id. ¶¶ 45(f),
e. Pennsylvania Liability
Plaintiffs claim that the Merger Documents fraudulently omitted
the existence of a contingent liability resulting from
Utility.com's pledge to the State of Pennsylvania that it would
provide discounted power for a period of twelve months to
residents of that state. (Id. ¶¶ 45(e), 54(e)). Plaintiffs urge that the financial statements in the Information
Statement, which were prepared by PriceWaterhouseCoopers, should
have reflected that contingent liability in order to comply with
GAAP. (Id. ¶ 61-63).
f. Uncollectible Accounts
The Merger Documents allegedly failed to disclose that
Utility.com faced substantial uncollectible receivables. (Id.
¶¶ 45(c); 54(c), 66). At one point in the First Amended
Complaint, plaintiffs allege that the amount of the uncollectible
receivables was $1 million. (Id.). At another point, plaintiffs
allege that "according to a former employee of the Company, who
was employed in various positions at the Company (leaving the
Company in January 2001), including technical project manager,
there was a huge percentage of uncollectible accounts,
approximately $2 million, and the Company could not get a handle
on the extent of the problem." (Id. ¶ 30). Plaintiffs contend
that the PWC financial statements should have reflected the
amount of uncollectible accounts receivable in order to comport
with GAAP. (Id. ¶¶ 61-63).
3. Due Diligence
Plaintiffs allege that Utility.com made misrepresentations
during the period of due diligence. These alleged misstatements
and omissions were contained in a business plan, financial
projections and two press releases that Utility.com provided
Plaintiffs claim that a business plan dated October 1999 that
Utility.com provided during due diligence was misleading because
it set forth an aggressive company growth strategy, which it
would effectuate through leveraging the brand name and idealab!
connections to reduce marketing costs, capitalizing on the
company's expertise with regulatory matters, utilizing superior
web-based tools to collect data on customers and taking advantage
of cost savings inherent in the internet-only business model.
(Id. ¶¶ 39(a), (b)). Utility.com expressed an intention to
pursue a marketing plan that was "designed to acquire profitable customers rapidly at the lowest
possible acquisition cost and in a manner consistent with
building a durable national energy-Internet-utility brand."
(Id. ¶ 39 (c)).
Plaintiffs allege that at some point during due diligence,
defendants provided plaintiffs financial projections that noted
expected revenues of $27,994,560 for Utility.com's electricity
product line in fiscal year 2000. (Id. ¶ 40). During due
diligence, defendants also allegedly provided plaintiffs with two
press releases, one dated April 24, 2000 and the other dated May
17, 2000. (Id. ¶¶ 41(a), (b)). The earlier dated press release
announced Utility.com's successful completion of $30 million in
second round venture financing from leading investors. (Id. ¶
41(a)). That press release quoted defendant King, who commented
that the additional funding would allow Utility.com to continue
to expand, and defendant Springer, who praised the company's
"experienced management team, compelling value proposition and
powerful brand identity" which made Utility.com "best positioned
to become the nation's leading Internet utility provider." (Id.
¶ 41(a)). The press release dated May 17, 2000 announced that the
company had enhanced its UtilityOne platform with software from
several partners, including Portal and Vitria, and that the
overhaul would enable "UtilityOne to support millions of
customers" and to perform a series of "tasks necessary for
effective, customer-friendly e-commerce. . . ." (Id. ¶ 41(b)).
In November of 2000, a few months after the closing of the
merger, Utility.com raised approximately $22 million in a Series
E financing. (Id. ¶¶ 8, 67-69). At that time, the Utility.com's
bylaws required it to obtain plaintiffs' approval for the
issuance of the shares for the Series E financing. (Id. ¶ 8).
Utility.com originally sought and obtained plaintiffs' consent.
(Id.). Subsequently, through its counsel, Utility.com provided
plaintiffs a revised consent form and allegedly advised that
plaintiffs did not have to sign the new version, because
Utility.com could simply use plaintiffs' earlier-signed signature
pages. (Id.). Utility.com allegedly represented that the later
version of the consent form did not contain material changes, but merely
differed from the earlier version in that typographical errors
were corrected. (Id.). In reality, according to plaintiffs, the
later version contained material alterations to the purchase
price and the structure of the transaction. (Id.).
During the same month in which Utility.com obtained its Series
E financing, November of 2000, it closed VCOM's New York office.
Approximately two and a half months later, on January 25, 2001,
an administrator was installed to liquidate Utility.com's assets.
(Id. ¶ 9). The liquidators commented that the failure of
Utility.com could be attributed, at least in part, to poor
management, a non-viable business model and inaccurate financial
reporting. (Id.). The liquidators also ended up paying out
certain sums to the State of Pennsylvania because Utility.com had
guaranteed certain cost-of-power reductions to residents of that
state. (Id. ¶ 73). Plaintiffs expected that stockholders would
receive nothing from the liquidation. (Id. ¶ 9).
5. Contractual Releases Signed in Conjunction with the Merger
Section 9.5 of the Merger Agreement that Plaintiffs signed on
June 30, 2000 included a merger clause that limited the scope of
the parties' agreement. It provided:
Entire Agreement; Assignment. This Agreement, the
Schedules and Exhibits hereto, and the documents and
instruments and other agreements among the parties
hereto referenced herein: (a) constitute the entire
agreement among the parties with respect to the
subject matter hereof and supersede all prior
agreements and understandings, both written and oral,
among the parties with respect to the subject matter
hereof; (b) are not intended to confer upon any other
person any rights or remedies hereunder; and (c)
shall not be assigned by operation of law or
otherwise except as otherwise specifically provided.
(MA at 62). In addition to the merger clause contained in the Merger
Agreement, plaintiffs also signed broadly worded releases in
connection with the closing of the transaction.*fn4
the releases was a precondition for the closing. (MA at 47).
A. The Standard
1. Motion to Dismiss the Amended Complaint Pursuant to
When reviewing a motion to dismiss a complaint for failure to
state a claim for relief pursuant to Fed.R.Civ.P. 12(b)(6), a
district court may only dismiss plaintiffs' claims if "it appears
beyond doubt that the plaintiff can prove no set of facts in
support of his claim which would entitle him to relief." Drake
v. Delta Air Lines, Inc., 147 F.3d 169, 171 (2d Cir. 1998)
(quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S. Ct. 99,
2 L. Ed. 2d 80 (1957)) (quotation marks omitted). A court must
treat all factual allegations in the complaint as true and draw
all reasonable inferences in plaintiffs' favor. See Ganino v.
Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000); Lee v.
Bankers Trust Co., 166 F.3d 540 (2d Cir. 1999).
In considering this motion, the Court has reviewed the First
Amended Complaint, as well as the documents referenced
extensively therein, namely the Merger Agreement and the
Information Statement. See Rothman v. Gregor, 220 F.3d 81,
88-89 (2d Cir. 2000) (internal citations omitted).
2. Pleading Requirements of Fed.R.Civ.P. 9(b) and the
PSLRA Federal Rule of Civil Procedure 9(b) provides that "[i]n all
averments of fraud or mistake, the circumstances constituting
fraud or mistake shall be stated with particularity." Although
that rule requires that "[a]ny fraud must be pled with
particularity," it "is applied assiduously to securities fraud."
Lentell v. Merrill Lynch & Co. Inc., 396 F.3d 161, 168 (2d Cir.
2005). The U.S. Court of Appeals for the Second Circuit
interprets Rule 9(b) to require that "[t]he complaint . . .
identify the statements plaintiff asserts were fraudulent and
why, in plaintiff's view they were fraudulent, specifying who
made them, and where and when they were made." In re Scholastic
Corp. Sec. Litig., 252 F.3d 63, 69-70 (2d Cir. 2001).
With respect to securities fraud allegations, the heightened
pleading requirements of Fed.R. of Civ. P. 9(b) "were
(essentially) codified in the Private Securities Litigation
Reform Act of 1995 [("the PSLRA")]," 15 U.S.C. § 78u-4.
Lentell, 396 F.3d at 168; see also Kalnit v. Eichler,
264 F.3d 131, 138 (2d Cir. 2001). The PSLRA mandated a uniform
national pleading standard for securities fraud actions that
mimics the standard the Second Circuit had derived from Rule
9(b), except insofar as the PSLRA requires particularity in the
pleading of the requisite mental state.*fn5 See Novak v.
Kasaks, 216 F.3d 300, 310 (2d Cir. 2000). Courts must dismiss
pleadings that fail to adhere to the requirements of the PSLRA.
See 15 U.S.C. § 78u-4(b)(3)(A); see also Novak,
216 F.3d at 307. B. Plaintiffs' Claims
Plaintiffs have brought five claims: (1) fraudulent inducement
against Utility.com and the Individual defendants; (2) violation
of Section 10(b) of the Securities and Exchange Act of 1934 (the
"Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5,
17 C.F.R. § 240.10b-5, promulgated thereunder against Utility.com and the
Individual Defendants; (3) violation of Section 20(a) of the
Exchange Act, 15 U.S.C. § 77o, against Primedia, the idealab!
Defendants and the Individual Defendants; (4) negligent
misrepresentation against Utility.com and the Individual
Defendants; and (5) common law fraud against Utility.com and the
Individual Defendants. This analysis begins with the causes of
action brought pursuant to federal securities law.
C. Section 29 Prohibits Broad Releases of Non-Matured Claims
Defendants contend that they are insulated from liability by
virtue of the sweeping release that each plaintiff signed in
connection with the merger closing. Plaintiffs maintain that the
releases are not legally enforceable waivers of securities fraud
claims. Indeed, "[i]t is well settled that parties cannot use
contractual limitation of liability clauses to shield themselves
from liability for their own fraudulent conduct." Turkish v.
Kasenetz, 27 F.3d 23, 27-28 (2d Cir. 1994). In particular,
Section 29(a) of the Exchange Act, 15 U.S.C. § 78cc(a),
invalidates releases that attempt to insulate beneficiaries from
the compliance with the Exchange Act.*fn6
Courts have held that Section 29(a) does not prohibit parties
from executing valid releases in connection with securities fraud
claims that have already matured. See Korn v. Franchard Corp.,
388 F. Supp. 1326, 1328 (S.D.N.Y. 1975); Mittendorf v. J.R.
Williston & Beane Inc., 372 F. Supp. 821, 834 (S.D.N.Y. 1974).
That interpretation enables parties to reach binding settlements
to resolve existing securities fraud disputes. The releases at issue here
did not constitute a settlement of an existing dispute, but
rather purported prospectively to waive plaintiffs' rights to
pursue causes of action of which they were not yet aware. Cf.
Lancer Offshore, Inc. v. Dominion Income Mgmt. Corp., No. 01
Civ. 4860, 2002 WL 441309, at *6 (S.D.N.Y. Mar. 20, 2002)
(enforcing a release against an Exchange Act claim when the
release had been negotiated in response to a threat to sue).
Section 29(a) forbids enforcement of that type of contract to bar
Exchange Act claims. See Seymour v. Bache & Co., Inc., No 75
Civ. 3722, 1976 WL 751, at *3 (S.D.N.Y. Jan. 14, 1976); Korn,
388 F.Supp. at 1328. Therefore, the August 25, 2000 releases do
not preclude plaintiffs' claims.
D. Securities Fraud in Violation of Sections 10(b) and 20(a)
of the Exchange Act and Rule 10b-5 Promulgated Thereunder
As the releases do not bar this action, the Court turns to the
defendants' contentions that the First Amended Complaint fails to
state a claim for violation of Sections 10(b) and 20(a) of the
Exchange Act. Section 10(b) makes it unlawful to "use or employ,
in connection with the purchase or sale of any security . . . any
manipulative or deceptive device or contrivance in contravention
of such rules and regulations as the Commission may proscribe."
15 U.S.C. § 78j(b). One such rule, Rule 10b-5, prohibits
"mak[ing] an untrue statement of material fact or [omitting] to
state a material fact necessary in order to make the statements
made, in light of the circumstances under which they were made,
not misleading. . . ." 17 C.F.R. § 240.10b-5. To state a claim
pursuant to these provisions, plaintiffs 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." Lawrence v.
Cohn, 325 F.3d 141, 147 (2d Cir. 2003) (quoting Ganino v.
Citizens Utils. Co., 228 F.3d 154, 161 (2d Cir. 2000)).
Plaintiffs have also alleged that the Individual Defendants,
the idealab! Defendants and Primedia are subject to
"controlling-person liability" pursuant to Section 20(a) of the
Exchange Act, 15 U.S.C. § 77o.*fn7 (FAC ¶¶ 87-90). To allege a proper claim
for controlling-person liability, plaintiffs must allege inter
alia an underlying securities law violation by the controlled
person. See Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir.
1998); Marcus v. Frome, 275 F. Supp. 2d 496, 503 (S.D.N.Y.
2003). Thus, the Court's analysis begins with plaintiffs' claim
pursuant to Section 10(b).
Plaintiffs allege misstatements and omissions occurring: 1) in
advance of the Merger Agreement; 2) in the Merger Documents and
during the period of due diligence; and 3) after the closing of
the transaction. The alleged misstatements and omissions are
addressed below in these chronological categories.
1. Statements or Omissions In Advance of the Merger Agreement
Plaintiffs may not maintain a securities fraud claim unless
they allege that they reasonably relied on a misrepresentation or
omission. Emergent Capital Inv. Mgmt. LLC v. Stonepath Group,
Inc., 343 F.3d 189, 195 (2d Cir. 2003). Plaintiffs have alleged
that they relied, at least in part, on several statements that
defendants made in advance of the signing of the Merger
Agreement. The Merger Agreement purported to "constitute the
entire agreement among the parties with respect to the subject
matter hereof and supersede all prior agreements and
understandings, both written and oral, among the parties with
respect to the subject matter hereof[.]" (MA at 62). That term of
the Merger Agreement the merger clause in combination with
other provisions of the Merger Documents and the facts alleged in
the First Amended Complaint, render plaintiffs' reliance on
statements made before the signing of the Merger Agreement unreasonable as a matter of
law.*fn8 See Emergent Capital, 343 F.3d at 195; Harsco
Corp. v. Segui, 91 F.3d 337, 343 (2d Cir. 1996).
Plaintiffs maintain that Section 29(a) of Exchange Act,
15 U.S.C. § 77cc(a), precludes enforcement of any waiver of Exchange
Act claims, and that the merger clause is therefore invalid. The
merger clause is not, however, like the releases discussed above.
It is not a waiver of claims, but rather a limited wavier of
reliance on certain representations. In Harsco Corp. v. Segui,
the U.S. Court of Appeals for the Second Circuit held that
Section 29(a) did not proscribe enforcement of a merger clause
negotiated between sophisticated parties as part of a
comprehensive agreement. 91 F.3d at 343. The Harsco Court
distinguished Rogen v. Ilikon Corp., 361 F.2d 260 (1st Cir.
1966) in which the U.S. Court of Appeals for the First Circuit
held that a non-reliance provision contravened Section 29(a) and
was therefore invalid on the ground that the parties in Rogen
had disparate levels of sophistication. Harsco,
91 F.3d at 344-45. The Harsco Court concluded that "there is nothing in
the complaint or the Agreement that indicates that Harsco was
duped into waiving the protections of the securities laws." Id.
at 344. The Second Circuit has continued to hold that in
appropriate circumstances, sophisticated parties may waive rights
to rely on statements made outside an agreement, thereby
precluding themselves from alleging fraud on the basis of those
statements. See Emergent Capital, 343 F.3d at 196; see also
Consolidated Edison, Inc. v. Northeast Utilities,
249 F. Supp. 2d 387, 402 (S.D.N.Y. Mar 21, 2003). To determine whether
plaintiffs' reliance was reasonable in light of the merger
clause, the Court must look to "the entire context of the
transaction, including factors such as its complexity and magnitude, the sophistication of the parties and the content of
any agreements between them." Emergent Capital,
343 F.3d at 195.
The parties to this litigation are sophisticated business
people who were advised by sophisticated counsel during the
extensive negotiations that led to the merger and the period of
confirmatory due diligence. (See IS at 22, 52; MA ¶ 8.1(b)).
Plaintiffs benefited from a series of warranties and
representations that Utility.com made in the Merger Agreement.
(See MA at 30-37). Those included detailed representations
related to Utility.com's organizational and capital structure;
Utility.com's authority to enter into the transaction, its
adherence to the law and its insurance coverage; the integrity
and completeness of Utility.com's financial statements, liability
disclosures and minute books; Utility.com's valid and alienable
leasehold and intellectual property rights; and Utility.com's
lack of affiliates, material financial changes since the
then-relevant balance sheet, pending litigation, insider
transactions and broker's fees outstanding from the merger
transaction. (See id.).
In light of the clear language of the merger clause, the
sophistication of the parties, the relative parity of bargaining
power, the litany of representations and warranties contained in
the Merger Agreement, as well as the cautionary language in the
Information Statement that qualified any pre-Merger Agreement
statements, plaintiffs have failed to proffer facts suggesting it
would have been reasonable for them to rely on representations
made in advance of the Merger Agreement. In Harsco, the Second
Circuit held that the plaintiff's reliance was unreasonable
Here there is a detailed writing developed via
negotiations among sophisticated business entities
and their advisors. That writing, we conclude,
defines the boundaries of the transaction. Harsco
brings this suit principally alleging conduct that
falls outside those boundaries.
91 F.3d at 343. Similarly in the instant action, plaintiffs
negotiated a comprehensive Merger Agreement with defined
boundaries. Insofar as plaintiffs claim they were defrauded by
representations made before the signing of the Merger Agreement, they are
"alleging conduct that falls outside those boundaries" and they
cannot establish the reasonableness of their reliance. Id.
Therefore, plaintiffs' Section 10(b) claim is dismissed insofar
as it relates to representations that occurred before the signing
of the Merger Agreement.
2. Statements or Omissions in the Merger Documents and During
As noted above, to state a claim pursuant to Section 10(b), "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." Lawrence v. Cohn, 325 F.3d 141, 147 (2d Cir.
2003) (quoting Ganino v. Citizens Utils. Co., 228 F.3d 154, 161
(2d Cir. 2000)). Fed.R.Civ.P. 9(b) and the PSLRA impose
particularity requirements on Section 10(b) complaints, mandating
that they "(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." Stevelman v. Alias Research, Inc.,
174 F.3d 79, 84 (2d Cir. 1999) (citations and internal quotation marks
omitted). Plaintiffs have satisfied the first and third of these
requirements with respect to statements that defendants allegedly
made during due diligence and in the merger documents. The First
Amended Complaint identifies which statements were allegedly
misleading and the particular documents that contained them. See
In re Globalstar Sec. Litig., No. 01 Civ. 1748, 2003 WL
2295163, at * 5 (S.D.N.Y. Dec. 15, 2003). Plaintiffs have failed,
however, to satisfy the second and fourth requirements.
a. Identification of the Speaker
The second particularity requirement imposes on plaintiffs an
obligation to identify the speaker of any allegedly misleading
statement. Plaintiffs vaguely charge statements made during due
diligence and in the Merger Documents against all defendants. A
number of courts have recognized that such indiscriminate defendant "clumping" does not adhere to the
particularity standards of Fed.R.Civ.P. 9(b) and the PSLRA.
See Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir.
1993) ("Rule 9(b) is not satisfied where the complaint vaguely
attributes the alleged fraudulent statements to `defendants.'");
DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242,
1247 (2d Cir. 1987) ("[W]hen fraud is alleged against multiple
defendants, a plaintiff must set forth separately the acts
complaint of by each defendant. A complaint may not simply clump
defendants together in vague allegations to meet the pleading
requirements of Rule 9(b)."); Leemon v. Burns,
175 F. Supp. 2d 551, 556 (S.D.N.Y. 2001) ("[A] complaint alleging fraud against
multiple defendants must state the allegations specifically
attributable to each individual defendant."); Polar Int'l
Brokerage Corp. v. Reeve, 108 F. Supp. 225, 237 (S.D.N.Y. 2000)
("The Complaint does not differentiate in any way between
defendants, nor does it attempt to link any of the defendants
with the alleged fraudulent statements.").
Plaintiffs claim that they may rely on the group pleading
doctrine and attribute the statements made during due diligence
and in the Merger Documents to all defendants. Group pleading is
an exception to the requirement that plaintiffs must identify the
speaker of an allegedly fraudulent statement with particularity.
It permits plaintiffs to "rely on a presumption that statements
in prospectuses, registration statements, annual reports, press
releases, or other group-published information, are the
collective work of those individuals with direct involvement in
the everyday business of the company." In re Oxford Health
Plans, Inc., 187 F.R.D. 133, 142 (S.D.N.Y. 1999) (internal
quotation marks omitted); see also Polar Int'l Brokerage Corp.,
108 F. Supp. 2d at 237. Nevertheless, the group pleading doctrine
is "extremely limited in scope[,]" applying "only to clearly
cognizable corporate insiders with active daily roles in the
relevant companies or transactions." Polar Int'l Brokerage
Corp., 108 F. Supp. 2d at 237. The Non Insider Defendants are not presumed to have
participated in the preparation of corporate publications. See
Schnall v. Annuity and Life Re (Holdings), Ltd., 3:02 Civ. 2133,
2004 U.S. Dist. LEXIS 1601, at *11 (D. Conn. Feb. 4, 2004)
("[O]utside directors, although almost by definition excluded
from the day-to-day management of a corporation, can fall within
the group pleading presumption when, by virtue of their statues
or a special relationship with the corporation, they have access
to information more akin to a corporate insider."). Plaintiffs
offer no specific allegations that suggest that the Non Insider
Defendants took part in the preparation of the Merger Documents
or due diligence disclosures, nor that they acted like corporate
insiders. Cf. Sperber Adams Assocs. v. JEM Mgmt. Assocs. Corp.,
90 Civ. 7405, 1992 U.S. Dist. LEXIS 93101, at *5 (S.D.N.Y. June
4, 1992) (outside director who prepared and disseminated offering
materials may be considered an insider for Fed.R.Civ.P. 9(b)
particularity purposes). Instead, plaintiffs rely on conclusory,
vague allegations that the Insider Defendants exercised control
over Utility.com.*fn9 Plaintiffs' conclusory allegations are
insufficient to satisfy the requirements of Fed.R.Civ.P. 9(b)
and the PSLRA. Consequently, plaintiffs may not invoke the group
pleading doctrine against the Non Insider Defendants. See In re
Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d 741, 768
(S.D.N.Y. 2001); Polar Int'l Brokerage Corp,
108 F. Supp. 2d at 237-38. Plaintiffs have failed to plead properly that the Non
Insider Defendants participated in making alleged misstatements
and omissions during due diligence or in the Merger Documents.
b. Why the Statements Were Allegedly Fraudulent
Plaintiffs may make use of the group pleading doctrine with
respect to the Insider Defendants, who by virtue of their
positions as executives of Utility.com can be presumed to have
had active daily roles in the company. Nevertheless, the group pleading doctrine
does not save plaintiffs' claims against the Insider Defendants,
because plaintiffs have failed to satisfy the fourth
particularity requirement indicating why the statements were
fraudulent. Plaintiffs have failed to convey through specific
factual allegations that the defendants made statements or
omissions that were contemporaneously misleading. See In re
Globalstar Sec. Litig., 2003 WL 2295163, at *5; In re Revlon,
Inc. Sec. Litig., No. 99 Civ. 10192, 2001 WL 293820, at *7
(S.D.N.Y. Mar. 27, 2001) (citing San Leandro Emergency Medical
Group Profit Sharing Plan v. Philip Morris Co., Inc.,
75 F.3d 801, 812-13 (2d Cir. 1996)).
To satisfy their pleading obligations, "plaintiffs must do more
than say that . . . statements . . . were false and misleading,
they must demonstrate with specificity why and how that is so."
Rombach v. Chang, 355 F.3d 164, 174 (2d Cir. 2004). The PSLRA
requires that "the complaint shall specify each statement alleged
to have been misleading, the reason or reasons why the statement
is misleading, and, if an allegation regarding the statement or
omission is made on information and belief, the complaint shall
state with particularity all facts on which that belief is
formed." 15 U.S.C. § 78u4(b)(1). According to the Second Circuit,
that PSLRA provision requires that "where plaintiffs rely on
confidential personal sources but also on other facts, they need
not name their sources as long as the latter facts provide an
adequate basis for believing that the defendants' statements were
false." Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir. 2000).
The Merger Agreement allegedly misrepresented material facts in
reporting that Utility.com had no significant undisclosed
liabilities, had not made any capital expenditure greater than
$10,000 since the date a balance sheet was issued to plaintiffs
and did not expect any material adverse effects as defined
therein. (FAC ¶ 44). In addition, section 3.16 of the Merger
Agreement represented that "none of the representations or
warranties made by [Utility.com] . . . contains or will contain
. . . any untrue statement of a material fact, or intentionally omits or
intentionally will omit . . . any material fact . . . in order to
make the statements contained herein or therein, in light of the
circumstances under which made, not misleading. . . ." (Id. ¶
46). Plaintiffs contend that the Information Statement, which was
provided to VCOM shareholders in connection with the merger, was
materially misleading, because it described Utility.com's
financial circumstances in positive terms (id. ¶ 48), it
highlighted the company's intention to expand its business (id.
¶¶ 49, 51, 53), it represented that the company offered "superior
customer service" (id. ¶ 50) and it listed the company's
"financial sponsors" (id. ¶ 51). Plaintiffs contend that the
Merger Agreement and the incorporated Information Statement
failed to disclose problems with Utility.com's business plan,
UtilityOne software, customer service and collection of
receivables; a contingent liability resulting from an agreement
to provide discounted electrical power to residents of
Pennsylvania; the intention to close VCOM's New York office; and
the existence of a major capital expenditure of $4,075,000 for
During due diligence, Utility.com allegedly made
misrepresentations and omissions in its business plan, financial
projections and two press releases that were provided to
plaintiffs. These documents allegedly contained unrealistically
rosy projections for Utility.com's financial future and
misleading praise for UtilityOne software's
Defendants contend that the "bespeaks caution" and "safe
harbor" doctrines should protect many of their statements as
immaterial, forward-looking prognostications. However, plaintiffs
have not alleged misrepresentations in the form of faulty
predictions. Rather, plaintiffs allege that defendants'
representations were false statements of contemporary or
historical circumstances to which these doctrines do not apply. See In re Indep. Energy Holdings
PLC Sec. Litig., 154 F. Supp. 2d 741, 755 (S.D.N.Y. 2001); In
re Complete Mgmt. Inc. Sec. Litig., 153 F. Supp. 2d 316, 340
(S.D.N.Y. 2000); In re AMF Bowling Sec. Litig., No. 99 Civ.
3023, 2001 U.S. Dist. LEXIS 3182, at *16 (S.D.N.Y. Mar. 22,
2001). The Court will therefore analyze the alleged misstatements
and omissions to determine whether they constitute misleading
representations of then-existing facts. Those alleged
misstatements and omissions are addressed seriatim below in the
following topical categories: the financial condition of
Utility.com, the Imagitas expenditure, alleged software and
customer service problems, closing of the VCOM office, the
Pennsylvania liability and uncollectible accounts.
i. Financial Condition
Plaintiffs allege several material omissions or misstatements
relating to the state of Utility.com's business at the time of
the merger. Plaintiffs specifically charge that the defendants
failed to convey accurately the failure of Utility.com's business
plan, the company's excessive expenditures to secure clients and
its lack of a skilled management team. Plaintiffs further contend
that the due diligence disclosures contained unrealistic
characterizations of Utility.com's business and its likely
Plaintiffs have not pled with proper particularity that the
financial characterization of Utility.com contained in the Merger
Documents and due diligence disclosures was materially misleading
when produced. Fraud cannot be pled by hindsight and plaintiffs
have not alleged facts indicating that the statements were false
at the time they were made. See In re: Carter Wallace Sec.
Litig., 220 F.3d 36, 42 (2d Cir. 2000); Novak,
216 F.3d at 309; Stevelman v. Alias Research Inc., 174 F.3d 79, 85 (2d Cir.
Plaintiffs have failed to allege properly that the statements
relating to Utility.com's financial condition were
contemporaneously false. Although plaintiffs need not allege "the
exact date and time" when defendants became aware of information
contrary to their statements, they must "supply some factual basis for the allegation that the defendants knew or
should have known that the statements were false at some point
during the time period alleged." Rothman v. Gregor,
220 F.3d 81, 91 (2d Cir. 2000) (quotation marks and citation omitted).
Retrospective frustration at the failure to meet the projections
spelled out in the Information Statement does not support a cause
of action for securities fraud. See In re: Carter Wallace Sec.
Litig., 220 F.3d at 42. That this high-risk dot com company
failed within approximately seven months of the merger does not
supply an adequate basis to conclude that the representations in
the relevant disclosures were false.
There are no particular allegations in the First Amended
Complaint that demonstrate that at the time of the preparation of
the Merger Documents, Utility.com's management team was indeed
unskilled or that the Utility.com's business plan had already
failed. The Information Statement explicitly cautioned plaintiffs
that Utility.com was risky, currently unprofitable, and likely
not to earn a profit in the foreseeable future. (See IS at 5,
9-11, 37-39). The Information Statement warned that the
effectiveness of Utility.com's business plan had yet to be
determined and the company's success depended on a series of
variables, such as ability to retain customers and develop
effective technology. (Id. at 10-11). Moreover, the Information
Statement included extensive warnings regarding the potential
variance from projected earnings and the potential inability of
Utility.com to manage growth effectively. (Id. at 11-12;
14-15). That document also cautioned that success of the merger
depended on retaining key managers, none of whom were obligated
to stay with the company. (See Id. at 9). Plaintiffs have
failed to allege with particularity that the eventualities of
which they were warned had already occurred by the time the
Merger Documents were signed.
Plaintiffs' allegations relating to the state of Utility.com's
business are insufficiently particular to demonstrate that any
defendants misrepresented or omitted a material fact. See
Rombach, 355 F.3d at 172 (requiring plaintiffs to "state with
particularity the specific facts in support of [plaintiffs']
belief that [defendants'] statements were false when made" to satisfy
Rule 9(b) and the PSLRA) (bracketed text in Rombach);
15 U.S.C. § 78u-4(b)(1).
ii. Imagitas Expenditure
Plaintiffs allege that the Merger Agreement failed to disclose
a $4.075 million payment to Imagitas for advertisements, even
though it purported to disclose all significant capital
expenditures over $10,000 since the date of Utility.com's
then-relevant balance sheet. (FAC ¶ 44, 45(g)). Assuming
arguendo that plaintiffs are correct that advertising outlays
should be listed among capital expenditures, the Court still has
found no allegations in the First Amended Complaint as to when
this alleged expenditure was made. If the $4.075 million were not
spent after the issuance of Utility.com's then-existing balance
sheet, the representation in the Information Statement would
appear not to be misleading. Moreover, plaintiffs do not
specifically allege that the $4.075 million was not counted in
the $10.2 million that Utility.com disclosed it had spent on
advertising and marketing during the six months leading up to
June 30, 2000. (See IS at 38).
Plaintiffs have not established with sufficiently particular
allegations that any defendant misrepresented or omitted a
material fact in relation to Utility.com's expenditure of $4.075
million for advertising. See Rombach, 355 F.3d at 172;
15 U.S.C. § 78u-4(b)(1).
iii. Alleged Software and Customer Service Problems
Plaintiffs contend that in the Merger Documents and during due
diligence, defendants misrepresented the functionality of
UtilityOne, the software that constituted the technological
foundation of Utility.com. Among several laudatory
representations regarding UtilityOne, the Information Statement
provided that the software was "scalable to 25 million
customers." (Id. ¶¶ 55-57). Plaintiffs have failed to allege
with the requisite particularity that the representations
regarding UtilityOne were materially misleading when made. Plaintiffs contend that the "core" of UtilityOne, its "2.0
Billing Engine[,]" "was virtually inoperable at all times it was
in use." (FAC ¶ 27). To substantiate that claim, plaintiffs point
to a November 3, 1999 memorandum sent to Michael Anderson
indicating that the 2.0 Billing Engine was non-functioning. In
addition, plaintiffs allege that "according to a former employee
of Utility.com, who was employed at the Company until January
2000, the 2.0 Billing Engine was not functional as of January
2000 and the Company could not process customers from San Diego,
California and, as a result, were not billing customers from San
Diego." (Id. ¶ 28). The memorandum and comment of the employee
do not shed light on the state of Utility.com's software at the
time of the merger, because, at some point "[s]hortly after
January 2000," Utility.com switched to a different billing engine
driven by software from Portal and Vitria (the "Portal System").
(Id. ¶¶ 28; 41(b)). Plaintiffs proffer allegations relevant to
problems Utility.com allegedly had with the Portal System. (FAC ¶
29). These allegations are deficient because they lack a temporal
nexus to the transaction at issue. Plaintiffs never allege with
particularity that the specific problems with UtilityOne were
occurring at the time of the preparation of the Merger Documents
or any point thereafter. The only temporal reference that
potentially implicates the functionality of the software at the
time of the Merger Documents is the alleged statement by an
unnamed employee that "the UtilityOne platform `never worked.'"
(FAC ¶ 29).*fn11 This allegation does not satisfy the
particularity requirement that Rule 9(b) and the PSLRA impose
with respect to allegations of material falsity. Plaintiffs have
not demonstrated with particularized allegations why the
statements in the Merger Documents praising UtilityOne were
The Information Statement included a warning that
"Utility.com's success depends upon the proper operation of
internally developed software systems as well as third-party
products." (Id. ¶ 65). It went on to caution that "[t]his software may contain
undetected errors, defects or bugs" and that "[a]lthough
Utility.com has not suffered significant harm from any errors or
defects to date, Utility.com may discover significant errors or
defects in the future that it may or may not be able to correct."
(Id.). Plaintiffs have failed to allege with the requisite
particularity that these statements were false at the time of the
Merger Documents. It is not clear from the allegations in the
First Amended Complaint that Utility.com had suffered
"significant harm" from glitches in the Portal System.
Plaintiffs have failed to meet their particularity burden in
alleging that defendants' statements relating to UtilityOne were
false when made. See Rombach, 355 F.3d at 172;
15 U.S.C. § 78u-4(b)(1).
Plaintiffs contend that Utility.com's positive representations
regarding its "superior customer service" operation were
misleading, because, according to a former Utiltiy.com employee,
the company's technical problems led "thousands of customers" to
email complaints which went unanswered "for months." (Id. ¶¶
30, 50). However, plaintiffs never convey allegations indicating
when this problem occurred. They acknowledge that Utility.com
remedied the problem, and enlisted "all employees [to] help
respond to the emails to eliminate the backlog." (Id.). The
First Amended Complaint does not specifically allege that
Utility.com had any problems with customer service at the time of
the merger. Plaintiffs do not properly allege that the failure to
disclose the alleged historical customer service snarl was
materially misleading at the time the Merger Documents were
prepared. To the extent such customer service problems might
recur, the Information Statement specifically warned that
"inconsistent quality of service could impact the level of demand
or acceptance of internet services." (IS at 11, 15). Plaintiffs have failed to meet their particularity burden in
alleging defendants' statements relating to its customer service
operation were misleading when made. See Rombach,
355 F.3d at 172; 15 U.S.C. § 78u-4(b)(1).
iv. Closing the VCOM Office
The Information Statement was misleading, according to
plaintiffs, because it did not disclose that defendants intended
to close VCOM's office in New York. (FAC ¶ 59). The Information
Statement explicitly warned that "[t]he difficulty of the
integration [of VCOM and Utility.com] may be increased by the
geographical separation of the two companies and their employees.
For example, Utility.com may not be able to retain key executives
and employees of VCOM after the merger." (IS at 7-8). This
cautionary statement put plaintiffs on notice of the possibility
that the VCOM office could be closed. Plaintiffs maintain that
because the decision to close VCOM's office had already been
made, the disclosures in the Information Statement were false.
(Id. ¶ 59). Plaintiffs never allege with any particularity,
however, that the decision to close the New York office of VCOM
had been made before the merger.
Plaintiffs fail to allege with particularity that the
representations in the Information Statement regarding the
closure of the VCOM office were misleading when made. See
Rombach, 355 F.3d at 172; 15 U.S.C. § 78u-4(b)(1).
v. Pennsylvania Liability
Plaintiffs contend that Utility.com violated GAAP by not
disclosing a contingent liability stemming from the company's
pledge to provide Pennsylvania residents discounted power. (FAC
¶¶ 61-64). Plaintiffs fail to allege with the requisite
particularity, however, that the pledge constituted a liability
at the time the Merger Documents were prepared. There are no
particularized allegations suggesting that these obligations had
become a liability that should have been disclosed. In any event,
the Information Statement disclosed that Utility.com had offered
rebates for new customers in the past and was currently offering a 20% discount to all of its customers
on electric service. (See IS at 36). The discount guaranteed to
the Pennsylvania residents was 20%, the same amount disclosed in
the Information Statement. (FAC ¶ 73).
Plaintiffs have failed to plead with particularity that
Utility.com's financial statements were misleading for failing to
disclose its agreement to provide discounted power to residents
of Pennsylvania. See Rombach, 355 F.3d at 172;
15 U.S.C. § 78u-4(b)(1).
vi. Uncollectible Accounts
The First Amended Complaint alleges that a former employee who
had been a technical project manager claimed that the company had
approximately $2 million in uncollectible accounts. (FAC ¶ 30).
At other points in the FAC, plaintiffs claim that the amount of
uncollected receivables was $1 million. (Id. ¶¶ 10, 45(c)). These
allegations are contradictory and therefore not properly
particular. Plaintiffs provide no specific allegations regarding
what accounts or types of accounts were allegedly delinquent. The
lack of particularity is underscored by the fact that at the time
of the Merger Agreement, the total amount that Utility.com
represented as its accounts receivable was approximately $119,000
and its total revenue since its inception was $1.03 million. (IS
at 37; FAC ¶ 60). Plaintiffs fail to explain how the
uncollectible accounts figure would have been so much greater
than the company's total accounts receivable and its total
historical revenue, other than to claim vaguely that billing
problems led to Utility.com's inability to ascertain the amount
of uncollectibles. (FAC ¶¶ 10, 60). That allegation does not cure
the deficiency of particularity in these allegations. Neither
does the claim that one unnamed employee said that the company
had a "high number of uncollectible accounts" and another unnamed
employee said "there was a huge percentage of uncollectible
accounts, approximately $2 million, and the Company could not get
a handle on the extent of the problem." (Id. ¶ 30). The Information Statement explicitly admonished that
"Utility.com's failure to implement adequate collection programs
could materially affect Utility.com's business, results of
operations and financial condition." (Id. ¶ 66). The allegations
in the First Amended Complaint are not sufficiently specific to
give rise to the inference that such collection problems had
already occurred and that the warning was therefore misleading.
See Rombach, 355 F.3d at 172; 15 U.S.C. § 78u-4(b)(1).
Plaintiffs have failed to allege with particularity that the
Merger Documents or due diligence disclosures contained
materially misleading statements or omissions. As plaintiffs have
failed to allege such falsity properly, the Court must dismiss
plaintiffs' Section 10(b) claim to the extent it relates to
alleged misrepresentations and omissions made in the Merger
Documents and due diligence disclosures.
3. Statements or Omissions After the Merger
Plaintiffs contend that following the merger they were misled
into consenting to the issuance of Series E preferred shares.
(FAC ¶ 69). Plaintiffs have failed to allege that this
misrepresentation caused them any specific harm. See Dura
Pharms., Inc. v. Broudo, ___ U.S. ___, 125 S.Ct. 1627,
___ L.Ed. 2d. ___ (2005). The Second Circuit requires securities fraud
plaintiffs to allege both transaction and loss causation. See
Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172 (2d Cir.
2005). "Transaction causation is akin to reliance, and requires
only an allegation that `but for the claimed misrepresentations
or omissions, the plaintiff would not have entered into the
detrimental securities transaction.'" Id. (quoting Emergent
Capital Inv. Mgmt., LLC v. Stonepath Group, Inc., 343 F.3d 189,
197 (2d Cir. 2003)). Plaintiffs have properly alleged transaction
causation by claiming that defendants deceived them into
inadvertently approving the transaction. (FAC ¶ 69).
Loss causation is akin to proximate cause in tort law and "is
the causal link between the alleged misconduct and the economic
harm ultimately suffered by the plaintiff." Lentell,
396 F.3d at 172. The PSLRA has codified the loss causation requirement. See id.
(noting that 15 U.S.C. § 78u-4(b)(4), which mandates that
plaintiffs allege that a violation of the Exchange Act "caused
the loss" codifies the loss causation requirement). "[P]leading
principles . . . require both that the loss be foreseeable and
that the loss be caused by the materialization of the concealed
risk[.]" Id.; Emergent Captial, 343 F.3d at 197; see also
Suez Equity Investors, L.P. v. Toronto-Dominion Bank,
250 F.3d 87, 95 (2d Cir. 2001). "[I]f the connection is attenuated, or if
the plaintiff fails to demonstrate a causal connection between
the content of the alleged misstatements or omissions and the
harm actually suffered, a fraud claim will not lie." Lentell,
396 F.3d at 174 (quoting Emergent Capital, 343 F.3d at 199
(quoting Suez Equity Investors, L.P. v. Toronto-Dominion Bank,
250 F.3d 87, 96 (2d Cir. 2001))) (quotation marks omitted). The
loss causation requirement imposes a limit on a person's
responsibility, even for wrongful conduct. Id.
Plaintiffs have not sufficiently alleged loss causation with
respect to the Series E financing. The First Amended Complaint
contains no indication as to what loss was occasioned by
procurement of the Series E financing. The merger had already
occurred and plaintiffs have not claimed that the subsequent
infusion of capital into the business caused any additional
injury. See Lentell, 396 F.3d at 176-77. Therefore, plaintiffs'
Section 10(b) claim is dismissed insofar as it pertains to the
representations relating to post-merger Series E financing.
4. Dismissal of the Claims Pursuant to Sections 10(b) and
With respect to the pre-merger statements, plaintiffs have
failed to plead reasonable reliance, because of the existence of
a valid, enforceable merger clause. In regard to the statements
in the Merger Documents and due diligence disclosures, plaintiffs
do not proffer the requisite, particular allegations to show the
Non Insider Defendants' roles in the preparation of those
documents. Moreover, plaintiffs do not properly allege that those
documents contained statements that were materially misleading
when made. In regard to the post-merger inducement to consent to
the Series E financing, plaintiffs have alleged no additional loss. In sum,
plaintiffs have not properly pled their Section 10(b) claim with
particularity. The Court need not address whether any defendant
acted with scienter, because plaintiffs have failed to establish
other essential elements of their Section 10(b) claim.
Plaintiffs' failure to state a claim for underlying liability
eviscerates their controlling-person liability claim pursuant to
Section 20. See Marcus v. Frome, 275 F. Supp. 2d 496, 503
(S.D.N.Y. 2003) ("To make out a prima facie case under Section
20(a) a plaintiff "must show a primary violation [of the Exchange
Act] by the controlled person and control of the primary violator
by the targeted defendant, and show that the controlling person
was in some meaningful sense a culpable participant in the fraud
perpetrated by the controlled person.") (quoting S.E.C. v. First
Jersey Sec., Inc., 101 F.3d 1450, 1472 (2d Cir. 1996)
(quotations and internal alterations omitted)); see also
Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir. 1998). As a
result of plaintiffs' failure to state a claim pursuant to
Section 10(b), their claim pursuant to Section 20(a) of the
Exchange Act is dismissed.
E. State Law Claims
In addition to their claims pursuant to federal securities
laws, plaintiffs bring three claims pursuant to state law, namely
fraudulent inducement, negligent misrepresentation and fraud.
Given that the Court has dismissed all federal claims, it will
not entertain plaintiffs' remaining state law claims, which are
apparently brought pursuant to this Court's supplemental
jurisdiction. See 28 U.S.C. § 1367(c); Motorola Credit Corp.
v. Uzan, 388 F.3d 39, 56 (2d Cir. 2004). Therefore, those claims
Plaintiffs have failed to comply with the directives of
Fed.R.Civ.P. 9(b) and the PSLRA in setting forth the alleged facts
that underlie their Sections 10(b) and 20(a) claims. Those claims
must be dismissed, and the Court declines to exercise its supplemental
jurisdiction over the remaining state law claims. Therefore,
defendants' motions to dismiss plaintiffs' First Amended
Complaint are granted.
Plaintiffs' request for leave to amend their complaint is
granted. Should plaintiffs choose to submit a second amended
complaint, they shall file it on or before June 24, 2005.