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DRESNER v. UTILITY.COM

May 18, 2005.

STEVEN DRESNER and ROBERT STARK, Plaintiffs,
v.
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.

I. BACKGROUND

  The relevant facts set forth in the First Amended Complaint ("FAC") are recounted below.

  A. The Parties

  1. Plaintiffs

  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).

  2. Utility.com

  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. ¶ 34).
• 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 merger. (Id.).

  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 individually below.

  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. ¶¶ 65-66).

  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 ...


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