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SEDONA CORPORATION v. LADENBURG THALMANN & CO.

August 8, 2005.

SEDONA CORPORATION, Plaintiff,
v.
LADENBURG THALMANN & CO., INC., et al., Defendants.



The opinion of the court was delivered by: LAURA TAYLOR SWAIN, District Judge

OPINION AND ORDER

Plaintiff Sedona Corporation ("Plaintiff" or "Sedona") brings this securities action against defendants Ladenburg Thalmann & Co., Inc. ("Ladenburg"); Pershing, LLC ("Pershing"), Westminster Securities Corporation ("Westminster"); Wm. V. Frankel & Co., Inc. ("Frankel"); Rhino Advisors, Inc. ("Rhino"); Markham Holdings Limited ("Markham"); Aspen International Ltd. ("Aspen"); Amro International, S.A., Roseworth Group Limited, and Cambois Finance Inc. (collectively, the "Amro Defendants"); Creon Management, S.A. ("Creon"); Thomas Badian ("Badian"); Thomas Tohn ("Tohn"); David Boris ("Boris"); Michael Vasinkevich ("Vasinkevich"); David Sims ("Sims"); H.U. Bachofen ("Bachofen") and Ultrafinanz AG (collectively, the "Ultrafinanz Defendants"); Dr. Batliner and Partner, Hans Gassner, and Dr. Herbert Batliner (collectively, the "Batliner Defendants"); Joseph A. Smith ("Smith"); J. David Hassan ("Hassan"); Anthony L.M. Inder Rieden ("Rieden"); and John Does 1 to 150 ("John Does")*fn1 (collectively, "Defendants").*fn2 Sedona's First Amended Complaint ("Compl.") asserts the following claims for relief against various combinations of the Defendants:*fn3 misrepresentation in violation of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b) ("Section 10(b)"), and Rule 10b-5 ("Rule 10b-5") promulgated by the Securities and Exchange Commission ("SEC") thereunder (First Cause of Action); manipulation in violation of Section 10(b) and Rule 10b-5 (Second Cause of Action); tortious interference with contract and tortious interference with business relationship (Third Cause of Action); violation of Section 1-401 of the Pennsylvania Securities Act of 1972 ("Pennsylvania Act"), 70 Pa. Stat.Ann. § 1-401 (Fourth Cause of Action); common law fraud and deceit (Fifth Cause of Action); civil conspiracy to commit fraud (Sixth Cause of Action); breach of contract (Seventh Cause of Action); disgorgement of profits from fraudulent and manipulative conduct and restitution under various provisions of the Exchange Act (Eighth Cause of Action); breach of fiduciary duty (Ninth Cause of Action); negligence (Tenth Cause of Action); negligent misrepresentation (Eleventh Cause of Action); and control person liability under Section 20 of the Exchange Act (Twelfth Cause of Action). (Compl. ¶¶ 107-67.) Among other relief, Sedona seeks an accounting of Defendants' profits from sales of Sedona stock, injunctive relief, and damages of at least $2,660,000,000.00. (Id. at 68-69.) This Court has jurisdiction of the instant action pursuant to 28 U.S.C. § 1331.

  Defendants have interposed a number of motions to dismiss the Complaint in its entirety with prejudice, moving pursuant to Rules 12(b)(2), 12(b)(6), and 9(b) of the Federal Rules of Civil Procedure, as well as under the Private Securities Litigation Reform Act of 1995 ("PSLRA"). Pursuant to Rule 12(b)(1) of the Federal Rules of Civil Procedure, certain defendants also move to dismiss the Plaintiff's state statutory and common law claims for lack of subject matter jurisdiction under 28 U.S.C. § 1367(c)(3). Defendants Vasinkevich, Smith, and Tohn further move for costs and attorneys' fees. Plaintiff also moves for partial relief from the discovery stay imposed by the PSLRA,*fn4 to obtain document preservation subpoenas and Wells submissions.

  For the following reasons, Defendants' motions to dismiss are granted in part and denied in part. Defendants Vasinkevich, Smith, and Tohn's motions for costs and attorney's fees are denied. Plaintiff's motions are denied as moot.

  BACKGROUND

  Plaintiff's allegations in its first Amended Complaint as to the facts underlying this action are taken as true for the purposes of these motions. Pennsylvania corporation Sedona, headquartered in King of Prussia, Pennsylvania, provides "Customer Relationship Management (CRM) application software and services for small to mid-sized businesses," specifically targeting institutions that provide financial services. (Compl. ¶ 44.) Sedona was a leading provider of CRM application software, but needed to secure more capital in order to fully capture its own substantial corner of the CRM application software market. (Id.)

  On July 1, 1999, Sedona was solicited by defendants Vasinkevich and Tohn, who submitted a proposal to Sedona offering their investment banking and capital financing services. (Id. ¶ 47.) One month later, Vasinkevich, who was a principal of defendant Ladenburg, again solicited Sedona. In an August 19, 1999 letter, Vasinkevich depicted Ladenburg as a "123-year old full-service investment bank" that "ha[d] access to more than $50 Billion in investment capital," and "specialize[d] in providing a method of financing that `offers market ambiguity as to timing and dollars raised, keeping short sellers and arbitrageurs at bay.'" (Id.) Sedona accepted Vasinkevich and Tohn's solicitations. Following the August letter, Bill Williams ("Williams"), Sedona's Chief Financial Officer, engaged in discussions with Vasinkevich and Tohn, who described Ladenburg as the "Goldman Sachs of small cap companies" with funding methods that were "non-toxic" and "minimized dilution." (Id. ¶ 51.) In a letter dated December 28, 1999, Vasinkevich reiterated Ladenburg's desire and ability to help Sedona realize the capital investment it required to achieve its business goals. (Id.)

  On the basis of these communications, Sedona decided to hire Ladenburg as its financial advisor and investment banker. (Id. ¶ 53.) It was at this time that Vasinkevich introduced defendant Badian to Sedona as a major investor. (Id. ¶ 54.) Badian, a principal of defendant Rhino, assured Sedona that Rhino was an accredited and long-term investor that had only Sedona's best interest in mind. (Id.) Sedona memorialized its hiring decision by signing a January 24, 2000, engagement letter. (Id. ¶ 55.) Shortly thereafter, Vasinkevich and Tohn persuaded Sedona to "increase the proceeds of the shelf registration to $50 Million," and Williams and defendant Boris, Ladenburg's Executive Vice President, executed an amended engagement letter, dated March 8, 2000 ("Engagement Letter"),*fn5 reflecting the increase in the anticipated funding. (Id. ¶ 56.)

  Ladenburg and Rhino convinced Sedona that they, along with other investors they would procure, including Markham, Aspen, Amro, Cuttyhunk, and the Sarlo Trust, would provide the $50 million. (Id. ¶¶ 56-57.) The initial financing was arranged through a February 25, 2000, purchase agreement for convertible debentures and warrants ("Purchase Agreement") executed by defendant Hassan on behalf of Markham, defendant Rieden on behalf of Aspen, defendant Bachofen on behalf of Amro, and Lewis on behalf of Cuttyhunk. (Id. ¶¶ 57-62.) Sarlo Trust also invested in the initial tranche. (Id. ¶ 57.) The Series G convertible preferred shares ("Series G") issued pursuant to the Purchase Agreement "were issued as a bridge loan to fund Sedona until it could draw down on the $50 million shelf registration promised by Ladenburg." (Pl.'s Mem. of Law in Opp'n to Defs. Rhino's and Badian's Mot. to Dismiss at 9 ("Pl.'s Opp'n"); Compl. ¶ 67.) Sedona, however, never received the full amount of funding from the investors, and Sedona now contends that the defendant investors "never intended to fund any material part of this $50 million." (Compl. ¶ 64.)

  During the first week of March 2000, around the time the initial financing for the Series G closed, Sedona's stock traded at its highest volume in history. (Id. ¶¶ 64-66.) "[I]n hindsight," Sedona claims that this "irregularit[y]" was a result of the Defendants' manipulation of the market. (Id. ¶ 64.) That is, Sedona views this high level of trading as representing what it characterizes as the "pump" portion of the Defendants' alleged scheme, with the stock peaking at a share price of $10.25, "before beginning its long and continuous slide to its February 2003 level of $0.19," as the stock was systematically "dumped." (Id. ¶ 66.) Sedona did not have to wait until February of 2003 to see its stock plummet, however, as by "June and July of 2000 . . . the stock . . . [was] down to a consistent and declining closing price of around $3.00 per share, a decline in market capitalization of $195,000,000.00 in approximately 90 days." (Id.)

  In the Complaint, Plaintiff principally alleges that the Defendants "manipulate[d] downward the stock price of Sedona with the cooperation of U.S. broker-dealers and market makers in order to profit from the manipulation and price decline and to take advantage of increased conversion rights resulting from the manipulation." (Id. ¶ 32.) According to Sedona, this type of "death spiral" scheme*fn6 was not novel to the Defendants, who are allegedly "accomplished practitioners of . . . stock manipulation and stock fraud." (Id. ¶ 33.) In support of its assertion, Sedona includes in its Complaint a chart listing a number of companies with drastic reductions in stock price, all of which, Sedona claims, were the result of similar manipulations by Defendants. (Id. ¶ 43.) In addition, Sedona refers to a February 26, 2003, SEC Complaint ("SEC Complaint") against defendants Rhino and Badian concerning their involvement with Sedona.*fn7 The SEC Complaint includes allegations that Rhino and Badian ignored a Purchase Agreement provision prohibiting short sales and "engaged in extensive short selling and pre-arranged trading on behalf of [their] client prior to exercising the conversion rights under the [Purchase Agreement]." (Id. ¶ 36; SEC Compl., Howard J. Kaplan Aff. ("Kaplan Aff.") Ex. F ¶ 2.) As a result, "Rhino and Badian manipulated Sedona's stock price to enhance a client's economic interest." (Id.) Rhino and Badian paid a $1 million dollar fine to settle the SEC claim. (Compl. ¶ 36.)

  On November 22, 2000, Sedona entered into a second convertible debenture purchase agreement with Amro, which provided Sedona with $3 million dollars in gross funding. (Kaplan Aff. Ex. E.) Sedona used approximately $2,246,000 of the proceeds from that transaction to "retire the Series G." (Compl. ¶ 82.) Following the execution of the second purchase agreement, Rhino and Badian allegedly conducted so many short sales in Amro's account, that "on March 22, 2001, the [National Association of Securities Dealers Automatic Quotation system (`NASDAQ')] placed a short restriction on Sedona stock that required that any future sales of Sedona would be subject to a mandatory closeout if there were a failure to deliver the securities after ten (10) days." (Id. ¶ 88.) Nonetheless, the NASDAQ restrictions did not prevent Defendants from continuing to sell Sedona's stock short. Rhino held an account for Amro with a Canadian broker-dealer who was not a member of the National Association of Securities Dealers, Inc. ("NASD"), and thus was not subject to the short sale restriction. (Id. ¶ 90.) It was through the Canadian account that Rhino continued to sell short Sedona's stock, from March 30, 2001 through mid-April 2001. (Id.) Several months later, in September 2001, Sedona received an anonymous report "alleging that manipulation and fraud had been perpetrated against it." (Id. ¶ 100.) In October 2001, based upon the allegations contained in the report, Sedona "refused to honor any more conversions from the [Purchase Agreement], and asked the SEC to investigate the allegations." (Id.) Amro sued Sedona in the Southern District of New York on October 24, 2001, Amro Int'l. S.A. v. Sedona Corp., No. 01 Civ. 9344(NRB) (the "Amro action"), for Sedona's failure to honor the conversions. (Id.) The Amro action was ultimately terminated and Sedona entered into settlement agreements with Roseworth, Cambois, Amro, and Rhino (collectively, the "Amro Settlement Defendants"), that included a release from future related liability ("the Release") for each of those defendants and their affiliates.*fn8 (Id. ¶ 101.)

  In the instant action, Sedona asserts that the Defendants' alleged market manipulation and fraudulent acts have made it "virtually impossible for Sedona to obtain additional financing or an investment of any type, except on a limited basis through existing shareholders." (Id. ¶¶ 102, 106.) Further, Sedona alleges that Defendants directly caused Sedona to be de-listed from the NASDAQ SmallCap Market on January 9, 2003, allowing Defendants more freedom to engage in illegal behavior, "as market participants were now governed by a less-regulated atmosphere in which to conduct their manipulative activity." (Id. ¶ 102.) DISCUSSION

  Motion to Dismiss Standard

  In deciding the Defendants' motions brought pursuant to Federal Rule of Civil Procedure 12(b)(6), the Court must take as true all well-pleaded facts alleged in Sedona's First Amended Complaint and draw all reasonable inferences in Sedona's favor. Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 507 U.S. 163, 164 (1993); Hernandez v. Coughlin, 18 F.3d 133, 136 (2d Cir. 1994). The Court must not dismiss the complaint "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of [its] claim which would entitle [it] to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957).

  Although the Court generally should not look outside of the pleadings to decide a motion to dismiss a complaint, the Court may consider "any written instrument attached to [the complaint] as an exhibit or any statements or documents incorporated in [the complaint] by reference." Rothman v. Gregor, 220 F.3d 81, 89 (2d Cir. 2000). Further, in securities actions, the Court may consider "public disclosure documents required by law to be, and that have been, filed with the SEC, and documents that the plaintiffs either possessed or knew about and upon which they relied in bringing the suit." Id. (citations omitted).

  Claims Against the Amro Settlement Defendants

  The Amro Settlement Defendants move to dismiss the Complaint as against them on the basis of the Release executed and delivered by Sedona in connection with the settlement of the Amro litigation. In apparent anticipation of such a motion, Sedona pleads in the Complaint that the Release is void and unenforceable by reason of having been entered into under "fraud and duress," at a time when "Sedona felt that it had no other option but to settle the outstanding litigation." (Compl. ¶ 101.) Sedona further argues that construction of the Release to cover the instant fraud and related claims would be inequitable because the Amro Settlement Defendants were actively working to conceal the relevant facts as to their conduct at the time the Release was given.

  Because the Release contains a New York choice of law provision and the parties rely on New York case law in their briefs, the Court interprets the Release in accordance with New York law. See, e.g., Nasik Breeding & Research Farm Ltd. v. Merck & Co., Inc., 165 F. Supp. 2d 514, 526 (S.D.N.Y. 2001) (finding that courts in the Second Circuit "have routinely enforced similar choice of law provisions even when a party challenges the contract as fraudulent" (citations omitted)). Under New York law, "a valid release which is clear and unambiguous on its face and which is knowingly and voluntarily entered into will be enforced as a private agreement between parties." DuFort v. Aetna Life Ins. Co., 818 F.Supp. 578, 581 (S.D.N.Y. 1993) (quoting Skluth v. United Merchs. & Mfrs., Inc., 559 N.Y.S.2d 280, 282 (1st Dept. 1990)). Such a release will be binding on the parties unless a legal defense such as fraud or duress is adequately asserted. Id.

  The Release provides in pertinent part that:
Sedona Corporation and its officers and directors in their individual capacity . . ., in consideration of good and valuable consideration received from Amro International, S.A., its officers, directors, affiliates, employees, agents, and advisors, including Rhino Advisors, Inc. (as well as the officers, directors, and employees of such affiliates and advisors) (collectively, the "Releasees"), . . . in full satisfaction hereby waive all claims, offsets, and defenses that they may have or have had against Releasees and hereby release, forever discharge and agree to hold harmless Releasees from and against all actions, causes of action, claims, suits, contracts, controversies, penalties, offsets, or damages, whether in law or equity, and whether known or unknown, that may have occurred prior to the date of this Release, including, but not limited to, those arising in connection with the Convertible Debentures and Warrants Purchase Agreement, dated as of November 22, 2000, . . . Sedona Corporation's 5% Convertible Debentures Due March 22, 2001 (as amended by an Agreement, dated as of April 26, 2001), and related Warrants and those asserted or that could have been asserted as a claim, counterclaim, offset or defense in, the [Amro action]. . . . This Release shall be governed by the laws of the State of New York.
(Maryann Peronti Decl. in Support of Pl.'s Mem. of Law in Opp'n to Amro Defs.' Mot. to Dismiss ("Peronti Decl.") Ex.2 (emphasis added).)

  Breadth of the Release

  The Release clearly and unambiguously provides that Sedona waives all claims, "known and unknown," against the Releasees, "including but not limited to" those claims "asserted or that could have been asserted as a claim, counterclaim, offset or defense in, the [Amro action]." (Id.) Although Sedona argues that the Release should not be construed to cover the alleged fraud at issue in this litigation because Defendants' alleged market manipulation was being concealed from Sedona at the time the Amro case was settled, the Complaint makes it clear that Sedona was aware of, and raised with the court the possibility of, market manipulation activity in the course of the Amro litigation. (See Compl. ¶ 100.) In addition, the settlement agreement itself includes a provision under which Amro agreed not to sell short Sedona stock either directly or through Rhino. Short sales are central to Plaintiff's market manipulation allegations in this case.

  Furthermore, the broad language of the Release specifically includes claims that may not have been known to the Plaintiff at the time of execution, such as those asserted herein. Accordingly, the terms of the Release cover Sedona's current claims. Because Sedona may, however, be able to prove that it executed the Release under duress, the Court will not dismiss Sedona's claims against the Amro Settlement Defendants, pursuant to the Release, at this stage of the litigation.

  Duress & Fraud Allegations

  Under New York law, a contract may be voided on grounds of duress upon proof that the defendant exerted an unlawful threat, which precluded the plaintiff's exercise of free will, during a situation in which the circumstances permitted no other alternative for the plaintiff. See Nasik Breeding & Research Farm Ltd. v. Merck & Co., Inc., 165 F. Supp. 2d 514, 527 (S.D.N.Y. 2001). Sedona claims that the Release was entered into under economic duress, alleging that "[t]he defendants . . . took advantage of Sedona, and threatened litigation and a default action, at a time when Sedona's finances were very limited due to the fraudulent misrepresentations and market manipulations of the defendants." (Compl. ¶ 101.) Sedona also quotes a January 4, 2002, e-mail from Badian to Marco Emrich, Sedona's then President and CEO, which "threaten[ed], `as I am sure you are aware, a public company that defaults on any debt security loses its eligibility for S-3 registrations and must file the more cumbersome and expensive SB-2 or S-1 if it wishes to register shares. There are of course other consequences.'" (Id.)

  It is well-settled that "[a] threat to do that which one has the right to do does not constitute duress." DuFort v. Aetna Life Ins. Co., 818 F. Supp. 578, 582 (S.D.N.Y. 1993) (quoting Gerstein v. 532 Broad Hollow Road Co., 429 N.Y.S.2d 195, 199 (1st Dep't. 1980)). However, although such threats are not inherently unlawful, a claim of economic duress may be viable where threats are made in conjunction with a financial situation unlawfully caused by a defendant. See Weinraub v. Int'l Banknote Co., Inc., 422 F.Supp. 856, 860 (S.D.N.Y. 1976) (denying summary judgment and finding a genuine issue of material fact as to whether Plaintiff was a victim of economic duress following the court's determination that, "[i]f the marked decrease in the value of that stock which jeopardized [plaintiffs'] loan was due to the misrepresentation and omissions of defendants, then one could well argue that plaintiffs' position [of financial hardship] . . . was occasioned by the fraudulent acts of defendants"). "The alleged duress must [ultimately] be proven to have been the result of defendant's conduct and not of the plaintiff's own necessities." Id. at 859 (citation omitted). Plaintiff claims such duress here.

  The very basis of Sedona's action is the claim that Defendants', including the Amro Settlement Defendants', manipulation of its stock led to financial hardship for Plaintiff. Sedona claims that, once placed in this situation, it was unable to exercise its free will by choosing not to settle and execute the releases. (See Compl. ¶ 101.) This lack of free choice is "[a] crucial element of coercion or duress." Korn v. Franchard Corp., 388 F. Supp. 1326, 1333 (S.D.N.Y. 1975). Sedona further alleges that "the [Settlement Defendants] continued to manipulate Sedona's stock, as before, during and after the releases were entered, intentionally concealing the manipulation from Sedona at the time it entered into the releases." (Compl. ¶ 101.) The Court finds that Sedona has sufficiently pled facts on the basis of which it may be able to defeat enforcement of the Release. Accordingly, the motion of the Amro Settlement Defendants to dismiss the Complaint on the basis of the Release is denied.

  Sedona's Federal Securities Claims Are Not Time Barred

  The moving Defendants' principal assertion in their motions to dismiss is that Sedona brought its federal securities claims outside of the relevant statute of limitations period, and that the claims thus must be dismissed as time barred. After a thorough review of the Complaint, documents incorporated therein, and relevant public disclosures, the Court finds that Plaintiff's federal securities law causes of action, as presented in the current pleadings, are not clearly untimely. Therefore, for the reasons explained below, Defendants' motions to dismiss Sedona's federal securities fraud claims as time barred are denied.

  Relevant Statute of Limitations

  Pursuant to Section 804(b) of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), "a private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of . . . the [federal] securities laws . . . may be brought not later than the earlier of — (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation." 28 U.S.C.A. 1658(b) (West 2002). This statute of limitations applies to all federal securities actions brought on or after July 30, 2002, the enactment date of Sarbanes-Oxley. Id. The instant action was commenced on May 5, 2003.

  Whether Sedona Was on Notice of the Alleged Violations Prior to May of 2001

  The passage of the Sarbanes-Oxley Act did not change the well settled law in this Circuit as to what constitutes "discovery of facts" sufficient to trigger the statute of limitations in a securities fraud action. The statute of limitations begins to run "when a reasonable investor of ordinary intelligence would have discovered the existence of fraud." Newman v. Warnaco Group, Inc., 335 F.3d 187, 193 (2d Cir. 2003) (quoting Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993)). Discovery of facts constituting a violation of the securities laws "includes constructive or inquiry notice as well as actual notice." Id. at 193 (quoting Rothman v. Gregor, 220 F.3d 81, 96 (2d Cir. 2000) (internal quotation marks omitted)). Inquiry notice arises when "the circumstances are such as to suggest to a person of ordinary intelligence the probability that the person has been defrauded." Jackson Nat'l Life Ins. Co. v. Merrill Lynch & Co., Inc., 32 F.3d 697, 701 (2d Cir. 1994) (quoting Armstrong v. McAlpin, 699 F.2d 79, 88 (2d Cir. 1983) (internal quotations omitted)). However, "[t]he fraud must be probable, not merely possible." Newman, 335 F.3d at 193.

  If the relevant information is contained within the Complaint and the papers incorporated by reference therein, the question of whether Sedona had notice of Defendants' alleged fraud may be determined as a matter of law at the motion to dismiss stage. See, e.g., LC Capital Partners, LP v. Frontier Ins. Group, Inc., 318 F.3d 148, 156 (2d Cir. 2003) (noting that it is appropriate on a motion to dismiss for the Court to determine whether Plaintiff was aware of the fraud as long as that information is contained within the complaint and incorporated papers) and cases cited therein. The Court must utilize an objective standard to determine whether the available information was sufficient to put the plaintiff on inquiry notice. See, e.g., Clark v. Nevis Capital Mgmt., LLC, No. 04 Civ. 2702(RWS), 2005 WL ...


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