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IN RE PARMALAT SECURITIES LITIGATION

United States District Court, S.D. New York


August 16, 2005.

In re PARMALAT SECURITIES LITIGATION. This document relates to: 04 Civ. 0030.

The opinion of the court was delivered by: LEWIS KAPLAN, District Judge

MEMORANDUM OPINION

Pavia e Ansaldo ("Pavia"),*fn1 an Italian law firm named as a defendant in the first amended consolidated class action complaint filed by purchasers of the securities of Parmalat Finanziaria S.p.A. and affiliates (collectively "Parmalat"), moves to dismiss for failure to state a claim, failure to plead fraud with particularity, and lack of subject matter jurisdiction. This action has been the subject of three previous opinions — disposing of the motions to dismiss of the auditor defendants (the "Auditors Opinion"),*fn2 a member of Parmalat Finanziaria S.p.A.'s Board of Statutory Auditors,*fn3 and the financial institution defendants (the "Banks Opinion")*fn4 — familiarity with which is assumed.

  I. The Complaint as It Applies to Pavia

  Gian Paolo Zini was a partner in Pavia and one of Parmalat's most important outside lawyers.*fn5 In 1997, he left Italy to open Pavia's New York office, of which Parmalat was the major, if not the only, client. In February 2001, Pavia's New York office closed, and all of the lawyers and staff working in it began working for Zini & Associates, P.C. ("Zini & Associates"), a new firm established by Zini.*fn6 Accordingly, the plaintiffs seek to hold Pavia liable only for activities conducted from January 5, 1999 (the start of the Class Period, as defined in the earlier opinions)*fn7 to February 2001.*fn8

  The complaint alleges that Pavia's New York office and later Zini & Associates were "the nerve center" of the Parmalat fraud. Zini and Pavia "drafted, negotiated and reviewed many of the legal documents that were necessary to effectuate the fraudulent transactions described" throughout the complaint. They "created various entities and engineered transactions to hide the Company's growing debt and divert Parmalat funds to [founder and chief executive officer Calisto] Tanzi and companies owned by his family."*fn9 Beyond these generalities, however, the complaint specifies Pavia's involvement in only two schemes.*fn10

  First, the complaint alleges that Pavia and Zini were involved in a scheme to fake the sale of certain Parmalat trademarks. Some years ago, Italy's antitrust authority ordered Parmalat to divest several brands and trademarks. Parmalat, however, allegedly could not find a buyer. On November 16, 2000, Parmalat therefore sold the trademarks for a stated value of $56 million to Newlat S.r.l. ("Newlat"), an Italian corporation that Pavia had created nine days before. In a set of transactions "arranged"*fn11 by Pavia, Newlat or its parent issued to Parmalat $56 million in promissory notes, which Parmalat recorded in its financial statements as a receivable from a third party.*fn12 This was quite misleading, because Parmalat knew that Newlat was a shell with no assets and never would pay the notes.*fn13

  The other alleged scheme also involved Parmalat's booking receivables from a shell corporation created by Zini. On June 23, 2000, Parmalat reported that it had purchased $88.4 million in bonds from Web Holdings, Inc. ("Web Holdings"), a company created by Pavia. Again, this was misleading because Web Holdings was merely a shell with the same address and telephone number as Pavia's New York office and Zini & Associates.*fn14 Indeed, Web Holdings, along with other shell companies, was used to divert funds to the Tanzi family and commit other frauds.*fn15 On July 10, 2001 — after Pavia's New York office closed but possibly in consequence of actions taken when it was still open — Parmalat booked a receivable in the amount of approximately $18 million from Western Alps Foundation, a Delaware entity that was controlled by Web Holdings and that had the same address as Zini & Associates. The amount of the receivable increased to $21.9 million at the end of 2001, and was $28.853 million by March 1, 2002.*fn16

  The complaint asserts causes of action against Pavia under Section 10(b) of the Securities Exchange Act of 1934*fn17 and Rule 10b-5 thereunder.*fn18 It asserts also a claim against Pavia under Section 20(a) of the Act*fn19 for alleged primary violations of Section 10(b) and Rule 10b-5 by Zini.

  II. Motions to Dismiss

  In deciding a Rule 12(b)(6) motion, the Court accepts as true all well-pleaded factual allegations in the complaint and draws all reasonable inferences in the plaintiffs' favor.*fn20 Dismissal is inappropriate "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief."*fn21 III. Pleading a Violation of Rule 10b-5

  Section 10(b) makes it unlawful "for any person, directly or indirectly . . . [t]o 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 prescribe as necessary or appropriate in the public interest or for the protection of investors." Rule 10b-5 in turn provides:

"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
"(a) To employ any device, scheme, or artifice to defraud,
"(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
"(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
"in connection with the purchase or sale of any security."
  Most claims under Rule 10b-5 allege misrepresentations or omissions in violation of Rule 10b-5(b). The elements of such claims are different from those based on alleged violations of subsections (a) and (c). Both types of claims, however, are subject to heightened pleading requirements regarding scienter. Under the Private Securities Litigation Reform Act ("PSLRA"), the complaint must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."*fn22 The required state of mind is "an intent to deceive, manipulate, or defraud."*fn23 A plaintiff may allege this intent sufficiently "either (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness."*fn24

  To state a claim based on a misrepresentation or omission in violation of Rule 10b-5(b), plaintiffs must allege that a defendant "(1) made misstatements or omissions of material fact; (2) with scienter; (3) in connection with the purchase or sale of securities; (4) upon which plaintiffs relied; and (5) that plaintiffs' reliance was the proximate cause of their injury."*fn25 These allegations must satisfy Rule 9(b) and the PSLRA. Rule 9(b) requires that the circumstances constituting fraud be stated with particularity, which means that the complaint must "(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."*fn26 The PSLRA is to similar effect, providing that for each allegation of a misrepresentation or misleading omission:

"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."*fn27
  To state a claim based on conduct that violates Rule 10b-5(a) or (c), the plaintiff must allege that a defendant (1) committed a deceptive or manipulative act, (2) with scienter, that (3) the act affected the market for securities or was otherwise in connection with their purchase or sale, and that (4) defendants' actions caused the plaintiffs' injuries.*fn28

  The PSLRA's pleading requirements regarding misleading statements and omissions do not apply to claims that allege no misrepresentation or omission but rest instead on Rule 10b-5(a) and (c). Such claims, however, nevertheless sound in fraud and therefore come within Rule 9(b). The plaintiffs therefore must specify what deceptive or manipulative acts were performed, which defendants performed them, when the acts were performed, and the effect the scheme had on investors in the securities at issue.*fn29

 

IV. Pavia's Liability for the Acts of Zini and Other Lawyers in Its New York Office
  Pavia argues that it is a studio associato, an Italian organizational form that is not liable for the torts of its member lawyers, and that the allegations regarding Zini therefore do not state a claim against it.*fn30 The plaintiffs respond that (1) New York, not Italian, law governs Pavia's liability for the actions of its New York lawyers because the relevant activities occurred here, (2) even if Italian law did govern, the Court should disregard Pavia's submissions regarding it because they consist only of translated snippets from potentially inapposite judicial decisions, and in any case, (3) Pavia misstates Italian law. The Court finds it necessary to address only the third point.

  The complaint alleges that Zini was a "partner" in Pavia, which gives rise at least to a reasonable inference that Pavia was a partnership. The plaintiffs maintain,*fn31 moreover, and Pavia acknowledges in its reply brief,*fn32 that beginning in the late 1990's, Italian law gave lawyers the option of forming a partnership or comparable entity, rather than a studio associato. It appears also that an Italian partnership is liable for the torts of its partners and employees committed in the course of the partnership business.*fn33

  Pavia maintains that it was organized as a studio associato, not a partnership. But this assertion is inconsistent with, or at least unsupported by, the complaint. The Court therefore is obliged for purposes of this motion to regard Pavia as a partnership that is liable for the torts of Zini and other Pavia employees committed in the course of Pavia's business. Of course, one assumes that the questions whether Pavia actually was organized as a studio associato or as a partnership and, if the former, whether it is liable under Italian law for the actions of its associates are subject to prompt and objective resolution. But the Court cannot make those determinations on a motion addressed to the face of the complaint.*fn34

  V. Sufficiency of the Rule 10b-5(b) Claim

  As this Court noted in the Auditors and the Banks Opinions, the Second Circuit has propounded a "bright line" rule pursuant to which a defendant will not be liable under Rule 10b-5(b) for a misstatement or omission of another unless the misstatement or omission is attributed to the defendant at the time it is made.*fn35 Here the complaint does not attribute any statements or actionable omissions to Zini or Pavia.*fn36 It therefore will be dismissed to the extent that it asserts a Rule 10b-5(b) claim against Pavia, either directly or through Section 20(a).

  VI. Sufficiency of the Rule 10b-5(a) and (c) Claim

  A. Primary Violation of Section 10(b)

  The allegations against Pavia, like those against the banks,*fn37 require the Court to consider the contours of Rule 10b-5(a) and (c).

  Under Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.,*fn38 aiding and abetting a primary violation of Rule 10b-5 by another does not give rise to liability. Thus, the question is whether the complaint sufficiently alleges that Zini (while he was at Pavia) and Pavia were primary violators of Section 10(b). The only allegations that the Court finds it necessary to analyze in any depth are those connected to the two schemes reviewed earlier in this opinion, as the complaint's other allegations against Pavia all are patently insufficient.*fn39 Most of the cases and commentary addressing the post-Central Bank liability of lawyers under Section 10(b) considered circumstances in which a lawyer either facilitated the misstatement or omission of another or directly made a statement (or omission) that reached investors.*fn40 Few decisions appear to have considered a situation like that alleged here, one in which lawyers allegedly designed and helped perpetrate transactions intended to misrepresent a client's financial situation. As in the Banks Opinion and for substantially the same reasons, the Court returns to the text of Section 10(b) and inquires whether Zini's and Pavia's acts as alleged in the complaint amounted to the use or employment of a deceptive device or contrivance.*fn41 The complaint alleges in substance that Parmalat sold assets and lent money to Newlat and Web Holdings, shell companies created and controlled by Zini and Pavia. In the case of Newlat, the sale was a fiction designed to allow Parmalat to book as receivables obligations that it knew would not be paid. In the case of Web Holdings, the loan from Parmalat was not a loan at all, but rather a payment to the Tanzi family. Depicting the payment as a loan rather than an outright transfer presumably served a dual function — it disguised the embezzlement, and it made Parmalat appear healthier than it was.

  Like the factoring and securitization of worthless invoices reviewed in the Banks Opinion, these transactions were "inventions, projects, or schemes with the tendency to deceive because they created the appearance of a conventional" sale and loan "when, in fact, the reality was quite different."*fn42 Nor is there any dispute that Zini and Pavia "used" or "employed" these devices.*fn43

  B. Other Elements of a Section 10(b) Claim

  Pavia challenges the sufficiency of the allegations regarding scienter. There is no need to dwell on this point. Zini and Pavia's creation and use of the shell entities, if proven, is more than sufficient circumstantial evidence of conscious misbehavior.*fn44 The requirements of causation and of a connection to the purchase and sale of securities are satisfied for purposes of the relevant allegations against Pavia, substantially for the reasons stated in the Banks Opinion.*fn45

  VII. Sufficiency of the Section 20(a) Claim

  Section 20(a) of the Exchange Act provides that:

"[e]very person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action."*fn46
A complaint asserting a claim under Section 20(a) must allege a primary violation of the securities laws and control by the defendant over the primary violator.*fn47

  The complaint adequately alleges certain primary violations committed by Zini. The only remaining issue is the sufficiency of the allegations regarding control of Zini by Pavia.

  To satisfy this requirement, the plaintiffs must allege that "the defendant possessed `the power to direct or cause the direction of the management and policies of [the allegedly controlled] person, whether through the ownership of voting securities, by contract, or otherwise.'"*fn48 Here the complaint alleges that "Pavia had direct involvement in and oversight of the day-to-day activities of Zini and its other partners and employees with respect to services they performed on behalf of Pavia for Parmalat related entities."*fn49 Zini is alleged to have been a partner in the firm.*fn50 Absent evidence to the contrary, plaintiffs are entitled to an inference that the partnership had the power to manage or direct any single partner.*fn51 While these allegations of control perhaps are not extremely detailed, they do not need to be at this stage.*fn52 They are sufficient to allege control for purposes of Section 20(a).*fn53 VIII. Subject Matter Jurisdiction

  Pavia argues that the Court lacks subject matter jurisdiction over the claims against it. It is mistaken. In assessing whether federal subject matter jurisdiction extends to claims based on transnational securities frauds, courts examine "(1) whether the wrongful conduct occurred in the United States, and (2) whether the wrongful conduct had a substantial effect in the United States or on United States citizens."*fn54 Here the allegations against Pavia center on the activities of its New York office. Accordingly, the Court has subject matter jurisdiction over the claims against Pavia. IX. Conclusion

  Pavia's motion to dismiss [04 MD 1653, docket item 106] is granted, and the complaint dismissed against Pavia, except to the extent that Counts XX and XXIII of the complaint seek to hold Pavia liable for its own and Zini's participation in the Newlat and Web Holdings transactions discussed above. The plaintiffs are granted leave to amend the complaint on or before September 8, 2005 to cure the deficiencies noted in this opinion. Should they amend, they shall serve and provide the Court with a red- or black-lined copy of the new pleading that highlights all differences between the new pleading and the First Amended Consolidated Class Action Complaint.

  SO ORDERED.


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