United States District Court, S.D. New York
November 4, 2005.
IN RE ADELPHIA COMMUNICATIONS CORPORATION SECURITIES AND DERIVATIVE LITIGATION. THIS MEMORANDUM AND ORDER APPLIES TO No. 03 Civ. 5755, The Adelphia Business Solutions Actions.
The opinion of the court was delivered by: LAWRENCE McKENNA, District Judge
MEMORANDUM AND ORDER
This action is part of a multi-district securities litigation
pending before this Court. In re Adelphia Commc'ns Corp. Sec.
and Derivative Litig., No. 03 MDL 1529.
In the instant case, the Wellsville Group has brought a
securities fraud class action on behalf of itself and all
stockholders of Adelphia Business Solutions, Inc. who purchased
their securities between January 6, 2000 and March 27, 2002
(collectively "plaintiffs").*fn1 (Compl. ¶¶ 1, 12-20.) In
their Consolidated Amended Class Action Complaint ("Complaint"),
plaintiffs have named as defendants John J. Rigas, Michael J.
Rigas, Timothy J. Rigas, and James P. Rigas (collectively "the
Rigases" or "defendants"), all of whom were directors and/or
senior officers of Adelphia Business Solutions ("ABIZ") between
2000 and 2002. (Id. ¶¶ 21-23.) ABIZ was a telecommunications
company providing local phone service, long distance service,
high-speed data transmission, and internet connectivity to business, government,
and educational customers. (Id. ¶ 2.) Plaintiffs have not named
ABIZ in this action, as it has filed for Chapter 11 bankruptcy.
(Id. ¶ 7.)*fn2
Plaintiffs claim violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, 15 U.S.C. § 78j;
15 U.S.C. § 78t(a). (See also Compl. ¶¶ 1, 90-99.) Plaintiffs contend that
from January 2000 to January 2002 ABIZ engaged in various
fraudulent schemes in order to artificially inflate the price of
ABIZ securities by including misrepresentations and fraudulent
statements in various publicly filed documents and press
releases. (Compl. ¶¶ 4-6, 23-26, 35-37.) These schemes include:
falsely reporting statistics relating to new customers; falsely
reporting corporate overhead expenses; and failing to disclose
debt for which it and its parent corporation, Adelphia
Communications Corp. ("ACC"), were liable. (Id. ¶¶ 38-62.)
Plaintiffs allege they would not have purchased or acquired ABIZ
at these artificially inflated prices if they had known of
defendants' misrepresentations. (Id. ¶¶ 81-83, 94.) In March
2002, it was revealed that ACC owed $2.3 billion in debt, for
which it and ABIZ were jointly obligated and which was not
reported on their balance sheets. (Id. ¶¶ 65, 66.) ABIZ also
announced that it would default on $15.3 million in secured
notes. (Id. ¶ 64.) Plaintiffs allege that, as a result, ABIZ
filed for bankruptcy. (Id. ¶¶ 6, 63-68.) ABIZ, now renamed
Telcove, is undergoing a reorganization that would allegedly
leave plaintiffs with no value for their shares of ABIZ stock.
(Id. ¶ 69.)*fn3 Plaintiffs allege that they have lost the total value of their investments in ABIZ, resulting in a
collective injury of $3,308,608. (Id. ¶¶ 6, 12.)
Defendants have filed a Motion to Dismiss both the 10(b) and
20(a) claims that are alleged in plaintiffs' Complaint, pursuant
to Federal Rules of Civil Procedure 12(b)(6) and 9(b). For the
reasons set forth below, the motion is granted in part and denied
in part. Plaintiffs, however, will be given limited leave to
amend their Complaint.
II. Section 10(b) Claim
Under Federal Rule of Civil Procedure 12(b)(6), a complaint
will be dismissed if there is a "failure to state a claim upon
which relief can be granted." Fed.R.Civ.Proc. 12(b)(6). A
court must read the complaint generously accepting the truth of
and drawing all reasonable inferences from well-pled factual
allegations. See Mills v. Polar Molecular Corp.,
12 F.3d 1170, 1174 (2d Cir. 1993). A court's function on a motion to
dismiss is "not to weigh the evidence that might be presented at
trial but merely to determine whether the complaint itself is
legally sufficient." Goldman v. Belden, 754 F.2d 1059, 1067 (2d
Cir. 1985). A court should dismiss a complaint only 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.'"
Valmonte v. Bane, 18 F.3d 992, 998 (2d Cir. 1994) (quoting
Conley v. Gibson, 355 U.S. 41, 45-46 (1957)).
To state a claim under Section 10(b) and Rule 10b-5, a
plaintiff must allege that the 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 plaintiff's reliance was the proximate cause of
their injury." In re IBM Corp. Sec. Litig., 163 F. 3d 102, 106
(2d Cir. 1998).*fn4
An allegation of securities fraud under Section 10(b) and Rule
10b-5 is subject to the heightened pleading requirements of
Federal Rule of Civil Procedure 9(b).*fn5 Rule 9(b) requires
a complaint alleging fraud to: "(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." Mills,
12 F.3d at 1175. In examining a complaint for compliance with Rule 9(b), a
court must "read the complaint generously, and draw all
inferences in favor of the pleader." Pompano-Windy City
Partners, Ltd. v. Bear Stears & Co., 794 F. Supp. 1265, 1280 (S.D.N.Y. 1992) (citation and quotations omitted). The purposes
of Rule 9(b) are: "(1) to provide a defendant with fair notice of
the claims against it; (2) to protect a defendant from harm to
its reputation or goodwill by unfounded allegations of fraud; and
(3) to reduce the number of strike suits." In re Livent, Inc.
Sec. Litig., 78 F. Supp. 2d 194, 213 (S.D.N.Y. 1999) (citing
DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242,
1247 (2d Cir. 1987)).
An allegation of a 10(b) violation is also subject to the
requirements of the Private Securities Litigation Reform Act of
1995 ("PSLRA"), 15 U.S.C. § 78u-4(b). The PSLRA requires that a
complaint "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. § 78u-4(b)(1). Further, the PSLRA requires a plaintiff to
"state with particularity facts giving rise to a strong inference
that the defendant acted with the required state of mind." Id.
at § 78u-4(b)(2). "Under the heightened pleading requirements of
Rule 9(b) and the PLSRA, plaintiffs must allege the first two
elements of a securities fraud claim fraudulent acts and
scienter with particularity." Gabriel Capital, L.P. v. NatWest
Fin., Inc., 94 F. Supp. 2d 491, 500 (S.D.N.Y. 2000).
Defendants argue that plaintiffs have not met any of the four
requirements of 9(b) or the PSLRA. The court will first address
the second prong whether plaintiffs have adequately identified
the speaker of the alleged fraudulent or misleading statements.
(Defs.' Mem. at 3-7; Defs.' Reply at 1-6.) The court will then
address the remaining three prongs together as they all relate to the particularity of
the statements themselves. Third, the court will address the
issue of causation.
1. Identification of Speaker
Defendants argue that under Rule 9(b) and the PSLRA, plaintiffs
are required to specifically identify the role of each defendant
in the alleged fraud, and cannot simply "lump the Rigas
defendants together without specifying their roles in the alleged
fraud." (Defs.' Mem. at 4; Defs.' Reply at 4-6.) However, the
group pleading doctrine is an exception to the requirement that a
complaint identify each defendant's fraudulent acts. Under this
doctrine, plaintiffs may "`rely on a presumption that statements
in prospectuses, registration statements, annual reports, press
releases, or other group-published information, are the
collective works of those individuals with direct involvement in
the everyday business of the company.'" In re Emex Corp. Sec.
Litig., No. 01 Civ. 4886, 2002 WL 31093612, at *7 (S.D.N.Y.
Sept. 18, 2002) (quoting In re Oxford Health Plans, Inc.,
187 F.R.D. 133, 142 (S.D.N.Y. 1999)). Here, plaintiffs can rely on
the group pleading exception because the Rigas defendants are
identified as holding positions that qualify them as "corporate
insiders with active daily roles," Polar Int'l Brokerage Corp.
v. Reeve, 108 F. Supp. 2d 225, 237 (S.D.N.Y. 2000), or as
members of the Board of Directors with equity interests in ABIZ
and access to information concerning the company's day-to-day
business.*fn6 See In re Oxford Health,
187 F.R.D. at 142-43. (See also Compl. ¶¶ 21-23, 97-98.) 2. Particularity as to Each Misstatement or Fraudulent
Defendants also argue that plaintiffs have not specified which
statements are false or misleading, when and where the statements
were made, and why the statements are misleading or fraudulent.
(Defs.' Mem. at 4-7; Defs.' Reply at 1-4.)
Plaintiff's allegations fall into three general categories.
Plaintiffs allege that defendants made false or misleading
statements regarding ABIZ's: (a) line counts (Compl. ¶¶ 38-53);
(b) corporate overhead expenses (id. ¶¶ 54-58); and (c)
exposure to off-balance sheet liabilities of its parent
corporation, ACC (id. ¶¶ 59-62). Plaintiffs allege that due to
these false statements, investors were lured into purchasing
stock in a company that appeared to be growing, which therefore
artificially inflated the stock price. In March 2002, when the
public finally became aware of the past misleading statements and
ABIZ filed for bankruptcy, investors were left holding worthless
stock. (Id. ¶¶ 63-69.)
a) Defendants Overstated Line Counts (Compl. ¶¶ 38-53)
ABIZ was a competing local exchange carrier ("CLEC") trying to
break into pre-existing local telephone markets. Plaintiffs
allege that the Rigases falsely portrayed ABIZ as a successful
CLEC, when it was actually failing, by overstating its "line
counts," which lured investors into purchasing ABIZ stock and
caused the price of ABIZ stock to rise. This resulted in
plaintiffs purchasing ABIZ stock at inflated prices. (Compl. ¶¶
2, 33-35, 52.) (1) Which statements were misleading and when and where the
statements were made.
"Line counts" are the number of new customers that a company
assigns to its available access lines (lines assigned to specific
phone numbers) in its various regions of service; line counts are
an indicator of growth in the CLEC market. The number of
customers retaining their lines is an indicator in calculating a
net line count (new lines minus disconnected lines) for ABIZ.
(Id. ¶ 38.) Plaintiffs allege defendants issued press releases
and filed financial statements with the Securities and Exchange
Commission that misrepresented ABIZ's customer base by
systematically inflating line counts.
Specifically, plaintiffs allege that defendants included
artificially inflated line count statistics in ABIZ's January 6,
2000 press release (Compl. ¶ 39); March 1, 2000 press release
(id. ¶ 41); Form 10-K filed with the SEC on March 30, 2000
(id. ¶ 43); Form 10-Q filed with the SEC on May 15, 2000 (id.
¶ 44); Form 10-Q filed with the SEC on August 14, 2000 (id. ¶
45); and Form 10-Q filed with the SEC on November 14, 2000 (id.
The court finds that these allegations sufficiently specify
which statements were misleading and when and where these
statements were made.
(2) Why the statements were misleading.
Plaintiffs allege defendants sought to create the perception
that ABIZ was a growing company by publicly reporting inflated
line count statistics in order to ensure that the company stayed
in business and to lure investors into purchasing stock.
Plaintiffs allege defendants knew or were deliberately reckless
in disregarding the actual level of line counts when publicly
reporting these statistics. (Id. ¶ 47). Plaintiffs allege that defendants inflated line counts through the entire class period
by using or approving certain practices. (Id. ¶¶ 39-53.)
Specifically, plaintiffs allege that ABIZ engaged in the practice
of "cramming" by adding hundreds of lines to existing customers
who never ordered them and then disconnecting the lines within
the same month without reporting the disconnections. Plaintiffs
allege that affected customers were not aware of the additional
lines in most cases and that this practice artificially inflated
line counts. (Id.) Plaintiffs also allege that ABIZ engaged in
the practice of "slamming" by entering "new" customer names into
its systems although the customers had never signed up for
service with ABIZ or had poor credit and could not afford new
service and then disconnected the lines in the same month without
reporting the disconnections. (Id.) Additionally, plaintiffs
allege that ABIZ entered businesses with poor credit as "new"
lines although they had not ordered new service or could not
afford new service, and ABIZ retained these customers in its
systems although they had disconnected their lines. (Id.)
Plaintiffs allege that ABIZ did not disclose any of these false
and deceptive sales practices or their effect on the company's
financial position. (Id. ¶¶ 47, 52-53.) Plaintiffs also allege
the inflation of line counts violates generally accepted
accounting principles ("GAAP"), which must be followed when
filing any documents with the Securities and Exchange Commission.
Specifically, plaintiffs allege that the inflation of line counts
violates Financial Accounting Standard No. 5 and Statement of
Financial Accounting Concept No. 6, which prohibit improper
recognition of fictitious revenues. (Id. ¶¶ 70-72.)
Plaintiffs make many specific allegations regarding the
inflation of line counts. For example, plaintiffs allege that
ABIZ's "Louisville and Philadelphia offices were particularly
aggressive in reporting line counts." (Id. ¶ 48.)Plaintiffs also
point to two specific incidents when the inflation came to light. Plaintiffs
allege that in November 2000 personnel in the operations unit
notified the corporate accounting department and top ABIZ
executives that "the line counts being reported to the public . . .
were grossly overstated and inaccurate." Plaintiffs allege the
executives told the operations unit personnel "not to speak about
the issue to anyone" and that they "would take care of this."
(Id. ¶ 51.) Plaintiffs also allege that in April 2001 ABIZ's
Philadelphia office could not fill a legitimate large line order
because its system reported an insufficient number of available
lines; the seemingly occupied lines, however, were actually
available and were improperly reported as active. (Id. ¶ 50.)
Defendants argue that plaintiffs have not alleged by how much
defendants inflated the line counts. (Defs.' Mem. at 5-6; Defs.'
Reply at 2-3.) The PSLRA, however, "does not require that
plaintiffs plead with particularity every single fact" when
plaintiffs plead "on information and belief." Novak v. Kasaks,
216 F.3d 300, 313 (2d Cir. 2000). As plaintiffs' allegations
regarding inflation of line counts are very specific in other
respects, the Court finds plaintiffs' allegations sufficiently
particular despite plaintiffs' failure to allege by how much the
line counts were inflated.
b) Defendants Falsely Reported Corporate Overhead Expenses
(Compl. ¶¶ 54-58)
Plaintiffs allege that ABIZ entered into agreements with its
parent company, ACC, under which ABIZ was obligated to share
corporate overhead services and other business expenses with ACC
and other companies owned by the Rigases. Plaintiffs allege
defendants arbitrarily decided how to allocate expenses and
payment obligations among the various Adelphia companies based,
not on any actual expenses incurred by the companies, but rather on the financial needs of the individual
companies. Plaintiffs also allege that defendants concealed this
arbitrary allocation. (Compl. ¶ 54.)
(1) Which statements were misleading and when and where the
statements were made.
Plaintiffs allege that defendants concealed the arbitrary
allocation of overhead expenses. Specifically, plaintiffs point
to ABIZ's July 7, 2000 proxy statement, which states that ABIZ
paid ACC for shared corporate overhead expenses in 1999 and that
the amount ABIZ paid was calculated "based on allocation of
Adelphia Communications' incremental costs incurred [to provide
ABIZ with] these services." (Id. ¶ 55-56.) Plaintiffs allege
this statement misrepresented to investors that the amount ABIZ
paid ACC for overhead expenses was related to the costs incurred
by ACC to provide the services to ABIZ, when in fact the amount
was calculated arbitrarily. Plaintiffs also complain that
defendants reported false and misleading "corporate overhead"
expense figures in Adelphia Communication's 10-Qs dated May 15,
2000, August 14, 2000, November 14, 2000, May 15, 2001, and
August 14, 2001. (Id. ¶ 57.)
The court finds these facts sufficient to allege which
statements were false and misleading and when and where the
statements were made.
(2) Why the statements were misleading.
Defendants argue that plaintiffs do not explain why and how the
agreements between ACC and ABIZ and the treatment of expenses was
improper or misallocated. (Defs.' Mem. at 6; Defs.' Reply at 3.)
Plaintiffs allege the corporate overhead statistics reported in
ABIZ's proxy statement and ACC's 10-Qs were misleading because
they did not reflect the actual usage of services between the various companies. Plaintiffs
specifically complain that defendants misallocated and improperly
treated corporate overhead expenses by: 1) failing to properly
document labor (including part-time employees of ABIZ),
operating, equipment, circuit network, and other costs to ABIZ or
ACC based on which company actually used these services; 2)
allowing ABIZ to use Remedy, Microsoft Veritas, and Oracle
software applications licensed only to ACC with no or inadequate
accounting or documentation; 3) allowing ABIZ to use and route
the hardware and network circuits of ACC with no or inadequate
accounting or documentation; 4) allowing ABIZ to use or share
office space of ACC with no or inadequate accounting or
documentation; and 5) allowing ABIZ to share powerlink network
sales, support, accounting, and provisioning services of ACC with
no or inadequate accounting or documentation. (Compl. ¶ 58.)
Plaintiffs also allege that because ABIZ included these
inaccurate overhead expense amounts in its SEC filings,
defendants also violated basic tenets of GAAP, including the
principles that financial reporting be "accurate," "reliable,"
and "complete." (Compl. ¶ 73.)
Plaintiffs, however, do not go beyond general allegations that
the allocation of overhead costs were "handled in an arbitrary
manner" or with "inadequate documentation." (See Compl. ¶¶
54-58.) Although plaintiffs explain to which costs they are
referring, e.g., labor, hardware, software licenses, plaintiffs do
not explain how the overhead costs were allocated nor do they
describe any practices used by defendants that amount to improper
allocation of these costs. Such general allegations are
insufficient to comply with Rule 9(b). Defendants also argue that plaintiffs have not identified the
corporate overhead sharing agreements between ABIZ and ACC to
which they refer (Defs.' Mem. at 6; Defs.' Reply at 3.) "Fraud
allegations may be based on information and belief as to facts
peculiarly within the opposing party's knowledge." Degulis v.
LXR Biotechnology, Inc., 928 F. Supp. 1301, 1310-11 (S.D.N.Y.
1996). "Moreover, in cases of corporate fraud, the requirements
of Rule 9(b) are relaxed as to matters particularly within the
opposing party's knowledge. . . . This is particularly the case
where, as here, discovery has not yet commenced." Id.
Plaintiffs have pled on "information and belief as to all other
matters [not within their personal knowledge]." (Compl. ¶ 1.) The
existence of overhead sharing agreements is not within
plaintiffs' personal knowledge. The source of plaintiffs'
"information and belief" as to the existence of one or more of
these agreements appears to be ABIZ's July 7, 2000 proxy
statement. That statement refers to a "Management Services
Agreement between [ABIZ] and Adelphia Communications dated April
10, 1998, with respect to shared corporate overhead expenses."
(Compl. ¶ 56.) Since one or more of defendants allegedly authored
this statement and defendants were ABIZ directors and/or officers
who had access to and control over ABIZ documents and business
activities (Compl. ¶¶ 21-23, 97-98), the content of these
agreements, and the agreements themselves, should be "peculiarly
within [defendants'] knowledge" and possession. See Degulis,
928 F. Supp. at 1310-11. Courts have allowed complaints alleging
fraud to survive motions to dismiss when such facts are within
defendants' knowledge. See, e.g., Vento & Co. of New York v.
Metromedia Fiber Newtork, Inc., No. 97 Civ. 7751, 1999 WL
147732, at *13 (S.D.N.Y. Mar. 18, 1999). Additionally, plaintiffs have pointed to a specific proxy
statement, allegedly authored by defendants, that refers to the
existence of an overhead sharing agreement. Defendants should
presumably know to which agreement they themselves were referring
when they wrote that statement. The Court finds this allegation
sufficient "to provide a defendant with fair notice of the claims
against it." See In re Livent, 78 F. Supp. 2d at 213.
Thus, the Court finds plaintiffs need not explain the details
of the provisions of the overhead expenses agreements, but the
Court finds plaintiffs have not pled with sufficient
particularity how defendants improperly allocated overhead costs.
c) Defendants Concealed ABIZ's Exposure to ACC Off-Balance
Sheet Debt (Compl. ¶¶ 59-62.)
Plaintiffs allege that ABIZ received loans from ACC and was
obligated to advance funds on demand to ACC, and that the two
companies were jointly obligated (along with other Rigas owned
entities) under certain credit facilities. Because of these joint
financial obligations, plaintiffs allege that ABIZ was required
to disclose in its financial statements any material adverse
information about ACC's financial position. Plaintiffs allege
that ACC materially understated its debt, for which ABIZ was
jointly liable. (Compl. ¶¶ 59-60.) In March 2002, ACC issued a
press release revealing it owed $2.3 billion in debt, for which
both it and ABIZ were jointly liable and which had not been
disclosed on their balance sheets. That same day, ABIZ filed for
bankruptcy. (Compl. ¶¶ 65-68.)
(1) Which statements were misleading and when and where the
statements were made. Plaintiffs allege ABIZ's July 6, 2001 proxy statement was false
and misleading because, although it disclosed the existence of
the credit facilities, it did not disclose ACC's off-balance
sheet liabilities. (Id. ¶ 61.) Plaintiffs then go on to allege
that "Defendant's 10-Q's and 10K's filed during the Class period"
were also false and misleading. (Id.)
Plaintiffs do not, however, allege to which specific 10-Qs and
10-Ks they are referring and which statements within those 10-Qs
and 10-Ks were false and misleading. Even if plaintiffs are
referring to the absence of statements, plaintiffs should be able
to point to which forms and which statements within those forms
should have disclosed the existence of jointly obligated debts.
Cf. Runes v. Gridcomm, Inc., No. B-86-473-TFGD, 1990 WL
483735, at *2 (D. Conn. Jan. 3, 1990). The Court finds that
plaintiffs have adequately alleged that the July 2001 proxy
statement was fraudulent but have not adequately alleged which
other statements were fraudulent.
(2) Why the statements were misleading.
Plaintiffs allege that ACC and other Rigas-owned entities,
including ABIZ, entered into agreements under which ACC and the
other entities were jointly liable for debts in excess $2
billion. Plaintiffs allege the Rigases failed to disclose these
material off-balance sheet liabilities in ACC's financials,
thereby materially understating ACC's debt. This information was
not disclosed until March 2002, and plaintiffs allege it should
have been disclosed earlier to ABIZ's investors because of ABIZ's
"interconnection" with and "dependen[cy] on the solvency" of ACC
resulting from the joint credit facilities. (Compl. ¶¶ 60-61.)
Plaintiffs also allege that because ABIZ failed to include ACC's
debt amounts in its SEC filings, defendants also violated basic
tenets of GAAP, including the principles that financial reporting be "accurate," "reliable,"
and "complete." (Compl. ¶ 73.)
Defendants argue that Plaintiffs have not identified the credit
facilities to which they refer. (Defs.' Mem. at 6; Defs.' Reply
at 4.) As explained above, the existence of these credit
facilities may be pled on information and belief as to facts
peculiarly within defendants' knowledge, and the requirements of
Rule 9(b) are relaxed as to matters particularly within the
opposing party's knowledge. See Degulis,
928 F. Supp. at 1310-11. The source of plaintiffs' information on the existence
of the credit facilities appears to be ABIZ's July 6, 2001 proxy
statement, which states "[ABIZ] and certain of Adelphia
Communications' other subsidiaries and affiliates are parties to
a joint bank credit facility" (Compl. ¶ 61), and ACC's December
31, 2000 press release, which again refers to these "credit
facilities" (Compl. ¶ 65).*fn7 Since one or more of
defendants allegedly authored these statements, the content of
these agreements and the agreements themselves should be
"peculiarly within [defendants'] knowledge" and possession. See
Degulis, 928 F. Supp. at 1310-11. "Plaintiffs have pleaded
sufficient facts at this stage to survive a motion to dismiss. . . .
Whether these allegations can be proven after discovery is
completed is another question." Vento & Co., 1999 WL 147732, at
Defendants also argue that plaintiffs do not adequately explain
how ABIZ would be "materially impacted" by ACC's debt. (Defs.'
Mem. at 6; Defs.' Reply at 4.) Plaintiffs argue that ABIZ, ACC,
and other Adelphia subsidiaries were jointly obligated to repay
debts under the joint credit facility agreement; that is, if ACC
was responsible for certain debts, ABIZ would also be responsible
for those debts. Therefore, the debts of ACC should have been disclosed to ABIZ investors so that ABIZ
investors would be aware of any debts that ABIZ may potentially
have to repay. (Compl. ¶¶ 59-60.) The Complaint could be clearer
with respect to this argument, as well as other allegations, but
as the Court must "read the complaint generously, and draw all
inferences in favor of the pleader," Pompano-Windy City,
794 F. Supp. at 1280, the Court finds these allegations sufficient to
plead how ABIZ would be impacted by ACC's debts.
In sum, the Court finds: (a) the allegations regarding line
counts are pled with sufficient particularity; (b) the
allegations regarding corporate overhead expenses are not pled
with particularity because plaintiffs do not explain how the
expenses were improperly allocated; and (c) the allegations
regarding off-balance sheet debt are not pled with particularity
as to which statements, besides the July 2001 proxy statement,
were fraudulent. The Court will allow plaintiffs leave to amend
their Complaint to cure these defects regarding particularity.
In federal securities fraud actions, plaintiffs must prove both
"(1) transaction causation (but for the fraudulent statement or
omission the plaintiff would not have entered into the
transaction); and 2) loss causation (the subject of the
fraudulent statement or omission was the cause of the actual loss
suffered)." Nairobi Holdings Ltd. v. Brown Bros. Harriman &
Co., No. 02 CIV. 1230, 2002 WL 31027550, at *8 (S.D.N.Y. Sept.
10, 2002). See also Lentell v. Merrill Lynch & Co.,
396 F.3d 161, 172 (2d Cir. 2005).
Defendants argue that plaintiffs have not adequately pled
transaction causation, also termed reliance. Particularly,
defendants argue that plaintiffs have adequately alleged neither
how the alleged fraudulent acts affected the price of ABIZ
securities, (Defs.' Mem. at 5-7; Defs.' Reply at 2-4), nor which purchases or
sales plaintiffs made in connection with the alleged
misstatements, (Defs.' Mem. at 4). However, since plaintiffs have
invoked the "fraud on the market theory," (Compl. ¶¶ 81-86; Pls.'
Opp. at 13-14), they are not required to allege any additional
The fraud on the market theory holds that "`in an open and
developed securities market, the price of a company's stock is
determined by the available information regarding the company and
its business [and that m]isleading statements will therefore
defraud purchasers of stock even if the purchasers do not
directly rely on the misstatements.'" In re Livent,
78 F. Supp. 2d at 213 n. 4 (quoting Basic Inc. v. Levinson, 485 U.S. 224,
241-42 (1988)). There is a presumption of reliance. In re Emex,
2002 WL 31093612, at *8.
Under this theory, it is presumed that defendants'
misstatements caused the price of ABIZ securities to fluctuate,
and plaintiffs need not show they made certain securities
purchases in reliance on specific misstatements.*fn8
Plaintiffs are not required to plead any particulars of reliance
as the fraud on the market theory satisfactorily pleads
Defendants also argue that plaintiffs have not adequately
alleged how they were harmed by the allegedly misleading
statements. (Defs.' Mem. at 5-7; Defs.' Reply at 2-4.) This is
essentially a loss causation argument.
Loss causation "is the causal link between the alleged
misconduct and the economic harm ultimately suffered by the
plaintiff." Lentell, 396 F.3d at 172 (citation and quotations omitted). "[T]o establish loss causation, a
plaintiff must allege . . . that the subject of the fraudulent
statement or omission was the cause of the actual loss suffered,
. . . i.e., that the misstatement or omission concealed something
from the market that, when disclosed, negatively affected the
value of the security." Id. at 173 (citation and quotations
omitted) (emphasis omitted).
Plaintiffs have pled exactly this. The Complaint alleges that
defendants' misrepresentations in ABIZ press releases and SEC
filings about line counts, overhead expenses, and off-balance
sheet debts caused ABIZ securities to trade at artificially
inflated prices, and that plaintiffs purchased ABIZ stock at
these artificially inflated prices. (Id. ¶¶ 38-62, 81-83, 94.)
Plaintiffs also allege that in March 2002, after ACC revealed the
existence of $2.3 billion of off-balance sheet debt under which
ACC and ABIZ were jointly obligated and ABIZ announced that it
would default on $15.3 million in secured notes, ABIZ was forced
to file for bankruptcy. (Id. ¶¶ 63-68.) ABIZ, now renamed
Telcove, is undergoing a reorganization, that would allegedly
leave plaintiffs with no value for their shares of ABIZ
stock.*fn9 (Id. ¶ 69.) Plaintiffs allege that, as a
result, they have lost their complete investments in ABIZ,
resulting in a collective injury of $3,308,608. (Id. ¶¶ 6, 12,
69.) The Court finds these allegations sufficiently plead loss
B. Purchase Requirement
To state a claim under 10(b), a plaintiff must allege a
material misstatement or omission "in connection with the
purchase or sale of a security." 15 U.S.C. § 78j. Only a
plaintiff who engages in a "purchase or sale" of securities has
the right to bring a private damages action. Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 732-49 (1975), expressly adopting the holding of Birnbaum
v. Newport Steel Corp., 193 F.2d 461, 464 (2d Cir. 1952).
In the present action, some class plaintiffs did not purchase
ABIZ shares on the market; rather, they were shareholders of ACC
and acquired ABIZ stock as a dividend on January 11, 2002.
(Compl. ¶ 3.) It is unclear from the Complaint which plaintiffs
received the stock as a dividend and which purchased them on the
open market. (See id.)
Defendants argue that those class members who received their
stock through ACC's spin-off of ABIZ stock cannot satisfy the
"purchase or sale" requirement of Section 10(b) because receipt
of a dividend does not qualify as a purchase, and therefore the
claims of those members should be dismissed. (Defs.' Mem. at 7-8;
Defs.' Reply at 6-9.) This Court agrees.
1. Second Circuit Precedent
Initially, in order to understand the term "purchase," the
Court looks to the statutory definitions. In the Securities
Exchange Act of 1934, in which Section 10(b) is found, the
definition section states: "[t]he terms `buy' and `purchase' each
include any contract to buy, purchase, or otherwise acquire. For
security futures products, such term includes any contract,
agreement, or transaction for future delivery."
15 U.S.C. § 78c(a)(13). The definition section is prefaced with the phrase
"unless the context otherwise requires." 15 U.S.C. 78c(a).
Notably, the words "for value" are not found in the definition
section of the 1934 Act, but are in the definition section of the
Securities Act of 1933, 15 U.S.C. § 77b(3). The Second Circuit
has expanded, in two seminal cases, on the "purchase or sale"
requirement as used in the 1934 Act. The Court will examine each case individually and then analyze how the two cases
provide a framework for analyzing the purchase and sale
a) Shaw v. Dreyfus
In Shaw v. Dreyfus, 172 F.2d 140, 141 (2d Cir. 1949), a
stockholder of Celanese Corporation brought a derivative action
against an officer, Dreyfus, for violations of Section 16(b) of
the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b). The
corporation had issued to common stockholders the right to
purchase additional stock at a discounted price of $50 per share.
Dreyfus received a large number of rights; he sold some of these
rights without exercising them. 172 F.2d at 141. Section 16(b)
prohibits the "unfair use of information which may have been
obtained by such beneficial owner, director, or officer by reason
of his relationship to the [corporation]" and provides that "any
profit realized by [such an insider] from any purchase or sale . . .
within any period of less than six months . . . shall inure
to and be recoverable by the [corporation]." 15 U.S.C. § 78p(b).
Plaintiff sought to recover the profits gained by Dreyfus through
the sale of the rights, arguing that he traded on insider
information. 172 F.2d at 141-42.
First, the Court held that Dreyfus's receipt of the stock
rights was not a purchase and was therefore not a transaction to
which Section 16(b) applied. The court reasoned that "[t]he
generally understood meaning of `purchase' is to acquire
something by one's own act or agreement for a price. Dreyfus
performed no act, made no agreement, paid no consideration for
the receipt of his rights." Id. at 142 (footnotes omitted). The
transaction, however, could be converted into a purchase if
Dreyfus had chosen to exercise the rights. Id.
The court also reasoned that such a transaction was not within
the purpose of 16(b), which is to "to protect the outside stockholders against
at least short-swing speculation by insiders with advance
information." Id. (citation and quotations omitted). "Inside
information which the directors may have cannot possibly be used
to the detriment of other stockholders in voting to grant rights
to all stockholders of record in proportion to their existing
holdings [because] all are treated equally." Id. It is in this
capacity that the court analogized the transaction to receipt of
stock dividends: "[the] preemptive right to be offered the new
stock and on equal terms inheres in their original shares and is
essentially analogous to a stock dividend." Id. Thus, Shaw
found three factors significant: whether Dreyfus performed an act
and made a choice to receive the rights; whether Dreyfus paid
consideration; and whether the transaction was within the purpose
b) Int'l Controls Corp. v. Vesco
The Second Circuit revisited the "purchase or sale" requirement
in Int'l Controls Corp. v. Vesco, 490 F.2d 1334 (2d Cir. 1974).
In Vesco, plaintiff corporation, International Controls Corp.
("ICC") brought an action against former directors for violations
of Section 10(b). Plaintiff alleged that Vesco and other
directors of ICC fraudulently induced the remaining ICC directors
to approve a dividend in kind of ICC's stock in its subsidiary,
the Fairfield Group, to ICC's shareholders. Id. at 1340-42. The
dividends of stock were issued on a pro rata basis to all
stockholders and did not require any consideration. Plaintiff
alleged that defendants' statements greatly undervalued the subsidiary, and that the directors would not have issued the
dividend had they known the true value of the Fairfield Group.
The court examined the issue of whether the issuance of a stock
dividend by the plaintiff corporation was a "sale" within the
meaning of 10(b). Id. at 1344-46. The court explained the
holding in Shaw and held that it "d[id] not find it
determinative" in the context of 10(b) because "`Congress itself
has cautioned that the same words may take on a different
coloration in different sections of the securities laws . . .
[and w]e must therefore address ourselves to the meaning of the
words "purchase or sale" in the context of 10(b).'" Id. at 1345
(quoting SEC v. Nat'l Sec., Inc., 393 U.S. 453, 466 (1969)).
The court then went on to interpret the term "sale" in the
context of 10(b). The Court considered "whether the fraudulent
conduct alleged . . . `is the type of fraudulent behavior which
was meant to be forbidden by [Section 10(b)].'" Id. (quoting
Nat'l Sec., 393 U.S. at 467). The court emphasized that "§
10(b) was intended by Congress to protect investors, including
corporations, from deceptive devices and contrivances which would
inhibit informed decision-making in the course of securities
transactions." Id. (citing Supt. of Ins. v. Bankers Life &
Cas. Co., 404 U.S. 6, 12 (1971)). The court found the issuance
of a dividend by a corporation to fit within 10(b)'s purpose
because the denial of material information to a corporation would
disable the corporation "from availing itself of an informed
judgment" when deciding to spin-off a subsidiary. Id.
The court also held that consideration was not necessary to
qualify a transaction as a sale because "a rote emphasis on
consideration [is] inconsistent with the broad scope of
protection under § 10(b) for those who engage in transactions
eventuating in the acquisition or disposition of securities."
Id. at 1346. c) Framework of Shaw and Vesco
Reading Shaw and Vesco together, there are three
significant factors that both cases focus upon. First, both
considered whether the transaction involved decision-making.
172 F.2d at 142; 490 F.2d at 1345. Other cases have followed this
line of reasoning. For example, in Fidelis Corp. v. Litton
Indus., Inc., 293 F. Supp. 164, 166 (S.D.N.Y. 1968),
shareholders of Fidelis brought a 10(b) action against Litton
Inc. for fraudulent misrepresentation. In a corporate buyout of
Fidelis by Litton, the stockholders of Fidelis had an election of
how many shares of Litton stock they would receive in exchange
for their stock in Fidelis and the assets of Fidelis. Id. at
166-67, 169. The Fidelis shareholders contended that they relied
on the misrepresentations made by Litton in agreeing to receipt
of a lower amount of Litton stock. Id. at 169. The court seemed
to find it pivotal that the Fidelis shareholders had a choice as
to how much Litton stock they would receive in the exchange and
that they chose the amount of stock based on fraudulent
information. Id. at 169-70. ("Since the Fidelis shareholders
had an election as to how much Litton stock they would receive
from Litton through Fidelis, they are deemed to be purchasers.")
Second, both Shaw and Vesco found significant whether the
transactions at issue were within the purpose of the statute that
defendants allegedly violated. 172 F.2d at 142; 490 F.2d at 1345;
see also Ingenito v. Bermec Corp., 376 F. Supp. 1154, 1180 n.
10 (S.D.N.Y. 1974) ("The Vesco Court relied heavily on the rule
that the securities laws are to be interpreted flexibly, in order
to affect Congress' purposes."). This second factor is closely
tied to the first: if the purpose of 10(b) is to make an informed
investment decision, Vesco, 490 F.2d at 1345, the opportunity
to make a decision is a prerequisite to this protection.
Finally, Shaw and Vesco suggest that Section 16(b) requires
that transactions are made with consideration in order to qualify
as a purchase or sale, but Section 10(b) does not.
172 F.2d at 142; 490 F.2d at 1346; see also Ingenito,
376 F. Supp. at 1180 n. 10 ("After [Vesco], it is not clear whether
consideration must pass between the parties for purposes of
determining whether a 10(b) purchase or sale has taken place.").
2. Application to Plaintiffs Acquisition of ABIZ Stock
Applying Shaw and Vesco and their progeny to the
transaction at issue, this Court finds that those plaintiffs who
were shareholders of ACC and received ABIZ stock as a dividend on
January 11, 2002 did not engage in a "purchase" within the scope
of Section 10(b).
First, plaintiffs did not participate in any sort of investment
decision. They made no election whether or not to receive ABIZ
stock (instead of a cash dividend), nor had any choice as to how
much ABIZ stock to receive in the dividend. Like the plaintiff in
Shaw, plaintiffs here did not "acquire something by [their] own
act or agreement for a price . . . [and] performed no act, made
no agreement . . . for the receipt of [their] rights."
172 F.2d at 142. Although Vesco and the transaction at issue both
involved issuance of dividends, Vesco is not controlling here
because the plaintiff in Vesco was the corporation that decided
to issue the dividend, 490 F.2d at 1340-42; whereas, here
plaintiffs are stockholders that passively received a dividend.
Simply receiving stock as a dividend does not have the element of
decision-making necessary for a "purchase."
Second, the transaction at issue is not the type meant to be
governed by 10(b). Section 10(b) seeks to ensure that investors
make decisions based on honest information and to prevent fraudulent information from impacting securities
investment decisions. Id. at 1345. Plaintiffs who received ABIZ
stock as a dividend cannot argue that defendants' fraudulent or
misleading statements prevented them "from availing [themselves]
of an informed judgment" in deciding to enter into a securities
transaction because those plaintiffs never made an investment
decision. See id. This is not the type of transaction
Congress intended to bring within the scope of Section
Finally, the court turns to the issue of consideration.
Although plaintiffs did not give any consideration for receipt of
the ABIZ stock, the court finds that fact not controlling after
Thus, the Complaint is dismissed as to any purported class
member who only received Adelphia Business stock as a
dividend.*fn12 III. Section 20(a) Claim
Defendants also move to dismiss plaintiffs' claim against the
Rigases for liability as control persons under Section 20(a) of
the Securities Exchange Act of 1934,
15 U.S.C. § 78t(a).*fn13 In order to make out a prima facie case under
Section 20(a), plaintiffs must show: "(1) a primary violation by
the controlled person; (2) control of the primary violator by the
defendant; and (3) `that the controlling person was in some
meaningful sense a culpable participant' in the primary
violation." Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir.
1998) (quoting SEC v. First Jersey Sec., Inc., 101 F.3d 1450,
1472 (2d Cir. 1996)).
A. Dual Claims for Primary and Secondary Liability
Defendants argue that Plaintiff cannot plead both primary and
secondary liability against the same set of defendants. (Defs.'
Mem. at 9.)
The Complaint alleges a 10(b) claim against the Rigas
defendants for various securities violations. (Compl. ¶¶ 90-94.)
The Complaint also contains a 20(a) claim against the defendants
alleging that they controlled ABIZ while ABIZ engaged in various
10(b) violations. (Id. ¶¶ 95-99.) (See also id. ¶ 96
("[E]ach of the Defendants acted as a controlling person of
Adelphia Business . . . [and] Adelphia Business, by the conduct
set forth herein, violated the federal securities law in the
manner set forth herein.")) Plaintiffs do not allege that the
Rigas defendants are both the controlling persons and the controlled persons in their 20(a) claim. Rather, plaintiffs
allege that ABIZ is the controlled entity and the Rigases are the
"`Controlling-person liability' under § 20 of the Securities
Exchange Act is a separate inquiry from that of primary liability
and provides an alternative basis of culpability." Suez Equity
Invs. v. Toronto-Dominion Bank, 250 F.3d 87, 101 (2d Cir. 2001).
"Although a defendant may ultimately not be held liable as both a
primary violator and a controlling person, such alternative
theories are permissible" in the pleadings stage. In re Parmalat
Sec. Litig., 375 F. Supp. 2d 278, 310 (2005) (citing In re
Scholastic Corp. Sec. Litig., 252 F. 3d 63, 77 (2d Cir. 2001));
see also In re Globalstar Sec. Litig., No. 01 Civ. 1748, 2003
WL 22953163, at *13 (S.D.N.Y. Dec. 15, 2003); Teamsters Local
445 Freight Div. Pension Fund v. Bombardier Inc., No. 05 Civ.
1898, 2005 WL 2148919, at *15 & n. 207 (S.D.N.Y. Sept. 6, 2005)
(quoting Parmalat with approval and allowing plaintiffs to
proceed with both 20(a) and 10(b) claims against the same set of
defendants); Fed.R.Civ.Proc. 8(e)(2) ("A party may set forth
two or more statements of a claim or defense alternately or
hypothetically, either in one count or defense or in separate
counts or defenses.").
B. Control Requirement
Finally, defendants contend that Plaintiffs have not
sufficiently alleged control on the part of defendant John Rigas.
Control for the purpose of Section 20(a) may be established by
showing that each individual defendant "possessed `the power to
direct or cause the direction of the management and policies'" of
ABIZ. See First Jersey, 101 F.3d at 1473 (quoting
17 C.F.R. § 240.12b-2). "`A person's status as an officer, director, or
shareholder, absent more, is not enough to trigger liability under § 20.'" Sloane
Oversees Fund, Ltd. v. Sapiens Int'l Corp., N.V.,
941 F. Supp. 1369, 1378 (S.D.N.Y. 1996) (quoting Hemming v. Alfin Fragrances,
Inc., 690 F. Supp. 239, 245 (S.D.N.Y. 1988)). To survive a
motion to dismiss under 20(a), a plaintiff need only "plead facts
which `support a reasonable inference that [defendants] had the
potential power to influence and direct the activities of the
primary violator.'" Sloane, 941 F. Supp. at 1378 (quoting Food
and Allied Serv. Trades Dept., AFL-CIO v. Millfeld Trading Co.,
841 F. Supp. 1386, 1391 (S.D.N.Y. 1994)).
Defendants contend that plaintiffs have not properly alleged
that defendant John Rigas is a control person because he is only
a minority shareholder of ABIZ (17%) and Chairman of its Board of
Directors but not an officer. (Defs.' Mem. at 10 & n. 2). A
defendant need not be an officer in order to fit within the scope
of 20(a). A court "must consider the total effect of the various
indicia of control in combination," rather than examining any one
indicia in isolation. In re Leslie Fay Cos., Inc. Sec. Litig.,
918 F. Supp. 749, 763 (S.D.N.Y. 1996).
The Complaint alleges that John Rigas was the Chairman of the
Board of Directors of ABIZ, the founder of ACC (ABIZ's parent
corporation), (Compl. ¶ 21), owned 17% of stock in ABIZ, (Compl.
¶ 22), and signed ABIZ's 1999 Annual Reports, (Compl. ¶ 43). The
Complaint also alleges that the Rigas family, headed by John
Rigas, owned a majority of the voting power of ABIZ stock,
directed the company's affairs, and caused the company to engage
in the alleged fraud. (See Compl. ¶¶ 5, 6, 22, 23, 39, 42-43,
47, 51, 53, 54, 55, 61, 63, 73, 89, 97-98). Further, the
Complaint alleges that defendants, including John Rigas,
"participat[e]d in and/or [were] aware of the Company's operations," had "intimate knowledge of the Company's
actual performance," "had unlimited access to copies of the
Company's reports, press releases [and] public filings" that were
allegedly misleading "and had the ability to prevent the
issuance" of those statements, and "had direct involvement in the
day-to-day operations of the Company." (Compl. ¶¶ 97-98; see
also Compl. ¶ 23.)
Other district courts in this Circuit have found allegations of
control sufficient in similar circumstances. See, e.g., In re
Leslie Fay, 918 F. Supp. at 763 (finding allegations of control
sufficient in the case of outside directors who held 12% of stock
and signed public disclosure documents that allegedly contained
misrepresentations); Robbins v. Moore Medical Corp.,
788 F. Supp. 179, 188 (S.D.N.Y. 1992) (finding allegations of control
sufficient as against defendants who were directors or officers
and signed company statements that were allegedly misleading);
see also In re Solucorp Indus., Ltd., No. 98 Civ. 3248, 2000
WL 1708186, at *7 (S.D.N.Y. Nov. 15, 2000) ("As either a member
of Solucorp's senior management or a director with access to
information regarding Solucorp's day-to-day business, the
individual defendants are alleged to have had the power and
influence to cause Solucorp to engage in the alleged fraudulent
This Court finds plaintiffs' allegations sufficient to support
a "reasonable inference" that John Rigas "had the potential power
to influence and direct the activities" of ABIZ. See Sloane,
941 F. Supp. at 1379. The motion to dismiss the 20(a) claim is
therefore denied. IV. Leave to Amend
While plaintiffs have not requested leave to amend any
deficient claims, the decision whether to grant leave to amend
rests within the sound discretion of the district court. See
Cresswell v. Sullivan & Cromwell, 922 F.2d 60, 72 (2d Cir.
1990). Pursuant to Federal Rule of Civil Procedure 15(a), leave
to amend a complaint "shall be freely granted when justice so
requires." See Cortec Indus., Inc. v. Sum Holding L.P.,
949 F.2d 42, 48 (2d Cir. 1991). However, plaintiffs need not be
granted leave to amend where amendment would be futile. See
Marchi v. Board of Coop. Educ. Servs. of Albany, 173 F.3d 469,
478 (2d Cir. 1999); Chill v. General Elec. Co., 101 F.3d 263,
272 (2d Cir. 1996).
Plaintiffs may, to the extent required, amend the Complaint
with respect to the 10(b) claims within 45 days of the date
hereof if they can cure the defects regarding particularity set
forth above. However, leave to amend is denied with respect to
plaintiffs who received ABIZ stock as a dividend because any
amendment would be futile. As it is unclear from the face of the
Complaint which plaintiffs fall into this category, plaintiffs
are to include in an amended complaint the names of those
plaintiffs who actually purchased ABIZ securities on the open
market. For the reasons stated above, defendants' motion to dismiss is
granted in part and denied in part, and plaintiffs are granted
limited leave to amend their Complaint.
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