United States District Court, S.D. New York
December 9, 2005.
In re PRONETLINK SECURITIES LITIGATION.
The opinion of the court was delivered by: RICHARD OWEN, District Judge
OPINION & ORDER
Class plaintiffs allegedly injured stockholders sue under §
10 of the Exchange Act of 1934, and Rule 10b-5 promulgated
thereunder, against the CEO, Jean Pierre Collardeau, and
Executive Vice President, Glen Zagoren, of the now-defunct
ProNetLink Company ("PNL"), as well as its outside auditors and
their putative successors in interest. Plaintiffs bring
additional claims against the CEO and the EVP for violating
Section 20(a) of the Exchange Act under a theory of control
person liability, and against CEO Collardeau for violating
Section 20A of the Exchange Act by engaging in insider trading.
The Second Consolidated Amended Complaint ("the complaint")
alleges that Collardeau and Zagoren engaged in a "pump and dump"
scheme wherein they artificially inflated the value of PNL stock
while secretly selling their shares to the public.*fn1 The complaint further alleges that defendant
Feldman Sherb & Co. the company's outside auditor knew or
recklessly disregarded repeated warnings that PNL would not be
able to perform as they represented, and damages are sought
against Sherb & Co. and Grassi & Co. as successors in interest to
Feldman Sherb.*fn2 Presently before me are defendants'
motions to dismiss the complaint.
PNL was formed in 1997 to facilitate international trade
through various tools and services accessible through its
website. Its primary assets were (1) its website,
www.ProNetLink.com, marketed to the public as a resource for
facilitating international business transactions among small and
medium sized companies, and (2) PNL-TV, a facility for producing
programming for the internet. PNL's initial public offering was
not a success. Despite selling 7.5 million shares through private
placements, it brought in only $150,000.*fn3 This inside
placement of PNL stock was allegedly the first step in executing
the pump and dump scheme by placing company stock secretly
within his personal control, Collardeau would be able to sell it
quietly while continuing to pump the stock to the public.
In March 1998, Collardeau retained the services of defendant
Glenn Zagoren, the president of Zagoren-Zozzora, Inc., a strategy
and marketing company. Zagoren was appointed a director of the
company in May 1998.
The alleged class period began on August 26, 1998, when the
company announced in a press release its first "live" broadcast
to increase the level of interest in the company's internet
broadcast operations, and to increase the price of the company's
stock. The complaint alleges that Zagoren and Collardeau repeatedly misled the public through
false public filings, press releases, shareholder meetings, and
postings on the internet. Most of the false claims were made
online, frequently by posting messages on business-oriented
websites and by directed internet advertising programs. One such
claim was made on the Silicon Investor website, where PNL
"project[ed] 40,000 members by the end of the year at $360 per
year."*fn4 Shortly after this statement was made, PNL stock
reached its all time high on May 13, 1998 of $8.09. In its
January 27, 2000 amended 10-Q, PNL represented that "as of
September 30, 1998, PNL had approximately 450 members (of which
40 were subscription paying members)." Plaintiffs also allege on
the basis of statements by an unidentified witness a former
employee of the company that PNL had no inside sales force at
all prior to August 1999. The only effort to sell PNL's "product"
was the use of outside telemarketers, which allegedly yielded no
subscriptions. Similar projections were made at the Annual
Shareholder's meeting held on December 4, 2000. In response to an
investor's question of how many premium subscribers had signed
up, Zagoren replied that the company boasted over 8,000 paid
subscribers, when in fact, the company had fewer than 20 paid
("premium") subscribers in 2000.*fn5
The principals issued a June 1998 press release announcing a
"Voluntary Stock Lockup." There, CEO Jean Collardeau pledged:
[T]he management of the company . . . will not sell
any of their restricted stock to the public for a
period of one year. . . . Jean Pierre Collardeau,
ProNetLink President and CEO and the other members of
the executive staff control 16,500,000 shares of
restricted stock. . . .' We want to show the market
and our investors that we are behind ProNetLink and we are here for the long term' said Mr.
Collardeau, `Our goal is to build the most
comprehensive import-export tool on the internet.'
This press release was intended to inspire confidence in
investors and to quell fears about the viability of PNL's
product. The "Voluntary Stock Lock-up" was "extended" on June 15,
1999. The press release stated: "Jean Pierre Collardeau, the
President of ProNetLink, who voluntarily locked up his shares
last year will continue to do so for an additional year. In
addition to the lock-up, Mr. Collardeau has not taken any salary
or compensation since the start of the company." Contrary to
these representations, the complaint asserts that throughout this
period, Collardeau had used secret alter-ego, or "nominee"
accounts, to trade PNL stock for substantial profits. On April
17, 2000, Collardeau sold over a million of his
previously-restricted PNL shares for $4.3 million in profit.
The class period has as its end July 2, 2001, which was
ProNetLink's disclosure by press release that the company had
filed a voluntary petition for bankruptcy under Chapter 7. At
this point, subsequently-appointed lead plaintiff Doreen Labit
undertook her factual investigation to determine whether to file
suit. On April 3, 2003, approximately 22 months after the
bankruptcy filing, the instant securities fraud class action was
All defendants move under Rules 9(b) and 12(b)(6) to dismiss
the complaint. In considering a motion to dismiss pursuant to
Fed.R.Civ.P. 12(b)(6), the Court must accept as true all
material factual allegations in the complaint, Atlantic Mutual
Ins. Co. v. Balfour Maclaine Int'l, Ltd., 968 F.2d 196, 198 (2d
Cir. 1992), and may grant the motion only where "it appears
beyond doubt that the plaintiff can prove no set of facts in
support of [its] claim which would entitle [it] to relief,"
Still v. DeBuono, 101 F.3d 888, 891 (2d Cir. 1996); see
Conley v. Gibson, 355 U.S. 41, 48 (1957). In addition to the
facts set forth in the complaint, the Court may also consider
documents attached thereto and/or incorporated by reference
therein, Automated Salvage Transp., Inc. v. Wheelabrator Envtl. Sys., Inc.,
155 F.3d 59, 67 (2d Cir. 1998), as well as matters of public record,
Pani v. Empire Blue Cross Blue Shield, 152 F.3d 67, 75 (2d Cir.
1998), cert. denied, 525 U.S. 1103 (1999).
As a threshold contention, all defendants assert that all of
plaintiffs' claims are timebarred. At the time of PNL's
bankruptcy filing, private causes of action under Section 10(b)
and Rule 10b-5 had, as an initial statute of limitations, one
year from the discovery of the violation.*fn6 See Lampf,
Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350
(1991). The Sarbanes-Oxley Act, passed July 30, 2002, extended
that period to two years as to any cause of action that was
within the said one year limitation. See 28 U.S.C. § 1658(b).
Or, in more detail, any 10(b)/Rule 10b-5 claim that was "live"
within its first year on this date had its limitations period
extended to two years from the date of discovery or five years
from the violation. 28 U.S.C. § 1658(b)[A](1)-(2). The question
of whether the present action was timely filed therefore depends
on whether the cause of action was live when Sarbanes-Oxley was
enacted. As set forth hereafter, I conclude that plaintiffs have
made such a showing and that certainly dismissing the suit on
statute of limitations grounds at this point would be premature.
Here, the statute of limitations starts to run when the party
bringing the action has actual or constructive notice of its
cause of action, the latter meaning when "a reasonable investor
of ordinary intelligence would have discovered the existence of
the fraud." Dodds v. CIGNA Securities, Inc., 12 F.3d 346, 350
(2d Cir. 1993). Inquiry notice in the 10(b)/Rule 10b-5 context, a
related concept, does however create a duty to inquire that
arises when the circumstances often called "storm warnings"
"would suggest to an investor of ordinary intelligence the
probability that she has been defrauded." Lentell v. Merrill
Lynch & Co, 396 F.3d 161, 168 (2d Cir. 2005). However, "the existence of fraud must be a
probability not a possibility," and "whether a plaintiff had
sufficient facts to place it on inquiry notice is often
inappropriate for resolution on a motion to dismiss." Id.
(internal citations omitted). After the duty to inquire arises,
knowledge of a cause of action can actually form in the mind of
the investor, or this knowledge can be imputed to the investor in
one of two ways: (i) "[i]f the investor makes no inquiry once the
duty arises, knowledge will be imputed as of the date the duty
arose"; and (ii) if some inquiry is made, "we will impute
knowledge of what an investor in the exercise of reasonable
diligence should have discovered concerning the fraud, and in
such cases the limitations period begins to run from the date
such inquiry should have revealed the fraud." Id. (quoting LC
Capital Partners, LP v. Frontier Ins. Group, Inc., 318 F.3d 148,
154 (2d Cir. 2003)) (internal citations omitted). While this
latter method (the "actual inquiry method") does consider the
actual time expended to investigate whether to bring suit, the
investor cannot simply extend the statute of limitations by her
own foot-dragging, since the test for when plaintiff "will be
deemed to have discovered securities fraud for purposes of
triggering the statute of limitations . . . is an objective one."
Coleman & Co. Securities, Inc. v. Giaquinto Family Trust,
236 F.Supp.2d 288, 307 (S.D.N.Y. 2002).
A bankruptcy filing does not necessarily trigger the statute of
limitations by itself if the plaintiff undertakes a diligent
inquiry. See Europadisk Holdings LLC v. Shelton, No. 03 Civ.
4505, 2004 WL 613109 at *4 (S.D.N.Y. 2004) ("Defendant argues
that the Company's June 11, 2002 bankruptcy filing, standing
alone, placed plaintiff on inquiry notice of the alleged fraud.
We do not find this rule anywhere in the case law, and we decline
to adopt it here. While bankruptcy may constitute a storm warning
in combination with other circumstances, it does not necessarily
do so per se."). Whether an inquiry was diligent is a question of
fact that should not be decided at the motion to dismiss phase. See In re Global
Crossing, Ltd. Securities Litigation, 313 F.Supp.2d 189, 203
Against the above, the parties dispute when plaintiffs were put
on inquiry notice. Defendants, in a bizarre reverse self-serving
assertion designed to exculpate to exculpate themselves here,
contend that the triggering notice of their liability was so much
earlier that the statute had run by the time plaintiffs did file
in 2002. Thus, the defendants contend that long prior to filing
for bankruptcy, not only did PNL release several pieces of
information that were "red flags" that put plaintiffs on inquiry
notice, but also that plaintiffs did nothing. For example,
Collardeau argues that PNL's SEC Form revisions and submissions
in 2000 put plaintiffs on actual notice that PNL's earlier
membership projections were false, and plaintiffs thus were put
on inquiry notice of fraud in 2000 at the latest. Therefore,
according to Collardeau, the then one-year statute was triggered
too early to overlap with Sarbanes-Oxley, and therefore ran well
before plaintiffs' filing. But the fact that the statements were
inaccurate does not mean that plaintiffs should have assumed the
statements were also fraudulent. The disclosures do not, as a
matter of law, indicate the probability of defendants' fraud.
Lentell, 396 F.3d at 168. Also, these disclosures were
contravened by several allegedly false and misleading statements
that could have caused a reasonable shareholder to think all was
well with PNL's business. For example, Collardeau allegedly
reassured shareholders at the December 4, 2000 shareholder
meeting by speaking of PNL's "very strong revenue-producing
possibilities," such as "virtual trade shows" for the United
Nations. Cmplt. ¶ 127. When a company's management tempers its
statements with "reliable words of comfort," as PNL's management
did, investors are not put on notice. LC Capital Partners, LP v.
Frontier Ins. Group, Inc., 318 F.3d 148, 155 (2d Cir. 2003). When PNL filed for bankruptcy, however, it became apparent to
the reasonable investor that fraud was a "probability not a
possibility." Lentell, 396 F.3d at 168. Therefore, plaintiffs
were put on inquiry notice of the alleged fraud as of that date.
Defendants contend that the statute of limitations began running
on that date, but this is only so had plaintiffs with this
knowledge done nothing. However, from the record before me, lead
plaintiff Labit, on inquiry notice, immediately undertook a
sufficiently diligent inquiry upon learning of the bankruptcy.
She, lacking the funds to hire an attorney, contacted other PNL
shareholders to contribute toward a common fund, and by the end
of that month had collected $5000 and retained a New York
bankruptcy lawyer. At that attorney's suggestion, Labit applied
to the Bankruptcy Court for an examination of the debtor under
Rule 2004, Fed.R.Bankr.P. She spearheaded
information-gathering efforts among PNL shareholders and was
approached by several confidential sources. One of these sources,
identified in the complaint as "W-1", claimed Collardeau had been
trading millions of dollars in PNL stock through "nominee"
accounts. Labit, while disturbed by this information, at this
point nevertheless considered it uncorroborated hearsay from a
potentially biased former employee of the company and decided to
investigate further. On her attorney's advice, she endeavored to
obtain an affidavit, but was unsuccessful. By January 2002,
however, Labit and her attorney had gathered and reviewed
sufficient evidence to form a reasonable belief that fraud was
afoot actual notice and suit was initiated the next month,
Thus, to lay out the statute of limitations timeline: after the
bankruptcy filing, totting up the time, the first 28 days after
inquiry notice was covered by Lead Plaintiff's diligence, at
which point, whether or not actual or constructive notice of a
violation was yet clear, were the one year 10(b) statute of
limitations to be deemed applicable and commenced, that one year
extended to the time of the newly-enacted and overlapping Sarbanes-Oxley
two-year extension, 28 U.S.C. § 1658.*fn7 Therafter, but
well within this overall period this suit was timely
I leave the ultimate determination of Labit's diligence and the
timeline for an appropriate occasion, such as summary judgment or
trial, should it be raised. See In re Global Crossing,
313 F. Supp. 2d at 203. The insider trading cause of action is timely in
any case, as the statute of limitations under Section 20A of the
Exchange Act is five years. 15 U.S.C. § 78t-1(b)(4).
Defendants Zagoren and accountant Feldman Sherb further contend
that plaintiffs have not sufficiently pled scienter. To plead
scienter, plaintiffs must "allege facts that give rise to a
strong inference of fraudulent intent . . . 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." Shields v. Citytrust Bankcorp
Inc., 25 F.3d 1124, 1128 (2d Cir. 1994). The scienter standard
in this circuit was not changed by the passage of the Private
Securities Litigation Reform Act. See Novak v. Kasaks,
216 F.3d 300, 311 (2d Cir. 2000). Reviewing the facts alleged in the
complaint and submissions, see earlier pages hereof, I conclude
that scienter is adequately alleged as to Zagoren and Feldman
Defendants argue that the complaint should be dismissed for
failing to allege loss causation. To state a claim under § 10(b),
the complaint must allege that plaintiff's injury was caused by
his or her reliance on defendant's actions. See DeMarco v.
Robertson Stephens Inc., 318 F. Supp. 2d 110, 119 (S.D.N.Y.
2004). Causation has two prongs: transaction, or "but-for"
causation, and "loss causation, i.e., that the subject of the
fraudulent statement or omission was the cause of the actual loss suffered. Id. (quoting Suez
Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95
(2d Cir. 2001). Defendants do not contest transaction causation.
The complaint adequately alleges loss causation, because it
describes a "pump and dump" scheme whereby defendants did "their
best to pump up the very bubble that then predictably collapsed."
DeMarco, 318 F. Supp. 2d at 124. Plaintiffs allege that
defendants Collardeau and Zagoren lied and concealed the truth to
inflate the share price, that Feldman Sherb was reckless or
knowing in failing to disclose the truth, and that plaintiffs
lost money when the truth was revealed. Defendants' contentions
that intervening causes such as the inability to find further
financing or the bursting of the general technology stock bubble
were to blame for the collapse of PNL's share price must await
the trial. See Emergent Capital Investment Management, LLC v.
Stonepath Group, Inc., 343 F.3d 189, 197 (2d Cir. 2003);
DeMarco, 318 F. Supp. 2d at 126.
Plaintiffs assert that the statement in PNL's December 14, 1999
SEC filing that "for the period from Inception through September
30, 1999, [Collardeau] did not receive any compensation for
services in any capacity to ProNetLink" is misleading because it
does not disclose the surreptitious stock sales, which were his
source of "income." Collardeau attacks this, but the statement
may or may not have been misleading, depending on Collardeau's
view of the monies coming in.
Plaintiffs allege that the following statement in the September
30, 1999 Form 10Q-A2 was misleading:
The company's revenue increased from $11,759 for the
three-month period ended September 30, 1998, to
$241,802 for the three month period ended September
30, 1999. 99.3% of the revenue in 1999 occurred as a
result of ProNetLink's bartering transactions." Cmplt. ¶ 90. I leave this issue to the trial judge.
While defendants Grassi and Sherb & Co. contend that they are
not successors in liability of Feldman Sherb, and therefore the
suit should be dismissed as against them, the plaintiffs allege
facts that put defendants' contentions in issue. I therefore deny
the motion to dismiss the suit as against Grassi and Sherb & Co.
at this juncture.
Grassi also seeks dismissal on the ground that it did not
receive service of the initial April 3, 2003 complaint within 120
days of filing. Rule 4(m) of the FRCP states in relevant part:
If service of the summons and complaint is not made
upon a defendant within 120 days after the filing of
the complaint, the court, upon motion or on its own
initiative after notice to the plaintiff, shall
dismiss the action without prejudice as to that
defendant or direct that service be effected within a
specified time; provided that if the plaintiff shows
good cause for the failure, the court shall extend
the time for service for an appropriate period.
Even if so, there is no reason to dismiss the action without
prejudice as to Grassi, for the properly-consolidated complaint
was served shortly thereafter, and what is accomplished by a
court-permitted reservice of the superseded initial complaint?
Defendant Collardeau argues that plaintiff's Section 20(a)
claim should be dismissed, because PNL was not named as a
defendant. See Griffin v. PaineWebber, Inc.,
84 F. Supp. 2d 508, 516 (S.D.N.Y. 2000). Plaintiffs respond that they did not
name PNL because of its bankruptcy, but it appears it should at
least be named. Id. Accordingly, while the Section 20(a) claim
is dismissed without prejudice, plaintiffs are allowed 30 days in
which to file an amended complaint naming PNL as a nominal
defendant. In all other respects, the Section 20(a) and 20A
claims are adequately pleaded.
The foregoing is So Ordered.
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