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IN RE VAN DER MOOLEN

December 13, 2005.

In Re VAN DER MOOLEN HOLDING N.V. SECURITIES LITIGATION.


The opinion of the court was delivered by: ROBERT SWEET, District Judge

OPINION

Defendants Van der Moolen Holding, N.V. ("VDM Holding"), Friedrich M.J. Bottcher ("Bottcher"), Frank F. Dorjee ("Dorjee"), James P. Cleaver ("Cleaver"), and Casper F. Rondeltap ("Rondeltap")*fn1 have moved pursuant to Rules 9(b) and 12(b) (6) to dismiss the amended consolidated class action complaint ("the Complaint") filed by co-lead plaintiffs Elizabeth Rick and Linda Greene (the "Plaintiffs"). Defendant Van der Moolen Specialists USA, LLC ("VDM Specialists")*fn2 has moved separately to dismiss the Complaint pursuant to Rules 9(b) and 12(b) (6).

For the reasons set forth below, the motions of VDM Holding and VDM Specialists are denied. The motions of the Individual defendants are granted in part and denied in part. Plaintiffs are granted leave to replead within thirty (30) days of entry of this opinion.

  Prior Proceedings

  This action was commenced on October 20, 2003, with the filing of a class action complaint against VDM Holding, VDM Specialists, Bottcher, Cleaver, Dorjee, and Rondeltap. By opinion and order dated April 14, 2004, co-lead plaintiffs were appointed and co-lead plaintiffs' requests with regard to the appointment of counsel were granted. See Rozenboom v. Van Der Moolen Holding, N.V., No. 03 Civ. 8284 (RWS), 2004 WL 816440, at *7 (S.D.N.Y. Apr. 14, 2004). The Complaint was filed on September 14, 2004. On November 22, 2004, VDM Holding, Bottcher, Dorjee, Cleaver, and Rondeltap moved to dismiss the Complaint. Also on November 22, 2004, VDM Specialists moved separately to dismiss the Complaint. Both motions were heard and marked as fully submitted on March 30, 2005.

  The Parties

  Plaintiffs purchased publicly traded shares of VDM Holding ADRs between October 18, 2001 and October 15, 2003 (the "Class Period").

  VDM Holding is a limited liability company organized and existing under the laws of the Netherlands. Its principal place of business in the United States is located at 45 Broadway, New York, New York.

  VDM Specialists, a limited liability company organized and existing under the laws of the United States, is a majority-owned subsidiary of VDM Holding. It was established on or about July 1999, when VDM Holding acquired majority interests in, and integrated the operations of, three previously separate NYSE specialist firms. VDM Specialists is a broker-dealer registered with the SEC pursuant to Section 15 (b) of the Exchange Act. As of August 31, 2003, VDM Specialists acted as the registered specialist for approximately 377 NYSE-listed securities, which then accounted for approximately 11% of the dollar volume and 12% of the share volume traded on the NYSE. According to VDM Holding's 2002 Annual Report, which is referenced in the complaint, VDM Specialists was at that time the fourth largest specialist firm on the NYSE.

  VDM Holding owns 75% of VDM Specialists. The other 25% of VDM Specialists is owned by its senior managers, senior traders and other individual members of VDM Specialists. These individual members of VDM Specialists are all employees of VDM Holding.

  Bottcher has been Chief Executive Officer ("CEO") and Chairman of the Management Board ("Chairman") of VDM Holding since January 2000. He has been a member of the VDM Holding Management Board (the "Board") since 1997. Bottcher is alleged to have signed certain false and misleading statements published by VDM Holding during the Class Period.

  Dorjee has been the Chief Financial Officer ("CFO") of VDM Holding since January 1, 2001. He has been a member of the VDM Board since April 11, 2001. Dorjee is alleged to have signed certain false and misleading statements published by VDM Holding during the Class Period.

  Cleaver has been a member of the VDM Holding Board since April 10, 2002. He has been Chairman of the VDM Specialists Board since 1998. Prior to joining VDM Specialists, Cleaver was the managing partner of an NYSE specialist firm acquired by VDM Holding in 1998. Cleaver is alleged to have signed certain false and misleading statements published by VDM Holding during the Class Period.

  Rondeltap has been a member of the VDM Specialists management committee since 2000, and he serves as VDM Specialists' spokesman. Rondeltap has been a member of VDM Holding's Board since April 9, 2003. Rondeltap is alleged to have signed certain false and misleading statements published by VDM Holding during the Class Period.

  The Action

  This action is brought on behalf of all persons who purchased American Depository Receipt shares ("ADRs")*fn3 in VDM Holding during the Class Period and who were damaged thereby. VDM Holding ADRS are alleged to have been traded actively on the NYSE throughout the proposed class period. VDM Holding, through one of its four operational segments known as VDM Specialists, acts as a Specialist firm on the New York Stock Exchange ("NYSE"). Specialist firms are responsible for maintaining a fair and orderly market in one or more specific securities and must adhere to NYSE rules that require specialist firms to refrain from trading on the specialist firm's own account when enough public investor orders exist to pair up naturally, without undue intervention.

  It is alleged that during the Class Period, VDM Holding materially overstated and artificially inflated its earnings, net income, and earnings per. The Complaint alleges that VDM Holding failed to disclose that throughout the Class Period, VDM Specialists derived a substantial share of its revenue from illegal trading practices and that subsequent declines in VDM Holding's revenue were attributable to the apparent cessation of such practices.

  Count One of the Complaint asserts that the Defendants violated Section 10(b) of the Securities Exchange Act of 1934 ("the Exchange Act") and Rule 10b-5 promulgated thereunder. Count Two asserts that VDM Holding and the Individual Defendants violated Section 20(a) of the Exchange Act.

  Facts

  The following facts are drawn from the Complaint and do not constitute findings of the Court.

  It should be noted that the Complaint's allegations concerning the general duties and obligations of a specialist, the improper trading allegedly engaged in by members of VDM Specialists and others, and the NYSE and SEC investigations into such trading practices are substantially similar to those contained in the Consolidated Complaint filed in In re NYSE Specialists Securities Litigation, No. 03 Civ. 8264 (RWS). Those allegations are described in significant detail in a companion opinion issued today in connection with the In re NYSE Specialists action. See In re NYSE Specialists Securities Litigation, No. 03 Civ. 8264 (RWS), slip op. at 11-29 (S.D.N.Y. Nov. 9, 2005). Familiarity with this companion opinion is assumed. VDM Holding principally engages in the trading of securities on exchanges in the United States and Europe. Its NYSE specialist operations are conducted exclusively through VDM Specialists.

  VDM Specialists' revenue is derived from two categories of activities: (1) executing trades as an agent, thereby earning a share of the commission on each trade that it facilitates, and (2) buying and selling stock shares on its own account, thereby capturing any profits that these trades generate. During the Class Period, VDM Holding derived a substantial majority of its revenue from VDM Specialists. For example, in 2000, 63.4% of VDM Holding's revenue was generated by VDM Specialists, and in the first six months of 2001, 72% of VDM Holding's revenue was so generated. During the Class Period, VDM Holding stated: "We depend heavily on our New York Stock Exchange specialist activities, and if they fail to grow as anticipated, it would hamper our revenue growth." (Compl. ¶¶ 42, 43.)

  It is alleged that from the start of the Class Period until at least January 2003, VDM Specialists breached its obligations and duties as an NYSE specialist by: (1) causing and allowing its traders to trade ahead of its customers; (2) interpositioning itself between matching public buy and sell orders; (3) failing to properly execute limit orders; and (4) freezing the Display Book (which reflects incoming orders to the NYSE) so that VDM Specialists could complete proprietary trades before completing orders entered by public investors.

  VDM Holdings made statements during the Class Period concerning its revenue and the financial performance of VDM Specialists, which are alleged to be false and misleading because they failed to disclose that VDM Specialists was engaged in illegal forms of proprietary trading. These alleged misstatements fall into two categories: (1) risk disclosures by VDM Holdings that implied that the Defendants were in compliance with NYSE rules, and (2) financial reports that failed to disclose that the revenue figures for VDM Specialists and VDM Holding were materially inflated as a result of VDM Specialists' reliance on illegal trading strategies. A description of all such statements is provided in the appendix to this opinion. Those statements relating to the revenue of VDM Specialists and VDM Holding are summarized below.

 
Quarter VDM VDM VDM VDM Holding Specialists Specialists Specialists Total Revenue Total Net Gain on Participation (Millions of Revenue Principal Rate*fn4 (%) Euros) Transactions
(Millions of Dollars)
Q1 `01 65.4 53.4 31.5 100.7 Q2 `01 51.7 41.6 32.1 81.2 Q3 `01 57.6 48.0 31.4 73.9 Q4 `01 61.8 51.6 30.7 89.3 Q1 `02 56.9 47.7 34.9 77.9 Q2 `02 66.4 55.8 34.5 86.3 Q3 `02 69.1 58.1 34.7 86.0 Q4 `02 59.7 49.1 34.4 77.2 (Improper trading alleged to have been curtailed by VDM

  Specialists in January 2003.) Q1 `03 40.7 31.6 31.7 48.4 Q2 `03 39.6 28.9 27.7 47.5 Q3 `03 37.3 27.4 27.7 43.3

  It is alleged that VDM Holding's financial statements during the Class Period violated SEC regulations and Generally Accepted Accounting Principles ("GAAP") in that they failed to: (1) disclose facts necessary to present a fair and truthful representation of VDM Specialists' trading activities; (2) provide required disclosures; and (3) identify and address those variables that were necessary for an overall understanding and evaluation of the company.

  On or about January 13, 2003, the NYSE notified VDM Holding that its Division of Market Surveillance had opened an investigation of VDM Specialists' conduct in connection with individual specialists' activities on the floor of the NYSE. As summarized in the chart below, it is alleged that once VDM Specialists learned of the NYSE investigation into its specialist trading activities (in or around January 2003), it was forced to curtail its illegal trading practices, which had a material adverse effect on VDM Specialists' revenue and participation rates and also on VDM Holding's revenue. However, it is alleged that instead of informing investors about the NYSE investigation on its profitability, VDM Holding told investors that the decline in income from VDM Specialists was the result of a challenging trading environment and modest increases in trading volume.

  On March 20, 2003, compliance officers of six of the seven NYSE specialists first met to discuss concerns about improper trading that had been raised in the NYSE's then-confidential investigation.

  On March 31, 2003, NYSE investigators began taking depositions in connection with the specialist investigation. VDM Holding did not disclose this information to its investors.

  On April 16, 2003, VDM Holding ADRs dropped 3.5% from $11.10 per share to close at $10.71 per share.

  On April 17, 2003, an article on the front page of The Wall Street Journal. stated that the NYSE was probing "whether at least two of [its] largest [specialist] firms may have engaged in "front-running," or trading ahead of clients. . . ." See Kate Kelly & Susanne Craig, Big Board Is Probing Specialists For Possible `Front-Running', Wall St. J., Apr. 17, 2003, at A1. That same day, the NYSE issued a one paragraph statement in which it disclosed that it had begun an investigation of several NYSE specialist firms for trading abuses. The closing price for VDM Holding ADRs on April 17, 2003 was $10.19 per share.

  On April 18, 2003, The Wall Street Journal identified VDM Specialists as a target of the NYSE investigation, indicated that the investigation was focused on allegations that specialists had intentionally provided inferior stock-execution prices to certain of their customers, and stated that the SEC had launched an investigation of trading practices at VDM Specialists and other specialist firms. See Kate Kelly & Susanne Craig, NYSE Probe Reaches 5 of 7 Specialist Firms — `Front-Running' Investigation Involves Biggest Companies, Wall St. J., Apr. 18, 2003, at C1. The following trading day, April 21, 2003, VDM Holding ADRs closed at $9.71 per share.

  On September 22, 2003, The Wall Street Journal reported that the SEC investigation had been expanded to examine whether specialist firms, including VDM Specialists, had traded ahead of customer orders. See Kate Kelly, Susanne Craig & Deborah Solomon, SEC Intensifies Inquiry at NYSE Of Trading Firms — Move Comes as Big Board Names Reed Interim Chief; Regulatory Role Questioned, Wall St. J., Sep. 22, 2003, at A1. That day, VDM Holding ADRs closed at $13.35 per share. The prior trading day, September 19, 2003, VDM Holding ADRs closed at $13.97 per share.

  On October 16, 2003, NYSE issued a press release stating that it was bringing disciplinary action and seeking fines from five specialist firms that had allegedly engaged in improper trading practices. That day, VDM Holding ADRs closed at $9.05. The day before, VDM Holding ADRs had closed at $10.61 per share.

  On March 30, 2004, VDM Specialists entered into a consent decree with the SEC and a substantially similar stipulation with the NYSE. These settlements state that between 1999 and 2003, VDMS Specialists engaged in interpositioning,*fn5 trading ahead, and failing to execute marketable limit orders. The settlements state that this conduct, which is estimated to have resulted in approximately $34.9 million of customer disadvantage between 1999 and 2003, violated VDM Specialists' duty to serve public customer orders over its own proprietary interests. Under the terms of these settlements, VDM Specialists neither admitted or denied these findings. Nonetheless, it agreed to pay $34.9 million in restitution and $22.7 million in civil fines to a fund benefitting customers allegedly disadvantaged from 1999 to 2003. On the day that the SEC and NYSE settlements were executed, VDM Holding ADRs closed at $9.29 per share. The previous day VDM Holding ADRs had closed at $8.91 per share.

  Based on the SEC and NYSE orders, Plaintiffs allege that Cleaver and Rondeltap (who were each members of VDM Specialists' management committee during some portion of the Class Period) and the other defendants had knowledge of the illegal trading practices engaged in by certain of VDM Specialists' traders. The SEC order stated, in pertinent part, that:
[c]ertain members of [VDM Specialists'] management committee engaged in interpositioning in one or more of the six stocks listed above [(i.e., Nortel Networks Corporation, PFE, Hewlett-Packard Company, Time Warner Inc., The Walt Disney Company, and Eli Lilly & Co.)], and these members of the management committee had the supervisory responsibility for [VDM Specialists'] trading operations on the NYSE floor, including supervising a floor captain who himself engaged in such interpositioning in one or more of the six stocks.
The NYSE provided VDMS with an examination report, dated December 26, 2001, showing that the firm had traded ahead and disadvantaged fourteen orders, including ten orders in Nortel Networks. The NYSE also provided VDMS with an examination report, dated December 30, 2002, which identified nineteen instances of trading ahead violations in Hewlett-Packard. Senior management at VDMS received these reports and reviewed them with NYSE staff.
See In the Matter of Van der Moolen Specialists USA, LLC, Corrected Order Instituting Administrative And Cease-And-Desist Proceedings (the "SEC Order"), Exchange Act Release No. 49,502, 83 SEC Docket 2366, 2004 WL 2093996, at ¶¶ 15-16 (Mar. 30, 2004).

  In April 2005, a grand jury in this district handed down criminal indictments against certain current and former individual specialists at the NYSE alleging violations of 15 U.S.C. §§ 78j (b) and 78ff and 17 C.F.R. § 240.10b-5. Since the information contained in these indictments can be judicially noticed by this Court, see Ives Labs., Inc. v. Darby Drug Co., 638 F.2d 538, 544 n. 8 (2d Cir. 1981), these materials will be considered in connection with this motion. See Kramer v. Time Warner Inc., 937 F.2d 767, 773 (2d Cir. 1991).

  Standards

  Defendants have moved for dismissal of the Complaint pursuant to Fed.R.Civ.P. 12(b) (6), 9(b), and the PSLRA. In considering a motion to dismiss pursuant to Rule 12(b) (6), the Court construes the complaint liberally, "accepting all factual allegations in the complaint as true, and drawing all reasonable inferences in the plaintiff's favor." Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002) (citing Gregory v. Daly, 243 F.3d 687, 691 (2d Cir. 2001)).

  However, "mere conclusions of law or unwarranted deductions" need not be accepted. First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 771 (2d Cir. 1994). Furthermore, the truth of factual allegations that are contradicted by documents properly considered on a motion to dismiss need not be accepted. See e.g., Rapoport v. Asia Elecs. Holding Co., 88 F. Supp. 2d 179, 184 (S.D.N.Y. 2000). The following materials may be considered on a Rule 12 (b) (6) motion:
(1) facts alleged in the complaint and documents attached to it or incorporated in it by reference, (2) documents "integral" to the complaint and relied upon in it, even if not attached or incorporated by reference, (3) documents or information contained in defendant's motion papers if plaintiff has knowledge or possession of the material and relied on it in framing the complaint, (4) public disclosure documents required by law to be, and that have been, filed with the Securities and Exchange Commission, and (5) facts of which judicial notice may properly be taken under Rule 201 of the Federal Rules of Evidence.
In re Merrill Lynch & Co., Inc., 273 F. Supp. 2d 351, 356-57 (S.D.N.Y. 2003) (footnotes omitted).

  "The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims." Villager Pond, Inc. v. Town of Darien, 56 F.3d 375, 378 (2d Cir. 1995) (quoting Scheuer v. Rhodes, 416 U.S. 232, 236 (1974)). In other words, "`the office of a motion to dismiss is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof.'" Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co. of New York, 375 F.3d 168, 176 (2d Cir. 2004) (quoting Geisler v. Petrocelli, 616 F.2d 636, 639 (2d Cir. 1980)). Dismissal is only appropriate when "it appears beyond doubt that the plaintiff can prove no set of facts which would entitle him or her to relief." Sweet v. Sheahan, 235 F.3d 80, 83 (2d Cir. 2000); accord Eternity Global Master Fund, 375 F.3d at 176-77.

  A claim under section 10 (b) sounds in fraud and must therefore meet the pleading requirements of Rule 9 (b), Fed.R.Civ.P. See, e.g., In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 69-70 (2d Cir. 2001). Such a claim must also satisfy certain requirements of the Private Securities Litigation Reform Act of 1995 ("the PSLRA"). See 15 U.S.C. §§ 78u-4 (b) (1) & 78u-4 (b) (2); see generally Novak v. Kasaks, 216 F.3d 300, 306-07 (2d Cir. 2000) (setting forth the heightened pleading standards of the PSLRA that must be met by a plaintiff who alleges securities fraud under Section 10 (b) and Rule 10b-5); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1127 (2d Cir. 1994) (stating that "[s]ecurities fraud allegations under § 10 (b) and Rule 10b-5 are subject to the pleading requirements of Rule 9 (b)").

  Rule 9 (b) provides that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally." Fed.R.Civ.P. 9 (b). The Second Circuit "has read Rule 9 (b) to require that a complaint [alleging fraud] `(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.'" Rombach v. Chang, 355 F.3d 164, 170 (2d Cir. 2004) (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)).

  In particular, the plaintiff must allege facts that "give rise to a strong inference of fraudulent intent." Novak, 216 F.3d 300, 307 (2d Cir. 2000). The Second Circuit has stated that this scienter requirement can be satisfied:
"`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.'"
Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995) (quoting Shields v. Citytrust Bancorp, Inc. 25 F.3d 1124, 1128 (2d Cir. 1994)).

  Rule 8's general pleading requirement and Rule 9(b)'s particularity requirement must be read together. See Ouaknine v. MacFarlane, 897 F.2d 75, 79 (2d Cir. 1990) (stating that "Rule 9 (b) . . . must be read together with Rule 8 (a) which requires only a `short and plain statement' of the claims for relief"); Credit & Fin. Corp. v. Warner & Swasey Co., 638 F.2d 563, 566 (2d Cir. 1981) (same); In re Initial Pub. Offering Sec. Litig. ("IPO"), 241 F. Supp. 2d 281, 327 (S.D.N.Y. 2003). These two rules have been read together to mean that a plaintiff need not plead evidentiary details. See, e.g., id. The Second Circuit has stated that it does "not require the pleading of detailed evidentiary matter in securities litigation." Scholastic, 252 F.3d 63, 72.*fn6 Courts of this district have stated that "the application of Rule 9 (b) . . . must not abrogate the concept of notice pleading." IPO, 241 F. Supp. 2d at 327 n. 46.

  DISCUSSION

  I. Plaintiffs Have Stated A Section 10(b) Claim As To VDM Specialists, VDM Holding, And The Individual Defendants

  Count I of the Complaint asserts that VDM Holding, VDM Specialists, and the Individual Defendants violated Section 10 (b) of the Exchange Act and Rule 10b-5. Section 10(b) provides in pertinent part as follows:
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 —
. . .
(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in ...

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