The opinion of the court was delivered by: William H. Pauley III, District Judge
Beginning in the fall of 2003, the stock price of Yukos Oil Company ("Yukos" or the "Company") dropped precipitously in response to various measures taken by the Russian Federation. In October 2003, the Russian Federation arrested Yukos' President, Mikhail Khodorkovsky ("Khodorkovsky"), and seized his equity holdings in the Company. Soon thereafter, the Russian Ministry of Taxation (the "Tax Ministry") charged Yukos with underpaying the previous years' taxes by approximately $27.5 billion and the Russian Federation confiscated Yukos' primary assets, sending the Company into an economic tailspin.
The named plaintiffs ("Plaintiffs") in this securities fraud putative class action purchased Yukos securities between January 22, 2003 and October 25, 2003 (the "Class Period"). They allege that Yukos, its outside auditor and certain of its executives and controlling shareholders knowingly concealed the risk that the Russian Federation would take action against Yukos by failing to disclose: (1) that Yukos had employed an illegal tax evasion scheme since 2000 (the "Tax Scheme Allegations"); and (2) that Khodorkovsky's political activity exposed the Company to retribution from the current Russian government (the "Political Activity Allegations"). Plaintiffs assert claims against all defendants pursuant to Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and assert claims for control person liability against the officer and shareholder defendants pursuant to Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).
Presently before this Court are the motion of defendants Yukos and Bruce K. Misamore ("Misamore," and together with Yukos, the "Yukos Defendants") and the motion of Group Menatep Limited ("Menatep") (collectively, "Defendants") to dismiss the Consolidated Amended Complaint (the "Complaint") pursuant to the Private Securities Litigation Reform Act of 1995 ("PSLRA") and Rules 9(b), 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure.*fn1 For the reasons that follow, Menatep's motion is granted in its entirety and the Yukos Defendants' motion is granted in part and denied in part.
Yukos is a Moscow-based joint-stock company whose shares trade on the Russian stock exchange. (Consolidated Amended Complaint, dated Mar. 9, 2005 ("Compl.") ¶ 31.) Yukos shares also trade indirectly on multiple European exchanges and over-the-counter in the United States as American Depository Receipts ("ADRs"). (Compl. ¶¶ 31, 183 & n.1.) At the beginning of the Class Period, Yukos was the largest oil producer in Russia. (Compl. ¶ 2.)
Khodorkovsky was Yukos' President, Chief Executive Officer and largest shareholder. (Compl. ¶¶ 10, 34.) The Complaint alleges that Khodorkovsky was part of a select group of Russian business leaders known as "oligarchs" who supported former Russian President Boris N. Yeltsin but were politically opposed to current Russian President Vladimir V. Putin ("Putin"). (Compl. ¶¶ 47, 85-87.) Misamore was the Chief Financial and Principal Accounting Officer of Yukos. (Compl. ¶ 36.) As such, he signed the Company's filings with the United States Securities and Exchange Commission ("SEC"). (Compl. ¶ 36.) The Complaint alleges that Khodorkovsky and Misamore were "directly involved in the day-to-day operations of the Company at the highest levels and [were] privy to confidential proprietary information." (Compl. ¶ 40.)
Menatep is a limited liability company organized under the laws of Gibraltar. (Compl. ¶ 32.) Khodorkovsy owned 28% of Menatep and Platon Lebedev ("Lebedev"), Menatep's Chief Executive Officer, owned 7%. (Compl. ¶¶ 32, 35.) Menatep owned and controlled 100% of Yukos Universal Ltd., which owned and controlled 61% of Yukos. (Compl. ¶ 32.)
Plaintiff Mykola Buinycki ("Buinycki") is a citizen of the United Kingdom who resides in Moscow and invested in Yukos ADRs. (Compl. ¶ 28; Certification of Mykola Buinycki, dated Aug. 17, 2004; Memorandum of Yukos Oil Company and Bruce K. Misamore in Support of Motion to Dismiss ("Yukos Defs. Mem.") at 40 n.48.) Plaintiff Roxwell Holdings Limited ("Roxwell Holdings") is a Bahamian corporation that purchased Yukos common stock on the Russian stock exchange during the Class Period. (Compl. ¶¶ 27, 183; Certification of Roxwell Holdings Limited, dated June 30, 2004 ("Roxwell Holdings Cert.").)
The Complaint describes Plaintiff Parsimony Ltd. ("Parsimony") as "a New York based corporation." (Compl. ¶ 29.) However, Parsimony is registered in the Channel Islands (Declaration of Luca Padulli, dated July 29, 2005 ("Padulli Decl.") ¶ 3) and its principal place of business and corporate headquarters, if any, have not been disclosed. The sole shareholder of Parsimony is Luca Padulli ("Padulli"), an Italian citizen who "resided" in New York during the Class Period and continues to do so "for at least five months per year." (Padulli Decl. ¶¶ 2-3.)
From New York, Padulli executed all of Parsimony's securities transactions that are at issue in this action. (Padulli Decl. ¶¶ 4-5.) Specifically, Padulli purchased bonds that were convertible into Yukos common stock. (Padulli Decl. ¶ 4; Certification of Adam Kinzer, dated Aug. 31, 2004 ("Parsimony Cert.").) The bonds were issued by a Swiss financial institution, UBS AG, and traded exclusively on the Luxembourg Stock Exchange. (Andreeva Decl. Ex. QQ: Bond Offering Mem., dated Aug. 29, 2001.) Because the bonds were not registered in the United States, they bore the restriction that they could "not be offered, sold or delivered within the United States or to U.S. Persons (as defined in Regulation S under the Securities Act . . .)." (Andreeva Decl. Ex. QQ.) Parsimony's investments were managed by Chasm Lake Management Services, LLC, a company based in New York. (Padulli Decl. ¶ 3.)
Together, these three Plaintiffs seek to represent a class of all entities and individuals that purchased these securities during the Class Period and were damaged thereby. (Compl. ¶ 182.)
II. The Tax Scheme Allegations
At all relevant times, the Tax Code of the Russian Federation prescribed a maximum income tax rate that incorporated two components: a tax payable to the federal budget and a tax payable to the budget of the taxpayer's local region. For example, in 2004, the statutory maximum rate was 24%, of which up to 6.5% could be collected by the federal government and up to 17.5% by regional governments. Russian Fed'n Tax Code Art. 284 § 1 (attached to the Declaration of Yulia Andreeva, dated June 3, 2005 ("Andreeva Decl.") as Ex. A). The Tax Code also prescribed a minimum rate for taxes payable to regional governments. In 2004, that rate was 13.5%. Russian Fed'n Tax Code Art. 284 § 1. However, the regional governments could offer tax benefits to reduce or even eliminate the regional budget liability of certain categories of resident taxpayers. Russian Fed'n Law of Enter. & Org. Profit Tax Art. 6 § 9 (Andreeva Decl. Ex. B). As a result of this regional variance in the effective federal income tax rate, taxpayers in the metropolitan regions of the Russian Federation, such as Moscow, paid higher taxes than taxpayers in remote regions, or "ZATOs."*fn2 (Compl. ¶ 61.)
Plaintiffs allege that from 2000 through 2003, Yukos grossly underpaid its taxes to the Russian Federation by illegally taking advantage of the ZATOs' preferential tax treatment. (Compl. ¶¶ 7, 61-64.) According to the Complaint, Yukos booked oil sales at "well below" market prices to seventeen trading companies, all of which were registered within ZATOs. (Compl. ¶¶ 7, 62.) Without taking physical possession, the trading companies sold the oil to customers at market prices and claimed the tax benefits of their ZATOs. (Compl. ¶¶ 7, 63.) However, the profits were "funneled . . . back to Yukos through defendant Menatep" and Yukos paid taxes only on the initial below-market sales while reaping substantial profits from the lowtax market-price sales. (Compl. ¶¶ 7, 62-63.)
Moreover, the Complaint alleges, the regional trading companies received the benefits of ZATO registration illegitimately because "[n]o business was actually conducted by the sham companies in the ZATOs" and they "did not process, store, or transport any oil products in the ZATOs." (Compl. ¶ 64.) As such, each "was an empty shell and an alter ego of Yukos and Menatep." (Compl. ¶ 61; see Compl. ¶ 7.) Plaintiffs further assert that Menatep controlled "the main bank" through which profits were allegedly redirected to Yukos. (Compl. ¶ 32.)
Plaintiffs allege that Defendants knew that the Yukos tax strategy presented enormous risk because it violated Russian law and because the Russian Federation had prosecuted other companies engaged in similar schemes. (Compl. ¶¶ 8, 77-80.) One of those companies was Yukos' competitor and another was Yukos' oil company subsidiary. (Compl. ¶¶ 68-72, 81-83.) Nonetheless, the Complaint alleges, Yukos issued materially misleading public statements that failed to disclose the risks or pertinent details of its tax strategy.
On February 13, 2003, Yukos reported earnings of $1.3 billion and net profits of $850 million for the third quarter of 2002. (Compl ¶¶ 5, 100.) The Company explained that its profits were "pushed down" as a result of a "one time" recognition of taxes that Yukos had deferred during the consolidation of its production facilities. (Compl ¶¶ 5, 100.) Khodorkovsky and Misamore reiterated these third-quarter financial results at an April 3, 2003 presentation to investors in London, but cautioned investors about the risk of increased tax liability "if regional income tax benefits were eliminated." (Compl. ¶ 102.) On April 24, 2003, Yukos announced that it would pay a dividend because of its strong financial results. (Compl. ¶ 104.)
On May 19, 2003, Yukos reported a net profit of $988 million and earnings per share of $0.46 for the fourth quarter of 2002. (Compl. ¶ 106.) The Company also published its yearly results, reporting net income of $3.058 billion and earnings per share of $1.42. (Compl. ¶ 106.) Yukos certified that these results conformed to U.S. Generally Accepted Accounting Principles ("GAAP"). (Compl. ¶ 106.) That same day, Yukos issued its 2002 Annual Report, which was signed by Misamore and filed with the SEC. (Compl. ¶ 108; Andreeva Decl. Ex. I.) In the Management's Discussion and Analysis section of that document, Yukos reported effective tax rates of 18.2% for 2001 and 19.6% for 2002 and due to "the lower tax rates for certain subsidiaries in several tax jurisdictions both within Russia and internationally." (Compl. ¶ 108; Andreeva Decl. Ex. I at 22.) The Annual Report assured investors that Yukos transacted business with related parties "on an arm's-length basis" and certified that the Company's results comported with "established international accounting principles." (Compl. ¶¶ 107-10.)
On July 7, 2003 and October 20, 2003, Yukos reported its financial results for the first and second quarters of 2003, respectively. (Compl. ¶¶ 114, 116.) The results, which were purportedly prepared in conformity with U.S. GAAP, reported increased net earnings and earnings per share. (Compl. ¶¶ 114, 116.) In the October earnings release, Yukos proclaimed that "profitability remains fairly high . . . and we are not expecting it to deteriorate." (Compl. ¶ 116.)
Plaintiffs allege that because the Company employed an "illegal tax scheme," the above statements overstated net profits and understated tax obligations. (Compl. ¶¶ 103, 105, 111, 117.) Moreover, the Complaint alleges that the Company's financial statements were not prepared in conformity with U.S. GAAP or other standards of financial reporting. (Compl. ¶¶ 103, 115, 117, 144-58.) Finally, Plaintiffs allege that the Company's representations regarding its effective tax rates should have disclosed that Yukos achieved those rates through "paper transactions" with "sham companies" at "well below-market prices." (Compl. ¶¶ 7, 61-64, 111(f).)
III. The Political Activity Allegations
Plaintiffs allege that at a secret meeting with Khodorkovsky and other oligarchs in 2000, Putin promised not to investigate potential wrongdoing at their companies if the oligarchs refrained from opposing Putin. (Compl. ¶¶ 9, 88.) Nearly three years later, at another such meeting, Khodorkovsky allegedly voiced his opinion that high-level officials in Putin's government should be ousted. (Compl. ¶ 94.) The Complaint alleges that Putin reacted negatively and intimated to Khodorkovsky that the Russian Federation might investigate Yukos' methods of acquiring oil reserves. (Compl. ¶ 94.) Despite Putin's warnings, Khodorkovsky publicly criticized Putin and financed opposition parties throughout the Class Period. (Compl. ¶¶ 9, 93-97.)
On January 22, 2003, Yukos issued a press release stating that the Company does not finance political parties and that "[w]hile they are at work, Company employees are prohibited from engaging in political activities . . . . Any professional political activity is incompatible with work at the Company." (Compl. ¶ 99.) Plaintiffs allege that this statement, together with Yukos' financial reports, were materially false and misleading because they failed to disclose that Khodorkovsky was actively engaged in "professional political activities" and that those activities, coupled with Putin's alleged threats, created a material risk to Yukos shareholders. (Compl. ¶¶ 9, 88, 93-98, 103(b), 105(c), 111(l), 115(a).)
IV. The Russian Federation's Enforcement Measures
On October 25, 2003, Russian Federation authorities arrested Khodorkovsky and charged him with fraud, embezzlement and evasion of personal income taxes. (Compl. ¶¶ 10, 118.) Days later, the Russian Government seized control of Khodorkovsky's 44% interest in Yukos as security against the approximately $1 billion he owed in taxes. (Compl. ¶¶ 11, 121.) Concurrently, the Tax Ministry revealed that it had been investigating Yukos' tax strategies. (Compl. ¶ 10.) The Department of Information and Public Relations of the General Prosecutors Office released a 30-page report that, inter alia, accused Khodorkovsky and Lebedev of fraudulently operating an illegal scheme at Yukos to avoid tax liability through shell company transactions. (Compl. ¶ 12.)
On December 29, 2003, the Tax Ministry concluded its audit of Yukos for tax year 2000 and issued a report (the "December 2003 Report"). (Compl. ¶ 14; Andreeva Decl. Ex. Q.) According to that report, Yukos implemented "an illegal tax evasion scheme by means of artificially founding dummy companies in the oil and afterproduct movement chain and registering them in territories with preferential tax treatment." (Andreeva Decl. Ex. Q at 7.) In short, the Tax Ministry found that the transfer of oil through the seventeen regional trading companies was an "illusion" because Yukos was "the true owner of the oil and afterproducts." (Andreeva Decl. Ex. Q at 8.) Yukos controlled each of the entities involved in these purported transactions and the entities "performed no activities in the place of their registration." (Andreeva Decl. Ex. Q at 9.) Thus, the Tax Ministry concluded, Yukos had illegally obtained the benefit of the ZATOs' preferential tax treatment and owed $3.4 billion to the Russian Federation in back taxes, interest and penalties for tax year 2000. (Compl. ¶ 14; Andreeva Decl. Ex. Q at 7-8, 104-05.) The Tax Ministry followed the December 2003 Report with a formal decision (the "April 2004 Resolution") that expanded on the foregoing findings. (Compl. ¶¶ 14, 65-67; Andreeva Decl. Ex. T.) In May 2004, the Moscow Arbitration Court agreed with the Tax Ministry and ordered Yukos to pay the amount assessed. (Compl. ¶ 16; Andreeva Decl. Ex. X.) Subsequently, the Tax Ministry revealed that Yukos had illegally used the same tax evasion scheme in 2001, 2002 and 2003, creating a total tax liability of $27.538 billion. (Compl. ¶¶ 16, 76, 128.)
As a result, Yukos defaulted on a $1 billion loan from private lenders and the Russian Government confiscated Yukos' assets, including its main production facility and billions of dollars from its bank accounts. (Compl. ¶¶ 17-19, 31, 126-27.) The price of Yukos securities "plummeted" in response to these events. (Compl. ¶¶ 21, 129; see Compl. ¶¶ 120, 122.)
Plaintiffs filed the first of these consolidated putative class actions on July 2, 2004. Of pertinence to the present motions, Plaintiffs assert securities fraud claims for primary liability under § 10(b) and Rule 10b-5 against all Defendants, and claims for control-person liability under § 20(a) against Misamore and Menatep.
Defendants raise three principal arguments in their motions to dismiss. First, they contend that that this Court must abstain under the act of state doctrine. Second, they assert that federal subject matter jurisdiction is lacking for two of the three named plaintiffs. Finally, they argue that the Complaint fails to state a claim for either primary violations of the securities laws or control person liability.
I. The Act of State Doctrine
Firmly entrenched as a principle of jurisprudence, the act of state doctrine prevents the courts of the United States from questioning "question the validity of public acts (acts jure imperii) performed by other sovereigns within their own borders." Republic of Austria v. Altmann, 541 U.S. 677, 700 (2004); see, e.g., Underhill v. Hernandez, 168 U.S. 250, 252 (1897) ("Every sovereign state is bound to respect the independence of every other sovereign state, and the courts of one country will not sit in judgment on the acts of the government of another, done within its own territory."). The doctrine "has its roots, not in the Constitution, but in the notion of comity between independent sovereigns." First Nat'l City Bank v. Banco Nacional de Cuba, 406 U.S. 759, 765 (1972); see Oetjen v. Cent. Leather Co., 246 U.S. 297, 303-04 (1918); Wiwa v. Royal Dutch Petroleum Co., 226 F.3d 88, 100 (2d Cir. 2000). It also venerates the separation of powers within the federal Government by precluding the judiciary from deciding matters of foreign policy that are properly the province of the executive and legislative branches. See Alfred Dunhill of London, Inc. v. Republic of Cuba, 425 U.S. 682, 697 (1976); Banco Nacional de Cuba v. Sabbatino, 376 U.S. 398, 423 (1964); Bi v. Union Carbide Chems. & Plastics Co., 984 F.2d 582, 586 (2d Cir. 1993). "If adjudication would embarrass or hinder the executive in the realm of foreign relations, the court should refrain from inquiring into the validity of the foreign state's act." Allied Bank Int'l v. Banco Credito Agricola de Cartago, 757 F.2d 516, 521 (2d Cir. 1985). The burden of establishing the doctrine's applicability to a particular dispute rests with the party that invokes it. Bigio v. Coca-Cola Co., 239 F.3d 440, 453 (2d Cir. 2001); Republic of Philippines v. Marcos, 806 F.2d 344, 359 (2d Cir. 1986).
Defendants urge this Court to abstain under the act of state doctrine because "[t]he adjudication of this dispute inevitably will require this Court to inquire into the actions and motives of the Russian Government in imposing confiscatory tax levies, penalties and interest on Yukos." (Yukos Defs. Mem. at 30.) Implicit in their argument and resplendent in other portions of their motion papers is the notion that the Russian Federation targeted Yukos unforeseeably and that the Tax Ministry's interpretation of the Russian Federation Tax Code was without precedent.
Defendants have not cited any precedent invoking the act of state doctrine to abstain from adjudicating a securities fraud action. Under the arguments advanced by Defendants, the doctrine would mandate abstention from any action in which a foreign corporation is alleged to have concealed conduct deemed illegal by its home country upon a defendant's mere assertion that the sovereign's determination was in error. Such an application of the act of state doctrine would effectively insulate foreign corporations from a large swath of securities fraud claims by United States investors.
The act of state doctrine does not preclude a court from deciding a case that implicates the motives or justifications of a foreign sovereign's official act but does not seek to invalidate or circumvent that act. W.S. Kirkpatrick & Co. v. Envtl. Tectonics Corp., Int'l, 493 U.S. 400, 401, 409 (1990) (holding that the doctrine does not bar "a court in the United States from entertaining a cause of action that . . . require[s] imputing to foreign officials an unlawful motivation . . . in the performance of . . . an official act"). Rather, the doctrine applies only "when a court must decide -- that is, when the outcome of the case turns upon -- the effect of official action by a foreign sovereign." W.S. Kirkpatrick, 493 U.S. at 406; accord United States v. Giffen, 326 F. Supp. 2d 497, 503 (S.D.N.Y. 2004) (holding the act of state doctrine inapplicable to the criminal prosecution of a U.S. citizen on charges that he bribed Kazakh officials because the Court would "not need to rule on the legality of any public acts by the Kazakh government"). The act of state doctrine does not compel abstention from "cases and controversies that may embarrass foreign governments, but merely requires that, in the process of deciding, the acts of foreign sovereigns taken within their own jurisdiction shall be deemed valid." W.S. Kirkpatrick, 493 U.S. at 409.
The Yukos Defendants contend that "any defense by Yukos beyond the pleadings stage necessarily will involve its claims that it was denied due process, and that it never would have suffered the consequences of having its business confiscated, had the Russian government properly applied Russian law." (Reply Memorandum of Yukos Oil Company and Bruce K. Misamore in Support of Motion to Dismiss at 11.) However, whether Yukos received due process in Russia is irrelevant. Neither party in this action seeks to enforce or disturb the actions taken by the Russian Federation. Cf. Norex Petroleum Ltd. v. Access Indus., Inc., 416 F.3d 146, 160 (2d Cir. 2005) (remanding for a determination as to whether plaintiff received due process in connection with an adverse Russian judgment to which defendants asked the court give preclusive effect). Moreover, in this action, the pertinent loss-causation inquiry concerns Defendants' alleged misstatements or omissions and the losses suffered by Yukos investors -- not the propriety of the Russian Federation's tax enforcement and penal actions. The central question is whether Defendants acted with fraudulent intent in withholding information from the investing public. Even if Defendants prevail with their arguments that the Russian Federation's interpretation of Russian law was untenable, the validity of the Russian Federation's acts would be unaffected. See United States v. Merit, 962 F.2d 917, 921 (9th Cir. 1992) (holding that, because of the act of state doctrine, the court regards as valid South Africa's failure to issue a warrant of extradition "[e]ven if the Republic did disregard its own laws" in doing so).*fn3
Likewise, a judgment in favor of Plaintiffs would not be tantamount to a ratification of the Russian Federation's actions.
Additionally, the Yukos Defendants cite Pasquantino v. Unitied States, 125 S.Ct. 1766 (2005), for the proposition that the common-law "revenue rule" militates against inquiring into the tax policies of foreign governments. (Yukos Defs. Mem. at 35-36.) The Second Circuit has explained the interplay between the act of state doctrine and the revenue rule as follows:
Under the act-of-state doctrine, the assessment of the validity of a foreign law is limited to its application within the sovereign's territory; under the revenue rule, United States courts avoid the application of a foreign sovereign's tax laws in the United States. Both approaches enable courts to avoid entanglement with questions about the underlying validity of a foreign sovereign's laws.
Attorney Gen. of Canada v. R.J. Reynolds Tobacco Holdings, Inc., 268 F.3d 103, 126 (2d Cir. 2001). Thus, in Pasquantino, the Supreme Court held that the United States Government could prosecute individuals for evading Canadian liquor taxes under this country's mail and wire fraud statutes because the "prosecution pose[d] little risk of causing the principal evil against which the revenue rule was traditionally thought to guard: judicial evaluation of the policy-laden enactments of other sovereigns." 125 S.Ct. at 1779. So too, because Plaintiffs here are not asking this Court to enforce the Russian tax judgments, this Court need not evaluate the policies behind the Russian Federation's tax legislation or the regional variance among effective federal income tax rates which Yukos is alleged to have exploited. As such, the revenue rule is inapposite.
In sum, this Court is not being called on to either invalidate or enforce the Russian Federation's measures, nor will the validity of those sovereign acts have any bearing on Defendants' motions to dismiss or on questions likely to affect the merits of this litigation. See also In re Yukos Oil Co., 321 B.R. 396, 409-10 (S.D. Tex. 2005) ("Although the acts of the Russian government doubtless have a significant impact upon the efforts of Yukos to reorganize itself financially, the filing and conduct of this Chapter 11 case does ...