The opinion of the court was delivered by: Robert W. Sweet, U.S.D.J.
Defendants Hilary L. Shane ("Shane"), First New York Securities, L.L.C. ("FNY Securities"), FNY Millennium Partners, L.P. ("FNY Millennium"), and FNY Capital Corp. ("FNY Capital") (collectively, "Defendants"), have moved pursuant to Rules 9(b) and 12(b)6, Fed. R. Civ. P., and the Private Securities Litigation Reform Act ("PSLRA") to dismiss the first amended complaint ("FAC") of plaintiffs CompuDyne Corporation ("CompuDyne") and William Blair Mezzanine Capital Fund II ("Blair") (collectively, "Plaintiffs"). For the reasons set forth below, the motions of Shane, FNY Securities, and FNY Millennium and FNY Capital are granted as to Plaintiffs' unjust enrichment claims, and are denied in all other respects.
The complaint by CompuDyne and Blair was filed on May 2, 2005. The FAC was filed on September 19, 2005.
Shane, FNY Securities, and FNY Millennium and FNY Capital filed their respective motions to dismiss on October 24, 2005. Plaintiffs filed their joint opposition to all Defendants' motions to dismiss on November 21, 2005. The motions were heard and marked fully submitted on December 7, 2005. The Parties
CompuDyne is a Nevada corporation with its headquarters and principal place of business in Maryland and is involved, inter alia, in the business of providing safety and security products. Its common stock actively trades on the Nasdaq National Market under the symbol "CDCY." As of August 14, 2001, CompuDyne had 5,078,522 shares of common stock outstanding. (FAC ¶ 4.)
Blair is an Illinois limited partnership and investment fund with its principal place of business in Illinois. (FAC ¶ 15.) As of August 14, 2001, Blair owned 1,075,507 shares of unregistered CompuDyne common stock and a warrant to purchase 297,924 shares of CompuDyne stock at $3.25 per share. (Id.)
Shane is a citizen and resident of the State of New York and in 2001 was registered with the National Association of Securities Dealers ("NASD") as a general securities representative at FNY Securities, where she served, inter alia, as a manager of hedge fund accounts and held Series 7 and 55. licenses. (FAC ¶ 6.)
FNY Securities, a New York limited-liability company with its principal place of business at 850 Third Avenue, New York, New York 10022, is a Manhattan-based broker-dealer and has been a member firm of NASD since 1985. (FAC ¶ 7.) According to its website, FNY Securities is a "leading global proprietary trading and money management firm with offices in New York, New Jersey and London" where, inter alia, its staff invest FNY Securities' capital in stock for their own profit and pay a certain percentage of their trading profits to the firm. (Id.) FNY Securities requires its staff to complete a training program lasting eighteen to twenty-four months, during which employees are paid a pro-rated salary. (Id.) Employees continue to receive a salary from FNY Securities after the training program is completed. At the time of the actions giving rise to the allegations contained herein, Shane was registered with the NASD as a general securities representative at FNY Securities. (Id.)
FNY Millennium is a limited partnership that maintains a business at the same location as FNY Securities, and in 2001 was an FNY Securities-affiliated hedge fund managed by Shane. (FAC ¶ 18.) Rather than investing FNY Securities' funds, FNY Millennium invests the funds of qualified outside investors. (Id. 19.)
FNY Capital, a wholly owned subsidiary of FNY Securities, is the general partner of a family of individually managed hedge funds, including FNY Millennium, operating under the umbrella of FNY Securities. (Id.) FNY Securities' website directs investors to contact FNY Securities for further information regarding FNY Capital and investing in its "family of funds." (Id.)
The following facts are drawn from the FAC, which includes "any documents incorporated in it by reference, annexed to it as an exhibit, or 'integral' to it because it 'relies heavily upon [such documents'] terms and effect[s].'" Pollock v. Ridge, 310 F. Supp. 2d 519, 524 (W.D.N.Y. 2004) (quoting Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002)). All well-pleaded allegations are accepted as true for the purpose of this motion. See Chambers, 282 F.3d at 152. The following statements do not constitute findings of the Court.
In August 2001, Blair wanted to sell its 1,075,507 unregistered shares of CompuDyne stock. (FAC ¶¶ 5, 13.) To facilitate the sale, CompuDyne approached Friedman, Billings, Ramsey & Co. ("FBR") in August 2001 and formally retained FBR on September 12, 2001 -- the day after the terrorist attacks on September 11, 2001. (FAC ¶ 13.) When the markets reopened on September 17, 2001, CompuDyne's stock traded much higher than it had during the preceding three years, presumably due to investor belief that there would be greater demand for CompuDyne's products following the 9/11 attacks. (FAC ¶ 14.) During the period September 17, 2001 through September 28, 2001, CompuDyne stock traded in a range between $10.05 and $18.78 per share, as compared to its close on September 11, 2001 of $8.25 per share. (Id.) Due to the increase in the price of CompuDyne stock, CompuDyne determined to sell stock alongside Blair through a private investment in public equity ("PIPE") offering. A PIPE transaction involves the sale of unregistered stock in a publicly owned company to sophisticated private investors. The stock sold in a PIPE offering is not freely transferable until the issuer registers the securities with the Securities and Exchange Commission ("SEC"). SEC rules requires that shares sold by means of a PIPE can only be sold to "accredited investors" who commit to purchase an agreed upon number of restricted shares for the offering price. (FAC ¶ 16.) The company agrees to file a registration statement for the shares which, once effective, will allow the company to deliver registered shares at the closing of the PIPE offering in exchange for payment. (Id.) Due to the increase of the number of shares available to trade, and accompanying dilution of the interests of existing stockholders in a company, the public announcement of a PIPE typically results in a decline in the market price of the subject company. It is for this reason that the shares offered by means of a PIPE are typically offered at a discount to the prevailing market prices before public announcement of the PIPE. (Id.)
Shane was a regular client of FBR while working at FNY Securities. (FAC ¶¶ 6-9, 21.) On September 28, 2001, FBR representative Paul Dell'Isola ("Dell'Isola") approached Shane as a prospective investor in the PIPE. (FAC ¶ 21.) After first obtaining Shane's agreement to keep the existence and nature of the PIPE confidential, FBR told her about the PIPE and agreed to send Shane the purchase agreement (the "Purchase Agreement") and the private placement memorandum ("PPM") by overnight mail. (FAC ¶¶ 21-25.) Immediately thereafter, according to the FAC, Shane initiated a fraudulent scheme to allow herself and the other Defendants to improperly profit from CompuDyne's PIPE. (FAC ¶ 29.)
Beginning on September 28, 2001, Shane sold CompuDyne stock short in two FNY Securities proprietary accounts and in the accounts of two FNY Securities-affiliated hedge funds managed by Shane. (FAC ¶ 29.) One of those hedge funds was FNY Millennium. (FAC ¶¶ 8, 61, 70(a)-(b).) Those short sales continued even after Shane received the PPM on September 29, 2001. The PPM provided several warnings and restrictions, including, inner alia, that "the federal securities laws imposed restrictions on trading based upon information regarding the offering," and that "[t]he Purchaser agrees to use the information contained in the Private Placement Memorandum for the sole purpose of evaluating a possible investment in the Shares." (FAC ¶ 28.) Shane continued to sell short shares of CompuDyne based upon material non-public information on October 1, 2, 3, and 4. (FAC ¶ 29-34.) At its peak, the total short position in the four accounts was approximately 88,100 shares. (FAC ¶¶ 33.)
Between October 3 and October 5, 2001, Shane bought shares of CompuDyne stock sufficient to cover the short sales and bring all accounts "flat" in Compudyne stock by the end of the day on Friday, October 5, 2001. (FAC ¶ 33-35.) The total profits from the trading in CompuDyne stock that Shane directed from September 28 through October 5, 2001 (the "Pre-Pricing Sales") were approximately $56,151. (FAC ¶ 36.)
During this period, as Shane knew, CompuDyne and FBR were gauging investor interest in the PIPE through, inter alia, private road shows, to determine at what discount from the market price the PIPE shares would be offered. (FAC ¶¶ 16, 19-20, 31, 69, 71-72.) Shane sent her representatives to attend one such road show at FNY Securities' offices on October 2, 2001.*fn1 (FAC ¶ 31.) On or before Friday, October 5, 2001, Shane indicated to FBR that she was interested in purchasing 500,000 shares of the PIPE at $14.00 per share. (FAC ¶ 37.)
The following Monday, October 8, 2001, FBR and CompuDyne agreed to price the PIPE at $12 per share. (FAC ¶ 40.) Shane, FNY Millennium, and FNY Capital were apprised of the price later that day (FAC ¶ 41), and at 5:38 p.m., two signature pages from the Purchase Agreement were faxed from FNY Securities' offices to FBR, one for 238,000 shares signed on behalf of FNY Millennium by
In addition to the warranties and representations in the Purchase Agreement described above, by signing the Purchase Agreement, Shane, FNY Millennium, and FNY Capital also warranted that each was "acquiring the number of shares . . . in the ordinary course of its business and for its own account for investment only and with no present intention of distributing any of such Shares." (FAC ¶ 28.) The FAC alleges that Shane, FNY Millennium, and FNY Capital did not intend to comply with this provision but rather to conduct extensive "naked" short sales, later using the shares obtained in the PIPE transaction to "cover" these short positions at a virtually guaranteed lower price, thereby generating huge, but illegal, profits. (FAC ¶¶ 45, 56-57, 60.)
On the morning of October 9, Shane resumed her trading of CompuDyne stock, selling short 122,900 shares by 11:44 a.m., when the PIPE was publicly announced. (FAC ¶¶ 44-46.)
Following the public announcement of the PIPE, Shane and FNY Millennium continued their naked short-selling through October 29, 2001, when the SEC declared effective the registration statement for the CompuDyne PIPE shares. (FAC ¶ 49-50.) At the close of trading on October 29, 2001, Shane and FNY Millenium had a combined total short position of 455,000 shares. (FAC ¶ 48.) On October 30, 2001 Shane and FNY Millenium sold short an additional 20,000 shares of CompuDyne stock, reaching a combined total short position of 475,000 shares -- the exact number of shares they had agreed to purchase in the PIPE. (FAC ¶ 51.)
On October 31, 2001, Shane and FNY Millenium covered their combined short position with the 475,000 shares of CompuDyne stock purchased in the PIPE for twelve dollars per share, reaping allegedly illegal profits exceeding $1 million. (FAC ¶¶ 52-54.) The shorting of the 475,000 shares was accomplished through 975 separate transactions, all of which were executed by FNY Securities. (FAC ¶ 55.)
On December 21, 2004, the NASD filed a complaint against Shane alleging fraud and insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. (FAC ¶ 3.) On May 18, 2004, the SEC filed a similar complaint. In connection with these civil complaints, Shane agreed to pay $1.45 million in profits and penalties and was permanently barred from associating with any NASD registered firm. (Id.)
The FAC alleges that as a result of Defendants' actions, the market price of CompuDyne stock increased in volatility and/or was artificially depressed during the period when the PIPE was being priced, causing Plaintiffs to sell the shares offered in the PIPE at an artificially depressed price. (FAC ¶¶ 61, 72.) Both Plaintiffs allege that but for the conduct of Defendants, they would have raised more money on the PIPE. CompuDyne additionally has alleged that it suffered unnecessary interest expense associated with capital borrowed to make up for the shortfall in proceeds from the PIPE. (FAC ¶ 74.)
The FAC asserts seven causes of action. Count I alleges violations by Shane, FNY Millennium, and FNY Capital of 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. Count II alleges "control person" liability of FNY Securities and FNY Capital under Section 20(a) of the Exchange Act, 15 U.S.C. 78t(a). Count III alleges common-law fraud on the part of Shane, FNY Millennium, and FNY Capital. Counts IV and V allege alternative claims of breach of contract and unjust enrichment, respectively, against Shane, FNY Millennium, and FNY Capital. Count VI alleges the respondeat superior liability of FNY Securities for the damages Plaintiffs suffered as a result of Shane's allegedly unlawful conduct. Count VII alleges that FNY Capital is liable under a theory of partnership liability for the damages Plaintiffs suffered as a result of the allegedly illegal short sales carried out through FNY Millennium. Discussion
On a motion to dismiss, "the facts in the complaint are presumed to be true and all factual inferences must be drawn in plaintiff's favor and against the defendants." Dietrich v. Bauer, 76 F. Supp. 2d 312, 324 (S.D.N.Y. 1999) ("Dietrich II"). A court should not grant a motion to dismiss "unless it appears beyond doubt, even when the complaint is liberally construed, that the plaintiff can prove no set of facts which would entitle him to relief." In re Vivendi Universal, S.A. Sec. Litig., No. 02 Civ. 5571 (RJH), 2004 U.S. Dist. LEXIS 7015, at *5 (S.D.N.Y. April 22, 2004). 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)). Defendants' burden on a motion to dismiss pursuant to Rule 12(b) (6) is indeed substantial, as "lilt has been said that the motion to dismiss for failure to state a claim is disfavored and is seldom granted." In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d 613, 621 (S.D.N.Y. 2003); see also Rothman v. Gregor, 220 F.3d 81, 92 (2d Cir. 2000). On a Rule 12(b)(6) motion, consideration is limited to the factual allegations in the complaint, "to documents attached to the complaint as an exhibit or incorporated in it by reference, to matters of which judicial notice may be taken, or to documents either in plaintiffs possession or of which plaintiffs had knowledge and relied on in bringing suit." Brass v. Am. Film Tech., Inc., 987 F.2d 142, 150 (2d Cir. 1993); see Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir. 1991).
Rule 9(b), Fed R. Civ. P., 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 Coro., 12 F.3d 1170, 1175 (2d Cir. 1993)). The pleading must be sufficiently particular to serve the three goals of Rule 9(b), which 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. See DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987); O'Brien v. Price Waterhouse, 740 F. Supp. 276, 279 (S.D.N.Y. 1990), aff'd, 936 F.2d 674 (2d Cir. 1991).
The Private Securities Litigation Reform Act of 1995 (the "PLSRA"), Pub. L. No. 104-67, 109 Stat. 737 (1995) (codified in scattered sections of 15 U.S.C.), imposes at least two additional pleading requirements -- commonly referred to as paragraphs (b) (1) and (b) (2) -- on securities actions. Paragraph (b) (1), which applies to securities claims alleging misstatements or omissions of material facts, requires that "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b) (1). Paragraph (b) (2) applies to securities claims "in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind," and requires that the complaint "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b) (2). The Motions To Dismiss Count I Are Denied
Count I of the FAC alleges violations of section 10(b) and Rule 10b-5 committed by Shane, FNY Millennium, and FNY Capital, arising out of the scheme described above. (FAC ¶¶ 64-77.)
Section 10(b) of the Exchange Act makes it unlawful for any person
[t]o use or employ, in connection with the purchase or sale of any security registered on a national securities exchange . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors.
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a)To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with ...