The opinion of the court was delivered by: Lewis A. Kaplan, District Judge
Plaintiff Michael Endico brings this action in his own right and derivatively on behalf of 9 South First Avenue Associates, LLC ("9 South") against Mark and William Fonte and two entities they control, ME Development Group, LLC, and Trifont Realty, LLC. The gist of the claim is that the Fontes fraudulently induced Endico to transfer to them a two-thirds interest in 9 South, which Endico previously had owned entirely, without paying him for it and then looted and otherwise wasted its assets. The sole alleged basis of federal jurisdiction is a claim under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act")*fn1 and Rule 10b-5 thereunder.*fn2 The matter is before the Court on plaintiff's motion for a preliminary injunction and defendants' motion to dismiss for lack of subject matter jurisdiction and failure to plead fraud with particularity under the Private Securities Litigation Reform Act*fn3 and Rule 9(b).*fn4
The complaint alleges that the Fontes presented Endico with an opportunity to participate in the purchase and rehabilitation of an apartment building in Manhattan. The idea was that Endico would put up a portion of the money, the Fontes would do the construction work and manage the project, and the parties each would own one-third of the entity holding the property. In a nutshell, Endico claims that he was defrauded. The Fontes tricked him into transferring two-thirds of 9 South without paying for it, caused 9 South to buy the property with Endico's money, mortgaged the property, and then looted the proceeds of the mortgage from 9 South. He claims that the membership interests that he sold were investment contracts and therefore securities under Section 3(a)(10) of the Exchange Act.*fn5 SEC v. W. J. Howey Co.*fn6 held that an "investment contract" is a contract, transaction or scheme "involv[ing] an investment of money in a common enterprise with profits to come solely from the efforts of others."*fn7 Endico therefore tries to establish that he was an entirely passive investor in order to show that any return to him was to come solely from the efforts of the Fontes. Closer inspection even of the portion of the complaint that Endico actually filed,*fn8 however, raises doubts on this score. It makes clear that Endico was a signatory for the 9 South checkbook, and indeed, plaintiff's counsel conceded at oral argument that Endico was the sole signatory. The complaint alleges further that the proceeds of the mortgage loan secured on the property were deposited in 9 South's account, and Endico wrote checks to disburse funds to the Fontes as they requested money.*fn9
The Amended and Restated Operating Agreement of 9 South (the "Operating Agreement") raises even more questions as to Endico's claim of passivity. While it designated the Fontes as Managing Members with power and authority to manage the business, it went on to limit that authority by providing that no one member could act for or obligate the company and by requiring the unanimous consent of the members -- and thus of Endico -- to sell or mortgage company property.*fn10
I. Preliminary Injunction Motion
In order to obtain a preliminary injunction, the movant must show (1) irreparable harm in the absence of the injunction and (2) either (a) a likelihood of success on the merits or (b) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly in the movant's favor.*fn11 Moreover, as plaintiff has the burden of pleading and providing the existence of subject matter jurisdiction, he must demonstrate an appropriate prospect of success on that issue in order to obtain a preliminary injunction.
It would be at least extremely doubtful that Endico will prevail on his claim that he was defrauded in connection with the sale of a "security" within the meaning of the Exchange Act, even if the complaint stated a legally sufficient claim, for the simple reason that there is no basis on this record to suppose that the membership interests that he sold were securities.
As an initial matter, Endico's argument rests on the premise that he was a passive investor in the purchase and rehabilitation of the property and that the membership interests he sold therefore were "securities" under W. J. Howey. But he does not accurately characterize the issue. The relevant focus is on what Endico sold, not what he was left with after the transaction. What he sold -- and what therefore must be a "security" in order for the transaction to come within Section 10(b) -- was the two-thirds interest in 9 South along with the Operating Agreement that made the Fontes the managing members of the entity. On Endico's account, the Fontes most assuredly were not passive investors whose expectations of profits were to be achieved or not solely as a result of the efforts of others. Hence, even if Endico was defrauded in connection with the sale transaction, it is at least exceptionally doubtful that the interests he sold were "securities" even if Endico thereafter was a passive investor in 9 South.
My doubts would remain even if I were to ignore this conceptual problem by focusing exclusively on Endico's position following the sale. While it may be that Endico was the babe in the real estate woods that he claims and that he was ill used by the Fontes, the fact remains that Endico retained important elements of control that, at least collectively, probably are inconsistent with the idea that he was a passive investor. Most significant, of course, is that he controlled the purse strings by virtue of his signature power over the 9 South checking account.*fn12 When the property was mortgaged, the money went into that account. When the Fontes needed or wanted money, they asked Endico for it and Endico wrote the checks. Nor may his veto power over the sale or encumbrance of company assets be ignored.
In sum, on the basis of the record now before me, I see no material prospect that Endico will succeed in establishing that the interests he sold were securities and therefore no material prospect that he will prevail on the merits of his Section 10(b) claim.
The foregoing are my findings of fact and conclusions of law with respect ...