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Nanopierce Technologies, Inc. v. Southridge Capital Management

January 29, 2008


The opinion of the court was delivered by: Sand, J.


Before the Court are three motions for summary judgment pursuant to Rule 56(c) of the Federal Rules of Civil Procedure. The three motions are addressed in the following order: first, the motion for summary judgment filed by Harvest Court (a co-defendant and subsidiary of Southridge); second, the motion for summary judgment filed by Counterclaim-Plaintiffs Kampmann and Metzinger (Nanopierce executives); and third, the motion for summary judgment filed by H. Glenn Bagwell, Jr. For the reasons stated below, Harvest Court's motion for summary judgment is granted, Kampman and Metzinger's motions for summary judgment are denied with respect to Counts 1, 7, 8, and 13, and granted with respect to Count 9. Bagwell's motion for summary judgment is denied.

I. Background*fn1

In a September 26, 2000, meeting at defendant Southridge's office, Nanopierce President Paul Metzinger negotiated an agreement with two Southridge employees, Defendants Singer and Pickett.*fn2 The negotiated agreement between Southridge and Nanopierce called for $7.5 million in initial financing in exchange for approximately 4.5 million shares of Nanopierce stock. The agreement also contained a provision providing "reset rights," which entitled the Southridge to additional shares of common stock in the event the stock price declines. The reset clause included three reset dates (at 65, 130, and 195 days after the closing) at which additional shares would be issued if the stock was trading below the initial purchase price. Finally, the agreement also provided for an additional $7.5 million in financing at a future date, on the condition that Nanopierce's stock met certain price and volume thresholds.

After the agreement was signed,*fn3 for approximately six months, until May 9, 2001 Defendants sold its Nanopierce stock nearly every day, accounting for 22.7% of the traded volume over the entire period. The stock price, which had closed at $2.63 on October 23, 2000, dropped steadily, reaching a low of $0.32 in April 2001, and closing at $0.51 on May 9, 2001. After the first reset date, Defendants requested, and Nanopierce issued, 2,143,975 reset shares pursuant to the formula. However, on the second reset date, April 30, 2001, Nanopierce refused to issue an additional 7,418,895 shares, and indicated that it would issue no further (reset) shares in the future.

Nanopierce filed a Complaint against Southridge and Harvest Court, alleging that Defendants manipulated the price of its stock, and that this incident was part of a pattern pursuant to which Defendants inserted conversion and reset provisions into financing agreements with other companies, and then proceed to drive down the stock price via dumping, short sales, and other means. Harvest Court initiated its own action against Nanopierce, alleging that Harvest Court had been fraudulently induced into entering the agreement by a series of misrepresentations by Nanopierce. Harvest Court subsequently recast those claims as counter- and third-party claims in this action. This Court addressed a number of motions to dismiss in 2002 and 2003 (see infra, footnote 1), and now the parties have filed motions for summary judgment with respect to the remaining claims.

II. Legal Standard

Summary judgment is appropriate when "there is no genuine issue as to any material fact and . the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c). This occurs when "the record taken as a whole could not lead a rational trier of fact to find for the non-moving party." Holtz v. Rockefeller & Co., Inc., 258 F.3d 62, 69 (2d Cir. 2001) (quoting Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587, 106 S.Ct. 1348, 89 L.Ed. 2d 538 (1986)). "A fact is 'material' for these purposes if it might affect the outcome of the suit under the governing law. An issue of fact is 'genuine' if the evidence is such that a reasonable jury could return a verdict for the nonmoving party." Holtz, 258 F.3d at 69 (internal quotations and citations omitted).

III. Harvest Court's Summary Judgment Motion

The motion for summary judgment filed by Harvest Court relies on two arguments. First, Harvest Court contends that Nanopierce is not legally entitled to rely on oral representations (assuming that any were made) when those representations were not included in the contract between the parties, and the contract itself contained a merger clause. Second, Harvest Court argues that the Second Circuit's decision in ATSI Communications, Inc. v. Shaar Fund, Ltd, 493 F.3d 87 (2d Cir. 2007), precludes liability for death spiral financing as a matter of law, unless some other manipulative behavior accompanies it. This Court finds Harvest Court's second argument persuasive. Because this Court agrees that the Second Circuit's ATSI decision precludes liability, Harvest Court is entitled to summary judgment.

A. The ATSI Decision

In this Court's 2002 decision denying Defendants' motion to dismiss, the Court noted that the "law of the Second Circuit on so-called open-market manipulation. is not yet fully settled." (10/10/02 Opinion at 13). Defendants argue that in the intervening years, however, the Second Circuit has settled the question of whether open-market sales, accompanied by a subjective intent to affect the price of a stock, could constitute market manipulation. And, in ATSI, the Second Circuit concluded that it was not.

The ATSI case is very similar to the conduct at issue in Nanopierce. See ATSI., 493 F.3d at 96. Like Nanopierce, the defendants in ATSI were accused of taking advantage of a struggling company by negotiating a "death spiral" financing deal. Once the contract was arranged, defendants sold their stock short in large volumes, driving down the price. Further, as here, the defendant was alleged to have had a pattern of engaging in this type of financing deal, with many of the companies it financed going bankrupt as an alleged result.

The Second Circuit held that allegations of death spiral financing were insufficient, standing alone, to defeat a motion to dismiss. The Court held that a defendant would need to "inject[] inaccurate information into the marketplace or create a false impression of supply and demand for the security. for the purpose of artificially depressing or inflating the price of the security." ATSI at 101. The Third Circuit, in a case endorsed by the Second Circuit in ATSI, noted that "increasing the supply of stocks by selling them on the open market in legitimate transactions to real buyers does not artificially affect prices and therefore cannot be manipulative." GFL Advantage Fund Ltd. v. Colkitt, 272 F.3d 189, 210 (3d Cir. 2001).

Notably, ATSI rejects a number of the factors that Nanopierce relies on to demonstrate market manipulation. For instance, short selling alone is not enough. ATSI at 101 ("To be actionable as a manipulative act, short selling must be willfully combined with something more to create a false impression of how market participants value a security."). Similarly, "death spiral" financing agreements are also not, even when combined with short selling, inherently manipulative. Id. ("Such securities provide distressed companies with access to much-needed capital and, so long as their terms are fully disclosed, can provide a transparent hedge against a short sale.").

The Second Circuit has spoken clearly about the principle that "[a] strong inference of scienter [sufficient to defeat a motion to dismiss] is not raised by alleging that a legitimate investment vehicle, such as the convertible preferred stock at issue here, creates an opportunity for profit through manipulation." Id. at 104. Such an allegation, standing by itself, is insufficient to defeat a motion to dismiss; it is certainly insufficient to defeat a motion for summary judgment.

Further, the Second Circuit emphasized the fact that these agreements are negotiated by sophisticated parties who are aware of the potential consequences. The Court noted that there was a "plausible nonculpable explanation" for the defendants' actions, which was that "ATSI and the defendants simply entered into mutually beneficial financing transactions." Id. at 104.

The facts in this case clearly demonstrate that Nanopierce understood the terms of the agreement, and knew that Harvest Court was not a long-term investor. One executive sent a letter to Nanopierce's shareholders several months after the deal closed, which noted that "in bad market conditions, these types of financing can have an unfavorable dilutive impact and exert a depressant effect on the price of the Company's stock. We are conducting numerous discussions with many other financial sources that we believe will provide more favorable financing to the Company with less adverse features." (3/7/01 Shareholder Letter, p. 4). Further, deposition testimony by Nanopierce executives demonstrates that they knew Harvest Court was not a long-term investor.*fn4 See Schrader Aff Exh. 41, Richards 10/14/02 Dep. at 173 ("Mr. Pickett said, as you know, that we are not long time investors ourselves and we may sell our stock."); Schrader Aff Exh. 41, Richards 10/14/02 Dep. at 166 ("we got out in the car and I said to Paul, can you believe this, they didn't even want to know what the company did, nothing, its [sic] like getting a gift from heaven, you know, okay, and we needed the money, okay?"). Nanopierce cannot reasonably have expected that an investor who "didn't even want to know what the company did" would be a long-term investor in the company's stock. Nanopierce clearly "needed the money," and knew of the potential "unfavorable" and "depressant" effect that the financing could have on the company's stock.

Nanopierce argues that Harvest Court's activities were improper because its investment carried no risk. See. Pl.'s Opp. Br. at 10 ("Selling the stock as [Harvest Court] did in order to lower the price and reap additional reset shares -- at no cost -- virtually insured Harvest Court an astronomical rate of return, and an opportunity to double its money. Such a return without risk is not an investment -- it's a scheme."). But Nanopierce vastly overestimates the certainty involved with this investment strategy. Harvest Court was investing in a very distressed company, as is evidenced simply by the fact that Nanopierce ...

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