United States District Court, E.D. New York
ROBERT LEVITT for himself and as custodian for Richard Levitt and Monica Levitt, STEPHEN G. SIBEN, PHILIP C. VITANZA for himself and Elizabeth Vitanza and Luke Vitanza, JOHN T. WHITE, GUY
WOOD, and TED M. and KATHRYN N. JONES, as Trustees, Plaintiffs,
J.P. MORGAN SECURITIES INC. and J.P. MORGAN CLEARING CORP., Defendants and Third-Party Plaintiffs,
RANDOLPH PACE, ALAN NOVICH, ADAM R. LIEBERMAN, WARREN SCHREIBER, JUDAH WERNICK, MICHAEL KRASNOFF, NANCY G. SHALEK, CRAIG L. KELLERMAN, WILLIAM E. SCUTERI, MATTHEW HAWLEY, and ROBERT J. PAULSON, Third-Party Defendants
For the Plaintiffs: Leslie Trager, Esq., New York, NY.
For the Defendants and Third-Party Plaintiffs: Michael D. Schissel, Esq., Peter L. Zimroth, Esq., Stephen M. Sacks, Esq., Anthony D. Boccanfuso, Esq., Kerry Ann Dziubek, Esq., Of Counsel, Arnold & Porter LLP, New York, NY.
For Alan Novich, Third-Party Defendant: David B. Friedrich, Esq., Of Counsel, Friedrich & Friedrich, LLC, Westhampton, NY.
For Warren Schreiber, Third-Party Defendant: Martin P. Unger, Esq., Thomas J. McNamara, Esq., Of Counsel, Certilman, Balin, Adler & Hyman, LLP, East Meadow, NY.
For Michael Krasnoff, Third-Party Defendant: Bradley Stewart Gross, Esq., Of Counsel, Law Offices of Bradley S. Gross, New York, NY.
For Nancy G. Shalek, Third-Party Defendant: Jason Andrew Masimore, Esq., Lisa Ann Cahill, Esq., Of Counsel, Hughes Hubbard & Reed LLP, New York, NY.
Randolph Pace, Third-Party Defendant, Pro se, Westhampton Beach, NY.
Adam R. Lieberman, Third-Party Defendant, Pro se, Lakewood, NJ.
Judah Wernick, Third-Party Defendant, Pro se, Woodmere, New York.
William E. Scuteri, Third-Party Defendant, Pro se, Sportylvania, VA.
Matthew Hawley, Third-Party Defendant, Pro se, Cortlandt Manor, NY.
Robert J. Paulson, Third-Party Defendant, Pro se, East Moriches, NY.
NO APPEARANCE: Craig L. Kellerman.
MEMORANDUM OF DECISION AND ORDER
ARTHUR D. SPATT, United States District Judge.
In this securities fraud civil action, the Plaintiffs Robert Levitt, for himself and as custodian for Richard Levitt and Monica Levitt; Stephen G. Siben; Philip C. Vitanza, for himself and Elizabeth Vitanza and Luke Vitanza; John T. White; Guy V. Wood; and Ted M. and Kathryn N. Jones, as Trustees (collectively the " Plaintiffs" ) assert four causes of action against the Defendants J.P. Morgan Securities Inc. and J.P. Morgan Clearing Corp. (collectively, the " Defendants" ), formerly Bear Stearns & Co. Inc. and Bear Stearns Securities Corp. (collectively, " Bear Stearns" ). Their four claims arise in connection with a fraudulent scheme perpetrated by Sterling Foster & Co. (" Sterling Foster" ), a brokerage firm, to manipulate the market for ML Direct Inc. (" ML Direct" ) securities during and after ML Direct's initial public offering (" IPO" ) in 1996.
In this regard, the Plaintiffs allege that Bear Stearns (1) participated in the fraudulent scheme with Sterling Foster in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5; (2) made knowingly false statements in violation of § 10b of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5; (3) exercised control over Sterling Foster so as to be liable as a control person under § 20(A) of the Securities Exchange Act, 15 U.S.C. § 78t(a); and (4) participated in and aided and abetted Sterling Foster's fraudulent scheme in violation of New York State common law.
Presently pending before the Court is (1) the Defendants' motion for summary judgment pursuant to Federal Rule of Civil Procedure (" Fed. R. Civ. P." ) 56 and (2) the Plaintiffs' cross-motion for summary judgment pursuant to Fed.R.Civ.P. 56. For the following reasons, the Defendants' motion for summary judgment is granted and the Plaintiffs' cross-motion for summary judgment is denied.
The Court assumes that the parties are familiar with the background of this case. Accordingly, the Court will only repeat those facts relevant to resolve the motion and cross-motion for summary judgment.
A. Sterling Foster and Bear Stearn's Agreement
In April of 1994, Sterling Foster, an introducing broker, entered into an agreement
with Bear Stearns under which Bear Stearns would serve as Sterling Foster's clearing firm, also known as a clearing broker. Generally, introducing brokers are responsible for soliciting customers; recommending the purchase or sale of securities to customers; and monitoring customers' transactions. On the other hand, clearing brokers provide various services such as processing; settling and clearing securities transactions; and preparing trade confirmations and account statements for introducing brokers' customers.
In an earlier opinion in this case, the Second Circuit provided an instructive overview of the role that clearing brokers and introducing brokers play in the securities industry:
A clearing firm clears trades, i.e., completes transactions by delivering securities to the purchasing broker-dealer and by making money payments to the selling broker-dealer. Clearing responsibilities include: receiving or delivering funds from or to the customer; maintaining records that reflect the transaction; and safeguarding the funds in the customer's account. A clearing firm is also responsible for maintaining records of all trades made by the customer, including sending confirmations, monthly statements, and dividends to the customer/investor. Additional clearing services include the extension of credit for the purchase of securities on margin. Small brokerage firms, commonly referred to as " introducing firms," typically lack sufficient capital, back office technology and personnel to " self clear." As a result, they enter into " carrying agreements" with clearing firms to out source clearing and other services. In addition to performing clearing functions, on occasion, the clearing firm executes transactions, thereby limiting the role of the introducing broker to simply soliciting investor sales. The clearing firm also provides name recognition for the introducing firm, frequently inflating the image of a small, unknown introducing firm. The name Bear Stearns, for example, lends credibility, stability, business savvy, and expertise to unknown introducing firms.
Levitt v. Bear Stearns & Co., Inc., 340 F.3d 94, 97-98 (2d Cir. 2003) (internal citations and quotation marks omitted) (hereinafter, " Levitt I" ).
Bear Stearns acted as Sterling Foster's clearing broker until March 27, 1997, and was Sterling Foster's clearing broker at all relevant times to this case. During this period, Sterling Foster engaged in several market manipulation schemes in connection with six separate public offerings, including the ML Direct IPO, which is the subject of the present lawsuit. The parties dispute the extent of Bear Stearns knowledge with respect to Sterling Foster's other fraudulent conduct prior to the ML Direct IPO.
B. Sterling Foster's Market Manipulation Scheme In Connection with the ML Direct IPO
The ML Direct IPO occurred in September of 1996. The Prospectus for the ML Direct IPO (the " Prospectus" ) stated that shares would be issued in 480,000 units consisting of two shares of common stock and one common stock purchase warrant. The issue was priced at $15 per unit, so that the price per share at the offering was approximately $7.50. The IPO was underwritten by Patterson Travis, Inc. (" Patterson Travis" ).
The Prospectus also disclosed that certain ML Direct insiders, referred to as " Selling Securityholders," owned 2.4 million shares of ML Direct common stock at the time of the offering. Pursuant to a " lock-up" agreement that was disclosed in
the Prospectus, the Selling Securityholders agreed not to sell their shares in the twelve months following the IPO unless they received permission to do so from Patterson Travis. In particular, the Prospectus stated that Patterson Travis had " no agreements or understandings with any of the Selling Securityholders with respect to release of the securities prior to the [expiration of the lock-up period] and ha[d] no present intention of releasing any or all of such securities prior to [the expiration of the lock-up period]." (Dziubek Decl., Exh. P.)
The Prospectus became effective on September 3, 1996 and trading began the following day, September 4, 1996. On that day, September 4, 1996, Sterling Foster bought almost 1.1 million shares of ML Direct common stock, which included 255,000 units and 566,825 shares of ML Direct common stock. This apparently caused the price of the ML Direct stock to rise to $15.25 per share by the close of trading that day.
Also on September 4, 1996, Sterling Foster sold almost 3.9 million shares of ML Direct to its customers at approximately $13.50 to $14.50 per share, with an average of $14.10 per share. Given that there were only 1.1 million shares for sale in the IPO, most of which Sterling Foster had purchased, Sterling Foster had sold approximately 2.86 million shares more than it actually owned. In taking this short position of 2.86 million shares, Sterling Foster was confronted with a problem: the only other available ML Direct shares by which they could cover their position were held by the Selling Securityholders and these shares were subject to the lock-up agreement. Moreover, because the ML Direct stock had risen to $15.25 by the close of trading on September 4, 1996, Sterling Foster would have had to pay over $43.69 million in order to cover its short position at the market price.
However, it seems Sterling Foster already had a remedy for this situation. In this regard, prior to the effective date of the IPO, September 3, 1996, and the opening of the after market, Sterling Foster and Patterson Travis entered into an undisclosed arrangement, under which Sterling Foster would purchase the Selling Securityholders shares after the offering at a below market price of $3.25 per share in order to cover Sterling Foster's short position. The Prospectus did not disclose this pre-existing arrangement to release the Selling Securityholder shares much earlier than the twelve-month lock-up agreement suggested.
Sterling Foster was required to deliver the shares it sold on September 4, 1996 to Bear Stearns by September 9, 1996 in order to cover its short position. Sterling Foster failed to deliver the shares by that date. Nevertheless, on September 10, 1996, Patterson Travis released the Selling Securityholders from their lock-up agreements and, pursuant to the undisclosed agreement, Sterling Foster purchased their shares at $3.25 per share. Sterling Foster's president, Adam Lieberman (" Lieberman" ), caused these shares to be delivered to Bear Stearns on September 11 and 12, 1996, and directed Bear Stearns to pay the Selling Securityholders $7.8 million, thereby covering its short position. When Sterling Foster covered its short position, it made a 400 percent underwriting profit consisting of the difference between the price at which it sold the shares to the public ($13.50 to $14.50 per share) and the price it paid to the Selling Securityholders ($3.25 per share).
Thus, the offering documents led the investing public, including Sterling Foster's customers, to believe that only 1.1 million shares of ML Direct were being
offered when, in fact, 3.9 million shares were being offered. Investors also believed that the market had set the price of $13 to $15 per share when, in actuality, that price had been artificially created by Sterling Foster, which was at the same time ...