United States District Court, S.D. New York
Jack Gerald Fruchter, Mitchell M.Z. Twersky, Jeffrey S. Abraham, Mark S. Hamill, Abraham Fruchter & Twersky LLP, New York, NY, for Plaintiff.
Thomas James Fleming, Renee Michele Zaytsev, Olshan Frome Wolosky LLP, New York, NY, for Defendants Iroquois Master Fund Ltd. and American Capital Management LLC.
OPINION & ORDER
DENISE COTE, District Judge.
The plaintiff brings this case under Section 16(b) ("Section 16(b)") of the Securities Exchange Act of 1934 ("Exchange Act") to recover on behalf of WPCS International Inc. ("WPCS") short-swing insider trading profits earned by Iroquois Master Fund Ltd. ("Iroquois") and American Capital Management ("ACM") (collectively "Defendants") while they were statutory insiders of WPCS. The Defendants have moved to dismiss the complaint, largely on the ground that their investment in WPCS is governed by an agreement that contains a conversion cap, which operates as a matter of law to prevent any one of them from becoming a beneficial owner of more than 10% of the company's shares. The plaintiff's allegation that investors have formed a Section 13(d) group is sufficient here to require denial of the motion to dismiss.
The plaintiff Eric Greenberg ("Greenberg") is a shareholder of WPCS. WPCS is a Delaware corporation whose common stock is registered with the Securities and Exchange Commission ("SEC"). Defendants, also WPCS shareholders, are companies organized under the laws of the Cayman Islands. Greenberg initiated this action on July 14, 2014, and following a motion to dismiss by Hudson Bay, amended the complaint on October 15 ("Complaint"). Defendants and Hudson Bay moved to dismiss the Complaint on November 10. That motion was fully submitted on December 12. On January 30, 2015, Greenberg stipulated to the dismissal of Hudson Bay from this action.
The Defendants and others participated in a private offering, infusing WPCS with capital in December 2012 in exchange for WPCS notes ("Notes") and warrants ("Warrants"). A year later, the Defendants and Hudson Bay sold BTX Trader, LLC ("BTX") to WPCS. The plaintiff believes that the sale of BTX provided the Defendants with the opportunity to make illegal short-swing profits on their investment in WPCS. For roughly two weeks following the announcement of the sale of BTX to WPCS, the volume trading of WPCS stock increased exponentially and its stock price fluctuated greatly.
Since each of the Defendants owned less than 10% of the outstanding shares of WPCS, the plaintiff has alleged that the Defendants and Hudson Bay formed a group to purchase and sell WPCS stock in violation of the securities laws. The plaintiff relies on two events to infer the formation of a group, and its concomitant purchase and sale of WPCS stock: their coordinated investment in WPCS and their combined purchase of BTX and its subsequent sale to WPCS.
The following facts are asserted in the Complaint and taken from documents integral to those claims. On December 4, 2012, WPCS obtained $4 million when it entered into a Securities Purchase Agreement ("SPA") with Defendants, Hudson Bay, and others (collectively "Buyers"). In exchange for the investment, the Buyers received $4 million in principal amount of convertible Notes and Warrants to purchase 15, 923, 567 shares of WPCS's common stock. In connection with the SPA, WPCS also entered into a registration rights agreement with Buyers ("Rights Agreement"). Iroquois' and ACM's Notes constitute approximately 31% and 3%, respectively, of the total value of the Notes issued pursuant to the SPA.
The SPA and Rights Agreement contain provisions describing the circumstances and manner in which the Buyers could purchase additional WPCS securities and sell the WPCS common stock obtained through conversion of the Notes. The Rights Agreement also describes scenarios in which the Buyers would be able to register their securities with the SEC. In each of these scenarios, the Rights Agreement requires that notice be given to each Buyer of the impending registration, and permits each Buyer to participate in the registration. If a particular registration was oversubscribed by the Buyers, the Rights Agreement describes a pro rata method of reducing the number of shares to be registered.
The SPA explains that the use of a single agreement was for the convenience of WPCS and should not create a presumption that the Buyers were acting as a group. It provides:
The obligations of each Buyer under the [SPA and Rights Agreement] are several and not joint with the obligations of any other Buyer.... Nothing contained herein or in any other [document], and no action taken by any Buyer pursuant hereto..., shall be deemed to constitute the Buyers as... a partnership, an association, a joint venture, or any other kind of group or entity, or create a presumption that the Buyers are in any way acting in concert.... The decision of each Buyer to purchase securities pursuant to [any document relating to this transaction] has been made by such buyer independently of any other Buyer.... Each Buyer shall be entitled to independently protect and enforce its rights.... The use of a single agreement to effectuate the purchase and sale of the securities contemplated hereby was solely in the control of [WCPS]... and was done solely for the convenience of [WPCS].... It is expressly understood and agreed that each provision contained in [the SPA and other transaction documents] is between [WPCS], each subsidiary and a Buyer, solely, ... and not between and among the Buyers.
(Emphasis supplied.) The Rights Agreement contains a similar provision.
Recognizing the impact of Section 16(b), the Notes contain a provision limiting the right of the holder to convert the Notes to achieve ownership in excess of 9.99% of common stock. Specifically, the Notes provide that:
Notwithstanding anything to the contrary contained in this Note, this Note shall not be exercisable by the Holder hereof, and [WPCS] shall not effect any conversion... to the extent (but only to the extent) that giving effect to such conversion or other share issuance hereunder the Holder (together with its affiliates) would beneficially own in excess of 9.99%... of the Common Stock.... For ...