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Orlan v. Spongetech Delivery Systems, Inc.

United States District Court, E.D. New York

March 24, 2017

JEFFREY P. ORLAN, et al., Plaintiffs,
v.
SPONGETECH DELIVERY SYSTEMS, INC., SECURTIIES LITIGATION, et al ., Defendants. QUANG LE, et al., Plaintiffs,
v.
SPONGETECH DELIVERY SYSTEMS, INC., SECURTIIES LITIGATION, et al ., Defendants.

          MEMORANDUM & ORDER

          DORA L. IRIZARRY CHIEF JUDGE

         Class Plaintiffs (“Plaintiffs”) were common shareholders in Spongetech Delivery Systems, Inc. (“Spongetech”), a publicly traded company that sold soap-filled sponges, inter alia. On March 29, 2012, the Court dismissed without prejudice the Third Claim of Plaintiffs' first consolidated amended class action complaint (“FAC”) pertaining to attorney defendant Jack Halperin (“Halperin”) for failure to state a claim for relief pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure and for failure to comply with the heightened pleading requirements of Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4. See Orlan v. Spongetech Delivery Systems, Inc., 2012 WL 1067975 (E.D.N.Y. Mar. 29, 2012).

         On May 1, 2012, Plaintiffs filed a second consolidated amended class action complaint (“SAC”) in which they reasserted the same causes of action in the Third Claim against Halperin. (See Second Consolidated Amended Class Action Complaint with Certifications (“SAC”) at ¶¶ 193-202, Dkt. Entry No. 69.) On June 1, 2012, Halperin filed a motion to dismiss the Third Claim of the SAC. (See Motion to Dismiss the Second Consolidated Amended Class Action Complaint (“Second Mot. to Dismiss”), Dkt. Entry No. 70, Orlan v. Spongetech Delivery Systems, Inc. et al (“Orlan I”), 10-cv-4093 (DLI)(RML).) Plaintiffs oppose. For the reasons set forth below, Halperin's motion to dismiss the Third Claim of the SAC, arising under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (“Exchange Act”), and the rules promulgated thereunder, is granted with prejudice.

         BACKGROUND[1]

I. The First Amended Complaint

         The Court presumes familiarity with its decision dismissing the Third Claim of Plaintiffs' FAC. Nonetheless, a brief recitation of the allegations in the FAC and the Court's findings as to those allegations is necessary to understand Plaintiffs' SAC.

         The FAC alleged that, from June 12, 2009 through September 29, 2009, Halperin prepared ninety-two attorney opinion letters containing materially false and misleading statements and omissions directing transfer agents to remove restrictive legends from restricted Spongetech stock and causing those shares to flood the market at artificially inflated prices. (See First Consolidated Amended Class Action Complaint (“FAC”), Dkt. Entry No. 46, Le et al v. Spongetech Delivery Systems, Inc. et al, 10-cv-4104.) According to the FAC, at the time he wrote the attorney opinion letters, Halperin knew that these Spongetech shares were unsaleable and not subject to any exemptions that would render removal of those restrictive legends proper. (Id. at ¶ 172.) The FAC further alleged that, in preparing those attorney opinion letters, Halperin facilitated the dumping of 2.5 billion shares of unregistered Spongetech stock onto the public market at artificially inflated prices which Plaintiffs purchased and sold in reliance on the representations in the attorney opinion letters. (Id. at ¶¶ 172, 174.)

         The FAC asserted that Halperin's actions constituted violations of federal securities laws, specifically Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (“Exchange Act”), and Rule 10b-5 promulgated thereunder, because Halperin's attorney opinion letters concealed from Spongetech shareholders the true value of the unregistered Spongetech stock released upon the public market. (Id. at ¶ 172.) In particular, the FAC alleged that Halperin: (1) issued ninety-two Rule 144[2] attorney opinion letters to transfer agents resulting in the removal of restrictive legends from over 922 million shares of unregistered Spongetech stock held by affiliated entities of Spongetech; (2) advised the transfer agent that the legends were removable because the affiliated entities had held the securities for six months or longer; (3) presented the affiliated entities as non-affiliated entities when he knew that they were indeed affiliated entities and had not held the securities for the requisite six-month period; and (4) caused these unregistered securities to be injected into the public market when he knew that the public lacked adequate current information about Spongetech's financial condition. (Id. at ¶¶ 101-110.)

         The FAC further alleged that, as a result of Halperin's misstatements and omissions, the price of Spongetech stock became inflated above its inherent value, thereby defrauding investors. (Id. at ¶ 174.)

         II. The Court's Dismissal of the FAC

         The Court evaluated the FAC in light of the heightened pleading standards mandated by both Rule 9(b) of the Federal Rules of Civil Procedure, which provides that “circumstances constituting fraud or mistake shall be stated with particularity, ” and the Private Securities Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4(b). Fed.R.Civ.P. 9(b). The PSLRA “insists that securities fraud complaints ‘specify' each misleading statement; that they set forth the facts ‘on which [a] belief' that a statement is misleading was ‘formed'; and that they ‘state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.'” Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 346 (2005) (quoting 15 U.S.C. §§ 78u-4(b)(1), (2)). Accordingly, a plaintiff asserting a claim for securities fraud pursuant to Section 10(b) of the Exchange Act and Rule 10b-5 must plead with particularity “that the defendant, in connection with the purchase or sale of securities, made a materially false statement or omitted a material fact, with scienter, and that the plaintiff's reliance on the defendant's action caused injury to the plaintiff.” Ganino v. Citizens Utilities Co., 228 F.3d 154, 161 (2d Cir. 2000).

         The Court found that the Third Claim of the FAC failed to comply with these standards because it did not sufficiently allege materiality, scienter or loss causation. See Orlan, 2012 WL 1067975.

         Specifically, with regard to scienter, the Court found that Plaintiffs failed to set forth, with the required degree of specificity, allegations in the FAC that Halperin had access to documentary evidence that belied the statements contained in his attorney opinion letters. Id. at *14. Moreover, the Court found that Plaintiffs failed to identify specifically the reports or statements containing the contradictory information. Id.

         Regarding loss causation, the Court concluded that, while Plaintiffs adequately pled transaction causation, they failed to plead that there existed a proximate causal link between the false statements contained in Halperin's attorney opinion letters and the economic harm they suffered. Id. at *14-15.

         In dismissing the Third Claim of the FAC without prejudice, the Court afforded Plaintiffs another opportunity to plead the elements of materiality, scienter and loss causation with greater specificity in order to satisfy the heightened pleading requirements of the PSLRA and Rule 9(b) of the Federal Rules of Civil Procedure. See Orlan, 2012 WL 1067975.

         III. Allegations Against Halperin in the SAC

         The allegations in the Third Claim of the SAC are identical to those in the Third Claim of the FAC. However, the SAC contains new allegations that fall into three general categories: (1) Halperin knew, or was reckless in not knowing, that the sale of 922 million restricted Spongetech shares was unauthorized; (2) Halperin conducted inadequate due diligence with respect to Spongetech's financial condition; and (3) Halperin's misrepresentations caused Plaintiffs to suffer economic loss. (SAC at ¶¶ 119, 125, 131, 132 and 162.)

         A. Unauthorized Sale

         Plaintiffs contend that Halperin knew that the sale and distribution of 922 million restricted Spongetech shares was unauthorized because he knew, or had access to publicly available facts, that Spongetech intended to reduce its number of common shares authorized and outstanding. (Id. at ¶ 119.) On July 29, 2009, Spongetech announced that it would “reduce the number of common shares that the Company has authorized to 900, 000, 000” and “lower its outstanding shares to approximately 500, 000, 000 shares.” (Id.) The SAC adds that, on February 28, 2009, Spongetech filed a Form 10-Q with the SEC reporting that it had approximately 722 million shares outstanding and issued. (Id.) ...


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