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Alpha Capital Anstalt v. Schwell Wimpfheimer & Associates LLP

United States District Court, S.D. New York

March 30, 2018

ALPHA CAPITAL ANSTALT and ELLIS INTERNATIONAL, LTD., Plaintiff,
v.
SCHWELL WIMPFHEIMER & ASSOCIATES LLP, DOV SCHWELL, MICHAEL HUGHES, WILLIAM SCHMITZ, ADEEB SABA, and MARK MATTHEWS, Defendants.

          MEMORANDUM OPINION AND ORDER

          GREGORY H. WOODS, United States District Judge

         In an effort to develop an efficient and affordable power co-generation system for residential and commercial buildings, a New York startup, Arista Power, found itself in need of funding for its projects. Instead of seeking third-party loans, Arista affiliates contrived a plan to privately sell stock options in its company that were held by family members of an Arista consultant and known securities-law violator. With the help of counsel, Arista officers put the plan into action, sparking sales that ultimately led to approximately $1 million in capital influx. At the same time, however, Arista's public filings concealed the private stock sales and instead credited the capital infusion to a loan that the company had secured from a third-party strawman. Following that raising of capital, Arista was still faced with financing needs and sought Plaintiffs' investment. Arista representatives spoke glowingly to Plaintiffs of the company's flagship project and its potential to light the way for future growth. Plaintiffs invested, but less than two years later, Arista's lights went out when the company filed for bankruptcy protection.

         Plaintiffs brought this action against various Arista officers, the company's general counsel, and the law firm of which two of the Individual Defendants are partners. Plaintiffs allege violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, as well as violations of Section 20(a) of the Exchange Act and claims for common-law fraud. Defendants have all moved to dismiss the amended complaint. Because Plaintiffs' allegations insufficiently plead loss causation; Plaintiffs' reliance on the misstatements of certain Individual Defendants is precluded by the parties' contractual agreements; and Arista's counsel is not pleaded to have made the alleged misleading statements, Defendants' motions are GRANTED in their entirety.

         I. BACKGROUND[1]

         A. The Key Players in the Alleged Fraud

         Arista Power (“Arista” or “the Company”) is a New York corporation headquartered in Rochester, New York that was formerly known as Future Energy Solutions, Inc. and WindTamer Corp. Amended Compl., ECF No. 74, ¶ 25. As WindTamer Corp., the company purported to develop and sell wind turbines and was first quoted publicly in November 2009 on the OTCQB with ticker symbol WNDT. Id. In 2010, the company developed its “Power on Demand” system, which utilized “inputs from multiple energy sources including solar, wind, fuel cells, generators, and the grid, in conjunction with a custom-designed battery storage system and a proprietary smart monitory technology, to release energy at optimal times to reduce peak power demand, thereby lowering electricity costs.” Id. ¶ 26. The first Power on Demand system was commissioned in the first quarter of 2011. Id. In conjunction with this shift in business operations, from development and sales of wind turbines to the more comprehensive Power on Demand system, WindTamer changed its name to Arista Power and its ticker symbol to ASPW in May 2011. Id. ¶ 27.

         At all times relevant to the issues raised in this case, Defendant William Schmitz served as Arista Power's chief executive officer (“CEO”) and was a member of the company's board of directors. Id. 18. Defendant Adeeb Saba served as Arista's chief operating officer (“COO”). Id. ¶ 19. Defendant Mark Matthews served as Arista's president in 2012 and 2013, and was thereafter a representative and agent of the company. Id. ¶ 20.

         Defendant Schwell Wimpfheimer & Associates LLP (“SWA”) is a law firm with offices in New York, New York. Id. ¶ 17. SWA was at all relevant times primary outside counsel to Arista Power. Id. During the relevant period, SWA's managing partner, Defendant Dov Schwell, also served as the chairman of the Arista board of directors and a member of the board's audit committee. Id. ¶ 16. As of April 28, 2010, Schwell also served as an Arista director. Id.

         Defendant Michael Hughes is an attorney admitted to the bars of the States of New York and New Jersey and a partner at SWA. Id. ¶ 15. Hughes was initially retained as a legal consultant to Arista Power in July 2008. Id. Five years later, in July 2013, Hughes assumed the role of Arista's general counsel. Id.[2] Hughes also served as an executive officer of the Company. Id. ¶ 8.[3]

         Non-party Peter Kolokouris joined Hughes in becoming a consultant to Arista Power in July 2008. Id. ¶¶ 34, 38. Twenty years earlier, Kolokouris had been charged by the SEC with securities fraud in connection with his alleged misappropriation of proceeds from an initial public offering of North Atlantic Fisheries, Inc. and his alleged receipt of illegal kickbacks from an underwriter. Id. ¶ 32. In connection with those charges, Kolokouris entered into a consent settlement with the SEC, under the terms of which he resigned as an officer and director of North Atlantic Fisheries and other entities; agreed to an injunction prohibiting him from serving as an officer or director or owning fifty percent or more of the securities of a public company; and disgorged over two million dollars. Id. ¶ 33.

         B. Kolokouris and Hughes Partner with Arista

         On July 10, 2008, Kolokouris entered into a handwritten “Option Agreement” with Arista (then Future Energy) which granted Kolokouris options to purchase 166, 000 shares of the company's stock-over fifteen percent of the Company's outstanding stock-at an exercise price of $1.00 per share. Id. ¶¶ 34, 40. Kolokouris subsequently assigned those stock options to entities affiliated with Kolokouris's family. Id. ¶ 41. In the related enforcement action, the SEC has alleged that the purpose of this stock transfer was to evade the bar that was imposed on Kolokouris in 1990 from owning five percent or more of the securities of a public company. Id.

         The Option Agreement also granted Hughes, Kolokouris's attorney, options to purchase 167, 000 shares of the company's common stock at the same exercise price of $1.00 per share. Id. ¶ 34. The Option Agreement contained a clause stating: “The Company acknowledges that Michael Hughes is an attorney and has represented the Investors and has not represented the Company.” Id. ¶ 35.

         On November 26, 2008, the Company disclosed that Hughes had “provided consulting services to the company in connection with its management structure and business development and product marketing strategies” since July 2008. Id. ¶ 36. The following year, the Company further disclosed that Hughes beneficially owned 1.66 million shares of the Company's stock through 609 MTH, Inc. and 7.89 million shares of Company stock through both 609 MTH, Inc. and another entity, 10EJH. Id. ¶ 37.

         On March 30, 2009, the Company disclosed that Kolokouris had “acted as a consultant to the Company since July 2008 . . . provid[ing] consulting services involving advice and assistance on its management structure and business development and developing a product marketing strategy and publicity strategy.” Id. ¶ 38 (alterations in original). The Company also disclosed that Kolouris's consulting role had included “assis[ting] the Company in locating auditing services, legal services, and assistance in locating financial market professionals to assist the Company.” Id. (alteration in original).

         In addition to its disclosure regarding Kolokouris's role as consultant, the Company also disclosed at that time that “Hughes ha[d] acted as consultant to the Company since July 2008” and “[d]uring this time [ ] provided consulting services involving advice and assistance on its management structure and business development and developing a product marketing strategy and publicity strategy.” Id. ¶ 39. The Company further disclosed that Hughes had “also assisted the Company in locating auditing services, legal services, insurance and assistance in locating financial market professional to assist the Company.” Id.

         C. The Switch is Flipped on the Plot to Privately Sell Kolokouris Family Stock

         In February 2011, Hughes, at Kolokouris's request, performed all of the legal work necessary to create TMK-ENT, Inc., an entity nominally owned and directed by Tim Davin, Kolokouris's neighbor. Id. ¶ 52.

         Beginning in the summer of 2012, Arista faced difficulty in raising capital for its operations. Id. ¶ 42. Hughes and Schmitz, working with Kolokouris, recommended that Arista raise short-term capital through private sales of the stock options that had been transferred to the Kolokouris family entities. Id. Kolokouris would transmit payment from these sales to Arista after withdrawing cash from accounts that he controlled. Id. ¶ 43.

         In late August 2012, Arista decided to put this plan into play. Id. ¶ 42. To effectuate the sales, Hughes and Schmitz, among other Arista affiliates, privately offered Kolokouris family stock to various of their acquaintances, including their friends, family members, tennis club associates, and others. Id. ¶¶ 44, 60. Kolokouris directed Hughes and Schmitz with respect to what stock to sell, the amounts to sell, and the price at which to sell it. Id. ¶ 60. Kolokouris himself took various steps to manipulate the price of publicly traded Arista stock so that the privately offered stock could be sold at an apparent discount. Id. ¶¶ 44, 76. Specifically, Kolokouris executed “manipulative stock transactions” in his family members' brokerage accounts and marked the closing price of Arista stock on a number of trading days. Id. ¶ 76. In this way, Kolokouris was able to increase and maintain Arista's public market stock price at a price above $1.00 per share, while the private sales of Kolokouris family stock were made at a discounted price. Id. ¶¶ 44, 76.

         In the fall of 2012, Hughes and Schmitz believed that the Company was legally required to disclose the influx of new capital. Id. ¶ 45. Accordingly, Arista's board of directors held a telephonic meeting on August 30, 2012 to discuss the funding. Id. ¶ 46. Among others, Schwell, Schmitz, and Hughes were in attendance. Id. The Company's CFO, charged with recording meeting minutes, took handwritten notes during the meeting. Id. Those notes indicated that Hughes discussed the idea of Arista “founder shares” being sold “privately to loan” funds to the Company; that Hughes, Schmitz, and another Company associate had already “locked in aprox $200K” in such private sales; and that Hughes and Schmitz planned to sell “up to $1 M[illion]” in stock. Id. (alteration in original).

         The day after that meeting, the CFO emailed a typewritten draft of her minutes from the August 30, 2012 meeting to Hughes for his review. Id. ¶ 47. That draft included the following description of the potential new funding for the Company:

Mr. Schmitz . . . explained, that . . . we are working on a financing plan with other [Arista] investors, who plan to sell a certain number of shares of [Arista's] stock, and will loan the proceeds from those private sales to [Arista]. Terms of the loan are being defined. There was a motion made by [Arista's Chairman] to allow Bill Schmitz and [the Chairman] to negotiate terms with the lender. [A Board member] seconded the motion and all were in favor.

Id. (alterations in original).

         Ten days later, on September 10, 2012, Arista publicly filed with the SEC a Form 8-K that was drafted and reviewed by Hughes and signed by Schmitz, in his capacity as Arista's CEO. Id. ¶¶ 49-50. That 8-K stated:

On September 4, 2012, [Arista] entered into a Loan Agreement with TMK-ENT, Inc. (the “Lender”) providing for a $500, 000 working capital revolving line of credit for [Arista]. Advances under the Loan Agreement, which will be evidenced by a committed revolving credit note (the “Note”), bear interest at 10% per year, payable annually. The Note matures on September 4, 2013, and all borrowings under the Loan Agreement are due and payable on that date.
As additional consideration for entering the Loan Agreement, [Arista] issued to the Lender warrants with a 10-year term to purchase an aggregate of 500, 000 shares of common stock of [Arista] at $1.80 per share pursuant to a Warrant Purchase Agreement (the “Warrant Purchase Agreement”). . . . The Lender is an accredited investor as defined under the Securities Act and Regulation D, was knowledgeable about [Arista's] operations and financial condition and had access to such information.

Id. ¶ 49.

         TMK-ENT never loaned Arista the $500, 000. Id. ¶ 53. Instead, “it was ‘generally understood by Arista'” that the amount of the purported loan was entirely contingent on the funds generated by the sale of Kolokouris family stock and paid to Arista from Kolokouris-controlled accounts. Id. ¶ 55. An email sent by an Arista board member on September 23, 2012 to Schmitz, with a copy to Hughes and the Arista board, including Schwell, reflected this understanding, inquiring, “With the 500k [credit facility] nearly complete, would it be possible if founding members would be willing to sell more stock to increase the facility?” Id. Arista's CFO also understood the true source of the funding; in an October 20, 2012 email, she “admitted” as much when she stated, “we have gotten a line of credit from TMK Enterprises (Peter [Kolokouris] has agreed to sell some of his stock to other investors, and is lending us that money)-10% interest-1 year loan.” Id. ¶ 64 (alteration in original).

         Also despite the 8-K's representations, as of the time of the September 2012 8-K filing, neither Arista nor TMK-ENT had executed the purported Loan Agreement, Warrant Purchase Agreement, or Note. Id. ¶ 56. Nor had TMK-ENT received any of the stated warrants. Id. Hughes and Schmitz knew that no such documents existed at that time. Id. It was not until September 26, 2012 that Hughes emailed a draft of the “TMK-ENT Credit Facility” to Schwell. Id. ¶ 59. In that email, Hughes explained that he was attaching the credit facility and related note and warrant, and that the facility was “very company friendly, with just a few real terms (barely) to make it arms-length.” Id. In its investigation, the SEC found that the credit facility and related documents were not finalized until October 2012 at the earliest, after being drafted by Hughes and signed by Schmitz. Id. ¶¶ 56-57. The SEC also determined that Hughes and Schmitz caused the forms to be back-dated to September 4, 2012, thereby creating the appearance that the final documents had existed at the time of the September 2012 8-K filing. Id. ¶ 57. Plaintiffs allege that Hughes and Schmitz understood the loan agreement with TMK-ENT to be a “ginned-up ‘agreement'” between Arista and the Kolokouris-controlled entity meant to “cover up Arista's actual dealings with Kolokouris” rather than an arms' length transaction. Id. ¶ 58.

         The minutes of the August 30, 2012 board meeting were not finalized until October 2012. Id. ¶ 65. On October 22, 2012, the CFO re-sent her August 31, 2012 draft of the minutes to Hughes, asking him again to review them. Id. In a response sent later that day, Hughes sent the CFO a revised version of the minutes, which read:

Mr. Schmitz . . . explained that . . . [Arista] is attempting to secure financing $500, 000 loan from TMK-ENT, Inc., a current shareholder of [Arista]. Terms of the loan are currently being negotiated, but it was expected that the loan would have a term of approximately one year, have an annual interest rate of ten percent and that [Arista] would issue to the lender a warrant to purchase up to 500, 000 shares of [Arista's] common stock at market price at the closing of the loan. The loan would not be secured by any of [Arista's] assets, and not guaranteed by any person.
After a discussion, a motion was made by [a Board member] and seconded by [another Board member], whereupon the following resolutions were unanimously adopted:
NOW THEREFORE, IT BE RESOLVED, the Company is authorized [to] enter into an agreement or agreements (collectively the “Loan Agreements”) with TMK-ENT, LLC (“TMK”) in which [Arista] would borrow up to $500, 000 from TMK, with an interest rate of no more than ten percent per year . . . .”

Id. (alterations in original). Plaintiffs allege that, as borne out by the SEC's allegations, Hughes knew that this revision to the board minutes was false and deceptive because the board had not discussed a loan from TMK-ENT during the August 30, 2012 meeting and the revised minutes make no mention of the sales of “founders” stock. Id. ¶ 66. Plaintiffs further adopt the SEC's allegation that these revised minutes were intended to conceal the actual substance of the board's August 30, 2012 meeting and to conform it instead to the September 2012 8-K. Id. ¶ 67. The board, chaired by Schwell, adopted a final version of the minutes on October 24, 2012, after additional changes were made. Id. ¶ 68. The final minutes did not reference the sale of Kolokouris family stock. Id.

         D. The Deception Continues

         Over the course of the next two years, Arista's public filings continued to make false and misleading statements, and contained material omissions, regarding the purported loan from TMK-ENT. Id. ¶ 69. The Company's Forms 8-K dated November 16, 2012, December 26, 2012, and May 30, 2013 falsely announced increases in the amount of the TMK-ENT loan, up to an ultimate sum of $1, 250, 000. Id. The following filings also contained related statements and omissions: Forms 10-Q dated November 13, 2012, May 13, 2013, August 13, 2013, November 12, 2013, May 15, 2014, August 14, 2014, and November 14, 2014; Forms 10-K dated March 28, 2013 and March 31, 2014; and Forms S-1 dated August 30, 2013, October 3, 2013, and April 30, 2014. Id. Schmitz, in his capacity as Arista's CEO, signed each of these filings, and Schwell, as chairman of the Company's board, signed the Forms 10-K. Id. ¶¶ 69-70. Hughes drafted or “at least” reviewed the filings and “assisted in their filing.” Id. ¶¶ 70, 72.

         Plaintiffs allege that, at the time of those filings, Hughes and Schmitz knew or recklessly disregarded that TMK-ENT was controlled by Kolokouris and did not have any independent source of funds, that TMK-ENT did not transfer any of the funds received by Arista, and that the purported loan was a “fictitious cover” for Arista financing by Kolokouris through sales of his family stock. Id. ¶ 73. Thus, the filings were false and misleading in that they characterized the $1 million in capital influx as the result of a loan agreement or line of credit from a purported third-party lender, when in fact the capital was raised by a known securities law violator. Id. ¶¶ 72, 74. Plaintiffs also allege that the filings painted for the investing public a false and misleading picture of the independence and integrity of the Company's management. Id. ¶ 75.

         Altogether, from September 2012 through February 2013, Hughes, Schmitz, and Kolokouris raised a total of at least $984, 700 through private sales of the Kolokouris family stock, the proceeds of which were given to Kolokouris. Id. ¶ 63. Kolokouris then remitted $1, 018, 500 to Arista by way of thirteen cashier's checks made payable to Arista with a handwritten memo that read “TMK Enterprises.” Id. Arista never repaid any of these monies, to TMK-ENT or anyone else. Id. All communications between Hughes and Schmitz and TMK-ENT during the relevant periods were with Kolokouris, and not with the corporation's legal owner. Id. ¶ 52.

         At some point in 2013, the SEC opened an investigation into Arista Power and Kolokouris. Id. ¶ 28. In connection with that investigation, the SEC issued various subpoenas to the Company and related individuals, including to Hughes. Id.

         E. Plaintiffs Are Persuaded to Invest in Arista

         Plaintiffs Alpha Capital Anstalt and Ellis International Ltd. are foreign entities, organized under the laws of Lichtenstein and Panama respectively. Id. ¶¶ 13-14. They were solicited by Arista in 2014 to invest in the Company. Id. ¶ 79. By early 2014, Arista was publicly representing its energy business engagements as two-fold: (1) the Company was developing and installing its proprietary Power on Demand (“POD”) system, and (2) the Company was engaged in selling solar energy systems. Id. ¶ 77. The POD system, Arista explained, stored energy from a variety of sources, including solar, wind, and fuel cells, and used the Company's proprietary technology to release energy at optimal times in order to maximize energy efficiency and reduce energy costs. Id. ¶ 78. Arista advertised its system as a “transformative technology, ” a key that would unlock the Company's growth. Id.

         In February 2014, Defendants Saba and Matthews met with Plaintiffs' representatives, Yosef Milgrom and Jay Spinner, in an effort to solicit Plaintiffs' investment in Arista securities. Id. ¶ 79. During that meeting, Saba and Matthews represented that the Company's POD system would more efficiently manage energy distribution and would cost less than alternative energy sources. Id. Saba and Matthews emphasized the critical importance of Arista's POD pilot project, which they both claimed was “already underway” at a residential building known as Rose/City Lights in Queens, New York (the “Rose/City Lights Project”). Id. Saba and Matthews described the project to Plaintiffs' representatives as the first large-scale application of the POD system which, if successful, would serve as the prototype for future projects and likely generate more significant opportunities for commercial application of the system in other buildings. Id. ¶¶ 80, 81. Saba and Matthews both advised Plaintiffs' representatives that Arista had already begun discussions with other buildings about installing the system. Id. ¶ 80.

         Also during the February 2014 meeting, as well as in follow-up conversations, Saba and Matthews each stated that the Company needed Plaintiffs' investment funds to “quickly complete the installation of the Rose/City Lights Project, ” which they anticipated would be done within 120 days of procuring such funds. Id. ¶ 81. Overall, Arista expected to raise $1.5 million, funding which would permit Arista to finish installation and which Saba and Matthews both represented was the only impediment to completion of the project. Id. ¶ 82. At no point during that meeting, or in conversations thereafter, did Saba or Matthews disclose to Plaintiffs that the SEC was investigating the Company. Id. ¶ 88.

         Based on the representations by Arista, Saba, and Matthews, and pursuant to a Securities Purchase Agreement (“SPA”) dated March 31, 2014, Plaintiffs collectively invested $955, 000 in Arista preferred stock, with Alpha Capital investing $800, 000 and Ellis International investing $155, 000. Id. ¶¶ 86, 88. Schmitz signed the SPA on behalf of Arista, as well as the Registration Statement filed with the SEC pursuant to which the securities were sold to Plaintiffs. Id. ¶ 87. Plaintiffs allege that, in deciding to invest in Arista, they also relied on representations made in an opinion letter authored by SWA. Id. ¶ 89.

         Plaintiffs later learned that, at the time of the February 2014 meeting with Saba and Matthews, Arista had no personnel on the premises of the Rose/City Lights Project. Id. ¶ 83. Plaintiffs also learned that, at both the time of the February 2014 meeting and also at the time of the March 31, 2014 investment, Arista had yet to begin installation of the POD system and had not even secured the permits and approvals from the New York City Department of Buildings, the New York State Energy Research and Development Authority, and from Con Edison that were necessary to commence work on the project. Id. ¶¶ 83-84. Nor had Arista submitted all of the required permit applications prior to Plaintiffs' investment. Id. ΒΆ 84. Plaintiffs therefore allege that the statements by Saba and ...


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