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Lipman v. Batterson

September 29, 2000

JEROME H. LIPMAN, JEROME H. LIPMAN, I.R.A. AND GERALD A. BECKER, INDIVIDUALLY AND ON BEHALF OF ALL OTHERS SIMILARLY SITUATED,
PLAINTIFFS-APPELLANTS,
V.
LEONARD A. BATTERSON, MICHAEL J. FRIDUSS, PETER S. FUSS, EDWARD W. LAVES, STEVEN LAZARUS, TOM L. POWERS, ORA E. SMITH, PAUL G. YOVOVICH, AND ILLINOIS SUPERCONDUCTOR CORPORATION,
DEFENDANTS-APPELLEES.



The opinion of the court was delivered by: Justice O'brien

Appeal from the Circuit Court of Cook County.

Honorable Ellis E. Reid, Judge Presiding.

Plaintiffs, three shareholders of Illinois Superconductor Corporation (ISC), appeal the circuit court's order dismissing their third-amended class action complaint against defendants, ISC and members of ISC's board of directors, for failure to state a cause of action. On appeal, plaintiffs argue that the circuit court erred in determining that plaintiffs should have brought their claims in a derivative action instead of a direct class action. We affirm.

The facts of this case, as derived from plaintiffs' third amended complaint, are as follows. ISC is a publicly traded Delaware corporation that develops and sells filters used in cellular telephone base stations. In early 1997, ISC needed additional funds to finance its operations. ISC unsuccessfully attempted to raise funds through a public offering of stock. The offering was abandoned, leaving ISC in need of $15 million.

ISC subsequently received a proposal for financing from Brown, Simpson LLC (Brown Simpson), a fund advisory firm based in New York City. Brown Simpson proposed providing up to $15 million by buying ISC preferred stock. This preferred stock would be convertible to ISC common stock at a price determined by a formula agreed upon by the parties. The financing would be made in steps, or " tranches," of up to $3 million each. On June 5, 1997, the ISC board approved the Brown Simpson financing arrangement.

Brown Simpson's intent was to make money by "short selling" large amounts of ISC's common stock. Short selling is accomplished by borrowing a stock and immediately selling the borrowed stock into the market at the current market price. The stock borrowed by a short seller must be replaced share for share at some time in the future. The short seller's goal is to later purchase shares of the stock at a lower price and use those cheaper shares to replace the borrowed stock. The short seller's profit is the difference between the proceeds he received from selling the borrowed stock and his cost to purchase the replacement stock.

Ordinarily, the short seller assumes the risk that the stock price will rise, thereby making it impossible to subsequently purchase stock at a price lower than the price at which he sold the borrowed stock. Here, though, plaintiffs alleged that ISC eliminated this risk in two ways. First, ISC provided Brown Simpson with "material, non public, confidential information" (hereinafter, the confidential information) about ISC's future business prospects which led Brown Simpson to believe that the market price of ISC stock would not likely rise. Second, ISC provided newly issued common stock to replace the stock that Brown Simpson sold short, thereby eliminating the risk that Brown Simpson would drive up the market price of ISC common stock by buying large quantities of that stock on the open market.

Counts I and II of plaintiffs' third amended complaint alleged that Brown Simpson agreed to the short-selling financing arrangement (hereinafter, the Brown Simpson financing arrangement) only after defendants disclosed the confidential information to Brown Simpson and concealed that information from plaintiffs. Plaintiffs pleaded that the Brown Simpson financing arrangement ultimately caused a "precipitous decline" in the price of ISC's common stock.

Count III alleged that the board of directors breached their fiduciary duty of due care by approving the Brown Simpson financing arrangement without first informing themselves that such an arrangement would depress the market price of the ISC common stock.

Counts IV and V alleged that the board of directors breached their fiduciary duty of due care by accepting the second and third "tranches" of funding pursuant to the Brown Simpson financing arrangement without first informing themselves that such funding would depress the market price of the ISC common stock.

Count VI alleged that the board of directors breached their fiduciary duty of loyalty by failing to provide plaintiffs with information that would have allowed plaintiffs to take curative action prior to the "precipitous decline" in the price of the ISC common stock.

Count VII alleged that the board of directors breached their fiduciary duty of loyalty by accepting the Brown Simpson financing arrangement even though they should have known that such an arrangement would depress the price of ISC common stock.

Counts VIII and IX alleged that the board of directors breached their fiduciary duty of loyalty by accepting the second and third tranches of funding pursuant to the Brown Simpson financing arrangement, even though they should have known that such a financing arrangement would depress the price of ISC common stock.

Count X alleged that defendants ISC and the ISC board of directors violated the Illinois Consumer Fraud and Deceptive Business Practices Act (815 ILCS 505/1 et seq. (West 1996)) by disclosing material, confidential information to Brown Simpson and concealing the same information from ...


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