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STARR v. !HEY

May 21, 2003

DAVID A. STARR, PLAINTIFF,
v.
!HEY, INC., A DELAWARE CORPORATION; ICONTACT.COM, INC., A DELAWARE CORPORATION; WILLIAM G. CHRISTIE; ROBERT A. BOWMAN; RICHARD WARD; RAHUL PRAKASH; ROGER DOW; TELCOM-INTERNET INVESTORS, LLC; TELC0M-ONLINE INVESTORS, LLC; TELCOM VENTURES, LLC; HARBOR CAPITAL, LLC; AND DUNCAN MACKAY, DEFENDANTS.



The opinion of the court was delivered by: William J. Hibbler, District Judge

MEMORANDUM OPINION AND ORDER

David Starr filed this five-count complaint pursuant to § 12(a)(1) of the 1933 Securities Act, 15 U.S.C. § 771(a)(1), § 5 and Regulation D of the 1933 Securities Act, 15 U.S.C. § 77e, and principles of commmon law. According to Starr, the Defendants sold him unregistered securities in connection with the merger of icontact.com, inc. and !hey, inc., and thus are liable for the diminution in its value. Rahul Prakash, Telcom-Internet Investors, Telcom-Online Investors, and Telcom Ventures (Prakash and Telcom Entities) have filed a motion to dismiss all claims against them pursuant to Fed.R.Civ.P. 12(b)(6). Robert Bowman and Harbor Capital filed a similar motion to dismiss. For the reasons stated herein, the Court GRANTS both motions and dimisses with prejudice all counts against Rahul Prakash, Telcom-Internet Investors, Telcom-Online Investors, Telcom Ventures, Robert Bowman, and Harbor Capital.

I. Factual Background

David Starr was employed by icontact as a software developer and by August 8, 2000, had accumulated 64,883 shares of icontact common stock. Pursuant to a "Stock Option Grant Certificate," Starr exercised an option to purchase additional shares on a cashless basis, and by September 8, 2000, had increased his total shareholding to 102,277. Starr began exercising his options shortly after receiving a mailing from icontact and its CEO, William Christie, notifying him of a proposed merger between icontact and !hey. The merger was approved by a majority of icontact shareholders, and Starr's icontact shares were converted into approximately 110,000 !hey shares. According to Starr, !hey represented to him on August 18, 2000, that his icontact shares were valued at $3.3127 per share, but in October 2000 represented to him that the converted icontact shares were in fact valued at only $0.30 per share.

In the five-count complaint, Starr seeks the difference between the value of shares as represented on August 18, 2000 and during October 2000. Starr alleges in Count I that icontact, !hey, and the individual Board members of icontact and !hey (including Prakash and Bowman) violated Sections 5 & 12 (1) of the 1933 Securities Act (the Act) because they sold unregistered securities to him. In Count II, Starr alleges that by reason of their status as controlling persons the individual Board members of icontact (including Prakash and Bowman) as well as other shareholders (including the Telcom entities and Harbor Capital) had the power to cause icontact and !hey to engage in the sale of unregistered securities and thus are liable for its acts. Count III alleges a breach of fiduciary duty. Count IV alleges a breach of contract because !hey did not redeem his shares at the price promised. Count V alleges that the individual Defendants converted Starr's property by refusing to redeem his shares.

II. Standard of Review

Motions to dismiss test the sufficiency of the complaint, not the merits of the case. Pickrel City of Springfield, Ill., 45 F.3d 1115 (7th Cir. 1995). The Court must accept as true all well-pleaded factual allegations and draw all reasonable inferences from them, Id. The Court will dismiss a complaint under Rule 12(b)(6) only if it appears that the plaintiff's can prove no set of facts that would entitle them to relief. Conley v. Gibson, 335 U.S. 41 (1957).

III. Analysis

A. Standing

At the outset, the Court holds that Starr lacks standing to bring this suit against the moving Defendants. As a general principle, a corporate shareholder does not have an individual right of action against third parties for damages to the shareholder resulting indirectly from injury to the corporation. Flynn v. Merrick, 881 F.2d 446, 449 (7th Cir. 1989); Twohy v. First Nat'l Bank of Chicago, 758 F.2d 1185, 1194 (7th Cir. 1985). There are certain exceptions to this general rule, such as when the shareholder's injuries are distinct from those of other shareholders. Twohy, 758 F.2d at 1194. But the mere diminution in the value of corporate assets is insufficient direct harm to give the shareholder standing to sue in his own right, because the corporation alone is the directly injured party. Flynn, 881 F.2d at 449. A derivative suit brought on behalf of the corporation is the proper vehicle for an individual shareholder to address the diminution of the value of his stock caused by alleged third-person malfeasance.

The Court agrees with Prakash and the Telcom Entities that Starr's claims, for the most part, are derivative. Counts I, II, and III all allege that the Defendants caused the value of Starr's stocks to be diminished as a result of their actions in the merger of icontact and !hey, and thus are derivative in nature. The language contained within Starr's complaint demonstrates beyond doubt the derivative nature of his suit. Starr alleges that the "value of [his] converted shares were valued at the equivalent of $.30 per share of icontact . . . substantially below [the] $3.3127" they were previously valued. Starr further alleges that the Defendants' "attempt[ed] to secure certain rights and benefits for themselves alone, at the expense of minority shareholders." (emphasis added). By the very allegations of his complaint, Starr demonstrates that his injury is one that results from the diminution of the value of his shares and one that he has in common with other shareholders. Accordingly, Starr lacks standing to assert Counts I, II, and III against the moving Defendants and those counts must be dismissed as to Prakash, Bowman, the Telcom Entities, and Harbor Capital on this ground alone. Even if Starr did have standing to pursue Counts I, II, and III, they would still fail for the reasons stated below

B. Count I — Section 12(1) Claim

Prakash moves to dismiss Count I of Starr's claim, arguing that he was exempt from the disclosure and registration requirements because: (1) the stocks were issued to Starr as part of an employee stock option plan, 15 U.S.C. § 77c(a)(2); (2) the transaction did not involve a public offering, 15 U.S.C. § 77d(2). Bowman moves to dismiss Count I of Starr's claim, arguing that he was not a seller for purposes of Section 12 (1), and therefore Starr cannot state a claim against him.

If a security or transaction is exempted under § 77c then a person cannot incur section 12(1) liability pursuant to § 77c. Donohoe v. Consolidated Operating & Prod. Corp., 982 F.2d 1130, 1140 (7th Cir. 1992) (observing that § 77e is subject to a number of exceptions and limitations); see also Associated Randall Bank v. Griffin, Kubik, Stephens & Thompson, Inc., 3 F.3d 208, 209 (7th Cir. 1993) (discussing exemption from securities regulation of most governmental securities); American Deposit Corp. v. Schacht, 84 F.3d 834, 856 (7th Cir. 1996) (Flaum, J., dissenting) (observing that Congress recognizes distinct nature of annuities and insurance contracts and exempts them from securities regulation). Section 77c (a)(2) provides that "except as hereinafter expressly provided, the provisions of this subchapter shall not apply to any of the following classes of securities: . . . a stock bonus, pension, or profit-sharing plan which meets the requirements under section 401 of Title 26." 15 U.S.C. ...


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