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AMZAK CORPORATION v. RELIANT ENERGY

January 27, 2004.

AMZAK CORPORATION, COUNTRYSIDE CABLE, INC., and GERALD KAZMA, Plaintiffs,
v.
RELIANT ENERGY, INC. (n/k/a CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC), R. STEVE LETBETTER, STEPHEN W. NAEVE and MARY P. RICCIARDELLO, Defendants



The opinion of the court was delivered by: JOAN H. LEFKOW, District Judge

MEMORANDUM OPINION AND ORDER

Plaintiffs, Amzak Corporation ("Amzak"), Countryside Cable Inc. ("Countryside"), and Gerald Kazma ("Kazma"), bring this law suit alleging that defendants, Reliant Energy, Inc. (n/k/a Centerpoint Energy Houston Electric, LLC) ("Reliant Energy"), R. Steve Letbetter ("Letbetter"), Stephen W. Naeve ("Naeve") and Mary P. Ricciardello ("Ricciardello") (collectively "defendants"), violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78k(b), and Rule 10b-5 promulgated under § 78j(b), by knowingly making misrepresentations and by failing to state material facts concerning publicly traded securities in Reliant Energy. Plaintiffs also allege (a) violation of § 20(a) of the Securities Exchange Act of 1934, 18 U.S.C. § 78t(a); (b) fraudulent misrepresentation under Illinois law; and (c) violation of the Illinois Consumer Fraud and Deceptive Business Practices Act. Defendants have moved to dismiss the claims for failure Page 2 to state a claim upon which relief may be granted under Federal Rule of Civil Procedure 12(b)(6) and for failure to satisfy the pleading requirements of Federal Rule of Civil Procedure 9(b), and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4(b) ("PSLRA"). For the reasons set forth below, defendants' motion is granted and plaintiffs' First Amended Complaint is dismissed without prejudice.

MOTION TO DISMISS STANDARDS

  A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) challenges the sufficiency of the complaint for failure to state a claim upon which relief may be granted. Gen. Elec. Capital Corp. v. Lease Resolution Corp., 128 F.3d 1074, 1080 (7th Cir. 1997). Dismissal is appropriate only if it appears beyond a doubt that the plaintiff can prove no set of facts in support of its claim that would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Kennedy v. Nat'l Juvenile Det. Ass'n, 187 F.3d 690, 695 (7th Cir. 1999). In ruling on the motion, the court accepts as true all well pleaded facts alleged in the complaint, and it draws all reasonable inferences from those facts in favor of the plaintiff. Jackson v. E.J. Brach Corp., 176 F.3d 971, 977 (7th Cir. 1999); Zemke v. City of Chicago, 100 F.3d 511, 513 (7th Cir. 1996).

  In addition to the mandates of Rule 12(b)(6), Federal Rule of Civil Procedure 9(b) requires "all averments of fraud" to be "stated with particularity," although "[m]alice, intent, knowledge, and other condition of mind of a person may be averred generally." "The rule requires the plaintiff to state the identity of the person who made the misrepresentation, the time, place, and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff." Vicom, Inc. v. Harbridge Merch. Servs., Inc., 20 F.3d 771, 777 (7th Cir. 1994); see also DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990) ("Although Page 3 states of mind may be pleaded generally [under Rule 9(b)], the `circumstances' must be pleaded in detail. This means the who, what, when, where, and how: the first paragraph of any newspaper story."). "`Because only a fraction of financial deteriorations reflects fraud,'. . . plaintiffs in securities cases must provide enough information about the underlying facts to distinguish their claims from those of disgruntled investors." Arazie v. Mullane, 2 F.3d 1456, 1458 (7th Cir. 1993) (quoting in part DiLeo, 901 F.2d at 628).

  Further, in addition to Rule 9(b), the PSLRA imposes "heightened pleading requirements" to discourage claims of "so-called `fraud by hindsight.'" In re Brightpoint, Inc. Sec. Litig., No. IP99-0870-C-H/G, 2001 WL 395752, at *3(S.D. Ind. Mar. 29, 2001). Section 78u-4(b) "requires a court to dismiss a complaint that fails to (1) identify each of the allegedly material, misleading statements, (2) state facts that provide a basis for allegations made on information and belief, or (3) state with particularity `facts giving rise to a strong inference that the defendant acted with the required state of mind.'" Id. at *4.

  ALLEGATIONS OF THE COMPLAINT

  Reliant Energy is an international energy services and energy delivery company providing services in North America and Western Europe. (First Am. Compl. ¶ 6.) In December 2000, Reliant Energy transferred substantially all of its unregulated business to its subsidiary, Reliant Resources, Inc. (First Am. Compl. ¶ 19.) In April 2001, Reliant Resources' shares were offered to the public in an initial public offering. Letbetter was Reliant Energy's President and Chief Executive Officer, and Naeve its Vice Chairman and Chief Financial Officer. (First Am. Compl. ¶ 6.) Ricciardello was Reliant Energy's and Reliant Resources' Chief Accounting Officer. (Id.) Page 4

  In May 2002, defendants announced that an internal investigation revealed that Reliant Resources had engaged in "Round-trip Transactions"*fn1 which had artificially inflated Reliant Resources' trading volume and revenues. (First Am. Compl. ¶ 24.) Plaintiffs allege that these transactions resulted in defendants' making certain false and misleading statements throughout the time period of August 2, 1999 through May 10, 2002. (First Am. Compl. ¶ 25.) During the time that Reliant Energy issued these false and misleading statements, its shares traded as high as $50.02 per share (on May 1, 2001) and, after curative statements made by Reliant Energy on May 10 and 13, 2002 regarding the Round-trip transactions, the market price of the stock fell to as low as $5.40 per share. (First Am. Compl. ¶ 24.)

  Plaintiffs' general theory of injury alleges that they all owned securities in Reliant Energy and, during the time the stock prices were inflated due to the Round-trip transactions and related false and misleading statements of defendants, they pledged these securities as collateral for certain loans issued by banks. (First Am. Compl. ¶ 13.) Plaintiffs allege that when the price of the stock declined prior to the disclosure by defendants of the Round-trip transactions and the banks required payment to supplement the collateral, plaintiffs relied on defendants' false and Page 5 misleading statements to base further investments into the loan collateral to avoid having the stock foreclosed and sold by the bank. (First Am. Compl. ¶¶ 15-18.) Moreover, according to plaintiffs, after the defendants' alleged false and misleading statements became known, the price of the securities dropped in value and pursuant to the respective loan agreements entered into with each lender, the lender demanded payments from plaintiffs for additional collateral. (Id.) Once again, rather than allow the lenders to collect through use of the collateral, plaintiffs made payments with other assets and suffered additional losses. (Id.) These payments were to replace the perceived value of the stock and prevent sale by foreclosing on the collateral. (Id.) According to plaintiffs, all of the above payments to their lenders after their initial pledge of Reliant Energy stock resulted in "constructive purchases" of additional shares of stock. (First Am. Compl. ¶ 14.)

  DISCUSSION

 A. Count I: Section 10(b)

  Section 10(b) of the Securities Exchange Act of 1934 provides,
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . [t]o use or employ, in connection with the purchase or sale of any security . . .[,] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission ["SEC"] may prescribe as necessary or appropriate in the public interest or for the protection of investors.
Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it unlawful for any person

  (a) To employ any device, scheme, or artifice to defraud, (b) [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were Page 6 made, not misleading, or (c) [t]o engage in any act, practice or course of business which operates or would ...


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