United States District Court, N.D. Illinois
January 27, 2004.
AMZAK CORPORATION, COUNTRYSIDE CABLE, INC., and GERALD KAZMA, Plaintiffs,
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
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
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.)
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
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.)
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
made, not misleading, or (c) [t]o engage in
any act, practice or course of business which
operates or would operate as a fraud or deceit
upon any person, in connection with the purchase
or sale of any security.
17 C.F.R. § 240.10b-5.
To establish liability under § 10(b) and Rule 10b-5, a plaintiff
must prove that "(1) the defendant made a false statement or omission (2)
of material fact (3) with scienter (4) in connection with the purchase or
sale of securities (5) upon which the plaintiff justifiably relied (6)
and that the false statement proximately caused the plaintiff's damages."
Caremark, Inc. v. Coram Health Care Corp.,
113 F.3d 645, 648 (7th Cir. 1997); Searls v. Glasser,
64 F.3d 1061, 1066-67 (7th Cir. 1995). Significantly, this remedy under §
10(b) and Rule 10b-5 is limited only to "actual purchasers and sellers"
of securities. Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 732 (1975).
Defendants' attack on plaintiffs' First Amended Complaint focuses on
the "in connection with the purchase or sale of securities" portion of
the above test. Plaintiffs' First Amended Complaint does not allege any
actual purchase of stock, or for that matter any sale of stock (despite
Marine Bank v. Weaver, 455 U.S. 551, 555 n.2 (1982) ("[A] pledge
of stock is equivalent to a sale for the purposes of the antifraud
provisions of the federal securities laws.") (citing Rubin v.
United States, 449 U.S. 424 (1981)), but instead focuses on a
so-called "constructive purchase" theory. According to plaintiffs, the
loans they received from their banks were based on the perceived value of
the stock at the time of the pledge. Plaintiffs submit that they could
not have undertaken such large loans absent their reliance on the value
of their collateral to back up the loan. When the value of the pledged
stocks dropped, and the lenders declared default, plaintiffs avoided the
loan default by paying the bank the lost value in the
collateral. This, the plaintiffs maintain, is a constructive
purchase of shares and resulted in additional investment risk.
As defendants point out, it is not clear how plaintiffs' "constructive
purchase" theory holds water. There is no allegation that the plaintiffs'
loan transactions with their banks resulted in additional shares of
Reliant Energy stock. There was also no actual purchase by plaintiffs of
the Reliant Energy stock when the purchase price was inflated. The
securities laws would, based on the allegations here, provide a remedy
for an individual who purchased the stock at issue between the dates of
August 2, 1999 through May 10, 2002, because the alleged false and
misleading statements inflated the actual value of the stock. But all
plaintiffs did was to take action to prevent foreclosure of their stock
which had been posted as collateral. Indeed, all the false and misleading
statements served to do was to allow plaintiffs to borrow more money with
less collateral, which resulted in the bank threatening foreclosure if
additional collateral was not supplied. The court acknowledges
plaintiffs' claim that they could not have undertaken such large loans
absent their reliance on the value of their collateral to back up the
loan. Whatever this scenario can be called, however, it was not a
purchase of a security as plaintiffs suggest.
Plaintiffs have little actual case law to support their view. They
point to American Cont'l Corp. v. Keating, 49 F.3d 541
(9th Cir. 1995), but that case is distinguishable on its facts. In
American Cont 7 Corp. a trustee had accepted certain
amounts of shares from a trust corporation as satisfaction of the trust
corporation's obligation to fund the trust. Id. at 545. Thus,
the trustee in that case acquired shares of the stock, which price had
been artificially inflated based on material misrepresentations.
Id. As defendants point out, in this case plaintiffs never
acquired any shares of Reliant Energy stock during the period of the
Plaintiffs also cite United States v. Rubin,
449 U.S. 424 (1980). In that case the petitioner was convicted of conspiring
to violate § 17(a) of the Securities Act of 1933. Id. at 428.
He challenged his conviction on grounds that a pledge of stock as
collateral for a bank loan is not an "offer or sale" under § 17(a).
Id. The petitioner had been vice president of a corporation
named Tri-State Energy, Inc., and had approached several banks seeking
loans to alleviate Tri-State's financial problems. Id. at 425.
Collateral was required for the loan eventually obtained, and petitioner
pledged stock in six companies which he represented as "being good,
marketable, and unrestricted." Id. at 426. These securities
were, in fact, worthless. Id. In rejecting the argument that
these pledges of securities were not "offers" or "sales," the Court noted
that it was not necessary for full title to pass to the transferee for
the transaction to be an "offer" or "sale" and that the bank, as would an
investor, is "relying on the value of the securities themselves,
and . . . must be able to depend on the representations made by the
transferor of the securities, regardless of whether the transferor
passes full title or only conditional and defeasible interest to
secure repayment of a loan." Id. at 430-31.
Plaintiffs submit that the circumstances in Rubin are
identical to this case, except that the lender was not left in a position
of default and the plaintiffs absorbed the loss in the true value of the
stock and have the right of action against the defendants. But
Rubin provides zero support for plaintiffs' theory that their
additional payments to supplement their collateral constituted
"constructive purchases" of Reliant stock even though no additional
shares of stock had been gained. Plaintiffs do not proceed under the
theory that their pledges of the stock, which as noted above would
constitute "sales" under the securities laws, were made in connection
with the fraudulent statements. Rubin's value in that situation
would also be dubious in light of the vastly
different factual scenario in that case, which allowed a pledge of
stocks to be considered an "offer" or "sale" of securities because the
bank relied on the material misrepresentations the pledgor made to induce
the bank to accept the worthless stock as collateral. Plaintiffs' theory
here focuses not on the pledges themselves but, rather, the subsequent
cash payments made to banks which plaintiffs believe constitute
"constructive purchases." Neither Rubin nor any other case
supports this constructive purchase theory. Because plaintiffs' do not
sufficiently allege that any false or misleading statements were in
connection with the purchase or sale of securities, their claim under
§ 10(b) and Rule 10b-5 cannot survive.
Plaintiffs previously asked for, and were granted, leave to file their
First Amended Complaint. Thus, this is the court's first opportunity to
examine the merits of plaintiffs' allegations. Given that the court is
not absolutely certain that no securities fraud action may lie under the
factual scenario presented here, plaintiffs will be afforded one more
chance to state a securities fraud claim. The court, therefore, dismisses
the Count I claim without prejudice.
B. Count II: Section 20(a)
The parties agree that this claim's survival depends on whether
plaintiffs' First Amended Complaint adequately states a claim under §
10(b) and Rule 10b-5. See In re Allscripts, Inc. Sees. Litig.,
2001 WL 743411, at *12 (N.D. Ill. June 29, 2001) ("If a Complaint does
not adequately allege an underlying violation of the securities
laws . . . the district court must dismiss the section 20(a) claim.").
Because the court dismissed the claims under § 10(b) and Rule 10b-5
without prejudice, it shall do the same for the § 20(a) claim.
C. State Law Claims
All that remains of plaintiffs' First Amended Complaint are state law
claims for fraudulent misrepresentation (Count III) and violation of the
Illinois Consumer Fraud and Deceptive Business Practices Act (Count IV).
These both being state law claims, the court must examine its
jurisdiction over these Counts. Plaintiffs' First Amended Complaint
alleges that jurisdiction is invoked over the state claims pursuant to
both this court's supplemental jurisdiction under 28 U.S.C. § 1367
and its diversity jurisdiction under 28 U.S.C. § 1332(a)(1). Since
all federal claims have been dismissed without prejudice, the court would
exercise its discretion to decline supplemental jurisdiction over the
state law claims until a federal claim has first been established.
See 28 U.S.C. § 1367(c)(3); ("The district court may decline
to exercise supplemental jurisdiction over a claim . . . if . . . the
district court dismissed all claims over which it has general
jurisdiction."); Grace v. Eli Lilly & Co., 193 F.3d 496,
501 (7th Cir. 1999) ("[I]t is the well-established law of this circuit
that the usual practice is to dismiss without prejudice state
supplemental claims whenever all federal claims have been dismissed
prior to trial.").
The supplemental jurisdiction issue, however, would be mooted if this
court were to have a basis for original jurisdiction under §
1332(a)(1). Diversity jurisdiction under § 1332(a)(1) requires
complete diversity of citizenship between the parties and an amount in
controversy exceeding $75,000 exclusive of interests and costs. While
plaintiffs' First Amended Complaint attempts to invoke this court's
diversity jurisdiction, its allegations are insufficient. Plaintiffs
correctly identify the citizenship of Amzak and Countryside. Each is
alleged to be a corporation, and both are listed as Delaware Corporations
with their principal places of business in Lisle, Illinois. The First
Amended Complaint makes no mention of Kazma's citizenship, instead
referring to his "residence" as being in Illinois. Residence,
however, is insufficient to invoke this court's diversity jurisdiction.
See, e.g., Macken v. Jensen, 333 F.3d 797, 799 (7th
Cir. 2003) ("[C]itizenship may differ from residence. . . .");
Meyerson v. Harrah's East Chicago Casino,
299 F.3d 616, 617 (7th Cir. 2002) ("[R]esidence and citizenship are not
synonyms and it is the latter that matters for purposes of the diversity
jurisdiction."). As for Letbetter, Naeve, Ricciardello, there is no
allegation at all concerning their citizenship.
Then there is the matter of Reliant. The First Amended Complaint
alleges that Reliant is a Texas Corporation with its principal place of
business in Texas. However, the First Amended Complaint also states that
Reliant is "n/k/a" or "now known as" Centerpoint Energy Houston Electric,
LLC. For purposes of diversity jurisdiction, corporations are treated
differently from limited liability companies. Compare Holtz v.
J.J.B. Billiard W.L. Lyons, Inc., 185 F.3d 732, 738 (7th Cir.
1999) ("In order to establish the citizenship of a corporation, a party
must establish both where it is incorporated and the location of its
principal place of business.") with Cosgrove v. Bartolotta,
150 F.3d 729, 732 (7th Cir. 1998) ("[T]he citizenship of an LLC for purposes
of diversity jurisdiction is the citizenship of its members."). Thus,
the plaintiffs, if they should choose to rely on diversity jurisdiction
as this court's basis to hear their state law claims, must plead
whether it is Reliant's citizenship as a corporation (or perhaps more
accurately, its former citizenship) or the citizenship of the individual
members of Centerpoint Energy Houston Electric, LLC that should be
considered for purposes of diversity jurisdiction.
For the reasons stated above, defendants' motion to dismiss is granted
[#24]. Plaintiffs' First Amended Complaint is dismissed without
prejudice. Plaintiffs are granted leave until February 27, 2004 to file
a Second Amended Complaint.