United States District Court, N.D. Illinois, Eastern Division
August 18, 2004.
AMZAK CORPORATION, COUNTRYSIDE CABLE, INC., and GERALD KAZMA, Plaintiffs,
RELIANT ENERGY, INC. and its successor in interest CENTERPOINT ENERGY, INC.; 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
On January 27, 2004, this court dismissed without prejudice the
First Amended Complaint of plaintiffs, Amzak Corporation
("Amzak"), Countryside Cable, Inc. ("Countryside"), and Gerald
Kazma ("Kazma"), against defendants, Reliant Energy, Inc. (and
its successor in interest CenterPoint Energy, Inc.) ("Reliant
Energy"), R. Steve Letbetter ("Letbetter"), Stephen W. Naeve
("Naeve") and Mary P. Ricciardello ("Ricciardello") (collectively
"defendants"). On March 3, 2004, plaintiffs filed their Second
Amended Complaint which, similar to the First Amended Complaint,
alleges that defendants (1) violated § 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78j(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; (2)
violated § 20(a) of the Securities Exchange Act of 1934,
18 U.S.C. § 78t(a); (3) committed fraudulent misrepresentation under Illinois law; and (4) violated the Illinois Consumer Fraud and
Deceptive Business Practices Act, 815 ILCS 505/1 et seq.
Defendants have moved to dismiss the Second Amended Complaint 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.
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. General 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.
ALLEGATIONS OF THE COMPLAINT
Reliant Energy is an international energy services and energy
delivery company providing services in North America and Western
Europe. (Sec. Am. Compl. ¶ 5.) During the time periods relevant
to this action, Reliant Energy was the owner of approximately
82.4% of the stock of Reliant Resources, Inc. ("Reliant
Resources"), an energy services company marketing power and
natural gas in North America and Western Europe. (Sec. Am. Compl.
¶ 5.) Also, defendants Letbetter, Naeve, and Ricciardello
("individual defendants") were executive officers of Reliant
Energy and/or Reliant Resources. (Sec. Am. Compl. ¶¶ 7-9.) On May 10, 2002, Reliant Resources disclosed that it had
engaged in so-called "roundtrip transactions" in which "it had
engaged in transactions with other power traders to buy and sell
power to each other simultaneously, and at the same price. . . ."
(Sec. Am. Compl. ¶ 64.) Reliant Resources announced that it was
undertaking a review of these transactions. (Id.) On May 13,
2002, after the review had taken place, Reliant Resources
announced in a press release that the roundtrip transactions had
the effect of improperly increasing revenues and improperly
inflating trading volume. (Sec. Am. Compl. ¶ 65.)
Plaintiffs allege that defendants made materially false and
misleading statements in SEC filings, press releases and other
communications regarding Reliant Energy's revenues before the
disclosure of the round-trip trades, and that those statements
artificially inflated Reliant Energy's stock price during the
August 2, 1999 to May 10, 2002 time period. (Sec. Am. Compl. ¶
87.) Plaintiffs describe a numbers of actions they undertook with
respect to Reliant Energy stock during that time period. On or
about October 1, 2000, plaintiffs secured loans from Harris Bank
by pledging their Reliant Energy stock as collateral. (Sec. Am.
Compl. ¶ 14.) Plaintiffs allege that this transaction effected a
transfer to the bank of "conditional and defeasible interests" in
their Reliant Energy stock. (Id.) When the price of the Reliant
Energy stock fell in June and July of 2001 (due to normal market
forces and not fraud), the Reliant Energy stock became
insufficient collateral for plaintiffs' loans with their bank.
Rather than allow the bank to foreclose on the stock, plaintiffs
transferred to the bank additional assets to serve as additional
collateral. According to plaintiffs, by doing this they
"purchase[d] from Harris Bank with cash from assets other than
Reliant Energy stock the conditional and defeasible interests in
such pledged shares of Reliant Energy stock, thereby in effect
redeeming their interests." (Sec. Am. Compl. ¶ 15.)
Plaintiffs allege a second similar scenario that took place in
the fall of 2001 when the share price of Reliant Energy stock
once again dropped and rendered plaintiffs' collateral
insufficient. The loan agreements at this point were with LaSalle
Bank. Plaintiffs again point out that they posted additional
collateral to LaSalle Bank in order to avoid foreclosure on their
Reliant Energy shares. (Sec. Am. Compl. ¶ 18.)
Plaintiffs assert damages because, on May 10 and 13, 2002, in
the wake of the curative statements disclosing the round trip
trades, Reliant Energy's stock fell from $24.60 on May 9, 2002 to
$15.87 on May 14, 2002. (Sec. Am. Compl. ¶ 66.) Plaintiffs claim
that absent the alleged misrepresentations they would not have
transferred the additional collateral amounts to their banks and
would have instead allowed the banks to foreclose on the shares.
(Sec. Am. Compl. ¶¶ 87-88.) Plaintiffs also allege that they
would have sold their Reliant Energy shares to several buyers who
approached them during the time period, but did not do so because
of the alleged misrepresentations. (Sec. Am. Compl. ¶¶ 101-05.)
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
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 HealthCare 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
Defendants once again argue that plaintiffs' Second Amended
Complaint fails because it does not allege any purchase or sale
of stock. Plaintiffs' § 10(b) claim in their First Amended
Complaint was dismissed on this ground. See Amzak Corp. v.
Reliant Energy, Inc., No. 03 C 0877, 2004 WL 407027, at *3-5
(N.D. Ill. Jan. 28, 2004). In their First Amended Complaint
plaintiffs described the transactions at issue as "constructive
purchases" of additional shares of Reliant Energy's stock.
Abandoning that theory in their Second Amended Complaint,
plaintiffs characterize their payments to supplement their
collateral as re-purchases of "conditional and defeasible interests" in Reliant Energy's stock. According to
plaintiffs, when they first pledged the stocks they gave up these
conditional and defeasible interests, and by pledging additional
assets as collateral when the price of the stock went down, they
purchased the conditional and defeasible interests back from the
As defendants point out, whether these transactions are
described as "constructive purchases" or purchases of
"conditional and defeasible interests," this transaction only
served as the transfer of additional assets to the banks to stop
foreclosure on the pledged stock. For the reasons expressed in
the January 27, 2004 memorandum opinion and order, the court does
not believe that this is a purchase or sale of a security.
Certainly no case has ever so held. Plaintiffs merely took action
to prevent foreclosure of their stock and did not acquire any
additional shares as a result of those actions. Because there is
no allegation of a purchase or sale of securities within the
relevant time period, the court dismisses the § 10(b)
B. Count II: Section 20(a)
This claim's survival depends on whether plaintiff's complaint
adequately states a claim under § 10(b) and Rule 10b-5. See In
re Allscripts, Inc. Secs. Litig., No. 00 C 6796, 2001 WL 743411,
at *12 (N.D. Ill. June 29, 2001) ("If a Complaint does not
adequately allege an underlying violation of the securities law
. . . the district court must dismiss the section 20(a) claim.").
Because the claims under § 10(b) and Rule 10b-5 have been
dismissed, the § 20(a) claim is likewise also dismissed. C. State Law Claims
Having dismissed the federal claims, all that remains are
plaintiffs' state law claims for common law fraud and
misrepresentation and violations of the Illinois Consumer Fraud
and Deceptive Business Practices Act. The plaintiffs have alleged
original jurisdiction over the state claims pursuant to
28 U.S.C. § 1332, which requires that all parties be of diverse citizenship
and the amount in controversy exceed $75,000 exclusive of
interest and costs. The Second Amended Complaint states that both
Amzak and Countryside are Delaware Corporations with their
principal places of business in Illinois. Kazma is also listed as
a citizen of Illinois. Reliant Energy and CenterPoint Energy,
Inc. ("CenterPoint") are Texas corporations with their principal
places of business in that state. The individual defendants are
all Texas citizens. Also, the amount in controversy exceeds
$75,000 exclusive of interest and costs. Thus, this court's
jurisdiction to consider the state claims rests in
28 U.S.C. § 1332(a)(1).
1. Common Law Fraud and Misrepresentation
To plead a claim for fraud under Illinois law, a plaintiff must
show: (1) a false statement of material fact was made; (2) the
defendant knew or believed the statement was false; (3) plaintiff
was justified in relying on the statement; (4) the defendant
intended to induce the other party to act; and (5) plaintiff
suffered damage due to the reliance. See Prime Leasing v.
Kendig, 332 Ill. App. 3d 300, 308-09, 773 N.E. 2d 84, 92
(2002). Defendants argue that plaintiffs' fraud claim fails for
(a) a lack of damages, (b) failure to plead reliance with the
required specificity, and (c) failure to plead that the
individual defendants knew the alleged misrepresentations were
false or that they intended to induce reliance. Starting with defendants' damages argument, they assert that
plaintiffs were not damaged by any alleged fraud insofar as they
pledged the shares when the price was allegedly inflated by the
false and misleading statements. Plaintiffs, in response, claim
damages in two ways. First they claim to be damaged because they
refrained from entering into "prepaid forward contracts" to sell
the pledged shares due to the alleged material misrepresentations
or omissions by defendants which created an inflated appearance
of value of the Reliant Energy stock. Plaintiffs note that had
they entered into these prepaid forward contracts, they would
have obtained a minimum share price of $24.50 per share, as
compared to a decline in value of approximately fifty percent
when the stock fell to $15.87 on the date following the
announcement of the improper round-trip trading. Second,
plaintiffs claim damages when they had to make payments to their
lenders to prevent them from selling the stock. According to
plaintiffs, they repurchased rights in the stock at this time and
to the extent the price at the time of the margin default buyback
was in excess of the later sales on the fraud-related collapse,
they suffered a loss.
Both of plaintiffs' theories on damages are flawed. Their first
theory, that they would have sold the shares based on prepaid
forward contracts, essentially complains that they did not sell
the stock while its price was artificially (and allegedly
fraudulently) inflated. Plaintiffs admit as much: "The difference
between the value at the time of the pledge and the later
unfavorable prices represents demonstrable damages suffered by
plaintiffs in forbearing a complete disposition of the shares."
(Pl. Resp. at 5.) This amounts to nothing more than a claim that
plaintiffs should be entitled to "profit from what they allege
was an unlawfully inflated stock value." Chanoff v. U.S.
Surgical Corp., 857 F. Supp. 1011, 1018 (D. Conn. 1994).
Significantly, plaintiffs do not allege, and are not understood
to argue, that the price after the disclosure was less than what the price would have been absent
the alleged fraud. See Small v. Fritz Cos., Inc.
30 Cal. 4th 167, 191 (2003) (Kennard, J. concurring). Phrased another way,
plaintiffs' theory of damages is not that they are attempting to
recover that amount (if any) which constitutes "the loss in value
attributable to fraud from that attributable to the disclosure of
truthful but unfavorable financial data." Id. Instead, as noted
above, plaintiffs' theory is that they should recover the
difference in value at the time of the pledge from the later
unfavorable price after disclosure of the alleged round-trip
trades. The court rejects such a theory of damages.
Plaintiffs' second theory of damages also fails. Plaintiffs
argue that they incurred out-ofpocket losses when they
transferred "other assets" to their lenders as additional
collateral when the loans became under-collateralized. But, once
again, no where do plaintiffs allege that they in fact lost any
of these out-of-pocket expenses. Instead, they assert that "[t]o
the extent the price at the time of the margin default buy-back
was in excess of the later sales on the fraud-related collapse,
plaintiffs suffered a loss in that amount." (Pl. Resp. at 6.) As
noted above, this would be nothing but a windfall to plaintiffs
and is not a recoverable theory of damages. Thus, plaintiffs
state law fraud and misrepresentation claims must fail on this
Even if plaintiffs had brought forth a workable theory on
damages, which they have not, the court agrees with defendants
that the Second Amended Complaint also does not plead reliance
with the requisite level of particularly mandated by Rule 9(b).
To sufficiently plead reliance, plaintiffs would have to link one
or more of the alleged misrepresentations with a specific act of
reliance. See Prime Leasing, 773 N.E. 2d at 93. Initially,
plaintiffs could not have relied on many of the alleged
misrepresentations for their "acts of reliance" (which include pledging the Reliant Energy shares for their loans, declining to
accept offers to sell their Reliant Energy shares via forward
sale contracts and choosing to prevent foreclosure by making
additional payments to their lender) because these acts occurred
between late 2000 through December 2001. (Sec. Am. Compl. ¶¶
101-04.) Defendants' alleged misrepresentations extended into
April 2002. (Sec. Am. Compl. ¶¶ 20-63.) Thus, none of these
alleged misrepresentations in 2002 could have induced reliance in
2001 or earlier.
Moreover, the Second Amended Complaint does not establish a
nexus between any particular alleged misrepresentation and a
specific act of reliance by plaintiffs. Instead, plaintiffs'
allegations of reliance in the Second Amended Complaint state
that they relied on "information publicly disseminated about
[Reliant Energy]'s business," "materially false and misleading
information disclosed by defendants," or "financial and other
information disseminated by Defendants." (Sec. Am. Compl. ¶¶ 101,
103, 106.) There is not, for example, a particular allegation
that an act of reliance (such as plaintiffs' declining to sell
their shares via forward sale contracts) was influenced by any
alleged misrepresentation. Plaintiffs' conclusional statements
listed above do not comply with the particularly requirements of
In response, plaintiffs point to Small v. Fritz Cos., Inc.
30 Cal. 4th 167, 191 (2003), but that case does not help them
with regard to reliance. All the Small case established (under
California law) was that a plaintiff may file a so-called "holder
action," where they could allege that they were wrongfully induced to hold rather than sell
stock.*fn3 Id. at 171. Plaintiffs would still need to
plead reliance with particularity, and the Court in Small noted
as much. See id. at 184 (noting that a plaintiff must allege
"specific reliance on the defendants' representations. . . .").
The plaintiffs have not done so in this case and, accordingly,
have not pled a required element for a fraud claim under Illinois
law. As such, their fraudulent misrepresentation claim is
dismissed on this ground also.
2. Illinois Consumer Fraud and Deceptive Business Practices
To state a claim under the Illinois Consumer Fraud and
Deceptive Business Practices Act, 815 ILCS 505/1 et seq. (the
"Act"), a plaintiff must allege specific facts that show (1) a
deceptive act or practice by the defendant; (2) the defendant's
intent that the plaintiff rely on the deception; (3) the
deception occurred in the course of conduct involving a trade or
commerce; and (4) the consumer fraud proximately caused the
plaintiff's injury. Perona v. Volkswagen of Am., Inc.,
292 Ill. App. 3d 59, 65, 684 N.E. 2d 859, 864 (1997). Additionally,
the plaintiff must be a "consumer" with respect to a defendant's
products. See Menard Inc. v. Countryside Indus., Inc., No. 01
C 7142, 2004 WL 1336382, *2-3 (N.D. Ill. June 14, 2004). The
statutory text defines a consumer as "any person who purchases or
contracts for the purchase of merchandise not for resale in the
ordinary course of his trade or business but for his use or that
of a member of his household." 815 ILCS 505/1(e). As previously
stated, the alleged misrepresentations or fraud in this case did
not induce the plaintiffs to purchase any additional stock.
Therefore, they are not consumers as defined by the statute. See Camel v. Lincoln
Nat'l Bank, No. 96 C 6595, 1997 WL 321679, at *10 (N.D. Ill.
June 6, 1997) (claim dismissed where plaintiff alleged that
misrepresentations only induced him to retain or sell but not
purchase stock). Because they are not consumers, the plaintiffs
cannot state a valid claim under the Act, and this claim must
also be dismissed.
For the reasons stated above, defendants' motion to dismiss is
granted [#46]. Because this was plaintiffs' third opportunity to
state a claim, and since they have not adequately done so, this
court's dismissal of all the claims shall be with prejudice. This
case is terminated.