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PREMIER CAPITAL MANAGEMENT v. COHEN

September 27, 2004.

PREMIER CAPITAL MANAGEMENT, L.L.C., et al., Plaintiffs,
v.
LARRY COHEN, et al., Defendants.



The opinion of the court was delivered by: JOAN GOTTSCHALL, District Judge

MEMORANDUM OPINION AND ORDER

Plaintiffs Premier Capital Management, LLC ("Premier Capital"), TMB, LLC, and Xen Investors, LLC have sued defendants Xentex Technologies ("Xentex"), Xentex's individual officers and directors (Larry Cohen, Brian Flanagan, Wan Hee Kim and Michael Turcotte), a Xentex shareholder (Ron Falese), Northview Bank and Trust, and the bank's president Blair Robinson, claiming that defendants violated federal securities laws, as well as several state statutes and common law prohibitions, when they fraudulently induced plaintiffs to invest in Xentex.*fn1 Among other claims in their prodigious 39-count complaint, plaintiffs have brought several state law claims against Xentex's officers and directors for (1) violations of the Virginia Securities Act ("VSA"), Va. Code Ann. § 13.1-522, (2) common law fraud, (3) br each of fiduciary duty, (4) negligent misrepresentation (against defendant Turcotte), and (5) accounting malpractice (against Turcotte). Before the court are two motions to dismiss: the motion of defendants Cohen, Kim, Turcotte and Falese (the "Xentex defendants") to dismiss plaintiffs' state law claims, and defendant Flanagan's separate motion to dismiss plaintiffs' state law claims.*fn2 For the reasons stated below, both motions to dismiss are granted in part and denied in part.

BACKGROUND

  According to the complaint, plaintiffs made two investments in Xentex, the first through a stock purchase, the second in the form of a promissory note. Xentex, through its CEO Jeff Batio and its Vice Chairman and Executive Vice President Douglas Tucker, first presented plaintiffs with an opportunity to invest at a meeting on November 1, 2000. At that time, Xentex was in the process of developing and launching a flip-pad computer known as the Voyager. During that meeting, plaintiffs received an Information Statement dated November 1, 2000 (the "Information Statement"), which contained numerous representations relating to Xentex, the Voyager computer, Xentex's plans for launching the Voyager into the market, and the ability of Xentex's supplier, Korean Data Systems ("KDS"), to finance, manufacture and service necessary hardware. In reliance on the representations made in the Information Statement, as well as certain oral representations made by Batio and Tucker at the November 1st meeting, plaintiffs invested more than $3.3 million in Xentex stock. Subsequently, on June 4, 2001, after certain additional representations by various members of Xentex's Board of Directors, plaintiffs loaned Xentex $650,000 in return for a promissory note. Plaintiffs now claim that the representations made in the Information Statement, the oral representations made at the November 1st meeting, and various other representations made in connection with the execution of the promissory note were false, and that, as a result, defendants have violated federal and state securities laws and breached various common law duties. Plaintiffs claim that defendants hid Xentex's deteriorating financial condition from plaintiffs, thereby obscuring the true value of plaintiffs' investment.

  ANALYSIS

  In evaluating a motion to dismiss, the court generally accepts all of plaintiffs' well-pled allegations as true and draws all reasonable inferences in plaintiffs' favor, Stachon v. United Consumers Club, Inc., 229 F.3d 673, 675 (7th Cir. 2000). Ordinarily, a plaintiff need only plead facts sufficient to place defendants on notice of the nature of the claims against them and the court will not grant the motion to dismiss unless it is "beyond doubt that the plaintiff can prove no set of facts in support of his claim which entitles him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Fed.R.Civ.P. 8(a).

  However, when pleading claims of fraud, plaintiffs must do more than merely place defendants on notice of their claims. Under Rule 9(b), a plaintiff must plead "the circumstances constituting fraud . . . with particularity." In re HealthCare Compare Corp. Secs. Litig., 75 F.3d 276, 281 (7th Cir. 1996). Specifically, the complaint must allege "the identity of the person making the misrepresentation, the time, place, and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff." Sears v. Likens, 912 F.2d 889, 893 (7th Cir. 1990). In other words, a plaintiff must allege "the who, what, when, where and how" of the fraud.*fn3 DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990).

  Before turning to the substance of defendants' motions to dismiss, the court must determine the appropriate pleading standard by which to measure plaintiffs' claims. As they must, plaintiffs agree that their common law fraud claims are subject to Rule 9(b)'s particularity requirements. However, plaintiffs argue that their remaining state law claims are subject to the less stringent notice pleading standard of Fed.R.Civ.P. 8(a) because fraud is not an element of those claims. Plaintiffs' argument ignores the fact that their VSA claims and breach of fiduciary duty claims are each premised on the same factual allegations — that defendants fraudulently induced plaintiffs to invest in Xentex by knowingly making false representations regarding Xentex's financial condition, current performance and business prospects. Although plaintiffs couch their VSA and breach of fiduciary duty claims under different legal theories, allegations of fraud lie at the core of each claim and, therefore, those claims are subject to Rule 9(b). Robison v. Caster, 356 F.2d 924, 925 (7th Cir. 1966) (holding that if a breach of fiduciary duty claim is based on allegations of a "scheme to defraud," the claim must be pled with particularity); Stephenson v. Hartford Life and Annuity Ins. Co., 02-C-3917, 2003 WL 22232968, *5-6 (N.D. Ill. Sept. 26, 2003) (subjecting plaintiffs' claims to Rule 9(b) standard because, although pled under different legal theories, each claim arose from the same allegations of fraud). With that standard in mind, the court will separately evaluate plaintiffs' claims.

  I. Plaintiffs' Claims Under The Virginia Securities Act

  As discussed above, plaintiffs' claims under the Virginia Securities Act must be pled with particularity pursuant to Fed.R.Civ.P. 9(b) as they are based on allegations of fraud. Plaintiffs' response briefs state their VSA claims quite clearly: plaintiffs argue that (1) Xentex made several specific misrepresentations in the sale of securities in violation of VSA § 13.1-522(A) and (2) Xentex's individual board members are liable for Xentex's misrepresentations under Section 13.1-522(C). However, plaintiffs' complaint is not so plain. Plaintiffs argue in their brief that their VSA claims against the individual directors spring directly from their VSA claims against Xentex. However, their complaint does not provide such a convenient cross-reference and the specific misrepresentations at the heart of each VSA claim are often unclear. For example, the VSA claims against Turcotte purport to hold Turcotte jointly and severally liable "for the conduct alleged in this Complaint" without specifying the "conduct" at issue or referring to any "primary violation" by Xentex. Rather, defendants and the court are left to comb through the remaining 116 pages of the complaint to determine the potential universe of misrepresentations for which Turcotte is allegedly liable under the VSA.

  Moreover, plaintiffs' allegations regarding their theory of liability are often ambiguous. In their brief, plaintiffs clearly state that, as "control persons," Xentex's directors are liable for misrepresentations that Xentex made to plaintiffs in the course of selling shares of Xentex. However, plaintiffs' VSA counts often focus on allegations of wrongdoing by the individual defendant — including alleged misrepresentations that appear unrelated to plaintiffs' November, 2000 purchase of securities. Plaintiffs' VSA counts rarely mention any misconduct by the alleged "primary violator," Xentex. For example, plaintiffs' VSA counts against Turcotte (Counts XI and XII) appear to be based on the "representations of Defendant" and list several specific misrepresentations and GAAP errors made by Turcotte. Counts XI and XII make no mention of any VSA violations by Xentex and do not refer to specific misrepresentations made by Xentex. At the end of Counts XI and XII the question remains: do plaintiffs seek to hold Turcotte directly liable under the VSA only for his own misrepresentations or do plaintiffs seek to hold him liable as a "control person" for Xentex's misrepresentations (which presumably include misrepresentations made by Xentex's individual directors)?

  Plaintiffs must plead the "who, what, when, where and how" of the fraud at the heart of each VSA claim. In other words, each defendant is entitled to know (1) the specific representations that form the basis of the claims against them, and (2) plaintiffs' theory for holding that defendant liable for those misrepresentations. As currently pled, plaintiffs' complaint falls short of that standard. Plaintiffs must either enumerate the specific misrepresentations that underlie each count or provide convenient cross-references that allow each defendant to locate those alleged misrepresentations. Moreover, the basis of each defendants' liability, whether as a "primary violator" or "control person" must be made clear. Based on the relative clarity of plaintiffs' briefs, the court believes that plaintiffs are fully capable of remedying the deficiencies described herein. Plaintiffs' claims under the Virginia Securities Act (Counts XI, XII, XX, XXI, XXVII, XXVIII, XXXI, XXXII, XXXIII, and XXXIV) are, therefore, dismissed without prejudice. Plaintiffs may amend their VSA counts in accordance with this opinion.*fn4

  II. Plaintiffs' Common Law Fraud Claims

  In contrast to plaintiffs' VSA claims, plaintiffs' common law fraud claims meet the particularity ...


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