United States District Court, N.D. Illinois, Eastern Division
October 18, 2005.
SHERWIN I. RAY, et al., Plaintiffs,
CITIGROUP GLOBAL MARKETS, INC., CITIGROUP, INC., and JOHN HENRY SPATZ, Defendants.
The opinion of the court was delivered by: MATTHEW KENNELLY, District Judge
MEMORANDUM OPINION AND ORDER
The plaintiffs in this case lost millions of dollars after
their shares of SmartServ Online, Inc. (SSOL), lost ninety-eight
percent of their value between January 2000 and June 2002. They
claim that a prominent investment advisor, John Spatz,
fraudulently induced them to invest in SSOL, causing them
significant losses. The Plaintiffs have sued Spatz, his employer,
Citigroup Global Markets, Inc., and its parent company,
Citigroup, Inc. (collectively, Citigroup), under sections 10(b)
and 20(a) of the Securities Exchange Act of 1934,
15 U.S.C. §§ 78j(b) and 78t(a). Plaintiffs have also asserted a state law
claim of negligent supervision. Defendants have moved for summary
judgment. For the following reasons, the Court grants the motion.
The plaintiffs are 155 individuals who purchased SSOL's
publicly traded stock between January 2000 and May 2002.
Citigroup is a global financial services firm that provides
investment and asset management services. John Spatz is an
institutional stockbroker employed by Citigroup. Howard Borenstein, Mel Stewart, and Angelo Armenta
are retail stockbrokers (collectively, "the brokers"), who claim
that they relied on Spatz's fraudulent misstatements when they
advised the plaintiffs to buy SSOL stock.
Plaintiffs allege that Citigroup and Spatz, in collaboration
with insiders at SSOL, fraudulently induced the plaintiffs to
purchase shares of SSOL stock by making a number of
misrepresentations to the brokers. Among other things, Spatz
allegedly told the brokers that SSOL had signed substantial
contracts with large corporations including Microsoft, Smith
Barney, and Verizon Wireless; that institutional investors at
Citigroup thought highly of SSOL and were going to invest
substantially in the stock; and that SSOL had obtained large
sources of financing. Plaintiffs claim that Spatz knew these
statements were false when he made them and used the retail
public to artificially inflate the price of SSOL stock. They
further allege that if they had known the truth behind Spatz's
misrepresentations, they would have sold their stock before its
value dropped and avoided the losses they suffered.
The brokers first met Spatz and began consulting with him in
June 2000. At that time, SSOL's stock was priced at more than
eighty dollars per share. Two years later, the stock barely
exceeded one dollar. The stock prices of SSOL's competitors
suffered a similar fate during the same time period: 724
Solutions lost 98.9% of its value; Aether Systems lost 98.39% of
its value; and Openwave Systems lost 94.35% of its value.
Summary judgment is appropriate when the pleadings,
depositions, answers to interrogatories, admissions, and
affidavits, if any, show that there is no genuine issue as to any
material fact and that the moving party is entitled to judgment
as a matter of law. FED. R. CIV. P. 56(c). The Court must view the facts in favor of the plaintiffs
and draw all reasonable inferences in their favor. Anderson v.
Liberty Lobby, Inc., 477 U.S. 242, 255 (1986).
1. Federal securities law claims
The Securities Exchange Act of 1934 makes it unlawful for any
use or employ, in connection with the purchase or
sale of any security registered on a national
securities exchange . . . any manipulative or
deceptive device or contrivance in contravention of
such rules and regulations as the [Securities and
Exchange] Commission may prescribe as necessary or
appropriate in the public interest or for the
protection of investors.
15 U.S.C. § 78(j)(b). Securities and Exchange Commission Rule
10b-5 prohibits the making of any "untrue statement of material
fact" in connection with the sale of securities.
17 C.F.R. § 240.10b-5. Implied by this statute and implementing regulation is
a private cause of action, which closely resembles a common law
action for fraud. Dura Pharms. v. Broudo, ___ U.S. ___,
125 S.Ct. 1627
, 1631 (2005). To prevail on such a claim, a plaintiff
must demonstrate that the defendant made a material
misrepresentation or omission with scienter in connection with
the purchase or sale of securities, that the plaintiff reasonably
relied on the misrepresentation, and that the plaintiff suffered
economic loss which was caused by the misrepresentation. Id. In
addition, a plaintiff may recover from an individual or entity,
including a brokerage firm, if the plaintiff demonstrates that
the firm "directly or indirectly" controlled a person liable for
securities fraud and the firm did not act in good faith.
15 U.S.C. § 78t(a); Harrison v. Dean Witter Reynolds, 79 F.3d 609,
614-15 (7th Cir. 1996).
The plaintiffs argue that based on the evidence they have
offered, a jury reasonably could find that Spatz committed
securities fraud and that Citigroup is jointly and severally
liable as a controlling entity. The defendants, on the other
hand, insist that no jury reasonably could find that Spatz's alleged misrepresentations caused plaintiffs'
losses, because the entire technology industry of which SSOL
was a part suffered an economic collapse during the relevant
time period, meaning the plaintiffs would have lost their
investment irrespective of Spatz's alleged misrepresentations.
The defendants also make other arguments, but we need not address
them, because this one is dispositive of the federal claims.
Loss causation is a required element of a 10b-5 action and is
similar to the proximate cause element in a common law fraud
action. See Dura Pharms., 125 S.Ct. at 1632. To present
evidence of loss causation, "it [i]s not sufficient for an
investor to allege only that it would not have invested but for
the fraud. Such an assertion alleges transaction causation, but
it does not allege loss causation. Rather, it is also necessary
to allege that, `but for the circumstances that the fraud
concealed, the investment . . . would not have lost its value.'"
Caremark, Inc. v. Coram Healthcare Corp. 113 F.3d 645, 648-49
(7th Cir. 1997) (quoting Bastian v. Petren Resources Corp.,
892 F.2d 680, 683 (7th Cir. 1990)) (citation omitted). In other
words, transaction causation is proof that a knowledgeable
investor would not have made the investment in question; loss
causation is proof that a particular misrepresentation had a
causal connection with the loss in value of the plaintiff's
investment.*fn1 See id.
In Bastian, the plaintiffs were investors in oil and gas
limited partnerships who sued the promoters of the partnerships after their investments lost money.
Bastian, 892 F.2d at 682. The district court granted the
defendants' motion to dismiss because the plaintiffs failed to
allege loss causation, and the plaintiffs appealed. Id. The
Seventh Circuit upheld the district court's order agreeing that
the plaintiffs failed to allege "why the[ir] investment was
wiped out." Id. at 684 (emphasis in original). The court said
that gas and oil prices steadily declined during the time period
in question, suggesting that the plaintiffs' loss was caused not
by the defendants' misrepresentations but by independent market
forces. Id. ("If the plaintiffs would have lost their
investment regardless of the fraud, any award of damages would be
The Seventh Circuit has repeatedly reaffirmed Bastian's
holding that a plaintiff may not recover for securities fraud
without offering evidence that his or her losses are attributable
to the defendant's fraud and not market forces. Law v. Medco
Research, Inc., 113 F.3d 781, 786-87 (7th Cir. 1997); Ryan v.
Wersi Elec. GmbH & Co., 59 F.3d 52, 54 (7th Cir. 1995). In
Law, the plaintiffs sued the defendant drug company for
securities fraud. Law, 113 F.3d at 784. The defendant urged the
court to affirm a lower court's grant of summary judgment
contending that the plaintiffs failed to present evidence of loss
causation. Id. at 786. The defendant offered the opinion of a
financial expert who compared the price movements of the
defendant's stock with that of other competing companies and
concluded that market forces and not any allegedly fraudulent
statements caused the plaintiffs' losses. Id. The court held
that summary judgment was proper because the plaintiffs did not
contest the expert's conclusions. Id. at 787.
In Ryan, the plaintiffs sued the defendants under the
Illinois Consumer Fraud Act for making fraudulent statements that
caused the plaintiffs to purchase the defendants' company.
Ryan, 59 F.3d at 52. Though the court recognized that the
plaintiffs presented evidence that the defendants made misrepresentations, the court held, citing
Bastian, that summary judgment was proper because the plaintiff
did not demonstrate that the misrepresentations had anything to
do with the company's failure. Id. at 54 ("Ryan fails to show
that his business losses were caused by [the misrepresentations]
as opposed to a general downturn in the market . . . or simple
cash flow mismanagement").
In this case, the plaintiffs must offer evidence from which a
jury reasonably could find that they would have lost less money
had SSOL's condition been as Spatz represented. Bastian,
892 F.2d at 685-86. The plaintiffs argue that some of their losses
must have been caused by the misrepresentations, because if they
had invested in Aether Systems instead of SSOL, they would have
lost thirteen million dollars instead of sixteen million dollars.
This is not evidence of loss causation. There are any number of
reasons why Aether Systems fared slightly better than SSOL during
the collapse of the technology market in the early part of the
present decade, and though it is theoretically possible that
SSOL's inability to secure particular contracts had something to
with this difference in outcome, theoretical possibilities are
insufficient to withstand a defendant's motion for summary
judgment. Before they can rely on Aether Systems' marginally
better performance, plaintiffs must put forth evidence through
expert opinion or otherwise from which a jury reasonably could
find that SSOL's poorer performance is attributable in some way
to the subject matter involved in Spatz's misrepresentations.
Plaintiffs have offered no such evidence.
The plaintiffs also allege in their brief without a single
citation to the voluminous record that Spatz caused the
plaintiffs to buy SSOL stock at an inflated price and that
"[w]hen the truth about SSOL became known in late May 2002, SSOL
began to collapse like the house of cards that it was." Pl. Resp. at 18. If this allegation were
supported by evidence, it might allow a jury reasonably to infer
loss causation. See Dura Pharms. Inc., 125 S.Ct. at 1635
(stating that a plaintiff can establish loss causation by
presenting evidence that a defendant's fraudulent statements
artificially inflated a stock price and that the stock price
dropped once the fraud was revealed to the public).
In fact, however, the allegation misstates the record. The
plaintiffs maintain that they discovered Spatz's alleged fraud in
late May 2002 and that the stock price collapsed almost
immediately. The evidence reflects, however, that by late May
2002 the price of SSOL stock had already collapsed. The stock
price had settled to just over two dollars per share, which was
down from sixty-five dollars per share in June 2000, when the
plaintiffs began purchasing SSOL stock based on Spatz's
recommendations. Moreover, even if SSOL's stock price dropped
slightly after the plaintiffs learned the truth about Spatz's
fraudulent statements, the plaintiffs have not presented evidence
from which a jury could determine when or how the fraudulent
statements came to light or what particular drop in price can be
attributed to the revelation. Consequently, no jury reasonably
could find that a drop in stock price between late May 2002 and
June 2002 was proximately caused by disclosure of the truth.
The Court next considers an exception to the ordinary rule of
loss causation, which allows a plaintiff to demonstrate loss
causation by offering evidence that the defendant fraudulently
represented an investment as one involving low risk. Bastian,
892 F.2d at 685-85. Bastian's primary holding is that a
plaintiff cannot recover for securities fraud by proving only
transaction causation. The court attempted, however, to harmonize
the decisions of other circuits by suggesting an additional
method for proving loss causation: Suppose a broker gives false assurances to his
customer that an investment is risk-free. In fact it
is risky, the risk materializes, the investment is
lost. Here there can be no presumption that but for
the misrepresentation the customer would have made an
equally risky investment. On the contrary, the fact
that the broker assured the customer that the
investment was free of risk suggests that the
customer was looking for a safe investment. Liability
in such a case (well illustrated by Bruschi v.
Brown, supra, 876 F.2d at 1527) is therefore
consistent with nonliability in a case such as the
Id. In Bastian, 892 F.2d at 686, the court concluded that the
plaintiffs did not satisfy this exception, but other courts in
this District have applied Bastian's increased risk exception
in favor of plaintiffs. See Medline Inds., Inc. Employee Profit
Sharing and Retirement Trust v. Blunt, Ellis & Loewi, Inc., No.
89 C 4851, 1993 WL 13436, *12 (N.D. Ill. Jan. 21, 1993);
Broderick v. Menconi, No. 88 C 0161, 1990 WL 51180 (N.D. Ill.
Apr. 12, 1990).
In this case, the plaintiffs assert in their brief that Spatz
made representations that SSOL was a "sure fire guarantee." Pl.
Revised Reply at 2. The record does not support this contention.
Plaintiffs cite the affidavit of Francis Weber, a broker with
Citigroup Global Markets, who testified not that Spatz said SSOL
was a low risk stock, but that he said SSOL would obtain millions
of dollars in revenue from contracts with large corporations.
Weber Aff. ¶ 8. In any event, the relevance of Weber's testimony
is questionable, because there is no claim that he advised any of
the plaintiffs to buy SSOL stock based on this statement by
Spatz. For these reasons, no jury reasonably could find, based on
the evidence offered by plaintiffs, that Spatz's misrepresented
the risk involved in purchasing SSOL stock.
Because the Court is granting summary judgment for defendants
on plaintiffs' securities fraud claims, plaintiffs' motion for
partial summary judgment requesting that Citigroup be deemed a
control person under 15 U.S.C. § 78t(a) is effectively rendered
moot. 2. State law claims
The plaintiffs' original complaint contained several state law
claims alleging a fraudulent scheme involving the purchase and
sale of stock. In an earlier decision, the Court dismissed those
claims pursuant to the Securities Litigation Uniform Standards
Act of 1998 (SLUSA), which prohibits a "covered class action"
based on state law alleging misrepresentations, omissions, or the
use of deception in connection with the purchase or sale of a
security. 15 U.S.C. § 78bb(f)(1). In that decision we noted,
citing Riley v. Merrill Lynch, Pierce, Fenner & Smith,
292 F.3d 1134, 1345 (11th Cir. 2003), that our ruling did not preclude the
plaintiffs from recasting their claims by alleging that Spatz's
misrepresentation caused them to retain rather than purchase or
sell their SSOL stock. Ray v. Citigroup, Inc., No. 03 C 3157,
2003 WL 22757761, *6 (N.D. Ill. Nov. 20, 2003). The plaintiffs
amended their complaint accordingly. More recently, however, the
Seventh Circuit held, contrary to Riley and our previous
ruling, that the SLUSA prohibits not only state law claims
alleging misrepresentation in connection with the purchase or
sale of securities, but also claims alleging misrepresentation in
connection with a plaintiff's retention of securities. See
Disher v. Citigroup Global Markets, 419 F.3d 649, 654 (7th Cir.
2005); Kircher v. Putnam Funds Trust, 403 F.3d 478, 484 (7th
Recognizing the import of these decisions, plaintiffs now
concede that most of their state law claims are precluded by the
SLUSA. Pl. Resp. at 21. They contend, nonetheless, that their
claim of negligent supervision may survive summary judgment
because it "does not rely on deceit or manipulation as an element
of the cause of action." Id. This argument, however, has
already been considered and rejected by the Third Circuit.
Rowinski v. Salomon Smith Barney, Inc., 398 F.3d 294, 300 (3d
Cir. 2005). In Rowinski, the plaintiffs argued that their state
law breach of contract claim was not preempted by the SLUSA because a
misrepresentation was not an essential legal element of their
claim. Id. The court rejected the argument, reasoning that the
SLUSA "preempts any covered class action `alleging' a material
misrepresentation or omission in connection with the purchase or
sale of securities" and that "preemption does not turn on whether
the allegations are characterized as facts or as essential legal
elements of a claim, but rather on whether the SLUSA
prerequisites are `alleged' in one form or another." Id.
(quoting 15 U.S.C. § 78bb(f)(1)); see also Professional Mgmt.
Ass'n, Inc., Employees' Profit Sharing Plan v. KPMG LLP,
335 F.3d 800, 803 (8th Cir. 2003) (dismissing plaintiffs' negligence
claim under the SLUSA because it contained allegations of
We agree with the reasoning of the Third Circuit and conclude
that a claim is not removed from the SLUSA's intended purview
only because a misrepresentation is not a legal element of the
state law claim. Instead, the determining factor is whether the
complaint alleges that misrepresentations were made in connection
with the purchase or sale of securities. Id. The negligent
supervision claim in this case plainly includes such allegations.
See Pl. Am. Compl. at 52 ("Citigroup breached its duties and
failed to supervise and control Spatz's actions,
misrepresentations, and misconduct."). Consequently, it is
preempted by the SLUSA.
For the foregoing reasons, the Court grants defendant's motion
for summary judgment [docket no. 154]. All other pending motions
are terminated [docket no. 158, 176]. The Clerk is directed to
enter judgment in favor of the defendants.
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