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RAY v. CITIGROUP GLOBAL MARKETS

October 18, 2005.

SHERWIN I. RAY, et al., Plaintiffs,
v.
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.

Facts

  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.

  Discussion

  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 person to

 
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' ...


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