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Burman v. Phoenix Worldwide Industries

August 30, 2005


The opinion of the court was delivered by: Reggie B. Walton United States District Judge


The plaintiffs bring this action alleging "statutory securities fraud, common law fraud and misrepresentation, negligent misrepresentation, breach of fiduciary duty and negligence." First Amended Complaint ("Compl.") at 1.*fn1 Currently before the Court is defendant Phoenix Worldwide Industries, Inc. ("Phoenix") and Dr. J. Al Esquivel Shuler ("Shuler")'s Rule 12(b)(6) Motion to Dismiss Amended Complaint and Alternative Rule 12(E) Motion for a More Definitive Statement ("Defs.' Mot.") and the plaintiffs' opposition thereto.*fn2 For the reasons set forth below, this Court grants in part, and denies in part the defendants' motion.*fn3

I. Factual Background

Shuler is the founder of Phoenix and at all relevant times has served as its President, Chief Executive Officer, Chairman of the Board of Directors, and majority stockholder. Compl.*fn4 ¶ 6. In 2001, the Phoenix Board of Directors included, among others, Shuler's wife, his brother, and Charles Levy. Id. ¶ 19. These three individuals, along with Shuler, constituted a majority of the Board of Directors. Id. On August 1, 2001, Phoenix issued a Private Placement Offering Memorandum ("PPM") to sell 2,000,000 shares of Phoenix common stock to "accredited investors" pursuant to Regulation D, Rule 506 of the Securities Act of 1933.*fn5 Id. ¶ 20. Under the PPM, Phoenix sought investments of ten million dollars at $5.00 per share. Id. ¶ 21. According to the plaintiffs, Phoenix needed "substantial capital infusions" as it was in arrears and in default on approximately a $2.6 million debt obligation to First Union Bank. Id.

Shortly after the PPM was issued, the plaintiffs became aware of the investment opportunity. Namely, in August 2001, Paul Burman was approached by an investment advisor, George Schwelling, who advised him of the opportunity to invest in Phoenix. Id. ¶ 24. Burman later shared that information with Robert Warriner and Jay Zawatsky, the investment manager for plaintiff Ingersoll & Bloch. Id. ¶¶ 24-25. Charles Levy, a director and shareholder in Phoenix, advised Sylvia Rolinski of the Phoenix opportunity. Id. ¶ 26.

The basis for the present action stems from a number of alleged misrepresentations that occurred during this solicitation period (September 2001 through January 2003) for the purchase of Phoenix stock. Id. ¶¶ 28, 31. In the plaintiffs' complaint, they divide the various alleged misrepresentations into two distinct categories-contract misrepresentations and IRS misrepresentations. The Court will do the same here.

(A) The Alleged Contract Misrepresentations

In Addendum E to the August 2001 PPM ("Addendum E"), Phoenix claimed risk adjusted gross revenue for the three year period following the issuance of the PPM totaling $2,885,087,858. Id. ¶ 32. Addendum E adjusted and analyzed Phoenix's scheduled gross income pursuant to a delineated risk assessment, applied to a set of identified product sales, ranging from a high of 100% to a low of 5%. Id. ¶ 33. According to the plaintiffs, Addendum E represented that a total of $39 million in gross revenue was "a 100% certainty for Years 1 through 3; an additional total of $14,500,000 was a 95% certainty in Year 2; an additional $243,743,675 was a 90% certainty in Years 1 and 2; and, an additional $189,029,044 was an 80% certainty in Year 1." Id. ¶ 37. In addition to Addendum E, on September 3, 2001, Phoenix prepared a written statement ("September 2001 Contracts Statement"), which purported to set out in a color-coded format various "Contracts in Progress." Id. ¶ 38. In this September 2001 Contracts Statement, seven contracts were highlighted in blue, representing "signed contracts," nine were highlighted in yellow, representing "contracts in process of being signed," and five were highlighted in green, representing "contracts pending." Id. ¶ 39. The plaintiffs opine, however, that even though the Contracts Statements have contracts highlighted in Blue, representing signed contracts, many were in fact not signed ("the Blue Contract Misrepresentations").

The plaintiffs contend that the representations made to the various plaintiffs, including the September 2001 Contracts Statements (and subsequent Contracts Statements), induced them to invest in Phoenix. For example, in February 2002, Levy purportedly represented to Rolinski that Phoenix had procured a contract with the Immigration and Naturalization Service-now the United States Citizenship and Immigration Services-to install sensors along the southern border of the United States ("the Border Contract"). Id. ¶ 40. Relying upon this information, which the plaintiffs now represent was a misrepresentation, Rolinski purchased 2,000 shares of Phoenix stock. Id. ¶¶ 40-42.

On May 15, 2002, Phoenix updated the 2001 Contracts Statement ("May 2002 Contracts Statement"). Id. ¶ 43. The May 2002 Contracts Statement again used a color-coded system and identified twelve contracts that had been signed; sixteen that were in the process of being signed; and five that were pending. Id. ¶¶ 43-44. At the end of May 2002, Zawatsky received a copy of the May 2002 Contracts Statement, along with the PPM, Addendum E, and the September 2001 Contracts Statement. Id. ¶ 46. After receiving these documents, Zawatsky and Levy spoke on the telephone. Id. ¶ 47. During that conversation, Levy represented that the "blue line items" were "done deals," and they represented "the minimum amount of sales revenue Phoenix was assured to generate over the next three years." Id. ¶ 49. In addition, Levy asserted that Phoenix anticipated going public by January 2004, at which time investors could divest. Id. ¶ 50. In the interim, however, Levy noted that investors would receive dividends approximately equal to their $5.00 per share investment as a result of the cash flow generated by the various contracts. Id. Based upon this information, which the plaintiffs now assert was false, Zawatsky, on behalf of Ingersol & Bloch, purchased 25,000 shares of Phoenix common stock at $5.00 per share. Id. ¶¶ 51-55. Also, on behalf of Ingersol & Bloch, Zawatsky later purchased an additional 25,000 shares of Phoenix common stock based upon the May 2002 Contracts Statement, after Levy informed him that Phoenix had secured a Department of Defense ("DoD") contract. This contract would purportedly result in Phoenix paying investors a dividend at nearly the $5.00 per share purchase price by December 2002. Id. ¶ 59. Zawatsky purchased an additional 100,000 shares on July 22, 2002, relying on both the May 2002 Contracts Statement and various statements allegedly made by Shuler to Zawatsky during his 2002 inspection of Phoenix's Florida facilities in conjunction with the DoD contract. Id. ¶¶ 60-62. Rolinski also made an additional purchase of 900 shares of Phoenix common stock based upon the May 2002 Contracts Statement and purported representations concerning the procurement of the DoD contract. Id. ¶¶ 57-58.

On August 2, 2002, Phoenix issued an August 2002 Contracts Statement. Id. ¶ 63. The August 2002 Contracts Statement again used a color-coded system and identified fifteen contracts that had been signed; sixteen that were in the process of being signed; and five that were pending. Id. On January 15, 2003, Rolinski purchased an additional 2000 shares of Phoenix common stock at $10.00 per share based upon the August 2002 Contracts Statement and representations allegedly made by Levy to Rolinski that Shuler had gone to Egypt and procured a billion dollar contract with that country. Id. ¶¶ 66-67. On August 27, 2002, based upon information received from Levy regarding the procurement of the Egypt contract, Robert Warriner purchased 5000 shares of Phoenix common stock. Id. ¶¶ 70-73. The plaintiffs claim, however, that the Egypt contract was never actually procured. Id.

Paul Burman also invested in Phoenix based upon alleged misrepresentations. Id. ¶¶ 74-86. Specifically, based upon representations that are purported to have been made to Burman by Shuler and Levy when Burman was inspecting the Phoenix facilities, the 2001 September Contracts Statement, the August 2002 Contracts Statement, and the representations concerning the procurement of the billion dollar contract with Egypt, all of which the plaintiffs contend were false, Burman purchased 61,400 shares of Phoenix's common stock in twelve successive transactions over a twelve month period. Id. ¶¶ 74-76.

(B) The Alleged IRS Misrepresentations

The plaintiffs allege that in connection with their purchase of the Phoenix common stock, in addition to the already discussed documents, they were provided with and relied upon audited financial statements prepared by Rachlin, Cohen & Holtz, LLP ("Rachlin"). Id. ¶¶ 87, 96. The 2001-2002 financial statement allegedly contained a number of "notes," which the plaintiffs contend were misrepresentations that induced them into purchasing Phoenix common stock. Id. ¶ 88. Two of these notes, Note 10 and Note 13, indicated that Phoenix had been in arrears in its payment of payroll taxes, but that "[i]n August 2002, the Company paid all current and overdue payroll taxes." Id. When further quiered by Zawatsky about the arrearages in May 2002, Levy purportedly reiterated that the unpaid taxes had in fact been paid. Id. ¶ 89. In July 2002, the plaintiffs' contend that Shuler also told Zawatsky that the payroll taxes had been paid. Id. ¶ 90.

The plaintiffs claim, however, that these arrearages were not paid and that the Internal Revenue Service placed a tax lien on Phoenix's real property until the payroll taxes were paid in full. Id. ¶ 91. Moreover, the plaintiffs assert that Rachlin should have disclosed these delinquencies in the audited financial statements they completed for Phoenix. Id. ¶ 94.

(C) This Action

The plaintiffs commenced this action on July 29, 2004. Following a round of initial briefing, the plaintiffs filed an amended complaint alleging eight separate claims. Id. ¶¶ 97-148. The plaintiffs assert five substantive claims against Phoenix and Shuler: (1) violations of section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder; (2) common law fraud, deceit, and misrepresentation; (3) negligent misrepresentation; (4) breach of fiduciary duties; and (5) violation of state Blue Sky laws. Id. ¶¶ 97-136. In addition, the plaintiffs ask this Court to appointment a receiver for the corporation, id. ¶¶ 137-38, and seek various forms of post-judgment injunctive relief, id. ¶¶ 139-42. Finally, the plaintiffs assert one claim of negligence against Rachlin. Id. ¶¶ 143-48. Defendants Phoenix and Shuler seek dismissal of the claims against them pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6), or for a More Definite Statement pursuant to Rule 12(E). The Court will address each of the defendants' arguments in turn.

II. Standard of Review

Rule 9(b) requires that a pleader state with particularity the circumstances constituting fraud or mistake. Fed. R. Civ. P. 9(b). "Rule 9(b)'s particularity requirement ensures that the opponent has notice of the claim, prevents attacks on his reputation where the claim for fraud is unsubstantiated, and protects against a strike suit brought solely for its settlement value." In re U.S. Office Prod. Sec. Litig., 326 F. Supp. 2d 68, 73 (D.D.C. 2004). Thus, because Rule 9(b) is "chiefly concerned with the elements of fraud, [and] the circumstances that the claimant must plead with particularity include matters such as the time, place, and content of the false misrepresentations, the misrepresented fact, and what the opponent retained or the claimant lost as a consequence of the alleged fraud." Id. (citing United States ex rel. Totten v. Bombardier Corp., 286 F.3d 542, 551-52 (D.C. Cir. 2002)). Accordingly, the plaintiffs must plead the "who, what, when, where, and how" with respect to the circumstances of the fraud. DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990). Thus, Rule 9 requires more than "pleadings [based] on information and belief," but rather "require[s] an allegation that the necessary information lies within the defendant's control" and "such allegations must also be accompanied by a statement of the facts upon which the allegations are based." Kowal v. MCI Communications Corp., 16 F.3d 1271, 1279 n.3 (D.C. Cir. 1994). "Rule 9(b)'s particularity requirement does not abrogate Rule 8's general requirement that a pleading contain a short and plain statement of the claim, and that each averment be simple, concise, and direct." In re U.S. Office Prod. Sec. Litig., 326 F. Supp. 2d at 74. On the other hand, Rule 9(b) requires the pleader to provide a higher degree of notice by adequately alleging all the elements for the cause of action. Id. Finally, "[c]onclusory allegations that a defendant's actions were fraudulent and deceptive are not sufficient to satisfy 9(b)." Shekoyan v. Sibley Int'l Corp., 217 F. Supp. 2d 59, 73 (D.D.C. 2002).

On a motion to dismiss for failure to state a claim upon which relief can be granted pursuant to Rule 12(b)(6), this Court must construe the allegations and facts in the complaint in the light most favorable to the plaintiffs and must grant the plaintiffs the benefit of all inferences that can be derived from the alleged facts. Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Barr v. Clinton, 370 F.3d 1196, 1199 (D.C. Cir. 2004) (citing Kowal, 16 F.3d at 1276). "[T]he complaint need only set forth 'a short and plain statement of the claim,' Fed. R. Civ. P. 8(a)(2), giving the defendant fair notice of the claim and the grounds upon which it rests." Kingman Park Civic Ass'n v. Williams, 348 F.3d 1033, 1040 (D.C. Cir. 2003) (citing Conley, 355 U.S. at 47). "Such simplified 'notice pleading' is made possible by the liberal opportunity for discovery and the other pretrial procedures established by the Rules to disclose more precisely the basis of both claim and defense and to define more narrowly the disputed facts and issues." Conley, 355 U.S. at 47-48. While many well-plead complaints are conclusory, the Court need not accept inferences or conclusory allegations that are unsupported by the facts set forth in the complaint. Kowal, 16 F.3d at 1276. Moreover, in deciding whether to dismiss a claim under Rule 12(b)(6), the Court can only consider the facts alleged in the complaint, documents attached as exhibits or incorporated by reference into the complaint, and matters about which the Court may take judicial notice. EEOC v. St. Francis Xavier Parochial Sch., 117 F.3d 621, 624-25 n.3 (D.C. Cir. 1997). A court may dismiss a claim pursuant to Rule 12(b)(6) only if the defendant can demonstrate "beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley, 355 U.S. at 45-46.

III. Analysis

In their dismissal motion, the defendants claim that each count of the plaintiffs' complaint is defective. Defs.' Mem. at 2-3.*fn6

(A) The Plaintiffs' Securities Fraud Claim

Count one of the plaintiffs' complaint alleges violations of Rule 10b-5 of the Code of Federal Regulations, 17 C.F.R. § 240.10b (2005), promulgated pursuant to Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b) (2000). Compl. ¶¶ 97-105. Rule 10b-5 "prohibit[s] fraudulent activities in connection with securities transactions." Novak v. Kasaks, 216 F.3d 300, 305 (2d Cir. 2000). And section 10(b) makes it unlawful

[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 Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C. ยง 78j(b). Rule 10b-5 is section 10(b)'s implementing regulation, and it provides that it is unlawful, in the connection ...

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