September 25, 2013
JAMES R. ZAZZALI, Plaintiff,
ALEXANDER PARTNERS, LLC, et al., Defendants.
GREGORY M. SLEET, District Judge.
On June 27, 2012, the plaintiff, James R. Zazzali ("Zazzali"), Trustee of the Diversified Business Services & Investments, Inc. ("DBSI") Private Actions Trust (the "PAT"), filed this suit against over 200 named defendants and 500 "John Doe" defendants. (D.I. 1.) The 245-paragraph Complaint alleges (1) violations of § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and SEC Rule 10b-5, (2) violations of § 20(a) of the Exchange Act, (3) breaches of contract, (4) common law fraud, (5) negligence, and (6) breaches of fiduciary duties. ( Id. )
A number of defendants have filed motions to dismiss under Rule 12(b)(6) of the Federal Rules of Civil Procedure, arguing that Zazzali has failed to state claim upon which relief may be granted and, in certain instances, has failed to meet the heightened pleading standards of Rule 9(b) and the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). Various defendants have also challenged the Complaint's viability in light of the filing time limits found in 28 U.S.C. § 1658(b). Zazzali consolidated his response to these motions m a single answering brief. (D.I. 322.) For the reasons that follow, the court will grant-in-part and deny-in-part the present motions.
This action stems, in part, from the November 2008 bankruptcy filing of ninety-three Diversified Business Services & Investments, Inc. ("DBSI") entities. (D.I. 1 at ¶ 9.) On September 11, 2009, the bankruptcy court approved the appointment of Zazzali as the Chapter 11 Trustee for the DBSI entities. (Id at ¶ 10.) On October 26, 2010, the bankruptcy court issued its Findings of Fact, Conclusions of Law, and Order Confirming Second Amended Joint Chapter 11 Plan of Liquidation. ( Id. at ¶ 12.) Zazzali serves as trustee for two of the four trusts-the PAT and the Estate Litigation Trust-that were formed pursuant to this confirmation order. ( Id. at ¶ 13.)
The Second Amended Joint Chapter 11 Plan of Liquidation created the PAT to hold certain causes of actions assigned by creditors and equity holders of DBSI. ( Id. at ¶ 14.) One category of claims held by the PAT are claims against "securities brokers/dealers" that provided services to DBSI. ( Id. at ¶ 14 n.5.) In general terms, Zazzali claims that certain members of the PAT acquired securities in the DBSI entities from one or more of the defendants named in this action. He alleges that the defendants were securities brokers, the registered representatives of brokers, or control persons of brokers that facilitated the sale of DBSI securities in what eventually turned out to be a classic "Ponzi scheme." ( Id. at ¶ 2, 21.)
III. STANDARD OF REVIEW
Rule 12(b)(6) allows a party to move to dismiss a complaint for failing to state a claim upon which relief may be granted. Fed.R.Civ.P. 12(b)(6). Dismissal is warranted where "it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations." Swierkiewicz v. Sorema N.A., 534 U.S. 506, 514 (2002). The court "accept[s] all factual allegations as true, construe[s] the complaint in the light most favorable to the plaintiff, and determine[s] whether, under any reasonable reading of the complaint, the plaintiff may be entitled to relief." Phillips v. Cnty. of Allegheny, 515 F.3d 224, 233 (3d Cir. 2008).
A well-pleaded complaint, however, must contain more than mere labels and conclusions. See Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). The court conducts a two-part analysis to determine whether dismissal is appropriate. See Fowler v. UPMC Shadyside, 578 F.3d 203, 210 (3d Cir. 2009). First, the factual and legal elements of a claim are separated. Id. The court accepts all well-pleaded facts as true but may disregard any legal conclusions. Id. at 210-11. The court notes, however, that where allegations "are no more than conclusions, [they] are not entitled to the assumption of truth." Iqbal, 556 U.S. at 679. After separating the legal and factual elements, the court asks whether the facts alleged are sufficient to demonstrate that the plaintiff has a "plausible claim for relief." Fowler, 578 F.3d at 211. "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Iqbal, 556 U.S. at 678. The heightened pleading requirements imposed by Rule 9(b) and the PSLRA are addressed below.
The court addresses each count of Zazzali's Complaint in turn.
A. Count One: Violations of § 10(b) of the Exchange Act and SEC Rule 10b-5
1. Section 10(b) and Rule 10b-5
Section 10(b) of the Exchange Act makes it unlawful through "any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange" to:
use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, 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."
Securities Exchange Act of 1934, Pub. L. No. 73-291, § 10(b), 48 Stat. 881, 891 (codified as amended at 15 U.S.C. § 78j). Rule 10b-5, promulgated by the SEC to implement § 10(b) of the Exchange Act, provides that:
[i]t 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,
(a) To employ any device, scheme, or artifice to defraud,
(b) To 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 the light of the circumstances under which they were made, not misleading, or
(c) To 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 security.
17 C.F.R. § 240.10b-5. The Supreme Court has instructed that the elements of a private securities action under § 10(b) are: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 157 (2008).
2. Heightened Pleading Requirements
Section 10(b) claims generally are subject to the heightened pleading requirements of both the PSLRA, see Institutional Investors Grp. v. Avaya, Inc., 564 F.3d 242, 252-53 (3d Cir. 2009), and Federal Rule of Civil Procedure 9(b), see In re Rockefeller Ctr. Props., Inc. Sec. Litig., 311 F.3d 198, 216-17 (3d Cir. 2002). While both standards are applicable to Zazzali's § 10(b) claims, "[t]o the extent that Rule 9(b) conflicts with the PSLRA, the statute supersedes it." Key Equity Investors, Inc. v. Sel-Leb Mktg. Inc., 246 F.App'x 780, 784 n.5 (3d Cir. 2007).
The PSLRA imposes two distinct pleading requirements on a plaintiff bringing a securities fraud action and requires that both be met in order for the claim to survive a motion to dismiss. See Avaya, Inc., 564 F.3d at 252. First, the complaint must "specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, § 101, 109 Stat. 737, 747 (codified at 15 U.S.C. § 78u-4(b)(l)). Further, the complaint must "with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2).
Rule 9(b) provides that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally." Fed.R.Civ.P. 9(b). The particularity requirements of Rule 9(b) with regard to the circumstances constituting fraud are "comparable to and effectively subsumed by the requirements of... the PSLRA." Avaya, Inc., 564 F.3d at 253 (internal quotation omitted). Rule 9(b)'s scienter requirement, on the other hand, has been superseded by the PSLRA. See In re Wilmington Trust Sec. Litig., 852 F.Supp.2d 477, 489 (D. Del. 2012).
For reasons discussed below, the court finds that Zazzali has adequately stated a claim for securities fraud under § 10(b) with respect to a narrow category of alleged misrepresentations.
a. Applicability of Rule 9(b) and PSLRA pleading requirements
As an initial matter, the court rejects Zazzali's argument that, as a trustee, his complaint should be held to relaxed pleading standards. (D.I. 322 at 3-4, 21-22.) For at least two reasons, the court is unconvinced that his Complaint should escape the heightened pleading requirements of Rule 9(b) and the PSLRA. First, most of the decisions cited by Zazzali discuss more liberal pleading requirements that might apply in the bankruptcy context. See, e.g., In re DBSI, Inc., No. 08-12687-PJW, 2011 WL 1810632, at *3 (D. Del. May 5, 2011) ("Rule 9's requirements... are relaxed in the bankruptcy context, particularly in cases such as the present in which a trustee has been appointed.") The present action is not a bankruptcy case, and Zazzali fails to point to a non-bankruptcy decision extending his proposed rule beyond that realm. Additionally, none of Zazzali' s referenced decisions support lowering the independent pleading bar imposed by the PSLRA. The particularity requirements set forth under the PSLRA were intended to '"substantially heighten' the existing pleading requirements, " In re Rockefeller Ctr. Props., Inc. Sec. Litig., 311 F.3d at 217, and they do not contain an exemption for trustee-initiated actions, see 15 U.S.C. §§ 78u-4(b)(1-2). In the absence of any authority supporting such an exception, the court is unwilling to force Zazzali' s interpretation upon this statutory language. As such, the court applies the standard Rule 9(b) and PSLRA heightened pleading requirements to Zazzali's § 10(b) claims.
b. Material misrepresentations connected to the purchase or sale of securities
Once again, the first requirement of a § 10(b) claim is "a material misrepresentation or omission by the defendant." Stoneridge Inv. Partners, 552 U.S. at 157. Under the PSLRA, Zazzali is further expected to "specify each statement alleged to have been misleading" and "the reason or reasons why the statement is misleading." 15 U.S.C. § 78u-4(b)(1). The court believes the Complaint meets these requirements with respect to at least one set of statements. While one might expect that the sheer number of defendants would prevent Zazzali from specifying each of their claimed misrepresentations, the Complaint seeks to clear this hurdle by identifying several uniform documents that were used in each of the challenged transactions.
First, Zazzali contends that the Broker Defendants executed a Soliciting Dealer Agreement with DBSI in connection with each security sold. (D.I. 1 at ¶ 40.) That agreement required the Broker Defendants to limit their representations in connection with the sale to those representations contained in the private placement memoranda ("PPMs") created by DBSI and to deliver a copy of the currently effective PPM to any potential investor prior to submission of a written investment offer. ( Id. ) The Complaint alleges that "[t]he PPM for each DBSI security indicated that the broker-dealer would be paid a due diligence fee'" and that "these statements were untrue and misleading because the Broker Defendants did not spend the due diligence fees to conduct independent due diligence investigations with regard to the DBSI securities." ( Id. at ¶ 55.)
Zazzali further contends that the Broker Defendants required the investors to sign a Subscription Agreement in connection with each sale of DBSI securities. ( Id. at ¶ 46.) According to the Complaint, each Subscription Agreement contained a certification by the Broker Defendant that "it had reasonable grounds to believe, on the basis of information supplied by the Purchaser, and any other pertinent information, ' that the DBSI security was a suitable investment for the Purchaser.'" ( Id. at ¶ 56.) The Subscription Agreements also allegedly included a statement "that each Broker Defendant acknowledged its membership in the Financial Industry Regulatory Authority ("FINRA") and [the Securities Investor Protection Corporation ("SIPC")] and its attendant obligation to comply with all federal and state laws, rules, and regulations." ( Id. ) The Complaint claims that, through this acknowledgment, each defendant effectively represented that it had undertaken a due diligence investigation. ( Id. ) Zazzali identifies the both "suitable investment" certification and the implicit representation that the defendants conducted a due diligence investigation as material misrepresentations given the defendants' alleged failure to conduct any such investigation. ( Id. )
Again, 15 U.S.C. § 78u-4(b)(1) requires the Complaint to "specify each statement alleged to have been misleading" and "the reason or reasons why the statement is misleading." Section 78u-4(b)(1) then provides that "if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." The court believes Zazzali has met these pleading responsibilities with respect to the certifications made in the Subscription Agreements but not the alleged misrepresentations in the PPMs.
The Supreme Court has recently explained that a person or entity does not "make" a statement for purposes of Rule 10b-5 liability unless he has "ultimate authority over the statement, including its content and whether and how to communicate it." Janus Capital Grp., Inc. v. First Derivative Traders, 131 S.Ct. 2296, 2302 (2011) ("Without control, a person or entity can merely suggest what to say, not "make" a statement in its own right."). In Janus, the Court found that an investment adviser could not be held liable under § 10(b) for false statements contained in the prospectuses of its client mutual fund, where it was the mutual fund that had ultimate control over the contents of the documents and filed them with the SEC. Id. While the adviser was heavily involved in preparing the prospectuses and made them available on its own website, it did not exercise sufficient control over their content to expose itself to liability in a private action. Id. at 2305. The Court used the metaphor of a speechwriter and speaker to explain its decision, noting that "[e]ven when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit-or blame-for what is ultimately said." Id. at 2302.
Here, the Complaint implicitly acknowledges that DBSI rather than the defendants controlled the content of the PPM. (D.I. 1 at ¶ 40, 45, Ex. H.) While the defendants may have delivered the PPMs to the investors, they did not have the requisite "ultimate authority over the statement." Zazzali makes much of the Janus Court's "speechwriter" example, suggesting that the Broker Defendants actually should be viewed as the "speaker" in that metaphor. (D.I. 322 at 6-7.) This view, however, represents a misunderstanding of the Court's example, which was seemingly meant to highlight the difference between merely helping another to "craft" his message and actually "making" one's own statement. See Janus, 131 S.Ct. at 2305. The mere fact that it was the defendants who distributed the PPMs to the investors does not justify attributing the statements therein to them. Analogously, the Janus Court stated that an investment adviser could not be liable for posting deficient prospectuses on its own website, since merely relaying the information in that way "does not indicate that the hosting entity adopts the document as its own statement or exercises control over its content." Id. at 2305 n.12. Accordingly, the court finds that Zazzali has failed to allege that any defendants actually made the alleged misrepresentations in the PPM and thus has failed to state a § 10(b) claim with regard to those statements.
On the other hand, the court believes the Complaint has adequately identified alleged misrepresentations in the Subscription Agreements. Unlike the PPM statements, the Subscription Agreement statements appear in certifications signed by the defendants. While the Subscription Agreements themselves appear to have been prepared by DBSI, they contain sections in which the broker-dealers were required to enter information and provide their own signatures, thereby independently endorsing particular statements. One such statement was the representation now challenged by Zazzali that the Broker Defendant "had reasonable grounds to believe, on the basis of information supplied by the Purchaser, and any other pertinent information, ' that the DBSI security was a suitable investment for the Purchaser.'" ( Id. at ¶ 56, Ex. I.) In providing this signed certification, the defendants did not merely host the challenged Subscription Agreement statements on a website or otherwise distribute them to investors- rather, they explicitly adopted them as their own statements. See Janus, 131 S.Ct. at 2305 n.12.
Additionally, while the Complaint does not separately list each defendant alongside his claimed misrepresentations, the uniform nature of the Subscription Agreement statements at issue make such an exhaustive format unnecessary. Courts have referred to Rule 9(b) and the PSLRA as "requir[ing] plaintiffs to plead the who, what, when, where and how" in asserting securities fraud. Avaya, Inc., 564 F.3d at 253 (quoting In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999)). The plaintiff, however, is not required to give the exact date, time, and location of the fraud in providing the "when" and "where"-making clear that it occurred upon the distribution of the Subscription Agreements to the investors is enough. See Bank One, Columbus, Ohio N.A. v. Fin. Ventures, LLC, No. C2-01-0049, 2002 WL 484308, at *3 (S.D. Ohio Mar. 26, 2002); Onesti v. Thomson McKinnon Sec., Inc., 619 F.Supp. 1262, 1265 (N.D. Ill. 1985). Likewise, the "who, " "what, " and "how" elements are satisfied here through Zazzali's identification of the particular Subscription Agreement statements at issue and his allegations that each of the defendants provided these documents to each of their investor customers. Finally, the Complaint also states with sufficient particularity the facts upon which Zazzali forms his belief of securities fraud, referencing the specific documents that contained the alleged misrepresentations, (D.I. 1 at ¶ 56), the particular facts that the defendants would have been aware of had they conducted independent due diligence, ( Id. at ¶¶ 189-93), and the third-party due diligence reports upon which the defendants actually may have relied, ( Id. at ¶¶ 194-203).
15 U.S.C. § 78u-4(b)(2) provides that the complaint must, "with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. "This scienter standard requires plaintiffs to allege facts giving rise to a strong inference' of either reckless or conscious behavior.'" Avaya, Inc., 564 F.3d at 267 (quoting Advanta, 180 F.3d at 534-35). The Third Circuit has further clarified that
[a] reckless statement is one involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.
Id. at 267 n.42 (quoting Advanta, 180 F.3d at 535). While scienter need not be conclusively demonstrated at the pleadings stage, its "inference... must be more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." Tellabs, Inc. v. Makar Issues & Rights, Ltd., 551 U.S. 308, 314 (2007).
Representative of the Moving Defendants' challenges on this point is defendant Dean McDermott's complaint that "a general allegation in reference to hundreds of defendants hardly shows that [an individual defendant] acted with the intent to deceive, manipulate, or defraud, ' or that he had a knowing or reckless state of mind.'" (D.I. 236 at 6.) The court, however, cannot agree with this assessment. While the Complaint does not individually address each defendant's mental state, it provides the necessary information about each of the "hundreds of defendants" in alleging that they were all broker dealers that represented they possessed knowledge that they could not have possibly had.
There is a difference between stating "I have reasonable grounds to believe this is a suitable investment for the investor, " and "this is a suitable investment for the investor." If Zazzali had challenged the latter representation, the court is not certain it could find scienter, as the alleged falsity of such a statement may have been the result of mere negligence. The former representation, however, says something about not only the suitability of the investment but also the speaker's knowledge. The essence of Zazzali's § 10(b) claims is not that the defendants mischaracterized the strength of the DBSI securities but that they misrepresented that they had reasonable grounds for believing in that strength.
Taking the Complaint's allegations as true and drawing all reasonable inferences in Zazzali's favor, the court finds that he has plead "facts giving rise to a strong inference' of either reckless or conscious behavior.'" Viewed properly, Zazzali's claim is that the defendants simply lied as to the extent of their knowledge about the DBSI securities, and the court has little trouble characterizing such a misrepresentation as reckless. The "danger of misleading buyers" through a misrepresentation about their own knowledge was "so obvious that the [defendants] must have been aware of it." Likewise, it cannot be within the ordinary standard of care for a broker to exaggerate the state of his own knowledge regarding a security. See de Kwiatkowski v. Bear, Sterns & Co., Inc., 306 F.3d 1293, 1302 (2d Cir. 2002) (noting that, in a nondiscretionary account, a broker's fiduciary duties include "giv[ing] honest and complete information when recommending a purchase or sale"). Moreover, the facts alleged here actually give rise to an inference of conscious behavior. When one makes a misrepresentation about external matters, he may, for any number of reasons, be unaware of that statement's falsity. On the other hand, when he describes the extent of his own knowledge, he is in complete command of the facts being conveyed and, absent sheer carelessness in his speech, can be expected to know of any inaccuracies. Taking these considerations together with the fact that the defendants had a clear financial incentive to encourage the sales, see Tellabs, Inc., 551 U.S. at 325 (noting that "motive can be a relevant consideration, and personal financial gain may weigh heavily in favor of a scienter inference"), the court believes an inference of reckless or conscious behavior is at least as plausible as any other inference.
d. Remaining § 10(b) elements
In addition to a material misrepresentation or omission connected to the purchase or sale of a security and scienter, a § 10(b) claim also requires "reliance upon the misrepresentation or omission;... economic loss; and... loss causation." Stoneridge Inv. Partners., 552 U.S. at 157. Only some of the Moving Defendants challenge the sufficiency of the Complaint with respect to these remaining elements, and the court finds that Zazzali has sufficiently plead reliance,  loss, and loss causation.
Finally, several of the Moving Defendants contend that Zazzali' s § 10(b) claims are time-barred under 28 U.S.C. § 1658(b), which provides that:
[A] private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws... may be brought not later than the earlier of-
(1) 2 years after the discovery of the facts constituting the violation; or
(2) 5 years after such violation.
28 U.S.C. § 1658(b). The Third Circuit has identified §1658(b)(l) as a statute of limitations and § 1658(b)(2) as a statute of repose. See In re Exxon Mobil Corp. Sec. Litig., 500 F.3d 189, 199 (3d Cir. 2007). "A period of limitation bars an action if the plaintiff does not file suit within a set period of time from the date on which the cause of action accrued. In contrast, a period of repose bars a suit a fixed number of years after an action by the defendant... even if this period ends before the plaintiff suffers any injury." Beard v. J.I. Case Co., 823 F.2d 1095, 1097 n.1 (7th Cir. 1987). Consistent with this traditional understanding, the five-year repose period of subsection (b)(2) begins to run on the date of the alleged misrepresentation. See In re Exxon Mobil, 500 F.3d at 200. Additionally, the Supreme Court has instructed that the two-year period set forth in subsection (b)(1) does not begin until the plaintiff discovers, or with reasonable diligence would have discovered, at least the facts of misrepresentation and scienter. See Merck & Co., Inc. v. Reynolds, 130 S.Ct. 1784, 1796 (2010).
As the Third Circuit explained in Bethel v. Jendoco Construction Corporation, 570 F.2d 1168 (3d Cir. 1978):
[T]he statute of limitations constitutes an affirmative defense to an action. Under the law of this and other circuits, however, the limitations defense may be raised on a motion under Rule 12(b)(6), but only if "the time alleged in the statement of a claim shows that the cause of action has not been brought within the statute of limitations."
Id. at 1174. It is well-settled that, "[i]f the bar is not apparent on the face of the complaint, then it may not afford the basis for a dismissal of the complaint under Rule 12(b)(6)." Id. Here, Zazzali filed the Complaint on June 27, 2012, and several of the Moving Defendants contend that he should have known of the facts constituting the alleged fraud prior to June 27, 2010, in light of both the October 27, 2008 investor suit charging DBSI with running a "Ponzi" scheme and the bankruptcy examiner's October 19, 2009 report concerning various DBSI financial improprieties. ( See, e.g., D.I. 253 at 16; D.I. 268 at 10-14.) The court cannot agree with their assessment. As Zazzali notes, "[t]he dates on which investors learned that certain DBSI Companies may have acted fraudulently tell one nothing about when Investors learned that the Broker Defendants had misrepresented their performance of due diligence." (D.I. 322 at 29.) While the Moving Defendants ultimately may be able to show that Zazzali and the PAT investors should have been aware of the facts constituting the Broker Defendants' alleged violations before June 27, 2010, it is not facially apparent at this stage.
It is clear, however, that any remaining § 10(b) claims based upon misrepresentations alleged to have been made before June 27, 2007 are barred by the five-year statute of repose set forth in 28 U.S.C. § 1658(b)(2). See In re Exxon Mobil, 500 F.3d at 200. The court will dismiss these claims.
B. Count Two: Violations of§ 20(a) of the Exchange Act
1. Section 20(a)
The Complaint also alleges violations of § 20(a) of the Exchange Act by the Broker-Dealer Parent Defendants and the Broker-Dealer Owner/Officer Defendants. (D.I. 2 at ¶¶ 215-219.) Section 20(a) of the Exchange Act provides:
Every person, who directly or indirectly, controls any person liable under any provision of this title or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person... unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
Securities Exchange Act of 1934, Pub. L. No. 73-291, § 20(a), 48 Stat. 881, 899 (codified at 15 U.S.C. § 78t). A claim under § 20(a) is a derivative claim requiring an underlying violation of the Exchange Act. See In re Rockefeller Ctr. Props., Inc. Sec. Litig., 311 F.3d at 211-12. Thus, in order to prevail on a § 20(a) claim, a plaintiff must demonstrate both that (1) the defendant "controlled another person or entity, " and (2) "that the controlled person or entity committed a primary violation of[§ 10(b)]." In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 284 (3d Cir. 2006). Additionally, the Third Circuit has required that the control person be "a culpable participant in the fraud." See Belmont v. MB Inv. Partners, Inc., 708 F.3d 470. 484-85 (3d Cir. 2013); In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d at 284 n.16; In re Heckman Corp. Sec. Litig., 869 F.Supp.2d 519, 543 (D. Del. 2012). While there is some uncertainty in this circuit as to whether § 20(a) requires that "culpable participation" actually be plead, see Belmont, 708 F.3d at 485 n.20 (declining to resolve the "difference of opinion" that has emerged among district courts in the Third Circuit), the court continues to believe that allegations of such culpable conduct are necessary, see In re Digital Island Sec. Litig., 223 F.Supp.2d 546, 560, 562 (D. Del. 2002) ("[T]he heightened standard of the PSLRA requires that a claim under Section 20(a) state with particularity the circumstances of both the defendants' control of the primary violator, as well as of the defendants' culpability as controlling persons."), aff'd, 357 F.3d 322 (3d Cir. 2004).
Zazzali contends that the Complaint adequately pleads control person liability under § 20(a) and disputes the continued viability of In re Digital Island in light of more recent decisions within the Third Circuit. See, e.g., Dutton v. Harris Stratex Networks, Inc., 270 F.R.D. 171, 181 (D. Del. 2010); In re Royal Dutch/Shell. Transp. Sec. Litig., 380 F.Supp.2d 509, 565 (D.N.J. 2005). In particular, Zazzali argues that (1) a § 20(a) plaintiff need not allege "culpable participation" and, (2) in cases where a trustee is prosecuting a complex fraud case, neither the circumstances of the defendant's "control" nor the circumstances of his "culpability" need to be plead with particularity. (D.I. 322 at 21-22.) For the reasons already noted in In re Digital Island and examined at some length by Judge Chesler in In re Merck & Co., Inc. Securities, Derivate & "ER/SA" Litigation, No. 05-1151-SRC, 2012 WL 3779309 (D.N.J. Aug. 29, 2012), the court rejects Zazzali's invitation to alter its approach to control person claims. Since the Complaint contains, at best, only conclusory allegations that the Broker-Dealer Parent Defendants and the Broker-Dealer Owner/Officer Defendants acted as "culpable participants" in connection with the claimed misrepresentations, the court finds that Zazzali has failed to adequately state a § 20(a) claim. (D.I. 1 at ¶ 216.)
C. Count Three: Breaches of Contract
In order to state a claim for breach of contract, a plaintiff generally must allege (1) the existence of a contractual obligation, (2) a breach of that obligation, and (3) a resulting injury to the plaintiff. See, e.g., Greenstar, LLC v. Heller, 814 F.Supp.2d 444, 450 (D. Del. 2011). The court finds that Zazzali has failed to state a sufficient contract claim. While the Subscription Agreements contain representations that the defendants "had reasonable grounds to believe, on the basis of information supplied by the Purchaser, and any other pertinent information, ' that the DBSI security was a suitable investment for the Purchaser, '" (D.I. 1 at ¶ 56), they are not alleged to contain any promises that the defendants would take future actions for the benefit of the investors. Zazzali thus has failed to identify an actual contractual obligation in the Subscription Agreements to which the defendants were subject. The Soliciting Dealer Agreements also provide no help to Zazzali, since they were agreements between only DBSI and the defendants, in which the investors were not intended third-party beneficiaries. (D.I. 1 at ¶¶ 40-42, Ex. H.)
D. Count Four: Common Law Fraud
A claim for common law fraud under Delaware law requires a plaintiff to plead "with particularity, " see Fed.R.Civ.P. 9(b), the following elements:
(1) defendant's false representation, usually of fact; (2) made either with knowledge or belief or with reckless indifference to its falsity; (3) with an intent to induce the plaintiff to act or refrain from acting; (4) the plaintiffs action or inaction resulted from a reasonable reliance on the representation; and (5) reliance damaged the defendant.
Browne v. Robb, 583 A.2d 949, 955 (Del. 1990); see also Heller, 814 F.Supp.2d at 452. Such claims are not subject to the pleading requirements of the PSLRA. Snowstorm Acquisition Corp., 739 F.Supp.2d at 708. For reasons discussed above, the court finds that, with the exception of the Subscription Agreement certifications, the Complaint fails to allege any misrepresentations with sufficient particularity. See supra Section IV.A.3.b-d. As such, the court will dismiss all common law fraud claims not based on the Subscription Agreement certifications.
E. Count Five: Negligence
In most cases, a negligence claim requires a plaintiff to plead: (1) a duty of care, (2) breach of that duty, and (3) that the breach proximately caused the plaintiff to suffer damages. See, e.g., Halchuck v. Williams, 635 F.Supp.2d 344, 346 (D. Del. 2009) (applying Delaware law); Shogen v. Global Aggressive Growth Fund, Ltd., No. 04-5695-SRC, 2007 WL 1237829, at *16 (D.N.J. Apr. 26, 2007) (applying New Jersey law); Schmechel v. Dille, M.D., 219 P.3d 1192, 1203 (Idaho 2009). Rule 9(b)' s heightened pleading bar generally does not apply to negligence claims. Here, Zazzali alleges that the defendants "owed Investors... duties to use such skill, prudence, and diligence as other members of their profession commonly possess and exercise in connection with the marketing and sale of the DBSI securities" and that they "breached this duty by failing to exercise reasonable care and competence in conducting their due diligence in connection with the marketing and sale of the DBSI securities." (D.I. 1 at ¶¶ 233-34.) Whether the defendants' failure to conduct due diligence investigations fell short of the standard of care ordinarily employed in the industry is a disputed question of fact that cannot be resolved at this early stage. As such, the court will deny the Moving Defendants' motion with respect to Count Five.
F. Count Six: Breaches of Fiduciary Duties
While it is not entirely clear what states' laws govern the fiduciary duties of the defendants, the parties' briefing focuses primarily on New York law. Under New York law, a broker's fiduciary duty to a nondiscretionary customer generally is limited to executing the transactions requested by the customer. See, e.g., Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 536 (2d Cir. 1999); Indep. Order of Foresters v. Donald, Lufkin & Jenrette, Inc., 157 F.3d 933, 941 (2d Cir. 1998). On this basis, some of the Moving Defendants contend that Count Six should be dismissed, noting that the Complaint does not allege that the defendants were unauthorized in carrying out the DBSI security purchases. ( See, e.g., D.I. 253 at 20.) There exists some authority, however, for proposition that "[o]n a transaction-by-transaction basis, " a broker not only must faithfully execute the ordered transaction but also "is obliged to give honest and complete information when recommending a purchase or sale." de Kwiatkowski, 306 F.3d at 1302. Additionally, it is unlikely that the law of New York will control as to all the defendants, and a number of other jurisdictions have endorsed at least somewhat more expansive fiduciary duties for brokers. See, e.g., Twp. of Spring v. Std. Ins. Co., 497 F.App'x 211, 214 n.1 (3d Cir. 2012); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F.Supp. 951, 952 (E.D. Mich. 1978), aff'd, 647 F.2d 165 (6th Cir. 1981); Patsos v. First Albany Corp., 741 N.E.2d 841, 849-50 (Mass. 2001); Merrill Lynch, Pierce, Fenner & Smith v. Perelle, 514 A.2d 552, 560-61 (Pa. Super. 1986). As such, the court will decline to dismiss Count Six at this juncture.
In accordance with its above conclusions, the court will grant-in-part and deny-in-part the present motions.
At Wilmington this 25th day of September 2013, consistent with the memorandum opinions issued this same date, (D.I. 420; D.I. 420), IT IS HEREBY ORDERED THAT:
(1) The Motion to Dismiss filed by Jason Bressler (D.I. 233) is GRANTED-IN-PART AND DENIED-IN-PART;
(2) The Motion to Dismiss filed by Dean McDermott (D.I. 235) is GRANTED-IN-PART AND DENIED-IN-PART;
(3) The Motion to Dismiss filed by Keith Witter (D.I. 237) is GRANTED-IN-PART AND DENIED-IN-PART;
(4) The Motion to Dismiss filed by Kasey Hafenbrack (D.I. 238) is GRANTED-IN-PART AND DENIED-IN-PART;
(5) The Motion to Dismiss filed by Mindy Ann Horowitz, Victor Kevin Kurylak, and Celeste Marie Leonard (the "First Montauk Owner/Officer Defendants") (D.I. 244) is GRANTED;
(6) The Motion to Compel Arbitration or, in the Alternative, Motion to Dismiss filed by Daniel Berckes, Sue Desrosier, and Syd Widga (D.I. 249) is GRANTED-IN-PART;
(7) The Motion to Dismiss filed by Richard Steven Babjak, Robert Alan Walter, Robert Daniel Yarosz, and World Equity Group (D.I. 252) is GRANTED-IN-PART;
(8) The Motion to Dismiss filed by Chester Ju, Shirley Ju, Anne Hayward, Alan Schryer, Lori Gilson, Kenneth Bolton, and Scott Thomas (D.I. 259) is GRANTED-IN-PART;
(9) The Motion to Dismiss filed by Jeffrey Augspurger, Gary Barton, Ron Barton, Tod Billings, Trent Bryerly, Scott Cavey, Allan Crumes, Ron Davies, Tim Duma, Mike Eden, David Kowalski, Robert Kuh, Chris Miller, Michael Myers, Dwain Owens, Mark Pearson, Royce Ruth and Cory Thomas (D.I. 261) is DENIED;
(10) The Motion to Dismiss filed by Jeffrey Augspurger, Gary Barton, Ron Barton, Tod Billings, Trent Bryerly, Scott Cavey, Allan Crumes, Ron Davies, Tim Duma, Mike Eden, David Kowalski, Robert Kuh, Chris Miller, Michael Myers, Dwain Owens, Mark Pearson, Royce Ruth and Cory Thomas (D.I. 264) is GRANTED-IN-PART;
(11) The Motion to Dismiss filed by Richard Allen Frueh and Donald James Gunn, Jr. (D.I. 265) is GRANTED-IN-PART AND DENIED-IN-PART;
(12) The Motion to Dismiss filed by Owen Fisher (D.I. 278) is GRANTED-IN-PART AND DENIED-IN-PART;
(13) The Motion to Dismiss filed by Philip Atwan, Stacey Jim Morimoto, John Paul Spring, and Christian Spring (D.I. 287) is GRANTED-IN-PART AND DENIED-IN-PART;
(14) The Motion to Dismiss filed by Bruce Ransom (D.I. 371) is GRANTED-IN-PART;
(15) The Motion to Join in certain other motions to dismiss for improper venue and lack of personal jurisdiction filed by Daniel Berckes, Sue Desrosier, and Syd Widga (D.I. 384) is DENIED AS MOOT;
(16) Those defendants who filed motions to dismiss pursuant to Rule 12(b)(3) of the Federal Rules of Civil Procedure and had their motions denied with respect to their Rule 12(b)(3) arguments are given leave to re-file appropriate motions to dismiss for improper venue, as set forth in the court's memorandum opinion. (D.I. 421 at 9 n.4.)
(17) The Complaint is DISMISSED as follows:
a. The claims under § 10(b) of the Exchange Act and 17 C.F.R. § 240.10b-5 (D.I. 1 at ¶¶ 205-14) are DISMISSED with respect to all but the alleged misrepresentations discussed in Paragraph 56 of the Complaint that were made on or after June 27, 2007;
b. The claims under § 20(a) of the Exchange Act (D.I. 1 at ¶¶ 215-19) are DISMISSED;
c. The claims for breach of contract (D.I. 1 at ¶¶ 220-26) are DISMISSED; and
d. The claims for common law fraud (D.I. 1 at ¶¶ 227-31) are DISMISSED with respect to all but the alleged misrepresentations discussed in Paragraph 56 of the Complaint; and
(18) As discussed throughout the court's memorandum addressing the various motions to dismiss under Rule 12(b)(6), Zazzali shall file a motion for leave to amend in order to:
a. Clarify the Complaint's allegations that all of the defendants made the statements discussed in Paragraph 56;
b. Clarify whether a "statement that each broker Defendant acknowledged its membership in the Financial Industry Regulatory Authority.... and SIPC and its attendant obligation to comply with all federal and state laws, rules, and regulations" actually appeared in the Subscription Agreements;
c. Clarify generally the use of the term "Broker Defendants" so as to address the confusion regarding which claims have been brought against which defendants; and
d. Optionally, to correct the Complaint's pleading deficiencies with respect to any of the claims dismissed by this order.