Gurary v. Winehouse
| Decision Date | 01 August 1998 |
| Docket Number | BIO-ME,NU-TECH,Nos. 98-7239,INC,s. 98-7239 |
| Citation | 190 F.3d 37 |
| Parties | (2nd Cir. 1999) MORDECHAI GURARY, Plaintiff-Appellant-Cross Appellee, V. ISAAC WINEHOUSE and ISAAC WINEHOUSE, doing business as Wall & Broad Equities, Defendants-Appellees, and, Defendant-Appellee-Cross-Appellant. (L), 98-7280(XAP) |
| Court | U.S. Court of Appeals — Second Circuit |
Appeal and cross-appeal from a decision of the United States District Court for the Southern District of New York (Louis L. Stanton, Judge), granting defendants' motions for summary judgment dismissing the complaint and denying the motion of defendant Nu-Tech Bio-Med, Inc. for sanctions.
Affirmed in part, vacated and remanded in part.
[Copyrighted Material Omitted] Before: WALKER, Circuit Judge, OAKES, Senior Circuit Judge, and KAPLAN, District Judge.*
Plaintiff appeals from a judgment of the district court (Stanton, J.) to the extent that it dismissed the plaintiff's claims under Section 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j, and Rule 10b-5 thereunder on the merits and his pendent state claims for lack of subject matter jurisdiction. One of the defendants cross-appeals from so much of the judgment as denied so much of its motion as sought sanctions under the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). We affirm so much of the judgment as dismissed plaintiff's case. We vacate and remand insofar as it denied the application for sanctions.
Nu-Tech Bio-Med, Inc.("Nu-Tech") was formed in 1981. Its common stock, which is the security that allegedly was manipulated, is traded on NASDAQ.
In late 1996,1 at a time when Nu-Tech common stock was trading at about $15 per share, Nu-Tech raised $14 million by issuing 14,000 shares of Series A Convertible Preferred Stock in a private placement at a price of $1,000 per share. This security had no voting rights and paid no dividends but was convertible into common at the lesser of (1) $17.50 per share, and (2) 75 percent of the average closing bid price of the common for the five trading days prior to the date of the holder's notice of conversion, with one-third of the holder's shares being convertible on each of the forty-fifth, the seventy-fifth, and the one hundred-fifth day after issuance. Nu-Tech was obliged to register the common stock into which the preferred was convertible. These characteristics had several notable implications.
First, the facts that the preferred (a) paid no dividends, (b)had no voting rights, and (c) was convertible to common at a bargain price, and that (d) the conversion right expired following the one hundred fifth day following issuance meant that the preferred almost inevitably would be converted.2
Second, purchasers of the preferred were likely to profit no matter what happened to the price of the common stock, provided only that the company survived. If the common traded below $23.33 per share immediately prior to conversion, the preferred would be converted at 75 percent of the price of the common (which would be less than $17.50). As long as the price of the common did not fall more than 25 percent following the conversion, the preferred shareholder would profit by conversion and sale of the common into which the preferred was converted.3 If the common traded above $23.33 immediately prior to conversion, the preferred would be converted at $17.50 (which would be less than 75 percent of the trading price of the common), thus virtually assuring an even greater profit.
Third, even if the preferred were to be converted into the minimum number of common shares,4 the preexisting common stock holders would be diluted very substantially. At the minimum conversion ratio of 57.14 shares of common per share of preferred, conversion of the entire issue of preferred would result in the issuance of 799,970 additional shares of common, whereas Nu-Tech had only about 2.4 million shares outstanding at the time of the private placement. Conversion at higher ratios (i.e., when the price of the common was below $23.33 per share) would increase the number of shares issued and therefore the dilution. Indeed, a sufficiently substantial drop in the price of the common could increase the conversion ratio so much that conversion would result in the former preferred shareholders owning a majority of the company's post-conversion common stock. Thus, the existence of the convertible preferred, in and of itself, doubtless exerted downward pressure on the price of the common.
The complaint alleges that defendant Isaac Winehouse, doing business as Wall & Broad Equities, organized a "cartel" to purchase a percentage of the Nu-Tech convertible preferred in the names of nominees. He then allegedly arranged for a number of securities firms to become market makers in Nu-Tech common stock and proceeded to sell the common short, allegedly to drive the price of the common stock down.
Plaintiff Mordechai Gurary purchased 1,000 shares of Nu-Tech common on October 31, 1996 and another 5,500 shares on November 7, 1996 at $14.60 and $15.50 per share, respectively. In or about December 1996, the stock price began to decline. A concerned Gurary spoke to J. Marvin Feigenbaum, chairman of Nu-Tech. Feigenbaum told him that he had spoken to Winehouse and threatened that Nu-Tech would refuse to register the common stock into which the preferred was convertible unless Winehouse and his group stopped shorting the common. He predicted that this threat would convince Winehouse to stop shorting the stock because a refusal to register the common issued upon conversion would force Winehouse to cover his short position by purchasing Nu-Tech common in the open market, perhaps at higher prices. Gurary, evidently comforted, then purchased another 1,000 shares on December 24, 1996 at a price of $11.75 per share.
Gurary claims subsequently to have learned that Winehouse and his associates had continued to short the stock using nominee names, having arranged to "borrow" an unlimited number of shares for that purpose from market makers. On February 18, 1997, Gurary again spoke to Feigenbaum, who told him that he had met that day with Winehouse and others in another attempt to stop the short selling. Feigenbaum told Gurary that Nu-Tech had offered to repurchase the group's preferred shares at cost plus ten percent and to allow it to keep its existing profits from the short sales if the group would stop its activities but that Winehouse had refused. Feigenbaum, however, told Gurary that Nu-Tech would not give in to Winehouse and would refuse to register the short sellers' shares. Later that day, Gurary bought another 8,350 shares of Nu-Tech common at a price of $11.57.
On March 12, 1997, Feigenbaum and another Nu-Tech board member met again with Winehouse and asked that Winehouse and his group accept registration of the common stock into which their preferred was convertible over a period of twelve months rather than insisting that it be registered immediately. Winehouse again refused and said that he would continue to sell short.
Nu-Tech common stock dropped approximately $6 per share over the next two days. On March 14, 1997, the company issued a press release which stated that the price decline could be attributed to "possible sales by shareholders." No mention was made of the discussions between Nu-Tech and Winehouse, allegedly to avoid disrupting Nu-Tech's efforts to acquire Physicians Clinical Laboratory, Inc. ("PCL") out of bankruptcy.
A few days later, Gurary was approached through an intermediary and spoke with Winehouse, who allegedly admitted to him that he deliberately had shorted the stock to drive the price down, said that he intended to continue, and advised Gurary to sell his shares because the price would drop to "a dollar."
Plaintiff commenced this action against Nu-Tech and Winehouse on May 23, 1997. The complaint contains three relevant claims for relief.5 The first charges Winehouse with manipulation of Nu-Tech's common stock in violation of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j, and Rule 10b-5 thereunder, 17 C.F.R.§ 240.10b-5, by the purchase of the convertible preferred and the shorting of the common.6 The second claim is against Nu-Tech and charges a 10b-5 violation in that Nu-Tech, motivated by a desire to avoid having Winehouse and other short sellers object to its effort to acquire certain debt securities of PCL in a transaction requiring bankruptcy court approval, "failed to reveal the sale to Winehouse and his group through the use of nominees, that there were meetings going on between Winehouse and his group and Nu-Tech; that Nu-Tech was aware of the short-selling by Winehouse and his group; [and] that Nu-Tech would refuse to register certain stocks due to the short-selling activities of Winehouse and his group . . ." In addition, it charges that Nu-Tech's March 14, 1997 press release was misleading for failure to disclose Winehouse's short sales and the discussions between Nu-Tech and Winehouse. The third claim for relief alternatively seeks recovery from both defendants under Section 349 of the New York General Business Law.
Both defendants moved to dismiss the complaint for failure to state a claim upon which relief may be granted. Gurary opposed the motions and submitted a nine page affidavit in which he recounted his conversations with Messrs. Feigenbaum and Winehouse in greater detail than was included in the complaint. His attorney also submitted an argumentative affidavit that claimed no personal knowledge of anything relevant to the case, but that suggested that Winehouse had violated Section 5 of the Securities Act, 15 U.S.C. § 77e.
In disposing of the motions, Judge Stanton specifically relied upon...
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