Emergent Capital Inv. V. Stonepath Group, Inc.

Citation343 F.3d 189
Decision Date04 September 2003
Docket NumberDocket No. 02-7503.
PartiesEMERGENT CAPITAL INVESTMENT MANAGEMENT, LLC., Plaintiff-Appellant, v. STONEPATH GROUP, INC., previously known as Net Value Holdings, Inc., Andrew Panzo and Lee Hansen, Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Martin Stein, New York, New York (Heller, Horowitz & Feit, P.C., New York, New York, of counsel), for Plaintiff-Appellant.

Richard M. Beck, Philadelphia, Pennsylvania (Klehr, Harrison, Harvey, Branzburg & Ellers LLP, Philadelphia, Pennsylvania; John C. Canoni, Kasowitz, Benson, Torres & Friedman LLP, New York, New York, of counsel), for Defendants-Appellees.

Before: VAN GRAAFEILAND, CARDAMONE, and JACOBS, Circuit Judges.

CARDAMONE, Circuit Judge.

This is a securities fraud action. It arises out of a failed investment by plaintiff Emergent Capital Investment Management, LLC (Emergent, plaintiff, or appellant), in the preferred stock of defendant Net Value Holdings, Inc., presently known as Stonepath Group, Inc. (NETV). Plaintiff alleges that during the negotiations leading up to its investment in defendant, NETV's officers, defendants Andrew Panzo and Lee Hansen, repeatedly misrepresented the size of NETV's largest asset, its investment in a company called Brightstreet.com, Inc. (Brightstreet). Emergent further asserts that defendants unlawfully failed to disclose defendant Panzo's history of failed investment projects undertaken in collaboration with one Howard Appel, an individual barred from the securities industry by the National Association of Securities Dealers (NASD). It is plaintiff's contention that Appel effectively controlled defendant through affiliated individuals and entities, a fact defendants should have but failed to disclose to Emergent. Read in the light most favorable to Emergent, the complaint suggests that Panzo, Appel and their affiliated entities artificially inflated the stock prices of the companies controlled by Appel, including NETV, sold their own stock in those companies at high profits, and thereafter allowed the stock prices to plummet, rendering worthless other shareholders' investments.

Plaintiff sued defendants in the United States District Court for the Southern District of New York before Judge Robert W Sweet. Defendants' motion to dismiss plaintiff's second amended complaint under Fed.R.Civ.P. 12(b)(6) was granted in a judgment entered April 22, 2002. The district court ruled that the content of the stock purchase agreement between the parties precluded plaintiff from establishing reasonable reliance on the alleged misrepresentations and omissions. It did find, however, that plaintiff's allegations of loss causation were sufficient.

To the extent that plaintiff's claims are premised on defendants' representations regarding the Brightstreet investment, we agree that it cannot establish reasonable reliance. Plaintiff's failure to insist that these representations be reflected in the written stock purchase agreement leads us to conclude that a sophisticated investor like Emergent could not have reasonably relied on them. Hence, that dismissal must be affirmed.

We find no similar defect in plaintiff's claims premised on alleged omissions regarding Panzo's investment history and Appel's control of NETV. We think that the second amended complaint contains legally sufficient allegations of a causal connection between the subject matter of these omissions and the ultimate decline in NETV's stock value, that is, loss causation. Accordingly, we vacate the dismissal of these claims.

BACKGROUND
A. Parties

Plaintiff Emergent, a Delaware limited liability company with its principal office in New York City, manages an investment fund. Its two managing members, Daniel Yun and Mark Waldron, own 90 percent of its stock. Both had previously worked in prominent Wall Street firms, and both have substantial business and investment experience. At the time of the events giving rise to this litigation, Emergent managed between $5 and $7 million in investments.

Defendant NETV, a Delaware corporation with its principal place of business in California, is a holding company specializing in Internet-based businesses. Defendant Andrew Panzo is the chairman of its board of directors and is its chief executive officer (CEO), and defendant Lee Hansen is its director and president. Hansen is also a former roommate and personal friend of Emergent's managing member Mark Waldron.

B. Factual Allegations of the Second Amended Complaint

The following facts are alleged in plaintiff's second amended complaint and must be accepted as true for purposes of reviewing a complaint dismissed under Rule 12(b)(6).

1. NETV's Solicitation of Emergent's Investment and the Resulting Stock Purchase

In January 2000 NETV began soliciting investors for a private placement of its securities. As part of this solicitation effort, NETV's president Hansen approached his former roommate and plaintiff's managing member, Mark Waldron, and arranged for a meeting in New York between the principals of the two companies. On January 20, Hansen and NETV's CEO Panzo met with Waldron and Yun.

During their presentation on the benefits of investing in NETV's preferred stock, Panzo and Hansen told Waldron and Yun that NETV had invested approximately $17 million in seven e-commerce companies, and that the largest of those investments was a $14 million purchase of a 12 percent equity interest in Brightstreet. The two NETV executives also gave Waldron and Yun a brochure detailing information regarding their company, which repeated their oral representations with respect to the size of the Brightstreet investment.

As a result of defendants' solicitation, plaintiff in March 2000 purchased 166,667 shares of NETV's preferred stock at $12 per share, making a total investment of $2 million. In the stock purchase agreement executed by the parties, NETV made extensive warranties and representations regarding its capital structure, indebtedness, involvement in litigation, ownership and leases of real and personal property, and other matters connected with its business. The stock purchase agreement, in addition, contained a standard merger clause, stating that the agreement, together with accompanying documents, "contain[ed] the entire understanding and agreement among the parties ... and supersede[d] any prior understandings or agreements between or among any of them."

Prior to Emergent's purchase of NETV stock, the size of the Brightstreet investment had not been publicly disclosed in NETV's regulatory filings. Two months later, in May 2000, NETV filed its 1999 Form 10-K with the Securities and Exchange Commission, disclosing that its investment in Brightstreet amounted to $4 million, not the $14 million that it had represented to plaintiff.

2. Panzo and Appel's Investment History and Appel's Ties to NETV

Neither in negotiations leading up to plaintiff's investment in NETV nor in the stock purchase agreement itself did defendants mention any connection between NETV and Howard Appel, who since 1991 had been barred by the NASD for life from associating with any member of that organization in any capacity. Disbarment of Appel for life came about, in part, because of his sale of unregistered securities to customers. Plaintiff later learned that defendant's CEO Panzo had had a long history of collaborating with Appel in various investment schemes. Further, through a series of affiliated entities and individuals Appel played a significant role in NETV's founding, financing and particularly, in its control.

Panzo's business relationship with Appel began in 1992-1993, when Panzo worked as an executive vice president in an investment bank owned and controlled by Appel. After leaving the bank, Panzo collaborated with Appel on a number of investment projects, and their collaboration followed the same general pattern. Appel, through an affiliated company, would acquire control of a public shell corporation and exercise that control to install Panzo as a director or a senior officer, because Appel himself, on account of his past record, could not be a director of a public company. With Panzo in a top management position, the company would transfer substantial quantities of stock or warrants to Appel and Panzo's affiliates, either in a sale transaction, or in payment for purported consulting or investment banking services, or as a finder's fee in anticipation of a merger. Then the two men — through extraordinarily complex corporate legal maneuvers, often by way of subsidiaries of the companies of which they were principals, such as reverse mergers, stock exchanges between public and private corporations, reverse stock splits, a bewildering list of corporate name changes, and other corporate devices — would end up with large amounts of stock or warrants to purchase stock. Appel affiliates would then sell the securities at a relatively high price, generating large profits for Appel and Panzo. Subsequently, these companies' stock became virtually worthless.

NETV itself was similarly created through a merger of a public shell corporation with a private company largely owned by persons who were affiliated with Appel, and who also had participated as shareholders in eight other Panzo-Appel ventures. After the merger, these persons became NETV shareholders, and additional quantities of NETV stock were first transferred to and later sold by another Appel affiliate.

C. Procedural History

Between January and March 2000, when Emergent negotiated with and invested in NETV, the price of NETV's common stock generally remained between $10 and $30 per share. That price later fell to below $1 per share. In the summer of 2000, as the NETV stock price was declining, Emergent demanded rescission of the stock purchase agreement. Once this demand had been rejected, it commenced in October 2000 its first civil action against ...

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