Gurary v. Winehouse

• Decision Date: 01 August 2000
• Docket Number: BIO-ME,INC,Docket No. 00-7151,NU-TECH
• Citation: 235 F.3d 792
• Parties: (2nd Cir. 2000) MORDECHAI GURARY, Plaintiff-Appellee, v. ISAAC WINEHOUSE and ISAAC WINEHOUSE, doing business as Wall & Broad Equities, Defendants, , Defendant-Appellant
• Court: U.S. Court of Appeals — Second Circuit

Page 792

235 F.3d 792 (2nd Cir. 2000)

MORDECHAI GURARY, Plaintiff-Appellee, v. ISAAC WINEHOUSE and ISAAC WINEHOUSE, doing business as Wall & Broad Equities, Defendants, NU-TECH BIO-MED, INC., Defendant-Appellant.

Docket No. 00-7151

August Term, 2000

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

Argued: September 19, 2000

Decided: December 19, 2000

Appeal from an order entered in the United States District Court for the Southern District of New York (Stanton, J.) denying the imposition of sanctions pursuant to the Private Securities Litigation Reform Act of 1995 and Federal Rule of Civil Procedure 11, the court having found that the claims made in the plaintiff's complaint were warranted by a conceivable nonfrivolous extension of existing law.

Affirmed in part, vacated and remanded in part.

[Copyrighted Material Omitted] MARTIN E. KARLINSKY, Camhy Karlinsky & Stein LLP, New York, NY (Douglas A. Amedeo, Camhy Karlinsky & Stein LLP, New York, NY, on the brief), for Defendant-Appellant.

DAVID JAROSLAWICZ, Jaroslawicz & Jaros, New York, NY (Robert J. Tolchin, Jaroslawicz & Jaros, New York, NY, of counsel), for Plaintiff-Appellee.

Before: WALKER, Chief Judge, and MINER and POOLER, Circuit Judges.

MINER, Circuit Judge:

Defendant-appellant Nu-Tech Bio-Med, Inc. ("Nu-Tech") appeals from an order entered in the United States District Court for the Southern District Court of New York (Stanton, J.) denying its motion for sanctions pursuant to the Private Securities Litigation Reform Act of 1995 ("PSLRA") and Federal Rule of Civil Procedure 11 ("Rule 11") against plaintiff-appellee Mordechai Gurary ("Gurary").

Gurary brought suit against Nu-Tech and defendant Isaac Winehouse ("Winehouse") to recover damages for securities fraud pursuant to section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j, and 17 C.F.R. § 240.10b-5 ("Rule 10b-5") thereunder. The district court granted summary judgment in favor of both defendants and denied their motions for sanctions under Rule 11. We affirmed the summary judgment but remanded for further findings regarding compliance with Rule 11 as mandated by the PSLRA. See Gurary v. Winehouse, 190 F.3d 37, 47 (2d Cir. 1999). On remand, the district court concluded that sanctions were not warranted because "[a] conceivable extension of existing law might" render Gurary's claims of securities fraud properly pleaded. Gurary v. Winehouse, No. 97-3803, 2000 WL 20706, at *1 (S.D.N.Y. Jan. 12, 2000). For the reasons that follow, we affirm in part, and vacate in part the order of the district court and remand for further proceedings consistent with this opinion.

BACKGROUND

In November 1996, Nu-Tech raised nearly $14 million by issuing shares of Series A Convertible Preferred Stock (the "preferred"). That stock, while having no voting rights and paying no dividends, was convertible into common stock at the lesser of $17.50 per share or 75 percent of the average closing price of the common stock for the five trading days prior to the date of the holder's notice of conversion. Because the preferred paid no dividends, had no voting rights, and was convertible to common stock at a bargain price, it would almost always be converted. In addition, purchasers of the preferred were likely to profit from conversion no matter what happened to the price of the common stock, provided that the company survived. That is, so long as the price of the common did not fall more than 25 percent after conversion, shareholders of the preferred would profit by conversion and sale of the common into which the preferred was converted.¹

This litigation arose out of an alleged scheme by defendant Winehouse in which Winehouse allegedly organized a "cartel" to purchase a percentage of Nu-Tech convertible stock in the names of nominees. He allegedly arranged for a number of securities firms to become market makers in Nu-Tech common stock, and then proceeded to sell the common stock short,² allegedly to drive down the price of the common stock. Gurary concedes that this alleged manipulation did not begin before November 6, 1996.

On October 31, 1996, Gurary purchased 1,000 shares of Nu Tech common stock at $14.60, and then on November 7, 1996, purchased another 5,500 shares at $15.50 per share. After becoming concerned about his investment when the stock price began to decline, Gurary spoke with J. Marvin Feigenbaum ("Feigenbaum"), chairman of Nu Tech, sometime in December 1996. Feigenbaum assured Gurary that he had alerted Winehouse 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 stock. Feigenbaum 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 stock at a possibly higher price in the open market. Based on Feigenbaum's assurances, Gurary purchased another 1,000 shares on December 24, 1996, at a price of $11.75 per share. Gurary claims to have subsequently learned that Winehouse and his associates arranged to "borrow" an unlimited number of shares from market makers for the express purpose of continuing to short the stock using nominee names.

Gurary spoke to Feigenbaum again on February 18, 1997. Feigenbaum told Gurary that he had met that day with Winehouse and others in another attempt to stop the short selling. Feigenbaum explained to Gurary that Nu Tech had offered to repurchase the group's preferred shares at cost plus ten percent and to allow the group to keep its existing profits from the short sales if it would cease its activities. Although Winehouse refused the offer, Feigenbaum told Gurary that Nu Tech would not surrender to Winehouse and would refuse to register the short sellers' shares. Apparently comforted by these assurances, Gurary bought another 8,350 shares of Nu Tech common at a price of $11.57 that same day.

On March 12, 1997, Feigenbaum and another Nu Tech board member met 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 refused this offer also and said that he would continue to sell short. Nu Tech common stock dropped approximately $6 per share over the next two days as the Winehouse group continued its short sales. Six days later, Gurary, in a conference call arranged by an intermediary, spoke directly with Winehouse, who allegedly admitted to him that he deliberately had shorted the stock to drive the price down, that he intended to continue, and advised Gurary to sell his shares because the price would drop to "a dollar."

On May 23, 1997, Gurary brought suit against Nu Tech and Winehouse in the United States District Court for the Southern District of New York as a result of the alleged manipulation of the Nu-Tech stock. Gurary's complaint principally alleged that defendants Winehouse and Nu-Tech manipulated 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 making numerous misstatements and omissions of material fact in connection with the purchase and sale of the convertible preferred stock and the shorting of the common stock.³

Both defendants moved to dismiss the complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief may be granted. In an Affidavit In Opposition to defendants' motion, Gurary's counsel, David Jaroslawicz, requested that he be granted leave to amend the complaint if the district court discovered any pleading deficiency. The district court, observing that Gurary's claims were based on four purchases, two purchases on October 31, 1996 and November 7, 1996, and two later purchases on December 24, 1996 and February 18, 1997, granted the motion in favor of Winehouse and Nu-Tech, after converting their 12(b)(6) motion into one for summary judgment.⁴ However, the district court did not comment on Gurary's request for leave to amend and therefore implicitly denied it.

Gurary appealed to this Court, and defendants Nu-Tech and Winehouse cross-appealed on the grounds that the district court improperly denied their motions for sanctions made pursuant to the PSLRA. In an opinion dated August 24, 1999, we affirmed in part, and vacated and remanded in part. With respect to Gurary's first purchase on October 31, 1996, we concluded that this purchase failed to state a cognizable claim under Rule 10b-5 because Gurary failed to "allege culpable deception in connection with the purchase or sale of a security" in that the alleged manipulation did not commence until November 6, 1996, and Gurary's first purchase preceded that date. Gurary, 190 F.3d at 45 (internal quotation marks omitted). We also concluded that Gurary's second purchase failed to state a cognizable claim under Rule 10b-5 because Gurary, at the very most, paid less for the security on November 7, 1996, than he otherwise would have as a result of the defendants' alleged fraud. We noted that a defrauded buyer may only recover "the excess of what he paid over the value of what he got," not the opposite. Id. at 46 (internal quotation marks omitted). With respect to Gurary's last two purchases, we concluded that because "there [was] no suggestion in the complaint or in Gurary's affidavit that Feigenbaum did not intend to do just what he promised at the times he made the statements [to Gurary]," Gurary's claim under Rule 10b-5 was "fundamentally flawed" as it failed to allege that Feigenbaum secretly intended not to perform or knew that he could not perform. Id. at 44. We also vacated and remanded in part for the district court to make "findings regarding compliance with Rule 11(b) [as...