In re 2THEMART.Com, Inc. Securities Litigation

• Decision Date: 17 July 2000
• Docket Number: No. SACV 99-1127 DOCANX.,SACV 99-1127 DOCANX.
• Citation: 114 F.Supp.2d 955
• Parties: In re 2THEMART.COM, INC. SECURITIES LITIGATION This Document Relates To: All Actions
• Court: U.S. District Court — Central District of California

Page 955

114 F.Supp.2d 955

In re 2THEMART.COM, INC. SECURITIES LITIGATION

This Document Relates To: All Actions

No. SACV 99-1127 DOCANX.

United States District Court, C.D. California.

July 17, 2000.

COPYRIGHT MATERIAL OMITTED

Michael D. Braun, Stull Stull & Brody, Los Angeles, CA, Kevin J. Yourman, Weiss & Yourman, Los Angeles, CA, Lynn L. Sarko, Elizabeth A. Leland, Keller Rohrback Law Offices, Seattle, WA, for Mary Ellen Harrington.

Keith B. Bardellini, Erin A. Owen, Donald S. Lee, Buchalter Nemer Fields & Younger, Los Angeles, CA, for Defendants.

ORDER DENYING DEFENDANTS' MOTION TO DISMISS AND MOTION TO STRIKE

CARTER, District Judge.

I. Introduction

This matter comes before the Court on Defendants' motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) and motion to strike pursuant to Federal Rule of Civil Procedure 12(f). Based on the materials and oral argument submitted by the parties, it appears that Plaintiffs' Consolidated Amended Complaint (hereinafter, "complaint") adequately states a claim for securities fraud upon which relief may be granted, and that the subject matter at issue in the motion to strike may be at issue in the case. Therefore, the Court denies both motions.

II. Factual Background

Defendant, 2TheMart.com, Inc. (hereinafter, "2TheMart"), was conceived in January 1999 by Defendants Magliarditi and Rebeil as a company that was to launch an e-commerce auction web site in direct competition to other auction web sites such as eBay.com. (Compl. at ¶ 2.) The web site was intended to be the core money-making strategy of the company. On January 19, 1999, the defendants announced the acquisition of CD Rom Yearbook, Inc., a publicly traded entity. As a result, 2TheMart acquired CD Rom Yearbook, Inc. as a shell company, changed the name of the company to 2TheMart.com, Inc., and became a publicly traded company on the NASD Electronic Bulletin Board identified as "TMRT." (See id. at ¶¶ 25-26.)

In a news wire announcement on January 19, 1999, Defendants stated that 2TheMart management included a "full team of operational, finance, marketing and technical personnel," that the web site was in "final development" and expected to be active by the second quarter of 1999 as a "preeminent" on-line auction site, and that the company had "retained the services of leading web site design and architecture consultants to design and construct the unique 2TheMart.com site." (See id. at ¶ 26.) Defendants made similar claims in a story released the following day on Business Wire. (See id. at ¶ 27.) The statements resulted in a rapid increase in the price of 2TheMart's stock from its closing price of $3.5 on January 18, 1999, to a close of $13 the following day. On January 20, 1999, the stock peaked at $50 before closing at $21.5. (See id. at ¶ 28; Pl. Suppl. Mem., Ex. B.)

On February 3, 1999, Defendants entered into an agreement with IBM to take the preliminary steps of identifying the business, technical and design requirements of the 2TheMart web site. (Compl. at ¶ 29.) Articles in the Los Angeles Times and Orange County Register asserted that "[m]ost new investors seem[ed] to have bought [2TheMart's] stock based solely on its news releases." (Id. at ¶ 35.) In order to provide additional information about 2TheMart, Defendants issued additional statements. On February 24, 1999, the company released a statement on Business Wire which stated that "2TheMart.com's business strategy will be to launch its E-commerce and person to person trading community in the second quarter of 1999," and that the web site was "currently in final development." (Id. at ¶ 39.) On March 1, 1999, Defendants also announced the addition of Chief Technology Officer Robert Allende. (See id. at ¶ 42.) In the same press release, the defendants again claimed that the site was in its "final development." (Id.)

On April 30, 1999, IBM delivered a "Phase 0 Solution Design" to Defendants which included a high level application design, budget planning estimate and schedule for implementation. (See id. at ¶¶ 49-50.) On June 1, 1999, Defendants signed a contract with IBM to design, build, and test their web site. This agreement gave a six month production plan for the completion of the site. (See id. at ¶¶ 29, 50.)

Defendants' August 26, 1999, public filing on Form 10 verified that IBM had not agreed to take the preliminary steps to set up the web site until February 2, 1999. The Form 10 filing also revealed that the preliminary plan would not be delivered to the defendants until April 30, 1999. Finally, the Form 10 filing also verified that the first contract between Defendants and IBM for the designing, building and testing of the web site was not entered into until June 1, 1999. (See id. at ¶¶ 43, 50.) With regard to the proposal for development entered into on June 1, 1999, section 2.7 of the contract stated that the project schedule and production plan set October 8, 1999, as the target delivery date for the web site. (See id. at 50.)

In preparation for the Form 10 filing, an audit was to be performed and published by Deloitte and Touche, LLP, but was delayed when Deloitte and Touche severed its relationship with Defendants on July 15, 1999. (See id. at ¶¶ 59-60.) Ultimately, an audit published by Grant Thornton LLP stated that "[2TheMart] is not yet generating revenues and, as shown in the financial statements, has incurred losses in its development stage. Also ... the Company has incurred substantial obligations and will need to raise capital to complete its development activities. These factors, among others ... raise substantial doubt about the Company's ability to continue as a going concern." (Id. at ¶ 59.)

On February 18, 2000, Plaintiff Harrington on behalf of herself and all others similarly situated filed a Consolidated Amended Complaint alleging that Defendants violated the Securities Exchange Act of 1934 [between January 19, 1999 and August 26, 1999 ("Class Period")]. (See id. at ¶ 1.) On April 3, 2000, Defendants filed a motion to dismiss and a motion to strike portions of the complaint. Plaintiffs filed their opposition on April 24, 2000. Defendants filed a reply brief on May 8, 2000. At oral argument on May 15, 2000, the Court ordered supplemental briefing on the issues of causation with regard to the statements and the stock price and whether Defendants profited from the fraud. Plaintiffs and Defendants filed their supplemental briefs on May 19 and May 26, 2000, respectively.

III. Legal Standard

Federal Rule of Civil Procedure 12(b)(6) provides for dismissal when the complaint fails to state a claim upon which relief can be granted. See Fed.R.Civ.P. 12(b)(6). A complaint fails to state a claim if it does not allege facts necessary to support a cognizable legal claim. See Balistreri v. Pacifica Police Dept., 901 F.2d 696, 699 (9th Cir.1988); Robertson v. Dean Witter Reynolds, Inc., 749 F.2d 530, 533-34 (9th Cir.1984).

In reviewing a Rule 12(b)(6) motion, the court must presume the truth of the factual allegations in the complaint and draw all reasonable inferences in favor of the non-moving party. See Parks Sch. of Bus., Inc. v. Symington, 51 F.3d 1480, 1484 (9th Cir.1995); see also Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir.1987). Dismissal under Rule 12(b)(6) is appropriate "only if it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations." Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 81 L.Ed.2d 59 (1984) (citing Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957))(dismissal appropriate only where "plaintiff can prove no set of facts in support of his claim which would entitle him to relief"); see also Ascon Properties, Inc. v. Mobil Oil Co., 866 F.2d 1149, 1152 (9th Cir.1989). The issue is not whether the plaintiff will ultimately prevail, but whether the plaintiff is entitled to offer evidence to support the plaintiff's claim. See Usher, 828 F.2d at 561.

IV. Analysis

In order to successfully state a claim of securities fraud under Rule 10b-5, Plaintiff must establish the following elements: (1) a misrepresentation, omission, or other fraudulent device, (2) the purchase or sale of securities in connection with the fraudulent device, (3) the defendant's scienter at the time of the misrepresentation or omission, (4) the materiality of the misrepresentation or omission, (5) justifiable reliance by plaintiff, and (6) damages. See 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. In their motion, Defendants allege that Plaintiffs' complaint must be dismissed because they fail to adequately state a claim of securities fraud. (See Mot. at 8.) Specifically, Defendants allege that Plaintiffs have failed to establish the elements of (1) scienter, (2) materiality of the alleged misrepresentations or omissions, and (3) justifiable reliance on the alleged misrepresentations or omissions. (See id.)

A. Scienter

The Private Securities Litigation Reform Act (PSLRA) requires that for each misrepresentation or omission, the complaint must "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). With regard to pleadings in the context of Rule 10b-5 claims, the Ninth Circuit has held that a plaintiff need allege not only that scienter existed, but that the plaintiff must also set forth "what is false or misleading about the statement, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading." GlenFed, Inc. Sec. Litig., 42 F.3d 1541, 1548 (9th Cir.1994) (en banc).

The Ninth Circuit recently addressed the standard for pleading scienter in a securities fraud action. See In re Silicon Graphics, Inc., Sec. Litig., 183 F.3d 970 (9th Cir.1999). In Silicon Graphics, the Ninth Circuit held that in order to establish scienter, ...