In re Citisource, Inc. Securities Litigation

• Decision Date: 12 September 1988
• Docket Number: No. 86 Civ. 1711 (GLG).,86 Civ. 1711 (GLG).
• Citation: 694 F. Supp. 1069
• Parties: In re CITISOURCE, INC. SECURITIES LITIGATION. D.H. BLAIR & CO., INC., Defendant Third-Party Plaintiff, v. CITY OF NEW YORK, Third-Party Defendant. D.H. BLAIR & CO., INC., Defendant Third-Party Plaintiff, v. HOLTZMANN, WISE & SHEPARD and David Berdon & Co., Third-Party Defendants.
• Court: U.S. District Court — Southern District of New York

694 F. Supp. 1069

In re CITISOURCE, INC. SECURITIES LITIGATION.

D.H. BLAIR & CO., INC., Defendant Third-Party Plaintiff, v. CITY OF NEW YORK, Third-Party Defendant.

D.H. BLAIR & CO., INC., Defendant Third-Party Plaintiff, v. HOLTZMANN, WISE & SHEPARD and David Berdon & Co., Third-Party Defendants.

No. 86 Civ. 1711 (GLG).

United States District Court, S.D. New York.

September 12, 1988.

COPYRIGHT MATERIAL OMITTED

Wilmer, Cutler & Pickering, Washington, D.C. (Gerard S. Citera, Arthur F. Mathews, Andrew B. Weissman, Maxwell O. Chibundu, Stephen H. Sachs, of counsel), Gusrae, Kaplan & Bruno, New York City (Martin Kaplan, Thomas Rigilano, of counsel), for defendant third-party plaintiff, D.H. Blair & Co., Inc.

Peter L. Zimroth, Corp. Counsel, New York City (Helene Fromm, Allen E. Burns, Steven Levi, of counsel), for third-party defendant, City of New York.

Lester Schwab Katz & Dwyer, New York City (Richard Granofsky, Steve Getzoff, of counsel), for third-party defendants, Holtzmann, Wise & Shepard.

OPINION

GOETTEL, District Judge:

Familiarity with the facts underlying this case is presumed; they have been well publicized, and were described in the Second Circuit's opinion in United States v. Friedman, 854 F.2d 535 (1988). As that description makes clear, the investigation which bared New York City's maggoted Parking Violations Bureau¹ (the "PVB") revealed as well the infestation of CitiSource, Inc. and the rot of the foundation on which that company was built. The value of CitiSource's stock rested primarily, if not solely, on the company's $22.7 million-dollar contract with New York City ("NYC") to provide hand-held computers which would issue parking tickets and otherwise assist enforcement of NYC's parking restrictions ("the contract"). That contract, and with it the value of CitiSource's stock, evaporated in January 1986, when the government's investigation of CitiSource became public and NYC canceled the contract.

It comes as no surprise, then, that certain of CitiSource's shareholders have filed a putative class action (the "Consolidated Complaint") naming as defendants CitiSource, its officers and directors, Geoffrey Lindenauer, and D.H. Blair & Co., Inc. ("Blair"). Blair acted as the sole underwriter of the initial public offering of CitiSource's stock, and the Consolidated Complaint alleges that in this position Blair violated section 11 of the Securities Act, 15 U.S.C. § 77k; section 12(2) of the Securities Act, 15 U.S.C. § 77l(2); section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5; and the common law (fraud).²

The gravamen of the plaintiffs' claims against Blair is that Blair either knew or recklessly disregarded facts which did cause or should have caused it to know that the CitiSource prospectus, and certain Form 10-K's and 10-Q's filed by CitiSource after its initial public offering, contained misrepresentations and omissions of material facts. These misrepresentations and omissions concerned, inter alia, the involvement of bribery, extortion and pretense in the award of the contract to CitiSource; the reasons underlying NYC's broad rights of termination under the contract;³ the degree to which CitiSource had (not) developed the technology for the computer, and a prototype thereof; and the identities of the principal shareholders of the company.

Blair, in turn, has filed third-party complaints against NYC, and against Holtzmann, Wise & Shepard, which acted as special counsel to CitiSource in connection with the issuance and sale of its stock to Blair and to the public. Each of these third-party defendants has moved, separately, to dismiss the third-party complaints against them.

NEW YORK CITY

Blair's action against NYC is premised on the actions of Geoffrey Lindenauer, Lester Shafran, the late Donald Manes, and Michael Zapantis (the "subject employees"). Blair alleges that at all pertinent times: NYC employed Lindenauer as the Assistant Commissioner of the DOT and the Deputy Director of the PVB; NYC employed Shafran as a Deputy Commissioner of the DOT and the Director of the PVB; Manes was the Borough President of Queens County, the Queens Democratic leader, and a member of NYC's Board of Estimate; and NYC employed Zapantis as special counsel to the PVB. According to its third-party complaint, these individuals made several misrepresentations and omissions of material fact to Blair, in their official capacities. These misrepresentations and omissions related to, inter alia: the bribery and extortion involved in obtaining the contract; the degree to which NYC's contract approval procedures allowed and indeed fostered corruption; the manner in which these procedures had been abused in securing the contract; the identity of the principals of CitiSource and their relationships with NYC; the probability that the contract would be cancelled; and inaccuracies contained in correspondence from CitiSource to the SEC. Unlike the other subject employees, Zapantis is alleged to have acted only negligently or recklessly, and not intentionally.

Based on these allegations, Blair's third-party complaint seeks to impose liability on NYC under a variety of theories. The first and third causes of action seek to recover for alleged violations of section 10(b) and Rule 10b-5. (The first cause of action is styled as a claim for contribution, and the third cause of action alleges that Blair is entitled to recover from NYC for the subject employees' alleged violations of section 10(b) and Rule 10b-5 under principles of respondeat superior.) The second cause of action seeks contribution for violations of the common law (fraud and negligent misrepresentation) by the subject employees. The fourth and fifth causes of action are framed as RICO claims under 18 U.S.C. § 1962(c) and (d), the fifth being styled as based upon principles of respondeat superior. The sixth cause of action alleges negligence in supervision and control. The third-party complaint also alleges that NYC is responsible under principles of respondeat superior for the negligent, fraudulent, and tortious activity of the subject employees.

New York has moved (a) to dismiss the third-party complaint pursuant to Fed.R. Civ.P. 12(b)(6), 14, and 9(b); (b) alternatively, to sever and stay Blair's action against it, pursuant to Fed.R.Civ.P. 14, pending the final disposition of the related consolidated stockholders' class action; and (c) for costs and disbursements of this motion.

I. Claims Sounding in Fraud

a. Whether section 10(b) and Rule 10b-5 apply to municipalities

NYC's first attack on the third-party complaint is its argument that as a municipality, it is not an entity to which the anti-fraud provisions of either section 10(b) or Rule 10b-5 apply. We disagree, for the following reasons.

Section 10(b) provides that "it shall be unlawful for any person ... to use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance...."⁴ (emphasis added) Until 1975, the term "person," as defined in section 3(a)(9) of the Exchange Act, 15 U.S.C. § 78c(a)(9), had been construed as excluding municipalities. In re New York City Municipal Securities Litigation, 507 F.Supp. 169, 184-85 (S.D.N. Y.1980) (listing cases). This construction of course had the consequence that section 10(b), and Rule 10b-5 promulgated thereunder, were inapplicable to municipalities.⁵ However, in 1975, the 94th Congress enacted the Securities Acts Amendments of 1975, Pub.L. No. 94-29, 89 Stat. 97 (1975), which amended the Exchange Act in several respects. As part of this legislation, the definition of "person" in section 3(a)(9) was amended to include a "government, or political subdivision, agency, or instrumentality of a government." At issue before us is whether by this amendment, municipalities were made subject to the anti-fraud provisions of section 10(b) and Rule 10b-5.

NYC seems to suggest that despite the well established existence in 1975 of an implied private right of action under section 10(b) and Rule 10b-5, of which Congress may be presumed to have been aware, Congress did not mean by including municipalities within the definition of person to subject them to section 10(b) liability. However, possibly because of the holding in In re Washington Public Power Supply System Securities Litigation, 623 F.Supp. 1466, 1478-1480 (W.D.Wa.1985), aff'd, 823 F.2d 1349 (9th Cir.1987), NYC does not strongly press this argument. Rather, its primary argument is that even if Congress did intend to subject municipalities to liability under the anti-fraud provisions of the Exchange Act, it so intended only insofar as municipalities acted in the capacity of issuers of securities.

With limited exceptions, we should not look beyond the express language of a statute in search of Congressional intent. We may do so only if the words of the statute are ambiguous, or if a literal reading of the statute would thwart the purpose of the statutory scheme or lead to an absurd result. See United States v. Public Utilities Commission of California, 345 U.S. 295, 315, 73 S.Ct. 706, 717, 97 L.Ed. 1020 reh'g denied, 345 U.S. 961, 73 S.Ct. 935, 97 L.Ed. 1380 (1953); United States v. American Trucking Associations, Inc., 310 U.S. 534, 543-44, 60 S.Ct. 1059, 1063-64, 84 L.Ed. 1345 reh'g denied, 311 U.S. 724, 61 S.Ct. 53, 85 L.Ed. 472 (1940). NYC does not argue that the words of the statute are ambiguous, and indeed they could not be clearer. They state that "the term `person' means a natural person, company, government, or political subdivision, agency or instrumentality of a government." This language contains no limitation; it contains nothing to indicate that "person" means a municipality only when that municipality is performing certain functions rather than others.⁶

With regard to the second circumstance in which we may look beyond the express language of a...