Steginsky v. Xcelera Inc. , 741 F.3d 365 ( 2014 )


Menu:
  • 13-1327-cv; 13-1892-cv
    Steginsky v. Xcelera Inc.
    In the
    United States Court of Appeals
    For the Second Circuit
    ________
    AUGUST TERM, 2013
    ARGUED: OCTOBER 30, 2013
    DECIDED: JANUARY 27, 2014
    Nos. 13-1327-cv; 13-1892-cv
    GLORIA STEGINSKY,
    Plaintiff-Appellant-Cross-Appellee,
    v.
    XCELERA INC., VBI CORPORATION, ALEXANDER M. VIK, GUSTAV M.
    VIK,
    Defendants-Appellees-Cross-Appellants,
    HANS EIRIK OLAV, OFC LTD.,
    Defendants-Appellees.
    ________
    Before: WALKER, CABRANES, and PARKER, Circuit Judges.
    ________
    Plaintiff Gloria Steginsky, a former minority shareholder of
    Xcelera Inc., appeals the dismissal of her securities fraud claims by
    the United States District Court for the District of Connecticut
    (Stefan R. Underhill, District Judge). Her complaint alleged that
    Xcelera insiders purchased Xcelera stock by making a tender offer
    2                                        Nos. 13-1327-cv; 13-1892-cv
    through a shell corporation without disclosing any information
    about Xcelera’s financial state. We hold that the duty of corporate
    insiders to either disclose material nonpublic information or abstain
    from trading is defined by federal common law and applies to
    unregistered securities, and that the district court thus erred in
    dismissing plaintiff’s insider trading claims. We VACATE the
    dismissal of her insider trading claims under sections 10(b), 20(a),
    and 20A(a) of the Securities Exchange Act, and of her pendent
    nonfederal claims for breach of fiduciary duty. However, we
    AFFIRM the dismissal of her market manipulation claims, and of her
    insider trading claims under section 14(e) of the Securities Exchange
    Act.
    ________
    JEFFREY S. ABRAHAM (Philip T. Taylor, on the brief),
    Abraham, Fruchter & Twersky, LLP, New York,
    NY, for Plaintiff-Appellant-Cross-Appellee.
    PETER J. MACDONALD (David F. Olsky, Jacob
    Press, Wilmer Cutler Pickering Hale and Dorr
    LLP, and Charles W. Pieterse, Whitman Breed
    Abbott & Morgan LLC, on the brief), Wilmer
    Cutler Pickering Hale and Dorr LLP, New York,
    NY, for Defendants-Appellees-Cross-Appellants.
    ________
    JOHN M. WALKER, JR., Circuit Judge:
    Plaintiff Gloria Steginsky, a former minority shareholder of
    Xcelera Inc., appeals the dismissal of her securities fraud claims by
    the United States District Court for the District of Connecticut
    (Stefan R. Underhill, District Judge). Her complaint alleged that
    Xcelera insiders purchased Xcelera stock by making a tender offer
    through a shell corporation without disclosing any information
    about Xcelera’s financial state. We hold that the duty of corporate
    insiders to either disclose material nonpublic information or abstain
    from trading is defined by federal common law and applies to
    3                                             Nos. 13-1327-cv; 13-1892-cv
    unregistered securities, and that the district court thus erred in
    dismissing plaintiff’s insider trading claims. We VACATE the
    dismissal of her insider trading claims under sections 10(b), 20(a),
    and 20A(a) of the Securities Exchange Act, and of her pendent
    nonfederal claims for breach of fiduciary duty. However, we
    AFFIRM the dismissal of her market manipulation claims, and of her
    insider trading claims under section 14(e) of the Securities Exchange
    Act.
    BACKGROUND
    Because the district court dismissed plaintiff’s claims on the
    pleadings, we must accept the complaint’s factual allegations as true
    for the purposes of this appeal. See ATSI Commc’ns, Inc. v. Shaar
    Fund, Ltd., 
    493 F.3d 87
    , 98 (2d Cir. 2007). Plaintiff Gloria Steginsky
    was a minority shareholder of Xcelera who sold her 100,010 shares
    in 2011 pursuant to a tender offer for $0.25 per share. She alleges
    violations of securities law and breaches of fiduciary duty by six
    defendants. Defendant Xcelera is a Cayman Islands holding
    corporation, based in Connecticut, with operating subsidiaries and
    financial interests in the computer and software industries. At all
    relevant times, Xcelera has been controlled by the three “Vik
    defendants”: Alexander Vik is Chairman of the Board and Chief
    Executive Officer; Gustav Vik is Director, Executive Vice President,
    Secretary, and Treasurer; and VBI Corporation (owned by
    Alexander and Gustav’s father, Erik Vik) is Xcelera’s majority
    shareholder.1 Defendant OFC Ltd. is incorporated in Malta and was
    created by the Vik defendants in 2010 as a vehicle to make a tender
    offer for Xcelera shares. Finally, defendant Hans Eirik Olav is an
    Xcelera Director who was listed as the OFC contact person with
    respect to the tender offer.
    1
    The complaint also notes that “according to a declaration filed by
    defendant Alexander M. Vik in [a separate case], ‘Xcelera is controlled by
    VBI.’” Complaint ¶ 11 (quoting Declaration of Alexander M. Vik at 6,
    Sebastian Holdings, Inc. v. Kugler, No. 3:08-cv-1131 (D. Conn. Oct. 31, 2008),
    ECF No. 23-2).
    4                                          Nos. 13-1327-cv; 13-1892-cv
    According to the complaint, Xcelera common stock traded on
    the American Stock Exchange for a high of $110/share in 2000 during
    the so-called dotcom bubble. In 2004, after the price plummeted to
    around $1/share, the Vik defendants began to refuse to make
    required filings with the Securities Exchange Commission (“SEC”).
    Because of this non-compliance, the American Stock Exchange
    delisted Xcelera stock in 2004, and the price then dropped to around
    $0.25/share. In 2006, the SEC revoked the registration of all Xcelera
    securities. Since 2005, none of the defendants have disclosed any
    information concerning Xcelera’s financial condition.
    After the de-registration of Xcelera securities by the SEC,
    investors were told by the company that they could sell their stock
    back to Xcelera for $0.25/share. In December 2010, OFC made a
    tender offer for Xcelera stock, listing Olav as the contact person, at
    $0.25/share. The complaint alleges that OFC is only a shell company,
    and that the tender offer was in fact orchestrated by Xcelera and the
    Vik defendants, who have previously used Maltese companies to
    conceal their identities. No information about Xcelera’s financial
    conditions was disclosed in connection with the tender offer. In
    April 2011, plaintiff sold her 100,010 shares of Xcelera common stock
    to OFC pursuant to the tender offer.
    In February 2012, plaintiff filed the complaint in this case,
    alleging breach of fiduciary duty and violations of sections 10(b),
    14(e), 20A(a), and 20(a) of the Securities Exchange Act through both
    market manipulation and insider trading. In June 2012, Xcelera and
    the Vik defendants moved to dismiss, and plaintiff sought a default
    judgment against OFC, who had failed to appear.2 The district court
    properly applied an identical standard in assessing the two motions
    and accepted all of the complaint’s factual allegations as true. See
    Fed. R. Civ. P. 12(b)(6); Trans World Airlines, Inc. v. Hughes, 
    449 F.2d 51
    , 69 (2d Cir. 1971) (“[A] default judgment entered on well-pleaded
    Olav entered an appearance in September 2012; he has not moved to
    2
    dismiss, nor was he the subject of plaintiff’s motion for a default
    judgment.
    5                                          Nos. 13-1327-cv; 13-1892-cv
    allegations in a complaint establishes a defendant’s liability.”), rev’d
    on other grounds, 
    409 U.S. 363
    (1973). The district court concluded,
    however, that plaintiff failed to state a claim as a matter of law, and
    therefore dismissed both her market manipulation and insider
    trading claims. It then concluded that it was “compelled” to dismiss
    the pendent fiduciary duty claims without prejudice to refiling in
    state court. Although the district court did not expressly address the
    §§ 20A(a) and 14(e) claims, it then denied plaintiff’s motion for
    default judgment and granted defendants’ motion to dismiss the
    complaint in its entirety. Steginsky v. Xcelera, Inc., No. 3:12-cv-188,
    
    2013 WL 1087635
    (D. Conn. Mar. 14, 2013). Plaintiff appeals the
    dismissal of her claims, and defendants cross-appeal the district
    court’s decision to not exercise supplemental jurisdiction over the
    pendent claims.
    DISCUSSION
    We review de novo a district court’s dismissal of a complaint
    under Rule 12(b)(6), accepting the complaint’s factual allegations as
    true and drawing all reasonable inferences in the plaintiff’s favor.
    
    ATSI, 493 F.3d at 98
    . A complaint alleging securities fraud must
    “state with particularity the circumstances constituting [the] fraud.”
    Fed. R. Civ. P. 9(b). Private securities fraud actions also must meet
    the heightened pleading requirements of the Private Securities
    Litigation Reform Act (“PSLRA”). When plaintiff alleges a false
    statement or omission, the complaint must specify “the reason or
    reasons why the statement is misleading” and must “state with
    particularity all facts on which that belief is formed.” 15 U.S.C.
    § 78u-4(b)(1). Additionally, when a cause of action requires proof of
    scienter, the complaint must “state with particularity facts giving
    rise to a strong inference that the defendant acted with the required
    state of mind.” 
    Id. § 78u-4(b)(2)(A).
    Plaintiff raises three types of claims, which we address in turn:
    (1) securities fraud through market manipulation; (2) securities
    fraud through insider trading; and (3) breach of fiduciary duty.
    6                                          Nos. 13-1327-cv; 13-1892-cv
    I. Market Manipulation Claims
    Plaintiff’s theory of market manipulation is that defendants
    manipulated the price of Xcelera stock downward by refusing to
    make required SEC filings starting in 2004, causing Xcelera to be de-
    listed by the American Stock Exchange in 2004 and then de-
    registered by the SEC in 2006. Defendants could then buy back
    Xcelera stock at artificially depressed prices. “Market manipulation
    requires a plaintiff to allege (1) manipulative acts; (2) damage
    (3) caused by reliance on an assumption of an efficient market free of
    manipulation; (4) scienter; (5) in connection with the purchase or
    sale of securities; (6) furthered by the defendant’s use of the mails or
    any facility of a national securities exchange.” 
    ATSI, 493 F.3d at 101
    .
    “Because a claim for market manipulation requires a showing of
    scienter, the PSLRA’s heightened standards for pleading scienter
    also apply.” 
    Id. at 102.
    Plaintiff’s counsel has previously asserted this theory while
    representing other minority shareholders in a different suit against
    Xcelera and the Vik defendants, which described the same refusal to
    make SEC filings. In a summary order in that case, we affirmed the
    district court’s denial of leave to amend the complaint to add
    securities law claims, concluding that “[a]bsent any allegation of a
    ‘going private’ transaction, tender offer, or scheme to take advantage
    of depressed share prices, we cannot conclude that [the] urged
    inference of scienter is compelling.” Feiner Family Trust v. VBI Corp.,
    352 F. App’x 461, 464 (2d Cir. 2009). In this case, the inference of
    fraud is strengthened by new allegations regarding the 2010 tender
    offer that were absent from the earlier suit, although the scheme
    remains somewhat implausible due to the six-year gap between the
    alleged decision to depress the stock in 2004 and the effort to
    repurchase stock in 2010.
    But we need not determine whether the market manipulation
    claims are adequately pled because it is plain that these claims are
    not timely filed. A securities fraud claim must be filed “not later
    than the earlier of—(1) 2 years after the discovery of the facts
    7                                           Nos. 13-1327-cv; 13-1892-cv
    constituting the violation; or (2) 5 years after such violation.” 28
    U.S.C. § 1658 (emphasis added). Plaintiff argues that the complaint
    was filed within two years of the tender offer, which was a fact
    necessary to establish scienter, and she points to the Supreme
    Court’s discussion of the onset of the two-year period in Merck &
    Co., Inc. v. Reynolds, 
    559 U.S. 633
    (2010). But in Merck, “no one
    doubt[ed] that [the complaint] was filed within five years of the
    alleged violation.” 
    Id. at 638.
    In this case, the alleged manipulation
    commenced with the refusal to make SEC filings from 2004 to 2006,
    which is more than five years before the complaint was filed in 2012.
    Because the market manipulation claims were untimely, they were
    properly dismissed, even though the district court dismissed them
    for failure to plead scienter. See Olsen v. Pratt & Whitney Aircraft, 
    136 F.3d 273
    , 275 (2d Cir. 1998) (“It is well settled that we may affirm on
    any grounds for which there is a record sufficient to permit
    conclusions of law, including grounds not relied upon by the district
    court.” (internal quotation marks omitted)).
    II. Insider Trading Claims
    Plaintiff’s insider trading claims are based on the alleged
    purchase of Xcelera securities by Xcelera insiders through the tender
    offer without disclosing to potential sellers any information about
    Xcelera’s financial state. Because the complaint was filed within two
    years of the 2010 tender offer (and the purchase of plaintiff’s shares
    in 2011), these claims are timely. See 28 U.S.C. § 1658.3
    “Under the ‘traditional’ or ‘classical theory’ of insider trading
    liability, § 10(b) [15 U.S.C. § 78j(b)] and Rule 10b–5 [17 C.F.R.
    § 240.10b-5] are violated when a corporate insider trades in the
    securities of his corporation on the basis of material, nonpublic
    3
    An even longer statute of limitations applies to plaintiff’s insider
    trading claims under section 20A. See 15 U.S.C. § 78t-1(b)(4) (“No action
    may be brought under this section more than 5 years after the date of the
    last transaction that is the subject of the violation.”).
    8                                             Nos. 13-1327-cv; 13-1892-cv
    information.” United States v. O’Hagan, 
    521 U.S. 642
    , 651-52 (1997).4
    Thus, “a corporate insider must abstain from trading in the shares of
    his corporation unless he has first disclosed all material inside
    information known to him.” Chiarella v. United States, 
    445 U.S. 222
    ,
    227 (1980). “[I]f disclosure is impracticable or prohibited by business
    considerations or by law, the duty is to abstain from trading.” SEC v.
    Obus, 
    693 F.3d 276
    , 285 (2d Cir. 2012).
    To establish an insider trading claim, it is not necessary to
    show that corporate insiders used the nonpublic information; it is
    sufficient to prove that they traded their corporation’s securities
    “while knowingly in possession of the material nonpublic
    information.” United States v. Rajaratnam, 
    719 F.3d 139
    , 159 (2d Cir.
    2013) (internal quotation mark omitted) (quoting United States v.
    Teicher, 
    987 F.2d 112
    , 119 (2d Cir. 1993)). Additionally, the Supreme
    Court has “dispensed with a requirement of positive proof of
    reliance, where a duty to disclose material information had been
    breached, concluding that the necessary nexus between the
    plaintiffs’ injury and the defendant’s wrongful conduct had been
    established.” Basic Inc. v. Levinson, 
    485 U.S. 224
    , 243 (1988); see also
    Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 
    552 U.S. 148
    , 159
    (2008).
    In this case, plaintiff has pled that the defendants are officers,
    directors, or controlling shareholders, which plainly makes them
    Xcelera insiders.5 According to the complaint, Alexander Vik and
    Gustav Vik are directors and officers; Erik Vik’s corporation—
    4 The alternative “misappropriation theory” of insider trading, which
    targets non-insiders, is not applicable here. See 
    O’Hagan, 521 U.S. at 652
    .
    5 Officers and directors are the “easiest category,” and controlling
    shareholders are insiders because they “have the same sort of access to
    information as a result of their position of power as the typical officer and
    director.” 18 Donald C. Langevoort, Insider Trading Regulation,
    Enforcement, and Prevention §§ 3:3-3:4 (2013); see 
    O’Hagan, 521 U.S. at 652
    ;
    
    Chiarella, 445 U.S. at 227
    .
    9                                               Nos. 13-1327-cv; 13-1892-cv
    defendant VBI—is the majority shareholder; Hans Eirik Olav is a
    director; and the Vik defendants control shell corporation OFC.
    These insiders are alleged to have traded in Xcelera securities
    through their control of OFC, when the Vik defendants caused OFC
    to purchase plaintiff’s Xcelera stock through the tender offer, with
    Olav listed as the contact person. And it is not disputed that
    defendants (including OFC) failed to provide any information to
    plaintiff about Xcelera’s financial state at any time leading up to her
    sale to OFC. Plaintiff thus claims that defendants are liable for OFC’s
    actions either as primary violators under section 10(b) or as “control
    persons” subject to secondary liability under section 20(a).6
    The district court held, however, that defendants had no duty
    to disclose any information before trading in Xcelera securities
    because the duty to disclose (1) does not apply to unregistered
    securities and (2) is defined by the law of the Cayman Islands, under
    which Xcelera was formed, and where no such duty exists. Both
    conclusions are in error: unregistered securities are not immune
    from the duty to disclose, and Cayman law is inapplicable.
    First, the duty of corporate insiders to abstain from trading or
    to disclose material inside information applies to unregistered
    securities. Section 10(b) explicitly applies to “any security registered
    on a national securities exchange or any security not so registered.” 15
    U.S.C. § 78j(b) (emphasis added). We have explicitly stated that
    “closed corporations that purchase their own stock have a special
    obligation to disclose to sellers all material information.” Castellano
    v. Young & Rubicam, Inc., 
    257 F.3d 171
    , 179 (2d Cir. 2001).
    Second, we hold that the fiduciary-like duty against insider
    trading under section 10(b) is imposed and defined by federal
    common law, not the law of the Cayman Islands. While we have not
    6
    Section 20(a) establishes secondary liability for “[e]very person who,
    directly or indirectly, controls any person” directly liable under the
    Securities Exchange Act. 15 U.S.C. § 78t(a); see SEC v. First Jersey Sec., Inc.,
    
    101 F.3d 1450
    , 1472 (2d Cir. 1996).
    10                                          Nos. 13-1327-cv; 13-1892-cv
    previously made the source of this duty explicit, we agree with one
    district court in this Circuit which concluded that insider trading
    cases from this Court and the Supreme Court have implicitly
    assumed that the relevant duty springs from federal law, and that
    looking to idiosyncratic differences in state law would thwart the
    goal of promoting national uniformity in securities markets. See
    United States v. Whitman, 
    904 F. Supp. 2d 363
    , 369 (S.D.N.Y. 2012)
    (collecting cases); see also McClure v. Borne Chem. Co., 
    292 F.2d 824
    ,
    834 (3d Cir. 1961) (“[The Securities Exchange Act] creates many
    managerial duties and liabilities unknown to the common law.”); In
    re Cady, Roberts & Co., 40 S.E.C. 907, 910 (1961) (“[T]he securities acts
    may be said to have generated a wholly new and far-reaching body
    of Federal corporation law.”); 18 Langevoort, supra, § 3:2.
    Defendants erroneously suggest that holding them subject to
    the duty to disclose would impose an affirmative duty on small,
    unregistered corporations to disclose audited financial statements.
    Under the Securities Exchange Act, “any insider ‘in possession of
    material inside information must either disclose it to the investing
    public, or, if . . . he chooses not to do so, must abstain from trading in
    or recommending the securities concerned while such inside
    information remains undisclosed.’” 
    Castellano, 257 F.3d at 179
    (emphasis added) (quoting SEC v. Tex. Gulf Sulphur Co., 
    401 F.2d 833
    , 848 (2d Cir. 1968) (en banc)). Defendants had no general
    affirmative duty to disclose once Xcelera was deregistered by the
    SEC, but they could not trade in Xcelera shares based on
    undisclosed material inside information that they possessed.
    Because the district court erred in concluding that the duty to
    disclose or abstain from trading did not apply to defendants, we
    vacate the dismissal of both the direct liability claims under section
    10(b) and Rule 10b–5 and the “control person” liability claims under
    section 20(a). Cf. Ganino v. Citizens Utilities Co., 
    228 F.3d 154
    , 170-71
    (2d Cir. 2000) (vacating the dismissal of a section 20(a) claim upon
    concluding that the district court improperly dismissed claims based
    on primary Rule 10b–5 violations).
    11                                            Nos. 13-1327-cv; 13-1892-cv
    Plaintiff also brought claims for insider trading under section
    20A(a) of the Securities Exchange Act, which provides an express
    private right of action for those who trade contemporaneously with
    an inside trader. 15 U.S.C. § 78t-1; see generally Jackson Nat’l Life Ins.
    Co. v. Merrill Lynch & Co., 
    32 F.3d 697
    , 703 (2d Cir. 1994) (concluding
    that § 20A liability requires an independent Securities Exchange Act
    violation). Because the district court did not address these claims,
    we vacate their dismissal and remand for further consideration.7
    However, we affirm the dismissal of plaintiff’s claims under
    section 14(e) of the Securities Exchange Act, 15 U.S.C. § 78n(e), for
    trading on material, nonpublic information in connection with a
    tender offer. SEC Rule 14e-3, which imposes liability under section
    14(e), states that if “any person” has taken substantial steps toward a
    tender offer, then it is unlawful for “any other person who is in
    possession of material information relating to such tender offer . . . to
    purchase or sell or cause to be purchased and sold any of such
    securities.” 17 C.F.R. § 240.14e-3(a) (emphases added). In this case,
    the allegation is not that someone possessed material nonpublic
    information about the tender offer—it is that the tender offer itself
    was made by corporate insiders who possessed material nonpublic
    information. The section 14(e) claims were thus properly dismissed.
    7
    The availability of section 20A in a case such as this appears
    unsettled. Compare Fujisawa Pharm. Co. v. Kapoor, 
    115 F.3d 1332
    , 1337 (7th
    Cir. 1997) (holding that section 20A may not be used by a person in privity
    with the insider because “[t]his interpretation would amount to saying
    that Congress, in attempting to provide additional relief for victims of
    insider trading, had inadvertently enacted a five-year statute of limitations
    applicable in effect to a vast number of Rule 10b-5 cases”), with Johnson v.
    Aljian, 
    490 F.3d 778
    (9th Cir. 2007) (holding that a 20A claim is actionable
    when the predicate 10b-5 claim is time-barred). However, it may be
    unnecessary to reach this question because plaintiff has adequately pled
    liability under section 10(b), and section 20A provides no additional
    remedy. Cf. O’Hagan, 
    521 U.S. 665
    n.11 (finding it unnecessary to address
    section 20A(a) when liability exists under section 10(b)).
    12                                        Nos. 13-1327-cv; 13-1892-cv
    III. Nonfederal Claims for Breach of Fiduciary Duty
    In addition to her claims under the Securities Exchange Act,
    plaintiff also alleged that Xcelera, Gustav Vik, Alexander Vik, and
    Olav breached their fiduciary duties under Cayman Island law to
    Xcelera’s minority shareholders, or aided and abetted the breach of
    such duties. After dismissing plaintiff’s federal claims, the district
    court declined to exercise supplemental jurisdiction over these
    pendent claims and dismissed them without prejudice to refiling in
    state court. Because we have reinstated plaintiff’s insider trading
    claims, we vacate the dismissal of these nonfederal claims.
    CONCLUSION
    For the reasons stated above, we AFFIRM the dismissal of
    plaintiff’s market manipulation claims and her section 14(e) insider
    trading claims; VACATE the dismissal of her insider trading claims
    under sections 10(b), 20(a), and 20A(a) of the Securities Exchange
    Act and her pendent nonfederal claims for breach of fiduciary duty;
    and REMAND for further proceedings consistent with this Opinion.