The opinion of the court was delivered by: GILES
Plaintiff has moved for class certification pursuant to Fed. R. Civ. P. 23(a) and 23(b)(3) on behalf of all persons or entities, who from January 1, 1983 to June 30, 1983, made a short sale of the stock of Technicom International, Inc. ("Technicom") and who sustained a financial loss in subsequently covering their short position. Albert Zlotnick's amended complaint alleges three distinct grounds for relief: defendants' alleged misrepresentations and omissions in connection with the sale of its securities violate (1) section 9 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78i (1982); (2) section 10 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j (1982), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1985); and (3) the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1962(c), 1962(d) (1982).
Plaintiff claims that after its formation in 1981, Technicom consummated an initial public offering of its stock at a price of $ 9.75 per share. Plaintiff avers that during 1982, defendants engendered interest in Technicom stock and inflated its market value by promoting the company with "highly positive statements" as to the company's earning prospects and by causing two stock splits. Plaintiff cites to a six-hundred percent (600 %) increase in the selling price of the stock from May to December 1982.
On January 13, 1983, plaintiff sold short
1,000 shares of Technicom at $ 16.875 per share. Again, five days later, he sold short an additional 1,000 shares of Technicom at an average of $ 19.30 per share. Plaintiff made the short sale based on his own analysis of Technicom's earnings and prospects. Pl's Am. Compl. at para. 21. An experienced investor, plaintiff exercised his own business judgment in basing his market analysis on (1) defendant's price-earnings ratio -- plaintiff believed that the company's stock was selling at a ratio equal to fifty times its current annualized earnings and (2) increased competition -- plaintiff believed that the company faced increasing competition that would likely diminish its profit margins and depress its future earnings. In making his investment decision in January, 1983, plaintiff did not rely upon or believe Technicom's alleged misleading statements, nor did he rely upon the market price of the stock as an indication of its true value. He chose to bet against the market, not with it. He gambled that the market value of the stock would plummet at some point in the future when the general investor public discovered the proper means of evaluating the stock. Necessarily, he believed that it was investor ignorance which was causing the price of the stock to rise.
Plaintiff's allegations of securities violations by defendants do not involve any preinvestment activity. Zlotnick claims that defendants undertook to maintain artificially or to inflate the price of Technicom through various stratagems. Each of these occurred after his commitment to purchase Technicom securities at some point in the future.
While plaintiff views the purchase of stock to cover his sale as "the transaction," the court views plaintiff's cause of action as based on one transaction. The court finds that the sale and subsequent covering of the sale of stock are the two elements of one short sale transaction. See e.g., Stock Exchange Practices, Report of Com. on Banking & Currency, S. Rep. No. 1455, 73d Cong., 2d Sess. 50-51 (1934).
It is well-established that a complaint shall not be dismissed for failure to state a claim "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claims which would entitle him to relief." Scheuer v. Rhodes, 416 U.S. 232, 236, 40 L. Ed. 2d 90, 94 S. Ct. 1683 (1974) (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1957) (footnote omitted)). All factual allegations of the complaint are to be accepted as true and reasonable inferences will be drawn to aid the pleader. D.P. Enterprises v. Bucks County Community College, 725 F.2d 943, 944 (3d Cir. 1984). However, a reviewing court will not create inferences in favor of plaintiff where the face of the pleadings does not so permit.
Plaintiff has failed to state a claim upon which relief may be granted. Plaintiff alleges a 10(b) violation.
To establish such a violation plaintiff must show "1) a false representation of 2) a material 3) fact; 4) defendant's knowledge of its falsity and his intention that plaintiff rely on it; 5) the plaintiff's reasonable reliance thereon; and 6) his resultant loss. Peil v. Speiser, 806 F.2d 1154 (3d Cir. 1986). Peil allows plaintiff to satisfy the reliance requirement by showing defendants made material misrepresentations. Id. slip op. at 15. While Peil provides a method to satisfy the reliance requirement without showing actual reliance, it did not alter the requirement that all the other necessary elements for maintaining a 10(b) action must be met. Thus, plaintiff must show that but for the defendant's misrepresentation or omission, he would not have acted.
The alleged activities of the defendant did not directly or indirectly cause plaintiff's investment loss. Plaintiff has emphasized his own investment knowledge and his own market analysis as the basis for his investment decision. Zlotnick erroneously contends that under Peil, he has satisfied his burden of proof requirement of transaction causation by showing that defendants made material misrepresentations. In Peil, the Third Circuit retained the requirement that in a 10(b) action, a plaintiff must still show a causal connection between defendants' action and plaintiff's purchase of stock. Peil n.11 at 1161. Zlotnick has not demonstrated a causal connection between defendants' action and his purchase of stock. Nothing done by defendants whether said or omitted was a factor in plaintiff's decision to short sell. Therefore, plaintiff cannot establish a 10(b) violation.
Plaintiff contends that Peil requires this court not dismiss his 10b-5 action. On the contrary, I find that Peil supports dismissal. Under the fraud on the market theory, a plaintiff can establish causation for a 10b-5 action by showing that "in making [his] purchase [he] relied on the price of the stock, which in turn had been skewed by fraudulent actions." Id. at 1156. However, fraud on the market is not an irrebuttable presumption. Defendants have available to them general defenses to a fraud on the market allegation.
One of these defenses is that plaintiff would have purchased the stock even if he had known of the misrepresentation. Plaintiff admits that he believed the value of Technicom stock was over-inflated at the time of his decision to sell short. As an experienced investor, Zlotnick knew that Technicom stock was selling at a ratio the equivalent of fifty percent its annualized earnings. (Am. Comp. para. 21). Based upon his own belief that the stock price was significantly inflated, plaintiff decided to engage in a short sale. The only reasonable inference that can be drawn from the pleadings is that plaintiff suspected that material information was not known by the market and that skewed the stock price. It could have made no difference to the short sale decision that the lack of information was accidental or intentional. The decision to engage in the short sale was a decision to profit from the overvaluation of the price of the stock. Plaintiff independently made this investment decision. ...