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May 1, 2001


The opinion of the court was delivered by: Edmund V. Ludwig, Judge.


In this securities fraud action, defendant Communication Services Group, Inc., formerly known as Universal Teleservices Network Corporation, and defendant Douglas R. Colkitt, M.D., move to dismiss the second amended complaint for failure to plead fraud with specificity, Fed.R.Civ.P. 9(b) or, in the alternative, for failure to state a claim, Fed.R.Civ.P. 12(b)(6).*fn1 Jurisdiction is federal question and supplemental, 28 U.S.C. § 1331, 1367.

I. Background

In addition to cash, UTP issued to each plaintiff a secured convertible debenture, dated September 11, 1997, as consideration for the sale of TDC.*fn4 The debentures were convertible into common stock of UTN upon the occurrence of a "liquidity event," which included a public offering by UTN. Id. ¶¶ 14, 16; ex. A. Plaintiffs had received other offers, but the prospect of the public offering — and its impact on the value of the debentures — made UTP's offer unusually attractive. Id. ¶¶ 18-21. On September 22, 1997, UTP obtained a letter of credit and the transaction was closed. Id. ¶ 15.

Prior to the sale, plaintiffs "inquired about the financial and general well being of UTN, UTP and their controlling shareholder, Dr. Colkitt," and "learned of nothing that would inhibit UTN from going public." Id. ¶ 22. To the contrary, in the summer of 1997, Randy Warren, acting as Colkitt's agent and as President of UTP, represented to plaintiffs that Colkitt's management skills and financial expertise were the foundation of the successful operations of his companies. Id. ¶¶ 17, 22; ex. A. On July 10, 1997, Warren and Colkitt's accountant gave Colkitt's personal financial statements to plaintiffs' business broker.*fn5 Id. ¶¶ 23, 28-31. The statements revealed that another company he controlled, Equimed, comprised as much as 30 percent of his assets. Id. ¶ 23.

Also, over the course of four or five conversations, Warren and Jones, another agent of Colkitt, told plaintiffs that UTN would make an initial public offering of its common stock "probably within a year." Id. ¶¶ 24-26. On September 18, 1997, Warren and Jones accompanied plaintiffs to Florida for a presentation by the brokerage firm Smith Barney and H.J. Meyers & Co., an investment banking company, regarding plans for UTN's public offering. At the four-day meeting, attended by 23 individuals representing 14 companies, including Equimed,*fn6 plaintiffs received "written materials concerning UTN going public." Id. ¶ 26. However, the public offering did not occur.

At some point after the sale was completed, plaintiffs discovered that, prior to the transaction: (1) Colkitt and companies he controlled were under investigation by the United States government for violation of the False Claims Act; and (2) deficiencies existed in Equimed's accounting practices that led to a dispute with its auditor, Ernst & Young. Id. ¶¶ 32-33. According to plaintiffs' allegations, had defendants timely disclosed this information — i.e., the impediments to UTN's public offering — the sale would not have been completed. Id. ¶ 35, 39.

Count one of the complaint alleges violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5;*fn7 count two, violations of Pennsylvania Securities Exchange Act of 1972, 70 Pa. C.S. § 1-401; count three, common law fraud; count four, negligent and innocent misrepresentation; count five, civil conspiracy; and count six, promissory estoppel. The relief requested includes "(a) the difference in value between the Secured Convertible Debenture if UTN went public as represented and the value of the Secured Convertible Debentures if UTN did not go public and (b) their lost opportunity and profit had Plaintiffs sold their shares in TDC to other interested purchasers." Am. cmplt. ¶ 51.

Defendants' objections to the complaint, in summary, are as follows: (1) fraud was not pleaded with specificity, as required by Federal Rule of Civil Procedure 9(b) and the Private Securities Litigation Reform Act of 1995, 15 U.S.C. ¶ 78u-4 et seq. (the Reform Act); (2) the securities, common law fraud, misrepresentation, and estoppel counts fail to state an actionable claim; (3) the common law fraud and misrepresentation claims are barred by the integration clause of the Stock Purchase Agreement; and (4) the securities claims are time-barred. Defendants also maintain that, because the only basis for jurisdiction is the federal securities claim, supplemental jurisdiction should not be exercised.

II. DiscussionA. Dismissal: failure to plead with specificity

Securities fraud claims must comply with heightened pleading standards set forth in Rule 9(b) and the Reform Act.*fn8 See EP MedSystems, Inc. v. EchoCath, 235 F.3d 865, 880 (3d Cir. 2000). Rule 9(b) provides that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed.R.Civ.P. 9(b). Although the rule ordinarily mandates plaintiffs to plead the "who, what, when, and where" details of the alleged fraud, the averments may contain specifics in some alternative fashion. However, plaintiffs must employ some means to "inject[] precision and some measure of substantiation into their allegations of fraud." Seville Indus. Mach. Corp. v. Southmost Mach. Corp., 742 F.2d 786, 791 (3d Cir. 1984); compare Seville, 742 F.2d at 791 (rule satisfied where complaint listed the specific pieces of equipment that were the subject of the alleged fraud, what equipment was involved in each of several alleged fraudulent transactions, and gave the content of the alleged misrepresentations), with Saporito v. Combustion Eng'g Inc., 843 F.2d 666, 675 (3d Cir. 1988), vacated on other grounds, 489 U.S. 1049, 109 S.Ct. 1306, 103 L.Ed.2d 576 (1989) (complaint dismissed where it alleged "the general content of the representations," but did not specify "who the speakers were . . . or who received the information . . .").

Our Court of Appeals has cautioned that Rule 9(b) should be applied flexibly and in a manner that is "sensitive to the fact that its application, prior to discovery, may permit sophisticated defrauders to successfully conceal the details of their fraud." Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96, 99-100 (3d Cir. 1983). Therefore, the particularity rule is relaxed "when factual information is peculiarly within the defendant's knowledge or control." Craftmatic Sec. Lit. v. Kraftsow, 890 F.2d 628, 645 (3d Cir. 1989).

Under the Reform Act, the complaint must set forth "each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed."*fn10 15 U.S.C. § 78u-4(b)(1). The Reform Act also requires the complaint to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind [i.e., scienter]," 15 U.S.C. § 78u-4 (b)(2). "This language . . . requires plaintiffs to plead `the who, what, when, where, and how'" of each act or omission giving rise to a fraudulent state of mind. In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999) (quoting DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990)). But it is "sufficient for plaintiffs [to] plead scienter by alleging `facts establishing a motive and ...

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