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.
The facts alleged in the complaint are as follows.*fn2 On September
11, 1997, plaintiffs Michael J. Rosen and Stephen F. Schatz sold their
common stock in The Development
Center, Inc. (TDC), a Pennsylvania corporation, to Universal Teleservices of
Pennsylvania Corporation (UTP), a Nevada corporation, pursuant to a Stock
Purchase Agreement. Closing papers were put in escrow pending UTP's receipt
of a letter of credit. At the time, UTP was an affiliate of Universal
Teleservices Network Corporation (UTN), also a Nevada corporation, which,
in turn, was owned by Dr. Colkitt.*fn3 Am. cmplt. ¶¶ 12-15.
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
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