WEBB v. FAIN, (D.Or. 2002)

JANICE M. STEWART, United States Magistrate Judge

INTRODUCTION

On May 17, 2002, plaintiffs, Vincent L. Webb ("Webb"), C.D. Micro, Inc., and C.D. Micro, LLC, filed this action against defendants, Chris Fain ("Fain"), Gordon Dillard ("Dillard"), and Doug Devine. Plaintiffs allege several instances of fraud and misrepresentation in violation of the Securities Exchange Act of 1934 ("Exchange Act") and 17 Oregon state law claims. On July 1, 2002, defendants filed Motions to Dismiss (dockets #3, #4, #5), which this court denied as moot in light of an order granting plaintiffs' Motion to Amend in Response to Defendants' Motions to Dismiss (docket #10).

Pursuant to 15 U.S.C. § 78j: "It shall be unlawful for any person . . . (b) To use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors."

Now before the court are Defendants' Motions to Dismiss Plaintiffs' First Amended Complaint (dockets #11, #12, #14) and Plaintiffs' Motion to File Second Amended Complaint (docket #16). For the reasons set forth below, plaintiffs' Motion is denied with leave to refile, or, in the alternative, to respond to defendants' Motions.

ANALYSIS I. Legal Standard

The role of pleadings is limited, and leave to amend is "freely given." Foman v. Davis, 371 U.S. 178, 182 (1962). Normally, the grant or denial of a motion to amend is a matter of court discretion. Sweeney v. Ada County, 119 F.3d 1385, 1392 (9th Cir 1997). Federal policy strongly favors determination of cases on their merits and amendments to pleadings should be allowed with "extreme liberality." United States v. Webb, 655 F.2d 977, 979 (9th Cir 1981) (citation omitted).

However, "[l]iberality in granting a plaintiff leave to amend is subject to the qualification that the amendment not cause undue prejudice to the defendant, is not sought in bad faith, and is not futile." Bowles v. Page Reade, 198 F.3d 752, 757 (9th Cir 1999) (citation omitted). "Futility of amendment can, by itself, justify the denial of a motion for leave to amend." Bonin v. Calderon, 59 F.3d 815, 845-46 (9th Cir 1995), cert denied, 516 U.S. 1051 (1996) (noting the factors to consider when determining whether to grant a motion to amend under FRCP 15 include undue delay, bad faith, prejudice to the opposing party, whether the party has previously amended his pleadings, and futility of amendment); see also DCD Programs, Ltd. v. Leighton, 833 F.2d 183, 188 (9th Cir 1987).

II. Merits of the Motion to Amend

The First Amended Complaint alleges that Webb and C.D. Micro, Inc., violated Rule 10b-5 of the Exchange Act (Third Cause of Action) which:

forbids the use, in connection with the purchase or sale of security: (1) any device, scheme, or artifice to defraud; (2) any untrue statement of a material fact; (3) the omission of a material fact necessary in order to make the statements made . . . not misleading; or (4) any other act, practice or course of business that operates . . . as a fraud or deceit.

The Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc., 532 U.S. 588, 593 (2001), quoting 17 C.F.R. § 240.10b-5 (2000) (internal quotations omitted).

A securities fraud violation under Section 10(b), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, requires that the plaintiff allege: "(1) a misstatement or omission (2) of material fact (3) made with scienter (4) on which [plaintiffs] relied (5) which proximately caused their injury." DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 388 (9th Cir 2002), citing McCormick v. Fund Am. Cos., 26 F.3d 869, 875 (9th Cir 1994). It is well-settled that only the "actual purchasers and sellers of securities" have standing to bring a private right of action for damages. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730-31 (1975).

Defendants' Motion to Dismiss the First Amended Complaint asserts that C.D. Mirco, LLC, is the only appropriate defendant on the federal securities fraud claim (Third Cause of Action) because it received 66b% of the outstanding stock of C.D. Micro, Inc., in exchange for its assets.

In an attempt to cure this defect, plaintiffs seek to file a Second Amended Complaint to amend this claim (Second Cause of Action, Count II) by substituting C.D. Micro, LLC, for C.D. Micro, Inc., as the party seeking damages. Plaintiffs also seek to add two additional Rule 10b-5 claims. Plaintiffs fail to explain how their proposed Second Amended Complaint cures the defects raised by defendants, and defendants did not respond to plaintiffs' Motion. Nevertheless, for the reasons that follow, this court finds that the proposed Second Amended Complaint does not cure the defects of the First Amended Complaint.

A. Count II

The amended federal securities fraud claim of the proposed Second Amended Complaint (Second Cause of Action, Count II) alleges that: "Had Webb and C.D. Micro LLC known of the true number of outstanding shares of Fainco, the state of the financial books and records of Fainco, and the true amount of liabilities of Fainco, they would not have purchased said stock." Id, ¶ 56. It alleges that Webb was a majority stockholder in C.D. Micro, LLC, prior to a buy/sell asset purchase agreement entered into on August 3, 2000, pursuant to which Webb became a majority stockholder in C.D. Micro, Inc. Id, ¶¶ 14, 15, 18.

Although plaintiffs seek to substitute C.D. Micro, LLC, the purchaser, for C.D. Micro, Inc., this claim still includes Webb as a plaintiff seeking damages. The proposed Second Amended Complaint fails to articulate how Webb, as an individual, was a purchaser or seller of securities. Instead, it appears that C.D. Micro, LLC, is the sole purchaser. Accordingly, this claim alleged by Webb fails to state a claim under Rule 10b-5.

B. Counts I III

This court also has concerns about the two new federal securities law claims added to the proposed Second Amended Complaint. Count III of the Second Cause of Action alleges that: "Fain and Dillard acted with scienter in that they knew the representations they were making regarding their authority to sell said stock were false and misleading and expected that these representations would be acted upon." Id, ¶ 68. It further alleges that "Fain and Dillard's acts of wrongfully distributing said shares to third parties . . . caus[ed] the ownership interest of valid shareholders of C.D. Micro Inc. such as Webb, to be diluted[,]" causing damages to Webb and C.D. Micro, Inc. Id, ¶ 69.

This claim appears to be based on a theory of dilution rather than on a purchase or sale of securities. Allegations of dilution unsupported by allegations of a purchase or sale are insufficient to support a claim under Rule 10b-5. See Gurary v. Winehouse, 190 F.3d 37, 46 n9 (2nd Cir 1999) (because Blue Chip Stamps limits recovery to only a buyer or seller of security, plaintiff cannot seek compensation for the decline in the price of shares caused by fraud). It is not alleged that Webb and C.D. Micro, Inc., bought any securities that declined in value. Accordingly, this claim may not state a viable Rule 10b-5 claim.

Count I of the Second Cause of Action alleges that: "Fain and Dillard acted with scienter in that they knew they had not in fact lost their stock certificates and through their deception caused C.D. Micro Inc to issue them additional certificates without additional consideration being received from Fain and/or Dillard." Proposed Second Amended Complaint, ¶ 50. This claim seems to be based on plaintiffs' reissuance of new stock certificates based on defendants' misrepresentations that they had lost the original stock certificates. Because C.D. Micro, Inc., issued the new stock certificates without consideration, it is unclear whether this claim involves any purchase or sale of a security.

CONCLUSION

Plaintiffs have failed to persuade this court that their proposed Second Amended Complaint cures the defects identified in defendants' Motions to Dismiss. Accordingly, plaintiffs' Motion to Amend is denied with leave to refile to cure the deficiencies of the First Amended Complaint and to explain why an amendment to add any new claims for violation of the federal securities laws would not be futile.

ORDER

For the reasons stated above, Plaintiffs' Motion to File Second Amended Complaint (docket #16) is DENIED with leave to refile by October 18, 2002, or, in the alternative, to respond to defendants' Motions to Dismiss by October 18, 2002. Defendants' pending Motions to Dismiss Plaintiffs' First Amended Complaint (dockets #11, #12, #14) are stayed until October 18, 2002.