FSP Stallion 1, LLC et al

Filing 70

ORDER Denying 47 Motion to Dismiss. Signed by Judge Philip M. Pro. (Copies have been distributed pursuant to the NEF - AXM)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 P re se n tly before the Court is Defendants' Motion to Dismiss Plaintiffs' C o m p la in t (Doc. #47), filed on November 4, 2008. Defendants Michael Luce, Joe Munsch, F a irw a y Signature Properties LLC, Evergreen Alliance Golf Limited, LP, and Stallion M o u n ta in LeaseCo, LLC filed a Joinder (Doc. #48) on November 4, 2008. Plaintiffs filed a n Opposition (Doc. #52) on December 1, 2008. Defendants filed a Reply (Doc. #65) on D e c e m b e r 23, 2008. I. BACKGROUND Plaintiffs are twenty-six separate and independent limited liability companies. (Compl. at 3.) Plaintiffs were investment vehicles which invested in tenant-in-common (" T IC " ) interests in the Stallion Mountain Country Club ("Stallion Mountain") located in L a s Vegas. (Id. at 6.) Defendant Golf Club of Nevada, Inc. ("Golf Club") operated S ta llio n Mountain from 1997 through February 2006. (Id. at 8.) Defendant William W a lte rs ("Walters") is Golf Club's president and director. (Id.) Defendant Michael F. Luce (" L u c e " ) co-owns Golf Club with Walters. (Id. at 9.) Defendant Joe R. Munsch (" M u n s c h " ) is a business associate of Walters and Luce, and the president of Defendant v. M IC H A E L F. LUCE, et al., Defendants. F S P STALLION 1, et al., P la in tif f s , UNITED STATES DISTRICT COURT D IS T R IC T OF NEVADA *** ) ) ) ) ) ) ) ) ) ) )

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E v e rg re e n Alliance Golf Limited, L.P. ("EAGL"), a golf course management company lo c a te d in Texas that did business with Walters, Luce, and The Walters Group companies. (Id. at 4, 9.) Plaintiffs allege that in 2005, Walters, Luce, and Munsch conspired to f ra u d u le n tly induce investors to purchase Stallion Mountain at an inflated price through a p riv a te placement of TIC interests in the property. (Id.) To effectuate the scheme, D e f e n d a n ts developed a private placement memorandum ("PPM") which offered up to $ 2 4 ,4 8 0 ,0 0 0 in TIC interests. (Id.) The offering was structured such that Golf Club would s e ll Stallion Mountain to Defendant Fairway Signature Properties, LLC ("Fairway"), an e n tity controlled by Luce and Munsch and created specifically for the purpose of sponsoring th e private placement and selling TIC interests to investors. (Id.) Under the PPM, the TIC in v e s to rs would lease Stallion Mountain to Defendant Stallion Mountain LeaseCo, LLC (" L e a s e C o " ), a company also owned and controlled by Luce and Munsch. (Id.) LeaseCo w o u ld be the master tenant under a lease agreement with the investors. (Id.) Under the s e v e n -ye a r lease agreement, LeaseCo would operate the business, receive all revenue, and p a y all expenses. (Id.) LeaseCo would pay rent to the investors in the form of debt service p a ym e n ts and a return on the equity investment. (Id.) LeaseCo was to hire EAGL as p ro p e rty manager. (Id. at 10-11.) According to the Complaint, Walters, Luce, Munsch, and their respective entities, G o lf Club, EAGL, Fairway, and LeaseCo, played a significant role in drafting and p re p a rin g the PPM. (Id. at 10.) Additionally, Plaintiffs allege that based on experience g a in e d from running Stallion Mountain for several years, Golf Club, Walters, and Luce w e re familiar with Stallion Mountain's financial performance, historic growth rate, revenue p o te n tia l, and risk factors. (Id. at 8-9.) Plaintiffs also allege Golf Club, Walters, and Luce o p e ra te d other golf courses in Las Vegas and hence were familiar with market conditions. (Id.) Plaintiffs contend that Munsch was experienced in operating golf courses nationally 2

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a n d in Las Vegas. (Id. at 9.) Plaintiffs allege the PPM contained a variety of false statements and omissions, in c lu d in g Exhibit G to the PPM, which contains historical economic performance re p re se n ta tio n s for Stallion Mountain from September 2004 through August 2005 (the " H is to ric a l Performance Representations"), and the Cash Flow Projections. (Id. at 13.) Plaintiffs contend the Historical Performance Representations and the Cash Flow P ro je c tio n s were misleading because Defendants failed to disclose information and d o c u m e n ts in their possession which contradicted these representations. In particular, Plaintiffs allege Defendants possessed internal operating budgets 1 f o r Stallion Mountain prepared in November 2005, around the same time as the PPM was b e in g prepared, which contained revenue and cash flow figures that were materially lower th a n those in the Cash Flow Projections. (Id. at 13-14, ¶ 42.) The Complaint also alleges D e f e n d a n ts possessed a June 2005 appraisal of Stallion Mountain performed by P ric e W a te rh o u s e C o o p e rs ("PWC Appraisal"). (Id. at 14, ¶ 43.) According to the C o m p la in t, the PWC Appraisal stated the Las Vegas market would experience minimal g ro w th over the short term and that it was unlikely the market would experience comparable g ro w th in the next few years. (Id.) In contrast, the Cash Flow Projections used double digit in c o m e growth rates. (Id.) Additionally, the PWC Appraisal projected significantly fewer g o lf rounds purchased each year from 2007 through 2010 than did the Cash Flow P ro je c tio n s . (Id.) The PWC Appraisal indicated net operating income was down 73% from A p ril 2004 through March 2005, yet the Cash Flow Projections show substantial increases f o r each year in the future. (Id. at 14-15.) The PWC Appraisal also contained data showing

Plaintiffs attach the alleged internal operating budget to their opposition. The parties dispute when the document was prepared and whether the Court ought to consider the exhibit. The Court need not consider the exhibit at this stage of the proceedings because the Complaint alleges the existence and contents of the alleged internal operating budget. 3

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d e c lin in g membership at Stallion Mountain, which was not disclosed to Plaintiffs. (Id. at 1 5 .) In February 2006, Golf Club sold Stallion Mountain to Fairway for $22,675,000. (Id. at 19.) Through April, May, and June 2006, Fairway sold the TIC interests to Plaintiffs. (Id.) From April 2006 to June 2007, LeaseCo paid the rents as provided in the lease. (Id.) However, in June 2007, LeaseCo ceased paying rent. (Id.) Upon LeaseCo ceasing p a ym e n ts , Plaintiffs learned Stallion Mountain had been operating at a deficit from its in c e p tio n . (Id. at 20.) Because LeaseCo was not paying EAGL's management fees, EAGL s e rv e d notice of its intent to cease managing Stallion Mountain. (Id.) LeaseCo and EAGL f a ile d to make a loan payment resulting in default. (Id.) Based on these and other allegations, Plaintiffs bring federal claims for securities f ra u d against Walters, Luce, Munsch, Fairway, LeaseCo, Golf Club, and EAGL (count one) a n d control person liability against Walters, Luce, and Munsch (count two). Plaintiffs also b rin g several supplemental state law claims. D e f e n d a n ts move to dismiss the federal securities claims and request the Court d e c lin e to exercise supplemental jurisdiction over the state law claims. With respect to the f e d e ra l securities claims, Defendants argue Plaintiffs do not identify any false statements in th e PPM, but instead allege that the actual performance did not meet the projections. Defendants argue fraud by hindsight does not state a claim. Defendants also argue the " b e s p e a k s caution" doctrine bars Plaintiffs' claims because the PPM contained sufficient c a u tio n a ry language to protect Defendants from securities fraud claims. Defendants c o n te n d Plaintiffs fail to plead scienter under the Private Securities Litigation Reform Act (" P S L R A " ). Defendants argue that because Plaintiffs fail to state a primary securities c la im , their control person claim also fails. Additionally, Defendants request the Court d e c lin e to exercise supplemental jurisdiction if the Court dismisses the federal claims. /// 4

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P la in tif f s respond that they identify several specific misrepresentations and they h a v e shown each of these is false because Defendants contemporaneously had in their p o s s e s s io n documents projecting substantially lower numbers and more negative trends w h ic h Defendants did not disclose. Plaintiffs further assert they adequately alleged scienter b a s e d on Defendants' knowledge and experience running Stallion Mountain as well as their p o s s e s s io n of actual contrary evidence at the time they made the representations and o m is s io n s in the PPM. As to the bespeaks caution doctrine, Plaintiffs argue that the d o c trin e does not give Defendants license to lie or mislead. Finally, Plaintiffs argue that b e c a u s e the Court should not dismiss the substantive securities claim, the Court should not d is m is s the control person claim or the supplemental state law claims. I I . MOTION TO DISMISS A . Pleading Fraud With Particularity F e d e ra l Rule of Civil Procedure 9(b) requires that "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." A p a rty bringing a claim under Rule 10b-5 and section 10(b) must plead the claims with p a rtic u la rity under Rule 9(b). In re Daou Sys., Inc., 411 F.3d 1006, 1014 (9th Cir. 2005). To satisfy this burden, the complaint "`must set forth more than the neutral facts necessary to identify the transaction.'" Yourish v. Cal. Amplifier, 191 F.3d 983, 993 (9th Cir. 1999) (f o o tn o te omitted) (quoting In re GlenFed Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994) (e n banc)). The "neutral facts" mean the "`time, place, and content of an alleged m isre p re s e n ta tio n .'" Id. at 993 n.10 (quoting GlenFed, 42 F.3d at 1547-48). In addition to p le a d in g these neutral facts, the plaintiff "`must set forth what is false or misleading about a s ta te m e n t, and why it is false. In other words, the plaintiff must set forth an explanation as to why the statement or omission complained of was false or misleading.'" Id. (quoting G le n F e d , 42 F.3d at 1548); see also 15 U.S.C. § 78u-4(b)(1). /// 5

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" S e c tio n 10(b) of the Exchange Act of 1934, 15 U.S.C. § 78j(b), makes it u n la w f u l `for any person . . . [t]o use or employ, in connection with the purchase or sale of a n y security . . . any manipulative or deceptive device or contrivance in contravention of s u c h rules and regulations as the Commission may prescribe[.]'" In re Daou Sys., Inc., 411 F .3 d at 1014. Pursuant to section 10(b), the SEC promulgated Rule 10b-5, which makes it u n la w f u l: (a ) To employ any device, scheme, or artifice to defraud, (b ) To make any untrue statement of a material fact or to omit to state a m a te ria l fact necessary in order to make the statements made, in light o f the circumstances under which they were made, not misleading, or (c ) To engage in any act, practice, or course of business which operates o r would operate as a fraud or deceit upon any person, in connection w ith the purchase or sale of any security. 1 7 C.F.R. § 240.10b-5. A projection becomes a "`factual' misstatement if (1) the statement is not actually believed, (2) there is no reasonable basis for the belief, or (3) the speaker is a w a re of undisclosed facts tending seriously to undermine the statement's accuracy." Provenz v. Miller, 102 F.3d 1478, 1487 (9th Cir. 1996) (quotation and emphasis omitted); In re VeriFone Sec. Litig., 11 F.3d 865, 870-71 (9th Cir. 1993). The Complaint identifies the time and location of the alleged misrepresentations a s the PPM offering. The Complaint identifies Walters, Luce, Munsch, and their entities, F a irw a y, LeaseCo, Golf Club, and EAGL, as substantial participants in drafting and p re p a rin g the PPM. As to what is false and why it is false, Plaintiffs identify several specific s ta te m e n ts and omissions. First, Plaintiffs identify the Historical Performance R e p re s e n ta tio n s , and specifically the statement that Stallion Mountain had a net operating in c o m e of $1,358,950 from September 2004 through August 2005. Although Plaintiffs re f e r to the fact that Stallion Mountain did not meet the projections in 2006 and 2007, P la in tif f s do not rely solely on post-purchase performance to demonstrate falsity. Rather, P la in tif f s note that the PWC Appraisal listed net operating income of only $492,535 for the 6

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p e rio d of April 2004 through March 2005. These periods do not exactly overlap, but they s h a re seven months worth of common data. Yet the PWC Appraisal is over $800,000 less in net operating income than the Historical Performance Representation. Plaintiffs argue th a t it is highly unlikely that the five month period from April 2005 through August 2005 w o u ld have generated sufficient net operating income to make the Historical Performance R e p re s e n ta tio n accurate, particularly because all indications are that net operating income at S ta llio n Mountain has been decreasing, not increasing, as shown through the post-purchase p e rf o rm a n c e . Next, Plaintiffs identify the Cash Flow Projections as misleading because the P P M uses the Historical Performance Representation as a starting point, materially affecting th e Cash Flow Projections that rely on those numbers. Furthermore, Plaintiffs allege the P P M projected revenues of over $6 million while a contemporaneous internal budget for S ta llio n Mountain projected total revenues of under $5 million. Additionally, the PPM p ro je c te d a positive net cash flow of over $50,000 in the first year, yet the internal operating b u d g e t projected a negative cash flow of nearly $700,000. Additionally, the Cash Flow P ro je c tio n s projected net operating income to increase each year, but the PWC Appraisal s h o w e d net operating income was down 73% in 2004 and down 43% from April 2004 th ro u g h March 2005. Finally, Plaintiffs allege the PPM projected substantially higher n u m b e rs of golf rounds for the first three years of operation than did the PWC Appraisal, a n d failed to disclose the negative trend in the PWC Appraisal of declining membership. P la in tif f s thus allege the PPM Cash Flow Projections were false because D e f e n d a n ts had in their possession documents suggesting those numbers were false, in f la te d , and unreasonably predicted dramatic turnarounds in trends. While projections n o rm a lly are non-actionable predictions, Plaintiffs allege Defendants were aware of u n d is c lo s e d facts tending seriously to undermine the Cash Flow Projections' accuracy. Plaintiffs adequately have alleged fraud with particularity. The Court will deny 7

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D e f e n d a n ts' motion to dismiss on this basis. B . Scienter U n d e r Federal Rule of Civil Procedure 9(b) "[m]alice, intent, knowledge, and o th e r conditions of a person's mind may be alleged generally." However, the PSLRA re q u ire s that where state of mind is a required element, the complaint must "state with p a rtic u la rity facts giving rise to a strong inference that the defendant acted with the required s ta te of mind." 15 U.S.C. § 78u-4 (b)(2). To prove a primary violation of Section 10(b) of th e Securities Exchange Act, the plaintiff must show, among other things, scienter. Dura P h a rm ., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005). The requisite scienter for a 10(b) c la im is "`a mental state embracing intent to deceive, manipulate, or defraud.'" S.E.C. v. R u b e ra , 350 F.3d 1084, 1094 (9th Cir. 2003) (quoting Ernst & Ernst v. Hochfelder, 425 U .S . 185, 194 n.12 (1976)). To determine whether a complaint supports a strong inference of scienter, the C o u rt accepts as true all factual allegations in the complaint and considers the complaint in its entirety, including documents incorporated into the complaint by reference and matters s u b je c t to judicial notice. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S . Ct. 2499, 2509 (2007). "The inquiry . . . is whether all of the facts alleged, taken c o lle c tiv e ly, give rise to a strong inference of scienter, not whether any individual a lle g a tio n , scrutinized in isolation, meets that standard." Id. (emphasis omitted). "[I]n d e te rm in in g whether the pleaded facts give rise to a `strong' inference of scienter, the court m u s t take into account plausible opposing inferences." Id. Thus, the court considers " p la u s ib le nonculpable explanations for the defendant's conduct" in addition to inferences f a v o rin g the plaintiff. Id. at 2510. "The inference of scienter must be more than merely `reasonable' or `p e rm is s ib le '-it must be cogent and compelling, thus strong in light of other explanations." Id. Ultimately, the court asks, "When the allegations are accepted as true and taken 8

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c o lle c tiv e ly, would a reasonable person deem the inference of scienter at least as strong as a n y opposing inference?" Id. at 2511. An example of evidence of scienter is alleging " in c o n s is te n t contemporaneous statements or information (such as internal reports) which w e re made by or available to the defendants." In re GlenFed, 42 F.3d at 1549. Plaintiffs allege Defendants Walters, Golf Club, and Luce had detailed in f o rm a tio n about Stallion Mountain's operations because they operated the club for several ye a rs prior to the sale. Additionally, Plaintiffs allege all Defendants had experience and k n o w le d g e of the Las Vegas golf market through their operation of other golf clubs in the c ity. Plaintiffs further allege Defendants had in their possession at the time they were c ra f tin g the PPM contrary negative information in the form of the PWC Appraisal and the in te rn a l operating budget. Viewing the Complaint's allegations collectively, Plaintiffs a d e q u a te ly have alleged facts supporting a strong inference of scienter. The Court therefore w ill deny Defendants' motion to dismiss on this basis. C. Bespeaks Caution T h e bespeaks caution doctrine permits a court to rule as a matter of law that a d e f e n d a n t's forward-looking representations contained sufficient cautionary language or risk disclosure to protect the defendant against a securities fraud claim. Provenz, 102 F.3d a t 1493; In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413 (9th Cir. 1994). The d o c trin e is designed to address the statement's materiality and the reasonableness of the p la in tif f 's reliance on optimistic projections when those projections are coupled with s u f f ic ie n tly particular cautionary language. In re Worlds of Wonder, 35 F.3d at 1414. To determine whether the "bespeaks caution" doctrine immunizes a defendant's a lle g e d ly false statements, the court examines any cautionary statements the defendant m a d e . Provenz, 102 F.3d at 1493. "The cautionary statements must be `precise' and `d ire c tly address[ ] . . . the [defendants'] future projections." Id. (quoting In re Worlds of W o n d e r, 35 F.3d at 1414). "Blanket warnings that securities involve a high degree of risk 9

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[ a re ] insufficient to ward against a federal securities fraud claim." Id. (quotation omitted). To prevent defendants from attempting to insulate false statements with c a u tio n a ry language, the doctrine applies "only to precise cautionary language which d ire c tly addresses itself to future projections, estimates or forecasts in a prospectus." In re W o rld s of Wonder, 35 F.3d at 1414 (quotation omitted). This Court declined to apply the b e s p e a k s caution doctrine to a prospectus that included cautionary language that there could b e no assurances that sufficient cash flow would exist to meet expenses. In re Stratosphere C o rp . Sec. Litig., 1 F. Supp. 2d 1096, 1117-18 (D. Nev. 1998). The plaintiffs alleged s p e c if ic cost overruns and construction delays of which the defendants were aware and w h ic h necessarily would affect operating revenues. Id. Thus, general cautionary language a b o u t the risks inherent in every construction enterprise did not immunize their m iss ta te m e n ts . Id. The Court should not grant a motion to dismiss based on the bespeaks c a u tio n doctrine unless the defendant's challenged document includes enough cautionary la n g u a g e or risk disclosure that "reasonable minds could not disagree that the challenged s ta te m e n ts were not misleading." In re Stac Elec. Sec. Litig., 89 F.3d 1399, 1408 (9th Cir. 1 9 9 6 ) (quotation omitted). A lth o u g h the PPM contains cautionary language and a listing of risk factors, P la in tif f s allege Defendants knew or had reason to believe the Cash Flow Projections were n o t accurate because they knew the Historical Performance Representations which were the s ta rtin g point were false. Additionally, Plaintiffs allege Defendants had in their possession b u t did not disclose the PWC Appraisal and the internal budget which contained materially d if f e re n t calculations of net operating income, projected income, projected growth, p ro je c te d golf rounds, and trends regarding net operating income and declining m e m b e rsh ip . However, the cautionary language did not advise investors that Defendants h a d contrary information or that Defendants did not actually believe the projections. Additionally, the PPM couches Defendants' assumptions as "reasonable" and based on 10

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" h is to ric a l" performance or trends, yet according to the Complaint the PWC Appraisal and in te rn a l operating budget suggest the assumptions were not reasonable and were contrary to h is to ric a l performance and trends. The Court therefore will deny Defendants' motion to d is m is s on this basis. D . Remaining Claims D e f e n d a n ts' motion to dismiss the remaining claims relies upon the dismissal of th e primary securities claim. Because the Court will deny Defendants' motion to dismiss th e primary securities claim, the Court will deny Defendants' motion to dismiss the control p e rs o n federal securities claim as well as the supplemental state law claims. I I I . CONCLUSION IT IS THEREFORE ORDERED that Defendants' Motion to Dismiss Plaintiffs' C o m p la in t (Doc. #47) is hereby DENIED.

D A T E D : May 1, 2009

_______________________________ PHILIP M. PRO United States District Judge

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