Orlan v. Spongetech Delivery Systems, Inc. et al
ORDER granting (70) Motion to Dismiss in case 1:10-cv-04093-DLI-RML AS TO DEFENDANT HALPERIN ONLY --- For the reasons set forth in the ATTACHED WRITTEN MEMORANDUM AND ORDER, Defendant Halperin's motion to dismiss the third claim in the second a mended complaint is granted. Accordingly, said claim, which is the only claim brought against Mr. Halperin, is dismissed, with prejudice, and the Clerk of the Court is directed to terminate Mr. Halperin on the docket of the consolidated cases. SO ORDERED by Chief Judge Dora Lizette Irizarry on 3/24/2017. Associated Cases: 1:10-cv-04093-DLI-RML, 1:10-cv-04104-DLI-RML (Irizarry, Dora)
UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
JEFFREY P. ORLAN, et al.,
MEMORANDUM & ORDER
SPONGETECH DELIVERY SYSTEMS, INC.,
SECURTIIES LITIGATION, et al.,
QUANG LE, et al.,
SPONGETECH DELIVERY SYSTEMS, INC.,
SECURTIIES LITIGATION, et al.,
DORA L. IRIZARRY, United States Chief District Judge:
Class Plaintiffs (“Plaintiffs”) were common shareholders in Spongetech Delivery Systems,
Inc. (“Spongetech”), a publicly traded company that sold soap-filled sponges, inter alia. On March
29, 2012, the Court dismissed without prejudice the Third Claim of Plaintiffs’ first consolidated
amended class action complaint (“FAC”) pertaining to attorney defendant Jack Halperin
(“Halperin”) for failure to state a claim for relief pursuant to Rule 12(b)(6) of the Federal Rules of
Civil Procedure and for failure to comply with the heightened pleading requirements of Rule 9(b)
of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act
(“PSLRA”), 15 U.S.C. § 78u-4. See Orlan v. Spongetech Delivery Systems, Inc., 2012 WL
1067975 (E.D.N.Y. Mar. 29, 2012).
On May 1, 2012, Plaintiffs filed a second consolidated amended class action complaint
(“SAC”) in which they reasserted the same causes of action in the Third Claim against Halperin.
(See Second Consolidated Amended Class Action Complaint with Certifications (“SAC”) at ¶¶
193-202, Dkt. Entry No. 69.) On June 1, 2012, Halperin filed a motion to dismiss the Third Claim
of the SAC. (See Motion to Dismiss the Second Consolidated Amended Class Action Complaint
(“Second Mot. to Dismiss”), Dkt. Entry No. 70, Orlan v. Spongetech Delivery Systems, Inc. et al
(“Orlan I”), 10-cv-4093 (DLI)(RML).) Plaintiffs oppose. For the reasons set forth below,
Halperin’s motion to dismiss the Third Claim of the SAC, arising under Section 10(b) of the
Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (“Exchange Act”), and the rules
promulgated thereunder, is granted with prejudice.
The First Amended Complaint
The Court presumes familiarity with its decision dismissing the Third Claim of Plaintiffs’
FAC. Nonetheless, a brief recitation of the allegations in the FAC and the Court’s findings as to
those allegations is necessary to understand Plaintiffs’ SAC.
The FAC alleged that, from June 12, 2009 through September 29, 2009, Halperin prepared
ninety-two attorney opinion letters containing materially false and misleading statements and
omissions directing transfer agents to remove restrictive legends from restricted Spongetech stock
and causing those shares to flood the market at artificially inflated prices. (See First Consolidated
Amended Class Action Complaint (“FAC”), Dkt. Entry No. 46, Le et al v. Spongetech Delivery
Systems, Inc. et al, 10-cv-4104.) According to the FAC, at the time he wrote the attorney opinion
letters, Halperin knew that these Spongetech shares were unsaleable and not subject to any
exemptions that would render removal of those restrictive legends proper. (Id. at ¶ 172.) The FAC
The Court’s discussion herein is limited to the claims filed against Halperin as he is the only defendant who
moved for dismissal of the Amended Complaint.
further alleged that, in preparing those attorney opinion letters, Halperin facilitated the dumping
of 2.5 billion shares of unregistered Spongetech stock onto the public market at artificially inflated
prices which Plaintiffs purchased and sold in reliance on the representations in the attorney opinion
letters. (Id. at ¶¶ 172, 174.)
The FAC asserted that Halperin’s actions constituted violations of federal securities laws,
specifically Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq.
(“Exchange Act”), and Rule 10b-5 promulgated thereunder, because Halperin’s attorney opinion
letters concealed from Spongetech shareholders the true value of the unregistered Spongetech
stock released upon the public market. (Id. at ¶ 172.) In particular, the FAC alleged that Halperin:
(1) issued ninety-two Rule 1442 attorney opinion letters to transfer agents resulting in the removal
of restrictive legends from over 922 million shares of unregistered Spongetech stock held by
affiliated entities of Spongetech; (2) advised the transfer agent that the legends were removable
because the affiliated entities had held the securities for six months or longer; (3) presented the
affiliated entities as non-affiliated entities when he knew that they were indeed affiliated entities
and had not held the securities for the requisite six-month period; and (4) caused these unregistered
securities to be injected into the public market when he knew that the public lacked adequate
current information about Spongetech’s financial condition. (Id. at ¶¶ 101-110.)
The FAC further alleged that, as a result of Halperin’s misstatements and omissions, the
Securities and Exchange Commission Rule 144 “establishes that ‘securities acquired directly or indirectly
from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public
offering’ are ‘restricted securities.’” Phlo Corp. v. Stevens, 62 F. App’x 377, 382 (2d Cir. 2003) (quoting 17 C.F.R.
§ 230.144). “To comply with Rule 144, a person ordinarily must meet numerous requirements concerning public
information, holding periods, number of shares, manner of sales, and notice to the [Securities and Exchange]
Commission. However, under subsection (k) of the Rule, if a person is not now and has not been an affiliate of the
issuer within the last three months, and at least two years have elapsed since the securities to be sold were last acquired
from an issuer or affiliate of the issuer, then that person need not comply with the other Rule 144 requirements.”
S.E.C. v. Kern, 425, F.3d 143, 148 (2d Cir. 2005); see 17 C.F.R. §§ 230.144(b), 230.144(c)-(h), 230.144(k). “An
affiliate of an issuer is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled
by, or is under common control with, such issuer.” 17 C.F.R. § 230.144(a)(1).
price of Spongetech stock became inflated above its inherent value, thereby defrauding investors.
(Id. at ¶ 174.)
The Court’s Dismissal of the FAC
The Court evaluated the FAC in light of the heightened pleading standards mandated by
both Rule 9(b) of the Federal Rules of Civil Procedure, which provides that “circumstances
constituting fraud or mistake shall be stated with particularity,” and the Private Securities
Litigation Reform Act (“PSLRA”), 15 U.S.C. § 78u-4(b). Fed. R. Civ. P. 9(b). The PSLRA
“insists that securities fraud complaints ‘specify’ each misleading statement; that they set forth the
facts ‘on which [a] belief’ that a statement is misleading was ‘formed’; and that they ‘state with
particularity facts giving rise to a strong inference that the defendant acted with the required state
of mind.’” Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 346 (2005) (quoting 15 U.S.C. §§ 78u4(b)(1), (2)). Accordingly, a plaintiff asserting a claim for securities fraud pursuant to Section
10(b) of the Exchange Act and Rule 10b-5 must plead with particularity “that the defendant, in
connection with the purchase or sale of securities, made a materially false statement or omitted a
material fact, with scienter, and that the plaintiff’s reliance on the defendant’s action caused injury
to the plaintiff.” Ganino v. Citizens Utilities Co., 228 F.3d 154, 161 (2d Cir. 2000).
The Court found that the Third Claim of the FAC failed to comply with these standards
because it did not sufficiently allege materiality, scienter or loss causation. See Orlan, 2012 WL
Specifically, with regard to scienter, the Court found that Plaintiffs failed to set forth, with
the required degree of specificity, allegations in the FAC that Halperin had access to documentary
evidence that belied the statements contained in his attorney opinion letters. Id. at *14. Moreover,
the Court found that Plaintiffs failed to identify specifically the reports or statements containing
the contradictory information. Id.
Regarding loss causation, the Court concluded that, while Plaintiffs adequately pled
transaction causation, they failed to plead that there existed a proximate causal link between the
false statements contained in Halperin’s attorney opinion letters and the economic harm they
suffered. Id. at *14-15.
In dismissing the Third Claim of the FAC without prejudice, the Court afforded Plaintiffs
another opportunity to plead the elements of materiality, scienter and loss causation with greater
specificity in order to satisfy the heightened pleading requirements of the PSLRA and Rule 9(b)
of the Federal Rules of Civil Procedure. See Orlan, 2012 WL 1067975.
Allegations Against Halperin in the SAC
The allegations in the Third Claim of the SAC are identical to those in the Third Claim of
the FAC. However, the SAC contains new allegations that fall into three general categories:
(1) Halperin knew, or was reckless in not knowing, that the sale of 922 million restricted
Spongetech shares was unauthorized; (2) Halperin conducted inadequate due diligence with
respect to Spongetech’s financial condition; and (3) Halperin’s misrepresentations caused
Plaintiffs to suffer economic loss. (SAC at ¶¶ 119, 125, 131, 132 and 162.)
A. Unauthorized Sale
Plaintiffs contend that Halperin knew that the sale and distribution of 922 million restricted
Spongetech shares was unauthorized because he knew, or had access to publicly available facts,
that Spongetech intended to reduce its number of common shares authorized and outstanding. (Id.
at ¶ 119.) On July 29, 2009, Spongetech announced that it would “reduce the number of common
shares that the Company has authorized to 900,000,000” and “lower its outstanding shares to
approximately 500,000,000 shares.” (Id.) The SAC adds that, on February 28, 2009, Spongetech
filed a Form 10-Q with the SEC reporting that it had approximately 722 million shares outstanding
and issued. (Id.) Plaintiffs argue that Halperin’s knowledge of and/or accessibility to this
information should have persuaded him to not include misleading statements in his attorney
opinion letters. (Id.)
B. Inadequate Due Diligence
Plaintiffs further assert that Halperin’s due diligence relating to researching Spongetech’s
financial condition was substandard. (Id.) The SAC contends that the Securities and Exchange
Commission’s (“SEC”) September 29, 2009 subpoena to Spongetech’s counsel seeking
information on its reviews, revenues and clients should have induced Halperin to conduct
additional due diligence into the facts supporting the statements contained in his attorney opinion
letters. (Id.) Similarly, the SAC alleges that a New York Post article from September 17, 2009
that suggested Spongetech was engaged in securities fraud also should have compelled Halperin
to cease issuing the attorney opinion letters. (Id.)
Moreover, in testimony before the SEC, Halperin admitted that he did not review any of
Spongetech’s current financial statements before making the representations contained in the
ninety-two opinion letters used to remove restrictive legends on unregistered Spongetech stock.
(Id. at ¶ 125.) Halperin further admitted that he did not investigate whether the loans that RM
Enterprises International, Inc. (“RME”) allegedly made to Spongetech between December 31,
2007 and March 17, 2008 actually were made before representing that the issuance of the restricted
shares to RME was in consideration for those purported loans. (Id. at ¶¶ 124, 125.) Halperin also
failed to confirm whether the purported loans had been made within the statutorily mandated oneyear period prior to the issuance of the restricted shares to RME before he represented in his
opinion letters that they had been made one year before. (Id. at ¶ 125.) Halperin conceded that
drafting between eighty and ninety attorney opinion letters for one company in a four-month period
was an inordinate volume. (Id.) Plaintiffs allege that Halperin further admitted in his SEC
testimony that he knew, or should have known, that “the entities he claimed were non-affiliates of
Spongetech were in fact affiliates and, in fact, some of the Transferees shared Spongetech’s office
address, information which was available to” him. (Id.) Under SEC Rule 144, an affiliate
ordinarily may not rely upon the exemption from the securities registration requirement provided
by Section 4(1) of the Securities Act of 1933, 15 U.S.C. § 77d, in distributing unregistered shares
of an issuer’s stock. S.E.C. v. Cavanaugh, 155 F.3d 129, 134 (2d Cir. 1998). Therefore, Plaintiffs
argue that the restricted shares Halperin recommended for release into the public market from
these affiliate entities circumvented the proper registration requirements from which they had no
exemption. (SAC at ¶ 129.)
C. Economic Loss
The SAC includes additional allegations that the false and misleading statements contained
in Halperin’s attorney opinion letters improperly induced the sale of 922 million Spongetech shares
causing “substantial dilution” of the shares being purchased by Plaintiffs. (Id. at ¶ 131.) The SAC
continues by alleging that, if Halperin had revealed that the new shares were restricted and
improperly placed in the public market, Plaintiffs would have realized that “the true value of the
improperly sold shares” was “zero or near zero.” (Id. at ¶ 132.) Halperin’s misrepresentations
caused Plaintiffs to purchase Spongetech stock at inflated prices thus causing them economic loss.
(Id.) Specifically, Plaintiffs allege that Halperin’s actions caused Plaintiffs to purchase shares at
prices that “would have been commensurate with a pool of approximately 700 million to 900
million publicly disseminated shares rather than a pool of over 2 billion shares.” (Id. at ¶ 162.)
As it did with Halperin’s motion to dismiss the FAC, the Court treats all factual allegations
in the SAC as true and draws all reasonable inferences in Plaintiffs’ favor. See Ganino, 228 F.3d
at 161. “Dismissal is proper ‘only if it is clear that no relief could be granted under any set of facts
that could be proved consistent with the allegations.’” In re Scholastic Corp. Sec. Litig., 252 F.3d
63, 69 (2d Cir. 2001) (quoting Hishon v. King & Spalding, 467 U.S. 69, 73 (1984)).
Given that the SAC charges the same securities law violations as the FAC, “[t]he complaint
must identify the statements plaintiff[s] assert were fraudulent and why, in plaintiff[s]’ view they
were fraudulent, specifying who made them, and where and when they were made.” In re
Scholastic Corp., 252 F.3d at 69-70.
As noted above, a complaint alleging securities fraud under Section 10(b) of the Exchange
Act is subject to the heightened pleading standards of Rule 9(b) of the Federal Rules of Civil
Procedure and the PSLRA.
Plaintiffs’ Section 10(b) and Rule 10b-5 Claims
Plaintiffs’ principal claims are brought pursuant to Section 10(b) of the Exchange Act and
Rule 10b-5 promulgated thereunder. To bring a cause of action pursuant to these provisions,
Plaintiffs must allege with particularity that Halperin: “(1) made misstatements or omissions of
material fact; (2) with scienter; (3) in connection with the purchase or sale of securities; (4) upon
which plaintiffs relied; and (5) that plaintiffs’ reliance was the proximate cause of their injury.”
Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 172 (2d Cir. 2005). Accordingly, Plaintiffs
must convey through factual allegations that Halperin made materially false statements, and that he
did so with scienter. See In re Globalstar Securities Litigation, 2003 WL 2295163, at *5 (S.D.N.Y.
Dec. 15, 2003).
A misstatement or omission is material if there is a substantial probability that a reasonable
investor would have considered it significant in making investment decisions. Ganino, 228 F.3d at
161. “Material facts include those that affect the probable future of the company and that may
affect the desire of investors to buy, sell, or hold the company’s securities.” Castellano v. Young
& Rubicam, Inc., 257 F.3d 171, 180 (2d Cir. 2001). “At the pleading stage, a plaintiff satisfies the
materiality requirement of Rule 10b-5 by alleging a statement or omission that a reasonable investor
would have considered significant in making investment decisions.” Ganino, 228 F.3d at 162.
The requisite scienter Plaintiffs must allege is “an intent to deceive, manipulate or defraud.”
Kalnit v. Eichler, 264 F.3d 131, 138 (2d Cir. 2001) (internal quotation marks and citation omitted).
In evaluating whether Plaintiffs have satisfied this requirement, “the court must read the complaint
in toto and most favorably to plaintiff.”
In re Regeneron Pharmaceuticals, Inc. Securities
Litigation, 2005 WL 225288, at *24 (S.D.N.Y. 2005) (internal quotation marks and citation
omitted). However, Plaintiffs must allege facts that give rise “to a strong inference that [defendants]
acted with the required state of mind, a weak yet reasonable inference of scienter” will not suffice.
15 U.S.C. § 78-u-4(b)(2); In re JP Morgan Chase Securities Litigation, 363 F. Supp. 2d 595, 618
(S.D.N.Y. 2005). Plaintiffs can establish scienter in either of two ways: “(a) by alleging facts to
show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that
constitute strong circumstantial evidence of conscious behavior or recklessness.” Novak v. Kasaks,
216 F.3d 300, 307 (2d Cir. 2000) (internal quotation marks and citation omitted).
As explained above, the Court dismissed the FAC because it failed to establish materiality,
scienter and loss causation for Halperin’s alleged misstatements and omissions in his attorney
opinion letters. Halperin asserts that none of the new factual allegations in the SAC regarding the
unauthorized sale of 922 million restricted Spongetech shares, the inadequate due diligence related
to Spongetech’s current financial condition and the economic loss Plaintiffs suffered remedies the
deficiencies that led the Court to dismiss the FAC.
Halperin argues that the SAC does not allege that Plaintiffs considered his opinion letters
when considering whether to invest in Spongetech. (Defendant’s Memorandum of Law in Support
of Motion to Dismiss (“Def. Mem. of Law”) at 10, Dkt. Entry No. 70-4, Orlan I, 10-cv-4093.)
Halperin correctly notes that Plaintiffs merely speculate that, if Halperin revealed the true nature of
the shares’ status in his attorney opinion letters, then Plaintiffs would not have purchased any stock
or suffered any losses. (Id.) Furthermore, Halperin contends that “Plaintiffs were not even aware
of [his] opinion letters” in order to consider them at the time of their stock purchases. (Id.)
Relying on two decisions issued by the United States District Court for the Southern District
of New York (“Southern District”) in 2010 and 2012, respectively, Plaintiffs counter that “[t]he
fact that the alleged misrepresentations were made to a transfer agent rather than to the public, …,
does not foreclose their being material.” S.E.C. v. Czarnik, 2010 WL 4860678, at *5 (S.D.N.Y.
Nov. 29, 2010); see S.E.C. v. Greenstone Holdings, Inc., 2012 WL 1038570 (S.D.N.Y. Mar. 28,
2012); Plaintiffs’ Memorandum of Law in Opposition to Motion to Dismiss (“Opp. Mem.”) at 1213, Dkt. Entry No. 73, Orlan I, 10-cv-4093.
Czarnik held that “investor reliance is not a necessary predicate for a finding of materiality.”
Czarnik, 2010 WL 4860678, *5. Czarnik further held that “a misstatement made in any phase of
the selling transaction can be material if a reasonable investor would have considered the
defendant’s alleged misrepresentations important, even if the statement is not made directly to the
investor.” Id. Greenstone Holdings held that a private written communication between an attorney
and a transfer agent does not foreclose a statement’s materiality insofar as the misrepresentations
contained in such a communication “may be considered important by a reasonable investor.”
Greenstone Holdings, 2012 WL 1038570 at *5.
However, as Halperin correctly notes in his reply papers, the case law above does not
include the heightened pleading requirements mandated by private securities actions under Section
10(b). (Defendant’s Reply Memorandum of Law (“Reply”) at 3-5, Dkt. Entry No. 75, Orlan I, 10cv-4093.) Indeed, reliance is the critical element in private actions under Rule 10b-5. Pacific
Investment Management Co. LLC v. Mayer Brown LLP, 603 F.3d 144, 156 (2d Cir. 2010).
Similarly, in Stoneridge Investment Partners, LLC v. Scientific Atlanta, the Supreme Court held
that a Section 10(b) private right of action does not reach a defendant when the investors did not
rely upon that defendant’s statements or representations. 552 U.S. 148, 152 (2008). Here, Plaintiffs
failed to plead sufficiently in the SAC that they relied upon Halperin’s statements in the attorney
opinion letters when purchasing or selling Spongetech stock. Thus, Plaintiffs failed to establish the
materiality element of their Section 10(b)/Rule 10b-5 claim. Accordingly, Halperin’s motion to
dismiss the Third Claim of the SAC is granted with prejudice.
The Court simply may end its Section 10(b)/Rule 10b-5 analysis since Plaintiffs failed to
establish materiality. Kalnit, 264 F.3d at 144 (upon finding that plaintiff failed to plead scienter
adequately, the court ruled that it was unnecessary to reach defendant’s arguments alleging
deficiencies in the manner in which plaintiff pleaded materiality or reliance). However, the Court
will continue with the scienter and loss causation prongs to exhaust the analysis fully.
As the Court stated in its March 29, 2012 Order, the crux of the scienter issue here is whether
Halperin acted recklessly in writing his attorney opinion letters. See Orlan, 2012 WL 1067975 at
*14. Since Plaintiffs failed to demonstrate that Halperin had a motive to defraud the shareholders,
they “must produce a stronger inference of recklessness.” Kalnit, 264 F.3d at 143; see Orlan, 2012
WL 1067975 at *13.
Recklessness is “at the least, . . . an extreme departure from the standards of ordinary care
. . . to the extent that the danger was either known to the defendant or so obvious that the defendant
must have been aware of it.” Novak, 216 F. 3d at 308 (internal quotation marks and citation
omitted). Indeed, an inference of recklessness “may arise where the complaint sufficiently alleges
that the defendants . . . knew facts or had access to information suggesting that their public
statements were not accurate” or “failed to check information they had a duty to monitor.” Id. at
311. “[T]o qualify as a strong inference, the inference of scienter must be more than merely
reasonable—it must be cogent and at least as compelling as any opposing inference of
nonfraudulent intent.” ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase
Co., 553 F.3d 187, 198 (2d Cir. 2009) (internal quotation marks and citation omitted). Thus, “‘to
determine whether a complaint’s scienter allegations can survive threshold inspection for
sufficiency, a court governed by’” the PSLRA “‘must engage in a comparative evaluation; it must
consider, not only inferences urged by the plaintiff, … but also competing inferences rationally
drawn from the facts alleged. An inference of fraudulent intent may be plausible, yet less cogent
than other, nonculpable explanations for the defendant’s conduct.’” South Cherry Street, LLC v.
Hennessee Group LLC, 573 F.3d 98, 111 (2d Cir. 2009) (emphases included) (quoting Tellabs, Inc.
v. Makor Issues & Rights, Ltd., 551 U.S. 308, 314 (2007)).
Halperin contends that Plaintiffs failed to establish reckless conduct in the following three
respects: (1) Halperin’s alleged admissions to inadequate due diligence in his testimony before the
SEC were false and taken out of context; (2) Halperin reasonably relied in good faith upon the
representations of Spongetech and its corporate officers in preparing the attorney opinion letters;
and (3) Halperin was not under a duty to anticipate materially adverse future events when preparing
the opinion letters. (Def. Mem. of Law at 12-20.)
Plaintiffs counter that Halperin’s SEC testimony was sufficiently particularized in the SAC
such that it demonstrated his “reckless abandonment of his important duties.” (Opp. Mem. at 1416.) In continued reliance on Czarnik and Greenstone Holdings, Plaintiffs further argue that
Halperin’s failure to review the information supporting the representations in his attorney opinion
letters constituted reckless conduct. (Id. at 16-17.)
As with the materiality analysis, the holdings in Czarnik and Greenstone Holdings are
inapplicable to an analysis of scienter under the heightened pleading requirements of the PSLRA.
“Although the Second Circuit has not directly addressed the issue, courts in this Circuit have
declined to extend the Supreme Court’s interpretation of the PSLRA’s strong inference standard in
Tellabs to [SEC] enforcement actions.” Czarnik, 2010 WL 4860678, at n. 4 (internal quotation
marks and citations omitted). Therefore, the lesser standard for recklessness used in the Czarnik
and Greenstone Holdings decisions has no bearing on whether Plaintiffs demonstrated scienter in
the instant matter.
In its March 29, 2012 Order, the Court provided Plaintiffs with specific guidance on how
to plead scienter with greater specificity by correlating Halperin’s attorney opinion letters with
conflicting statements that were publicly available at the time he drafted those letters. Orlan, 2012
WL 1067975, n. 6. Plaintiffs failed to heed this guidance. Plaintiffs’ enumeration of admissions
Halperin made during his SEC testimony did not indicate how or where it contradicted statements
he made in his attorney opinion letters. (SAC at ¶ 125.) Furthermore, the admissions were not pled
with particularity as Plaintiffs failed to attach the actual SEC record of testimony or specific
citations thereto. See Marcus v. Frome, 275 F. Supp. 2d 496, 502-03 (S.D.N.Y. 2003) (court found
that plaintiff failed to satisfy scienter requirement when it alleged that the chief executive officer
of a corporation and the attorney preparing the opinion letter regarding the purchase of its shares
had access to documents informing them that the representations in the letter were false; however,
plaintiffs failed to cite to any particular documents contradicting the representations contained in
the letter). Here, Plaintiffs also failed to provide any reference to the specific loan documents of
which they allege that Halperin was aware or to plead with particularity the portions of those loan
documents that exhibited some indicia of fraud. (SAC at ¶¶ 124, 125.) Therefore, Halperin’s
alleged admissions before the SEC do not rise to the level of recklessness necessary to establish
scienter. Accordingly, Halperin’s motion to dismiss the Third Claim of the SAC is granted with
C. Loss Causation
“It is long settled that a securities-fraud plaintiff ‘must prove both transaction and loss
causation.’” Lentell, 396 F.3d at 172 (quoting First Nationwide Bank v. Gelt Funding Corp., 27
F.3d 763, 769 (2d Cir. 1994)). As noted above, the Court already held that Plaintiffs adequately
pled transaction causation in its March 29, 2012 Order, therefore, it moves to a loss causation
analysis. Orlan, 2012 WL 1067975, at *15.
Loss causation “is the causal link between the alleged misconduct and the economic harm
ultimately suffered by the plaintiff.” Lentell, 396 F.3d at 172 (internal quotation marks and citation
omitted). The PSLRA specifically codified this common law requirement: “In any private action
arising under this chapter, the plaintiff shall have the burden of proving that the act or omission of
the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover
damages.” 15 U.S.C. § 78u-4(b)(4). “Thus to establish loss causation, ‘a plaintiff must allege …
that the subject of the fraudulent statement or omission was the cause of the actual loss suffered,’
that the misstatement or omission concealed something from the market that, when disclosed,
negatively affected the value of the security.” Lentell, 396 F.3d at 173 (quoting Suez Equity
Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95 (2d Cir. 2001) (emphasis included)).
“The loss causation inquiry typically examines how directly the subject of the fraudulent statement
caused the loss, and whether the resulting loss was a foreseeable outcome of the fraudulent
statement.” Suez Equity, 250 F.3d at 96. “Related factors include whether intervening causes are
present.” Id. “In the end, whether loss causation has been demonstrated presents a public policy
question, the resolution of which is predicated upon notions of equity because it establishes who,
if anyone, along the causal chain should be liable for the plaintiffs’ losses.” Id. Ultimately,
however, “[l]oss causation is a fact-based inquiry” and it is insufficient “to allege that a defendant’s
misrepresentations and omissions induced a ‘purchase-time value disparity’ between the price paid
for a security and its ‘true “investment quality.”’” Lentell, 396 F.3d at 174 (quoting Emergent
Capital Investment Management, LLC v. Stonepath Group, Inc., 343 F.3d 189, 198 (2d Cir. 2003)).
In support of their loss causation argument, Plaintiffs allege that the misstatements
contained in Halperin’s attorney opinion letters caused “hundreds of thousands” of unregistered
and previously restricted Spongetech shares to enter the public market at prices incommensurate
with the actual volume of two billion shares available for purchase and sale. (SAC at ¶ 162.) The
SAC further alleges that Plaintiffs purchased these shares at prices consistent with the availability
of 700 million to 900 billion shares in the market as previously advertised. (Id.) Ultimately, the
SAC contends that Halperin’s false statements caused the value of Spongetech’s stock to become
substantially diluted and valueless. (Id. at ¶¶ 131, 132; Opp. Mem. at 18.)
Halperin counters that Plaintiffs’ failure to demonstrate their reliance on the opinion letters
in purchasing Spongetech securities forecloses their loss causation argument. (Def. Mem. of Law
at 20.) Halperin also correctly notes that revelation of the Spongetech securities fraud through the
series of New York Post articles published between September 17, 2009 and September 28, 2009
constitutes an intervening event responsible for the decline in the price of the shares. (Reply at 910; see SAC at ¶¶ 143-151.) Notwithstanding Plaintiffs’ contention that the loss they suffered was
foreseeable by Halperin and that the loss was caused by the materialization of the concealed risk
of stock dilution, Halperin’s relationship to Plaintiffs’ investment loss and the misstated
information was not sufficiently direct to warrant liability for the securities fraud. If a defendant’s
connection to the loss and the risk concealment is attenuated, “or if the plaintiff fails to demonstrate
a causal connection between the content of the alleged misstatements or omissions and the harm
actually suffered, a fraud claim will not lie.” Lentell, 396 F.3d at 174 (internal quotation marks
and citations omitted).
Where, as here, “substantial indicia of the risk that materialized are unambiguously
apparent on the face of the disclosures alleged to conceal the very same risk, a plaintiff must allege
(i) facts sufficient to support an inference that it was defendant’s fraud—rather than other salient
factors—that proximately caused plaintiff’s loss; or (ii) facts sufficient to apportion the losses
between the disclosed and concealed portions of the risk that ultimately destroyed the investment.”
Id. at 177. Plaintiffs have done neither, and thus offer no factual basis to support the allegation
that the misrepresentations and omissions in the attorney opinion letters caused the losses flowing
from the well publicized SEC mandate that Spongetech redo its financial statements. (SAC at ¶¶
143-151.) The origins of this mandate stem from perceived improprieties committed by the
company’s auditor and the alleged forgery of certain attorney opinion letters, inter alia. (Id. at ¶¶
119, 143-151.) Halperin’s lack of connection to the preparation of Spongetech financial statements
renders his role in causing Plaintiffs’ economic suffering attenuated. Similarly, the use of some
of his attorney opinion letters by Spongetech corporate officers to remove restrictive legends from
shares unregistered and otherwise restricted shares for transfer to affiliated entities did not directly
involve Halperin. Accordingly, Plaintiffs failed to adequately plead loss causation and Halperin’s
motion to dismiss the Third Claim of the SAC is granted with prejudice.
Manipulation and Scheme Liability
Plaintiffs further contend that Halperin and Spongetech corporate officers acted in concert
with one another and “directly participated in the scheme” to prepare and sign attorney opinion
letters containing false information causing 2.5 billion unregistered shares of Spongetech to flood
the market at artificially inflated prices. (SAC at ¶ 196; Opp. Mem. at 18.) However, the Supreme
Court’s decision in Stoneridge foreclosed Plaintiffs’ theory of scheme liability. In Stoneridge,
plaintiffs sought to hold two companies liable for their participation in fraudulent transactions that
allowed the issuer of securities to overstate its revenue.
Stoneridge, 552 U.S. at 153-55.
Notwithstanding the deceptive nature of the defendants’ conduct, which enabled the issuer to
conceal the misrepresentations in its financial statements, the Supreme Court found that the critical
element of reliance was absent. Id. at 159. It explained that
[Defendants’] deceptive acts were not communicated to the public. No member of
the investing public had knowledge, either actual or presumed, of [defendants’]
deceptive acts during the relevant times. [Plaintiffs], as a result, cannot show
reliance upon any of [defendants’] actions except in an indirect chain that we find
too remote for liability.
Like the defendants in Stoneridge, Halperin is alleged to have facilitated the dilution of
Spongetech shares and the inflation of its stock price in the public market by concealing the true
state of its financial condition from investors. However, Halperin correctly notes that Plaintiffs
failed to allege that they had knowledge of the misrepresentations in his attorney opinion letters
because those letters were never communicated to Plaintiffs. (Def. Mem. of Law at 18.) Thus,
Stoneridge forecloses Plaintiffs’ claim of scheme liability and that claim is hereby dismissed.
For the reasons set forth above, Halperin’s motion to dismiss the Third Claim, arising under
Section 10(b) of the Exchange Act and the rules promulgated thereunder, is granted with prejudice.
Dated: Brooklyn, New York
March 24, 2017
DORA L. IRIZARRY
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