Steginsky v. Xcelera Inc. , 741 F.3d 365 ( 2014 )

13-1327-cv; 13-1892-cv
Steginsky v. Xcelera Inc.
In the
United States Court of Appeals
For the Second Circuit
________
AUGUST TERM, 2013
ARGUED: OCTOBER 30, 2013
DECIDED: JANUARY 27, 2014
Nos. 13-1327-cv; 13-1892-cv
GLORIA STEGINSKY,
Plaintiff-Appellant-Cross-Appellee,
v.
XCELERA INC., VBI CORPORATION, ALEXANDER M. VIK, GUSTAV M.
VIK,
Defendants-Appellees-Cross-Appellants,
HANS EIRIK OLAV, OFC LTD.,
Defendants-Appellees.
________
Before: WALKER, CABRANES, and PARKER, Circuit Judges.
________
Plaintiff Gloria Steginsky, a former minority shareholder of
Xcelera Inc., appeals the dismissal of her securities fraud claims by
the United States District Court for the District of Connecticut
(Stefan R. Underhill, District Judge). Her complaint alleged that
Xcelera insiders purchased Xcelera stock by making a tender offer
2 Nos. 13-1327-cv; 13-1892-cv
through a shell corporation without disclosing any information
about Xcelera’s financial state. We hold that the duty of corporate
insiders to either disclose material nonpublic information or abstain
from trading is defined by federal common law and applies to
unregistered securities, and that the district court thus erred in
dismissing plaintiff’s insider trading claims. We VACATE the
dismissal of her insider trading claims under sections 10(b), 20(a),
and 20A(a) of the Securities Exchange Act, and of her pendent
nonfederal claims for breach of fiduciary duty. However, we
AFFIRM the dismissal of her market manipulation claims, and of her
insider trading claims under section 14(e) of the Securities Exchange
Act.
________
JEFFREY S. ABRAHAM (Philip T. Taylor, on the brief),
Abraham, Fruchter & Twersky, LLP, New York,
NY, for Plaintiff-Appellant-Cross-Appellee.
PETER J. MACDONALD (David F. Olsky, Jacob
Press, Wilmer Cutler Pickering Hale and Dorr
LLP, and Charles W. Pieterse, Whitman Breed
Abbott & Morgan LLC, on the brief), Wilmer
Cutler Pickering Hale and Dorr LLP, New York,
NY, for Defendants-Appellees-Cross-Appellants.
________
JOHN M. WALKER, JR., Circuit Judge:
Plaintiff Gloria Steginsky, a former minority shareholder of
Xcelera Inc., appeals the dismissal of her securities fraud claims by
the United States District Court for the District of Connecticut
(Stefan R. Underhill, District Judge). Her complaint alleged that
Xcelera insiders purchased Xcelera stock by making a tender offer
through a shell corporation without disclosing any information
about Xcelera’s financial state. We hold that the duty of corporate
insiders to either disclose material nonpublic information or abstain
from trading is defined by federal common law and applies to
3 Nos. 13-1327-cv; 13-1892-cv
unregistered securities, and that the district court thus erred in
dismissing plaintiff’s insider trading claims. We VACATE the
dismissal of her insider trading claims under sections 10(b), 20(a),
and 20A(a) of the Securities Exchange Act, and of her pendent
nonfederal claims for breach of fiduciary duty. However, we
AFFIRM the dismissal of her market manipulation claims, and of her
insider trading claims under section 14(e) of the Securities Exchange
Act.
BACKGROUND
Because the district court dismissed plaintiff’s claims on the
pleadings, we must accept the complaint’s factual allegations as true
for the purposes of this appeal. See ATSI Commc’ns, Inc. v. Shaar
Fund, Ltd., 493 F.3d 87, 98 (2d Cir. 2007). Plaintiff Gloria Steginsky
was a minority shareholder of Xcelera who sold her 100,010 shares
in 2011 pursuant to a tender offer for $0.25 per share. She alleges
violations of securities law and breaches of fiduciary duty by six
defendants. Defendant Xcelera is a Cayman Islands holding
corporation, based in Connecticut, with operating subsidiaries and
financial interests in the computer and software industries. At all
relevant times, Xcelera has been controlled by the three “Vik
defendants”: Alexander Vik is Chairman of the Board and Chief
Executive Officer; Gustav Vik is Director, Executive Vice President,
Secretary, and Treasurer; and VBI Corporation (owned by
Alexander and Gustav’s father, Erik Vik) is Xcelera’s majority
shareholder.1 Defendant OFC Ltd. is incorporated in Malta and was
created by the Vik defendants in 2010 as a vehicle to make a tender
offer for Xcelera shares. Finally, defendant Hans Eirik Olav is an
Xcelera Director who was listed as the OFC contact person with
respect to the tender offer.
1
The complaint also notes that “according to a declaration filed by
defendant Alexander M. Vik in [a separate case], ‘Xcelera is controlled by
VBI.’” Complaint ¶ 11 (quoting Declaration of Alexander M. Vik at 6,
Sebastian Holdings, Inc. v. Kugler, No. 3:08-cv-1131 (D. Conn. Oct. 31, 2008),
ECF No. 23-2).
4 Nos. 13-1327-cv; 13-1892-cv
According to the complaint, Xcelera common stock traded on
the American Stock Exchange for a high of $110/share in 2000 during
the so-called dotcom bubble. In 2004, after the price plummeted to
around $1/share, the Vik defendants began to refuse to make
required filings with the Securities Exchange Commission (“SEC”).
Because of this non-compliance, the American Stock Exchange
delisted Xcelera stock in 2004, and the price then dropped to around
$0.25/share. In 2006, the SEC revoked the registration of all Xcelera
securities. Since 2005, none of the defendants have disclosed any
information concerning Xcelera’s financial condition.
After the de-registration of Xcelera securities by the SEC,
investors were told by the company that they could sell their stock
back to Xcelera for $0.25/share. In December 2010, OFC made a
tender offer for Xcelera stock, listing Olav as the contact person, at
$0.25/share. The complaint alleges that OFC is only a shell company,
and that the tender offer was in fact orchestrated by Xcelera and the
Vik defendants, who have previously used Maltese companies to
conceal their identities. No information about Xcelera’s financial
conditions was disclosed in connection with the tender offer. In
April 2011, plaintiff sold her 100,010 shares of Xcelera common stock
to OFC pursuant to the tender offer.
In February 2012, plaintiff filed the complaint in this case,
alleging breach of fiduciary duty and violations of sections 10(b),
14(e), 20A(a), and 20(a) of the Securities Exchange Act through both
market manipulation and insider trading. In June 2012, Xcelera and
the Vik defendants moved to dismiss, and plaintiff sought a default
judgment against OFC, who had failed to appear.2 The district court
properly applied an identical standard in assessing the two motions
and accepted all of the complaint’s factual allegations as true. See
Fed. R. Civ. P. 12(b)(6); Trans World Airlines, Inc. v. Hughes, 449 F.2d
51, 69 (2d Cir. 1971) (“[A] default judgment entered on well-pleaded
Olav entered an appearance in September 2012; he has not moved to
2
dismiss, nor was he the subject of plaintiff’s motion for a default
judgment.
5 Nos. 13-1327-cv; 13-1892-cv
allegations in a complaint establishes a defendant’s liability.”), rev’d
on other grounds, 409 U.S. 363 (1973). The district court concluded,
however, that plaintiff failed to state a claim as a matter of law, and
therefore dismissed both her market manipulation and insider
trading claims. It then concluded that it was “compelled” to dismiss
the pendent fiduciary duty claims without prejudice to refiling in
state court. Although the district court did not expressly address the
§§ 20A(a) and 14(e) claims, it then denied plaintiff’s motion for
default judgment and granted defendants’ motion to dismiss the
complaint in its entirety. Steginsky v. Xcelera, Inc., No. 3:12-cv-188,
2013 WL 1087635 (D. Conn. Mar. 14, 2013). Plaintiff appeals the
dismissal of her claims, and defendants cross-appeal the district
court’s decision to not exercise supplemental jurisdiction over the
pendent claims.
DISCUSSION
We review de novo a district court’s dismissal of a complaint
under Rule 12(b)(6), accepting the complaint’s factual allegations as
true and drawing all reasonable inferences in the plaintiff’s favor.
ATSI, 493 F.3d at 98. A complaint alleging securities fraud must
“state with particularity the circumstances constituting [the] fraud.”
Fed. R. Civ. P. 9(b). Private securities fraud actions also must meet
the heightened pleading requirements of the Private Securities
Litigation Reform Act (“PSLRA”). When plaintiff alleges a false
statement or omission, the complaint must specify “the reason or
reasons why the statement is misleading” and must “state with
particularity all facts on which that belief is formed.” 15 U.S.C.
§ 78u-4(b)(1). Additionally, when a cause of action requires proof of
scienter, the complaint must “state with particularity facts giving
rise to a strong inference that the defendant acted with the required
state of mind.” Id. § 78u-4(b)(2)(A).
Plaintiff raises three types of claims, which we address in turn:
(1) securities fraud through market manipulation; (2) securities
fraud through insider trading; and (3) breach of fiduciary duty.
6 Nos. 13-1327-cv; 13-1892-cv
I. Market Manipulation Claims
Plaintiff’s theory of market manipulation is that defendants
manipulated the price of Xcelera stock downward by refusing to
make required SEC filings starting in 2004, causing Xcelera to be de-
listed by the American Stock Exchange in 2004 and then de-
registered by the SEC in 2006. Defendants could then buy back
Xcelera stock at artificially depressed prices. “Market manipulation
requires a plaintiff to allege (1) manipulative acts; (2) damage
(3) caused by reliance on an assumption of an efficient market free of
manipulation; (4) scienter; (5) in connection with the purchase or
sale of securities; (6) furthered by the defendant’s use of the mails or
any facility of a national securities exchange.” ATSI, 493 F.3d at 101.
“Because a claim for market manipulation requires a showing of
scienter, the PSLRA’s heightened standards for pleading scienter
also apply.” Id. at 102.
Plaintiff’s counsel has previously asserted this theory while
representing other minority shareholders in a different suit against
Xcelera and the Vik defendants, which described the same refusal to
make SEC filings. In a summary order in that case, we affirmed the
district court’s denial of leave to amend the complaint to add
securities law claims, concluding that “[a]bsent any allegation of a
‘going private’ transaction, tender offer, or scheme to take advantage
of depressed share prices, we cannot conclude that [the] urged
inference of scienter is compelling.” Feiner Family Trust v. VBI Corp.,
352 F. App’x 461, 464 (2d Cir. 2009). In this case, the inference of
fraud is strengthened by new allegations regarding the 2010 tender
offer that were absent from the earlier suit, although the scheme
remains somewhat implausible due to the six-year gap between the
alleged decision to depress the stock in 2004 and the effort to
repurchase stock in 2010.
But we need not determine whether the market manipulation
claims are adequately pled because it is plain that these claims are
not timely filed. A securities fraud claim must be filed “not later
than the earlier of—(1) 2 years after the discovery of the facts
7 Nos. 13-1327-cv; 13-1892-cv
constituting the violation; or (2) 5 years after such violation.” 28
U.S.C. § 1658 (emphasis added). Plaintiff argues that the complaint
was filed within two years of the tender offer, which was a fact
necessary to establish scienter, and she points to the Supreme
Court’s discussion of the onset of the two-year period in Merck &
Co., Inc. v. Reynolds, 559 U.S. 633 (2010). But in Merck, “no one
doubt[ed] that [the complaint] was filed within five years of the
alleged violation.” Id. at 638. In this case, the alleged manipulation
commenced with the refusal to make SEC filings from 2004 to 2006,
which is more than five years before the complaint was filed in 2012.
Because the market manipulation claims were untimely, they were
properly dismissed, even though the district court dismissed them
for failure to plead scienter. See Olsen v. Pratt & Whitney Aircraft, 136
F.3d 273, 275 (2d Cir. 1998) (“It is well settled that we may affirm on
any grounds for which there is a record sufficient to permit
conclusions of law, including grounds not relied upon by the district
court.” (internal quotation marks omitted)).
II. Insider Trading Claims
Plaintiff’s insider trading claims are based on the alleged
purchase of Xcelera securities by Xcelera insiders through the tender
offer without disclosing to potential sellers any information about
Xcelera’s financial state. Because the complaint was filed within two
years of the 2010 tender offer (and the purchase of plaintiff’s shares
in 2011), these claims are timely. See 28 U.S.C. § 1658.3
“Under the ‘traditional’ or ‘classical theory’ of insider trading
liability, § 10(b) [15 U.S.C. § 78j(b)] and Rule 10b–5 [17 C.F.R.
§ 240.10b-5] are violated when a corporate insider trades in the
securities of his corporation on the basis of material, nonpublic
3
An even longer statute of limitations applies to plaintiff’s insider
trading claims under section 20A. See 15 U.S.C. § 78t-1(b)(4) (“No action
may be brought under this section more than 5 years after the date of the
last transaction that is the subject of the violation.”).
8 Nos. 13-1327-cv; 13-1892-cv
information.” United States v. O’Hagan, 521 U.S. 642, 651-52 (1997).4
Thus, “a corporate insider must abstain from trading in the shares of
his corporation unless he has first disclosed all material inside
information known to him.” Chiarella v. United States, 445 U.S. 222,
227 (1980). “[I]f disclosure is impracticable or prohibited by business
considerations or by law, the duty is to abstain from trading.” SEC v.
Obus, 693 F.3d 276, 285 (2d Cir. 2012).
To establish an insider trading claim, it is not necessary to
show that corporate insiders used the nonpublic information; it is
sufficient to prove that they traded their corporation’s securities
“while knowingly in possession of the material nonpublic
information.” United States v. Rajaratnam, 719 F.3d 139, 159 (2d Cir.
2013) (internal quotation mark omitted) (quoting United States v.
Teicher, 987 F.2d 112, 119 (2d Cir. 1993)). Additionally, the Supreme
Court has “dispensed with a requirement of positive proof of
reliance, where a duty to disclose material information had been
breached, concluding that the necessary nexus between the
plaintiffs’ injury and the defendant’s wrongful conduct had been
established.” Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988); see also
Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 552 U.S. 148, 159
(2008).
In this case, plaintiff has pled that the defendants are officers,
directors, or controlling shareholders, which plainly makes them
Xcelera insiders.5 According to the complaint, Alexander Vik and
Gustav Vik are directors and officers; Erik Vik’s corporation—
4 The alternative “misappropriation theory” of insider trading, which
targets non-insiders, is not applicable here. See O’Hagan, 521 U.S. at 652.
5 Officers and directors are the “easiest category,” and controlling
shareholders are insiders because they “have the same sort of access to
information as a result of their position of power as the typical officer and
director.” 18 Donald C. Langevoort, Insider Trading Regulation,
Enforcement, and Prevention §§ 3:3-3:4 (2013); see O’Hagan, 521 U.S. at 652;
Chiarella, 445 U.S. at 227.
9 Nos. 13-1327-cv; 13-1892-cv
defendant VBI—is the majority shareholder; Hans Eirik Olav is a
director; and the Vik defendants control shell corporation OFC.
These insiders are alleged to have traded in Xcelera securities
through their control of OFC, when the Vik defendants caused OFC
to purchase plaintiff’s Xcelera stock through the tender offer, with
Olav listed as the contact person. And it is not disputed that
defendants (including OFC) failed to provide any information to
plaintiff about Xcelera’s financial state at any time leading up to her
sale to OFC. Plaintiff thus claims that defendants are liable for OFC’s
actions either as primary violators under section 10(b) or as “control
persons” subject to secondary liability under section 20(a).6
The district court held, however, that defendants had no duty
to disclose any information before trading in Xcelera securities
because the duty to disclose (1) does not apply to unregistered
securities and (2) is defined by the law of the Cayman Islands, under
which Xcelera was formed, and where no such duty exists. Both
conclusions are in error: unregistered securities are not immune
from the duty to disclose, and Cayman law is inapplicable.
First, the duty of corporate insiders to abstain from trading or
to disclose material inside information applies to unregistered
securities. Section 10(b) explicitly applies to “any security registered
on a national securities exchange or any security not so registered.” 15
U.S.C. § 78j(b) (emphasis added). We have explicitly stated that
“closed corporations that purchase their own stock have a special
obligation to disclose to sellers all material information.” Castellano
v. Young & Rubicam, Inc., 257 F.3d 171, 179 (2d Cir. 2001).
Second, we hold that the fiduciary-like duty against insider
trading under section 10(b) is imposed and defined by federal
common law, not the law of the Cayman Islands. While we have not
6
Section 20(a) establishes secondary liability for “[e]very person who,
directly or indirectly, controls any person” directly liable under the
Securities Exchange Act. 15 U.S.C. § 78t(a); see SEC v. First Jersey Sec., Inc.,
101 F.3d 1450, 1472 (2d Cir. 1996).
10 Nos. 13-1327-cv; 13-1892-cv
previously made the source of this duty explicit, we agree with one
district court in this Circuit which concluded that insider trading
cases from this Court and the Supreme Court have implicitly
assumed that the relevant duty springs from federal law, and that
looking to idiosyncratic differences in state law would thwart the
goal of promoting national uniformity in securities markets. See
United States v. Whitman, 904 F. Supp. 2d 363, 369 (S.D.N.Y. 2012)
(collecting cases); see also McClure v. Borne Chem. Co., 292 F.2d 824,
834 (3d Cir. 1961) (“[The Securities Exchange Act] creates many
managerial duties and liabilities unknown to the common law.”); In
re Cady, Roberts & Co., 40 S.E.C. 907, 910 (1961) (“[T]he securities acts
may be said to have generated a wholly new and far-reaching body
of Federal corporation law.”); 18 Langevoort, supra, § 3:2.
Defendants erroneously suggest that holding them subject to
the duty to disclose would impose an affirmative duty on small,
unregistered corporations to disclose audited financial statements.
Under the Securities Exchange Act, “any insider ‘in possession of
material inside information must either disclose it to the investing
public, or, if . . . he chooses not to do so, must abstain from trading in
or recommending the securities concerned while such inside
information remains undisclosed.’” Castellano, 257 F.3d at 179
(emphasis added) (quoting SEC v. Tex. Gulf Sulphur Co., 401 F.2d
833, 848 (2d Cir. 1968) (en banc)). Defendants had no general
affirmative duty to disclose once Xcelera was deregistered by the
SEC, but they could not trade in Xcelera shares based on
undisclosed material inside information that they possessed.
Because the district court erred in concluding that the duty to
disclose or abstain from trading did not apply to defendants, we
vacate the dismissal of both the direct liability claims under section
10(b) and Rule 10b–5 and the “control person” liability claims under
section 20(a). Cf. Ganino v. Citizens Utilities Co., 228 F.3d 154, 170-71
(2d Cir. 2000) (vacating the dismissal of a section 20(a) claim upon
concluding that the district court improperly dismissed claims based
on primary Rule 10b–5 violations).
11 Nos. 13-1327-cv; 13-1892-cv
Plaintiff also brought claims for insider trading under section
20A(a) of the Securities Exchange Act, which provides an express
private right of action for those who trade contemporaneously with
an inside trader. 15 U.S.C. § 78t-1; see generally Jackson Nat’l Life Ins.
Co. v. Merrill Lynch & Co., 32 F.3d 697, 703 (2d Cir. 1994) (concluding
that § 20A liability requires an independent Securities Exchange Act
violation). Because the district court did not address these claims,
we vacate their dismissal and remand for further consideration.7
However, we affirm the dismissal of plaintiff’s claims under
section 14(e) of the Securities Exchange Act, 15 U.S.C. § 78n(e), for
trading on material, nonpublic information in connection with a
tender offer. SEC Rule 14e-3, which imposes liability under section
14(e), states that if “any person” has taken substantial steps toward a
tender offer, then it is unlawful for “any other person who is in
possession of material information relating to such tender offer . . . to
purchase or sell or cause to be purchased and sold any of such
securities.” 17 C.F.R. § 240.14e-3(a) (emphases added). In this case,
the allegation is not that someone possessed material nonpublic
information about the tender offer—it is that the tender offer itself
was made by corporate insiders who possessed material nonpublic
information. The section 14(e) claims were thus properly dismissed.
7
The availability of section 20A in a case such as this appears
unsettled. Compare Fujisawa Pharm. Co. v. Kapoor, 115 F.3d 1332, 1337 (7th
Cir. 1997) (holding that section 20A may not be used by a person in privity
with the insider because “[t]his interpretation would amount to saying
that Congress, in attempting to provide additional relief for victims of
insider trading, had inadvertently enacted a five-year statute of limitations
applicable in effect to a vast number of Rule 10b-5 cases”), with Johnson v.
Aljian, 490 F.3d 778 (9th Cir. 2007) (holding that a 20A claim is actionable
when the predicate 10b-5 claim is time-barred). However, it may be
unnecessary to reach this question because plaintiff has adequately pled
liability under section 10(b), and section 20A provides no additional
remedy. Cf. O’Hagan, 521 U.S. 665 n.11 (finding it unnecessary to address
section 20A(a) when liability exists under section 10(b)).
12 Nos. 13-1327-cv; 13-1892-cv
III. Nonfederal Claims for Breach of Fiduciary Duty
In addition to her claims under the Securities Exchange Act,
plaintiff also alleged that Xcelera, Gustav Vik, Alexander Vik, and
Olav breached their fiduciary duties under Cayman Island law to
Xcelera’s minority shareholders, or aided and abetted the breach of
such duties. After dismissing plaintiff’s federal claims, the district
court declined to exercise supplemental jurisdiction over these
pendent claims and dismissed them without prejudice to refiling in
state court. Because we have reinstated plaintiff’s insider trading
claims, we vacate the dismissal of these nonfederal claims.
CONCLUSION
For the reasons stated above, we AFFIRM the dismissal of
plaintiff’s market manipulation claims and her section 14(e) insider
trading claims; VACATE the dismissal of her insider trading claims
under sections 10(b), 20(a), and 20A(a) of the Securities Exchange
Act and her pendent nonfederal claims for breach of fiduciary duty;
and REMAND for further proceedings consistent with this Opinion.