2001 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

11-16-2001

GFL Advantage Fund v. Colkitt

Precedential or Non-Precedential:

Docket 00-2428

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Recommended Citation

"GFL Advantage Fund v. Colkitt" (2001). 2001 Decisions. Paper 265.

http://digitalcommons.law.villanova.edu/thirdcircuit_2001/265
Filed November 16, 2001 

UNITED STATES COURT OF APPEALS 

FOR THE THIRD CIRCUIT 

No. 00-2428 

GFL ADVANTAGE FUND, LTD., 

a British Virgin Islands Corporation, 

v. 

DOUGLAS R. COLKITT 

Douglas Colkitt 

 Appellant 

On Appeal from the United States District Court 

for the Middle District of Pennsylvania 

(No. 4:CV-97-0526) 

District Judge: Honorable James F. McClure, Jr. 

Argued October 9, 2001 

Before: SCIRICA, GREENBERG and COWEN, 

Circuit Judges 

(Filed: November 16, 2001) 

 Peter S. Russ (argued) 

 Gregory J. Krock 

 Buchanan Ingersoll 

 One Oxford Centre, 20th Floor 

 301 Grant Street 

 Pittsburgh, PA 15219-1410 

 Attorneys for Appellee 
 Peter Konolige 

 Marcy L. Colkitt & Associates, P.C. 

 983 The Woods, Suite 618 

 Old Eagle School Road 

 Wayne, PA 19087 

 James P. Kimmel, Jr. (argued) 

 P.O. Box 1139 

 Kennett Square, PA 19348 

 Attorneys for Appellant 

OPINION OF THE COURT 

GREENBERG, Circuit Judge: 

This matter comes on before this court on defendant

Douglas R. Colkitt's appeal from the district court's order 

for summary judgment in favor of plaintiff GFL Advantage 

Fund, Ltd. against Colkitt entered on April 25, 2000, and 

on appeal from an order entered on July 17, 2000, denying 

reconsideration of the April 25 order. For the reasons stated 

herein, we will affirm the orders of the district court. 

I. BACKGROUND 

A. FACTUAL HISTORY 

Douglas Colkitt, who earned both his medical degree and 

MBA from the University of Pennsylvania in 1979, is the 

founder and majority shareholder of two small 

capitalization medical services businesses -- EquiMed, Inc. 

("EquiMed") and National Medical Financial Services

Corporation ("National Medical"). As of February 1996, 

Colkitt held 20,783,633 (73%) of EquiMed's 28,589,717 

outstanding shares of common stock, and as of May 1996, 

he owned 2.8 million (38%) of National Medical's 7,426,844 

outstanding shares of common stock. See GFL Advantage 

Fund, Ltd. v. Colkitt, No. 4:CV-97-0526, Memorandum and 

Order at 4 (M.D. Pa. July 17, 2000). 

Beginning in 1996, Colkitt sought financing to pursue 

various business ventures unrelated to EquiMed and 

 2 
National Medical. After unsuccessfully attempting to secure 

financing from traditional commercial lending institutions, 

Colkitt contacted alternative lenders that might be willing 

to structure "convertible or exchange transactions," 

whereby Colkitt would be able immediately to convert his 

vast stockholdings into cash. In particular, Colkitt 

endeavored to borrow money by pledging his common stock 

as collateral and providing the lender with the right to 

convert or exchange the debt for the shares pledged by 

Colkitt. 

In the spring of 1996, Colkitt's broker identified GFL 

Advantage Fund, Ltd. ("GFL") as a possible lender, and on 

May 24, 1996, Colkitt obtained a loan of $3,000,000 from 

GFL. Under the terms of the note ("National Medical note"), 

GFL had the right after 30 days of the date of the note to 

exchange up to $1.5 million of its outstanding principal for 

shares of National Medical stock held by Colkitt at an 

exchange rate of 82% of the average market price. GFL 

could exchange the remainder of the unpaid balance for 

shares of National Medical 60 days after the date of the 

note. The average market price was computed by taking the 

average of the stock's closing prices for the five days 

immediately prior to the exchange request. In essence, the 

note gave GFL the right to require Colkitt to repay the loan 

with National Medical stock valued at a discount of 18% of 

the five-day average closing price, thus giving GFL an 

immediate paper profit as it would receive stock with a 

premium value to repay a debt of a lesser amount. 

Several months later on August 5, 1996, Colkitt entered 

into a similar transaction with GFL for a $10,000,000 loan. 

The structure of the second note ("EquiMed note") was akin 

to that of the National Medical note, except the parties 

agreed that GFL could convert the debt into shares of 

Colkitt's other business, EquiMed, Inc., at an exchange rate 

of 83% of the average market price. In addition, GFL could 

convert up to $5 million of the outstanding principal after 

60 days of the date of the note and could convert the 

balance of the principal 30 days thereafter. 

Nearly four months after issuing the initial $3,000,000 

loan to Colkitt, GFL made its first of six exchange demands 

for National Medical stock. On September 13, 1996, GFL 

 3 
exchanged $250,000 of debt for 34,130 shares of National 

Medical stock at the average market price of $9.20 and an 

exchange or conversion price of $7.32. On September 19, 

1996, GFL exchanged $135,000 of loan principal for 18,726 

shares at an average market price of $9.075 and a 

conversion price of $7.21. On October 10, 1996, GFL

converted $257,000 of debt into 47,081 shares at an

average closing price of $6.925 and a conversion price of 

$5.46. On December 5, 1996, GFL exchanged $100,000 of 

unpaid principal for 14,845 shares at an average market 

price of $8.725 and an exchange price of $6.74. On 

December 19, 1996, GFL converted $200,000 of debt into 

34,588 shares at an average market price of $7.525 and a 

conversion price of $5.78. Finally, on January 7, 1997, GFL 

demanded an exchange of $545,000 of loan principal for 

100,223 shares, but the request was withdrawn after

Colkitt dishonored GFL's earlier exchange demand for 

EquiMed stock. 

GFL waited until November 1996, more than 3 months 

after the date of the EquiMed note, before making its first 

exchange demand for EquiMed shares. On November 27,

1996, GFL demanded that Colkitt convert $560,000 in

outstanding principal into EquiMed stock. With a five-day 

average closing price of $4.50, GFL received 150,555 shares 

of EquiMed at an exchange rate price of $3.72. GFL's next 

exchange demand for EquiMed stock occurred on January 

3, 1997, when GFL sought to convert $1,430,000 in unpaid 

principal, but Colkitt dishonored the request. 

Unknown to Colkitt at the time, and on the same day in 

September 1996 as GFL's first exchange demand for 

National Medical stock, GFL began short selling National 

Medical stock. As we have explained: 

 Short selling is accomplished by selling stock which 

 the investor does not yet own; normally this is done by 

 borrowing shares from a broker at an agreed upon fee 

 or rate of interest . . . . The short seller is obligated, 

 however, to buy an equivalent number of shares in 

 order to return the borrowed shares . . . . Herein lies 

 the short seller's potential for profit: if the price of 

 stock declines after the short sale, he does not need all 

 the funds to make this covering purchase; the short 

 4 
 seller then pockets the difference. On the other hand, 

 there is no limit to the short seller's potential loss: if 

 the price of the stock rises, so too does the short 

 seller's loss, and since there is no cap to a stock's 

 price, there is no limitation on the short seller's risk. 

Zlotnick v. Tie Communications, 836 F.2d 818, 820 (3d Cir. 

1988). See also 17 C.F.R. S 240.3b-3 (defining short sale as 

"any sale of a security which the seller does not own or any 

sale which is consummated by the delivery of a security 

borrowed by, or for the account of, the seller"); Black's Law 

Dictionary 1339 (7th ed. 1999) (defining short sale as the 

"sale of a security that the seller does not own or has not 

contracted for at the time of sale, and that the seller must 

borrow to make delivery"). In other words, short sellers are 

betting that the stock price will decline between the time 

they sell the borrowed stock and the time they must

"cover," i.e., purchase replacement shares to repay the 

borrowed stock. Short selling, which is closely regulated, 

see, e.g., 17 C.F.R. S 240.10a-1, is a legitimate trading 

strategy for stocks that traders believe are overvalued. 

GFL's first short sale of National Medical stock occurred 

on September 13, 1996, when it sold 32,500 shares at a 

price of $10.00 per share. On September 16, 1996, GFL 

sold short 15,000 shares of National Medical at $9.13 per 

share. On September 17, 1996, GFL sold short 5,000 

shares at $9.25 per share. On October 11, 1996, GFL sold 

short 3,000 shares at $8.25 per share. Finally, on October 

14, 1996, GFL sold short 7,000 shares of National Medical 

at $8.25 per share. GFL sold short a total of 62,500 shares 

of National Medical stock over a one-month period. 

GFL also sold EquiMed shares short. On November 8, 

1996, GFL sold short a total of 18,400 shares of EquiMed 

-- 10,000 shares at $5.50 per share and 8,400 shares at 

$5.48 per share. On November 11, 1996, GFL sold short 

32,500 shares at $5.38 per share. On November 12, 1996, 

GFL sold short 16,000 shares at $5.25 per share. On

November 14, 1996, GFL sold short 8,500 shares at $5.25 

per share. Finally, on November 22, 1996, GFL sold short 

3,300 shares of EquiMed stock at $5.00 per share. Over 

this two-week period in November 1996, GFL sold short a 

total of 78,700 shares of EquiMed stock. 

 5 
GFL explains that it engaged in short sales of National 

Medical and EquiMed stock as a hedging strategy against 

"delivery risk." Under the terms of the notes, the exchange 

price was based on the average closing price during the five 

trading days preceding the exchange request. 

Consequently, the exchange price was locked in on the date 

of the exchange request, thus shifting onto GFL the risk 

that the stock's price would drop more than the 17% or 

18% discount. In other words, "if the stock price dropped 

more than the agreed-upon discount before GFL was able 

to sell the exchanged shares, GFL would be in a loss 

position." Br. of Appellee at 7. GFL claims it sold short to 

protect itself in the event that the price of the stock 

declined further after GFL made the exchange request but 

before GFL was able to sell the shares. 

The theory of Colkitt's case, however, is that GFL sold 

National Medical and EquiMed shares short in an effort to 

depress the prices of the stocks. Indeed, Colkitt contends 

that the market price of National Medical dropped 17.5% 

between GFL's first and last short sales of National Medical 

stock, and that the market price of EquiMed declined by 

18.5% between GFL's first short sale of EquiMed stock and 

GFL's first exchange demand.1 Colkitt argues that GFL 

purposely depressed the stock prices so that Colkitt would 

be forced to exchange more shares to retire the same 

amount of debt. He asserts that GFL was able to obtain an 

additional 27,882 shares of EquiMed and an additional 

11,658 shares of National Medical due to the respective 

declines in the stocks' prices. 

_________________________________________________________________ 

1. Inexplicably, Colkitt measures the price decline of EquiMed stock 

during the period between GFL's first short sale on November 8, 1996, 

and GFL's first exchange demand on November 27, 1996, rather than 

between GFL's first short sale on November 8, 1996, and its last short 

sale on November 22, 1996. As GFL points out, however, if the price 

decline of EquiMed stock is measured during the period between GFL's 

first and last short sales, EquiMed's price drop would be approximately 

2%. See Br. of Appellee at 36. More specifically, the price of EquiMed on 

the day of the first short trade on November 8 was $5.25 per share, 

whereas the price on the day of the last short sale on November 22 was 

$5.13. See id. at 36 n.13. This $.12 drop represents only a 2.3% 

decrease. 

 6 
As noted above, Colkitt refused to honor GFL's exchange 

request for EquiMed shares on January 3, 1997. Instead, 

Colkitt notified GFL in December 1996 and early January 

1997 that he intended to prepay all unpaid principal and 

interest in cash. Colkitt contends that GFL improperly 

rejected his request to prepay the unpaid balance, even 

though the notes contemplated such prepayment. GFL 

responds that it did not reject outright Colkitt's offer to 

prepay, but rather refused to allow Colkitt to dictate the 

terms of any prepayment and disagreed with Colkitt about 

the amounts due. GFL admits that it does not believe that 

Colkitt had a right to prepay, but insists that it"accepted 

Colkitt's offer to prepay whatever amount Colkitt believed 

was then due, reserving for itself the right to contest the 

disputed balance." Br. of Appellee at 13. GFL claims that 

Colkitt neither responded to its overtures nor attempted to 

prepay or pay any amounts to GFL. 

B. PROCEDURAL HISTORY 

On April 4, 1997, GFL filed a complaint against Colkitt 

alleging breach of his obligations on the National Medical 

and EquiMed notes. On June 6, 1997, Colkitt filed an 

answer, affirmative defenses, and six counterclaims. The 

affirmative defenses and counterclaims alleged, inter alia, 

that GFL engaged in securities fraud and market 

manipulation in violation of various federal and state 

securities laws by temporarily depressing the prices of 

National Medical and EquiMed stock through its 

concentrated short sales. Colkitt claimed that GFL engaged 

in the scheme so that it could exchange debt for shares at 

an artificially low price and earn enormous windfall profits 

when prices returned to their normal levels. On March 31, 

1998, the district court adopted a magistrate judge's 

recommendations that Colkitt's counterclaims be 

dismissed. The district court dismissed one counterclaim 

with prejudice and the balance without prejudice. 2 On April 

_________________________________________________________________ 

2. The Court dismissed counterclaims I (Section 10(b) of the Security 

Exchange Act of 1934 and Rule 10b-5 under the Act), III (Section 29 of 

the Securities Exchange Act of 1934), IV (Pennsylvania Securities Act), 

and V (common law fraud) without prejudice for lack of specificity. The 

court dismissed counterclaim II (Section 17 of the Securities Act of 1933) 

 7 
20, 1998, Colkitt filed amended counterclaims in an effort 

to cure the deficiencies of the original counterclaims, but 

on February 2, 1999, the district court again dismissed 

Colkitt's inadequately pled counterclaims without prejudice 

for lack of specificity. 

On April 25, 2000, the district court granted summary 

judgment in favor of GFL based largely on the reasoning of 

In re Olympia Brewing Co. Securities Litigation , 613 F. 

Supp. 1286 (N.D. Ill. 1985). The court concluded that, 

because short selling is not an unlawful trading practice, it 

would not draw the inference that GFL manipulated the 

market price of EquiMed and National Medical stocks

simply because GFL engaged in substantial short selling of 

the stocks. The court also determined that Colkitt failed to 

present evidence that GFL's short sales had an appreciable 

effect on the prices of the stocks. Finally, the court 

concluded that even if the short sales did depress prices, 

Colkitt failed to show that "the declines in price are 

attributable to false information injected into the market by 

the short sales and not to information otherwise available 

to the market." GFL Advantage Fund, Ltd. v. Colkitt, No. 

4:CV-97-0526, Memorandum and Order at 22 (M.D. Pa. 

Apr. 25, 2000). 

On July 17, 2000, the district court denied Colkitt's 

motion for reconsideration and entered final judgment in 

favor of GFL. The court clarified its earlier ruling on GFL's 

motion for summary judgment, explaining that the evidence 

of GFL's short sales alone was insufficient to establish 

Colkitt's claims of securities fraud and market 

manipulation because selling stocks short is lawful. The 

court declared that "[t]here must be some circumstances 

beyond the mere occurrence of short sales to suggest that 

_________________________________________________________________ 

with prejudice, subject to reinstatement in the event that we recognize a 

private right of action under Section 17 of the Securities Act of 1933, 15 

U.S.C. S 77q(a). The court dismissed counterclaim count VI (unjust 

enrichment) without prejudice because the equitable remedy of unjust 

enrichment is not available when a contract exists between the parties. 

Although the court initially dismissed count VI with prejudice, the court 

concluded on reconsideration that the order was in error and changed 

the dismissal to a dismissal without prejudice. 

 8 
the short sales were part of a scheme to manipulate the 

market," which Colkitt failed to proffer. GFL Advantage 

Fund, Ltd. v. Colkitt, No. 4:CV-97-0526, Memorandum and 

Order at 14 (M.D. Pa. July 17, 2000). The court then 

proceeded to reject Colkitt's argument that numerous 

inferences that he believed should be drawn from the 

factual record created genuine issues of material fact that 

precluded summary judgment. The court refused to accept 

any of Colkitt's proffered inferences -- each of which Colkitt 

has raised on appeal -- and reaffirmed its decision that 

GFL was entitled to summary judgment as a matter of law. 

II. JURISDICTION AND STANDARD OF REVIEW 

A. JURISDICTION 

The district court had subject matter jurisdiction over 

GFL's breach of contract action pursuant to 28 U.S.C. 

S 1332 based upon diversity of the parties and the amount 

in controversy. The district court entered final judgment in 

this case on July 17, 2000, and appellant filed a timely 

notice of appeal on August 15, 2000. Therefore, we have 

jurisdiction pursuant to 28 U.S.C. S 1291. 3 

_________________________________________________________________ 

3. As noted above, the district court twice dismissed certain of Colkitt's 

counterclaims without prejudice for lack of specificity. In some 

circumstances, such a dismissal could deprive us of appellate 

jurisdiction as "ordinarily we do not have jurisdiction under 28 U.S.C. 

S 1291 of an appeal from an order partially adjudicating a case when an 

appellant has asserted a claim in district court which it has withdrawn 

or dismissed without prejudice." Erie County Retirees Ass'n v. County of 

Erie, 220 F.3d 193, 201 (3d Cir. 2000). Our case law, however, allows us 

to exercise appellate jurisdiction under 28 U.S.C.S 1291 when the 

district court has divested itself of the case entirely. See id. at 202. 

Here, 

although the district court's orders dismissed Colkitt's counterclaims 

without prejudice, the court's summary judgment order effectively barred 

Colkitt from re-filing them, for the court concluded that Colkitt's 

affirmative defenses -- which were identical to his counterclaims -- 

failed as a matter of law. Consequently, the court's order granting 

summary judgment in favor of GFL terminated the suit so far as the 

court was concerned. See Trent v. Dial Med. of Fla., Inc., 33 F.3d 217, 

220 (3d Cir. 1994) ("Even dismissals without prejudice have been held to 

be final and appealable if they `end [ ] [the] suit so far as the District 

Court was concerned . . . .' ") (citation omitted). Therefore, we have 

jurisdiction over this appeal. 

 9 
B. STANDARD OF REVIEW 

We review the district court's grant of summary judgment 

de novo and apply the same standard as the district court 

applied in the first instance. See Lucent Info. Mgmt., Inc. v. 

Lucent Tech., Inc., 186 F.3d 311, 315 (3d Cir. 1999). We 

may affirm summary judgment in favor of GFL only if, after 

drawing all reasonable inferences from the record in the 

light most favorable to Colkitt, "there is no genuine issue as 

to any material fact" and GFL is "entitled to a judgment as 

a matter of law." Fed. R. Civ. P. 56(c). As the nonmoving 

party, Colkitt must create a genuine issue of material fact 

by presenting sufficient evidence to permit a jury to find in 

his favor. See Anderson v. Liberty Lobby, Inc. , 477 U.S. 242, 

248, 106 S. Ct. 2505, 2510 (1986). To defeat summary 

judgment, he "cannot rest simply on the allegations in the 

pleadings," but "must rely on affidavits, depositions, 

answers to interrogatories, or admissions on file." Bhatla v. 

U.S. Capital Corp., 990 F.2d 780, 787 (3d Cir. 1993). 

Therefore, it will be appropriate to affirm summary

judgment for GFL if we conclude that there is insufficient 

evidence for a reasonable jury to return a verdict for 

Colkitt. 

III. DISCUSSION 

A. RESCISSION OF THE NOTES PURSUANT TO SECTION 

29 

Colkitt contends that the National Medical and EquiMed 

notes are unenforceable by reason of Section 29 of the 

Securities Exchange Act of 1934 ("Exchange Act") because 

GFL violated the anti-fraud provisions under Section 10(b) 

of the Exchange Act and Rule 10b-5 promulgated 

thereunder. Section 29(b) provides in relevant part that: 

 Every contract made in violation of any provision of this 

 chapter or of any rule or regulation thereunder, . .. [or] 

 the performance of which involves the violation of, or 

 the continuance of any relationship or practice in 

 violation of, any provision of this chapter or any rule or 

 regulation thereunder, shall be void. 

15 U.S.C. S 78cc(b) (emphasis added). Colkitt argues that 

GFL violated Section 10(b) and Rule 10b-5 when it engaged 

 10 
in market manipulation by short selling National Medical 

and EquiMed stock in an effort to depress the share prices, 

and when it engaged in fraudulent deception by concealing 

its plan to short sell National Medical and EquiMed stock. 

See Br. of Appellant at 24. Colkitt asserts that the notes are 

void and unenforceable under Section 29(b) because the 

notes were "made in violation of" Section 10(b) and Rule 

10b-5 insofar as (1) they were part of GFL's scheme to 

manipulate the market prices of National Medical and 

EquiMed stock and (2) they contain omissions of material 

fact about GFL's short selling strategy. See Reply Br. of 

Appellant at 19. 

GFL argues that Colkitt's Section 29(b) affirmative

defense fails for two reasons. First, Section 29(b) is a 

remedial provision that is triggered only when another 

section of the Exchange Act has been violated. As 

addressed below, GFL maintains that it did not engage in 

either market manipulation or securities fraud in violation 

of Section 10(b), and therefore, there is no underlying 

offense to trigger Section 29(b). See infra pp. 17-36. Second, 

GFL contends that Colkitt fails to state a proper Section 

29(b) defense inasmuch as Colkitt alleges that it is GFL's 

short selling, not the National Medical and EquiMed notes, 

that is unlawful. GFL argues that only "unlawful contracts," 

not "unlawful transactions" executed pursuant to lawful 

contracts, may be rescinded under Section 29(b). 

We deal with GFL's second contention first, which is 

supported by the limited body of case law on the point. For 

instance, in Slomiak v. Bear Stearns & Co., 597 F. Supp. 

676, 677 (S.D.N.Y. 1984), plaintiff opened a margin account 

and a repurchase account with defendant Bear Stearns. He 

purchased millions of dollars of government bonds in his 

margin account -- less than 10% with cash and the 

remainder with loans by Bear Stearns. See id. When

plaintiff was notified of a margin call on his account and 

failed to muster the $155,000 in additional margin 

demanded, Bear Stearns liquidated the government bonds 

in plaintiff's account. See id. Plaintiff alleged that Bear 

Stearns violated Section 10(b) and Rule 10b-16 by failing to 

provide him at the time he opened his accounts with a 

written statement explaining the terms under which Bear 

 11 
Stearns would extend him credit. See id. Based on these 

alleged violations, plaintiff sought to rescind all of his bond 

transactions pursuant to Section 29(b). See id. at 681. The 

court concluded that plaintiff could not rescind the 

transactions, explaining: 

 The complaint alleges that Bear Stearns failed to send 

 plaintiff a written credit disclosure statement in 

 violation of Rule 10b-16 at the time he opened his 

 accounts; it does not allege that the customer 

 agreements establishing his margin and repurchase 

 accounts at Bear Stearns were themselves unlawful 

 . . . . `[U]nder S 29 of the Exchange Act, only unlawful 

 contracts may be rescinded, not unlawful transactions 

 made pursuant to lawful contracts.' 

Id. at 681-82 (quoting Zerman v. Jacobs , 510 F. Supp. 132, 

135 (S.D.N.Y. 1981), aff'd, 672 F.2d 901 (2d Cir. 1981) 

(table)). Because Bear Stearns's alleged violation of Rule 

10b-16 was "clearly collateral to the contract agreement 

governing the account," the court determined that the 

firm's failure to provide the written statement to plaintiff 

did "not justify rescission of the account agreement itself or 

the transactions undertaken pursuant to that agreement." 

Id. at 682-83. 

In Drasner v. Thomson McKinnon Securities, Inc. , 433 F. 

Supp. 485, 488-89 (S.D.N.Y. 1977), plaintiffs maintained 

margin accounts with defendant Thomson McKinnon 

Securities between 1973 and 1975. Plaintiffs began selling 

naked options in 1974 and profited handsomely off the 

transactions until 1975, when the market began spiking 

upward. See id. Between January and May 1975, plaintiffs 

incurred substantial losses on their options until Thomson 

McKinnon finally closed their accounts and liquidated their 

collateral. See id. at 489. Plaintiffs sought to rescind the 

options contracts pursuant to Section 29(b) because

Thomson McKinnon allegedly violated Regulation T by

failing to direct plaintiffs to deposit the required amount of 

initial margin in their accounts. See id. The court rejected 

plaintiffs' claim, stating that Section 29(b) "only renders 

void those contracts which by their terms violate the Act or 

the rules and regulations thereunder . . . for it is only such 

contracts which are `made in violation of,' or`the 

 12 
performance of which involves the violation of' the statute 

and the rules and regulations thereunder." Id. at 501-02. 

The court explained that even if Thomson McKinnon had 

violated Regulation T, Section 29(b) was inapplicable 

because the options contracts that plaintiffs sought to 

rescind were governed by a valid, lawful contract whose 

terms did not violate the Exchange Act or any regulations 

promulgated thereunder. See id. at 502. 

Colkitt responds to GFL's argument by citing Regional 

Properties, Inc. v. Financial and Real Estate Consulting Co., 

678 F.2d 552, 560 (5th Cir. 1982), which challenges

Drasner's narrow construction of Section 29(b). In Regional 

Properties, two real estate entrepreneurs brought suit 

against their broker and his firm, Financial and Real Estate 

Consulting Co. ("Financial"), alleging that the broker had 

violated Section 15(a)(1) of the Exchange Act by selling 

limited partnership interests for them without having 

registered with the SEC as a broker-dealer. See id. at 556. 

The entrepreneurs and their affiliated corporations sought 

to rescind their agreements with Financial pursuant to 

Section 29(b) in light of the broker's violations of Section 

15(a)(1). See id. The court rejected Drasner's conclusion 

that Section 29(b) renders void only those contracts that 

"by their terms" violate the Exchange Act and instead 

interpreted Section 29(b) as "render[ing] voidable those 

contracts that are either illegal when made or as in fact 

performed." Id. at 560. The court concluded that rescission 

was proper because, although plaintiffs sought to avoid 

contracts that were "perfectly lawful on their face," the 

performance of the contracts by Financial nevertheless 

"resulted in a violation of the Act." Id. at 561. The court 

added: "That these contracts, under different 

circumstances, could have been performed without 

violating the Act is immaterial." Id. 

Although the court of appeals in Regional Properties 

rescinded the contracts therein and explicitly rejected 

Drasner's narrow reading of Section 29(b), its opinion is 

nevertheless consistent with the outcomes in Drasner, 

Slomiak, and Zerman. In particular, the violations of the 

Exchange Act alleged in Drasner, Slomiak , and Zerman were 

"collateral or tangential to the contract between the 

 13 
parties," whereas the violation alleged in Regional Properties 

was "inseparable from the performance of the contract" that 

plaintiffs were attempting to void. Slomiak, 597 F. Supp. at 

682. The parties could -- and did -- perform the contracts 

at issue in Drasner, Slomiak, and Zerman without 

committing any violations of the Exchange Act, but the 

broker in Regional Properties could not carry out his 

obligations under the agreements without violating the 

Exchange Act, for performance of the agreements entailed 

selling partnership interests, which the broker lawfully 

could not do due to his failure to register as a brokerdealer. 

The other two cases cited by Colkitt are also consistent 

with this analysis. In both cases, the courts voided loan 

agreements because the banks violated Regulation U, which 

governs the amount of money that a bank can lend for the 

purchase of registered securities. In Grove v. First National 

Bank of Herminie, 489 F.2d 512, 513 (3d Cir. 1974) (per 

curiam), bank employees failed to explain to plaintiff that 

under federal law, the bank "could lend only a certain 

percentage of the market value of stock to purchase

registered securities." Concluding that the bank had 

violated Regulation U, we held that Section 29(b) precluded 

the bank from recovering a deficiency, "even if the borrower 

knowingly and intentionally deceives the bank as to the 

actual purposes of the loans." Id. at 516. 

In Stonehill v. Security National Bank, 68 F.R.D. 24, 28 

(S.D.N.Y. 1975), a bank sought to recover the outstanding 

balance on a loan, but the borrower claimed that the loan 

was void and unenforceable because the bank issued the 

loan in violation of Regulation U. The bank argued that 

even if the borrower's obligations were void due to the 

bank's alleged violation of Regulation U, it still could 

recover from the guarantor. See id. at 33. The court 

disagreed, holding that "if the principal obligation violates 

Regulation U, a guarantee of that obligation is void under 

S 29(b) of the Exchange Act." Id. The court explained that 

"allow[ing] a bank to recover on a guarantee even though 

the underlying loan violated Regulation U would encourage 

banks to extend credit in violation of the margin 

requirements." Id. at 34. 

 14 
As with the violation of Section 15(a)(1) in Regional 

Properties, the violations of Regulation U in Grove and 

Stonehill were inseparable from the underlying agreements 

between the parties: the banks could not perform their 

obligations under the loan agreements (i.e., lend money to 

the borrowers so that they could purchase securities) 

without violating Regulation U. In fact, the loans were 

"made in violation of" the Exchange Act because a greater 

percentage of the loans was used to purchase securities 

than is allowed under Regulation U. 

The same cannot be said for GFL's obligations under the 

National Medical and EquiMed notes in this case. GFL's 

allegedly unlawful short sales of National Medical and 

EquiMed stock were nothing more than "collateral or

tangential" to the notes. Colkitt insists that performance of 

the contracts "involves a violation of" securities laws 

because "performance itself (exchange of shares and

repayment of the loan plus interest) . . . supports GFL's 

illegal short selling by giving GFL shares with which to 

cover the short sales." Br. of Appellant at 25 n.8. Despite 

the theory of Colkitt's case, however, GFL's short sales are 

completely independent of the parties' respective obligations 

under the terms of the notes -- namely, GFL's obligation to 

lend Colkitt a total of $13,000,000, and Colkitt's obligation 

to repay the loans at GFL's option with shares of National 

Medical and EquiMed stock. In the end, GFL's alleged 

unlawful activity (i.e., its short sales) is too attenuated from 

the parties' valid, lawful contracts (i.e., the National Medical 

and EquiMed notes) or GFL's performance thereunder.

Therefore, we conclude that the notes were neither made 

nor performed in violation of any federal securities laws as 

is required for rescission under Section 29(b). 4 

B. MARKET MANIPULATION 

Colkitt argues that the district court erred in rejecting his 

affirmative defense that the notes are void pursuant to 

Section 29(b) due to GFL's alleged market manipulation, as 

_________________________________________________________________ 

4. Notwithstanding our conclusions as to the scope of Section 29(b), we 

will discuss the market manipulation and securities fraud issues as our 

conclusions on them are critical to our disposition of Colkitt's appeal 

from the dismissal of his counterclaims. See supra note 3. 

 15 
there exist genuine issues of material fact regarding 

whether GFL's short sales constituted market manipulation 

in violation of Section 10(b) and Rule 10b-5. GFL argues, 

however, that Colkitt has not presented enough evidence to 

create triable issues on any of the elements of market 

manipulation.5 

_________________________________________________________________ 

5. GFL also insists that Colkitt cannot obtain reversal of summary 

judgment with respect to GFL's alleged manipulation of National 

Medical's price because Colkitt abandoned his market manipulation and 

securities fraud claims with respect to National Medical by conceding 

that GFL's short sales of National Medical stock did not violate any 

securities laws. See Br. of Appellee at 19-21. To support its contention, 

GFL quotes a passage from Colkitt's opposition to GFL's motion for 

summary judgment, which states that "[t]he short selling of National 

Medical presents an interesting contrast to the short selling of EquiMed." 

Id. at 20 (quoting Colkitt's Brief in Opposition to Summary Judgment at 

6 (App. 000837)). GFL claims that this statement, along with other 

unspecified passages in Colkitt's opposition and his motion for 

reconsideration, led the district court to limit its rulings to only the 

EquiMed note. 

GFL's argument is without merit. A review of the district court's April 

25, 2000 Memorandum reveals that the court addressed Colkitt's market 

manipulation and securities fraud claims as to both EquiMed and 

National Medical. Indeed, National Medical is mentioned throughout the 

district court's summary judgment and reconsideration rulings. There is 

no indication in the district court's rulings that Colkitt abandoned these 

claims or that the court limited its rulings to only the EquiMed note. 

GFL also distorts the meaning of the above-quoted passage by taking 

it out of context. When Colkitt admitted that the short sales of National 

Medical differed in some respects to the short sales of EquiMed, he was 

referring only to GFL's contention that it engaged in the short sales as 

a hedging strategy. As will be explained in more detail below, see infra 

pp. 28-30, Colkitt's expert maintains that selling short prior to the 

fiveday period before the exchange demand is not a legitimate hedging 

strategy, but instead an attempt to profit from declining stock prices. 

The expert insists that if GFL were only trying to hedge against a 

possible drop in price after the exchange demand (so-called "delivery 

risk"), GFL could have eliminated that risk by selling short during the 

five-day period before the exchange demand -- in essence, locking in the 

sale price during the same period the average closing price would be 

calculated. Colkitt's statement was simply an "acknowledgment that, 

unlike the EquiMed shorts, the National Medical shorts, by their timing, 

could at least qualify as a hedge strategy" because they were made 

 16 
1. Elements of Market Manipulation Under Section 10(b) 

and Rule 10b-5 

As an initial matter, the parties disagree about the specific 

elements of market manipulation under Section 10(b) and 

Rule 10b-5. To complicate matters further, we seemed not 

to have addressed squarely what elements are required to 

establish a claim of market manipulation, particularly in 

the context of a Section 29(b) affirmative defense, and the 

case law from other courts of appeals and district courts on 

this issue provides limited guidance. Section 10(b) states in 

relevant part that "[i]t shall be unlawful for any person 

. . . [t]o 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" promulgated by the SEC. 15 U.S.C.S 78j. Rule 

10b-5 provides in relevant part that "[i]t shall be unlawful 

for any person . . . [t]o employ any device, scheme, or 

artifice to defraud." 17 C.F.R. S 240.10b-5. 

Noting that Section 10(b) outlaws but does not define a 

"manipulative or deceptive device or contrivance," Colkitt 

turns to Section 9(a) of the Exchange Act to determine the 

elements of the offense of market manipulation. Section 

9(a) prohibits individuals from effecting "a series of 

transactions in any security registered on a national 

securities exchange . . . creating actual or apparent active 

trading in such security, or raising or depressing the price 

of such security, for the purpose of inducing the purchase 

or sale of such security by others." 15 U.S.C.S 78i(a)(2). 

Based on this passage and the Supreme Court's decision in 

Aaron v. SEC, 446 U.S. 680, 695, 100 S.Ct. 1945, 1955 

(1980), in which the Court recognized scienter as an 

element of a Section 10(b) claim, Colkitt maintains that 

summary judgment was improper because he created 

genuine issues with respect to each of the following 

_________________________________________________________________ 

within the days immediately preceding GFL's exchange demands for 

National Medical stock. Reply Br. of Appellant at 5. This narrow 

admission cannot be construed as a complete waiver of his 

counterclaims and affirmative defenses with respect to the National 

Medical note. 

 17 
elements of market manipulation: (1) GFL engaged in a 

series of transactions in the registered securities; (2) the 

purpose of GFL's short sales was to induce others to sell 

the securities; (3) GFL's short sales created "actual or 

apparent active trading" in the securities or depressed the 

prices of the securities; and (4) GFL acted with scienter. 

GFL responds that Colkitt has mischaracterized the 

elements of market manipulation by applying an overly 

broad description of prohibited activities set forth under 

Section 9(a) and by ignoring the specific requirements of 

market manipulation that have evolved over time. GFL 

points out that market manipulation is "virtually a term of 

art when used in connection with the securities market. It 

connotes intentional and willful conduct designed to 

deceive or defraud investors by controlling or artificially 

affecting the price of securities." Ernst & Ernst v. 

Hochfelder, 425 U.S. 185, 199, 96 S.Ct. 1375, 1384 (1976). 

GFL asserts that Colkitt disregards two necessary elements 

of a market manipulation claim -- that "GFL injected 

inaccurate information into the marketplace" and that 

GFL's conduct "affected the price" of National Medical and 

EquiMed stock. Br. of Appellee at 24. 

The first disputed element is whether Colkitt must 

demonstrate that GFL injected inaccurate information into 

the marketplace or created a false impression of market 

activity. Like the district court, GFL relies on Olympia 

Brewing, 613 F. Supp. at 1292, in which the district court 

emphasized that the "essential element" of a market

manipulation claim is the injection of "inaccurate 

information" into the market. GFL observes that even the 

cases cited by Colkitt "recognize that market manipulation 

requires an additional element, something beyond 

otherwise legal trading, which specifically injects false 

information into the market and/or creates an artificial 

demand for the underlying security." Br. of Appellee at 22 

(emphasis added). Colkitt responds, however, that he is not 

required to present evidence that "GFL injected affirmative 

misinformation into the market," but only needs to 

demonstrate that "GFL's short trades were made for the 

undisclosed purpose of artificially depressing share prices." 

Reply Br. of Appellant at 9 (emphasis added). 

 18 
Notwithstanding Colkitt's assertion to the contrary, the 

parties appear to be in accord on this point. Indeed, the 

difference between their positions seems to be one without 

distinction. Both GFL and Colkitt focus on the need to 

demonstrate that some action was taken to artificially 

depress or inflate prices, whether by purposely making 

false statements or by employing illegitimate, deceptive 

trading techniques that mislead investors about the price or 

demand for a stock. 

To the extent that the parties' respective positions are at 

odds, however, GFL advances a sounder construction of a 

Section 10(b) market manipulation claim, for it is less 

vague than Colkitt's. The Supreme Court has indicated that 

market manipulation "generally refers to practices, such as 

wash sales, matched orders, or rigged prices, that are 

intended to mislead investors by artificially affecting market 

activity." Santa Fe Indus. v. Green, 430 U.S. 462, 476, 97 

S.Ct. 1292, 1302 (1977). "The gravamen of manipulation is 

deception of investors into believing that prices at which 

they purchase and sell securities are determined by the 

natural interplay of supply and demand, not rigged by 

manipulators." Gurary v. Winehouse, 190 F.3d 37, 45 (2d 

Cir. 1999). In that vein, courts must distinguish between 

legitimate trading strategies intended to anticipate and 

respond to prevailing market forces and those designed to 

manipulate prices and deceive purchasers and sellers. 

Although Colkitt's construction properly reflects the 

aspiration of Section 10(b) of preventing market activities 

that artificially depress prices, it provides little guidance on 

which activities artificially affect prices and which activities 

legitimately impact prices. 

Requiring a Section 10(b) plaintiff to establish that the 

alleged manipulator injected "inaccurate information" into 

the market or created a false impression of market activity 

cures this problem. Such a construction permits courts to 

differentiate between legitimate trading activities that 

permissibly may influence prices, such as short sales, and 

"ingenious devices that might be used to manipulate

securities prices," Santa Fe Indus., 462 U.S. at 477, 97 S. 

Ct. at 1303, such as wash sales and matched orders. As 

the court in Olympia Brewing, 613 F. Supp. at 1292,

 19 
stated, "[r]egardless of whether market manipulation is 

achieved through deceptive trading activities or deceptive 

statements as to the issuing corporation's value, it is clear 

that the essential element of the claim is that inaccurate 

information is being injected into the marketplace." 

The second disputed element is whether Colkitt must

establish that GFL's allegedly manipulative conduct

actually depressed the prices of National Medical and 

EquiMed stock. GFL argues that market manipulation in 

violation of Section 10(b) and Rule 10b-5 requires that the 

allegedly unlawful conduct impact a security's price. GFL 

cites three cases to support its position, but all three are 

unhelpful. First, although we stated in Rosenberg v. Hano, 

121 F.2d 818, 821 (3d Cir. 1941) (footnote omitted), that 

"the party claiming injury must plead and prove some 

change in price, because of the prohibited acts," the case 

involved an alleged violation of Section 9, not Section 10(b) 

and Rule 10b-5. Second, the opinion in United States v. 

Russo, 74 F.3d 1383, 1394 (2d Cir. 1996), is not significant 

here because it only addressed the propriety of the portion 

of the district court's jury instruction on the scienter 

element that defined artificial price as the price level above 

the stock's actual value as determined by market forces. 

Third, the decision in In re Blech Securities Litigation, 928 

F. Supp. 1279, 1298 (S.D.N.Y. 1996) (citation omitted), 

directly contradicts GFL's position by stating that"[t]he 

absence of allegations of market dominance and price 

movement are not fatal to" a claim of market manipulation, 

for although "these may be classic attributes of market 

manipulation, they are not requisites." 

Colkitt's position is somewhat inconsistent on this point. 

On the one hand, he takes great pains to argue that GFL's 

short sales depressed the price of National Medical by 

17.5% and the price of EquiMed by 18.5%. On the other 

hand, when confronted with evidence that the prices of the 

stocks were on a sharp downward trend before and after 

GFL's short sales, thus raising serious doubts about the 

true reason for the declining prices, Colkitt reverses course 

and argues that he need not prove that GFL's alleged 

scheme was successful in depressing prices. Colkitt insists 

that he only must establish that GFL attempted to depress 

 20 
prices by selling shares short. To muddy the waters even 

more, Colkitt appears to make a concession that an impact 

on price must be established when he states in his reply 

brief: "A jury must also decide whether GFL's short trades 

had an affect [sic] on share prices." Reply Br. of Appellant 

at 11. 

Despite his flip-flopping on the issue, Colkitt appears to 

be correct that he need not prove that GFL's manipulative 

conduct actually depressed prices. The Court of Appeals for 

the Fifth Circuit concluded in Chemetron Corp. v. Business 

Funds, Inc., 718 F.2d 725, 728 (5th Cir. 1983), that Section 

10(b), unlike Section 9(a), does not require that a plaintiff 

prove the allegedly unlawful activities had an effect on the 

price of the stock. Although any damages that Colkitt 

would be entitled to recover under his Section 10(b) and 

Rule 10b-5 counterclaim would be contingent on proving 

that GFL's conduct actually depressed prices, proof of price 

movement is not necessary to establish a violation of 

Section 10(b) and Rule 10b-5 and therefore is not necessary 

to support his assertion of an affirmative defense under 

Section 29(b).6 

_________________________________________________________________ 

6. Although maintaining a private right of action under Section 10(b) 

requires a plaintiff to prove reliance and damages (usually reflected in 

the stock's price movement), Section 29(b) only requires a violation of 

Section 10(b), not the maintenance of a private suit under Section 10(b). 

Therefore, looking to the statutory language of the anti-fraud provision, 

we note that an individual violates Section 10(b)-- and therefore triggers 

Section 29(b) -- when he or she employs manipulative or deceptive 

devices in connection with the purchase or sale of securities. This 

situation is analogous to a government prosecution under Section 10(b), 

in which the government is not required to meet the normal standing 

requirements imposed on those asserting a private remedy, inasmuch as 

the government need not demonstrate that the defendant's conduct 

induced reliance by investors or affected the price of the security. See, 

e.g., United States v. Haddy, 134 F.3d 542, 549 (3d Cir. 1998) (holding 

that reliance is not an element of the crime of stock manipulation). 

Even if we were to embrace the position of GFL and the district court 

that proof of an effect on price is necessary to establish a claim of 

market manipulation, the district court still erred in concluding that 

Colkitt failed to create a genuine issue of material fact with respect to 

price movement. As already noted, Colkitt claims that the price of 

 21 
We are satisfied that, at bottom, neither party properly 

articulates the elements of market manipulation under 

Section 10(b) in the context of a Section 29(b) affirmative 

defense. Because we have not squarely addressed this 

issue, we must set forth the necessary elements for such a 

claim. In this regard, we conclude that to establish a 

Section 29(b) affirmative defense of market manipulation in 

violation of Section 10(b) and Rule 10b-5, Colkitt must 

present evidence that (1) in connection with the purchase 

or sale of securities, (2) GFL engaged in deceptive or 

manipulative conduct by injecting inaccurate information 

into the marketplace or creating a false impression of 

supply and demand for the security (3) for the purpose of 

artificially depressing or inflating the price of the security. 

2. Evidence Supporting Colkitt's Claim of Market 

Manipulation 

Colkitt's affirmative defense based upon GFL's alleged 

market manipulation fails because he cannot demonstrate 

_________________________________________________________________ 

National Medical dropped 17.5% and the price of EquiMed plummeted 

18.5% during the period of GFL's short sales. The district court 

concluded, however, that these statistics are "not evidence that the value 

of the shares was affected by the short sales: the free fall began before 

the short sales and continued well after the short sales." GFL Advantage 

Fund, Ltd. v. Colkitt, No. 4:CV-97-0526, Memorandum and Order at 21 

(M.D. Pa. July 17, 2000). The district court observed that the price of 

EquiMed declined steadily from $15.00 on February 1, 1996, to $2.4583 

on January 2, 1998, including a dramatic drop of 27.6%, from $7.25 to 

$5.25, during the 24-day period immediately preceding GFL's short 

sales. See id. at 20-21. The court also noted that National Medical 

plummeted from $12.875 on May 1, 1996, to $0.4375 on January 2, 

1998. See GFL Advantage, Ltd. v. Colkitt, No. 4:CV-97-0526, 

Memorandum and Order at 18 (M.D. Pa. Apr. 25, 2000). Based on these 

long-term, downward trends in the stocks' prices, the district court 

concluded that Colkitt could not prove that GFL's short sales had an 

effect on the price of either National Medical or EquiMed stock. Although 

the court was correct that other factors clearly were contributing to the 

slide in prices, it was not within the court's province to weigh the 

evidence as a finder of fact. Whether and how much GFL's alleged 

unlawful conduct contributed to the downturn in prices would have been 

issues for the jury if Colkitt's case had survived GFL's motion for 

summary judgment. Contrary to the district court's conclusion, Colkitt 

clearly created genuine issues as to whether GFL's short sales affected 

the prices of National Medical and EquiMed. 

 22 
that GFL engaged in any deceptive or manipulative conduct 

by injecting false inaccurate information into the 

marketplace or creating a false impression of supply and 

demand for the stock. As the district court explained 

repeatedly in its two rulings, Colkitt has not presented any 

evidence that GFL did anything but lawfully engage in short 

sales of National Medical and EquiMed stock. The fact that 

these short sales may have contributed to a decline in the 

stocks' prices is not evidence of deceptive or manipulative 

conduct, for there is no reason to believe these prices were 

depressed artificially. See Sullivan & Long, Inc. v. Scattered 

Corp., 47 F.3d 857, 864 (7th Cir. 1995) (concluding that 

defendant's "unprecedented massive short selling" did not 

create "a false impression of supply and demand" because 

on the other side of defendant's transactions were"real 

buyers, betting against [defendant], however foolishly, that 

the price of [the] stock would rise"); Olympia Brewing, 613 

F. Supp. at 1296 (stating that "short selling is simply not 

unlawful, even in large numbers and even if the trading 

does negatively affect the purchase price"). Indeed, the 

district court stated it well when it wrote that it is 

unreasonable "to infer unlawful intent from lawful activity 

alone." GFL Advantage Fund, Ltd. v. Colkitt , No. 4:CV-97- 

0526, Memorandum and Order at 19 (M.D. Pa. July 17,

2000). 

In the cases Colkitt cites in which courts concluded that 

a party's short selling was part of a scheme to manipulate 

stock prices, the short selling was in conjunction with some 

other deceptive practice that either injected inaccurate 

information into the market or otherwise artificially affected 

the price of the stock. See Russo, 74 F.3d at 1387, 1390, 

1391 (defendants used short sales in concert with 

"unauthorized placements" and "parking" of stock in

customers' accounts to generate false credits that funded 

their "stock-kiting scheme" designed to artificially inflate 

stock prices); United States v. Regan, 937 F.2d 823, 829 (2d 

Cir. 1991) (defendants sought to depress temporarily the 

price of stock by arranging to have 40,000 shares sold 

short secretly to a broker-dealer without disclosing to the 

dealer the identity of the seller or the moving party behind 

the deal); United States v. Charnay, 537 F.2d 341, 344 (9th 

Cir. 1976) (to facilitate a take-over bid, defendants 

 23 
artificially depressed stock prices by getting others to sell 

86,100 shares short and "guaranteeing these sellers by 

secret understanding a recovery of $22 per share 

irrespective of the price obtained on the Exchange"); 

Advanced Magnetics, Inc. v. Bayfront Partners, Inc. , No. 92 

Civ. 6879 (CSH), 1996 WL 14440 (S.D.N.Y. Jan. 16, 1996) 

(defendant attempted to depress stock prices through short 

sales that contravened Section 10(a) of the Exchange Act 

and Rule 10a-1 thereunder, which prohibits a short sale 

"below the price at which the last sale" of the security was 

reported), vacated in part on other grounds, 106 F.3d 11 (2d 

Cir. 1997). 

The remaining cases of market manipulation Colkitt cites 

likewise involved either injection of inaccurate information 

into the market or creation of a false impression of supply 

and demand for a stock. See Santa Fe Indus., 430 U.S. at 

467, 97 S.Ct. at 1298 (defendant obtained "fraudulent 

appraisal" of stock that severely undervalued its worth "in 

order to lull the minority stockholders into erroneously 

believing that [its cash-exchange offer] was generous"); 

Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 

792-93 (2d Cir. 1969) (in an effort to inflate prices and 

thwart a corporate take-over, defendant "painted the tape" 

by purchasing large blocks of stock in the open market at 

inflated prices while simultaneously making large secret 

and unreported sales at lower prices to partially finance the 

purchases); Blech, 928 F. Supp. at 1286, 1298 (defendant 

arranged "sham transactions" to inflate prices by 

improperly directing trades into and out of brokerage 

accounts at the firm without the authorization of the 

owners of the accounts); SEC v. Kimmes, 799 F. Supp. 852, 

856-57 (N.D. Ill. 1992) (defendant maintained artificially 

high stock prices by buying and selling stock through 

"undisclosed nominee accounts," distributing"false and 

misleading registration statements," and filing"false and 

materially misleading period reports" with the SEC), aff'd 

sub nom., SEC v. Quinn, 997 F.2d 287 (7th Cir. 1993); SEC 

v. Malenfant, 784 F. Supp. 141, 144-45 (S.D.N.Y. 1992) 

(defendant arranged "matched buy and sell orders" to 

"create a misleading appearance of active trading in the 

Texscan common stock" and thus drive up the price of the 

 24 
stock). Once again, Colkitt fails to proffer any evidence that 

GFL engaged in any such inappropriate conduct. 

Colkitt attempts to overcome this dearth of evidence of 

deceptive or manipulative conduct on the part of GFL by 

claiming that short sales, by their very nature,"convey to 

market participants negative information about the 

prospects of the firm." Br. of Appellant at 39. Colkitt's 

argument misses the mark, however, because conveying 

negative information about a firm does not constitute 

market manipulation unless the information is untruthful. 

Indeed, legitimate short sales often convey negative 

information about a company insofar as short sales suggest 

that a stock's price is overvalued, but that does not mean 

that such sales distort the market. To the contrary, short 

selling can help move an overvalued stock's market price 

toward its true value, thus creating a more efficient 

marketplace in which stock prices reflect all available 

relevant information about the stock's economic value. See 

Sullivan & Long, 47 F.3d at 861-62. 

Colkitt maintains that National Medical and EquiMed

were not overvalued. He insists that, because GFL did not 

argue before the district court that it sold short because it 

believed the stocks were overvalued, Colkitt is entitled to 

the inference that "the short sales were made at least in 

part to convey to the market the false impression that the 

stocks were overvalued so as to result in a decline in share 

prices." Br. of Appellant at 40 (emphasis in original). It 

would not be reasonable to draw such an inference, 

however, for to do so would fly in the face of uncontradicted 

evidence that the prices of National Medical and EquiMed 

were on a dramatic slide before and after GFL's short sales. 

If we were to draw any inference from the record evidence 

about the value of National Medical and EquiMed, it would 

be that the market considered the stocks to be overvalued 

and that GFL simply was responding to market forces, 

rather than distorting them, by engaging in short sales. 

An examination of Colkitt's other requested inferences,7 

_________________________________________________________________ 

7. The parties disagree about the standard of review that should be 

applied to Colkitt's requested inferences. GFL contends that the standard 

 25 
see Br. of Appellant at 30-35, exposes Colkitt's claims for 

what they are -- nothing more than a general attack on the 

lawful practice of short selling. For instance, Colkitt's first 

two inferences -- that GFL had a "unique financial 

incentive" to depress the prices of National Medical and 

EquiMed because its profits increased as the market prices 

decreased,8 and that short selling "conveys negative 

information" about the company being short sold and

contributes to a drop in share prices -- are general 

criticisms of short selling. These inferences, even if granted, 

are of no help to Colkitt in trying to prove market

manipulation, inasmuch as short selling is a lawful

investment strategy. Colkitt's next three requested

inferences -- that GFL's short sales constituted a large 

percentage of shares sold on a daily basis, that GFL's short 

_________________________________________________________________ 

is abuse of discretion because Colkitt raised these inferences for the 

first 

time when it filed its motion for reconsideration. Colkitt maintains that 

the standard is plenary because he raised all of the evidence and 

advanced all of the arguments at earlier stages in the litigation. This 

point is moot, however, because we would uphold the district court's 

rulings with respect to the inferences under either standard. 

8. Colkitt believes that GFL's incentive to depress prices is "unique" 

because the structure of the convertible notes allows GFL to receive more 

shares -- and thus higher profits -- as the stocks' prices decline. This 

incentive, however, is not unique to GFL's situation. All short sellers 

receive higher profits as the stock's price declines. Indeed, these higher 

profits in the face of declining prices are why traders engage in short 

sales. They are betting that the stock's price will decline, and if it 

does 

so, they will have to spend less money buying replacement stock to cover 

the borrowed shares, thus allowing them to pocket the difference. 

Colkitt's differentiation between GFL and other short sellers based on 

the structure of the National Medical and EquiMed notes is misguided. 

Whether GFL acquires $100,000 worth of shares from Colkitt in 

exchange for debt (as GFL did here) or in exchange for cash (as short 

sellers normally do when they cover) is irrelevant. In either situation, 

GFL will be able to obtain more shares from Colkitt if prices decline. 

Thus, if this "unique" incentive to depress prices is evidence that GFL 

engaged in market manipulation, then all short traders are likewise 

guilty of manipulating markets in violation of Section 10(b). Of course, 

this position is untenable, for as already explained, short selling is 

perfectly lawful. 

 26 
sales caused a 17.5% decline in National Medical and an 

18.5% decline in EquiMed,9 and that these price slumps 

allowed GFL to obtain an additional 11,658 shares of 

National Medical and an additional 27,882 shares of

EquiMed from Colkitt -- are equally unavailing. Once again, 

short selling, even in large volumes, is not in and of itself 

unlawful and therefore cannot be regarded as evidence of 

market manipulation. That short selling may depress share 

prices, which in turn may enable traders to acquire more 

shares for less cash (or in this case, for less debt), is not 

evidence of unlawful market manipulation, for they simply 

are natural consequences of a lawful and carefully 

regulated trading practice.10 

Colkitt's remaining inferences are equally groundless. 

Because a court is required to indulge only reasonable 

inferences, we reject Colkitt's last three requested 

inferences. For instance, Colkitt insists that GFL's use of 

four different brokers to execute the short trades is 

evidence that GFL tried to conceal its short sales from 

market participants, including Colkitt. This inference is 

unreasonable as GFL needed to use four brokers because 

none of them had enough shares necessary for GFL to

_________________________________________________________________ 

9. As already noted, see supra note 1, Colkitt greatly exaggerates 

EquiMed's price decline. The price of EquiMed on the day of the GFL's 

first short sale on November 8, 1996, was $5.25 per share, and its price 

on the day of GFL's last short sale on November 22, 1996, was $5.13. 

Consequently, the price of EquiMed dipped only $.12, or 2.3%. 

10. A passage in Colkitt's reply brief further undermines his theory that 

short sales are manipulative because they depress prices. He writes: "It 

is reasonable and makes economic sense to infer that short selling drives 

down share prices, because each short sale is, itself, a `sale,' 

increasing 

supply . . . ." Reply Br. of Appellant at 15 (emphasis added). In other 

words, Colkitt believes that short sales are manipulative because they 

increase the stock's supply and drive down its price. This, of course, is 

true (assuming demand remains constant), but it is also true for all 

stock sales, whether they are from long positions or short positions. The 

rationale of Colkitt's theory would lead to the absurd result of outlawing 

any sales practice that increases a security's supply and consequently 

may affect its price. Colkitt fails to understand that increasing the 

supply of stocks by selling them on the open market in legitimate 

transactions to real buyers does not artificially affect prices and 

therefore 

cannot be manipulative. 

 27 
borrow to carry out all of its short sales, which is not 

unusual when dealing with small cap stocks. See Br. of 

Appellee at 39 (citing Cason Aff. P 13 (App. 001080)). 

Colkitt's next requested inference relates to GFL's

assertion that it sold National Medical and EquiMed short 

to hedge against the stocks' declining prices and to lock in 

the notes' 17.5% and 18.5% profit spreads. Colkitt offers 

expert testimony that GFL's short sales could not have been 

part of a legitimate hedging strategy because too much time 

elapsed between the short sales and the exchange 

demands. The expert avers that if GFL were only trying to 

protect itself against declining prices after it made its 

exchange demand, it could have eliminated that "delivery 

risk" by selling short during the five-day period before the 

exchange demand, thus locking in the sale price during the 

same period the average closing price would be determined. 

Because GFL waited so long after the short sales to make 

its exchange demands, the expert contends GFL was not 

simply hedging against slumping prices, but was 

"increas[ing] the likelihood of increasing profits through 

artificially (and temporarily) lowering the price of EquiMed."11 

Br. of Appellant at 16-17 (quoting Expert Report of

Professor Steven R. Grenadier P 20. (App. 000860-000861)). 

Accepting as true Grenadier's position that GFL could 

have hedged against all risk by selling short during the fivedays prior to the exchange demands, a court reasonably 

could infer that GFL not only sought to protect itself, but 

also endeavored to reap further profit from the stocks' 

declining prices by selling short. To infer that these 

"premature" short sales were executed to manipulate

prices, however, would be an unreasonable leap. Indeed, 

Grenadier admits in his deposition that he does not have 

an opinion about whether GFL's short sales artificially 

depressed the prices of EquiMed stock. See Grenadier Dep. 

at 37 (App. 001016). Therefore, although it may be 

reasonable to infer from Grenadier's report that GFL's short 

_________________________________________________________________ 

11. Grenadier mentions only EquiMed because GFL sold National 

Medical short during the five-day period prior to its exchange demands 

to the stock. Therefore, even under Grenadier's theory, GFL's short 

trades of National Medical qualify as a legitimate hedging strategy. 

 28 
sales were intended not only to hedge against declining 

prices but to profit from them, it would be unreasonable to 

infer that GFL's short sales were deceptive or manipulative, 

especially considering that the expert concedes that he does 

know whether the trades had the effect of manipulating the 

prices.12 

Finally, in the words of the district court, Colkitt's last 

requested inference amounts to "baseless and desperate 

mudslinging." Colkitt asserts that GFL was sued twice "for 

engaging in manipulative short selling" thus evidencing that 

it engaged in that type of conduct with regard National 

Medical and EquiMed stock. Br. of Appellant at 35. GFL 

responds that it was not even involved in Global Intellicom, 

Inc. v. Thomson Kernaghan & Co., No. 99-CIV-342, 1999 

WL 544708 (S.D.N.Y. July 27, 1999). Instead, the case 

involved a former employee whose allegedly unlawful

conduct occurred after he left GFL. GFL also asserts that 

the action in JTS Corp. v. GFL Advantage Fund, Ltd. was 

dismissed in the early stages of the litigation after it filed 

for Rule 11 sanctions against the plaintiff. Based on GFL's 

averments, it would be entirely inappropriate to grant 

Colkitt's requested inference that these two lawsuits are 

evidence of GFL's alleged market manipulation in this case. 

At bottom, the core of Colkitt's argument is premised on 

his belief that short selling artificially depresses prices and 

presumably should be banned as a market manipulation. 

Unfortunately for Colkitt, however, short selling is lawful, 

and courts have held that short selling, even in massive 

volume, is neither deceptive nor manipulative when carried 

out in accordance with SEC rules and regulations. See 

_________________________________________________________________ 

12. Other portions of Grenadier's report also appear to undermine such 

a conclusion. In particular, Grenadier endorses the conclusions of 

Harvard Business School's Paul Asquith and Lisa Meulbroek that short 

trading would have an impact on the value of the securities if the 

number of shares sold short constituted 2.5% or more of the total 

outstanding shares. See Grenadier Dep. at 80-81 (App. 001017-001018). 

In this case, GFL sold short a total of 78,700 shares of EquiMed, which 

constituted only .275% of EquiMed's 28,589,717 outstanding shares. 

Therefore, under the standard embraced by Colkitt's own expert, GFL's 

short sales of EquiMed stock would not be expected to have a noticeable 

impact on the stock's price. 

 29 
Sullivan & Long, 47 F.3d at 864-65. Therefore, to make out 

a claim of market manipulation, Colkitt must present 

evidence that GFL engaged in some other type of deceptive 

behavior in conjunction with its short selling that either 

injected inaccurate information into the marketplace or 

created artificial demand for the securities. Colkitt has 

offered nothing but evidence that GFL engaged in lawful 

short sales of National Medical and EquiMed, which alone 

is insufficient to prevail on a claim of market manipulation 

in violation of Section 10(b) and Rule 10b-5. 

Another reason why Colkitt's market manipulation claim 

fails is because he has not met the scienter requirement by 

offering evidence that GFL engaged in short sales for the 

purpose of artificially depressing the prices of National 

Medical and EquiMed stock. Citing our opinion in In re 

Advanta Corp. Securities Litigation, 180 F.3d 525, 535 (3d 

Cir. 1999), Colkitt argues that he has met the recklessness 

standard for liability under Section 10(b). He contends that 

GFL's conduct constitutes "an extreme departure from the 

standards of ordinary care" and "presents a danger of 

misleading buyers and sellers that is either known to the 

defendant or is so obvious that the actor must have been 

aware of it." Id. (internal quotation marks omitted). 

According to Colkitt, evidence of GFL's alleged recklessness 

includes: GFL's "powerful economic incentive" to depress 

the stocks' prices; "voluminous scholarly evidence" that 

GFL's short sales would convey a "negative impression" of 

the companies; the dramatic drop in the stocks' prices 

during the period of GFL's short selling; the additional 

39,540 shares that GFL "extracted" from Colkitt because of 

the declining prices; GFL's use of four brokers to conceal 

his short sales; the conclusion of Colkitt's expert that GFL's 

short sales were not part of a legitimate hedging strategy; 

and GFL's having been sued twice for similar conduct. 

In essence, Colkitt recycles his arguments that he 

advanced in support of his contention that GFL's short 

trades were manipulative and deceptive. Some of this 

evidence and the requested inferences to be taken 

therefrom already have been discredited -- GFL's use of 

multiple brokers, whether GFL's short sales were a 

legitimate hedge strategy, and the alleged lawsuits against 

 30 
GFL for engaging in short selling -- and the rest of the 

evidence and inferences are, once again, general attacks on 

the practice of selling short -- the powerful incentive to 

depress prices, the negative impression of the company 

conveyed by short sales, the actual drop in National 

Medical and EquiMed prices, and the additional shares GFL 

obtained because of the declining prices. All that this 

information proves is that GFL engaged in the lawful 

practice of selling stock short and that these short sales 

may or may not have affected the price of National Medical 

and EquiMed stock. This evidence neither establishes that 

GFL's short sales were manipulative nor demonstrates that 

GFL executed the trades for the purpose of depressing the 

stocks' prices. Perhaps, if Colkitt had offered evidence that 

GFL's short sales violated SEC rules (for instance, if GFL 

failed to cover properly the short sales in violation of Rule 

10a-2, or if GFL made short sales below the last sales price 

in violation of Rule 10a-1), Colkitt might have been able to 

establish that GFL's conduct was intentionally or recklessly 

manipulative or deceptive. In the absence of evidence that 

GFL engaged in any wrongful conduct, however, Colkitt's 

claim of market manipulation must fail. Therefore, we will 

affirm summary judgment in favor of GFL with respect to 

the market manipulation claim. 

C. SECURITIES FRAUD 

Colkitt also claims that the notes should be voided

pursuant to Section 29(b) on the grounds that GFL 

committed securities fraud in violation of Section 10(b) and 

Rule 10b-5 when it failed to disclose its intent to

manipulate the prices of National Medical and EquiMed 

stock through short sales. GFL responds that it had no 

duty to disclose its intent to engage in short sales and that 

Colkitt has not established that he either relied on this 

alleged omission of fact or suffered a cognizable injury as a 

result of the reliance. 

1. Elements of Securities Fraud Under Section 10(b) and 

Rule 10b-5 

It is well settled that a claim of securities fraud under 

Section 10(b) requires proof "that the defendant (1) made 

misstatements or omissions of material fact; (2) with 

 31 
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." 

Weiner v. Quaker Oats Co., 129 F.3d 310, 315 (3d Cir. 

1997) (citation and internal quotations omitted). The parties 

apparently agree that the third element has been 

established, as there is no dispute that the alleged fraud 

was related to the purchase or sale of National Medical and 

EquiMed securities. Therefore, Colkitt must establish 

genuine issues with respect to the following elements: 

omissions of material fact, reliance, cognizable injury, and 

scienter.13 

2. Evidence Supporting Colkitt's Claim of Securities 

Fraud 

Colkitt asserts that GFL concealed from him two critical 

pieces of information that constitute omissions of material 

fact: (1) GFL's intention to sell short National Medical and 

EquiMed stock; and (2) GFL's actual short sales of the 

stock. Colkitt maintains that GFL had an affirmative duty 

to disclose this information because it was material and he 

would not have entered into the contracts with GFL if he 

had known it planned to sell the stocks short. 

Analysis of a securities fraud claim under Section 10(b) 

and Rule 10b-5 includes two steps: "First, was the 

defendant under a duty to disclose at the time at issue? 

Second, was the alleged omission or misstatement 

material? If, under the facts of this case, no duty to disclose 

exists, or if the undisclosed facts are not material, there is 

no liability under Rule 10b-5." Staffin v. Greenberg, 672 

F.2d 1196, 1202 (3d Cir. 1982). A duty to disclose arises 

only when one party to a transaction has material 

information that the other party is entitled to have because 

of some relationship of trust and confidence between the 

parties, such as when one party is a fiduciary, corporate 

insider, or "tippee." See Chiarella v. United States, 445 U.S. 

222, 229, 100 S.Ct. 1108, 1115 (1980). The Supreme Court 

has determined that "[a]n omission of fact is material if 

_________________________________________________________________ 

13. Colkitt submits the same evidence of scienter in support of both his 

securities fraud claim and his market manipulation claim. See supra pp. 

30-31. 

 32 
there is a substantial likelihood that a reasonable

shareholder would consider it important in deciding" 

whether to invest. Basic, Inc. v. Levinson, 485 U.S. 224, 

231, 108 S.Ct. 978, 983 (1988) (quoting TSC Indus., Inc. v. 

Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2132 

(1976)). Materiality is a mixed question of law and fact and 

should be decided as a matter of law "[o]nly when the 

disclosures or omissions are so clearly unimportant that 

reasonable minds could not differ." In re Craftmatic Sec. 

Litig., 890 F.2d 628, 641 (3d Cir. 1990). 

Colkitt's securities fraud claim falters for at least one and 

possibly two reasons. To start with, he failed to present any 

evidence that GFL intended to engage in short sales at the 

time it loaned the money to Colkitt. See In re Phillips 

Petroleum Secs. Litig., 881 F.2d 1236, 1245 (3d Cir. 1989) 

(stating that "a statement of intent need only be true when 

made; a subsequent change of intention will not, by itself, 

give rise to a cause of action under Section 10(b) or Rule 

10b-5"). More significantly, even if we can draw an

inference that GFL had such a plan, it did not have a duty 

to disclose its intentions. 

Colkitt argues that GFL had a duty to disclose its 

intentions because such a disclosure was necessary to 

clarify GFL's "implicit" representations that the debt-forstock exchange price would be "based upon the accurate, 

unbiased and untainted market price quoted by the stock 

market." Br. of Appellant at 48. Colkitt explains that 

Section 10(b) and Rule 10b-5 impose a "duty to disclose 

any material facts that are necessary to make disclosed 

material statements, whether mandatory or volunteered, 

not misleading." Craftmatic, 890 F.2d at 641. He asserts 

that GFL's implicit guarantee that the exchange price would 

be based upon prevailing market forces "was rendered 

grossly misleading by GFL's failure to disclose that it 

intended to short sell EquiMed and National Medical." Br. 

of Appellant at 48-49. 

We must reject Colkitt's argument for it is premised on 

the misguided notion that short sales distort markets and 

thus produce inaccurate, biased, and tainted market prices. 

As already explained, short sales executed in accordance 

with SEC rules and regulations not only are lawful, but also 

 33 
do not distort markets or create a false impression of 

supply and demand because they are legitimate 

transactions with real buyers on the other side of the sale 

who are betting that the stock's price will rise. See Sullivan 

& Long, 47 F.3d at 864. Contrary to Colkitt's assertion, 

GFL's short sales did not render its guarantee misleading, 

and GFL consequently did not have a duty to disclose to 

Colkitt its intention to engage in short selling. Therefore, 

because Colkitt failed to create a genuine issue with respect 

to GFL making an omission of material fact, we will affirm 

summary judgment in favor of GFL with respect to the 

securities fraud claim. 

D. REINSTATEMENT OF FEDERAL SECURITIES LAW 

COUNTERCLAIMS 

Colkitt argues that the district court erred when it 

dismissed his amended counterclaims for lack of specificity 

on February 2, 1999. He simply states that he pled his 

amended counterclaims, which span 30 pages, with 

sufficient specificity pursuant to Fed. R. Civ. P. 9. We need 

not consider these contentions, however, because, as we 

have explained, Colkitt failed to create genuine issues of 

material fact as to certain elements of his corresponding 

affirmative defenses, and thus, his counterclaims must fail 

on the merits as well. 

E. VIOLATIONS OF PENNSYLVANIA LAWS 

1. Securities Claims 

Section 1-508 of the Pennsylvania Securities Act bars the 

basing of certain suits on contracts that violate state 

securities laws. See Pa. Stat. Ann. tit. 70,S 1-508 (1994). 

Section 1-401 of the Pennsylvania Securities Act prohibits 

the use of any "device, scheme or artifice to defraud" and 

the omission of any "material fact necessary in order to 

make statements made, in light of the circumstances under 

which they were made, not misleading." Id. S 1-401(a), (b). 

Finally, Pennsylvania common law permits "[t]he recipient 

of a misrepresentation [to] avoid the contract by showing 

that the misrepresentation was either fraudulent or

material." Germantown Mfg. Co. v. Rawlinson , 491 A.2d 

138, 141 (Pa. Super. Ct. 1985). As GFL asserts, these 

provisions are "functionally identical" to Section 29(b) and 

 34 
Section 10(b) of the Exchange Act. See Rosen v. 

Communication Serv. Group, Inc., 155 F. Supp. 2d 310, 321 

n.14 (E.D. Pa. 2001) ("Section 401 of the Pennsylvania 

Securities Act is modeled after Rule 10b-5 of the federal 

securities laws, and requires virtually the same elements of 

proof."). Therefore, Colkitt's state securities and common 

law fraud claims fail for the same reasons his federal 

securities claims fail. 

2. Breach of Contract Claim 

Colkitt argues that GFL is barred under Pennsylvania law 

from enforcing the notes because GFL committed a material 

breach of the contracts by refusing to accept Colkitt's 

prepayment, even though the notes contain no language 

prohibiting prepayment. Colkitt claims that he notified GFL 

in late December 1996 and early January 1997 that he 

would prepay all outstanding principal and interest on the 

notes, but GFL improperly rejected Colkitt's request for 

prepayment in hopes of declaring the notes in default and 

collecting millions of dollars in penalties. 

GFL responds that it did not outright reject Colkitt's 

request for prepayment, but conditionally accepted the 

prepayment offer while reserving its rights to dispute the 

balance due. GFL not only disagreed with Colkitt about the 

amounts due, but refused to allow Colkitt to dictate the 

terms of any prepayment. Because of its conditional

acceptance of Colkitt's offer, GFL maintains that whether or 

not the notes permitted prepayment is not at issue. 14 GFL 

also argues that Colkitt's failure to tender any prepayments 

-- or any payments, for that matter -- undermines his 

position that he was attempting to make a full prepayment 

of outstanding principal and interest. 

_________________________________________________________________ 

14. The district court, responding to Colkitt's assertion that the notes 

do 

not permit GFL either to reject or accept conditionally an offer of 

prepayment, stated that "nothing in the agreements requires GFL to 

accept prepayment in an amount unilaterally imposed by Colkitt." GFL 

Advantage Fund, Ltd. v. Colkitt, No. 4:CV-97-0526, Memorandum and 

Order at 24 (M.D. Pa. Apr. 25, 2000). Thus, the court concluded that 

"GFL's acceptance while reserving its rights to the disputed amount does 

not constitute a breach of contract." Id. 

 35 
More importantly, however, Colkitt admitted that he was 

in material breach of his obligations on the notes before his 

first prepayment offer. In particular, he was in default on 

his interest obligations, he failed to maintain a pledge of 

securities in escrow, and he neglected to file required 

disclosure documents with the SEC. See Colkitt Dep. at 

272-73, 261-62, 195-97 (App. 000581-000582, 000577-

000578, 000552-000554). In light of these prior breaches, 

the district court did not err in granting summary judgment 

in favor of GFL on its breach of contract claim. 

F. DAMAGES 

The district court granted GFL damages in the amount of 

$21,121,989.39. Colkitt argues that the damages should be 

limited to principal and interest outstanding as of the date 

of his prepayment request, which would reduce the 

damages to $11,740,198. 

First, Colkitt believes that GFL forfeited its right to collect 

anything but principal and interest when it rejected 

Colkitt's prepayment offer. As already addressed, he 

maintains that GFL's refusal to accept prepayment 

constituted a breach of contract and that if GFL had 

accepted his prepayment offer as it allegedly was obligated 

to do, he would have owed only $11,740,198. Colkitt

cannot prevail on this argument, however, as he never 

actually tendered the $11,740,198 prepayment. Depriving 

GFL of the interest and penalties due on a balance that 

Colkitt never paid would reward him unfairly for his breach 

by allowing him to hold onto GFL's money interest free for 

nearly four and a half years. 

Second, Colkitt argues that GFL is prohibited from 

recovering both the 20.5%/22% "premium" and the 14%

"default interest" because they constitute an unenforceable 

penalty "that is disproportionate to the value of the 

performance promised or the injury that has actually 

occurred." Br. of Appellant at 64 (quoting Finkle v. Gulf & 

Western Mfg. Co., 744 F.2d 1015, 1021 (3d Cir. 1984)). 

Colkitt claims that the "premiums" exceed the profit GFL 

would have been able to earn had it exchanged all of the 

debt for shares of National Medical and EquiMed and sold 

the shares on the market. He also insists that adding 14% 

 36 
"default interest" to the premiums is simply punitive and 

constitutes unenforceable liquidated damages. 

We reject Colkitt's request to reduce the damage award. 

Both the "premiums" and the "default interest" compensate 

GFL for distinct economic losses suffered by GFL as a 

result of Colkitt's breach. The 20.5% and 22% "premiums" 

represent the grossed-up value of the 17% and 18% 

discounts guaranteed in the notes. The premiums are

intended to restore GFL to the position where it would have 

been if GFL had been able to convert all of the debt into 

National Medical and EquiMed stock. In contrast, the 

"default interest" is intended to compensate GFL for 

damages it incurred since Colkitt's breach -- namely, the 

deprivation of its money over the past four and a half years. 

Not only were these provisions included in contracts that 

were negotiated at arm's length, but contrary to Colkitt's 

assertions, they also would restore GFL to the position that 

it would have held if Colkitt had not breached the notes. 

IV. CONCLUSION 

For the foregoing reasons, we will affirm the orders of the 

district court entered on April 25, 2000, and July 17, 2000. 

A True Copy: 

Teste: 

 Clerk of the United States Court of Appeals 

 for the Third Circuit 

 37