The Court agrees with Prakash and the Telcom Entities that Starr’s claims, for the most part,
are derivative. Counts I, II, and III all allege that the Defendants caused the value of Starr's stocks
to be diminished as a result of their actions in the merger of icontact and they, and thus are
derivative in nature. The language contained within Start’s complaint demonstrates beyond doubt
the derivative nature of his suit. Starr alleges that the “value of [his] converted shares were valued
at the equivalent of $.30 per share of icontact . . . substantially below [the] $3,.3127" they were

’ “attempt[ed] to secure certain rights

previously valued. Starr further alleges that the Defendants
and benefits for themselves alone, at the expense of minority shareholders.” (cmphasis added). By the
very allegations of his complaint, Starr demonstrates that his injury is one that results from the
diminution of the value of his shares and one that he has in common with other shareholders.
Accordingly, Starr lacks standing to assert Counts I, II, and III against the moving Defendants and
those counts must be dismissed as to Prakash, Bowman, the Telcom Entities, and Harbor Capital on
this ground alone. Even if Starr did have standing to pursuc Counts I, II, and III, they would still fail
for the reasons stated below.
B, Count I —- Section 12(1) Claim

Prakash moves to dismiss Count I of Starr's claim, arguing that he was exempt from the
disclosure and registration requirements because: (1) the stocks were issued to Starr as part of an
employee stock option plan, 15 U.S.C. § 77c(a)(2); (2) the transaction did not involve a public
offering, 15 U.S.C. § 77d(2). Bowman moves to dismiss Count] of Starr's claim, arguing that he was
not a seller for purposes of Section 12(1), and therefore Starr cannot state a claim against him.

Ifa security or transaction is exempted under § 77c then a person cannot incur section 12 (1)

liability pursuant to § 7c. Donohoe v. Consolidated Operating & Prod. Corp., 982 F.2d 1130, 1140

4



controls any person liable under sections 77k or 771 of this title, shall also be liable jointly and
severally with and to the same extent as such controlled person to any person to whom such
controlled person is liable... .” 15 U.S.C. § 780. In order to state a claim for control person
liability, a plaintiff must allege: (1) a primary violation; (2) that the defendant actually exercised
control over the general operations of the primary violator; and (3) that the control person had the
power or ability (even if not exercised) to control the specific transaction that is alleged to give rise
to liability. Donohoe v, Consolidated Operating & Prod. Corp., 30 F.3d 907, 911-12 (7th Cir. 1994);
Harrison v. Dean Witter Reynolds, Inc., 974 F.2d 873, 880 (7th Cir, 1992). Starr’s allegations in this
regard consist of but a single paragraph: “By reason of their shareholder status, senior management
positions and/or directorships as alleged above, these individual and corporate defendants had the
power to influence, and exercised such power, to cause icontact and Shey to engage in the unlawful
acts and conduct complained of herein.” Starr self-servingly pleads a bare legal conclusion—that the
individual and corporate defendants were control persons, But Start alleges no facts, other than the
Defendants’ status as shareholders, senior managers, or directors, to support his conclusion. Courts
within this District have consistently held that a plaintiff may not premise control person liability
solely upon status within the company. See, e.g., Donovan v. ABC-NACO, Inc., No. 02 C 1951, 2002
WL 1553259, * 6 (N.D. Il. Jul. 15, 2002); In ve Westell Tech., Inc., Sec. Litig., No. 00 C 6735, 2001
WL 1313785, *12 (N.D. Ill. Oct. 26, 2001); Kaufman v. Motorola, Inc., No. 95 C 1069, 1999 WL
688780, * 16 (N.D. Ill. Apr. 16 1999); Whirlpool Fin. Corp. v. GN Holdings, Inc., 873 F. Supp. 111,
120 (N.D. Ill. 1995); Feldman v. Motorola, Inc., No. 90 C 5887, 1993 WL 497228, * 10 (N.D. IIL
Oct. 14, 1993); Craig v. First American Capital Res., 740 F. Supp. 530, 537 (N.D. Ill. 1990), Instead,

courts have required plaintiffs to plead sufficient facts to mect the two-part test announced in

9



he “acquire[d] his securities pursuant to [an Employee Stock Option Plan].” Generally, Starr is
correct that the Court may not consider materials outside the pleadings without converting the
motion into one for summary judgment, which the Court declines todo, See Covington ¥. Illinois Sec.
Serv., Inc., 269 F.3d 863, 864-65 (7th Cir. 2001).

But the exhibits that Starr attaches to his complaint are fair game. Menominee Indian Tribe
of Wisc. v. Thompson, 11 F.3d 449, 456 (7th Cir. 1998). Starr attaches to his complaint a “Stock
Option Grant Certificate.” It is clear from reading the document that the certificate is part of an
employee stock option plan, for it contains a provision alerting Starr that the option is not a
guarantee of continued employment rights. Thus, at a minimum, it appears from the face of the
complaint that some of Starr’s shares were acquired through an employee stock option plan, contrary
to his assertion in his brief. Nevertheless, the document does not, on its face, demonstrate that ic
meets the requirements of 26 U.S.C. § 401, as the exemption mandates. Further, merely because
some of Starr's shares were acquired through an employee stock option plan does not mean thar all
of the shares were so acquired. Starr insists in his brief that his initial acquisition of shares was a
direct investment in icontact, and thus the exemption listed in § 77c would nor apply. At this stage
of the litigation, the Court must accept this allegation as truc and dismissal on § 77c grounds is thus
improper at this time.

Prakash also argues that the securities were not issued in a public offering, and thus exempt
from the Securities Act registration requirement by 15 U.S.C. § 77d. But nothing in the complaint
(or in Prakash's brief for that matter) demonstrates whether the securitics were issued in a public or
a private offering. Prakash argues that the burden is on Starr to plead that the securities were

involved in a public offering and not on him to prove that they were involved in a private offering.

6



(7th Cir. 1992) (observing that § 77e is subject to a number of exceptions and limitations); see also
Associated Randall Bank v. Griffin, Kubik, Stephens & Thompson, Inc., 3 F.3d 208, 209 (7th Cir. 1993)
(discussing exemption from securities regulation of most governmental securities); American Deposit
Corp. v. Schacht, 84 F.3d 834, 856 (7th Cir. 1996) (Flaum, J., dissenting) (observing that Congress
recognizes distinct nature of annuities and insurance contracts and exempts them from securities
tegulation). Section 77c(a) (2) provides that “except as hereinafter expressly provided, the provisions
of this subchapter shall not apply to any of the following classes of securities: ... a stock bonus,
pension, or profit-sharing plan which meets the requirements under section 401 of Title 26.” 15
U.S.C. § 77c(a) (2). Thus, stocks acquired pursuant to an employee stock option plan are generally
exempt from the registration requirements of the Act, and therefore if Starr's shares were issued
pursuant to such a plan his claim must necessarily fail.

Start argues, however, that § 77c does not apply, pointing to paragraph forty-eight of his
complaint, which reads “iconcact and !hey failed to file a registration statement for the merger . . .
and failed to rely on any exemption from registration.” Stark argues that his allegation must be taken
as true and therefore Prakash’s motion must be denied. But paragraph forty-eight contains a bare
legal conclusion—that no exemption excuses icontact’s and they’s failure to register the
securities—not a statement of fact, and thus the Court need not accept it as truc. Panaras v. Liquid
Carbonic Ind. Corp., 74 F.3d 786, 792 (7th Cir. 1996). In support of his motion, Prakash invites the
Court to dismiss Count I of Starr's complaint against him because Start’s holdings in icontact and
they were acquired pursuant toa stock option plan, attaching an affidavit of icontact’s CEO, William
Christie averting that Starr’s shares were issucd pursuant to such a plan. Starr protests that the

Court should not consider the affidavit in ruling on a 12(b)(6) motion and steadfastly denies that

5



C1134, 1996 WL 494245, *11 (N.D. Ill. Aug, 28, 1996); Endow, Albertine, 812 F. Supp. 1479, 1494
(N.D. Ill 1993), In other words, a person who solicits an offer to buy a security, while acting as the
agent of the issuer of the security, shares the status of statutory seller. Pinter, 486 U.S. 643-45, Thus,
in otder to be liable under section 12(1), Prakash and Bowman must have cither sold the securities
to Starr of actively solicited the purchase.

Starr's complaint alleges that Prakash and Bowman as board members of icontact “solicited
Starr, through Christie,” and thus are liable under section 12(1) for the sale of an unregistered
security. But officers and directors of a corporate seller are noc “sellers” for purposes of section 12(1)
solely by virtue of their positions within the company. See Royal American Managers, Inc. v. IRC
Holding Corp., 885 F.2d 1011, 1017 (2nd Cir. 1989). Here, the complaint contains no allegations
that demonstrate that Bowman and Prakash did any active solicitation. Indeed the complaint does
not allege any contact whatsoever between Starr and Bowman or Prakash. Starr’s complaint
contains only the conclusory allegation that because icontact CEO Christie solicited his approval of
the merger that Bowman and Prakash, as board members, also solicited him. The Court is not
convinced. The guidance in Pinter is clear: only those who actively solicit the purchase of
unregistered securities can be liable under Section 12(1), Pinter, 486 U.S. 643-47; see also Endo, 812
F. Supp. at 1494, Start’s complaint fails to allege that Bowman and Prakash actively participated in
the solicitation or sale of unregistered securities and therefore Count I must be dismissed as to them.
Cc. Count If — Controlling Persons Liability

Count II of the complaine alleges that Prakash, Bowman, the Telcom Entitics, and Harbor
Capital are liable under 15 U.S.C. § 770 as control persons of icontact or !hey. The Act provides,
in relevant part, that “[c]very person who, by or through stock ownership, agency, or otherwise . . .

8


1 Minute Order Form (06/97)

United States District Court, Northern District of Illinois

Nemcofvianeudee | William J. Hlibbler | Stns iovter
CASE NUMBER 01 C 6087 DATE 05/16/2003

CASE Starr v, they, Inc., et al

TITLE

{Un the following bax (a) indicate the party filing the motion, ¢-g., plaintiff, defendant, 3rd party plaintiff, and (b) state briefly the
MOTION: nature of the motion being presented.]
Bowman & Harbor Capital’s Motion to Dismiss (doc. # )
Prakash & Telcom et al’s Motion to Dismiss (doc. #31)

DOCKET ENTRY:
(1) Oo Filed motion of [ use listing in “Motion” box above.]
(2) a Brief in support of motion due
(3) oO Answer briefto motion due___. Reply toanswer bricfdue__
(4) o Ruling/Hearingon set for at
(5) a Status hearing [held/continucd to] [set for/re-set forlon set for at
(6) a Pretrial conference [held/continued to] [set for/re-set forlon__—_set for at
?) Qo Trial [set for/re-set for]on at
(8) Oo (Bench/Jury trial] [Hearing] held/continuedto at
(9) ia) This case is dismissed [with/without] prejudice and without costs [by/agreement/pursuant to]

OFRCP4(m) General Rule 21 OFRCP4i(a)() 0 FRCP41(a)(2).
(10) @ [Other docket entry] . Enter memorandum opinion and order. For the attached reasons, the Defendants’ motions

to dismiss are GRANTED. All counts against Rabul Prakash, Telcom Internet Investors, Telcom-Online Investors,
Telcom Ventures, Robert Bowman, and Harbor Capital are dismissed with prejudice,

(11) Oo [For further detail see order on the reverse side of the original minute order.)

No notices required, advised in open court,

No notices required, «gumbo ft

Notices mailed by judge’s staff. M AY 5 5 7803
2.
Notified counsel by telephone. date docket}
Y_ | Dockering to mail notices. i” lh.

Mail AO 450 form. te. dockeving deputy initials

Copy to judge/magistrace judge,

date mailed notice

courtroom . tee
JHC depury’s
initials

“Datedtime received in ; ;
°* eeacral Clerk's, Office muiling deputy initials
tj



the merger by registering the securities that icontact and !hey issued to him. At the outsct, the
Court is hard pressed to see how the Telcom Entitics and Harbor Capital, both sharcholders in
icontact or hey just as Starr was, would owe him any fiduciary duty whatsoever. But in any cvent,
as noted in the Court’s discussion of Counts | and II, none of the individual Defendants had any duty
to Starr under the Securitics Act. The Defendants’ motion to dismiss Count III is GRANTED as
to Prakash, Bowman, the Telcom Entities, and Harbor Capital.

In Count V, Starr alleges that the named Defendants converted his shares of !hey when they
refused to redeem his shares. Conversion requires a plaintiff to show that: (1) the defendant
wrongfully assumed control over property; (2) his right to immediate possession of the property has
been denied by the defendants; and (3) he has made a demand for the property. But the only entity
that would be required to redeem Start’s shares of !hey would be ‘hey itself; Starr has no right to
immediate redemption of the shares from the named Defendants. In other words, only !hey was
obligated to redeem the shares and so only !hey could conceivably be liable for a refusal to redeem
them. Starr could perhaps state a claim for conversion against the moving defendants if he alleged,
for example, that Prakash, Bowman, the Telcom Entities, or Harbor Capital had swiped his stock
certificates and refused to return them (but that clearly is not what happened). Defendants’ motions
to dismiss Count V of Starr's complaint is GRANTED as to Prakash, Bowman, the Telcom Entities,
and Harbor Capital.

IV. Conclusion

For the foregoing reasons, the motions to dismiss of Prakash, Bowman, the Telcom Entitics,

and Harbor Capital are GRANTED and the Court dismisses with prejudice all counts against the

moving Defendants. Starr's complaint remains pending against the non-moving Defendants, but as

11



Harrison: (1) that defendants exercised control over the primary violator; and (2) that defendants
exercised control over the operations constituting the specific violation. For example, a plaintiff
sufficiently pleaded control person liability where the complaint alleged that the defendant was the
majority shareholder (and therefore had control over the directors) and other defendants caused the
corporation to disseminate to its minority sharcholders information containing false and misleading
statements, Canel v. Lincoln Nat'l Bank, No. 96 C 6595, 1997 WL 321679, *7 (N.D. Ill. Jun. 6,
1997), Another plaintiff successfully avoided dismissal because the complaint alleged that the
directors had day-to-day control over the opcrations of the corporation and the power to control the
particular transaction in question. In re Nanophase Tech. Corp. Sec. Litig., No. 98 C 3450, 2000 WL
1154631, *7 (N.D, Ill. Aug. 14, 2000). Similarly, a court denied the motion to dismiss of directors
who allegedly could have, but had not, prevented the dissemination of misleading information. In
ve First Merch. Acceptance Corp, Sec. Litig., No. 97 C.2715, 1998 WL 781118, *12-13 (N.D. IIL Nov.
4, 1998). Here, Starr presents nothing to support his claim that the individual defendants were
control persons other than his sweeping and self-serving statement that the defendants should be
liable solely by virtue of shareholder status or directorships. Such allegations are insufficient to state
a claim for control person liability, and the Defendants’ motions to dismiss Count II as to Prakash,
Bowman, the Telcom Entities, and Harbor Capital is GRANTED,
D. Counts I & V — Common Law Claims

Starr’s common law claims are frivolous at best. First, Starr claims that Prakash, Bowman,
the Telcom Entities, and Harbor Capital breached a fiduciary duty they owed him because they failed
to disclose to him sufficient information in regards to the merger. Starr’s claim is predicated on the

assumption that the Defendants had some duty under the Act to disclose to him information about

10



Prakash’s argument has no merit. The burden of demonstrating that an exemption applies rests upon
the party invoking the exemption, and thus Starr need not plead facts to demonstrate that it docs
not apply. SEC v. Ralston Purina Co., 346 U.S. 119, 126, 73S, Cr. 981, 985 (1953). Starr has not
pleaded himself out of Court. Nothing in the amended complaint demonstrates that § 77 or § 77d
are applicable, and at this stage of the litigation, the Court takes Start’s well-pleaded allegation that
the securities were unregistered as true. However, given the language of the Stock Option Grant
Certificate as well as the restrictive legend on the reverse of Starr's stock certificates informing him
thar they have not been registered, the Court cautions Starr that, should it later be revealed that he
knowingly misrepresented material facts (for cxample, facts that demonstrate the sccurities were
issued pursuant to an employee stock option plan or that they were privately issued, and thus that
the § 77c or § 77d exemptions are applicable), the Court will consider sanctions against him.
Despite the fact that § 77c and § 77d provide no grounds to warrant dismissal at this stage
of the litigation, Count I must still be dismissed as to both Prakash and Bowman. Liability under
Section 12(1)! of the Securities Act is limited to those who pass or offer secutities. Pinter v. Dahl,
486 U.S. 622, 108 S. Cr. 2063 (1988). Collateral participants in the sale of securities are not liable
as sellers under section 12(1). Id. at 650, Instead, liability extends only to those either sell
unregistered securities or who actively solicit a purchase motivated in part by a desire to serve his
own financial interest or those of the seller. Id. at 645-47; see also Danis v. USN Communications,

Inc., 73 F. Supp. 2d 923, 936 (N.D. Ill, 1999); Wheaten v. Mathews Holmquist & Assoc., Inc., No. 94

"In his brief, Bowman refers to Section 12(2). But Section 12(2) regulates the use of
fraud in the sale of sccurities. 15 U.S.C. § 77[(a)(2). Section 12(1) governs the sale of securities
in violation of 15 U.S.C. § 77e, which is at issue in this case. 15 U.S.C. § 77l(a)(1).

7



the price promised. Count V alleges that the individual Defendants converted Starr’s property by
refusing to redeem his shares.
Tl. Standard of Review

Motions to dismiss test the sufficiency of the complaint, not the merits of the case. Pickrel
v. City of Springfield, Ill, 45 F.3d 1115 (7th Cir. 1995), The Court must accept as true all well-
pleaded factual allegations and draw all reasonable inferences from them. Id. The Court will dismiss
a complaint under Rule 12 (b) (6) only if it appears that the plaintiffs can prove no set of facts that
would entitle them to relief. Conley v. Gibson, 335 U.S. 41 (1957).

III. Analysis

A. Standing

Atthe outset, the Court holds that Starr lacks standing to bring this suit against the moving
Defendants. As a general principle, a corporate sharcholder does not have an individual right of
action against third parties for damages to the shareholder resulting indirectly from injury to the
corporation. Flynn v. Merrick, 881 F.2d 446, 449 (7th Cir. 1989); Twohy v. First Nat'l Bank of
Chicago, 758 F.2d 1185, 1194 (7th Cir. 1985). There are certain exceptions to this general rule,
such as when the shareholder’s injuries are distinct from those of other shareholders, Twohy, 758
F.2d at 1194, But the mere diminution in the value of corporate assets is insufficient direct harm
to give the sharcholder standing to sue in his own right, because the corporation alone is the directly
injured party. Flynn, 881 F.2d at 449. A derivative suit brought on behalf of the corporation is the

proper vehicle for an individual shareholder to address the diminution of the value of his stock

caused by alleged third-person malfeasance.



with prejudice all counts against Rahul Prakash, T elcom-Internet Investors, Telcom-Online
Investors, Telcom Ventures, Robert Bowman, and Harbor Capital.
I. Factual Background

David Start was employed by icontact as a software developer and by August 8, 2000, had
accumulated 64,883 shares of icontact common stock. Pursuant to a “Stock Option Grant
Certificate,” Start exercised an option to purchase additional shares on a cashless basis, and by
September 8, 2000, had increased his total shareholding to 102,277. Starr began exercising his
options shortly after receiving a mailing from icontact and its CEO, William Christie, notifying him
of a proposed merger between icontact and !hey. The merger was approved by a majority of icontact
sharcholders, and Starr's icontact shares were converted into approximately 110,000 !hey shares.
According to Starr, !hey represented to him on August 18, 2000, that his icontact shares were valued
at $3.3127 per share, but in October 2000 represented to him that the converted icontact shares
werc in fact valued at only $0,30 per share.

In the five-count complaint, Starr seeks the difference between the value of shares as
represented on August 18, 2000 and during October 2000. Starr alleges in Count I that icontact,
they, and the individual Board members of icontact and !hey (including Prakash and Bowman)
violated Sections 5 & 12(1) of the 1933 Securitics Act (the Act) because they sold unregistered
securities to him. In Count Il, Starr alleges that by reason of their status as controlling persons the
individual Board members oficontact (including Prakash and Bowman) as well as other shareholders
(including the Telcom entitics and Hatbor Capital) had the power to cause icontact and !hey to
engage in the sale of unregistered securities and thus arc liable for its acts. Count III alleges a breach
of fiduciary duty. Count [V alleges a breach of contract because !hey did not redeem his shares at

2


IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION r

DAVID A. STARR,
Plaintiff,

Case No. 01 C 6087

The Honorable William J. Hibbler

!HEY, INC., a Delaware corporation;
ICONTACT.COM,ING., a Delaware corporation;
WILLIAM G, CHRISTIE; ROBERT A. BOWMAN;
RICHARD WARD; RAHUL PRAKASH; ROGER DOW;
TELCOM- INTERNET INVESTORS, LLC; TELCOM-
ONLINE INVESTORS, LLC; TELCOM VENTURES,
LLC; HARBOR CaPITAL, LLC; AND DUNCAN
MACKAY,

Defendants.
MEMORANDUM OPINION AND ORDER

David Starr filed this five-count complaint pursuant co § 12 (a) (1) of the 1933 Securities Act,

15 U.S.C. § 771(a)(1), § 5 and Regulation D of the 1933 Sccurities Act, 15 U.S.C. § 77e, and
principles of common law. According to Starr, the Defendants sold him unregistered securities in
connection with the merger of icontact.com, inc. and they, inc., and thus are liable for the
diminution in its value. Rahul Prakash, Teleom-Internet Investors, Telcom-Online Investors, and
Telcom Ventures (Prakash and Telcom Entities) have filed a motion to dismiss all claims against

them pursuant to Fed. R. Civ. P. 12(b)(6). Robert Bowman and Harbor Capital filed a similar

motion to dismiss. For the reasons stated herein, the Court GRANTS both motions and dimisses

Wr |



this opinion makes clear, Starr is skating on thin ice. Should it later be revealed that Starr's claims
in response to Prakash’s § 77¢ and § 77d are false, and Starr knew them to be false, Starr risks the

possibility of Rule 11 sanctions against him.

IT 1S SO ORDERED.

Sal fod hic b ALL

Dated The Honofgtle William J. Hibbler
United States District Court