Opinion ID: 1249351
Heading Depth: 2
Heading Rank: 2

Heading: ATSI's Market Manipulation Claims

Text: Section 10(b), in proscribing the use of a manipulative or deceptive device or contrivance, id. § 78j(b), prohibits not only material misstatements but also manipulative acts. Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994). Under the statute: Manipulation is virtually a term of art when used in connection with securities markets. The term refers generally to practices, such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity. Section 10(b)'s general prohibition of practices deemed by the SEC to be manipulative  in this technical sense of artificially affecting market activity in order to mislead investors  is fully consistent with the fundamental purpose of the [Exchange] Act to substitute a philosophy of full disclosure for the philosophy of caveat emptor. . . .  Santa Fe Indus. v. Green, 430 U.S. 462, 476-77, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977) (alteration in original) (citations omitted). Thus, manipulation connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities. Ernst & Ernst, 425 U.S. at 199, 96 S.Ct. 1375. The critical question then becomes what activity artificially affects a security's price in a deceptive manner. Although not explicitly described as such, case law in this circuit and elsewhere has required a showing that an alleged manipulator engaged in market activity aimed at deceiving investors as to how other market participants have valued a security. The deception arises from the fact that investors are misled to believe 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); see also Mobil Corp. v. Marathon Oil Co., 669 F.2d 366, 374 (6th Cir.1981) (stating that the Supreme Court has indicated that manipulation under § 10(b) refers to means unrelated to the natural forces of supply and demand); cf. Pagel, Inc. v. SEC, 803 F.2d 942, 946 (8th Cir.1986) (agreeing with the SEC that [w]hen individuals occupying a dominant market position engage in a scheme to distort the price of a security for their own benefit, they violate the securities laws by perpetrating a fraud on all public investors); Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 796 (2d Cir.1969) (holding that nondisclosure of large open market purchases combined with large secret sales to deter stockholders from participating in a competing tender offer violated Rule 10b-5 by distort[ing] the market picture and deceiv[ing] the [issuer's] stockholders). In identifying activity that is outside the natural interplay of supply and demand, courts generally ask whether a transaction sends a false pricing signal to the market. For example, the Seventh Circuit recognizes that one of the fundamental goals of the federal securities laws is to prevent practices that impair the function of stock markets in enabling people to buy and sell securities at prices that reflect undistorted (though not necessarily accurate) estimates of the underlying economic value of the securities traded, and thus looks to the charged activity's effect on capital market efficiency. [4] See Sullivan & Long, Inc. v. Scattered Corp., 47 F.3d 857, 861 (7th Cir.1995). The Seventh Circuit's focus on disruptions to the efficient pricing of a security is consistent with our view that in preventing market rigging, § 10(b) seeks a market where competing judgments of buyers and sellers as to the fair price of the security brings about a situation where the market price reflects as nearly as possible a just price. SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1466 (2d Cir.1996) (quoting H.R.Rep. No. 73-1383, at 11 (1934)). In an efficient market, trading engineered to stimulate demand can mislead investors into believing that the market has discovered some positive news and seeks to exploit it, see In re Initial Pub. Offering Sec. Litig., 383 F.Supp.2d 566, 579 (S.D.N.Y.2005), aff'd Tenney v. Credit Suisse First Boston Corp., No. 05-3450-cv, 2006 WL 1423785 (2d Cir. May 19, 2006); the duped investors then transact accordingly. To prevent this deleterious effect on the capital markets, the Third Circuit distinguishes manipulative from legal conduct by asking whether the manipulator inject[ed] inaccurate information into the marketplace or creat[ed] a false impression of supply and demand for the security . . . for the purpose of artificially depressing or inflating the price of the security. GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 207 (3d Cir.2001); see also Jones v. Intelli-Check, Inc., 274 F.Supp.2d 615, 627-28 (D.N.J.2003). Market manipulation is forbidden regardless of whether there is a fiduciary relationship between the transaction participants. See United States v. Russo, 74 F.3d 1383, 1391-92 (2d Cir.1996); United States v. Regan, 937 F.2d 823, 829 (2d Cir.1991). A market manipulation claim, however, cannot be based solely upon misrepresentations or omissions. Lentell v. Merrill Lynch & Co., 396 F.3d 161, 177 (2d Cir.2005). There must be some market activity, such as wash sales, matched orders, or rigged prices. See Santa Fe, 430 U.S. at 476, 97 S.Ct. 1292. Furthermore, short selling  even in high volumes  is not, by itself, manipulative. GFL, 272 F.3d at 209. Aside from providing market liquidity, short selling enhances pricing efficiency by helping to move the prices of overvalued securities toward their intrinsic values. See id. at 208; Sullivan & Long, 47 F.3d at 861-62 (discussing the defendants' short sales as arbitrage that eliminates disparities between price and value); In re Scattered Corp. Sec. Litig., 844 F.Supp. 416, 420 (N.D.Ill.1994); John D. Finnerty, Short Selling, Death Spiral Convertibles, and the Profitability of Stock Manipulation 2-3 (Mar.2005), available at http://www. sec.gov/rules/petitions/4-500/jdfinnerty050505.pdf; Ralph S. Janvey, Short Selling, 20 Sec. Reg. L.J. 270, 272 (1992). In essence, taking a short position is no different than taking a long position. To be actionable as a manipulative act, short selling must be willfully combined with something more to create a false impression of how market participants value a security. Similarly, purchasing a floorless convertible security is not, by itself or when coupled with short selling, inherently manipulative. Such securities provide distressed companies with access to much-needed capital and, so long as their terms are fully disclosed, can provide a transparent hedge against a short sale.
Market manipulation requires a plaintiff to allege (1) manipulative acts; (2) damage (3) caused by reliance on an assumption of an efficient market free of manipulation; (4) scienter; (5) in connection with the purchase or sale of securities; (6) furthered by the defendant's use of the mails or any facility of a national securities exchange. See Schnell v. Conseco, Inc., 43 F.Supp.2d 438, 448 (S.D.N.Y.1999); Cowen & Co. v. Merriam, 745 F.Supp. 925, 929 (S.D.N.Y.1990). Because a claim for market manipulation is a claim for fraud, it must be pled with particularity under Rule 9(b). See Internet Law Library, Inc. v. Southridge Capital Mgmt., 223 F.Supp.2d 474, 486 (S.D.N.Y.2002); U.S. Envtl., 82 F.Supp.2d at 239; see also Rooney Pace, Inc. v. Reid, 605 F.Supp. 158, 162-63 (S.D.N.Y.1985) (applying Rule 9(b) to a market manipulation claim). A claim of manipulation, however, can involve facts solely within the defendant's knowledge; therefore, at the early stages of litigation, the plaintiff need not plead manipulation to the same degree of specificity as a plain misrepresentation claim. See Internet Law Library, 223 F.Supp.2d at 486; U.S. Envtl., 82 F.Supp.2d at 240; cf. Rombach, 355 F.3d at 175 n. 10 (relaxing the standard where information was likely to be in the exclusive control of the defendants and analysts). Accordingly, a manipulation complaint must plead with particularity the nature, purpose, and effect of the fraudulent conduct and the roles of the defendants. See In re Blech Sec. Litig., 928 F.Supp. 1279, 1291 (S.D.N.Y.1996) (adopting this test as set forth in the unpublished decision Baxter v. A.R. Baron & Co., No. 94 Civ. 3913, 1995 WL 600720 (S.D.N.Y. Oct.12, 1995)); see also Compu-Dyne Corp. v. Shane, 453 F.Supp.2d 807, 821 (S.D.N.Y.2006); U.S. Commodity Futures Trading Comm'n v. Bradley, 408 F.Supp.2d 1214, 1222 (N.D.Okla.2005) (market manipulation under the Commodity Exchange Act); Fezzani v. Bear, Stearns & Co., 384 F.Supp.2d 618, 642 (S.D.N.Y.2004); In re Royal Ahold N.V. Sec. & ERISA Litig., 351 F.Supp.2d 334, 372 (D.Md.2004); Log On Am., Inc. v. Promethean Asset Mgmt., 223 F.Supp.2d 435, 445 (S.D.N.Y.2001); U.S. Envtl., 82 F.Supp.2d at 240; In re Blech Sec. Litig., 961 F.Supp. 569, 580 (S.D.N.Y.1997). But see Intelli-Check, 274 F.Supp.2d at 629 (articulating requirements for a less stringent pleading standard in the Third Circuit). General allegations not tied to the defendants or resting upon speculation are insufficient. This test will be satisfied if the complaint sets forth, to the extent possible, what manipulative acts were performed, which defendants performed them, when the manipulative acts were performed, and what effect the scheme had on the market for the securities at issue. Baxter, 1995 WL 600720, at ; see also Miller v. Lazard Ltd., 473 F.Supp.2d 571, 587 (S.D.N.Y.2007); In re Sterling Foster & Co. Sec. Litig., 222 F.Supp.2d 216, 270 (E.D.N.Y.2002); Blech, 961 F.Supp. at 580. This standard meets the goals of Rule 9(b) while also considering which specific facts a plaintiff alleging manipulation can realistically plead at this stage of the litigation. Because a claim for market manipulation requires a showing of scienter, the PSLRA's heightened standards for pleading scienter also apply. Therefore, the complaint must plead with particularly facts giving rise to a strong inference that the defendant intended to deceive investors by artificially affecting the market price of securities. See 15 U.S.C. § 78u-4(b)(2); Section II.A, supra. This pleading requirement is particularly important in manipulation claims because in some cases scienter is the only factor that distinguishes legitimate trading from improper manipulation.
ATSI's allegations that the Levinson Defendants, Wolfson, and Rose Glen manipulated the market are based on (1) high-volume selling of ATSI's stock with coinciding drops in the stock price, (2) trading patterns around conversion time, (3) the stock's negative reaction to positive news, and (4) the volume of trades in excess of settlement during a 10-day period in 2003. We agree with the district court that these allegations are inadequate under Rule 9(b). In sum, ATSI has offered no specific allegations that the defendants did anything to manipulate the market; it relies, at best, on speculative inferences. Moreover, ATSI has failed to adequately plead scienter. ATSI's complaint alleges high-volume selling between April 13, 2000 and April 18, 2000, resulting in a 44% decline in stock price. ATSI narrows the list of potential culprits to these defendants because ATSI's major shareholders said that they were not selling stock, leaving only the defendants with large enough blocks of shares to trade at the observed volumes. These allegations fail to state even roughly how many shares the defendants sold, when they sold them, and why those sales caused the precipitous drop in stock price. And the complaint is devoid of facts supporting ATSI's belief that these defendants had sufficient shares to engage in the high-volume trading alleged. Even though the complaint alleges trading volumes of up to 1.5 million shares per day, ATSI reported in its April 14, 2000 Form S-3 that the Shaar Fund held only 492,308 shares of its common stock. The complaint and relevant documents do not reveal how many shares Wolfson and Rose Glen held. ATSI argues that the Shaar Fund's 3,000 shares of Series D Preferred Stock were eventually converted into 8.3 million common shares  sufficient to support the observed trading volumes. This allegation does not help ATSI, however, because the complaint states that the Shaar Fund did not begin converting those preferred shares until December 12, 2000, many months after the high-volume selling. The complaint then alleges that there was a drop in ATSI's stock price in the days leading up to the defendants' conversion of the Preferred Stock. It alleges that in the absence of manipulation, (1) the Reference Price for conversion should approximate the average price during the 30 days prior to the look-back period and (2) that trading volumes during the look-back periods should have been equal to the average for the previous quarter. We agree with the district court's view that ATSI's position is ludicrous. ATSI Commc'ns, 357 F.Supp.2d at 719. One does not observe constant prices or trading volumes in the stock markets. Cf. Cent. Nat'l Bank of Mattoon v. U.S. Dep't of Treasury, 912 F.2d 897, 902 (7th Cir.1990) ([T]he value of a company is rarely constant over an entire year. . . . ). The complaint next alleges that manipulation may be inferred from the stock's negative reaction to positive news. The district court was mistaken in dismissing this circumstance on the grounds that the announcement concerns events with no apparent connection to the defendants or this case. ATSI Commc'ns, 357 F.Supp.2d at 719. The premise of ATSI's theory is that an issuer's stock price, in the absence of manipulation, should increase when good news is announced. [5] Under such a theory, the subject of the news and the defendants do not need to be connected. Nevertheless, this allegation cannot save the complaint because ATSI pleads no particular connection between the negative reaction of the stock price and anything the defendants did. Adopting ATSI's reasoning would subject large holders of convertible preferred stock to the risk of suit under § 10(b) whenever the stock price does not react to news as the issuer expects. See Rombach, 355 F.3d at 171 (stating that Rule 9(b) serves, inter alia, to safeguard a defendant's reputation from improvident charges of wrongdoing and protect him against strike suits). Finally, the complaint rests on an inference of manipulation based upon Depository Trust Company records showing that 8,256,493 shares were traded in excess of settlements during the 10-day period before the AMEX suspended trading of ATSI's stock. Trading volume increased over this period, yet the percentage of trading volume that settled decreased. ATSI claims that the only plausible explanation is that the trades did not result in any change in beneficial ownership, indicating wash trades, matched trades, phantom shares, and other manipulative trading. The inference ATSI asks us to draw is too speculative even on a motion to dismiss. See Segal v. Gordon, 467 F.2d 602, 606, 608 (2d Cir.1972) (holding that distorted inferences and speculations could not meet Rule 9(b)'s requirements). Nowhere does ATSI particularly allege what the defendants did  beyond simply mentioning common types of manipulative activity  or state how this activity affected the market in ATSI's stock. This data could easily be the result of internal settlements within broker-dealers that do not involve the Depository Trust Company. Manipulation is also unlikely given that ATSI's closing share price during this period started at $0.08 per share and ended at $0.08 per share. For similar reasons, none of these allegations, nor anything else in the complaint, meets the PSLRA's requirements for pleading scienter. See 15 U.S.C. § 78u-4(b)(2). A strong inference of scienter is not raised by alleging that a legitimate investment vehicle, such as the convertible preferred stock at issue here, creates an opportunity for profit through manipulation. See Ganino, 228 F.3d at 168-69. These circumstances are present for any investor in floorless convertibles. Cf. Chill v. Gen. Elec. Co., 101 F.3d 263, 267 & n. 5 (2d Cir.1996) (holding that a generalized motive that an issuer wishes to appear profitable, which could be imputed to any public for-profit enterprise, was insufficiently concrete to infer scienter); In re Alstom SA Sec. Litig., 454 F.Supp.2d 187, 197 (S.D.N.Y.2006) (stating a similar proposition for corporate insiders). Accordingly, there is a plausible nonculpable explanation[ ] for the defendants' actions that is more likely than any inference that the defendants intended to manipulate the market, see Tellabs, 127 S.Ct. at 2510: ATSI and the defendants simply entered into mutually beneficial financing transactions. Further, because ATSI has not adequately pled that the defendants engaged in any short sales or other potentially manipulative activity, there is no circumstantial evidence of manipulative intent. See Ganino, 228 F.3d at 168-69. Accordingly, more specific allegations are required.
The complaint is plainly insufficient in alleging that Trimark engaged in market manipulation. [6] It only alleges that Trimark was the principal market maker in ATSI's stock, that Trimark knew or should have known of the manipulation, and that ATSI believes that Trimark was a cooperating broker-dealer. Wholly absent are particular facts giving rise to a strong inference that Trimark acted with scienter in manipulating the market in ATSI's common stock and any allegations of specific acts by Trimark to manipulate the market, much less how those actions might have affected the market.