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LegalEase Sample – Memorandum on Private Placement NEW JERSEY

To: Large Law Firm, New York, NY

From: LegalEase Solutions, LLC

Date: 1/16/2006

Re: Private Placement Memorandum/Fraud Allegations/Reasonable Reliance


You have asked us to research, identify and summarize the key cases on the issue of what might be held to constitute reasonable reliance on representations made in a private placement memorandum offering interests in a fund. These issues require discussion of:

Relevant Cases


1. In re Milestone Sci. Sec. Litig., 103 F. Supp. 2d 425 (S.D.N.J. 2000)

Defendant corporation and officers moved to dismiss, pursuant to Fed. R. Civ. P. 9(b) and 12(b)(6), the amended complaint of plaintiff securities purchasers in a class action for securities fraud pursuant to § 10(b) and § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C.S. §§ 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5.

Plaintiff securities purchasers brought an securities fraud action against defendant corporation and officers for alleged violations of § 10(b) and § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C.S. §§ 78j(b) and 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5. Plaintiffs filed an amended complaint, alleging that defendants, in an effort to increase and maintain an artificially high market price for securities, failed to promptly disseminate accurate and truthful information in connection with its operations, business, products, earnings, and present and future business prospects. Plaintiffs argued thatThe Court agreed with the district Court in that the plaintiff’s fraud claims were properly dismissed, because a sophisticated investor could not have reasonably relied on the alleged fraudulent representation of Equitable agents directly contradicted by Equitable’s documents. published reports, news articles, and filings with the Securities and Exchange Commission were misleading. The court noted that plaintiffs were required to satisfy the heightened pleading requirements of Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act, 15 U.S.C.S. § 78u-4 et seq. Motion to dismiss was granted. The Court held that the plaintiffs failed to meet the heightened pleading requirements for a securities fraud complaint absent credible, particularized allegations that defendants knowingly or recklessly provided misleading or fraudulent statements or omissions in connection with its operations.

The Court observed that to establish a claim under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, a plaintiff must plead (1) a false representation, or omission, of a material fact, (2) knowledge or reckless disregard of its falsity by a defendant and the intention that a plaintiff rely on the falsity, (3) reasonable reliance thereon by a plaintiff, and (4) a resultant loss. Id at 66.

The reliance of a plaintiff on alleged misstatements or omissions must be reasonable; the burden of proof is upon the defendant to show reliance was not reasonable. See Kline, 24 F.3d at 493 (citing Straub v. Vaisman & Co., 540 F.2d 591, 598 (1976)). Where the security involved is traded in an open and efficient market, a plaintiff need not show individual and specific reliance on the misrepresentation of a defendant. A plaintiff may instead rely upon the fraud on the market theory and claim only that he or she suffered injury in the capacity as a purchaser or seller of a security in such a market. Id at 67.

2. Smerenko v. Cendant Corp. 223 F.3d 165 (3rd Cir. 2000)

Plaintiffs and the class of similarly situated investors appealed from a district court order dismissing their claims for securities fraud filed under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The court vacated and the district court’s order.

The Court of Appeals repeated the standard that to state a valid claim under Rule 10b- 5, a plaintiff must show that the defendant (1) made a misstatement or an omission of a material fact (2) with scienter (3) in connection with the purchase or the sale of a security (4) upon which the plaintiff reasonably relied and (5) that the plaintiff ‘s reliance was the proximate cause of his or her injury. Id. at 174.

The Court of Appeals found that plaintiffs alleged sufficient facts to establish the
elements of reliance and loss causation and that the district court applied the incorrect analysis for determining whether the complaint alleged that the purported misrepresentations under § 10(b) and Rule 10b-5 were made “in connection with” the purchase or the sale of a security. The fact that defendants’ alleged misrepresentations did not implicate the investment value of the securities in question was insufficient to defeat plaintiffs’ claims. Accordingly, because the standard the court articulated, applying the materiality and public dissemination approach, was different from the one applied by the district court, the judgment of the district court was vacated and remanded for further proceedings.

The Court of Appeals went on to disagree with the defendant’s argument that it is unreasonable as a matter of law to rely on information concerning a tender offer or a merger before the transaction is finalized, we disagree. The Court referred to a Supreme Court case which cautioned that “no particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.” Basic, Inc., 485 U.S. at 239. The Court of Appeals reasoned that other courts have similarly held that information concerning a tender offer may be material while the transaction is still in the planning stage. The Court stated, “If it may be reasonable for an investor to find information concerning a tentative tender offer or a merger important when making an investment decision, we see no reason why the conditional nature of
those transactions should necessarily prevent the investor from reasonably relying on that information as well.” Id. 181.

3. Weiner v. Quaker Oats Co., 129 F.3d 310 (3rd Cir. 1997)

Plaintiff stockholders bought shares in defendant corporation while it was negotiating a leveraged purchase of another company. Six weeks before the purchase closed, defendant issued an annual report setting forth its debt to capitalization ratio (ratio) and its projected earnings over time. After closing, the ratio changed, which caused plaintiffs’ stock to decrease in value. Plaintiffs sued the corporation and its chairman under §§ 10(b) and 20(a) of the Securities and Exchange Act of 1934, 15 U.S.C.S. §§ 78j(b) and 78t(a), and SEC rule 10b-5, 17 C.F.R. § 240.10b5, and the trial court granted defendants’ motion to dismiss. On appeal, the court held that the annual report, when considered with other reports containing the same ratio, could lead a reasonable investor to believe that the ratio would not change. Thus, the ratio was material and plaintiffs stated a cause of action under rule 10b-5 on that issue. However, because the projected earnings were qualified by the phrase “over time,” they were not material. The court affirmed the judgment on the claim based on projected earnings reversed it on the claim based on the ratio, and remanded the case for further proceedings.

The Court observed that in general, Section 10(b) and Rule 10b-5 do not impose a duty on defendants to correct prior statements — particularly statements of intent — so long as those statements were true when made. The Court referred to In re Phillips Petroleum, 881 F.2d at 1245, in this context. However, the Court also observed that “there can be no doubt that a duty exists to correct prior statements, if the prior statements were true when made but misleading if left unrevised.” Id. To avoid liability in such circumstances, “notice of a change of intent be disseminated in a timely fashion.” Id. at 1246. Whether an amendment is sufficiently prompt is a question that “must be determined in each case based upon the particular facts and circumstances.” Id.

The Court held that, therefore, defendants have failed to establish that plaintiffs can prove no set of facts in support of their claim, which would entitle them to relief. The complaint alleges facts on the basis of which a reasonable fact finder could determine that Quaker’s statements regarding its total debt-to-total capitalization ratio guideline would have been material to a reasonable investor, and hence that Quaker had a duty to update such statements when they became unreliable. Id at 318

4. EP Medsystems Inv., v. Ecocath, Inc., 235 F.3d 865 (3rd Cir. 2000)

Plaintiff filed suit against defendant alleging that the chief executive officer of defendant enticed plaintiff into investing $ 1,400,000 in defendant by assuring plaintiff that lengthy negotiations had already taken place with four prominent companies to market certain new defendant products, and that contracts with these companies were “imminent.” Relying on cautionary language contained in public documents filed by defendant with the Securities Exchange Commission, the district court held that these representations were immaterial as a matter of law under the “bespeaks caution” doctrine and the general test for materiality. It also held that plaintiff failed to adequately plead scienter, reasonable reliance, and loss causation. The complaint was dismissed and plaintiff appealed. The court reversed the decision of the district court, finding that there was a statement of fact in the context presented by plaintiff’s complaint that could be found to meet the requirement of materiality. Moreover, a trier of fact could find that reliance was reasonable and that there was the requisite causal connection between the assurances and plaintiff’s loss, i.e., its investment. The court reversed the order dismissing the complaint and remanded for further proceedings in accordance with this opinion; there was a statement of fact in the context presented by plaintiff’s complaint that could be found to meet the requirement of materiality.

5. William Kozin & Kurt Kozin v. Richard J. Dunn, Kevin R. Dunn, 2005 U.S. Dist. LEXIS 18156 (D.N.J. 2005)

Plaintiffs, a father and his son, sued defendants, a corporation, its president, and its secretary, alleging, inter alia, common law fraud and securities fraud under Rule 10b- 5, 17 C.F.R. § 240.10b-5, and § 10(b) (15 U.S.C.S. § 78j(b)) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78a et seq. Defendants moved to dismiss the common law fraud and federal securities fraud claims for failure to state a claim.

Plaintiffs alleged that defendants approached them seeking investments and made various fraudulent misrepresentations concerning the corporation’s sources of financing and specific targets for imminent acquisition. In reliance on these statements, the father lent the corporation $ 150,000, and the son entered into an employment agreement with the corporation. The corporation defaulted under the terms of the promissory note and never paid the son under the employment agreement. The court determined that plaintiffs adequately alleged common law fraud under Fed. R. Civ. P. 9(b) based upon, inter alia, defendants’ fraudulent misrepresentations that were supported by certain documents and their detrimental reliance. However, the federal securities fraud claims were dismissed under the Private Securities Litigation Reform Act because (1) plaintiffs failed to show scienter based upon motive and opportunity due to the individual defendants’ shareholder status and based upon recklessness and (2) the complaint did not plead falsity adequately since plaintiffs did not show why the statements were misrepresentations.

The court granted defendants’ motion to dismiss with respect to the federal securities fraud claims and dismissed those claims without prejudice. The court denied the motion to dismiss with respect to the common law fraud claims.

6. Grace Cowit, v. Roberts Pharmaceutical Corp., 1996 U.S. Dist. LEXIS 22506 (D.N.J. 1996)

Plaintiff stock purchaser, on behalf of herself and all others similarly situated, filed a claim alleging misrepresentation and fraud in connection with the purchase of stock in the defendant corporation. Defendants, three principal financial offers, were also named as parties. Defendants filed a motion for dismissal of the purchaser’s amended complaint under Fed. R. Civ. P. 12(b)(6) and for partial dismissal under Fed. R. Civ. P. 9(b).

Defendants sought dismissal of the purchaser’s claims on the basis that: (1) the
complaint failed to allege an actionable misrepresentation or omission; (2) the purchaser failed to set forth any ground for alleging scienter for the alleged fraud; (3) the purchaser’s claims lacked the specificity required under Fed. R. Civ. P. 9(b). The court was reluctant to characterize many of the statements and omissions as misleading at this stage of the case. Many of the statements, required additional facts and a wider context to determine whether they were actionable as a matter of law. The court could not find that defendants’ alleged statements and/or omissions were not actionable as a matter of law. Although several of the statements could constitute mere “puffing,” others were not “so obviously unimportant” to a reasonable investor that they could not violate the securities laws. The court was not persuaded that the complaint suffered from a lack of particularity under Fed. R. Civ. P. 9(b). As to whether statements by Wall Street analysts were actionable under Rule 9(b), the court found in favor of defendants and should grant the motion to dismiss based on these allegations.

The court ordered that the motion of defendants for dismissal under Fed. R. Civ.
P. 9(b) of that portion of the complaint based upon statements allegedly made to a Wall Street analysts be granted. The court further ordered that the motion of defendants for dismissal under Fed. R. Civ. P. 12(b)(6) be denied.

7. Morton I. Thomas Edco Surgical Supply Co., Inc. V. Duralite Company, Inc., 524 F.2d 577 (3rd Cir. 1975)

Defendants, former business partners of plaintiff, appealed an order of the United States District Court for the District of New Jersey, assessing damages against defendants, a corporation and individuals, under § § 10(b), 20 and 29(b) of the Securities Exchange Act of 1934, 15 U.S.C.S.§ § 78j, 78t, and 78cc(b), and S.E.C. Rule 10b-5.

Plaintiff and individual defendants were partners in Defendant Corporation. After some time, plaintiff withdrew. To discuss the sale of plaintiff’s stock, plaintiff met a defendant partner, who indicated to plaintiff that the stock was valueless and that defendant corporation had little chance of continuing. Defendants were meanwhile discussing a merger with another company. Plaintiff agreed to transfer the stock in exchange for cancellation of indebtedness. When plaintiff discovered that the corporation had become a subsidiary of another, he sued for damages based on misrepresentation under § § 10(b), 20 and 29(b) of the Securities Exchange Act of 1934, 15 U.S.C.S.§ § 78j, 78t, and 78cc(b), and S.E.C. Rule 10b-5. The lower court awarded damages to plaintiff. On appeal, the court affirmed. The court held that the lower court did not err in finding that defendants were culpable because they knew that the corporation’s prospects were improving, the knowledge was material, and that defendants misrepresented plaintiff, and plaintiff relied on the misrepresentation.

The court affirmed the order except as to defendant corporation. That portion of
the order was reversed and remanded for further consideration of damages. The Court held that the elements of a plaintiff’s case on liability for securities fraud include knowledge by the defendants, intent to defraud, or scienter, failure to disclose to the plaintiff, materiality of the facts, and, in some instances, reliance by the plaintiff.