In re StockerYale Securities 05-CV-177-SM 09/27/06 UNITED STATES DISTRICT COURT

DISTRICT OF NEW HAMPSHIRE

In r e : StockerYale Civil N o . 05-cv-177-SM Securities Litigation Opinion N o .

O R D E R

Plaintiffs in this class action bring suit against

StockerYale, Inc., its Chief Executive Officer (Mark W .

Blodgett), its Chief Financial Officer (Francis J. O’Brien), its

Chief Operating Officer (Ricardo A . Diaz), and one of its

directors (Lawrence W . Blodgett). Plaintiffs’ First Amended

Complaint (document n o . 18) alleges: violations of section 10(b)

of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)) and

Rule 10b-5 (

.10b-5), by StockerYale and Mark

Blodgett (Count I ) ; violations of section 20A of the Act (15

U.S.C. § 78t-1), by StockerYale, Mark Blodgett, and Lawrence

Blodgett (Count I I ) ; and violations of section 20(a) of the Act

(15 U.S.C. § 78t(a)), by Mark Blodgett, Diaz, and O’Brien (Count

III). The crux of plaintiffs’ claim is that StockerYale issued

false or misleading press releases on April 19 and 2 1 , 2004,

which resulted in a dramatic increase in the price of StockerYale

shares, and that Mark Blodgett and Lawrence Blodgett unlawfully

benefitted from their knowledge of the falsity of those press

releases by selling StockerYale shares the day after the first

press release was issued, shortly before it’s accuracy was called into question in the media, and near the peak of the stock’s

brief spike in price.

Before the court are: a motion to dismiss filed by

StockerYale and Mark Blodgett (document n o . 2 0 ) ; a motion to

dismiss filed by Lawrence Blodgett, Diaz, and O’Brien (document

n o . 2 2 ) ; and a motion to strike portions of the memorandum of law

in support of document n o . 20 as well as two exhibits appended

thereto (document n o . 2 4 ) . For the reasons given, defendants’

motions to dismiss are denied and plaintiffs’ motion to strike is

granted.

Motion to Strike

Plaintiffs move to strike two exhibits appended to

defendants’ legal memorandum, as well as various references to

facts in that memorandum. Specifically, plaintiffs object to

defendants’ reliance o n : (1) a “market commentary” titled “Near-

Term Spotlight – The Security Industry,” by Paul Tracy, editor of

StreetAuthority Market Advisor (Defs.’ Mem. of Law (document n o .

2 1 ) , Ex. F ) ; (2) a set of six graphs purporting to depict prices

of six different “microcap security stocks” (id., Ex. G ) ; and (3)

various factual allegations supporting defendants’ interpretation

of the press releases that plaintiffs claim to have been false or

misleading.

2 “The fate of a motion to dismiss under Rule 12(b)(6)

ordinarily depends on the allegations contained within the four

corners of the plaintiff’s complaint.” Young v . Lepone,

, 10-11 (1st Cir. 2002). However, “[w]hen the factual

allegations of a complaint revolve around a document whose

authenticity is unchallenged, ‘that document effectively merges

into the pleadings and the trial court can review it in deciding

a motion to dismiss under Rule 12(b)(6).’”

at 11 (quoting

Beddall v . State S t . Bank & Trust Co.,

2 , 17 (1st Cir.

1998); citing 2 JAMES W M . MOORE ET A L . , MOORE’S FEDERAL PRACTICE ¶

12.34[2] (3d ed. 1997)). As well, the Federal Rules of Evidence

permit a court to take judicial notice of facts “capable of

accurate and ready determination by resort to sources whose

accuracy cannot reasonably be questioned.” F E D . R . EVID. 201(b).

Market commentary. The “market commentary” attached as

Exhibit F to defendants’ memorandum of law was published on April

1 2 , 2004 – five days before the first StockerYale press release

was issued – and it discusses the “red-hot” performance of

several stocks in the “security sector.” Plaintiffs move to

strike Exhibit F on grounds that it is not relevant to their

complaint and is also immaterial, irrelevant, and inadmissible as

both opinion testimony and hearsay. Defendants counter that the

article is background information subject to judicial notice

3 under F E D . R . EVID. 201(b), and is “pertinent to the action.” In

re Polaroid Corp. Sec. Litig., 134 F . Supp. 2d 176, 182 (D. Mass.

2001).

The disputed market commentary is not “pertinent to the

action” because it is not a document on which plaintiffs’ action

is based. See

(citing Romani v . Shearson Lehman Hutton,

(1st Cir. 1991); Fudge v . Penthouse Int’l, Ltd.,

(1st Cir. 1988)). Nor are the editorial

comments and analysis contained in the commentary about overall

trends in the security sector the kind of information that is

subject to judicial notice. See Kramer v . Time Warner, Inc.,

6 7 , 773 (2d Cir. 1991) (“The [district court’s]

illustrative reference to the condition of the junk bond market

was thus not a ground for decision and does not run afoul of the

rule that a district court must confine itself to the four

corners of the complaint when deciding a motion to dismiss under

Rule 12(b)(6).”). And, while the strictly factual information

contained in the market commentary describing the market

capitalization and earnings of E F J Incorporated, N A P C O Security

Systems, I P I X Corp., Arotech Corp., and Magal Security Systems is

probably subject to judicial notice, because that information

consists of facts “capable of accurate and ready determination by

resort to sources whose accuracy cannot reasonably be

4 questioned,” F E D . R . EVID. 201(b), defendants have not shown how

such information is relevant to the pending motions.

Stock price data. Attached as Exhibit G to the memorandum

is a set of graphs titled, collectively, “April 2004 Stock Prices

of Comparable Microcap Security Companies,” which purports to

show the stock prices for Alanco Technologies, Arotech, Bulldog

Technologies, ComCam, Inc., I C T S International, and Metal Storm

Ltd. about the time StockerYale issued the two disputed press

releases. Plaintiffs move to strike Exhibit G on grounds that it

is not relevant to their complaint and is of questionable

evidentiary value.

As with the market commentary, the stock price information

in Exhibit G is not pertinent to the issues currently before the

court, and so are not considered.

Facts in the memorandum of law. Plaintiffs also contend

that defendants’ memorandum of law relies on asserted facts drawn

from beyond the four corners of the complaint.1 To the extent

1 In particular, plaintiffs contend that defendants impermissibly discuss StockerYale’s shift from delivering prototype lasers to supplying production lasers, and argue that the press releases at issue were not false or misleading because they announced the start of regular shipments of production lasers – despite the absence of facts asserted in the complaint or text of the press releases to support such an argument.

5 that is the case, those facts not properly before the court will

be disregarded.

Motions to Dismiss

1. The Legal Standard

A motion to dismiss for “failure to state a claim upon which

relief can be granted,” F E D . R . C I V . P . 12(b)(6), requires the

court to conduct a limited inquiry, focusing not on “whether a

plaintiff will ultimately prevail but whether the claimant is

entitled to offer evidence to support the claims.” Scheuer v .

Rhodes, 416 U . S . 2 3 2 , 236 (1974). When considering a motion to

dismiss under F E D . R . C I V . P . 12(b)(6), the court must “accept as

true the factual allegations of the complaint and construe all

reasonable inferences therefrom in favor of [plaintiff].” Perry

v . N . E . Bus. Serv., Inc.,

(1st Cir. 2003)

(citing Beddall,

6 ) . However, the court need not

credit “claims that are made in the complaint if they are ‘bald

assertions’ or ‘unsupportable conclusions.’” United States ex

rel. Karvelas v . Melrose-Wakefield Hosp.,

2 0 , 224 (1st

Cir. 2004) (quoting Arruda v . Sears, Roebuck & Co.,

3 ,

18 (1st Cir. 2002)). Finally, “[a] district court may grant a

12(b)(6) motion to dismiss for failure to state a claim upon

which relief can be granted only if ‘it clearly appears,

according to the facts alleged, that the plaintiff cannot recover

6 on any viable theory.’” Pomerleau v . W . Springfield Pub. Sch.,

(1st Cir. 2004) (quoting Correa-Martinez v .

Arrillaga-Belendez,

9 , 52 (1st Cir. 1990)).

Because count one of plaintiffs’ complaint has been brought

under section 10(b) of the Securities Exchange Act, it is subject

to a heightened pleading standard, set out in statute and rule.

Under the provisions of the Private Securities Litigation Reform

Act (“PSLRA”) of 1995:

In any private action arising under this chapter in which the plaintiff alleges that the defendant–

(A) made an untrue statement of material fact; or (B) omitted to state a material fact necessary in order to make the statements made, in light of the circumstances in which they were made, not misleading;

the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.

15 U.S.C. § 78u-4(b)(1). Furthermore:

In any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.

7 15 U.S.C. § 78u-4(b)(2).

The First Circuit has held that “[t]he PSLRA imposes

requirements for pleading with particularity that are consistent

with [the] circuit’s prior rigorous requirements for pleading

fraud with particularity under Fed.R.Civ.P. 9(b).” Greebel v .

FTP Software, Inc.,

(1st Cir. 1999). According

to Rule 9 ( b ) , “[i]n all averments of fraud or mistake, the

circumstances constituting fraud or mistake shall be stated with

particularity.” Moreover, “[t]he particularity requirement is

regarded by the Court of Appeals for this Circuit as being of

fundamental importance.” In re Boston Tech., Inc. Sec. Litig.,

3 , 52 (D. Mass. 1998). The particularity

“requirement ‘entails specifying in the pleader’s complaint the

time, place, and content of the alleged false or fraudulent

representations.’” Arruda v . Sears, Roebuck & Co.,

3 ,

19 (1st Cir. 2002) (quoting Powers v . Boston Cooper Corp.,

(1st Cir. 1991)). In addition, “the complaint must

set forth specific facts that make it reasonable to believe that

the defendant knew that a statement was materially false or

misleading. The rule requires that the particular times, dates,

places, or other details of the alleged fraudulent involvement of

the actors be alleged.” Boston Tech.,

8 (quoting Gross v . Summa Four, Inc.,

8 7 , 991 (1st Cir.

1996) (emphasis added)).

Moreover, “[i]t is not the law that a 10b-5 complaint is to

be judged on the basis of the general flavor derived from an

issuer’s collective statements over a long period of time.”

Boston Tech.,

6 . Rather, “[10b-5] allegations

[must be organized] into discrete units that are, standing alone,

each capable of evaluation.”

at 55-56 (quoting Shapiro v .

UJB Fin. Corp.,

7 2 , 284 (3d Cir. 1992)). However,

the fact that a statement is literally accurate does not preclude liability under federal securities laws. “Some statements, although literally accurate, can become, through their context and manner of presentation, devices which mislead investors. For that reason, the disclosure required by the securities laws is measured not by literal truth, but by the ability of the material to accurately inform rather than mislead prospective buyers.” McMahan v . Wherehouse Entertainment, Inc.,

, 579 (2d Cir. 1990). Under the foregoing standards, “emphasis and gloss can, in the right circumstances, create liability.” Isquith v . Middle S . Utils., Inc.,

, 203 (5th Cir. 1988).

Lucia v . Prospect S t . High Income Portfolio, Inc.,

7 0 ,

175 (1st Cir. 1994) (citations omitted).

Finally, “[u]nder the PSLRA, the complaint must state with

particularity facts that give rise to a ‘strong inference’ of

scienter, rather than merely a reasonable inference.” Mesko v .

9 Cabletron Sys., Inc (In re Cabletron Sys., I n c . ) ,

1 , 38

(1st Cir. 2002) (citing 15 U.S.C. § 78u-4(b)(2); Greebel,

). That i s , “[i]t is clear that scienter

allegations now must be judged under the ‘strong inference’

standard at the motion to dismiss stage.” Greebel,

.

2. Factual Background

StockerYale designs and manufactures lasers. At all times

relevant to this suit, Mark Blodgett was StockerYale’s Chairman

and Chief Executive Officer; Ricardo Diaz was StockerYale’s Chief

Operating Officer; and Francis O’Brien was StockerYale’s

Executive Vice President, Chief Financial Officer, and Treasurer.

Lawrence Blodgett was a StockerYale director.

In July, 2002, StockerYale entered into an agreement with

BAE Systems (“BAE”) to supply BAE with seven “reference lasers”

for “National Defense use,” at a price of $91,350. Two of the

lasers were to be delivered by September 1 3 , 2002, with the

remaining five to be delivered by November 2 2 , 2002. (Pls.’ O b j .

to Defs.’ Mot. to Strike (document n o . 2 7 ) , Ex. 4.)

On October 1 1 , 2002, StockerYale issued a press release

which stated, in pertinent part:

10 StockerYale, Inc. (NASDAQ: STKR), an independent supplier of photonics-based products, has been awarded a contract from BAE SYSTEMS to supply custom-designed thermoelectrically cooled lasers for their Advanced Threat Infrared Countermeasures (ATIRCM) system.

StockerYale will initially supply several specialized lasers to the Nashua, N.H.-based Information & Electronic Warfare Systems (IEWS) business unit in the fourth quarter of 2002, with the opportunity for long- term deliveries through 2020.

BAE SYSTEMS’ ATIRCM is the next-generation countermeasure to protect military aircraft from infrared-guided missiles. This system is currently designated for installation on the U.S. Army AH-64, UH- 6 0 , CH-47, EH-60, and various other aircraft.

(Defs.’ Mem. of Law (document n o . 2 1 ) , Ex. C.) Plaintiffs allege

that the October 11 press release was intended to announce the

July, 2002, contract, but its reference to “long-term deliveries

through 2020” appears to be inconsistent with the July, 2002,

contract. That contract called for only two deliveries, in

September and November, 2002. Thus, it is not clear whether the

October 11 press release referred to StockerYale’s July, 2002,

contract with BAE or to some other agreement between the two

companies. Fortunately, however, that press release is not

central to plaintiffs’ claims.

In December, 2003, StockerYale entered into another contract

with BAE, for “Repackaging of 2 ATIRCM Reference Lasers and

completion of 2 prototypes,” at a price of $70,000. The two

11 prototype units were scheduled for delivery by April 1 4 , 2004.

(Pls.’ O b j . to Defs.’ Mot. to Strike (document n o . 2 7 ) , Ex. 3.)

Unlike the July, 2002, contract, which specified that the

subject lasers were for “National Defense use,” the December,

2003, contract included no such specification, nor did it include

a Defense Priority and Allocation Requirements (“DPAS”) rating,

which is required for contracts supporting both military and

homeland security programs. The contract provided no other

information regarding the uses to which the prototype lasers

might be put.

On January 6, 2004, the United States Department of Homeland

Security (“Homeland Security”) announced that three contractors,

including BAE, had each been awarded $2 million in Phase I of a

project to determine the viability of technology designed to

protect commercial aircraft against shoulder-fired missiles.

Upon learning of BAE’s Homeland Security contract, Mark

Blodgett directed StockerYale’s Vice President of Corporate

Marketing to prepare a press release announcing that the

December, 2003, contract between StockerYale and BAE was

connected to BAE’s January, 2004, Homeland Security contract.

12 BAE gave StockerYale no information suggesting any such

connection, and the proposed press release was never issued.

In April, 2004, BAE placed an order with StockerYale for

twenty-one lasers, at a price of $200,000.2

On April 1 9 , 2004, StockerYale issued a press release titled

“StockerYale Receives Order from BAE for Specialized Lasers

Integral to Military Missile Countermeasure Systems.” That press

release was subtitled: “The Company is Also Developing Customized

Lasers for Missile Countermeasure System on Commercial Planes.”

It stated, in pertinent part:

StockerYale, Inc. (NASDAQ: STKR - News), a leading independent provider of photonics-based products, has received a noteworthy order from BAE SYSTEMS to supply lasers that are integral to an airborne military missile defense system. The Company’s specialized lasers are part of the Advanced Threat Infrared

2 In paragraph 46 of the First Amended Complaint, plaintiffs characterize the April, 2004, transaction as “a small and financially immaterial order for 21 lasers worth about $200,000 pursuant to the old previously announced July 2002 contract with BAE Systems.” However, the July, 2002, contract between StockerYale and BAE was for the sale of only seven lasers, the last of which were to be delivered by November 2 2 , 2002. Moreover, while plaintiffs cite paragraph fifteen of a Securities and Exchange Commission (“SEC”) complaint against StockerYale as the basis for their characterization of the April, 2004, transaction as a delivery pursuant to the July, 2002, contract, the SEC complaint actually refers to the April, 2004, transaction as part of a separate contract between BAE and StockerYale.

13 Countermeasure (ATIRCM) system, which is the next- generation countermeasure system designed to protect military aircraft from infrared-guided missiles.

The Company is also developing a customized laser for the development of a missile countermeasure system for commercial planes under a recent contract received from the Nashua, N.H.-based Information & Electronic Warfare Systems (IEWS) business unit of BAE. This commercial missile defense system is an adaptation of the ATIRCM system concept. BAE is one of three companies awarded a contract from the Department of Homeland Security to determine the feasibility of adapting the military missile-defense system for commercial planes. If the systems can be adapted, design contracts will be awarded to one or two of the companies to build and test prototypes.

“We are pleased to have been chosen by BAE once again to participate in this important program designed to protect aircraft from attack by shoulder-launched missiles,” said Mark W . Blodgett, StockerYale’s chief executive officer. “By successfully developing and delivering customized lasers for BAE’s ATIRCM military system, StockerYale is well positioned to deliver a variation of this laser for use within this prospective commercial application.” Blodgett concluded, “We realize the importance and practical implications that such a commercial countermeasure system could have and look forward to supporting BAE on this project.”

(Defs.’ Mem. of Law (document n o . 2 1 ) , Ex. A.)

StockerYale did not seek BAE’s approval of the April 19

press release, in violation of its obligation to do so under

established BAE corporate policy. Moreover, at least one

StockerYale official (Luc Many, Senior Vice-President for Sales

and Marketing) counseled against issuing the press release, on

grounds that: (1) the April, 2004, order was “old news” resulting

14 from a 2002 contract; (2) StockerYale had not been able to verify

that its December, 2003, contract with BAE was related to BAE’s

Homeland Security contract; and (3) BAE had not approved the

press release, and would find it unacceptable. When BAE learned

of the April 19 press release, it notified StockerYale that the

two lasers it purchased pursuant to the December, 2003, contract

were not for uses related to its Homeland Security contract.

Moreover, StockerYale had not received any order related to BAE’s

January, 2004, Homeland Security contract.

On April 1 9 , 2004, the date of the press release quoted

above, StockerYale shares began trading at $1.43. Shortly after

the press release was issued, the stock rose to a daily high of

$4.28, and closed at $4.15. In after-hours trading that day,

StockerYale traded at a high of $6.04 per share.

On April 2 0 , 2004, StockerYale opened at $6.70, hit a daily

high of $7.75, and closed at $3.74, after hitting a daily low of

$3.53.3 That same morning, Mark Blodgett sold $1.64 million

worth of StockerYale shares(at $6.56 per share). Also that

morning, Lawrence Blodgett sold $352,000 worth of StockerYale

shares, in two blocks (at $6.12 per share and $7.19 per share).

3 Trading volume on April 2 0 , 2004, was approximately 500 times greater than the average volume for the previous thirty days.

15 Early in the morning of April 2 0 , CNBC Nasdaq reporter

Leslie Laroche contacted StockerYale’s Vice President for

Corporate Marketing, James Gargas, and inquired about the “new

orders” reported in the April 19 press release. Gargas told

Laroche that the order had not resulted from a new contract, but

was related to an existing contract with BAE, announced to the

public in October, 2002. He also told Laroche that StockerYale

was providing BAE with prototype lasers for its contract to

develop a prototype system to protect aircraft from shoulder-

launched lasers.

At approximately 1:05 p.m. on April 2 0 , after the Blodgetts

had made their trades, Laroche broadcast a report on the April 19

press release, telling viewers that she had learned that

StockerYale had not received a new contract, but was merely

filling orders under an old, previously announced agreement with

BAE. After that report aired, StockerYale shares fell from their

daily high of $7.75 to a closing price of $3.74.

On April 2 1 , 2004, after the close of trading, presumably in

response to the CNBC report and/or the information StockerYale

received from BAE, StockerYale issued another press release,

titled “StockerYale Provides Additional Information with Respect

16 to Orders Received from BAE.” That release, issued at Mark

Blodgett’s direction, stated, in pertinent part:

StockerYale, Inc. (NASDAQ: STKR - News), a leading independent provider of photonics-based products provides additional information with respect to orders received from BAE.

StockerYale’s press release of April 1 9 , 2004 referenced two orders that the Company had received from BAE Systems.

The Company wishes to provide additional information with respect to the terms of those orders.

The first order mentioned was a production order from BAE under its contract with the U.S. government to supply an airborne military defense system against heat-seeking missiles. BAE was awarded that contract in October 2002 and in a press release dated October 1 1 , 2002 the Company announced that it had been awarded a contract from BAE to supply the Company’s thermoelectrically cooled laser to BAE for its ATIRCM program. The contract that BAE has with the U.S. government calls for deliveries through 2020 and StockerYale expects to receive additional orders under this contract.

The second order that the Company received from BAE Systems was an order for the delivery of customized lasers for an adaptation of the military ATIRCM system for use on commercial or military airplanes.

(Defs.’ Mem. of Law (document n o . 2 1 ) , Ex. B.)

While the April 21 press release represented that

StockerYale was supplying lasers to BAE pursuant to an agreement

between BAE and the U.S. Government that called for deliveries

from BAE to the government through 2020, the actual completion

17 date of BAE’s contract to deliver ATIRCM systems is July 1 4 ,

2007.

When it learned of the April 21 press release, one day after

it was issued, BAE complained to StockerYale that both press

releases were inaccurate, and insisted that StockerYale remove

them from the company’s web site. StockerYale complied

immediately, but never fully corrected the misrepresentations

contained in the two press releases.

At the close of trading on April 2 1 , before the April 21

press release was issued, StockerYale shares were trading at

$3.17. StockerYale opened at $4.81 on April 2 2 , and reached a

daily high of $4.99 before closing at $3.68. On May 2 4 , 2005,

the last day of the class period, StockerYale closed at $0.76 per

share.

Also on May 2 4 , 2005, the SEC filed a civil action against

Mark Blodgett and StockerYale, alleging violations of section

10(b) of the Exchange Act and Rule 10b-5, based on the issuance

of the April 19 and 21 press releases.4 That action resulted in

4 The SEC first informed StockerYale of its investigation on August 6, 2004. On August 1 0 , 2004, StockerYale issued a Form 8-K disclosing the SEC’s investigation into the two press releases. When the investigation was disclosed to the public, StockerYale shares reached a low of $0.84 in after-hours trading.

18 consent judgments against Blodgett and StockerYale under which

Blodgett was ordered to pay disgorgement of $754,877 and a civil

penalty of $120,000, and both StockerYale and Mark Blodgett were

enjoined from committing any further violations of section 10(b).

This action followed. In i t , plaintiffs claim that the

April 19 press release was false and misleading because it stated

that: (1) StockerYale was developing a customized laser for a

missile countermeasure to protect commercial aircraft; (2)

StockerYale was doing so as part of a Homeland Security project;

and (3) StockerYale had received an order from BAE to supply

lasers to protect commercial aircraft. Plaintiffs further claim

that the April 21 press release was false and misleading because

it reiterated the misrepresentations stated in the April 19 press

release and further misrepresented that BAE had a contract to

deliver military missile-defense systems to the U.S. government

through 2020.

3. StockerYale and Mark Blodgett (document n o . 20)

Defendants5 move to dismiss Count I , plaintiffs’ section

10(b) claim, on grounds that: (1) every statement in the April,

2004, press releases was either an accurate statement of

5 Throughout this section, the term “defendants” is used to refer to StockerYale and Mark Blodgett.

19 historical fact, an expression of opinion or belief, or a

forward-looking statement accompanied by meaningful cautionary

language; (2) plaintiffs fail to allege sufficient facts to

support a strong inference of scienter; and (3) plaintiffs do not

adequately plead loss causation. Defendants also move to dismiss

Count II on grounds that plaintiffs’ failure to state a claim

under section 10(b) necessarily requires dismissal of their

section 20A claim. Mark Blodgett moves to dismiss Count III on

grounds that plaintiffs have failed to allege facts establishing

that he is subject to control person liability.

A. Count I – The Section 10(b) Claim

Section 10(b) of the Securities Exchange Act of 1934

provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange–

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley A c t ) , any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

20

8 j . Rule 10b-5, promulgated by the SEC, provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

.10b-5. “The Supreme Court has described the

‘basic elements’ of a claim under Rule 10b-5 as including: (1) ‘a

material misrepresentation (or omission)’; (2) ‘scienter, i.e., a

wrongful state of mind’; (3) ‘a connection with the purchase or

sale of a security’; (4) ‘reliance’; (5) ‘economic loss’; and (6)

‘loss causation.’” Brody v . Stone & Webster, Inc. (In re Stone &

Webster, Inc., Sec. Litig.),

8 7 , 193 (1st Cir. 2005)

(quoting Dura Pharm., Inc. v . Broudo,

(2005)

(emphasis omitted); citing Wortley v . Camplin,

8 4 , 294

(1st Cir. 2003); Geffon v . Micrion Corp.,

9 , 34 (1st

Cir. 2001)).

21 A statement is false or misleading if the person making it

has actual factual knowledge, at the time of the statement, that

makes the statement false or misleading. See, e.g., Cabletron,

6 ; Aldridge v . A.T. Cross Corp.,

2 , 79

(1st Cir. 2002).

In the First Circuit, “general averments of defendants’ knowledge of material falsity [do] not suffice.” Gross,

. A 10b-5 plaintiff must allege “details of [defendants’] alleged fraudulent involvement,” including specifics as to what defendants had knowledge of and when.

To satisfy this requirement, complaints typically identify internal reports, memoranda, or the like, and allege both the contents of those documents and defendants’ possession of them at the relevant time. See, e.g., Serabian [v. Amoskeag Bank Shares, I n c . ] , 24 F.3d [357,] 368 [(1st Cir. 1994)] (plaintiffs, “cit[ing] to reports and documents presented to defendants at relevant times that were inconsistent with the defendants’ public statements . . . satisfies the necessary pleading requirements.”) Moreover, such citation must be “specifically” made.

Recently, in Shaw [v. Digital Equip. Corp.],

(1st Cir. 1996)], the Court ruled that merely alleging the existence of a highly efficient reporting system – even one that would logically lead to internal reports on the relevant subject matter – was not enough. The Court wrote that such allegations “may speak to the question of how defendants might have known what they allegedly knew, but [they are insufficient] absent some indication of the specific factual content of any single report generated by the alleged reporting system.”

& n . 38 (emphasis in original).

Boston Tech.,

(footnote omitted).

“Liability under section 10(b) and Rule 10b-5 also requires

scienter, ‘a mental state embracing intent to deceive,

22 manipulate, or defraud.’” Cabletron,

(quoting

Ernst & Ernst v . Hochfelder,

, 193 n.12 (1976)). “To

prove scienter, a plaintiff “must show either that the defendants

consciously intended to defraud, or that they acted with a high

degree of recklessness.” Stone & Webster,

(quoting Aldridge,

2 ) . However, “this circuit has

rejected any rigid formula for pleading scienter, preferring to

rely on a ‘fact-specific approach’ that proceeds case by case.”

Cabletron,

(citing Aldridge,

2 ;

Greebel,

9 6 ) .

1. The April 19 Press Release

Based on a statement-by-statement analysis, defendants argue

that every sentence in the April 19 press release is literally

true, and say they cannot be held liable for plaintiffs’

misinterpretation of their accurate statements. That claim is of

questionable merit, given the fact that the press release

represented that StockerYale was “developing a customized laser

for the development of a missile countermeasure system for

commercial planes under a recent contract received from the

Nashua, N.H.-based Information & Electronic Warfare Systems

(IEWS) business unit of BAE” - an assertion that BAE flatly

rejected as false. Nevertheless, even if each of the individual

sentences in the April 19 press release was literally accurate,

23 and even though the press release “nowhere states that the

prototype laser is being funded by monies from the [Homeland

Security],” (Defs.’ Mem. of Law (document n o . 21) at 1 0 ) , that

press release plainly suggested that StockerYale had a contract

with BAE to provide BAE with lasers for BAE to use in fulfilment

of a Homeland Security contract. The press release expressly

stated that “BAE [was] one of three companies awarded a contract

from the Department of Homeland Security,” and the only plausible

reason for StockerYale to include a reference to BAE’s Homeland

Security contract in a press release announcing StockerYale’s

contract with BAE is to imply a connection between StockerYale’s

contract with BAE and BAE’s contract with Homeland Security.

Because plaintiffs have adequately alleged that the customized

lasers StockerYale agreed to sell BAE in December, 2003, were not

for BAE’s Homeland Security project, they have adequately alleged

that the April 19 press release contained a false or misleading

statement.

However, under the relevant pleading standard, that is not

enough to survive defendants’ motion to dismiss. Not only must

plaintiffs allege a false statement, they must also allege, with

factual support, that the person making the statement knew it was

false. The facts alleged, if proven, would establish that

24 defendants did not know that the prototype lasers were for use in

BAE’s Homeland Security project, yet implied that they were.

The complaint adequately alleges that StockerYale did not

know that the lasers in question would be used by BAE in its

Homeland Security project as part of a system to protect

commercial aircraft, and had no reason to think, or represent,

that they would b e . Obviously, the positive implication was

fraught with economic significance. As it turns out, the

baseless implication was not just misleading, it was actually

false. The allegations in the complaint are sufficient to

support a claim that StockerYale knew that the press release

contained false or misleading information at the time it was

issued, because it knew that there was no reasonable basis to

make the misleading and deceptive statements (or, at a minimum,

implications) that it stood to gain substantially from BAE’s

governmental contracts. Moreover, even if those allegations are

insufficient to support a claim that StockerYale consciously

intended to defraud, they are certainly sufficient to support a

claim that it acted with a high degree of recklessness. See,

e.g., Aldridge,

2 ; Greebel,

.

Because plaintiffs have adequately alleged defendants’

contemporaneous possession of facts that established the false or

25 misleading nature of the April 19 press release (i.e., that

nothing supported the clear implications disseminated),

defendants are not entitled to dismissal of Count I as it relates

to the April 19 press release.

2. The April 21 Press Release

Plaintiffs make two claims concerning the April 21 press

release. They say it misrepresented the duration of BAE’s

October, 2002, agreement with the U.S. government to supply an

airborne military defense system against heat-seeking missiles,

and that it perpetuated the false statements in the April 21

press release concerning the relationship between the

StockerYale-BAE contract and the BAE-Homeland Security contract.

Plaintiffs adequately allege the falsity of StockerYale’s

statement that “[t]he contract that BAE has with the U.S.

government calls for deliveries through 2020,” by citing a

Department of Defense press release that listed January 1 4 , 2007,

as the completion date of BAE’s ATIRCM contract. Plaintiffs have

also alleged facts from which it would be reasonable to infer

that Mark Blodgett and/or other StockerYale employees knew very

well that the representations regarding BAE’s ATIRCM contract,

including its termination date, had no substantial basis in facts

known to them — that i s , the stated facts were simply invented by

26 StockerYale. Accordingly, liability for the statement in the

April 21 press release concerning the duration of BAE’s ATIRCM

contract with the U.S. government, is adequately pled.

Plaintiffs’ second claim regarding the April 21 press

release also survives defendants’ motion to dismiss. As

explained above, plaintiffs adequately allege that the April 19

press release misleadingly suggested that StockerYale was

providing lasers to BAE for BAE’s use in fulfilling its Homeland

Security contract. Plaintiffs also allege that after BAE

learned of the April 19 press release, a BAE representative

advised StockerYale that the December, 2003, contract between

StockerYale and BAE was not connected with BAE’s January, 2004,

Homeland Security contract. Given that information, plaintiffs

argue that it was false or misleading for StockerYale to state,

in the April 21 press release, that “[t]he second order the

Company received from BAE Systems [i.e., the December, 2003,

order] was an order for the delivery of customized lasers for an

adaptation of the military ATIRCM system for use on commercial or

military airplanes.”

Plaintiffs have alleged facts from which it would be

reasonable to infer that pertinent StockerYale officials had no

basis for claiming that the lasers StockerYale provided under the

27 December, 2003, agreement were for use in an adaptation of BAE’s

military A T I R C M system for commercial or military airplanes. In

the aftermath of the April 19 press release, which falsely

implied that StockerYale was providing lasers for use BAE’s

Homeland Security project – a project directed toward the

protection of commercial airplanes – the April 21 statement that

StockerYale was providing lasers for BAE’s adaptation of A T I R C M

lasers for military or commercial use was tantamount to a

statement that StockerYale was providing lasers for BAE’s

Homeland Security project. Because StockerYale is alleged to

have known, before the April 21 press release was issued, that

B A E was not using StockerYale lasers for its Homeland Security

project, plaintiffs have adequately alleged both the falsity of

the April 21 press release and StockerYale’s knowledge of that

falsity.

StockerYale has also adequately alleged scienter.

“[E]vidence of conscious wrongdoing . . . may provide the

‘something more’ necessary to prove scienter.” Cabletron,

(quoting Greebel,

; citing A . Morales

Olazabal, The Search for “Middle Ground”: Towards a Harmonized

Interpretation of the Private Securities Litigation Reform Act’s

New Pleading Standard, 6 STAN. J . L . B U S . & F I N . 153, 187-88 (2001)

(“[T]he obvious should not go unstated, and that is that

28 allegations of intentionally fraudulent conduct also will permit

the drawing of a strong inference of scienter.”)).

Here, plaintiffs allege that StockerYale was told, directly

by BAE, that StockerYale’s lasers were not being used as part of

BAE’s Homeland Security project. But, rather than stating that

in its April 21 press release, StockerYale held to its earlier

statement that it was providing lasers for BAE’s adaptation of

its ATIRCM system for use on military or commercial airplanes - a

project identified as a Homeland Security project in the April 19

press release. That i s , although StockerYale did not include a

Homeland Security reference in its April 21 press release, it did

not expressly disclaim a connection with BAE’s Homeland Security

project, even when given substantial reason to believe that

readers of the April 19 press release would have concluded that

StockerYale was claiming it provided lasers for BAE’s Homeland

Security project. Thus, plaintiffs’ “complaint survives the

requirement that its pleadings raise a strong inference of

scienter.” Aldridge,

(explaining that “the fact

that the defendants published statements when they knew facts

suggesting that statements were inaccurate or misleadingly

incomplete is classic evidence of scienter”) (citing State Bd. of

Admin. v . Green Tree Fin. Corp.,

, 665 (8th Cir.

2001)).

29 Moreover, defendants’ failure to seek BAE’s prior approval

of the April 21 press release demonstrated a “high degree of

recklessness,” Stone & Webster,

(citation

omitted), given StockerYale’s established obligation to do so and

BAE’s interest in the subject matter, as evidenced by BAE’s quick

response to the April 19 press release.

Finally, plaintiffs have adequately alleged loss causation.

Defendants suggest that plaintiffs fail to allege loss causation

because the allegation that defendants never corrected

misinformation in the two press releases precludes them from

alleging a necessary element of loss causation, namely that

revelation of defendants’ misrepresentation caused StockerYale

stock to drop in value. Defendants further argue that the

factual allegations in plaintiffs’ complaint do not adequately

eliminate company-specific developments and industry-wide market

factors as potential reasons for the fluctuations in the price of

StockerYale shares during the class period. Even under the

relatively strict standard imposed by Dura,

,

plaintiffs have adequately alleged loss causation.

In Dura, the Supreme Court rejected “a Ninth Circuit holding

that a plaintiff can satisfy [the loss causation] requirement

. . . simply by alleging in the complaint and subsequently

30 establishing that ‘the price’ of the security ‘on the date of

purchase was inflated because of the misrepresentation.’” 544

U . S . at 344 (quoting

, 938 (9th Cir. 2003)) (emphasis

omitted). Instead, the Supreme Court held that “a person who

‘misrepresents the financial condition of a corporation in order

to sell its stock becomes liable to a relying purchaser ‘for the

loss’ the purchaser sustains ‘when the facts . . . become

generally known’ and ‘as a result’ share value ‘depreciate[s].’”

544 U . S . at 344 (quoting RESTATEMENT (SECOND) OF TORTS § 548A, cmt.

b , at 107) (1977)).

Notably, the rule in Dura does not require that the party

accused of making a misrepresentation also be the source of

corrective information that results in a decline in stock prices.

Plaintiffs’ allegation that defendants themselves never corrected

the misinformation contained in the April 21 press release does

not preclude pleading loss causation. Moreover, plaintiffs do

allege that StockerYale shares dropped fifteen percent, to $1.27

per share, on the day the S E C informed StockerYale it was

investigating the accuracy of the two press releases. And, they

further allege that when the public was informed of the S E C

investigation, by means of a Form 8-K filed by StockerYale, its

stock dropped to $0.84 per share in after-hours trading. That is

enough to meet the requirements established in Dura concerning

31 the causal connection between the release of corrective

information and the decline in the price of StockerYale shares.

Defendants’ reference to a wide range of economic and other

factors that may have caused or contributed to the decline in

price of StockerYale shares raises issues that will be addressed

at later stages of this litigation, but those possibilities do

not warrant dismissal, given the factual allegations discussed

above. Similarly, the possible existence of trends in the

industry at the time of the run-up in StockerYale share prices

presents an issue of fact, but does not overcome plaintiffs’

properly supported allegation of a rise in stock prices directly

after and attributable to the April 19 and 21 press releases.

Because plaintiffs have adequately alleged the false or

misleading nature of the April 19 and 21 press releases,

defendants’ scienter, and loss causation, defendants are not

entitled to dismissal of Count I .

B. Count II – The Section 20A Claim

Defendants’ only argument concerning plaintiffs’ section 20A

claim is that dismissal of the section 10(b) claim requires

dismissal of the section 20A claim. That is a correct statement

of the law:

32 To state a claim for insider trading, the plaintiffs must have adequately alleged a violation of the Exchange Act. See, e.g., [In re] Advanta Corp. [Sec. Litig.], 180 F.3d [524,] 541-42 [(3d Cir. 1999)] (“claims under section 20(A) are derivative, requiring proof of a separate underlying violation of the Exchange Act”); Jackson Nat. Life Ins. C o . v . Merrill Lynch & Co., Inc.,

9 7 , 703 (2d Cir. 1994) (“[T]o state a claim under § 20A, a plaintiff must plead a predicate violation of the ’34 Act or its rules and regulations”); Colby [v. Hologic, I n c . ] , 817 F. Supp. [204,] 215 [(D. Mass. 1993)] (insider trading claim deficient: plaintiff “has not sufficiently alleged what ‘materially adverse information’ any defendant possessed during the ‘class period’ and hence there can be no duty to avoid trading or to make disclosure to equalize knowledge of insiders and the investing public”). Because the plaintiffs have not stated a claim under Section 10(b), their Section 20A claim also fails.

Carney v . Cambridge Tech. Partners, Inc.,

(D. Mass. 2001). Here, however, plaintiffs’ section 10(b)

claim has not been dismissed. Accordingly, Mark Blodgett is not

entitled to dismissal of Count I I .

C . Count III – The Section 20(a) Claim

Mark Blodgett argues that the section 20(a) claim against

him must be dismissed because plaintiffs make only boilerplate

allegations against him, rather than concrete allegations that he

controlled the content and issuance of the disputed press

releases in a way that could subject him to “control person”

liability. Blodgett’s argument is without merit.

33 The “control person” liability section of the Securities and

Exchange Act (section 20(a)), provides:

Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder 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, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.

Stone & Webster,

n.3 (quoting 15 U.S.C. §

78t(a)). “The elements of § 20(a) are generally stated to be (i)

an underlying violation of the same chapter of the securities

laws by the controlled entity, . . . and (ii) control of the

primary violator by the defendant.” Id. at 194(citing 15 U.S.C.

§ 78t(a); Aldridge,

).

Here, plaintiffs’ section 20(a) claim against Mark Blodgett

is not based on mere boilerplate assertions concerning Blodgett’s

position with StockerYale. Rather, plaintiffs allege that

Blodgett regularly directed the drafting and issuance of

StockerYale press releases, including the one dated April 2 1 .

That is more than sufficient to state a claim under section

20(a).

34 4. Lawrence Blodgett, Diaz, and O’Brien (document n o . 22)

Lawrence Blodgett is a defendant in Count II (section 20A,

insider trading), while Diaz and O’Brien are defendants in Count

III (section 20(a), control person liability).

Lawrence Blodgett is not entitled to dismissal of the claim

against him for the same reasons that Mark Blodgett is not

entitled to dismissal of Count I I .

Diaz and O’Brien move to dismiss the section 20(a) claim

against them on grounds that plaintiffs have failed t o : (1) state

an underlying section 10(b) claim; (2) adequately allege that

Diaz and O’Brien were control persons within the meaning of

section 20(a); and (3) allege facts giving rise to a strong

inference that Diaz and O’Brien acted with scienter.

As discussed above, plaintiffs have adequately alleged

section 10(b) claims. As the court of appeals for this circuit

recently explained, Ҥ 20(a) does not on its face obligate the

plaintiff to plead or prove scienter (or any other state of mind)

on the part of the controlling persons named as a defendant.”

Stone & Webster,

(footnote omitted). Thus, the

only possible ground for dismissal is the argument that

35 plaintiffs have failed to adequately allege that Diaz and O’Brien

were control persons.

For purposes of the statute under which plaintiffs seek to

hold Diaz and O’Brien liable,

[t]he term “control” (including the terms “controlling,” “controlled by,” and “under common control with”) means under the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.

.12b-2. “Ordinarily, ‘[c]ontrol is a question of

fact’ not to be ‘resolved summarily at the pleading stage.’”

Brumbaugh v . Wave Sys. Corp.,

(D. Mass.

2006) (quoting Cabletron,

(citation omitted)).

Diaz and O’Brien argue that plaintiffs’ assertion of a claim

for control person liability rests on little more than a

boilerplate allegation that Diaz and O’Brien were corporate

officers, and that more is required, including allegations that

Diaz and O’Brien participated in drafting or issuing the press

releases at issue here. Defendants read the complaint too

narrowly, ignoring some of plaintiffs’ factual allegations, and

they read the law concerning control person liability too

36 broadly, effectively transforming control person liability into

direct liability.

Plaintiffs do not simply allege that Diaz and O’Brien were

officers of StockerYale; they also allege that both were directly

responsible for the day-to-day management of the company,

possessed the power and authority to control the content of

StockerYale’s press releases, and were provided copies of the two

press releases before they were issued or shortly thereafter,

thus giving them the opportunity to prevent issuance or cause

them to be corrected. S o , this is not a case in which control

person liability is premised solely on a defendant’s corporate

title.

Diaz and O’Brien base their motion to dismiss on plaintiffs’

failure to allege facts establishing their direct involvement in

drafting or issuing the two StockerYale press releases, but a

plaintiff need not make such allegations to state a claim under

section 20(a). See, e.g., In re Allaire Corp. Sec. Litig.,

(D. Mass. 2002) (“Control person liability,

unlike primary liability, does not require that individuals have

issued the false or misleading statements, but merely that the

individuals have controlled the entity that issued the

statements.”).

37 To be sure, Diaz and O’Brien may defend against plaintiffs’

control person liability claim, but

Unlike Rule 10b-5, § 20(a) does not on its face obligate the plaintiff to plead or prove scienter (or any other state of mind) on the part of the controlling persons named as a defendant. Instead, the burden is shifted. The defendant can rebut liability by proving that he or she “acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.”

Stone & Webster,

(quoting 15 U.S.C. § 78t(a));

see also Donohoe v . Consol. Operating & Prod. Corp.,

0 7 ,

912 (7th Cir. 1994) (“because good faith was an affirmative

defense to control person liability, the burden of proving good

faith was on the defendants”) (emphasis in the original). But of

course, a plaintiff is under no obligation to plead the facts

necessary to negate an affirmative defense that may (or may not)

be raised. Thus, defendants have raised no viable challenge to

plaintiffs’ claim under section 20(a).

Because plaintiffs have alleged facts sufficient to

establish their claim for control person liability against Diaz

and O’Brien, Diaz and O’Brien are not entitled to dismissal Count

III.

38 Conclusion

For the reasons given, plaintiffs’ motion to strike

(document n o . 24) is granted and both motions to dismiss

(document nos. 20 and 22) are denied.

SO ORDERED.

Steven J . McAuliffe :hief ^Judge

September 2 7 , 2006

cc: Mark L . Mallory, Esq. Christine Friedman, Esq. Jennifer A . Eber, Esq. William L . Chapman, Esq. Laurence Rosen, Esq. Alexander J. Walker, Esq. Francis G. Kelleher, Esq. Inez H . Friedman-Boyce, Esq. R. Todd Cronan, Esq. Stephen R. Galoob, Esq. Douglas C . Doskocil, Esq.

39