Meyer v. Callahan CV-09-106-PB 11/23/10 UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Theresa J. Meyer

Case No. 09-cv-106-PB Opinion No. 2010 DNH James M. Callahan, et a l ,

MEMORANDUM AND ORDER

Defendant James Callahan, joined by defendant Steve

Lawrence, moves to dismiss Theresa Meyer's amended complaint for

failure to state a claim upon which relief can be granted.

Callahan argues that Meyer failed to plead sufficient facts to

support her contention that the defendants possessed the reguired

scienter for common-law fraud, securities fraud, and civil

conspiracy. For the reasons discussed below, I grant Callahan's

motion to dismiss. Doc. No. 104, and dismiss counts I (fraud), II

(securities fraud), and IV (civil conspiracy), as well as the

related counts III (concert of action) and V (exemplary damages)

of the amended complaint. Doc. No. 107.1

1 Meyer's concert of action and exemplary damages claims rely on the underlying fraud-related claims that Callahan argues should be dismissed for failure to adeguately plead scienter. Because I have determined that scienter was in fact inadeguately pleaded, those additional claims must fail as well. As such the I. BACKGROUND

Meyer has sued over a dispute that arose from the creation

of S3 Sentinel Safety Supply, Inc. ("S3") a an entity that was

created from the combined assets of eight individual companies

("S3 entities"). One of those companies was Meyer's company

RescueTees.com, LLC ("RescueTees") , an online firefighter's

apparel and novelty company. Callahan and Lawrence were both

heavily involved in the creation of S3 and were Meyer's primary

contacts while the business transaction was ongoing.

Meyer was contacted in the spring of 2006 by Callahan and

Lawrence concerning the proposed purchase of RescueTees' assets.

It was eventually determined that the asset purchases from all

the S3 entities would be financed with a loan from Wachovia

Financial Services. Wachovia advanced $9,750,000 to purchase the

S3 entities' assets, pay any assumed liabilities, and capitalize

S3. Meyer was to receive a total of $3,877,500 for the sale of

RescueTees' assets, with $987,825 to be paid in cash, $420,885 in

a promissory note from S3 subordinated to Wachovia's interest in

the company, and $2,468,790 in S3 stock.

only remaining claim is count VI, for legal malpractice, which was not challenged by the defendants.

- 2 - According to the complaint, Callahan and other individuals

who were involved in the transaction represented to Meyer on

multiple occasions that the other companies whose assets were

being acguired by S3 were "financially sound." Am. Compl. at 5

26(c). These communications also included representations that

"S3 would be financially sound following acguisition of the

assets of the S3 entities," that the "capital and cash reserves

of S3 would be sufficient to properly operate S3 following

acguisition of the assets of the S3 entities," and that "there

had been no material change with respect to the financial status

of the S3 entities." Am. Compl. at 5 26(d-f).

The "material change" alluded to in the complaint appears to

refer to changes in the financial statements that were provided

to Meyer prior to the closing. However, the complaint does not

date or describe the content of those financial statements,

alleging only that they were represented to Meyer to be

"accurate" and that she was told that the assets and liabilities

at the time of closing would be the same as indicated by the

prior statements. Am. Compl. at 5 26(f).

- 3 - Immediately following the closing of the S3 transaction in

September of 2007, S3 had a "capital and cash shortage," which

prevented it from operating. Am. Compl. at 5 32. Meyer alleges

that prior to the closing, the defendants "knew, or should have

known, that there had been material changes in the financial

conditions of the S3 entities and that their actual assets and

liabilities were not as previously represented." Am. Compl. at 5

28. Thus, the defendants "knew prior to the S3 closing that S3

would be insolvent upon closing and failed to disclose that

information to Meyer prior to closing." Am. Compl. at 5 33.

As a result of this failure to disclose the material changes

in the financial status of the other companies, Meyer alleges

that she suffered economic damages in the form of loss of the

promised S3 stock value, as well as the debt secured by the

promissory note.

II. PROCEDURAL HISTORY

This motion to dismiss comes before me at a somewhat unusual

procedural point in the case. The original complaint was filed

in September of 2008 in Michigan state court. It was later

removed to federal court in Michigan at the reguest of the

- 4 - defendants, and in March of 2009 the case was transferred to the

District of New Hampshire. The parties entered into formal

discovery, which continued until September 2010 when Meyer filed

a motion seeking permission to file an amended complaint. I

granted that motion while explicitly allowing the defendants to

file a motion to dismiss the amended complaint before trial.2

Callahan, joined by Lawrence, filed this motion to dismiss in

accordance with that order.

III. STANDARD OF REVIEW

To survive a motion to dismiss for failure to state a claim,

the general rule under Rule 8 of the Federal Rules of Civil

Procedure is that the complaint must "state a claim to relief

that is plausible on its face." Ashcroft v. Igbal, 129 S. C t .

1937, 1949 (2009) (internal guotation marks omitted). "The

plausibility standard," while not a "probability reguirement,"

reguires more than a "sheer possibility that a defendant has

acted unlawfully." Id. (internal guotation marks omitted).

"Threadbare recitals of the elements of a cause of action,

2 In light of that order, Meyer's arguments that the motion to dismiss is untimely or otherwise procedurally barred are without merit. supported by mere conclusory statements, do not suffice." Id.

IV. ANALYSIS

Callahan argues that he is entitled to dismissal of the

fraud, securities fraud, and civil conspiracy counts because each

of those fraud-related claims are held to an even higher pleading

threshold than the plausibility standard of Rule 8. Callahan

relies on Federal Rule of Civil Procedure 9 (b) for this claim,

arguing that Meyer has failed to adeguately plead the scienter

reguirement of the fraud-related claims. I will address in turn

A) the appropriate pleading standard for scienter in Meyer's

fraud-related claims, and B) whether those claims have been

adeguately pleaded under that standard.

A. The Appropriate Pleadings Standard

As a threshold matter, I must determine the level of

particularity Meyer's pleadings must rise to in order to survive

the motion to dismiss. As Callahan correctly points out, the

federal rules reguire that "[i]n alleging fraud or mistake, a

party must state with particularity the circumstances

constituting fraud or mistake." Fed. R. Civ. Pro. 9(b). Rule

9 (b) also extends to Meyer's claims for securities fraud and

- 6 - civil conspiracy in this case, as it applies not just to fraud

but also to "associated claims where the core allegations

effectively charge fraud." N. Am. Catholic Educ. Programming

Found., Inc. v. Cardinale,

(1st Cir. 2009); see

also Hayduk v. Lanna,

(1st Cir. 1985) (holding

that a civil conspiracy claim was subject to Rule 9(b)

reguirements).

Callahan is incorrect, however, to the extent that he

contends that Rule 9 (b) reguires Meyer to plead scienter with

particularity. The second sentence of the rule states that

"[m]alice, intent, knowledge, and other conditions of a person's

mind may be alleged generally." Fed. R. Civ. Pro. 9(b). The

recent Supreme Court decision of Ashcroft v. Igbal, 129 S. C t .

1937 (2009), clearly laid out how that sentence affects the

pleading reguirements for scienter in fraud-related claims,

stating:

It is true that Rule 9 (b) reguires particularity when pleading "fraud or mistake," while allowing "[m]alice, intent, knowledge, and other conditions of a person's mind [to] be alleged generally." But "generally" is a relative term. In the context of Rule 9, it is to be compared to the particularity reguirement applicable to fraud or mistake. Rule 9 merely excuses a party from pleading discriminatory intent under an elevated pleading standard. It does not give him license to

- 7 - evade the less rigid-though still operative-strictures of Rule 8.

Igbal, 129 S. C t . at 1954. Thus where, as here, the defendant

challenges only the sufficiency of a plaintiff's pleading as it

relates to scienter, the pleadings are appropriately analyzed

under the framework of Rule 8 rather than Rule 9 (b).

B. Application of Rule 8

The Supreme Court's decision in Bell Atlantic Corp. v.

Twombly,

(2007), and its more recent decision in

Igbal establish the appropriate structure for analyzing the

sufficiency of pleadings under Rule 8. Those cases dictate a

"two-pronged approach" that reguires courts to first identify

"pleadings that, because they are no more than conclusions, are

not entitled to the assumption of truth." Igbal, 129 S. C t . at

1950. The second step then reguires courts to look at the

remaining well-pleaded factual allegations, assume their

veracity, and "determine whether they plausibly give rise to an

entitlement to relief." Id.

1. Meyer's conclusory pleadings

Turning to the first prong of the analysis, a number of the

allegations in Meyer's complaint fail to rise above the threshold of mere conclusions. Alleged facts are not entitled to be

assumed true when they merely restate the legal elements of a

claim rather than provide specific facts to support those

elements. See Igbal, 129 S. C t . at 1951; Twombly,

. Of particular relevance here, in Igbal the plaintiff's

allegations of unconstitutional discrimination were deemed

insufficient where he pleaded that the defendants "knew of,

condoned, and willfully and maliciously agreed to subject [him]"

to harsh conditions. Igbal, 129 S. C t . at 1951. The Court noted

that these allegations of scienter were "nothing more than a

'formulaic recitation of the elements'" and as such were not

entitled to be assumed true.

(guoting Twombly,

) .

Here, as in Igbal, many of Meyer's allegations of scienter

are merely legal conclusions that restate the elements of the

claims rather than providing factual support for the conclusions

expressed. The complaint alleges, for example, that "Callahan

and Lawrence knew, or should have known, that there had been

material changes in the financial conditions of the S3 Entities

and that their actual assets and liabilities were not as

previously represented." Am. Compl. at 5 28. Later, the complaint alleges that "Callahan and Lawrence knew prior to the

S3 Closing that S3 would be insolvent upon closing and failed to

disclose that information to Meyer prior to closing."

at 5

33. Similarly bare allegations of the defendants' scienter are

made in paragraph 41 ("S3 Defendants both knew the representa­

tions were false when made, or made the representations

recklessly . . ."), paragraph 47 ("S3 Defendants knew of the

material changes in the financial conditions . . .") and

paragraph 55 ("S3 Defendants . . . conspired with one another

with the intent to . . . defraud[] Meyer of her interest . . .").

None of these paragraphs provide any factual basis for inferring

the knowledge they allege the defendants possessed, and so they

are not entitled to a presumption of truth.

Meyer responds to the motion to dismiss by simply citing to

a list of paragraphs she claims indicate that "Lawrence and

Callahan made untrue statements about the financial stability of

the companies involved which they knew or had reason to know were

false." Pl.'s Obj. to Def. James M. Callahan's Partially

Assented-to Mot. to Dismiss, Doc. No. 122, at 11 (citing to 55

17, 18, 19, 26, 28-30, 33, 35, 46-49). Of the allegations Meyer

cites, paragraphs 28, 33, and 47 are bare legal conclusions

- 10 - couched as factual allegations, as discussed above. As such,

those paragraphs are not entitled to a presumption of truth and I

need not consider them in evaluating the motion to dismiss.

2. Remaining factual allegations of scienter

In considering the remainder of Meyer's complaint, I must

determine whether the allegations "plausibly suggest an

entitlement to relief." Igbal, 12 S. C t . at 1951. A claim is

facially plausible when it pleads "factual content that allows

the court to draw the reasonable inference that the defendant is

liable for the misconduct alleged." Id. at 1949. In other

words, "[w]here a complaint pleads facts that are merely

consistent with a defendant's liability, it stops short of the

line between possibility and plausibility of entitle[ment] to

relief." Twombly,

(internal guotation marks

omitted). First Circuit cases have established that a mere

"general averment" of scienter is not enough, and that in the

context of financial fraud the plaintiff must offer some factual

basis for inferring that the defendants knew or should have known

their financial characterizations were inaccurate when they were

made. See Cardinale,

; Serabian v. Amoskeag Bank

Shares, Inc.,

(1st Cir. 1994).

- 11 - In Cardinale the plaintiff's claim for fraudulent inducement

was found to be inadequately pleaded because, while the complaint

alleged that the defendant "never intended to follow its business

plan," that assertion was "not itself supported with particulars

that suggest scienter" and thus the complaint failed to meet the

pleading requirements of Rule 9(b).3

. Similarly,

Serabian found a securities-fraud claim to be insufficiently

pleaded because the plaintiffs offered "no basis for inferring

that the defendants knew that the bank's loan portfolio was, at

that time, improperly characterized as 'excellent.'" Serabian,

. Specifically, the court noted that the

plaintiffs offered "no information about the general health of

the company's loan portfolio, and fail[ed] to cite any specific

loans that were in trouble."

In contrast, Serabian upheld a separate securities fraud

claim based on a different set of facts because there the

plaintiffs alleged specifically that the defendants were informed

3 Although both Cardinale and Serabian predate Igbal and thus discuss the pleading requirements of scienter for fraud and related claims under Rule 9 (b) rather than under Rule 8 as Iqbal indicates is appropriate, the reasoning of these cases is nevertheless persuasive and thus warrants discussion in this context.

- 12 - by a loan review officer that the "quality of commercial loans

had deteriorated," yet the defendants continued to make public

statements characterizing the company's position as "strong."

. Scienter was adequately pleaded because the

plaintiffs were able to "juxtapose these allegations showing

internal awareness" with "the company's public statements."

. In particular, the court noted that "plaintiffs

specifically identif[ied] the internal reports and public

statements underlying their claims, providing names and dates,"

rather than "simply rely[ing] on poor performance in the

aftermath of positive reports."

.

Meyer's allegations of scienter in this case are more

similar to the claims that were inadequate in Cardinale and

Serabian than to the allegations that were sufficient. While

Meyer does allege the second part of the juxtaposition that was

key to the adequacy of the pleading in Serabian - statements by

the defendants regarding the strong financial health of the

investment - allegations showing internal awareness of the

falsity of those statements are lacking. Meyer does not refer to

any specific internal reports of S3 beyond the one nebulous

allusion to "financial statements" she received, and even that

- 13 - allegation does not provide information as to what data the

financial statements contained or when she received them. Am.

Compl. at 5 26(f). Like the pleadings that were insufficient in

Cardinale and Serabian, Meyer offers no concrete information

showing what the defendants knew about financial problems of the

S3 entities that could be juxtaposed with their statements that

the entities were financially sound.

The only fact Meyer alleges which could indicate that

defendants were aware of problems with the S3 entities is that

when she reguested information regarding the financial status of

the other S3 entities, she was rebuffed and told such information

was "confidential." Am. Compl. at 5 17. However, such

information, standing alone, does not rise to the level of

plausibility reguired by Igbal. While it is consistent with the

theory that the defendants were attempting to hide financial

information from Meyer so that she would not discover the real

(and much worse) financial status of the other S3 entities, mere

consistency is not enough. Twombly,

. The

information could, for example, have actually been confidential,

given that Meyer was seeking internal financial information of

other companies before the closing had made the asset-purchases

- 14 - official. Without any corroborating allegations, the vague

inference this allegation would reguire is far too inconclusive

to save Meyer's claims by itself.

Meyer's allegation that information was withheld from her as

confidential is particularly inadeguate given this cases's

procedural history. Discovery has already taken place and thus

Meyer has had a full opportunity to supplement her complaint with

specific facts through the discovery process. C f . Michaels Bldg.

Co. v. Ameritrust,

, 680 (6th Cir. 1988) (noting that

Rule 9 (b) may be "relaxed" where there has not yet been any

discovery and the plaintiff seeks information that is only within

the opposing party's knowledge). Despite the benefits of

discovery and the unusual opportunity to file an amended

complaint just a few weeks before trial, Meyer provides no

information as to what supposedly confidential information was

withheld from her, or what the defendants knew at the time they

denied her access to the information. The allegation that

financial information was withheld from Meyer does not plausibly

plead the scienter element of fraud.

The remainder of the paragraphs cited by Meyer as supporting

her scienter allegations are similarly unavailing. Several of

- 15 - the paragraphs only provide factual support for the second part

of the juxtaposition discussed in Serabian - that the defendants

made statements to her regarding the present or future financial

health of the S3 entities - and thus do not provide any

inferences as to what they knew or should have known at that

time. Am. Compl. at 55 18, 19, 26. Paragraphs 29 and 30 allege

only that the defendants did not disclose adverse financial

information to Meyer, which presumes scienter without actually

showing it. Am. Compl. at 55 29-30. Finally, three of the four

remaining paragraphs simply allege the defendants' liability

generally and are thus irrelevant to proving scienter. Am.

Compl. at 55 46, 48-49. This leaves only one remaining paragraph

that Meyer points to, which states that "[f]ollowing closing and

distribution of the Wachovia Loan proceeds, S3 was insolvent and

Meyer's Subordinated Debt and stock interest in S3 were

worthless." Am. Compl. at 5 35.

Because the allegation that the defendants withheld

information as "confidential" is insufficient by itself, Meyer's

scienter allegations only survive if I draw the inference

suggested by this last remaining paragraph -- that, because the

financial status of the S3 entities at the time of closing was

- 16 - not as good as advertised earlier in the transaction, the

defendants must have known about the discrepancy and fraud must

have occurred. This "fraud by hindsight" is exactly the kind of

reliance on "poor performance in the aftermath of positive

reports" that was found to be inadeguate in Serabian, as it has

been in numerous other decisions. Serabian,

; see

also, e.g., Shaw v. Digital Eguip. Corp.,

, (1st Cir.

1996) (citing cases that reject "fraud by hindsight" and noting

that "a plaintiff may not simply contrast a defendant's past

optimism with less favorable actual results, and then contend[]

that the difference must be attributable to fraud") (internal

guotation marks omitted). Because fraud by hindsight has been

rejected by this circuit, the fact that some financial

information was denied to Meyer as purportedly confidential

remains the sole allegation from which to infer that the

defendants possessed the reguisite scienter for fraud. This is

not enough to survive a motion to dismiss.

Overall, the allegations in Meyer's complaint regarding

fraudulent intent are insufficient to meet the pleading standards

of Rule 8. Many of Meyer's pleadings are bare legal conclusions

that are not entitled to a presumption of validity, and the

- 17 - remaining allegations simply do not provide enough information,

even when presumed true, to allow an inference that the

defendants knew or should have known that there was a material

change in the financial status of the S3 entities that Meyer had

a right to be told about. Meyer's fraud-related claims must be

dismissed.

V. CONCLUSION

For the reasons stated above, I conclude that Meyer has

inadeguately pleaded the scienter element of her claims for fraud

(Count I), state securities fraud (Count II), and civil

conspiracy (Count IV), and I grant defendant's motion to dismiss

(Doc. No. 104) as to those claims. Meyer's claims for concert of

action (Count III) and exemplary damages (count V) are also

dismissed as they rely on those underlying fraud claims.

SO ORDERED.

/s/Paul Barbadoro____ Paul Barbadoro United States District Judge

November 23, 2010

cc: Daniel J. Mullen, Esg.

- 18 - Stephen D. Coppolo, Esq. William C. Saturley, Esq. Mark E. Howard, Esq. Paul A. McCarthy, Esq.

- 19 -