1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 Case No. C-05-4800 PJH PLAINTIFFS’ MPA IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT George S. Trevor (Bar No. 127875) LAW OFFICES OF GEORGE S. TREVOR 300 Tamal Plaza, Suite 180 Corte Madera, California 94925 Telephone: (415) 924-7147 Facsimile: (415) 924-7159 John F. Friedemann (Bar No. 115632) Kyle M. Fisher (Bar No. 127334) FRIEDEMANN GOLDBERG LLP 420 Aviation Boulevard, Suite 201 Santa Rosa, California 95403 Telephone: (707) 543-4900 Facsimile: (707) 543-4910 Attorneys for Plaintiffs UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF CALIFORNIA SAN FRANCISCO DIVISION ELLEN RUBKE, as Trustee of the 1986 Rubke Living Trust, and JACK FERGUSON, individually and on behalf of all similarly situated shareholders of Napa Community Bank, Plaintiffs, vs. CAPITOL BANCORP LTD., a Michigan corporation, and JOSEPH D. REID, Defendants. No. C-05-4800 PJH [PSLRA] PLAINTIFFS’ MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT Date: June 7, 2006 Time: 9:00 a.m. Courtroom: 3, 17 th Floor Judge: Honorable Phyllis J. Hamilton
Transcript
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Case No. C-05-4800 PJH
PLAINTIFFS’ MPA IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT
George S. Trevor (Bar No. 127875) LAW OFFICES OF GEORGE S. TREVOR 300 Tamal Plaza, Suite 180 Corte Madera, California 94925 Telephone: (415) 924-7147 Facsimile: (415) 924-7159 John F. Friedemann (Bar No. 115632) Kyle M. Fisher (Bar No. 127334) FRIEDEMANN GOLDBERG LLP 420 Aviation Boulevard, Suite 201 Santa Rosa, California 95403 Telephone: (707) 543-4900 Facsimile: (707) 543-4910 Attorneys for Plaintiffs
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
SAN FRANCISCO DIVISION
ELLEN RUBKE, as Trustee of the 1986 Rubke Living Trust, and JACK FERGUSON, individually and on behalf of all similarly situated shareholders of Napa Community Bank, Plaintiffs, vs. CAPITOL BANCORP LTD., a Michigan corporation, and JOSEPH D. REID,
Defendants.
No. C-05-4800 PJH
[PSLRA]
PLAINTIFFS’ MEMORANDUM OF POINTS AND AUTHORITIES IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT
Date: June 7, 2006 Time: 9:00 a.m. Courtroom: 3, 17th Floor Judge: Honorable Phyllis J. Hamilton
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TABLE OF CONTENTS
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- i Case No. C-05-4800 PJH
PLAINTIFFS’ MPA IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT
I. STATEMENT OF ISSUES ................................................................................................ 1 II. INTRODUCTION .............................................................................................................. 1 III. FACTUAL BACKGROUND ............................................................................................. 2 IV. ARGUMENT ...................................................................................................................... 8
A. General Standards On Motion To Dismiss ............................................................. 8 B. The Complaint States A Valid Claim Under Section 11 Of The Securities
Act ........................................................................................................................... 9 1. The Section 11 Claim is not Subject to the Pleading Requirements
of the PSLRA .............................................................................................. 9 2. The Complaint Alleges Material Omissions and Misrepresentations
of Fact ....................................................................................................... 10 a. The Failure to Disclose the True Value of NCB Stock................. 10 b. The Failure to Disclose the Minority Shareholders
Committee’s Fairness Opinion...................................................... 11 c. Capitol’s Fairness Opinions .......................................................... 13 d. Capitol’s Services Provided to NCB............................................. 13 e. Other Misrepresentations and Omissions...................................... 14
3. Plaintiffs are not Required to Plead Loss Causation................................. 15 C. Plaintiffs’ Third And Fifth Causes Of Action State Claims Under
Sections 10(b) And 14(e) Of The Exchange Act And Rule 10b-5 ....................... 16 1. The Third Cause of Action Contains Sufficient Allegations of
Falsity........................................................................................................ 16 a. Collusion by Capitol with the NCB Board ................................... 17 b. Withdrawal by Fax........................................................................ 18 c. Reid’s Exercise of Options ........................................................... 19
2. The Complaint States Sufficient Claims Under Section 14(e) of the Exchange Act ............................................................................................ 19
3. The Complaint Raises a Strong Inference of Scienter .............................. 20 D. The Complaint States Claims For “Control Person” Liability Against Reid........ 21 E. SLUSA And Preemption Of Plaintiffs’ State Law Causes Of Action.................. 23 F. Leave To Amend Any Deficiencies Should Be Granted ...................................... 23
V. CONCLUSION................................................................................................................. 24
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TABLE OF AUTHORITIES
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- ii Case No. C-05-4800 PJH
PLAINTIFFS’ MPA IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT
CASES Adams v. Kinder-Morgan, Inc.,
340 F.3d 1083 (10th Cir. 2003) , modified and reh'g denied 2003 U.S. LEXIS 18775 (10th Cir. Aug. 29, 2003) .............................................................................................. 22
Basic, Inc. v. Levinson, 485 U.S. 224 (1988) ................................................................................................................ 11
Bourjaily v. United States, 483 U.S. 171 (1987) .................................................................................................................. 8
Chang v. Chen, 80 F.3d 1293 (9th Cir. 1996)...................................................................................................... 9
Conley v. Gibson, 355 U.S. 41 (1957) .................................................................................................................... 8
DSAM Global Value Fund, 288 F.3d 388 (9th Cir. 2002).................................................................................................... 20
Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971 (9th Cir. 1999).................................................................................................... 12
Herman & MacLean v. Huddleston 459 U.S. 375 (1983) ............................................................................................................ 9, 14
Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990)............................................................................................ 20, 21
Howard v. Everex Sys., 228 F.3d 1057 (9th Cir. 2000)........................................................................................ 8, 21, 22
Howard v. Hui, No. C 92-3742-CRB, 2001 U.S.Dist. LEXIS 15443 (N.D. Cal. Sept. 24, 2001) ................... 22
In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267 (3d Cir. 2004).............................................................................................. 12, 15
In re Daou Systems, Inc., 411 F.3d 1006 (9th Cir. 2005)........................................................................................ 9, 10, 14
In re Gap Stores Sec. Litig., 79 F.R.D. 283 (N.D.Cal. 1978) ......................................................................................... 12, 15
In re Network Assocs., Inc. II Sec. Litig., 2003 WL 24051280, (N.D.Cal. March 25, 2003) ................................................................... 22
In re Nuko Information Sys., Inc., 199 F.R.D. 338 (N.D. Cal. 2000) ............................................................................................ 16
In re Pacific Gateway Exchange, Inc. Sec. Litig., 169 F.Supp.2d 1160 (N.D.Cal. 2001) .............................................................................. passim
In re Silicon Graphics Sec. Litig., 183 F.3d 970 (9th Cir. 1999).................................................................................................... 20
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In re Stac Electronic Sec. Litig., 89 F.3d 1399 (9th Cir. 1996), cert. denied, 520 U.S. 1103 (1997) ............................................ 9
In re WorldCom, Inc. Sec. Litig., 294 F Supp 2d 392 (S.D.N.Y. 2003)...................................................................................... 22
Kaplan v. Rose, 49 F.3d 1363 (9th Cir. 1994)...................................................................................................... 9
Livid Holding Ltd. v. Salomon Smith Barney, Inc., 403 F.3d 1050 (9th Cir. 2004).............................................................................................. 2, 16
Lone Star Ladies Inv. Club v. Schlotzsky's Inc., 238 F.3d 363 (5th Cir. 2001).................................................................................................... 10
Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, ___ U.S. ___, 126 S.Ct. 1503 (2006) ..................................................................................... 23
Metz v. United Counties Bancorp, 61 F.Supp.2d 364 (D.N.J. 1999) ............................................................................................. 12
No. 84 Employer-Teamster Joint Council Pension Fund v. America West Holding Corp., 320 F.3d 920 (9th Cir. 2003).................................................................................................... 16
Nursing Home Pension Fund v. Oracle Corp., 380 F.3d 1226 (9th Cir. 2004).................................................................................................... 8
Ronconi v. Larkin, 255 F.3d 423 (9th Cir. 2001).................................................................................................... 20
Schreiber v. Burlington Northern, Inc., 472 U.S. 1 (1985) .................................................................................................................... 19
Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987) ................................................................................................................ 11
Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097 (9th Cir. 2003).............................................................................................. 9, 10
PLAINTIFFS’ MPA IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS COMPLAINT
I. STATEMENT OF ISSUES
1. Whether the Complaint states a claim under Section 11 of the Securities Act of
1933 (“Securities Act”) for misrepresentation or omission of material facts in Capitol Bancorp’s
offer for the exchange of its stock for that of Napa Community Bank.
2. Whether the claims alleged by the Complaint under the Securities Exchange Act of
1934 (“Exchange Act”) have been made with the specificity required by the Private Securities
Litigation Reform Act of 1995 (“PSLRA”) and Federal Rule of Civil Procedure 9(b).
3. Whether the Complaint states a claim for “control person” liability under Section
15 of the Securities Act or Section 20 of the Exchange Act.
4. Whether plaintiffs’ state-law claims are preempted by the Securities Litigation
Uniform Standards Act of 1998 (“SLUSA”).
5. Whether the Complaint states claims for the violation of California securities laws,
as well as state-law causes of action for breach of fiduciary duty and abuse of control.
II. INTRODUCTION
Defendants Capitol Bancorp Ltd. (“Capitol”) and Joseph D. Reid, by selecting a few
discrete allegations that they believe to be defective, argue that the entire Complaint is fatally
flawed and must be dismissed. Defendants are wrong. The Complaint alleges in more than
sufficient detail a clear scheme by defendants to convince plaintiffs and the class to tender their
shares of Napa Community Bank (“NCB”) stock for far less than their true value. The Complaint
details what was false and misleading in the tender offer documents, what the true facts were,
and, as to claims under the Exchange Act, why a strong inference of scienter can be drawn from
these allegations. Nothing further is necessary for defendants to answer the Complaint.
Accordingly, as explained below, defendants’ motion to dismiss the Complaint must be denied, or
alternatively leave should be granted to amend any minor deficiencies.
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III. FACTUAL BACKGROUND1
This action arises out of a tender offer by defendant Capitol Bancorp, Ltd., a Michigan
bank holding company, in which it offered to exchange its publicly traded shares for shares of
NCB common stock (referred to as the “Exchange Offer”). Joseph D. Reid (“Reid”), the
president of Capitol, is also named as a defendant. The Exchange Offer commenced on June 2,
2005, and on June 30, 2005 it expired. Complaint, ¶26. Capitol, through the Exchange Offer,
acquired approximately 404,000 additional shares of NCB’s common stock. Complaint, ¶ 12.
In 2001, Capitol began soliciting investors, mostly in Napa County, to provide capital for
a new community-based bank in Napa County. Capitol used its typical business plan, which
ensured that Capitol, and thus Reid, would always control majority ownership of the new bank.
After three years of operations, Capitol would offer the minority shareholders Capitol’s stock for
that of the local banks at a price that represented 150% of the appraised book value of the stock,
which, in many cases, was a significant discount from the shares’ fair market value. Complaint,
¶¶ 17-18.
The offering circular that Capitol provided in connection with the 2001 sale of NCB
common stock stated that in Capitol’s previous tender offers, the minority shareholders of the
banks had been allowed to vote to approve the transaction. Capitol also stated that it would vote
its shares in accordance with the wishes of a majority of the minority shareholders. This was
reiterated by Reid at a meeting of NCB’s board of directors after NCB’s formation. Complaint,
¶ 19.
During the formation and capitalization of NCB, Capitol formed a holding company for
NCB that was named First California Northern (referred to herein as “NCB Holdings”). The only
function of NCB Holdings was to hold and own approximately 51% of NCB’s total shares. It had
no other material assets, and its financial statements were consolidated with those of NCB.
1 In considering whether a complaint states a valid claim, the Court must take all of the well-pleaded factual allegations in the complaint as true, and must construe all allegations of material fact most favorably to the plaintiff. Livid Holding Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 946 (9th Cir. 2005). Therefore, the factual allegations in the Complaint must be considered in that light.
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Capitol sold about 49% of NCB Holding to other investors and kept 51% for itself through an
intermediate subsidiary. Complaint, ¶ 20.
In approximately May 2004, Capitol offered to exchange its own shares for those of NCB
Holdings at a ratio that translated to a price of 167% of the book value of the common stock of
NCB Holdings. That exchange offer was accompanied by a fairness opinion from JMP Financial,
Inc., a Michigan-based firm, which stated that the NCB Holdings shareholders received fair value
in that exchange. One or more directors and officers of NCB also held shares in NCB Holdings
and participated in the NCB Holdings share exchange in 2004. Complaint, ¶ 20. As explained
below, the 167% value ratio is much higher than Capitol’s June 2005 offer to purchase the stock
of NCB.
NCB began operations in or about March 2002 and soon became one of the best
performing Capitol-affiliated banks. Throughout NCB’s existence, Capitol has maintained direct
and indirect control over NCB, and has always been the controlling shareholder. Capitol asserted
its control by having Reid and other officers of Capitol serve as “Advisory Directors” on the NCB
board of directors. Reid attended numerous meetings of NCB’s board of directors and enjoyed
substantial authority over the affairs of NCB.2 Complaint, ¶ 21.
Capitol’s control over NCB manifested itself in Capitol’s ability to manipulate the book
value of NCB’s stock in preparation for the Exchange Offer. Between March 2002 and June 30,
2005, the date the Exchange Offer expired, Capitol took a number of actions which artificially
lowered NCB’s book value. For example, Capitol reduced NCB’s profitability, and therefore the
book value of the NCB shares, by charging unreasonably inflated fees for back-office processing
services Capitol provided to NCB. Capitol also charged NCB to cover “expenses” that were
supposedly incurred by one of Capitol’s subsidiaries. Although banking laws prohibited Capitol
from passing those costs along to NCB because they were not arms-length transactions and
represented undeclared dividends, Capitol did so anyway. Complaint, ¶ 22.
In early 2005, certain NCB shareholders formed a “Minority Shareholders Committee” to
2 This authority even extended to the point where Reid was able to make changes in the minutes of NCB’s board meetings.
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address Capitol’s unduly heavy influence over NCB as well as Capitol’s intent to acquire outright
ownership of NCB. The Minority Shareholders Committee called for a shareholder meeting to
discuss Capitol’s offer to purchase NCB shares. Complaint, ¶ 23. However, as the controlling
shareholder of NCB, Capitol refused to allow the meeting. In the meantime, Capitol and Reid
undertook a campaign to convince the NCB shareholders that the Minority Shareholder
Committee and its members were biased, and to attack the Committee’s concerns as unfounded.
Finally, Capitol elected to attempt to acquire complete ownership of NCB through an exchange of
stock, without seeking the vote of the NCB shareholders. Of course, this was contrary to
Capitol’s previous representations that any such acquisition would be subject to the approval of
the NCB minority shareholders. Complaint, ¶ 24.
The Minority Shareholders Committee obtained fairness opinions from two California-
based appraisal firms, The Findley Group and Hoefer & Arnett, Incorporated. Both opinions
stated that the fair market value of NCB shares was at least $21 per share. Based on information
and belief, the Complaint alleges that Capitol was provided with both opinions before the
Exchange Offer was made. The Minority Shareholders Committee also demanded that the NCB
board of directors obtain an independent opinion on the fair market value of NCB shares and
make a recommendation to NCB shareholders regarding the adequacy of the Exchange Offer.
However, because of the control wielded by Capitol, the NCB board failed to take such action.
Complaint, ¶ 25.
On or about June 2, 2005, just over three years after NCB’s March 2002 founding, Capitol
made the Exchange Offer to NCB’s shareholders, offering to exchange Capitol stock for all
outstanding shares of NCB common stock for a price (payable in shares of Capitol stock) equal to
approximately 150% of the book value of NCB’s common stock. The Exchange Offer documents
(“the Offer Documents”) included a cover letter from Reid in which he referred to the original
offering circular and “the plan” that Capitol had to acquire investors’ shares in the proposed
manner. The expiration date of the Exchange Offer was June 30, 2005. Complaint, ¶ 26. The
terms of the Exchange Offer were set forth in certain documents, including an S-4 registration
statement, that Capitol filed with the U.S. Securities and Exchange Commission (“the SEC”) on
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or about April 28, 2005.3 Reid signed that registration statement on June 2, 2005, and it was
declared effective. The Exchange Offer Documents were sent by Capitol to every member of the
plaintiff class. Complaint, ¶ 27.
The Exchange Offer established a formula for computing the exact number of shares
Capitol was to issue to the NCB shareholders in exchange for their NCB shares. Capitol
represented that the book value of NCB stock was approximately $10.60 per share, meaning that
Capitol was to issue approximately $15.90 worth of Capitol shares for each NCB share tendered
in response to the Exchange Offer. That ratio worked out to approximately 0.49 Capitol shares in
exchange for each NCB share. Complaint, ¶ 28.
Even before the Exchange Offer was made, and during its pendency, Capitol and Reid
actively reiterated that an understanding or arrangement existed whereby Capitol would buy the
NCB stock at 150% of those shares’ book value, which they represented as fair regardless of the
success of NCB. However, the actual absence of any such agreement or obligation by Capitol, as
well as the arbitrary and artificially low price established for the NCB stock therein, was never
disclosed in connection with the Exchange Offer. Complaint, ¶ 29.
The material misrepresentation of the Exchange Offer price paid for NCB shares resulted
from a number of intentional acts engaged in by Capitol and Reid. First, Capitol used a biased
and misleading fairness opinion in connection with the Exchange Offer. In order to convince the
NCB shareholders whose stock it offered to purchase, Capitol (but not NCB) procured a fairness
opinion from JMP Financial, Inc. (“JMP”). JMP had prepared numerous other “fairness”
opinions on behalf of Capitol in previous acquisitions of interests in Capitol’s community-based
banks, and had also prepared the opinion for Capitol’s earlier acquisition of the stock of NCB
Holdings. JMP’s fairness opinions were nothing if not consistent; almost all of its “fairness”
opinions for Capitol found that approximately 150% of book value was the fair value of the target
bank’s shares. Even more notably, the fairness opinion that JMP prepared in connection with the
Exchange Offer had been substantially drafted approximately one year before the Exchange Offer
3 An amendment was filed by Capitol on or about May 27, 2005.
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was even propounded. This demonstrated that Capitol intended to offer the arbitrary price of
150% of book value for the NCB shares regardless of their fair market value. Of course, none of
these facts were disclosed in the Offer Documents. Complaint, ¶¶ 30, 31.
Also not mentioned in the Offer Documents was that just over one year earlier, when the
book value of NCB was lower, JMP had delivered its opinion to the NCB Holdings shareholders
that an exchange offer valued at 167% of the NCB Holdings’ book value was fair to the NCB
Holdings shareholders. Of course, that value was almost exclusively based on the value of NCB
since NCB Holdings had no material assets or operations other than the shares of NCB.
Complaint, ¶ 30. What would have been evident from those facts, if they had been known, is that
JMP – a captive appraiser for Capitol – had found that 167% of book value was a fair price for
the shares of Capitol’s subsidiary NCB Holdings, which held nothing but NCB common stock,
but that only 150% of book value for essentially the same stock was a fair price when offered to
the NCB shareholders. Complaint, ¶ 30.
Also absent from the Offer Documents was any meaningful explanation of the “services”
provided by Capitol to NCB, or the fees charged to NCB by Capitol for those services. With the
exception of vague footnotes in NCB’s financial statements, which were part of the Offer
Documents, defendants failed to disclose the existence of, or explain, Capitol’s agreements with
NCB for those services. Even these footnotes were misleading because they did not accurately
disclose the amount being paid to Capitol. The financial statements also set forth different
amounts that were paid by NCB to Capitol for the preceding years. No information was given
about the particulars of any agreements that Capitol might have had with NCB for those services;
how the costs were figured; how those fees were calculated or agreed upon; or any other such
information. Of course, the Offer Documents were devoid of any indication of the truth: that the
fees charged by Capitol to NCB were not fair and reasonable for the services provided, and that
they violated banking laws and rules. Because the fees paid by NCB for these services reduced
the profitability of NCB and its book value, they had an adverse impact on the amount received
by NCB shareholders in exchange for the NCB common stock. Complaint, ¶ 35.
The Offer Documents suffered from a number of other material defects. First, Capitol
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failed to disclose that the Minority Shareholder Committee had obtained its own fairness opinion
which stated that the fair market value of NCB stock was at least $21 per share. Complaint, ¶21,
31. Also undisclosed was the fact that before the Exchange Offer, Capitol had opined that the
common stock of NCB was worth approximately $30 per share. Complaint, ¶ 31. Also included
was another fairness opinion proposal by Howe Barnes, Inc., a Chicago-based firm retained by
Capitol, which incorrectly relied upon price models for banks in non-California markets.
Complaint, ¶ 32. The Offer Documents also stated that “NCB’s Board of Directors has not
solicited or received any other proposals for the potential exchange or sale of NCB’s shares of
common stock which are not owned by Capitol” – a false statement, since before the Exchange
Offer expired, certain shareholders of NCB and others had made an offer to purchase stock of
NCB for $17.50 per share. Complaint, ¶ 33. Also, the Offer Documents claimed that no
information or statements outside of the Exchange Offer had been authorized, when in fact
defendants had urged NCB’s officers and directors to contact NCB’s shareholders, including the
plaintiff class, to tell them that unless they accepted Capitol’s Exchange Offer, their NCB shares
would be worthless or illiquid for many years. This was done in order to pressure the NCB
shareholders into tendering their shares to Capitol pursuant to the Exchange Offer. Complaint,
¶ 34.
Defendants committed a number of other violations in connection with the Exchange
Offer. They failed to disclose that they encouraged NCB’s board members to tender their shares,
so that Capitol could tell the other NCB shareholders that all of the NCB board members had
tendered their shares. This, of course, would create the impression that the NCB board members
regarded the Exchange Offer as favorable. However, they did not disclose that at least one of the
NCB board members later withdrew that member’s tender of shares to Capitol. Complaint, ¶ 36.
Capitol also indicated that any withdrawal of a tender of an NCB shareholder’s stock could not be
accomplished by fax, which was not the case. Also, defendants failed to disclose that the vesting
and exercise of NCB options owned by Reid was accelerated, which allowed Reid to take early
ownership of additional NCB stock. That, in turn, strengthened his voting position and diluted
the per-share value of the NCB minority shareholders’ stock. Complaint, ¶ 37.
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During the pendency of the Exchange Offer, plaintiffs and the class accepted Capitol’s
Exchange Offer and exchanged their NCB common stock for Capitol stock at the price stated in
the offer. That price was materially below the true value of the NCB shares. The class members
made the decision to tender their shares in reliance upon the misrepresentations and omissions of
material fact that were inherent in the Exchange Offer. Complaint, ¶ 38. Plaintiffs filed this
action on behalf of themselves and the class on November 23, 2005. Dkt. 1.
The Exchange Offer was the product of defendants’ manipulation and omission of many
material facts that directly resulted in an artificial deflation of the price paid to class members for
their NCB stock. Those misrepresentations and omissions caused NCB’s shareholders to tender
their shares to Capitol in exchange for shares of Capitol’s common stock, at a price (embodied in
the exchange ratio) that was significantly below the true value of NCB stock. The
misrepresentations and omissions of material facts in the Exchange Offer and the Offer
Documents violated both the Securities Act and the Exchange Act and rules thereunder. Both
defendants are liable principally for these violations, and Reid is liable as a “control person.”
IV. ARGUMENT
A. General Standards On Motion To Dismiss
Dismissal is appropriate under Federal Rule of Civil Procedure 12(b)(6) only when a
plaintiff’s allegations fail “to state a claim upon which relief can be granted.” It is well settled
that a motion to dismiss will be denied “unless it appears beyond doubt that the plaintiff can
prove no set of facts in support of his claim which would entitle him to relief.” Conley v. Gibson,
355 U.S. 41, 45-46 (1957); Howard v. Everex Sys., 228 F.3d 1057, 1060 (9th Cir. 2000). In
considering whether the Complaint states a valid claim, the Court must take all of the well-
pleaded factual allegations in the Complaint as true, and must construe all allegations of material
fact most favorably to the plaintiff. Nursing Home Pension Fund v. Oracle Corp., 380 F.3d 1226,
1229 (9th Cir. 2004). Moreover, a court’s duty to draw inferences in favor of plaintiff remains
unchanged by the Private Securities Litigation Reform Act (“PSLRA”). Helwig v. Vencor Inc.,
251 F.3d 540, 553 (6th Cir. 2001). The Court cannot parse the Complaint too finely; it must
consider the pleading in its entirety. Bourjaily v. United States, 483 U.S. 171, 179-80 (1987).
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The Complaint here states each cause of action sufficiently and withstands scrutiny under
the correct legal standards. Therefore, defendants’ motion to dismiss should denied. Finally,
dismissal without leave to amend is appropriate only when the Court is satisfied that the
deficiencies of the complaint could not possibly be cured by amendment. Chang v. Chen, 80 F.3d
1293, 1296 (9th Cir. 1996).
B. The Complaint States A Valid Claim Under Section 11 Of The Securities Act
The Complaint’s first cause of action sufficiently pleads a claim under Section 11 of the
Securities Act. To state a claim under Section 11, plaintiffs need only allege that: (1) the Offer
Documents contained an omission or misrepresentation; and (2) the omission or
misrepresentation was material. In re Stac Electronic Sec. Litig., 89 F.3d 1399, 1403-04 (9th Cir.
1996). “Material” means only that the misrepresented or omitted facts would have misled a
reasonable investor about the nature of his or her investment. Kaplan v. Rose, 49 F.3d 1363,
1371 (9th Cir. 1994). Scienter – fraudulent state of mind – is not an element of a cause of action
for a violation of Section 11 . Herman & MacLean v. Huddleston (“Huddleston”), 459 U.S. 375,
382 (1983).
1. The Section 11 Claim is not Subject to the Pleading Requirements of the PSLRA
Defendants argue first that the Section 11 claims are based upon a “unified course of
fraudulent conduct” and thus are subject to the heightened pleading standards of Rule 9(b) of the
Federal Rules of Civil Procedure and the PSLRA. See In re Daou Systems, Inc., 411 F.3d 1006,
1027 (9th Cir. 2005), cert. denied, 74 U.S.L.W. 3471 (U.S. 2006). That contention fails for two
reasons. First, defendants’ statement of the holding in Daou is incomplete. Daou followed the
Ninth Circuit’s earlier holding in Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097 (9th Cir. 2003).
In both cases, the Ninth Circuit held that the heightened pleading standards of the PSLRA apply
to Section 11 claims only if the plaintiff alleges a “unified course of fraudulent conduct” and
relies entirely upon that course of conduct as the basis of the claim. Daou, 411 F.3d at 1027,
citing Vess, 317 F.3d at 1103-04. In cases where the Section 11 claim is not based entirely upon a
fraudulent course of conduct, only those allegations regarding fraud must be stated with more
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particularity, and then only under rule 9(b). Id., citing Lone Star Ladies Inv. Club v. Schlotzsky's
Inc., 238 F.3d 363, 368 (5th Cir. 2001).
The Complaint here does not sound entirely in fraud, and therefore cannot be subject to
the PSLRA’s pleading standards. The Complaint is replete with instances of factually incorrect
or incomplete representations in the Offer Documents that do not depend on any particular state
of mind of the defendants. See Complaint, ¶¶ 30-35 (alleging the failure to disclose existence of
other offers for NCB stock, nature and value of services provided by Capitol to NCB, etc.). The
Exchange Offer incorporated those omissions and misrepresentations when it became effective.
See Complaint, ¶ 41.
Contrary to defendants’ incorrect reading of Daou, the fact that there are also fraudulent
or otherwise intent-based omissions and misrepresentations alleged in the Complaint, see ¶ 36, is
irrelevant; the entirety of the factual allegations must be based on fraud in order for the PSLRA’s
standards to come into play. Daou, 411 F.3d at 1027; Vess, 317 F.3d at 1103-04. And, as
explained infra, the omissions and misrepresentations of fact inherent in the Exchange Offer were
material. Such allegations are all that is necessary to state a claim for a violation of Section 11.
More specificity is not required, and certainly not the heightened standard of the PSLRA.
Therefore, defendants’ argument fails.
2. The Complaint Alleges Material Omissions and Misrepresentations of Fact
Defendants argue that several factual matters alleged in the Complaint are not material,
and that the Complaint therefore fails to state a Section 11 claim. As addressed here seriatim, all
of defendants’ contentions are without merit, and the motion to dismiss the first cause of action
must be denied.
a. The Failure to Disclose the True Value of NCB Stock
Defendants argue that even if they did misstate the true value of NCB stock, that
misstatement would not be actionable under Section 11. That is incorrect. First of all, “[w]hen a
corporation makes a disclosure – whether it be voluntary or required – there is a duty to make it
complete and accurate.” Roeder v. Alpha Industries, Inc., 814 F.2d 22, 26 (1st Cir. 1987). If
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defendants made a statement about what the supposed value of NCB stock was, their statement
must be complete and accurate. The Complaint, in paragraphs 30 and 43, alleges that defendants’
statements were neither complete nor accurate. That representation is undoubtedly material; one
can hardly imagine a more significant assertion than one regarding the value of the stock at issue
in the Exchange Offer. Although defendants argue that “[c]ourts do not sit in judgment of the
‘fairness’ of a price,” Motion to Dismiss at 9, Section 11 requires that the information received by
investors is not misleading. See Shearson/American Express, Inc. v. McMahon, 482 U.S. 220,
251-252 (1987) (purpose of securities laws is to promote disclosure and place investors on same
footing as industry members). The Complaint alleges that defendants withheld material
information about the true value of the NCB stock from the Offer Documents, and thus the
Complaint sufficiently alleges a claim for violation of Section 11.
Defendants note that the Complaint alleges that there was a difference between the
appraised exchange values for NCB stock in 2004 (when an offer for NCB Holdings shares
opined that 167% of NCB’s book value was fair) and 2005 (which found 150% to be fair).
Although defendants do not say so directly, they seem to argue that the mere fact that the
exchange ratio changed from one offer to the other is not evidence of a misrepresentation or
omission in the later offer at issue here. That is hardly the point. The merits of whether the ratio
should or should not have been the same are not at issue; what is significant here is that the fact
that the two values were different was not disclosed in the Offer Documents. Such a difference
would be material to a reasonable investor, as a reasonable investor might naturally discern the
difference and consider why a lower exchange ratio was being offered in this case. Kapps v.
Torch Offshore, Inc., 379 F.3d 207, 213-14 (1st Cir. 2004), citing Basic, Inc. v. Levinson, 485
U.S. 224 (1988).
b. The Failure to Disclose the Minority Shareholders Committee’s Fairness Opinion
Defendants claim that plaintiffs have inadequately alleged the particulars as to “who
provided the fairness opinion to Capitol or who at Capitol received it,” Motion to Dismiss at 9,
and that this alleged failure requires dismissal. Defendants’ arguments are incorrect.
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Defendants argue that these facts must be pled particularly under the PSLRA. Id., citing
In re Pacific Gateway Exchange, Inc. Sec. Litig., 169 F.Supp.2d 1160 (N.D.Cal. 2001). That
case, however, involved section 10(b) claims that were clearly governed by the PSLRA. As
already established, the PSLRA is not applicable to the Section 11 claims here.
Defendants’ second point – that the Minority Shareholders Committee eliminated any
default by defendants by disclosing the Committee’s fairness opinion and fairness memorandum
in the lawsuit filed before the close of the Exchange Offer – is equally meritless. Defendants rely
on Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971 (9th Cir. 1999) in support of the
proposition that the Committee’s disclosure of its own fairness opinion and fairness memorandum
negated any harm done by the omission of that information from the Offer Documents.
Heliotrope, however, did not concern Section 11 of the Securities Act, but rather involved a
fraud-on-the-market theory of loss causation under section 10(b) of the Exchange Act. The
Heliotrope court held that because the omitted information was already on the market through
other means when the transaction took place, the seller’s omission could not have had any effect
on the price of the stock. Id.
Here, however, we are not dealing with a 10(b) claim, where causation is an element of
the claim. A plaintiff in a Section 11 claim does not have to plead causation. In re Adams Golf,
Inc. Sec. Litig., 381 F.3d 267, 276-77 (3d Cir. 2004); In re Gap Stores Sec. Litig., 79 F.R.D. 283,
297 (N.D.Cal. 1978). Rather, Section 11(e) allows the issuer to disprove causation as an
affirmative defense. That portion of Section 11, however, puts the burden of proof on the issuer,
not the plaintiff. Plaintiffs are not required to “plead around” such affirmative defenses.4 Adams
Golf, 381 F.3d at 276-77.
In this case, all that plaintiffs are required to plead is that there was an omission or
misrepresentation of a material fact (here, the higher stock value expressed in the Minority
4 Later in their motion, defendants cite Metz v. United Counties Bancorp, 61 F.Supp.2d 364 (D.N.J. 1999) for the proposition that plaintiffs must plead causation in their Section 11 claim. Although Metz assumes that such is the case, it gives no explanation for its assumption. The rationale in Metz (or, rather, the lack of it) is undermined by the fact that Section 11(e) treats causation as a matter to be raised by way of defense. The holding of Adams Golf is clearly the more sound expression of the operation of Section 11(e).
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Shareholders Committee’s fairness opinions) in the Offer Documents. Section 11 also addresses
misrepresentation or omission of facts that come into the public domain through means other than
the offering document. Kapps, 379 F.3d at 213 (“the definition of ‘material’ under Section 11 is
not strictly limited to information that is firm-specific and non-public”). Therefore, the fact that
the Minority Shareholders Committee’s own opinion of the fair price of the stock might have
been available publicly before the Exchange Offer closed is irrelevant to the Section 11 claim
against Capitol.5
c. Capitol’s Fairness Opinions
Capitol asserts that the allegations regarding JMP’s lack of independence were not pled
with particularity. As explained above, no such requirement exists with regard to the Section 11
claim. In addition, the Complaint does allege that the fairness opinion prepared by JMP and
incorporated in the Exchange Offer was drafted approximately one year before the Exchange
Offer occurred. Complaint, ¶ 31. As that paragraph explains further, that fact demonstrates that
defendants intended to use the JMP fairness opinion to justify the exchange ratio of 150%
regardless of whether the NCB stock bore a corresponding fair market value by the time the
Exchange Offer was made. It cannot be said that such facts are immaterial; indeed, common
sense would compel a finding that they are quite significant in light of the time elapsed between
the preparation of the fairness opinion and the making of the Exchange Offer. Therefore, the
allegation that defendants failed to disclose those facts in the Offer Documents is sufficient for a
Section 11 claim.
d. Capitol’s Services Provided to NCB
Capitol contends that its disclosure of the nature of the services it provided to NCB was
adequate because it gave a brief description of those services and disclosed the amounts paid by
5 Plaintiffs object to defendants’ request that the Court take judicial notice of the Minority Shareholders Committee’s lawsuit and newspaper articles in the Napa County area regarding the Exchange Offer. See Request for Judicial Notice (“RFJN”) Exs. 6, 8, 11, 14. The purpose of the securities laws is to demand full disclosure of all material facts. Required SEC filings are the means by which such disclosure is promoted. Allowing judicial notice of articles in a small local newspaper or requiring investors to repeatedly view the Court’s docket for relevant complaints is an unwarranted and improper use of judicial notice. In fact, it is Capitol that has the obligation to inform the solicited investors if a lawsuit is filed that may materially affect the offer.
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NCB. Capitol’s description of those services in the Exchange Offer is so general as to be
meaningless. The Exchange Offer states that Capitol “provide[s] transactional, processing, and
administrative support and mentoring to aid in the effective growth and development of its banks”
and “provides access to support services and management with significant experience in
community banking.” (RFJN Ex. 4 at 256). That “disclosure” is nothing more than a mission
statement or even ad copy. It falls far short of being a meaningful disclosure of the quality,
quantity, and nature of Capitol’s “services” to NCB. The figures disclosed by Capitol as to the
amounts paid by NCB for these “services” add nothing to the equation, as the reader could not
possibly make an intelligent assessment of whether the amounts charged were warranted for
services that were described in such a vague manner. The disclosure was therefore inadequate.
Defendants also contend that plaintiffs have not adequately pled the effect of the
undisclosed fees upon the profitability or book value of NCB. As explained above, those matters
relate to causation and do not need to be pled in a Section 11 cause of action.
e. Other Misrepresentations and Omissions
Defendants complain that several other factual allegations in the Complaint do not support
plaintiffs’ Section 11 cause of action, because (allegedly) the claim is based upon matters that
occurred after the Exchange Offer became effective, and therefore defendants could not have
known that their statements were false when made.6 See Motion to Dismiss at 11, citing, inter
alia, Yourish v. Cal. Amplifier, 191 F.3d 983, 993 (9th Cir. 1999). Once again, defendants have
misconstrued the pleading requirements for a Section 11 claim. Their contention that there is
nothing in the Complaint to suggest that “Defendants knew their statement was false when
made,” Motion to Dismiss at 11, is an improper attempt to inject a scienter requirement into a
Section 11 claim where none exists. Whether defendants knew of the false nature of a statement
in the Offer Documents is irrelevant, as negligent or even innocent misrepresentations and
omissions are actionable under Section 11. Huddleston, 459 U.S. at 382; Daou, 411 F.3d at 1027.
6 Defendants also argue that plaintiffs must plead certain facts regarding who made the statements, to whom they were made, and other such matters with the particularity required by the PSLRA. As noted above, that is incorrect.
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In fact, the court in Adams Golf noted the lack of a scienter requirement in Section 11 when it
held that the district court erred in dismissing a Section 11 claim that was based upon statements
that occurred after an offering became effective. Adams Golf, 381 F.3d at 274 n. 7. Accordingly,
it is of no moment that some of the facts alleged in the Complaint as a basis for the Section 11
claim might not have been known to defendants when the Exchange Offer became effective.
Defendants also argue that plaintiffs must plead certain facts regarding who made the
statements, to whom they were made, and other such matters with the particularity required by the
PSLRA. As noted above, that is incorrect. Defendants also argue that the Complaint supposedly
does not plead facts showing that the misrepresentations or omissions “actually caused investors
to do anything they would not have done otherwise.” That contention asks the Court to impose a
requirement that plaintiffs plead causation and reliance in a Section 11 claim, which they are not
required to do. Gap Stores, 79 F.R.D. at 297
3. Plaintiffs are not Required to Plead Loss Causation
Defendants advance a final contention with respect to the Section 11 cause of action: that
“Plaintiffs must plead that the allegedly false or misleading statements or omissions by
Defendants caused the stock that Plaintiffs received to be worth less than the price they paid for
it.” Motion to Dismiss at 12. As shown above, loss causation is not required to be pled in a
Section 11 claim. Moreover, the fact that the stock might have risen in price since plaintiffs
received it through the exchange does not mean that plaintiffs have not suffered damages. The
gravermen of this action is that plaintiffs did not realize as much benefit from the exchange as
they might have done if the Exchange Offer had disclosed all material facts and had not
misrepresented the facts that it did disclose (e.g., the value of NCB’s stock). Under the
allegations of the complaint, complete and accurate disclosure of all material facts would have
resulted in plaintiffs receiving a greater number of Capitol shares from the Exchange Offer.
Plaintiffs have properly pled all elements of their Section 11 claim, and defendants’ motion must
be denied.
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C. Plaintiffs’ Third And Fifth Causes Of Action State Claims Under Sections 10(b) And 14(e) Of The Exchange Act And Rule 10b-5
Under the PSLRA, the Exchange Act claims (under Section 10(b) and Rule 10b-5, and
Section 14(e)) are sufficient if the Complaint sets forth “each statement alleged to have been
misleading, [and] the reason or reasons why the statement is misleading.” 15 U.S.C. § 78u-
4(b)(1); Pacific Gateway, 169 F.Supp.2d at 1165. In reviewing the Complaint, the Court must
consider “whether the total of plaintiffs’ allegations, even though individually lacking, are
sufficient to create a strong inference that defendants acted with deliberate or conscious
recklessness.” Livid Holdings, 416 F.3d at 948 quoting No. 84 Employer-Teamster Joint Council
Pension Fund v. America West Holding Corp., 320 F.3d 920, 938 (9th Cir. 2003), cert. denied,
540 U.S. 966 (2003) (“America West”). “[M]otive and opportunity coupled with highly material
misrepresentations or omissions may well satisfy the [PSLRA’s requirement for pleading
scienter].” In re Nuko Information Sys., Inc., 199 F.R.D. 338, 342 (N.D. Cal. 2000) (citations
omitted).
While the PSLRA’s standards are stringent, they are not designed to hinder the
prosecution of meritorious cases. The Ninth Circuit has warned district courts to be “cautious not
to raise the bar of the PSLRA any higher than that which is required under its mandates.”
America West, 320 F.3d at 946. Allegations as to falsity and scienter are generally evaluated in a
“unitary inquiry” in determining whether they meet the standards of the PSLRA. America West,
320 F.3d at 932.
The allegations of the third and fifth causes of action in the Complaint meet these
standards handily. Therefore, defendants’ motion as to those causes of action must be denied.
1. The Third Cause of Action Contains Sufficient Allegations of Falsity
The Court should look first to the allegations set forth in the third cause of action itself.
That passage of the Complaint pleads the general requirements of a 10(b) claim, incorporating the
previous factual allegations. Defendants, hoping to discourage the Court from reading all of the
allegations, focus on a very few. However, the Court must consider all of the factual allegations;
finding fault with just a few will not bar a Section 10(b) claim. Livid Holdings, 403 F.3d at 1057.
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Defendants contend first that plaintiffs’ fraud claims cannot be based upon the allegation
that defendants fostered the impression that they would purchase the class’ shares of NCB stock
at 150% of their book value three years after the founding of NCB, and that that price would be
fair. See Complaint, ¶ 29. Because the Exchange Offer – and the Offering Circular before it in
2001 – both disclaimed the existence of any such impression or agreement, or any promise that
the exchange price would be fair, defendants contend that those allegations cannot support a 10(b)
claim. That argument misses the point entirely. Whether a contract or other agreement was made
by Capitol is beside the point. The issue is whether the characterization of the facts by the
Exchange Offer was false or misleading by reason of its incorporation of misstatements or
omissions of material fact. Capitol cannot avoid liability by including a half-truth about the fact
that it had no “contractual obligation” to make an offer at a fair price. Such a statement leaves
wide open the possibility that other obligations might have been incurred, or other promises or
impressions might have been made, regarding the contemplated Exchange Offer. When the
Exchange Offer was declared effective, it did not disclose that defendants had fostered the
impression that the plaintiff class’ NCB shares would be purchased for 150% of their book value,
and that that price would be fair.
The statements in the Exchange Offer that defendants rely upon should not be treated as
innocuous words of caution. They are direct misrepresentations that no agreement or
understanding about the exchange price to be paid by Capitol for the NCB stock existed, when in
fact one did exist and had been actively perpetuated by Capitol for years. That is all that is
required for a sufficient pleading of falsity in a Section 10(b) claim.
a. Collusion by Capitol with the NCB Board
Defendants next contend that the Complaint does not adequately plead the specifics of the
collusion between Capitol and the NCB board or the facts surrounding one of the NCB board
members’ withdrawal of his or her tender of NCB shares. See Complaint, ¶ 36. That contention
is a misreading of the PSLRA’s pleading standards. All that the PSLRA requires is that the
plaintiffs allege what misleading statement was made, and why it was misleading. Pacific
Gateway, 169 F.Supp.2d at 1165. Paragraph 36 meets those requirements. Plaintiffs allege
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therein that Capitol made the misleading statement that all of the NCB board members had
tendered their shares. That statement was misleading for two reasons: (1) it created a false
impression that the NCB board members thought favorably of the Exchange Offer (which,
naturally, would have encouraged the NCB shareholders to tender their shares as well); and (2) it
was false, as at least one NCB board member had withdrawn the tender of his or her shares. Id.
Where the allegations are not made upon information and belief, there is no requirement that
plaintiffs cite chapter and verse about the raw facts, such as who made a particular statement or
when it was made. Id. Moreover, the Complaint alleges such detail since the misleading
statement was made in the Offer Documents by Capitol and Reid, a signator of the registration
statement. The Complaint states sufficient facts about Capitol’s collusion with the NCB board
and the failure to disclose the withdrawal of one NCB board members’ tender.
b. Withdrawal by Fax
Defendants contend that paragraph 37 of the Complaint alleged that “a tender of shares
could not be accomplished through facsimile,” and that such a statement, even if false, would not
be material. See Motion to Dismiss at 15. That is a complete misstatement of that paragraph.
The Complaint actually alleges that the Exchange Offer falsely stated that faxed withdrawals of
tenders would not be sufficient. Complaint, ¶ 37. That, of course, is a material
misrepresentation. If a class member had tendered his or her shares and then realized that the
price offered by Capitol in the Exchange Offer was not adequate, inaccurately figured, or
otherwise unfair, and then read in the Exchange Offer that withdrawals could not be
accomplished by fax, that incorrect indication could very well have presented a significant
logistical barrier to withdrawing the tender. It is completely logical to infer that this
misrepresentation might have dissuaded a shareholder from withdrawing the tender of his or her
NCB shares to Capitol in hopes that a better price could be negotiated. The incorrect statement
that a withdrawal of the tender via fax would not be sufficient is a material misstatement that can
form a factual basis for the third cause of action.
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c. Reid’s Exercise of Options
Paragraph 37 also alleges that Capitol failed to disclose that Reid had enjoyed the
accelerated vesting and exercise of options in NCB stock and his resulting acquisition of
additional NCB stock, which strengthened his ownership interest and diluted that of the minority
shareholders of NCB. Those allegations are sufficient to demonstrate what misleading statement
was made (a failure to disclose those facts) and why it was misleading (because the minority
shareholders did not know that their interest and voting power had been diluted by Reid’s
exercise of his options). A shareholder’s true voting power and interest in the company are, of
course, material. See Stuebler v. Xcelera.com, 430 F.3d 503, 505-06 (1st Cir. 2005) (where
dilution of voting power was an undisclosed material fact). The failure to disclose the true facts
surrounding Reid’s options in NCB stock is therefore actionable under Section 10(b).
2. The Complaint States Sufficient Claims Under Section 14(e) of the Exchange Act7
Section 14(e) of the Exchange Act imposes liability for false and misleading statements
made in connection with a tender offer. Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 10
(1985). Although the pleading requirements of the PSLRA apply, the requisite state of mind in a
Section 14(e) action is negligence, as opposed to knowledge or deliberate recklessness. Pacific
Gateway, 189 F.Supp.2d at 1166.
Defendants contend that the third and fifth causes of action are deficient because,
according to them, the failure to disclose that the price being offered by Capitol for the NCB
stock was below the “true value” of the NCB stock is not actionable. Motion to Dismiss at 15-16.
The failure to state a fair price for NCB stock is not the only misrepresentation that supports the
Section 14(e) claim. As explained above, the Complaint alleges many other negligent and
fraudulent acts and omissions that form the basis of plaintiffs’ claims here. And as defendants
point out, the causes of action incorporate those factual allegations. Since, as plaintiffs have
7 Defendants contend that the third and fifth causes of action fail to state Section 14(e) claims. Only the fifth cause of action relates to Section 14(e); the third cause of action is a Section 10(b) and Rule 10b-5 claim.
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already demonstrated, the Section 10(b) and Rule 10b-5 claims have been properly pled, the
Section 14(e) causes of action must survive as well. Defendants’ motion must be denied.
3. The Complaint Raises a Strong Inference of Scienter
To state a claim under Rule 10b-5, plaintiffs must allege that defendants engaged in
manipulative conduct with “scienter.” DSAM Global Value Fund, 288 F.3d 388 (9th Cir. 2002).
The PSLRA requires that plaintiffs plead facts raising a “strong inference” of deliberate or
knowing conduct by defendants. In re Silicon Graphics Sec. Litig., 183 F.3d 970, 974 (9th Cir.
1999). The facts pled here fulfill that requirement. Therefore, the motion to dismiss the third and
fifth causes of action must be denied.
The Court must look at the allegations of the Complaint taken as a whole rather than
looking at the allegations in a piecemeal manner when deciding whether plaintiffs adequately
plead scienter. Ronconi v. Larkin, 253 F.3d 423, 437 (9th Cir. 2001). The Ninth Circuit defines
scienter as acting with intent or deliberate recklessness. Silicon Graphics, 183 F.3d at 976.
Recklessness is defined as:
a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.
Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (quotations omitted), cert.
denied, 499 U.S. 976 (1991).
Plaintiffs have alleged far more facts to establish scienter than what defendants
characterize as mere “motive and opportunity” allegations. For example, the Complaint alleges
that when the Exchange Offer was made and the fairness opinion by JMP (which stated that an
exchange ratio of 150% was fair) was provided, defendants failed to disclose the existence of the
earlier fairness opinion by JMP that justified a higher exchange ratio for NCB stock. Complaint,
¶¶ 20, 30. Those allegations, logically, raise a strong inference that defendants wanted to conceal
the higher previous fairness opinion, since the shareholders to whom the Exchange Offer was
made might refuse to tender their shares if they thought Capitol’s appraiser would support a
higher price as it had in the past. The Complaint also sets forth how Capitol artificially lowered
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the book value of NCB shares by “charging” NCB inflated fees for back-office services,
Complaint, ¶¶ 22, 35; prevented meetings of the board of directors from being called, ¶ 23; and
chose to acquire complete ownership of NCB through the Exchange Offer and without a vote of
NCB’s shareholders. Complaint, ¶ 24.
These facts and others show a pattern from which it can logically be inferred that
defendants were attempting to manipulate the minority NCB shareholders into accepting the
Exchange Offer and tender their NCB shares to Capitol at below fair market price and without
being able to have a shareholders’ vote on the terms of the tender offer. Those allegations raise a
strong inference that defendants acted with the requisite state of mind. The Complaint alleges
more than enough facts to raise a strong inference of scienter on the part of defendants.
Defendants’ motion thus fails in this respect.
D. The Complaint States Claims For “Control Person” Liability Against Reid
The second cause of action asserts a claim against Reid, the president of Capitol, for
derivative “control person” liability based upon Section 15 of the Securities Act, which derives
from the Section 11 claim against Capitol. The fourth cause of action contains a similar claim
against Reid under Section 20 of the Exchange Act as a derivative of the Section 10(b) and
Rule 10b-5 claims against Capitol. Both causes of action are stated with sufficient detail and
particularity. Therefore, defendants’ motion to dismiss those claims must be denied.
In order to state a cause of action for “control person” liability against Reid, the
Complaint must allege (1) a primary violation of federal securities law; and (2) the exercise of
actual power or control over the primary violator (in this case, Capitol). Howard v. Everex
Systems, Inc., 228 F.3d 1057, 1065 (9th Cir. 2000); Hollinger , 914 F.2d at 1578 . Whether a
particular person is a “control person” is usually such a fact-intensive inquiry that the matter
cannot be decided on a motion to dismiss. Howard, 228 F.3d at 1065, citing Kaplan, 49 F.3d at
1382. Therefore, although the provisions of Rule 9(b) require more specific pleading of “control
person” liability, that requirement is met simply by alleging that the control person was active in
the daily affairs of the company or exercised specific control over the preparation and release of
the financial statements. Howard v. Hui, No. C 92-3742-CRB, 2001 U.S.Dist. LEXIS 15443 at
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*10 (N.D. Cal. Sept. 24, 2001), citing Howard, 228 F.3d at 1067 n. 13. An allegation that a
named person – in this case, Reid – occupied an important position in Capitol “is sufficient at the
pleadings stage to state a claim that the defendant was a control person[.]” In re Network Assocs.,
Inc. Sec. Litig., 2003 U.S. Dist. LEXIS 14442, 2003 WL 24051280, at *8,. n.18 (N.D.Cal.
March 25, 2003). Moreover, and contrary to what defendants contend, the president of a
corporation is presumed to be a “control person.” Adams v. Kinder-Morgan, Inc., 340 F.3d 1083,
1108 (10th Cir. 2003).
The Complaint contains sufficient allegations to establish that Reid was a “control person”
of Capitol. As to liability under Section 15 of the Securities Act, plaintiffs allege that Reid, as the
president of Capitol, had “operational control of Capitol” and “had the power and authority, and
exercised the same, to cause Capitol to engage in the wrongful conduct complained of herein.”
Complaint, ¶ 47. As to the Section 20 claims against Reid (which proceed from the Section 10(b)
and Rule 10b-5 claims against Capitol), the Complaint alleges the following:
Defendant Reid acted as a controlling person of Capital [sic] within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of his high-level position, and ownership and contractual rights, participation in and/or awareness of Capitol’s operations and/or intimate knowledge of the registration statement filed by Capitol with the SEC, Reid had the power to influence and control and did influence and control, directly or indirectly, the decision-making of Capitol, including the content and dissemination of the various statements that [P]laintiff[s] contends [sic] are false and misleading. Reid was provided with or had unlimited access to copies of the Company’s reports, public filings and other statements alleged by Plaintiffs to be misleading prior to and/or shortly after these statements were issued and had the ability to prevent the issuance of the statements or cause the statements to be corrected.
In particular, Reid had direct and supervisory involvement in the day-to-day operations of Capitol, and therefore, is presumed to have had the power to control or influence the particular transactions giving rise to the securities violations as alleged herein, and exercised the same.
Complaint, ¶¶ 61-62. Reid also signed the registration statement for the Exchange Offer, which
was filed with the SEC and contained misrepresentations and omissions of material facts.
Complaint, ¶ 27. Such facts are sufficient to support a claim for control person liability. In re
WorldCom, Inc. Sec. Litig., 294 F Supp 2d 392, 419-20 (S.D.N.Y. 2003).
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These allegations are more than sufficient to state “control person” causes of action
against Reid under Section 15 of the Securities Act and Section 20 of the Exchange Act. The
Complaint alleges particularly that Reid had the ability to control Capitol’s daily operations and
the statements made in the offer, and that he signed the offer. None of these are surprising
propositions given Reid’s position as president of the company. The second and fourth causes of
action have therefore stated sufficient claims for “control person” liability against Reid.
Defendants’ motion in that regard must therefore be denied.
E. SLUSA And Preemption Of Plaintiffs’ State Law Causes Of Action
Defendants argue that the Supreme Court’s recent decision in Merrill Lynch, Pierce,
Fenner & Smith, Inc. v. Dabit, ___ U.S. ___, 126 S.Ct. 1503 (2006) makes clear that the
law claims expressed in the sixth through eighth causes of action. In light of the Dabit Court’s
pronouncements on the scope of SLUSA preemption, plaintiffs will dismiss those causes of
action and will not oppose defendants’ motion further on those points.8
F. Leave To Amend Any Deficiencies Should Be Granted
Even if the Complaint does bear any defects, leave to amend should be granted.9 The
aspects of the Complaint with which defendants take issue are nothing more than factual details.
There is no reason why the Complaint cannot be amended to allege facts, events, and other
matters in more detail or to explain certain claims more fully, if the Court finds that necessary.
Such amendments are permitted almost universally, especially in the first instance. See Pacific
Gateway, 189 F.3d at 1168 (granting leave to file a second amended complaint, and providing
guidance thereon). Accordingly, to the extent the allegations as to any claim are insufficient,
plaintiffs respectfully request that they be granted leave to file an amended complaint.
8 Given this result, there is no need to discuss the issue of whether those causes of action have been pled with sufficient factual support or particularity. 9 Because the sixth through eighth causes of action appear to be barred by SLUSA as interpreted by Dabit, plaintiffs do not believe that those claims are susceptible of amendment.
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V. CONCLUSION
For the foregoing reasons, plaintiffs respectfully request that the Court deny defendants’
motion to dismiss the Complaint, or alternatively that leave be granted to correct any deficiencies.
Dated: May 1, 2006
LAW OFFICES OF GEORGE S. TREVOR
By: /s/ George S. Trevor______________ George S. Trevor
300 Tamal Plaza, Suite 180 Corte Madera, California 94925 Telephone: (415) 924-7147 Facsimile: (415) 924-7159
John F. Friedemann (Bar No. 115632) Kyle M. Fisher (Bar No. 127334) FRIEDEMANN GOLDBERG LLP 420 Aviation Boulevard, Suite 201 Santa Rosa, California 95403 Telephone: (707) 543-4900 Facsimile: (707) 543-4910 Attorneys for Plaintiffs
