Pergament v Roach

[*1] Pergament v Roach 2008 NY Slip Op 50403(U) [18 Misc 3d 1141(A)] Decided on February 14, 2008 Supreme Court, Nassau County Warshawsky, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on February 14, 2008
Supreme Court, Nassau County

Marc A. Pergament, the Chapter 7 Bankruptcy Trustee for the Estate of American Biogenetic Sciences, Inc., Plaintiff,

against

Alfred J. Roach, RONALD I. HELLER, DAVID S. NAGELBERG, KENNETH J. KOOCK, MARTIN H. MEYERSON, M.H. MEYERSON & CO., INC., LAWRENCE KUPFERBERG, in his individual capacity and as trustee of the RACHEL BETH HELLER 1997 TRUST and the EVAN TODD HELLER 1997 TRUST, DONEHEW FUND LIMITED PARTNERSHIP, ROBERT DONEHEW, R. DAVE GARWOOD, DAVID BIGGS, TYLER RUNNELS, KEVIN CHAROS, ANTHONY CHAROS, DELAWARE CHARTER GUARANTY AND TRUST COMPANY, in its capacity as trustee of the RONALD HELLER IRA, DAVIS S. NAGELBERG IRA, and the MARTIN H. MEYERSON IRA, JACQUELINE KNAPP, JANICE HALL-NESSES, JOHN DAVIES, INVEST, INC. and PETER W. JANSSEN, Defendants.



016425/2001

Ira B. Warshawsky, J.

Motion by the M.H. Meyerson defendants for summary judgment dismissing the complaint is denied. Motion by the M.H. Meyerson defendants to preclude the testimony of expert witness Ronald D'Antoni is granted in part and denied in part. Cross-motion by plaintiff for sanctions is denied.

This is an action for breach of fiduciary duty. Plaintiff Marc Pergament is the Chapter 7 bankruptcy trustee for the estate of American Biogenetic Sciences, Inc. American Biogenetic was a bio-pharmaceutical company in the business of researching, developing, and marketing cardiovascular and neuro-biology products. Defendant Alfred Roach founded the company in 1983 and was the Chairman of its board of directors. American Biogenetic's stock was traded on the NASDAQ national securities market. In the late 1990's, American Biogenetic still had not yet achieved profitability. The company was in need of new capital both to continue operations and to comply with NASDAQ's $ 4 million net tangible assets requirement.

On May 20, 1998, in an effort to raise capital, American Biogenetic issued a series of convertible debentures to three offshore hedge funds in a private placement. Although the transaction brought in $ 4 million of new capital, it involved serious risks for the issuer. The debentures were convertible into common stock in four monthly stages beginning September 17, 1998. The "conversion price," or ratio of debentures to shares, was related to the market price of the stock, less a discount which increased if the debenture was held for a longer period of time.[FN1] However, the debentures were "floorless," in that there was no minimum conversion price. Thus, the debenture holders had an incentive to drive the market price of the stock down because the lower the market price, the lower the conversion price, and the more stock the debenture holders would receive in exchange for their debentures. Nevertheless, the issuer had an "escape hatch." If American Biogenetic would be required to issue more than 4 million shares of common stock upon conversion of all of the debentures, it reserved the right to pay cash for the debentures in lieu of shares.[FN2]

Following the issuance of debentures, the price of American Biogenetic stock began rapidly to decline. Between May 20 and August 20, 1998, the price fell from $1.50 to .75 per share. According to plaintiff, the debenture holders, or others acting in concert with them, drove [*2]the price down by short selling. In any event, short selling of American Biogenetic stock increased significantly during that time.

On August 13, 1998, American Biogenetic retained defendant M.H. Meyerson & Co. as a financial advisor. Defendant Martin H. Meyerson was the chief executive officer of M.H. Meyerson. Defendant Kenneth Kook was the vice chairman and a director of M.H. Meyerson. Defendants Ronald Heller, David Nagelberg, and Anthony Charos were officers or employees of the company. According to the "financial advisory agreement," M.H. Meyerson was to provide "customary financial consulting advice as is reasonably requested." As compensation for its consulting services, M.H. Meyerson was given warrants to purchase 400,000 shares of American Biogenetic's common stock. 150,000 warrants were exercisable immediately at a price of $1.50 per share. Two other blocks of warrants were exercisable in the future at higher prices per

share.[FN3] Following the retainer of M. H. Myerson as financial advisor, the price of American Biogenetic stock continued to decline.

On September 24, 1998, American Biogenetic received a letter from NASDAQ, noting that the company's stock was trading at less than $1.00, the minimum price for a company to be listed on the NASDAQ national market. In the letter, NASDAQ informed American Biogenetic that the company would be delisted, if it did not demonstrate compliance with the minimum price requirement within 90 days.

On October 27, 1998, American Biogenetic's stock was trading at approximately .19 per share. On that date, American Biogenetic entered into a series of "purchase and investment agreements" which form the basis of the present action. Pursuant to these purchase and investment agreements, American Biogenetic issued 10.8 million shares of common stock at a price of $.25 per share. The purpose of the private placement was to raise capital to repurchase the convertible debentures in the hope of causing the company's stock to rise back to NASDAQ's minimum price requirement. Plaintiff alleges that the M.H. Meyerson defendants "conceived" the private placement, and that all of the defendants participated in the investment by purchasing shares.

Alfred Roach, American Biogenetic's Chairman, purchased 4 million shares in the private placement. According to plaintiff, 3,020,000 shares were purchased by M.H. Meyerson employees or their family members. Defendants Lawrence Kupferberg, Donehew Fund Limited Partnership, Robert Donehew, R. Dave Garwood, David Biggs, Tyler Runnels, Kevin Charos, Jacqueline Knapp, Janice Hall-Nesses, John Davies, and Invest, Inc. were purchasers who are not alleged to be directly related to M.H. Meyerson or the issuer.

Immediately after the private placement on October 27, 1998, the price of American Biogenetic stock began to rise. The stock climbed to a high of $1.72 per share on November 12, 1998 and then settled in the range of $1.20 per share through March 31, 1999. Meanwhile, on November 11, 1998, American Biogenetic repurchased the debentures at a cost of $3,852,000. Plaintiff alleges that it was not public knowledge that the debentures were going to be repurchased until that date. Of the funds used to repurchase the debentures, $2.7 million was [*3]proceeds of the private placement and $1,152,000 came from other monies which were available to the company. In December 1998, American Biogenetic filed a registration statement with the SEC to permit the defendants to resell to the public the shares which they had purchased in the private placement. Plaintiff alleges that between July 1999 and April 2000, the M. H. Meyerson defendants sold shares for an aggregate amount of $3,361,082, realizing a net profit of 124%.Plaintiff further alleges that the issuance of the stock in the private placement caused a "50% dilution" of the interest of the other stockholders, which allowed defendants to reap their profits.This action for breach of fiduciary duty was commenced by a shareholder on October 26, 2001. After a bankruptcy petition was filed, American Biogenetic's trustee in bankruptcy was substituted as the plaintiff. Plaintiff alleges that the private placement purchase price of .25 per share was grossly inadequate for the American Biogenetic stock. Although the purchase price exceeded the .19 closing price on October 27, 1998, it was significantly below the price at which the stock had traded between March 31 and August 31, 1998. Moreover, plaintiff alleges that the price of the stock was "artificially depressed" because of the outstanding debentures and the unusually high level of short selling activity. Plaintiff further alleges that the purchasers in the private placement had access to inside information, namely that 1) the debentures were soon to be repurchased, and 2) a new chief executive officer, John North, was to be hired on November 2, 1998.

In the first cause of action of the complaint, plaintiff alleges that Roach and the M.H. Meyerson defendants breached their fiduciary duties of loyalty to American Biogenetic. Plaintiff alleges that the duty of loyalty permitted these defendants to engage in a business transaction with American Biogenetic only if the terms of the transaction were fair to the company. Plaintiff further alleges that the private placement was fundamentally unfair to American Biogenetic. In the second cause of action of the complaint, plaintiff alleges that Roach and the M.H. Meyerson defendants had a duty to act in good faith, with the care of an ordinarily prudent person, and in the best interests of American Biogenetic. Plaintiff alleges that these defendants breached these duties in connection with the private placement transaction.

By order dated May 13, 2005, this court granted the M.H. Meyerson defendants' motion for summary judgment dismissing the breach of fiduciary claims, on the ground that defendants were not under a fiduciary duty to American Biogenetic with respect to the private placement. However, the Appellate Division, holding that there was a triable issue as to whether M.H. Meyerson had a fiduciary relationship with American Biogenetic, modified this court's order. The court reasoned that the provision in the agreement requiring M.H. Meyerson to provide "customary financial consulting advice as is reasonably requested," coupled with the deposition testimony as to discussions regarding equity financing, raised triable issues as to whether there was a fiduciary relationship between M.H. Meyerson and American Biogenetic. The Appellate Division affirmed the granting of summary judgment as to the remaining claims against the M.H. Meyerson defendants.

Certain of the M. H. Meyerson defendants, namely Ronald Heller, David Nagelberg, Kenneth Kook, Martin H. Meyerson, and Anthony Charos, now renew their motion for summary [*4]judgment as to the breach of fiduciary duty claims.[FN4] Defendants argue that, as a matter of law, they were not under a fiduciary duty because financial advice was not sought with respect to the private placement. Defendants further argue that the terms of the private placement were fair, and the transaction was negotiated at arm's length. Finally, defendants argue that because American Biogenetic's board made an "independent decision" to retire the debentures through the private placement, the board did not rely upon the superior knowledge of the defendants.

Alternatively, these defendants move to strike the report of plaintiff's expert witness, Ronald D'Antoni, and to preclude his testimony. D'Antoni, an investment banker, is of the opinion that American Biogenetic could have obtained a price of close to $1.00 per share if it had repurchased the debentures before conducting the private placement. D'Antoni is of the further opinion that M.H. Meyerson was a fiduciary by virtue of its position as a financial adviser. Finally, D'Antoni is of the opinion that M.H. Meyerson breached its fiduciary duty by insider trading, i.e. trading with knowledge that the debentures were about to be repurchased, which was material non-public information.

A fiduciary who commits a breach of his duty as a fiduciary is guilty of tortious conduct to the person for whom he should act. Restat 2d of Torts § 874[b]. A cause of action for breach of fiduciary duty sounds in either intentional or negligent conduct. Shapiro v. Rockville Country Club, Inc., 22 AD3d 657 (2d Dep't 2005). Under either theory, to prove a breach of fiduciary duty, plaintiff must establish that defendant's misconduct was the direct and proximate cause of the losses claimed. Northbay Construction Co. v. Bauco Construction Corp., 38 AD3d 737 (2d Dept't 2007). A person who knowingly assists a fiduciary in committing a breach of trust is himself guilty of tortious conduct and is subject to liability for the harm which is caused to the beneficiary. Restat Torts 2d § 874[c]. However, the measure of liability may be different since the one who knowingly assists the fiduciary is responsible only for harm caused or profits that he himself has made from the transaction. Id.

"A fiduciary relationship exists between two persons when one of them is under a duty to act for or give advice for the benefit of another upon matters within the scope of the relation. Such a relationship, necessarily fact-specific, is grounded in a higher level of trust than normally present in the marketplace between those involved in arm's length business transactions. Generally, where parties have entered into a contract, courts look to that agreement to discover the nexus of the parties' relationship and the particular contractual expression establishing the parties' interdependency. If the parties do not create their own relationship of higher trust, courts should not ordinarily transport them to the higher realm of relationship and fashion the stricter duty for them. However, it is fundamental that fiduciary liability is not dependent solely upon an agreement or contractual relationship between the fiduciary and the beneficiary but results from the relation." EBC I, Inc. v. Goldman, Sachs & Co., 5 NY3d 11, 19-20 [2005][citations omitted].An underwriting contract, in which an investment firm agrees to purchase an entire allotment of securities with a view to reselling them to the public, ordinarily does not of itself create a fiduciary relationship. Id. at 20. However, a fiduciary duty may arise if the [*5]underwriter assumes an "advisory relationship" with the issuer by inducing the issuer to repose confidence in the underwriter's knowledge and expertise. Thus, an underwriter might have a duty to advise the issuer as to a fair price for the initial public offering, to deal fairly with the issuer, and advise the issuer as to any conflicts of interest concerning the pricing of the security. Id. In EBC I, the Court of Appeals further stated that upholding an issuer's fiduciary duty claim against an underwriter would not potentially conflict with the "highly complex regulatory framework designed to safeguard investors." Id. at 21.

The agreement between American Biogenetic and M.H. Meyerson was a financial advisory agreement rather than an underwriting contract. However, to the degree that M.H. Meyerson was pursuant to the agreement to give financial consulting advice to American Biogenetic, then a fiduciary relationship arose. Moreover, the relationship between the parties may have given rise to a fiduciary obligation with respect to the private placement, even if equity financing was not expressly included in the financial advisory agreement.

In order for the "private placement" exemption from the registration requirement to apply, those to whom the offering is made must have access to financial information concerning the issuer, similar to what would be found in a registration statement. Berckeley Investment Group v. Colkitt, 455 F.3d 195, 215 (3rd Cir. 2006). Such investors are able to fend for themselves and do not need the protection of the Securities Act. Id. However, the financial sophistication of prospective purchasers in a private placement would not prevent the issuer from relying upon the knowledge and expertise of its financial consultant. Indeed, the issuer might repose even greater confidence in its consultant under those circumstances. Moreover, because M.H. Meyerson was being paid with warrants which were exercisable at prices significantly above the current market, American Biogenetic may have believed that its interests and those of its advisor were aligned. EBC I, Inc. v. Goldman, Sachs & Co., supra, 5 NY3d at 21.

However, because many of the purchasers were M.H. Meyerson employees or their family members, the financial advisor also had an incentive to obtain the stock for its "friends and family" at a lower price. Yet, it appears that American Biogenetic's board was aware that certain purchasers were affiliated with M.H. Meyerson, the issuer's financial advisor. Thus, M.H. Meyerson did not breach a fiduciary duty by failing to disclose its "conflict of interest" in arranging the offering price.

An underwriter who manages a public distribution of a corporation's shares is a fiduciary of the corporation and may not profit from corporate information obtained in its capacity as underwriter. Frigitemp Corp. v. Financial Dynamics Fund, 524 F.2d 275, 279 (Cir 1975). Similarly, officers and directors of the corporation are fiduciaries who may be made to account to the corporation for profits derived from the use of corporate inside information. Id. at 278. However, a defendant does not assume a fiduciary duty to a corporation merely by being a potential purchaser in a private placement. Id. at 279.

In the "purchase and investment agreement," American Biogenetic covenanted and agreed that the proceeds of the sale of shares would be used solely for redeeming the outstanding convertible debentures. Thus, defendants were clearly in possession of material nonpublic information concerning the plan to retire the debentures, and, possibly, concerning the hiring of a new chief executive officer. However, the purchasers in a private placement frequently acquire favorable inside information which leads them to invest in the company. Thus, defendants did [*6]not breach any fiduciary duty to American Biogenetic by purchasing shares based upon inside information.

Nevertheless, the court concludes that there is a triable issue of fact as to whether M.H. Meyerson breached a fiduciary duty by failing to advise American Biogenetic as to a fair price for its stock. Whether the price of a stock is fair will turn on such factors as the issuer's historical performance, estimates of its business potential and earnings prospects, an assessment of its management, and consideration of these factors in relation to market valuation of companies in related businesses. EBC I, Inc. v. Goldman, Sachs & Co., supra, 5 NY3d at 26-27. A purchaser in a private placement may also consider the price at which the security might eventually be resold in a securities market. If the company's management were concerned with the market price of its stock in the future, it might not seek "solely to maximize the proceeds raised in the offering." Id. at 27. Thus, a "tangle of factors" affects the price of any security, including stock being offered in a private placement. McCabe v. Ernst & Young, 494 F.3d 418, 433 (3d Cir 2007).

The fact that the price of American Biogenetic stock rose immediately after the private placement is not necessarily an indication that the stock was underpriced. After an initial public offering, the price of a stock will frequently rise in the aftermarket. See EBC I, Inc. v. Goldman, Sachs & Co., supra, 5 NY3d at 25 [Read, J. dissenting]. Similarly, the fact that institutional or sophisticated investors have taken a position in a company may boost investor confidence in a stock. Thus, the stock of a publicly traded company may perhaps be expected to rise after the company offers stock in a private placement. Nevertheless, because of the rapid price increase in American Biogenetic stock after October 27, 1998, the court cannot conclude as a matter of law that the stock was offered for a fair price in the private placement.

American Biogenetic's board was clearly aware of factors which were depressing the price of its stock, namely the outstanding debentures and the high level of short selling activity. Nevertheless, the existence of these factors may have led the board to repose greater confidence in the expertise of its financial advisor. Although the decision to complete the private placement was made by American Biogenetic's board, the court cannot conclude as a matter of law that improper advice from M.H. Meyerson was not a substantial factor contributing to the board's decision. Accordingly, defendants' motion for summary judgment dismissing the breach of fiduciary claims is denied.

The admissibility and limits of expert testimony lie primarily in the sound discretion of the trial court. People v. Lee, 96 NY2d 157, 162 (2001).The trial court must determine whether jurors are able to draw conclusions from the evidence based on their day-to-day experience, common observation, and knowledge. Id. Essentially, the trial court assesses whether the proffered expert testimony would aid a lay jury in reaching a verdict. Id. The court should be wary not to exclude expert testimony merely because, to some degree, it invades the jury's province. Id. Indeed, it is within the court's discretion to permit an expert to offer an opinion as to the ultimate issue of fact to be determined at trial. People v. Miller, 91 NY2d 372, 379 (1998)."Particularly in complex cases involving the securities industry, expert testimony may help a jury understand unfamiliar terms and concepts." People v. Schwartz, 21 AD3d 304, 308 (1st Dep't 2005). However, "[T]he line between admissible and inadmissible expert testimony as to the customs and practices of a particular industry often becomes blurred when the testimony [*7]concerns a party's compliance with customs and practices that implicate legal duties." Berckeley Investment Group v. Colkitt, supra, 455 F.3d at 218. Although the customs and practices of the securities industry implicate legal duties, the court has discretion to permit expert testimony on the subject, provided the expert does not give an opinion as to what is required under the securities law or whether the defendant complied with the Securities Act. Id.

The court has ruled that defendants did not breach a fiduciary duty by purchasing shares based upon inside information. Accordingly, plaintiff's expert will be precluded from offering testimony on the subjects of what constitutes "material nonpublic information" and who are considered to be "insiders." However, subject to proper qualification, the expert will be permitted to testify as to the level of trust reposed in a financial advisor based upon custom and practice in the securities industry. The expert will also be permitted to testify as to the fairness of the price for the stock, given all of the various factors. Thus, defendants' motion to preclude is granted as to insider trading and otherwise denied.

At a conference on July 26, 2007, the court granted defendants permission to file a renewed motion for summary judgment. Contrary to plaintiff's characterization, defendants did not re-file the same summary judgment motion previously made to the court. Because defendants have not engaged in frivolous conduct, plaintiff's motion for attorney's fees and expenses is denied. 22 NYCRR § 130-1.1.

This shall constitute the decision and order of the court.

A conference will be held before the undersigned on March 4, 2008, at 9:30 A.M.

Dated: February 14, 2008

J.S.C. Footnotes

Footnote 1:If the debenture was converted before November 17, 1998, the conversion price was 87% of the average closing bid price for five days preceding the date of conversion. If conversion occurred between November 17, 1998 and February 14, 1999, the conversion price was 86% of the 5-day average price. If conversion occurred between February 15, 1999 and May 20, 1999, the conversion price was 85% of the average price. The conversion price was 84% of the average price if conversion occurred after May 20, 1999(Defendants' Ex. 3 at Ex. J).

Footnote 2:The cash price was the principal amount of the debentures plus a premium which was related to the number of shares which would otherwise be issuable and the difference between the highest selling price of the stock on the conversion date and the applicable conversion price(Defendants' Ex. 3 at Ex. J).

Footnote 3:150,000 warrants were exercisable at a price of $2.50 seven months after the agreement, and 100,000 warrants were exercisable 13 months after the agreement at a price of $3.00 per share(Defendants' Ex. 3 at Ex. D).

Footnote 4:Defendants Tyler Runnels and Kevin Charos assert that they were not employees of M.H. Meyerson. While the breach of fiduciary claims were reinstated against these two defendants, they are not moving to renew their summary judgment motion at this time.