United States District Court, D. New Jersey
June 7, 2005.
ROCKER MANAGEMENT, L.L.C. ET AL., Plaintiffs,
LERNOUT & HAUSPIE SPEECH PRODUCTS N.V. ET AL., Defendants.
The opinion of the court was delivered by: JOHN LIFLAND, Senior District Judge
MEMORANDUM AND ORDER (Lernout, Hauspie, and Bastiaens)
Plaintiffs Rocker Management, LLC, Rocker Partners, LP, Rocker
Offshore Management Company, Inc., and Compass Holdings Ltd.
(collectively, "Rocker") have asserted claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 (the
"Exchange Act"), 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5,
17 C.F.R. § 240.10b-5, promulgated thereunder by the United States
Securities and Exchange Commission ("SEC"), against Defendants
Jozef Lernout, Pol Hauspie, Gaston Bastiaens, Carl Dammekens,
Allan Forsey, Ellen Spooren, Erwin Vandendriessche, Gerald
Calabrese,*fn1 Klynveld Peat Marwick Goerdeler
Bedrijfsrevisoren (a/k/a KPMG Bedrijfsrevisoren or KPMG Belgium),
KPMG International ("KPMG"), KPMG UK, KPMG LLP, Paul Behets, and
SG Cowen Securities Corporation ("Cowen") (collectively,
"Defendants").*fn2 Plaintiffs also bring state law claims
for tortious interference with prospective economic advantage,
conspiracy to tortiously interfere, and aiding and abetting
Before the Court are the Motions of individual defendants Jozef
Lernout, Pol Hauspie, and Gaston Bastiaens ("Individual
Defendants") to dismiss Counts I, II, V, VI, and VII of the First
Amended Complaint and Jury Demand for failure to state a claim
under Federal Rules of Civil Procedure 12(b)(6), 9(b), and the
Private Securities Litigation Reform Act,
15 U.S.C. § 78u-4(b)(1), (2) (the "PSLRA" or "Reform Act").*fn3 For the
reasons set forth below, these motions will be denied.
The facts are taken from Plaintiffs' 315-paragraph, 132-page
Amended Complaint. Lernout & Hauspie Speech Products N.V. ("L&H"
or "the Company"), formed in 1987 by Jozef Lernout and Pol
Hauspie, was a Belgian-American company that specialized in speech recognition, text-to-speech
conversion, and digital speech compressions. (Am. Comp. ¶¶ 1,
12). L&H's stock was traded on American and European exchanges.
Since its initial public offering in 1995, L&H reported rapid
growth in its revenues due to its domination of its software
market, its acquisition of other companies, and its development
of revolutionary and "industry first" products. (Am. Compl. ¶
32). Following public announcements in late 1999 and the first
quarter of 2000 concerning both its reported revenues and its
products, in addition to "strong buy" recommendations from L&H's
investment banker, SG Cowen Securities Corporation ("Cowen"), and
revenue compilations by its independent auditor, L&H's stock
price rose from less than $19 in late November 1999 to a high of
$72 in 2000 upwards of a 300% increase. (Id. ¶¶ 2, 63). The
increase in stock price is alleged to be the result of a scheme
of fraud and deception on the part of L&H together with its
related capital funds, officers and directors, accountants, and
investment bankers. The unveiling of that scheme in the latter
half of 2000, due to investigative reporting by the Wall Street
Journal, sent the stock price into a tailspin. The exchanges then
halted trading in the stock, and L&H sought refuge in bankruptcy
Plaintiffs are hedge funds that, while also purchasing shares
of stocks believed to be likely to appreciate, identify and sell
short*fn4 shares of stocks that they believe to be likely to
decline in price. Beginning in June 1998, Plaintiffs established
and built short positions in L&H stock for essentially three
reasons: (1) L&H's senior management had a poor track record,
having previously run another technology company, Quarterdeck,
into the ground based on an aggressive growth-by-acquisition
strategy that they appeared to be repeating at L&H (2) there
was a limited market available for L&H's products; and (3) Rocker
doubted whether L&H had sound fundamentals for its business.
(Id. ¶ 100).
Plaintiffs charge that Defendants engaged in a scheme to
squeeze*fn5 Plaintiffs out of the L&H market by releasing
fraudulent information to the market, causing the price of L&H
stock to double and triple from the prices at which Plaintiffs
had sold short. The inflation of the price of L&H stock squeezed
Plaintiffs, forcing them to reduce their net short positions
through cover purchases at artificially high prices, resulting in
substantial realized losses in the tens of millions of dollars.
(Id. ¶ 5).
A. KPMG Certification of L&H's 1998 Financials
On April 9, 1999, KPMG Belgium published its Independent
Auditor's Report on L&H's financial statements for the year
ending December 31, 1998. (Id. ¶ 51). KPMG Belgium allegedly
made several false statements in those certified financials.
First, financial statements falsely reported L&H's 1998 revenues.
KPMG Belgium itself withdrew its own certification in late 2000
and disclosed to the investing public that its financial
statements "should not be relied upon." (Id. ¶¶ 4, 123). L&H's
Audit Committee later acknowledged that the statements inflated
L&H's actual income by nearly $28 million (including by 24% and
23% in the last two quarters of 1998, respectively). Second, KPMG
Belgium represented that it conducted an "independent" audit,
thereby indicating that it had no financial interest or ties to
L&H management. In fact, the KPMG "global account partner" for
L&H who was responsible for overseeing the audit, Paul Behets,
took a position with an L&H-related entity shortly after
overseeing and certifying these falsified financials. (Id. ¶
267). Third, KPMG Belgium represented that it "conducted [its] audits in accordance with
generally accepted auditing standards in the United States." The
financials violated many important aspects of United States
generally accepted accounting principles ("U.S. GAAP"), involving
the backdating of contracts, contracts entered into with related
parties, and the existence of side agreements releasing customers
of their obligation to pay. (Id. ¶ 209-10). Finally, KPMG
Belgium represented that the financials were "free of material
misstatement," and that the financials "present fairly, in all
material respects, the financial position of Lernout & Hauspie
Speech Products, N.V.," when, in fact, they falsely inflated
L&H's revenue by almost $28 million. (Id. ¶ 52).
B. L&H's Press Releases and Cowen's "Strong Buy"
On December 8, 1999, L&H issued a press release claiming that
its Internet translation services were to be offered on a
Microsoft website. This press release falsely stated that this
development represented an endorsement of L&H's translation
product by Microsoft. The press release quoted L&H's Chief
Executive Officer, Gaston Bastiaens, as stating that "Microsoft's
decision to offer our translation services . . . is a powerful
statement. . . . [and] emphatic recognition of the outstanding
quality, accuracy, and breadth of L&H's translation capabilities." In fact, however, this decision was simply an
advertisement for which L&H may have paid, and did not represent
any sort of endorsement by Microsoft of L&H's product. Microsoft
was actively looking for a buyer for its 7% stake in L&H. It is
alleged that the false press release had the intended effect of
pumping up the stock price given the power of a Microsoft
imprimatur in the software industry: the stock climbed in the
20's in heavy trading following the December 8th press release.
(Id. ¶¶ 55-63).
Later that month, on December 28, 1999, L&H issued a press
release proclaiming the financial success of its Korean
operation. L&H had previously acquired a Korean company, Bumil
(an acquisition on which Cowen consulted and for which KPMG did
due diligence), which subsequently operated as L&H's Korean
subsidiary. The press release, which again quoted Bastiaens,
stated that (1) L&H-Korea had closed "several deals with
customers in the telecommunications, enterprise solutions, and
embedded technologies markets"; (2) L&H experienced "strong
demand" for its products in Asia; and (3) L&H had sold its
software products to securities firms such as Hyundai Securities,
Samsung Securities, LG Securities, Daishin Securities, Daewoo
Securities, and 10 other Asian securities firms. Later
disclosures contradicted those claims of success in Asia; many of
the companies identified in the press release denied being L&H customers, there was no "strong demand" in Asia, and officials
from both Samsung Securities and LG Securities denied ever having
made any purchases from L&H. In fact, L&H's own Audit Committee
later recommended reversing every single dollar in L&H-Korea
revenues because these "customers" and this "strong demand" did
not exist. (Id. ¶ 4a-e). L&H's stock continued to trade in the
mid-20s through late 1999 and early 2000.
On January 5, 2000, Cowen issued "strong buy" recommendations
to the investing public. (Id. ¶ 69). Among other things, the
report repeated that L&H had signed deals with Asian customers
(i.e., Hyundai Securities, Samsung Securities, LG Securities,
Daishin Securities, and Daewoo Securities). Cowen's
recommendation stated that L&H's revenue results were
"impressive," rising "from about $100MM in 1997 to our 2000
estimate of slightly over $500MM." It further states that L&H's
"impressive" revenues would stop "endless short yammering in
1999." (Id. ¶ 69). Cowen presumably had knowledge to the
contrary, given that, in September 1999, it had performed its own
independent analysis of, among other things, financial and
operating data, internal financial analyses and internal
financial forecasts and reports relating to Bumil, as well as L&H
financial and operating data provided by L&H to Cowen. (Id. ¶
Shortly thereafter, on January 7, 2000, L&H filed a Form F-3
Registration Statement with the SEC for the issuance of $150 million of common
stock. This Registration Statement incorporated by reference KPMG
Belgium's certification of L&H's 1998 financial statements.
(Id. ¶ 4). As indicated by KPMG Belgium's later withdrawal and
the Audit Committee restatement, the 1998 revenues were falsely
inflated by almost $28 million in improperly-recorded revenue.
(Id. ¶ 81).
On February 7, 2000, L&H issued a press release about a new
"industry first" technology demonstrated at a trade conference,
i.e., a hand-held dictation device that would allow the "user
to `listen' to e-mail summaries as well as fulltext email," and
also issue computer commands by voice. In fact, the device was
secretly hardwired to a personal computer for the demonstration.
(Id. ¶¶ 76-82).
In early 2000, more press releases issued boasting of L&H's
massive increases in revenue. On February 9, 2000, the Company
announced a stock split following the reporting of "record"
revenues. That release indicated that L&H had revenues of $110
million for the fourth quarter of 1999, a 43.5% increase over
fourth quarter 1998 revenue, and revenue of $344 million for the
entire year of 1999, an increase of 62.7% over 1998 revenue.
(Id. ¶ 91). The following day, another "strong buy"
recommendation issued from Cowen stating that L&H realized $110
million in fourth quarter 1999 reported revenue, L&H booked "a
record 80 contracts for the quarter," and had a "surge in Asia
business." (Id. ¶ 95). The record revenues for 1999 and the supposed surge in Asian
business were fabricated. L&H's Audit Committee later recommended
the reversal of $182 million in L&H-Korea revenues. (Id. ¶¶ 3,
94d, 125). More than half of the revenue reported by L&H for 1999
was later reversed. (Id. ¶ 94d).
From December 1999 through March 2000, the price of L&H stock
rose to over $70 (split adjusted) an increase of more than 300%
from its early December 1999 trading price. (Id. ¶ 102).
C. L&H's Falsification of Revenues
According to L&H's restated results for 1999, L&H earned $169.5
million that year a decline of 20% from reported revenues of
$211.6 million for 1998 and less than half of the $344.2 million
L&H originally reported as 1999 revenue. (Id. ¶ 259).
Plaintiffs allege that, despite its declining revenues, L&H
created the false appearance of "record" revenues in a variety of
ways. First, L&H executed a "start-up" customer scam whereby,
among other things, investment funds affiliated with L&H would
create a "start-up" shell corporation, also often referred to as
a "Language Development Company" or "LDC" that would receive an
infusion of cash from the investment fund. The start-up would
sign a contract to pay L&H a so-called license fee that would
then be reported on L&H's books as revenue. To the extent that
any money actually changed hands on these start-up deals, the start-up paid L&H cash that originated with the
L&H-related investment fund and, thus, the revenue was
self-funded. (Id. ¶¶ 85-88). Second, L&H concealed the fact
that its 1999 revenue in its traditional markets in Europe and
the United States had declined by 20%, while the reported revenue
in Asia rose by 1900%. (Id. ¶ 94a). Third, revenues attributed
to Koscom ($5-10 million), Hung Chang ($5 million), Hyundai
Securities ($5-10 million) and LG Securities were grossly
overstated. Other Asian customers were, in reality, L&H-related
start-ups providing self-funded revenue, or, like Samsung
Securities, were never L&H customers at all. (Id. ¶ 94b-e).
The massive revenues supposedly realized in Asia were the
result of socalled "factoring agreements" with Korean banks. In a
typical factoring agreement, a company assigns an account
receivable on a customer contract to a bank, and the bank then
provides the company with cash equivalent to the amount of the
receivable. If the factoring is with recourse, however, the
company must repay the cash to the bank if the customer fails to
pay the account receivable, and in this situation the factoring
agreement is little different from a loan. L&H's factoring
agreements were, in fact, with recourse, and L&H would leave the
money on deposit with the bank as security. Nevertheless, L&H
would recognize these de facto loans on its books as revenue. In
this manner, L&H was able to create the illusion of revenue from its contracts with the shell,
"start up" customers who were never going to pay L&H. However,
when the bank did not receive payment on the account receivable,
the bank seized the cash deposit to make itself whole. In this
fashion, over $100 million in supposed L&H Korean "revenue"
disappeared from the company's bank accounts. (Id. ¶¶ 150-53).
As revealed by a report commissioned by L&H's own Audit
Committee, L&H used the following accounting tricks to improperly
record revenue: (1) booking revenue absent a contract; (2)
booking revenue when collectibility was in doubt; (3) booking
revenue on contingent contracts and/or prior to delivery; and (4)
entering into side agreements with customers, which released them
of their obligation to pay money to L&H. (Id. ¶¶ 126-143).
In mid- to late-2000, investigative reporting by the Wall
Street Journal caused defendants' fraudulent scheme to unravel.
L&H announced that it would refile financial statements for 1998,
1999, and the first half of 2000 due to "certain errors and
irregularities." In a May 2001 SEC filing, L&H announced that it
was reversing $373 million of $535 million in revenue (70%)
reported by L&H for 1998, 1999, and 2000. (Id. ¶ 261).
Additionally, KPMG Belgium withdrew its audit report of L&H's
1998 and 1999 results, stating that its prior opinions "should no
longer be relied upon." (Id. ¶ 123). The Audit Committee recommended reversal of $27.9 million, $174.7 million and $119.1
million in previously reported revenue for 1998, 1999, and the
first two quarters of 2000, respectively. (Id. ¶ 259).
The impact on L&H was disastrous. Senior executives of L&H,
Gaston Bastiaens and Ellen Spooren, resigned and company
co-founders Jo Lernout and Pol Hauspie were ejected from the
board of directors. L&H filed for bankruptcy court protection in
both the United States and Belgium. The SEC commenced
investigation into the wrongdoings and criminal prosecutors in
Belgium charged Bastiaens, Lernout, and Hauspie with stock-fraud
and money-laundering, securing Bastiaens' extradition from the
United States so that he could stand trial.
Plaintiffs allege that the Individual Defendants, as directors
and officers of L&H, are liable as direct participants in the
aforementioned conduct. Count I of the First Amended Complaint
alleges that Defendants violated Section 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5
promulgated thereunder, 17 C.F.R. § 240.10b-5. Count II alleges
that the Individual Defendants are "controlling persons" who are
jointly liable for the corporate misconduct of L&H under Section
20(a) of the Exchange Act. Counts III and IV do not apply to the
Individual Defendants. Count V alleges that the Individual
Defendants tortiously interfered with Plaintiffs' prospective
economic advantage i.e., their anticipated profit on short sales of
L&H stock. Count VI alleges that Defendants conspired to
tortiously interfere with Plaintiffs' prospective economic
advantage and to commit the various acts of misconduct set forth
in the other Counts. Count VII alleges that Defendants aided and
abetted L&H's tortious interference with Plaintiffs' economic
advantage, providing ample assistance to the scheme to inflate
the price of L&H stock.
I. Motion to Dismiss
A motion to dismiss pursuant to Federal Rule of Civil Procedure
12(b)(6) should be granted only if it "appears beyond doubt that
the plaintiff can prove no set of facts in support of his claim
that would entitle him to relief." In re Cybershop.com Sec.
Litig., 189 F. Supp.2d 214, 223 (D.N.J. 2002) (quoting Conley
v. Gibson, 355 U.S. 41, 45-46 (1957)). When resolving a motion
to dismiss, a district court must accept all well-pleaded
allegations in the complaint as true, and view them in the light
most favorable to the plaintiff. Doug Grant, Inc. v. Greate Bay
Casino Corp., 232 F.3d 173, 183 (3d Cir. 2000). However, the
court need not credit "bald assertions" or "legal conclusions."
Morse v. Lower Merion School Dist., 132 F.3d 902, 906 (3d Cir.
1997). A. Section 10(b) and Rule 10b-5 Claims
To state a claim pursuant to Rule 10b-5, Plaintiff must allege
that (1) the defendant made a misrepresentation or omission of a
material fact; (2) scienter motivated the defendant's
misrepresentation or omission; (3) the defendant made the
misrepresentation or omission in the context of a securities
purchase or sale; (4) the plaintiff relied upon defendant's
misrepresentation or omission; and (5) the plaintiff's reliance
proximately caused damages. In re Cybershop.com Sec. Litig.,
189 F. Supp. 2d at 224. Scienter may be pled by alleging facts
(1) that demonstrate "`a motive and opportunity to commit
fraud,'" or (2) that "constitute circumstantial evidence of
either reckless or conscious behavior." In re Advanta Corp. Sec.
Litig., 180 F.3d 525, 534-35 (3d Cir. 1999) (quoting Weiner v.
Quaker Oats Co., 129 F.3d 310, 318 n. 8 (3d Cir. 1997)).
A plaintiff alleging false or misleading statements or
omissions of material fact must meet the heightened pleading
requirements of both Rule 9(b) and the PSLRA. In re
Cybershop.com, 189 F. Supp. 2d at 225. Rule 9(b) requires that
allegations of fraud, and the circumstances constituting the
fraud, be pled with particularity. Id. While the particularity
requirement may be relaxed where factual information is within
defendant's knowledge or control, "boilerplate and conclusory
allegations will not suffice." In re Burlington Coat Factory
Sec. Litig., 114 F.3d 1410, 1418 (3d Cir. 1997).
Federal Rule of Civil Procedure 9(b) demands that a plaintiff
plead (1) a specific false representation [or omission] of
material fact; (2) knowledge by the person who made it of its
falsity; (3) ignorance of its falsity by the person to whom it
was made; (4) the intention that it should be acted upon; and (5)
that the plaintiff acted upon it to his damage. In re
Rockefeller Center Properties, Inc. Sec. Litig., 311 F.3d 198,
216 (3d Cir. 2002) (citing Shapiro v. UJB Fin. Corp.,
964 F.2d 272, 284 (3d Cir. 1992)). Rule 9(b) requires plaintiffs to
identify the source of the allegedly fraudulent misrepresentation
or omission. Id. (citing Klein v. General Nutrition Cos.,
Inc., 186 F.3d 338, 345 (3d Cir. 1999)). In short, "Rule 9(b)
requires, at a minimum, that plaintiffs support their allegations
of securities fraud with all of the essential factual background
that would accompany `the first paragraph of any newspaper story'
that is, the `who, what, when, where and how' of the events at
issue." Id. at 217 (quoting In re Burlington,
114 F.3d at 1422).
The PSLRA imposes an additional "layer of factual
particularity" on allegations of securities fraud. In re
Rockefeller Center Properties, Inc. Secs. Litig.,
311 F.3d at 217-18. Under the PSLRA, a complaint alleging a 10(b) violation
is insufficient unless it "specifies each statement alleged to
have been misleading, the reason or reasons why the statement is
misleading, and, if an allegation regarding the statement or omission is made on
information and belief[,] . . . state[s] with particularity all
facts on which that belief is formed." In re Cybershop.com,
189 F. Supp.2d at 226 (citing 15 U.S.C. § 78u-4(b)(3)(A)). All
allegations of scienter must be supported by facts stated "with
particularity" and must give rise to a "strong inference" of
scienter. In re Advanta Corp. Sec. Litig., 180 F.3d at 535
(quoting 15 U.S.C. 78u-(b)(2)). "[T]o the extent that Rule 9(b)'s
allowance of general pleading with respect to mental state
conflicts with the PSLRA's requirement that plaintiffs `state
with particularity facts giving rise to a strong inference that
the defendant acted with the required state of mind,'
15 U.S.C. § 78u-4(b)(2), the PSLRA `supersedes Rule 9(b) as it relates to
Rule 10b-5 actions.'" In re Alpharma Inc. Sec. Litig., No.
02-3348, at * 13 (3d Cir. June 15, 2004) (quoting In re
Advanta, 180 F.3d at 531 n. 5).
Courts have permitted securities fraud plaintiffs to rely on
the so-called "fraud on the market" theory, which allows for a
rebuttable presumption of reliance by the plaintiffs on an
efficient market that reflects material information in the stock
price. In re Westinghouse Sec. Litig., 90 F.3d 696, 710 (3d
Cir. 1996). Short sellers, by definition, do not believe that the
price of the stock accurately reflects such relevant information
and, therefore, cannot benefit from the presumption of reliance.
Plaintiff short sellers are therefore required to allege actual reliance in that (1) the misrepresentation or fraudulent
act raised the price of stock; (2) at the time of cover,
plaintiff relied on the integrity of the market price of the
stock; and (3) reliance on the stock's price at the time of cover
was reasonable. Zlotnick v. Tie Communications, 836 F.2d 818,
821-22 (3d Cir. 1988). Reliance is adequately pled only where
short sellers were unaware of any fraudulent activity by
defendants at the time of cover. See Jones v. Intelli-Check,
Inc., 274 F. Supp.2d 615, 633 (D.N.J. 2003). Phrased
differently, reliance on the market price cannot be reasonable if
plaintiffs had knowledge of fraud or misrepresentations at the
time of cover.
The Individual Defendants jointly argue that Plaintiffs cannot
sufficiently allege the element of reliance for a Section 10(b)
and Rule 10b-5 claim given that Plaintiffs, as short sellers,
acknowledge believing very early on that L&H was overvalued and
that its technology was over-hyped. The fact that Plaintiffs did
not rely on any alleged misstatements in their decision to sell
short, Defendants contend, is fatal to their Section 10(b) and
Section 20(a) claims. In addition, the Individual Defendants
argue that Plaintiffs' state law claims of tortious interference
and conspiracy to tortiously interfere should be dismissed for
lack of subject matter jurisdiction or, alternatively, for
failure to state a claim. Plaintiffs counter that reliance is just one of many ways to
establish the element of causation common to any tort claim.
Plaintiffs urge that a short seller's loss can just as readily be
caused by a fraudulent scheme as a traditional investor's loss,
provided the fraud caused the short seller to engage in the cover
transaction. Specifically, Plaintiffs argue that the fraudulent
scheme's artificial inflation of the stock price after they had
taken a substantial short position was the direct and proximate
cause of Plaintiffs' decision to cover, thus satisfying the
element of transaction causation. In making that argument,
Plaintiffs rely on Zlotnick v. Tie Communications,
836 F.2d 818, 824 (3d Cir. 1988), where the Third Circuit held that a
short seller can recover by showing that his decision to cover
was connected with the fraud inasmuch as "[t]he rise may . . .
have increased [the short seller's] risk of loss beyond
acceptable levels, causing him to purchase. It may have lead him
to conclude that the stock would take so long to decline in value
that the cost of maintaining his short position would exceed his
potential gain." According to Plaintiffs, that is exactly what
happened in this case. Further, Plaintiffs maintain that while
they had misgivings about certain publicly disclosed accounting
practices at L&H, they had no knowledge whatsoever about the
fraudulent scheme of 1999 and 2000 so as to preclude their
ability to prove reasonable reliance.
The Court concludes that Plaintiffs have sufficiently pled
reliance under Zlotnick and should be permitted the opportunity to demonstrate
that the fraudulently inflated price of L&H stock was a material
factor in their decision to cover insofar as the rise in stock
price increased their risk of loss beyond acceptable levels,
causing them to cover and incur substantial losses, or that the
fraudulently-induced price led them to conclude that the stock
would take so long to decline in value that the cost of
maintaining their short position would exceed their potential
gain. See Zlotnick, 836 F.2d at 824. Plaintiffs have
adequately alleged that, while they believed L&H stock to be
overvalued, they had no knowledge of the ultimate fraud that
caused their losses at the time they made covering purchases.
Compare Jones, 274 F. Supp. 2d at 633 (dismissing securities
fraud claims where plaintiffs had brought a fraud claim based on
accounting methods of which they were plainly aware at all
Next to be addressed are whether the factual allegations are
sufficient to withstand a Motion to Dismiss as to each Individual
Jozef Lernout, a co-founder of L&H, acted as Managing Director
of the L&H Board since its organization in 1987, as President
from January 1994 until October 1996, co-Chairman since October
1996, and as co-Chairman of the Office of the Chief Executive
since 1996. (Am. Compl. ¶ 14). Lernout also served as a director of the FLV Fund from 1996 to 1997. Lernout resigned his
management position with L&H on November 9, 2000. (Id.).
Lernout allegedly played critical roles in orchestrating and
implementing "start-up" customer scams, controlling several
L&H-related investment funds used as a vehicle for the "start-up"
scam, such as FLV Fund, Flanders Language Valley Foundation, and
L&H Investment Company. (Id. ¶¶ 14, 15, 274b). According to a
former L&H salesperson, it was "understood" that if FLV Fund
invested $1 million in a start-up then L&H would receive "about
$300,000" in license fees from that start-up. (Id. ¶ 172). In
October 1999, FLV Fund invested $10 million in four Singapore
start-ups, which promptly paid $8 million of that money to L&H.
(Id. ¶ 173). As a condition for investing in a start-up, FLV
Fund would demand that the start-up sign a contract to pay 20% of
the investment to L&H as a "fee," with the understanding that the
"fee" need never be paid something that happened on at least 22
separate occasions. (Id. ¶ 178). These related-party "deals"
accounted for 10% of L&H's revenue in 1998 and 25% of its 1999
revenues, without any disclosure to investors about related-party
status. (Id. ¶ 173).
Lernout signed the January 2000 Registration Statement that is
alleged to have contained falsified 1998 financial figures. (Am.
Compl. ¶ 75). In January 2000, Lernout received an e-mail informing him that revenue had
been improperly recorded for the fourth quarter of 1999. (Id.
¶¶ 131-32). Another e-mail dated April 4, 2000 informed him that
$8 million in supposed revenue for a customer contract had been
improperly recorded in the first quarter of 2000, and that
another customer had not made a purchase at all, but had instead
simply requested information. (Id. ¶ 133). Lernout also
allegedly actively participated in the Korean fraud by providing
$25 million to L&H Korea to placate the banks who issued
factoring agreements,*fn6 thereby prolonging the fraud.
(Id. ¶¶ 158-60).
Lernout argues that other than signing a public filing
incorporating by reference KPMG Belgium's certification of L&H's
1998 financial statements (Id. ¶¶ 73-75), none of the
statements Plaintiffs allege to be false and misleading
financial statements and press releases may be attributed to
him. Lernout further argues that the Amended Complaint fails to
plead facts giving rise to a "strong inference" that he acted
with scienter concerning accounting irregularities, related-party
transactions, and involvement with the Korean subsidiary. The mere fact that he signed the 2000 Registration
Statement, Lernout contends, is insufficient to establish
scienter and there are no additional facts suggesting that he had
information that the statement was false. Lernout also argues
that there is no sufficient link between the two e-mails he
received indicating that a contract had not been signed, (id. ¶
131), and that a customer had requested certain information in
order to finalize an agreement, (id. ¶ 133), and the erroneous
financial statements. The argument goes that awareness that a
particular contract had not yet been signed provides no link as
to whether revenue had been inappropriately recognized for that
The Court concludes that the allegations against Lernout are
sufficient both as to his making actionable misstatements and as
to his acting with the requisite scienter. Lernout signed the
January 2000 Registration Statement, thus directly linking him to
republication of the falsified financial results reported for the
company for the calendar year 1998. Those results were inflated
by almost $28 million by virtue of the start-up customer scam and
other schemes. The Amended Complaint alleges Lernout's knowing
participation in schemes contributing to the artificial inflation
of the price of L&H stock in that he directed and influenced
several investment funds to implement the start-up customer scam;
that he knew of gross distortions in accounting for revenue and
ignored such information; and that he arranged for the $25 million payment to the head of L&H Korea
as an "earn out" payment that he knew was used to placate Korean
banks and thus fuel the factoring scheme. These allegations are
sufficient to demonstrate the requisite scienter to survive a
motion to dismiss.
Hauspie, a co-founder of L&H, served as Managing Director since
its organization in 1987, Chairman from January 1994 until
October 1996, and as co-Chairman of the Board since October 1996.
Hauspie also served as a member of the Office of the Chief
Executive since February 1996 and as co-Chairman of the Office
since October 1996. (Am. Compl. ¶ 15). In addition, Hauspie
served as a director of the FLV Fund from 1996 to 1997. (Id.)
Hauspie resigned from his executive positions on November 9,
2000. (Id.). Thereafter, in January 2001, Belgian authorities
charged Hauspie with "criminal money laundering." (Id.).
Hauspie, together with Lernout, allegedly orchestrated and
implemented the aforementioned "start-up" customer scams,
controlling several L&H-related investment funds used as a
vehicle for the "start-up" scam such as FLV Fund, Flanders
Language Valley Foundation, and L&H Investment Company. (Id. ¶¶
14, 15, 274b). Hauspie was the director of FLV Fund's management
arm until 1997. (Id. ¶ 167). According to the report of L&H's Audit Committee, Hauspie
directly participated in the fraudulent scheme to report false
revenues by signing side letters with customers exempting them
from their contractual payment obligations. (Id. ¶ 274b). The
Committee recommended that disciplinary action be taken against
him. (Id. ¶¶ 125, 274b).
Hauspie also signed the January 2000 Registration Statement.
(Id. ¶ 75). In January 2000, he received e-mails informing him
that revenue had been improperly recorded for the fourth quarter
of 1999, (id. ¶¶ 131-32). In April 2000, another email alerted
him that $8 million in supposed revenue for a customer contract
had been improperly recorded in the first quarter of 2000, and
that another so-called customer had not made a purchase at all
but had instead simply requested information. (Id. ¶ 133).
Hauspie also allegedly participated in the Korean fraud by
providing $25 million to L&H Korea to placate the banks who
issued factoring agreements. (Id. ¶¶ 158-60).
Hauspie argues that the Amended Complaint fails to meet the
heightened pleading requirements of the PSLRA and Rule 9(b) both
as to false or fraudulent statements and scienter. Specifically,
Hauspie contends that the Amended Complaint does not allege that
he made any false statements, that he was directly involved in creating the accounting statements, or that he
engaged in any reckless conduct. Hauspie further contends that
Plaintiffs have failed to adequately allege motive or opportunity
to commit fraud insofar as there are no allegations that he sold
any L&H stock during the relevant time period.
The Court concludes that the allegations against Hauspie are
sufficient both as to his making actionable misstatements and as
to acting with the requisite scienter. Hauspie is clearly linked
to the January 2000 Registration Statement, having signed that
document. That statement repeated and republished the financial
results reported for the company for the calendar year 1998.
Those results were inflated by almost $28 million by virtue of
the start-up customer scam and other schemes with which Hauspie
is directly linked. Further, the allegations in the Amended
Complaint are quite strong as to Hauspie's knowledge and
participation in various schemes contributing to the artificial
inflation of the price of L&H stock. That Hauspie is not alleged
to have sold any L&H stock during the relevant time does not
matter. It is alleged that Hauspie directed and influenced
several investment funds used to implement the start-up customer
scam; that he knew of gross distortions in accounting of revenue
and apparently ignored such information; that he signed side
agreements with particular start-up companies releasing them of
contractual obligations under their license agreements; and that he arranged for the $25 million payment to the head of L&H Korea
as an "earn out" payment that he knew was used to placate Korean
banks and thus fuel the factoring scheme. The allegations are
sufficient to demonstrate the requisite scienter to survive a
motion to dismiss.
Gaston Bastiaens joined L&H in October 1996 as President and
became Chief Executive Officer in May 1997, serving in both posts
until his resignation on August 25, 2000. (Am. Compl. ¶ 16).
Bastiaens allegedly played a key role in orchestrating and
directing the fraudulent scheme to artificially inflate the price
of L&H's stock, (id. ¶ 16), and then sold his L&H stock options
for over $900,000. Following his arrest by United States
authorities, Bastiaens was extradited to Belgium to await trial
before a Belgian criminal court on stock-fraud charges. (Id.).
L&H's Audit Committee recommended "disciplinary action" against
Bastiaens due to his misconduct.
Bastiaens allegedly authored, and was directly quoted in, press
releases containing false and misleading financial information.
Specifically, he wrote and was quoted in a December 8, 1999 press
release claiming that L&H's Internet translation services were to
be offered on a Microsoft website, despite his knowledge that the
Microsoft "deal" did not represent any sort of endorsement of L&H by Microsoft (id. ¶¶ 56-57); he drafted and was quoted in a
December 28, 1999 press release touting supposed financial
success of L&H's Korean operation, notwithstanding his knowledge
that many of the "customers" claimed in Korea were not, in fact,
bona fide customers (id. ¶¶ 66, 67); he signed the January 2000
Registration Statement, which reported inflated 1998 revenues
(id. ¶ 75); he drafted a February 7, 2000 press release
concerning dummied "industry-first handheld" devices; he drafted
and was quoted in a February 9, 2000 press release, which falsely
claimed that L&H had realized "record" revenues (id. ¶ 92); and
he participated in the issuance of the false financial figures
for 1998, 1999, and the first quarter of 2000 (id. ¶ 274c).
The following allegations in the Amended Complaint pertain
specifically to Bastiaens:
On July 26, 1999, Bastiaens received a "private and
confidential" letter from KPMG advising him that the
accounting practices at L&H were "leading to a
mismatch between recognizing revenues and their
associated costs in the correct time period. . . . ."
(Id. ¶ 249);
Likewise, another e-mail informed Bastiaens that $8
million in supposed revenue for a customer "contract"
had been improperly recorded in the first quarter of
2000. In fact, the e-mail advised that there was no
contract and no customer at all to the contrary,
the socalled "customer" had done nothing more than
make an inquiry about L&H's products, and L&H's
ultra-aggressive sales force had taken the liberty of
booking $8 million in "revenue" from this supposed
"customer." (Id. ¶ 133); In a September 1999 e-mail sent by the KPMG partner
in Korea, Bastiaens was warned that "[i]t will be
impossible for [L&H Korea] to uphold the
internationally accepted accounting financial
practices if they happen to be different from the
current practices. . . ." (Id. ¶ 144);
Bastiaens actively participated in the Korean fraud
by providing $25 million to L&H Korea to placate the
banks who issued the factoring agreements, and
thereby prolong the fraud. In January 2000, Bastiaens
recommended accelerating an "earn out" payment of $25
million to the former principal of Bumil (who was
then heading L&H Korea), due to the subsidiary's
purported success. In fact, however, and according to
a message sent by the Bumil principal to Lernout and
Hauspie, the $25 million allowed him to "keep my
promise to Korean banks and those banks will rely on
L&H Korea and will help us much better than before."
(Id. ¶¶ 158-160);
When the fraud in Korea first came to light in
August 2000, Bastiaens appeared with Cowen's Rob
Stone on CNBC's show Business Center. During that
appearance, Bastiaens claimed that the Wall Street
Journal's report of dummied customers was
"absolutely incorrect" because "[w]e have over 150
corporate customers." (Id. ¶ 112).
Bastiaens argues that in addition to not adequately alleging
the element of reliance in a securities fraud claim, the
allegations against him do not meet the pleading requirements of
the PSLRA and Rule 9(b) for the following reasons:
failure to contain particularized allegations that
Bastiaens was involved in the creation of the
accounting at issue or knew any SEC filing or
statement attributed to him in a press release was
the Complaint asserts that KPMG audited all of the
financial statements addressed in the SEC filings or press
releases at issue and KPMG had complete and
unrestricted access to L&H books and records, giving
KPMG unrestricted access to the Company;
allegations that a defendant, because of his
position as President of L&H for four years, "must
have known" a statement was false do not meet the
PSLRA's or Rule 9(b)'s pleading requirements;
the Complaint recognizes that, just weeks before
L&H's problems in Korea became known, Bastiaens
bought L&H stock. Purchase of stock by a senior
officer like Bastiaens creates an inference of the
absence of fraud and thus can not help meet the
pleading requirements of the PSLRA or Rule 9(b).
The Court is satisfied that the aforementioned allegations
against Bastiaens are sufficiently particularized to withstand a
motion to dismiss the Section 10(b) claim. Bastiaens, in his
capacity as President and CEO of L&H, is directly tied to several
misstatements: He allegedly drafted several false press releases,
is quoted in those press releases, and signed the fraudulent
January 2000 Registration Statement.
The Court is further persuaded that the allegations are
sufficient to create a strong inference that Bastiaens acted with
the requisite scienter. Bastiaens is alleged to have had actual
knowledge of the fraud. In 1999, accountants and auditors
informed Bastiaens about a "mismatch" between the booking of
revenues and costs in the same period, and that it would be
"impossible" for L&H Korea to adhere to international accounting practices. (Am. Compl. ¶¶ 144,
249). Bastiaens' protestations that KPMG is at fault ring
particularly hollow and, in any event, the Court cannot credit
Bastiaens' contradictory assertions on a motion to dismiss.
Bastiaens also arranged for a $25 million payment to the head of
L&H Korea to fuel the factoring scheme, (id. ¶¶ 158-160), and
in an alleged cover-up claimed during a television interview that
L&H Korea had over 150 customers. (Id. ¶ 112).
That Bastiaens allegedly purchased 625,000 shares of L&H stock
in July 2000 just as the fraudulent scheme broke does not
necessarily negate an inference of scienter on his part. It is
true that, in some instances, stock purchases by a primary
alleged wrongdoer can negate an inference of motive to defraud.
See, e.g., Maldonado v. Dominguez, 137 F.3d 1, 12, n. 9 (1st
Cir. 1998); Allison and Sperber v. Brooktree Corp.,
999 F. Supp. 1342, 1353 (S.D. Cal. 1998) (noting that plaintiffs "have a
particularly difficult task to demonstrate motive by means of
stock sales when the primary alleged wrongdoer was purchasing,
and not selling, stock"). However, that is not the case here. The
Complaint alleges that Bastiaens bought the stock from an
L&H-controlled investment fund for what amounted to an "I owe
you." The Amended Complaint also alleges that Messrs. Lernout and
Hauspie, not Bastiaens, continued to vote those shares despite
Bastiaens' supposed purchase. (Id. ¶ 114).
In sum, the Court concludes that the allegations against
Bastiaens sufficiently allege that he acted with the requisite
scienter for purposes of Section 10(b) liability.
B. Section 20(a) Claim
Count II of the Amended Complaint alleges that the Individual
Defendants violated Section 20(a) of the Exchange Act.
15 U.S.C. § 78t(a). Under Section 20(a), a "controlling person" may be
liable to an injured party under section 10(b) of the Exchange
Act "to the same extent" as the corporation or other controlled
entity. In re Chambers Devel Sec. Litig., 848 F. Supp. 602, 618
(W.D. Pa. 1994). To state a claim under Section 20(a), plaintiffs
must allege (1) a primary 10b-5 violation; (2) scienter; and (3)
control of the primary violator. J. Clark Poling v. K. Hovnanian
Enterpr., 99 F. Supp. 2d 502, 514 (D.N.J. 2000). Liability under
Section 20(a) is predicated upon an independent violation of the
Exchange Act. In re Advanta, 180 F.3d at 541.
Having already determined that Plaintiffs have sufficiently
alleged a primary 10b-5 violation and scienter as to Hauspie,
Lernout, and Bastiaens, the Court will turn to whether Plaintiffs
have adequately alleged the control element as to those
individuals. Control is defined as the "possession, direct or
indirect, or the power to direct or cause the direction of the management and
policies of a person whether through the ownership of voting
securities, by contract or otherwise." 17 C.F.R. § 230.405.
It is argued that Plaintiffs have not adequately pled control
over L&H insofar as there are no specific allegations of these
individuals' significant degree of day-to-day operational control
over L&H. The First Amended Complaint generally alleges that the
"Individual Defendants, by reason of their stock ownership,
directorships, and/or management positions, were controlling
persons of L&H and had the power and influence to cause L&H to
engage in the unlawful practices complained of herein." (Am.
Compl. ¶ 270). Further, it is alleged that the "officers and
directors of L&H, by virtue of his or her high-level position
with the Company, directly participated in the management of the
Company, [were] directly involved in the day-to-day operations of
the Company at the highest level, and [were] privy to
confidential proprietary information concerning the Company and
its business, operations, and accounting practices as alleged
herein." (Id. ¶ 271).
While status or position alone do not constitute control for
purposes of § 20(a), see In re Cryomedical Sciences, Inc. Sec.
Litig., 884 F. Supp. 1001, 1020 (D. Md. 1995), courts in this
circuit have acknowledged that control person claims need not be pleaded with particularity so long as the underlying
Section 10(b) violation is properly pled. See Derensis v.
Coopers & Lybrand Chartered Accountants, 930 F. Supp. 1003, 1013
(D.N.J. 1996) (noting that there is an "`overwhelming trend in
this circuit to allow [S]ection 20(a) actions to withstand Rule
9(b) motions based on a simple pleading of control'") (citation
omitted). Indeed, courts have found allegations very similar to
those in the Amended Complaint to be sufficient for control
person liability. E.g., In re Rent-Way Sec. Litig.,
209 F. Supp. 2d 493, 524 (W.D. Pa. 2002); In re Campbell Soup Co. Sec.
Litig., 145 F. Supp. 2d 574, 599-600 (D.N.J. 2001). In In re
Rent-Way, the court found control person liability adequately
alleged and stated that
each of the individual defendants had direct and
supervisory involvement in the day-to-day operations
of Rent-Way by virtue of their positions, ownership
rights and contractual rights, and consequently that
they had the power to influence and control the
particular transactions giving rise to the alleged
securities violations that are the basis of this
action. Each of these defendants is also alleged to
have signed one or more statements filed with the SEC
that were eventually restated, and to have had the
ability to control the contents of these various
209 F. Supp. 2d at 524. Likewise, in In re Campbell Soup Co.,
the court found control person liability sufficiently alleged
upon the following facts:
Defendant Morrison, as President and CEO, and
Defendant Anderson, as Vice President and CFO,
"directly participated in the management of the Company, [were] directly involved
in the day-today operations of the Company at the
highest level, and [were] privy to confidential
proprietary information concerning the Company and
its business operations, [etc.] . . . and were
involved in drafting, producing, reviewing,
approving, and/or disseminating" the allegedly
145 F. Supp. 2d at 599-600 (alterations in original).
The Court is satisfied that the allegations in the Amended
Complaint concerning Lernout, Hauspie, and Bastiaens show that
these individuals not only held high-level positions within the
company, but had and exercised considerable control and influence
over L&H operations. Such allegations are sufficient to withstand
a motion to dismiss claims concerning Section 20(a) control
C. Tortious Interference, Conspiracy, and Aiding and Abetting
The Court now turns to whether Plaintiffs have sufficiently
alleged common law claims of tortious interference with
prospective economic advantage, aiding and abetting, and
conspiracy as to Lernout, Hauspie and Bastiaens. A prima facie
case of tortious interference with prospective economic advantage
requires (1) a continuing or prospective economic advantage, (2)
that defendant knew of such advantage, (3) that defendant
interfered with that advantage "with malice," i.e., in a manner "transgressive of generally accepted standards of common
morality," and (4) that as a result of the interference, the
plaintiff suffered injury. Printing Mart-Morristown v. Sharp
Elecs. Corp., 116 N.J. 739, 757 (1989). Causation is satisfied
if, had there been no interference, "there was a reasonable
probability that the victim of the interference would have
received the anticipated economic benefits." Id. at 759
(citation omitted); see also Fineman v. Armstrong World
Indus., Inc., 980 F.2d 171, 186 (3d Cir. 1992).
The Individual Defendants argue that the claim for tortious
interference with prospective economic advantage should be
dismissed because Plaintiffs do not allege essential elements of
their claim namely, a prospective business relationship with a
third party, that there was a "reasonable probability" that they
would have received economic benefits from their short selling
but for the alleged interference, and intentional interference
with malice on the part of each Defendant. It is further argued
that the conspiracy and aiding/abetting claims must also be
dismissed because each claim requires the existence of an
underlying tort. Finally, as to the conspiracy claim, Defendants
argue that Plaintiffs have not alleged special damages, see
Eli Lilly and Co. v. Roussel Corp., 23 F. Supp. 2d 460, 494
(D.N.J. 1998) (listing special damages as element of civil
conspiracy claim). The Court concludes that Plaintiffs should be permitted to test
their common law claims during discovery. Plaintiffs allege that
they had a prospective economic advantage due to the profits
anticipated from their short sales, as well as in their
relationship with hedge fund investors, and that Defendants
intentionally and with malice interfered with Plaintiffs' ability
to secure that gain. (Am. Compl. ¶¶ 307-09). At this stage of the
litigation, the Court is unable to assess the precise nature of
Plaintiffs' short-sale and investor relationships and Defendants
have not met their burden of demonstrating that it is beyond
doubt that Plaintiffs cannot establish the requisite tripartite
situation to proceed on the tortious interference claim. See
Eli Lilly and Co., 23 F. Supp. 2d at 494.
As to anticipated profits, the Amended Complaint alleges that
"[b]y selling L&H stock short, Plaintiffs were in the pursuit of
a reasonably certain, and protectable, economic gain due to the
overvalued nature of that stock." (Am. Compl. ¶ 307). While short
selling is a highly risky investment strategy, Plaintiffs have
adequately alleged that they would probably have made a profit in
this strategy. See, e.g., Am. Compl. ¶¶ 5-6, 100.
It follows that the claims for conspiracy and aiding and
abetting are not subject to dismissal for lack of an underlying
tort. See Landy v. FDIC, 486 F.2d 139, 162 (3d Cir. 1973)
(noting that first element of aiding and abetting is "that an independent wrong exist"); Farris v. County of Camden,
61 F. Supp. 2d 307, 330 (D.N.J. 1999) (dismissing claims for civil
conspiracy to tortiously interfere because they were "dependent
upon the viability of [the] substantive claims for tortious
interference," which were dismissed); Eli Lilly and Co.,
23 F. Supp. 2d at 497 (holding that dismissal of underlying cause of
action requires dismissal of conspiracy claim).
Finally, with no explanation or analysis, Individual Defendants
argue that Plaintiffs have not alleged that they suffered any
special damages as a result of the conspiracy. Given that
Plaintiffs have pled tens of millions of dollars of damages, and
that Individual Defendants devote nothing more than a passing
reference to the notion that these alleged damages are somehow
insufficient, the Court is not inclined to dismiss the conspiracy
claim at this juncture.
Accordingly, IT IS on this 7th day of June 2005,
ORDERED that the Motions of Defendants Pol Hauspie, Jozef
Lernout, and Gaston Bastiaens to dismiss Counts I (Section 10(b)
of the Exchange Act and Rule 10b-5 promulgated thereunder) and II
(Section 20(a) of the Exchange Act) pursuant to Federal Rules of
Civil Procedure 12(b)(6) and 9(b) are denied; and it is further ORDERED that the Motions of Defendants Pol Hauspie, Jozef
Lernout, and Gaston Bastiaens to dismiss Counts V (Tortious
Interference with Prospective Economic Advantage), VI (Conspiracy
to Tortiously Interfere), and VII (Aiding and Abetting Tortious
Interference) are denied.