The plaintiff corporation alleged that defendant investors made material misrepresentations in connection with their purchase of convertible preferred stock from plaintiff in violation of Rule 10b-5 and, thereafter, engaged in illegal market manipulation. Due to its troubled condition, in order to attract investors, the convertible preferred stock issued by the plaintiff could be converted into common stock at a discount to market value.
Plaintiff claimed that despite defendants having represented when purchasing the convertible preferred stock that they would be long-term investors and would not undertake activities to depress the stock, defendants thereafter engaged in a wrongful scheme to drive down plaintiff’s stock price by first shorting the stock to reduce the price and then converting their preferred stock at below market rates to cover their short position at a substantial profit. Defendants successfully moved to dismiss, contending, among other things, that plaintiffs failed to plead the alleged manipulation with the particularity required by the PSLRA and F. R. Civ. P. 9(b).
The Second Circuit affirmed the dismissal. The court ruled that the plaintiff’s allegations that the defendants’ fraudulent intent could be inferred from (i) the high volume of selling coinciding with large drops in stock price, (ii) the stock’s negative reaction to positive news, and (iii) the high volume of trades in excess of “settlements” during the 10 day period before AMEX suspended trading in plaintiff’s stock were, at best, speculative and did not constitute a “strong inference” of scienter as required by the PSLRA. The Court, expressly found that there were more plausible, non-culpable explanations for defendants “trading activities and that the fact that the attributes of the convertible preferred stock “create[d] an opportunity for profit through manipulation” fell short of establishing the requisite “strong inference” of scienter. (ATSI Communications, Inc. v. The Shaar Fund, Ltd., 2007 WL 1989336 (2nd Cir. July 11, 2007))