Plaintiff’s Response to PWC’s Motion for Summary Judgment

Harward v. UBS Warburg

Description: This case was a securities fraud case brought by plaintiffs against international investment bank and securities firm UBS Warburg.  Plaintiffs merged their company with another company and accepted $43 million worth of the other company’s shares of stock as the sale price for the acquisition.  After the transaction closed, various misrepresentations in the acquiring company’s financial statements came to light that caused the stock to plummet in value and the company to eventually be de-listed.  UBS was the underwriter on the acquiring company’s IPO that had occurred shortly before it acquired the plaintiffs’ company.  UBS filed a summary judgment motion arguing that it did not recklessly make any misrepresentations in the prospectus and other offering materials for the IPO and that it did not render substantial assistance to the acquiring company in carrying out its fraud. This brief was filed by Heygood, Orr & Pearson on behalf of their client.

No. 02-9881
MARK HARWARD, ANGELA HARWARD,
BRENDA STONER, THOMAS STONER,
MERRILL WERTHEIMER, SS MAHANT-
SHETTI, HOWARD TIGELAAR, CATHY
TIGELAAR, KENNETH SCHIBLER,
MARY SCHIBLER, SCOTT LANE,
CANDACE LANE, and HARWARD
CHILDREN’S 1999 TRUST,Plaintiffs,v.PRICEWATERHOUSECOOPERS L.L.P. and
UBS WARBURG L.L.C.,

Defendants.

IN THE DISTRICT COURT OF
DALLAS COUNTY, TEXAS
44TH JUDICIAL DISTRICT

PLAINTIFFS’ RESPONSE TO UBS WARBURG L.L.C’S

MOTION FOR SUMMARY JUDGMENT

Plaintiffs file this Response to the Motion of UBS Warburg L.L.P. for Summary Judgment (the “Motion”), and would respectfully show the Court as follows:

INTRODUCTION

Defendant UBS Warburg L.L.C. (“UBS”) is a global investment banking and securities firm with approximately 50,000 employees worldwide.  UBS was the lead underwriter for the 2001 IPO of HPL Technologies, Inc. (“HPL”), a provider of yield optimization software formed in 1989.  UBS analysts also tracked and reported on HPL after the IPO was completed.  Plaintiffs are former shareholders of Texas corporation Covalar Technologies Group Inc. and its wholly-owned subsidiary, TestChip Technologies, Inc. (collectively referred to as “CTG”).  Plaintiffs relied on HPL’s Prospectus and the UBS analyst reports in deciding to sell their shares in CTG for shares in HPL in a February 2002 merger transaction.

Well after the merger was complete, Plaintiffs learned that the financial statements of HPL upon which they relied were filled with numerous inaccuracies and misrepresentations.  They also learned that the UBS analyst reports contained false representation of fact as well as unsupported and unreasonable opinions.  As a result of these misrepresentations and their ultimate public disclosure in July 2002, the price of HPL stock plummeted from $14.10 per share on July 18, 2002 to as low as $4.00 per share on July 19, 2002 before trading was halted.  Trading never reopened on the NASDAQ, which recently de-listed HPL.  Shares in HPL have recently traded over the counter at less than 22 cents per share.  Plaintiffs’ shares in HPL, which had been valued at approximately $33,000,000 at the time of the merger, have been revealed to be essentially worthless.  As set forth more fully below, UBS is liable for the losses experienced by Plaintiffs as a result of its inadequate due diligence on the HPL IPO, its role as an underwriter of the IPO, its responsibility for the false statements contained in the HPL Prospectus and its false and misleading statements and opinions contained in its analyst reports.   Its Motion should therefore be denied.

OBJECTIONS TO UBS’ SUMMARY JUDGMENT EVIDENCE

Plaintiffs object to the Affidavit of Phokian Potamianos attached to UBS’ Motion as Exhibit D.  Specifically, Plaintiffs object to paragraph 6 of the Affidavit.  In the second sentence of that paragraph, Potamianos states that “[n]either I, nor anyone else at UBS, knew that David Lepejian had presented incorrect financial information about HPL to UBS, PWC, or the public.”  Plaintiffs object to this affidavit testimony because it is clearly based on speculation; Potamianos cannot possibly offer testimony as to the state of mind of all of UBS’ thousands of employees.  Nor, given the testimony of UBS employees regarding the separation between the investment banking side of UBS and the analyst side, can he speak on behalf of the analysts that covered HPL, such as Byron Walker. Even if he purports to speak only on behalf of those persons who worked on the HPL IPO, to the extent his testimony is not based on speculation, it is based on hearsay and is therefore inadmissible. Plaintiffs also object to the last two sentences of paragraph 6 wherein Potamianos states: “After the announcement, I spoke to certain other key members of the UBS HPL team,  Everyone was equally stunned by the revelation.” Plaintiffs object that the affidavit testimony is vague and ambiguous because it fails to identify by name the “key members of the UBS HPL team,” making it impossible for Plaintiffs to controvert the testimony.  Moreover, Plaintiffs object to the testimony because it is based on hearsay conversations and is therefore inadmissible.  For the foregoing reasons, Plaintiffs request that the Court strike the affidavit testimony of Phokian Potamianos referenced above.

BACKGROUND FACTS

I.          HPL goes public with financials audited by PWC and a Prospectus approved of

and distributed by UBS.

 

HPL is a provider of yield optimization software solutions for semiconductor companies.  This lawsuit arises out of the gross misstatements of HPL’s financial condition in publicly-filed financial statements and other documents.  These misstatements pervaded HPL’s Prospectus and other publicly-filed documents prepared in connection with its initial public offering of equity securities (“IPO”) in July 2001.

PWC served as the independent auditor of HPL’s financial statements that were included in HPL’s IPO prospectus.  PWC included its report in the IPO prospectus stating that, among other things, HPL’s financial statements were audited in accordance with generally accepted auditing standards (“GAAS”) and were in conformity with generally accepted accounting principals (“GAAP”).

UBS served as the lead underwriter for HPL’s IPO and was involved in the negotiations of the Merger.  UBS made explicit and implicit representations that it had investigated the business and financial condition of HPL, and made explicit and implicit favorable recommendations of HPL’s stock to the public and to the Plaintiffs.

HPL had previously attempted an initial public offering in 2000.  At that time, the lead underwriter was Donaldson, Lufkin & Jenrette (“DLJ”), including two investment bankers, Shannon Soqui and Phokion Potamianos.  PWC was HPL’s outside auditor at the time of the IPO.  After the startling discovery that one of HPL’s officers had been the subject of felony criminal action involving a former employer and due to problems with HPL’s revenue, that IPO was aborted.  PWC and UBS both had full and complete knowledge of the aborted IPO.  Following the aborted IPO, Soqui and Potamianos left DLJ and joined UBS in or about November 2000.  By February 2001, UBS, led by Soqui and Potamianos, pitched a new IPO to HPL.

During the period that UBS acted as lead underwriter in HPL’s initial public offering, UBS provided coverage of HPL’s stock and assisted in the merger between HPL and CTG.  UBS research analysts, including Byron Walker and Zack Galler,  issued a series of glowing reports about HPL’s stock.  In the analyst reports, UBS made misrepresentations regarding HPL.  For example, in the August 28, 2001 report, UBS stated that HPL followed conservative revenue recognition policies.  Likewise, UBS falsely stated that there were no credit risks with respect to HPL’s outstanding balances in its reports.

UBS Paine Webber, a related UBS entity, made a multi-million dollar loan to David Lepejian in October 2001 outside UBS’ standard lending parameters that eventually made its way into the accounts of HPL under the guise of customer payments.  Because HPL stock collateralized this loan, UBS had a direct financial interest in maintaining the market price of HPL stock.

II.        HPL acquires CTG in a $43 million cash and stock merger.

On January 29, 2002, HPL entered into an agreement to acquire all outstanding shares and options of CTG for $10 million in cash and up to 2.5 million shares of HPL common stock, for a total purchase price of approximately $43 million.  Plaintiffs were shareholders of CTG at the time, and Plaintiffs Mark Harward, Brenda Stoner and Merrill Wertheimer were involved in the negotiations with HPL over the purchase of CTG.  Between them, at the time of the Merger, Plaintiffs owned or controlled approximately 93% of the stock of CTG.  Plaintiff Harward was CTG’s President and Chief Executive Officer and signed the Agreement and Plan of Merger (the “Merger Agreement”) as the representative of the shareholders of CTG.

In entering into the Merger Agreement, Plaintiffs relied on HPL’s Prospectus which had been issued as part of HPL’s IPO and the financial statements included in the IPO Registration Statement, which had been audited by PWC.  Plaintiffs also reviewed and relied upon analyst reports of HPL stock published by UBS.  HPL was represented in the negotiations to acquire CTG by UBS, and UBS representatives met with Plaintiffs in December 2001 to discuss and negotiate the merger.

III.       Disclosure of the misrepresentations in HPL’s financial statements causes HPL           stock to drop like a rock.

On July 19, 2002, HPL stunned the marketplace when it issued a press release announcing that it had initiated an investigation into financial and accounting irregularities involving revenue reported during prior periods.  HPL reported that a material amount of revenue was improperly recognized during one or more earlier periods.  As a result of the HPL press release, HPL’s shares fell as much as 72% before NASDAQ regulators halted the trading.  HPL stock, which had closed at $14.10 per share on July 18, 2002, dropped to as low as $4.00 per share on July 19, 2002 before trading was halted.  Trading never reopened on the NASDAQ, which de-listed HPL.  Shares in HPL have recently traded over the counter at approximately 22 cents per share.  Plaintiffs’ shares in HPL, which had been valued at approximately $33,000,000 at the time of the merger, are essentially worthless.  Ultimately, HPL amended its 10-K in November 2002 in a reaudit conducted by PWC and materially reduced its revenue for the 2002 fiscal year by $9.1 million, or 68%, to $4.3 million.

ARGUMENT AND AUTHORITIES

I.          The Motion should be denied as to Plaintiffs’ claims for aiding and abetting a violation of the Texas Securities Act.

 

A.        The evidence creates a fact issue as to whether UBS acted recklessly in making the misrepresentations which aided and abetted HPL’s securities fraud.

 

1.         Plaintiffs need not show that UBS had a “general awareness” of its role in the primary violation; rather, Plaintiffs need only show that UBS acted recklessly.

 

UBS claims in its Motion that to state a claim against UBS as an aider and abettor under the Texas Securities Act, Plaintiffs must demonstrate that UBS had a “general awareness” of its role in HPL’s primary violation.  Motion at p. 19.  A close examination of the Texas Securities Act and Texas law interpreting and applying that act, however, demonstrates the falsity of this proposition.  First and foremost, the Texas Securities Act does not state that “general awareness” is an element of a cause of action under that act.  Rather, it states as follows regarding aider and abettor liability:

A person who directly or indirectly with intent to deceive or defraud or with reckless disregard for the truth or the law materially aids a seller, buyer, or issuer of a security is liable under Section 33A, 33B or 33C jointly and severally, with the seller, buyer, or issuer, and to the same extent as if he were the seller, buyer, or issuer.

Tex. Rev. Civ. Stat. Ann. art. 581-33(F)(2) (Vernon 2003).

Moreover, the cases UBS cites for its “general awareness” argument lack support.  For example, UBS cites Frank v. Bear Stearns & Co., 11 S.W.3d 380 (Tex. App. – Houston [14th Dist.] 2000, pet. denied) for the proposition that a plaintiff must show that the defendant had general awareness of its role in the primary violation to be liable as an aider and abettor under the Texas Securities Act.  The Frank case merely cited a law review article for this novel proposition.  See Frank, 11 S.W.3d at 384.  The two Texas cases cited by that law review article were Abbott v. Equity Group, Inc., 2 F.3d 613 (5th Cir. 1993) and Insurance Co. of North America v. Morris, 928 S.W.2d 133 (Tex. App. – Houston [14th Dist.] 1996), rev’d on other grounds, 986 S.W.2d 667 (Tex. 1998).  The Court of Appeals in Morris, however, merely stated that the trial court had instructed the jury that it had to show general awareness of the primary violation and that the evidence adduced at trial satisfied this burden; at no point did the Court of Appeals or the Texas Supreme Court adopt the general awareness test advocated by PWC.  And in Abbott, the Court merely cited another Fifth Circuit case, Abell v. Potomac Ins. Co., 858 F.2d 1104 (5th Cir. 1998), which interpreted Rule 10B-5 of the Federal Securities Act and which has been vacated.  Finally, the case of Crescendo Investments, Inc. v. Bryce, 61 S.W.3d 465, 472 (Tex. App. – San Antonio 2001, pet. denied) merely cited Frank for the proposition that general awareness is an element under the Texas Securities Act.  Simply put, nothing in any of the cases cited by UBS stands for the proposition that a plaintiff proceeding under the Texas Securities Act need show that an aider and abettor had general awareness of its role in the primary violation in order to be subject to liability.

A recent case by the Fort Worth Court of Appeals demonstrates the fallacy of UBS’  argument.  In Sterling Trust Co. v. Adderley, No. 2-00-336-CV, 2003 WL 21770799 (Tex. App. – Fort Worth July 31, 2003, pet. filed), the Court rejected the notion that “general awareness” was an element of aider and abettor liability under the Texas Securities Act.  See id. at *3.  The court first noted that the Texas Securities Act contained no language which would support the necessity of demonstrating general awareness.  Id. Moreover, the Court closely scrutinized the Frank and Crescendo cases, noting that the Frank opinion relied heavily on a law review article interpreting the Texas Securities Act in light of the Federal Securities Act and that the Crescendo opinion relied solely on FrankId. Moreover, the Court held that, as stated above, in Morris, the trial court’s jury instruction that an aider and abettor must be aware of the securities law violation was not challenged on appeal and that the Texas Supreme Court merely reviewed the evidence to support the aider finding in light of the charges submitted.  Id. at *3.  The Fort Worth Court of Appeals noted:

The language of the TSA does not require proof that an aider is generally aware of its role in the securities violation to be liable as an aider.  Because we must give effect to the TSA as written by the legislature, we hold that the trial court did not abuse its discretion by failing to give Sterling’s requested jury instruction on general awareness.

 

Id. at *4.

As set forth above, a plaintiff need not show that an aider and abettor act with general awareness of the primary violation at issue.  Rather, the plaintiff must merely show that the aider and abettor acted with an “intent to deceive or defraud or with reckless disregard for the truth or the law.” Tex. Rev. Civ. Stat. Ann. art. 581-33(F)(2) (Vernon 2003);  In re Triton Energy Ltd. Sec. Litig., No. 5:98-CIV-256, 2001 WL 872019 at *10 (E.D. Tex. March 30, 2001) (“Severe recklessness does not require that the defendant be aware of the actual falsity of his or her representation.”).

2.         The evidence creates a fact issue as to whether UBS acted recklessly or  with an intent to deceive or defraud.

a.         UBS ignored fraud warnings from its own clients.

The evidence in this case clearly creates a genuine issue of material fact as to whether UBS acted with reckless disregard for the truth or law or with an intent to deceive or defraud.[1] For example, UBS ignored numerous warnings of fraud from its own clients.  While some of the warnings took the form of complaints regarding HPL’s high DSOs (day sales outstanding, a measure of how long it is taking customers to pay for HPL’s products and services), others were far more explicit.  For example, UBS received the following e-mail message prior to the time the IPO closed:

______________________________________________________________________________

From:                                      Byron.Walker~ubsw.com

Sent:                                 Monday, July 23, 2001 9:24 AM

To:                                    Zack.Galler@ubsw.com

Subject:                            FW: HPL feedback from dreyfus

 

Zack, Lets talk about this. Byron

 

Original Message

 

From:   Mills Barry [mailto:mills.b©dreyfus.comj

Sent:  Friday, July 20, 2001 12:37 PM

To: ‘Marchiano, Nina’

Subject RE: UBS Warburg Clobal TMT Daily 7/20/01

 

Were going to pass on hpl. I think its a time bomb. 120 DSO’s is horrific. Whenever any company has such high DSOs it means that the customer is not satisfied. If they were, they’d pay for it. I don’t care about international exposure being the culprit

 

Secondly, management doesn’t disclose much in their backgrounds in the red.

 

Third, the CEO is personally getting paid a royalty for the businesses the

company sold.

 

This whole thing smells like a dirty rat.

 

Barry Mills, CFA

The Dreyfus Corporation

200 Park Aye, 55th Floor

New York, NY 10166

212-922-6370

______________________________________________________________________________

 

Exhibit A (emphasis added).              Messrs. Walker and Galler were UBS analysts who authored the HPL analyst reports on which Plaintiffs relied.  Mr. Mills was a financial analyst with the Dreyfus Corporation.  Despite the tenor of the e-mail and the fact that it indicates Byron Walker wanted to talk to Zack Galler about it, Mr. Galler testified that he does not recall discussing it with Mr. Walker. Deposition of Zack Galler attached hereto as Exhibit B at pp. 199-201.  UBS also received the following e-mail shortly after the IPO closed:

_____________________________________________________________________________

From:                                Galler, Zack

Sent:                                 Wednesday, August 29, 2001 4:31 AM

To:                                    Walker, Byron; Levine, Scott-J

Subject:                            Typical email re: HPLA

 

Typical email from a client– – –

DSO’s 163 days from 98 in one quarter!!! I can’t ever remember such a surge (and a huge red flag.) Even some of the most notorious frauds didn’t show anything of that magnitude. Did anyone pay cash at all last quarter? And exactly where are these international sales to? The republic of Swindlevakia? I wouldn’t touch this with a million foot poll.

_____________________________________________________________________________

Exhibit C (emphasis added).  The author of this e-mail was Fred Hickey, who writes a technology newspaper.  UBS analyst Byron Walker testified that Hickey is a “competent analyst” who “does good fundamental research” and whose opinions he respects.  Deposition of Byron Walker attached hereto as Exhibit D at p. 196.  As the e-mail states, this message was “typical” of the responses from UBS’ customers when advised of the investment opportunity in HPL.  In fact, in his deposition, UBS analyst Zack Galler testified that he received approximately “two dozen” similar communications in the August-September 2001 time frame.  Galler Depo at pp. 229-231.   And yet UBS went forward with the IPO and never warned investors like Plaintiffs of the fraud warnings it had received.

b.         UBS knew that Homi Fatemi, a convicted felon, was a key member of HPL’s sales staff but conspired with HPL to cover up this fact.

 

Prior to HPL’s failed IPO in 2000, Homi Fatemi was an officer of HPL who served as HPL’s Vice President of Sales.  Exhibits E-G.  Before being hired by HPL in 1998, Fatemi plead no contest to a charge of grand theft involving his theft from his employer, Advanced Micro Devices (“AMD”), of more than $100,000.  Id. His criminal past was discovered by UBS and HPL “during the underwriting process” for HPL’s attempted 2000 IPO.  Exhibit E; Deposition of Ita Geva attached hereto as Exhibit H at p. 39.  The discovery of Fatemi’s criminal past was one of the key factors which delayed HPL’s IPO from 2000 to 2001.  Deposition of Phokian Potamianos attached hereto as Exhibit I at pp. 38-39, 132-3.  As UBS’ lead investment banker on the HPL IPO stated:

The principal reason [the 2000 IPO] was delayed was because Homi was effectively on the — was an executive at the firm.  The idea was that Homi would have to stand down from that role, and I think the company went through some decision making as to what his role should be because Homi Fatemi, as I understand it, was quite sort of an important salesperson for the company.  That was my understanding of it.

Potamianos Depo at pp. 38-40.

As a result of the failure of the IPO, Fatemi was supposedly “demoted.”  Geva Depo at p. 39. The “demotion” allowed UBS to omit from the 2001 Prospectus any mention of Fatemi’s criminal past.  Potamianos Depo at 83-4.  In reality, however, Fatemi’s “demotion” was nothing more than window dressing.  The only thing that changed was his title; he did not take a pay cut and CFO Ita Geva could not identify anything that changed with respect to his responsibilities.  Geva Depo at pp. 91-92.  HPL employee Tom Ho testified that he never saw any evidence that Fatemi was demoted or that his duties changed.  Deposition of Tom Ho attached hereto as Exhibit J at pp. 105.  Ho also testified that at the time of the IPO, Fatemi remained “the main sales executive at HPL.”  Ho Depo at pp. 78, 161.  Even HPL’s attorneys stated that Fatemi remained “a sales and marketing director of the company.”  Exhibit E at UBS012224.  Despite his criminal conviction, UBS did nothing to investigate Fatemi’s continued involvement with HPL’s sales after the failed 2000 IPO.  Potamianos Depo at pp. 82-3 (“From the moment that Mr. Fatemi was no longer on the executive board, from the moment that Mr. Fatemi was no longer part of management, in principle, he was being managed by others, that was not a focus of mine.”).

AMD, the victim of Fatemi’s fraud, was one of HPL’s major customers.  Exhibit K at p. 37; Exhibit L at p. 3.  After stealing from AMD, Fatemi was fired and his stock options were cancelled.  Clearly investors such as Plaintiffs would consider Fatemi’s conviction of stealing more than  $100,000 from one of HPL’s biggest customers to be material.  Despite this fact, the IPO Prospectus mentioned nothing of Fatemi’s criminal past and merely stated in cryptic fashion that “Mr. Fatemi served as an executive officer of the company until June 2000, at which point he became our Director — Sales & Marketing.”  Exhibit K at p. 44.  Several courts have held that omissions regarding the criminal background of corporate officers or employees provide a strong inference of recklessness in the preparation of offering documents.  See, e.g., Brerard v. Sachnoff & Weaver, Ltd., 941 F.2d 142, 144 (2d Cir. 1991) (finding that attorney’s “failure to mention Berg’s conviction in the initial offering memorandum could be considered reckless as a matter of law.”); SEC v. Electronics Warehouse, Inc., 689 F.Supp. 53, 66-7 (D. Conn. 1988) (court granted summary judgment in favor of SEC against attorney for underwriter after finding that he was “reckless as a matter of law” in failing to disclose in IPO that president of company had been indicted for mail fraud).  UBS’ obvious cover-up of Homi Fatemi’s criminal conviction was likewise reckless as a matter of law.

c.         UBS made a large loan to HPL CEO David Lepejian which was  collateralized by stock in HPL, creating an obvious conflict of interest.

 

UBS also acted recklessly by making a large loan to HPL CEO David Lepejian which was collateralized by stock in HPL.  UBS’ own documents indicated that the loan was “outside standard lending parameters,” but concluded the loan was worthwhile “given the UBSW relationship and expected UBSPW expanding relationship.”  Exhibit M.  As this document indicated, investment bank UBS Warburg (“UBSW”) and brokerage firm UBS Paine Webber (“UBSPW”) collaborated on the loan.  UBS investment banker Phokian Potamianos testified that UBSPW broker Duncan Naylor informed him of the loan and that there was “fairly constant dialogue between investment banking and Paine Webber.”  Potamianos Depo at pp. 121-22.

Although the loan was supposedly to be used to fund an orphanage in Armenia, UBS did nothing to verify Lepejian’s use of the funds; in fact, Potamianos testified that he never followed up with Lepejian on the matter because “I am not going to ask him what he is doing with his money.”  Potamianos Depo at p. 126.  What Lepejian was doing with his money was funneling it back into HPL to artificially inflate its revenues and cover up his fraud.  Exhibit N at pars. 1, 4.

Not only did the UBS loan allow Lepejian to hide his fraud, it also created an immense conflict of interest within UBS.  The fact that the loan to Lepejian was collateralized by his HPL stock gave UBS’ analysts an obvious incentive to prop up the price of HPL stock through their unreasonably optimistic reports and recommendations.  See, e.g., In re Worldcom Sec. Litig., No. 02 Civ. 3288, 2003 WL 21219049 at * 10 (S.D.N.Y. May 19, 2003) (“The loans [to WorldCom’s CEO] were secured in part by WorldCom stock, a fact that gave Citigroup an additional incentive to prop up the price of WorldCom stock to protect its investment.”); Affidavit of William H. Purcell attached hereto as Exhibit O at par. 62.  Nowhere in its analyst reports did UBS divulge that it had loaned millions of dollars to David Lepejian secured by stock in HPL.  As one court has recently stated:

Having chosen to speak to the investing public through the issuance of analyst reports, they had an obligation to communicate in good faith and to disclose material information.  To the extent that there is a substantial likelihood that a fuller and more specific disclosure of their relationship to WorldCom would have been considered by a reasonable person to be important when deciding based on the information conveyed in the analyst reports, to buy or sell WorldCom securities, then the omission of that disclosure may be found by a fact finder to have been a material omission.

Id. at * 35.  UBS’ failure to disclose this obviously material information is further evidence of its recklessness.

d.         UBS’ analyst reports were false and misleading and represented an obvious attempt to prop up the price of HPL’s stock.

 

UBS initiated coverage of HPL in August 2001 with a “Buy” rating.  Exhibit P.  The UBS analyst report projected phenomenal net income growth of 155% and 131% in fiscal 2002 and fiscal 2003 respectively.  Id. at UBS000879.  The report also stated when discussing HPL’s high day sales outstanding (“DSOs”) that “HPL believes there is little to no potential nonpayment issues associated with the outstanding receivables, as all products have been deployed and received customer signoff before being invoiced.”  Id. at UBS000900.  In addition to these statements, the UBS report made specific factual statements which were false or misleading, including the following:

  • “HPL has structured its larger perpetual contracts so that revenue can be recognized in predictable patterns over multiyear periods.”
  • The agreement between HPL and Canon had associated revenues which grew “from zero to $6 million in one year.”
  • “HPL follows conservative policies for revenue recognition.”
  • “If acceptance criteria exist, recognition is deferred until customer acceptance occurs.”

Id. at UBS000884, UBS000895, UBS000902; Exhibit N.  Subsequent analyst reports also contained false statements of material fact, including the following:

  • “While the reported DSOs for the June quarter were high, they were not out of character for a small company with a large base of foreign customers.”
  • “HPLA’s customers are large, top-tier, international customers.  There is no credit risk.”
  • “The DSO issue is being addressed.  There is still no credit risk.”
  • “The high DSO issue (163 days) is being addressed.  There is no credit risk with any of the outstanding receivables. . . .”

Exhibits Q, R, N.

During the time that UBS continued to recommend HPL as a “Buy” and make excuses for its high DSOs, the price of HPL stock dropped from $12.64 to as low as $3.80.  Exhibits P, R.  Amazingly, with the stock at $4.75 per share, UBS upgraded HPL from a “Buy” to a “Strong Buy.”  Exhibit S.  Even more troubling, this upgrade completely ignored UBS’ own upgrade criteria.  In an internal memo dated September 10, 2001, HPL analyst Byron Walker stated that an upgrade on HPL would be a function of “the reporting of meaningful reduction in DSOs, and/or significant new contracts not in the model.”  Exhibit T.  Just 24 days later, UBS upgraded HPL from a “Buy” to a “Strong Buy” despite the fact that DSOs had not decreased and there had been no new contracts not in the model.  Exhibits Q, S.  UBS analyst Zack Galler, who was listed as a co-author of the upgrade report, stated that he was “concerned about upgrading” HPL and told lead analyst Byron Walker that the upgrade was a “gutsy call.”  Galler Depo at pp. 256-67.  This is further evidence of UBS’ recklessness.

e.         UBS’ due diligence was woefully inadequate.

As set forth in the affidavit of Plaintiffs’ expert William Purcell, UBS’ due diligence as part of the IPO was woefully inadequate.  Among the evidence supporting this conclusion is the following:

  • espite knowledge of the importance of HPL’s sales through Canon/Toshiba, UBS  never spoke with anyone from Canon or Toshiba, never visited with anyone at Canon in Japan and does not appear to have even reviewed the contract between HPL and Canon.  Purcell Affidavit at pars. 30-35.
  • UBS’ call sheets indicate that they never contacted Toshiba during their customer calls.  Exhibits U, V.
  • UBS’ customer calls focused on customers’ future plans to buy HPL’s software rather than on confirming the past and existing sales reported by HPL.  Potamianos Depo at pp. 63-64; Purcell Affidavit at par. 38; Exhibit V.
  • UBS failed to investigate the continuing role of convicted felon Homi Fatemi following his supposed demotion.  Potamianos Depo at pp. 82-3; Purcell Affidavit at pars. 40-42.
  • UBS failed to investigate HPL’s revenue recognition and instead relied entirely on PWC.  Potamianos Depo at pp. 61-2, 65, 118, 211; Walker Depo at pp. 30, 48-9, 212; Purcell Affidavit at pars. 43-47.
  • UBS failed to adequately investigate HPL’s extremely high DSOs and instead relied solely on HPL’s explanation of the problem.  Potamianos Depo at pp. 115-117; Purcell Affidavit at pars. 56-59.
  • UBS ignored the obvious conflict of interest created by its loan to David Lepejian collateralized by HPL stock and did nothing to investigate Lepejian’s use of the loan  proceeds.  Purcell Affidavit at pars. 58-60; Potamianos Depo at pp. 120-23, 126, 127, 129; Exhibit M.
  • UBS’ lead investment banker, Phokian Potamianos, testified that he spent a mere 20-24 hours on due diligence.  Potamianos Depo at pp. 63-4; Purcell Affidavit at par. 36.

Such inadequate due diligence provides evidence of UBS’ recklessness.  Purcell Affidavit at par. 63 (“In fact, in my opinion, UBS’due diligence of HPL for the July 2001 IPO was performed far below industry standards and, indeed, UBS acted recklessly in its due diligence.”).

f.          As a result of its inadequate due diligence, UBS published a  Prospectus with false and misleading financial statements.

 

As a result of its inadequate due diligence, UBS published a Prospectus with false and misleading financial statements.  Exhibits N, W.  Evidence of such misleading statements in the prospectus supports an inference of recklessness.  See, e.g., Robbins v. Gitano Group, No. 91 Civ. 1440, 1992 WL 276837 at *7 (S.D.N.Y. Sept. 25, 1992) (finding inference of recklessness by underwriter “[b]ecause the underwriter defendants were monitoring the financial condition any may be viewed as warranting that condition to the public, at least in connection with Gitano’s public offering in the first half of 1990.”).

g.         The magnitude of the financial misstatements in the Prospectus  supports a finding of recklessness.

In addition to the foregoing evidence, the evidence of the reaudit of HPL shows the magnitude of PWC’s misrepresentations, as illustrated below:

Total Revenues – software licenses, consulting services, maintenance and other 2001 2002
As originally reported and included in audited financial statements $13,419,000 $37,514,000
As restated $4,315,000 $4,513,000
Percent change (68%) (88%)

 

Income (loss) from continuing operations before income taxes (pre-tax earnings/(loss)) 2001 2002
As originally reported and included in audited financial statements $2,154,000 $13,754,000
As restated $(6,245,000) $(15,825,000)
Percent change (390%) (215%)

 

Net income/(loss) 2001 2002
As originally reported and included in audited financial statements $541,000 $6,744,000
As restated $(6,435,000) $(14,917,000)
Percent change (1,289%) (321%)

 

Affidavit of D. Paul Regan attached hereto as Exhibit W at par. 8.  Several courts have held that the magnitude of the misstatements at issue is probative of fraudulent intent and recklessness. See, e.g., In re Worldcom Sec. Litig., No. 02 Civ. 3288, 2003 WL 21488087 at * 7 (S.D.N.Y. June 25, 2003) (“Although the size of the fraud alone does not create an inference of scienter, the enormous amounts at stake, coupled with the detailed allegations regarding the nature and extent of WorldCom’s fraudulent accounting and Anderson’s failure to conduct a thorough and objective audit create a strong inference that Anderson was reckless in not knowing that its audit opinions materially misrepresented WorldCom’s financial state.”); In re First Merchants Acceptance Corp. Sec. Litig., No. 97 C 2715, 1998 WL 781118 at *10 (N.D. Ill. Nov. 4, 1998) (“Other circumstances suggesting fraudulent intent can include the presence of ‘red flags’ or warning signs that the financial reports are fraudulent, as well as the magnitude of the fraud alleged.”); In re Microstrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 652 (E.D. Va. 2000) (“the greater the magnitude of the irregularities, and the more frequent the violations, the stronger is the inference that conscious fraud or recklessness is the explanation for the auditor’s role in the violations.”).

h.         UBS’ failure to take action in response to numerous “red flags”  supports a finding of recklessness.

 

Another sign of UBS’ recklessness can be found in its failure to investigate numerous “red flag” warning signs which could have revealed David Lepejian’s fraudulent activities.  Such “red flags” include the following:

  • When UBS lead analyst Zack Galler asked HPL to provide quantitative figures and customer information regarding its software revenue, HPL refused, stating “for now we prefer not to include figures and not to identify the clients.”  Exhibit Y.
  • When David Lepejian provided customer contact information to UBS so that it could make customer calls, he failed to provide contact information for Toshiba, one of HPL’s biggest clients and one of the primary vehicles for his fraud.  Exhibit U.
  • Homi Fatemi, HPL’s Vice President of Sales, was a convicted felon.  Exhibits E-G.
  • HPL’s DSOs were incredibly high.  Purcells Affidavit at pars. 56-59.
  • More than 40% of HPL’s revenues were derived from sales to a foreign distributor. Exhibit K at p. 37.
  • More than 80% of HPL’s revenue for the quarter ending March 31, 2001, was invoiced on the last day of the quarter, a Saturday.  Exhibit Z.

UBS’ failure to take any action in response to such obvious “red flags” leads to an inference of recklessness.  See, e.g., In re Enron Corp. Sec. Deriv. & ERISA Litig., 235 F.Supp.2d 549, 707 (S.D. Tex. 2002) (“Moreover, given the fact that the complaint is filled with allegations of red flags and warnings at least some of which should have alerted an underwriter doing a due diligence investigation to look deeper and question more, the Court finds that the complaint adequately alleges Section 11 claims”); In re Worldcom Sec. Litig., 2003 WL 21219049 at * 8 (finding evidence of recklessness where “Numerous other ‘red flags’ should have alerted the Underwriter Defendants to WorldCom’s fraudulent accounting practices and should have been investigated by them”); In re Microstrategy, Inc. Sec. Litig., 115 F. Supp. 2d at 653 (“[m]any courts have held that allegations that an auditor ignored ‘red flags’ is probative of fraudulent intent or recklessness.”);   In re The Leslie Fay Companies, Inc., 871 F. Supp. 686, 699 (S.D. N.Y. 1995) (“Allegations that, with gross recklessness, BDO ignored multiple ‘red flags’ could reasonably support an inference that BDO acted with intent.”); In re First Merchants Acceptance Corp. Sec. Litig., 1998 WL 781118 at *10 (“Other circumstances suggesting fraudulent intent can include the presence of ‘red flags’ or warning signs that the financial reports are fraudulent, as well as the magnitude of the fraud alleged.”); CMNY Capital, L.P. v. Deloitte & Touche, 821 F. Supp. 152, 166 (S.D. N.Y. 1993) (“An accountant can act recklessly by disregarding a ‘red flag’ in a given factual setting.”); In re Worldcom Sec. Litig., 2003 WL 21488087 at * 4 (finding evidence of recklessness where Arthur Andersen “failed to recognize the warning signs of fraud.”).

B.        UBS rendered substantial assistance to HPL.

1.         UBS underwrote the IPO.

 

It is clear that UBS provided substantial assistance to HPL.  First and foremost, UBS acted as the lead underwriter on HPL’s IPO.  Exhibit K at p. 56.  In doing so, UBS lent its name and reputation to the offering.  And UBS investment banker Phokian Potamianos admitted that “the investing public relies on the reputation of many things in an IPO.  The underwriter is one of them.”  Potamianos Depo at p. 61.

2.         UBS lent funds to Lepejian, which he apparently used to lower HPL’s  DSOs by funneling the money to HPL.

 

As set forth above, UBS made an unusual loan to HPL CEO David Lepejian which was collateralized by stock in HPL.  UBS’ own documents indicated that the loan was “outside standard lending parameters,” but concluded the loan was worthwhile “given the UBSW relationship and expected UBSPW expanding relationship.”  Exhibit M.  Although the loan was supposedly to be used to fund an orphanage in Armenia, UBS did nothing to verify Lepejian’s use of the funds; in fact, Potamianos testified that he never followed up with Lepejian on the matter because “I am not going to ask him what he is doing with his money.”  Potamianos Depo at p. 126.  What Lepejian was doing with his money was funneling it back into HPL to artificially inflate its revenues and cover up his fraud.  Exhibit N at pars. 1, 4.

3.         UBS published numerous analyst reports regarding HPL, rating the  company a “Buy” and a “Strong Buy.”

UBS initiated coverage of HPL in August 2001 with a “Buy” rating.  Exhibit P.  The UBS analyst report projected phenomenal net income growth of 155% and 131% in fiscal 2002 and fiscal 2003 respectively.  Id. at UBS000879.  On October 3, 2001, UBS upgraded HPL from a “Buy” to a “Strong Buy”  in contravention of its own upgrade criteria.  Exhibits Q, S, T.  UBS analyst Zack Galler, who was listed as a co-author of the upgrade report, stated that he was “concerned about upgrading” HPL and told lead analyst Byron Walker that the upgrade was a “gutsy call.”  Galler Depo at pp. 256-57.  As set forth below, Plaintiffs relied on the UBS analyst reports in agreeing to the merger with HPL.

4.         UBS actually assisted with the merger between HPL and CTG.

After HPL’s successful IPO in the Summer of 2001, UBS laid out the landscape of companies that it thought would make appropriate partners for HPL.  Potamianos Depo at p. 167.  One of the companies they included was CTG.  Potamianos Depo at pp. 167-168.  In the Fall of 2001, UBS was asked to work on the HPL/CTG merger transaction.  Potamianos Depo at p. 74.  UBS presented a form for the Merger and Acquisition committee to review in order to make a decision as to whether or not to participate in the merger and acquisition with CTG.  Potamianos Depo at pp. 154-155; Exhibit AA.  On October 15, 2001, UBS sent a letter agreement to HPL proposing a fee consisting of a $400,000 fairness opinion fee and a transaction fee of $800,000.  Exhibit BB.

Even though UBS and HPL failed to come to terms with regard to a fee for UBS’s efforts in connection with the merger, UBS continued to provide advice, counsel, support documents and approval with regard to negotiations between CTG and HPL.  UBS obtained information on CTG financials and prepared an analysis of the same.  Exhibit CC.  UBS also prepared a preliminary due diligence request list and term sheet.  Exhibits DD-FF; Potamianos Depo at p. 254.  Furthermore, UBS assigned the code name “Project Metropolis” to the HPL/CTG merger negotiations.  Potamianos Depo at p. 251-252.  UBS reviewed the financials and valuation of CTG to understand CTG’s revenue flows and to prepare for a December 14, 2001 negotiation meeting with CTG.  Potamianos Depo at p. 261-262; Exhibit GG.  UBS drafted the HPL presentation for the meeting and conducted a preliminary analysis of CTG’s financials.  Exhibits HH, II.  Prior to the meeting, CTG personnel had several conversations with UBS regarding the meeting and the due diligence lists and other information that UBS required.  Deposition of Merrill Wertheimer attached hereto as Exhibit MM at p. 93.

On December 14, Merrill Wertheimer and Brenda Stoner went to UBS’s office in San Francisco to make a presentation regarding CTG.  Wertheimer Depo at p. 87.  Merrill Wertheimer initially thought that the meeting was just between UBS and CTG and wasn’t even certain that HPL would be there. Wertheimer Depo at p. 91.  In fact, Lepejian indicated to Wertheimer that he needed UBS approval and that he had agreed to run any acquisitions by UBS at the time of the public offering; UBS approval was essential before Lepejian went forward with any deals.  Harward Depo at p. 500; Wertheimer Depo at pp. 88, 90.    It was clear to Plaintiffs that UBS was affiliated with and working with HPL on the transaction.  Wertheimer Depo at p. 91.

The purpose of the December 2001 meeting was to review information that UBS had suggested that CTG provide to HPL.  Deposition of Mark Harward attached hereto as Exhibit KK at pp. 126, 498.  Two groups from UBS were present, one from the investment banking side and one from the financing side. Wertheimer Depo at p. 88-89.  The meeting, which occurred at UBS Warburg’s office, was a continuation of negotiations. Harward Depo at p. 127.  At the meeting, the management team of CTG made a presentation to UBS and HPL laying out their investment summary, thesis and customer base.  Potamianos Depo at p. 240.  CTG personnel were told that UBS was trying to help negotiate the price down on the merger deal.  Harward Depo at p. 497.  At the meeting, the UBS people asked questions and participated in the discussions.  Wertheimer Depo at pp. 88-89; Deposition of Brenda Stoner attached hereto as Exhibit LL at p. 132; Harward Depo at p. 240.  After the meeting, UBS performed an ability to pay analysis for the CTG merger.  Exhibit JJ.  In short, UBS hosted the meeting, listened to the presentation and offered their perspective and advice on the valuation of the business.  Potamianos Depo at pp. 196-197, 241.

5.         Conclusion.

The facts set forth above clearly raise an issue of fact as to whether UBS aided and abetted HPL’s primary violation of the Texas Securities Act.  See, e.g., IIT, an International Investment Trust v. Cornfeld, 619 F.2d 909, 925 (2d Cir. 1980) (in reversing motion to dismiss aiding and abetting claim, court held that evidence that underwriters “associate[ed] themselves with the venture, participated in it as something they wished to bring about, and sought by their action to make it a success” supported existence of substantial assistance); In re Worlds of Wonder Sec. Litig., 721 F.Supp. 1140, 1146 (N.D. Cal. 1989) (in denying motion to dismiss aiding and abetting claim against underwriters and accountant, court held that “[s]ubstantial assistance is sufficiently alleged where plaintiffs claim that they relied on the professional’s reputation when deciding to invest.”); In re Chaus Sec. Litig., No. 88 Civ. 8641, 1990 WL 188921 at *13 (S.D.N.Y. 1990) (holding that plaintiff stated claim for aiding and abetting by alleging that the underwriters “provided substantial assistance by not disclosing the varied business problems [of their client] while at the same time actively marketing the initial public offering.”); Roberts v. Peat, Marwick, Mitchell & Co., 857 F.2d 646, (9th Cir. 1988) (cause of action for aiding and abetting against accountant stated by alleging that “the investors relied on Peat, Marwick’s reputation when deciding to invest and that they would not have invested had Peat, Marwick disclosed the alleged fraud.”).  The Motion should therefore be denied.

II.        The Motion should be denied as to Plaintiffs’ claims for fraud.

 

A.        UBS made false representations.

 

1.         The statements in the Prospectus are attributable to UBS.

 

UBS alleges that it cannot be held liable for any misstatements in the Prospectus because such representations were by others and were not the representations of UBS.  Many courts, however, have clearly rejected attempts by underwriters to disassociate themselves from statements made in prospectuses which they approved.  For example, the Southern District of New York has stated as follows:

The underwriters say that the prospectus is the company’s prospectus, not theirs.  Doubtless this is the way they customarily regard it.  But the Securities Act makes no such distinction.  The underwriters are just as responsible as the company if the prospectus is false.  And prospective investors rely upon the reputation of the underwriters in deciding whether to purchase the securities.

Escott v. Barchris Constr. Corp., 283 F.Supp. 643, 696 (S.D. N.Y. 1968); In re Worldcom, Inc. Sec. Litig., 2003 WL 21219049 at *8 (“As underwriters of the 2000 and 2001 Offerings the Underwriter Defendants were responsible for the contents and dissemination of the Registration Statements, which contained material misrepresentations and upon which plaintiffs relied in purchasing WorldCom Securities.”).

The reason underwriters are  held responsible for misstatements in a prospectus has been succinctly stated by the Southern District of Texas in its recent Enron opinion:

An underwriter’s relationship with the issuer gives the underwriter access to facts that are not equally available to members of the public who must rely on published information.  And the relationship between the underwriter and its customers implicitly involves a favorable recommendation of the issued security.  Because the public relies on the integrity, independence and expertise of the underwriter, the underwriter’s participation significantly enhances the marketability of the security.  And since the underwriter is unquestionably aware of the nature of the public’s reliance on his participation in the sale of the issue, the mere fact that he has underwritten it is an implied representation that he has met the standards of his profession in his investigation of the issuer.

In re Enron Corp., 235 F.Supp.2d at 612; see also Chris-Craft Ind., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370 (2d Cir. 1973) (“An underwriter by participating in an offering constructively represents that statements made in the registration materials are complete and accurate.  The investing public properly relies upon the underwriter to check the accuracy of the statements and the soundness of the offer; when the underwriter does not speak out, the investor reasonably assumes that there are no undisclosed material deficiencies.  The representations in the registration statement are those of the underwriter as much as they are those of the issuer.”).  None of the cases cited by UBS involve the responsibility of an underwriter for material misstatements in a prospectus or other public filing.  See Motion at p. 14, n. 53.

Another reason underwriters are held responsible for statements in a prospectus and may not simply lay blame at the foot of the corporation and its officers is because the underwriter is charged with a duty to thoroughly investigate representations of management to ferret out any misstatements, omissions or outright fraud:

In a sense, the positions of the underwriter and the company’s officers are adverse.  It is not unlikely that statements made by company officers to an underwriter to induce him to underwrite may be self-serving.  They may be unduly enthusiastic.  As in this case, they may, on occasion, be deliberately false.

The purpose of Section 11 is to protect investors.  To that end the underwriters are made responsible for the truth of the prospectus.  If they may escape that responsibility by taking at face value representations made to them by the company’s management, then the inclusion of underwriters among those liable under Section 11 affords the investors no additional protection.  To effectuate the statute’s purpose, the phrase “reasonable investigation” must be construed to require more effort on the part of the underwriters than the mere accurate reporting in the prospectus of “data presented” to them by the company.  It should make no difference that this data is elicited by questions addressed to the company officers by the underwriters, or that the underwriters at the time believe that the company’s officers are truthful and reliable.  In order to make the underwriters’ participation in this enterprise of any value to the investors, the underwriters must make some reasonable attempt to verify the data submitted to them.  They may not rely solely on the company’s officers or on the company’s counsel.  A prudent man in the management of his own property would not rely on them.

Escott, 283 F.Supp. at 696-97.

Given the foregoing, the importance of the duties placed on underwriters cannot be understated:

Self-regulation is the mainspring of the federal securities laws.  No greater reliance in our self-regulatory system is placed on any single participant in the issuance of securities than upon the underwriter.  He is most heavily relied upon to verify published materials because of his expertise in appraising the securities issue and the issuer, and because of his incentive to do so.  He is familiar with the process of investigating the business condition of a company and possesses extensive resources for doing so.  Since he often has a financial stake in the issue, he has a special motive thoroughly to investigate the issuer’s strengths and weaknesses.  Prospective investors look to the underwriter – a fact well known to all concerned and especially to the underwriter – to pass on the soundness of the security and the correctness of the registration statement and prospectus.

Chris-Craft Ind., 480 F.2d at 370.  Simply put, UBS cannot blame others for the misstatements in the Prospectus given its role as underwriter of the HPL IPO.

2.         The Prospectus contains false statements of material fact.

 

As it must, UBS concedes in its Motion that the Prospectus contains false statements of material fact.  Motion at p. 13 (“Plaintiffs seek to hold UBS responsible in two ways for the incorrect financial information provided by HPL.”).  Among the false statements of fact are the following:

  1. p.1 – “We recognized revenues of $13.4 million and operating income of $4.5 million … for the year ended March 31, 2001. Over the last two fiscal years, our largest customers, each of which accounted for more than $500,000 in revenues, were the following semiconductor companies:  Advanced Micro devices, Dominion Semiconductor, FASL, Fujitsu Microelectronics, LSI Logic, ST Microelectronics, Silicon Storage Technology, Teradyne and Toshiba.”
  1. p.4 – financial information reported for 2001
  1. p.6 – “In each of the years ended March 31, 2001 . . . customers that individually accounted for at least 10% of our revenues together represented 74% . . . of our revenues.  In the year ended March 31, 2001, sales to Dominion Semiconductor, FASL, Fujitsu Microelectronics and Toshiba accounted for 22%, 21%, 21% and 10%, respectively, of our revenues.”
  1. p.12 – “Sales to customers located outside the United States accounted for approximately 48% of our revenues in the years ended March 31, 2001.”
  1. p.19 – financial information reported for 2001
  1. p.21 – “Revenues from international sales amounted to . . . 48% in . . . 2001.”
  1. p.21 – “Revenues from software licenses are recognized upon execution of a binding agreement and delivery of the software, provided that: the fee is fixed and determinable; vendor specific objective evidence exists to allocate a portion of the total license fee to any undelivered elements of the arrangement; collection is probable; there are no remaining obligations by us; and the agreement does not contain customer acceptance clauses.  If customer acceptance clauses exist, revenues are recognized upon customer acceptance.”
  1. p.22 – “For perpetual licenses with multiple obligations (e.g., deliverable and undeliverable products, post-contract support and other services), we allocate revenues to the undelivered element of the contract based on objective evidence of its fair value. . . . We recognize revenues allocated to undelivered products when the criteria for software license revenues set forth above are met.”
  1. p.22 – “Revenues from sales made through the distributor are recognized when the distributor has sold the software licenses or service to the customers.”
  1. p.23 – Results of operations data financial information for 2001
  1. p.23 – “Total revenues increased 262% to $13.4 million for the year ended March 31, 2001.”
  1. p.23 – “As a percentage of revenues, gross margins remained relatively unchanged at 92% for the year ended March 31, 2001 compared to 93% for the year ended March 31, 2000.”
  1. p.27 – Quarterly financial information for 2001.
  1. p.28 – Net cash provided by operating activities for the year ended March 31, 2001 was approximately $2.0 million. . . . The increase in cash flow was primarily due to increased revenues.”
  1. F-10 – “The Company recognizes revenues in accordance with the provisions of Statement of Position (“SOP”) 97-2, “Software Revenues Recognition,” as amended by SOP 98-4, SOP 98-9 and Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements” issued by the Securities Exchange Commission.”
  1. F-11 – “If consulting or other services sold in connection with a software license are essential to the functionality of the software, the Company recognizes revenue on either a percentage-of-completion or completed contract basis.  To date, the services the Company has sold have not been essential to the functionality of the Company’s software.”
  1. F-11 – “For contracts with multiple obligations (e.g., deliverable and undeliverable products, post-contract support and other services), the Company allocates revenues to the undelivered element of the contract based on objective evidence of its fair value. . . . The Company recognizes revenues allocated to undelivered products when the criteria for software license revenues set forth above are met.”
  1. F-11 – “Revenues from sales made through this distributor are recognized when the distributor has sold the software licenses or service to the customers.”

Exhibits K, N.  As set forth above, UBS as the underwriter is responsible for these misstatements.

3.         Statements made in the analyst reports are also actionable.

 

The UBS analyst reports upon which Plaintiffs relied contain false statements of material fact as well as actionable opinions.  UBS initiated coverage of HPL in August 2001 with a “Buy” rating.  Exhibit P.  The UBS analyst report projected phenomenal net income growth of 155% and 131% in fiscal 2002 and fiscal 2003 respectively.  Id. at UBS000879.  The report also stated when discussing HPL’s high DSOs that “HPL believes there is little to no potential nonpayment issues associated with the outstanding receivables, as all products have been deployed and received customer signoff before being invoiced.”  Id. at UBS000900.  In addition to these statements, the UBS report made specific factual statements which were false or misleading, including the following:

  • “HPL has structured its larger perpetual contracts so that revenue can be recognized in predictable patterns over multiyear periods.”
  • The agreement between HPL and Canon had associated revenues which grew “from zero to $6 million in one year.”
  • “HPL follows conservative policies for revenue recognition.”
  • “If acceptance criteria exist, recognition is deferred until customer acceptance  occurs.”

Id. at UBS000884, UBS000895, UBS000902; Exhibit N.  Subsequent analyst reports also contained false statements of material fact, including the following:

  • “While the reported DSOs for the June quarter were high, they were not out of character for a small company with a large base of foreign customers.”
  • “HPLA’s customers are large, top-tier, international customers.  There is no credit risk.”
  • “The DSO issue is being addressed.  There is still no credit risk.”
  • “The high DSO issue (163 days) is being addressed.  There is no credit risk with any of the outstanding receivables. . . .”

Exhibits Q, R, N.  Each of these false statements of material fact is actionable.

To the extent the analyst reports contain opinions rather than facts, such as the “Buy” and “Strong Buy” opinions referenced above, they are still actionable.  In re Apple Computer Sec. Litig., 886 F.2d 1109, 113 (9th Cir. 1989) (“projections and general expressions of optimism may be actionable under the federal securities laws.”).  As the Ninth Circuit has explained:

A projection or statement of belief contains at least three implicit factual assertions: (1) that the statement is genuinely believed, (2) that there is a reasonable basis for that belief, and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement.  A projection or statement of belief may be actionable to the extent that one of these implied assertions is false.

Id. at 1113.  Here, there is ample evidence raising a fact issue as to whether such implied assertions are false.  See Section  I.A.(2) above.  And Plaintiffs’ expert, William Purcell, has opined that UBS did not have a sufficient factual basis for its “Buy” and “Strong Buy” opinions in its analyst reports.  Purcell Affidavit at par. 74.

Under Texas law, there are numerous exceptions to the general rule that opinions are not actionable.  For example, an exception exists where the speaker has superior knowledge of the subject matter about which he is speaking.  See, e.g., Trenholm v. Ratcliff, 898 S.W.2d 269, 277 (Tex. 1995) (“Superior knowledge by one party may also provide the occasion for fraud.”); McCollum v. P/S Investments, Ltd., 764 S.W.2d 252, 254 (Tex. App.–Dallas 1988, writ denied) (an exception to the general rule “exists when the person giving the opinion has knowledge superior to that of the person relying upon the opinion, as, for example, when the facts underlying the opinion are not equally available to both parties.”); Wright v. Carpenter, 579 S.W.2d 575, 580 (Tex. Civ. App.–Corpus Christi 1979, writ ref’d n.r.e.) (“Representations as to matters not equally open to parties are legally statements of fact and not opinions.”).  The facts clearly demonstrate that UBS had superior knowledge to Plaintiffs.  As the underwriter of HPL’s IPO, UBS had complete access to HPL’s books and records.  As UBS investment banker Phokian Potamianos admitted, UBS had access to HPL’s financials, customer base and “many of the inner workings of the company.”  Potamianos Depo at p. 59.  And Potamianos admitted that HPL did not deny UBS access to any information it sought.  Id. (“we pretty much have free rein to pursue what we are looking for in the business”).  Plaintiffs, to the contrary, were denied access to such materials and were told by HPL that they could rely on the audited financials and other information contained in the IPO prospectus.  Stoner Depo at p. 142 (“We were told we would only have access to public documentation”).

Another exception to the general rule that opinions are not actionable exists “when an opinion is based on past or present facts.”  Trenholm¸ 646 S.W.2d at 927.   UBS’ numerous opinions regarding HPL’s financial performance and its DSOs are clearly opinions based on past or present facts.  For this additional reason, the opinions in its analyst reports are actionable as a matter of law.

B.        UBS acted knowingly or recklessly.

 

As set forth in Section I.A(2) above, the evidence in this case clearly creates a genuine issue of material fact as to whether UBS acted with reckless disregard for the truth or law or with an intent to deceive or defraud.  Plaintiffs incorporate by reference the evidence, argument and authorities set forth in Section I.A(2) above as if fully set forth herein.

C.        UBS had an intent to induce reliance.

 

1.         UBS misstates the appropriate test for intent.

UBS claims that it is entitled to summary judgment on Plaintiffs’ fraud claim because there is no evidence UBS intended “to induce these specific plaintiffs to enter into the merger agreement with HPL.”  Motion at p. 16.  Under Texas law, however, Plaintiffs need not show that UBS intended to induce these specific plaintiffs to enter into the specific transaction at issue.  Rather, under Texas law, a defendant is potentially liable for fraud “to the person or class of persons the maker intended or has reason to expect will act in reliance upon the misrepresentation.”  Ernst & Young v. Pacific Mutual Life Ins. Co., 51 S.W.3d 573, 578 (Tex. 2001) (citing Restatement (Second) of Torts § 531).  The United States District Court for the Southern District of Texas recently stated :

Under this Section, as in the case of a fraudulent misrepresentation (see §531), it is not necessary that the maker should have any particular person in mind as the intended, or even a probable, recipient of the information.  In other words, it is not required that the person who is to become the plaintiff be identified or known to the defendant as an individual when the information is supplied.

In re Enron Corp., 235 F. Supp. 2d at 608 (emphasis added).  Finally, the Restatement itself recognizes that the ultimate plaintiff need not be known to the defendant at the time the misrepresentation is made:

The maker may have reason to expect that his misrepresentation will reach any of a class of persons, although he does not know the identity of the person whom it will reach or indeed of any individual in the class.  Thus the business man who furnishes fraudulent information concerning his credit to the commercial credit agency has reason to expect that it will reach and influence any subscriber of the agency who may be interested in extending credit to him, although he does not know who the subscribers are.  The class may include a rather large group, such as potential sellers, buyers, creditors, lenders or investors, or others who may be expected to enter into dealings in reliance upon the misinterpretation.

Restatement (Second) of Torts § 531, comment e; see also Mid States Development, L.L.C. v. Fidelity Nat’l Title Ins. Co., Inc., No. Civ. A. 399 CV 1966M, 2001 WL 1172215 at *3 (N.D. Tex. Sept. 28, 2001) (applying Section 531 standard and rejecting argument that defendant could not be liable for fraud because it did not know of the existence of the plaintiff entities at the time of the misrepresentation).  UBS’  Motion clearly misstates the law on the element of intent.[2]

2.         UBS had an intent to induce persons within the same class as Plaintiffs to rely on the Prospectus.

 

UBS’  Phokian Potamianos admitted that the reputation of the company’s underwriter is one of the things the investing public relies on.  Potamianos Depo. at p. 61.  And, according to UBS, its name is “a seal of quality guaranteeing trust, dependability, and professionalism ….”  Purcell Affidavit at par. 17.  Potamianos also admitted that investors rely on the research of investment banks like UBS “to sometimes make decisions to invest or divest of stocks.”  Potamianos Depo. at p. 11.  And UBS knew that the proceeds of the Prospectus were to be used in part to acquire other companies.  Exhibit K at pp. 2, 10.

Even though Plaintiffs need not show that UBS intended for them — as opposed to a group of which they are members — to rely, the truth is that UBS knew of Plaintiffs well before the merger between HPL and CTG and had reason to believe they would rely on the Prospectus.  Phokian Potamianos testified that David Lepejian told him that he had had conversations with CTG “for three years before the IPO” and “that once the IPO was completed, he looked forward to the opportunity of merging with TestChip Technologies if they would be more willing to do so with him as a public company.”  Potamianos Depo. at pp. 71-72.  As William Purcell has stated in his affidavit, “HPL and UBS knew and had reason to expect that the Plaintiffs (the primary owners of TestChip Technologies, “TestChip”) would be relying on the HPL IPO Prospectus.”  Purcell Affidavit at pars. 14, 15.  This evidence raises an issue of fact on intent.

D.        Plaintiffs justifiably relied.

1.         Plaintiffs directly relied.

The evidence clearly demonstrates that Plaintiffs Harward, Stoner and Wertheimer relied on the Prospectus, UBS’ role as underwriter of the HPL IPO and UBS’ analyst reports in agreeing to sell their shares in CTG for shares in HPL through the January 2002 merger.  Mark Harward testified that UBS’ underwriting of the HPL IPO was a very important part of his consideration.  Harward Depo at p. 375.  He also testified that he relied on various UBS analyst reports.  Id. at pp. 135, 299-303, 356-57, 375-76, 401-03, 507.  Finally, he testified that he believed that the statements in the Prospectus upon which he relied, including HPL’s audited financials, had been vouched for by UBS as the lead underwriter of the IPO.  Id. at pp. 358, 359, 400, 506-07, 521, 532.

Brenda Stoner also relied on UBS and its role in the drafting of the Prospectus.  Stoner Depo at pp. 122-23, 175, 146, 186, 238, 241.  She also relied on the due diligence she expected a lead underwriter like UBS would engage in before underwriting a public offering.  Id. at p. 147. She relied as well on analyst reports authored by UBS.  Id. at pp. 176-178, 186, 227.  In fact, she testified, she felt that the UBS analyst reports were more reliable than other analyst reports because she knew UBS had been the lead underwriter of HPL’s IPO, had been given greater access to HPL’s financial information and presumably had done more due diligence.  Id. at pp. 176-78, 232-34.   She stated that the UBS analyst report rating HPL stock a Strong Buy “was a very — very strong positive factor” in her agreeing to the merger.  Id. at p. 231.

Similarly, Plaintiff Merrill Wertheimer relied on UBS in agreeing to the merger, including relying on the due diligence he believed they had conducted.  Wertheimer Depo at pp. 30, 40, 175.  He also relied on the fact that UBS was underwriting the HPL IPO.  Id. at 172.  Like Harward and Stoner, Wertheimer also relied on the UBS analyst reports.  Id. at pp. 41, 45.

Plaintiffs Mahant Shetti and Scott Lane also relied on UBS’ analyst reports.  Deposition of Mahant Shetti attached hereto as Exhibit NN at pp. 194-96; Deposition of Scott Lane attached hereto as Exhibit OO at pp. 145-150.  Lane also relied on the Private Placement Memorandum, which he understood UBS had participated in drafting.  Id. at pp. 61-2.  Plaintiff Kenneth Schibler relied on the Prospectus as well, which he believed UBS had a role in preparing.  Deposition of Kenneth Schibler attached hereto as Exhibit PP at pp. 79-80, 82-3, 93, 13,1 142-44.  And Plaintiff Howard Tigelaar also relied on the information in the Prospectus and Joint Information Statement.  Deposition of Howard Tigelaar attached hereto as Exhibit QQ at pp. 92-98, 189-91.  Clearly, the majority of the Plaintiffs directly relied on UBS in entering into the merger.

2.         Plaintiffs indirectly relied.

In addition to directly relying on UBS’ misrepresentations, several of the Plaintiffs indirectly relied on such misrepresentations in deciding to sell their stock in CTG for stock in HPL.  Under Texas law, “[i]ndirect reliance is sufficient to support a fraud claim or the misrepresentations made to an intermediary.”  Ameristar Jet Charter, Inc. v. Signal Composites, Inc., No. Civ. A. 398 CV 1360M, 2001 WL 1172184 at *5 (N.D. Tex. Sept. 28, 2001).  In J.C. Hawkins v. Upjohn Co., 890 F. Supp. 609 (E.D. Tex. 1994), a group of consumers brought suit against a pharmaceutical manufacturer for conspiring to commit fraud and market a known unreasonably dangerous product, namely Halcyon and Xanax.  The manufacturer moved to dismiss the complaint.  In arguing that the Court should dismiss the claim for conspiracy to commit fraud, Upjohn argued that the plaintiffs could not show reliance since the alleged misrepresentations were made to the FDA in order to persuade it to approve marketing of the drugs rather than being made directly to the plaintiffs.  The Court rejected this argument, recognizing that a claim for fraud can proceed based on indirect reliance, stating as follows:

The only element arguably lacking in plaintiffs’ complaint is that of plaintiffs’ acting in reliance on the material misrepresentation, since there is no allegation that plaintiffs relied directly on any representation made by defendants.  However, the allegation of indirect reliance is clear.  Plaintiffs assert that the FDA relied on defendant’s representations in permitting the distribution of the drugs in question within the United States and that plaintiffs relied on the FDA’s assessment as to the drugs’ safety in choosing to use the drugs.  Such indirect reliance is sufficient to state a claim of fraud.

Id. at 612.

There is ample evidence that the other CTG shareholders relied on Harward, Stoner and Wertheimer – officers and controlling shareholders of CTG – in deciding to sell their shares in CTG. For example, Plaintiff Shetti agreed in his deposition that in making his decision to sell his shares in CTG to HPL, he “relied upon Mr. Harward, Mrs. Stoner and Mr. Wertheimer, and the others at CTG to diligently analyze information then available to them.”  Shetti Depo at p. 72.  Similarly, Plaintiff Angela Harward testified that she relied on the decision of her husband, Mark Harward, to sell CTG to HPL and to “diligently analyze the information then available to him in reaching his decision on whether or not to sell CTG to HPL and then recommend a course of action that was in the best interests of CTG and its shareholders.”  Deposition of Angela Harward attached hereto as Exhibit RR at p. 25.  Plaintiff Tom Stoner similarly testified that he relied on his wife, Brenda Stoner, and on Mark Harward to diligently analyze information available to them while reaching their decision.  Deposition of Tom Stoner attached hereto as Exhibit SS at p. 42.  Plaintiffs Scott Lane, Kenneth Schibler and Howard Tigelaar also relied in part on the decisions and judgment of Harward, Stoner and Wertheimer in deciding to sell their stock.  Lane Depo at p. 109; Schibler Depo at pp. 93, 130-31, 216-17; Tigelaar Depo at pp. 54-55, 100-05, 187-90.  Finally, Plaintiffs Mary Schibler, Cathy Tigelaar and Candace Lane testified that they each relied upon their husbands, who relied on the HPL Prospectus, to decide whether to exchange their shares in CTG for shares of HPL.  See Deposition of Mary Schibler attached hereto as Exhibit TT at pp. 18-19; Deposition of Cathy Tigelaar attached hereto as Exhibit UU at pp. 49-50; Deposition of Candace Lane attached hereto as Exhibit VV at pp. 14-15.  As set forth above, such indirect reliance is more than adequate under Texas law.[3] For this reason, the Motion should be denied as to Plaintiffs’ fraud claims.

3.         Reliance is a fact question.

Finally, summary judgment on Plaintiffs’ fraud claim should be denied because issues of reliance present fact questions that are inappropriate for summary judgment.  See, e.g., Jones v. Ray Ins. Agency, 59 S.W.3d 739, 754 (Tex. App.–Corpus Christi 2001, pet. denied) (“ordinarily the issue of reliance in a fraud case is a question of fact”); Dan Lawson & Assoc. v. Miller, 742 S.W.2d 528, 530 (Tex. App.– Fort Worth 1988, no writ) (“Summary judgment should never be granted when the issues are inherently those for a jury or trial judge, as in cases involving intent, reliance, reasonable care, uncertainty and the like.”); Hilton v. Texas Investment Bank, 650 S.W.2d 545, 547 (Tex. App.–Houston [14th Dist.] 1983, no writ) (same).  The evidence set forth above clearly creates an issue of fact regarding Plaintiffs’ direct and indirect reliance which renders summary judgment inappropriate.

III.   The Motion should be denied as to Plaintiffs’ claim for statutory fraud.

A.        UBS made false representations of material fact.

 

As set forth in Section II.A above, UBS made false representations of material fact in the Prospectus and analyst reports.  Plaintiffs incorporate by reference the evidence, argument and authorities set forth in Section II.A above as if fully set forth herein.

B.        UBS had an intent to induce reliance.

 

As set forth inSee Section II.C above, UBS had an intent to induce reliance by Plaintiffs.  UBS knew that potential investors in HPL would rely on the Prospectus and UBS analyst reports in deciding whether to invest in HPL, whether by purchase, merger or acquisition.  Plaintiffs incorporate by reference the evidence, argument and authorities set forth in Section II.A above as if fully set forth herein.

C.        Plaintiffs justifiably relied.

 

As set forth in Section II.D above, there is ample evidence that Plaintiffs relied, both directly and indirectly, on the representations of UBS in the Prospectus and UBS analyst reports in agreeing to sell their shares in CTG for shares in HPL through the Merger.  Moreover, as set forth above, issues of reliance present questions of fact not suitable for summary judgment.  Plaintiffs incorporate by reference the evidence, argument and authorities set forth in Section II.D above as if fully set forth herein.

D.        UBS had actual awareness.

 

Under Section 27.01(d), a defendant may be liable for the misrepresentations of another if he has actual awareness of the falsity of their representation, fails to disclose such falsity to the person defrauded and benefits from the misrepresentation.  UBS moves for summary judgment on the basis that Plaintiffs have no evidence that UBS had actual awareness of the falsity of HPL’s representations.  Under the statute, actual awareness “may be inferred where objective manifestations indicate that a person acted with actual awareness.”  Tex. Bus. & Comm. Code §27.01(a).  In the instant case, there is ample evidence — set forth in detail in Section I.A (2) above — from which UBS’  actual awareness of the falsity of its representations regarding HPL’s financial condition may be inferred.  Such evidence creates a fact issue regarding UBS’  awareness, which mandates that summary judgment be denied.[4]

IV.       The Motion should be denied as to Plaintiffs’ claims for negligent misrepresentation.

 

A.        UBS made false representations of fact.

 

As set forth in Section II.A above, UBS made false representations of material fact in the Prospectus and analyst reports.  Plaintiffs incorporate by reference the evidence, argument and authorities set forth in Section II.A above as if fully set forth herein.

B.        Plaintiffs are within the class of persons entitled to bring a claim for negligent misrepresentation.

 

1.         UBS need not have been aware of the individual Plaintiffs.

 

UBS claims that it is entitled to summary judgment on Plaintiffs’ negligent misrepresentation claim because it did not knowingly communicate any information directly to Plaintiffs.  It states that for liability to attach, it must have supplied information “to a known party for a known purpose.”  Motion at pp. 16-7.  This is simply wrong.  According to the Restatement (Second) of Torts §552, which has been expressly adopted by Texas courts, liability for negligent misrepresentation extends to “a person or one of a limited group of persons for whose benefit and guidance [the defendant] intends to supply the information or knows that the recipient intends to supply it.”  Restatement (Second) of Torts §552(2)(a) (1977).   Comment g of the Restatement rejects the idea that the communication at issue must be made directly to the plaintiff.  Restatement (Second) of Torts  §552, comment g (1977).(“direct communication of the information to the person acting in reliance upon it is not necessary.”).  And Comment h of the Restatement specifically rejects the notion that the defendant must know of the specific identity of the eventual plaintiff, stating that “it is not necessary that the maker should have any particular person in mind as the intended, or even the probably, recipient of the information.”  Restatement (Second) of Torts §552, comment h (1977).  In other words, the Restatement explains, “it is sufficient, in other words, insofar as the plaintiff’s identity is concerned, that the maker supplies the information for repetition to a certain group or class of persons and that the plaintiff proves to be one of them, even though the maker never had heard of him by name when the information was given.”  Id.

Courts applying Texas law have reached this same conclusion.  For example, the United States District Court for the Southern District of Texas recently stated as follows:

Under this Section, as in the case of a fraudulent misrepresentation (see §531), it is not necessary that the maker should have any particular person in mind as the intended, or even a probable, recipient of the information.  In other words, it is not required that the person who is to become the plaintiff be identified or known to the defendant as an individual when the information is supplied.

In re Enron Corp., 235 F. Supp. 2d at 608.  The Dallas Court of Appeals similarly rejected as “too artificial a distinction,” any attempt to construe Section 552 so as to “limit the class of third parties who may recover to those actually and specifically known by the defendant.”  Blue Bell, Inc. v. Peat Marwick Mitchell & Co., 715 S.W.2d 408, 412 (Tex. App. – Dallas 1986, writ ref’d n.r.e.).  UBS’  attempt to limit negligent misrepresentation claims to those specific individuals or entities known by a defendant at the time of the misrepresentation seeks to distort Texas law as well as the Restatement of Torts on which it is based.

2.         Plaintiffs need only show that UBS knew or should have known that a limited group of which Plaintiffs are members would receive the prospectus.

 

In order to be within the limited group of persons entitled to bring a claim for negligent misrepresentation against UBS, Plaintiffs need only show that UBS knew or should have known that a group of which they are members would receive the prospectus.  See, e.g., Blue Bell, 715 S.W.2d at 412 (“We hold that if, under current business practices and the circumstances of that case, an accountant preparing audited financial statement knows or should know that such statements will be relied upon by a limited class of persons, the accountant may be liable for injuries to members of that class relying on his certification of the audited reports.”); see also Cook Consultants, Inc. v. Larson, 700 S.W.2d 231, 234 (Tex. App. – Dallas 1985, writ ref’d n.r.e.) (“The conflicting policies are best harmonized by limiting liability to the person or class of persons whom the maker of the representation intends to benefit or who foreseeably may be expected to rely on the information.”).

The evidence conclusively demonstrates that UBS knew that HPL would receive and rely on this information in the prospectus.  UBS’  Phokian Potamianos admitted that the reputation of the company’s underwriter is one of the things the investing public relies on.  Potamianos Depo. at p. 61. And, according to UBS, its name is “a seal of quality guaranteeing trust, dependability, and professionalism ….”  Purcell Affidavit at par. 17.  Potamianos also admitted that investors rely on the research of investment banks like UBS “to sometimes make decisions to invest or divest of stocks.”  Potamianos Depo. at p. 11.  And UBS knew that the proceeds of the Prospectus were to be used in part to acquire other companies.  Exhibit K at pp. 2, 10.

Even though Plaintiffs need not show that UBS intended for them — as opposed to a group of which they are members — to rely, the truth is that UBS knew of Plaintiffs’ identity well before the merger between HPL and CTG and had reason to believe they would rely on the Prospectus.  Phokian Potamianos testified that David Lepejian told him that he had had conversations with CTG “for three years before the IPO” and “that once the IPO was completed, he looked forward to the opportunity of merging with TestChip Technologies if they would be more willing to do so with him as a public company.”  Potamianos Depo. at pp. 71-12.   The evidence clearly establishes that UBS knew or should have known that potential investors like Plaintiffs would receive and rely on the Prospectus and UBS’ analyst reports. See Purcell Affidavit at pars. 12-15.

C.        Plaintiffs justifiably relied.

 

As set forth in Section II.D above, there is ample evidence that Plaintiffs relied, both directly and indirectly, on the representations of UBS in the Prospectus and UBS analyst reports in agreeing to sell their shares in CTG for shares in HPL through the Merger.  Moreover, as set forth above, issues of reliance present questions of fact not suitable for summary judgment.  Plaintiffs incorporate by reference the evidence, argument and authorities set forth in Section II.D above as if fully set forth herein.

V.        The Motion should be denied as to Plaintiffs’ claims for conspiracy.

The Motion should be denied as to Plaintiffs’ conspiracy claims.  A civil conspiracy is “a combination of two or more persons to accomplish an unlawful purpose, or to accomplish a lawful purpose by unlawful means ….”  Tilton v. Marshall, 925 S.W.2d 672, 680 (Tex. 1996).  In order to establish a conspiracy, the plaintiff must plead and prove the existence of the following:

(1) two or more persons; (2) an object to be accomplished; (3) a meeting of minds on the object or course of action; (4) one or more unlawful, overt acts; and (5) damages as the proximate result.

Massey v. Armco Steel Co., 652 S.W.2d 932, 934 (Tex. 1983).  Texas courts have consistently held that conspiracies may be proven by circumstantial evidence.  As one court has stated, Abecause of the secretive nature of conspiracies, courts allow a  plaintiff to show conspiracy by circumstantial rather than direct evidence.@  Bernstein v. Portland Savings & Loan Ass=n, 850 S.W.2d 694, 705 (Tex. App. B Corpus Christi 1993, writ denied); Chevalier v. Animal Rehabilitation Center, Inc., 839 F. Supp. 1224, 1230 (N.D. Tex. 1993) (AA civil conspiracy need not be shown by direct evidence and is ordinarily established by circumstantial evidence@).  Consistent with this relaxed standard of proof, courts have held that an agreement between the conspirators, one of the predicates of a conspiracy, Aneed not be formal, the understanding may be tacit, and each conspirator need not know the details of the conspiracy.@  Bernstein, 850 S.W.2d at 705.

Many courts have also noted that a conspiracy claim may be proven by reasonable inferences since conspirators are unlikely to formalize their agreements.  The Texas Supreme Court has stated:

When men enter into conspiracies, they are not likely to call in a witness ….  In such cases, the injured party must necessarily have recourse to circumstantial evidence.  For it is only by the inferences and deductions which men properly and naturally draw from the acts of others in such cases, that their intentions can be ascertained.  They are not likely to proclaim them in the hearing of witnesses.

Carroll v. Timmers Chevrolet, Inc., 592 S.W.2d 922, 926 (Tex. 1979); see also International Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567, 581 (Tex. 1963) (Athe general rule is that conspiracy liability is sufficiently established by proof showing concerted action or other facts and circumstances from which the natural inference arises that the unlawful, overt acts were committed in furtherance of common design, intention, or purpose of the alleged conspirators.@  ).

Under the foregoing standards, the uncontroverted facts of the instant case raise a genuine issue of material fact regarding the existence of a meeting of the minds between UBS and HPL.  For example, there is substantial evidence that UBS conspired with HPL to cover up the criminal background of Homi Fatemi.  Prior to HPL’s failed IPO in 2000, Homi Fatemi was an officer of HPL who served as HPL’s Vice President of Sales.  Exhibits E-G.  Before being hired by HPL in 1998, Fatemi plead no contest to a charge of stealing more than $100,000 from his employer, Advanced Micro Devices (“AMD”).  Id. His criminal past was discovered by UBS and HPL “during the underwriting process” for HPL’s attempted 2000 IPO.  Exhibit E; Geva Depo at p. 39.  The discovery of Fatemi’s criminal past was one of the key factors which delayed HPL’s IPO.  Potamianos Depo at pp. 38-39, 132-3.  As UBS’ lead investment banker on the HPL IPO stated:

The principal reason [the 2000 IPO] was delayed was because Homi was effectively on the — was an executive at the firm.  The idea was that Homi would have to stand down from that role, and I think the company went through some decision making as to what his role should be because Homi Fatemi, as I understand it, was quite sort of an important salesperson for the company.  That was my understanding of it.

Potamianos Depo at pp. 38-40.

As a result of the failure of the IPO, Fatemi was supposedly “demoted.”  Geva Depo at p. 39. The “demotion” allowed UBS to omit from the 2001 Prospectus any mention of Fatemi’s criminal past.  Potamianos Depo at 83-4.  In reality, however, Fatemi’s “demotion” was nothing more than window dressing.  The only thing that changed was his title; he did not take a pay cut and CFO Ita Geva could not identify anything that changed with respect to his responsibilities.  Geva Depo at pp. 91-92.  HPL employee Tom Ho testified that he never saw any evidence that Fatemi was demoted or that his duties changed.  Ho Depo at p. 105.  Ho also testified that at the time of the IPO, Fatemi remained “the main sales executive at HPL.”  Ho Depo at pp. 78, 161.  Even a letter from HPL’s attorneys confirmed that Fatemi remained “a sales and marketing director of the company.”  Exhibit E at UBS012224.

Despite his criminal conviction, UBS did nothing to investigate Fatemi’s continued involvement with HPL after the failed 2000 IPO.  As a result, Phokian Potamianos believed that Fatemi was a “junior salesperson.”  Potamianos Depo at p. 87.  Moreover, after his supposed demotion, UBS essentially ignored Fatemi’s criminal past.  Potamianos Depo at pp. 82-3 (“From the moment that Mr. Fatemi was no longer on the executive board, from the moment that Mr. Fatemi was no longer part of management, in principle, he was being managed by others, that was not a focus of mine.”).

AMD, the victim of Fatemi’s fraud, was one of HPL’s major customers.  Exhibit K at p. 37; Exhibit L at p. 3.  After stealing from AMD, Fatemi was fired and his stock options were cancelled.  Clearly investors such as Plaintiffs would consider Fatemi’s conviction of stealing more than  $100,000 from one of HPL’s biggest customers to be material.  Despite this fact, the IPO Prospectus mentioned nothing of Fatemi’s criminal past and merely stated in cryptic fashion that “Mr. Fatemi served as an executive officer of the company until June 2000, at which point he became our Director — Sales & Marketing.”  Exhibit K at p. 44.  Such evidence creates a fact issue regarding the existence of a conspiracy between UBS and HPL.

CONCLUSION AND PRAYER

WHEREFORE, PREMISES CONSIDERED, Plaintiffs pray that the Court deny Defendant UBS Warburg L.L.P.’s Motion for Summary Judgment and award Plaintiffs  such other and further relief to which they are justly entitled.

Respectfully submitted,
HEYGOOD, ORR & PEARSON
2331 W. Northwest Highway
Second Floor
Dallas, Texas 75220
(214) 237-9001 (Telephone)
(214) 237-9002 (Telecopier)


[1] While “general awareness” is not the proper test, Plaintiffs assert that the evidence detailed below raises an issue of fact on both the applicable recklessness standard as well as the general awareness standard advocated by UBS.

[2] UBS’  misstatement of the law in this regard is especially troubling given its citation to Ernst & Young in the same paragraph in which it argues for a standard that is in contravention of the Texas Supreme Court’s pronouncement in that case.  Motion at p. 16.

[3] While the claims of Mr. Stoner, Mrs. Harward, Mrs. Tigelaar, Mrs. Schibler and Mrs. Lane should not be dismissed, the Court should note that dismissal of these claims will not impact Plaintiffs’ ability to recover their full damages herein. The shares in CTG owned by these five plaintiffs were clearly under the sole management and control of their spouses.  In fact, the stock certificates representing the shares in CTG exchanged for shares in HPL were originally issued solely in the names of Brenda Stoner and Messrs. Harward, Tigelaar, Schibler and Lane.  Under Texas law, these shares were under their sole management and control and any claims for damages incurred as a result of their disposition may be brought solely in the names of these Plaintiffs.  See Tex. Fam. Code §§3.102, 3.104 (Vernon 2003); Jean v. Tyson-Jean, 118 S.W.3d 1 (Tex. App. – Houston [14th Dist.] 2003, no pet.); Medenco, Inc. v. Myklebust, 615 S.W.2d 187 (Tex. 1981); Cummings v. Johnson, 616 F.2d 1069 (9th Cir. 1979).

[4] Actual awareness also serves as a predicate for the recovery of exemplary damages for a statutory fraud violation.  While actual damages may be recovered under 27.01(a) without a showing of actual knowledge, to recover exemplary damages, the plaintiff must show that the defendant made “a false representation or false promise with actual awareness of the falsity thereof ….”  Tex. Bus. & Comm. Code §27.01(c).