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Detroit Street Partners Inc. v. Lustig

United States District Court, D. Colorado

July 25, 2019

DETROIT STREET PARTNERS, INC. and BIRCHWOOD RESOURCES INC., Plaintiffs, JAMES A. LUSTIG, ALLIED FUNDING, INC., BENNETT PAUL “BUZZ” ALTERMAN, ALTERMAN HARRISON INVESTMENTS, INC., ARROWHEAD INVESTMENTS, INC., CLFS EQUITIES, LLLP, NANCY DAVIS, DAVIS FAMILY OFFICE, INC., TODD J. EBERSTEIN, GLOBAL CAP LIMITED, INC., WILLIAM HALL, ANDREW HARRISON, HAVEN CAPITAL VENTURES INC., JAL VENTURES CORPORATION, KEN LANDE, LION GATE CAPITAL, INC., MACK INVESTOR GROUP, INC., MELISSA MACKIERNAN, MESA INVESTMENT PARTNERS, LLC, STEWART “SKIP” MILLER, BRANDON PERRY, PINEHURST CAPITAL, INC., PREAKNESS CAPITAL MANAGEMENT INC., QUANDARY CAPITAL INC., RANCHO HOLDINGS, LLC, KENNETH RICKEL, RIO NORTE CAPITAL, INC., SMM INVESTMENTS, INC., WILLIAM SANDLER, STEVE SHOFLICK, UNITED CAPITAL MANAGEMENT, INC., and AARON WOLK, Defendants.

          ORDER GRANTING DEFENDANTS' MOTIONS TO DISMISS IN PART, DISMISSING STATE-LAW CLAIMS WITHOUT PREJUDICE, AND TERMINATING CASE

          William J. Martinez United States District Judge.

         When a company becomes publicly traded on a stock market in the United States, it must go through an “initial public offering, ” or “IPO.” But the very first shares a company offers for sale on a public exchange, known as “IPO shares, ” are not themselves publicly available. Rather, they are allocated amongst major investment banks underwriting the IPO, and the banks offer those shares at a specified price to whomever they wish (more or less). Then the shares may be traded on the stock exchanges, and frequently that trading activity quickly pushes their value much higher than the price at which they were purchased from the investment banks. And because IPO shares so often jump in value once they reach the public markets, well-heeled investors do whatever they must (more or less) to remain on the investment banks' short list of persons to whom IPO shares will be offered.

         This lawsuit is about an allegedly unlawful scheme to curry the investment banks' favor and thus to obtain more IPO shares. Plaintiffs Detroit Street Partners, Inc. (“Detroit Street”), and Birchwood Resources, Inc. (“Birchwood”) (together, “Plaintiffs”), accuse Defendants of using false pretenses to carry out a scheme by which they received many more IPO shares than they would have if they had behaved honestly.

         Before the Court are two motions to dismiss, one each from the “Lustig Defendants”[1] and the “Perry Defendants.”[2] (ECF Nos. 149, 151.) Each motion asks the Court to throw out the case for various and often overlapping reasons. As explained below, the Court grants Defendants' motions as to Plaintiffs' claims for relief arising under federal law because Plaintiffs do not allege a federal claim that reaches Defendants' alleged conduct. And, with no federal claim to pursue, the Court declines to continue exercising jurisdiction over Plaintiffs' claims arising under Colorado law. Those claims will be dismissed without prejudice to refiling in state court.[3]

         I. LEGAL STANDARDS

         The Lustig Defendants' motion raises arguments for dismissal under Federal Rules of Civil Procedure 12(b)(1) and 12(b)(6), and the Perry Defendants' motion raises Rule 12(b)(6) arguments.

         A. Rule 12(b)(1)

         Rule 12(b)(1) permits a party to move to dismiss for “lack of subject-matter jurisdiction.” “[Federal] [d]istrict courts have limited subject matter jurisdiction and may [only] hear cases when empowered to do so by the Constitution and by act of Congress.” Randil v. Sanborn W. Camps, Inc., 384 F.3d 1220, 1225 (10th Cir. 2004) (internal quotation marks omitted). “A court lacking jurisdiction cannot render judgment but must dismiss the case at any stage of the proceedings in which it becomes apparent that jurisdiction is lacking.” Basso v. Utah Power & Light Co., 495 F.2d 906, 909 (10th Cir. 1974).

         Rule 12(b)(1) motions generally take one of two forms: a facial attack or a factual attack. Holt v. United States, 46 F.3d 1000, 1002 (10th Cir. 1995). A facial attack “raises the question whether the complaint, on its face, asserts a non-frivolous claim ‘arising under' federal law.” Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186, 213 n.9 (1974) (quoting 28 U.S.C. § 1331). A factual attack “may go beyond allegations contained in the complaint and challenge the facts upon which subject matter jurisdiction depends.” Holt, 46 F.3d at 1003.

         In this case, the Lustig Defendants bring a facial attack (ECF No. 149 at 2 n.1, 10-15), [4] so the Court cannot stray from the allegations of the complaint.

         B. Rule 12(b)(6)

         Under Rule 12(b)(6), a party may move to dismiss a claim in a complaint for “failure to state a claim upon which relief can be granted.” The 12(b)(6) standard requires the Court to “assume the truth of the plaintiff's well-pleaded factual allegations and view them in the light most favorable to the plaintiff.” Ridge at Red Hawk, LLC v. Schneider, 493 F.3d 1174, 1177 (10th Cir. 2007). In ruling on such a motion, the dispositive inquiry is “whether the complaint contains ‘enough facts to state a claim to relief that is plausible on its face.'” Id. (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). Granting a motion to dismiss “is a harsh remedy which must be cautiously studied, not only to effectuate the spirit of the liberal rules of pleading but also to protect the interests of justice.” Dias v. City & Cnty. of Denver, 567 F.3d 1169, 1178 (10th Cir. 2009) (internal quotation marks omitted). “Thus, ‘a well-pleaded complaint may proceed even if it strikes a savvy judge that actual proof of those facts is improbable, and that a recovery is very remote and unlikely.'” Id. (quoting Twombly, 550 U.S. at 556).

         II. ALLEGATIONS OF THE COMPLAINT

         The Court assumes the following to be true for purposes of resolving Defendants' motions to dismiss. The following narrative comes from Plaintiffs' Amended Consolidated Complaint (ECF No. 83), to which the Court will refer to simply as “the Complaint.” All “¶” citations, without more, are to the Complaint.

         Plaintiffs “are securities traders that opened accounts at eight of the world's most prominent and recognized banks, ” such as J.P. Morgan, Deutsche Bank, Goldman Sachs, Morgan Stanley, and Barclays. (¶ 2.) The Court will refer to these various banks as “the Banks.” Non-party David Berlin controls both Plaintiffs and directs their securities trading. (Id.) At J.P. Morgan, Berlin conducted his trades exclusively through Plaintiff Birchwood until 2013, at which time he began trading exclusively through Plaintiff Detroit Street. At the other Banks, he traded through Birchwood and Detroit Street simultaneously for some time, but has traded through Detroit Street only since 2013. (Id.)

         Before 2008, J.P. Morgan would give preferential IPO share access to investors with at least $10 million in their J.P. Morgan trading accounts. (¶¶ 69-70.) Birchwood met that threshold beginning in 2005, and earned $3 to $5 million dollars per year over the next few years from the sale of IPO shares offered to it by J.P. Morgan. (¶ 69.)

         In 2008, “without notifying Birchwood, J.P. Morgan changed its policy such that it would allocate IPO Shares to its private banking clients based on the amount of commission revenue each account generated for J.P. Morgan through trading in securities, rather than the amount each account had on deposit.” (¶ 70.) Under the new policy, “of which Birchwood was at first unaware, ” those with at least $10 million on account and those who generated at least $600, 000 in trading commissions (regardless of the size of the account) would compete for preference when J.P. Morgan had IPO shares to allocate. (¶ 71.) Going forward, “[t]o remain top-tier clients, and thereby to receive the most IPO Share allocations, a J.P. Morgan customer would have to generate as much as $100, 000 in commissions every month.” (Id. (emphasis removed).) Moreover,

[b]ecause of the way J.P. Morgan's rules were structured, multiple clients generating trading commissions for it would collectively be allocated a larger number of IPO Shares by J.P. Morgan than an individual client generating the same total amount of commission[s]. For example, if Companies A, B, C, D, and E each separately generated $600, 000 in commissions for J.P. Morgan in one year, for a total of $3 million, the total number of IPO Shares that were allocated to them, collectively, would be larger than the number of IPO Shares allocated to Company F, which had itself generated $3 million in commissions for J.P. Morgan that same year.

(¶ 72.)

         This commission-based system for earning IPO share preference was already in place at the Banks other than J.P. Morgan from the time Plaintiffs began trading at those Banks in 2006. (¶ 75.) As with the post-2008 J.P. Morgan system, the other Banks each required “as much as $100, 000 in commissions every month” to “remain top tier clients, ” but the “rules were structured such that multiple clients generating trading commissions for any one Bank would collectively be allocated a larger number of IPO Shares by that Bank than an individual client generating the same total amount of commission[s].” (¶¶ 75-76.)

         Sometime in or around the year 2011, Defendants, led by Defendant James Lustig, devised or participated in a scheme to take advantage of the Banks' IPO share allocation policies. Specifically, Defendants set up numerous entities (“Affiliates”), which then opened trading accounts with the Banks. (¶ 9.) When opening these accounts, the Affiliates would state on required forms that they were capitalized through personal and family wealth and that no “restricted person” had a beneficial interest in trading profits. (¶ 87(b), (i).) In truth, they were actually capitalized through money loaned by the Lustig Defendants, and Lustig would qualify as a restricted person with a beneficial interest. (Id.) Once the accounts were opened, the Affiliates would conduct trades at the Lustig Defendants' direction solely for the purpose of generating commissions-usually by selling a quantity of a certain stock through one Bank and soon after buying the same quantity of the same stock through a different Bank. (¶ 87(c)-(h).) The Affiliates thus generated commissions at two Banks but also limited their exposure to the economic consequences of the trades. The Affiliates then received IPO share allocations, sold those shares at a profit on the open market, and remitted up to 40% of the profits to the Lustig Defendants. (¶ 87(k).)

         This scheme

enabled Lustig to profit from a far greater number of IPO Shares than he would have had he simply generated commissions for the Banks in his own account with each Bank through legitimate trading. Indeed, but for the [scheme], the majority of the IPO Shares that Lustig has received and/or profited from would, under the policies of the Banks, instead have been allocated to Plaintiffs and other innocent clients of the Banks.[5] As a result of the [scheme], Plaintiffs have seen a steady decrease in the amount of IPO Shares allocated to them, and thus a steady decrease in the profits that they have earned on the sale of such IPO Shares.

(¶ 17.)

         III. PROCEDURAL HISTORY & CLAIMS FOR RELIEF

         Plaintiffs filed this lawsuit on December 13, 2017, naming various of the Defendants, some of whom have since been dismissed. (See ECF No. 1.) On January 24, 2018, for reasons not important to recount here, Plaintiffs filed a separate lawsuit, Civil Action No. 18-cv-0190, that was, in substance, an amendment to the original complaint in this lawsuit. The Court consolidated the two lawsuits and gave Plaintiffs leave to file an amended consolidated complaint. (ECF No. 78.)

         The Amended Consolidated Complaint-what the Court refers to as “the Complaint”-asserts fifteen claims for relief:

• knowingly conducting or participating in an enterprise through a pattern of racketeering activity, in violation of the Colorado Organized Crime Control Act (“COCCA”), Colo. Rev. Stat. § 18-17-104(3) (“Claim 1”);
• using proceeds knowingly derived from a pattern of racketeering activity to invest in an enterprise, in violation of COCCA, § 18-17-104(1)(a) (“Claim 2”);
• using a pattern of racketeering activity to knowingly acquire an interest in an enterprise, in violation of COCCA, § 18-17-104(2) (“Claim 3”);
• conspiracy to violate COCCA, § 18-17-104(4) (“Claim 4”);
• employing a device, scheme, or artifice to defraud in connection with securities, in violation of the Colorado Securities Act (“CSA”), Colo. Rev. Stat. § 11-51-501(1)(a) (“Claim 5”);
• making fraudulent statements or material omissions in connection with securities, in violation of the CSA, § ...

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