Case 1:11-cv20549KMW Document 47 Entered on FLSD Docket 05/02/2011 Page 1 of 35
IN THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF FLORIDA
MIAMI-DADE DIVISION
SID MURDESHWAR,
Plaintiff,
Case No. 1:1 1-cv-20549-UU
SEARCHMEDIA HOLDINGS LIMITED etal.,
Defendants.
MOTION TO DISMISS AMENDED COMPLAINT BY DEFENDANTS SEARCHMEDIA HOLDINGS LIMITED, PHILLIP FROST, ROBERT FRIED, RAO UPPALURI, STEVEN RUBIN, GLENN HALPRYN,
THOMAS BEIER, DAVID MOSKOWITZ, AND SHAWN GOLD
Tracy A. Nichols, Esq. Louise McAlpin, Esq. Stephen P. Warren, Esq. HOLLAND & KNIGHT LLP 701 Brickell Ave., Suite 3000 Miami, FL 33131
Attorneys for Defendants SearchMedia Holdings Limited, Robert Fried, Phillip Frost, Rao Uppaluri, Steven Rubin, Glenn Halpryn, Thomas Beier, David Moskowitz, and Shawn Gold
Case 1:11-cv20549KMW Document 47 Entered on FLSD Docket 05/02/2011 Page 2 of 35
TABLE OF CONTENTS
INTRODUCTION
1
STATEMENT OF FACTS
2
PROCEDURAL HISTORY
7
ARGUMENT
8
1. PLAINTIFFS HAVE FAILED TO STATE A CLAIM FOR SECURITIES FRAUD AGAINST SEARCHMEDIA OR THE IDEATION DEFENDANTS UNDER SECTION 10(b) OF THE EXCHANGE ACT . ................................................................... 8
A. The Amended Complaint Does Not Plead Particular Facts Giving Rise to a Strong Inference that the Ideation Defendants Acted with Scienter........................9
B. Plaintiffs Have Failed to Plead Facts Giving Rise to a Strong Inference that SearchMedia Had Scienter.....................................................................................15
C. The Amended Complaint Fails to Attribute the Pre- and Post-Merger Statements to the Ideation Director Defendants . ................................................... 16
II. THE AMENDED COMPLAINT FAILS TO STATE A SECTION 14(a) CLAIM AGAINST THE IDEATION DEFENDANTS OR SEARCHMEDIA. ............................ 20
A. Plaintiffs Have Not Sufficiently Pled that the Opinions Underlying the Section 14(a) Claim Were Subjectively False . ...................................................... 22
B. The Ideation Defendants Were Not Negligent in Failing to Uncover the Accounting Improprieties at SMIL Prior to the Merger . ....................................... 23
III. THE AMENDED COMPLAINT FAILS TO ADEQUATELY ALLEGE A CLAIM FOR "CONTROL PERSON" LIABILITY . ...................................................................... 27
CONCLUSION..............................................................................................................................28
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TABLE OF AUTHORITIES
Page(s) CASES
Brown v. Enstar Group, Inc., 84 F.3d 393 (11th Cir. 1996)
Bruhl v. Conroy, No. 03-23044-Civ, 2007 WL 983228 (S.D. Fla. Mar. 27, 2007)
Bryant v. Avado Brands, Inc., 187 F.3d 1271 (llthCir. 1999) ................................................................................
California Pub. Employees'Ret. Sys. v. Chubb Corp., CIV. NO. 00-4285(GEB), 2002 WL 33934282 (D.N.J. June 26, 2002) ..................
Desaigoudar v. Meyercord, 223 F.3d 1020 (9th Cir. 2000)
Durgin v. Mon, 659 F. Supp. 2d 1240 (S.D. Fla. 2009)
Fisher v. Kansas, 467 F. Supp. 2d 275 (E.D.N.Y. 2006) ......................................................................
Gaines v. Guidant Corp., 1:03CV00892-SEB-WTL, 2004 WL 2538374 (S.D. Ind. Nov. 8, 2004) .................
Gould v. Am. Hawaiian S.S. Co., 351 F. Supp. 853 (D. Del. 1972)...................................................................
Harris v. IVAX Corp., 182 F.3d 799 (11th Cir. 1999) ......................................................................
Hayes v. Crown Central Petroleum Corp., 78 Fed Appx. 857 (4th Cir. 2003).................................................................
Hubbard v. BankAtlantic Bancorp, Inc., 625 F. Supp. 2d 1267 (S.D. Fla. 2008) .........................................................
In re Bank ofAmerica Corp. Sec., Deny, and ERISA Litig., No. 09 MD 2058 (PKC), 2010 WL 3448194 (S.D.N.Y. Aug. 27, 2010) .....
28
17.18
3,8
12
20
18,19
.20, 22
11
24, 26, 27
20
.20, 22
3,27
22
In re Bayou Hedge Fund Litig., 534 F. Supp. 2d 405 (S.D.N.Y. 2007), affd sub nom. S. Cherry St., LLC v. Hennessee Group LLC, 573 F. 3d 98 (2d Cir. 2009) ..................................................................................11
11
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In re Eagle Building Tech., Inc. Sec. Litig., 319 F. Supp. 2d 1318 (S.D. Fla. 2004).
In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248 (ND. Cal. 2000) ........................................................
In re Nokia Corp. Sec. Litig., 1998 U.S. Dist. LEXIS 4100 (S.D.N.Y. Mar. 31, 1998) ..............................
In re Pegasus Wireless Corp. Sec. Litig., 657 F. Supp. 2d 1320 (S.D. Fla. 2009) .................................
In re Sensormatic Elecs. Corp. Sec. Litig., No. 018346, 2002 WL 1352427 (S.D. Fla. June 10, 2002)..
In re Sunterra Corp. Sec. Litig., 199 F. Supp. 2d 1308 (M.D. Fla. 2002) ................................
In re Technical Chem. Sec. Litig., 2001 WL 543769 (S.D. Fla. Mar. 20, 2001).........................
In re Textainer Partnership Sec. Litig., 2005 WL 3801596 (ND. Cal. Feb. 17, 2006)
In re Tibco Software, Inc. Sec. Litig., No. C-05-2146-SBA, 2006 WL 1469654 (ND. Cal. May 25, 2006)
In re Verisign, Inc. Deny. Litig., 531 F. Supp. 2d 1173 (ND. Cal. 2007)
12
12, 22, 24, 25
11
17, 18, 19
17
14
19
22
10
.20, 27
Knollenberg v. Harmonic, Inc., 152 Fed. Appx. 674 (9th Cir. 2005)..........................................................................
Mathews v. Centex Telemanagement, Inc., No. C-92-1837-CAL, 1994 WL 269734 (ND. Cal. June 8, 1994) ..........................
Mizzaro v. Home Depot, Inc., 544 F.3d 1230 (11th Cir. 2008)
Plumbers & Pipe/Itters Local Union 719 Pension Fund v. Zimmer-Holdings, Inc., 1:08-CV-01041-SEB-DM, 2011 WL338865 (S.D. Ind. Jan. 28, 2011) ..................
Podany v. Robertson Stephens, Inc., 318 F. Supp. 2d 146 (S.D.N.Y. 2004).
Rosenzweig v. Azurix Corp., 332 F.3d 854 (5th Cir. 2003)
20
10
passim
11
23
14
iii
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Roth v. OfficeMax, Inc., 527 F. Supp. 2d791 (ND. Ill. 2007) .......................................................................................12
Rudolph v. Utstarcom, 560 F. Supp. 2d 880 (N.D. Cal. 2008) .....................................................................................27
Schultz v. Applica Inc., 488 F. Supp. 2d 1219 (S.D. Fla. 2007) ....................................................................................16
Shidler v. All American Life & Fin. Corp., 775 F. 2d. 917 (8th Cir. 1985) .....................................................................................20, 24, 27
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007)...................................................................................................................9
Theoharous v. Long, 256 F.3d 1219 (11th Cir. 200 1) ...............................................................................................28
Trans World Corp v. Odyssey Partners, 561 F. Supp. 1315 (S.D.N.Y. 1983).........................................................................................24
STATUTES
15 U.S.C. §78t(a) ..........................................................................................................................27
15 U.S.C. §78u-4(b)(1) ...................................................................................................................8
15 U.S.C. §78u-4(b)(2) ...................................................................................................................8
OTHER AUTHORITIES
Daniel S. Floyd et al., Securities Litigation (2011) .......................................................................15
Rule14a-9 ......................................................................................................................................20
lv
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INDEX OF EXHIBITS
Document
Ideation Form S-1/A
Exhibit 99.1 to Ideation Form 8-K
Ideation Form 8-K
Ideation Form 424133
P. Frost Form 4
SearchMedia Form 8-K
P. Frost Form 4
Exh. 99.1 to SearchMedia Form 8-K
SearchMedia Form 6-K
SearchMedia Form 10-Q
P. Frost Form 4
R. Uppaluri Form 4
S. Rubin Form 4
R. Fried Form 4
P. Frost Form 4
Date Filed with Securities and
Exchange Commission
Nov. 1, 2007
Apr. 1, 2009
Apr. 6, 2009
Oct. 5, 2009
Jan. 8, 2010
Jan. 6, 2010
Jan. 26, 2010
Feb. 3, 2010
Nov. 16, 2010
Dec. 16, 2010
Feb. 1, 2010
Nov. 28, 2007
Nov. 28, 2007
Nov. 28, 2007
Nov. 28, 2007
Exhibit No.
A
B
C
D
E
F
U
H
I
J
K
L
M
N
0
v
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MOTION TO DISMISS
Pursuant to Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure and the
Private Securities Litigation Reform Act of 1995 ("PSLRA"), Defendants SearchMedia Holdings
Limited, Robert Fried, Phillip Frost, Rao Uppaluri, Steven Rubin, Glenn Halpryn, Thomas Beier,
David Moskowitz and Shawn Gold move to dismiss the Amended Complaint. [D.E. 4 .]
MEMORANDUM OF LAW
Introduction
In 2009, Ideation Acquisition Corp. ("Ideation") acquired SearchMedia International
Limited ("SMIL"), a Chinese media company (the "Merger"). The combined company changed
its name to SearchMedia Holdings Limited ("SearchMedia"). After the Merger, SearchMedia's
new management and the Ideation directors who stayed on the board of the surviving company
discovered that the prior owners at SMIL had substantially inflated the financial results that
Ideation and its shareholders relied on in deciding to buy the Chinese company. Over a ten-
month period in 2010, SearchMedia brought in new officers to run the company, conducted an
internal review, publicly disclosed the findings to investors and the Securities and Exchange
Commission ("SEC"), restated SMIL's financial statements, implemented remedial measures,
and commenced legal proceedings against SMIL's management.
In this case, Plaintiffs have sued not only the SMIL wrongdoers but also the other
victims—Ideation's former management and SearchMedia—under Section 14(a) of the Securities
Exchange Act for alleged misstatements in the proxy seeking approval of the Merger and under
Section 10(b) of the Securities Exchange Act for allegedly-false statements made before and
after the Merger. Plaintiffs plead no facts nor plausible theory to explain why any rational
person muchless successful entrepreneurs who committed substantial resources to this
transaction, made nothing and lost substantial amounts when they announced the accounting
1
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problems wouldintentionally enter into a transaction and knowingly overpay for a company
whose audited revenues turned out to be woefully overstated. As such, the claims asserted
against the Ideation Defendants and SearchMedia should be dismissed.
Statement of Facts
Ideation was formed in 2007 by a group of experienced business executives, including
Dr. Phillip Frost, a successful entrepreneur with extensive experience building companies such
as IVAX Corp. and, Robert Fried, a digital media entrepreneur and accomplished motion picture
producer with many years of experience founding and operating traditional and digital media
companies. (Am. Compl. ¶J 1, 4.) They were joined by Rao Uppaluri, Steven Rubin, Thomas
Beier, Shawn Gold, Glenn Halpryn, and David Moskowitz. Id. ¶ 4. Together, this group is
referred to as the Ideation Defendants.
Ideation was a Special Purpose Acquisition Company formed for the purpose of
acquiring or merging with one or more businesses. Id. ¶ 2. In connection with the formation of
Ideation, certain of the Ideation Defendants and their affiliates bought $2.4 million of Ideation
common stock and warrants in a November 2007 private placement. (Am. Compl. ¶ 4.) The
common stock issued to Ideation's management in the private placement was placed into escrow
and could not be released until one year after a business combination was completed. See Exh.
A at 12.1 The warrants were similarly held in escrow until 90 days following a business
combination. Id. at 76. To fund the business combination, Ideation conducted an initial public
offering ("IPO") of its stock and warrants in November 2007 that raised gross proceeds of $80
1 Although Ideation's registration statement is not cited or quoted in the Amended Complaint, the Court may take judicial notice of SEC filings and consider them in ruling on this motion to dismiss. See Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1278 (11th Cir. 1999); Hubbard v. BankAtlantic Bancorp, Inc., 625 F. Supp. 2d 1267, 1279 (S.D. Fla. 2008). All of the exhibits attached to this Motion were filed with the SEC.
2
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million. (Am. Compl. ¶ 2.) Certain of the Ideation Defendants and their affiliates purchased
$1.25 million of securities in the IPO. See Exhs. L-O. Ideation advised that it would only
acquire a business with audited financial statements and a fair market value that was at least
equal to 80% of Ideation's net assets. (Am. Compl. ¶ 3.a.)
Following the IPO, Ideation's management began evaluating prospective businesses.
Ideation ultimately identified a total of 122 companies for potential consideration. In the fall of
2008, Ideation began exploring opportunities in China and engaged Oppenheimer & Co. as its
financial advisor. See Exh. Dat 100-01.
SearchMedia International Limited
In November 2008, Ideation learned about a company named SMIL. Formed in 2005,
SMIL was a privately-held media company that was purported to be one of the largest integrated
operators of outdoor billboard and in-elevator advertising networks in China. (Am. Compl. ¶ 5.)
SMIL's largest shareholder was the global financial services company Deutsche Bank AG.,
which had made a substantial investment in an August 2007 private placement of SMIL's stock.
See Exh. Dat 164, 231.
Between November 2008 and April 2009, Ideation's management, its financial advisor,
and its legal advisors in the U.S. and China participated in numerous discussions and meetings
with SMIL's board of directors and management, traveled to SMIL's headquarters, reviewed
SMIL's diligence items, toured SMIL's facilities and media locations in China, interviewed
clients of SMIL, and negotiated the terms of a potential acquisition. Id. at 101-04. In March
2009, Ideation retained BDO China Shu Lun Pan Certified Public Accountant to review the
finances and internal controls of SMIL's largest subsidiaries. Id. at 104. Later that month,
Ideation's board of directors voted unanimously to approve a business combination with SMIL.
Id.
3
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In April 2009, Ideation announced that it had agreed to merge with SMIL. If the Merger
was approved by Ideation's stockholders, Ideation would be renamed SearchMedia and SMIL's
shareholders would receive approximately 44% ownership in the surviving entity. (Am. Compl.
¶ 5.) Ideation explained that SMIL's existing China-based management team would remain in
place. Ideation also disclosed that The Frost Group, LLC, a private investment firm in which
Frost, Uppaluri and Rubin are members, had committed to purchase up to $18.25 million of
Ideation shares to support the Merger and ensure a minimum level of cash after closing. See
Exh. D at 4.
Ideation Mails Proxy to Shareholders
On October 5, 2009, Ideation mailed a definitive proxy statement/prospectus ("Proxy") to
its shareholders. The Proxy included SMIL's historical financial statements for 2007 and 2008,
which had been audited by the independent accounting firm of KPMG. See Exh. D at F-36-79.
KPMG opined that SMIL's financial statements presented fairly in all material respects the
financial condition of SMIL in accordance with accounting principles generally accepted in the
United States of America ("U.S. GAAP"). Id. at F-36.
The Proxy explained that Ideation's board of directors had determined that SMIL satisfied
the 80% fair market value requirement. Id. at 115. Based on a variety of analyses, including
comparisons to three companies in the outdoor advertising industry that were directly
comparable to SMIL, Ideation's board derived a minimum equity valuation of $176.7 million for
SMIL. Id. That valuation substantially exceeded the $60.9 million value that was required to
satisfy the 80% test. Id.
4
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Ideation Warned About Certain Merger Risks
Although Ideation's board of directors had voted in favor of merging with SMIL, it
recognized that the Merger was not without risk. The Proxy contained no fewer than sixty-one
"Risk Factors." Id. at 37-63. One of the risk factors related to SMIL's failure to maintain
internal controls. The Proxy disclosed that KPMG had previously found deficiencies in SMIL's
internal control procedures which, in the judgment of KPMG, adversely affected SMIL's ability
to initiate, authorize, record, process and report financial data reliably in accordance with GAAP
such that there was more than a remote likelihood that a misstatement of its financial statements
that was more than inconsequential would not be prevented or detected. The Proxy explained
that although SMIL had undertaken remedial steps to correct these control deficiencies, the
"implementation of these measures may not fully address these control deficiencies, and to date
these control deficiencies have not been remedied." Id. at 39.
Ideation also warned that SMIL had rapidly acquired a large number of companies that
had various degrees of, and frequently lacked, systems and controls. Id. at 37. Ideation
explained that if measures to integrate the acquired companies were not successful, SMIL had
"limited ability to detect and prevent material inaccuracies, misstatements or even fraud at the
acquired businesses." Id. Ideation also warned that "[although SearchMedia has conducted due
diligence with respect to its acquisitions, it may not have implemented sufficient due diligence
procedures and may not be aware of all of the risks and liabilities associated with such
acquisitions." Id. at 38.
Shareholders Approve the Merger
On October 27, 2009, Ideation's shareholders approved the Merger. As planned, Ideation
changed its name to SearchMedia. Certain members of Ideation's board of directors remained in
place following the acquisition, while others did not. Defendants Fried, Rubin, and Halpryn
5
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became non-employee, outside directors of SearchMedia. Defendants Frost, Uppaluri, Beier,
Gold, and Moskowitz resigned their positions. No member of Ideation's management or board
assumed any managerial, officer or employee role in SearchMedia. (Am. Compl. ¶J 27-34.)
In December 2009, SearchMedia's board of directors authorized a stock and warrant
repurchase program through which the Company repurchased $3.8 million in warrants in January
2010. See Exh. J at 16. Additionally, one member of The Frost Group bought 50,000 shares of
SearchMedia common stock in the open market in January 2010. See Exhs. E, G, K.
Over the next several months, SearchMedia made several changes to its management
team. In January 2010, the Company brought in Wilfred Chow, who had nearly 20 years of
experience in financial markets in China, as the Chief Financial Officer. See Exh. F. The
following month, the Company appointed Paul Conway, who had previously served as Managing
Director of Media Investment Banking at Oppenheimer & Co., as SearchMedia's Chief
Executive Officer. See Exh. H.
SearchMedia Delays Filing of Annual Report and Begins to Discover Items Leading to Restatement
In March 2010, SearchMedia announced that it would delay the filing of its annual report
because its review of the 2009 financial results was "taking longer than anticipated as the
Company is assessing the materiality of certain uncollectible accounts receivable related to sales
generated primarily in the in-elevator business, which the Company believes will likely result in
significant adjustments from previously disclosed estimated financial results for 2009." (Am.
Compl. ¶ 73.) The Company also disclosed that that it was discussing appropriate remedies with
several of the original SMIL shareholders including cancellation of shares they received in the
Merger. Id.
6
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In April 2010, the Company provided an update on its internal accounting review and
released preliminary unaudited financial results for 2009. Id. ¶ 76. It explained that following
the Merger, the Company had discovered "operational and other issues" in the in-elevator
division and that it had responded by bringing in new senior management" (i.e., Conway and
Chow). Id. The Company further disclosed that, as a result of the Company's investigation, it
appeared the Company would reverse approximately $16 to $18 million of revenue previously
reported for the first nine months of 2009. Id
In August 2010, SearchMedia disclosed that the impact of the accounting issues had
expanded and that, as a result of its ongoing investigation, the Company would restate SMIL's
financial statements for 2007 and 2008. Id ¶ 80. The Company disclosed that it estimated that
SMIL had overstated its revenue in 2007 and 2008 by approximately $6 million and $25 million,
respectively. Id. The Company further stated that it was continuing to pursue legal remedies
against former SMIL owners, including cancellation of their shares acquired in the Merger. Id.
In November 2010, SearchMedia filed its annual report for 2009 and restated SMIL's
financial statement for 2008. Id. ¶ 90. Notably, the restatement pertained entirely to accounting
issues that pre-dated the Merger. A short time later, the Company announced that it had
"commenced claims against the former shareholders and directors of [SMIL] for breaches of
representations, warranties and covenants contained in the [Merger's] Share Exchange
Agreement." Exh. I.
Procedural History
This lawsuit was commenced in September 2010 as a proposed class action for two
purported subclasses: (a) those who purchased SearchMedia (formerly Ideation) securities
between April 1, 2009 and August 20, 2010; and (b) those who held Ideation common stock on
October 2, 2009 and were eligible to vote at Ideation's shareholder meeting on October 27, 2009.
7
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(Am. Compi. ¶ 1)2 The Amended Complaint asserts claims under Sections 10(b), 14(a), and
20(a) of the Securities Exchange Act of 1934. Under the Section 14(a) claim, Plaintiffs allege
the Defendants made actionable misstatements and omissions in the preliminary and definitive
proxies issued in connection with the Merger. Under the Section 10(b) claim, Plaintiffs contend
the Defendants made materially misleading statements and omissions about SMIL's financial
results and future prospects in the proxies and public statements before and after the Merger.
The Section 20(a) claim purports to hold the individual defendants vicariously liable for primary
violations by the corporate defendants.
Argument
I. PLAINTIFFS HAVE FAILED TO STATE A CLAIM FOR SECURITIES FRAUD AGAINST SEARCHMEDIA OR THE IDEATION DEFENDANTS UNDER SECTION 10(b) OF THE EXCHANGE ACT.
To state a securities fraud claim under Section 10(b) of the Securities Exchange Act of
1934, a plaintiff must show: (1) a misstatement or omission; (2) of a material fact; (3) made with
scienter; (4) on which the plaintiff justifiably relied; and (5) that proximately caused the
plaintiff's injury. Bryant, 187 F.3d at 1281. The PSLRA imposes two additional pleading
requirements. First, the plaintiff must identify "each statement alleged to have been misleading"
and provide the specific reasons why each statement was misleading. 15 U.S.C. § 78u-4(b)(1).
Second, for each alleged misrepresentation or omission, the plaintiff must "state with
particularity the facts giving rise to a strong inference that the defendant acted with the required
2 The named Defendants are SearchMedia, SMIL, the Ideation Defendants (Frost, Fried, Uppaluri, Rubin, Beier, Gold, Halpryn, and Moskowitz), SMIL's management team (Garbo Lee, Qinying Liu, Earl Yen, and Jennifer Huang), and Searchlvledia's CEO (Paul Conway). Plaintiffs have not yet served the Complaint and summons on the SMIL Defendants and Conway, who reside in China. This Court has ordered that "any Defendant for whom a return of service is not filed on or before July 29, 2011 SHALL be dismissed without prejudice." [D.E. 43.]
Case 1:11cv-20549KMW Document 47 Entered on FLSD Docket 05/02/2011 Page 15 of 35
state of mind [i.e., scienter]." 15 U.S.C. § 78u-4(b)(2). Plaintiffs' failure to satisfy the
heightened particularity and scienter pleading requirements is discussed in more detail below.
A. The Amended Complaint Does Not Plead Particular Facts Giving Rise to a Strong Inference that the Ideation Defendants Acted with Scienter.
The Amended Complaint fails to plead particular facts giving rise to a strong inference
that the Ideation Defendants acted with scienter. In determining whether a strong inference of
scienter exists, the Court must take into account plausible opposing inferences. Tellabs, Inc. v.
Makor Issues & Rights, Ltd., 551 U.S. 308, 314 (2007). It is not enough for a plaintiff to assert
purely speculative theories. Instead, the facts alleged must give rise to a strong inference of
scienter that is "more than merely reasonable or permissible" and the inference of scienter must
be "cogent and at least as compelling as any opposing inference of nonfraudulent intent." Id. at
314. "In sum, the reviewing court must ask: When the allegations are accepted as true and taken
collectively, would a reasonable person deem the inference of scienter cogent and at least as
compelling as any opposing inference?" Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1240
(11th Cir. 2008) (citations omitted).
The allegations in the Amended Complaint, viewed collectively, support only one
plausible inference (and if not the only inference, certainly the most compelling one): the
Ideation Defendants were the victims, not the perpetrators, of a fraud. The Ideation Defendants
committed significant personal resources in support of this transaction. It is economically
nonsensical to suggest—as Plaintiffs do thatthe Ideation Defendants would knowingly pursue
an acquisition based on a price they knew to be substantially inflated. It also defies economic
logic to believe that three Ideation directors (Frost, Rubin, and Uppaluri) would agree to make
additional purchases of Ideation stock (up to $18.25 million) in support of the Merger even
9
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though they knew, under Plaintiffs' theory, that the stock price was significantly inflated. See
Exh. C at 4.
Investments after the Merger likewise support only one plausible inference rebutting
any notion of scienter. Immediately after the Merger, SearchMedia's board of directors approved
a stock and warrant repurchase program up to $5 million, through which the Company
repurchased $3.8 million of its warrants. See Exh. J at 16. These warrant repurchases, which
confirm the Ideation Defendants' belief that SearchMedia's stock was undervalued, not
artificially inflated, negate any inference of scienter. See In re Tibco Software, Inc. Sec. Litig.,
No. C-05-2146-SBA, 2006 WL 1469654, at *18 (N.D. Cal. May 25, 2006) ("Stock repurchase
programs actually negate a finding of scienter."); Mathews v. Centex Telenianagenient, Inc., No.
C-92-1837-CAL, 1994 WL 269734, at *6 (N.D. Cal. June 8, 1994) (noting in Section 10(b)
lawsuit that it "would have made no sense" for the corporation to repurchase its own stock "if
defendants knew the prices to be inflated"). At the same time of the warrant repurchase, one of
the Ideation Defendants purchased a substantial number of SearchMedia shares on the open
market, further negating any inference of scienter. See Exhs. K-M.
It was only after a new CFO and new CEO were installed in January and February 2010
that the Company began to unravel the accounting improprieties committed by SMIL prior to the
Merger. That was followed by an announcement from the new CEO that certain accounts
receivable related to the in-elevator division were not collectible. (Am. Compl. ¶ 73.) In August
2010, the Company announced for the first time that it could not substantiate certain revenues
and that it would restate SMIL's financial statements for 2007 and 2008. Id. ¶ 80. The Company
subsequently announced that it had commenced legal action against the former shareholders and
directors of SMIL.
10
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This pattern of events gives rise to a strong inference that the Ideation Defendants first
learned about accounting improprieties after the Merger. The Amended Complaint does not
point to one specific fact, internal report, or confidential witness statement that indicates the
Ideation Defendants knew prior to the Merger of any of the accounting problems that eventually
led to the restatement. To the contrary, the facts pled show exactly the opposite.
One of the most compelling facts that Plaintiffs admit is that the Ideation Defendants
voluntarily disclosed the problems with SMIL's accounting and operations once they and new
management discovered them. See Gaines v. Guidant Corp., 1:03CV00892-SEB-WTL, 2004
WL 2538374, at *18 (S.D. Ind. Nov. 8, 2004) ("[I]n light of Defendants' repeated, voluntary
disclosures of negative information regarding Ancure, as contained in the Complaint, the
allegations considered as a whole preclude a strong inference of scienter."); Plumbers &
Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, Inc., 1:08-CV-01041-SEB-DM,
2011 WL 338865, at *18 (S.D. Ind. Jan. 28, 2011) ("Defendants' openness in discussing the
matter in April and May actually weighs against a conclusion of scienter on their part."); In re
Nokia Corp. Sec. Litig., 1998 U.S. Dist. LEXIS 4100, at *38 (S.D.N.Y. Mar. 31, 1998) (finding
that voluntarily disclosing negative information "undercuts" allegation that defendants acted
recklessly). They did so to their financial detriment inasmuch as their shares were still subject to
a lock-up agreement.
Without any facts to demonstrate that the Ideation Defendants actually knew about the
accounting improprieties at SMIL before the Merger, Plaintiffs instead speculate that the
Ideation Defendants must have been severely reckless for failing to uncover the accounting
issues during their pre-Merger investigation because they "held themselves out as sophisticated
veterans in the arena of mergers and acquisitions" and "represented that they had conducted due
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diligence of SMIL." (Am. Compl. ¶J 96, 98.) Conclusory allegations that a defendant failed to
conduct adequate due diligence do not support an inference of scienter. See In re Bayou Hedge
Fund Litig., 534 F. Supp. 2d 405, 416 (S.D.N.Y. 2007) ("South Cherry's alternative allegation
that Hennessee Group failed to perform due diligence commensurate with industry standards is
inadequate to plead scienter."), affd sub nom. S. Cherry St., LLC v. Hennessee Group LLC, 573
F.3d 98 (2d Cir. 2009); see also California Pub. Eniployees'Ret. Sys. v. Chubb Corp., CIV. NO.
00-4285(GEB), 2002 WL 33934282, at * 19 (D.N.J. June 26, 2002) (rejecting plaintiffs'
argument that defendants "must have" known about the true facts at target company because of
due diligence review). The reality is that there is always a material risk, even after conducting
reasonable due diligence, that an acquiring company will discover that something is amiss at the
target company once it begins to actually operate the company post-closing. See, e.g., In re
McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248 (ND. Cal. 2000) (involving company
that discovered $327 million in improperly recorded transactions following acquisition); Roth v.
OfJiceMax, Inc., 527 F. Supp. 2d 791 (ND. Ill. 2007) (following acquisition, acquiring company
restated financial results and terminated certain employees). In fact, Ideation expressly warned
of this risk, stating: "[e]ven if we conduct extensive due diligence on a target business with
which we combine, we cannot assure you that this diligence will surface all material issues that
may be present inside a particular target business." Exh. A at 22.
Plaintiffs also assert that the magnitude of the financial restatement gives rise to a strong
inference of scienter. In some instances a large overstatement of revenue may provide support
for an inference that the company's incumbent directors and officers acted with scienter, see, e.g.,
In re Eagle Building Tech., Inc. Sec. Litig., 319 F. Supp. 2d 1318, 1326 (S.D. Fla. 2004), but it
does not support an inference that an acquiring company's directors and officers acted with
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scienter, especially where, as here, the GAAP violations occurred prior to a merger, there were
no "red flags" putting them on notice that the financials were inaccurate, and the target company
had audited financial statements that according to the independent auditor had been prepared
in conformity with U.S. GAAP. See Home Depot, 544 F.3d at 1247 (finding allegations
regarding widespread nature and amount of fraud were insufficient to draw inference that high-
ranking officials acted with scienter, especially where there were no claimed communications
connecting officials to fraud).
Plaintiffs further posit that scienter may be inferred from the Ideation Defendants'
"financial motivation" to consummate the Merger. Had Ideation not completed a business
combination by November 19, 2009 (the "Combination Deadline"), it would have ceased
operations and liquidated. Under such a scenario, the shareholders would have received a pro
rata distribution of Ideation's remaining assets, but the stock and warrants that had been issued to
Ideation's insiders in the November 2007 private placement would have become worthless.
Based on this hypothetical scenario, Plaintiffs allege the Ideation Defendants were motivated to
withhold information about SMIL's accounting issues because the shareholder vote on the SMIL
acquisition was scheduled approximately one month before the Combination Deadline, which
left too little time to terminate the SMIL deal and complete a business combination with another
company. (Am. Compl. ¶ 118.)
Contrary to Plaintiffs' characterization of pre-Merger events, the Merger was anything
but a rushed affair. Ideation identified SMIL as a potential target and signed a confidentiality
agreement more than one year before the Combination Deadline. See Exh. D at 101. That was
followed by a lengthy due diligence period and the announcement in April 2009 that Ideation
had entered into a merger agreement with SMIL. If, as Plaintiffs contend, the Ideation
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Defendants had discovered the accounting improprieties, it would have happened before April
2010. which would have left sufficient time for Ideation to terminate the transaction with SMIL
and pursue a business combination with another potential target (including ten targets with which
Ideation previously had signed term sheets). Id. at 10 1-02.
Even if there had not been sufficient time to acquire another business, Plaintiffs'
"financial motivation" theory makes no sense for at least two reasons. First, the Ideation
Defendants purchased more than $1 million in stock and warrants in the Ideation IPO (in
addition to purchasing shares in the private placement). If Ideation had liquidated, the Ideation
Defendants would have received cash for all of the IPO shares and warrants, which would have
almost equaled their pre-IPO private investments in Ideation. Second, the shares that the
Ideation Defendants purchased in the private placement were held in escrow for a period of one
year following the business combination and therefore could not be sold. See Exh. A at 12.
Consequently, if the Ideation Defendants had been financially motivated to enrich themselves at
the expense of shareholders, they would have waited for the one-year lock-up period to expire
before disclosing the accounting improprieties. Instead, they made the disclosure during the
summer of 2010, before the lock-up period expired. In doing so, the Ideation Defendants acted
against their own financial self-interest because they had not yet had an opportunity to sell their
stock, which negates any inference of scienter. See Home Depot, Inc., 544 F.3d at 1253 ("In this
case, the amended complaint says nothing about suspicious stock transactions by any of the
individual defendants, an omission that weighs against inferring scienter."); Rosenzweig v.
Azurix Corp., 332 F.3d 854, 867 (5th Cir. 2003) ("[T]here is no allegation that defendants sold
their [company] shares, calling into question the alleged motive to artificially inflate the stock
price."); In re Sunterra Corp. Sec. Litig., 199 F. Supp. 2d 1308, 1326 (M.D. Fla. 2002) ("This
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lack of sales by these high-level insiders . . . certainly weighs against an inference of scienter.").
In fact, to date, none of the Ideation Defendants other than Shawn Gold (who in March 2011 sold
1,000 of the 10,000 shares he holds) have sold a single warrant or share of SearchMedia stock,
including any of the shares and warrants they purchased in the IPO and in the open market.
B. Plaintiffs Have Failed to Plead Facts Giving Rise to a Strong Inference that SearchMedia Had Scienter.
Plaintiffs also fail to plead particular facts giving rise to a strong inference that
SearchMedia acted with scienter. Because a corporation has no state of mind, a plaintiff who
asserts a Section 10(b) or 14(a) claim against a corporation must demonstrate that a high-ranking
corporate officer made (or participated in the making of) a false or misleading statement with the
necessary scienter, in which case the officer's state of mind may be imputed to the corporation.
See Home Depot, 544 F.2d at 1252 (holding that, for purpose of determining corporation's
scienter, "we 'look to the state of mind of the individual corporate official or officials who make
or issue the statement (or order or approve it or its making or issuance, or who furnish
information or language for inclusion therein, or the like).") (quoting Southland Sec. Corp. v.
INSpire Ins. Solutions, Inc., 365 F.3d 353, 366 (5th Cir. 2004)); see also Daniel S. Floyd et al.,
Securities Litigation, § 3:4.3 (2011) (noting that Eleventh Circuit rejected "collective scienter"
theory which imputes scienter to the company of unnamed officers or directors without requiring
plaintiffs to link a specific speaker acting with scienter in making a specific false statement).
1. SearchMedia Had No Pre-Merger Scienter.
As explained above, the facts alleged in the Amended Complaint do not support a strong
inference that any of the Ideation Defendants acted with scienter for the Pre-Merger Statements.
See supra Section I.A. It necessarily follows that SearchMedia (then Ideation) did not act with
scienter for the Pre-Merger Statements. See Home Depot, 544 F.2d at 1252 (dismissing Section
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10(b) claims against Home Depot because plaintiff "failed to plead scienter adequately for any of
the individual defendants"). Because the SMIL Defendants did not hold any positions at
SearchMedia until the Merger was consummated, their state of mind cannot be imputed to the
corporation for the Pre-Merger Statements. See Schultz v. Applica Inc., 488 F. Supp. 2d 1219,
1227 (S.D. Fla. 2007) (explaining that only "[t]he knowledge of individuals who exercise
substantial control over a corporation's affairs is properly imputable to the corporation").
2. There Is No Post-Merger Corporate Scienter.
Plaintiffs contend that SearchMedia has conceded that it acted with scienter when any of
the SMIL Defendants made false or misleading statements after the Merger because
SearchMedia has commenced claims against the former shareholders and directors of SMIL for
fraud. (Am. Compl. ¶J 91-92.) This vague and conclusory assertion is not the type of
particularized allegation required by the PSLRA. The Amended Complaint does not allege who
among the group of former SMIL directors and shareholders is being pursued on the legal
claims, what each of those individuals knew that constituted fraud, and when they supposedly
knew it. See Home Depot, 544 F.3d at 1237 (holding that to satisfy heightened pleading
requirements for fraud against the corporation, plaintiff must specifically plead which corporate
officer or director made the false statement and facts establishing that the speaker acted with
scienter). By failing to identify a specific statement by a specific speaker acting with scienter,
Plaintiffs have not plead scienter against SearchMedia for the Post-Merger Statements.
C. The Amended Complaint Fails to Attribute the Pre- and Post-Merger Statements to the Ideation Director Defendants.
The Amended Complaint seeks to impose lob-S liability on the Ideation Defendants not
only for the statements in the preliminary and final Proxy but also for four statements before the
Merger and six statements after the Merger. (Am. Compl. ¶J 53-56, 67, 68, 70, 73, 76, 78.)
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However, most of the Ideation Defendants cannot be held liable for any of these ten statements
because they did not make any of the challenged statements, nor can any of the statements be
attributed to them under the group pleading doctrine. 3 Although the Amended Complaint cites at
length from these ten allegedly actionable statements in press releases, investor presentations and
SEC filings, only two of the Ideation Defendants are actually quoted in a few of the challenged
statements—Frost in one Pre-Merger Statement and Fried in one Post-Merger and three Pre-
Merger Statements. 4
1. The Ideation Outside Directors Are Not Liable for the Pre-Merger Statements Under the Group Pleading Doctrine.
Without any actual quotes to point to for most of the Ideation Defendants, Plaintiffs
attempt to attribute the Pre- and Post-Merger Statements to them through the use of the group
pleading doctrine. (Am. Compl. ¶ 42.) Under that doctrine, a plaintiff may impute a company's
public filings, press releases, or other "group published" information "to all inside corporate
officers and directors, who are presumed to have knowledge of and involvement in the day to
day affairs of the company." In re Sensorni at/c Elecs. Corp. Sec. Litig., No. 018346, 2002 WL
1352427, at *4 (S.D. Fla. June 10, 2002) (emphasis added); see also Bruhl v. Conroy, No. 03-
23044-Civ, 2007 WL 983228, at *2 (S.D. Fla. Mar. 27, 2007).
No such presumption applies, however, to non-employee outside directors unless the
complaint includes specific, fact-based allegations that the "outside director either participated in
the day-to-day operations of [the Company, or prepared or communicated the Company's group
published information at a particular time." In re Pegasus Wireless Corp. Sec. Litig., 657 F.
The Ideation Defendants concede that the statements in the preliminary and final Proxy can be attributed to them and, therefore, they rely on their scienter and forward-looking statements arguments to dismiss those statements.
For the reasons more fully explained above, Plaintiffs have failed to state a Section 10(b) claim against Fried or Frost based on these limited quotes in Pre- or Post-Merger Statements.
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Supp. 2d 1320, 1326 (S.D. Fla. 2009) (holding that group pleading doctrine could not salvage
conclusory allegations that outside director was signatory to, and responsible for, corporation's
public statements).
Here, the Amended Complaint suggests that the group pleading doctrine is applicable to
the Ideation Defendants based on vague allegations about their positions in the Company and
access to unnamed reports and press releases. (Am. Compl. ¶ 42.) Such rote and conclusory
allegations are precisely the type of allegations that have been rejected by this Court and other
courts as not supporting the application of the group pleading doctrine to outside directors such
as Frost, Halpryn, Beier, Moskowitz and Gold (the "Ideation Outside Directors"). See Bruhi,
2007 WL 983228, at * 1 (finding allegations in initial complaint that director defendants
published and furnished reports "too vague and conclusory" to support finding that directors
actually made a false or misleading statement); In re Pegasus, 657 F. Supp. at 1325; Durgin v.
Mon, 659 F. Supp. 2d 1240, 1254 (S.D. Fla. 2009) (refusing to apply group pleading doctrine
where complaint contained "conclusory allegations regarding the role Defendants played in the
Company"). Because the Amended Complaint does not plead specific facts demonstrating that
the Ideation Outside Directors were directly involved in the everyday business of Ideation and
the preparation of the Pre-Merger Statements, the group pleading doctrine cannot salvage
Plaintiffs' claims against them based on those statements. 5
Frost is quoted in a single Pre-Merger Statement, an April 1, 2009 press release, as saying: "Searchlvledia has built a strong market position in China's fast-growing outdoor advertising market and is well positioned to continue its impressive growth trend." (Am. Compl. ¶ 53.) Frost cannot be held liable for that lone statement because the Amended Complaint fails to sufficiently plead why that statement was false or that Frost acted with scienter when he made it. Moreover, the quote is not actionable because, as explained in footnote 6 below, it is a forward-looking statement of opinion that is protected by the PSLRA's safe harbor for forward-looking statements.
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2. The Ideation Defendants Cannot Be Liable for Any Post-Merger Statements That They Did Not Make and That Cannot Be Attributed to Them.
After the Merger, five of the Ideation Defendants (Uppaluri, Frost, Moskowitz, Beier,
and Gold), were not affiliated as officers or directors with SearchMedia and, therefore, did not
sign, nor were they quoted in, the six Post-Merger Statements. Thus, these five Ideation
Defendants cannot possibly be held liable for any of the Post-Merger Statements. See In re
Pegasus, 657 F. Supp. at 1326 (ruling as a matter of law in favor of director where Section 10(b)
claim was based on alleged misrepresentations defendant did not make).
The only Ideation Defendants who continued to serve as directors after the Merger in
SearchMedia were Fried, Rubin, and Halpryn. No Ideation Defendant continued in any capacity
as an officer or employee of SearchMedia. Because they served only as outside directors they
cannot be held liable under the group pleading doctrine for the Post-Merger Statements made by
others because Plaintiffs have not sufficiently alleged that they were actively involved in
SearchMedia's day-to-day affairs. 6 See In re Pegasus, 657 F. Supp. 2d at 1326; Durgin, 659 F.
Supp. 2d at 1254. Accordingly, the Section 10(b) claims against the Ideation Directors founded
upon the Pre- and Post-Merger Statements should be dismissed as a matter of law for failure to
sufficiently plead any actionable statement by them. 7
6 Fried was quoted in only one of the Post-Merger Statements, an April 16, 2010 press release, in which he disclosed that operational issues had been discovered at the Jingli subsidiary, advised that Searchlvledia would likely reverse certain revenues previously reported for 2009, and noted personnel changes and enhancements to the Company's management processes. (Am. Compl. ¶ 76.) Plaintiffs claim these statements were false because Fried did not disclose the magnitude of the accounting irregularities at the Company and Searchlvledia eventually wrote off more revenue than projected. Id. ¶ 77. Such fraud by hindsight pleading is insufficient to sustain any claim founded on this one Post-Merger Statement by Fried. See In re Technical Chem. Sec. Litig., 2001 WL 543769, at *6 (S.D. Fla. Mar. 20, 200 1) (rejecting "hindsight approach to alleging fraud").
Several of the Pre- and Post-Merger Statements are non-actionable because they are forward-looking statements. Under the PSLRA's safe harbor, forward-looking statements are immunized if either they are accompanied by meaningful cautionary statements or plaintiffs do not sufficiently allege that the
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II. THE AMENDED COMPLAINT FAILS TO STATE A SECTION 14(a) CLAIM AGAINST THE IDEATION DEFENDANTS OR SEARCHMEDIA.
To state a claim under Section 14(a) and SEC Rule 14a-9, a plaintiff must allege, among
other things, a false or misleading statement or omission of material fact in a proxy statement,
and that the misrepresentation or omission was made with the requisite level of culpability.
Desaigoudar v. Meyercord, 223 F.3d 1020, 1022 (9th Cir. 2000); In re Verisign, Inc. Deny.
Litig., 531 F. Supp. 2d 1173, 1211 (ND. Cal. 2007). "Under the PSLRA, a § 14(a) claim must
be pled with particularity." Verisign, 531 F. Supp. 2d at 1211; Hayes v. Crown Central
Petroleum Corp., 78 Fed Appx. 857, 862 (4th Cir. 2003). Accordingly, a plaintiff must "specify
each statement that is alleged to have been misleading, [and] the reason or reasons why the
statement is misleading," and for each defendant state particularized facts that give rise to a
strong inference of the requisite culpability negligence for statements of fact; and actual
knowledge of falsity for opinions. Fishery. Kansas, 467 F. Supp. 2d 275, 281 (E.D.N.Y. 2006);
Knollenberg v. Harmonic, Inc., 152 Fed. Appx. 674, 683 (9th Cir. 2005); Shidler v. All American
challenged statements were made with actual knowledge of theft falsity. See Harris v. IVAX Corp., 182 F.3d 799, 803 (11th Cir. 1999) (explaining two prongs of the safe harbor provide alternate bases for protection of forward-looking statements). Here, the challenged forward-looking statements discussed: future revenue projections for SMIL (Am. Compl. ¶J 54, 56); the Ideation Defendants' beliefs about SN'IIL's future prospects (Ed. ¶J 53, 59, 63); and estimates of the financial impact that would likely result from the post-Merger discovery of operational issues at a SMIL subsidiary (Ed ¶ 76). These statements were immunized under the first prong of the safe harbor because they were accompanied by meaningful warnings about important factors that could influence the forecasts, including the precise risk that ultimately occurred, namely, unforeseen wrongdoing at SMIL and its subsidiaries. See Ideation Proxy, at 39 (warning that "[f]ailure to maintain an effective system of internal control over financial reporting may adversely affect Searchlvledia's ability to accurately report its financial results or prevent fraud"); Ed. at 38 ("Although [SMIL] has conducted due diligence with respect to its acquisitions, it may not have implemented sufficient due diligence procedures and many not be aware of all of the risks and liabilities associated with such acquisitions. Any discovery of adverse information concerning the acquired companies could have a material adverse effect on [SMIL's] business, financial condition and results of operations."); Ed at 112 (noting that projections in Proxy are "not fact and should not be relied upon as being necessarily indicative of future results, and readers of this Proxy are cautioned not to place undue reliance on the prospective financial information"). In addition, these forward-looking statements are not actionable under the second prong of the statutory safe harbor because, as demonstrated in Section I.A. below, Plaintiffs have failed to demonstrate that the Ideation Defendants satisfied the less demanding, severely reckless, scienter standard.
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Life & Fin. Corp., 775 F. 2d. 917, 927 (8th Cir. 1985) (affirming dismissal of Section 14(a)
claim based on supposedly misleading facts in proxy where complaint did not sufficiently allege
a strong inference of negligence).
Here, Plaintiffs claim that the Ideation Defendants made false and misleading statements
in Ideation's preliminary and definitive Proxies in violation of Section 14(a). (Am. Compl. ¶J
58-61.) Specifically, Plaintiffs allege that shareholders were misled into approving the Merger
by the following information and opinions in the Proxy:
1. SMIL's financial information for 2007 and 2008; (Am. Compl. ¶ 58)
2. The Ideation Defendants' opinions that:
. "[SMIL] has demonstrated an attractive financial profile;"
. "[SMIL's] business model is highly scalable;"
• "[SMIL's] business will continue to demonstrate an attractive financial profile;" and
• "Although financial projections are inherently uncertain. . . the projections for [SMIL's] business are reliable;" (Id. ¶ 59)
3. A disclosure that, in connection with the audit of SMIL's financial statements for 2007 and 2008, its independent auditors identified "significant control deficiencies in its internal control procedures," and that, thereafter, SMIL "undertook certain remedial steps to address certain deficiencies, including hiring additional accounting staff and training its new and existing accounting staff and conducting due diligence on companies with which it does business to identify parties." (Id. ¶ 60); and
4. The Ideation Defendants' opinion that SMIL had a fair market value of at least 80% of Ideation's net assets. (Id. ¶ 61).
According to Plaintiffs, the Ideation Defendants and SearchMedia (then Ideation) were
negligent in including these opinions and information in the Proxy because, had the Ideation
Defendants exercised reasonable care in conducting due diligence prior to the Merger, they
would have uncovered the accounting improprieties at SMIL. Id. ¶J 7, 62, 65, 105, 116.
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A. Plaintiffs Have Not Sufficiently Pled that the Opinions Underlying the Section 14(a) Claim Were Subjectively False.
Two of the four categories of supposedly actionable statements in the Proxy, Nos. 2 and
4, are statements of opinion about the fair market value of SMIL and its future prospects. The
scienter standard under Section 14(a) for opinions is an actual knowledge standard. Plaintiffs
must plead, with the requisite specificity, that the opinion was both objectively and subjectively
false. See Hayes, 78 Fed. Appx. at 864 (4th Cir. 2003) ("Liability may arise under Section 14(a)
for false statements of reasons, opinion, and belief that are knowingly made."); In re Textainer
Partnership Sec. Litig., 2005 WL 3801596, at *9 (N.D. Cal. Feb. 17, 2006) (dismissing Section
14(a) claim founded upon opinion that asset sale was fair because plaintiff failed to sufficiently
allege that the defendants did not actually hold the opinion stated); In re McKesson, 126 F. Supp.
2d at 1267 ("In the case of a fairness opinion . . . the plaintiff must plead with particularity why
the statement of opinion was objectively and subjectively false."). Here, the Section 14(a) claim
based on these opinions should be dismissed because the Amended Complaint does not allege
(nor could it for the reasons discussed in Section l.A.) that the Ideation Defendants did not
subjectively believe what they opined. 8 See In re Bank ofAnierica Corp. Sec., Deny, and ERISA
Litig., No. 09 MD 2058 (PKC), 2010 WL 3448194, at *39 (S.D.N.Y. Aug. 27, 2010)
(dismissing, in part, Section 14(a) claims regarding BoA statements about its due diligence of
Merrill Lynch acquisition and adequacy of Merrill's assets because no showing that BoA
8 Likewise, the Section 14(a) claim founded upon the statements in category No. 3 above, relating to internal control deficiencies identified by KPMG, should also be dismissed for failure to satisfy the PSLRA's mandate requiring the reasons why those statements were false or misleading. Nowhere does the Amended Complaint allege that the internal control deficiencies were not found, that they were different than what was reported, or that SMIL did not take the remedial steps indicated in the Proxy. Thus, these challenged statements cannot form the basis for any Section 14(a) claim. See Fisher, 467 F. Supp. 2d at 284 (granting motion to dismiss where "Plaintiffs allegations [were] insufficient to state a claim pursuant to Section 14(a). .
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directors knew such statements were false when made); Podany v. Robertson Stephens, Inc., 318
F. Supp. 2d 146, 154 (S.D.N.Y. 2004) (affirming dismissal based on opinion statement because
"Lilt is not sufficient to allege . . . that it would have been possible to reach a different opinion
than that reached by defendants based on information available to defendants at the time, or even
that the defendant's opinion was unreasonable").
B. The Ideation Defendants Were Not Negligent in Failing to Uncover the Accounting Improprieties at SMIL Prior to the Merger.
The remainder of Plaintiffs' Section 14(a) claim is based on the premise that the Ideation
Defendants were negligent during their due diligence process in failing to uncover the problems
in SMIL's audited financials and that such problems were so significant that the Ideation
Defendants were reckless in failing to detect them. Although Plaintiffs claim the due diligence
process was flawed, they do not dispute that it included, among other things: a nearly year-long
due diligence process, Ideation's retention of financial, legal and accounting advisors to assist in
the process, numerous meetings in the U.S. and China, interviews with SMIL customers, reliance
on clean audit opinions from KPMG for SMIL's 2007 and 2008 financial statements, and
knowledge that Deutsche Bank had made a substantial investment in SMIL. Exh. D at 39, 101-
04, 114, F-36.
Ignoring these facts, Plaintiffs instead group all the defendants together and make the
conclusory allegation that the due diligence process was flawed. 9 Plaintiffs do not, however,
Although the Amended Complaint seeks to impose Section 14(a) liability on all of the Ideation Defendants, it includes only a single conclusory allegation about three of them (Fried, Uppaluri and Rubin), namely, that they traveled to China to meet with the SMIL management team and to "review diligence items and tour the facilities." (Am. Compl. ¶J 27, 29, 30.) This lone allegation fails to attribute specific knowledge and conduct to each particular defendant, as is required by the PSLRA. The Amended Complaint includes no allegations regarding the remaining Ideation Defendants' purported role in the due diligence. Because the Amended Complaint does not explain each of the Ideation Defendants' supposed role in the due diligence or their knowledge or access to critical SMIL financial information, it fails to satisfy the PSLRA's pleading requirements for stating a Section 14(a) claim against any of them.
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allege that the Ideation Defendants received any emails, memos, or letters or attended any
meetings in which they learned about accounting problems at SMIL during the due diligence
process. Instead, the primary fact Plaintiffs point to in support of their conclusion that there is a
strong inference that the Ideation Defendants acted negligently in including SMIL's audited
financials in the Proxy was that the accounting problems later discovered were so big they
should have been found sooner. (Am. Compl. ¶ 105.) Under this approach, any director of any
company making an acquisition would be strictly liable for a subsequent restatement after the
acquisition even if the due diligence efforts were textbook perfect, the financials of the target
were certified with clean opinions, and the directors did not know and had no reason to know of
any misstatements in the target's financials. This attempt to impose strict liability under Section
14(a) has been rejected universally by courts addressing the issue. See Shidler, 775 F.2d at 927
("A strict liability rule would impose liability for fully innocent misstatements. It is too blunt a
tool to ferret out the kind of deceptive practices Congress sought to prevent in enacting section
14(a)."); Gould v. Am. Hawaiian S.S. Co., 351 F. Supp. 853, 860 (D. Del. 1972) (in holding that
Section 14(a) did not impose strict liability standard, the court reasoned: "[T]he liability sections
should be interpreted to afford incentives to directors to undertake active and rigorous scrutiny of
corporate activities, and should not be construed to make such efforts of no significance in
precluding liability for misstatements against which a director cannot reasonably protect.").
The case of In re McKesson HBOC, Inc. Securities Litigation, 126 F. Supp. 2d 1248
(ND. Cal. 2000), which is factually similar to the instant case, is instructive on what must be
alleged to survive a motion to dismiss a Section 14(a) claim. In McKesson, shareholders brought
See Trans World Corp v. Odyssey Partners, 561 F. Supp. 1315, 1320 (S.D.N.Y. 1983) (granting motion to dismiss Section 14 claims because "the complaint's repeated references to action of the 'defendants,' without differentiation among the various defendants, is unacceptable . . . each defendant is entitled to know precisely what [the plaintiff] is alleging as to him or it").
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a Section 14(a) claim against the directors of the acquiring corporation, McKesson, Inc., when
within four months of the acquisition, they learned there were accounting improprieties at the
acquired company, HBO & Company (HBOC), that rendered its financial statements in the
proxy inaccurate. Id. at 1248. Although HBOC's financial statements had previously been
audited by Arthur Andersen, those financials were restated after the acquisition due to more than
$300 million in improperly recorded transactions at HBOC. Id. at 1253.
Like the Plaintiffs here, the plaintiffs in McKesson argued that due to the sheer magnitude
of the problems uncovered after the acquisition, the McKesson directors were liable under
Section 14(a) for failing to uncover the issues during their due diligence before the acquisition.
The court disagreed. In granting the McKesson directors' motion to dismiss, the court reasoned
that "[w]hile Arthur Andersen may or may not have been negligent in failing to uncover the
improprieties, there is no suggestion in the complaint that . . . [the] McKesson [directors] could
have known, even with reasonable diligence, that HBOC was engaged in massive accounting
fraud." Id. at 1267. Thus, the court held that the directors' reliance on the Arthur Andersen audit
was justifiable and that it negated the necessary inference of negligence to state a Section 14(a)
claim against the McKesson directors. Id. at 1268.
As in McKesson, the Plaintiffs here have not alleged sufficient facts to create a strong
inference that any of the Ideation Defendants acted negligently. Other than the bare conclusion
that the due diligence did not uncover the accounting improprieties at SMIL prior to the Merger,
the Amended Complaint is devoid of any suggestion as to why the due diligence was flawed.
Plaintiffs have not alleged one fact known to the Ideation Defendants prior to the closing that
shows a strong inference of negligence. To the contrary, Plaintiffs admit that the Ideation
Defendants engaged experts including independent accountants, lawyers and a financial advisor
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to assist them in their due diligence efforts and that KPMG audited SMIL's financials and gave it
a clean bill of financial health.
The mere fact that, in hindsight, neither the professionals nor the Ideation Defendants
uncovered the later-found accounting irregularities at SMIL, does not satisfy Plaintiffs' burden of
showing a strong inference that the Ideation Defendants acted negligently in approving the
Proxy. See Gould, 351 F. Supp. at 866 ("[Negligence standard does not make impermissible
any reliance on expertise of legal or financial counsel in areas pertinent to their respective
expertise," or "impose upon directors the role of guarantors or insurers of the accuracy of proxy
statements."). To the extent Plaintiffs' claim rests on the untenable notion that Section 14(a)
required the Ideation Defendants, who were not officers or directors of SMIL, to second-guess
and reevaluate the judgment of hired professionals, it should be dismissed because Section 14(a)
does not impose such unreasonable demands on directors. See Gould, 351 F. Supp. at 865
(noting Section 14(a) does not require directors "to recalculate or reassemble financial or other
reports absent some evident misstatement or irregularity which should be within the directors'
knowledge and the exercise of reasonable care would necessitate either correcting or directing to
the expert's attention").
Nor have the Plaintiffs alleged any particularized facts that, if true, would show that (1)
the Ideation Defendants were at fault for not selecting the experts with reasonable care; (2) their
reliance on the professionals was unreasonable; or (3) the Ideation Defendants were privy to
information that contradicted the audited financial statements or other information provided to
them by the professionals. Ultimately, the allegations in the Amended Complaint do not create a
strong inference of negligence that is at least as probable as a non-fraudulent explanation,
namely that the Ideation Defendants conducted a reasonable investigation under the
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circumstances and had no reasonable ground to question the accuracy of the challenged
statements in the Proxy. 10 Thus, the Section 14(a) claim against the Ideation Defendants and
SearchMedia should be dismissed for failure to plead the requisite culpability." See Shidler, 775
F.2d at 926 (affirming dismissal of Section 14(a) claim where defendant was not negligent in
issuing proxy statement); Rudolph v. Utstarconi, 560 F. Supp. 2d 880, 892 (ND. Cal. 2008)
(dismissing section 14(a) claim because plaintiff failed to adequately plead that defendants acted
negligently); Verisign, Inc., 531 F. Supp. 2d at 1212 (dismissing Section 14(a) claim because
plaintiffs failed "to plead the required state of mind with particularity as to each defendant, as
required by the PSLRA"); Gould, 351 F. Supp. at 859 (rejecting standard that would make "a
director who made a detailed examination of corporate records and obtained legal and financial
counsel to advise him. . . liable even if the materials supplied him were deliberately falsified in a
manner which he could not have ascertained").
III. THE AMENDED COMPLAINT FAILS TO ADEQUATELY ALLEGE A CLAIM FOR "CONTROL PERSON" LIABILITY.
The Amended Complaint also fails to state a claim against the Ideation Defendants for
control person liability under Section 20(a) of the Exchange Act. See 15 U.S.C. § 78t(a). In
order to state a control person claim, a plaintiff must allege: (1) a primary violation of the
securities laws by a controlled person; (2) that the defendant had the power to control the general
business affairs of the controlled person; and (3) that the defendant had the requisite power to
directly or indirectly control or influence the specific corporate policy which resulted in the
10 Because Plaintiffs are unable to establish that any of the Ideation Defendants acted with the requisite culpability, they are likewise unable to state an actionable Section 14(a) claim against Searchlvledia (then Ideation), the corporate entity those defendants managed. See Hubbard, 625 F. Supp. 2d at 1289 ("Plaintiff has not adequately pled scienter as to any of the Individual Defendants; therefore Plaintiff has failed to adequately plead scienter as to BankAtlantic.").
Given that the challenged statements in the preliminary and definitive versions of the Proxy do not satisfy the negligence standard required under Section 14(a), it necessarily follows that they do not satisfy the heightened scienter standard required under Section 10(b).
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primary liability. Theoharous v. Long, 256 F.3d 1219, 1227 (11th Cir. 2001). The Amended
Complaint asserts that the Ideation Defendants acted as controlling persons of SearchMedia.
(Am. Compl. ¶J 159-62, 167-72.) Because the Amended Complaint fails to adequately assert an
underlying violation of the Exchange Act against SearchMedia, however, Plaintiffs' Section
20(a) claims must be dismissed as well. See Brown v. Enstar Group, Inc., 84 F.3d 393, 396-97
(11th Cir. 1996).
Conclusion
For all the foregoing reasons, SearchMedia and the Ideation Defendants respectfully
request that this Court enter an order dismissing all claims in the Amended Complaint against
them.
Dated: May 2, 2011 Respectfully submitted,
HOLLAND & KNIGHT LLP
By: Is/Tracy A. Nichols Tracy A. Nichols Florida Bar No. 454567 tracynichols(äThklaw. corn Louise McAlpin Florida Bar No. 983810 1ouisemca1pi11(hk1aw. corn Stephen P. Warren Fla. Bar No. 788171 stephen.warrefl(äthklawcom 701 Brickell Avenue, Suite 3000 Miami, Florida 33131 Tel: (305) 374-8500 Fax: (305) 789-7799
Attorneys for Defendants SearchMedia Holdings Limited, Robert Fried, Phillip Frost, Rao Uppaluri, Steven Rubin, Glenn Halpryn, Thomas Beier, David Moskowitz, and Shawn Gold
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CERTIFICATE OF SERVICE
I HEREBY CERTIFY that on May 2, 2011, I electronically filed the foregoing document
with the Clerk of the Court using CM/ECF. I also certify that the foregoing document is being
on all counsel listed below either via transmission of Notices of Electronic Filing generated by
CM/ECF or U.S. Mail:
By CM/ECF Notification
Peter A. Binkow pbinkow(glancylaw.com Glancy Binkow & Goldberg LLP 1801 Avenue of the Stars Suite 311 Los Angeles, CA 90067
Lester R. Hooker lhooker(saxenawhite.com Joseph E. White, III jwhite(saxenawhite.com Saxena White P.A. 2424 North Federal Highway Boca Raton, FL 33431
By U.S. Mail
Lionel Z. Glancy Michael Goldberg Glancy Binkow & Goldberg LLP 1801 Avenue of the Stars Suite 311 Los Angeles, CA 90067
Howard G. Smith 3070 Bristol Pike Suite 112 Bensalem PA 19020
Is/Tracy A. Nichols Tracy A. Nichols
#10284043 v7