Plotkin v. IP Axess Inc.

United States Court of Appeals
Fifth Circuit
F I L E D
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT April 21, 2005

_______________________ Charles R. Fulbruge III
Clerk
No. 03-41380
_______________________

ANDREW PLOTKIN, as Trustee for Zachary S. Plotkin Trust
dated 12/17/95; ANDREW PLOTKIN, as Trustee for
Natalie R. Plotkin Trust dated 12/17/95;
ROBERT PLOTKIN, as Beneficiary of Robert Plotkin IRA;
ROBERT PLOTKIN IRA ROLLOVER DATED 11/10/99;
ROBERT PLOTKIN; NANCY PLOTKIN; MANUEL PLOTKIN,

Plaintiffs - Appellants,

versus

IP AXESS INC., ETC.; ET AL.,

Defendants,

MICHAEL A. McDONNELL; JAMES G. SCOGIN,

Defendants-Appellees.

Appeal from the United States District Court
For the Eastern District of Texas

Before JONES, SMITH, and STEWART, Circuit Judges.

EDITH H. JONES, Circuit Judge:

In this appeal, we review the district court’s dismissal

with prejudice of a securities fraud complaint filed by Robert

Plotkin and members of his family (collectively “Plotkin”) against

IPaxess, Inc. (“IPaxess”) and two of its officers, Michael A.

McDonnell (“McDonnell”) and James G. Scogin (“Scogin”). Plotkin’s

complaint alleges that the defendants committed securities fraud
under federal and Illinois laws by making false or misleading

statements in press releases, and that Plotkin purchased common

stock in IPaxess based on these statements. The district court

dismissed the complaint for failure to state a claim upon which

relief can be granted. For the reasons stated below, we AFFIRM IN

PART, REVERSE IN PART, and REMAND.

I. BACKGROUND

From the late 1990s to 2001, Data Race, Inc. d/b/a

IPaxess, was a fledgling technology company with executive offices

in Plano, Texas. The company’s principal business was the design,

manufacture and marketing of communication products enabling remote

access to all elements of corporate communications networks,

including the Internet and Intranet. IPaxess’s lead product for

purposes of this suit was the VocalWare IP remote access system.

Throughout the relevant period, defendant McDonnell served as the

Chief Operating Officer, President, Chief Executive Officer and

Director of the company, while Scogin was its Controller, Senior

Vice President-Finance, Chief Financial Officer, Secretary and

Treasurer. Scogin also apparently served as the Company’s Investor

Relations Officer.

According to Plotkin’s Second Amended Complaint (the

“Complaint”), IPaxess struggled financially before the events in

question: Revenues decreased from approximately $1.9 million in

its 1998 fiscal year to approximately $800,000 in 1999 and only

2
$316,000 for 2000. The Complaint goes on to allege that, during

much of 2000, the defendants carried out a campaign to attract new

investors in the company’s common stock and to persuade existing

investors to increase their holdings. The campaign allegedly

proceeded with the issuance of several false and misleading press

releases that induced Plotkin to purchase considerable amounts of

IPaxess stock. He bought stock for himself and family members

following two press releases issued on May 25, 2000, and one on

August 18, 2000.1 This case centers around the three press

releases.

1. May 25 Releases

In the May 25 press releases, IPaxess announced a letter

of intent and a purchase order involving IPaxess, Associated Global

Partners (“AGPI”), and Lynxus, Inc. (“Lynxus”). The first press

release stated, in relevant part:

IPaxess, formerly DATA RACE, Inc. (Nasdaq: RACE) today
announced a letter of intent to enter into a strategic
partnership with Associated Global Partners/Lynxus, Inc.
(AGPI/Lynxus).

* * *

Under terms of the agreement AGPI and Lynxus Inc. will be
granted exclusive international marketing rights for
IPaxess products for all business associated with the IP
education solution opportunities in any country in which
they are actively engaged in business partnerships. The

1
In reliance on the two May 25 releases, Plotkin purchased, for
himself and for the other plaintiffs, 68,800 shares of the company’s stock at a
cost of $393,439.25. In reliance on the August 18 press release, the plaintiffs
made their final purchases of the company’s stock: 13,300 shares at a total cost
of $80,323.76.

3
 agreement calls for an annual commitment of $25 million
of net purchases from IPaxess.

“Going forward, this strategic relationship with
AGPI/Lynxus represents an important component of
IPaxess’s worldwide distribution strategy, and will
enable us to expand our market opportunity by delivering
the VocalWare IP technology to a broader range of
customers,” stated IPaxess President and CEO, Michael
McDonnell. “AGPI/Lynxus’s decision to market VocalWare
IP as a best-of-breed solution confirms that IPaxess is
on the way to becoming a recognized leader in remote
communications technology.”

In the second May 25 press release, IPaxess announced

that it had received a multimillion dollar purchase order from

AGPI/Lynxus:

IPaxess, formerly DATA RACE, Inc. (Nasdaq: RACE) today
announced receipt of a $6.5 million purchase order for
the VocalWare IP remote work technology from AGPI/Lynxus,
Inc., an application service provider which supplies
internet access solutions to businesses, schools,
churches and homes.

The releases also described the operations of IPaxess’s

new customers and announced the companies’ contributions to the

planned joint undertakings:

With current or developing operations in Latin America,
Africa, Asia and the Middle East, AGPI is rapidly
becoming a leading provider of telecommunications
transport services, with networks designed to complement
existing global carrier networks. Lynxus, Inc.
(www.lynxus.com) is one of North America’s fastest
growing enhanced application service providers. Their
Education Business Unit is currently deploying a safe,
reliable, affordable internet access solution to schools
in Atlanta, Georgia, funded through the FCC’s Universal
Services Fund program.

* * *

AGPI has designed and is implementing a fiber optic
network in South America, the Caribbean, and Africa,

4
 which will provide carriers with high quality
transmission and advanced network capabilities. As a
technology partner, Lynxus (www.lynxus.com) will provide
strong infrastructure support, offering a full array of
Internet solutions.

IPaxess, AGPI and Lynxus Inc. will work together to
provide advanced, integrated IP remote access solutions
for a number of global opportunities currently under
development. AGPI will provide independent transport
services. Lynxus will provide innovative applications
services, and IPaxess will implement their patented
VocalWare(TM) IP remote access solution.

Each press release concluded with a boilerplate

cautionary statement:

This press release contains various “forward-looking
statements” which represent the Company’s expectations or
beliefs concerning future events, including its belief
regarding the impact on the Company of the new
technology. These forward-looking statements involve
numerous risks, uncertainties and assumptions, and actual
results could differ materially from anticipated results.
There can be no assurance as to the amount or timing of
revenue from the new technology.

The deals described in these press releases failed

quickly and spectacularly. Public statements by IPaxess trace the

turn of events. The company shipped approximately $700,000 of

Vocalware products and user licenses to Lynxus within three to four

months of the May 25 announcements. While the company booked the

revenue at the time of shipment, as was its custom, its auditors

KPMG disputed this action, evidently because they were unpersuaded

of Lynxus’s ability to pay. On November 21, 2000, the company

announced that it had acquiesced in KPMG’s advice and withdrew the

$700,000 from its revenue statement for the first quarter of 2001.

Nevertheless, KPMG resigned from auditing IPaxess.

5
 Having failed to receive even a dollar of the promised

$25 million annual purchases from the AGPI/Lynxus association, or

a dollar of the announced $6.5 million equipment purchase, or even

a dollar of the $700,000 shipment (the products were eventually

returned to IPaxess), the company publicly admitted the deals’

collapse in February 200l. The company stated that it had “been

able to maintain its connection to the Caribbean project,” for

which the products had been shipped. In a shareholder “letter”

published on the company website about that time, McDonnell

asserted that Lynxus had been unable to pay because one of its

customers had delayed paying Lynxus. No mention was made that

Lynxus had filed bankruptcy three weeks earlier.

2. August 18 Press Release

The August 18, 2000, press release announced, in a bold

face subheading, that “Agreements Are in Place with Major Customers

for Commercial Shipments in September 2000.” In this release,

IPaxess named several major companies including Time Warner Cable-

San Antonio and Continental Airlines. The August 18 press release

states as follows:

IP AXESS(TM) Announces Closure of VocalWare(TM) IP
Integrated Server Beta Program.

Agreements in Place With Major Customers for Commercial
Shipments In September, 2000.

IP AXESS, formerly DATA RACE (Nasdaq: RACE), today
announced that it has closed participation in the
VocalWare IP integrated server beta program. Customers
participating in the beta trial include Time Warner Cable

6
 of San Antonio, Continental Airlines, Associated Global
Partners/Lynxus, Inc., as well as a global carrier and an
agency of the federal government. These first installa-
tions position IP AXESS to ship commercially available
product in September 2000.

“The Enterprise Access Compact PCI Server is unparalleled
in the scale, scope and flexibility of its design,” said
Michael McDonnell, IP AXESS’s president and chief execu-
tive officer. “These organizations have established
themselves as leaders in the application of remote access
solutions and pioneers in the use of IP protocols to
effectively converge voice and data connectivity. We are
excited about our beta partners’ remote access applica-
tion plans and commencement of shipment of the Enterprise
Access Server (2G) to partners of such distinction. We
look forward to working closely with them as we begin
implementation.”

Plotkin alleges that this notice touted “agreements” that never

existed. In any event, none of them ever generated ongoing

business for IPaxess.

According to Plotkin’s Complaint, the price of the

company stock rose after the May 25 and August 18 press releases.

Within a few months, however, after the revelation that the Lynxus

revenue must be removed from the company’s books, and after the

publicized deals failed to come through, the stock sank steadily.

On May 11, 2001, the plaintiffs filed their initial

seven-count federal complaint in Illinois against IPaxess,

McDonnell, and Scogin, setting forth claims under sections 10(b)

and 20(a) of the Securities Exchange Act of 1934, codified at 15

U.S.C. § 78j(b), and Securities Exchange Commission Rule 10b-5,

7
codified at 17 C.F.R. § 240.10b-5.2 Plotkin also alleged a common

law fraud claim, along with a violation of the Illinois Consumer

Fraud and Deceptive Business Practices Act. The case was

transferred to the Eastern District of Texas. The district court

had to sever Plotkin’s claims against IPaxess, which filed for

Chapter 11 bankruptcy relief in July 2002.

The individual defendants, McDonnell and Scogin, moved to

dismiss the Complaint for failure to state a claim upon which

relief can be granted. The Magistrate Judge to whom the motion was

referred issued his first Report and Recommendation (“First

Magistrate Report”) recommending dismissal of the Complaint’s

federal claims. He concluded that Plotkin failed to identify a

factual basis that would make the three press releases false or

misleading; failed adequately to allege scienter; failed to satisfy

the pleading standards in the Private Securities Litigation Reform

Act of 1995 (“PSLRA”), 15 U.S.C. §§ 78u-4 and 78u-5 (2000); and the

statements in the releases were not actionable because they were

forward-looking and accompanied by sufficient cautionary language.

See 15 U.S.C. § 78u-5(c)(1)(A)(“safe harbor”). In a second report,

the Magistrate Judge recommended the dismissal of the state law

causes of action for analogous reasons. The district court adopted

2
The Complaint asserts that the individual defendants, McDonnell and
Scogin, are liable because, throughout the Stock Purchase Period, each was a
“controlling person” of IPaxess within the meaning of Section 20(a) of the
Exchange Act. Liability of the individual defendants is predicated, in part, on
the actions of their company; thus, this opinion refers to the conduct of the
company in issuing the press releases.

8
both reports without substantive comments, dismissed the federal

and state law claims with prejudice, and rendered its final

judgment. Plotkin has appealed.

II. DISCUSSION

We review de novo the district court’s dismissal of the

securities fraud complaint against McDonnell and Scogin for failure

to state a claim upon which relief can be granted. Rosenzweig v.

Azurix Corp., 332 F.3d 854, 865 (5th Cir. 2003). In determining

whether Plotkin has “stat[ed] a claim upon which relief can be

granted,” FED. R. CIV. P. 12(b)(6), we must accept the well-pleaded

facts alleged in Plotkin’s Complaint as true and construe the

allegations in the light most favorable to Plotkin. Id. We do not

accept as true conclusory allegations, unwarranted factual

inferences, or legal conclusions. Southland Sec. Corp. v. INSpire

Ins. Solutions, Inc., 365 F.3d 353, 361 (5th Cir. 2004).

To demonstrate a violation of Section 10(b) of the

Securities Exchange Act of 1934 and SEC Rule 10b-5, a securities

fraud plaintiff must prove that the defendant made a

(1) misstatement or omission (2) of material fact (3) in connection

with the purchase or sale of a security, which was made (4) with

scienter, and upon which (5) the plaintiffs justifiably relied, (6)

proximately causing injury to the plaintiffs. Rosenzweig, 332 F.3d

at 865. The Private Securities Litigation Reform Act (“PSLRA”),

codified at 15 U.S.C. §§ 78u-4 and 78u-5, requires a securities

9
fraud plaintiff like Plotkin to plead these substantive elements

with particularity.3 The PSLRA’s particularity requirement incor-

porates, at a minimum, the pleading standard for fraud actions

under Federal Rule of Civil Procedure 9(b). Rosenzweig, 332 F.3d

at 866. In this court, the Rule 9(b) standards require specificity

as to the statements (or omissions) considered to be fraudulent,

the speaker, when and why the statements were made, and an explana-

tion why they are fraudulent. Nathenson v. Zonagen, 267 F.3d at

412 (citing Williams v. WMX Technologies, Inc., 112 F.3d 175, 177

(5th Cir. 1997)).

3
The PSLRA speaks to the requirements of a securities law class
action complaint as follows:

(b) Requirements for securities fraud actions
(1) Misleading statements and omissions
In any private action arising under this chapter in
which the plaintiff alleges that the defendant SS
(A) made an untrue statement of a material fact; or
(B) omitted to state a material fact necessary in order
to make the statements made, in the light of the circumstances in
which they were made, not misleading; the complaint shall specify
each statement alleged to have been misleading, the reason or
reasons why the statement is misleading, and, if an allegation
regarding the statement or omission is made on information and
belief, the complaint shall state with particularity all facts on
which that belief is formed.
(2) Required state of mind
In any private action arising under this chapter in
which the plaintiff may recover money damages only on proof that the
defendant acted with a particular state of mind, the complaint
shall, with respect to each act or omission alleged to violate this
chapter, state with particularity facts giving rise to a strong
inference that the defendant acted with the required state of mind.
(3) Motion to dismiss; stay of discovery
(A) Dismissal for failure to meet pleading requirements
In any private action arising under this chapter, the
court shall, on the motion of any defendant, dismiss the complaint
if the requirements of paragraphs (1) and (2) are not met.

15 U.S.C. § 78u-4(b).

10
 The PSLRA pleading standard for scienter is especially

challenging for plaintiffs. A valid complaint must plead specific

facts giving rise to a “strong” inference of scienter. See U.S.C.

§ 78u-4(b)(1); Nathenson, 267 F.3d at 406-07 (5th Cir. 2001). The

Fifth Circuit has elaborated that scienter generally encompasses

severe recklessness. See Broad v. Rockwell Intern. Corp., 642 F.2d

929, 961-62 (5th Cir. 1981) (en banc). Thus, a securities fraud

plaintiff must prove that the defendant either consciously

misbehaved in issuing the releases, or was so severely reckless

that it demonstrates that the defendant must have been aware of the

danger of misleading the investing public. See Mercury Air Group,

Inc. v. Mansour, 237 F.3d 542, 546 n.3 (5th Cir. 2001) (“[Scienter]

encompasses reckless indifference such that the omission or

misrepresentation was ‘so obvious that the defendant must have been

aware of it.’”) (quoting Rubinstein v. Collins, 20 F.3d 160, 169

(5th Cir. 1994)); see also Southland Securities Corp., supra, 365

F.3d at 366.

1. Alleged misstatements or omissions of the May 25, 2000,
press releases.

The Complaint adequately pleads that material omissions

from the May 25 releases rendered those releases misleading. A

fair reading of the May 25 press releases would reasonably induce

investors to believe that IPaxess had a legitimate expectation of

revenues from the agreements it had just struck with AGPI and

Lynxus. The first May 25 press release states that “[t]he

11
agreement [strategic partnership with AGPI/Lynxus] calls for an

annual commitment of $25 million dollars of net purchases from

IPaxess.” Likewise, the second release announced that IPaxess

anticipated imminent revenue from these companies: “IPaxess . . .

today announced receipt of a $6.5 million purchase order for the

VocalWare IP remote work technology from AGPI/Lynxus, Inc.”

Considering that total revenues for IPaxess had been reported as

$835,798 for fiscal 1999, and just over $300,000 in the year ended

June 30, 2000, the announcement of these transactions would have

been regarded by a reasonable investor as particularly significant.

A reasonable investor reading the releases would also

have formed the impression that AGPI and Lynxus were significant

international companies which could serve as credible business

partners to IPaxess. Concerning AGPI, the releases state: “With

current or developing operations in Latin America, Africa, Asia and

the Middle East, AGPI is rapidly becoming a leading provider of

telecommunications transport services.” The releases describe

Lynxus as “one of North America’s fastest growing enhanced

application providers.”

These impressions were not dispelled by the press

releases’ standard warnings about the risks and uncertainties

facing IPaxess as it started selling new products. Both releases

included the warning: “There can be no assurance as to the amount

or timing of revenue from the new technology.” Although it is true

that letters of intent and purchase orders do not necessarily

12
guarantee the receipt of cash, IPaxess’s announcement of these

agreements properly raised the inference that IPaxess expected its

partners to perform under the agreements. The laudatory

description of AGPI/Lynxus reinforced the expectation. The

cautionary statements did not mention the potential uncertainty of

AGPI’s or Lynxus’s ability to comply with the contracts.

The district court concluded, however, that Plotkin

failed to plead facts permitting the inference that Lynxus/AGPI

lacked the business potential to pay for the products they ordered.

We disagree. The Complaint alleges that Lynxus was actually a very

small company with reported revenues of $7 million in 1999 and that

AGPI was incorporated, by Lynxus’s CEO, less than six months before

the news releases. The Complaint also states that Lynxus filed for

bankruptcy on January 23, 2001, a mere eight months after the deals

had been publicized. Further, by the time of the lawsuit, AGPI’s

status with the Georgia Secretary of State was “active/

noncompliance,” i.e., that it had not filed a timely annual

registration statement with accompanying minimal fee. The

Complaint also alleges that within only three to four months of the

May 25 press releases, KPMG, the company’s auditors, disagreed so

strongly over the company’s desire to reflect as revenue a $700,000

shipment to Lynxus that, even after the company acquiesced in the

auditors’ caution and restated its revenue, KPMG resigned. The

Complaint states that, contrary to the press releases, neither AGPI

nor Lynxus engaged in the scope of operations attributed to it.

13
 Although some of these allegations concern matters that

transpired after the press releases, they are so temporally

connected that they shed light on the financial condition of the

companies at the time of the announcements and bolstered Plotkin’s

suspicion that, at the time AGPI and Lynxus entered into contracts

with IPaxess, those companies could not perform their obligations.

We subscribe to the rule that a “Plaintiff cannot charge Defendants

with intentionally misleading their investors about facts

Defendants may have become aware of after making allegedly

misleading statements to the public.” Lain v. Evans, 123 F. Supp.

2d 344, 350 (N.D. Tex 2000). Nevertheless, allegations of later-

emerging facts can, in some circumstances, provide warrant for

inferences about an earlier situation. For example, the fact that

a business files for bankruptcy on “Day Two,” may, under the right

surrounding circumstances, provide grounds for inferring that the

business was performing poorly on “Day One.” See Novak v. Kasaks,

216 F.3d 300, 313 (2nd Cir. 2000) (“even six months after the Class

Period, substantial amounts of ‘Box and Hold’ inventory still dated

from 1993 and 1994 . . . supports the inference that inventory

during the Class Period was similarly dated.”). Further discovery

may refute the inferences, but it is not unwarranted to infer that

when a company’s big deal collapses so fast, something was amiss at

the outset.

The appellees, echoing the magistrate judge’s analysis,

contend that the press releases were neither false nor materially

14
misleading for several reasons. First, the negative facts that

Plotkin points to about AGPI/Lynxus post-dated the press releases.

As we have demonstrated, however, events following so closely on

the heels of IPaxess’s announcement of a major new business rela-

tionship and signed sales contracts cast doubt on the viability of

those transactions from their inception.

Appellees also assert that generalized, positive

statements about a company’s prospects are not actionable under

federal securities law. Nathenson, 267 F.3d at 419. This

proposition, while true in isolation, overlooks not only that the

announcement of signed, allegedly lucrative contracts is a

statement of fact, not a generalized positive statement, but that,

in context, the touting of AGPI/Lynxus was designed to create an

impression that a substantial payoff would soon flow from the

contracts.4 The contextualized understanding of the positive

statements about AGPI/Lynxus also defeats the defendants’

contention that the negative information about those parties

unearthed by Plotkin does not render the May 25 releases materially

false or misleading. The average investor would certainly be

surprised to learn that contrary to the depiction of AGPI/Lynxus in

4
Defendants analogize Plotkin’s criticism of the press releases to
that of plaintiffs who charged that Azurix Corp., an Enron subsidiary, falsely
failed to explain the risks of its worldwide water privatization investments.
See Rosenzweig, 332 F.3d at 869. The difference is that Azurix at least
conducted the business whose prospects it overestimated, while here, neither AGPI
nor Lynxus appears to have done anything concrete from IPaxess’s standpoint
toward completing the contracts. The distinction is one of kind rather than of
degree.

15
the press releases, the two companies were new, small and related

to each other. Such characteristics would tend to undermine the

investor’s impression of the solidity of the new contracts and

would imply instead that IPaxess had embarked on a speculative

venture. The omission of those facts was material to a reasonable

investor’s appreciation of the implications of the deals for

IPaxess’s bottom line.5

Finally, while the defendants characterize some of the

statements in these two releases as “forward-looking” and subject

to the PSLRA's safe harbor provision because of the releases’

cautionary language, they acknowledge that the facts concerning the

contracts are not forward-looking predictions.6 See Griffin v. GK

Intelligent Systems, Inc., 87 F. Supp. 2d 684 (S.D. Tex. 1999)

(holding that the defendant’s announcement that it had entered into

a three-year agreement from which it expected to realize $12

million in revenues referred to then-present factual conditions and

thus did not fall within the safe-harbor provision of the PSLRA).

Our analysis is independent of the statements contained in the

5
Defendants draw another false analogy with this court’s decision in
Southland Securities Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 361
(5th Cir. 2004), in which this court held that the description of a contract was
not made misleading by the omission of the requirements of a payment bond and a
three-stage implementation procedure. Id. at 375 n. l5. We pointed out,
however, that the entire contract had been filed with the SEC, and added, “all
without any apparent adverse effect on the stock price.” Id. Here, by contrast,
the press release acknowledging failure of the deals with AGNI/Lynxus
precipitated, or at least foreshadowed, the end of IPaxess.
6
See 15 U.S.C. § 78u-5(i)(1)(A), (B), (C) (defining “forward-looking
statements” as: (i) projections of revenues, income, earnings, or other finan-
cial items, (ii) plans and objectives for future operations, and (iii) statements
of future economic performance).

16
releases that are properly designated as forward-looking

representations concerning IPaxess.7

2. Scienter allegations as to the May 25, 2000 press
releases.

The district court concluded that Plotkin failed to plead

facts giving rise to a strong inference of the defendants’

fraudulent intent, as is required to state a claim under Rule

10b-5. We disagree. Plotkin alleged specific facts about the

agreements giving rise to a strong inference that IPaxess knew or

was severely reckless in not knowing at the time of the releases

that Lynxus/AGNI were not able or were not likely to be able to

make the payments they contracted to make. According to the

Complaint, IPaxess was a struggling company that announced to the

public that it had reached agreements with Lynxus and AGPI that

would bring them multimillion dollar revenues, which would amount

7
In their brief, the defendants identify several statements in the May
25 press releases which can be regarded as “forward looking”:

“Ipaxess, AGPI and Lynxus Inc. will work together to provide
advanced, integrated IP remote access solutions for a number of
global opportunities currently under development . . . .”

“Going forward, this strategic relationship with AGPI/Lynxus
represents an important component of IPaxess’s worldwide
distribution strategy. . . .”

“IPaxess is on the way to becoming a recognized leader in remote
communications technology. . . .”

“These installations position IPaxess to ship commercially available
product in September 2000.”

“We look forward to working closely with them as we begin
implementation.”

(R. 1092-93, 1101-02).

17
to a thirty-fold increase from the revenues IPaxess reported in

1999. It is reasonable to assume, given the importance of these

deals to the company, that IPaxess would have familiarized itself

with the financial condition of Lynxus/AGNI and would have

discovered details about their poor financial condition – including

the facts that Lynxus earned revenues of $7 million in 1999, and

that AGPI was incorporated less than six months prior to the

issuance of the May 25 releases. Given the reasonableness of the

inference that Plotkin possessed material facts casting doubt on

its contracting partners’ credibility, the district court was

incorrect to fault Plotkin for failing to allege specific facts

conclusively proving that IPaxess knew this information. Cf. Novak

v. Kasaks, 216 F.3d 300, 308 (2d Cir. 2000) (stating that an

egregious refusal to see the obvious, or to investigate the

doubtful, may in some cases give rise to an inference of

recklessness).

Additionally, Plotkin alleges that IPaxess has referred

in inconsistent ways to shipments of its product under the

agreement, strengthening the permissible inference that IPaxess

intended to deceive or mislead its investors. In its December 2001

Form 10-K annual report with the SEC, IPaxess referred to its

agreements with Lynxus as “beta agreements” (a industry term

referring to testing agreements where testers typically receive a

temporary usage license): “From the beta agreements the Company

shipped 35 VocalWare servers and 840 VocalWare user licenses for

18
approximately $701,000 [to Lynxus].”8 By contrast, when IPaxess

first announced the agreements in its May 25 releases, IPaxess

indicated that AGPI and Lynxus had ordered the products under

normal commercial sales terms: “IPaxess, formerly DATA RACE, Inc.

(Nasdaq: RACE) today announced receipt of a $6.5 million purchase

order for the VocalWare IP remote work technology from

AGPI/Lynxus.” If IPaxess accurately stated in its later SEC filing

that the May 25 deal with AGPI/Lynxus was a beta agreement rather

than a normal commercial sale, then it is curious why this

seemingly important qualifying detail was omitted in the earlier

press release.9

3. Alleged misstatements or omissions of the
August 18, 2000 press releases.

The district court concluded that Plotkin failed to plead

sufficient facts to illustrate that anything in the August 18 press

8
IPaxess’s 2001 Annual Report on Form 10-K states:

The Company entered into beta program agreements with a major global
carrier, a major cable provider, a major airline and an agency of
the federal government for the VocalWare IP integrated server. From
the beta agreements the Company shipped 35 VocalWare servers and 840
VocalWare user licenses for approximately $701,000 and entered into
an exclusive licensing rights agreement for approximately $365,000
with LYNUX [sic]. In January 2001, these servers were returned
based on non-payment from LYNUX and the Company notified LYNUX that
the exclusive licensing rights agreement had been terminated. The
Company in the quarter ended December 31, 2000 reversed the accounts
receivable and deferred the revenue for approximately $365,000.
9
Because the district court ruled that no violation of Rule 10b-5 had
been adequately pled, it further ruled that accordingly there could be no
secondary liability of either of the individual defendants as “controlling
persons” of IPaxess under § 20(b) of the Exchange Act, 15 U.S.C. § 78t(b). Our
reversal of this holding will require the court on remand to address the
potential § 20(a) liability of McDonnell and Scogin in respect to the May 25
releases.

19
release was false or misleading. On this issue, we agree with the

court.

Under Plotkin’s reading, the August 18 release

represented the statement that IPaxess had commercial sales

agreements in place with Time Warner Cable of San Antonio,

Continental Airlines, Associated Global Partners/Lynxus, Inc., a

global carrier, and an agency of the federal government. Plotkin

pleaded that this statement is an outright lie because no such

commercial shipping agreements ever existed.

The defendants respond that Plotkin misinterpreted the

August 18 press release and that, properly understood, it is

correct in its particulars. According to the defendants, the press

release does not announce commercial sales agreements, but, rather,

refers to agreements for participation in IPaxess’s beta trials, as

part of its established marketing strategy. IPaxess’s four-step

selling strategy called for it to ship product to prospective

customers on a trial basis and, if the customer decided to keep the

product, to bill the customer after the trial period. Shipments to

IPaxess’s beta partners were, therefore, simply part of IPaxess’s

efforts to generate sales.

The press release expressly refers to beta agreements and

does not announce the striking of commercial sales agreements with

the listed companies. The release can only properly be read as

telling investors that the participants in the beta test had been

selected and that beta trials were ongoing. The announcement

20
advised the reader that IPaxess had “closed participation in the

VocalWare IP integrated server beta program” (meaning that the

selection of the participants had concluded) and lists customers

“participating in the beta trial.” Later, the release describes

these organizations as beta partners: “We are excited about our

beta partner’s [sic] remote access application plans and

commencement of shipment of the Enterprise Access Server (2G) to

partners of such distinction.”

The subheading of the release, which states: “Agreements

in Place With Major Customers for Commercial Shipments in

September, 2000,” tends to suggest more than this. However, the

text of the release does not reiterate or clarify what was meant in

this subheading. Neither does the text of the press release

announce, as Plotkin alleges, that IPaxess had binding contracts

for commercial sales with Time Warner Cable-San Antonio and

Continental Airlines as well as a global carrier and an agency of

the federal government. Rather, the text of the press release

repeatedly refers to the idea that these various organizations were

participants in a beta program.

4. Plotkin’s state law claims.

In addition to his federal claims, Plotkin also asserts

common law fraud and violations of the Illinois Consumer Fraud and

Deceptive Business Practices Act (the “Consumer Fraud Act”). In

support of these state law causes of action, Plotkin relies on the

21
same allegations of fraudulent acts that support his federal

securities claim. In opposition to these claims, IP Axess makes

the same arguments it made against Plotkin’s federal claims – that

Plotkin’s complaint fails to allege any fraudulent

misrepresentations in conformity with Rule 9(b) of the Federal

Rules of Civil Procedure.

Under Illinois common law fraud,10 “although a statement

may be technically true, it may nevertheless be fraudulent where it

omits qualifying material since ‘a half-truth is sometimes more

misleading than an outright lie.’” Harwood v. Piser Memorial

Chapels, 430 N.E.2d 553, 519 (Ill. App. Ct. 1981) (citing St.

Joseph Hospital v. Corbetta Const. Co., Inc., 316 N.E.2d 51, 71

(Ill. App. Ct. 1974)). The Second Magistrate Report dismissed

Plotkin’s common law fraud claim based on its prior analysis that

Plotkin failed to plead sufficient facts to warrant a finding that

any of the press releases were false or misleading. (Second

Magistrate Report at 1-2.) As discussed above, Plotkin has

sufficiently pled that IP Axess’s May 25 press releases were

misleading. Thus, the district court erred in dismissing Plotkin’s

common law fraud claim on this basis. The defendant states no

other basis for dismissal under Illinois law, so Plotkin states a

10
Under Illinois law, the elements Plotkin needs to satisfy in order
to establish common law fraud are: “(1) a false statement of material fact;
(2) defendant's knowledge that the statement was false; (3) defendant's intent
that the statement induce the plaintiff to act; (4) plaintiff's reliance upon the
truth of the statement; and (5) plaintiff's damages resulting from reliance on
the statement.” Connick v. Suzuki Motor Co., Ltd., 675 N.E.2d 584, 591 (Ill.
1997).

22
claim for Illinois common law fraud based on the allegations of

misleading May 25 releases.

As for the Consumer Fraud Act claim,11 the Second

Magistrate Report dismissed it on the grounds that the May 25

statements Plotkin complains of are “statements pertaining to

future events.” (Second Magistrate Report at 4) (citing Prime

Leasing, Inc. v. Kendig, 773 N.E. 2d 84, 92 (Ill. App. Ct. 2002)).

We hold above that IP Axess’s May 25 releases contained material

statements of then-present factual conditions — transactions that

had already occurred. To the extent described above, the district

court erred in dismissing Plotkin’s Consumer Fraud Act claim. The

defendant’s second ground for urging dismissal of the Consumer

Fraud Act claim – that Plotkin has insufficiently alleged fraud

with respect to the May 25 press releases – has also been

rejected.12

III. CONCLUSION

Plotkin has alleged a set of facts under which he could

prove at trial his argument that the May 25 releases were

11
The elements of a claim under the Consumer Fraud Act are: (1) a
deceptive act or practice by the defendant; (2) the defendant's intent that the
plaintiff rely on the deception; (3) the occurrence of the deception in the
course of conduct involving trade and commerce; and (4) actual damage to the
plaintiff (5) proximately caused by the deception. Oliveira v. Amoco Oil Co.,
776 N.E.2d 151, 160 (2002).
12
The district court did not err, however, in dismissing the state law
claims based on IP Axess’s August 18 press release. As stated above, we agree
that the press release could not properly be read in the manner urged by Plotkin.

23
deceptively selective disclosures, meeting the first element of a

Rule 10b-5 claim (material misstatement or omission). Plotkin has

also met his burden under Rule 12(b)(6) and the PSLRA by alleging

specific facts about the May 25 agreements giving rise to a strong

inference that IPaxess issued the May 25 press releases with

scienter. The district court did not err in dismissing all claims

against McDonnell and Scogin based on IPaxess’s August 18 press

release. Finally, the district court erred in dismissing the state

law causes of action with respect to the May 25 press releases. We

remand to the district court for further proceedings consistent

with this opinion.

AFFIRMED IN PART, REVERSED IN PART, AND REMANDED.

24