First Department Affirms the Denial of Pre-Action Disclosure

• Posted on: Jan 29 2024

By: Jeffrey M. Haber

In prior articles, this Blog examined CPLR § 3102, the statutory provision that permits pre-action disclosure. See here and here. We do so again in connection with our examination of the Matter of Khorassani v. Financial Industry Regulatory Authority, 2024 N.Y. Slip Op. 00354 (1st Dept. Jan. 25, 2024) (here).

CPLR § 3102(c) provides that “[b]efore an action is commenced, disclosure to aid in bringing an action, to preserve information or to aid in arbitration, may be obtained, but only by court order.” Pre-action disclosure can be used “to enable the plaintiff to frame a complaint,” “to preserve evidence for a forthcoming lawsuit,” and to “ascertain[ ] the identities of prospective defendants.” Pre-action disclosure may not, however, be used to ascertain whether a prospective plaintiff has a cause of action worth pursuing. In other words, “[p]re-action discovery is not permissible as a fishing expedition to ascertain whether a cause of action exists.” Accordingly, a petition for pre-action discovery will only be granted when the petitioner demonstrates that he/she has a meritorious cause of action and that the information sought is material and necessary to the actionable wrong. 

Finally, petitions for pre-action disclosure should be filed in the venue that will adjudicate the matter. 

Matter of Khorassani v. Financial Industry Regulatory Authority

[Eds. Note: the background discussion comes from the verified petition filed in support of the application for pre-action discovery.]

In June 2021, Torchlight Energy Resources (“Torchlight Energy”) merged with, and became, Meta Materials, Inc. (“Meta Materials” or “MMAT”). After the merger, Meta Materials traded on the NASDAQ under the ticker symbol “MMAT”.

In connection with the merger, Meta Materials issued a special dividend in the form of Series A Preferred shares (“MMTLP”) to the holders of Torchlight Energy common stock before the merger. MMLTP shares were not intended to be traded on any public exchange, and were only intended to be a dividend placeholder for shareholders who owned Torchlight Energy shares prior to the merger.

In October 2021, the MMTLP shares were listed on the Over-The-Counter Market with the assistance of an unidentified securities broker. Thereafter, unidentified brokers and market makers began trading shares of MMTLP on the open market.

In July 2022, the company’s board of directors voted to spin off the assets of Torchlight Energy into a new company called Next Bridge Hydrocarbons, Inc. (“Next Bridge”). In connection with the transaction, MMAT filed a Form S-1 Registration Statement (the “Registration Statement”) with the Securities and Exchange Commission (“SEC”) to register the issuance of stock in Next Bridge. After four amendments, Next Bridge’s Registration Statement was approved by the SEC in November 2022.

Shortly after the Registration Statement became effective, short interest in MMTLP shares grew. By early December 2022, the volume of short sales exceeded the volume of stock that was not shorted by traders. As a result, on December 9, 2022, FINRA halted trading of MMTLP shares.

FINRA’s halt in trading resulted in the failure by unknown and unidentified brokers to settle their short positions. As a result, Petitioner claimed that he was harmed, in addition to the Company’s other retail investors.

Petitioner sought the “Blue Sheets” maintained by FINRA to allow him to ascertain the names, addresses, and basis of liability of the unknown brokers and market makers to frame his claims, which Petitioner said he intended to bring against the unknown and unidentified brokers and market makers for spoofing, naked short selling, market manipulation, and fraud.

The motion court denied the petition, holding that Petitioner (a) was using CPLR § 3102 for purposes other than ascertaining the identity of the defendants, and (b) failed to assert a meritorious cause of action for fraud. The motion court found that the allegations and arguments in the petition were speculative and conclusory and, as a result, concluded that the petition was an improper fishing expedition.

On appeal, the Appellate Division, First Department affirmed.

Focusing on whether the discovery sought was material and necessary, the Court held that it was not since Petitioner “admit[ted] that he [was] not able to set forth the particulars of the illegal trading by any specific broker and that he [did] not know the times, dates and particulars of the alleged illegal trading activity.” 

Moreover, said the Court, even if “the data in question” was “relevant,” Petitioner’s allegations were “conclusory” and fell “far short of the showing necessary to obtain pre-action disclosure.” In other words, Petitioner failed to state a meritorious cause of action for fraud. 

Footnotes

1. Bumpus v. New York City Transit Auth., 66 A.D.3d 26 (2d Dept. 2009); see also Stewart v. New York City Transit Auth., 112 A.D.2d 939 (2d Dept. 1985).
2. Uddin v. New York City Transit Auth., 27 A.D.3d 265 (1st Dept. 2006). See also Matter of Gleich v. Kissinger, 111 A.D.2d 130, 131 (1st Dept. 1985).
3. Bishop v. Stevenson Commons Assocs., 74 A.D.3d 640 (1st Dept. 2010), lv. denied, 16 N.Y.3d 702 (2011) (quoting Liberty Imports v. Bourguet, 146 A.D.2d 535 (1st Dept. 1989)).
4. Holzman v. Manhattan & Bronx Surface Transit Operating Auth., 271 A.D.2d 346, 347 (1st Dept. 2000); see also Thomas v. MasterCard Advisors, LLC, 74 A.D.3d 464 (1st Dept. 2010).
5. See Perez v. NY Presbyterian Hosp., 11 Misc. 3d 722 (Civ. Ct., N.Y. County 2006); Estate of Matter of Wallace, 239 A.D.2d 14 (3d Dept. 1998).
6. Blue Sheets (known as Electronic Blue Sheets) are files that are maintained by FINRA. Blue Sheets contain both trading and account holder information. See Financial Industry Regulatory Authority, Electronic Blue Sheets (EBS), https://www.finra.org/filingreporting/electronic-blue-sheets-ebs.
7. Slip Op. at *1.
8. Id. (citing Matter of GTV Media Grp., Inc. v. Confidential Global Investigations, 205 A.D.3d 539, 539-540 (1st Dept. 2022)).

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP. 

This article is for informational purposes and is not intended to be and should not be taken as legal advice.