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adopting first-offered test for unregistered securities and collecting cases
Summary of this case from P. Stolz Family Partnership L.P. v. DaumOpinion
Civil No. 02-3709 (JRT/FLN).
June 30, 2003.
William J. Joanis and April M. Guerin, Joanis Law Group, Minneapolis, MN, Attorneys for Plaintiffs.
Alice McInerney and Richard L. Stone, Kirby McInerney Squire, New York, NY, Attorneys for Plaintiffs.
Michael C. McCarthy and Dawn Van Tassel, Maslon Edelman Borman Brand, Minneapolis, MN, Attorneys for Defendants.
Dave Johnson, Eldon C. Miller, John Felt, Todd Miller, Paul Kuehn, Bill Kuehn, Jeffrey L. Houdek, and Jeff Rahm, Attorneys for Defendants.
Thomas B Hatch, Robins, Kaplan, Miller Ciresi, LLP., Minneapolis, MN, Attorneys for Defendants.
Roger Tadson, Pat Maloney, Chuck Reynolds, Rick Reynolds and mark Beese, Attorneys for Defendants.
Thomas Brooks, Attorney for Defendants, pro se.
MEMORANDUM OPINION AND ORDER GRANTING MOTIONS TO DISMISS
This case involves the bankruptcy and receivership of MJK Clearing, Inc. ("MJK"). Plaintiffs are investors who lent funds to MJK. They allege that defendants, individuals formerly associated with MJK, sold them unregistered securities in violation of Section 12(a)(1) of the Securities Exchange Act of 1933 (the "Securities Act"), 15 U.S.C. § 771(a)(1). Two separate groups of defendants have filed motions to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure: a group of 8 individuals consisting of Dave Johnson, Eldon C. Miller, John Feltl, Todd Miller, Paul Kuehn, Bill Kuehn, Jeffrey L. Houdek, and Jeff Rahm (the "Johnson defendants"), and a group of 5 individuals consisting of Roger Tadson, Pat Maloney, Chuck Reynolds, Rick Reynolds, and Mark Beese (the "Tadson defendants"). Each group now files a motion to dismiss.
The remaining defendant, Thomas Brooks, has answered plaintiffs' complaint but is not a party to any of the pending motions.
BACKGROUND
This case revolves around financial instruments called Securities Demand Notes ("SDNs"). An SDN was the vehicle by which plaintiffs individually lent money to MJK. Each plaintiff executed an SDN, whereby he or she agreed to pay a specified sum upon demand to MJK. Each SDN was secured by a pledge of securities. In exchange for pledging the securities to MJK, plaintiffs received monthly interest. Borrowing money through an SDN was advantageous to MJK because although the SDNs were disclosed publicly, they did not count toward its "aggregate indebtedness."
Plaintiffs allege that the SDNs were securities, and that defendants failed to properly register the SDNs as such. The issues on this motion, however, involve only questions about the statute of limitations. The SDNs were executed over a period of time, but the most recent was executed on May 31, 2001. MJK was ordered to be liquidated on September 27, 2001. Plaintiffs' filed their complaint in this action on September 25, 2002. The parties do not dispute any dates, but they sharply disagree over which statute of limitations applies, and the interpretation of the relevant limitations periods.
ANALYSIS
Section 12(a)(1) of the Securities Act provides a remedy for violations of the Act's registration requirements. See 15 U.S.C. § 771(a)(1). Section 12(a)(1) is governed by limitations periods contained in Section 13 of the Act. Section 13 provides:
No action shall be maintained to enforce any liability created under section 77k or 77 l(a)(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created under section 77 l(a)(1) of this title, unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under section 77k or 77 l(a)(1) of this title more than three years after the security was bona fide offered to the public, or under section 77 l(a)(2) of this title more than three years after the sale.15 U.S.C. § 77m. Defendants' motions present the following questions:
(1) Does the one-year statute of limitations begin to run when the alleged violation occurred, or should the Court equitably toll the statute until the date on which alleged violation was discovered?
(2) If the one-year statute of limitations is tolled, was plaintiffs' complaint still timely?
(3) When did the three-year statute of limitations begin to run?
Defendants' motions are complementary; the Johnson defendants focus on the one-year statute of limitations, while the Tadson defendants address the three-year limitations period.
I. Submissions of Material Outside the Pleadings
The Court must first address the fact that defendants have submitted materials outside the pleadings with their motions. Defendants contend, and plaintiff does not dispute, that the Court can consider these materials without converting their 12(b)(6) motion into one for summary judgment. The affidavits of Michael C. McCarthy and Nancy A. Voth and their attachments consist of materials that are part of the public record, and which do not contradict the complaint. Therefore, the Court may consider them in deciding defendants' motions to dismiss. State ex rel. Nixon v. Coeur D'Alene Tribe, 164 F.3d 1102, 1107 (8th Cir. 1999) ("In this circuit, Rule 12(b)(6) motions are not automatically converted into motions for summary judgment simply because one party submits additional matters. . . .").
II. Section 13's One-Year Limitations Period
Section 13 of the Securities Act provides that "[n]o action shall be maintained to enforce any liability created under . . . section 77 l(a)(1) of this title, unless brought within one year after the violation upon which it is based." 15 U.S.C. § 77m. Defendants argue that, under the plain language of the statute, the limitations period begins running when the violation occurs. Defendants concede that for the purposes of this motion, the last relevant act constituting a "violation" under § 77m was the execution of the initial SDN agreements. The latest such agreement was executed on May 31, 2001, more than one year before this action was filed. Under defendant's interpretation it would therefore be time-barred. Plaintiffs do not dispute that the most recent violation occurred more than one year before this case was filed. They argue, however, that the Court should invoke the doctrine of equitable tolling and begin the limitations period only when the violations were discovered.
Under the doctrine of equitable tolling, a plaintiff may sue after the statutory time period has expired if she has been prevented from doing so due to circumstances beyond her control. Shempert v. Harwick Chemical Corp., 151 F.3d 793, 797-98 (8th Cir. 1998); Evans v. Rudy Luther Toyota, Inc., 39 F. Supp.2d 1177, 1182 n. 3 (Minn. 1999). Plaintiffs claim that the doctrine applies here because they could not have known the wide scope of MJK's SDN offerings. Because defendants' "scheme" was "undetectable," plaintiffs argue, the one-year statute of limitations should be tolled until they discovered the breadth of defendants' SDN offerings. (See Pl. Br. at 5.) This happened less than one year before the action was filed.
The Eighth Circuit has held that a § 12(a)(1) claim "must be brought within one year after the violation." Gridley v. Cunningham, 550 F.2d 551, 552 (8th Cir. 1977) (emphasis added). Nevertheless, plaintiffs argue that the doctrine of equitable tolling is generally imputed to all federal statutes, and therefore should apply to § 13's one-year limitations period. The Court disagrees. The plain text of § 13, congressional intent, and the purpose of the limitation itself all demonstrate that this view is the "correct result."
Plaintiffs are correct that equitable tolling is read into every federal statute. However, they ignore the corollary that congressional intent as to a particular statute of limitations is paramount. Barton v. Peterson, 733 F. Supp. 1482, 1490 (N.D. Ga. 1990) ("Equitable tolling, though read into every federal statute of limitations, cannot be applied in the face of contrary congressional intent."). The Court cannot ignore the fact that "the basic inquiry is whether congressional purpose is effectuated by tolling the statute of limitations in given circumstances." Burnett v. New York Central R.R. Co., 380 U.S. 424, 427 (1965). To determine whether equitable tolling applies in a specific case, the Court must "examine the purposes and policies underlying the limitation provision, the Act itself, and the remedial scheme developed for the enforcement of the . . . Act." Id.
Examining these factors here demonstrates that equitable tolling to provide for a "discovery rule" is inappropriate for several reasons. First, the plain text of § 13 makes clear that a § 12(a)(1) claim "must be brought within one year after the violation." Gridley, 550 F.2d at 552. See Cook v. Avien, Inc., 573 F.2d 685, 691 (1st Cir. 1978) ("[U]nder the explicit language of § 13, the limitations period runs from the date of the violation irrespective of whether the plaintiff knew of the violation.") (citing Gridley). Plaintiff has cited no authorities for why this Court should apply a general maxim in the face of clear statutory language.
Second, other parts of § 13 demonstrate that if Congress wanted to allow for a discovery rule in § 12(a)(1) claims, it could have expressly done so. For example, § 13 also contains a statute of limitations applicable to § 12(a) (2) of the Securities Act. This passage provides that no action shall be maintained "unless brought within one year after the discovery of the untrue statement. . . ." 15 U.S.C. § 77m (emphasis added). Thus, Congress's "legislative message is clear; by including a discovery rule limitation for certain claims, in the very same statutory provision, Congress clearly reflected its intent to prohibit application of the discovery rule" to § 12(a)(1) claims. McCullough v. Leede Oil Gas, Inc., 617 F. Supp. 384, 387 (W.D. Okla. 1985).
Finally, the Court finds "little justification" to apply a discovery rule or equitable tolling to causes of action which, like plaintiffs', do not involve allegations of fraud. Id. The court in McCullough noted that the "discovery rule, or any equitable tolling on the basis of fraudulent concealment, is premised on a fraudfeasor's ability to conceal his violation." Id. Although plaintiffs here claim they could not know the breadth of defendants' SDN offerings, they do not allege that defendants fraudulently concealed their failure to register the SDNs. Indeed, because registration of securities is a matter of public record, "a seller of securities cannot conceal the fact that the securities he sells are not registered." Id. Plaintiffs' complaint does not allege fraud or misrepresentation; it alleges nothing more than failure to register. Thus, plaintiffs' contention that the breadth of defendant's enterprise was unknown is irrelevant. Because the registration status of the SDNs was always knowable, there is no later date to which the statute of limitations need be equitably tolled. The doctrine simply does not apply in these circumstances.
The United States Supreme Court has suggested, in dicta, that "the equitable tolling doctrine is fundamentally inconsistent with the 1-and-3-year structure" of § 13's statutes of limitations. Lampf, Pleva, Lipkin, Prupis Petigrow v. Gilbertson, 501 U.S. 350, 363 (1991). The vast majority of courts also agrees that equitable tolling does not apply to claims under § 12(a)(1) of the Securities Act. See, e.g., Cook, 573 F.2d at 691; Gardner v. Investors Diversified Capital, Inc., 805 F. Supp. 874, 878 (Colo. 1992) (holding that the § 13 limitations period is triggered upon violation, and that "equitable tolling is inapplicable to [§ 12(a)(1)] claims"); Hardy v. First Amer. Bank, 774 F. Supp. 1078, 1081-82 (M.D. Tenn. 1991) (holding that the equitable tolling doctrine is fundamentally inconsistent with the § 13 statute of limitations); Barton, 733 F. Supp. at 1490 (compiling cases and stating that the "better reasoned authority holds that equitable tolling and fraudulent concealment are not available to toll the one-year statute of limitations for [§ 12(a)(1)] registration claims"). See generally, Thomas Lee Hazen, Law of Securities Regulation, § 7.10[3] ("[T]he apparent majority of courts have indicated that section 12(a)(1)'s one-year period should not be tolled.").
Plaintiffs cite several cases for the proposition that equitable tolling generally applies to causes of action under § 12(a)(1). These cases do not stand for such a sweeping proposition, and they are all distinguishable. For example, Perry v. Investors Planning Inc., No. 96-6027, 1996 WL 606380 (10th Cir. Oct. 23, 1996) and Anixter v. Home-Stake Production Co., 939 F.2d 1420 (10th Cir. 1991) both provide for a discovery rule, but hold that such a rule "encompasses the concept of fraudulent concealment." Perry, 1996 WL 606380 at *3. See Anixter, 939 F.2d at 1434. As discussed above, fraudulent concealment is not relevant in a registration action because it is impossible to conceal the fact that a security is not registered. Thus, these cases are inapposite. Plaintiffs also rely upon Short v. Belleville Shoe Mfg. Co., 908 F.2d 1385 (7th Cir. 1990). That case, however, did not find that equitable tolling applied to § 12(a)(1) claims, but merely discussed, without holding, that equitable tolling might extend the limitation period from one to three years. See id. at 1391. Finally, plaintiffs rely upon Katz v. Amos Treat Co., 411 F.2d 1046 (2d Cir. 1969). In that case, the court held that equitable tolling applied only because the defendant fraudulently assured the plaintiff that registration would be completed shortly. See id. at 1055. Not only was there no such assurance in this case, but as discussed above, more recent courts have held that such fraud is irrelevant to a registration claim under § 12(a)(1). See, e.g., McCullough, 617 F. Supp. at 387 ("While [a seller] may misrepresent that the securities are properly registered, or that registration is not required, he cannot prevent a purchaser from discovering the true facts as to a lack of registration."). The Court thus concludes that equitable tolling does not apply to registration claims under § 12(a)(1) of the Securities Act.
Therefore, because plaintiffs' complaint was filed more than one year after the most recent SDN was executed, the complaint is untimely under § 13 of the Securities Act, and defendants' motions to dismiss must therefore be granted.
Even if a discovery rule did apply here, plaintiffs' complaint would still be untimely. Under a discovery rule, the limitations period starts running when a violation is discovered or should have been discovered by the exercise of reasonable diligence. Gridley v. Cunningham, 550 F.2d 551, 553 (8th Cir. 1977); Davidson v. Wilson, 763 F. Supp. 1465, 1468-69 (D. Minn. 1990), aff'd, 973 F.2d 1391 (8th Cir. 1992). Here, it is evident that if plaintiffs had exercised reasonable diligence, they should have learned of the SDNs' non-registration when they executed the SDN agreements. The SDN agreements clearly state that the SDNs "may be publicly offered and sold without registration. . . ." (McCarthy Aff. Ex. B at Bates No. MJK 42903.) Plaintiffs also could have earned that the SDNs were not registered by checking the Securities Exchange Commission's public records. Both of these facts were sufficient to put plaintiffs on notice that the SDNs were not registered securities. Therefore, even if a discovery rule applies, the § 13 one-year statute of limitations should begin to run, at the latest, from the date on which the SDNs were executed, and the complaint would therefore still be untimely.
Because plaintiffs' complaint is untimely, the Court is without jurisdiction to entertain it. Therefore, even though defendant Thomas Brooks has not filed a motion to dismiss, the Court must dismiss the case against him as well.
III. Section 13's Three-Year Limitations Period
Defendants argue that even if plaintiffs' complaint was somehow timely under the one-year statute of limitations, it still fails under § 13's three-year statute of limitations. The Court agrees.
The limitations provisions in § 13 "must be read cumulatively, and not alternatively." Ballenger v. Applied Digital Solutions Inc., 189 F. Supp.2d 196, 199 (D. Del. 2002). Thus, the action must be brought both within one year of the alleged violation and within three years of the time the security was bona fide offered to the public. Id.
Section 13 of the Securities Act provides that "[i]n no event shall any such action be brought to enforce a liability created under section . . . [12(a)(1)] more than three years after the security was bona fide offered to the public. . . ." 15 U.S.C. § 77m. The parties disagree over the proper interpretation of the phrase "bona fide offered to the public," and thus over when the three-year statute of limitations began to run.
Defendants claim that the three-year period begins running when unregistered securities are first offered to the public for sale, meaning when they are first purchased or sold. The earliest SDN in this case is dated November 15, 1998, and became effective on December 31, 1998. Therefore, under defendants' interpretation, plaintiffs' complaint is time-barred because it was filed on September 25, 2002, outside the three-year time limit. Plaintiffs contend that such language should not be imported into the statute. They argue that if any language must be inferred it should be that the statute runs from when the unregistered security was last offered for sale. Plaintiffs do not specify what this "last" date is, but presumably they would argue for a date that is less than three years before September 25, 2002.
Courts are divided on the question of how to define "bona fide offered to the public," but the vast majority agrees with defendants that the statute begins running when the unregistered security is first offered for sale. See, e.g., Ballenger v. Applied Digital Solutions Inc., 189 F. Supp.2d 196, 199-200 (Del. 2002) (holding that the statutory language compels a holding that three-year period begins when securities are first offered to the public, not when they were last offered); Zola v. Gordon, 685 F. Supp. 354, 360 (S.D.N.Y. 1988) ("The majority of courts have held that the three year period begins to run from the date the security is first offered to the public.") (citation and quotation marks omitted); Waterman v. Alta Verde Indus., Inc., 643 F. Supp. 797, 807-08 (E.D.N.C. 1986) (holding that "the clear weight of authority" holds that the three-year period begins when securities are first offered to the public); Morley v. Cohen, 610 F. Supp. 798, 815-16 n. 18 (Md. 1985) (same); LeCroy v. Dean Witter Reynolds, Inc., 585 F. Supp. 753, 760 n. 4 (E.D. Ark. 1984) ("Most authorities agree that the three-year period commences on the date the security was initially bona fide offered to the public." (emphasis original)); Morse v. Peat, Marwick, Mitchell Co., 445 F. Supp. 619, 621 n. 3 (S.D.N.Y. 1977) ("[A] `bona fide' offering of securities is the `first' offering to the public for purposes of § 13."); Osborne v. Mallory, 86 F. Supp. 869, 873 (S.D.N.Y. 1949).
Plaintiffs' attempt to distinguish this case fails. Plaintiffs argue that Waterman is of "dubious" applicability here because a subsequent appeal did not address the statute of limitations. This contention is without merit. The plaintiff in Waterman brought both federal and state claims. The district court held that § 13's three-year statute of limitations began running upon the first offering to the public, and that the plaintiff's federal claim was therefore time-barred. Waterman v. Alta Verde Indus., Inc., 643 F. Supp. 797, 808 (E.D.N.C. 1986). The court held in plaintiff's favor, however, on his state law claim. Id. at 809. The defendant appealed, but the Fourth Circuit, in an unpublished decision, affirmed the district court's ruling for plaintiff on the state law claim. See Waterman v. Alta Verde Indus., Inc., Nos. 87-1505, 87-1515, 1987 WL 39014 at **1-2 (4th Cir. Nov. 17, 1987). The plaintiff had also appealed the district court's ruling on the statute of limitations, but the court of appeals declined to reach this question since it had already found for plaintiff, stating that he was "not entitled to double recovery." Id. at *2. Although the Fourth Circuit did not analyze the district court's ruling on the statute of limitations, the lower court's thorough discussion on the subject loses none of its persuasive force. See Waterman, 643 F. Supp. at 808-09.
Plaintiffs' cases acknowledge that this is the majority view, but hold that having the statute of limitations operate in this way would undermine the remedial purposes of the Securities Act. It appears that only three cases have agreed with plaintiffs' view. See Bradford v. Moench, 809 F. Supp. 1473, 1485-90 (Utah 1992); Hudson v. Capital Mgmt. Int'l, Inc., No. C-81-1737, 1982 WL 1384 at *3 n. 3 (N.D. Cal. Jan. 6, 1982); In re Bestline Prod. Securities Antitrust Lit, MDL No. 162, 1975 WL 386 at **1-2 (S.D. Fla. Mar. 21, 1975). These cases reason that if the statute of limitations runs from when an unregistered security is first offered to the public, unscrupulous securities dealers can escape all liability if they manage to go three years without getting caught. See Bradford, 809 F. Supp. at 1490; In re Bestline, 1975 WL at *2.
Plaintiffs' appeal to the remedial purposes of the Securities act is enlightening, but the Court's analysis cannot end there. The U.S. Supreme Court has held that to determine congressional intent regarding a statute of limitations, a court must consider the policies underlying the limitation provision itself along with the act's overall remedial purpose. Burnett, 380 U.S. at 427. In doing so, the Court must keep in mind that all statutes of limitations necessarily derogate the purpose of the statutes that they govern. See N.V. Levensverzekering-Maatschappij Van De Nederlanden v. United States, 121 F. Supp. 116, 117 (Conn. 1954). In imposing limitations periods, legislatures opt for a policy that grants eventual repose for potential defendants, even though some claims that are otherwise valid will be lost. The overwhelming majority of courts agrees that the three-year limitations imposes such a cutoff for § 12(a)(1) claims, and plaintiffs have not shown why this Court should find differently. At best, plaintiffs may note a flaw in § 13 as it pertains to the Securities Act's general purpose, but "the only way to remedy the statutory language is to have the statute amended or repealed." Ballenger, 189 F. Supp.2d at 200. Therefore, in the absence of authority undermining the majority rule, the Court agrees that the three-year limitations period of § 13 begins running from when the securities were first offered to the public. Accordingly, even if plaintiffs' complaint was timely under the one-year statute of limitations, it would be time-barred under this limitation period.
ORDER
Based on the foregoing, all the records, files, and proceedings herein, IT IS HEREBY ORDERED that:
1. The motion to dismiss by defendants Dave Johnson, Eldon C. Miller, John Feltl, Todd Miller, Paul Kuehn, Bill Kuehn, Jeffrey L. Houdek, and Jeff Rahm [Docket No. 13] is GRANTED.
2. The motion to dismiss by defendants Roger Tadson, Pat Maloney, Chuck Reynolds, Rick Reynolds, Mark Beese, and Al Gramentz [Docket No. 17] is GRANTED.
3. Plaintiffs' Complaint [Docket No. 1] is DISMISSED WITH PREJUDICE.