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SANTIAGO ALFARO v. E.F. HUTTON & CO.

April 2, 1985

SANTIAGO ALFARO and ARARAQUARA CITRUS, INC., on behalf of themselves and all others similarly situated
v.
E.F. HUTTON & COMPANY, INC.



The opinion of the court was delivered by: POLLAK

 This action was initiated in July 1984 by Santiago Alfaro and Araraquara Citrus, Inc., a corporation wholly owned by Mr. Alfaro, on behalf of themselves and all other similarly situated individuals. The complaint alleges that the named plaintiffs and other individuals purchased limited partnership interests in Energy Resources 1981-A Ltd. ("Energy Resources") after July 8, 1981, as a result of the promotion of these interests by defendant E.F. Hutton & Co. ("Hutton"). Plaintiffs claim that defendant Hutton made numerous misrepresentations regarding the nature and riskiness of this investment which caused them to enter into the deal. They assert that Hutton knew that these representations were false at the time they were made or that defendant acted with reckless disregard as to the truth of these representations. The complaint presents six counts including claims under (1) section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and Rule 10(b)-5; (2) section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l; (3) the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1964(c); and (4) Pennsylvania common law for (a) fraud; (b) breach of fiduciary duty; and (c) negligence.

 In late August 1984, plaintiffs filed a motion for class certification. Defendant did not respond directly to that motion but, on September 14, 1984, filed a motion to dismiss the complaint pursuant to Rule 12(b)(6). Plaintiffs have responded to that motion and defendant has filed a reply to plaintiffs' response.

 The motion raises a number of challenges to each count of the complaint. Although there is some overlap in the arguments raised in opposition to different counts, the challenges to each count are sufficiently distinct to allow me to address the objections in the sequence in which the counts are presented in the complaint.

 1) Section 10(b) and Rule 10(b)-5 claim

 Count One of the complaint charges Hutton with violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and Rule 10(b)-5 promulgated thereunder. This securities fraud claim is challenged in the present motion on three grounds: (1) the opinions and predictions which are alleged to have been misrepresentations cannot form a basis for liability; (2) the statute of limitations had expired on this claim prior to the filing of the complaint; and (3) fraud is not pleaded with the necessary specificity. I will address each of these contentions in this order.

 a) Opinions and predictions as misrepresentations

 Count One alleges that defendant misrepresented to plaintiffs that the proposed investment in Energy Resources (1) was a low risk investment; (ii) would yield a three-to-one return on fifty percent of the proceeds which would be invested in low risk development wells; (iii) would call for fifty percent of the proceeds to be invested in controlled exploratory drilling; (iv) would involve a large number of wells to minimize the risk; and (v) was likely to produce a six-to-one return on investment over time. Count One also charges that defendant stated that there was minimal risk that the letters of credit to be provided by plaintiffs would be called. Hutton contends that this type of misrepresentation may not form the basis for a securities fraud claim. Hutton cites numerous cases for the proposition that expressions of opinion and predictions are not actionable as fraud. Defendant's brief at 11. However, defendant recognizes that under certain "limited circumstances" a fraud claim may be asserted on the basis of misrepresentations of opinion. Opinions or predictions not made in good faith or made with the knowledge that they are not based upon a sound, factual or historical basis are actionable under section 10(b) and rule 10(b)-5. See, e.g., Marx v. Computer Sciences Corporation, 507 F.2d 485 (9th Cir. 1974); Eichen v. E.F. Hutton & Co., Inc., 402 F. Supp. 823, 829 (S.D. Cal. 1975); Schuller v. Slick Corporation, [1974-1975 Transfer Binder] CCH Fed. Sec. L. Rep. P95,065 (S.D.N.Y. 1975); Nicewarner v. Bleavins, 244 F. Supp. 261, 264 (D. Colo. 1965). Hutton contends that the complaint fails to allege the necessary bad faith or scienter to support liability for these allegedly faulty predictions and opinions and therefore Count One must be dismissed.

 Plaintiffs respond that the complaint more than adequately alleges a claim for securities fraud under section 10(b) and rule 10(b)-5 despite the fact that the alleged misrepresentations were opinions or predictions. Plaintiffs assert that the complaint properly alleges that when these predictions and opinions were made Hutton was aware that it did not have a factual basis for such representations. Plaintiffs also note that defendant, in its brief, suggests that it should be obvious that opinions and predictions of the nature of those allegedly made by Hutton could never be made with assurance. Plaintiffs contend that this admission by defendant shows that defendant should be liable for its statements because defendant knew that potential investors were relying upon representations which could not be made with assurance.

 
Paragraph 26 of the complaint states:
 
Defendant acted with knowledge of the falsity of its statements and the materiality of its omissions or with reckless disregard for the truth or falsity thereof.

 Although this language could have been more carefully chosen to correspond to the type of misrepresentation alleged (i.e., it would have been more appropriate to allege that defendant knew that it lacked information on which to base these opinions and predictions or that the information which defendant possessed did not support these statements), under the liberal pleading standard of the Federal Rules of Civil Procedure, this statement sufficiently alleges that defendant knew that it lacked support for these predictions and opinions or acted in reckless disregard of this fact.

 The Federal Rules of Civil Procedure require that fraud and mistake be pleaded with specificity. Rule 9(b). However, intent and knowledge may be averred generally. Therefore, the very general nature of the allegation of scienter in the present complaint does not warrant dismissal or amendment of the complaint. See Denny v. Carey, 72 F.R.D. 574, 580 (E.D. Pa. 1976). *fn1"

 b) Statute of limitations

 In the absence of an express statute of limitations in the federal statute upon which the securities fraud claim is based, it is necessary to turn to the law of the forum state for the appropriate limitations period. Biggans v. Bache Halsey Stuart Shields, 638 F.2d 605 (3d Cir. 1980). In the present case there are two statutes of limitations from which to choose. One potentially applicable statute of limitations is provided by 42 Pa. Cons. Stat. Ann. § 5524(7). That statute applies to common law fraud claims brought in Pennsylvania courts and requires that all such claims be brought within two years. Alternative limitations periods are established in the Pennsylvania Securities Act, 70 Pa. Cons. Stat. Ann. § 1-504(a). That Act states that an action under that Act must be brought within three years "after the act or transaction constituting the violation or the expiration of one year after the plaintiff receives actual notice or upon the exercise of reasonable diligence should have known of the facts constituting the violation, whichever shall first expire."

 The question to be resolved in choosing the appropriate statute of limitations is what limitations period would apply to a state law claim which parallels the federal claim asserted. In general under Pennsylvania law, when the suit involves a claim against a broker rather than a seller of securities, the courts of this Circuit apply the two-year common law fraud limitations period. E.g., Sharp v. Coopers & Lybrand, 649 F.2d 175, 191-92 (3d Cir. 1981); Biggans v. Bache Halsey Stuart Shields, 638 F.2d 605 (3d Cir. 1980); Fickinger v. C.I. Planning Corp., 556 F. Supp. 434 (E.D. Pa. 1982). This result stems from the fact that the Pennsylvania Securities Act only allows recovery against "sellers" of securities so that claims against brokers who are not in privity with the plaintiffs must be brought under a common law fraud theory in Pennsylvania. However, when the defendant sold securities to the plaintiff and was in privity with the plaintiff, the plaintiff would have a claim under the Pennsylvania Securities Act. Thus, to determine which state law cause of action is most similar to the present claim, I must consider whether the present section 10(b) claim alleges that Hutton acted as a "seller " of securities or merely a broker. If Hutton's role was one which placed it in privity with plaintiffs, the section 10(b) claim would parallel a claim under the Pennsylvania Securities Act and its statute of limitations would apply. If, on the other hand, Hutton was not in privity with plaintiffs, the two-year limitations period for common law fraud would apply.

 The current complaint alleges that Hutton acted as a "sales agent" to sell interests in Energy Resources, a Texas limited partnership. It also alleges that plaintiffs "purchased" and defendant "sold" the limited partnership interests in Energy Resources. Therefore, there is some suggestion that defendant was acting outside of the typical realm of activities of a broker and may have been in the position of the "seller" of the partnership interests in question.

 Under the unique factual scenario alleged, I cannot determine from the face of the complaint which statute of limitations should apply. Therefore, faced with a motion to dismiss, I must assume that either limitations period may apply and allow the claim to stand if it would not be time-barred under either one of them.

 "Although state law provides the limitations period, federal law determines when the period commences to run." Biggans v. Bache Halsey Stuart Shields, 638 F.2d 605, 607 n.3 (3d Cir. 1980). Thus, I must turn to federal principles to determine the date which starts the running of the appropriate limitations period - whether that period be one year, two years, or three years. "Under the federal equitable tolling doctrine the statute does not begin to run until the plaintiff knew or exercising reasonable diligence should have known of the alleged fraud." Id. at 608 n.3. Furthermore, the "active concealment of fraudulent conduct tolls the statute of limitations in favor of the defrauded party until such time as he actually knew of the fraudulent conduct of the opposing party. " Engl v. Berg, 511 F. Supp. 1146, 1151 (E.D. Pa. 1981).

 In the present case Hutton argues that the action is time-barred because plaintiffs have failed to plead with specificity why they were unable to discover the fraud more than one year prior to the filing of the present action. E.g., Hill v. Equitable Trust Co., 562 F. Supp. 1324, 1340 (D. Del. 1983). Plaintiffs respond that they need not plead the details of their efforts to discover the fraud with specificity and that, even if such specific pleading is required, they have pleaded fraudulent concealment in a manner sufficient to withstand the current challenge.

 With regard to this issue, paragraph 22 of the complaint states:

 
By reason of defendant's concealment of their scheme, plaintiffs and the other investors had no reason to suspect wrongdoing until January 1984 at the earliest, and had no reason to suspect that a fraud had been committed until the completion of the investigation conducted by plaintiffs' counsel in June 1984.

 Therefore, the complaint clearly alleges when the fraud was discovered by plaintiffs and why plaintiffs did not discover the fraud earlier. The reason presented for plaintiffs' failure to discover the fraud until 1984 was the concealment of the fraud by defendant. The activities which constituted concealment are catalogued in paragraphs 19 to 21 of the complaint.

 In these circumstances, I need not address the broad question raised by defendant -- whether, in all securities fraud complaints, the plaintiff must allege in detail when he learned of the fraudulent conduct, why discovery was not made earlier, and what diligent efforts were made to unearth the fraud. E.g., Hill v. Equitable Trust Co., 562 F. Supp. 1324, 1340 (D. Del. 1983); Brick v. Dominion Mortgage & Realty Trust, 442 F. Supp. 283, 292 (W.D.N.Y. 1977). The only question before me is the more limited issue whether a plaintiff who asserts that discovery of the fraud was delayed by defendant's concealment must allege with specificity the circumstances of the alleged concealment efforts by defendant.

 It is well established that fraudulent concealment must be pleaded with specificity. E.g., Armstrong v. McAlpin, 699 F.2d 79 (2d Cir. 1983); Herm v. Stafford, 663 F.2d 669 (6th Cir 1981); Rich-Taubman Associates v. Stamford Restaurant Operating Co., 587 F. Supp. 875 (S.D.N.Y. 1984); Kilmartin v. H.C. Wainwright & Co., 580 F. Supp. 604 (D. Mass. 1984); Butler v. Rye, 544 F. Supp. 143 (D. Mo. 1982). Plaintiffs have suggested no reason to depart from this general principle in the present case where the allegations regarding discovery of the fraud depend upon allegations of concealment of the fraud by defendant. Therefore, I conclude that the same degree of pleading specificity is required when the claim of inability to discover the fraud rests upon an assertion of concealment as when fraud is alleged in any other pleading.

 To determine whether plaintiffs' allegations of fraudulent concealment are sufficient, it is necessary to consider the general standards which apply to pleadings of fraud. Because these issues are also raised by defendant's overall challenge to the sufficiency of the substantive allegations of securities fraud under section 10(b) and rule 10(b)-5, I will address them together.

 c) Specificity of fraud pleading

 Rule 9(b) of the Federal Rules of Civil Procedure states:

 
In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other conditions of mind of a person may be averred generally.

 Defendant's motion attacks the sufficiency of both the allegations of fraudulent concealment and of securities fraud. Defendant contends that the complaint fails to identify the nature of the fraud, when the allegedly fraudulent misrepresentations were made, and the circumstances under which they were made. In particular, defendant asserts that plaintiffs have failed to distinguish the conduct with which defendant is to be charged and the conduct of nondefendants such as Energy Resources. Plaintiff responds to these contentions by asserting that defendant is relying upon pleading standards not applicable under the law of this Circuit and that the complaint is more than sufficient under Third Circuit standards.

 The Court of Appeals for the Third Circuit, speaking through Judge Hunter, recently addressed the scope of the specificity requirement of Rule 9(b) in Seville Industrial Machinery v. Southmost Machinery, 742 F.2d 786 (3d Cir. 1984):

 
We approach this question mindful of our recent admonition that in applying Rule 9(b), "focusing exclusively on its 'particularly' language 'is too narrow an approach and fails to take account of the general simplicity and flexibility contemplated by the rules.'" Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96, 100 (3d Cir. 1983) (quoting 5 C. Wright & A. Miller, Federal Practice and Procedure § 1298, at 407 (1969)). We conclude that the district court subjected Seville's allegations of fraud to too strict a scrutiny. Rule 9(b) requires plaintiffs to plead with particularity the "circumstances" of the alleged fraud in order to place the defendants on notice of the precise misconduct with which they are charged, and to safeguard defendants against spurious charges of immoral and fraudulent behavior. It is certainly true that allegations of "date, place or time" fulfill these functions, but nothing in the rule requires them. Plaintiffs are free to use alternative means of injecting precision and some measure of substantiation into their allegations of fraud. In the present case, Seville adequately satisfied the requirements of Rule 9(b) by incorporating into the complaint a list identifying with great specificity the pieces of machinery that were the subject of the alleged fraud. Moreover, Seville divided this list into five "exhibits" and identified which pieces of equipment were the subject of which alleged fraudulent transaction. The complaint sets forth the nature of the alleged misrepresentations, and while it does not describe the precise words used, each allegation of fraud adequately describes the nature and subject of the alleged misrepresentation. In sum, we conclude that Seville has alleged the fraud-based offenses with sufficient particularity to withstand a motion to dismiss under Rule 9(b).

 Thus, as a general matter, Rule 9(b) should not be applied so strictly as to deprive a legitimate plaintiff of his opportunity to develop his case through discovery while a "sophisticated defrauder [] . . . successfully conceals] the details of [his] fraud," Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96, 100 (3d Cir. 1983). Furthermore, "when the transactions are numerous and take place over an extended period of time, less specificity is required." In re Catanella and E.F. Hutton and Co. Securities Litigation, 583 F. Supp. 1388, 1398 (E.D. Pa. 1984). Moreover, less specificity is required when the complaint presents the claims of a class and individual identification of the circumstances of the fraud as to each class member would require voluminous pleadings. E.g., In re Caesars Palace Securities Litigation, 360 F. Supp. 366, 388 (S.D. N.Y. 1973); Contract Buyers League v. F & F Investment, 300 F. Supp. 210 (N.D. Ill. 1969).

 Upon consideration of the present complaint in light of these general precepts, I conclude that plaintiffs' allegations of securities fraud are, for the most part, adequate. With regard to the allegations under section 10(b) and rule 10(b)-5, plaintiffs have alleged six different types of misrepresentations which were made to them by defendant. *fn2" Although these are not presented verbatim as they were stated to the plaintiffs, these allegations are more than sufficient to put Hutton on notice of the nature of the misrepresentations which it is alleged to have made. Because these misrepresentations were allegedly made to approximately eighty potential plaintiffs in different parts of the country and were not made in writing, it would be unduly burdensome to demand the plaintiffs state the date on which each such representation was made, the times of such representations and the specific locations involved.

 Plaintiffs allege that these representations were made orally by brokers employed by defendant. Plaintiffs also allege that the misrepresentations were made between May 7, 1981 and the time of the purchase of the partnership interests sometime after July 8, 1981. In light of the nature of the fraud alleged (i.e., oral misrepresentations) and the nature of the present case (i.e., a proposed class action), these allegations, while not models of specificity, are sufficient to place defendant on notice of the nature of the claims asserted against it and to assure that plaintiffs' claims are not spurious. *fn3"

 However, one portion of the securities fraud allegation is deficient and should be amended to amplify the claim asserted. That section of the complaint is found in paragraph 16, which reads as follows:

 
Defendant Hutton prepared a Private Placement Memorandum soliciting investments in Energy Resources on or about May 7, 1981. That memorandum was deliberately general, however, and did not provide potential investors with much of the more detailed information needed by them. Pursuant to a marketing strategy devised by defendant Hutton, such information was to be provided by individual Hutton brokers to prospective investors. All of the information imparted by the brokers, however, emanated from Hutton's central offices.

 The Private Placement Memorandum referred to in that paragraph is not appended to the complaint. In addition, no further discussion is provided to explain the nature of the alleged deficiencies in that Memorandum or the nature of the information needed by investors which was purposefully not included therein. If plaintiffs seek to assert not only that defendant, acting through its brokers, made oral misrepresentations as described in paragraph 17, but also, through the omission of material from the Private Placement Memorandum, violated section 10(b) and rule 10(b)-5, plaintiffs must expand upon the allegations with regard to that Memorandum.

 Furthermore, paragraph 16 states that defendant devised a marketing strategy under which information would be provided to potential investors by individual brokers. In these allegations plaintiffs assert that the alleged oral misrepresentations discussed in paragraph 17 were directed by defendant's central offices. Plaintiffs provide no factual support for these conclusory claims of central office involvement in the alleged fraud. It is just such unsupported and conclusory claims which Rule 9(b) is designed to combat. To the extent that plaintiffs wish to assert that the alleged fraud was the result of a strategy of defendant's central office, plaintiffs must provide some factual support for those allegations.

 With regard to Hutton's concern that the complaint fails to distinguish between its conduct and the conduct of nondefendants, I find that argument unpersuasive. The allegations of securities fraud in paragraphs 15 through 18 and 23 through 28 refer solely to conduct of defendant's central office and its brokers. The alleged misrepresentations were allegedly made by defendant's brokers while the defendant is alleged to have constructed the Private Placement Memorandum and the general strategy. None of these allegations suggest that nonparties were responsible for any of the alleged wrongdoing.

 Unlike the bulk of the substantive securities fraud allegations, the allegations of fraudulent concealment found in paragraphs 19 through 21 of the complaint ...


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