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PELL v. WEINSTEIN

March 20, 1991

RICHARD M. PELL, JAMES R. MILLER AND JAMES O'BRIEN, PLAINTIFFS,
v.
MICHAEL WEINSTEIN, ERNEST GLANZ, RICHARD BOBER, BRUCE M. BLOOM, PHILIP KAGAN, PHILIP ERARD, FINKLE & ROSS, CERTIFIED PUBLIC ACCOUNTANTS, AND DENIS LUSTIG, A CERTIFIED PUBLIC ACCOUNTANT, DEFENDANTS.



The opinion of the court was delivered by: McCLURE, District Judge.

  MEMORANDUM

I. BACKGROUND

This action was commenced by plaintiffs on November 26, 1988. In response to the defendants' motions to dismiss the complaint, plaintiffs filed an amended complaint on March 7, 1989, pursuant to Fed.R.Civ.P. 15(a). Once again, all of the defendants have filed motions to dismiss the complaint.

This action arises from the acquisition of PacStar Corporation, Inc., ("PacStar"), by a corporation known as Coated Sales, Inc., ("Coated Sales"). The plaintiffs, Richard Pell, James Miller and James O'Brien, were all shareholders in PacStar at the time of its acquisition. The complaint alleges that Coated Sales' acquisition of PacStar was completed through, and accompanied by, violations of federal and state securities laws, federal criminal statutes and other tortious activities.

II. RELEVANT FACTS

The facts as alleged in the amended complaint may be summarized as follows:

PacStar and Coated Sales were in the textile business. Coated Sales publicly touted a corporate strategy of acquiring other textile companies and approached PacStar for that purpose. Subsequently, Coated Sales acquired PacStar through three agreements: an Agency Agreement dated July 1, 1986; an Employment Agreement dated July 1, 1986; and an Agreement and Plan of Merger ("Merger Agreement") dated March 2, 1987 (collectively "the Agreements").

Pursuant to the Agency Agreement, PacStar was to act as Coated Sales' exclusive sales agent for certain products. The Agency Agreement also granted Coated Sales the option to merge PacStar into Coated Sales or an affiliate by purchasing the PacStar stock for cash and 100,000 shares of Coated Sales restricted common stock. Coated Sales' option was exercisable at its discretion, throughout the term of the Agency Agreement, which expired on June 30, 1988.

At the time the Agency Agreement was entered into, plaintiff Richard Pell was the sole shareholder of PacStar. Pell agreed that his PacStar stock would remain subject to Coated Sales' option, that he would not dispose of his stock in any manner which would preclude the option and, in the event Pell chose to use his PacStar stock to compensate Timothy Lafferty and plaintiffs James Miller and James O'Brien, Pell agreed to transfer the stock to these employees "subject to the option".

On January 13, 1987 Coated Sales notified plaintiffs of its intention to exercise the option and sometime thereafter provided the plaintiffs with Coated Sales' Prospectus, dated July 10, 1986, and Form 10-Q for the period ending November 30, 1986. Pursuant to the Merger Agreement, on March 2, 1987, Coated Sales acquired from the plaintiffs and Lafferty the PacStar stock for cash and 100,000 shares of restricted Coated Sales common stock, as provided in the Agency Agreement. In or about May of 1988 plaintiffs first became aware of the existence of some amount of fraudulent activity in the internal operation of Coated Sales. Subsequently, on November 26, 1988, plaintiffs initiated this action.

The plaintiffs claim that they were induced into entering this obligation by misrepresentations contained in Coated Sales' Prospectus and Form 10-Q, and that the sale violated, inter alia, the Securities Act 1933 ("1933 Act"), the Securities and change Act of 1934 ("1934 Act") and state securities law. The plaintiffs maintain that each defendant occupied a key position or relationship with Coated Sales that facilitated the alleged scheme. Defendants Michael Weinstein, Ernest Glantz, Richard Bober, Bruce Bloom, Philip Kagan and Philip Erard ("officer/director defendants") were officers and/or directors of Coated Sales during the relevant periods. The remaining defendants, Finkle & Ross and Denis Lustig, were involved in the preparation and dissemination of Coated Sales' financial information.*fn1

III. SALE OF UNREGISTERED SECURITIES

Counts I and III allege violations of Section 12(1) of the 1933 Act, 15 U.S.C. § 77l(1), by the officer/director defendants and Denis Lustig, as an aider and abettor, respectively. Section 12(1) creates civil liability for the offer or sale of an unregistered security in violation of Section 5 of the 1933 Act, 15 U.S.C. § 77e. Section 5 prohibits the use of any means or instruments of transportation or communication in interstate commerce or of the mails for the purpose of delivering or selling an unregistered security. The defendants maintain that this claim is barred by the relevant limitations period.

Section 13 of the 1933 Act, 15 U.S.C. § 77m, provides:

  No action shall be maintained . . . to enforce a
  liability created under section 77l(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 . . . 77l(1) of this title
  more than three years after the security was bona
  fide offered to the public.

Courts have interpreted the date of the violation as the later of the offer, sale or delivery of the stock. See Doran v. Petroleum Management Corp., 576 F.2d 91, 93 (5th Cir. 1978).

In the instant case, the limitations period began to run on March 2, 1987, when the securities were delivered to the plaintiffs, and the original complaint was not filed until November 22, 1988, more than one and a half years later. However, plaintiffs claim that the statute should be equitably tolled because they did not discover the alleged fraud until after the limitations period had expired. This argument lacks merit.

At no time were the plaintiffs led to believe that the securities were registered. In fact, the plaintiffs knew from the outset that the securities would not be registered. Moreover, although there is a split of authority concerning the application of the discovery rule and equitable tolling to the one-year limitation period governing nonregistration claims, a vast majority of the cases have concluded that the limitations period runs from the date of the violation regardless of whether the plaintiff knew of the violation. See Cook v. Avien, 573 F.2d 685, 691 (1st Cir. 1978); Gridley v. Cunningham, 550 F.2d 551, 552-53 (8th Cir. 1977); McCullough v. Leede Oil & Gas, Inc., 617 F. Supp. 384, 387 (W.D.Okl. 1985); Felts v. National Account System Assoc., Inc., 469 F. Supp. 54, 64 (N.D. Miss. 1978); Mason v. Marshall, 412 F. Supp. 294, 299 (N.D.Tex. 1974), aff'd, 531 F.2d 1274 (5th Cir. 1976); Ferland v. Orange Groves of Florida, Inc., 377 F. Supp. 690, 703 (M.D.Fla. 1974); Shuman v. Sherman, 356 F. Supp. 911, 912-13 (D.Md. 1973); Moerman v. Zipco, Inc., 302 F. Supp. 439, 445 (E.D.N.Y. 1969), aff'd, 422 F.2d 871 (2d Cir. 1970).

Based on these cases, this Court also concludes that neither the discovery rule nor equitable tolling are applicable to the one-year limitation period governing nonregistration claims because the language of the statute militates against such an application, and there is little justification for the application of this rule outside fraud-based causes of action. See McCullough v. Leede Oil & Gas, Inc., 617 F. Supp. at 386-88.*fn2

Therefore, since these claims were not asserted within the applicable limitations period, Counts I and III of the amended complaint will be dismissed.

IV. SALE OF SECURITIES BY MEANS OF PROSPECTUS OR ORAL
    COMMUNICATION

Counts II and IV allege violations of Section 12(2) of the 1933 Act, 15 U.S.C. § 771(2), by the officer/director defendants and Denis Lustig, as an aider and abettor, respectively. The officer/director defendants and Lustig have made motions to dismiss these counts for failure to state a claim upon which relief can be granted, pursuant to Fed.R.Civ.P. 12(b)(6).

A.  Standard of Review

A motion to dismiss under Fed.R.Civ.P. 12(b)(6) admits the well pleaded allegations of the complaint, but denies their legal sufficiency. Hospital Building Co. v. Trustees of the Rex Hospital, 425 U.S. 738, 740, 96 S.Ct. 1848, 1850, 48 L.Ed.2d 338, 341 (1976). "It is the settled rule that `a complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Leone v. Aetna Cas. & Sur. Co., 599 F.2d 566, 567 (3rd Cir. 1979), quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957).

The complaint must be read in a light most favorable to the plaintiff with every doubt resolved in plaintiff's favor. In Re Arthur Treacher's Franchisee Litigation, 92 F.R.D. 398, 422 (E.D.Pa. 1981).*fn3

B.  Section 12(2)

Section 12(2) of the 1933 Act, 15 U.S.C. § 77l(2) imposes liability upon any person who:

  offers or sells a security . . . by the use of any
  means or instruments of transportation or
  communication in interstate commerce or of the
  mails, by means of a prospectus or oral
  communication, which includes an untrue statement
  of a material fact or omits to state a material
  fact necessary in order to make the statements, in
  light of the circumstances under which they were
  made, not misleading (the purchaser not knowing of
  such untruth or omission), and who shall not
  sustain the burden of proof that he did not know,
  and in the exercise of reasonable care could not
  have known, of such untruth or omission.*fn4
  (emphasis added).

Plaintiffs' amended complaint does not refer to any oral communication. They claim that untrue material facts were contained in and material facts were omitted from the prospectus, dated July 10, 1986, and Form 10-Q, for the period ending November 30, 1986, which were provided to them after January 13, 1987, the date Coated Sales notified the plaintiffs of its intention to exercise the option.

The defendants contend that by the time the prospectus and Form 10-Q came into existence, and were allegedly reviewed by the plaintiffs, Coated Sales had already obtained the contractual right to sell its stock to Pell, and to Miller and O'Brien to the extent that they would later acquire PacStar stock from Pell. Simply stated, the defendants claim that the purchase of Coated Sales stock was completed on July 1, 1986, when the option was created, and since the prospectus and Form 10-Q both came into existence after July 1, 1986, the offer or sale could not have possibly been made "by means of a prospectus."

The plaintiffs argue that the sale did not occur until March 2, 1987, when the Merger Agreement was signed and the exchange actually occurred.

C.  Date of the Sale

The date of the "sale" of securities occurs when the parties become obligated to perform. Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 891 (2d Cir. 1972).

  `Commitment' is a simple and direct way of
  designating the point at which, in the classical
  sense, there was a meeting of the minds of the
  parties; it, marks the point at which the parties
  obligated themselves to perform even if the formal
  performance of their agreement is to be after a
  lapse of time.

Id.

Plaintiffs contend that the Agency Agreement was fully revocable and, as such, could not be considered a "sale" of securities as a matter of law. They argue that the Agency Agreement did not obligate them to purchase Coated Sales stock, but merely created an option allowing Coated Sales to merge with PacStar upon the occurrence of various conditions. The only conditions plaintiffs refer to are contained in paragraphs 6(B), 12 and 13(H) of the Agency Agreement.

Paragraph 13(H) states, "The option contained herein shall terminate upon termination of the Agency Agreement or default." The Agency Agreement states at paragraph 13(A) that the termination date was June 30, 1988; however, it does not contain any specific default provisions. Since Coated Sales exercised the option before the termination date, the plaintiffs were not empowered to renege on the transaction under this paragraph.

Likewise, paragraph 6(B) of the Agency Agreement did not release the plaintiffs from their binding commitment. Paragraph 6(B) provides:

  For the calendar year ended December 31, 1987,
  Coated Sales shall provide audited results of
  Booked Sales Orders, not later than February 28,
  1988. PacStar shall have 30 days to review said
  results and to avail itself of Audit and
  Accounting procedures provided for in Paragraph 12
  below. In the event that booked orders are less
  than Fifteen Million Dollars ($15,000,000) for the
  period from the date of this Agreement through
  December 31, 1987, then either party shall have
  the right to terminate ...

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