UNITED STATES DISTRICT COURT, DISTRICT OF NEW JERSEY
December 21, 1978
James R. ROBERTS, on behalf of himself and all others similarly situated, Plaintiff,
MAGNETIC METALS COMPANY, Magmetco, Inc., D. C. Langworthy, and Butcher & Singer, Inc., Defendants
The opinion of the court was delivered by: BROTMAN
I. Factual Background
Plaintiff James R. Roberts has filed this class action complaint against Magnetic Metals Company (hereinafter Metals), Magmetco, Inc., Butcher & Singer, Inc., and D.C. Langworthy, president of both Metals and Magmetco, for alleged violations of the Securities Exchange Act of 1934, as amended, 15 U.S.C. § 78aa Et seq. (hereinafter the 1934 Act). Various pendent state claims are also alleged.
Prior to June 25, 1975, plaintiff was the record holder of 600 shares of Metals common stock. At that time Metals was a publicly-held company, eighty-four percent of whose common stock was owned by defendant Langworthy and members of his family. In early May 1975, Langworthy announced a proposed merger of Metals with a newly-formed corporation, Magmetco, of which he was also the president. Under the proposed merger, the non-Langworthy shareholders were to receive $ 6.50 in cash for each share of Metals stock. The merger was contingent upon two-thirds approval of these 194,330 non-Langworthy shares. After approval by the S.E.C., the defendants mailed proxy materials to each record holder of Metals stock as of May 22, 1975. At the meeting of the stockholders on June 25, 1975, the merger was approved with only 37,426 of the non-Langworthy shares voting in the negative. This action was commenced on January 5, 1978, two and one half years after the merger vote.
There are three counts to the complaint. Count I alleges that the May 31 proxy statement was false and misleading and caused the plaintiff to approve the merger despite grossly inadequate consideration in violation of section 14(a) of the 1934 Act and Rule 14a-9.
Count II incorporates the factual allegations of Count I by reference. It is alleged that such facts also state a claim under section 10(b) of the 1934 Act and Rule 10b-5.
Count III alleges that the same actions of defendants Metals and Langworthy violated their fiduciary duties to plaintiff. It is finally claimed that the merger amounted to common law and statutory fraud.
Defendants Metals, Magmetco, and Langworthy have moved for summary judgment pursuant to Fed.R.Civ.P. 56 on the ground that the federal securities claims are barred by the statute of limitations. Defendant Butcher & Singer, a broker and dealer in securities which rendered a pre-merger opinion concerning the fair value of the Metals common stock, joins in this motion for summary judgment. Additionally, Butcher urges the court to dismiss the complaint for plaintiff's failure to plead adequately fraudulent concealment and for failure to allege the requisite scienter. In each instance a violation of Fed.R.Civ.P. 9(b) is claimed. All defendants urge that, because the federal claims are time-barred, the court lacks pendent jurisdiction over the state claims. Both sides have submitted extensive and thorough briefs. Oral argument was heard on April 21, 1978. The court will deal with the various counts of the complaint seriatim.
II. Section 10(b) and Rule 10b-5 Claims (Count II)
Unlike other federal securities statutes, section 10(b) of the 1934 Act does not contain its own statute of limitations.
In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 210 n.29, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976), the Supreme Court indicated that, in the absence of a relevant federal statute of limitations, the law of limitations of the forum state should be applied in actions under the 1934 Act. In this case, the parties agree that New Jersey law controls but differ over which is the appropriate law. Although the Court did not address this issue in Ernst & Ernst, other Supreme Court decisions have indicated that the "most analogous" or "most appropriate" statute should be used. See Occidental Life Ins. Co. v. E. E. O. C., 432 U.S. 355, 53 L. Ed. 2d 402, 97 S. Ct. 2447, 2455 (1977); Johnson v. Railway Exp. Co., 421 U.S. 454, 462, 95 S. Ct. 1716, 44 L. Ed. 2d 295 (1975). In a section 10(b) action, the Court of Appeals for the Second Circuit has indicated that the court should apply the most similar statute which best effectuates the purpose of the federal legislation. Berry Petroleum Company v. Adams & Peck, 518 F.2d 402, 407 (2nd Cir. 1975); Brick v. Dominion Mortg. & Rlty. Trust, 442 F. Supp. 283, 301 (W.D.N.Y.1977); See Gelman v. Westinghouse Electric Corp., 556 F.2d 699, 701 (3rd Cir. 1977). In this case, the parties are at loggerheads as to whether the limitations provision governing the New Jersey Uniform Securities Law (commonly known as the blue sky law)
or common law fraud
applies. The former statute limits the time for commencing an action to "2 years after the contract of sale" whereas the latter allows an action to be commenced within six years of the date of the fraud.
The defendants point to a large number of cases holding that a state's blue sky provision, rather than a statute governing common-law fraud, applies to actions brought under section 10(b). See, e. g., Forrestal Village, Inc. v. Graham, 179 U.S.App.D.C. 225, 551 F.2d 411 (1977); Dupuy v. Dupuy, 551 F.2d 1005 (5th Cir. 1977); Fox v. Kane-Miller Corp., 542 F.2d 915 (4th Cir. 1976); Parrent v. Midwest Rug Mills, Inc., 455 F.2d 123 (7th Cir. 1972); Vanderboom v. Sexton, 422 F.2d 1233 (8th Cir.), Cert. denied, 400 U.S. 852, 91 S. Ct. 47, 27 L. Ed. 2d 90 (1970); Brick v. Dominion Mortg. & Rlty. Trust, supra. Defendants stress the similarities between the New Jersey blue sky statute and the federal action under section 10(b). They argue that scienter is a necessary element of both the state and federal securities action. Brick, supra at 304; Cf. Garnatz v. Stifel, Nicolaus & Co., 559 F.2d 1357, 1363 (8th Cir. 1977). They emphasize the similarity in language between the New Jersey Uniform Securities Law and 10(b), and, perhaps most importantly, urge that:
"(t)he (blue sky) statute promotes the full and accurate disclosure of information in connection with stock sales, precisely the same purpose as that of Rule 10b-5."
Dupuy, supra at 1024 n.31; See Brick, supra at 304.
The plaintiff attempts to distinguish the cases relied on by the defendants and also puts forward a not insubstantial number of cases holding that a general fraud provision is more appropriate for section 10(b) than a state's blue sky law. See, e. g., IDS Progressive Fund v. First Michigan Corp., 533 F.2d 340 (6th Cir. 1976); Arneil v. Ramsey, 550 F.2d 774 (2nd Cir. 1977); Jenne v. Amrep Corp., No. 77-0487 (CCH Fed.Sec.Rptr. P 96,343) (D.N.J., filed February 14, 1978); Klapmeier v. Peat, Marwick, Mitchell & Co., 363 F. Supp. 1212 (D.Minn.1973). The plaintiff disputes defendants' proposition that the intent requirements of both statutes are the same. He urges that the New Jersey's Uniform Law provides no relief to a seller of securities who is defrauded in the sale, that damages are more restricted in New Jersey than under section 10(b), and that the New Jersey statute contains a privity requirement. He contends that the purpose of the federal securities laws is remedial and thus, irrespective of which statute is superficially more analogous, federal courts should apply the longer statute of limitations. Taking into account these distinguishing factors, plaintiff urges application of N.J.S.A. 2A:14-1.
The court is impressed with plaintiff's well-reasoned attempts to distinguish the current situation from the cases relied on by the defendants. Undoubtedly, there are several important differences between a section 10(b) action and the remedy provided by the New Jersey Uniform Securities Law. Most notably, the New Jersey law provides no cause of action for an aggrieved seller of securities. In fact the legislative history of section 102(a) of the Uniform Securities Act, upon which the New Jersey law was modeled,
disputes the need for a statutory provision:
Although the lower federal courts have uniformly implied a civil cause of action against fraudulent buyers under the SEC rule, the federal courts when applying federal law do not have at their disposal all of the common-law and equitable remedies of deceit and rescission which are available to the state courts without benefit of statute.
Loss & Cowett, Blue Sky Laws, supra (App. I) at 252.
Since the plaintiff in this action has no possible remedy under the New Jersey blue sky law and since the legislative history specifically refers aggrieved buyers to the common law, a credible argument exists that the six-year limitation provision of N.J.S.A. 2A:14-1 should apply. Furthermore, it is arguable that section 10(b) and Rule 10b-5 provide a broader remedy than the Uniform Securities Act. Since the former provisions encompass any manipulative or deceptive device used in contravention of SEC rules and since the New Jersey statutory restriction is limited to untrue statements of material facts, a common-law fraud action might be thought to more nearly resemble an action under section 10(b). But see Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S. Ct. 1292, 1299-1304, 51 L. Ed. 2d 480 (1977). Finally, while damages are allowed under both section 10(b) and the New Jersey Uniform Law, there is little dispute that damages under the latter statute are much more restricted. For this reason too, a common-law fraud action is thought to be more analogous to a section 10(b) action.
Despite the absence of a seller remedy under New Jersey's Uniform Securities Act and despite other pertinent distinctions between section 10(b) and New Jersey's statute, the court believes that the two-year provision of N.J.S.A. 49:3-71(e) should control the time within which the instant suit must be filed. To begin at the most obvious level, there are many similarities in wording between the New Jersey blue sky provision and section (b) of Rule 10b-5. See Brick, supra at 304. As mentioned earlier, this is because the state provision was specifically modeled on the federal provision. Furthermore, the mens rea elements are not noticeably different. In New Jersey a buyer of securities must show that "the seller knew of the untruth or omission and intended to deceive the buyer." N.J.S.A. 49:3-71(a)(2). At the present time, scienter or intent is a necessary allegation in any action brought pursuant to section 10(b) or Rule 10b-5. Ernst & Ernst, supra; see Cramer v. General Telephone & Elect. Corp., No. 77-2372, 582 F.2d 259 at 273 (3rd Cir. 1978). Additionally, plaintiff's "privity" argument is erroneous. The plain wording of the New Jersey statute, similarly to the federal law, provides for actions against anyone who "materially aids" or "directly or indirectly controls" the primary defendant. See N.J.S.A. 49:3-71(b).
While it is possible to discuss at length the similarities and distinctions between section 10(b) and the New Jersey Uniform Securities Law, such nuances would tend to confuse rather than clarify the problem. The duty of this court is not to apply the limitations period of the state statute under which the plaintiff might obtain relief. Were this the controlling question, the six-year fraud provision would necessarily apply. This court's analysis, as mentioned earlier, must instead focus on: (1) the most similar or analogous statute which; (2) best effectuates the purpose of the federal legislation. Berry, supra at 407; Brick, supra at 301. As far as the first part of the analysis is concerned, there is little question that the New Jersey Uniform Securities Law, as opposed to common-law fraud, more nearly resembles the Securities Exchange Act of 1934. The wording of the statutes is parallel and the New Jersey law is, in part, modeled on the 1934 Act. Indeed, a primary statutory policy of the New Jersey law is "to co-ordinate the interpretation and administration of (the New Jersey law) with related Federal regulations." N.J.S.A. 49:3-75; See State v. Russell, 119 N.J.Super. 344, 350, 291 A.2d 583 (App.Div.1972).
The second part of the limitations analysis necessitates an examination of the Federal policy behind securities' regulation. As plaintiff correctly points out, one of the primary purposes of these federal laws is to compensate aggrieved sellers and buyers for the losses they sustain on account of proscribed securities practices. See Berry, supra at 409. At the same time, as in all limitations questions, there is frequently a point after which policymakers decide to compromise a law's remedial purposes in favor of counterveiling policies. In the securities field, these counterveiling policies include the elimination of stale claims, the elimination of uncertainty in corporate ventures, the prevention of harassment of corporations by disappointed market investors, and the maintenance of corporate businesses free from the drain of expensive and frequently prolonged litigation. In the field of securities regulation Congress has consistently resolved this balancing analysis in favor of relatively short limitations periods in private civil suits. Civil liabilities under sections 11 and 12(2) of the Securities Act of 1933 (15 U.S.C. §§ 77k and 77L (2)) are limited to one year after the violation should have been discovered, or three years at the outside. (15 U.S.C. § 77m). Identical provisions are provided in sections 9(e), 18(c), and 29(b) of the Securities Exchange Act of 1934. (15 U.S.C. §§ 78i(e), 78r(c), and 78cc(b)). Actions under section 16(b) of the 1934 Act (15 U.S.C. § 78p(b)) are limited absolutely to two years after the event. Indeed, Professor Louis Loss, a draftsman of the Uniform Securities Act and eminent scholar in the field of securities regulation, has suggested that these federal limitations provisions would be much more appropriate for a section 10(b) action than Any analogous state limitations section. Loss, Securities Regulation, Supra at 3898-3900.
Based on the close similarity in purpose between the Securities Exchange Act of 1934 and the New Jersey Uniform Securities Law and because of Congress' consistent policy in opting for relatively short limitation periods in other sections of the 1933 and 1934 Acts, the court finds N.J.S.A. 49:3-71(e) more appropriate as a standard for section 10(b) actions.
III. Section 14(a) and Rule 14a-9 Claims (Count I)
Plaintiff also alleges that the proxy materials distributed in support of the Metals-Magmetco merger in June 1975 were false and misleading in violation of section 14(a) of the Act and Rule 14a-9 promulgated thereunder. The facts supporting this claim are similar to the section 10(b) claim and are set forth in forty-one paragraphs in Count I. The defendants urge that the two-year statute contained in N.J.S.A. 49:3-71(e) likewise bars this section 14(a) action while plaintiff argues that, even if the two-year statute applies to the section 10(b) claims, the six-year fraud statute applies to the section 14(a) claims.
To begin with, it is clear that a section 14(a) action is different from one brought under section 10(b). In Cramer v. General Telephone & Electronics, 443 F. Supp. 516 (E.D.Pa.1977), Aff'd No. 77-2372, 582 F.2d 259 (3rd Cir. 1978), the court pointed out that, in order to maintain a claim under section 14(a), a plaintiff must show "that specific proxy statements were materially false and misleading, that there was a causal connection between the alleged violation of the proxy rules, and the injury suffered by the plaintiff. (citations omitted)." Moreover, the Third Circuit has held that negligence, not scienter, is enough to hold individuals liable under section 14(a). Gould v. American-Hawaiian Steamship Co., 535 F.2d 761, 777 (3rd Cir. 1976).
Despite these differences, there are two reasons why the court feels compelled to apply the blue sky statute and not the general fraud provision. First, although the sections are usually employed in different contexts, in a merger situation (such as the present) where the alleged fraud involves misrepresentations in connection with a minority stockholder's sale of stock to the merging interest, the two sections overlap. Cf. SEC v. National Securities, Inc., 393 U.S. 453, 468, 89 S. Ct. 564, 21 L. Ed. 2d 668 (1969); Joyce v. Joyce Beverages, Inc., 571 F.2d 703 (2nd Cir. 1978).
Since the action sought to be restrained is similar, all of the considerations that call for application of the blue sky statute in a section 10(b) action apply with equal force. Second, insofar as the plaintiff seeks to distinguish a section 14(a) action from a section 10(b) action, the arguable distinctions weigh in favor of applying a Shorter rather than a longer statute of limitations. In Gould, supra, the Third Circuit stated:
Section 14(a) and Rule 14a-9(a) may be more closely analogized to section 11 of the Securities Act of 1933 (than to section 10(b) of the 1934 Act), as amended by the Act of 1934, 15 U.S.C.A. § 77k, which deals with civil liability for false registration statements. Each section . . . proscribes a type of disclosure or lack of it, i. e., false or misleading statements or omissions of material facts, and each enumerates specific classes of individuals who bear liability for failure to meet the required standard of disclosure. Moreover, each involves single specific documents which are of primary importance in two fundamental areas of securities regulation, sales of securities and the exercise of the shareholders' voting power.
535 F.2d at 777.
The fact that causes of action under section 11 must be brought within the time limitations of the one to three year federal statute (15 U.S.C. § 77m) indicates that a section 14(a) action should receive similar treatment for limitations purposes.
Thus, the court finds the two-year New Jersey blue sky provision more appropriate for a section 14(a) action and federal policy will best be effectuated by its use. Berry, supra at 407.
IV. Tolling Provisions/Fraudulent Concealment
Application of the New Jersey blue sky law does not necessarily put an end to plaintiff's action even though the lawsuit was not initiated until two and one half years following approval of the merger. Plaintiff seeks to avail himself of the doctrine of fraudulent concealment. He urges that, as a matter of law, he did not wait unreasonably long in conducting an investigation or filing suit. Defendants acknowledge the doctrine of fraudulent concealment but claim that plaintiff had all the information involving the so-called fraud on May 31, 1975, the date the proxy materials were mailed. Additionally, defendant Butcher & Singer seeks dismissal because the plaintiff has failed to aver specifically the facts underlying the alleged fraudulent concealment.
The applicable statute of limitations normally begins to run when the plaintiff discovers the fraud or in the exercise of reasonable diligence should have discovered the fraud. Hupp v. Gray, 500 F.2d 993 (7th Cir. 1974); Klein v. Shields, 470 F.2d 1344 (2nd Cir. 1972); Osadchy v. Gans, 436 F. Supp. 677 (D.N.J.1977). When the statute begins to run is a question of federal law, Stull v. Bayard, 561 F.2d 429, 432 (2nd Cir. 1977); Arneil v. Ramsey, 550 F.2d 774 (2nd Cir. 1977), and is often but not always called the doctrine of fraudulent concealment. See Hupp v. Gray, supra; Morgan v. Koch, 419 F.2d 993 (7th Cir. 1969); Holmberg v. Armbrecht, 327 U.S. 392, 66 S. Ct. 582, 90 L. Ed. 743 (1946). Where there are sufficient facts available to the plaintiff to put him on notice of the fraud, Arneil, supra, or when the circumstances should arouse his suspicion, Hupp, supra, the statute begins to run. The statute is not tolled where the plaintiff is merely unaware of the facts or law, Morgan, supra, but only where the plaintiff seeks to learn the facts in the exercise of reasonable care and diligence. Id. Of course the statute does not await plaintiff's leisurely discovery of the fraud. Klein v. Bower, 421 F.2d 338, 343 (2nd Cir. 1970); See Osadchy v. Gans, supra at 681-83.
In seeking to avoid the impact of the New Jersey Uniform Securities Law, plaintiff avers:
Plaintiff acted reasonably and with due diligence at all times. Plaintiff discovered defendants' material omissions and misrepresentations only after employing legal counsel to investigate and report. Plaintiff could not in the exercise of due diligence have discovered the fraud alleged herein at any time prior to the completion of the investigation and report of such counsel because defendants at all times acted to suppress and fraudulently conceal all facts and information regarding their fraudulent and otherwise illegal conduct.
Complaint, P 19.
The court agrees with defendant Butcher & Singer that the conclusory allegations in paragraph 19 fail to satisfy the pleading requirements of fraudulent concealment and Fed.R.Civ.P. 9(b). Dayco Corp. v. Goodyear Tire & Rubber Co., 523 F.2d 389 (6th Cir. 1975); Brick v. Dominion Mortg. & Rlty. Trust, supra at 291-92; Kroungold v. Triester, 407 F. Supp. 414 (E.D.Pa.1975); Premier Industries v. Delaware Valley Financial Corp., 185 F. Supp. 694 (E.D.Pa.1960); See generally C. Wright and A. Miller, Federal Practice and Procedure, §§ 1297, 1298 (1969). Plaintiff has failed to assert what actions by the defendants constituted the alleged suppression of facts. He has failed to elaborate why such facts were not discoverable within the two-year statute and has failed to allege with particularity why it took him so long to consult with his attorney and why they needed so much time to prepare a complaint.
Despite the failure of the plaintiff, the court is not inclined at this time to dismiss the complaint. Compare Brick, supra at 292, With Premier Industries, supra at 696-97. The plaintiff indicates in his brief in opposition to this motion that he became aware of the alleged fraud only after defendant Langworthy sold out his shares in Magmetco to Inductotherm, Inc., in 1977 for a price equal to more than $ 14.00 per old Metals' share. While these allegations are clearly not sufficient to carry the plaintiff's burden on the tolling issue as a matter of law, it is not altogether evident that, if presented in proper form, these facts would be inadequate to defeat summary judgment. For the most part, courts have agreed that the tolling or fraudulent concealment issue is properly resolved on a motion for summary judgment only if there is no evidence from which a jury could conclude that plaintiff, in the exercise of reasonable diligence, should not have discovered the alleged fraud within the limitations period. See Arneil, supra at 781; Fox v. Kane-Miller Corp., supra at 917, Affirming, 398 F. Supp. 609, 626-29 (D.Md.1975); Kubik v. Goldfield, 479 F.2d 472, 477 n.12 (3rd Cir. 1973); Klein v. Bower, 421 F.2d 338, 343-44 (2nd Cir. 1970); Johns Hopkins University v. Hutton, 422 F.2d 1124, 1131 (4th Cir. 1970); Berry, supra at 410-11; Cf. Brick, supra at 304-05.
Because of plaintiff's limited burden in this regard, at least insofar as a jury is concerned, the court will grant plaintiff twenty days to amend his complaint to meet the particularity requirements of Fed.R.Civ.P. 9(b) and the fraudulent concealment doctrine. Furthermore, as per defendants' alternative request, the court shall allow sixty days to take discovery limited to the tolling or fraudulent concealment issue. See Defensive Instruments, Inc. v. RCA Corp., 385 F. Supp. 1053 (W.D.Pa.1974), Aff'd, 530 F.2d 963 (3rd Cir. 1976). When the tolling issue has been properly elucidated through amendment of the pleadings and discovery, the court will decide if the issue is properly for the jury or the court.
V. Miscellaneous Contentions
Defendant Butcher & Singer argues that Count II should be dismissed against it for failure to allege scienter or intent, required in actions under section 10(b). Ernst & Ernst, supra; Gross v. Diversified Mortgage Investors, 438 F. Supp. 190 (S.D.N.Y.1977); Weinberger v. Kendrick, 451 F. Supp. 79, CCH-Fed.Sec.Law Rptr. P 96,378 (S.D.N.Y.1978). The court has examined the complaint and finds that paragraphs 8, 15, 17, and 18, satisfy the pleading requirements of Ernst & Ernst and Rule 9(b). See Cramer v. General Telephone, supra at 272-273.
Finally, the court shall not exercise its pendent jurisdiction over the common law claims unless it finds that a jury issue exists respecting the tolling provisions of the New Jersey blue sky limitations period. See United Mine Workers v. Gibbs, 383 U.S. 715, 726, 86 S. Ct. 1130, 16 L. Ed. 2d 218 (1966).
Defendants' motion for summary judgment based on the statute of limitations is, for the time being denied, as is the motion of Butcher & Singer to dismiss for failure to plead fraudulent concealment with particularity. The motion of Butcher & Singer to dismiss for failure to comply with Rule 9(b) is denied. The discovery order heretofore entered with the consent of the parties shall be modified to allow discovery limited solely to the tolling problem. The appropriate order shall be entered.