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KRONFELD v. FIRST JERSEY NATL. BANK

June 13, 1986

AARON KRONFELD, et al., Plaintiffs,
v.
FIRST JERSEY NATIONAL BANK, FIRST NATIONAL STATE BANK OF NJ, FLAGSHIP SECURITIES, INC., HALPERT, OBERST & CO., GIBRALTER SECURITIES CO., LISS, TENNER & GOLDBERG, INC., MCDONALD & CO. SECURITIES, INC., et al., Defendants



The opinion of the court was delivered by: ACKERMAN

 This litigation arises from the largest default on municipal bonds in American history. The bonds, $2.25 billion of which were sold on the public market, were issued by the Washington Public Power Supply System ("WPPSS") from 1977 to 1981 to finance two nuclear power plants in the State of Washington. Approximately 1400 purchasers of the bonds have brought suit here and in 21 similar actions across the nation against the underwriters and sellers of the bonds. The factual background as alleged by plaintiffs can be briefly stated. The WPPSS is a municipal corporation which constructs and operates electric power generating and transmission plants and facilities in the State of Washington. In 1968, WPPSS, the Bonneville Power Administration ("BPA"), a federal agency, and some local utilities undertook the construction of three nuclear power plants and financed them through the issuance of WPPSS revenue bonds. The bonds were through a "net billing" arrangement, effectively guaranteed by BPA. In 1973, the group decided to build a fourth and fifth nuclear plant ("Plants 4 and 5") which would be financed by WPPSS bonds, backed by "Participants Agreements" between the utilities -- but not the BPA -- to guarantee them. These bonds were marketed approximately from 1977 to 1981, during the time when the bonds financing the first three nuclear plants were also marketed. Despite the differences in the guarantees of the bonds, the bonds for Plants 4 and 5 were issued and marketed in a way similar to the other bonds. Almost from their inception, the Plant 4 and 5 projects were beset by poor planning, scheduling delays, cost overruns and ineffective management. In January 1982, the participating utilities terminated construction on Plants 4 and 5 before they were completed. Then, in June 1983, the Washington Supreme Court ruled that certain of the participating utilities lacked authority to guarantee the debts on Plants 4 and 5. Shortly, thereafter, the Participating Agreements were held to be unenforceable and the utilities were relieved of their obligation to guarantee the bonds relating to the projects. The project were formally dissolved in July 1983. BPA later informed the bondholders that it had not guaranteed the bonds for Plants 4 and 5. See Amended Complaint paras. 8-25.

 This suit has been brought by 1400 plaintiffs from across the nation who purchased Plant 4 and 5 bonds from 1977 to 1983. Defendants are the sellers and underwriters of the bonds who transacted business in this district, or who sold bonds to purchasers residing in this district. The proposed amended complaint asserts claims for conspiracy to violate and violations of Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b)(1981) and Rule 10b-5, 17 C.F.R. § 240.10b-5(1985), for violations of the Racketeer Influenced and Corrupt Organizations Act of 1970 ("RICO"), 18 U.S.C. § 1962(a) through (d), and for negligent representation, fraud and deceit, and breach of fiduciary duties in violation of state law. Similar suits have been brought by the plaintiffs against other defendants in districts all over the nation.

 Plaintiffs initially moved to consolidate all cases in one district for pre-trial proceedings under 28 U.S.C. § 1407. On October 2, 1985, the Judicial Panel on Multidistrict Litigation denied the motion to transfer, not persuaded that common questions of fact predominate over individual questions of fact. Meanwhile, two defendants, Gibralter Securities and J. B. Hanauer & Co., filed answers.

 Defendants Flagship Securities, Municipal Investors Service, Inc.; Mid-State Securities Corp.; First Fidelity Bank; Fiss Tenner & Goldberg, Inc.; R.W. Peters, Rickel Co., Inc.; Halpert, Oberst and Co.; McDonald & Co. Securities ("Flagship Securities defendants") originally moved to dismiss the complaint under Rule 12(b)(6) and 9(b) and for the award of attorneys' fees under Rule 11. First Jersey National Bank joined this motion. Defendants Ryan, Beck & Co. and John J. Ryan & Co. made essentially the same motion, as did defendants J.B. Hanauer & Co. and Gibralter Securities Co. Most recently, plaintiffs have moved to amend their complaint under Rule 15(a). Flagship Securities defendants have refiled their motion to dismiss under Rule 12(b)(6). Since the proposed amended complaint may cure some of the defects raised by the defendants' motion to dismiss, the Court will first address the motion to amend.

 Federal Rule of Civil Procedure 15(a) provides that a party may amend a pleading once as a matter of course before a responsive pleading is served; otherwise, a party may amend only by leave of court or by consent. Such leave "shall be freely given when justice so requires." Fed.R.Civ.Pro. 15(a). The Supreme Court has enumerated the circumstances under which leave to amend may be denied: "In the absence of any apparent or declared reason -- such as undue delay, bad faith or dilatory motive on the part of the movant, repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the opposing party by virtue of allowance of the amendment, etc. -- the leave sought should, as the rules require, be "freely given." Foman v. Davis, 371 U.S. 178, 182, 9 L. Ed. 2d 222, 83 S. Ct. 227 (1962).

 Only defendants J. B. Hanauer & Co. and Gibralter Securities Co. have filed answers before the motion to amend. The motions to dismiss filed by other defendants do not constitute a "responsive pleading" so as to bar a party from amending as a matter of course. Fed.R.Civ.Pro. 7(a); Neifeld v. Steinberg, 438 F.2d 423, 425 n.3 (3d Cir. 1971). Thus, the plaintiffs may, as a matter of right, amend their claims against those defendants who have not answered.

 They must have leave of the court, however, to amend their claims against the two defendants who have answered. It does not appear that the amendment would cause undue delay or that plaintiffs have a dilatory motive. This litigation is in its earliest stages and hardly any discovery or pre-trial preparation has taken place. Plaintiffs assert that the amendments incorporate new evidence they became aware of after the filing of the complaint and simplify the complaint as a whole. The only conceivable prejudice to defendants is that two defendants may have to file an additional answer and defendants had to file an unnecessary motion to dismiss. Defendants seek the award of such costs. But the motion to dismiss is not rendered moot by the amendment, as defendants themselves state in their memorandum in opposition to the motion for leave to amend, which states: "The amended complaint suffers from exactly the same defects as the original complaint . . ." (Joint Memorandum of Defendants, at p. 2.) Defendants raise the same legal argument in this memorandum as they did in their memoranda in support of their original motion to dismiss and rely on previous briefs submitted on some issues. The Court finds no significant prejudice to defendants who have not answered if leave to amend is granted. But the costs of defendants Gibralter Securities and J. B. Hanauer in preparing their first answer shall be compensated by plaintiffs. Movants primary opposition is that this proposed amended complaint also cannot withstand the motion to dismiss, and therefore leave to amend would be futile. See Massarsky v. General Motors Corp., 706 F.2d 111, 125 (3d Cir. 1983), cert. denied 464 U.S. 937, 78 L. Ed. 2d 314, 104 S. Ct. 348 (1984). Since the same basic legal challenges are raised to the first complaint and the proposed amendments, the Court will treat the motions to dismiss as addressed to the proposed amended complaint. Plaintiffs' leave to amend is granted.

 Count II, also brought by all plaintiffs against the conspirator defendants, alleges that the underwriters' (conspirator defendants and co-conspirator) marketing and sales of the bonds through misrepresentations and omissions constituted an "enterprise" and their acts constituted a "pattern of racketeering," as defined by RICO. The income derived from these activities alleged were used in the establishment, maintenance of control, and conduct of the affairs of enterprise, in violation of 18 U.S.C. § 1962(a)-(d).

 Counts III, IV, V, VI are brought only by plaintiffs who purchased bonds from one of the 16 named defendants (referred to in Amended Complaint as "purchasing plaintiffs"). Count III alleges that defendants individually violated Section 10(b) and Rule 10b-5 by knowingly or recklessly making the misrepresentations and omissions described in Count 1 in connection with the sale of bonds to purchasing plaintiffs. That conduct is also the basis for the claims of negligent misrepresentations (Count IV), fraud (Count V) and breach of fiduciary duty (Count VI).

 When assessing a Rule 12(b) motion to dismiss, the Court must accept as true all factual allegations in the complaint and view them in a light most favorable to plaintiff. DP Enterprises, Inc. v. Bucks County Community College, 725 F.2d 943, 944 (3d Cir. 1984); Eberts v. Westinghouse Electric Corp., 581 F.2d 357, 359 (3d Cir. 1978). 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." Conley v. Gibson, 355 U.S. 41, 45-46, 2 L. Ed. 2d 80, 78 S. Ct. 99 (1969).

 The parties have also submitted some documents outside the complaint for the Court's consideration. For example, plaintiffs have submitted the affidavit of Michael Hausfeld, plaintiffs' counsel, attesting to the reasonableness of the inquiry made before the complaint was filed; defendants' submission of newspaper and magazine pieces detailing the travails of WPPS project (see exhibits to J.B. Hanauer & Co. and Gibraltar Securities Co.'s Memorandum in Support of Motion to Dismiss); plaintiff's submission of confirmation of stock purchases by two plaintiffs (see Exhibits D and E to Plaintiff's Memorandum in Opposition to Motion to Dismiss to J.B. Hanauer & Co. and Gibraltar Securities Co.).

 When the Court considers these documents in determining whether the complaint fails to state a claim, it must treat the motion to dismiss as one for summary judgment. Fed.R.Civ.P. 12(b). Summary judgment will only be granted if "there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). The party moving for summary judgment must demonstrate the absence of all genuine issues of material fact. Adickes v. S.H. Kress Co., 398 U.S. 144, 153, 26 L. Ed. 2d 142, 90 S. Ct. 1598 (1970). The court must construe all of the allegations and evidence in a light most favorable to the party opposing the motion and must resolve any doubts about the existence of genuine issues of fact against the moving party. United States v. Diebold, Inc., 369 U.S. 654, 655, 8 L. Ed. 2d 176, 82 S. Ct. 993 (1962); Sunshine Books, Ltd. v. Temple University, 697 F.2d 90, 95 (3d Cir. 1982).

 Defendants initially contend that the fraud claims in the complaint do not meet the requirements of Rule 9(b) and thus should be dismissed. *fn1" Rule 9(b) reads in part "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." This requirement of particularity has been applied to fraud allegations under the federal acts as well as state law. Goldman v. Belden, 754 F.2d 1059, 1069 (2d Cir. 1985); Haroco, Inc. v. American Nat. Bank and Trust Co. of Chicago, 747 F.2d 384, 403 (7th Cir. 1984), aff'd 473 U.S. 606, 53 U.S.L.W. 5067, 87 L. Ed. 2d 437, 105 S. Ct. 3291 (1985); Christidis v. First Pennsylvania Mortgage Trust, 717 F.2d 96, 99 (3d Cir. 1983); McKee v. Pope Ballard Shepard & Fowle, Ltd., 604 F. Supp. 927, 928-31 (N.D.Ill. 1985); Seiler v. E.F. Hutton & Co., 102 F.R.D. 880, 886 (D.N.J. 1984).

 The allegations of fraudulent misrepresentations and omissions in the amended complaint are structured in a novel fashion. Exhibit 1 to the amended complaint lists the names of broker/dealers or banks (including defendants here) which sold WPPSS bonds relating to Plant Nos. 4 and 5 ("bonds"), the plaintiffs to which they sold the bonds, the home state of these plaintiffs, the date of purchase of the bonds, and the face amount of the bonds. Amended Complaint, para. 4.

 Exhibit 4 to the amended complaint allegedly contains some of the specific misrepresentations and omissions made by 13 of the defendants to some of the plaintiffs. It has five columns (headed 'A', 'B', 'C', 'D', 'E') and with respect to each of the plaintiffs, one or more of the columns are checked. It contains the following legend, entitled "Defendants' Misrepresentations to Plaintiffs:"

 
A. I was told that these bonds were backed by the Federal Government.
 
B. I was told that these bonds were backed by the BPA.
 
C. I was told that these bonds were backed by Washington State.
 
D. It was "implied" to me that these bonds were backed by a federal agency or Washington State.
 
E. I was told that the safety and backing of our bonds were the same as that of WPPSS 1, 2 and 3.

 Complaint, Exhibit 4.

 Count I also alleges generally that conspirator defendants and co-conspirators did not disclose to plaintiffs that the entities participating in the Plants 4 and 5 project did not have authority to unconditionally guarantee the debt; that the project power requirements were unreliable and inflated; that cost overruns occurred along with schedule delays, that the project management was inadequate, that BPA did not guarantee the project debt or have authority over the project. Amended Complaint para. 39.

 Defendants/movants contend these fraud allegations are insufficiently particular in the following respects. The allegations of misrepresentations do not indicate the specific contents of the fraudulent misrepresentations or where, when, by whom, or how the misrepresentations were made. Nor do the allegations concerning the material omissions committed by defendants include specific allegations about which representations suffered from these omissions or the factual basis of defendants' duty to disclose that information to plaintiffs. Additionally, no facts are alleged to support the allegations that defendants knew or recklessly disregarded the falsity of their representations or deception resulting from their omission.

 The special pleading requirements embodied in Rule 9(b) derive "from the historically disfavored status of fraud claims at common law." Note, Pleading Securities Fraud Claims With Particularity Under Rule 9(b), 97 Harv. L. Rev. 1432, 1433 (1984). Three policies have generally been said to underlie this special treatment of fraud claims: (1) Ensuring plaintiff has investigated and reasonably believes a fraud has occurred, (2) providing adequate notice to defendants so that they can respond to this claim, and (3) protecting the reputation of defendants. Seville Indus. Machinery v. Southmost Machinery, 742 F.2d 786 (3d Cir. 1984), cert. denied, 469 U.S. 1211, 105 S. Ct. 1179, 84 L. Ed. 2d 327 (1985); Sovern, Reconsidering Federal Civil Rule 9(b); 104 F.R.D. 143, 164 (1984).

 The Third Circuit, however, has recently admonished that when applying Rule 9(b), "focusing exclusively on its particularity 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)). Rule 8's general requirement that a pleading only contain "a short and plain statement of the claim" must also be given effect. Fed. R. Civ. Pro. 8(a).

 Defendants refer to caselaw, largely from the Second Circuit, holding that fraud claims must specifically allege the exact representations that were made or not made, in what documents or conversations they appeared, and where, when, and to whom they were made. Memorandum of Law of Defendants Halpert, Oberst and Co., et al., at pp. 13-14; see, e.g., Goldman v. Belden, 754 F.2d at 1069-70; Wayne Inv., Inc. v. Gulf Oil Corp., 739 F.2d 11, 13 (1st Cir. 1984); Barclays Bank of New York v. Goldman, 517 F. Supp. 403, 415 (S.D.N.Y. 1981). A great deal of caselaw adopts such requirements. The Third Circuit, however, has moved toward a more lenient application of Rule 9(b). This approach can be gleaned from its recent decision in Seville Indus. Machinery v. Southmost Machinery, supra. In that case, the plaintiffs alleged fraud on the part of the defendants when they made four misrepresentations, each in connection with the sale or purchase of several pieces of industrial machinery. The district court dismissed these allegations under Rule 9(b) because they did not state with minimal particularity the details of the fraud, including the date, time and place of the alleged misrepresentations. 567 F. Supp. 1146, 1156 (D.N.J. 1983). The Third Circuit reversed the dismissal, reasoning as follows:

 
We approach this question mindful of our recent admonition that in applying Rule 9(b), 'focusing exclusively on its "particularity" language 'is 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). (footnote omitted)

 Id., 742 F.2d at 791. Likewise, while not alleging the factual context or exact words of the misrepresentations, the complaint here does describe the nature and subject of the representations at issue with some specificity. In the exhibits to the complaint, it states the dates of the securities purchases in connection with which the representations were made, the buyer and seller of the securities and the specific amount of the stock purchased. Another exhibit specifies which misrepresentations were made by individual defendants. The complaint does not make sweeping allegations that all defendants committed one fraud, as defendants suggest.

 District courts in this Circuit subsequently have applied the Seville Court's reading of Rule 9(b). Markovich v. Vasad Corp., 617 F. Supp. 142, 145 (E.D.Pa. 1985); Binkley v. Sheaffer, 609 F. Supp. 601, 603-04 (E.D.Pa. 1985); Alfaro v. E. F. Hutton & Co., Inc., 606 F. Supp. 1100, 1107-10 (E.D.Pa. 1985); McClendon v. Continental Group, Inc., 602 F. Supp. 1492, 1509 n.10 (D.N.J. 1985); Thomas v. Tramiel, 105 F.R.D. 568, 571-72 (E.D.Pa. 1985). Alfaro is especially instructive in the present case. There, a class of approximately eighty plaintiffs brought securities fraud and RICO claims against defendant for alleged misrepresentations made to them in connection with the sale of securities. The Court, addressing a motion to dismiss under Rule 9(b) similar to one at issue here, referred to Seville and to other caselaw holding (1) when the transactions are numerous and take place over an extended period of time, less specificity in pleading of fraud is required, In re Catanella and E.F. Hutton and Co. Securities Litigation, 583 F. Supp. 1388, 1389 (E.D.Pa. 1984); see also Hirt v. UM Leasing Corp., 614 F. Supp. 1066, 1072 (D.Neb. 1985); General Acc. Ins. Co. of America v. Fidelity and Deposit Co. of Maryland, 598 F. Supp. 1223, 1232 (E.D.Pa. 1984); (2) where 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, less specificity is required, In re Caesars Palace Securities Litigation, 360 F. Supp. 366, 388 (S.D.N.Y. 1973). The complaint in Alfaro alleged six "different types of [oral] misrepresentations" made to the eighty plaintiffs in a format similar to that in the amended complaint here. The Court concluded:

 
Although these [representations] 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 ...

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