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National Rural Electric Cooperative Association v. Breen Capital Services Corp.


March 28, 2001


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



Defendants, Breen Capital Services Corporation ("BCSC"), Breen Capital Services LLC, Breen Capital Group, Breen Capital Investment Corporation ("BCIC"), J. Douglas Breen, Robert C. Silcox, and Donald E. Williams (collectively "Defendants"), move to dismiss Counts I, II, and III of Plaintiff National Rural Electric Cooperative Association's ("Plaintiff") Amended Complaint pursuant to Fed. R. Civ. P. 12(b)(6) and Counts III, IV, V, and VI pursuant to Fed. R. Civ. P. 12(b)(1).

For the reasons set forth in this opinion, Defendants' motion to dismiss is hereby denied.

I. Procedural History

On September 23, 1999, Plaintiff *fn1 filed suit against Defendants in the United States District Court for the Eastern District of Virginia. (See Defs.' Exh. A.) On February 11, 2000, based upon the principle of forum non conveniens, Judge Leonie M. Brinkema ordered the case transferred to the District of New Jersey. (See Defs.' Exh. B.)

On April 10, 2000, Plaintiff filed an Amended Complaint with this Court. (See Defs.' Exh. C.) In the Amended Complaint, Plaintiff brought a securities fraud claim against Defendants based upon five counts: violation of the Securities Exchange Act (1934) § 10(b) and 10(b)(5) (Count I); violation of the Securities Exchange Act (1934) § 20(a) (Count II); the New Jersey Uniform Securities Act § 49:3-52 and § 49:3-71 (a)(2)-(4)(Count III); fraud (Count IV); conspiracy to commit fraud (Count V); negligent misrepresentation (Count VI); and constructive fraud (Count VII).

Counts I and III were brought against Breen Entities *fn2 and Breen in his individual capacity. Count II was brought against Breen, Silcox and Williams. Counts IV, V, VI, VII were brought against the combined Defendants.

On May 10, 2000, Defendants moved to dismiss Plaintiff's suit. Defendants argue that such a motion should be granted because Plaintiff failed to bring suit within the required statute of limitations period and because there is no diversity jurisdiction.



Defendants are engaged in the business of tax lien servicing. In 1993 and 1994, a trust, for which Defendants Breen, Silcox, and Williams were the indirect beneficial owners, ("Trust") purchased tax liens *fn3 from Jersey City. (See Am. Compl. ¶ 27.)

Defendants paid for these tax liens by raising cash from bonds they sold in 1993 and 1994 ("1993 Bonds" and "1994 Bonds"). (See Am. Compl. ¶¶ 21, 27.) Subordinate promissory notes were issued to Jersey City by Defendants for the difference still owed between the value of the tax liens purchased and the actual cash paid for the tax liens. (See Am. Compl. ¶ 27.) Likewise, purchasers of the 1993 Bonds and 1994 Bonds received a secured interest in the tax liens.

Defendants, as issuer of these bonds, were responsible for paying back the bondholders. The Trust's ability to pay the principal and interest on the bonds was contingent upon the Trust's capability to collect the amount due on the outstanding tax liens. (See Am. Compl. ¶ 21.) If the Trust failed to collect all or a sufficient amount of the value of the outstanding tax liens, then the Trust would inevitably default on its bond payments.


A couple of years later, Jersey City still held approximately $26,500,000 in outstanding subordinate promissory notes that had yet to be paid off by Defendants. In March 1996, Jersey City, fearful of losing the value on these notes, entered into restructuring negotiations with Defendants regarding the 1993 and 1994 Bonds. *fn4 (See Am. Compl. ¶¶ 35-36.)

In mid-1996, Defendant BCIC purchased the 1994 Bonds for $4,500,000. (See Am. Compl. ¶ 47.) It presumably did this to "silence criticisms from the original holders of the bonds" for the poor performance of the bonds. (Id.) In the summer of 1996, BCIC sought to sell the 1994 Bonds it now owned. (See Am. Compl. ¶¶ 49-50.) Defendants hired Fahnestock & Company, Inc. to act as its agent and market the 1994 Bonds. (See Am. Compl. ¶ 50.) Fahnestock & Company, Inc. presented the sale opportunity to First Albany Company. (Id.)


In December 1996, First Albany Company conveyed the information to Plaintiff. (See Am. Compl. ¶ 51.) Although Plaintiff was interested in purchasing the 1994 Bonds, it expressed reservations because of its inability to obtain reliable information regarding the risk and performance of the 1994 Bonds. (See Am. Compl. ¶ 52.)

Between December 1996 and February 1997, David Lausa, First Albany Company's in-house trader, addressed Plaintiff's concerns directly to Defendant Breen. (See Am. Compl. ¶ 53.) Plaintiff alleges that Defendant Breen, who was an officer and owner of Defendant BCIC, made a number of significant misrepresentations to Lausa about the strength of the 1994 Bonds and the tax liens securing those bonds. Lausa, in turn, conveyed these statements to Plaintiff.

Plaintiff states that Breen advised Lausa that the 1994 Bonds were "performing well and were accordingly priced at or near par" and moreover that the 1994 Bonds "were fully and adequately secured, and that the collateral was producing stable cash flows." (See Am. Compl. ¶ 55.) Plaintiff also states that Breen asserted that "a deal was in the works that might result in the bondholders being paid off within three to nine months." (See Am. Compl. ¶ 59.) Lastly, Defendant Breen allegedly assured Lausa that the only reason Defendants sought to sell the 1994 Bonds was because the Defendants desired short-term liquidity. (See Am. Compl. ¶ 57.)

In February 1997, Plaintiff, acting on behalf of NRECA Plans, purchased from Defendant BCIC the 1994 Bonds for the price of $4,900,000. This price was supposedly close to the par value of the bonds.


Plaintiff contends that it detrimentally relied upon Defendant Breen's misleading statements. Plaintiff claims it was deceived into believing that enough cash was being earned from the tax liens securing the 1994 Bonds so that such cash could be used to pay off the bonds that Plaintiff would afterward purchase. (See Am. Compl. ¶¶ 1, 3.) Plaintiff states that in reality, the 1994 Bonds and the tax liens securing those bonds were in a feeble state caused by the inability of the Defendants to collect the cash for the outstanding tax liens. As a consequence, the 1993 and 1994 Bonds were in financial distress-a significant piece of information that Defendant Breen failed to disclose. *fn5 In fact, in September 16, 1996, Breen Entities sent out a memorandum to the holders of the 1993 Bonds stating that principal and interest payments would not be made on time and that insufficient cash was being generated from redemption of the tax liens. (See Am. Compl. ¶ 40.) Although the 1994 Bonds were also in the same financial crisis, a similar memo was not issued because BCIC-a Breen Entity-owned the 1994 Bonds at the time. (Id.)

Plaintiff further insists that the 1994 Bonds were not worth their par value as Defendants had Plaintiff believe. (See Am. Compl. ¶¶ 68, 70.) Finally, Plaintiff states that it was never advised by Defendants regarding the restructuring negotiations taking place between the Defendants and Jersey City or of the suit filed by Jersey City against Defendants on September 25, 1997. (See Am. Compl. ¶¶ 72, 75.)



Fed. R. Civ. P. 12(b)(6) allows a party to move for a dismissal based upon the pleader's failure to state a claim upon which relief can be granted. Defendants move to dismiss Counts I, II, and III of Plaintiff's Amended Complaint pursuant to 12(b)(6). Defendants argue that Plaintiff failed to state a claim upon which relief may be granted because Plaintiff failed to meet the required statute of limitations period for claims brought under the Securities Exchange Act (1934) § 10(b) and 10(b)(5); the Securities Exchange Act (1934) § 20(a); and the New Jersey Uniform Securities Act § 49:3-52 and § 49:3-71 (a)(2)-(4).

Courts generally disfavor Rule 12(b)(6) motions and rarely grant them. Panek v. Bogucz, 718 F. Supp. 1228, 1229 (D.N.J. 1989). On a motion to dismiss for failure to state a claim, all allegations in the complaint must be accepted as true and the plaintiff must be given the benefit of every favorable inference that can be drawn from those allegations. See United States v. Gaubert, 499 U.S. 315, 327 (1991); Conley v. Gibson, 355 U.S. 41, 48 (1957); ALA, Inc. v. CCAir, Inc., 29 F.3d 855, 859 (3d Cir. 1994); Wisniewski v. Johns-Manville Corp., 812 F.2d 81, 83 n.1 (3d Cir. 1987).

1. Federal Claims

The United States Supreme Court has held that for purposes of litigation under the Securities Exchange Act (1934) § 10(b), 10(b)(5), and § 20(a), plaintiff must institute litigation within one year after the discovery of the facts constituting the violation and within three years after such violation. See Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350; Barnes v. Printron, Inc., 1998 WL 778378 (S.D.N.Y. Nov. 5, 1998). This one year statute of limitations is triggered when it is determined that "plaintiffs ... have sufficient information of possible wrongdoing to place them on "inquiry notice" or to excite "storm warnings" of culpable activity. Once on inquiry notice, plaintiffs have a duty to exercise reasonable diligence to uncover the basis for their claims and are held to have constructive notice of all facts that could have been learned through diligent investigation during the limitations period." Gruber v. Price Waterhouse, 697 F. Supp. 859, 864 (E.D.Pa. 1988), aff'd, 911 F.2d 960 (3d Cir. 1990). See also In Re The Prudential Insurance Company of America Sales Practices Litigation, 975 F. Supp. 584 (D.N.J. 1996). Therefore, the core issue in this case is whether Plaintiff's suit, which was filed on September 23, 1999, was brought within one year of discovering the alleged fraud committed by Defendants.

Defendants insist that Plaintiff *fn6 was placed on notice before September 23, 1998 regarding the poor performance of the 1994 Bonds. Defendants believe that by January 1998, Plaintiff was aware of the suit filed by Jersey City. (See Defs.' Brief 8.) Defendants further argue that by June 1998, Plaintiff was aware of Jersey City's attempt to foreclose on the tax liens securing the 1993 and 1994 Bonds. (Id.)

Defendants arguments are flawed for a number of reasons. The existence of a prior securities fraud lawsuit against a defendant is not sufficient to place an investor on inquiry notice, so as to trigger the one-year statute of limitations period. See Dietrich v. Bauer, 76 F. Supp.2d 312, 345 (S.D.N.Y. 1999). Furthermore, Defendants support their first two arguments by mistakenly relying upon factual allegations made in the original complaint as opposed to the Amended Complaint. (See Defs.' Brief 9, n. 2.)

Under Fed. R. Civ. P. 15(a) a party may amend their pleading once as a matter of right before a responsive pleading is served. Once plaintiff amends the original complaint, the Amended Complaint becomes the superseding document and renders the original complaint legally inoperative. Fritz v. Standard Security Life Insurance Company of New York, 676 F.2d 1356, 1358 (11th Cir. 1982); Miller v. Glanz, 948 F.2d 1562, 1565 (10th Cir. 1991); Dluhos v. Floating & Abandoned Vessel, 162 F.3d 63, 68 (2d Cir. 1998). See also Sutton v. United Air Lines, Inc., 527 U.S. 471, 475 (1999) (stating that a pending Rule 12(b)(6) motion to dismiss is addressed to the Amended Complaint). In the present case, Plaintiff exercised its right under Fed. R. Civ. P. 15(a) and properly submitted an Amended Complaint. Therefore, this Court will only look to the facts as alleged in the four corners of the Amended Complaint.

Plaintiff clearly states in the Amended Complaint that after Jersey City filed suit against Defendants in September 1997, none of the Defendants informed Plaintiff about the breakdown in the restructuring negotiations or the lawsuit itself. (See Am. Compl. ¶ 75.) Accepting all the stated factual allegations in the Amended Complaint as being true, this Court nevertheless finds that the earliest conceivable moment that Plaintiff could arguably have been on notice of fraud regarding the 1994 Bonds was November 1998 when Defendants, through their counsel Andrew Solomon, informed Plaintiff that they "were going to attempt to mediate *fn7 their differences with Jersey City." (See Am. Compl. ¶ 78)(footnote added). Such a statement should have placed Plaintiff on notice to inquire as to what caused the need for Defendants to enter into mediation proceedings with Jersey City. Assuming such a statement is true, Plaintiff still brought suit within the one year statute of limitations by filing suit in September 1999.

Defendants also argue that trading records and account statements that Plaintiff received regarding the 1994 Bonds "diclose[d] a dramatic negative discrepancy between prior representations of the defendant and the actual results" and thus placed Plaintiff on notice to inquire. (See Defs.' Brief 13.) Defendants contend that such information was contained in the first three quarterly statements dated June 1997, September 1997 and December 1997. Defendants contend that these statements demonstrate that the 1994 Bonds were "dramatically under-performing and producing unstable cash flows". (See Defs.' Brief 14.) Defendants argue that its principal payment for June 1997 was $34,502.75; $0.00 for September 1997; and $18,958.40 for December 1997. (Id.) Defendants believe that such nominal payments to an outstanding principal value of $4,758,453.51 should have placed Plaintiff on inquiry notice that the 1994 Bonds were failing to produce adequate cash flow. (Id.)

It should first be noted that the under-performance of stocks or bonds is not an immediate indication of fraud so as to put the Plaintiff on notice. See McKowan Lowe & Co., Ltd. v. Jasmine Ltd., 127 F. Supp 2d. 516 (D.N.J. 2000) (holding that decline in stock prices alone, which caused "concern" to investor, was insufficient to have put him on inquiry notice of alleged securities fraud so as to trigger running of statute of limitations period). See also Phillips v. Kidder, Peabody & Co., 782 F. Supp. 854, 863 (S.D.N.Y. 1991) (citing Briskin v. Ernst & Ernst, 589 F.2d 1363, 1368 (9th Cir. 1978) ("Financial reverses can result from a host of causes other than fraud, and a steep decline in stock price may well be ambiguous")). In addition, Defendants neglect to illustrate that they made full payments on the interest for the June 1997 and September 1997 quarters in the sum of $104,685.98 and $103,926.92, respectively. (See Pl.'s Brief 20.) Moreover, according to Plaintiff's Amended Complaint, Defendant Breen assured Plaintiff that it was common for payments on the principal to be made in lump sums and that the bonds remained strong. (See Am. Compl. ¶¶ 76-77.)

Based upon the full payment of the interest due in the second and third quarters and the reassurances made by Defendants regarding the payments on the principal and the continued strength of the 1994 Bonds, this Court must accept Plaintiff's statement that it did not suspect any fraudulent wrongdoing.

Lastly, Defendants argue that Defendant Breen told Lausa, prior to Plaintiff buying the 1994 Bonds, "that a deal was in the works that might result in the bondholders being paid off within three to nine months." Defendants argue that Plaintiff was on inquiry notice by October 1997 when the nine months passed by and no deal was struck resulting in the bondholders not being paid off. (See Defs.' Brief 11.) However, the simple fact that a buyout has not taken place is insufficient to place a plaintiff on inquiry notice. See Moore v. A.G. Edwards & Sons, Inc., 631 F. Supp. 138, 142-43 (E.D. LA. 1986) (holding that the court would not draw the conclusion that plaintiffs were put on inquiry notice of fraud by the mere fact that the buyout of stocks by defendants did not occur).

2. State Claims

Under N.J.S.A. 49:3-71(g), a suit must not be brought "more than two years after the contract of sale or the rendering of the investment advice, or more than two years after the time when the person aggrieved knew or should have known of the existence of his cause of action, whichever is later."

Defendants argue that Plaintiff's state claim is time barred because the contract to purchase the 1994 Bonds took place on February 1997 and the suit was brought on September 23, 1999. Thus, more than two years have passed since the purchase of the 1994 Bonds and the commencement of suit. This Court agrees with the conclusion reached by the Defendants regarding the first statutory provision.

Defendants attack the second provision by stating that Plaintiff brought suit more than two years after the time when Plaintiff knew or should have known of the existence of the alleged fraud committed regarding the sale of the 1994 Bonds. Again, Defendants base their argument on the fact that Plaintiff was on notice when "Plaintiff had actual knowledge that Defendant Breen's supposed assurances as to the performance of the `94 Bonds were dramatically contradicted by their performance, as evidenced by the quarterly Payment Date Statements." (See Defs.' Brief 15.)

Here, this Court must disagree with the analysis of the Defendants. As stated above, the earliest moment that Plaintiff could have been placed on notice, as indicated in its Amended Complaint, is November 1998. This Court also accepts Plaintiff's argument that even if the filing of the Jersey City lawsuit should have placed Plaintiff on notice, suit under the New Jersey claim would not be time barred because the Jersey City lawsuit was filed on September 25, 1997 and Plaintiff filed their lawsuit on September 23, 1999. (See Pl.'s Brief 22.) Thus, the suit was filed within the two year statute of limitations.

Since the Jersey City lawsuit occurred after Plaintiff's purchase of the 1994 Bonds, the second provision of the statute is legally controlling. Accordingly, the New Jersey state claim will not be dismissed.


Pursuant to Fed. R. Civ. P. 12(b)(1), Defendants next move to dismiss the state claims as articulated in Counts III, IV, V, and VI. Under Rule 12(b)(1) a court must grant a motion to dismiss if the court lacks subject matter jurisdiction.

Defendants argue that because the securities fraud claims are time barred, there is no federal question. The Court, however, having determined that the federal claims are not barred by the statute of limitations has subject matter jurisdiction pursuant to 15 U.S.C. § 78aa (securities fraud) and 28 U.S.C. § 1331 (federal question). Consequently, this Court has supplemental jurisdiction to hear the state law claims pursuant to 28 U.S.C. § 1367. Therefore, Defendants' motion to dismiss pursuant to Rule 12 (b)(1) is denied.


For the foregoing reasons, Defendants' motion to dismiss is denied.

William G. Bassler, U.S.D.J.

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