Baldwin v. Kulch, et a l . CV-98-333-M 08/26/99 UNITED STATES DISTRICT COURT FOR THE
DISTRICT OF NEW HAMPSHIRE
William R. Baldwin; Joan S. Baldwin
_____ v. Civil No. 98-333-M
Kulch Associates, Inc.; Charles Kulch; Does 1-100
O R D E R
In this suit, brought under the Securities Act of 1993, 15
U.S.C. § 771(a)(1), (2), and the Securities Exchange Act of 1934,
15 U.S.C. § 78j, plaintiffs allege that defendants Kulch
Associates, Inc., Charles Kulch, and Does 1-100 (collectively
referred to as Kulch) fraudulently induced them to purchase stock
in National Wood Products, Inc. (National Wood). In addition to
the counts based on federal securities laws, plaintiffs also
assert claims based on New Hampshire's Blue Sky Law, New
Hampshire Revised Statutes Annotated (RSA) 421-B, and common law.
Currently before the court is defendants' motion to dismiss the
amended complaint, to which plaintiffs object.1
^iso before the court is plaintiffs' Supplemental Memorandum of Law in Opposition to Defendants' Motion to Dismiss (document 19), wherein plaintiffs assert that defendants' motion Background
_____ The complaint is based on the allegation that defendants
solicited plaintiffs' purchase of stock in National Wood.
Approximately eighteen months after plaintiffs made their second
and final investment in National Wood, they learned that the
company had filed for bankruptcy protection.
Prior to its demise. National Wood was a wood products
manufacturing company located in New Hampshire. Defendants
initially solicited the Baldwins in October 1995, informing them
that National Wood was a profitable investment that would
generate generous returns. The Baldwins also were informed that
Kulch was a Certified Public Accountant. Based on these
assurances, the Baldwins invested five thousand dollars in
National Wood's stock. Kulch solicited a second investment from
the Baldwins in December 1995. Again, defendants represented
that Kulch was a Certified Public Accountant and that the
financial condition of National Wood was such that generous
returns could be had on an investment in the company. Based on
to dismiss is untimely because the motion to extend time for filing motions to dismiss granted by the court on November 25, 1998, set December 20, 1998, as the deadline for filing. Defendants filed their motion to dismiss on December 21, 1998; as December 20, 1998, fell on Sunday, the motion was timely. See Fed. R. Civ. P . 6(a).
2 those representations, the Baldwins say they invested another
fifteen thousand dollars in National Wood stock.
At a stockholders' meeting in July of 1996, Kulch again
solicited the Baldwins to invest more money in National Wood
stock. At that meeting, Kulch presented the Baldwins with
financial statements, prepared on Kulch Associates, Inc.'s
letterhead, that showed National Wood as having a positive cash
flow and assets in excess of liabilities. The Baldwins did not
make an additional investment, but decided against liguidating
their twenty thousand dollar investment, given Kulch's
representations.
In June of 1997 National Wood filed a voluntary Chapter 11
petition for reorganization, and in September of 1997 the case
was converted to a Chapter 7 liguidation proceeding. It is
generally accepted that there will be no assets to distribute to
creditors and investors. The Baldwins have also learned that
Kulch was not, and is not, a licensed accountant.
By order of October 29, 1998, the court (Devine, J.)
dismissed those counts of the complaint based on section 12(1) of
the Securities Act of 1933, RSA 421-B:5, RSA 309-B, and a common
law breach of fiduciary duty theory. Plaintiffs' filed a First
Amended Complaint on November 20, 1998, which is the subject of
defendants' pending motion to dismiss.
3 Discussion
1. Standard of Review
a. The Federal Rules
Because defendants filed an answer to plaintiffs' amended
complaint, and the pleadings closed, defendants' Rule 12(b)(6)
motion will be treated as a Rule 1 2 (c) motion for judgment on the
pleadings. See Fed. R. Civ. P. 7(a), 12(c); see also Metromedia
Steakhouses Co. v. Resco Management, Inc., No. 93-416, slip op.
at 3 (D.N.H. Mar. 10, 1994). Like a motion to dismiss, a motion
for judgment on the pleadings shall be granted only if "it
appears beyond doubt that the plaintiff[s] can prove no set of
facts in support of [their] claim." Santiago de Castro v.
Morales Medina, 943 F.2d 129, 130 (1st Cir. 1991); see also
Republic Steel Corp. v. Pennsylvania Enq'q Corp., 785 F.2d 174,
182 (7th Cir. 1986) (the standard of review is essentially the
same for a 12(b)(6) and a 12(c) motion). In making this
determination, the court must accept plaintiffs' allegations as
true and indulge every reasonable inference in plaintiffs' favor.
See Santiago de Castro, 943 F.2d at 130.
In the context of a motion to dismiss a claim of fraud or
misrepresentation, however, the claim must also meet the special
pleading reguirements of Fed. R. Civ. P. 9(b). Romani v.
Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir. 1991); Havduk
4 v. Lanna, 775 F.2d 441, 443 (1st Cir. 1985). Rule 9(b) provides,
"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." Fed. R. Civ. P. 9(b). The
purpose of Rule 9(b)'s particularity reguirement is "to apprise
the defendant of fraudulent claims and of the acts that form the
basis for the claim[s]." Havduk, 775 F.2d at 443. The United
States Court of Appeals for the First Circuit "has been
'especially rigorous' in applying Rule 9(b) in securities fraud
actions 'to minimize the chance that a plaintiff with a largely
groundless claim will bring a suit and conduct extensive
discovery in the hopes that the process will reveal relevant
evidence.'" Maldonado v. Dominguez, 137 F.3d 1, 9 (guoting Shaw
v. Digital Equip. Corp., 82 F.3d 1194, 1223 (1st Cir. 1996);
Romani, 929 F.2d at 878. Under Rule 9(b), a party alleging fraud
must "'(1) specify the statements that the plaintiff contends
were fraudulent, (2) identify the speaker, (3) state where and
when the statements were made, and (4) explain why the statements
were fraudulent.'" Suna v. Bailey Corp., 107 F.3d 64, 68 (1st
Cir. 1997) (guoting Shields v. Citvtrust Bancorp, Inc., 25 F.3d
1124, 1127 (2d Cir. 1994)). The court must dismiss a securities
case under Rule 9(b) where the complaint merely pleads "fraud by
5 hindsight." See, e.g., Suna, 107 F.3d at 70; Greenstone v.
Cambex Corp., 975 F.2d 22, 25-26 (1st Cir. 1992); Romani, 929
F.2d at 878. In other words, "a general averment that defendants
'knew' earlier what later turned out badly" does not convey the
necessary particularity that Rule 9(b) reguires. Greenstone, 975
F .2d at 25.
b. The Private Securities Litigation Reform Act
_____ To curb perceived abuses in private securities lawsuits.
Congress enacted the Private Securities Litigation Reform Act of
1995 (PSLRA). 15 U.S.C. § 78u-4. The act "establish[es] uniform
and more stringent pleading reguirements." H.R. Conf. Rep. 104-
369. Congress sought to resolve a split among the circuits
regarding the appropriate pleading standards for securities fraud
actions. See William S. Lerach & Eric Alan Isaacson, Pleading
Scienter Under Section 21D (b) (2) of the Securities Exchange Act
of 1934, 33 Sa n D i e g o L. R e v . 893, 894 (1996). The PSLRA provides
that in securities fraud cases "the complaint shall specify each
statement alleged to have been misleading, [and] the reason or
reasons why the statement is misleading 15 U.S.C.
§ 78u-4(b)(1). The act further reguires that when a claim
reguires scienter the complaint must "state with particularity
6 facts giving rise to a strong inference that the defendant acted
with the reguired state of mind." 15 U.S.C. § 78u-4(b)(2).
The PLSRA builds upon previous case law interpreting Rule
9(b) 's pleading reguirements. Section 78u-4(b) (1) "effectively
codifies Ninth Circuit law interpreting [Rule] 9(b)'s provision
reguiring circumstances constituting fraud to be alleged with
particularity." Lerach & Isaacson, supra, at 894. Previous
Ninth Circuit law reguired plaintiffs to "'set forth what is
false or misleading about a statement, and why it is false. In
other words, the plaintiff must set forth an explanation as to
why the statement or omission complained of was false or
misleading.'" Id. (guoting In re GlenFed Securities Litiq., 42
F.3d 1541, 1548 (9th Cir. 1994) (en banc)). The pleading
standard relating to scienter is based upon Second Circuit case
law reguiring the complaint to include facts supporting a strong
inference of fraudulent intent. See In re Silicon Graphics, 1996
WL 664639, *5 (N.D. Cal. Sep. 25, 1996). There has been some
debate, however, regarding whether Congress intended to adopt the
Second Circuit's strong inference test, which could be satisfied
by showing motive and opportunity to commit fraud. See id.
While some courts have interpreted the PSLRA's strong inference
standard as a wholesale adoption of the Second Circuit standard,
others have concluded that Congress intended to strengthen the
7 pleading standard. The First Circuit is in the latter category.
Although it has not yet applied this provision, the First Circuit
has stated that it does "not interpret the new standard to differ
from that which this court has historically applied." Maldonado
v. Dominguez, 137 F.3d 1, 9 (1st Cir. 1998). Moreover, the First
Circuit explicitly has rejected the Second Circuit's "motive and
opportunity" test. See id. at 10 n.6.
2. Defendants' Motion for Judgment on the Pleadings
_____ The pending motion targets each count of the amended
complaint. In particular, defendants argue that Counts I through
IV fail to meet the pleading reguirements of Rule (9)b and the
PSLRA. Defendants also assert that Count VIII is barred by the
statute of limitations and Count IX fails to state a claim.
Defendants further point out that the court's Order of
October 29, 1998, uneguivocally dismissed Counts VI and VII. The
court agrees. Indeed, inclusion of these counts in the Amended
Complaint arguably contravenes Rule 11's reguirement that before
signing a complaint, an attorney must ascertain that "the claims
. . . and other legal contentions [in a pleading] are warranted
by existing law or by a nonfrivolous argument for the extension,
modification, or reversal of existing law . . . ." Fed. R. Civ.
P. 11 (b) (2) .
8 _____ a. Plaintiff's Waiver Argument
_____ Plaintiffs main argument is that defendants have waived
their objections by failing to raise them in their first
responsive pleading. Although plaintiffs' brief only refers
specifically to defendants' PLSRA arguments, plaintiffs' waiver
argument appears to pertain to defendants' reliance on Rule 9 as
well. The entirety of plaintiffs' argument is as follows: "It
is axiomatic that affirmative defenses and non-jurisdictional
objections which are not posited at the outset of the action are
waived, and thus the Defendants have no right to raise the PSLRA
. . . ." Memorandum of Law in Opposition to Defendants' Motion
to Dismiss at 2, 3, 4. Although it is not axiomatic, in some
instances the federal rules do dictate that failure to raise a
defense amounts to a waiver. See Fed R. Civ. P. 8(c), 12(g).
According to applicable rules, in addition to a number of
defenses explicitly enumerated in Rule 8 (c), a defendant must
include any matter constituting an affirmative defense in its
answer. Although there may be room for debate regarding which
defenses gualify as "affirmative defenses" within the meaning of
Rule 8(c), plaintiffs' argument does not present a close case.2
2Plaintiffs' argument that "non-jurisdictional objections" not raised in the first responsive pleading are waived, is incorrect. Whether or not failure to assert a defense amounts to a waiver cannot be determined by categorizing the defense as
9 Rule 9 (b) and the PSLRA govern the manner in which a plaintiff
must plead, just as Rule 8 (a) governs pleading of civil actions
that do not allege fraud. These are the standards against which
the court judges an allegation that the complaint fails to state
a claim upon which relief may be granted. See Judge v. City of
Lowell, 160 F.3d 67, 72 (1st Cir. 1998); C harles A lan W right & A rthur
R. M i l l e r , F e d e r a l Practice and Procedure § 1356, at 294 ("The purpose
of a motion under Rule 12(b)(6) is to test the formal sufficiency
of the statement of the claim for relief . . . . Thus, the
provision must be read in conjunction with Rule 8 (a) , which sets
forth the reguirements for pleading a claim . . . ."). According
to Rule 12, although some of the defenses enumerated in
subsection (b) are waived if not raised, " [a] defense of failure
to state a claim upon which relief can be granted . . . may be
made in any pleading permitted or ordered under Rule 7 (a), or by
motion for judgment on the pleadings, or at the trial on the
merits." Fed. R. Civ. P. 12(h)(2).
b. Failure to Plead with Specificity
(1) Section 10(b) and Rule 10b-5
Section 1 0 (b) of the Securities Exchange Act, and Rule 10b-5
promulgated thereunder, prohibit any person from, directly or
jurisdictional or nonjurisdictional.
10 indirectly, committing fraud in connection with the purchase or
sale of securities. See 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b
5 (1994); Rand v. Cullinet Software, Inc., 847 F. Supp. 200, 204
(D. Mass. 1994). "[T]o prevail on a rule 10b-5 claim, a
plaintiff must show: (1) a material misstatement or omission by
the defendant; (2) scienter; (3) reliance; and (4) due care by
the plaintiff." Rand, 847 F. Supp. at 204-05 (citing Blue Chip
Stamps v. Manor Drug Stores, 421 U.S. 723, 730 (1975)).
Under Rule 9, "'each defendant's role in the fraud must be
particularized.'" Schaffer v. Timberland Co., 924 F. Supp. 1298
1321-22 (D.N.H. 1996) (guoting Shields v. Amoskeaq Bank Shares,
Inc., 766 F. Supp. 32, 40 (D.N.H. 1991)). The entirety of
plaintiffs' allegations is that in October 1995 and again in
December 1995, defendants (defined as Charles Kulch, Kulch
Associates, Inc., and Does 1 through 100) "represented to
Plaintiffs that National Wood was a sound and profitable wood
products company and that Plaintiffs' investments would generate
dividends as well as a generous rate of return," and that
"National Wood was poised to dominate the easel manufacturing
market during the 1996-1997 holiday shopping season, and that
such market power would further enhance the value of Plaintiffs'
investments." Complaint 55 7, 8, 16. These allegations clearly
do not specify each defendant's role in the fraud and fall far short of meeting the particularity requirements of Rule 9 and the
PSLRA.
The first element of a securities fraud claim is a material
misstatement. There is no allegation here that defendants'
statements were untrue when they were made. "It is well
established that plaintiffs in a securities action have not
alleged actionable fraud if their claim rests on the assumption
that the defendants must have known of the severity of their
problems earlier because conditions became so bad later on."
Serabian v. Amoskeaq Bank Shares, Inc., 24 F.3d 357, 361 (1st
Cir. 1994). Although "'predictions "are not exempt" from the
securities laws . . . they are actionable only if the forecast
might affect a "reasonable investor" in contemplating the value
of a corporation's stock.'" Suna v. Bailey Corp., 107 F.3d 64,
70 (1st Cir. 1997) (quoting Colbv v. Holoqic, Inc., 817 F. Supp.
204, 211 (D. Mass. 1993)). The only factual allegation
plaintiffs offer in support of their contention that the
defendants' statements were fraudulent is that approximately
eighteen months after plaintiffs made their second investment.
National Wood filed a Chapter 11 bankruptcy petition, which was
subsequently converted to a Chapter 7 proceeding. "Had
[plaintiffs] presented facts known by [defendants], and
contemporaneous with the statements above, that would show that
12 [the companies] anticipated success was unlikely, such facts
would have adequately alleged a claim of securities fraud." Id.
at 70. Although plaintiffs do allege that "many facts which
would be detrimental to National Wood, all of which facts were
known to the Defendants, and each of them, were withheld from the
Plaintiffs," Complaint 5 20, the complaint never suggests what
these facts might be.
Needless to say, plaintiffs' allegations do not "state with
particularity facts giving rise to a strong inference that the
defendant[s] acted with the required state of mind." 15 U.S.C.
§ 78u-4(b). Not only do the pleadings not support the inference
that defendants knew their statements were untrue, the pleadings
fail even to provide factual allegations that could support the
inference that defendants' statements were in fact false when
made.
(2) Section 12(2)
_____ The PSLRA, by express provision, does not apply to claims
arising under the Securities Act of 1933. See 15 U.S.C. § 78u-
4 (b) (stating requirements apply to "any private action arising
under this chapter"). Rule 9(b), however, does apply to an
action brought under section 12(2) when a complaint is based on
"allegations . . . of a unified course of fraudulent conduct
13 . . . Shaw, 82 F.3d at 1223. Although "[f]raud is not an
element of a claim under . . . Section . . . 12(2), and a
plaintiff asserting such a claim may avoid altogether any
allegations of scienter or reliance," a 12(2) claim "may yet
'sound[] in fraud.'" Id. (guoting Haft v. Eastland Finan. Corp.,
755 F. Supp. 1123, 1126 (D.R.I. 1991)).
Accordingly, the guestion is whether "fraud might be said to
'lie at the core of the action.'" Id. (guoting Havduk, 775 F.2d
at 443). In Shaw, the First Circuit declined to apply Rule 9(b)
to a section 12(2) claim because "[a]lthough the complaint does
assert that defendants actually possessed the information that
they failed to disclose, those allegations cannot be thought to
constitute 'averments of fraud,' absent any claim of scienter and
reliance." Id. at 1223. In this case, the complaint's vagueness
makes it difficult to determine whether fraud lies at its core.
Although plaintiffs have alleged reliance, allegations of
scienter, as discussed above, are plainly lacking. Nonetheless,
plaintiffs do seem to have attempted to plead fraud; their
complaint contains many fraud-based counts premised on identical
underlying conduct. In contrast, the complaint to which the
First Circuit did not apply Rule 9 (b) " [did] not contain a claim
for relief under section 10(b) and Rule 10b-5. [The complaint],
rather, was intentionally drafted to omit claims of fraud, and
14 [was] limited to claims brought under sections 11 and 12(2)
Shaw, 903 F. Supp. 173, 176 (D. Mass. 1995), aff'd in part and
rev'd in part, 82 F.3d 1194 (1st Cir. 1996); see Shaw, 82 F.3d at
1223. Accordingly, it is appropriate to apply Rule 9(b) to this
claim, which in turn dictates its dismissal for the reasons
stated above. See supra section 2 (b)(1).
Moreover, even if the complaint does not sound in fraud
sufficiently to justify application of Rule 9(b), the court finds
that plaintiffs have failed to meet even the minimal reguirements
of a section 12(2) claim. See Suna, 107 F.3d at 71-72. To
successfully allege a violation of section 12(2), plaintiffs must
point to "an untrue statement of a material fact." Plaintiffs in
this case have not indicated what was untrue about defendants'
statements, except that their predictions turned out to be
incorrect. Further, "'soft, puffing statements . . . generally
lack materiality because the market price of a share is not
inflated by vague statements predicting growth.'" Id. (guoting
Raab v. General Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993).
c. Section 12(1) Claim
_____ In Count VIII of their amended complaint, plaintiffs replead
their claim under section 12(1) of the Securities Act of 1933.
Defendants, however, argue that this count is untimely under the
15 applicable statute of limitations, which states, "No action shall
be maintained to enforce any liability created under . . .
section 771(1) [12(1)] of this title, unless brought within one
year after the violation upon which it is based." 15 U.S.C.
§ 77m. While the limitations provision applicable to section
12(2) specifically states that an action may be brought "within
one year of the discovery of the untrue statement or omission, or
after such discovery should have been made by the exercise of
reasonable diligence," such language is notably absent from the
provision relating to 12(1). The majority rule, which the First
Circuit follows, is that "the limitations period runs from the
date of the violation irrespective of whether the plaintiff knew
of the violation." Cook v. Avien, 573 F.2d 685, 691 (1st Cir.
1978); see Blatt v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
916 F. Supp. 1343, 1353 (D.N.J. 1996) (the "vast majority of
cases have concluded that the limitations period runs from the
date of the violation regardless of whether the plaintiff knew of
the violation."). Straightforward application of the rule
clearly bars plaintiffs' section 12(1) claim, which was filed
more than three years after plaintiffs' final investment in
National Wood. Indeed, plaintiffs tacitly agree, as they offer
no argument suggesting the claim is timely. Although the statute
of limitations is an affirmative defense that can be waived if
16 not pled in the first responsive pleading, plaintiffs' waiver
argument is inapplicable to this issue as defendants' answer did
plead the limitations defense.
3. State-Law Claims
_____ As plaintiffs' federal claims are hereby dismissed, and the
amount in controversy does not meet the minimum reguired to
establish diversity jurisdiction, the court declines to exercise
supplemental jurisdiction over plaintiffs' state-law claims. See
28 U.S. C. §1367(c) (1994); Camelio v. American Fed'n, 137 F.3d
666, 672 (1st Cir. 1998) ("balance of competing factors
ordinarily will weigh strongly in favor of declining jurisdiction
over state law claims where the foundational federal claims have
been dismissed at an early stage in the litigation") .
Conclusion
For the abovementioned reasons, defendants' motion to
dismiss (document 16) is granted as to all federal claims; the
state claims are dismissed without prejudice to plaintiffs'
pursuing them in state court. The clerk shall enter judgment
accordingly.
17 SO ORDERED.
Steven J. McAuliffe United States District Judge
August 26, 1999
cc: Leonard W. Foy, Esg. Andrew W. Serell, Esg.