Tyco Int’l v. Kozlowski and Swartz

2005 DNH 068

• Court: District Court, D. New Hampshire
• Decided: April 21, 2005
• Docket: Case 02-md-1335-PB
• Status: Published

Opinion

Tyco Int’l v . Kozlowski and Swartz 02-md-1335-PB 04/21/05

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Tyco International Ltd. MDL Docket No. 02-1335-B Civil No. 03-CV-1339-PB v. Opinion No. 2005 DNH 068 L . Dennis Kozlowski and Mark H . Swartz

MEMORANDUM AND ORDER

Tyco International, Ltd. brings this suit against L . Dennis

Kozlowski, its former Chief Executive Officer, and Mark H .

Swartz, its former Chief Financial Officer, pursuant to Section

16(b) of the Securities and Exchange Act of 1934, 15 U.S.C. §

78p(b) (“Section 16(b)”). It seeks disgorgement of approximately

$30 million in short-swing trading profits resulting from

prohibited transactions in Tyco stock. Kozlowski and Swartz have

moved to partially dismiss Tyco’s Amended Complaint pursuant to

Fed. R. Civ. P. 12(b)(6), arguing that 17 of the stock

transactions (the “Challenged Transactions”) referenced in the

Amended Complaint are barred by Section 16(b)’s two-year statute of limitations.1

I. BACKGROUND AND PROCEDURAL HISTORY

On December 6, 2002, Tyco filed a complaint against

Kozlowski and Swartz to recover improper short-swing profits on a

total of 50 transactions, 24 by Kozlowski and 26 by Swartz. On

October 3 , 2003, defendants moved to partially dismiss the

original complaint on the ground that Tyco’s claims concerning a

number of the allegedly prohibited transactions were time-barred.

On March 1 6 , 2004, I granted defendants’ motions while granting

Tyco leave to file an amended complaint pleading equitable

tolling. See In re Tyco Int’l Ltd. Multidistrict Litig. (MDL

1335), 2004 DNH 47 at * 2 . Tyco filed its Amended Complaint on

May 1 4 , 2004.

In the Amended Complaint, Tyco alleges that Kozlowski and

Swartz each engaged in multiple prohibited transactions involving

1 Defendants specifically argue that Tyco’s claims based on Kozlowski’s transactions 3-14 and Swartz’s transactions 5-9, as numbered in Tyco’s Amended Complaint at pages 18-20 and 34-36, were filed after Section 16(b)’s two-year statute of limitations had run. In their motion to dismiss, defendants have not challenged the remaining 33 transactions identified in the Amended Complaint.

-2- Tyco securities in violation of Section 16(b). With respect to

Kozlowski’s transactions 3-5 and 1 2 , and Swartz’s transaction 5 ,

Tyco alleges that on October 1 0 , 2000, and again on November 1 3 ,

2001, defendants filed a Form 4 2 with the Securities and Exchange

Commission (“SEC”), improperly claiming that the transactions

were exempt under Rule 16b-3.3 Amended Complaint (“Am. Compl.”)

¶¶ 1 7 , 2 2 , 2 7 , 5 1 , 106. Tyco further alleges that by erroneously

claiming that the transactions were exempt, defendants concealed

that the short-swing profits resulting from the transactions were

subject to disgorgement. Id. ¶¶ 1 8 , 2 3 , 2 8 , 5 3 , 107. Tyco thus

contends that because the transactions were never properly

reported on a Form 4 filing, the statute of limitations under

Section 16(b) should be equitably tolled until September 2002,

when it first discovered defendants’ false exemption claims. Id.

¶¶ 1 9 , 2 4 , 2 9 , 5 4 , 108.

2 A Form 4 is the document insiders must file with the SEC to disclose short-swing profits. See 17 C.F.R. § 240.16a-3(a) & ( g ) . A Form 4 must be filed within ten days after the close of the calendar month in which the transaction occurred. 15 U.S.C. § 78p(a). 3 Rule 16b-3 requires that the terms of each disposition of a security must be approved in advance by the issuer’s shareholders, its board of directors, or a committee that is comprised solely of two or more Non-Employee Directors. 17 C.F.R. § 240.16b-3(d)(1).

-3- Similarly, with respect to Kozlowski’s transactions 6-11,

and Swartz’s transactions 6 and 7 , Tyco alleges that defendants

“did not properly disclose the entire transaction in a Form 4

they filed with the SEC on October 1 0 , 2000.” Am. Compl. ¶¶ 3 3 ,

3 6 , 3 9 , 4 2 , 4 5 , 4 8 , 1 1 2 , 115. Tyco charges that these

transactions were not properly disclosed until defendants filed a

subsequent Form 4 with the SEC on November 1 3 , 2001, nearly

thirteen months later. Id. According to Tyco, the statute of

limitations should be equitably tolled as to these transactions

until at least November 1 3 , 2001, when defendants filed the

completed Form 4 . Id.

Finally, with respect to Kozlowski’s transactions 13 and 1 4 ,

and Swartz’s transactions 8 and 9, Tyco alleges that defendants

never reported these transactions on a Form 4 filed with the SEC,

and only disclosed them on a Form 5 filed on November 1 3 , 2001.

Am. Compl. ¶¶ 5 6 , 6 1 , 1 1 8 , 123. In addition, Tyco alleges that

defendants again erroneously claimed that the transactions were

exempt under Rule 16b-3. Id. at ¶¶ 5 6 , 6 1 , 1 1 8 , 123. Tyco thus

maintains that the statute of limitations for these transactions

should be tolled until September 2002, when it first discovered

-4- defendants’ false exemption claims for these transactions. Id.

at ¶¶ 5 8 , 6 3 , 1 2 0 , 125.

II. STANDARD OF REVIEW

In evaluating a motion to dismiss under Fed. R. Civ. P.

12(b)(6), the court must accept as true all well-pleaded factual

allegations in the complaint and construe all reasonable

inferences in favor of the plaintiff. Beddall v . State S t . Bank

& Trust Co., 137 F.3d 1 2 , 16 (1st Cir. 1998). A complaint should

not be dismissed under Rule 12(b)(6) unless “it is clear that no

relief could be granted under any set of facts that could be

proved consistent with the allegations.” Lalonde v . Textron,

Inc., 369 F.3d 1 , 6 (1st Cir. 2004)(quoting Swierkiewicz v .

Sorema N.A., 534 U.S. 506, 514 (2002)). The issue at this

embryonic stage of the litigation, therefore, “is not whether a

plaintiff will ultimately prevail but whether the claimant is

entitled to offer evidence to support the claims.” Scheuer v .

Rhodes, 416 U.S. 2 3 2 , 236 (1974).

In an appropriate case, an affirmative defense, including

the statute of limitations, may be adjudicated on a Rule 12(b)(6)

-5- motion to dismiss. See In re Colonial Mortgage Bankers Corp.,

324 F.3d 1 2 , 16 (1st Cir. 2003). An appropriate case is one in

which two conditions are met. See id. First, “the facts that

establish the defense must be definitively ascertainable from the

allegations of the complaint. . . .” Id.; Blackstone Realty LLC

v . FDIC, 244 F.3d 193, 197 (1st Cir. 2001). Second, “the facts

so gleaned must conclusively establish the affirmative defense.”

In re Colonial Mortgage, 324 F.3d at 16 (emphasis added); see

also Blackstone Realty LLC, 244 F.3d at 197 (noting that review

of the complaint must “leave no doubt” that the plaintiff’s

action is barred by the asserted defense); c f . Cervantes v . City

of San Diego, 5 F.3d 1273, 1277 (9th Cir. 1993)(finding dismissal

based on statute of limitations defense inappropriate where the

complaint “adequately allege[d] facts showing the potential

applicability of the equitable tolling doctrine”) (emphasis in

original). Because, as I explain below, the second condition has

not been met in this case, adjudication of defendants’ argument

that the Challenged Transactions are barred by the statute of

limitations and are not subject to equitable tolling is

inappropriate at this early stage of the litigation.

-6- III. ANALYSIS

Defendants charge that equitable tolling is unwarranted in

this case because Tyco has failed to comply with Fed. R. Civ. P

9 ( b ) , which they claim requires Tyco to plead with particularity

facts showing that: (1) defendants concealed the basic facts

that would reveal their alleged wrongdoing; (2) Tyco did not have

actual or constructive notice of these facts; and (3) Tyco

exercised reasonable diligence to uncover defendants’ wrongdoing.

See J. Geils Band Employee Benefit Plan v . Smith Barney Shearson,

Inc., 76 F.3d 1245, 1255 (1st Cir. 1996); Salois v . Dime Sav.

Bank of New York, 1996 WL 33370626, at *7 (D. Mass. Nov. 1 3 ,

1996), aff’d, 128 F.3d 20 (1st Cir. 1997). Defendants argue that

because Tyco has failed to satisfy all three of these elements,

equitable tolling is not warranted, and its claims based on the

Challenged Transactions must be dismissed. I disagree.

The first flaw in defendants’ argument is that it is based

on the incorrect assumption that Tyco’s equitable tolling

argument is subject to Rule 9 ( b ) . Several courts have concluded

that plaintiffs need not prove that a defendant’s concealment of

facts in a Form 4 filing was fraudulent in order to toll the

-7- statute of limitations. See Rosen ex rel. Egghead.com, Inc. v .

Brookhaven Capital Mgmt. Co., 179 F. Supp. 2d 3 3 0 , 338 (“a §

16(b) plaintiff need do no more than prove [defendant’s] failure

[to file § 16(a) reports], which ipso facto establishes

defendant’s wrongful concealment preventing plaintiff’s discovery

of the claim”); Blau v . Albert, 157 F. Supp. 816, 819 (D.N.Y.

1957)(noting that the court’s holding in Grossman v . Young is not

limited to fraudulent concealment because “[c]oncealment . . .

whether intentional or inadvertent, effectively prevents suit and

demands the mitigating construction of the statute of

limitations)(emphasis added); Grossman v . Young, 72 F. Supp. 375,

378 (D.N.Y. 1947)(explaining that under Section 16(b) an insider

has an “absolute duty to make prompt and frequent reports of the

activities that may give rise to . . . an action” for short-swing

trading); but see Donoghue v . Am. Skiing Co., 155 F. Supp. 2d 7 0 ,

74-75 (S.D.N.Y. 2001)(holding that Fed. R. Civ. P. 9(b) applies

to equitable tolling of Section 16 claims and requiring that

fraudulent concealment be pled with particularity). Because I

find these cases persuasive, I agree that Tyco’s equitable

tolling argument is not subject to the requirements of Rule 9 ( b ) .

Accordingly, no more than a “short plain and statement” of the

-8- argument is required here. See Fed. R. Civ. P. 8 ( a ) .

Second, reading the Amended Complaint generously, as I must

on a motion to dismiss, I conclude that Tyco has sufficiently

alleged that it lacked adequate notice of defendants’ wrongful

conduct to support an equitable tolling claim. As the Second

Circuit recently explained, because the “prophylaxis of Section

16 works by imposing an ‘absolute duty’ of disclosure” upon

insiders, that “mechanism would be impaired if the tolling

triggered by non-compliance was ended or defeated by mere inquiry

notice.” Litzler v . CC Invs., L.D.C., 362 F.3d 203, 208 (2d Cir.

2004); see also Whittaker v . Whittaker Corp., 639 F.2d 516, 528

(9th Cir. 1981)(explaining that “[o]nly by full compliance with

Section 16(a) can the security holders be charged with adequate

notice of the transaction”)(internal citations omitted). Because

inquiry notice is insufficient to defeat an equitable tolling

claim in this context, Tyco’s allegation that it first learned of

the defendants’ improper short-swing profits in September 2002 is

sufficient to support its equitable tolling argument.

Defendants respond by arguing that Tyco cannot claim

equitable tolling because defendants filed Form 4s for each of

-9- the challenged transactions. In support of this proposition,

defendants cite to Tristar Corp. v . Freitas, 84 F.3d 550 (2d Cir.

1996). In Tristar, the Second Circuit indicated that where the

requirements of Section 16(a) are met, a plaintiff is able to

“determine easily and quickly whether any statutory insider has

profited from a short-swing transaction.” Id. at 553.

Defendants also cite to Donoghue, in which the court concluded

that because the Form 4 filed with the SEC in that case set forth

the relevant names, dates of the transactions, number of shares

bought and sold, and the price per share, plaintiffs had all of

the information they needed to bring a Section 16(b) claim. 155

F. Supp. 2d at 75-76. Defendants thus argue that precedent in

this area suggests that courts have adopted a bright line test

regarding the notice provided by Form 4 and the applicability of

equitable tolling. I reject this argument. Tyco charges that

the Form 4s filed by the defendants were materially incomplete or

incorrect. Whether equitable tolling is warranted under these

circumstances requires further development of the facts and

therefore may best be resolved on summary judgment once discovery

has closed.

-10- IV. CONCLUSION

Because I conclude that the Amended Complaint adequately

alleges facts showing the potential applicability of equitable

tolling, I deny defendants’ motion to dismiss. (Doc. N o . 2 0 4 ) .

SO ORDERED.

Paul Barbadoro United States District Judge

April 2 1 , 2005

c c : Counsel of Record

-11-