In Re Chaus Securities Litigation
MEMORANDUM OPINION AND ORDER
Plaintiffs Lisa A. Phifer, I. Bibicoff Inc. Pension Trust Fund, Gerald S. Susman and Diana Goldshlack bring this action alleging violations of §§ 11 and 12(2) of the Securities Act of 1933 (the “1933 Act”), as amended,
BACKGROUND
This action is the consolidation of four separate actions brought between December 7, 1988 and January 13, 1989. The original complaint (the “1988 Complaint”) charged the Chaus Defendants and Lead Underwriters with violations of §§ 11 and 12(2) of the Securities Act of 1933 (Count I), § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder (Count II) and supplemental state law claims for negligence and negligent misrepresentation (Count III).
In this Court’s prior opinion,
In re Chaus Sec. Litig.,
[Current] Fed.Sec.L.Rep. (CCH) ¶ 95,646 at 97,888,
The Amended Complaint was subsequently filed on December 18, 1990. It alleges that due to misrepresentations and omissions by the Chaus Defendants and Lead Underwriters, plaintiffs were induced to purchase stock in BCI, a corporation engaged in the design, manufacture and marketing of women’s clothing. Specifically, plaintiffs claim that the Chaus Defendants and Lead Underwriters misrepresented BCI as experiencing a dramatic growth in profitability during the period immediately before the IPO by allowing its customers excessive credits for mark-down merchandise, chargebacks and sales discounts, Amended Complaint at ¶ 27, reporting accounts receivables from its customers based on “gross sale prices” without adjusting downward for advance markdown money, id. at ¶ 28, delaying gross sales attributable to fiscal 1985 to fiscal 1986, id. at ¶ 27, and allocating more advertising expense as a percentage of gross sales to fiscal 1985 than 1986. Id. The effect of these manipulations, according to plaintiffs, was to overstate BCI’s true income and assets. Id. at 11 28.
Plaintiffs further allege that the Chaus Defendants engaged in illegal and discriminatory price rebates to BCI’s customers, id. at ¶ 31, that BCI never built any significant management infrastructure, controls or systems, id. at ¶ 32, and that BCI failed to perform marketing evaluations, id. at H 33, relying instead on the personal instinct and tastes of Bernard and Josephine Chaus. Id. at ¶ 41. The Prospectus allegedly failed to disclose that BCI had “recklessly” added new product lines without employing experienced personnel, and that its management did not have good insight into the market. Id. at 1140. Plaintiffs contend that the Chaus Defendants and Lead Underwriters concealed BCI’s lax and inadequate financial and accounting controls, id. at 1143, and failed to disclose the extent to which BCI’s quota problems hindered importation of their foreign manufactured goods. Id. at 11 42.
Plaintiffs also allege that the Chaus Defendants and Lead Underwriters artificially created demand
for
BCI stocks in order to attract investors by conducting informational meetings, where negative aspects of BCI were minimized and unjustified analogies were made with Liz Claiborne, another successful women’s apparel company.
Id.
at 1136. As a result, the IPO was expanded from 6.0 million to 6.9 million shares of
Lastly, plaintiffs contend that several passages in the 1986 and 1987 Annual Reports were false and misleading when made because defendants knew or recklessly disregarded price manipulations, lack of adequate financial and accounting controls and the reduction of H.R. Macy & Company’s patronage. Plaintiffs allege, however, that because of defendants’ misrepresentations, they were not on notice of defendants’ fraud until September 23, 1988, when BCI reported a $10.9 million loss, id. at 111157-58, and October 18, 1988, when BCI issued an annual report disclosing a pre-tax loss of $21 million. Id. at ¶ 50.
DISCUSSION
1. Relation Back of the Amended Complaint
As a preliminary matter, the Court must determine whether the Amended Complaint should relate back to the date of the 1988 Complaint for statute of limitations purposes. The Chaus Defendants argue that plaintiffs’ claims should not relate back for two reasons: first, since service of process of the 1988 Complaint on Bernard and Josephine Chaus was faulty, the Amended Complaint is actually plaintiffs’ first complaint for statute of limitations purposes; 2 second, the Amended Complaint raises new factual allegations of fraudulent manipulation of accounts receivable that do not arise out of the same transactions or occurrences as do those pled in the 1988 Complaint.
A. Relation Back Under Rule 40)
If service of the summons and complaint is not made upon a defendant within 120 days after the filing of the complaint and the party on whose behalf such service was required cannot show good cause why such service was not made within that period, the action shall be dismissed as to that defendant without prejudice upon the court’s own initiative with notice to such party or upon motion.
The Chaus Defendants contend that plaintiffs’ failure to serve either of the Chauses with the summons and complaint within the 120-day time frame contemplated by
Plaintiffs contend that service of process was duly made by serving copies of the summons and complaint on the Chaus’s then attorneys and, on an occasion several months hence, by leaving copies of the process with a manager at BCI’s New York offices. Plaintiffs argue, however, that in the event the Court were to find service ineffective, application of
With respect to service of process of the 1988 Complaint on the Chauses, the record is clear that such service was patently defective, the Chauses were never served with the summons and 1988 Complaint and plaintiffs have failed to establish good cause for failing to do so. The undated certificate of service of Richard Kil-sheimer, Esq. (annexed as Exhibit “K” to
In addition, the purported affidavit of service of Peter A. Kabcenell (annexed as Exhibit “L” to the Greenfield Affidavit), stating that process was served on the Chauses “by delivering true copies thereof to Joanne Trezzam Manager of Administration, at 1410 Broadway, New York, New York,” is unsigned and unsworn and therefore of no probative evidentiary value. Even had Kabcenell’s affidavit been sworn, it fails to aver that copies of the process were subsequently mailed as is required under C.P.L.R. § 308 where substituted service upon a person of suitable age and discretion is attempted. Thus the affidavit, even had it been duly sworn, is facially defective as to service on the Chauses.
Finally, the Court finds that plaintiffs have failed to show good cause why service was not made within the time proscribed by rule 4(j). Significantly, plaintiffs do not seek to establish good cause for failing to properly serve the summons and 1988 Complaint in accordance with
Having determined that the 1988 Complaint was never served on the Chaus-es, the Court must decide whether the Amended Complaint should relate back to the filing of the 1988 Complaint in order to fix a date upon which the Court will deem process to have been served. In a case closely analogous to the case at bar, the United States District Court for the Northern District of Illinois observed as follows:
Finally, Fujitsu, Ltd. has also waived its objection to the sufficiency of service of process based onRule 4(j) .... It is true that on its own initiative the Court could have dismissed the action as to Fujitsu, Ltd. without prejudice. We did in fact dismiss the action as to Fujitsu, Ltd. on December 21, 1984, though on other grounds. The effect of that dismissal is the same as a dismissal under 4(j), without prejudice. We did grant leave for [the third-party plaintiff] to attempt to serve Fujitsu again, if not barred by the statute of limitations or other law. That is essentially the effect of a 4(j) dismissal without prejudice. In neither casewould the date of service relate back to the original date the ... complaint was filed, rather it would run from the date the process was actually served, after the dismissal.
Zisman v. Seiger,
The Court finds that under the reasoning of
Zisman,
the Amended Complaint should not relate back to the filing of the 1988 Complaint and should be deemed filed on December 18, 1990. Since the claims against the Chauses do not relate back, they are time-barred under the applicable statutes of limitations. Plaintiffs’ §§ 11 and 12 claims are time-barred by operation of the one-year/three-year limitation period of Section 13 of the 1933 Act since the Amended Complaint was neither filed nor served until December of 1990, undisputedly more than four years after the IPO and more than two years after plaintiffs, by their own admission, discovered the alleged fraud set forth in the Amended Complaint.
See
Amended Complaint at If 55. Similarly, since the Amended Complaint as against the Chauses was first filed after the Second Circuit’s decision in
Ceres Partners v. GEL Associates,
B. Relation Back Under Rule 15(c) 3
The Chauses also argue that, even assuming that the 1988 Complaint was properly served, the Amended Complaint should not relate back for purposes of Rule 15(c). See generally 6A Wright, Miller & Kane, Federal Practice and Procedure § 1497 (when complaint is dismissed without prejudice, amended pleading which amplifies factual allegations of new pleading or asserts new claims based on earlier factual allegations generally relates back to original pleading). They contend that in this case, because the Amended Complaint, inter alia, involves new allegations of accounts receivable fraud requiring different proof covering different time periods, the Amended Complaint may not relate back and are barred by the applicable statutes of limitations. Specifically, the Chauses contend that
plaintiffs have alleged an entirely different case centering upon defendants’ putative “accounting manipulations” in connection with BCI’s accounts receivable and the supposed illegal and covert agreement to issue customers credits, allowances and markdowns, thereby rendering the accounts receivable, and hence the assets and income, of BCI overstated. {See Amended Complaint at ¶¶ 27-31.) None of the new allegations are related to or arise out of the original fraudulent conduct alleged.
Memorandum of Law of Defendants Bernard Chaus, Inc., Bernard Chaus and Josephine Chaus in Support of Motions to Dismiss Complaint and for Summary Judgment, at 48.
Whenever the claim or defense asserted in the amended pleading arose out of the conduct, transaction or occurrence set forth or attempted to be set forth in the original pleading, the amendment relates back to the date of the original pleading.
Application of these principles to this case indicates that the Amended Complaint should relate back to the original pleading pursuant to
II. Statute of Limitations
A. §§ 11 and 12(2) Claims
Section 13 of the 1933 Act provides as follows:
No action shall be maintained to enforce any liability created under section11 [ 15 U.S.C. § 77k ] orsection 12(2) [15 U.S.C. § 771(2) ] unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created undersection 12(1) [15 U.S.C. § 771(1) ], unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under section 11 [15 U.S.C. § 77k ] orsection 12(1) [15 U.S.C. § 771(1) ] more than three years after the security was bona fide offered to the public, or undersection 12(2) [15 U.S.C. § 771(2) ] more than three years after the sale.
(1) the time and circumstances of the discovery of the fraudulent statement; (2) the reasons why it was not discovered earlier (if more than one year has lapsed); and (3) the diligent efforts which plaintiff undertook in making or seeking such discovery.
Quantum Overseas, N.V. v. Touche Ross & Co.,
In
Chaus I,
this Court dismissed plaintiffs’ Sections 11 and 12(2) claims without prejudice because of failure to plead compliance with the first
Quantum
requirement, holding that, “[w]ithout alleging the ‘time and circumstances’ of her discovery, the plaintiff has failed to plead compliance with the statute of limitations.” [Current] Fed.Sec.L.Rep. (CCH) ¶ 95,646 at 98,000,
distinct averments as to the time when the fraud, mistake, concealment, or misrepresentation was discovered, and what the discovery is, so that the court may clearly see, whether, by the exercise of ordinary diligence, the discovery might not have been made before.
Armstrong v. McAlpin,
1. First Quantum Element: Time and Circumstances
With respect to the first prong, the time and circumstances of the discovery of the fraud, the complaint alleges:
In reliance upon all of the information available to the investing public, plaintiffs undertook no particular efforts in making or seeking to make the discovery of the fraudulent nature of defendants’ statements, nor should they reasonablyhave undertaken any such efforts, until September 23, 1988, when BCI reported its $10.9 million loss.
Plaintiffs were prevented from discovering the false and misleading nature of defendants’ conduct, until September 23, 1988, by defendants’ own reassurances, concealment and coverup in publicly filed documents and statements issued and disseminated to the investing public. After September 23, 1988, plaintiffs consulted with their counsel, who conducted a diligent investigation of the information then available to them, and commenced suit immediately thereafter.
Amended Complaint, at iff 57-58. Although the Amended Complaint alleges that plaintiffs were prevented from discovering the fraud until September 23, 1988, it does not state whether it was discovered on that date or by whom. Nor does the Amended Complaint allege even in conclu-sory terms the circumstances surrounding plaintiffs discovery of the alleged fraud. Although alleging that “BCI reported its $10.9 million loss” on September 23, 1988, the Amended Complaint does not state the significance of this “report,” why it triggered plaintiffs’ “investigation,” or how, why or when plaintiffs came to “discover” the asserted fraud. Rather, it merely alleges that on some undetermined date, plaintiffs consulted with counsel who conducted an “investigation.” Amended Complaint, at if If 57-58.
In addition, there is no allegation describing precisely what information was made available to plaintiffs on September 23, 1988, which led them to conclude that a fraud had been perpetrated. According to the Amended Complaint, the revealing report could not have been BCI’s 1988 Annual Report, since plaintiffs expressly allege that the Report was made available only “on or about October 18, 1988.” Amended Complaint, at 11 50. Plaintiffs also allege that when the Report was published “it became apparent for
the first time
that the Company’s sales would decline to $272 million ... and it would report a pre-tax loss of almost $21 million_ (emphasis added)” Amended Complaint, at 1150. This allegation is inconsistent with that contained in Paragraph 58 (i.e., “discovery” of a reported $10.9 million loss on September 23, 1988), and further clouds the circumstances surrounding plaintiffs’ discovery of the fraud. Accordingly, the Court finds that these allegations do not satisfy the requirements of Section 13 as they do not indicate the time and circumstances surrounding the discovery of the alleged fraud.
See Hill v. Der,
2. Third Quantum Element: Reasonable Diligence
The reasonable diligence standard requires a plaintiff to file suit when the possibility of fraud should have been apparent,
Ingenito v. Bermec Corp.,
Plaintiffs allege in the Amended Complaint that they “took no particular efforts in making or seeking to make discovery” of the alleged fraud, Amended Complaint, at 1157, and thus concede their abject failure to have engaged in any diligent effort to discover the alleged fraud. Such a concession is fatal to plaintiffs’ attempt to plead compliance with the statute of limitations.
See Cohen v. Prudential-Bache Sec., Inc.,
Indeed, although some purchasers of BCI shares might initially have been alerted to possible violations of law as a result of BCI’s press release dated September 17, 1987, in which references were made to BCI’s adverse financial results caused, in part by “provisions for inventory mark-downs and off-price sales,” such press release also stated that “Earnings were also negatively impacted by increased costs related to the start-up of two new divisions, the addition of new warehouses, more showrooms and foreign facilities, as well as increases in production, selling, shipping and administrative personnel.”
1988 Complaint, at ¶ 45. In view of plaintiffs’ own concession that “some purchasers of BCI shares might initially have been alerted to possible violations of law as a result of BCI’s press release dated September 17, 1987,” there is little point in arguing either that plaintiffs here may not reasonably be deemed similarly alerted or that plaintiffs should be absolved from the duty of inquiry which assuredly arose in connection with the September 17 press release.
Accordingly, as plaintiff’s fail to plead facts sufficient to satisfy Section 13 of the 1933 Act,
B. Section 10(b) and Rule 10b-5 Claims
The Chaus Defendants and Lead Underwriters argue that plaintiffs’ Section 10(b) claims are also barred by the applicable statute of limitations. In 1991, the Supreme Court determined that the limitations period applicable to implied private claims under Section 10(b) and Rule 10b-5 is the one-year/three-year structure applicable to most express causes of action under the 1934 Act.
See Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,
— U.S. -,
In
James B. Beam Distilling Co. v. Georgia,
— U.S. -,
On December 19, 1991, however, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991, eliminating the retroactive effect of
Lampf.
Pub.L. No. 102-242, § 476, 105 Stat. 2236 (1991) (to be codified as § 27A of the Securities Exchange Act of 1934,
Plaintiffs commenced this action on December 7, 1988. On June 19, 1991, the Second Circuit’s decision in
Ceres Partners v. Gel Assoc.,
In
Welch v. Cadre Capital,
Examining the first
Chevron
factor, adoption of a uniform federal limitations period changes the practice in this Circuit, which was clear at the time the alleged fraud was discovered, of looking to the law of the forum state for an appropriate statute of limitations for 10b-5 claims.
Welch I,
As for the second Chevron factor, the Court of Appeals in Welch I held that if the rule in question is the new limitations period itself, its retroactive application will always further the new rule: A new, shorter period will end a lawsuit filed beyond the new limits, and a new, longer period will allow a lawsuit otherwise barred. Id. The Court of Appeals indicated, however, that the Supreme Court did not likely contemplate such a mechanical application of the Chevron test, and went on to hold that
[bjecause [all limitations periods] serve primarily individual, rather than institutional, interests and do so by giving potential litigants prior notice of their rights, application of a limitations period not yet in existence at the time the suit was commenced clearly does not further either of the competing interests [of advancing the remedial and deterrent purposes of the particular cause of action and preserving the defendant’s interest in repose].
Welch I,
Here, however, as the Lead Underwriters argue, and the Court agrees, the posture of the case highlights an important, if not the primary, purpose of the
Ceres
opinion warranting retrospective application here.
Chaus
is a putative class action, potentially involving several thousand plaintiffs. If the Court declines to apply
Ceres
retroactively, the Court will have to look to the state of each non-resident class plaintiff to determine whether their claims would be time-barred.
See Ceres,
As a consequence [of referring to state law], if two suits are brought in different states seeking damages for a single act in violation of the federal securities laws, one suit may be barred while the other is not. Indeed, in a single such suit brought in a state whose law requires borrowing of the laws of an out-of-state plaintiff, the claims of some plaintiffs may be time-barred while those of other plaintiffs are not. The ABA Task Force concluded that this disarray serves no public purpose. This uncertainty and lack of uniformity promote forum shopping by plaintiffs and result in wholly unjustified disparities in the rights of parties litigating identical claims in different states. Neither plaintiffs nor defendants can determine their rights with any certainty. Vast amounts of judicial time and attorneys’ fees are wasted. Moreover, managements of publicly held companies, as well as their auditors and attorneys, are frequently unable to assess the impact of possible litigation under rule 10b-5. This deprives investors of information adequate for informed evaluation of such companies’ potential liabilities.
Id. at 355 (citation omitted). Accordingly, as the rationale of Ceres would serve to streamline this action in substantial furtherance of the uniform limitations period’s stated goal, the Court holds that the circumstances and posture of this case favor retrospective application.
As for the third
Chevron
factor, the courts have held that the retroactive application of
Ceres
does not produce substantial inequitable results when the statute of limitations is unchanged by retroactive application.
See, e.g., Hill v. Equitable Trust Co.,
In this case, retroactive application of
Ceres
would not produce inequitable results. If the Court applied
Ceres
retroactively, then the one-year/three-year statute of limitations would apply. If the Court did not apply
Ceres
retroactively, then the Court would look to the pertinent laws of the forum state to determine the appropriate statute of limitations,
see Zola v. Gordon,
Although it is unclear whether failure to affirmatively plead compliance with the limitations period applicable to claims under Section 10(b) may properly result in dismissal under
Once the defendant has raised the statute of limitations defense to a securities fraud claim, it is the plaintiff's burden to demonstrate they have filed their complaint within the limitations period. Such compliance must be apparent from the complaint.
Dolsky v. Johnson,
[Current] Fed.Sec.L.Rep. (CCH) ¶ 95,840, at 99,078,
CONCLUSION
For the reasons set forth in Section I.A.1, the Chaus’s motion, pursuant to
SO ORDERED.
Notes
. Plaintiffs' claims against the Lead Underwriters relate only to these defendants’ activities in connection with the initial public offering (the "IPO"), namely, the Prospectus and information
. In
Chaus I,
this Court declined to address the issue of whether process had been served in accordance with
. Although the preceding analysis under
. While the complaint in
Quantum
was dismissed with prejudice, that dismissal rested on the running of the limitations period, not upon failure to meet the pleading requirements.
See
. New York’s borrowing statute provides:
An action based upon a cause of action accruing without the state cannot be commencedafter the expiration of the time limited by the laws of either the state or the place without the state where the cause of action accrued, except that where the cause of action accrued in favor of a resident of the state the time limited by the laws of the state shall apply.
C.P.L.R. § 202 (McKinney 1972).
. Data Access was decided on April 8, 1988, eight months prior to service of the 1988 Complaint.