Mosesian v. Peat, Marwick, Mitchell & Co.

• Decision Date: 07 March 1984
• Docket Number: Nos. 83-5638,83-5639,s. 83-5638
• Citation: 727 F.2d 873
• Parties: Fed. Sec. L. Rep. P 99,707 Peter MOSESIAN, Plaintiff-Appellant, v. PEAT, MARWICK, MITCHELL & CO., et al., Defendants-Appellees, Charles L. FLETCHER and Milton Fredman, as Co-Trustees of Royal Inns of America, Inc., a California corporation, et al., Plaintiffs-Appellants, v. PEAT, MARWICK, MITCHELL & CO., a partnership, and Earl Gagosian, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 873

727 F.2d 873

Fed. Sec. L. Rep. P 99,707

Peter MOSESIAN, Plaintiff-Appellant, v. PEAT, MARWICK, MITCHELL & CO., et al., Defendants-Appellees, Charles L. FLETCHER and Milton Fredman, as Co-Trustees of

Royal Inns of America, Inc., a California

corporation, et al., Plaintiffs-Appellants, v. PEAT, MARWICK, MITCHELL & CO., a partnership, and Earl

Gagosian, Defendants-Appellees.

Nos. 83-5638, 83-5639.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Nov. 7, 1983.

Decided March 7, 1984.

Melvyn I. Weiss, New York City, William S. Dato, David J. Yardley, Milberg, Weiss, Bershad, Specthrie & Lerach, San Diego, Cal., for plaintiffs-appellants.

Victor M. Earle, III, Peat, Marwick, Mitchell & Co., New York City, for defendants-appellees.

Appeal from the United States District Court for the Southern District of California.

Before CHOY and ANDERSON, Circuit Judges, and SOLOMON, ^* District Judge.

SOLOMON, Senior District Judge:

These appeals present the issue of when the statutes of limitations began to run in these securities fraud cases.

Peter Mosesian, appellant, on behalf of himself and the other stockholders of Royal Inns of America, Inc. (Royal Inns), filed an action against the company's auditor Peat, Marwick, Mitchell & Co. (Peat Marwick). He alleged that Peat Marwick, in violation of its duty as a certified public accountant, issued false and misleading reports on the financial condition of Royal Inns and affiliated companies. He further alleged that on the basis of these reports, he and other stockholders purchased or held Royal Inns stock and lost money.

Charles L. Fletcher and Milton Fredman, co-trustees in the bankruptcy of Royal Inns, filed an action on behalf of the bankruptcy estate against Peat Marwick on many grounds. They seek to recover the fees Royal Inns paid Peat Marwick to audit its books and the overpayments of income taxes resulting from Peat Marwick's improper accounting methods.

Peat Marwick denied these allegations and raised a number of affirmative defenses including the statute of limitations. The court segregated the statute of limitations defense and granted appellants a jury trial on that issue. The jury in the class action case rejected the statute of limitations defense and found that the class action was timely filed. The court entered judgment for Peat Marwick notwithstanding the verdict.

On the trustees' case, the court, on its own motion at the conclusion of the evidence, directed a verdict in favor of Peat Marwick.

Mosesian and the trustees appeal.

Facts

Royal Inns was a public corporation with about 8,000 shareholders. It was founded in 1965 by Earl Gagosian with the idea of having the corporation enter into a number of limited partnerships with investors to build and operate motor hotels. It later expanded, and through subsidiaries, followed the same format to build and operate restaurants (Jolly Kings) and lounges (Lost Knights) in or near Royal Inns hotels. By 1973, there were sixty-nine Royal Inns hotels, fifty-two Jolly Kings restaurants and forty-five Lost Knights cocktail lounges.

In 1967, Royal Inns hired Peat Marwick as its auditor. To deal with Royal Inns' form of enterprise, Peat Marwick used two accounting procedures which are the basis of both of these actions.

First, Royal Inns listed as income "advances to" and "investments in" its joint ventures and limited partnerships. Royal Inns reported these items, so-called "receivables," at full value until 1972, when it established a huge reserve for bad debts. Plaintiffs alleged that a larger bad debt reserve should have been established before 1972.

Second, Royal Inns reported as income a construction fee, known as "development and construction profit" (DCP), which was equal to part of the capital investment of the other partners to its joint ventures. This concept allowed Royal Inns to recognize income on its construction projects although construction costs exceeded capital investment plus mortgage financing.

Royal Inns suffered losses from the operation of its hotels, restaurants and lounges, but its financial statements showed more than $7 million in DCP income over a period of several years. As long as it continued to expand and build new projects, Royal Inns could continue to claim DCP income on its books which exceeded operating losses and thereby show a net profit. Actually, however, new projects entailed increased operating losses. ¹ When expansion slowed and there was less DCP to offset the operating losses, the financial statements began to show Royal Inns in a serious financial condition.

In 1975, Royal Inns filed a petition for reorganization under Chapter X of the old Bankruptcy Act. ² The bankruptcy trustees investigated the collapse of Royal Inns and on December 22, 1976 submitted a detailed report that identified questionable accounting practices used by Peat Marwick and attributed in part the company's problems to those practices. Shortly after the report was made public, Peter Mosesian filed an action against Peat Marwick and others ³ on behalf of himself and the other Royal Inns shareholders. Mosesian alleged violations of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) and of Rule 10b-5, 17 C.F.R. Sec. 240.10b-5. He also alleged common law fraud and breach of fiduciary duty.

The bankruptcy trustees brought a separate action on behalf of Royal Inns against Peat Marwick and Earl Gagosian. The trustees alleged conspiracy, breach of fiduciary duty, fraud, negligence, breach of contract, and a violation of former California Corporation Code Sec. 3018. They sought to recover the fees Royal Inns paid Peat Marwick to audit its books, and also the income tax Royal Inns paid on DCP because they contend that DCP should not have been reported as income.

Because the events which form the basis of both actions occurred more than three years before the actions were filed, Peat Marwick raised a statute of limitations defense in each action. In the class action, Mosesian asserts that the three-year statute did not begin to run until the wrongdoing was discovered or until a reasonably prudent investor would have discovered it. Mosesian asserts that a reasonably prudent investor would not have been alerted or would not have discovered the wrongdoing until the trustees' report was made public just a few months before he filed the action. The district court bifurcated the trial and limited the first phase to the issue of when a reasonably prudent investor would have discovered the alleged wrongdoing. The jury ⁴ found that the action was timely filed, but the district court granted Peat Marwick's motion for a judgment notwithstanding the verdict. Mosesian appeals.

The trustees in their action sought to avoid the statute of limitations defense. They assert that Earl Gagosian, the founder and president of Royal Inns, was involved in the fraudulent scheme, and that he dominated Royal Inns to such an extent that the company was incapable of bringing this action earlier. At the conclusion of the evidence, the district court on its own motion directed a verdict against the trustees. The trustees appeal.

Discussion

I. The Class Action

Congress did not provide a statute of limitations for private actions brought under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The federal courts therefore borrow the forum state's statute of limitations for fraud actions. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 210 n. 29, 96 S.Ct. 1375, 1389 n. 29, 47 L.Ed.2d 668 (1976); Hilton v. Mumaw, 522 F.2d 588, 601 (9th Cir.1975). The California three-year limit applies here. Cal.Code Civ.P. Sec. 338(4); United California Bank v. Salik, 481 F.2d 1012 (9th Cir.), cert. denied, 414 U.S. 1004, 94 S.Ct. 361, 38 L.Ed.2d 240 (1973). ⁵ State law determines the length of the limitations period; federal law determines when the period begins to run, Admiralty Fund v. Hugh Johnson & Co., 677 F.2d 1301, 1309 (9th Cir.1982), which in this action is the date plaintiff discovered the fraud or could have done so in the exercise of reasonable diligence, id.; Hilton v. Mumaw, 522 F.2d at 602.

Mosesian filed the class action complaint in January, 1977. The action is time-barred if Mosesian discovered or should have discovered the alleged wrongdoing before January, 1974. The question of when it was or should have been discovered is a question of fact. Admiralty Fund v. Hugh Johnson & Co., 677 F.2d at 1309; Robuck v. Dean Witter & Co., Inc., 649 F.2d 641, 644 (9th Cir.1980); Hilton v. Mumaw, 522 F.2d at 602. It may be decided as a matter of law only when "uncontroverted evidence irrefutably demonstrates plaintiff discovered or should have discovered the fraudulent conduct." Kramas v. Security Gas & Oil Inc., 672 F.2d 766, 770 (9th Cir.), cert. denied, --- U.S. ----, 103 S.Ct. 444, 74 L.Ed.2d 600 (1982).

The standard is no less exacting, and is probably more exacting, when a court sets aside a jury verdict. A judgment notwithstanding the verdict is appropriate when "the evidence permits only one reasonable conclusion as to the verdict." Flores v. Pierce, 617 F.2d 1386, 1389 (9th Cir.1980) (quoting Kay v. Cessna Aircraft Co., 548 F.2d 1370, 1372 (9th Cir.1977)). Neither the district court nor this court may weigh the evidence or order a result it finds more reasonable if substantial evidence supports the jury verdict. William Inglis & Sons Baking Co. v. ITT Continental Baking Company, Inc., 668 F.2d 1014, 1026 (9th Cir.1981), cert. denied, --- U.S. ----, 103 S.Ct. 57, 74 L.Ed.2d 61 (1982).

Peat Marwick asserted that DCP was a generally accepted accounting practice at the time it prepared these statements, and it denies any wrongdoing. Nevertheless, it identifies seven "red flag" events which occurred in 1972 and 1973 and which it contends are sufficient as a matter of law to alert a reasonably prudent investor of wrongdoing on the part of Peat Marwick.

1. Sudden...