Kennedy v. Josephthal & Co., Inc.

• Decision Date: 26 March 1987
• Docket Number: No. 85-1833,85-1833
• Parties: Blue Sky L. Rep. P 72,496, Fed. Sec. L. Rep. P 93,186 Thorburn KENNEDY, Trustee, et al., Plaintiffs, Appellees, v. JOSEPHTHAL & COMPANY, INC., et al., Defendants, Appellees. Edward M. Swartz and Fredric Swartz, Plaintiffs, Appellants.
• Court: U.S. Court of Appeals — First Circuit

Page 798

814 F.2d 798

Blue Sky L. Rep. P 72,496, Fed. Sec. L. Rep. P 93,186

Thorburn KENNEDY, Trustee, et al., Plaintiffs, Appellees, v. JOSEPHTHAL & COMPANY, INC., et al., Defendants, Appellees Edward M. Swartz and Fredric Swartz, Plaintiffs, Appellants.

No. 85-1833.

United States Court of Appeals First Circuit.

Argued Nov. 4, 1986.

Decided March 26, 1987.

Alan L. Cantor with whom Swartz & Swartz, Boston, Mass., was on brief for plaintiffs, appellants.

Alan I. Raylesberg with whom Barry Michael Okun, Rosenman Colin Freund Lewis & Cohen, New York City, and Gerald H. Abrams, Newton, Mass., were on brief for defendant, appellee Josephthal & Co., Inc.

Before CAMPBELL, Chief Judge, TORRUELLA, Circuit Judge, and PIERAS, ^* District Judge.

PIERAS, District Judge.

We review here the grant of a summary judgment and other dispositive motions, by the United States District Court for the District of Massachusetts, in favor of defendant, Josephthal & Co. The plaintiffs, Thorburn Kennedy, as Trustee of the Thorburn Kennedy Revocable Trust, Edward Swartz, and Frederic Swartz, originally brought claims against defendant in December 1981, based on the sale of shares of a limited partnership called NRG Coal Associates 1979-II (NRG). The purpose of the partnership was to profit by the mining and selling of coal. Apparently, no coal was mined or sold. Plaintiffs sought damages from their broker, who facilitated the purchase of the limited partnership shares.

The district court held, in various memorandum opinions, that (1) plaintiffs' claim under section 12(2) of the Securities Act of 1933 was time barred; (2) plaintiffs' claims of fraud under section 10(b) of the Securities Exchange Act of 1934, section 410 of the Massachusetts Securities Act, and the common law must be dismissed because, as a matter of law, plaintiffs could not have justifiably relied on the oral representations of the defendant that were at variance with the private offering memorandum elucidating the investment; (3) defendants did not offer an unregistered security in violation of section 301 of the Massachusetts Securities Act; and (4) leave would not be granted to plaintiffs to file a second amended complaint. ¹ Plaintiffs Edward and Fredric Swartz appeal each of these rulings. For the reasons set forth, we affirm the district court in all respects.

I.

In late 1979, the appellants invested $20,000.00 in cash and signed promissory notes for $180,000.00 to acquire two-and-one-half units in NRG. Although they had dealt for some time with one Josephthal broker on other financial matters, appellants' transactions on this occasion were through another Josephthal employee, Neal Sinclair. As placement agent for the investment, Josephthal provided appellants with a Confidential Offering Memorandum issued by Josephthal and the general partner of NRG. This memorandum contained information in a form common to other investment prospectuses.

In this offering memorandum and appellants' talks with Sinclair lie the heart of appellants' claims of fraudulent misrepresentation and omission. The Confidential Offering Memorandum is replete with warnings. First, it states that only the general partner of NRG is authorized to give any information concerning the partnership and its proposed operations; that any information not contained in the memorandum nor given by the general partner must not be relied upon. It continues with a warning that the offering involves a high degree of risk. The specific risk factors are also set out, preceded by this legend:

Risk Factors

Investment in the partnership involves a high degree of risk. Therefore, it is suitable only for those persons having a continuing high amount of annual income and a substantial net worth who can afford to bear such risks and have no need for liquidity from their investments. Each prospective investor should consider carefully the risk factors attendant to the purchase of units, including, but not limited to, those discussed below, and should consult his own legal, tax and financial advisors with respect thereto.

The numerous and detailed risks cited in the offering memorandum include that such mining operations would be unprofitable at the prevailing price of coal even if the operation fully developed the field; that there was no assurance that the coal was economically recoverable; that the partnership expected to cease operation if coal could not be mined profitably; that similar ventures had been unprofitable because of the prevailing price of coal; that investors could be liable for additional working capital or payment of principal and interest on debt if NRG were unable to maintain operations; that the mining contractor had no employees, no assets, and no operating history; that there were no short- or long-term commitments by anyone to purchase the coal mined by NRG; and that the general partner of NRG was a general partner of an adjacent and competing coal tract.

The warnings, designed to protect the offeror, revealed that NRG would, in all likelihood, utterly fail as a viable coal mining operation. Appellants nevertheless executed documents stating that they had read the offering memorandum, appreciated the risks involved, and could afford to lose their investment. In putting their money down, appellants claimed to have relied on the following statements made by Sinclair: (1) that contracts for the sale of coal by the partnership were "in the mill" or words to that effect; (2) that the partnership was ready to start producing coal; (3) that this was a "safe investment with a lot of protection" or words to that effect; (4) that the partnership would be profitable even at the then existing price of coal; (5) that defendant Josephthal had fully investigated the proposed venture and determined it to be bona fide; (6) that NRG had an excellent track record and the investors in their limited partnership programs had never experienced a call on their letters of credit; and (7) that defendant Josephthal would monitor the progress of the venture on behalf of the investors.

While not impossible, it somewhat strains credulity for appellants to claim that they made this investment for the purpose of profiting by the mining and selling of coal. Appellants were informed in the offering memorandum that there was no coal operation in place to make a return on their investment. In today's investment world, however, "performance" may not necessarily mean an increase in value due to beating the competition in the normal course of the production of goods and services. Pure speculation in commodities, including the means of producing those commodities, may prove more enticing than the more mundane role of actually owning part of a coal mine. Tax shelters, too, are sometimes more useful to investors than another real investment. These considerations may have been behind appellants' gamble but we need not consider them. ² Appellants claim, and we base our decision on the allegation that they wished to purchase an interest in a coal mining operation and that the misrepresentations and omissions of appellee falsely made that investment seem attractive.

The investment apparently now lost, appellants filed suit in the Massachusetts Commonwealth courts on December 28, 1981. The suit was subsequently removed to federal district court, where the complaint was dismissed for the reasons cited supra. We review these seriatim.

II. Statute of Limitations on Section 12(2) of the Securities Act of 1933

Appellants contend that appellee's misrepresentations and omissions violated section 12(2) of the Securities Act of 1933, 15 U.S.C. Sec. 77l (2). Section 13 of the 1933 Act provides a clear statute of limitations for section 12(2): "within one year after the discovery of the untrue statement or omission, or after such discovery should have been made by the exercise of reasonable diligence." 15 U.S.C. Sec. 77m. If appellants are to escape the limitation on this action, they must show that the statute was tolled between the sale of the partnership units in December 1979 and at least December 28, 1980, one year before the suit was filed.

Fraudulent concealment tolls the statute of limitations

where the party injured by the fraud remains in ignorance of it without any fault or want of diligence or care on his part ... until the fraud is discovered, though there be no special circumstances or efforts on the part of the party committing the fraud to conceal it from the knowledge of the other party.

Bailey v. Glover, 88 U.S. (21 Wall.) 342, 348, 22 L.Ed. 636 (1875) (footnote omitted). The statute will be tolled even without affirmative acts on the part of the defendant unless the plaintiff, through reasonable diligence, discovered or should have discovered the fraud. Cook v. Avien, Inc., 573 F.2d 685, 695 (1st Cir.1978). Appellants claim that appellee's fraudulent concealment so tolled the statute, in that appellants could not have discovered the fraud because of appellee's continuing fraudulent misrepresentations and omissions.

Appellants need not, however, have fully discovered the nature and extent of the fraud before they were on notice that something may have been amiss. Inquiry notice is triggered by evidence of the possibility of fraud, not full exposition of the scam itself. Sleeper v. Kidder, Peabody & Co., 480 F.Supp. 1264, 1267 (D.Mass.1979), aff'd, 627 F.2d 1088 (1st Cir.1980); see also Cook, 573 F.2d at 696; Klein v. Bower, 421 F.2d 338, 343 (2d Cir.1970). This circuit has characterized the facts that trigger inquiry notice as "sufficient storm warnings to alert a reasonable person to the possibility that there were either misleading statements or significant omissions involved in the sale." Cook, 573 F.2d at 697.

We are faced here with the great glowering clouds of the offering memorandum and the quite different forecast of Sinclair. For example, the offering memorandum, after warning that only the general...