Cahill v. Ernst & Ernst

• Decision Date: 14 March 1978
• Docket Number: No. 77-C-294.,77-C-294.
• Citation: 448 F. Supp. 84
• Parties: John D. CAHILL, Plaintiff, v. ERNST & ERNST, Defendant.
• Court: U.S. District Court — Eastern District of Wisconsin

448 F. Supp. 84

John D. CAHILL, Plaintiff, v. ERNST & ERNST, Defendant.

No. 77-C-294.

United States District Court, E. D. Wisconsin.

March 14, 1978.

John C. Carlson, Lawton & Cates, Madison, Wis., for plaintiff.

William H. Alverson, Godfrey & Kahn, Milwaukee, Wis., for defendant.

MEMORANDUM AND ORDER

WARREN, District Judge.

The defendant in the above-entitled action has moved to dismiss Count I of this action on several grounds as set forth in its memorandum. The initial basis for the motion is that Count I of the complaint is barred by the applicable statute of limitations.

At a status conference held in this matter on November 17, 1977, the Court issued a memorandum and order in the related case of Colonial Bank and Trust Co. v. American Bankshares Corp., 442 F.Supp. 234 (E.D.Wis.1977). That decision held that Wis.Stats. § 551.59(5) was the statute of limitations applicable to a § 10b-5 action arising in this state. The above decision is incorporated herein. The Court also informed the plaintiff that it would take judicial notice of the pleadings filed in the case of Colonial Bank and Trust Co. v. American Bankshares, Civil Action No. 75-C-638, hereinafter referred to as Case No. 75-C-638 a case also pending before this Court. The effect of taking judicial notice of this matter was to convert the instant motion to one for summary judgment. See Grand Opera Co. v. Twentieth Century-Fox Film Corp., 235 F.2d 303, 307 (7th Cir. 1956). The plaintiff was, therefore, granted an additional thirty days to respond to the motion.

Section 551.59(5) of the Wisconsin Statutes provides that:

No action shall be maintained under this section unless commenced before the expiration of 3 years after the act or transaction constituting the violation or the expiration of one year after the discovery of the facts constituting the violation, whichever first expires . . ..

The act or transaction constituting the violation in question occurred on May 16, 1974, exactly three years prior to the filing of the complaint. There is no contention that the first part of § 551.59(5) bars this action. The defendant contends, however, that the plaintiff in this action discovered the facts constituting the violation prior to May 17, 1976, and since this action was not commenced until May 17, 1977, it is barred. Specifically, the defendant contends that the discovery of the fraud occurred when the plaintiff appeared in Case No. 75-C-638 by answering the complaint therein on January 22, 1976.

On November 3, 1975, Colonial Bank and Trust Company commenced an action against American Bankshares Corporation and several others, including both the plaintiff and the defendant herein. Plaintiff appeared therein by answering the complaint on January 22, 1976. The complaint in No. 75-C-638 refers to alleged misrepresentations and failures to state material facts in American Bankshares Corporation's financial statements for the year 1973; and alleges that plaintiff there was induced to make loans aggregating $3,000,000 on May 17, 1974 in reliance thereon. Paragraph 9 of that complaint alleges that, among other things, Ernst & Ernst represented to Colonial that with the addition of $3,000,000 in capital, American City Bank would be in sound financial condition; that a charge of $3,000,000 to American City's loan loss reserve was sufficient to cover all losses on loans which could be anticipated; that in all other respects American City's loan portfolio was in sound condition; and that the addition of $3,000,000 to American City's capital was all that would be required to satisfy the requirements of the Comptroller and of sound banking practices.

Paragraph 11 of that complaint alleges, among other things, that Ernst & Ernst was charged with knowledge of, but failed to disclose to Colonial, the inadequacy of City Bank's loan loss reserve; an unreported loss of $900,000 from the purchase and sale of bonds; and that the book value of Bankshares' common stock was at most nominal.

The case at bar was commenced on or about May 17, 1977. The basic premise of the complaint in the case at bar is essentially identical to that of Case No. 75-C-638; namely, that plaintiff Cahill purchased Bankshares' stock on May 17, 1974, and borrowed money from the Colonial Bank to finance such purchase, in reliance on Bank-shares' financial statements for the year 1973. Paragraph 9 of the instant complaint recites that defendant represented to plaintiff that with the addition of $3,000,000 in new capital, American City would be in sound financial condition; that the charge of $3,000,000 to American City's loan loss reserve was sufficient to cover all losses on loans which could be anticipated; that in all other respects American City's loan portfolio was in sound condition; and that the addition of $3,000,000 to American City's capital was all that would be required to satisfy the requirements of the Comptroller and of sound banking practices.

Paragraph 10 of the instant complaint alleges that defendant failed to disclose to plaintiff that American City's loan loss reserve was grossly inadequate and was understated by millions of dollars; that American City had suffered an unreported loss of $900,000 in connection with its bond trading; and that the book value of Bankshares was, on May 17, 1974, at most nominal.

The plaintiff contends that his receipt of the complaint in Case No. 75-C-638 does not constitute a "discovery of the facts constituting the violation." Two arguments are advanced: First, that Colonial's knowledge cannot be imputed to him and, second, that there was nothing in the complaint to put him on notice that the defendant was guilty of anything more than poor judgment or perhaps negligence.

In order to decide whether the receipt of the complaint in Case No. 75-C-638 constitutes "discovery of the facts constituting the violation," the Court must examine § 551.59(5) to determine what is meant by "discovery." Before doing so, however, the Court would like to address itself to an argument raised by the defendants.

The defendants state at page 7 of their reply brief of January 18, 1978 that "while state law supplies the appropriate limitations period for a Rule 10b-5 action, it is a federal question when the statutory period begins to run." While the Court would agree with the defendant's statement of the law, it finds that it has no applicability to this case.

The statement from the defendant's brief is the embodiment of the equitable doctrine of fraudulent concealment first announced by the Supreme Court in Bailey v. Glover, 88 U.S. 342, 21 Wall. 342, 22 L.Ed. 636 (1874), and explained by the Seventh Circuit in Hupp v. Gray, 500 F.2d 993 (1974). That doctrine tolls the running of the state statute of limitations applied to federal actions until such time as the defrauded plaintiff knows or should have known of the fraud. "The doctrine developed to prevent wrongdoers from concealing their actions and then perpetrating a further fraud by using the statute of limitations as a shield." Morgan v. Koch, 419 F.2d 993 (7th Cir. 1969).

The equitable doctrine of fraudulent concealment is applicable only in those cases where the application of the state statute would otherwise bar the action. Its use operates to extend the point at which the limitation period begins from that as set out in the state statute to a point where the plaintiff learned of the fraud or should have learned of it. The federal doctrine has been utilized in those cases where the state statute starts the running of the limitation period at the point of the violation, regardless of the plaintiff's knowledge. If the state statute provides that the limitation period begins to run when the plaintiff has knowledge of the fraud or should have had knowledge of it, the federal doctrine simply has no applicability.

Similarly, the doctrine only operates to extend the period. A statute which limits a fraud action to six years from the violation or two years from the time the fraud is, or with reasonable diligence, could have been discovered, whichever is longer, is not shortened by the doctrine of fraudulent concealment. The action can be brought during the sixth year, even though it was discovered in the first.

The Wisconsin statute applicable to this case provides that the action must be commenced within three years of the violation or within 1 year of discovery, whichever is shorter. The plaintiff has met the longer limitations period and has no need of invoking the tolling doctrine. The shorter one-year provision begins running upon "discovery." Since the doctrine does not operate to shorten the period by starting the limitations period prior to when the state statute would commence its running and itself is defined in terms of discovery, it has no applicability to this shorter one-year limitation.

If this action is barred, it is barred by operation of the Wisconsin statute that provides that the action must be brought within one year of the discovery of the...