Alfaro v. EF Hutton & Co., Inc.

• Decision Date: 01 April 1985
• Docket Number: Civ. A. No. 84-3276.
• Citation: 606 F. Supp. 1100
• Parties: Santiago ALFARO and Araraquara Citrus, Inc., on behalf of themselves and all others similarly situated v. E.F. HUTTON & COMPANY, INC.
• Court: U.S. District Court — Eastern District of Pennsylvania

606 F. Supp. 1100

Santiago ALFARO and Araraquara Citrus, Inc., on behalf of themselves and all others similarly situated v. E.F. HUTTON & COMPANY, INC.

Civ. A. No. 84-3276.

United States District Court, E.D. Pennsylvania.

April 1, 1985.

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Richard D. Greenfield, Carole A. Broderick, David B. Zlotnick, Greenfield, Chimicles & Lewis, Haverford, Pa., for plaintiffs.

William G. Campbell, Lindsey Miller-Lehman, F. Joseph Warin, Kutak, Rock & Campbell, Washington, D.C., Leonard Barrack, Jerry Rodos, Barrack, Rodos & Bacine, Philadelphia, Pa., for defendant.

OPINION

LOUIS H. POLLAK, District Judge.

This action was initiated in July 1984 by Santiago Alfaro and Araraquara Citrus, Inc., a corporation wholly owned by Mr. Alfaro, on behalf of themselves and all other similarly situated individuals. The complaint alleges that the named plaintiffs and other individuals purchased limited partnership interests in Energy Resources 1981-A Ltd. ("Energy Resources") after July 8, 1981, as a result of the promotion of these interests by defendant E.F. Hutton & Co. ("Hutton"). Plaintiffs claim that defendant Hutton made numerous misrepresentations regarding the nature and riskiness of this investment which caused them to enter into the deal. They assert that Hutton knew that these representations were false at the time they were made or that defendant acted with reckless disregard as to the truth of these representations. The complaint presents six counts including claims under (1) section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and Rule 10(b)-5; (2) section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l; (3) the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1964(c); and (4) Pennsylvania common law for (a) fraud; (b) breach of fiduciary duty; and (c) negligence.

In late August 1984, plaintiffs filed a motion for class certification. Defendant did not respond directly to that motion but, on September 14, 1984, filed a motion to dismiss the complaint pursuant to Rule 12(b)(6). Plaintiffs have responded to that motion and defendant has filed a reply to plaintiffs' response.

The motion raises a number of challenges to each count of the complaint. Although there is some overlap in the arguments raised in opposition to different counts, the challenges to each count are sufficiently distinct to allow me to address the objections in the sequence in which the counts are presented in the complaint.

1) Section 10(b) and Rule 10(b)-5 claim

Count One of the complaint charges Hutton with violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and Rule 10(b)-5 promulgated thereunder. This securities fraud claim is challenged in the present motion on three grounds: (1) the opinions and predictions which are alleged to have been misrepresentations cannot form a basis for liability; (2) the statute of limitations had expired on this claim prior to the filing of the complaint; and (3) fraud is not pleaded with the necessary specificity. I will address each of these contentions in this order.

a) Opinions and predictions as misrepresentations

Count One alleges that defendant misrepresented to plaintiffs that the proposed investment in Energy Resources (1) was a low risk investment; (ii) would yield a three-to-one return on fifty percent of the proceeds which would be invested in low risk development wells; (iii) would call for fifty percent of the proceeds to be invested in controlled exploratory drilling; (iv) would involve a large number of wells to minimize the risk; and (v) was likely to produce a six-to-one return on investment over time. Count One also charges that defendant stated that there was minimal risk that the letters of credit to be provided by plaintiffs would be called. Hutton contends that this type of misrepresentation may not form the basis for a securities fraud claim. Hutton cites numerous cases for the proposition that expressions of opinion and predictions are not actionable as fraud. Defendant's brief at 11. However, defendant recognizes that under certain "limited circumstances" a fraud claim may be asserted on the basis of misrepresentations of opinion. Opinions or predictions not made in good faith or made with the knowledge that they are not based upon a sound, factual or historical basis are actionable under section 10(b) and rule 10(b)-5. See, e.g., Marx v. Computer Sciences Corporation, 507 F.2d 485 (9th Cir.1974); Eichen v. E.F. Hutton & Co., Inc., 402 F.Supp. 823, 829 (S.D.Cal.1975); Schuller v. Slick Corporation, 1974-1975 Transfer Binder CCH Fed.Sec.L.Rep. ¶ 95,065 (S.D. N.Y.1975); Nicewarner v. Bleavins, 244 F.Supp. 261, 264 (D.Colo.1965). Hutton contends that the complaint fails to allege the necessary bad faith or scienter to support liability for these allegedly faulty predictions and opinions and therefore Count One must be dismissed.

Plaintiffs respond that the complaint more than adequately alleges a claim for securities fraud under section 10(b) and rule 10(b)-5 despite the fact that the alleged misrepresentations were opinions or predictions. Plaintiffs assert that the complaint properly alleges that when these predictions and opinions were made Hutton was aware that it did not have a factual basis for such representations. Plaintiffs also note that defendant, in its brief, suggests that it should be obvious that opinions and predictions of the nature of those allegedly made by Hutton could never be made with assurance. Plaintiffs contend that this admission by defendant shows that defendant should be liable for its statements because defendant knew that potential investors were relying upon representations which could not be made with assurance.

The motion to dismiss presents the limited question whether, if the allegations in the complaint were proved, they would suffice to warrant a finding of liability. Defendant correctly notes that the types of misrepresentations alleged in the complaint are essentially predictions of likely return on the proposed investment and expectations as to how the money invested would be used and opinions as to the riskiness of the venture. However, such statements may be actionable under section 10(b) and rule 10(b)-5 if, when the statements were made, the defendant did not have a good faith belief that it had the information on which it could predicate the opinion or prediction expressed. McLean v. Alexander, 599 F.2d 1190, 1198 (3d Cir.1979). E.g., Beissinger v. Rockwood Computer Corp., 529 F.Supp. 770, 780-81 (E.D.Pa.1981) (the defendant must have a sound, factual or historical basis for the opinion or prediction). Therefore, the question to be determined at this time is whether plaintiffs have alleged the necessary scienter on the part of defendant with regard to these alleged misrepresentations. I conclude that they have.

Paragraph 26 of the complaint states:

Defendant acted with knowledge of the falsity of its statements and the materiality of its omissions or with reckless disregard for the truth or falsity thereof.

Although this language could have been more carefully chosen to correspond to the type of misrepresentation alleged (i.e., it would have been more appropriate to allege that defendant knew that it lacked information on which to base these opinions and predictions or that the information which defendant possessed did not support these statements), under the liberal pleading standard of the Federal Rules of Civil Procedure, this statement sufficiently alleges that defendant knew that it lacked support for these predictions and opinions or acted in reckless disregard of this fact.

The Federal Rules of Civil Procedure require that fraud and mistake be pleaded with specificity. Rule 9(b). However, intent and knowledge may be averred generally. Therefore, the very general nature of the allegation of scienter in the present complaint does not warrant dismissal or amendment of the complaint. See Denny v. Carey, 72 F.R.D. 574, 580 (E.D.Pa.1976).¹

b) Statute of limitations

In the absence of an express statute of limitations in the federal statute upon which the securities fraud claim is based, it is necessary to turn to the law of the forum state for the appropriate limitations period. Biggans v. Bache Halsey Stuart Shields, 638 F.2d 605 (3d Cir.1980). In the present case there are two statutes of limitations from which to choose. One potentially applicable statute of limitations is provided by 42 Pa.Cons.Stat.Ann. § 5524(7). That statute applies to common law fraud claims brought in Pennsylvania courts and requires that all such claims be brought within two years. Alternative limitations periods are established in the Pennsylvania Securities Act, 70 Pa.Stat.Ann. § 1-504(a). That Act states that an action under that Act must be brought within three years "after the act or transaction constituting the violation or the expiration of one year after the plaintiff receives actual notice or upon the exercise of reasonable diligence should have known of the facts constituting the violation, whichever shall first expire."

The question to be resolved in choosing the appropriate statute of limitations is what limitations period would apply to a state law claim which parallels the federal claim asserted. In general under Pennsylvania law, when the suit involves a claim against a broker rather than a seller of securities, the courts of this Circuit apply the two-year common law fraud limitations period. E.g., Sharp v. Coopers & Lybrand, 649 F.2d 175, 191-92 (3d Cir.1981); Biggans v. Bache Halsey Stuart Shields, 638 F.2d 605 (3d Cir.1980); Fickinger v. C.I. Planning Corp., 556 F.Supp. 434 (E.D. Pa.1982). This result stems from the fact that the Pennsylvania Securities Act only allows recovery against "sellers" of securities so that claims against brokers who are not in privity with the plaintiffs must be brought under a...