Luksch v. Latham

• Decision Date: 22 December 1987
• Docket Number: No. C-84-5584 EFL.,C-84-5584 EFL.
• Citation: 675 F. Supp. 1198
• Court: U.S. District Court — Northern District of California
• Parties: Derrick LUKSCH, Karen Luksch, Karl Luksch, and Ingeborg Luksch, Plaintiffs, v. James A. LATHAM, Latham Resources Corporation, Capital Analysts, Inc., and Touche Ross & Co., Defendants.

675 F. Supp. 1198

Derrick LUKSCH, Karen Luksch, Karl Luksch, and Ingeborg Luksch, Plaintiffs, v. James A. LATHAM, Latham Resources Corporation, Capital Analysts, Inc., and Touche Ross & Co., Defendants.

No. C-84-5584 EFL.

United States District Court, N.D. California.

December 22, 1987.

Thomas J. LoSavio, Low, Ball & Lynch, San Francisco, Cal., for plaintiffs.

John M. Anderson, Landels, Ripley & Diamond, Paul Renne, Cooley, Godward, Castro, Huddleson & Tatum, San Francisco, Cal., for defendants.

ORDER DENYING SUMMARY JUDGMENT

LYNCH, District Judge.

This securities fraud case presents the question whether, as a matter of law, knowledge of the information contained in offering memoranda must be imputed to investors upon their receipt of such memoranda, for the purpose of determining when the investors were on constructive notice so as to start the running of the statute of limitations. As described below, the Court concludes that such knowledge should not be legally imputed to investors, except in the unusual case where a court can determine, upon review of the detailed factual circumstances and all the relevant factors, that as a matter of law a reasonable trier of fact could not fail to find that the investors either actually knew the information or should have discovered it in the exercise of reasonable diligence.

BACKGROUND

Plaintiffs made several investments in limited partnerships formed to engage in oil and gas drilling projects. After their investments allegedly proved disastrous, plaintiffs brought this suit asserting a variety of claims including federal securities fraud, state corporations law violations, common-law fraud and deceit, negligent misrepresentation, and professional malpractice.

Defendant James A. Latham ("Latham") was a general partner and prime mover in the projects, and defendant Latham Resources Corporation ("Resources") was allegedly a shell corporation improperly used by Latham for his personal benefit. Defendant Touche Ross & Co. provided opinions for the offering memoranda for the projects and was the accounting firm for the managing general partner, Latham Exploration Company ("LEXCO"). Defendant Capital Analysts, Inc. ("Capital") was a broker dealer and investment advisor that allegedly also acted as the underwriter for the partnership offerings.

Pursuant to its Order of November 4, 1987, the Court hereby rules on defendant Capital's motion for partial summary judgment. Capital moves for summary judgment that plaintiffs' claims based on five alleged oral misrepresentations are barred by the applicable statutes of limitations. The oral misrepresentations relate to 1) the degree of risk of the investments, 2) assurances of return on the investments, 3) assurances that letters of credit would never be called, 4) assurances that contributions of voluntary assessments would involve no additional risk, and 5) the previous investment success of defendant Latham.

Capital relies solely on the ground that plaintiffs were, as a matter of law, on constructive or inquiry notice of their claims upon receipt of offering materials that directly contradicted the oral representations.¹ It essentially urges the adoption of a rule of law that knowledge of the contents of such materials must automatically be imputed to investors who receive them, without any factual inquiry into what such investors actually knew or should have discovered in the exercise of reasonable diligence.²

Capital's motion in support of this per se rule of imputation upon receipt is discussed below with respect to each of plaintiffs' remaining claims:

1) Count Three for violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder;

2) Count Five for violation of state corporations law, Cal.Corp.Code §§ 25401, 25501 (West 1977);

3) Count Six for fraud and deceit, Cal. Civ.Code §§ 1572, 1573 (West 1982); id. §§ 1709, 1710 (West 1985);

4) Count Seven for negligent misrepresentation, id. §§ 1572, 1573 (West 1982); id. §§ 1709, 1710 (West 1985).³

DISCUSSION

A. Federal Claims

Because Congress has not provided a statute of limitations for section 10(b) and rule 10b-5 securities fraud claims, the courts borrow the appropriate state statute applicable to frauds generally. E.g., Volk, 816 F.2d at 1411-12; Mosesian v. Peat, Marwick, Mitchell & Co., 727 F.2d 873, 876 (9th Cir.), cert. denied, 469 U.S. 932, 105 S.Ct. 329, 83 L.Ed.2d 265 (1984); Admiralty Fund v. Hugh Johnson & Co., 677 F.2d 1301, 1308-09 (9th Cir.1982). The appropriate statute here is Cal.Code Civ.Proc. § 338(4) (West 1982), which provides for a three-year period of limitations. E.g., Mosesian, 727 F.2d at 876; Johnson, 677 F.2d at 1308-09.

However, federal law determines when the statute begins to run. E.g., Johnson, 677 F.2d at 1309; McConnell v. Frank Howard Allen & Co., 574 F.Supp. 781, 787 (N.D.Cal.1983). Federal law deems the statute to start to run on "the date plaintiff discovered the fraud or could have done so in the exercise of reasonable diligence." Mosesian, 727 F.2d at 877 (citations omitted). "The extent to which a plaintiff used reasonable diligence is tested by an objective standard." E.g., Volk, 816 F.2d at 1417 (citing Kramas v. Security Gas & Oil Inc., 672 F.2d 766, 770 (9th Cir.), cert. denied, 459 U.S. 1035, 103 S.Ct. 444, 74 L.Ed.2d 600 (1982)).

Defendant Capital's motion turns on this requirement of "reasonable diligence." Capital argues in essence that reasonable diligence always requires investors to read the prospectus, and that upon receipt of the prospectus investors should therefore be deemed to have knowledge of clear contradictions between the prospectus and oral representations that have been made to the investors. Under the logic of this proposed per se imputation rule, since knowledge of such contradictions puts investors on constructive notice of fraud and starts the statute of limitations running, Capital asserts that deciding the instant motion is a simple affair: the Court need only 1) note that plaintiffs concededly received offering materials more than three years before they filed suit and 2) determine that the materials do in fact and in no uncertain terms contradict the oral misrepresentations.

Capital's principal authority in support of its motion is the recent decision of the First Circuit in Kennedy v. Josephthal & Co., 814 F.2d 798 (1st Cir.1987). The Kennedy court considered whether investors' claims based on section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l(2), were barred by the statute of limitations. Id. at 802-03. In relevant part, section 13 of the 1933 Act bars claims not brought "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. § 77m.

Although the Kennedy court recognized that "normally, the exercise of reasonable diligence would be a question of fact and not amenable to summary disposition," 814 F.2d at 803 (citation omitted), it found that where each oral representation was directly contradicted by the clear language of the prospectus plaintiffs were on inquiry notice that triggered the duty to exercise reasonable diligence. Id. at 802-03. The court therefore held plaintiffs' section 12(2) claims were time barred, reasoning that:

As a matter of law, the exercise of reasonable diligence would require more of plaintiffs than merely viewing two sets of statements, one of which logically cannot be true, and chosing sic one of those sets. We believe no reasonable fact finder could determine that plaintiffs exercised reasonable diligence.

Id. at 803.

Capital argues that the Court should apply the same reasoning and reach the same result in the case at bar. However, the Court declines to do so for a number of reasons. First, it is not clear that Kennedy was intended to be read so broadly. Like most of the other cases relied on by defendant, it appears to be distinguishable from the motion at bar because plaintiffs in Kennedy apparently had actual as opposed to merely constructive knowledge of the contents of the offering materials.⁴ Although the Kennedy opinion unfortunately is not explicit on this point, it seems to assume that plaintiff investors actually read the prospectus as well as heard the oral representations. See, e.g., 814 F.2d at 803 (plaintiffs "chose which sets of statements they wished to believe," "merely viewing two sets of statements ... and chosing sic one of those sets").

Second, even if some cases do intend to hold that mere receipt of a contradictory prospectus necessarily starts the statute of limitations running, the Court does not believe that the Ninth Circuit would or should adopt such a broad vision of constructive notice. For example, in Rochelle v. Marine Midland Grace Trust Co. of New York, 535 F.2d 523, 531-33 (9th Cir.1976), the Ninth Circuit refused to impute knowledge of proxy materials filed with the Securities and Exchange Commission ("SEC") to a company holding debentures, even though it was a sophisticated investor. In declining to do so, the Rochelle court explicitly invoked the fundamental policy considerations underlying the securities laws:

We are mindful that the overriding purpose of Section 10(b) and Rule 10b-5 was to protect the purity of the securities market and that private claims for relief thereunder are a means to that end. We would impair the larger purpose if we were to expand the concept of constructive notice to defeat such claims.

Id. at 532-33.

The Ninth Circuit generally views the question of when a reasonably diligent investor should have discovered a claim as one appropriate for the factfinder to determine after trial rather than one for a judge to decide as a matter of law on summary judgment. Thus, in Briskin v. Ernst & Ernst, 589 F.2d 1363, 1367-68 (9th Cir. 1978), the Ninth Circuit rejected imputation of...