Miller v. New America High Income Fund

• Decision Date: 09 January 1991
• Docket Number: 90-10845-MA.,Civ. A. No. 90-10782-MA
• Citation: 755 F. Supp. 1099
• Parties: Eric MILLER and Robert Lucia, on behalf of themselves and all others similarly situated, Plaintiffs, v. The NEW AMERICA HIGH INCOME FUND, Ostrander Capital Management Corp., Patricia Ostrander, Richard E. Floor, Bernard J. Korman, Joseph L. Bower, Franco Modigliani, Ernst E. Monrad, Ellen Terry, Bateman Eichler, Hill Richards, Inc., Butcher Corporation, and Michael R. Milken, Defendants. Pete and Pat BOMIRETO, Jt, John Silak, Mary Bruce, and C.H. Rhumann, on behalf of themselves and all others similarly situated, Plaintiffs, v. The NEW AMERICA HIGH INCOME FUND, Ostrander Capital Management Corp., Patricia Ostrander, Richard E. Floor, Bernard J. Korman, Joseph L. Bower, Franco Modigliani, Ernst E. Monrad, Ellen Terry, Bateman Eichler, Hill Richards, Inc., Butcher Corporation, and Michael R. Milken, Defendants.
• Court: U.S. District Court — District of Massachusetts

755 F. Supp. 1099

Eric MILLER and Robert Lucia, on behalf of themselves and all others similarly situated, Plaintiffs, v. The NEW AMERICA HIGH INCOME FUND, Ostrander Capital Management Corp., Patricia Ostrander, Richard E. Floor, Bernard J. Korman, Joseph L. Bower, Franco Modigliani, Ernst E. Monrad, Ellen Terry, Bateman Eichler, Hill Richards, Inc., Butcher Corporation, and Michael R. Milken, Defendants.

Pete and Pat BOMIRETO, Jt, John Silak, Mary Bruce, and C.H. Rhumann, on behalf of themselves and all others similarly situated, Plaintiffs, v. The NEW AMERICA HIGH INCOME FUND, Ostrander Capital Management Corp., Patricia Ostrander, Richard E. Floor, Bernard J. Korman, Joseph L. Bower, Franco Modigliani, Ernst E. Monrad, Ellen Terry, Bateman Eichler, Hill Richards, Inc., Butcher Corporation, and Michael R. Milken, Defendants.

Civ. A. Nos. 90-10782-MA, 90-10845-MA.

United States District Court, D. Massachusetts.

January 9, 1991.

Nancy Gertner, Dwyer, Collora & Gertner, Boston, Mass., for plaintiffs Eric Miller et al.

Nancy Gertner, Silverglate, Gertner, Fine & Good, Boston, Mass., for plaintiffs Robert Lucia et al.

Patricia A. Early, Choate, Hall & Stewart, Boston, Mass., for The New America High Income Fund and Ostrander Capital Management Corp.

Peter M. Saparoff, Helen Ann Robichaud, Gaston & Snow, Boston, Mass., for Bernard J. Korman, Joseph L. Bower, Franco Modigliani, and Ernst E. Monrad.

J. Dennis Faucher, Saul, Ewing, Remick & Saul, Philadelphia, Pa., for Bateman Eichler, Hill Richards, Inc. and Butcher & Singer, Inc.

MEMORANDUM AND ORDER

MAZZONE, District Judge.

Plaintiffs, representatives of a putative class (the "Plaintiff Class") of all purchasers of the common stock of New America High Income Fund ("New America" or "the Fund") between the dates February 19, 1988, and October 13, 1989, and representatives a putative subclass (the "IPO Subclass") of all purchasers of common stock pursuant to the Fund's initial public offering ("IPO") (prospectus dated February 19, 1988), brought this suit¹ against defendants New America and its investment advisor, Ostrander Capital Management Corporation; individually against the Fund's directors (two of whom are also officers of Ostrander Capital); against Bateman Eichler, Hill Richards Incorporated and Butcher Corporation, in their capacity as lead underwriters and also as representatives of a putative defendant class of all underwriters who participated in the IPO; and individually against Michael Milken,² alleging violations of federal securities statutes and regulations, common-law fraud and negligent misrepresentation, and civil RICO. The action is before the court on defendants' motion to dismiss pursuant to Fed.R.Civ.P. 12(b)(6) and 9(b). For the reasons stated below, the motion to dismiss is allowed with respect to all claims except those stated under §§ 11 and 12(2) of the Securities Act.

I. BACKGROUND

A. Allegations in the Amended Complaint

New America, a Maryland corporation with a principal place of business in Massachusetts, was organized in early 1988 with the express purpose of investing in the then booming business in "high yield" fixed-income securities, better known as "junk bonds." The Fund's highly lever-aged capital structure was comprised of $105 million of senior extendible notes (the "Notes"), 790 shares of preferred stock with a liquidation preference of $100,000 each (the "Preferred Shares"), and common stock. The common stock was first offered in conjunction with a registration statement and prospectus dated February 19, 1988; the initial public offering consisted of 23 million shares at $10 each. At all times since the initial offering, the common stock has been publicly traded on the New York Stock Exchange.

Beginning in April, 1989, revelations about the default rates of high-yield securities began to shake the foundations of the junk bond market. The most important of these, according to the complaint, was a report in the Wall Street Journal of April 14, 1989, on an unpublished study, compiled by Professor Paul Asquith of the Massachusetts Institute of Technology and others, which found that the true rate of default of junk bonds was much higher than the investment community then believed. At first, New America downplayed the significance of these revelations, but on October 6, 1989, it "slashed" the monthly dividend on the common stock (from 11.5 to 10 cents), Amended Complaint ¶ 81, exposing its own crumbling foundations. The stock, which had once sold for as high as $11, fell to $5.375 per share. Id. ¶ 82. Plaintiffs chose October 13, 1989, as the end of the class period, presumably because enough information was available at that time to put them on notice of the true state of New America's affairs.

Plaintiffs allege that New America, its investment advisor, the directors, the underwriters, and Milken are all liable for the role they played in these events. According to the amended complaint, these defendants all conspired with Drexel Burnham Lambert, Inc. ("Drexel" or "DBL"), to create and use New America "as a purchaser of last resort for that portion of DBL's high yield bond underwritings resulting from its merger and acquisition activities which DBL and Milken were having difficulty marketing." Id. ¶ 88(c). The plaintiffs allege that defendants were all "direct, necessary and substantial participants" in a conspiracy to "enable New America to complete the IPO and to inflate and maintain the price of New America stock by issuing materially false and misleading information." Id. ¶ 14(a). The false and misleading communications mentioned specifically in the complaint include the prospectus, the President's Letter accompanying the Fund's Annual Report for the fiscal year ended December 31, 1988 (issued March 10, 1989), and the Semi-Annual Report of June 30, 1989, issued sometime in July, after the revelations about the fragility of the junk bond market.³ These communications are actionable, plaintiffs allege, because defendants knew at the time these statements were issued that they were in themselves materially misleading to prospective shareholders or failed to correct misleading impressions attributable to prior statements.

In general terms, plaintiffs claim that defendants "glowing representations as to the Fund's future prospects and reassurance as to its ability to maintain the high yield of return on an investment in the Fund," id. ¶ 88, were actionably misleading. More specifically, the complaint groups the defendants' purportedly misleading statements into five categories.

First, the defendants misled the Plaintiff Class by understating the actual risk of default associated with junk bonds and overstating the potential rewards associated with them. "The studies used by DBL in support of its default statistics had not adequately accounted for bond exchanges, the effect of aging bonds, and the potential or likelihood of increased future defaults from companies issuing bonds used to finance mergers or acquisitions." Id. ¶ 88(a).

Second, defendants failed to disclose that the market for high-yield bonds was dependent on "a network of purchasers (`the inner circle') of high yield bonds" that Milken had created and "upon whom he could rely to purchase significant portions of DBL's offerings." Id. ¶ 88(b).

Third, "the `high yield' bonds which were purchased by the Fund were not selected on the basis of a professional effort to maximize investment potential and to protect the shareholders through diversification," but instead were chosen pursuant to the conspiracy to create a market of last resort for Drexel's bonds. Id. ¶ 88(c).

Fourth, defendants failed to disclose "significant risks with respect to the high yield bonds which comprised the assets of the Fund" and the vulnerability of the Fund's entire portfolio caused by its being "skewed toward the higher risk end of the high yield bond market since it contained those bonds which were not favorably received by DBL's best customers." Id. ¶ 88(d).

Fifth, defendants failed to disclose their "knowledge that so-called `bid prices' for high yield bonds were artificially inflated." Id. ¶ 88(e).

B. Standard for Dismissal

At this stage of the litigation, the court is required to view the allegations in the light most favorable to the plaintiffs, and a complaint can be dismissed only if it appears beyond doubt that plaintiffs can prove no set of facts which would entitle them to relief. Lessler v. Little, 857 F.2d 866, 867 (1st Cir.1988), cert. denied, 489 U.S. 1016, 109 S.Ct. 1130, 103 L.Ed.2d 192 (1989). Thus, for the purpose of analyzing the plaintiffs' claims, the court will accept the complaint's allegations and proceed on the assumption that the defendants were indeed active participants in a scheme to provide a market for the bonds that Drexel was having trouble selling and that New America was created in furtherance of that scheme.

II. MISREPRESENTATIONS IN THE PROSPECTUS

A. Section 11 Violations

In Count I of the amended complaint, the putative IPO Subclass asserts a cause of action under § 11 of the Securities Act of 1933, 48 Stat. 74, as amended, 15 U.S.C. § 77k, against New America, Ostrander Capital, the directors, and the underwriters.⁴ Section 11 provides a cause of action for any person acquiring a security issued in connection with a registration statement, any part of which, when it became effective, "contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading," against any director or underwriter. 15 U.S.C. § 77k(a).

As set forth above, plaintiffs list several species of misrepresentations and omissions for which, they assert, defendants should be held liable. In light of the lenient requirements of a complaint under Rule 12(b)(6) scrutiny, I find that the plaintiffs' allegations are sufficient to withstand a motion for...