TFC BANKING AND SAV., FA v. Arthur Young & Co., Civ. No. 4-87-809.

• Decision Date: 14 April 1988
• Docket Number: Civ. No. 4-87-809.
• Citation: 706 F. Supp. 1408
• Parties: TCF BANKING AND SAVINGS, F.A., Plaintiff, v. ARTHUR YOUNG & COMPANY, Defendant.
• Court: U.S. District Court — District of Minnesota

706 F. Supp. 1408

TCF BANKING AND SAVINGS, F.A., Plaintiff, v. ARTHUR YOUNG & COMPANY, Defendant.

Civ. No. 4-87-809.

United States District Court, D. Minnesota, Fourth Division.

April 14, 1988.

Frank A. Dvorak, Stephen P. Kelley and Thomas C. Power, Mackall, Crounse & Moore, Minneapolis, Minn. (Gregory J. Pulles, TCF Banking & Savings, F.A., Corporate Banking, Minneapolis, Minn., of counsel), for plaintiff.

James S. Simonson, Gray, Plant, Mooty, Mooty & Bennett, Minneapolis, Minn., John Matson, Arthur Young, New York City, for defendant.

MEMORANDUM AND ORDER

MacLAUGHLIN, District Judge.

This matter is before the Court on defendant's motion to dismiss for failure to state a claim upon which relief can be granted. Defendant's motion will be granted in part and denied in part.

FACTS

Plaintiff TCF Banking and Savings, P.A. (TCF) is a stock savings and loan association chartered under federal law with a place of business in Minnesota. Defendant Arthur Young & Co. is a professional partnership of certified public accountants. In August 1984 TCF was asked by Midwest Federal Savings & Loan Association (Midwest) to participate in a $16.9 million loan to Lewis Farris, Jr. and Clint Murchison, Jr. The sole security for the loan was stock owned by Farris and Murchison in Nevada National Bancorporation (NNBC), a one-bank holding company. Prior to agreeing to participate in the loan, TCF obtained the 1983 annual report of NNBC. The report "included a consolidated balance sheet, consolidated statements of operations, stockholders' equity, and changes in financial positions," and incorporated financial information of the Nevada National Bank (NNB), a wholly-owned subsidiary of NNBC. Complaint par. 13. Defendant Arthur Young prepared the 1983 annual report together with accompanying notes and an audit report. Complaint par. 14. TCF alleges it relied on the materials prepared by Arthur Young in deciding to participate in the Farris-Murchison loan agreement. Complaint par. 12.

On September 14, 1984 TCF extended credit in the amount of $11.4 million to Farris and Murchison; Midwest advanced an additional $5.5 million. Farris pledged 810,314 shares of NNBC stock as collateral for the entire loan and Murchison pledged an additional 732,242 shares. Under the terms of the loan agreement the principal was payable upon demand and interest was due quarterly. By December 31, 1984 Farris and Murchison were in default because of their failure to pay interest. Complaint par. 18. However, TCF and Midwest apparently attempted to work out a new payment schedule and did not immediately foreclose on the stock. When the work-out negotiations failed, they foreclosed.

At a private sale on March 25, 1986 TCF and Midwest purchased¹ the 810,314 shares pledged by Farris at a per-share price of $11.11 for a total purchase price of $9,002,589. On April 18, 1986 at a second private sale they purchased the 732,242 shares of NNBC stock pledged by Murchison also at $11.11 per share, for a total price of $8,135,209. TCF contends the purchase price of $11.11 per share was determined in reliance on the 1983 and 1984 annual reports of NNBC which were again prepared by defendant. Complaint par. 23. TCF and Midwest applied the combined purchase price of the stock to the outstanding amount of the loan obligation, resulting in cancellation of the principal indebtedness but leaving an amount of $2,470,356 due and owing as interest. In June 1987 TCF and Midwest sold the stock they had foreclosed upon at a price of $7.04 per share, for a total amount of $10,859,594, a loss of $6,278,117 from the original foreclosure price. TCF alleges that after April 1986 it learned that the 1983, 1984 and 1985 annual reports of NNBC were all materially misleading. This litigation ensued.

The complaint is in five counts. Count I alleges Arthur Young violated 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. Count II alleges a violation of the Minnesota Uniform Securities Act, Minn.Stat. § 80A.01 et seq. Count III alleges a claim of common law negligence. Count IV states a claim for common law fraud and Count V alleges a claim for common law malpractice. Jurisdiction is properly invoked under 15 U.S.C. § 78aa, 28 U.S.C. § 1331 and principles of pendent jurisdiction. All five counts of the complaint are premised on the assertion that the 1983, 1984 and 1985² annual reports were materially false and misleading. Defendant now moves under Fed.R.Civ.P. 12(b)(6) to dismiss the complaint on the grounds that it fails to state a claim for which relief can be granted. In support of its motion defendant advances a potpourri of arguments including (1) the section 10(b) claim fails to state fraud with particularity as required by Fed.R.Civ.P. 9(b); (2) the section 10(b) claim is barred by the statute of limitations (3) the Minnesota Uniform Securities law claim is barred because defendant is not a seller of securities; (4) the Minnesota Uniform Securities law claim is barred by the statute of limitations; and (5) the state law negligence and malpractice claims must be dismissed because plaintiff cannot show that defendants actually knew that TCF would rely on the annual reports as required by state law.

DISCUSSION

In reviewing a motion to dismiss for failure to state a claim the Court presumes all factual allegations to be true and all reasonable inferences from those allegations are construed in favor of the non-moving party. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974); Stephens v. Associated Dry Goods Corp., 805 F.2d 812, 814 (8th Cir.1986). The appropriate inquiry is not whether plaintiff will ultimately prevail but whether he will be allowed to introduce evidence to support his claims. Scheuer, 416 U.S. at 236, 94 S.Ct. at 1686. Because dismissal on the pleadings is an extreme remedy it is not favored by the courts and is employed only when "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-02, 2 L.Ed.2d 80 (1957) (footnote omitted); see Robinson v. MFA Mutual Insurance Co., 629 F.2d 497, 500 (8th Cir.1980).

A. The Section 10(b) Claim

The section 10(b) claim is premised on the assertion that the defendant

engaged in, and/or aided and abetted, a plan, a scheme and unlawful conspiracy and course of conduct with NNBC, pursuant to which it knowingly or recklessly engaged in acts, transactions, practices and courses of business which operated as a fraud upon Plaintiff TCF and made intentionally and/or recklessly various untrue statements of material facts and omitted material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading to Plaintiff TCF. Defendant Arthur Young participated in this scheme with the knowledge that its purpose and effect was to induce Plaintiff TCF, MWF and others to purchase and sell NNBC stock at artificially inflated prices. Plaintiff TCF made such purchases of stock in reliance on, directly or indirectly, the untrue statements made by Defendant Arthur Young.

Complaint par. 30. In particular, the complaint identifies two specific defects with the NNBC 1983 and 1984 annual reports. First, it alleges that the 1983 and 1984 reports were false and misleading in that the allowance for credit losses of NNB (the wholly-owned subsidiary of NNBC) was far less than what the allowance should have been as determined by generally accepted accounting principles and generally accepted auditing standards. Complaint par. 15, 24. Second, it alleges that the 1983 report failed to disclose that NNB's trust department had incurred a $2 million liability which was not reflected in the financial statements of NNBC. Complaint par. 16. The plaintiff similarly criticizes the 1984 report for failing to disclose "substantial liabilities" incurred by NNB's trust department. Complaint par. 24. The complaint alleges that as a result of these omissions and misrepresentations the 1983 and 1984 reports overstated NNBC's income and assets for the years in question. Complaint par. 24. Defendant first maintains these allegations fall far short of the specificity required for pleading fraud under Fed.R. Civ.P. 9(b).

1. Failure to Plead Fraud with Particularity

Rule 9(b) of the Federal Rules of Civil Procedure provides:

In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge and other condition of mind of a person may be averred generally.

The specificity requirement of rule 9(b) is a marked departure from the general simplified pleading philosophy of the federal rules. 5 C.Wright & A. Miller, Federal Practice and Procedure § 1297 at 405 (1969). In the context of securities litigation the rule serves three distinct purposes. First, it deters the use of complaints as a pretext for fishing expeditions of unknown wrongs designed to compel in terrorem settlements. Second, it protects against damage to professional reputations resulting from allegations of moral turpitude. Third, it ensures that a defendant is given sufficient notice of the allegations against him to permit the preparation of an effective defense. Ross v. A.H. Robins, 607 F.2d 545, 557 (2d Cir.1979), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 64 L.Ed.2d 802 (1980); Stewart v. Fry, 575 F.Supp. 753, 756 (E.D.Mo.1983).

The United States Court of Appeals for the Second Circuit has strictly applied rule 9(b) in the securities fraud context as a means of deterring frivolous suits. 2A Moore's Federal Practice par. 9.033 at 9.51 (2d ed. 1987). See, e.g., Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 120 (2d Cir.1982); Quantum Overseas, N.V. v. Touche Ross & Co., 663 F.Supp. 658, 666-67 (S.D.N.Y.1987). In cases involving securities fraud...