White v. Melton

• Decision Date: 11 February 1991
• Docket Number: 90 Civ. 0498 (SWK).
• Citation: 757 F. Supp. 267
• Court: U.S. District Court — Southern District of New York
• Parties: Jeff J. WHITE, individually and on behalf of all those similarly situated, Plaintiffs, v. Andrew J. MELTON, Jr., Charles A. Fiumefreddo, Sheldon Curtis, Arthur D. Forster, Kenton J. Hinchliffe, Bruce N. Alpert, Dean Witter Government Securities Plus, Dean Witter Reynolds, Inc. and Dean Witter Financial Services, Inc., Defendants.

757 F. Supp. 267

Jeff J. WHITE, individually and on behalf of all those similarly situated, Plaintiffs, v. Andrew J. MELTON, Jr., Charles A. Fiumefreddo, Sheldon Curtis, Arthur D. Forster, Kenton J. Hinchliffe, Bruce N. Alpert, Dean Witter Government Securities Plus, Dean Witter Reynolds, Inc. and Dean Witter Financial Services, Inc., Defendants.

90 Civ. 0498 (SWK).

United States District Court, S.D. New York.

February 11, 1991.

Berger & Montague, Philadelphia, Pa. by Stephen D. Ramos, for plaintiffs.

Paul Weiss Rifkind Wharton & Garrison, New York City (Lewis A. Kaplan, Richard A. Rosen, Steven L. Vollins, of counsel), for defendants other than Dean Witter Government Securities Plus.

Gordon Hurwitz Butowsky Weitzen Shalov & Wein, New York City (David M. Butowsky, Victor J. Rocco, Michael B. Reuben, Ronald B. McGuire, of counsel), for defendant Dean Witter Government Securities Plus.

MEMORANDUM OPINION AND ORDER

KRAM, District Judge.

This securities fraud case requires the Court's construction of a relatively recent change in the disclosure requirements of the Securities and Exchange Commission ("the SEC" or "the Commission") under Regulation C of the Securities Act of 1933, 15 U.S.C. § 77a et seq. ("the '33 Act"), relating to open-end diversified management investment companies, or mutual funds. Presently before the Court is defendants' motion to dismiss the complaint under Federal Rule of Civil Procedure ("Fed.R.Civ.P.") 12(b)(6), or, alternatively, for summary judgment pursuant to Rule 56, Fed.R.Civ.P.¹ Plaintiff opposes the motion.

BACKGROUND²

In 1982 the SEC determined that the disclosures it required in mutual fund prospectuses had become "too long and complex." 48 Fed.Reg. 37928, 37929 (Aug. 22, 1983). The Commission accordingly revised the regulations and adopted a new form for registering mutual funds, simplifying the prospectus that each investor would receive. Id.; Rules 495, 495, and 497, 17 C.F.R. § 230 (1989). In addition, the new regulations required that the registrants make available to investors, upon request and without charge, a Statement of Additional Information ("SAI") in order to provide more extensive information to those who desire it. Id.

However, the SEC recognized the possible concern on the part of some mutual funds that "omitting information from the simplified prospectus could expose them to liability" under the fraud provisions of the '33 Act.³ Id. at 37930. The SEC therefore sought comment as to whether this concern was legitimate and, if so, how it could be resolved consistent with the Commission's desire to streamline the prospectuses. After receiving comments, the Commission decided to permit registrants to incorporate the SAI into the prospectus by reference. The Commission stated that:

if a mutual fund incorporates the Statement of Additional Information by reference, the Statement would be a part of the prospectus as a matter of law.

Id. The new Registration Form N-1A includes three parts: Part A is the simplified prospectus; Part B is the Statement of Additional Information; and Part C relates to other information required by the registration statement.⁴ 17 C.F.R. § 230.495(a) (1989).

In this putative class action, an investor complains that a critical piece of information was wrongfully omitted from the February 3, 1987 Prospectus and Registration Statement (the "Prospectus") of defendant Dean Witter Government Securities Plus Fund ("Plus Fund"). However, plaintiff concedes that the information was contained in the SAI, which was incorporated by reference on the cover of the Prospectus. Defendants' Local Rule 3(g) statement, ¶ 4 (uncontested); Plus Fund Prospectus, dated February 3, 1987, attached as Exhibit A to Affidavit of Marilyn K. Cranney, Esq. (hereinafter "Cranney Aff.") at 1 (noting that additional information about the fund is contained in the Statement of Additional Information, which is available at no charge upon request and which is incorporated by reference into the Prospectus); Plus Fund Statement of Additional Information, dated February 3, 1987, attached as Exhibit B to Cranney Aff.

The Plus Fund is a mutual fund that invests principally in U.S. government securities. The individual defendants were officers of the Plus Fund at the time of the initial offering. Defendant Dean Witter Reynolds, Inc. is the Plus Fund's investment manager, underwriter and distributor. Defendant Dean Witter Financial Services, Inc. is a financial services company that owns the shares of Dean Witter Reynolds, Inc.

When shareholders buy Plus Fund shares, they pay no commission or "sales load" at the time of purchase. Instead, the charge is imposed at the time shares are redeemed. The longer the investor retains the shares, the lesser the charge. For example, if the shareholder redeems his shares in the first year of purchase, he pays a 5% commission; if he redeems in the second year, he pays a 4% commission; the commission similarly declines to 0% after the sixth year. This method of calculating commissions is known as a Contingent Deferred Sales Charge, or "CDSC." The purpose of the CDSC is to encourage investors into longer-term holdings.

The Plus Fund also grants an "Exchange Privilege," i.e., shareholders may transfer their holdings into other money market funds with different investment goals, some of which may carry no sales commission at all. However, if an investor shifts his money from the Plus Fund program into a money market fund without commission charges, and then switches his money back into the Plus Fund, the time spent in the other fund would not count towards the reduction of the CDSC commission. This rule, known as the "freeze" rule, is at the center of the present dispute. The freeze rule does not appear in the defendants' February 3, 1987 Prospectus which was provided to plaintiff; instead, it is noted in the SAI.⁵ Subsequent Plus Fund registration statements did include the freeze rule in the Prospectus itself.

Plaintiff asserts liability under §§ 10(b), 11, 12(2) and 20 of the '33 Act and SEC Rule 10b-5 promulgated thereunder. He does not specify in the Complaint how much he lost as a result of the alleged non-disclosure.⁶

DISCUSSION

I. Standards for Summary Judgment

Summary judgment is appropriate where "the pleadings, depositions, answers to interrogatories and admissions on file, together with affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Rule 56(c). In testing whether the movant has met this burden, the Court must resolve all ambiguities against the movant. Lopez v. S.B. Thomas, Inc., 831 F.2d 1184, 1187 (2d Cir.1987) (citing United States v. Diebold, Inc., 369 U.S. 654, 655, 82 S.Ct. 993, 994, 8 L.Ed.2d 176 (1962)).

The moving party bears the initial burden of demonstrating the absence of a genuine issue of material fact. Adickes v. S.H. Kress and Co., 398 U.S. 144, 157, 90 S.Ct. 1598, 1608, 26 L.Ed.2d 142 (1970). The movant may discharge this burden by demonstrating to the Court that there is an absence of evidence to support the nonmoving party's case on which that party would have the burden of proof at trial. Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986).⁷ The non-moving party then has the burden of coming forward with "specific facts showing that there is a genuine issue for trial." Rule 56(e). The non-movant must "do more than simply show that there is some metaphysical doubt as to the material facts." Matsushita Electric Industrial Co. v. Zenith Radio Corp., 475 U.S. 574, 586, 106 S.Ct. 1348, 1356, 89 L.Ed.2d 538 (1986). Speculation, conclusory allegations and mere denials are not enough to raise genuine issues of fact. To avoid summary judgment, enough evidence must favor the non-moving party's case such that a jury could return a verdict in its favor. See Anderson v. Liberty Lobby, 477 U.S. 242, 248, 106 S.Ct. 2505, 2510, 91 L.Ed.2d 202 (1986) (interpreting the "genuineness" requirement).

II. Court's Consideration of the SAI.

Plaintiff urges the Court not to consider the SAI but to look solely to the Prospectus in determining whether the Complaint survives the instant motion. Defendants respond that because the SAI was incorporated into the Prospectus by reference, the freeze rule effectively "appeared" in the Prospectus. They accordingly ask the Court to consider that the SAI, as well as the Prospectus, is before it for purposes of this motion.

The Court considers that the SAI is in fact before it, both because the SAI was incorporated by reference into the Prospectus, which itself is referred to in plaintiff's Complaint (¶¶ 17, 18, 19), and also because defendants included it among their moving papers for summary judgment, annexed as Exhibit B to the Cranney Affidavit. Fed.R. Civ.P. 56(c); see Feinman v. Schulman Berlin & Davis, 677 F.Supp. 168, 170 n. 3 (S.D.N.Y.1988). The SEC expressly provided that SAIs incorporated by reference are deemed "a part of the prospectus as a matter of law." 48 Fed.Reg. at 37930. Plaintiffs may not selectively quote from the Prospectus and then argue that the Court should not consider it in its entirety, including referenced portions such as the SAI, in order to avoid summary judgment. The SAI is an integral part of the evidence in this case and is properly before the Court on this motion for summary judgment.

III. Placement of the "Freeze" Rule

The substantive question before the Court is whether, as a matter of law, the information about the freezing of the CDSC calculation had to appear in the Prospectus itself, or whether it was permissible for it to appear in the SAI, as incorporated into the Prospectus by reference.

The SEC envisaged that new prospectuses called for by Part A of Form N-1A,

standing alone, will meet the standard of section 10(a) of the 1933 Act. That is, the simplified prospectus will contain the information

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