Securities Law - Illinois Securities Law Statute of Limitations

This case is interesting because the plaintiffs abandoned claims under the Illinois Securities Law - to avoid a dismissal on the ground that the action was time-barred.

Plaintiffs in the case captioned Carpenter, et al. v. Exelon Enterprises Company, LLC, and Exelon Corporation, Appeal No. 1-09-1222 (4th Circuit), sued Exelon claiming that Exelon abused its position as majority shareholder of InfraSource in such a way that the rights of the minority shareholders were violated and not represented fairly in a merger and sale transactions.

Exelon filed a motion to dismiss on the grounds that it was barred by the three-year Illinois Statute Of Limitations. The trial court denied Exelon’s motion to dismiss determining that the Illinois Securities Law limitation period was inapplicable and plaintiffs’ suit was therefore timely filed within the residual five-year limitation period found in § 13-205 of the Code Of Civil Procedure. However, the trial court stayed the proceedings and certified the issue of the appropriate statute of limitations for an interlocutory appeal.

Exelon filed a motion to dismiss on the grounds that the Statute Of Limitations under the Illinois Securities Law of three years was applicable and the case should be dismissed. The Plaintiffs did not respond to the motion choosing to voluntarily dismiss their initial complaint and they refiled an amended complaint. In the amended complaint, the plaintiffs abandoned their Illinois Securities Law claims and proceeded under Delaware law instead.

The amended complaint contained additional allegations of the conduct of Exelon and contained an explicit statement that it purported to be brought under Delaware law and did not allege that defendants’ conduct constituted a violation of the Illinois Securities Law. Plaintiffs sought damages in excess of $11,000,000. Exelon again filed a motion to dismiss complaining, notwithstanding the changes in the amended complaint, that the manner for which relief was sought was still provided under the Illinois Securities Law and it was therefore barred by the three-year statute of limitations. The trial court disagreed and found that the suit was properly filed within the five-year limitation of § 13-305 of the Code. The trial court entered an order denying Exelon’s Motion To Dismiss but stayed further proceedings and certified the following question for interlocutory appeal, as the trial court found this issue involving the question of law upon which substantial ground for difference of opinion existed:
“Whether plaintiffs’ claim that Exelon Enterprises Company, LLC, as majority shareholder of InfraSource, Inc., breached its fiduciary duties in connection with InfraSource, Inc.’s 2003 merger transaction is governed by the three year statute of limitations contained in the Illinois Securities Law of 1953, 815 ILCS 5/13(d).”

The trial court granted Exelon’s petition for leave to appeal the interlocutory order of the trial court denying the motion to dismiss.

The trial court made reference to of § 13 of the Illinois Securities Law which delineates the private and other civil remedies available for violations of the Law. It pointed out that of § 13(A) provides that every sale in violation of the provisions of the Act is voidable at the election of the purchaser and that § 13(B) and § 13(C) outline various notice and mitigation requirements that a purchaser must fulfill before electing the option of rescission. Subsection 13(D) provides a three-year statute of limitation.

Exelon cited various federal cases which held that the Illinois three-year statute of limitation provided a bar to certain claims for relief. On the other hand, Plaintiff states that the claim is one of minority shareholder oppression and not covered by the Illinois Securities Law or the statute of limitations.

The Defendant, Exelon, argued that of § 13(F) and of § 13(G) provides injunctive relief as well as a right of rescission to “any party in interest”. The Court while acknowledging a contrary holding by a federal court in Klein v. George G. Kerasotes Corp., 500 F.3d 669 (7th Cir. 2007) held that plaintiffs were not barred by the three-year statute of limitations.

The Appellate Court held that the three-year limitation contained in of § 13 applies to relief under § 13 for which relief is granted by § 13. Section 13 provides only for (1) a retroactive right of rescission to purchase under subsection 13(A) and (2) a prospective remedy to the Illinois Secretary Of State and “any party in interest” under of § 13(F) and of § 13(G). Section 13 does not concern retroactive common law damage claims for breach of fiduciary duty both by sellers of securities in general or minority shareholders in particular. For the three year limitation contained in § 13(D) does not apply does not apply to claims of the plaintiffs against Exelon. Therefore the certified question is answered in the negative. Such being the case, the five-year of limitations applies and the case is timely.

Abandoning a claim for relief under the Illinois Securities Law was successful.

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Securities Law - Statute of Limitations Merck v. Reynolds

On April 27, 2010, the United States Supreme Court issued its decision in Merck & Co v Reynolds, 08-905. The issue was whether the plaintiff's claim was barred under the applicable statute of limitation. The Statute of Limitations for securities claims alleging fraud, deceit or contrivance is that the claim must be filed not later than 2 years after disclosure of facts constituting the violation or 5 years after the violation. 28 U.S.C. Section 1658(b).

There have been division in the circuits on when a claim accures and whether a plaintiff had to have notice of scienter. Scienter has been defined as a mental state embracing intent to deceive, manipulate, or defraud. Ernest & Ernest, .v Hochfelder, 425 U. S, 185. In a 10b-5 case the plaintiff must prove that a defendant made a material misstatement with intent to deceive, not merely innocently or negligently.

The case arose out of the controversy involving the drug Vioxx. The District Court held that the state of Limitations barred the claim because investors were placed on inquiry notice of the claim more than 2 years before they filed suit. Inquiry notice exists when the victim is aware of facts that would lead a reasonable person to investigate and consequently acquire knowledge of the defendants misrepresentations, Great Rivers Cooperative v Farmland Industries, Inc. 120 Fed. 3rd 893

In September 2001 the FDA released a letter that stated that Merck had misstated the safety of the drug. The District Court referred to various press articles to support that proposition because of the widespread adverse publicity the investors were on notice more that 2 years before the lawsuit was filed The Third Circuit reversed and said that was not sufficient t to establish inquiry notice. The Court also stated that Merck at about the same time issued notices describing the drugs safety.

The Supreme Court granted certiorari and said that a plaintiff was required to discover facts of scienter. It started with the statutory language that the limitations period begins to run once there has been discovery of facts constituting the violation and noted that scienter was both a fact and an element of a Sec.10 (b) 5 violation. The Court concluded that facts of scienter can be distinct from establishing that there has been a material misrepresentation because an incorrect prediction does not show whether the speaker deliberately lied or just made an in an innocent error. The Court held that the statute of limitations does not begin to run until the plaintiff discovers or a reasonably diligent plaintiff would have discovered facts constituting the violation. Thus, the plaintiff's claims were not barred by the statute of limitations.

The Supreme Court affirmed the decision of the Third Circuit to the effect that Plaintiff’s claim was not barred by the statute of Limitations.

The case is also interesting because the decision of the Supreme Court was unanimous.

Edward X. Clinton, Sr.
www.clintonlaw.net

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Corporate Law - Agent Lacks Authority to Bind Company

CORPORATE LAW - COURT HOLDS THAT PURPORTED AGENT LACKED AUTHORITY TO BIND CORPORATION TO SUSPICIOUS TRANSACTIONS WHICH WERE HARMFUL TO THE CORPORATION.


Herbert W. Fritzsche, et al. v. Gregory LaPlante and M. Christine Rock, 2-09-0329, Illinois Appellate Court Second District.

This issue raised in this case is whether or not a corporate officer had the authority to bind the corporation to some highly unusual transactions. The backstory is that the corporate officer was the daughter of the founder and President of the company and that she was apparently involved a feud with her siblings.

M. Christine Rock, acting as secretary/treasurer of a family corporation, Fritzsche Industrial Park (FIP) and as holder of a power of attorney for her father, Herbert W. Fritzsche, signed a lease agreement with her live-in boy friend, Gregory LaPlante. The lease named the Industrial Park as lessor and Gregory as lessee. The premises included 16 properties within the Industrial Park. Christine Rock owned 60 shares of a total of 1,000 shares that were issued and outstanding. Her father owned the majority of 685 shares. Christine Rock, at about the same time, also signed a promissory note in favor of Gerald Shaver in the principle amount of $450,000. The maker of the note was listed as Fritzsche Industrial Park and Park National Bank as Trustee under a Land Trust.

Plaintiffs, the corporation and other family members, filed this lawsuit alleging that Christine acted without Corporate authority and entered into the lease and note and without any authority as her father’s power of attorney in entering into the Lease Agreement. Because Christine refused to furnish records of rents and expenses, the shareholders informed her that she would be removed as Secretary/Treasurer. The suspect transactions were entered into after Christine learned that she would soon be removed as Secretary/Treasurer.

Plaintiffs filed a motion for summary judgment alleging that even if Christine had been the true Secretary/Treasurer of FIP and Herbert’s power of attorney, she still would not have had the authority to enter into the lease or the note. Plaintiffs allege that Christine did not have the authority to enter into the lease under either the common law or a statute. An affidavit was attached to the Plaintiff’s Motion For Summary Judgment which stated that at no time did the shareholders of FIP or the Board meet to vote on the lease or the note and that the Board never authorized Christine to act on behalf of FIP with regard to the lease or the note. Because there was no approval by the Board of Directors Ms. Rock lacked authority to cause the corporation enter into the lease or the note.

Ms. Rock and her boyfriend argued that Board approval and other corporate formalities were not required in order to allow Christine to execute the lease. Defendants stated that some of the properties included in the lease were not owned by Fritzsche but were owned by Herbert or some other member of the Fritzsche family and, therefore, corporate formalities were not necessary.

The trial court granted summary judgment for the plaintiffs - the corporation and Herbert W. Fritzsche.

Defendants appealed the grant of summary judgment. The Appellate Court affirmed the grant of summary judgment in all respects. The Appellate Court held that the Trial Court was correct in ruling that Christine did not have authority to enter into the lease or the note.

Under common law, the mere fact that a corporation has the power to make a certain type of contract does not, of itself, clothe even the highest officer of the corporation with the apparent authority to bind the corporation to such a contract. Corn Belt Bank v. Lincoln Savings & Loan Ass’n, 19 Ill.App. 3d 238, 245 (1983). Further, officers have no apparent authority to make unusual or extraordinary contracts on behalf of a corporation. Corn Belt Bank, 119. Ill.App. 3d at 245. “’If the president of a corporation were authorized to make contracts of this character without action of the directors and without notice to or knowledge of anyone, the directors would not at any time know whether it was headed for bankruptcy.’” Sacks v. Helene Curtis Industries, Inc., 340 Ill. App. 76, 91 (1950), quoting Warszawa v. White Eagle Brewing Co., 299 Ill. App, 509. Plaintiffs further argued that the Lease of the entire industrial park was an extraordinary transaction and that Illinois common law and its statutes prohibit an officer from entering into extraordinary and unusual contracts and/or contracts involving substantially all of the corporations assets, outside the ordinary course of business, without the board's consideration and approval.

The Court concluded that the Lease was an extraordinary transaction and, it implied, one that no rational corporation would approve. "Here, FIP/Christine transferred numerous properties contained int he Fritzsche Industrial Park to Gregory, a nonfamily member and a nonofficer/nonshareholder. The Lease does not specify Gregory's obligations to FIP's existing tenants. Although the Lease includes properties under trust, no trustees ever signed the Lease. Although the Lease involved 26 different properties (PINs), it seems no professionals, such as attorneys or realtors, were involved in drafting the Lease; defendants are the only signatories and/or witnesses to the Lease. Perhaps most strangely, the Lease seems to provide Gregory profit with little to no risk or investment. If he generates income, he pays a relatively small percentage of that income to the corporation; if he generates no income, he pays the corporation only taxes due to the government. As such, under common law, the Lease is the sort of transaction that would require authorization by the Board."

The Court also made specific reference to the Illinois Compiled Statutes, § 805 ILCS 5/11.55 which provides that where a sale, lease or exchange of assets involves, 'all, or substantially all, the property and assets ...of a corporation,' the board of directors must adopt a resolution recommending the transaction, whereupon said resolution shall be submitted to a vote by the shareholders at a meeting. § 805 ILCS 5/11.60(1).

The court held that the Lease essentially put the corporation out of business and, thus, was an extraordinary transaction.

In regard to the note that was executed, the Court made specific reference to Fritzsche’s by-laws entitled “Contracts, Loans, Checks and Deposits” which states “No loan shall be conducted on behalf of the Corporation and no evidence of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors." Of course, the promissory note was never submitted to the Board for its consideration. The Court held that Christine was not permitted to bind the corporation by executing the note and that the note was void and unenforceable.

Thus, the Appellate Court found that Christine was not authorized to enter into the lease or make the note and, accordingly, affirmed the Trial Court’s grant of summary judgment to plaintiffs. The opinion contains a through discussion of corporate formalities and the need to comply.

Edward X. Clinton, Sr.

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Securities Law - Wells Notice

A Wells Notice advises a public company or a principal officer of a public company that the Securities & Exchange Commission is considering enforcement action because of some alleged violation of the Securities Laws. The company or individual is given a chance to respond and explain why enforcement action should not be brought. Not all Wells’ Notices lead to enforcement action. The term “Wells Notice” is named after Senator John Wells, who in 1972 chaired a committee to review SEC enforcement procedures.

Goldman Sachs received a Wells Notice in July 2009 in connection with the sale by Goldman Sachs of a synthetic collateralized debt obligation known as Abascus 2007-AC-1. The notice was not disclosed to shareholders or otherwise made public. Corporate lawyers believe that it depends on the facts whether a Wells Notice should be disclosed. Plaintiff’s lawyers generally take the position that such notices should be disclosed because they are material. In other words an SEC investigation has proceeded to the point that the staff is considering proceeding against the company or a principle officer. Two class actions have been filed so far against Goldman Sachs alleging, among other things, that the Wells Notice was concealed from investors.

According to an article in the Wall Street Journal dated April 10, 2010, five Senior Executives of Goldman Sachs Group Inc., including the firm’s co-general counsel, sold $65.3 million worth of stock after the firm received notice of possible fraud charges, which later drove its stock down 13%. There is no suggestion in the article that those executives had any knowledge of the Wells Notice.

The SEC has alleged in the well-publicized case against Goldman Sachs that the firm made misrepresentations and material omissions in the marketing in 2007 of a collateralized debt obligation known Abascus 2007 AC-1.

The public will learn much more about Wells Notices after there is further disclosures by either Goldman Sachs or the SEC.

Ira Schochet, a partner in the New York law firm of LaBaton, Sucharow LLP, responded to the argument that disclosing Wells Notices just repeats unproven allegations.
However, Schochet stated that if there is a substantial defense, issuers can disclose that as well. Schochet is also President of the National Associations of Shareholder and Consumer Attorneys, a group of about 100 law firms that represent investors and consumers.

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Business Debts - The Bankruptcy Court Will Not Discharge A Debt Where The Underlying Loan Was Procured Through Fraud

In Ojeda v. Goldberg, No. 09-2008, the Seventh Circuit affirmed a determination of the District Court (Judge Gottschall) that a debt was not dischargeable because the underlying loan was procured through fraud.

This case is of interest even to those who do not practice in the bankruptcy area as bankruptcy considerations often govern corporate transactions.

Facts:

The Goldbergs were creditors of Ernest and Beverly Ojeda. The parties executed a short-term high-interest-rate loan in August 1998. The Ojedas were unable to pay the principal when the loan came due. However, they obtained numerous extensions of the loan's maturity date until January 2006 when the Ojedas defaulted.

In February 2006, the Ojedas filed for bankruptcy. Gail Goldberg filed an adversary proceeding against the Ojedas seeking a declaration that the $600,000 loan was not dischargeable because it was procured fraudulently.

The Ojedas owned (through corporations) two McDonald's restaurants. The Ojedas later sold the McDonald's franchises.

When the loan came up for renewal, the Ojedas did not disclose to the Goldbergs that they had sold the McDonald's restaurants. The District Court held that the entire debt $600,000 should be exempt from discharge because the Ojedas led Gail Goldberg to believe that they still owned the McDonald's restaurants when they did not. In fact, the district court noted that the Ojedas continued to use the checkbook for the McDonald's restaurants to pay interest long after the restaurants were sold.

The Seventh Circuit, in an opinion by Judge Kanne, affirmed. The legal standard is as follows:

For a creditor to receive an exception from discharge under 11 U.S.C. Section 523(a)(2)(A), the creditor must show that (a) the debtor made a false representation; (b) that the debtor knew was false and was made with intent to deceive; (c) upon which the creditor justifiably relied.

The Seventh Circuit agreed with the Bankruptcy and District Court that the Ojedas had made false representations with the intent to deceive the Goldbergs. The more difficult question was whether Gail Goldberd had justifiably relied on the Ojedas representations that they still owned the McDonald's restaurants. As the Court noted, "justifiable reliance is a less demanding standard than reasonable reliance" and Ms. Goldberg met that standard.

The Court noted that the Ojedas continued to use checks bearing the McDonald's information. Unless the Plaintiff possessed outside information, "there was no conceivable way that [Ronald Goldberg] could have been alerted to the sale (of the restaurants) when the Ojedas continued to give the impression that the sale never occurred." In sum, the Seventh Circuit was satisfied that the sale of the McDonald's restaurants was concealed and that the Goldbergs justifiably relied on the misrepresentations.

The Seventh Circuit further held that "a fraudulently induced forbearance constitutes an extension or renewal of credit for purposes of Section 523." The Goldbergs met their burden of proving that the forbearance was fraudulently induced in that (a) they had valuable collection remedies at the time of the misrepresentation; (b) they did not exercise those remedies based upon the misrepresentation; and (c) the remedies lost value during the extension period." Opinion at page 13.

Comment: Clients often believe that filing bankruptcy will wipe away their debts. However, bankruptcy courts often scrutinize transactions to determine if they were fair to all parties. Here, the debtors' trickery (hiding the fact that two fast food restaurants were sold) proved to be their undoing.


Edward X. Clinton, Jr.

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Securities Law - Statute of Limitations Decision - Merck & Co., v. Reynolds, 08-905

SECTION 10(b)-5 STATUTE OF LIMITATIONS

The U.S. Supreme Court on April 27, 2010 has furnished clarity to the question of when does the statute of limitations begin to run § 10(b)-5 Securities lawsuits. Plaintiffs filed a securities fraud action under § 10(b)-5 on November 6, 2003. The District Court dismissed the complaint on the ground that the filing was not timely because the plaintiff should have been alerted to the possibility of Merck’s misrepresentation prior to November 3, 2001 because of a study (the VIGOR study) showing adverse cardiovascular results when the Merck Drug Vioxx was used. The applicable statues of limitations provides in part “private right of action involving a claim for fraud, deceit, manipulation or contrivance in contravention of a regulatory requirement concerning the securities laws … may be brought not later than the earlier of (1) two years after the discovery of facts constituting the violation; or, (2) 5 years after such violation. 29 U.S.C. § 1658(b)(1).

The Complaint alleged that Merck defrauded investors by promoting the drug Vioxx when it knew of the serious safety issues of Vioxx. In 1998, internal Merck clinical trials showed that serious cardiovascular events occurred six times more frequently in patents given Vioxx. Merck claimed that the plaintiff should have known more than two years before filing the Complaint and the District Court agreed.

The Third Circuit reversed and said that although there were storm warnings about the use of Vioxx, they did not put plaintiff on inquiry. Merck sought review in the United States Supreme Court because of disagreements in the Circuits.

Justice Breyer wrote the opinion of the Supreme Court which unanimously affirmed the decision of the Third Circuit. Judge Breyer in his opinion states that the parties and the Solicitor General agree that § 1658(b)(1)’s word “discovery” refers not only to plaintiff’s actual discovery of certain facts, but also to the facts that a reasonably diligent plaintiff would have discovered. The opinion discusses the use of the word “discovery” by various authors and by the Supreme Court itself. In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991), the court said that private sections under 10(b)-5 actions “must be commenced within one year after the discovery of the facts constituting the violation and within three years after such violation.” The opinion went on to state that the word “discovery” as used in the statute encompasses not only those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known.

The Court then considered and dismissed various arguments suggesting that plaintiffs had knowledge more than two years prior to the filing of its Complaint. The Court concluded that the limitation period in § 1658(b)(1) begins to run once the plaintiff did discover or a reasonably diligent plaintiff would have discovered the facts constituting the violation, whichever comes first.

In determining the time at which ”discovery” of those “facts” occurred, such terms as “inquiry notice,” and “storm warnings” may be useful to the extent they identify time when the facts would have prompted a reasonably diligent plaintiff to begin investigating. But the actual limitation period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered “the facts constituting the violation,” including scienter, irrespective of whether the actual plaintiffs undertook a reasonably diligent investigation.

Judge Stevens wrote a concurring opinion and Justice Scalia wrote a concurring opinion joined by Justice Thomas.

A big defeat for Merck but important clarity when analyzing the § 10(b)-5 Statute Of Limitations.

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Securities Law - Investment Company Act - Supreme Court Reverses Seventh Circuit And Follows Judge Posner's Dissent

SUPREME COURT UPHOLDS POSNER DISSENT

On March 30, 2010 The United States Supreme Court unanimously reversed the Seventh Circuit Court Of Appeals in the case of Jones et al. v. Harris Associates, L.P. Harris Associates, No. 08-586. Harris Associates is a mutual fund case involving investment advisory fees that can be charged by an advisor to Oakmark, a captive mutual fund which Harris Associates organized. For about 30 years the principle set forth in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F. 2d 923, a Second Circuit case was considered the settled law. Gartenberg set forth two versions of a test to determine whether fees charged a mutual fund violates § 36(b) of the Investment Company Act of 1940: (1) whether the fee schedule represents a charge that was within the range of what would have been negotiated at arm’s-length in the light of all of the surrounding circumstances, and (2) to be guilty of a violation of § 36(b), the advisor must charge a fee that is so disproportionately large that it bears no reasonable relation to the services rendered and could not have been the product of arm’s-length bargaining.

In the United States District Court Judge Kocoras held that the fees charged were proper under the Gartenberg test and granted summary judgment in favor of Harris Associates. Plaintiffs’ mutual fund investors appealed to the Seventh Circuit, 527 F.3d 629 (May 2008). The Seventh Circuit in an opinion by Judge Easterbrook held that the Seventh Circuit disapproves the Gartenberg approach and stated that “a fiduciary must make full disclosure and play no tricks but it is not subject to a cap on compensation.” “The Trustees of a mutual fund, rather than a judge or jury, determine how much an advisory service is worth.” The judgment of the District Court granting summary judgment in favor of Harris Associates was affirmed.

The case then becomes even more interesting. There was a petition for rehearing. The panel voted unanimously to deny the petition. A Judge called for a vote on the suggestion for rehearing en banc but the majority did not favor such rehearing and it was denied. Judge Posner with Judges Rovner, Wood, Williams and Tinder dissented. Judge Posner wrote a dissent to the denial. The dissent quotes the Oakmark Prospectus and states “Subject to the overall authority of the board of trustees, [Harris Associates] furnished continuous investment supervision and management to the Funds and also furnishes office space, equipment and management personnel.” The Oakmark Fund, “Prospectus,” Jan. 28, 2008, p. 36. Recall Professor Kuhnen’s observation that “when directors and the management are more connected, advisers capture more rents and are monitored by the board less intensely.”

There now being a split in the Circuits, the Supreme Court granted certiorari. 559 U.S. ____ (2010). On March 30, 2010 Judge Alito wrote for the unanimous court and reversed the judgment of the Seventh Circuit. The Supreme Court concluded that Gartenberg was correct in its formulation of what § 36(b) requires: to face liability under § 36(b) an investment advisor must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and it could not have been the product of arm’s-length bargaining. The Supreme Court stated that the Investment Company Act modifies fiduciary duty in a significant way: it shifts the burden of proof from the fiduciary to the party claiming breach, 15 USC, § 88-35(b)(1) to show that the fee is outside the range that arm’s length bargaining would produce.

Judge Alito went on to state that by focusing almost entirely on the element of disclosure the Seventh Circuit Panel erred. See, 527 F.32 at 632 (An investment provider “must make full disclosure and play no tricks but is not subject to a cap on compensation”). Judge Alito stated that although the Gartenberg standard may lack sharp and analytical clarity, it had provided a workable standard for nearly three decades. The judgment of the Seventh Circuit was vacated and the case remanded.
In the writer’s opinion, the reversal of the Seventh Circuit was important for another reason.

Had the ruling of the Seventh Circuit not been overturned businesses would argue in unrelated matters that accurate disclosure would justify other actions without further examination.

Edward X. Clinton, Sr.

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