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KROME v. MERRILL LYNCH & CO.

June 17, 1986

RONALD L. KROME, SCOTT FREEMAN, RAYMOND JACKSON and CARL SACKS, Trustees of the University Emergency Services Profit Sharing Trust, MILDRED SHARKEY, MICHAEL COURTNEY and ROBERT PACQUETT, Trustees of Eastside Wholesale Supply Employees Pension Plan and Trust, JOHN J. O'KEEFE, JOSEPH STAMELL and JAMES PETERSON, SR., Trustee of the Greenfield Lumber Co. Employee Profit Sharing Trust, Plaintiffs,
v.
MERRILL LYNCH & CO., INC. and MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, Defendants



The opinion of the court was delivered by: EDELSTEIN

OPINION AND ORDER

EDELSTEIN, District Judge:

This is a civil action alleging violations of Section 12(1) of the Securities Exchange Act of 1933 ("1933 Act"), 15 U.S.C. § 771(1); Section 12(2) of the the 1933 Act, 15 U.S.C. § 771(2); Section 17 of the 1933 Act, 15 U.S.C. § 77q; Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78j and Rules 10b-5 and 10b-10 promulgated thereunder, 17 C.F.R. 240.10b-5, 10b-10; and the Investment Company Act ("ICA"), 15 U.S.C. § 80a-1 et seq. Defendants have moved, pursuant to Federal Rule of Civil Procedure 12(b)(6), to dismiss the causes of action under Section 12(2) of the 1933 Act as to all but two plaintiffs based on the statute of limitations, the causes of action under Sections 12(2) and 17 of the 1933 Act and Section 10(b) of the 1934 Act and Rules 10b-5 and 10b-10, and the cause of action under the ICA for failure to state a claim. The motion is granted in part and denied in part. Plaintiffs have moved for class certification. This motion is granted.

 BACKGROUND

 This action arises out of Merrill Lynch, Pierce, Fenner & Smith Incorporated's ("Merrill Lynch") sale of Treasury Investment Growth Receipts ("TIGRs") to the public beginning in approximately August 1982. Plaintiffs are purchasers of TIGRs.

 TIGRs are in the nature of zero coupon bonds which are sold at a discount from their face value. The face value is due on the date of maturity. Plaintiffs allege that Merrill Lynch made claims to the public in offering circulars and prospectuses that TIGRs were a Merrill Lynch innovation combining the special features of zero coupon bonds with the security of United States government backing.

 Plaintiffs contend that Merrill Lynch represented that the payment obligations on the TIGRs would be covered by the principal and interest payments on United States Treasury Bonds ("Treasury Bonds") purchased by Merrill Lynch in sufficient amounts for such purposes, and that the TIGRs represent ownership of future principal and interest payments on the Treasury Bonds. The named plaintiffs purchased their TIGRs at different times. For purposes of this Opinion, it is convenient to divide plaintiffs into two groups: those purchasing TIGRs in 1983 ("1983 Group") and those purchasing in 1984 ("1984 Group"). *fn1"

 Plaintiffs allege that Merrill Lynch violated the 1933 Act and the 1934 Act by failing to disclose material information with respect to TIGRs and by issuing false statements concerning the TIGR program. Plaintiffs allege that Merrill Lynch violated numerous provisions of the ICA by, among other actions, offering TIGRs for sale through the mails without registering; that the TIGR program employs Merrill Lynch as a broker underwriter; that Merrill Lynch represented that TIGRs were guaranteed by the United States government; and that Merrill Lynch acted as an investment advisor to the TIGR program without a written contract.

 Defendants have moved, pursuant to Rule 12(b)(6), to dismiss the Section 12(2) claim as to the 1983 group, portions of the Section 12(2) claim, the Section 10(b) and Rules 10b-5 and 10b-10 claims, the Section 17 claim and the ICA claims.

 I. MOTION TO DISMISS

 A. The Statute of Limitations as Implicated in the 1983 Group: Section 12(2) Claims.

 Plaintiffs claim that defendants used brochures, offering circulars, and prospectuses containing untrue statements of material facts and omissions of material facts as means to offer and sell TIGRs. Plaintiffs further claim that transportation in and communication through interstate commerce and the mails were used. Plaintiffs allege that this conduct violated Section 12(2) of the 1933 Act.

 Defendants move to dismiss the Section 12(2) claim as to the 1983 Group on the ground that it is barred by the statute of limitations. Defendants claim that the plaintiffs in the 1983 Group failed to comply with the requirement that an aggrieved party either commence an action under the statute within one year following purchase, or affirmatively plead facts establishing compliance with the statute. Sufficient pleading includes establishing plaintiffs' diligence in attempting to discover alleged misstatements and omissions. Alfaro v. E.F. Hutton & Co., 606 F. Supp. 1100, 1107 (E.D. Pa. 1985); Brick v. Dominion Mortgage & Realty Trust, 442 F. Supp. 283, 291-92 (W.D.N.Y. 1977); see 15 U.S.C. § 771(2).

 The statute of limitations for Section 12(2) is prescribed by Section 13 of the 1933 Act which provides in relevant part, "[N]o action shall be maintained to enforce any liability under section . . . 12(2) of this title unless 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. Where the very statute that creates the cause of action also contains a limitations period, the statute of limitations not only bars the remedy but also destroys the liability. Cook v. Avien, Inc., 573 F.2d 685, 695 (1st Cir. 1978). Therefore, the burden of showing compliance with the Section 12(2) statutory period of limitations rests with the plaintiff. Id. Section 13 has been interpreted as substantive rather than procedural, in that it is viewed as setting forth an essential ingredient to a private cause of action based on Section 12(2). Limitations of this sort require factual determinations which should not be resolved on a motion to dismiss, but rather should be left for final determination at trial. Bull v. American Bank and Trust Co. of Pennsylvania, 18 Sec. Reg. & L. Rep. (BNA) 315, 316 (E.D. Pa. Jan. 13, 1986); Kroungold v. Triester, 407 F. Supp. 414, 419 (E.D. Pa. 1975).

 Section 13 establishes a reasonable diligence requirement so that an action is considered timely if the action is commenced within one year after the possibility of fraud should have been apparent. See Hill v. Der, 521 F. Supp. 1370, 1389 (D. Del. 1981); 15 U.S.C. § 77m. To adequately plead compliance with this requirement, the plaintiff must set forth: (1) the time and circumstances of the discovery of the fraudulent statement; (2) the reasons why it was not discovered earlier (if more than one year has lapsed); and (3) the diligent efforts which plaintiff undertook in making or seeking such discovery. Hill v. Der, 521 F. Supp. at 1389; Kroungold, 407 F. Supp. at 419.

 In the case at bar, plaintiffs allege that "[t]his action has been brought within one year after the discovery of the omissions or after such discovery should have been made by the exercise of reasonable diligence and within three years after the sale of the securities." Complaint at [P] 40. Conclusory allegations, such as these, are insufficient to satisfy the pleading requirements of Section 13. See Hill v. Der, 521 F. Supp. at 1387.

 Plaintiffs contend, however, that defendants may not inequitably take advantage of their own wrong by relying on the statute of limitations as a bar to a cause of action. See Katz v. Amos Treat & Co,, 411 F.2d 1046, 1055 (2d Cir. 1969); see also Glus v. Brooklyn Eastern District Terminal, 359 U.S. 231, 232-33, 3 L. Ed. 2d 770, 79 S. Ct. 760 (1959). For the doctrine of equitable tolling to apply, a plaintiff must allege and prove that the defendant took positive steps after the commission of the initial fraud to keep it concealed. The complaint must, therefore, set forth essential facts supporting the claim of fraudulent concealment. Hill v. Equitable Trust Co., 562 F. Supp. 1324, 1344 (D. Del. 1983). The present complaint fails to allege such facts, and is, therefore, insufficient to invoke the doctrine of equitable tolling.

 Thus, plaintiffs' claims under Section 12(2) of the 1933 Act contained in their second cause of action are dismissed. Plaintiffs, within ten days of this Opinion, may file an amended complaint. The complaint must be amended to properly Plead either the issue of reasonable diligence or equitable tolling as outlined in this opinion. See Hill v. Der, 521 F. Supp. at 1389.

 B. Failure to State a Claim for Which Relief Can be Granted.

 Defendants seek to dismiss the Claims based on Sections 17 of the 1933 Act and Section 10(b) of the 1934 Act and Rules 10b-5 and 10b-10 promulgated thereunder and the ICA claims for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6).

 1. § 10, § 12(2) and § 17 Claims

 Plaintiffs claim that defendants violated Section 10(b) of the 1934 Act and Rules 10b-5 and 10b-10 promulgated thereunder as well as Section 12(2) and 17 of the 1933 Act. Plaintiffs allege that defendants have done this by offering TIGRs for purchase and sale to the public through interstate commerce and the mails when the brochures and prospectuses contained materially false statements and material omissions regarding markups, the amount added on to the price of a security that is paid to the seller. Further, plaintiffs assert that defendants knew of and intended to deceive plaintiffs or alternatively acted with reckless disregard in not realizing the misleading nature of the information provided. By relying on the omissions and misstatements, plaintiffs allege that they sustained damages after purchasing TIGRs.

 a. Rule 10b-10

 Defendants move to dismiss the Rule 10b-10 claim on the ground that the Rule limits disclosure of markups to situations in which three specific criteria are met. Under the Rule, markups must only be disclosed where the following three conditions are satisfied: 1) the transaction involves an equity security; 2) the broker-dealer is not a market-maker; and 3) the broker-dealer makes contemporaneous offsetting purchases on the sale of securities from or to another person. Defendants deny that any of these situations apply, claiming: 1) that TIGRs are debt instruments; 2) that plaintiffs make no specific allegations of Merrill ...


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