The opinion of the court was delivered by: SHIRLEY WOHL KRAM
MEMORANDUM OPINION AND ORDER
SHIRLEY WOHL KRAM, U.S.D.J.
Plaintiffs Lisa A. Phifer, I. Bibicoff Inc. Pension Trust Fund, Gerald S. Susman and Diana Goldshlack bring this action alleging violations of §§ 11 and 12(2) of the Securities Act of 1933 (the "1933 Act"), as amended, 15 U.S.C. §§ 77k and 77l(2), § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act" or "1934 Act"), as amended, 15 U.S.C. § 78j(b) and Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5, promulgated thereunder. Defendants Bernard Chaus, Inc. ("BCI"), Bernard Chaus and Josephine Chaus (collectively, the "Chaus Defendants"), move to dismiss the Consolidated and Amended Complaint (the " Amended Complaint") (1) pursuant to Rule 4(j) of the Federal Rules of Civil Procedure, for failure to serve timely process, (2) pursuant to Section 13 of the 1933 Act, 15 U.S.C. § 77m, for failure to comply with the applicable statute of limitations, (3) pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, for failure to state a claim upon which relief may be granted and (4) pursuant to Rule 9(b) of the Federal Rules of Civil Procedure, for failure to plead fraud with particularity. In addition, the Chaus Defendants move for an order, pursuant to Rule 56 of the Federal Rules of Civil Procedure, granting them summary judgment dismissing the complaint on the grounds that the applicable statutes of limitation bar plaintiffs' claims. Defendants Merrill Lynch, Pierce, Fenner & Smith, Inc. and Bear Stearns & Co. Inc. (the "Lead Underwriters")
move to dismiss the Amended Complaint (1) pursuant to § 13 of the 1933 Act and appropriate case law, for failure to comply with the applicable statute of limitations (2) pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure, for failure to state a claim upon which relief may be granted and (3) pursuant to Rule 9(b) for failure to plead fraud with particularity.
This action is the consolidation of four separate actions brought between December 7, 1988 and January 13, 1989. The original complaint (the "1988 Complaint") charged the Chaus Defendants and Lead Underwriters with violations of §§ 11 and 12(2) of the Securities Act of 1933 (Count I), § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder (Count II) and supplemental state law claims for negligence and negligent misrepresentation (Count III).
In this Court's prior opinion, In re Chaus Sec. Litig., [Current]Fed. Sec. L. Rep. (CCH) P 95,646 at 97,888 (S.D.N.Y. Nov. 20, 1990) ("Chaus I"), familiarity with which is assumed, this Court dismissed all three counts of the 1988 Complaint. Count I was dismissed without prejudice for failure to plead compliance with the statute of limitations, failure to state a claim under Rule 12(b)(6) and failure to plead fraud with particularity in accordance with Rule 9(b). Count II was dismissed without prejudice under Rules 12(b)(6) and 9(b). Count III was dismissed with prejudice.
The Amended Complaint was subsequently filed on December 18, 1990. It alleges that due to misrepresentations and omissions by the Chaus Defendants and Lead Underwriters, plaintiffs were induced to purchase stock in BCI, a corporation engaged in the design, manufacture and marketing of women's clothing. Specifically, plaintiffs claim that the Chaus Defendants and Lead Underwriters misrepresented BCI as experiencing a dramatic growth in profitability during the period immediately before the IPO by allowing its customers excessive credits for mark-down merchandise, chargebacks and sales discounts, Amended Complaint at P 27, reporting accounts receivables from its customers based on "gross sale prices" without adjusting downward for advance mark-down money, id. at P 28, delaying gross sales attributable to fiscal 1985 to fiscal 1986, id. at P 27, and allocating more advertising expense as a percentage of gross sales to fiscal 1985 than 1986. Id. The effect of these manipulations, according to plaintiffs, was to overstate BCI's true income and assets. Id. at P 28.
Plaintiffs further allege that the Chaus Defendants engaged in illegal and discriminatory price rebates to BCI's customers, id. at P 31, that BCI never built any significant management infrastructure, controls or systems, id. at P 32, and that BCI failed to perform marketing evaluations, id. at P 33, relying instead on the personal instinct and tastes of Bernard and Josephine Chaus. Id. at P 41. The Prospectus allegedly failed to disclose that BCI had "recklessly" added new product lines without employing experienced personnel, and that its management did not have good insight into the market. Id. at P 40. Plaintiffs contend that the Chaus Defendants and Lead Underwriters concealed BCI's lax and inadequate financial and accounting controls, id. at P 43, and failed to disclose the extent to which BCI's quota problems hindered importation of their foreign manufactured goods. Id. at P 42.
Lastly, plaintiffs contend that several passages in the 1986 and 1987 Annual Reports were false and misleading when made because defendants knew or recklessly disregarded price manipulations, lack of adequate financial and accounting controls and the reduction of H. R. Macy & Company's patronage. Plaintiffs allege, however, that because of defendants' misrepresentations, they were not on notice of defendants' fraud until September 23, 1988, when BCI reported a $ 10.9 million loss, id. at PP 57-58, and October 18, 1988, when BCI issued an annual report disclosing a pre-tax loss of $ 21 million. Id. at P 50.
I. Relation Back of the Amended Complaint
As a preliminary matter, the Court must determine whether the Amended Complaint should relate back to the date of the 1988 Complaint for statute of limitations purposes. The Chaus Defendants argue that plaintiffs' claims should not relate back for two reasons: first, since service of process of the 1988 Complaint on Bernard and Josephine Chaus was faulty, the Amended Complaint is actually plaintiffs' first complaint for statute of limitations purposes;
second, the Amended Complaint raises new factual allegations of fraudulent manipulation of accounts receivable that do not arise out of the same transactions or occurrences as do those pled in the 1988 Complaint.
A. Relation Back Under Rule 4(j)
Rule 4(j) of the Federal Rules of Civil Procedure provides, in pertinent part:
If service of the summons and complaint is not made upon a defendant within 120 days after the filing of the complaint and the party on whose behalf such service was required cannot show good cause why such service was not made within that period, the action shall be dismissed as to that defendant without prejudice upon the court's own initiative with notice to such party or upon motion.
Fed. R. Civ. P. 4(j). If a plaintiff cannot establish "good cause" for failure to meet the deadline, dismissal is mandatory. Yosef v. Passamaquoddy Tribe, 876 F.2d 283, 287 (2d Cir. 1989), cert. denied, 494 U.S. 1028, 110 S. Ct. 1474, 108 L. Ed. 2d 611 (1990).
The Chaus Defendants contend that plaintiffs' failure to serve either of the Chauses with the summons and complaint within the 120-day time frame contemplated by Rule 4(j) requires dismissal of the Amended Complaint on statute of limitations grounds. They argue that because the 1988 Complaint was never served, the Amended Complaint is actually the first complaint and cannot "relate back" to the filing of the 1988 Complaint. As such, according to plaintiffs, the Amended Complaint, having been served on December 18, 1990, beyond three years from the IPO, and is thus barred by the applicable statutes of limitation.
Plaintiffs contend that service of process was duly made by serving copies of the summons and complaint on the Chaus's then attorneys and, on an occasion several months hence, by leaving copies of the process with a manager at BCI's New York offices. Plaintiffs argue, however, that in the event the Court were to find service ineffective, application of Rule 4(j) is unwarranted under the circumstances since the Chauses will suffer no actual prejudice from a liberal application of the rule.
With respect to service of process of the 1988 Complaint on the Chauses, the record is clear that such service was patently defective, the Chauses were never served with the summons and 1988 Complaint and plaintiffs have failed to establish good cause for failing to do so. The undated certificate of service of Richard Kilsheimer, Esq. (annexed as Exhibit "K" to the affidavit of Richard D. Greenfield ("Greenfield Aff."), sworn to December 8, 1989) one of plaintiffs' attorneys, indicates that on or about December 6, 1988, he served a copy of the summons and 1988 Complaint on the Chauses then attorney, Howard Wilson ("Wilson"), and his law firm, Rosenman & Colin. Richard Greenfield ("Greenfield"), a senior partner of the firm of Greenfield & Chimicles, plaintiffs' lead counsel, similarly avers that he forwarded a copy of the process to the Chaus's then counsel by courier. See Greenfield Aff., at P 6. Greenfield also avers that Wilson and his firm held themselves out as counsel to the Chauses, had had extensive negotiations with plaintiffs' counsel and displayed his name on all pleadings filed by the Chaus Defendants in this litigation. See Greenfield Aff., at PP 7-8. Greenfield nowhere claims, however, that Wilson, or any other member of his firm, expressly or impliedly agreed to waive the requirement of service of process with respect to the Chauses by accepting service on their behalf. While plaintiffs may have undertaken to extend the professional courtesy of forwarding to their adversaries' counsel a copy of a pleading concurrently being filed and served, the Court declines to construe acceptance of such a transmission as the equivalent of receipt of proper notice of the pendency of the suit and a knowing waiver by the Chauses of the requirement of proper service of process. See Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 94 L. Ed. 865, 70 S. Ct. 652 (1950). To construe the facts here as a waiver of the defendants' right to have process properly served upon them would permit the finding of a waiver in virtually every case in which plaintiff's counsel is aware of the identity of his adversary, and would effectively obliterate the requirement of proper service of process and the due process concerns that such requirement safeguards.
In addition, the purported affidavit of service of Peter A. Kabcenell (annexed as Exhibit "L" to the Greenfield Affidavit), stating that process was served on the Chauses "by delivering true copies thereof to Joanne Trezzam Manager of Administration, at 1410 Broadway, New York, New York," is unsigned and unsworn and therefore of no probative evidentiary value. Even had Kabcenell's affidavit been sworn, it fails to aver that copies of the process were subsequently mailed as is required under C.P.L.R. § 308 where substituted service upon a person of suitable age and discretion is attempted. Thus the affidavit, even had it been duly sworn, is facially defective as to service on the Chauses.
Finally, the Court finds that plaintiffs have failed to show good cause why service was not made within the time proscribed by rule 4(j). Significantly, plaintiffs do not seek to establish good cause for failing to properly serve the summons and 1988 Complaint in accordance with Rule 4(j), but appear to rely instead on their contention that the Chauses were properly served. As the Court finds that service was patently defective for the reasons set forth above, it declines to find that plaintiffs fail to satisfy the "good faith" requirement of Rule 4(j).
Having determined that the 1988 Complaint was never served on the Chauses, the Court must decide whether the Amended Complaint should relate back to the filing of the 1988 Complaint in order to fix a date upon which the Court will deem process to have been served. In a case closely analogous to the case at bar, the United States District Court for the Northern District of Illinois observed as follows:
Finally, Fujitsu, Ltd. has also waived its objection to the sufficiency of service of process based on Rule 4(j) . . . It is true that on its own initiative the Court could have dismissed the action as to Fujitsu, Ltd. without prejudice. We did in fact dismiss the action as to Fujitsu, Ltd. on December 21, 1984, though on other grounds. The effect of that dismissal is the same as a dismissal under 4(j), without prejudice. We did grant leave for [the third-party plaintiff] to attempt to serve Fujitsu again, if not barred by the statute of limitations or other law. That is essentially the effect of a 4(j) dismissal without prejudice. In neither case would the ...