The opinion of the court was delivered by: FRANCES
UNITED STATES MAGISTRATE JUDGE
The plaintiff in this class action, Robert D. Phillips, alleges that Kidder, Peabody & Co. ("Kidder") violated federal securities laws and committed common law fraud in connection with a public offering of stock in Computer Depot, Inc. ("CDI" or "the company"). The parties consented to my jurisdiction for all purposes pursuant to 28 U.S.C. § 636(c). The plaintiff alleges violations of Sections 11 and 12(2) of the 1933 Securities Act, 15 U.S.C. §§ 77k and 77l(2), Section 10(b) of the 1934 Securities Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Kidder now moves for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure. For the reasons that follow, the defendant's motion is granted.
CDI is a now-defunct corporation that operated a chain of retail personal computer outlets. CDI began its operations in March 1981 with one leased computer center located in a Dayton's department store in Minneapolis, Minnesota. CDI marketed its computer products through leased space in major department stores, taking advantage of the department stores' customer traffic, advertising, and consumer credit arrangements. The stores benefitted from CDI's computer expertise, its relationship with suppliers, and its ability to secure volume discounts. By 1984, CDI was operating forty-one computer centers in fifteen states and the District of Columbia.
CDI made a public stock offering in 1984 in order to finance future expansion. Kidder, a lead underwriter for this public offering, issued a Prospectus in connection with the offering on July 12, 1984. When the value of the stock subsequently plummeted, litigation ensued. On June 25, 1986, Ronald Kassover, another CDI shareholder filed an action in the federal district court for the District of Minnesota. His motion for class certification, however, was denied on April 27, 1987, as was a motion by Mr. Phillips to intervene in the Minnesota action. Kassover v. Computer Depot, Inc., 691 F. Supp. 1205, 1214 (D. Minn. 1987), aff'd, 902 F.2d 1571 (8th Cir. 1990) (table).
In his amended class action complaint, the plaintiff alleges that the Prospectus contained the following false or misleading representations: (1) "[CDI] believes that a new computer center can generally achieve profitability . . . within a relatively short period after it opens;" (2) "[CDI] believes that it is able to remain price competitive due to its large volume of purchases which permits it to take advantage of high levels of price discounts;" (3) "subject to obtaining financing and to the other conditions relating to opening new stores, [CDI] presently plans to open approximately 90 new computer centers in calendar 1985;" and (4) CDI would approximately break even during the second quarter ended July 28, 1984. Am. Complaint, P 58. Specifically, the plaintiff alleges that the defendant failed to disclose the following material facts: adverse change in the personal computer industry ("industry shake-out") which led to decreases in prices and intensified competition; substantial losses incurred in the thirteen weeks preceding the public offering; and significant inventory shrinkage
and inadequacy of CDI's internal inventory controls. Am. Complaint, P 59.
Kidder now moves for summary judgment, arguing that: (1) the claims regarding CDI's inventory shrinkage and all class claims are barred by the statute of limitations; (2) the accuracy of each statement in the Prospectus is established by undisputed facts; (3) contrary to the plaintiff's allegation, the Prospectus did disclose allegedly "omitted" facts with regard to falling computer prices and the competitiveness of the computer industry; and (4) Kidder affirmed the statements in the Prospectus based on extensive due diligence and had a reasonable basis for adopting any forward-looking statements concerning CDI's future.
The defendant brought a prior motion for summary judgment on February 1, 1991. The Honorable Shirley Wohl Kram, United States District Judge, denied the motion without prejudice to renewal on the ground that further discovery was necessary. Phillips v. Kidder, Peabody & Co., 782 F. Supp. 854, 866 (S.D.N.Y. 1991).
A motion for summary judgment shall be granted only when it is clear 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." Fed. R. Civ. P. 56(c). The moving party has the initial burden of demonstrating the absence of a genuine issue of material fact. Adickes v. S.H. Kress & Co., 398 U.S. 144, 157, 26 L. Ed. 2d 142, 90 S. Ct. 1598 (1970). The non-moving party has the burden of coming forward with "specific facts showing that there is a genuine issue for trial." Fed. R. Civ. P. 56(e). There must be enough evidence in favor of the non-moving party's case such that a jury could return a verdict in its favor. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986). "The mere existence of some alleged factual dispute between the parties will not defeat an otherwise properly supported motion for summary judgement; the requirement is that there be no genuine issue of material fact." Id. at 248.
The plain language of Rule 56(c) mandates the entry of summary judgment, after adequate time for discovery and upon motion, against a party who fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial. In such a situation, there can be "no genuine issue as to any material fact," since a complete failure of proof concerning an essential element of the non-moving party's case necessarily renders all other facts immaterial.
Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986).
"For purposes of summary judgment [in a securities fraud claim], our inquiry is confined to whether a genuine issue of material fact exists as to: (1) whether the alleged misrepresentations or omissions are material; (2) whether [the] plaintiffs were justified in relying on the misrepresentations and omissions; and (3) whether the misrepresentations or omissions were the actual and proximate cause of [the] plaintiffs' losses." Medline Industry, Inc. Employee Profit Sharing & Retirement Trust v. Blunt, Ellis & Loewi, Inc., 1993 U.S. Dist. LEXIS 581, No. 89 Civ. 4851, 1993 WL 13436, at *4 (N.D. Ill. Jan. 21, 1993) (footnote omitted). A plaintiff bears the burden of persuasion in alleging facts which suggest that the statements were "made or reaffirmed without a reasonable basis or [were] disclosed other than in good faith." Roots Partnership v. Lands' End, Inc., 965 F.2d 1411, 1418 (7th Cir. 1992) (quoting Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 513 (7th Cir. 1982)). Where the facts of a case lead to conflicting inferences and conclusions, summary judgment is precluded. In re Chaus Securities Litigation, 1990 U.S. Dist. LEXIS 15810, No. 88 Civ. 8641 (SWK), 1990 WL 188921, at *4 (S.D.N.Y. Nov. 20, 1990) (citing Robertson v. Seidman & Seidman, 609 F.2d 583, 591 (2d Cir. 1979)).
B. Statute of Limitations
Prior to addressing the substantive arguments contained in the defendant's motion, I turn to the issue of the statute of limitations. The defendant's argument in this regard is two-fold: it argues that all class claims are time barred, and that the amended claims with respect to the break even forecast are barred even if they relate back to the original complaint.
The plaintiff argues that this Court has already ruled that the statute of limitations was tolled during the pendency of the Kassover litigation with regard to both individual and class claims. In support of this argument the plaintiff cites six decisions by three different judges that purportedly reject, explicitly or implicitly, the defendant's argument that the class claims are barred.
Indeed, the defendant has raised this argument previously on several occasions: in its first motion for summary judgment, on reargument of that motion, and in its objection to my report and recommendation. Thus, it would appear anomalous to approach this subject so late in the case. However, upon closer examination of these decisions, it is clear that although several opinions ruled on the timeliness of individual claims, no judge has passed on the viability of the class claims.
There is no dispute that the plaintiff's individual claims were tolled by the Kassover litigation. In my May 30, 1991 Report and Recommendation I found that "the statute of limitations for Mr. Phillips was tolled for the approximately ten months that the Kassover class action motion was pending, and it is therefore 'deemed' to have been filed for limitations purposes on September 7, 1986." Report and Recommendation dated May 30, 1991 at 7 (emphasis supplied; citation omitted). Judge Kram adopted this finding. Phillips, 782 F. Supp. at 859.
During reargument on the defendant's initial summary judgment motion, Judge Preska stated that "we all agree that the action is deemed filed on September 7, 1986 and, therefore the question is whether the plaintiff was on inquiry notice prior to September 7, 1985." Transcript of the Hearing dated January 29, 1993 at 2 (emphasis supplied). Contrary to the plaintiff's position, neither the written opinions nor the transcript of that hearing give any indication that the Court ruled on anything but Mr. Phillips' individual claims.
Indeed, it would have been inappropriate for the Court to address the timeliness of the class claims until the class was certified on September 16, 1994.
The plaintiff's argument that the decision to certify the class and accompanying opinions implicitly rejected the defendant's statute of limitations defense is unpersuasive. The Supreme Court has explicitly prohibited inquiry into the merits of the case on a motion for class certification:
We find nothing in either the language or history of Rule 23 that gives a court any authority to conduct a preliminary inquiry into the merits of a suit in order to determine whether it may be maintained as a class action.
Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177, 40 L. Ed. 2d 732, 94 S. Ct. 2140 (1974). The Second Circuit adheres to this rule. See Sirota v. Solitron Devices, 673 F.2d 566, 570-71 (2d Cir.) (pre-certification inquiry inappropriate because class certification motions are subject to less rigorous procedural standards than motions to dismiss or motions for summary judgment), cert. denied, 459 U.S. 838, 74 L. Ed. 2d 80, 103 S. Ct. 86 (1982); Brickman v. Tyco Toys, Inc., 731 F. Supp. 101, 107 (S.D.N.Y. 1990) (district court may not look to merits of securities fraud claim in determining whether class certification is appropriate).
Finally, the plaintiff argues that the opinion granting him leave to amend the complaint, filed after the class was certified, constituted an implicit finding that the statute of limitations was equitably tolled for both the plaintiff and the class. This argument also fails. While the Court held that the amended allegations were factually related to the prior complaint, it made no finding as to the statute of limitations. Memorandum and Order dated Oct. 13, 1994 at 9-10. The motion to amend could have been denied, of course, if amendment were clearly futile, see Azurite Corp. Ltd. v. Amster & Co., 52 F.3d 15, 19 (2d Cir. 1995) (citing Foman v. Davis, 371 U.S. 178, 182, 9 L. Ed. 2d 222, 83 S. Ct. 227 (1962)); Ketchum v. Cruz, 961 F.2d 916, 920 (10th Cir. 1992), and an amendment is futile if the cause of action sought to be added is barred by the statute of limitations. Mackensworth v. S.S. American Merchant, 28 F.3d 246, 251 (2d Cir. 1994).
However, motions to amend are subject to a very liberal standard and leave to amend "shall be freely given when justice so requires." Fed. R. Civ. P. 15(a); Ronzani v. Sanofi S.A., 899 F.2d 195, 198 (2d Cir. 1990). To overcome the hurdle of futility on a motion to amend, the claim need only be colorable, not invincible. See Lopez v. John Hancock Mutual Life Insurance Co., 115 F.R.D. 316, 317 (S.D.N.Y. 1987) (motion to amend granted where plaintiff alleged that doctrine of equitable estoppel barred assertion of statute of limitations defense and thus defamation claim was colorable). The assessment of the case's merits is very limited, and cannot bar subsequent inquiry into affirmative defenses such as the statute of limitations. In Lopez the court granted leave to amend without prejudice to raising the statute of limitations argument later and stated:
In briefing the equitable estoppel issue, the parties have created, in effect, a miniature motion for summary judgment. . . . The Court has not lost sight, however, that the instant motion is one to amend the complaint and that an analysis of the sufficiency of the proposed defamation count must remain subordinate to Rule 15 principles. . . . The Court agrees that plaintiffs ought to be afforded an opportunity to test [their] claims on the merits.
Id. at 317-18 (citations omitted).
The amendments sought by the plaintiff in this case stated a colorable claim, and thus it was appropriate to grant leave to amend. However, that ruling did not constitute explicit consideration of the affirmative statute of limitations defense.
Having disposed of the plaintiff's "law of the case" contentions, I now turn to the merits of Kidder's statute of limitations arguments. In the seminal decision on the subject, American Pipe & Construction Co. v. Utah, 414 U.S. 538, 38 L. Ed. 2d 713, 94 S. Ct. 756 (1974), the Supreme Court held that "the commencement of the original class suit tolls the running of the statute for all purported members of the class who make timely motions to intervene after the court has found the suit inappropriate for class action status." Id. at 553. See also Crown, Cork & Seal Co. v. Parker, 462 U.S. 345, 346, 76 L. Ed. 2d 628, 103 S. Ct. 2392 (1983) (filing of class action tolls statute of limitations for other members of putative class until class certification denied). The Second Circuit in Korwek v. Hunt, 827 F.2d 874 (2d Cir. 1987) considered "whether the tolling rule [of American Pipe] applies to permit the filing by putative class members of a subsequent class action nearly identical in scope to the original class action which was denied certification." Id. at 876. The Court held that the American Pipe tolling doctrine did not apply to subsequently filed class actions following "a definitive determination of the inappropriateness of class certification." Id. at 879. Several other circuits have adopted a similar rule. See Griffin v. Singletary, 17 F.3d 356, 359 (11th Cir. 1994), cert. denied, U.S. , 115 S. Ct. 723 (1995); Andrews v. Orr, 851 F.2d 146, 149 (6th Cir. 1988); Robbin v. Fluor Corp., 835 F.2d 213, 214 (9th Cir. 1987); Salazar-Calderon v. Presidio Valley Farmers Association, 765 F.2d 1334, 1351 (5th Cir. 1985), cert. denied, 475 U.S. 1035, 89 L. Ed. 2d 353, 106 S. Ct. 1245 (1986), 493 U.S. 821, 107 L. Ed. 2d 45, 110 S. Ct. 79 (1989); Bertrand v. Industrial Development Authority of City of Chandler, Arizona, 1990 U.S. Dist. LEXIS 18328, No. Civ. 89-1087 (PH RCB), 1990 WL 264525 at *3 (D. Ariz. Sept. 13, 1990); Burns v. Ersek, 591 F. Supp. 837, 839-40 (D. Minn. 1984).
The Korwek rule is based on the principle that the statute of limitations for class claims should not be tolled indefinitely as successive class actions are brought but class certification is denied. Korwek, 827 F.2d at 878-79. This appears to undermine the utility of class actions, since it permits an erroneous denial of class certification to effectively foreclose the claims of all class members who do not have a sufficient financial stake to warrant their commencing or intervening in an individual action. Nevertheless, this is clearly the law of the Second Circuit and must be followed here.
The plaintiff argues that Korwek rule does not apply to this case, because the court in Kassover did not make the definitive determination of inappropriateness contemplated by the Second Circuit. Specifically, the plaintiff asserts that the district court denied the class certification because they found Mr. Kassover to be an inappropriate class representative. It is true that some courts refuse to apply the no-tolling rule where prior certification was denied based on inadequacy of class representative. See, e.g. In re Quarterdeck Office Systems, Inc. Securities Litigation, 854 F. Supp. 1466, 1994 WL 374452 at *5 (C.D. Cal. March 29, 1994); Shields v. Smith, 1992 U.S. Dist. LEXIS 15718, C-90-0349 (FMS), 1992 WL 295179 at *3 (N.D. Cal. Aug. 14, 1992); Shields v. Washington BanCorporation, 1992 U.S. Dist. LEXIS 4177, 1992 WL 88004 at *2 (D.D.C. 1992); but see Griffin, 17 F.3d at 359 (no tolling where class certification denied based on named plaintiff's lack of standing).
However, the court in Kassover based its decision on two grounds, only one of which concerned the adequacy of Mr. Kassover as a class representative. Kassover, 691 F. Supp. at 1213. The Kassover court further found the class action device to be inappropriate:
Id. at 1214 (citations omitted). This finding falls squarely under the Korwek rule. Thus, I find that the pendency of the Kassover action did not toll the class claims in this action.
The statute of limitations for Section 11 and 12(2) claims is set forth in Section 13 of the Securities Act which provides:
No action shall be maintained to enforce any liability created under section 77k or 77l(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created under section 77l(1) of this title, unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under section 77k or 77l(2) of this title more than three years after the sale.
The same limitations period governs Section 10b claims. Ceres Partners v. GEL Associates, 918 F.2d 349, 363-64 (2d Cir. 1990) (abandoning borrowing from state statute of limitations and adopting uniform rule); see also Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 361, 115 L. Ed. 2d 321, 111 S. Ct. 2773 (1991) (adopting uniform federal statute of limitations for 10(b) claims). Although this action was commenced prior to Ceres and Lampf, the rule announced in those cases applies retroactively. Welch v. Cadre Capital, 946 F.2d 185, 187-88 (2d Cir. 1991). Indeed, Judge Kram, in a prior opinion in this case, explicitly held that "it is clear that the one year/three year limitations period adopted in Lampf must be applied to the present case." Phillips, 782 F. Supp. at 865 (citations omitted).
Thus, all claims in this action are governed by the same statute of limitations. The complaint in the instant action was filed on July 10, 1987. Therefore, applying the one year statute of limitations, the claims must be dismissed if, by exercising reasonable diligence, the class could have discovered prior to July 10, 1986 the facts that give support to its claims.
CDI filed for bankruptcy on December 20, 1985. Thus, the class was on notice of potential claims against the defendant at that time. See In re Integrated Resources Real Estate Ltd. Partnerships Securities Litigation, 815 F. Supp. 620, 664 (S.D.N.Y. 1993); Gruber v. Price Waterhouse, 697 F. Supp. 859, 865 (E.D. Pa 1988), aff'd, 911 F.2d 960 (3d Cir. 1990). Accordingly, the class claims are barred by the statute of limitations.
The second prong of the defendant's statute of limitations argument is that the plaintiff's individual claims relating to CDI's second quarter losses are barred even if they relate back to his original claims. The plaintiff argues that his "break even" claims have already been held to be timely in the decision granting him leave to amend. As discussed above, I reject the plaintiff's contention that the decision granting leave to amend precludes consideration of the statute of limitations on summary judgment.
The court may grant the defendant summary judgment as a matter of law if it determines that the "plaintiff was placed on notice of the probability of fraud, and he failed to exercise reasonable diligence in discharging that duty to inquire[.]" Lenz v. Associated Inns and Restaurants Co., 833 F. Supp. 362, 371 (S.D.N.Y. 1993). "A plaintiff in a federal securities case will be deemed to have discovered fraud for purposes of triggering the statute of limitations when a reasonable investor of ordinary intelligence would have discovered the existence of the fraud." Dodds v. Cigna Securities, Inc., 12 F.3d 346, 350 (2d Cir. 1993) (citations omitted), cert. denied, U.S. , 114 S. Ct. 1401, 128 L. Ed. 2d 74 (1994).
The plaintiff argues that "since neither defendant nor CDI ever disclosed that a writedown of inventory caused the quarterly loss, plaintiff had no way to discover and was not on inquiry notice as to why CDI failed to 'break even' in the second quarter until he received documents in response to his subpoena duces tecum in May, 1994." Plaintiff's Memorandum of Law in Opposition to the Motion for Summary Judgment, at 7 n.5. However, two documents available to all CDI shareholders in September of 1984 contradict this assertion. First, the Form 10-Q, "Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934" for the second quarter of 1984 attributes the losses to inventory adjustments:
Cost of goods sold decreased and gross profit increased as a percentage of net sales from the second quarter and the first half of the last fiscal year to the same periods of the current fiscal year due to larger volumes of sales which enabled the Company to take advantage of higher levels of price discounts from its suppliers. However, for the second quarter and the first half of the current fiscal year the benefits of supplier price discounts were partially offset by greater than anticipated inventory adjustments and by reduced margins on certain IBM products following price reduction announced by IBM in June, 1984.
Id. at 7 (emphasis supplied). Second, CDI's Second Quarter Report to Shareholders, mailed to all shareholders in September 1984, reported the loss of $ 482,000 for the second quarter and stated that "[a] principal factor in this year's second quarter loss was greater than anticipated inventory adjustments at the end of the quarter." Letter to Shareholders from Stephen B. Parker, Chairman, dated September 1984. The next issue, then, is to determine whether these reported losses gave the plaintiff adequate notice of his possible claims.
Losses reported in annual shareholder documents do not automatically place shareholders on notice of potential fraud. Siebert v. Nives, 871 F. Supp. 110, 114 (D. Conn. 1994) (increase in loan loss reserves does not automatically trigger shareholder suspicion). In Siebert the Court rejected the defendants' claim that the disclosure of losses in the annual report put investors on notice, particularly in light of the reassuring statements elsewhere in the report. Id. at 114-15. Then-District Judge Cabranes noted:
It surely cannot be the case that every annual report which records corporate losses signals some underlying fraud. While decreased profits and increased loan loss reserves may be consistent with fraud in some cases, they are also symptomatic of a variety of non-fraudulent ills, ranging from poor business judgment to unfavorable market conditions.
The size of losses is one factor in determining whether the shareholders received any warning signals. The courts have commented that generally only abnormally large losses would put investors on inquiry notice. See, e.g., Boley v. Pineloch Associates, Ltd., 1990 U.S. Dist. LEXIS 9912, No. 87 Civ. 5124 (JMW), 1990 WL 113201, at *5 (S.D.N.Y. Aug. 2, 1990) (reported losses did not put investors on notice where "the lower-than-projected occupancy and rental rates communicated by the quarterly reports could have easily been attributable to economic conditions beyond the defendants' control [and] the divergence between the projections and performance was disappointing, but not alarming"); cf. Bresson v. Thomson McKinnon Securities, Inc., 641 F. Supp. 338, 345 (S.D.N.Y. 1986) (disclosure of projected losses, loss of investment banker, drastic reduction of work force, and planned sale of 33% of reserves put investors on notice of potential for omissions and misstatements in prospectus); Anisfeld v. Cantor Fitzgerald & Co., 631 F. Supp. 1461, 1466 (S.D.N.Y. 1986) (investors were on inquiry notice where partnership suffered large losses that increased every year since its inception and $ 1.4 million in advanced funds was necessary to stave off foreclosure).
The losses reported to the shareholders in this case (18 cent per share loss for the second quarter) were not of such magnitude as to trigger immediate suspicion. They were not accompanied by forecasts of imminent foreclosure, bankruptcy or other financial failure. Additionally, like the documents at issue in Siebert, the shareholders' report in this case included references to increased sales and expansion and made reassuring statements, such as "there have been a number of favorable developments for Computer Depot that are not yet reflected in our financial results." The innocuous term "inventory adjustment" to which the above documents attribute losses did not constitute sufficient "storm warnings" to the plaintiff to commence inquiry into a potential ...