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Cohain v. Klimley

September 20, 2010

DAVID COHAIN D.D.S., ET AL.,
v.
LAURA KLIMLEY, ET AL., PLAINTIFFS, DEFENDANTS.
D. KENT SISSEL, ET AL., PLAINTIFFS,
v.
LAURA KLIMLEY, ET AL., DEFENDANTS.
WAYNE E. PULLINS, DAVID E. PULLINS AND DIANNE H. PULLINS, PLAINTIFFS,
v.
JOHN PALMERO, DEFENDANT.



The opinion of the court was delivered by: Paul G. Gardephe, U.S.D.J.

MEMORANDUM OPINION & ORDER

The three above-captioned cases arise from Plaintiffs' purchase of debt instruments from VWE Group, Inc., a company that filed a bankruptcy petition on June 1, 2004.

Plaintiff David Cohain and twenty-three additional Plaintiffs filed suit against Defendants Laura Klimley, Maxine Eimicke, John Palmero, the Hereford Credit and Collection Agency, Inc. and the Victor W. and Maxine Eimicke Foundation on June 2, 2008, in the United States District Court for the Southern District of New York (the "Cohain Action").*fn1 The case was assigned to Judge William C. Conner.

That same day, Plaintiff D. Kent Sissel and twenty additional Plaintiffs filed suit against the same five Defendants in the United States District Court for the Southern District of Iowa (the "Sissel Action").*fn2 On March 16, 2009, Judge John A. Jarvey granted Klimley's motion to transfer the action to the Southern District of New York, where it was assigned to Judge Conner. (Dkt. No. 1-38)

Both the Cohain and Sissel Actions were assigned to this Court following Judge

Conner's death in July 2009.

Plaintiffs Wayne E. Pullins, David E. Pullins and Dianne H. Pullins (the "Pullins Plaintiffs") filed suit against Defendant John Palmero on April 3, 2008, in the United States District Court for the Southern District of Ohio (the "Pullins Action"). On April 21, 2009, Judge Thomas M. Rose granted Palmero's motion to transfer this action to the Southern District of New York, where it was assigned to this Court. (Dkt. No. 1-24)

Defendants Klimley and Palmero move to dismiss the Cohain Complaint pursuant to Fed. R. Civ. P. 12(b)(6), and move for judgment on the pleadings in the Sissel Action pursuant to Fed. R. Civ. P. 12(c). Palmero also moves to dismiss the Pullins Action; his motion to dismiss will be treated as a motion for judgment on the pleadings pursuant to Fed. R. Civ. P. 12(c).*fn3

For the reasons set forth below, the motions to dismiss and for judgment on the pleadings filed by Defendants Klimley and Palmero in the Cohain and Sissel Actions will be GRANTED. Palmero's motion for judgment on the pleadings in the Pullins Action will be GRANTED in part and DENIED in part.

BACKGROUND

In 1958, Victor Eimicke formed VWE Group, Inc. ("VWE"). VWE sold materials designed to assist employers in "the hiring, firing and motivation of employees." (Cohain Cmplt. ¶ 11; Sissel Cmplt. ¶ 11; Pullins Cmplt. ¶ 10) VWE later began producing and selling greeting cards, a business which ultimately accounted for the majority of its revenues. (Id.) In December 2003, VWE sold the greeting card business. (Id.) On June 1, 2004, VWE filed a bankruptcy petition pursuant to Chapter 11 of the U.S. Bankruptcy Code. (Cohain Cmplt. ¶ 12; Sissel Cmplt. ¶ 12; Pullins Cmplt. ¶ 11)

Defendant Laura Klimley, Victor Eimicke's daughter, served as Vice President and as a director of the Company. (Cohain Cmplt. ¶ 6, 14; Sissel Cmplt. ¶ 6, 14) Defendant John Palmero served as an officer and director of VWE, as well as its controller. (Cohain Cmplt. ¶ 8; Sissel Cmplt. ¶ 8; Pullins Cmplt. ¶ 9)

Throughout its existence, VWE offered debt instruments "with terms from 90 days to 5 years, interim maturity periods of between 1 and 3 years, and interest rates from 10 to 23%" (the "Notes"). (Cohain Cmplt. ¶ 13; Sissel Cmplt. ¶ 13; Pullins Cmplt. ¶ 12) When VWE filed its bankruptcy petition, the aggregate outstanding principal of the Notes was more than $26 million. (Cohain Cmplt. ¶ 13; Sissel Cmplt. ¶ 13; Pullins Cmplt. ¶ 13)

The Complaints allege that VWE posted a large annual net loss in every year between 1993 and 2003, in large part because of the "consistent and continuous issuance" of new Notes. (Cohain Cmplt. ¶ 16-17; Sissel Cmplt. ¶ 16-17; Pullins Cmplt. ¶ 15-16)

The Complaints further allege that despite the Defendants' knowledge of VWE's poor financial condition, VWE "paid cash dividends" and "clearly excessive salaries" to the Eimicke family. (Cohain Cmplt. ¶ 18-19; Sissel Cmplt. ¶ 18-19; Pullins Cmplt. ¶ 17-18) Additionally, the Complaints claim that VWE made advances in excess of $1.5 million to its officers and directors (Cohain Cmplt. ¶ 20; Sissel Cmplt. ¶ 20; Pullins Cmplt. ¶ 19), including numerous advances to Klimley, who allegedly played no active role in the Company's affairs between 1999 and 2004. (Cohain Cmplt. ¶ 20; Sissel Cmplt. ¶ 20) The Complaints also allege that other members of the Eimicke family received advances and loans from VWE, and made inappropriate use of the Company's corporate credit cards. (Cohain Cmplt. ¶ 21-22; Sissel Cmplt. ¶ 21-22)

The Cohain and Sissel Complaints go on to allege that the officers and directors met on "at least a yearly basis" to "approve the continuation of the Company's illegal Note Program; approve the Company's aforesaid illegal dividends and excessive salaries; and review detailed financial records of the Company prepared by Palmero . . . that clearly demonstrated the continuing and ever deepening insolvency of the Company, the expansion of the illegal Note Program and the existence of the aforesaid illegal salaries." (Cohain Cmplt. ¶ 23; Sissel Cmplt. ¶ 23) Klimley is also alleged to have participated in annual shareholder meetings, where the shareholders approved "the financial records of the Company which clearly disclosed the gross insolvency of the Company." (Cohain Cmplt. ¶ 24; Sissel Cmplt. ¶ 24)

In 1982, Klimley formed Hereford Credit and Collection Agency, Inc. (Cohain Cmplt. ¶ 25; Sissel Cmplt. ¶ 25) The Company paid Hereford a fee each year; the amount of the fee is alleged to be "roughly" the same as the amount Hereford paid in salaries and dividends to Klimley and her sister Alicia Eimicke. (Id.)

The Cohain and Sissel Complaints also outline various efforts made by members of the Eimicke family to avoid the payment of state and federal income taxes. Victor Eimicke is alleged to have taken loans from VWE in lieu of his salary, with no intention of repaying the loans. (Cohain Cmplt. ¶ 26; Sissel Cmplt. ¶ 26) Eimicke and his wife Maxine are also alleged to have established a foundation, to which they gifted Notes issued by VWE. (Cohain Cmplt. ¶ 27; Sissel Cmplt. ¶ 27)

The Complaints also allege that VWE "instituted and maintained a policy of not disseminating" financial information to creditors or investors in Company Notes. (Cohain Cmplt. ¶ 27; Sissel Cmplt. ¶ 27; Pullins Cmplt. ¶ 20) Each of the Complaints claims that Plaintiffs purchased Notes in reliance on allegedly false representations by Klimley, Palmero and others involved in the Company about VWE's financial health. (Cohain Cmplt. ¶¶ 30, 34-40; Sissel Cmplt. ¶¶ 30, 34-40; Pullins Cmplt. ¶¶ 22-38, 42)

VWE filed a bankruptcy petition in June 2004, and the Complaints claim that "there is little or no possibility that the Company will successfully emerge from its Chapter 11 bankruptcy filing or generate any meaningful sum from the sale of its assets for repayment of Plaintiffs." (Cohain Cmplt. ¶¶ 12, 41; Sissel Cmplt. ¶¶ 12, 41; Pullins Cmplt. ¶¶ 11, 45) In October 2007, Alicia Eimicke -- Klimley's sister and VWE's former President -- was indicted on thirty-five counts of theft, securities fraud and racketeering. (Cohain Cmplt. ¶ 43; Sissel Cmplt. ¶ 43) She pled guilty to those charges on March 28, 2008, allegedly admitting that the Notes issued by the Company were part of an "illegal [P]onzi scheme." (Id.)

Plaintiffs in the Cohain Action bring claims for violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 (Count 1) (Cohain Cmplt. ¶¶ 44-50); violations of Section 20(a) of the Securities Exchange Act of 1934 (Count 2) (Cohain Cmplt. ¶¶ 51-53); fraud (Count 3) (Cohain Cmplt. ¶¶ 54-58); recovery of a fraudulent conveyance (Count 4) (Cohain Cmplt. ¶¶ 59-61); waste of corporate assets (Count 5) (Cohain Cmplt. ¶¶ 62-64); self-dealing and deepening insolvency (Count 6) (Cohain Cmplt. ¶¶ 65-67); civil conspiracy (Count 7) (Cohain Cmplt. ¶¶ 68-70); breach of fiduciary duty (Count 8) (Cohain Cmplt. ¶¶ 71-73); and racketeering (Count 9) (Cohain Cmplt. ¶¶ 74-81).

Plaintiffs in the Sissel Action assert these same nine claims (Counts 1-9) (Sissel Cmplt. ¶¶ 44-81) and a claim under Iowa's Blue Sky Law. (Count 10) (Sissel Cmplt. ¶¶ 82-87)

Plaintiffs in the Pullins Action bring claims for violations of Sections 12(1) and (2) of the Securities Act of 1933 (Count 1) (Pullins Cmplt. ¶¶ 46-58); violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 (Count 2) (Pullins Cmplt. ¶¶ 59-64); violations of Section 15 of the Securities Act of 1933 (Count 3) (Pullins Cmplt. ¶¶ 65-67); violations of Section 20(a) of the Securities Exchange Act of 1933 (Count 4) (Pullins Cmplt. ¶¶ 68-70); fraud (Count 5) (Pullins Cmplt. ¶¶ 71-75); civil conspiracy (Count 6) (Pullins Cmplt. ¶¶ 76-78); violations of Ohio Revised Code § 1707 (Count 7) (Pullins Cmplt. ¶¶ 79-86); breach of fiduciary duty (Count 8) (Pullins Cmplt. ¶¶ 87-89); and racketeering (Count 9) (Pullins Cmplt. ¶¶ 90-97).

DISCUSSION

"To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 129 S.Ct. 1937, 1949 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). "In considering a motion to dismiss . . . the court is to accept as true all facts alleged in the complaint," Kassner v. 2nd Ave. Delicatessen Inc., 496 F.3d 229, 237 (2d Cir. 2007) (citing Dougherty v. Town of N. Hempstead Bd. of Zoning Appeals, 282 F.3d 83, 87 (2d Cir. 2002)), and must "draw all reasonable inferences in favor of the plaintiff." Id. (citing Fernandez v. Chertoff, 471 F.3d 45, 51 (2d Cir. 2006)).

"When determining the sufficiency of plaintiffs' claim for Rule 12(b)(6) purposes, consideration is limited to the factual allegations in plaintiffs' . . . complaint, . . . to documents attached to the complaint as an exhibit or incorporated in it by reference, to matters of which judicial notice may be taken, or to documents either in plaintiffs' possession or of which plaintiffs had knowledge and relied on in bringing suit." Brass v. Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993). "The standard for granting a Rule 12(c) motion for judgment on the pleadings is identical to that of a Rule 12(b)(6) motion for failure to state a claim." Patel, 259 F.3d at 126.

I.THE FEDERAL SECURITIES LAW CLAIMS MUST BE DISMISSED

A.The Claims for Primary Securities Law Violations are Time-Barred

1.The Applicable Statutes of Limitations

Plaintiffs in all three actions assert claims for securities fraud under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

"[A] private federal action for securities fraud must be commenced before the earlier of '2 years after the discovery of the facts constituting the violation' or '5 years after such violation.'" Staehr v. Hartford Fin. Servs. Group, 547 F.3d 406, 411 (2d Cir. 2008) (quoting 28 U.S.C. § 1658(b)).

"The two-year statute of limitations for securities fraud claims under the Exchange Act begins to run only after the plaintiff 'obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge.'" Staehr, 547 F.3d at 411 (quoting LC Capital Partners, LP v. Frontier Ins. Group, Inc., 318 F.3d 148, 154 (2d Cir. 2003) (quoting Kahn v. Kohlberg, Kravis, Roberts & Co., 970 F.2d 1030, 1042 (2d Cir.1992))).

"When there is no actual knowledge, but 'the circumstances would suggest to an investor of ordinary intelligence the probability that she has been defrauded, a duty of inquiry arises, and knowledge will be imputed to the investor who does not make such an inquiry.'" Staehr, 547 F.3d at 411 (quoting Dodds v. Cigna Sec., 12 F.3d 346, 350 (2d Cir. 1993)).

Plaintiffs in the Pullins Action also assert a claim for violations of Sections 12(a)(1) and (2) of the Securities Act of 1933. Claims brought under Section 12 of the Securities Act "are subject to the one-year statute of limitations set out under Section 13 of the Securities Act."*fn4 In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp. 2d 272, 285 (S.D.N.Y. 2009) (citing 15 U.S.C. § 77m; Dodds v. Cigna Securities, Inc., 12 F.3d 346, 349-50, 350 n.2 (2d Cir. 1993)). "The limitations period begins to run when the plaintiff 'obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge.'"*fn5 In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp. 2d at 285 (quoting Kahn v. Kohlberg, Kravis, Roberts & Co., 970 F.2d 1030, 1042 (2d Cir. 1992)).

2.Plaintiffs Were On Notice of the Alleged Securities Violations in June 2004

"Whether a plaintiff was placed on inquiry notice is analyzed under an objective standard. This objective determination can be resolved as a matter of law -- it need not be made by a trier of fact." Staehr, 547 F.3d at 427 (internal citations omitted). Indeed, "courts can 'readily resolve the issue' of inquiry notice as a matter of law on a motion to dismiss -- as has been done in 'a vast number of cases' in this circuit -- where 'the facts needed for determination of when a reasonable investor of ordinary intelligence would have been aware of the existence of fraud can be gleaned from the complaint and papers . . . integral to the complaint.'" Id. at 412 (quoting Lentell v. Merrill Lynch & Co., 396 F.3d 161, 168 (2d Cir. 2005)).

"[W]hen the circumstances would suggest to an investor of ordinary intelligence the probability that she has been defrauded, a duty of inquiry arises, and knowledge will be imputed to the investor who does not make such an inquiry. Such circumstances are often analogized to 'storm warnings.'" Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993) (internal citations omitted). The "storm warnings" doctrine has been used to evaluate inquiry notice in cases involving claims for violations of both Section 10(b) of the Securities Exchange Act of 1934 and Section 12 of the Securities Act of 1933. See, e.g., In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp. 2d 272 (S.D.N.Y. 2009) (applying the storm warnings doctrine in dismissing Securities Act claims, including those asserted under Section 12, as time-barred); In re Salomon Analyst Winstar Litig., 373 F. Supp. 2d 241 (S.D.N.Y. 2005) (applying the storm warnings doctrine in dismissing claims asserted under Section 10(b) as time-barred).

In In re Salomon Analyst Winstar Litigation, the court applied the storm warnings doctrine in determining when plaintiffs were on inquiry notice of their fraud claim, "the core" of which was that "defendants failed to disclose, irrationally minimized, or outright denied with no reasonable basis in fact, Winstar's precarious financial condition." 373 F. Supp. 2d at 245. The court concluded that plaintiffs were "plainly [] on inquiry notice of their claims no later than April 18, 2001, when Winstar announced it had filed for bankruptcy protection." Id.

Other courts in this district have similarly found that a bankruptcy petition puts plaintiffs on inquiry notice of claims arising from investments in companies whose financial woes previously went undisclosed or were misrepresented.*fn6 See, e.g., BRS Associates, L.P. v. Dansker, 246 B.R. 755, 770 (S.D.N.Y. 2000) ("'In the securities context, district courts in the Second Circuit have ruled that a plaintiff is placed on inquiry notice by his or her actual or constructive knowledge of facts or circumstances indicating that an investment may have gone awry.' The Court finds that the Plaintiffs were on inquiry notice of the RICO violations as of November 6, 1990, when they learned that Coronet was in bankruptcy proceedings.") (quoting In re Integrated Resources Real Estate Ltd. Partnerships Sec. Litig., 850 F. Supp. 1005, 1118 (S.D.N.Y. 1993)); Phillips v. Kidder, Peabody & Co., 933 F. Supp. 303, 307, 312 (S.D.N.Y. 1996) (finding that "the class was on notice of potential claims" relating to a public offering, after which "the value of the stock subsequently plummeted," when the company filed a bankruptcy petition).

Here, Plaintiffs' Securities Exchange Act and Securities Act claims are founded on Klimley and Palmero's alleged "fail[ure] to disclose" VWE's "precarious financial condition" and "outright deni[al] with no reasonable basis in fact" that VWE was in a "precarious financial condition." See In re Salomon Analyst Winstar Litig. 373 F. Supp.2d at 245. The Complaints further allege that Plaintiffs, in purchasing the Notes, relied on these false statements. See, e.g., Cohain Cmplt. ¶¶ 46-47; Sissel Cmplt. ¶¶ 46-47; Pullins Cmplt. ¶¶ 53-55, 61-62. Assuming such reliance, the falsity of assurances concerning VWE's financial health would have become apparent when VWE filed its bankruptcy petition. Accordingly, Plaintiffs were on inquiry notice of their claims when VWE filed its bankruptcy petition on June 1, 2004.*fn7 See In re Salomon Analyst Winstar Litig. 373 F. Supp. 2d at 245; BRS Associates, L.P., 246 B.R. at 770; Phillips, 933 F. Supp. at 312.

3.Plaintiffs Commenced the Instant Actions After the Statutes of Limitations Expired

Because Plaintiffs were on inquiry notice of their securities law claims as of June 1, 2004, Section 10(b) claims would have to be asserted by June 1, 2006, in order to be timely. See Staehr, 547 F.3d at 411 (the statute of limitations for actions under Section 10(b) is "the earlier of '2 years after the discovery of the facts constituting the violation' or '5 years after such violation.'") (quoting 28 U.S.C. § 1658(b)). Section 12 claims would have to be asserted by June 1, 2005, in order to be timely. See In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp.2d at 285 (setting forth the one-year statute of limitations applicable to Section 12 claims) (citing 15 U.S.C. § 77m).

The Cohain and Sissel Actions were filed on June 2, 2008, two years after the statute of limitations on their Section 10(b) claims expired and three years after the statute of limitations on their Section 12 claims expired. Accordingly, Plaintiffs' securities law claims in Cohain and Sissel are barred by the statute of limitations.

The Pullins Action was filed on April 3, 2008, long after the expiration of the statutes of limitations for the Pullins Plaintiffs' Section 10(b) and Section 12 claims. The Pullins Plaintiffs argue, however, that the relevant date for assessing the timeliness of their claims is not April 3, 2008, but January 26, 2005 -- the date they and others ...


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