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finding a limited private right of action to have an investment advisory contract voided under Section 215 where the performance of the contract violates the IAA
Summary of this case from In re Evergreen Mut. Funds Fee LitigationOpinion
04 Civ. 2702 (RWS).
March 2, 2005
PETER A. LAGORIO, ESQ., LAW OFFICE OF PETER A. LAGORIO, Boston, MA, ALAN N. ALPERN, ESQ., New York, NY, Attorneys for Plaintiff.
RICHARD J. MORVILLO, ESQ., RICHARD L. BEIZER, ESQ., CROWELL MORING, Attorneys for Defendants Nevis Capital Management, LLC, Jon C. Baker and David R. Wilmerding, III, Washington, DC, R. NICHOLAS GIMBEL, ESQ., STEPHEN P. McFATE, ESQ., McCARTER ENGLISH, Attorneys for Defendants Nevis Capital Management, LLC, Jon C. Baker and David R. Wilmerding, III, New York, NY, PAUL A. RAGUSA, ESQ., BAKER BOTTS, Attorneys for The Nevis Fund, Inc., New York, NY, J. BRADLEY BENNETT, ESQ., JULIA E. GUTTMAN, ESQ., ALEX J. BOURELLY, ESQ., BAKER BOTTS, Attorneys for The Nevis Fund, Inc. Washington, DC, Attorneys for Defendants.
OPINION
The defendants Nevis Capital Management, LLC ("Nevis Capital"), Jon C. Baker ("Baker"), David R. Wilmerding, III ("Wilmerding") (collectively, the "Nevis Capital Defendants") and The Nevis Fund, Inc. (the "Fund") (collectively, the "Defendants") have moved under Rules 12(b) and 9(b), Fed.R.Civ.P., to dismiss the complaint of Joan Hardy Clark ("Clark"), alleging seven separate counts: (I) violation of section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, against all of the Defendants; (II) "controlling person" liability under section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), against the Nevis Capital Defendants; (III) violation of section 206 of the Investment Advisers Act of 1940 (the "Advisers Act"), 15 U.S.C. § 80b-6, against Nevis Capital; (IV) common law fraud against the Defendants; (V) negligent misrepresentation against the Defendants; (VI) breach of fiduciary duty against the Nevis Capital Defendants; and (VII) aiding and abetting breach of fiduciary duty against the Nevis Capital Defendants.
For the reasons set forth below, the motion of the Nevis Capital Defendants is granted with respect to Counts I, II, III, IV and V, and the motion of the Fund is granted with respect to Counts I, IV and V. The motions are otherwise denied. Clark is granted leave to replead in accordance with this opinion and order. Prior Proceedings
This action was commenced on April 8, 2004. The instant motions were heard and marked fully submitted on September 29, 2004.
The Parties
Clark, a New York resident, invested $400,000 in the Fund in three separate transactions on November 23, 1999, January 26, 2000, and March 3, 2000. (See Compl. at ¶ 4.)
It is alleged that Nevis Capital is a registered investment advisor based in Maryland and that Nevis Capital acted as the investment advisor to the Nevis Fund at all relevant times. (See id. at ¶ 5.)
According to the complaint, the Fund is a registered open-end mutual fund organized and based in Maryland. (See id. at ¶ 8.) It is alleged that since the Fund's inception on June 29, 1998 the Fund has been managed by Nevis Capital. (See id.)
Wilmerding is alleged to be a resident of Maryland who at all relevant times acted as President as well as a Director of Nevis Capital, and a Director of the Fund. (See id. at ¶ 7.) Baker is alleged to be a resident of Maryland who at all relevant times acted as Executive Vice-President and a Director of Nevis Capital, as well as a Director of the Fund. (See id. at ¶ 6.) It is alleged that both Wilmerding and Baker shared responsibility for setting investment policies, directing advertising and directing public reporting and communications for the Fund and for Nevis Capital. (See id. at ¶ 8.)
The Facts
The following factual background is drawn from the allegations of the complaint and from documents referenced in and integral to the complaint, as well as from public documents filed with the Securities and Exchange Commission (the "SEC"). See Rothman v. Gregor, 220 F.3d 81, 88-89 (2d Cir. 2000) (observing that the court may consider "any written instrument attached to [the complaint] as an exhibit or any statements or documents incorporated in it by reference, as well as public disclosure documents required by law to be, and that have been filed with the SEC, and documents that the plaintiffs either possessed or knew about and upon which they relied in bringing the suit") (internal citations omitted); Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991) (stating that "when a district court decides a motion to dismiss a complaint alleging securities fraud, it may review and consider public disclosure documents required by law to be and which actually have been filed with the SEC, particularly where plaintiff has been put on notice by defendant's proffer of these public documents"). The allegations of the complaint are accepted as true for the purposes of this motion,see Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002), and do not constitute findings of fact by the Court.
Clark has alleged that her investment of $400,000 in the Fund from November 29, 1999 through March 3, 2000 was made in reliance upon certain material misrepresentations and omissions by the Defendants concerning investments in shares of the Fund and that she has suffered substantial damages as a result. (See Compl. at ¶¶ 4, 9, 18, 19.)
According to the complaint, between December 1998 and July 2000, the Defendants made false and misleading statements and omitted material information in the Fund's prospectus, annual and semi-annual reports, advertisements and other public statements regarding the Fund and the "true reasons" for the Fund's performance. (Id. at ¶ 10.) Specifically, each of the Defendants are alleged to have represented that the Fund achieved cumulative investment returns of 90.1% as of May 31, 1999, 154.6% as of September 30, 1999, and 286.5% as of December 31, 1999. (See id. at ¶ 11.) According to the complaint, the Defendants failed to disclose that such returns were achieved only by the Defendants' internal scheme of allocating to the Fund approximately 993,000 shares of approximately 69 initial public offerings ("IPOs"), and, immediately thereafter, selling the shares for large profits within one to thirteen days of acquisition. (See id.) This undisclosed "flipping" scheme allegedly enabled the Defendants to deceptively market, promote and sell shares of the Fund to the public, including Clark, based upon the "false and misleading pretense" that the Fund's resulting investment performance was attributable to its purported long-term investment strategy. (Id.; see also id. at ¶ 14.)
Many of Clark's allegations closely track a recent order issued by the SEC which settled allegations against the Nevis Capital Defendants. See SEC, In re Nevis Capital Management, LLC et al., Admin. Proc. No. 3-11201, 2004 WL 236571 (Feb. 9, 2004) (making certain findings and imposing remedial sanctions and a cease-and-desist order). In that proceeding, the Nevis Capital Defendants neither admitted nor denied the SEC's allegations. See id. at *1.
The Defendants' scheme is alleged to have had the purpose and effect of: (a) inflating the reported returns of the Fund without disclosing that such returns were attributable to the IPO flipping scheme; (b) inflating the reported returns of the Fund without disclosing that such returns were contingent upon the Defendants' continued ability to implement and prolong the IPO flipping scheme; (c) attracting additional investors to the Fund, including Clark; and (d) increasing fees payable to Fund managers. (See id.) The Defendants' motives allegedly included boosting the reported returns for the Fund during 1999 in order to attract new investors, thus increasing investment management fees payable to the Defendants, in that such fees were higher than the Defendants otherwise would collect from other clients. (See id. at ¶ 23.) Absent the substantial first-day gains attributable to the undisclosed IPO scheme, the cumulative "returns" for the Fund would otherwise have been approximately as follows:
As of Cumulative Returns Instead of 5/31/99 -5% (loss) 90.1% (gain) 9/30/99 -3.6% (loss) 154.6% (gain) 12/31/99 41% (gain) 286.5% (gain)
(See id. at ¶ 13.)
It is alleged that after the Defendants publicized the reported returns for the Fund set forth above the net inflow of investors' dollars into the Fund increased dramatically from approximately $9 million to $70 million during the six month period from July through December 1999, and further, to $317 million by March 31, 2000. (See id. at ¶ 12.) This increase in assets resulted in a corresponding increase in the management fees paid by the Fund directly to Nevis Capital and indirectly to Wilmerding and Baker. (See id.)
Prior to Clark's purchases "and at all relevant times thereafter," the Defendants' public statements concerning the Fund and the Defendants' investment objectives employed therein are alleged to have been materially false and misleading. (Id. at ¶ 16.) The complaint cites the following examples:
(a) The Nevis Fund's Registration Statement dated June 23, 1998, its Prospectus dated July 2, 1998, its Form 485 IPOS filed with the SEC on or about July 26, 1999, and its Prospectus dated September 28, 1999 all stated that the Fund's investment objective is "'long-term capital appreciation.'" (Id. at ¶ 16(a) (emphasis omitted).)
(b) In the Management's Discussion and Analysis of Fund Performance (the "MDA") in the Fund's Annual Report for the fiscal year ended May 31, 1999, which Wilmerding drafted with Baker's assistance, the Defendants stated that the Fund had benefitted from market volatility and its ability to purchase a number of securities at attractive prices. (See id. at ¶ 16(b).) The Defendants said that "'the Fund's relatively small asset base enabled us to be more nimble with purchases and sales than we could have been with a much larger asset base.'" (Id.) The MDA then gave the allegedly misleading impression that certain holdings had contributed to the Fund's returns through May 31, 1999: namely, Vitesse Semiconductor Corp. ("Vitesse") and Staar Surgical Co. ("Staar") which had appreciated 305% and 60%, respectively, during the preceding five to seven months. (See id.) According to the complaint, the shares of Vitesse and Staar held by the Fund actually had appreciated by much smaller amounts because the Fund held those securities for only one business day and thirteen business days, respectively, during the fiscal year, rather than the five- to seven-month periods referenced in the May 1999 Annual Report. (See id.) The Defendants did not disclose in the Annual Report the actual holding periods for these two securities, nor did they disclose that the Fund's performance was primarily attributable to IPO investments. (See id.)
(c) Wilmerding gave an interview to the author of a SmartMoney.com article entitled "A New Champion" dated July 29, 1999, in which Wilmerding understated the impact of IPO investments on the Fund's performance. (See id. at ¶ 16(c).) In the interview, Wilmerding discussed Nevis Capital's general investment philosophy for all of its investment advisory clients, and attributed the Fund's success to the Defendants' philosophy of analyzing company earnings and their long-term investment strategy. (See id.) He did not inform the reporter that the Fund's extraordinary performance was primarily attributable to IPOs; thus, the article indicated that "'some'" of the Fund's performance was related to IPO investments. (Id.) As a result, the article published by SmartMoney.com contained misleading information about the Fund. (See id.) The article focused on non-IPO securities that had appreciated significantly since the first of the year, such as Vitesse, when the Fund did not hold that security throughout much of the period of appreciation. (See id.)
(d) Wilmerding misrepresented to the author of the SmartMoney.com article entitled "Top of the Charts: Running Start," dated October 1999, that the Fund's success was attributable to the Defendants' strategy of looking at long-term earnings growth, citing as an example the non-IPO security Rational Software. (See id. at ¶ 16(d).) As a result, the published article contained false and misleading information suggesting that the Fund had achieved its returns because it had "'stockpile[d]'" Rational Software shares, which had appreciated in value by 174% from its market low price. (Id.) In fact, although it had purchased some Rational Software shares near the market low, the Fund did not "stockpile" Rational Software shares at the market-low price; its total Rationale Software position did not appreciate by 174% and the Fund actually had an unrealized net loss totaling approximately $38,500 on its Rational Software position through September 30, 1999. (See id.) Wilmerding also failed to disclose, and so the published article did not indicate, that the Fund's exceptional performance was primarily attributable to IPO investments. (See id.)
(e) Wilmerding misrepresented the impact of IPOs on the Fund's performance to the author of the SmartMoney.com article entitled "From Out of Nowhere," dated December 28, 1999. (See id. at ¶ 16(e).) The article reports a question to Wilmerding about the extent of the Fund's investment in IPOs as follows:
SmartMoney.com: How many IPOs did you involve yourself with?
DW: It's not a lot. To give you an idea, given that this fund started at $9.99 on 12/13/98 and is at $34 and change today, we made a distribution in November that was only $2.65. Which is basically a combination of what trading we did do and a couple IPOs. So the bulk of the gain here is unrealized.
(Id.) The Fund actually had purchased shares of 69 IPOs between December 1998 and December 1999. (See id.) The article did not state that the Fund's exceptional performance was primarily attributable to these IPO investments and Wilmerding's responses are alleged to imply the contrary. (See id.)
(f) The Fund's Prospectus dated September 27, 1999 (the "September 1999 prospectus") reported the Fund's first fiscal year return of 90.1%, but did not disclose the substantial extent to which this performance was attributable to IPO investments or that such returns could not be sustained as the asset base for the Fund increased. (See id. at ¶ 16(f).) Furthermore, the September 1999 prospectus contained information alleged to be misleading to shareholders and prospective investors, in that the September 1999 prospectus emphasized the Defendants' "'long-term approach to investing'" and their in-depth analysis of companies' earnings growth when such strategies did not apply to the Fund's IPO investments. (Id.)
(g) A press release dated July 1, 1999, which was posted on Nevis Capital's website at the direction of Wilmerding and Baker, also did not disclose the impact of the Fund's IPO investments. (See id. at ¶ 16(g).) The press release highlighted the Fund's one-year cumulative return of 109.6%, with Baker and Wilmerding attributing "'a great deal of the Fund's success to its concentrated portfolio of growth companies.'" (Id.) The press release, however, did not disclose that the Fund had participated in IPOs or that the Fund's performance was primarily attributable to IPO investments. (See id.)
In addition, it is alleged that, prior to her first purchase of Fund shares on November 23, 1999, Clark contacted the Fund by telephone and inquired directly as to the investment strategy behind its impressive publicly-reported investment return figures. (See id. at ¶ 17.) Clark asked about whether the Fund concentrated heavily in IPOs, and was told that the Fund employed a long-term investment strategy and had only a small to moderate exposure to IPOs of similar or comparable degree as other long-term growth funds. (See id.) It is alleged that this fact was important to Clark as an investor desiring to invest in a mutual fund vehicle that employed a long-term investment strategy and that did not have investment returns which were artificially or temporarily inflated through short-term trading in IPOs, which were contingent upon short-term gains derived from IPOs, or which were attributable primarily to IPO flipping or IPO investments. (See id.)
The Defendants allegedly failed to make adequate corrective disclosures to alert Clark to the facts set forth above until the Fund issued a prospectus supplement dated August 18, 2003, which disclosed the initiation of SEC proceedings against managers of the Fund, stating, in pertinent part:
On July 31, 2003, the Securities and Exchange Commission (SEC) initiated public administrative and cease and desist proceedings against Nevis Capital Management, LLC (Nevis), which is the Fund's investment adviser, and David R. Wilmerding, III and Jon C. Baker, who are the Fund's portfolio managers. The SEC's primary allegations relate to disclosures by Nevis and the Fund of Nevis's initial public offering (IPO) allocation policy and the positive impact of IPO performance on the Fund. The allegations relate in particular to IPO allocations made by Nevis between December 1998 and December 1999. The SEC alleges that these actions violated certain federal securities law.
(Id. at ¶ 15.)
Specifically, the SEC alleged that the Nevis Capital Defendants "had an undisclosed policy to allocate IPO shares only to Snowdon and the Nevis Fund, and they also failed to disclose that they could earn greater fees if they allocated IPO shares only to Snowdon and the Nevis Fund rather than to their other clients." See SEC, Administrative and Cease-and-Desist Proceedings Instituted Against Nevis Capital Management LLC, David R. Wilmerding, III and Jon C. Baker In Connection With Their IPO Allocation Practices and Disclosures, SEC Release Nos. 8261, 48262, 2154 26144, 2003 WL 21767052, at *1 (July 31, 2003). In addition, between December 1998 and July 2000, the Nevis Capital Defendants were alleged to have "made false and misleading statements and omitted material information in the Nevis Fund's prospectus, annual and semi-annual reports and advertisements regarding the reason for the Nevis Fund's performance." Id. at *2. The Nevis Capital Defendants were further alleged to have misrepresented "that the Fund's returns were attributable to their long-term investment strategy" and failed to disclose that "the Nevis Fund's performance was primarily attributable to IPO investments," instead stating that the Fund had invested in only "'a couple IPOs.'" Id.
According to the SEC allegations, Snowdon Limited Partnership was an unregistered investment company which had been formed by Nevis Capital.
On February 9, 2004, the SEC issued an Order Making Findings and Imposing Remedial Sanctions and Cease-And-Desist Order in the administrative proceeding instituted against the Nevis Capital Defendants, wherein the SEC censured Nevis Capital, Wilmerding and Baker; ordered Nevis Capital, Wilmerding and Baker to cease and desist from committing or causing any future violations of the Investment advisers Act; and ordered that Nevis Capital, Wilmerding and Baker pay certain civil penalties in the approximate aggregate amount of $2 million dollars for their respective roles, acts and omissions. (See Compl. at ¶ 20.)
Absent the Defendants' continued ability to implement and prolong their undisclosed and highly speculative IPO flipping scheme, and subsequent to the time of Clark's investments in the Fund, the Fund's investment performance and share price dropped precipitously, causing Clark to suffer substantial damages as a result. (See id. at ¶ 19.)
The Rule 12(b)(6) Standard
In considering a motion to dismiss pursuant to Rule 12(b)(6), Fed.R.Civ.P., the Court construes the complaint liberally, "accepting all factual allegations in the complaint as true, and drawing all reasonable inferences in the plaintiff's favor,"Chambers, 282 F.3d at 152 (citing Gregory v. Daly, 243 F.3d 687, 691 (2d Cir. 2001)), although "mere conclusions of law or unwarranted deductions" need not be accepted. First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 771 (2d Cir. 1994).
"'[T]he issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims.'" York v. Ass'n of Bar of City of New York, 286 F.3d 122, 125 (2d Cir.) (quoting Scheuer v. Rhodes, 416 U.S. 232, 236 (1974)), cert. denied, 537 U.S. 1089 (2002). In other words, "'the office of a motion to dismiss is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof.'" Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co. of New York, 375 F.3d 168, 176 (2d Cir. 2004) (quotingGeisler v. Petrocelli, 616 F.2d 636, 639 (2d Cir. 1980)). "[T]he court should not dismiss the complaint for failure to state a claim 'unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Ricciuti v. New York City Transit Auth., 941 F.2d 119, 123 (2d Cir. 1991) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)); accord Eternity Global Master Fund, 375 F.3d at 176-77.
Discussion A. Clark's Federal Securities Fraud Claims Are Partially Time-Barred
Following passage of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), Pub.L. No. 107-204, 116 Stat. 745 (2002), a complaint filed on or after July 30, 2002 asserting a private securities fraud claim "may be brought no later than the earlier of (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation." 28 U.S.C. § 1658(b). "'Discovery of facts for the purposes of this statute of limitations includes constructive or inquiry notice, as well as actual notice.'" Newman v. Warnaco Group, Inc., 335 F.3d 187, 193 (2d Cir. 2003) (quoting Rothman, 220 F.3d at 96 (internal quotation marks omitted)). The Defendants contend that Clark's three fraud claims brought under the federal securities laws are barred by the statute of limitations established by Sarbanes-Oxley, as she had notice of the Fund's investments in IPOs and the impact of those investments on the Fund's performance on July 28, 2000, at the very latest, rendering her complaint, filed more than two years after that date, time-barred.
The limitations period in Sarbanes-Oxley applies both to claims brought pursuant to sections 10(b) and 20(a) of the Exchange Act, see, e.g., Marcus v. Frome, 329 F. Supp. 2d 464, 475 (S.D.N.Y. 2004), and to claims brought pursuant to the Advisers Act. See Flood v. Makowski, No. 03 Civ. 1803, 2004 WL 1908221, at *32 (M.D. Pa. Aug. 24, 2004).
It is well established that "when 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." Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993). "'The test as to when fraud should with reasonable diligence have been discovered is an objective one.'" Id. (quoting Armstrong v. McAlpin, 699 F.2d 79, 88 (2d Cir. 1983) ("'[T]he means of knowledge are the same thing in effect as knowledge itself.'") (citation omitted)). Thus, "'[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.'" Newman, 335 F.3d at 193 (quoting Dodds, 12 F.3d at 350). "The circumstances that give rise to a duty of inquiry are often referred to as 'storm warnings.'" Levitt v. Bear Stearns Co., Inc., 340 F.3d 94, 101 (2d Cir. 2003).
"To constitute 'storm warnings,' the information 'must be such that it relates directly to the misrepresentations and omissions the Plaintiffs later allege in their action against the defendants.'" In re Salomon Analyst Winstar Litig., No. 02 Civ. 6171 (GEL), 2005 WL 23301, at *4 (S.D.N.Y. Jan. 5, 2005) (quotingNewman, 335 F.3d at 193). An investor need not have "notice of the entire fraud being perpetrated to be on inquiry notice."Dodds, 12 F.3d at 351-52; accord Newman, 335 F.3d at 193. Nonetheless, "[t]he fraud must be probable, not merely possible."Newman, 335 F.3d at 193 (citing Jackson Nat'l Life Ins. Co. v. Merrill Lynch Co., 32 F.3d 697, 701 (2d Cir. 1994); de la Fuente v. DCI Telecomm., Inc., 206 F.R.D. 369, 381 (S.D.N.Y. 2002)).
Where a duty of inquiry arises, knowledge of a fraud may be imputed to an investor in one of two ways. "If the investor makes no inquiry once the duty arises, knowledge will be imputed as of the date the duty arose." LC Capital Partners, LP v. Frontier Ins. Group, Inc., 318 F.3d 148, 154 (2d Cir. 2003) (citingDodds, 12 F.3d at 350; Armstrong, 699 F.2d at 88); accord Lentell v. Merrill Lynch Co., 396 F.3d 161, 168 (2d Cir. 2005). If, however, the investor makes some inquiry once the duty has arisen, "we will impute knowledge of what an investor "in the exercise of reasonable diligence, should have discovered" concerning the fraud, and in such cases the limitations period begins to run from the date such inquiry should have revealed the fraud." LC Capital Partners, 318 F.3d at 154 (citing Rothman, 220 F.3d at 98) (internal citations omitted); accord Lentell, 36 F.3d at 168. "Once the facts on the face of the complaint and related documents give rise to a duty of inquiry, it is appropriate to require a plaintiff, resisting a motion to dismiss on limitations grounds, at least to allege that inquiry was made." LC Capital Partners, 318 F.3d at 156 (concluding that the district court's grant of a motion to dismiss on statute-of-limitations grounds was appropriate where the plaintiff had conceded that no inquiry was made until well after the duty to inquire arose).
The Second Circuit has recognized that "whether a plaintiff had sufficient facts to place it on inquiry notice is 'often inappropriate for resolution on a motion to dismiss under Rule 12(b)(6).'" LC Capital Partners, 318 F.3d at 156 (quotingMarks v. CDW Computer Ctrs., Inc., 122 F.3d 363, 367 (7th Cir. 1997)). Nonetheless, 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 . . . forms that are integral to the complaint, resolution of the issue on a motion to dismiss is appropriate."Dodds, 12 F.3d at 352 n. 3 (observing that the notice issue has been resolved on a motion to dismiss in "a vast number of cases"); accord Lentell, 36 F.3d at 168; LC Capital Partners, 318 F.3d at 156; In re Salomon Analyst Winstar Litig., 2005 WL 23301, at *4.
It is Clark's position that the Defendants' alleged practices of manipulating IPO allocations and IPO flipping profits were first disclosed in connection with the July 31, 2003 SEC proceeding against the Nevis Capital Defendants, described in a Fund prospectus supplement on August 18, 2003, and that, until that time, there was no basis for her legal action or any public information about the practices which would have been revealed by any inquiry. The Defendants have argued that the statute of limitation began to run well before August 2003 because the Fund's 2000 Annual Report, filed with the SEC on July 28, 2000, contained sufficient storm warnings concerning the fraud alleged here to give rise to a duty to inquire. As a consequence, according to the Defendants, Clark's federal securities claims are time-barred.
Although not specifically incorporated by reference in Clark's Complaint, the 2000 Annual Report may be considered in connection with the Defendants' motions. See Rothman, 220 F.3d at 88-89.
The Defendants point to the following statement contained in the Fund's 2000 Annual Report as giving rise to a duty to inquire:
Your Fund has benefited substantially from initial public offerings (IPOs) during its most recent fiscal year and since its inception. For example, based on your Fund's net asset value as of May 31, 2000, and assuming reinvestment of distributions to shareholders, we believe that net realized and unrealized first-day gains from IPOs purchased by the Fund contributed approximately 50.3% of the Fund's total return during the recent fiscal year, and approximately 69.8% of its total return since commencement of operations. In particular, the Fund received $10,299,576 ($7.45 per share) of first-day realized or unrealized gains from IPOs during its recent fiscal year, and $12,919,032 ($16.62 per share) since commencement of operations on June 28, 1998. These gains were particularly noteworthy given the Fund's relatively small asset base during 1998 and much of 1999. There is no guarantee, and in fact it is unlikely, that the Fund will benefit from these types of gains in the future. Moreover, if Fund assets remain at or near current levels, or if they increase, the impact of future first-day IPO gains, if any, on the Fund is likely to be substantially lower.
(Declaration of Kelly A. McCormick, dated July 6, 2004 ("McCormick Decl."), Exh. D at 2 (emphasis supplied and footnotes omitted).) In footnotes to this same passage, it was explained with respect to the dollar figures listed in the main text that
These amounts represent the change in value between the initial offering price of each IPO security purchased by the Fund and the closing price of that security on the first day of trading or, if the Fund sold its IPO shares on the first day of trading, the change in value between the issue price and the price at which the shares were sold during the first day of trading.
(McCormick Decl., Exh. D. at 3 n. 2 (emphasis supplied).) All of the misrepresentations and omissions alleged in the complaint occurred prior to issuance of the 2000 Annual Report. (See, e.g., Compl. at ¶¶ 9, 10 (alleging that "false and misleading statements" were issued between "December 1998 and July 2000").)
Clark has alleged several distinct theories of fraud with regard to the Defendants' purported misrepresentations and omissions, which theories may be grouped into four general categories. First, Clark has alleged that some or all of the Defendants failed to disclose that the Fund's "exceptional performance was primarily attributable to IPO investments." (Id. at ¶ 16(d); see also id. at ¶¶ 16(b), 16(c), 16(e), 16(f) 16(g).) Second, Clark has alleged that the Fund's September 24, 1999 prospectus did not disclose that the 90.1% return identified therein "could not be sustained as the asset base for the . . . Fund increased." (Id. at ¶ 16(f).) Third, Clark has alleged that the Defendants engaged in a scheme of selling the IPO shares "immediately after" their allocation to the Fund "for large profits within 1-13 days of acquisition." (See id. at ¶¶ 11, 27.) Finally, Clark has alleged that the Defendants engaged in a scheme involving the improper allocation of IPO shares to the Fund. (See id. at ¶¶ 11, 27.)
With respect to the first theory of fraud alleged in the complaint, involving the degree to which the Fund's returns during the relevant period were the result of investments in IPOs, the 2000 Annual Report specifically addressed the substantial benefit the Fund had received from investing in IPOs since its inception, acknowledging that nearly 70% of the Fund's total return since its commencement was attributable to net realized and unrealized first-day gains from IPOs purchased by the Fund. Thus, insofar as Clark has alleged that the Defendants failed to disclose that the Fund's performance was primarily attributable to investments in IPOs, instead allegedly misrepresenting the Fund's returns as attributable to a long-term investment strategy or to returns from certain non-IPO holdings, the 2000 Annual Report disclosed the very fact of which Clark claims she had no notice until 2003, placing Clark on actual notice of the fraud she now alleges. As Clark has neither alleged, nor even suggested, that she took any steps to investigate possible fraud prior to 2003, her federal securities fraud claims premised on this first theory of fraud are time-barred, notice of the underlying facts having arisen more than two years before Clark commenced this action.
Clark's second theory of fraud is similarly foreclosed by the running of the statute of limitations. Clark has alleged that the Fund's September 1999 prospectus failed to disclose that the significant return reported therein could not be sustained as the asset base for the Fund grew. However, a supplement to that same prospectus, dated and filed with the SEC on November 15, 1999 (i.e., several days prior to Clark's first investment in the Fund) announces under the heading "PERFORMANCE RISK" that,
The Fund may participate in the initial public offering (IPO) market. An investment by the Fund in IPOs may have a magnified impact on the Fund's total returns because of the Fund's small asset base. As the Fund's assets grow, the effect of an investment in IPOs on the Fund's total returns will likely decline, which may reduce the Fund's total returns.
(McCormick Decl., Exh. C, at 1 (emphasis supplied).) Further, the 2000 Annual Report filed on July 28, 2000 expressly identified the significant role played by IPO investments in creating the high returns achieved by the Fund since its inception, observed that these gains were particularly noteworthy given the small asset base during 1998 and 1999, and expressly acknowledged the unlikelihood that the Fund would continue to benefit from such gains in the future. According to the 2000 Annual Report, "if Fund assets remain at or near current levels, or if they increase, the impact of future first-day IPO gains, if any, on the Fund is likely to be substantially lower." (McCormick Decl., Exh. D, at 2.)
These statements, taken together, are sufficient to place a reasonable investor on notice of the probability that the significant returns previously achieved by the Fund would not be sustained going forward, particularly if the assets of the Fund were to increase, the very fact that Clark alleges was not disclosed to her by the September 1999 prospectus. As Clark has neither alleged nor even suggested that she took any steps to investigate possible fraud prior to 2003, her knowledge is imputed as of the day the 2000 Annual Report was filed, and her fraud claim premised on the asset-base theory is barred.
Notably, neither the Fund's August 2003 prospectus disclosing the SEC investigation nor the SEC's own release on the same topic from July 2003 makes any reference to the Fund's asset base or the effect of any increase in that asset base on the Fund's returns, casting further doubt on the notion that Clark's duty to inquire might have arisen in 2003 rather than in 2000.
Clark's third theory of fraud, involving the purported IPO flipping scheme by which the Defendants are alleged to have sold shares in IPOs for large profits within one to thirteen days of acquisition, is also time-barred. The 2000 Annual Report explicitly acknowledged that the Fund might "s[ell] its IPO shares on the first day of trading" (McCormick Decl., Exh. D. at 3) — the very activity of which Clark has complained — and noted the substantial returns attributable to first-day realized and unrealized gains from IPOs purchased by the Fund. (See McCormick Decl., Exh. D, at 2). It was further explained that "[t]he first day gains for IPOs since inception break down to $6.56 per share in realized gains and $10.05 per share in unrealized gains," providing further perspective on the degree to which the Fund sold IPO shares on the first day of trading and realized gains thereby. (McCormick Decl., Exh. D, at 3.) Even if these references to first-day sales do not provide actual notice as to the extent to which such so-called flipping was occurring, they are more than adequate to suggest to an investor of ordinary intelligence that same-day sales of newly acquired IPO shares were occurring, giving rise to a duty to inquire. Clark has failed to allege that she made any efforts to investigate this theory of fraud prior to 2003, nor has she identified anything in the 2003 disclosures themselves which makes reference to same-day trading in IPOs or trading in IPOs within one to thirteen days of acquisition by the Fund, further undercutting her claim that no duty to inquire arose until 2003. Accordingly, as no investigation was undertaken, the statute of limitations began to run with respect to this third fraud theory in 2000 and Clark's federal securities fraud claims premised on the Defendants' so-called flipping scheme is time-barred.
Clark's fourth and final theory of fraud is the sole theory not barred by the statute of limitations under Sarbanes-Oxley. Nothing in the 2000 Annual Report gives any indication that the allocation of IPOs to the Fund may have been inequitable, as Clark has alleged, nor is it evident from the face of the complaint that the "precipitous" drop in the Fund's share price alleged by Clark to have occurred at some unspecified time subsequent to her investments (Compl. at ¶ 19) would have been sufficient to alert her to this particular fraud. It therefore may not be concluded at this stage that Clark's federal securities fraud claims, premised on a theory of inequitably allocated IPOs, are time-barred.
B. The Motion of the Defendants to Dismiss the Section 10(b) and Rule 10b-5 Cause of Action Is Granted
The Defendants have moved to dismiss the section 10(b) and Rule 10b-5 claim on the grounds that Clark has failed to allege fraud with particularity; that she has not adequately alleged reasonable reliance on the statements that she has claimed are false and misleading; and that she has failed to plead scienter adequately. The Fund has also argued that certain alleged misstatements and omissions by Wilmerding and Baker may not be imputed to the Fund.
To state a claim under section 10(b) and Rule 10b-5 promulgated thereunder, a plaintiff must plead that "in connection with the purchase or sale of securities, the defendant, acting with scienter, made a false material representation or omitted to disclose material information and that plaintiff's reliance on defendant's action caused [plaintiff] injury." Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995) (internal quotation marks omitted); accord Lawrence v. Cohn, 325 F.3d 141, 147 (2d Cir. 2003).
A claim under section 10(b) sounds in fraud and must therefore meet the pleading requirements of Rule 9(b), Fed.R.Civ.P. See, e.g., In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 69-70 (2d Cir. 2001). Such a claim must also satisfy certain requirements of the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). See 15 U.S.C. §§ 78u-4(b)(1) 78u-4(b)(2);see generally Novak v. Kasaks, 216 F.3d 300, 306-07 (2d Cir. 2000) (setting forth the heightened pleading standards of the PSLRA that must be met by a plaintiff who alleges securities fraud under Section 10(b) and Rule 10b-5); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1127 (2d Cir. 1994) (stating that "[s]ecurities fraud allegations under § 10(b) and Rule 10b-5 are subject to the pleading requirements of Rule 9(b)").
To satisfy Rule 9(b), Fed.R.Civ.P., a complaint setting forth a claim pursuant to section 10(b) and Rule 10b-5 "must '(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why the statements were fraudulent.'" Shields, 25 F.3d at 1128 (quoting Mills v. Polar Molecular Corp., 12 F.3d 1170, 1175 (2d Cir. 1993)); accord Stevelman v. Alias Research Inc., 174 F.3d 79, 84 (2d Cir. 1999). To plead a material misrepresentation or omission under the PSLRA, "the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information or belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4(b)(1).
Although Clark has alleged the who, what and when of numerous misrepresentations and omissions, the complaint fails to make plain in what way any of the misrepresentations and omissions alleged were misleading with respect to the alleged scheme to inequitably allocate IPOs to the Fund, as distinct from the other theories of fraud advanced in the complaint and barred by the statute of limitations, as set forth above. Moreover, the allegations concerning Clark's telephone call placed at some point prior to November 23, 1999 to the Fund lack the requisite specificity as to when the statements alleged were made and by whom. Accordingly, Clark's section 10(b) and Rule 10b-5 claim premised on a theory of inequitable allocation of IPOs is dismissed for failure to comply with the PSLRA and Rule 9(b), Fed.R.Civ.P., with leave granted to replead.
In view of this dismissal, the Defendants' remaining arguments concerning Clark's section 10(b) and Rule 10b-5 claim need not be reached.
C. The Section 20(a) Cause of Action Is Dismissed
As the second cause of action in her Complaint, Clark has alleged controlling person liability under section 20(a) of the Exchange Act against the Nevis Capital Defendants. Section 20(a) provides as follows:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable . . . to the same extent as such controlled person . . . unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.15 U.S.C. § 78t(a).
"In order to plead control person liability under section 20(a), plaintiff must demonstrate: (1) a primary violation by a controlled person; (2) control of the primary violator by the defendant; and (3) the controlling person's culpability in the primary violation." Kalnit v. Eichner, 85 F. Supp. 2d 232, 245 (S.D.N.Y. 1999) (citing Boguslavsky v. Kaplan, 159 F.3d 715, 720 (2d Cir. 1998)). Clark has alleged that Nevis Capital acted as a "controlling person" of the Fund, and that Baker and Wilmerding acted as "controlling persons" of both Nevis Capital and the Fund. (Compl. at ¶ 32.) Clark's section 20(a) claim is otherwise premised on the same allegations of fraud as her section 10(b) and Rule 10b-5 claim. (See id. at ¶¶ 33-36.)
"[A]bsent a primary violation, a plaintiff cannot state a claim of control person liability under section 20(a)." Kalnit, 85 F. Supp. 2d at 245. As Clark has failed to plead the primary violation under section 10(b) and Rule 10b-5 with sufficient particularity for the reasons stated above, her section 20(a) claim fails on that basis, and must be dismissed, with leave granted to replead. D. The Advisers Act Claim Is Dismissed
Relying on Kalnit v. Eichner, 85 F. Supp. 2d 232 (S.D.N.Y. 1999), the Nevis Capital Defendants have argued that, even assuming that Clark had adequately pled a claim under section 10(b) and Rule 10b-5, her section 20(a) claim would still fail, as a person is either a "control person" or a "primary violator" under section 20(a) — but cannot be both. In Kalnit, the plaintiff sought to hold the individual directors of the corporate defendant liable as control persons for misrepresentations and omissions that they themselves were alleged to have made. See Kalnit, 85 F. Supp. 2d at 245. In order to establish liability under section 20(a) as to the individual defendants in that case, the plaintiff necessarily would have had to establish those very defendants' liability as primary violators. See id. The court concluded, therefore, that, "under plaintiff's own theory, the Directors could not be control persons and section 20(a) does not apply." Id.
Although Kalnit casts doubt on Clark's argument that a defendant could ultimately be held liable as both a primary violator under section 10(b) and as a control person of another primary violator pursuant to section 20(a) with regard to the same underlying conduct, the logical inconsistency that required dismissal of the section 20(a) claim in Kalnit is not present here, where multiple misrepresentations and omissions by various of the Defendants have been alleged and it is conceivable that one Defendant ultimately might be found to be a primary violator while another Defendant might be found to be a control person under section 20(a). As the Federal Rules of Civil Procedure permit the pleading of claims in the alternative, see Fed.R.Civ.P. 8(e)(2), Clark is not precluded from pleading that the Nevis Capital Defendants are both primary violators and control persons, as the Nevis Capital Defendants have suggested.
Count III of Clark's complaint, brought against Nevis Capital alone, is for violations of section 206 of the Advisers Act, 15 U.S.C. § 80b-6, and is assertedly based upon section 215 of the Advisers Act, 15 U.S.C. § 80b-15.
There is no private cause of action under § 206 of the Advisers Act, 15 U.S.C. § 80b-6. See, e.g., Goldstein v. Malcolm G. Fries Assoc., Inc., 72 F. Supp. 2d 620, 624-25 (E.D. Va. 1999) ("Although § 206 established federal fiduciary standards governing the conduct of investment advisors in order to benefit their respective clients, it does not give rise to a private cause of action for damages. Section 206 simply proscribes certain conduct and does not create or alter any civil liabilities.") (citing Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 19-20 (1979)) (internal citation omitted). There is, however, a limited private right of action to have an investment advisory contract voided under section 215 of the Advisers Act if the formation or performance of the contract violates the Advisers Act. See Transamerica Mortgage Advisors, 444 U.S. at 24. With the rescission of an investment advisory contract, the rescinding party may seek "consideration given under the contract, less any value conferred by the other party." Id. at 24, n. 14 (internal citation omitted). "Restitution does not include compensation for any losses from an investment alleged to have been made as a result of an investment adviser's conduct." Washington v. Baenziger, 656 F. Supp. 1176, 1178 (N.D. Cal. 1987) (citing Transamerica Mortgage Advisors, 444 U.S. at 24, n. 14).
Only parties to an investment advisory contract may sue for rescission under section 215. See Zurich Capital Markets Inc. v. Coglianese, 332 F. Supp. 2d 1087, 1114 (N.D. Ill. 2004) ("In order to sue under the Act and seek rescission of the contract, [a plaintiff investor] must be a party to the contract.") (citingShahidi v. Merrill Lynch, Pierce, Fenner Smith, Inc., No. 2:02CV483FTM29S[C, 2003 WL 21488228, at *3 (M.D. Fla. Apr. 28, 2003) (concluding that the plaintiff "shareholders have no standing to individually sue either defendant in this case to void the contracts"); Soderberg v. Gens, 652 F. Supp. 560, 564 (N.D. Ill. 1987) (observing that the courts limit claims to "persons actually in an adviser/client relationship")); Neely v. Bar Harbor Bankshares, 270 F. Supp. 2d 44, 49 (D. Me. 2003) (observing that "there is no right of action under the Act unless there is first an investment adviser contract between the parties") (citing Paul S. Mullin Assoc., Inc. v. Bassett, 632 F. Supp. 532, 537 (D. Del. 1986) (stating that "only the parties to [an investment adviser] contract can avail themselves of the remedy of rescission")); Washington, 656 F. Supp. at 1178 (holding that only parties to an investment adviser contract are proper parties in a claim brought under section 215).
Clark has alleged that she purchased shares of the Fund (see Compl. at ¶ 4), and that Nevis Capital served as an investment adviser to the Fund. (See id. at ¶¶ 5, 39). She has further alleged that Nevis Capital served as an investment adviser to her "as an investor" to the Fund pursuant to the Advisers Act. (Id. at ¶ 39.) Apart from the conclusory assertion that she is "entitled to rescind her investment advisory contract with Nevis Capital . . . and recover all fees paid in connection with her enrollment pursuant to such agreement" (id. at ¶ 46), Clark has pled no facts concerning the existence of an investment advisory contract between Nevis Capital and herself, when any such agreement was entered into by the alleged parties thereto, or whether she provided any consideration to Nevis Capital for rendering investment advice. See Washington, 656 F. Supp. at 1177 (noting that "investment advisers," for purposes of the Advisers Act, are those who receive consideration for rendering investment advice).
In opposition, Clark does not dispute Nevis Capital's contention that she has failed to allege the existence of an investment advisory contract between her and Nevis Capital. Rather, she urges that, as a current shareholder of the Fund, she possesses a private right of action under section 215. Clark has cited no authority for this proposition, which is, in any event, contrary to the rule that only parties to an investment advisory contract may sue under section 215. See, e.g., Norman v. Salomon Smith Barney, Inc., 350 F. Supp. 2d 382, 388 (S.D.N.Y. 2004) (observing that "the remedies under the IAA are only available where an investor brings suit on the investment adviser's allegedly improper conduct (or vice versa) pursuant to a contract for services"); see also Zurich Capital Markets, 332 F. Supp. 2d at 1114 (dismissing the notion that an investor in a particular fund could be considered a client of an investment advisor to that fund under a "broad reading" of the Advisers Act and explaining that, "[g]iven the restricted reading of claims under the Act by the Supreme Court, the Court refuses to adopt [the plaintiff investor's] broad definition here").
Clark further contends that, even if an investment advisory contract only existed between Nevis Capital and the Fund, she, nonetheless, possesses standing as a continuous shareholder since November 1999 to pursue her claim for rescission of the contract at issue derivatively. Clark has cited no authority in support of the proposition that an investor not a party to an investment advisory contract may sue derivatively on the contract, nor are there any allegations in the complaint that would support a derivative action here. Compare Zurich Capital Markets, 332 F. Supp. 2d at 1115 (discussing the pleading requirements under Rule 23.1, Fed.R.Civ.P., with respect to derivative actions in the context of a section 215 claim).
Accordingly, as there are no factual allegations from which it might be inferred that Clark was a party to an investment advisory contract with Nevis Capital, and no allegations such as might support a derivative claim here, Count III of the complaint is dismissed, with leave granted to replead.
E. The State Causes of Action Are Dismissed In Part
Clark has pled as her fourth and fifth causes of action against all the Defendants liability under state law for fraud and negligent misrepresentation, and as her sixth and seventh causes of action against the Nevis Capital Defendants liability for breach of fiduciary duty as well as aiding and abetting a breach of fiduciary duty. For the reasons set forth below, Defendants' motions to dismiss Counts IV and V are granted and the Nevis Capital Defendants' motion to dismiss Counts VI and VII is denied.
1. The Fraud Claim Is Dismissed
The Defendants contend, and Clark has conceded, that New York law applies to her common law fraud claim. See generally Sack v. Low, 478 F.2d 360, 366 (2d Cir. 1973) (holding that a cause of action in a securities suit accrues where the plaintiffs suffer the loss, i.e., "where they lived and conducted their investment activities").
To state a claim for fraud under New York law, a plaintiff must allege with particularity (1) a misrepresentation of a material fact; (2) the falsity of that misrepresentation; (3) scienter, or intent to defraud; (4) plaintiff's reasonable reliance on that representation; and (5) damage caused by such reliance. See Granite Partners, L.P. v. Bear, Stearns Co., Inc., 58 F. Supp. 2d 228, 257 (S.D.N.Y. 1999); Vermeer Owners, Inc. v. Guterman, 78 N.Y.2d 1114, 1116, 578 N.Y.S.2d 128, 129, 585 N.E.2d 377, 378 (N.Y. 1991). The special pleading requirements of Rule 9(b) also apply to allegations of common law fraud. See Perma Research Dev. Co. v. Singer Co., 410 F.2d 572, 576 (2d Cir. 1969); Granite Partners, 58 F. Supp. 2d at 286.
Clark's common law fraud claim is subject to a different statute of limitations than her federal securities fraud claims and, consequently, is not limited to a specific theory of fraud.See N.Y.C.P.L.R. § 213(8) (providing that the time within which an action based upon fraud must be commenced "shall be the greater of six years from the date the cause of action accrued or two years from the time the plaintiff or the person under whom the plaintiff claims discovered the fraud, or could with reasonable diligence have discovered it"); see also Topps Co. v. Cadbury Stani S.A.I.C. f/k/a/ Productos Stani Sociedad Anonima Industrial y Commercial, No. 99 Civ. 9437 (CSH), 2004 WL 2914096, at *1 n. 1 (S.D.N.Y. Dec. 15, 2004) (observing that, although N.Y.C.P.L.R. § 213(8) was amended in August 2004, no substantive distinctions exist between the pre-amendment construction of the statute and the post-amendment version). The Defendants have argued, however, that Clark's common law fraud claim suffers from the same defects asserted by the Defendants in connection with Clark's section 10(b) and Rule 10b-5 claim, namely, a lack of particularity, the absence of adequate allegations as to reasonable reliance, and the failure to adequately allege scienter. Each issue will be addressed in turn.
a. The Fraud Claim Is Pled With Sufficient Particularity With Respect to the Published Alleged Misrepresentations and Omissions
The Defendants contend that Clark has neglected to plead how the various published alleged misrepresentations and omissions set forth in paragraph 16 of the complaint were misleading. Although, as stated above, nothing in the complaint demonstrates how any of the alleged misrepresentations or omissions were misleading with respect to the allocation theory of fraud, the complaint adequately identifies how the statements at issue were misleading with respect to the remaining theories of fraud.
Thus, the Fund's investment objective of "long-term capital appreciation," stated in the Fund's September 1999 prospectus (Compl. at ¶ 16(a)) is alleged to be misleading in light of the alleged IPO flipping scheme, a necessarily short-term endeavor. Likewise, the statements set forth at subparagraph 16(b) of the complaint about the stock price appreciation of certain Fund holdings purportedly held for multiple months when they were allegedly held for "only one business day and 13 business days, respectively" are alleged to be misleading in that they further contributed to the illusion that the Fund was experiencing positive returns through long-term capital appreciation of its holdings and concealed what Clark contends is the truth, i.e., that the Fund's performance "was primarily attributable to IPO investments." (Id. at ¶ 16(b).) Similarly, Wilmerding's July 29, 1999 statements attributing the Fund's success to its "long term investment strategy," while omitting mention of the dependence of the Fund's performance on IPOs at a time when the Fund would have allegedly suffered investment losses absent its undisclosed IPO flipping scheme (see id. at ¶ 13), are alleged to be misleading for comparable reasons.
With respect to the remainder of the published statements set forth in the complaint, each of them is alleged to have been false and misleading by virtue of their common omission that the Fund's performance was primarily attributable to IPO flipping. (See, e.g., id. at ¶¶ 16(d), 16(e), 16(f) 16(g).)
Clark also has alleged a direct misrepresentation in the course of her telephone inquiry to the Fund, made at some point "prior to her first purchase of shares of the Nevis Fund on November 23, 1999." (Id. at ¶ 17.) According to the complaint, Clark called and "inquired as to the Nevis Fund's investment strategy behind its impressive publicly reported investment return figures." (Id.) She also allegedly asked about "whether the Nevis Fund concentrated heavily in IPOs" and "was told that [the] Nevis Fund employed a long-term investment strategy and had only a small to modest exposure to IPOs of similar or comparable degree as other long-term funds." (Id.) Although these allegations, which indicate that Clark may have been misled with respect to the degree to which the Fund relied upon IPO investments, are sufficient to satisfy the requirement of Rule 9(b) that a complaint indicate how a particular statement was misleading, Clark has not alleged with any particularity when the call was made. Paragraph 17 also fails to satisfy the particularity requirements with respect to Wilmerding and Baker, as the complaint fails to identify the Fund representative, whether Clark called the Fund's offices in Maryland, or whether she called some other person in some other location. See In re Merrill Lynch Co., 273 F. Supp. 2d 351, 369-71 (S.D.N.Y. 2003) (holding that a plaintiff must supply particularity regarding an alleged misstatement, including who made it and when it was made), aff'd sub nom. Lentell v. Merrill Lynch Co., 396 F.3d 161 (2nd Cir. 2005). Accordingly, the allegations of paragraph 17 fail to satisfy Rule 9(b), Fed.R.Civ.P.
b. Scienter Has Been Adequately Pled
The Defendants have argued that the complaint fails to allege scienter with the requisite degree of particularity. Pursuant to Rule 9(b), "[m]alice, intent, knowledge, and other condition of mind of a person may be averred generally." Fed.R.Civ.P. 9(b). Notwithstanding the generosity of this standard, however, the Second Circuit has expressly cautioned that "we must not mistake the relaxation of Rule 9(b)'s specificity requirement regarding condition of mind for a 'license to base claims of fraud on speculation and conclusory allegations.'" Acito, 47 F.3d at 52 (quoting Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990)). In other words, "plaintiffs must allege facts that give rise to a strong inference of fraudulent intent." Id.;see also Novak, 216 F.3d at 307. "A strong inference of fraudulent intent may be established (a) by alleging facts to show that defendants had both motive and opportunity to commit fraud, or (b) by alleging facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness." In re Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir. 2000) (internal quotation marks and citations omitted).
The complaint alleges that the central purpose of the Defendants' alleged scheme was to attract investors to the Fund by concealing that the high returns from its purported long-term investment strategy were in fact primarily attributable to its undisclosed IPO flipping scheme, resulting in higher fees payable to the Nevis Capital Defendants. (See Compl. at ¶¶ 11, 23.) It further alleges a sequence of events by which the purpose was carried out and the management fees paid by the Fund directly to Nevis Capital and indirectly to Wilmerding and Baker increased as the Fund's net assets grew from a dramatic rise in investment net inflow. (See id. at ¶ 12.) These allegations are more than adequate to show opportunity, but they are not sufficient to show motive.
The Second Circuit has held that "the existence, without more, of executive compensation dependent upon stock value does not give rise to a strong inference of scienter." Acito, 47 F.3d at 54; accord Kalnit v. Eichler, 264 F.3d 131, 140 (2d Cir. 2001). An allegation that the Defendants "had a motive to commit the fraud because the better the funds' performance, the higher their fees, is analogous to the argument previously rejected that an executive has a motive to commit fraud merely because his compensation is tied to stock price," and such an allegation is insufficient to provide the requisite motive. Steed Finance LDC v. Laser Advisers, Inc., 258 F. Supp. 2d 272, 278 (S.D.N.Y. 2003); see also Vogel v. Sands Bros. Co., Ltd., 126 F. Supp. 2d 730, 739 (S.D.N.Y. 2001) (concluding that an investment bank's alleged desire to realize greater transaction fees is insufficient to show an improper motive); Primavera Familienstiftung v. Askin, 173 F.R.D. 115, 124 (S.D.N.Y. 1997) (observing that, "[a]lthough the desire to enhance income may motivate a person to commit fraud, allegations that a defendant stands to gain economically from fraud do not satisfy the heightened pleading requirements of Rule 9(b)," and concluding that the complaint failed to state a motive for fraud where the defendant fund manager was alleged to have a motive "to misrepresent its fund management strategy and methods and to overstate the Funds' performance, both to attract investments and to reap higher fees on the inflated profits"). Accordingly, the allegations of the complaint are inadequate to show scienter under the motive-and-opportunity analysis.
Even if the allegations of the complaint were sufficient to show motive with respect to the Nevis Capital Defendants, allegations that the alleged scheme was concealed so as to increase the asset base of the Fund are not sufficient to establish scienter with respect to the Fund under a motive-and-opportunity theory. See, e.g., Kalnit, 264 F.3d at 139-40 (noting that the Second Circuit has rejected allegations such as a desire for the corporation to appear profitable as "insufficient" to plead motive); Chill v. Gen. Elec. Co., 101 F.3d 263, 268 (2d Cir. 1996) (rejecting as a motive for fraud the corporation's supposed interest in justifying to its shareholders a large investment in its subsidiary as a motive that could be "imputed to any publicly-owned, for profit endeavor").
Clark has also argued that the complaint gives rise to a strong inference of fraudulent intent by virtue of allegations that constitute strong circumstantial evidence of conscious misbehavior or recklessness. "Such a strong inference may arise where the complaint sufficiently alleges that the defendant (1) engaged in deliberately illegal behavior; or (2) knew facts or had access to information suggesting that his public statements were not accurate; or (3) failed to check information that he had a duty to monitor." BHC Interim Funding, L.P. v. Finantra Capital, Inc., 283 F. Supp. 2d 968, 981 (S.D.N.Y. 2003) (citingNovak, 216 F.3d at 311). In the present case, Clark has alleged that the Defendants, including the Fund and its principal managers, knew that the Fund's investment returns were primarily attributable to the IPO flipping alleged, but nonetheless repeatedly omitted to state the reasons for the high returns reported. The disparity between the Defendants' knowledge of the impact of the alleged IPO flipping on the Fund's performance and the public disclosures to the contrary raises a strong inference of conscious misbehavior.See, e.g., Novak, 216 F.3d at 311-12. Accordingly, Clark's common-law fraud claim may not be dismissed for failure to plead scienter adequately.
c. The Fraud Claim Is Dismissed For Failure to Adequately Plead Justifiable Reliance
According to the Defendants, Clark's fraud claim fails because she has failed to allege reasonable or justifiable reliance as is required to state a common law claim for fraud. "As an essential element of a cause of action for fraud, . . . [justifiable] reliance must be pleaded with particularity pursuant to [Federal Rule of Civil Procedure] 9(b)." Bank of America Corp. v. Lemgruber, No. 02 Civ. 1041 (DAB), 2005 WL 19274, at *22 (S.D.N.Y. Jan. 5, 2005) (quoting Lutin v. New Jersey Steel Corp., Nos. 93 Civ. 6612 (AGS) 95 Civ. 4965 (AGS), 1996 WL 636037, at *7 (S.D.N.Y. Nov. 1, 1996) (quoting Learning Works, Inc. v. The Learning Annex, Inc., 830 F.2d 541, 546 (4th Cir. 1987))) (internal quotation marks omitted and alterations in original).
Both New York State courts and the courts of this circuit have employed "reasonable reliance" and "justifiable reliance" interchangeably in considering common law fraud claims arising under New York law. See Computech Int'l, Inc. v. Compaq Computer Corp., No. 02 Civ. 2628 (RWS), 2004 WL 1126320, at *9 (S.D.N.Y. May 21, 2004) (collecting cases).
Clark has alleged that, "[b]etween December 1998 and July 2000, [D]efendants caused materially false and misleading statements to be issued concerning investments in shares of Nevis Fund, on which plaintiff relied in purchasing shares of Nevis Fund. . . ." (Compl. at ¶ 9.) She has further alleged that she acquired shares of the Fund "[i]n reliance upon [D]efendants' . . . written and oral misrepresentations. . . ." (Id. at ¶ 18.) More specifically, she claims to have acquired shares in the Fund having relied "directly or indirectly on the false and misleading statements made by the [D]efendants, and/or upon the integrity of the market in which the securities trade, and/or on the absence of material adverse information that was known or recklessly disregarded by [D]efendants but not disclosed in public statements by [D]efendants. . . ." (Id. at ¶ 27.)
As the Fund argues and Clark concedes by her silence, a plaintiff who has allegedly acquired shares in a mutual fund, the price for which is unaffected by alleged misrepresentations and omissions concerning the fund itself, may not establish reliance by invoking the integrity of the market or the so-called fraud-on-the-market theory, by which information available to the public is presumed to be reflected in the value of a security and reliance is imputed to the purchaser of such securities. Put simply,
[F]raud-on-the-market does not apply here because the share price of a mutual fund is not affected by alleged misrepresentations or omissions. The share price of a mutual fund is determined by the value of all the underlying securities it holds at a given time, and the fund price fluctuates with the price of those underlying securities.Young v. Nationwide Life Ins. Co., 183 F.R.D. 502, 510 (S.D. Tex. 1998) (concluding, in the context of a motion for class certification, that the plaintiffs could not claim "that they relied upon an improperly inflated price that resulted from Defendants' misrepresentations" in order to establish reliance). Thus, to plead the reliance element of her fraud claim, Clark must have directly relied upon one or more of the misrepresentations and omissions alleged. As Clark has made only conclusory, nonspecific allegations of reliance, including allegations suggesting temporal inconsistencies, and as she has alleged no facts to demonstrate reliance or that any such reliance was direct, as opposed to indirect or based solely upon "the integrity of the market" (Compl. at ¶ 27), the circumstances of the fraud alleged here have not been pled with sufficient particularity, and Clark's common law fraud claim is dismissed, with leave granted to replead.
The sole set of misrepresentations alleged to have been made directly to Clark by telephone (see Compl. at ¶ 17) has not been pled with sufficient particularity for the reasons set forth above, and, therefore, provides no basis to conclude that reliance has been adequately pled.
For example, Clark has alleged that she relied upon statements issued between December 1998 and July 2000 in purchasing shares of the Fund, although her last purchase of shares in the Fund was in early March 2000, three months before the end of the stated period of reliance. (See Compl. at ¶¶ 4, 8, 9.)
Because the conclusory allegations of the complaint fail to establish that Clark relied upon the misrepresentations and omissions alleged, the Defendants' remaining arguments concerning the reasonableness of any such reliance need not be reached.
2. The Negligent Misrepresentation Claim Is Dismissed
The Defendants have contended that Clark's negligent misrepresentation claim accrues under New York law, and Clark has not suggested otherwise. See Krumme v. WestPoint Stevens Inc., 238 F.3d 133, 138 (2d Cir. 2000) (stating that "implied consent . . . is sufficient to establish choice of law");accord Int'l Bus. Machines, Inc. v. Liberty Mut. Fire Ins. Co., 303 F.3d 419, 423 (2d Cir. 2002). New York law, therefore, will be applied to Count V of the Complaint. See Guildhall Ins. Co. v. Silberman, 688 F. Supp. 910, 912-13 (S.D.N.Y. 1988) (observing that, "[i]n negligence actions, relevant considerations include the domicile of the parties, the place where the tortious conduct occurred, and where the injury was suffered," and concluding that New York law applies to a negligent misrepresentation claim) (internal quotation marks and citation omitted).
According to the Defendants, Clark's negligent misrepresentation claim is barred by New York's Martin Act, N.Y. Gen. Bus. Law § 352 et seq., an argument conceded by Clark.See Nanopierce Techs., Inc. v. Southridge Capital Mgmt. LLC, No. 02 CIV. 0767 (LBS), 2003 WL 22052894, at *2-4 (S.D.N.Y. Sept. 2, 2003); Granite Partners, L.P. v. Bear Stearns Co., 17 F. Supp. 2d 275, 291-92 (S.D.N.Y. 1998). Count V is, therefore, dismissed.
3. The Breach of Fiduciary Duty Claims Are Not Dismissed
Clark and the Nevis Capital Defendants agree that, pursuant to New York law, Nevis Capital's state of incorporation, Maryland, governs claims for breach of fiduciary duty. See, e.g., High View Fund, L.P. v. Hall, 27 F. Supp. 2d 420, 428 n. 6 (S.D.N.Y. 1998) (citing Walton v. Morgan Stanley Co., 623 F.2d 796, 798 n. 3 (2d Cir. 1980)).
The applicable statute of limitations in Maryland for claims for breach of fiduciary duty is three years from the time of accrual. See Moreland v. Aetna US Healthcare, Inc., 831 A.2d 1091, 1095, 152 Md. App. 288, 295 (Md.Ct.Spec.App. 2003); Md. Com. Law Code Ann. § 5-101. The cause of action accrues when the plaintiff knew or should have known the underlying facts. See Moreland, 831 A.2d at 1095, 152 Md. App. at 295-96. The Nevis Capital Defendants urge that the fiduciary duty claims are therefore barred under Maryland law, by virtue of the notice they assert was provided to Clark by the filing of the Fund's 2000 Annual Report and the consequential running of the period of limitation.
Insofar as Clark had actual or constructive notice of the fact that the Fund's returns were primarily attributable to IPOs, that the returns achieved early on might not continue as the asset-base of the Fund grew, and that the Fund engaged in same-day sales of newly acquired IPO shares, for the reasons set forth above, her fiduciary duty claims against the Nevis Capital Defendants accrued no later than the filing of the Fund's 2000 Annual Report and are therefore time-barred. However, to the extent that Clark's fiduciary duty claims relate to the allegations concerning allocation of IPOs to the Fund, those claims accrued on or about July 31, 2003. As Clark's complaint was filed within three years of that date, her fiduciary duty claims related to the allocation of IPOs to the Fund are not time-barred, and the Nevis Capital Defendants' motion to dismiss these claims, thus limited, is denied.
Conclusion
For the reasons set forth above, the Defendants' motions to dismiss the complaint are granted in part and denied in part, and Clark is granted leave to replead in accordance with this opinion and order within twenty (20) days of entry of this opinion and order.
It is so ordered.