The opinion of the court was delivered by: ENRIGHT
WILLIAM B. ENRIGHT, UNITED STATES DISTRICT JUDGE
Several actions have been consolidated in this class action and shareholder derivative suit. Plaintiffs Flora Masry, Markleebeth, Inc., Milton Hollander, Morton Gordon, and William Boyle allege seven causes of action based on federal securities laws and state common law. MDC Holdings, Inc. is engaged in real estate development, sales, and financing businesses. Drexel Burnham Lambert is MDC's underwriter and investment banker, and Touche Ross & Co. is MDC's accountant. Plaintiffs allege that the three groups of defendants (MDC, Drexel, and Touche) issued a series of favorable public statements about the financial performance, management, and future business prospects of MDC which were materially false and misleading. These statements allegedly operated to inflate artificially the market price of MDC securities during the time plaintiffs purchased stocks and bonds (April 1, 1985 to April 6, 1989).
The Securities and Exchange Commission ("SEC") investigated the transactions and reports. On May 18, 1988, MDC began to reveal adverse facts about the SEC's investigation of the accounting for certain transactions, the actual corporate losses, and the amount of the quarterly dividend. Plaintiffs allege that the disclosures between May 18 and November 22, 1988 were incomplete. They allege that it was not until April 6, 1989, when MDC released its 1988 Annual Report, that the full truth about MDC began to be revealed.
On September 11, 1989, MDC agreed to settle the SEC charges with respect to eight real estate transactions during fiscal years 1985 through 1987. The SEC found that:
MDC failed to comply with Section 13(b)(2)(B) of the Exchange Act, with respect to the dissemination of, coordination with, or consideration by responsible officials in MDC's accounting, finance, legal and operations departments of information required to account properly for the transactions described in this Order, in that it failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are executed in accordance with management's general or specific and that transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and any other criteria applicable to such statements.
Findings and Order of the SEC, page 15.
Plaintiffs allege that as a result of the defendants' conduct, MDC traded at artificially inflated prices of over $ 22 per share. Following the disclosures of adverse facts, the price declined to $ 1 per share.
The principal parties, MDC and its directors and officers, have settled. Three groups of non-settling defendants are before the court:
(1) The "individual Drexel defendants" include four members of the High Yield Bond Department (Michael Milken, Lowell Milken, James Dahl, Bruce Newberg) and 28 individuals from Drexel, including Frederick Joseph, Robert Linton, William Brown, Richard Bruce, Maurits Edersheim, Edwin Kantor, Roger Jospe, Anthony Lamport, David Meadow, Stanley Schiff, Joseph Vitanza, Peter Schild, John Kissick, John Coffin, George Anderson, Haig Casparian, Hercules Segalas, Alexander Chapro, Aaron Eshman, Stephen Weinroth, Andrew Morse, Burton Siegel, David Kay, Herbert Bachelor, Eugene Glaser, Richard Wright, Allan Sher, and Leon Black (hereinafter "Frederick Joseph defendants"). Plaintiffs name these defendants in the counts based on § 10(b), fraud and deceit, and negligent misrepresentation. The complaint accuses Drexel of compelling MDC to issue substantially more debt than it could afford so that Drexel could force MDC to purchase high risk securities issued or marketed by Drexel. Drexel also made allegedly false statements in its research reports about the financial health of MDC. The individual Drexel defendants allegedly caused Drexel to engage in the unlawful conduct.
(2) The "foreign Drexel defendants" include Lambert Brussels Associates Limited Partnership, Pargesa Holding S.A., and Groupe Bruxelles Lambert, S.A. These are parent companies of the American firm of Drexel Burnham Lambert. Plaintiffs name these defendants in the counts based on § 10(b), fraud and deceit, and negligent misrepresentation. Plaintiffs allege that because of their direct or indirect ownership of Drexel, these defendants had the power to control Drexel's unlawful conduct.
On September 17, 1990, the court conducted a hearing on the various motions to dismiss. The following week, on September 24, 1990, the court entertained the plaintiffs' motion for class certification. This decision addresses the motions made at both of those hearings.
PERSONAL JURISDICTION OVER THE FOREIGN DREXEL DEFENDANTS
Drexel Burnham Lambert, Inc. ("Drexel") is owned by an American parent corporation, Drexel Burnham Lambert Group ("DBL Group"). DBL Group filed a bankruptcy petition in February 1990, and thus is not named as a defendant in this action. Drexel is named in the complaint, but subsequently filed for bankruptcy.
Plaintiffs also name other Drexel related corporations as defendants: Lambert Brussels Associates Limited Partnership ("LBA"), a Bermuda partnership whose partners are European companies; Groupe Bruxelles Lambert S.A. ("GBL"), a Belgian corporation; and Pargesa Holding S.A. ("Pargesa"), a Swiss corporation. Plaintiffs assert three claims against LBA, GBL, and Pargesa ("foreign Drexel defendants"): Rule 10(b)(5), common law fraud and deceit, and negligent misrepresentation. The foreign Drexel defendants move to dismiss the complaint under Rule 12(b)(1), alleging lack of personal jurisdiction; under Rule 9(b) for failure to plead fraud with the required particularity; under Rule 12(b)(6) for failure to state a claim on which relief can be granted; and under Rule 12(b)(4) for failure to properly serve Pargesa.
One of the foreign Drexel defendants, Pargesa, submitted a supplemental reply memorandum. The clerk's office refused to file it because it was not timely and the court has not considered it.
At the September 17, 1990 hearing, plaintiffs submitted GBL's 1985 annual report which shows overlapping directors and officers, a merger certificate between Lambert Brussels Real Estate Corporation into Lambert Brussels Financial Corporation, and 1989 Delaware franchise tax reports for several subsidiaries. These materials were obtained pursuant to Magistrate McCue's August 28, 1990 protective order on jurisdictional discovery. The court allowed the foreign Drexel defendants five days in which to respond to the exhibits, and plaintiffs five days thereafter in which to respond. The court has received and considered these responses.
Plaintiffs bear the burden of demonstrating personal jurisdiction. In order to avoid a motion to dismiss, plaintiffs must make a prima facie showing of jurisdiction. Data Disc. Inc. v. Systems Tech. Assoc., Inc., 557 F.2d 1280, 1285 (9th Cir. 1977). Plaintiffs are "obligated to come forward with facts, by affidavit or otherwise, supporting personal jurisdiction." Scott v. Breeland, 792 F.2d 925, 927 (9th Cir. 1986). Ultimately, whether at trial or at a preliminary hearing on the issue of jurisdiction, plaintiff must demonstrate jurisdiction by a preponderance of the evidence. Data Disc, 557 F.2d at 1285.
Plaintiffs urge the court to exercise general jurisdiction over the defendants, thus the question is whether the non-resident parent carries on continuous and systematic activities in the forum through a subsidiary such that it may be brought into causes of action that are unrelated to its contacts with the forum. Kramer Motors, Inc. v. British Leyland, Ltd., 628 F.2d 1175, 1177 (9th Cir.), cert. denied, 449 U.S. 1062, 66 L. Ed. 2d 604, 101 S. Ct. 785 (1980). The mere existence of the parent-subsidiary relationship is an insufficient basis on which to acquire personal jurisdiction over the parent. Transure, Inc. v. Marsh and McLennan, Inc., 766 F.2d 1297, 1299 (9th Cir. 1985); Mizokami Bros. of Arizona, Inc. v. Baychem Corp., 556 F.2d 975, 977 (9th Cir. 1977), cert. denied, 434 U.S. 1035, 54 L. Ed. 2d 783, 98 S. Ct. 770 (1978).
Plaintiffs argue that the foreign Drexel defendants have engaged in substantial, continuous, and systematic activities in the United States and therefore this court has general jurisdiction over them. LBA owns 26.3% of DBL Group, the parent company of the broker-dealer defendant Drexel. LBA has the right to designate nominees for a minority of the directors of DBL Group and Drexel. In turn, GBL owns 57% of LBA, and Pargesa owns 25% of LBA. The complaint alleges that "because of their direct or indirect ownership of defendant Drexel," the foreign Drexel defendants are control persons. Plaintiffs assert that they have shown day-to-day control of the subsidiaries by the foreign Drexel defendants. This conclusory assertion is not supported by the evidence.
Defendants have provided evidence that they do not have substantial activities in the United States. Defendants provide a declaration by Didier Bellens, Senior Vice President of Pargesa stating that Pargesa does not maintain a place of business, any employees, an interest in any property, a mail box, a telephone listing, or a bank account in the United States. Nor is Pargesa qualified or licensed to do business in the United States. Arnold van Zeeland, Manager of Relations with American Subsidiaries and Special Operations of GBL, submitted a similar declaration about LBA and GBL. Both declarations state that the foreign Drexel defendants did not participate in MDC's public announcements or Drexel's research reports on which plaintiffs base their complaint. Plaintiffs have not provided any facts to refute these declarations.
Plaintiffs' strongest argument is that LBA applied for and received exemptions from regulation by the SEC. In the case cited by plaintiffs, the foreign defendant filed a registration with the SEC in order to trade its stock on American securities markets. Newport Components Inc. v. NEC Home Electronics, Inc., 671 F. Supp. 1525, 1540 (C.D. Cal. 1987). Registering with and transacting business under the auspices of the SEC was one factor in determining whether the foreign defendant had purposefully availed itself of the benefits and protections of federal law. Id. Defendants attempt to distinguish the case by arguing that obtaining an exemption is the opposite of registering with the SEC. The distinction is not as clear cut as defendants' suggest, however, since obtaining an exemption shows that LBA was concerned with abiding by federal law. Nonetheless, even accepting the plaintiffs' view that this act is relevant, by itself, it does not establish a basis for personal jurisdiction.
Plaintiffs also note that the LBA-nominated board members of DBL Group voted to approve the settlement between Drexel and the SEC. However, these votes are the result of board representation and do not constitute the type of day-to-day control needed to establish jurisdiction. Kramer Motors, 628 F.2d at 1178 (foreign parent's mere approval of a marketing scheme developed by American subsidiary does not constitute the kind of deliberate forum protection-invoking act which the law requires).
Plaintiffs remaining arguments focus on the inter-relationship between the defendants and their various holdings, and the activities of defendants' other American subsidiaries. The other subsidiaries are not defendants in this suit. These relationships do not show continuous or systematic activity by the parent companies. Id. Finally, the defendants' contacts with European investors is irrelevant to this motion.
In sum, plaintiffs have not made a prima facie showing of personal jurisdiction over the foreign Drexel defendants. Plaintiff has not presented facts showing that these defendants have the requisite minimum contacts with the United States or that they in fact control the subsidiaries' activities. Therefore, the court hereby grants the foreign Drexel defendants' motion to dismiss for lack of personal jurisdiction. The dismissal is without prejudice, so that if plaintiffs uncover facts showing a prima facie case of jurisdiction, they can seek leave to amend the complaint to add these defendants.
In light of the dismissal, there is no need to reach the foreign Drexel defendants' other arguments based on Rule 9(b), failure to state a claim, and ineffective service of process.
RULE 9(B) PARTICULARITY REQUIREMENT FOR FRAUD ALLEGATIONS
The individual Drexel and Touche defendants move to dismiss the complaint on various grounds. Each makes substantially the same argument. They argue that plaintiffs have failed to state any claim on which relief could be granted and have failed to plead fraud with the specificity required by Rule 9(b).
The court grants the timely motions made by several defendants to join the motions to dismiss by co-defendants. Frederick Joseph's papers are joined by Gary Winnick, Joseph Murphy, James Dahl, Issac Burnham, II, Michael Gellert, and Sylvan Schefler; Lowell Milken's papers are joined by Gary Winnick and James Dahl; Michael Milken's papers are joined by Gary Winnick.
A. Individual Drexel Defendants
The complaint contains three fraud based claims to which Rule 9(b) applies: count one for § 10(b), count two for § 18, and count four for fraud and deceit. Rule 9(b) requires particularity in pleading the circumstances of fraud. Fed. R. Civ. P. 9(b). Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987). The complaint must identify the circumstances of fraud such that the defendant can prepare an adequate answer from the allegations. Id. While statements of the time, place, and nature of the alleged fraudulent activities are sufficient, mere conclusory allegations of fraud are not. Id.
In Wool, the Ninth Circuit relaxed the Rule 9(b) standard for suits involving corporate fraud. "In cases of corporate fraud where the false or misleading information is conveyed in prospectuses, registration statements, annual reports, press releases, or other 'group-published information,' it is reasonable to presume that these are the collective actions of the officers." Id. at 1440. In such cases, Rule 9(b) can be met by pleading the misrepresentations with particularity and, if possible, the roles of the individual defendants in the misrepresentations. Id. This relaxed rule applies when the individual defendants are a "narrowly defined group of officers" who had direct involvement in the corporation's day-to-day affairs and in the financial statements in particular. Id. The rule also applies to the board of directors. Blake v. Dierdorff, 856 F.2d 1365, 1369 (9th Cir. 1988).
Plaintiffs argue that the relaxed Wool standard should be extended to apply to the individual Drexel defendants. Plaintiffs ask the court to apply Wool to "any identifiable group that appears, based on some factual circumstance, to have had a role in disseminating the misleading information at issue."
At the outset, it is important to note the two types of misleading publications at issue. The complaint seeks to hold the Drexel individuals collectively responsible for two categories of misrepresentations: (1) a variety of allegedly misleading documents issued by MDC and (2) the allegedly false research reports published by Drexel.
As to the first category, the misleading documents by MDC, the Wool standard does not apply. Plaintiffs' proposed reading of Wool is too broad. Drexel was the underwriter for MDC. The position held by these parties in relation to MDC is not analogous to that held by the officers or directors of MDC. That is, they did not have direct involvement in MDC's day-to-day affairs or its publications. The Ninth Circuit refused to extend the relaxed Wool standard a situation where plaintiff attempted to hold corporate outsiders (accountants, stockbrokers, and attorneys) responsible for the corporation's statements. Moore v. Kayport Package Express, Inc., 885 F.2d 531, 540 (9th Cir. 1989). Courts have refused to extend the Wool standard to individuals aside from the officers or directors without a showing of "a special relationship between the individual(s) and the corporation in question warranting such treatment." Klein v. King, [1989 Transfer Binder]Fed. Sec. L. Rep. (CCH) P 94,501, at 93,195 (N.D. Cal. 1989), later proceeding, 1990 U.S. Dist. LEXIS 5392, at 35-37. Plaintiffs have not alleged a special relationship between MDC and Drexel. Accordingly, the group pleading on this category of statements is improper. Plaintiff cannot make blanket references, but must inform each defendant of the conduct which constitutes the alleged violation. Lubin v. Sybedon Corp., 688 F. Supp. 1425, 1443 (S.D. Cal. 1988). The fact that plaintiffs are not entitled to the Wool presumption of collective responsibility taints every aspect of the complaint that attempts to hold the individual Drexel defendants liable for statements by MDC.
As to the second category of statements, false research reports published by Drexel, Wool does apply. In this case, plaintiffs allege that Drexel made misstatements about the financial health of MDC in research reports originated by Drexel. (Complaint para. 67, 77, 83). To the extent that plaintiffs seek to hold individual Drexel officers and directors liable for the published documents of Drexel, rather than MDC, the complaint is sufficient if it identifies the misrepresentations with particularity and, where possible, identifies the roles of the individual defendants in the misrepresentations. Wool, 818 F.2d at 1440.
The complaint here adequately identifies the specific misstatements produced by Drexel. (Complaint para. 67, 77, 83). It identifies the facts allegedly known by the defendants and explains why the statements were false. (Complaint para. 56, 108-10). However, the complaint does not identify the roles of the individual defendants in the misrepresentations. Rather, the complaint conclusively states that the named defendants were officers and directors of Drexel. (Complaint para. 32). It does not allege what positions these defendants held, or in what respect they were involved in preparing the allegedly false reports about MDC. Plaintiffs must give some detail demonstrating collective responsibility before they are entitled to benefit from the Wool presumption. In re Genentech Securities Litigation, [1989 Transfer Binder] (CCH)Fed. Sec. L. Rep. P 94,544 at 93,482 (N.D. Cal. 1989) ("plaintiffs have failed to plead the direct involvement necessary to raise an inference of collective responsibility).
The importance of a factual basis showing direct involvement by each defendant is illustrated by the errors in this complaint. For instance, the complaint alleges that Lowell Milken was an officer or director of Drexel. (Complaint para. 32). Lowell Milken's attorney submitted a declaration that in fact Lowell was never a director or officer. Bruce Newberg is in a similar situation. Thus, plaintiffs' pleading technique has led to some inaccuracies, inaccuracies that could be prevented by identifying the roles of these individuals. See also Fed. R. Civ. P. 11 (signed pleadings certify that to the best of the signer's knowledge, information, and belief, after reasonable inquiry, the pleading is well grounded in fact) (emphasis added).
Similarly, the complaint fails to differentiate between primary and secondary liability. Plaintiffs must allege facts such that each defendant can distinguish his potential primary liability from his potential secondary liability. Lubin, 688 F. Supp. at 1443.
Accordingly, the court grants the motion to dismiss the fraud based claims, count one § 10(b) and count four fraud and deceit, against the individual Drexel defendants.
Touche provided independent auditing services for MDC and issued opinions on MDC's financial statements for fiscal years 1984 to 1987. Plaintiffs allege that Touche knew or recklessly disregarded adverse facts about MDC's finances. (Complaint para. 119). Plaintiffs also allege that Touche knew that MDC's annual reports and quarterly financial statements were presented in a manner that violated generally accepted accounting procedures. (Complaint para. 121).
Touche argues that the complaint does not satisfy Rule 9(b)'s particularity requirement because the allegations could be made with respect to virtually any audit by any accounting firm of any set of financial statements that are claimed to be false.
The court disagrees and finds that the complaint meets the particularity requirement as to Touche and the misrepresentations involved in the accounting. The complaint identifies the allegedly false reports and details why each of the statements made were misleading, for example, by overstating the value of MDC's investments. (Complaint para. 57-59, 69, 103, 108-110, 118, 120). It also describes Touche's role in preparing the statements. The complaint notes that Touche had access to MDC's financial and business information, but recklessly disregarded facts which indicated that Touche should have qualified its opinions on MDC's financial statements. (Complaint para. 108, 109, 118, 121). Therefore, Rule 9(b) does not provide a basis for dismissing the fraud based claims against Touche.
MOTIONS TO DISMISS FOR FAILURE TO STATE A CLAIM
Several defendants have made various motions to dismiss the claims against them for failure to state a claim. Fed. R. Civ. P. 12(b)(6). The individual Drexel defendants challenge the § 10(b) claims; Lowell Milken, Michael Milken, Gary Winnick, and James Dahl challenge the negligent misrepresentation claim; and Touche challenges the § 18 claim. In ruling upon a motion to dismiss, a court must accept all material allegations in the complaint as true and must construe the ...