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United States District Court, N.D. California

January 23, 2004.

HEALTHTRAC, INC., Plaintiff,

The opinion of the court was delivered by: BERNARD ZIMMERMAN, Magistrate Judge


Healthtrac, Inc., filed this action against three former officers and directors, Sinclair, Baillie and Mol, alleging that defendants misused the corporation's securities while they controlled it in violation of Federal and State law. Defendants Sinclair and Mol have now moved to dismiss plaintiff's Third Amended Complaint ("Third Complaint")*fn1 on the grounds that the claims brought pursuant to 15 U.S.C. § 78p Page 2 ("Section 16") are time barred and the court should decline to exercise supplemental jurisdiction over the state claims.*fn2 Defendant Mol also moves to dismiss based on plaintiff's lack of capacity to sue. Mol motion, p. 5-7.*fn3

I. Plaintiff Has The Capacity to Sue Pursuant to Federal Rule of Civil Procedure 17(b).

  Defendant Mol argues that plaintiff lacks capacity to bring this action because it is either a suspended California corporation, or has not obtained a certificate pursuant to California Corporations Code § 2200, et. seg. As alleged in its complaint, however, plaintiff is a Canadian corporation and not a California corporation.*fn4 Third Complaint, ¶ 4. Pursuant to Rule 17(b) of the Federal Rules of Civil Procedure "[t]he capacity of a corporation to sue or be sued shall be Page 3 determined by the law under which it was organized." Fed.R.Civ.P. 17(b); Joseph Muller Corp. Zurich v. Societe Anonyme de Gerance et D'Armement, 451 F.2d 727, 729 (2d. Cir. 1971) (stating that because corporations had capacity to sue where they were incorporated-France and Switzerland, respectively-they had capacity to sue in federal courts pursuant to Rule 17(b). . .). Defendant Mol fails to cite any Canadian authority suggesting that plaintiff lacks capacity to sue in federal court here. Absent such authority, this argument is rejected.

  II. The Statute of Limitations Bars Plaintiff's Section 16 Claims with respect to Disclosed Trades.

  The Third Complaint alleges violations of Section 16 involving both disclosed and undisclosed trades. Third Complaint, ¶ 75-78, 79-83. The allegations involving undisclosed violations of Section 16 are directed against defendant Sinclair only.

  With respect to the disclosed trades, Sinclair and Mol argue that plaintiff's claim for recovery of short-swing profits*fn5 pursuant to Section 16(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78p(b), is time-barred and should be dismissed. See 15 U.S.C. § 78p(b) (stating that "[s]uit to recover such profit may be instituted . . . by the Page 4 issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer . . . but no suit shall be brought more than two years after the date such profit was realized"). According to the Third Complaint, Sinclair reported his last short-swing transaction on October 27, 2000, and Mol reported his last short-swing transaction on June 14, 2000.*fn6 Third Complaint, ¶ 75(a)-(e). Plaintiff filed its complaint on November 27, 2002, one month after the statute of limitations had run on the last reported transaction.

  Plaintiff does not dispute its late filing. Instead, plaintiff urges the court to toll the statute of limitations under the doctrine of "adverse domination", or "other applicable equitable principles".*fn7 Opp. 4. In certain situations, application of the adverse domination doctrine tolls the statute of limitations for a corporation's cause of action against its directors while the directors control the corporation. Mosesian v. Peat, Marwick, Mitchell & Co., 727 F.2d 873, 879 (9th Cir. 1984) (adverse domination may toll Page 5 statute of limitations in an action for fraud and related state law violations where a plaintiff can "show full, complete and exclusive control in the directors or officers charged," by "effectively negating the possibility that an informed stockholder or director could have induced the corporation to sue.").

  Plaintiff cites no authority, and the court can find none, applying adverse domination or other equitable principles to toll the statute of limitations where an insider promptly files the required 16(a) reports. Whether to apply the adverse domination doctrine to toll the statute of limitations turns on whether tolling would further the legislative intent in enacting Section 16(b). Whittaker v. Whittaker Corp., 639 F.2d 516, 527 (9th Cir. 1981) citing American Pipe and Construction Co. v. Utah, 414 U.S. 538, 559 (1974). Because both the language of Section 16(b) and the legislative history are silent with regard to equitable tolling, courts look to the general legislative purpose behind Section 16. Id. at 527-28. That statute imposes strict liability for any insider trade and may be enforced by the corporation or by any shareholder on behalf of the corporation. Accordingly, where an insider failed to file the required reports disclosing short-swing trades, the Ninth Circuit applied principles of equitable tolling and held that the two-year limitations period contained in Section 16(b) "begins to run when the transactions are disclosed in the insider's Section 16(a) report." Whittaker, 639 F.2d at 530; accord Blau v. Albert, 157 F. Supp. 816, 817-19 (S.D.N.Y. 1957) Page 6 (noting that "[i]t would be a simple matter for the unscrupulous to avoid the salutary effect of Section 16(b) which provides a remedy for the recovery of short-term profits, simply by failing to file monthly reports in violation of subdivision (a) and thereby concealing from prospective plaintiffs the information they would need to adequately protect their interest. Such a construction would reward the violation of the statute and would manifestly frustrate congressional intent"); Grossman v. Young, 72 F. Supp. 375, 380 (S.D.N.Y. 1947).*fn8

  The holding in Whittaker, however, does not help plaintiff, and actually helps defendants, since it is undisputed that the 16(a) reports were timely filed and the statute of limitations has already run. And unlike in Whittaker, Grossman and Blau, equitable tolling is not necessary to effectuate Section 16(b) in this case. Defendant Sinclair and Mol's Section 16(a) reports provided constructive notice of the short-swing trades, enabling any shareholder or the corporation to commence an action to recover the short-swing profits. In fact, a shareholder, Samuel Chambers, submitted two written demands to Healthtrac, Inc. requesting that it "redress certain violations of Section 16 and return Page 7 profits realized" to the corporation. Third Complaint 25:8-10. After the corporation failed to take any action, Mr. Chambers filed lawsuits in 2001 against Sinclair and Mol, and in 2002 against Sinclair, Mol and Baillie (the "Chambers lawsuits") seeking to recover precisely the same short-swing profits at issue in this case.*fn9 Third Complaint, ¶ 67-74. A review of Healthtrac and its predecessor's Annual Reports filed with the Securities and Exchange Commission reveals that during 2000, there were three "Executive Officers" other than Sinclair and Baillie on Healthtrac's Board; Kevin Wielgus, Grayson Hand, and Greg Burnett, and that Pierre Prefontaine has been on the Board since at least April 2000 and is a member of the Board that authorized this suit. See Healthtrac Annual Reports filed June 13, 2003, June 13, 2002, May 29, 2001, June 6, 2000, and Quarterly Report dated October 17, 2000 available at Plaintiff fails to explain what, if any, obstacles prevented any of these officers or directors from bringing a timely Section 16 claim against any of the defendants. Their presence along with the Chambers lawsuits, however flawed they allegedly were, Page 8 undermine plaintiff's argument that equitable tolling is necessary because it was impossible for anyone to bring a Section 16 action within the two-year period. Plaintiff cites no case in which a shareholder brought an action on behalf of the corporation and the court nevertheless equitably tolled the statute of limitations when the corporation sued.*fn10

  It is clear that the legislature intended to curb insider trading abuses by requiring that all short-swing trades be disclosed and providing for strict liability. Applying adverse domination as proposed by plaintiff could conceivably undermine this intent. One incentive insiders have to file 16(a) reports is the certainty that any liability flowing from the short-swing trade will extinguish after two years. Section 16 provides no such protection to the insider who fails to disclose because the statute is tolled and any liability risk is potentially indefinite. Whittaker, 639 F.2d at 530, If adverse domination were to toll the statute of limitations even where there was proper disclosure, many insiders would be exposed to the same open-ended risk regardless of whether they reported. The "unscrupulous" insider might conclude that he is willing to risk the chance that the short-swing trade will not be revealed and not file his 16(a) report. This cannot be the result intended by Congress. Page 9

  III. The Statute of Limitations Bars Plaintiff's Section 16 Claims with respect to Undisclosed Trades.

  Plaintiff alleges that in or about February 19, 1999, Sinclair "committed undisclosed violations, for which [he] has not accounted to [plaintiff] or its shareholders."*fn11 Third Complaint, ¶¶ 79-80. Plaintiff bases its allegations on a Form 144, Notice of Proposed Sale of Securities, that states Sinclair intends to sell 4 million shares that were acquired on dates plaintiff believes are false. Id. Plaintiff is unable to determine whether Sinclair sold the 4 millions shares, and if so, whether he was required to file a Section 16 report disclosing a short-swing trade.

  Defendant Sinclair argues this claim should be dismissed for failure to comply with both the Private Securities Litigation Reform Act ("PSLRA") and Rule 9(b) of the Federal Rules of Civil Procedure, both of which impose a heightened pleading standard for cases involving fraud. See 15 U.S.C. § 78u-4(b)(2); Fed.R.Civ.P. 9(b). In addition, if plaintiff's claim is controlled by the PSLRA, a stay of discovery would be imposed pending defendants' motions to dismiss.

  Without discussing whether the PSLRA applies to plaintiff's claim for undisclosed violations of Section 16 or whether Section 16 claims must satisfy Rule 9(b), I find that the allegations in paragraphs 79 and 80 of the Third Complaint Page 10 are sufficiently detailed to state a claim against Sinclair. The allegations identify a specific date around which Sinclair purportedly sold the four million shares. The Third Complaint does not make vague claims against unidentified defendants for undetermined acts.*fn12

  For the foregoing reasons, IT IS HEREBY ORDERED that the motions of Sinclair and Mol to dismiss plaintiff's Section 16 claims with respect to disclosed trades are GRANTED on the grounds that the claims against them are time-barred.*fn13 By stipulation of the parties, this ruling also operates to dismiss Section 16 claims against defendant Baillie.

  IT IS FURTHER ORDERED that defendant Sinclair's motion to dismiss plaintiff's claims with respect to undisclosed trades alleged in paragraphs 79 and 80 of the Third Complaint is DENIED. Plaintiff and defendant Sinclair must complete initial disclosures with respect to this claim no later than February 6, 2004. All other discovery is stayed pending a case management conference that is scheduled for Monday, Page 11 February 23, 2004 at 4:00 p.m.

  IT IS FURTHER ORDERED that the court declines to exercise supplemental jurisdiction over plaintiff's remaining state law claims against Mol and Baillie and they are DISMISSED WITHOUT PREJUDICE. Pursuant to 28 U.S.C. § 1367, plaintiff may re-file its state law claims in the proper state court within thirty days. Defendant Sinclair's motion to dismiss plaintiff's state law claims is taken under submission.

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