inference that they would not have suffered loss if the facts were as they understood them to be at the time of purchase.
Indeed, the "RISK FACTORS" section of the Prospectus defeats any such suggestion. (Prospectus, at 7-9.) That section plainly discloses that there was "no assurance" that operational cash flow would be sufficient to meet debt service obligations. The section also states that the Company's failure to comply with "financial and operating covenants" would permit the senior lenders to accelerate the maturity of the Revolving Credit Facility and prohibit any payments on the Debentures. (Id. at 7.) Plaintiffs have not alleged that the Company was in fact in compliance with the covenants.
The other circumstance on which Plaintiffs rely -- the alleged precipitous decline in the value of the Debentures -- actually undermines the claim of loss causation here. Plaintiffs do not contest the senior lenders' plainly-disclosed right to suspend payment on the Debentures for 120 days in the event of a default on the financial covenants. A precipitous decline in the value of the Debentures at the time that fully-disclosed right was exercised indicates strongly that Plaintiffs' loss resulted from GECC's legitimate public announcement of a covenant default, rather than from any action GECC subsequently took to prohibit payment on the senior loan.
Bruschi v. Brown, 876 F.2d 1526 (11th Cir. 1989), does not call this conclusion into question. In Bruschi, the Eleventh Circuit concluded that loss causation is adequately alleged where plaintiff asserts that defendant induced her to enter into a risky transaction by misrepresenting the transaction as safe and that plaintiff "suffers a loss resulting from the risky nature of the investment." 876 F.2d at 1531. The Bastian court distinguished Bruschi on the ground that the oil and gas investors in Bastian were not told that their investments were risk-free. Similarly, here, Plaintiffs have not alleged that the Prospectus represented the Debentures as risk-free; not have Plaintiffs alleged facts supporting a conclusion that the loss they experienced was a function of a risk of which they were unaware. Instead, as discussed above, it was the Company's default which resulted in the Debentures' market value plummeting.
The circumstances here are similar to those before the Second Circuit in Citibank, N.A. v. K-H Corp., 968 F.2d 1489, 1495-96 (2nd Cir. 1992). In Citibank, plaintiff bank had loaned money to a company for purchase of aerospace subsidiaries, relying in part on the willingness of the company's sole stockholder to make a large equity contribution. When the company defaulted on its loan, plaintiff learned that defendant, the seller of the subsidiaries, had concealed from plaintiff the fact that the stockholder had substituted a promissory note for a portion of the cash contribution. The Second Circuit affirmed dismissal of the bank's § 10(b) claim. The court reasoned that the cause of plaintiff's loss was borrower's default on the loan; defendant's failure to disclose the additional loan it had made to borrower's principal would support a finding of transaction causation, the court reasoned, but not loss causation. The Citibank court cited the Seventh Circuit's decision in Bastian in support of this conclusion. Id. at 1495. Here, similarly, the apparent cause of loss to Plaintiffs, who were subordinated to the senior lenders, was Specialty's failure to meet its financial obligations, not Defendants' exercise of an allegedly undisclosed remedy.
Plaintiffs' failure to plead loss causation requires dismissal of their claims under § 10(b) (Count I) and their common law fraud claims (Count IV). The parties' memoranda limit their discussion of the loss causation requirement to Plaintiffs' § 10(b) claim. It appears well-settled that loss causation is not a requirement of a cause of action under § 11; instead, absence of loss causation is an explicit defense to a § 11 claim, see Bastian v. Petren Resources Corp., 892 F.2d 680, 685 (7th Cir. 1990); Lyne v. Arthur Andersen & Co., 772 F. Supp. 1064, 1067 (N.D. Ill. 1991). Accordingly, Plaintiffs' failure to plead loss causation does not require dismissal of Count II.
There is some support in this district, however, for imposing such a requirement on claims under § 12(2). See Scholes v. Schroeder, 744 F. Supp. 1419, 1423-24 (N.D. Ill. 1990); Xerox Financial Servs. Life Ins. Co. v. Salomon Bros., Inc., No. 92 C 1767, 1992 WL 151923, at *6 (N.D. Ill. June 18, 1992); Robin v. Falbo, No. 91 C 2894, 1992 WL 188429, at *1 n.2 (N.D. Ill. July 24, 1992). But see Caviness v. Durand Resources Corp., F.2d , 1993 WL 3404, at *8 (4th Cir. 1993); American Federation of State, County and Municipal Employees v. Federal Deposit Ins. Corp., F. Supp. , 1992 WL 437946, at *10 (D. D.C. 1992); cf. Pommer v. Medtest Corp., 961 F.2d 620, 628 (7th Cir. 1992) (distinguishing § 10(b) measure of damages from appropriate measure of damages under §§ 11 and 12 and referring to the § 10(b) measure as principle of loss causation). Because the parties have not briefed the issue, however, dismissal of Count III on this ground would not be appropriate.
Reliance on Offering Materials Other Than the Prospectus
In their original motions to dismiss, Defendants Specialty and SPE Acquisition relied on the Registration Statement and Senior Loan Agreement in support of their argument that the offering materials were not materially misleading as a matter of law. The District Court denied that motion on grounds that it relied on matters outside the scope of the Amended Complaint and the Prospectus, attached as an exhibit to the Amended Complaint. Prior to their bankruptcy filing, Defendants Specialty and SPE Acquisition sought reconsideration of that ruling. Significant authorities do support the conclusion that Defendants may fairly rely on other offering materials in support of a motion to dismiss a securities fraud claim.
As Defendants note, Plaintiffs' Amended Complaint refers frequently to the Registration Statement.
In Mancini v. Prudential Bache/Fogelman Harbour Town Properties, No. 90 C 5213, 1991 WL 171966 (N.D. Ill. Sept. 3, 1991), plaintiffs, investors in a real estate limited partnership, alleged that defendants' offering materials contained misrepresentations and omissions. Despite frequent references to those offering materials, plaintiffs failed to attach any of them to their complaint. When defendants submitted the offering materials as exhibits to their motion to dismiss, plaintiffs argued that the court must disregard the materials or convert the motion to dismiss to a motion for summary judgment. Citing 5 Charles Wright & Arthur Miller, FEDERAL PRACTICE AND PROCEDURE, § 1327, at 762-63 (1990), Judge Plunkett of this court reasoned, however, that where plaintiffs made "copious reference" to the pertinent offering materials, those materials might properly be considered in support of defendants' motion. 1991 WL 171966, at *12.
Chief Judge Moran reached a similar result in In re First Chicago Corp. Secur. Litig., 769 F. Supp. 1444 (N.D. Ill. 1991), in which plaintiff charged a bank with violations of federal securities laws. Ordinarily, the court observed, in deciding a motion to dismiss under Rule 12(b)(6), the court is restricted to considering allegations of the complaint and must treat the motion as one for summary judgment if matters outside the pleading are considered. Exhibits to the complaint are considered for all purposes, however, and "pertinent documents that a plaintiff fails to append to his complaint but that a defendant attaches to his motion to dismiss will be treated similarly." Id. at 1450. In support, In re First Chicago cites Wright and Miller and decisions from two Courts of Appeals, Field v. Trump, 850 F.2d 938, 949 (2d Cir. 1988) ("In determining whether [securities fraud] claims were properly dismissed under Rule 12(b)(6), we may of course refer to the Offer to Purchase and the 1984 Proxy Statement, which were annexed to defendants' motion to dismiss and are documents that are integral to plaintiff's claims"), cert. denied, 489 U.S. 1012 (1989); and Fudge v. Penthouse Int'l, Ltd., 840 F.2d 1012, 1015 (1st Cir.), cert. denied, 488 U.S. 821 (1988).
More recently, in Kramer v. Time Warner Inc., 937 F.2d 767 (2nd Cir. 1991), the court concluded that documents required by law to be filed with the Securities Exchange Commission may be considered on a motion to dismiss even if such documents were not attached to the complaint. Otherwise, the court reasoned, "complaints that quoted only selected and misleading portions of such documents could not be dismissed under Rule 12(b)(6) even though they would be doomed to failure." Id. at 774. See also I. Meyer Pincus & Assoc., P.C. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d Cir. 1991) (considering disclosures in challenged prospectus, in spite of plaintiff's failure to attach prospectus to the complaint); Teagardener v. Republic-Franklin Inc. Pension Plan, 909 F.2d 947, 949 (6th Cir. 1990) (reference to document was permissible where language of document and meaning of its terms were central to plaintiffs' complaint), cert. denied, 112 L. Ed. 2d 670, U.S. , 111 S. Ct. 678 (1991); In re VMS Secur. Litig., 752 F. Supp. 1373, 1394 n.21 (N.D. Ill. 1990) ("when plaintiffs fails to introduce a pertinent document as part of his pleading, defendant may introduce the exhibit as part of his motion attacking the pleading"); In re Bally Mfg. Secur. Corp. Litig., 141 F.R.D. 262, 265 n.2 (N.D. Ill. 1992) (same).
These authorities support the conclusion that Defendants may fairly rely on disclosures contained in the Registration Statement and Senior Loan Agreement in support of their argument that Plaintiffs' securities fraud claims should be dismissed. In fight of the current procedural posture, however, this Report takes no position on any additional arguments based upon either the Registration Statement or the Senior Loan Agreement. Notably, however, Plaintiffs have not explicitly challenged Defendants' assertions that the Senior Loan Agreement in fact discloses information that Plaintiffs claim has been withheld.
Defendants have not demonstrated that Plaintiffs can establish no set of facts which would entitle them to relief on their securities fraud claims. Specifically, Plaintiffs have adequately pleaded that the Prospectus was materially misleading because it failed to explain that the senior lenders could, in the event of a covenant default, control the Company's cash flow and create a payment default. Plaintiffs have not, however, adequately pleaded loss causation. Accordingly, Plaintiffs' § 10(b) claim (Count I) and their common law fraud claim (Count IV) should be dismissed. Although Plaintiffs' § 11 claim (Count II) is clearly not subject to a requirement that loss causation be pleaded, their § 12(2) claim (Count III) may be subject to such a requirement. Because no party has briefed this question, however, dismissal of Count III on this ground would not be appropriate. Similarly, beyond their arguments concerning whether the Prospectus is materially misleading, the parties have not addressed Plaintiffs' state law claim for negligent misrepresentation, asserted against Defendant underwriters (Count V). Because such a claim would also appear to be subject to a requirement of pleading "loss causation," however, Count V should also be dismissed. The court may in its discretion grant Plaintiffs leave to file an amended complaint.
Date: February 26, 1993
REBECCA R. PALLMEYER
United States Magistrate Judge