scheme and (2) relied solely on the promoters' efforts, (3) in hopes of attaining a profit. At issue here is whether Plaintiffs have sufficiently pleaded the existence of a "common enterprise" as required in Howey and as defined by the Seventh Circuit.
The Circuit Courts are split on the standard for demonstrating a "common enterprise". See Mordaunt v. Incomco, 469 U.S. 1115, 83 L. Ed. 2d 793, 105 S. Ct. 801 (1985) (White, J., dissenting from denial of writ of certiorari). According to the Fifth Circuit, commonality is established through "promoter dominance", meaning "whether the fortunes of the investments collectively" are "essentially dependent upon promoter expertise." See SEC v. Continental Commodities Corp., 497 F.2d 516, 522 & n.12 (5th Cir. 1974); SEC v. Koscot Interplanetary, Inc., 497 F.2d 473 (5th Cir. 1974). In contrast with the Fifth Circuit rule, which is often called "vertical commonality", the Seventh, Sixth, and Third Circuits require a different test, called "horizontal commonality". See Stenger v. R.H. Love Galleries, Inc., 741 F.2d 144, 146 (7th Cir. 1984); Hart v. Pulte Homes of Michigan Corp., 735 F.2d 1001, 1004 (6th Cir. 1984); Salcer v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 682 F.2d 459, 460 (3d Cir. 1982).
Generally, horizontal commonality exists when multiple investors pool their investments and receive pro rata profits. Stenger, 741 F.2d at 146; Hirk v. Agri-Research Council, Inc., 561 F.2d 96, 100-01 (7th Cir. 1977); Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.), cert. denied, 409 U.S. 887, 34 L. Ed. 2d 144, 93 S. Ct. 113 (1972); see also Secon Serv. Sys. v. St. Joseph Bank & Trust, 855 F.2d 406, 411 (7th Cir. 1988) (stating that pooling is required for an "investment contract", citing Milnarik v. M-S Commodities, Inc., 457 F.2d at 276-78.).
This case is a close call. On the one hand, there is nothing in the Amended Complaint that indicates that the Plaintiffs expected anything like pro rata payment of profits. The success of one Plaintiff's investment and his profit from any increased value in his land was not to be shared pro rata with his co-investors. On the other hand, in virtually every other respect, Plaintiffs' Amended Complaint indicates that their investments were securities. The investments at issue were sold on a large scale basis to unsophisticated investors. According to the Amended Complaint, the lots were not sold as homesites or for any personal use.
Plaintiffs were not entitled, without the Defendants' approval, to improve their land or sell their interest in it until title passed. Even in those circumstances, Defendants were permitted a right of first refusal. The success of Plaintiffs' investments rested on the common improvement of the properties through Defendants' promised provision of infrastructure, golf courses, and other amenities. Thus, the Defendants' proposed common undertaking was the "thread on which everybody's beads were strung." SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 348, 88 L. Ed. 88, 64 S. Ct. 120 (1943). In the opinion of the Court, Plaintiffs' allegations that their investments rose and fell together, and their allegations tending to show that they all shared a common risk in the development are sufficient to withstand a motion to dismiss. Two cases are particularly instructive in this regard.
In Aldrich v. McCulloch Properties, Inc., 627 F.2d 1036 (10th Cir. 1980), a case decided without the benefit, or hinderance, of a discussion of horizontal or vertical commonality, the Tenth Circuit found that a class of plaintiffs had alleged the existence of a security, sufficient to withstand a motion to dismiss. The Aldrich plaintiffs alleged that they purchased, from real estate developers, lots of land, with investment intent, based on the developers' promotional representations that the land would be developed for the plaintiffs' common benefit and that a trust would be established to construct and operate the facilities. Id. at 1039. In holding that the plaintiffs had stated facts sufficient to withstand a motion to dismiss, the Tenth Circuit reasoned that its conclusion was dictated by the Supreme Court's emphasis on the developer's means of promotion in United Housing foundation, Inc. v. Forman, 421 U.S. 837, 44 L. Ed. 2d 621, 95 S. Ct. 2051 (1975), and by a factual question regarding whether the properties were to be used primarily for investment purposes.
In Hart v. Pulte Homes of Michigan Corp., 735 F.2d 1001 (6th Cir. 1984), the Sixth Circuit distinguished Aldrich in holding that the plaintiffs therein had failed to allege the existence of a security. The Hart plaintiffs had separately purchased 23 model homes from the defendant, a real estate developer and residential builder. The homes were to be used not as residences, but as investments; they were leased back to the defendant for use as model homes. When the homes did not appreciate in value, the plaintiffs sued. In holding that the plaintiffs had failed to state a claim, the Sixth Circuit found that, unlike in Aldrich, the fate of each investor's investment was not tied to the development of that investor's subdivision. Id. at 1005. The Hart court noted that the plaintiffs' complaint made no allegations regarding a pooling of risks and investments among the plaintiffs. Id. As a result, the plaintiffs had failed to demonstrate the "horizontal commonality" required by the Sixth and Seventh Circuits. See id. at 1004 (citing to Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.), cert denied, 409 U.S. 887, 34 L. Ed. 2d 144, 93 S. Ct. 113 (1972)).
In the opinion of the Court, Plaintiffs have alleged facts sufficient to demonstrate the existence of a security, despite the fact that they may fail to satisfy the strictest interpretation of the "horizontal commonality" requirement. While the Seventh Circuit's decisions in Hirk v. Agri-Research Council, Inc., 561 F.2d 96 (7th Cir. 1977), Milnarik v. M-S Commodities, Inc., 457 F.2d 274 (7th Cir.), cert. denied, 409 U.S. 887, 34 L. Ed. 2d 144, 93 S. Ct. 113 (1972), and Secon Service System Inc. v. St. Joseph Bank & Trust Co., 855 F.2d 406 (7th Cir. 1988), might be read to require both a pooling of funds for common benefit and a pro rata distribution of profits, those cases may also be read to require only a pooling of funds for common benefit and a mutually shared investment risk. In the opinion of the Court, an investment plan's pro rata distribution of profits, or lack thereof, should not be a litmus test for the existence of a security. Therefore, the Court reads the Seventh Circuit precedent to permit a finding that Plaintiffs sufficiently have alleged the existence of a security to withstand a motion to dismiss.
Neither Hirk, nor Milnarik, nor Secon turned on the defendants' failure to distribute pro rata profits. Rather, each case's discussion of "investment contracts" required a "pooling of funds". Such a pooling of funds, and a pooling of risk, is here alleged. Like in Aldrich, and unlike in Hart, the fortunes of the Plaintiffs' investments were tied to, and entirely dependant upon, the efforts of the developers for the success of each investment. Plaintiffs have thus demonstrated both horizontal and vertical commonality. But cf. Wals v. Fox Hill Dev. Corp., 828 F. Supp. 623, 625 (E.D. Wis. 1993) (granting defendants' motion for summary judgment when profits from time-share development project were not pooled despite fact that plaintiffs' investment risk was shared with others).
Accordingly, as Plaintiffs allege that the "investment contracts" in this case were marketed as investment opportunities, were not available for residential use or individual improvement, and required mutual shared risk, the Court finds that Plaintiffs have alleged facts demonstrating the existence of a security.
C. Whether Plaintiffs' Rule 10b-5 Claims are Time Barred
With respect to Plaintiffs' Rule 10b-5 claim, the primary issue in contention is whether the claim is time-barred. According to the Amended Complaint, Plaintiffs entered into their installment contracts between 1969 and 1975. (Am. Compl. P 24.) They filed their original Complaint in this case on December 31, 1981, at least six years after the latest date the investment contracts were entered into. Defendants thus contend that Plaintiffs have failed to satisfy the requirements of any applicable statute of limitations.
Analysis of this issue requires several inquiries, every one of which is contested by the parties. The Court must determine (1) which statute of limitations applies, the one supplied by federal common law or the one supplied by Illinois statutory law; (2) when that statute starts to run; and (3) if, and when, that statute stops running, i.e. whether, and for how long, the applicable statute is "tolled."
1. The Applicable Statute of Limitations and the Short Decision
As the remedy for a violation of Rule 10b-5 was implied by a court, rather than created by Congress, courts have had to look elsewhere for the remedy's applicable statute of limitations. See Short v. Belleville Shoe Mfg. Co., 908 F.2d 1385, 1387-88 (7th Cir. 1990) (discussing the history of the Seventh's Circuit's adoption of state and federal statutes of limitation), cert. denied, 115 L. Ed. 2d 1052, 111 S. Ct. 2887 (1991). Until the Seventh Circuit's decision in Short v. Belleville Shoe Mfg. Co., 908 F.2d 1385 (7th Cir. 1990), cert. denied, 115 L. Ed. 2d 1052, 111 S. Ct. 2887 (1991), courts in this Circuit borrowed statutes of limitations from state blue sky law. Id. at 1387.
In Short, the Seventh Circuit changed course and held that "federal and not state law supplies the statute of limitations in suits under § 10(b) and Rule 10b-5." Id. at 1389. There, the Seventh Circuit adopted section 13 of the Securities Exchange Act of 1933, 15 U.S.C. § 77m (1988). That section states:
No action shall be maintained to enforce any liability created under section 77k or 771(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created under section 771(1) of this title, unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under section 77k or 771(1) of this title more than three years after the security was bona fide offered to the public, or under section 771(2) of this title more than three years after the sale.
15 U.S.C. § 77m (1988). Under section 13, a plaintiff must bring a securities action within one year after discovering fraud, but no more than three years after the date the security was sold. The section thus creates a one year statute of limitations and a three year statute of repose. Although this one/three combination was adopted and applied in Short, that decision specifically stated that it left open "all questions concerning retroactive application" of that decision. Short, 908 F.2d at 1389.
Retroactivity questions were apparently resolved, when the Supreme Court decided the two cases entitled Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 111 S. Ct. 2773, 115 L. Ed. 2d 321 (1991), and James B. Beam Distilling Co. v. Georgia, 501 U.S. 529, 111 S. Ct. 2439, 115 L. Ed. 2d 481 (1991), thereby ushering in the retroactive application of section 13. In Lampf, as the Seventh Circuit had previously done in Short, the Supreme Court adopted, for all Rule 10b-5 actions, the statutes of limitations and repose provided by section 13 of the Securities Act of 1933. The Lampf decision, coupled with rules of retroactivity adopted in Beam, thus required the retroactive application of section 13 in all Rule 10b-5 cases. Reacting to the Lampf and Beam decisions, Congress amended section 27A of the Securities Exchange Act of 1934 Act to cancel the retroactive effect of the decisions. The amended section 27A returned certain litigants to pre-Lampf/Beam law.
As the Seventh Circuit decided Short before Lampf/Beam, that decision constitutes the pre-Lampf/Beam law in this Circuit. Thus, in this Circuit, the law was essentially as the Supreme Court later interpreted it in Lampf. However, the rules governing retroactive application of case law were found in Chevron Oil Co. v. Huson, 404 U.S. 97, 30 L. Ed. 2d 296, 92 S. Ct. 349 (1991), not Beam. The Chevron Oil case provided a three step test to determine if a case should be applied retroactively. Under that case, a new rule is to be applied only prospectively, and not retroactively, where:
(1) the decision at issue overrules clear precedent on which litigants may have relied or addresses an issue of first impression which was not foreshadowed; (2) retroactive application of the decision would retard the operation of a federal statute; and (3) retroactive application would result in substantial inequity.
McCool v. Strata Oil Co., 972 F.2d 1452, 1459 (citing Chevron Oil, 404 U.S. at 106-07). With respect to the Short decision, the Chevron Oil test essentially has been collapsed into a single inquiry: can the plaintiff demonstrate reliance on a previous limitations period. McCool, 972 F.2d at 1459. If so, the previous limitations period, and not section 13, applies.
Here, Plaintiffs claim that when they filed this action, they relied on the then existing Illinois statute of limitations, Ill. Ann. Stat. ch. 121 1/2, para. 137.13D (Smith-Hurd 1960), which they claim permitted indefinite tolling of their claims upon a showing of the Defendants' fraudulent concealment of their securities' fraud. To resolve this issue, then, the Court must determine whether, under Short and Chevron, the Plaintiffs relied on paragraph 137.13D when filing this lawsuit. In the opinion of the Court, this issue requires material outside the Amended Complaint and therefore cannot be resolved on a motion to dismiss.
Plaintiffs claim that they first had actual knowledge of the facts leading to this lawsuit in January of 1981. Assuming that, for Short statute of limitations purposes, the Plaintiffs' ten year installment contracts were "sold" on the date of purchase, and not when the last payment was made, see infra part IV.C.2, the "new" federal statute of limitations, adopted in Short, began to run in the years of purchase, i.e. from 1969 to 1975. Therefore, the federal statute of repose, if applicable, cut off Plaintiffs' claims beginning with the first claim, in 1972, and ending with the last claim, in 1975. Thus, if Short were applied, Plaintiffs' claims would have been cut off before they ever knew about them.
Several courts in this district have stated, or implied, that a plaintiff faced with similar circumstances could not demonstrate reliance, as a matter of law. See, e.g., Lewis v. Hermann, 775 F. Supp. 1137, 1143-46 (N.D. Ill. 1991), reconsideration denied, 783 F. Supp. 1131 (N.D. Ill. 1991); In re VMS Sec. Litig., 752 F. Supp. 1373 (N.D. Ill. 1990). The basis for this position comes from Short itself.
In Short, the Seventh Circuit abruptly stated, without analysis, that the plaintiff therein could not have relied on Illinois law "because she claims to have been unaware of the basis for litigation until a short time before filing suit." 908 F.2d at 1390. Following this lead, the district judge in Lewis v. Hermann stated:
Similar to the plaintiff in Short, because Lewis was unaware of his claims until after the new period of repose [section 13] had expired, he could not have delayed filing in reliance on Illinois law.