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March 26, 2002


The opinion of the court was delivered by: Bucklo, District Judge.


Wafra Leasing Corporation ("Wafra") invested in a securitization of financial contracts by Prime Capital Corporation and Prime Leasing Corporation (collectively "Prime"), and its investment went bad. Wafra sued Prime and several of its officers and directors, as well as KPMG L.L.P., Prime's auditor, and Bischoff & Swabowski ("B & S"), its attorneys, for securities fraud under § 10(b) and § 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), 78t(a), Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, and several state causes of action. The Prime defendants answered the complaint. KPMG, Mark Bischoff and B & S, and Thomas Ehmann and Vern Landeck move to dismiss Wafra's complaint. I grant the motions in part and deny them in part.


Prime is a specialty finance company that originated and serviced financial contracts including equipment leases, loans and installment purchase agreements. From 1993 to 1999, Prime securitized the financial contracts to raise capital. Wafra invested in the 1999 securitization.

However, as early as 1997, according to the complaint, Prime was diverting and misappropriating rent payments belonging to the SPVs by holding the funds for more than two days and commingling the funds with its own. This resulted in shortfalls of money required to be deposited in the lock-box account for the benefit of the SPVs, so Prime allegedly kited misdirected funds from the next month's receipts to pay its investors, which created a shortfall for the next month as well. Wafra alleges that the diversion and misappropriation raises an inference that Prime was insolvent, and that it hid this fact from investors by kiting misdirected payments from the following month.

In May 1999, in the midst of this alleged scheme, Wafra invested in the 1999 securitization. Wafra alleges that Prime's financial stability was critical to its ability to service the contracts and ensure that investors received a full return on their investments. According to the complaint, Prime's financial failure could only lead to a breakdown of the servicing arrangement and a loss to the holders of notes issued by the SPVs. As of the closing on May 4, 1999, Prime's annual Form 10-K report for 1998 had not been filed, so Wafra relied on financial information from the 1997 10-K and on representations of Prime's financial health by various of Prime's officers, the description of the securitization in the PPM, and on opinion and valuation letters from B & S and KPMG, respectively its attorneys and auditors. Nobody disclosed the diversion, misappropriation or kiting prior to the closing.

After the closing, however, certain "red flags" about Prime's financial condition surfaced. The delayed 1998 10-K was issued on May 28, 1999, and included an auditor's report by KPMG dated May 20, 1999-just sixteen days after the closing-in which KPMG stated that Prime had transferred several million dollars to the SPVs in 1999 that were required to have been transferred in 1998. In Prime's August 1999 second quarter quarterly report, Prime reported that it needed more capital to "meet its ongoing liquidity needs." In a July 1999 proxy statement, two and a half months after the closing, Prime disclosed that, in January 1999, more than three months before the closing, its president and CEO had made a loan of $900,000 to Prime. Prime announced in November 1999 that KPMG, its auditor of many years, had resigned, and that KPMG had brought to Prime's attention "the existence of certain irreconcilable differences between the account detail and the general ledger" relating to transactions in prior years, but that KPMG had not required an adjustment. Prime's third quarter report in November 1999 indicated that its liquidity problems had worsened. Despite its financial difficulties, Prime still continued to make the required monthly payments to Wafra.

In April 2000, the securitization trustee notified Prime that there had been several defaults under the indentures and servicing agreements. On June 9, 2000, Prime held a conference call in which Wafra's president participated. Prime's vice president disclosed that Prime had misappropriated funds from the securitization trusts and used some of those funds for its own purposes, and that it would be unable to continue servicing the financial contracts. Wafra says this is the first whiff it had of any wrongdoing. Prime defaulted on the principal payment due to Wafra on June 15, 2000, and, although Wafra continues to receive interest payments, Wafra has not received any principal payments from Prime since May 2000. Wafra claims that it has lost $3.4 million, plus interest and expenses, as a result of the defendants' alleged fraud.


On a motion to dismiss, I accept all well-pleaded factual allegations in the complaint as true and draw all inferences in favor of the non-moving party. Johnson v. Rivera, 272 F.3d 519, 520 (7th Cir. 2001). I may not dismiss a 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." Conley v. Gibson. 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957).

Ordinarily, I may not consider facts outside of the complaint on a motion to dismiss, but there is a well-recognized exception: I may consider documents that are referred to in the plaintiffs complaint and that are central to its claim without converting this motion to one for summary judgment. See Menominee Indian Tribe of Wisc. v. Thompson, 161 F.3d 449, 456 (7th Cir. 1998); Help At Home Inc. v. Medical Capital L.L.C., 260 F.3d 748, 752 (7th Cir. 2001). But see Berthold Types Ltd. v. Adobe Systems Inc., 242 F.3d 772, 775 (7th Cir. 2001). In addition, a plaintiff is entitled to supplement its complaint with factual narration that is consistent with the complaint, and I may consider those additional facts for the purposes of this motion. See Help At Home Inc., 260 F.3d at 752-53.

III. Federal Claims

To state a claim under SEC Rule 10b-5, promulgated under § 10(b) of the Securities Exchange Act of 1934, "a plaintiff must allege that the defendant (1) made a misstatement or omission, (2) of material fact, (3) with scienter, (4) in connection with the purchase or sale of securities, (5) upon which the plaintiff relied, and [that] (6) that reliance proximately caused plaintiffs injuries." In re HealthCare Compare Corp. Secs. Litig., 75 F.3d 276, 280 (7th Cir. 1996). The allegations of the complaint must also comply with the Private Securities Litigation Reform Act of 1995 ("PSLRA"), 15 U.S.C. § 78u-4 (b).

All of the defendants argue that Wafra's federal securities claims are barred by the statute of limitations, and KPMG argues that certain claims against it are barred by the statute of repose. The Officers and KPMG argue that Wafra's claims fail for a lack of justifiable reliance. The Officers and the Bischoff defendants also argue, for several independent reasons, that Wafra fails to state a claim for securities fraud.

A. Statute of Limitations

Rule 10b-5 claims are governed by a one-year statute of limitations and a three-year statute of repose. Lampf Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991). The one-year period:

begins to run not when the fraud occurs, and not when the fraud is discovered, but when (often between the date of occurrence and the date of the discovery of the fraud) the plaintiff learns, or should have learned through the exercise of ordinary diligence in the protection of one's legal rights, enough facts to enable him by such further investigation as the facts would induce in a reasonable person to sue within a year.

Fujisawa Pharm. Co.. Ltd. v. Kapoor, 115 F.3d 1332, 1334 (7th Cir. 1997). Whether a plaintiff had sufficient information to place it on inquiry notice is a question of fact, Marks v. CDW Computer Ctrs., Inc., 122 F.3d 363, 367 (7th Cir. 1997), but "if a plaintiff pleads facts that show its suit barred by a statute of limitations, it may plead itself out of court under a Rule 12(b)(6) analysis." Whirlpool Fin. Corp. v. GN Holdings, Inc., 67 F.3d 605, 608 (7th Cir. 1995).

Wafra filed the complaint in this case on June 8, 2001. The moving defendants argue*fn1 that Wafra's securities fraud claim is barred by the statute of limitations. The defendants say that the clock started running as early as 1999, when Prime made public disclosures that indicated its financial distress. Wafra, however, argues that the time began to run only when it was first injured; i.e., when Prime failed to make the securitization payment due on June 15, 2000; or at the earliest on June 9, 2000, when Prime disclosed its misappropriation and diversion to Wafra in a conference call.

Prime's poor financial condition was revealed by a series of public disclosures in 1999: the July 1999 proxy statement that disclosed a January 1999 (pre-closing) loan to Prime of nearly a million dollars from its CEO, Compl. ¶ 49; Prime's August 1999 quarterly report that stated that Prime would need more capital resources to meet its liquidity needs, id. ¶ 48; Prime's November 1999 announcement of the resignation of KPMG, its longtime auditors, in which Prime revealed some undefined accounting irregularities involving past transactions, id. ¶ 50; and the November 1999 quarterly report that indicated more serious liquidity problems, specifically Prime's inability to fund new financial contracts, id. ¶ 52.*fn2 The defendants say that these announcements contradicted Prime's alleged oral representations of financial health, so that there were "suspicious circumstances" that obligated Wafra to investigate further.

The complaint contains lengthy allegations about the failure to disclose information about Prime's finances, and the defendants ask me to infer therefore that the financial failure, and not the misappropriation, diversion and kiting scheme, was the essence of the fraud. However, in response to Ehmann and Landeck's motion to dismiss, Wafra explains that the lock-box account and the Indenture agreement, as well as the provision for a back-up servicer, were established to protect Wafra's interests in the event of Prime's financial failure, and that the only way that Wafra could be injured under the arrangement was from a compromise of the lock-box account. Resp. to Ehmann and Landeck's Mot. at 11-12; see also Resp. to KPMG's Mot. at 4 ("Wafra is not suing KPMG for failing to disclose any of [the] information" about Prime's deteriorating financial status.). According to Wafra, the fraud alleged is more than Prime's misrepresentation of its financial condition; it is also, and more importantly, the alleged kiting scheme (which Wafra says was designed specifically to prevent discovery of Prime's insolvency) that compromised the lock-box mechanism. Drawing all reasonable inferences in favor of Wafra at this stage, see In re HealthCare, 75 F.3d at 279, the complaint and Wafra's additional factual narration allege that, if Prime had properly handled its financial problems, the backup servicer would have prevented a loss to the investors, but because Prime diverted and misappropriated funds and hid that fact from investors through the kiting scheme, the lock-box arrangement failed and the investors lost money. Mere notice of Prime's failing finances was insufficient to give notice of the fraud without knowing that the funds from the lock-box account had been misappropriated.

Wafra suggests that it should not be charged with notice of the alleged fraud until its injury actually occurred, i.e., until Prime failed to make the payment due on June 15, 2000, because it could not have sued without an injury, and that it was not injured until the monthly payments stopped. This theory has been conclusively rejected by the Seventh Circuit:

Discovering that one has lost money is not the same as discovering that one has been defrauded. . . . [T]he question is when the investors discovered (or should have discovered) the deceit, not when the full consequences of that deceit are felt. An investor can be defrauded before any loss is realized. Discovery of the fraud means the discovery of the misrepresentation.

Eckstein v. Balcor Film Investors, 8 F.3d 1121, 1127-28 (7th Cir. 1993) (citations omitted). Wafra may not have known until June 2000 that its investment was a total loss, but the relevant question is not when it appreciated the scope of its loss; rather, the question is when it had access to enough information to know that it had been knowingly lied to, which is all that inquiry notice requires. See Law v. Medco Research, Inc., 113 F.3d 781, 786 (7th Cir. 1997) ("In a fraud case . . . [w]hen the ...

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