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WACHOVIA SECURITIES, LLC v. NEUHAUSER

November 4, 2004.

WACHOVIA SECURITIES, LLC, a Delaware corporation, Plaintiff,
v.
DAVID NEUHAUSER, ANDREW A. JAHELKA, RICHARD O. NICHOLS, LEON A. GREENBLATT, III, Defendants.



The opinion of the court was delivered by: WILLIAM HART, Senior District Judge

MEMORANDUM OPINION AND ORDER

Plaintiff Wachovia Securities LLC*fn1 contends that defendants David Neuhauser, Andrew Jahelka, Richard Nichols, and Leon Greenblatt*fn2 misused Wachovia margin accounts opened in the names of Loop Corp. and NOLA, LLC. Loop and NOLA are not defendants in the present lawsuit. The Loop and NOLA accounts allegedly were being used to surreptitiously obtain a controlling interest in Health Risk Management, Inc. ("HRMI"). When NASDAQ discontinued trading of HRMI stock, Wachovia was left with a $2,900,000 margin call that has not been paid. Wachovia contends Loop and NOLA were shell companies and that the Neuhauser Individuals are liable for the unpaid margins either directly or as alter egos of the two entities.

Initially, based on arbitration provisions in the margin accounts of the two entities, Wachovia brought an arbitration proceeding against the two entities and the Neuhauser Individuals as well. The Neuhauser Individuals then filed a lawsuit in the Circuit Court of Cook County, Illinois in which they sought a declaration that they were not bound by any arbitration provision of the margin accounts and also requested an injunction preventing Wachovia from proceeding against them in arbitration. The state court lawsuit was removed to federal court based on complete diversity of citizenship. In federal court, Wachovia answered the removed complaint and also filed a countercomplaint against the Neuhauser Individuals in which Wachovia raised federal securities law, state law fraud, breach of contract, and alter ego claims. At a court hearing, Wachovia subsequently represented that it would no longer proceed against the Neuhauser Individuals in the arbitration proceeding and instead would proceed against them in this federal lawsuit. Wachovia continued the arbitration proceeding as against the two entities. The parties then submitted an agreed draft order, which was entered by the court. The order dismissed the action that had been removed and realigned Wachovia as plaintiff with its counterclaims as the complaint.*fn3 Wachovia thereafter moved the arbitration panel to stay the arbitration as regards the Neuhauser Individuals.

  Presently pending are two motions of the Neuhauser Individuals. They move to reinstate their original action on the ground that Wachovia only stayed the arbitration action against them and did not actually dismiss it. The Neuhauser Individuals also move to dismiss Wachovia's Complaint for failure to state a basis for relief.

  Wachovia contends that it requested a stay so that it could reinstate the arbitration against the Neuhauser Individuals in the event that, in the lawsuit, it proves the Neuhauser Individuals are alter egos of Loop and NOLA. They further contend that a stay is preferable to a dismissal because the Neuhauser Individuals may be difficult to find for service in the event that it becomes necessary to bring them back into a dismissed arbitration proceeding. Statements that Wachovia may later proceed against the Neuhauser Individuals in arbitration, however, are inconsistent with Wachovia's statements in a hearing in the federal lawsuit. At a hearing, counsel for Wachovia stated that Wachovia "will litigate in the district court rather than in arbitration. . . . So the issues that would have been raised in the arbitration will now be raised in our counterclaim,. . . ." May 24, 2004 Tr. at 5. In a further colloquy, the court stated: "Now, the parties can always waive arbitration, so that is okay. But if anybody wants arbitration, you have to ask for it and you have to make the appropriate motion for it. And you can forego that and resolve the case apparently on the counterclaim, right?" Id. at 6. Counsel for Wachovia responded: "Correct, Judge. And the arbitration will proceed as to other entities." Id. Following the May 24 hearing, the parties submitted an agreed draft order that was entered by the court. The order included a representation by Wachovia that it is "not proceeding with its claims" against the Neuhauser Individuals in arbitration. Based on these representations, the Neuhauser Individuals' removed action was dismissed with prejudice.

  Wachovia makes no argument as to why the federal action would be inadequate to obtain any necessary relief from the Neuhauser Individuals. If Wachovia is successful in the present lawsuit, there would be no need for further proceedings against these individuals in the arbitration. Based on its prior representations, Wachovia will now be expressly ordered to dismiss the arbitration action as against the Neuhauser Individuals. Since that order will be entered, there will be no need to reinstate the action of the Neuhauser Individuals. Wachovia's complaint contains eight counts labeled as follows: (I) Common Law Fraud; (II) [Federal] Securities Fraud; (III) Conspiracy to Commit Fraud; (IV) Declaratory Judgment — Alter Ego (Loop Corp.); (V) Declaratory Judgment — Alter Ego (NOLA, LLC); (VI) Piercing the Corporate Veil (Loop Corp.); (VII) Piercing the Corporate Veil (NOLA, LLC); and (VIII) Breach of Contract. Jurisdiction is based on both federal question jurisdiction over Count II and diversity jurisdiction. Although some of the agreements relied upon have a New York choice of law provision, the parties agree that Illinois law applies to the issues presently being raised regarding the state law counts. The Neuhauser Individuals contend all counts are subject to dismissal on a Rule 12(b)(6) motion.

  On a Rule 12(b)(6) motion to dismiss, plaintiff's well-pleaded allegations of fact are taken as true and all reasonable inferences are drawn in plaintiff's favor. Leatherman v. Tarrant County Narcotics Intelligence & Coordination Unit, 507 U.S. 163, 164 (1993); Dixon v. Page, 291 F.3d 485, 486 (7th Cir. 2002); Stachon v. United Consumers Club, Inc., 229 F.3d 673, 675 (7th Cir. 2000). Ordinarily, a complaint need not set forth all relevant facts or recite the law; all that is required is a short and plain statement showing that the party is entitled to relief. Fed.R. Civ. P. 8(a)(2); Boim v. Quranic Literacy Institute, 291 F.3d 1000, 1008 (7th Cir. 2002); Anderson v. Simon, 217 F.3d 472, 474 (7th Cir. 2000), cert. denied, 531 U.S. 1073 (2001); Scott v. City of Chicago, 195 F.3d 950, 951 (7th Cir. 1999). Ordinarily, a plaintiff in a suit in federal court need not plead facts; conclusions may be pleaded as long as the defendant has at least minimal notice of the claim. Fed.R. Civ. P. 8(a)(2); Swierkiewicz v. Sorema N.A., 534 U.S. 506, 512 (2002); Scott, 195 F.3d at 951; Albiero v. City of Kankakee, 122 F.3d 417, 419 (7th Cir. 1997); Jackson v. Marion County, 66 F.3d 151, 153-54 (7th Cir. 1995). However, to the extent fraud is alleged, it must be pleaded with particularity. See Fed.R. Civ. P. 9(b); Slaney v. The International Amateur Athletic Federation, 244 F.3d 580, 597 (7th Cir.), cert. denied, 534 U.S. 828 (2001); Shapo v. O'Shaughnessy, 246 F. Supp. 2d 935, 955-56 (N.D. Ill. 2002). Additionally, even if not required to plead specific facts, a plaintiff can plead itself out of court by alleging facts showing there is no viable claim. See Slaney, 244 F.3d at 597; Kauthar SDN BHD v. Sternberg, 149 F.3d 659, 669-70 n. 14 (7th Cir. 1998), cert. denied, 525 U.S. 1114 (1999); Jackson, 66 F.3d at 153-54.

  Ordinarily, as long as they are consistent with the allegations of the complaint, a plaintiff may assert additional facts in its response to a motion to dismiss. Brokaw v. Mercer County, 235 F.3d 1000, 1006 (7th Cir. 2000); Forseth v. Village of Sussex, 199 F.3d 363, 368 (7th Cir. 2000); Albiero, 122 F.3d at 419; Gutierrez v. Peters, 111 F.3d 1364, 1367 n. 2 (7th Cir. 1997). However, Rule 9(b) requires that the necessary allegations be in the complaint itself. Kennedy v. Venrock Associates, 348 F.3d 584, 593 (7th Cir. 2003), cert. denied, 124 S. Ct. 1889 (2004); Abrams v. Van Kampen Funds, Inc., 2002 WL 1160171 *2 (N.D. Ill. May 30, 2002); Chicago District Council of Carpenters Welfare Fund v. Angulo, 169 F. Supp. 2d 880, 886 (N.D. Ill. 2001); Implant Innovations, Inc. v. Nobelpharma AB, 1995 WL 562092 *5 (N.D. Ill. Sept. 14, 1995). Additional allegations contained in the responsive brief, however, may indicate that plaintiff should be given the opportunity to amend the complaint to comply with Rule 9(b). See Ziemba v. Cascade International, Inc., 256 F.3d 1194, 1213 (11th Cir. 2001); Angulo, 169 F. Supp. 2d at 886; Implant Innovations, 1995 WL 562092 at *5. While additional allegations contained in a responsive brief are not considered to be incorporated in the complaint, documents that are referred to in the complaint and that are central to a claim that is made may be considered to be part of the complaint even if not actually attached to the complaint. Rosenblum v. Travelbyus.com Ltd., 299 F.3d 657, 661 (7th Cir. 2002); Duferco Steel Inc. v. M/V Kalisti, 121 F.3d 321, 324 n. 3 (7th Cir. 1997); Venture Associates Corp. v. Zenith Data Systems Corp., 987 F.2d 429, 431 (7th Cir. 1993). Where the document may properly be considered, the actual document will override inconsistent descriptions of the document alleged in the body of the complaint. See Rosenblum, 299 F.3d at 661 (quoting 5 Wright & Miller, Federal Practice & Procedure: Civil 2d § 1327 at 766 (1990)); In re Wade, 969 F.2d 241, 249 (7th Cir. 1992); Beam v. IPCO Corp., 838 F.2d 242, 244-45 (7th Cir. 1988).

  In the complaint itself, it is unnecessary to specifically identify the legal basis for a claim as long as the facts alleged would support relief. Forseth, 199 F.3d at 368; Scott, 195 F.3d at 951; Albiero, 122 F.3d at 419; Bartholet v. Reishauer A.G. (Zurich), 953 F.2d 1073, 1078 (7th Cir. 1992); Dodaro v. Village of Glendale Heights, 2003 WL 1720030 *8 (N.D. Ill. March 31, 2003). The plaintiff is not bound by legal characterizations of the claims contained in the complaint. Forseth, 199 F.3d at 368; Kirksey v. R.J. Reynolds Tobacco Co., 168 F.3d 1039, 1041 (7th Cir. 1999). However, in response to a motion to dismiss that raises the issue, the plaintiff must identify a legal basis for a claim and make adequate legal arguments in support of it. Kirksey, 168 F.3d at 1041-42; Stransky v. Cummins Engine Co., 51 F.3d 1329, 1335 (7th Cir. 1995); Levin v. Childers, 101 F.3d 44, 46 (6th Cir. 1996); Gilmore v. Southwestern Bell Mobile Systems, L.L.C., 224 F. Supp. 2d 1172, 1175 (N.D. Ill. 2002); Carpenter v. City of Northlake, 948 F. Supp. 759, 765 (N.D. Ill. 1996). Rule 9(b) requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally." The circumstances of fraud generally include "the identity of the person who made the misrepresentation, the time, place and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff." Slaney, 244 F.3d at 599; General Electric Capital Corp. v. Lease Resolution Corp., 128 F.3d 1074, 1078 (7th Cir. 1997). A complaint must outline the alleged misrepresentations and reasonably notify a defendant of the specifics of the alleged fraudulent activity, including the particular defendant's role. Lachmund v. ADM Investor Services, Inc., 191 F.3d 777, 782 (7th Cir. 1999); Goren v. New Vision International, Inc., 156 F.3d 721, 730 (7th Cir. 1998); Midwest Grinding Co., Inc. v. Spitz, 976 F.2d 1016, 1020 (7th Cir. 1992); Ward Enterprises, Inc. v. Bang & Olufsen, 2003 WL 22859793 *1 (N.D. Ill. Dec. 2, 2003); Gilmore v. Southwestern Bell Mobile Systems, L.L.C., 210 F.R.D. 212, 224 (N.D. Ill. 2001). Fair notice is the most basic consideration. Vicom, Inc. v. Harbridge Merchant Services, Inc., 20 F.3d 771, 777-78 (7th Cir. 1994); In re Bridgestone/Firestone Inc. Tires Products Liability Litigation, 2002 WL 31689264 *8 (S.D. Ind. Nov. 20, 2002); Gilmore, 210 F.R.D. at 224. Additionally, the requirements of Rule 9(b) may be relaxed where the plaintiff makes an adequate showing that necessary information is within the control of a defendant so that particularized pleading cannot be fully accomplished prior to receiving discovery. See Emery v. American General Finance, Inc., 134 F.3d 1321, 1323 (7th Cir.), cert. denied, 525 U.S. 818 (1998).

  The Neuhauser Individuals contend the Count II federal securities fraud claim is untimely. This claim is based on Section 10(b) (15 U.S.C. § 78j(b)) and Rule 10b-5 (17 C.F.R. § 240.10b-5). The Complaint was filed on May 21, 2004. In the Complaint, Wachovia alleges that the Neuhauser Individuals' "scheme came to light on or about May 21, 2001, when the NASDAQ halted trading of the common stock of HRMI on the news that the company's independent auditors had resigned. At this time, the stock declined from a prior day's close of $7.5 per share to $4.75 per share." Compl. ¶ 36. Accordingly, Wachovia demanded that Loop and NOLA, and eventually the Neuhauser Individuals, provide sufficient funds to satisfy the margin requirement. Id. at ¶¶ 37-39. These demands going unheeded, Wachovia "began to explore potential legal remedies." The Neuhauser Individuals contend that, based on the facts alleged in the Complaint, Wachovia was on inquiry notice as of May 21, 2001, but did not raise its securities fraud claim until three years later. The Neuhauser Individuals further contend that this is beyond the one-year discovery period/three-year statute of repose that was in effect for § 10(b)/Rule 10b-5 claims as of 2001. See Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364 (1991); Levitan v. McCoy, 2001 WL 1117279 *5 (N.D. Ill. Sept. 21, 2001); Stauffer v. Westmoreland Obstetric and Gynecologic Associates, S.C., 2001 WL 585510 *5 (N.D. Ill. May 25, 2001); Great Neck Capital Appreciation Investment Partnership, L.P. v. Pricewaterhouse Coopers, L.L.P., 137 F. Supp. 2d 1114, 1125 (E.D. Wis. 2001). Alternatively, they contend the claim is untimely under the two-year discovery period/five-year statute of repose that became effective July 30, 2002. See 28 U.S.C. § 1658(b). Wachovia argues that the allegations of the Complaint do not conclusively establish inquiry notice as of May 21, 2001. It also argues that the two-year period of § 1658(b) applies and further contends that this period did not begin to run until August 16, 2001, based on estoppel due to alleged settlement negotiations with the Neuhauser Individuals. Alternatively, Wachovia contends the filing of the arbitration proceeding equitably estopped the running of the limitation period for the securities fraud claims.

  Wachovia contends that when it was placed on inquiry notice is a question of fact that cannot be resolved on a Rule 12(b)(6) motion. Inquiry notice that begins the running of the limitation period for a securities fraud claim arises "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 Pharmaceutical Co. v. Kapoor, 115 F.3d 1332, 1334 (7th Cir. 1997). However, the Seventh Circuit has rejected the proposition that, on a motion to dismiss, allegations of a "conjunction of optimistic forecasts with a sharp drop in price establishes inquiry notice as a matter of law." LaSalle v. Medco Research, Inc., 54 F.3d 443, 447 (7th Cir. 1995). See also Law v. Medco Research, Inc., 113 F.3d 781, 783 (7th Cir. 1997); Abrams v. Van Kampen Funds, Inc., 2002 WL 1160171 *10 (N.D. Ill. May 30, 2002). Here, the relationship is even more attenuated because the Neuhauser Individuals were purchasers of HRMI stock, not officers or directors of the corporation who would more likely appear to have control over the corporation or nonpublic knowledge of events that could affect the stock's price. In addition to knowledge of the drop in price that precipitated the margin call, some information about the relationships between the Neuhauser Individuals, Loop, and NOLA, their percentage of ownership of HRMI stock, and the cause of the drop in value of HRMI stock was also necessary before Wachovia would be on inquiry notice. There is no allegation in the Complaint that, as of May 21, 2001, Wachovia already had knowledge of all the HRMI stock that Greenblatt controlled through accounts with other brokers. Although, Wachovia alleges that it began an investigation following the margin call, it does not allege the precise dates that the investigation began or when it learned particular facts. The Neuhauser Individuals focus on the allegation that the "scheme came to light on or about May 21, 2001." Viewed in isolation at face value, that conclusory allegation supports that sufficient notice existed as of May 21, 2001. The additional and more specific factual allegations contained in the Complaint, however, support only that May 21, 2001 was the date the stock price dropped that resulted in a margin call and ultimately further investigation. The Complaint does not show the precise date when inquiry notice would be satisfied.

  In response to the motion to dismiss, however, Wachovia concedes that its securities fraud claim accrued by August 2001. Wachovia contends that its May 2004 Complaint is timely because the two-year limitation period of § 1658(b) applies and it brought the arbitration action in May 2003. Taking as true that the securities fraud claim did not accrue until August 2001, the former one-year statute of limitation had not expired prior to the effective date of § 1658(b). While the Neuhauser Individuals argue that the enactment of § 1658(b) did not revive claims for which the statute of limitations had already expired, see In re Enterprise Mortgage Acceptance Co., L.L.C. Securities Litigation, 295 F. Supp. 2d 307 (S.D.N.Y. 2003), they do not dispute that § 1658(b) applies to securities fraud claims for which the previously existing limitation period had not yet expired as of July 30, 2002. Therefore, Wachovia had until August 2003 to bring its claim.

  The question is whether bringing the arbitration action in May 2003 equitably estopped the further running of the limitation period. At the time Wachovia brought its securities claims in this court, the arbitration proceeding against the Neuhauser Individuals was still pending. Wachovia relies on New York Stock Exchange Rule 606(a) which provides: "Where permitted by law, the time limitation(s) which would otherwise run or accrue for the institution of legal proceedings shall be tolled when a duly executed Submission Agreement is filed by the claimant(s). The tolling shall continue for such period as the New York Stock Exchange, Inc. shall retain jurisdiction upon the matter submitted." National Association of Securities Dealers Rule 10307 is essentially identical.

  Parties may agree to extend a period of limitation. See Stephan v. Goldinger, 325 F.3d 874, 876 (7th Cir.), cert. denied, 124 S. Ct. 227 (2003). Thus, to the extent the parties had an arbitration agreement, the arbitration proceeding that was instituted would have tolled the limitation period during the pendency of the arbitration proceeding. Since the arbitration proceeding was initiated prior to the expiration of the limitation period and the claims were raised in this court while the arbitration proceeding was still pending, the federal securities law claims are timely as long as there was an enforceable arbitration agreement. However, if there was no enforceable arbitration agreement as against the Neuhauser Individuals, improperly naming them in the arbitration ...


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