United States District Court, D. Minnesota
James W. Smith, Jr., on his own behalf and on behalf of those similarly situated, Plaintiff,
Questar Capital Corporation, Yorktown Financial Companies, Inc., and Allianz Life Insurance Companies of North America, Defendants.
Daniel E. Gustafson, Karla M. Gluek, and David A. Goodwin, Gustafson Gluek PPLC, Robert E. Gordon, Scott L. Adkins, and Stephen McGuinness, Gordon & Doner, PA, Charles E. Scarlett, Bradford M. Gucciardo, and Scott D. Hirsch, Scarlett Gucciardo
& Hirsch, PA, for Plaintiff.
Anthony N. Cicchetti, Carlton Fields Jorden Burt, P.A., Roland C. Goss and James F. Jorden, Carlton Fields Jorden Burt P.A., and Wendy J. Wildung, Faegre Baker Daniels LLP, for Defendants.
MEMORANDUM OPINION AND ORDER
SUSAN RICHARD NELSON, District Judge.
This matter is before the Court on Defendants' Motion to Dismiss Plaintiff's First Amended Class Action Complaint ("Amended Complaint"). [Doc. No. 48]. For the reasons set forth below, Defendants' motion is granted in part and denied in part.
Plaintiff and putative class representative James W. Smith, Jr. ("Smith") is an investor who resides in Florida and a customer of Defendant Questar Capital Corporation ("Questar"). (Am. Compl. ¶ 15 [Doc. No. 42].) Questar is a Minnesota corporation with its principal place of business in Minnesota. (Id. ¶ 16.) Questar publicly solicited, offered, and sold securities that were issued by non-party Diversified Business Services & Investments, Inc. ("DBSI") and its various subsidiaries and affiliates. (Id. ¶ 14.) DBSI is an Idaho corporation with its principal place of business in Idaho. (Id. ¶ 8.) A now-defunct Ponzi scheme, DBSI purported to finance the purchase of various real estate ventures. (Id.)
Defendant Yorktown Financial Companies, Inc. ("Yorktown") is an Indiana corporation with its principal place of business in Minnesota. (Id. ¶ 16.) Defendant Allianz Life Insurance Companies of North America ("Allianz") is a Minnesota corporation with its principal place of business in Minnesota. (Id.) The Amended Complaint alleges that Yorktown and Allianz "directly or indirectly control Questar." (Id. ¶ 116.)
On or about February 19, 2008, DBSI 2008 Notes Corporation, a DBSI subsidiary, issued a confidential Private Placement Memorandum ("PPM") for $90, 000, 000 in corporate notes that bore 9.5% interest ("2008 Notes"). (Id. ¶ 12.) The marketing materials described the notes as paying 9.5% annually for a period of eight years and being "unconditionally guaranteed" by DBSI Housing Inc. (Id. ¶ 20, 23.) They stated that interest was "simple interest paid monthly, " and the investor would receive "steady monthly payments from an 8-year Note." (Id. ¶ 20.) They further indicated that funds would be used by the DBSI Group of Companies for "locating, acquiring, developing, managing and providing real estate investment opportunities throughout the country." (Id.) Moreover, these materials stated that DBSI had "Debt Experience and Track Record" since 1994. (Id.) Between October 2006 and November 2008, Questar disseminated these documents and brochures to existing and prospective customers. (Id. ¶ 23.)
In or about February 2008, Smith met with Robert Carlson ("Carlson"), a Questar representative,  at Smith's office in Miami, Florida, to discuss a $50, 000 investment recommended by Carlson to Smith. (Id. ¶ 21.) The proposed investment consisted of a note issued by DBSI 2008 Notes Corporation, represented by Carlson as a safe and conservative investment. (Id.) Carlson assured Smith that DBSI was a well-established company, and that the note would provide the desired flow of income on a monthly basis, reliably and without interruption. (Id.) Smith purchased one note issued by DBSI 2008 Notes Corporation for $50, 000 ("Smith Note"). (Id. ¶ 15.)
It is alleged that from approximately October 16, 2006 to October 16, 2012, members of the putative class similarly purchased or acquired DBSI-issued securities from Questar. (Id. ¶¶ 11, 23.)
In order to purchase the DBSI 2008 Notes Corporation offering, Questar required Smith and all members of the putative class to execute a "New Account Form" agreement. (Id. ¶ 24; New Account Form, Ex. F to Am. Compl. [Doc. No. 42-6 at 2-5].) Attached to the New Account Form is a document entitled "Questar Capital Sponsorship Program Disclosure." (Sponsorship Program Disclosure, Ex. F to Am. Compl. [Doc. No. 42-6 at 6].) The Sponsorship Program Disclosure informs the potential investor that Questar "receives compensation from these partners over and above the standard concessions disclosed in the product prospectuses, and that compensation is a material factor in entering into partnership." (Id.) It further discloses that "[t]his compensation is used to offset the costs of due diligence"-that is, "an in depth due diligence analysis of the product sponsor." (Id.)
In November 2008, DBSI and various subsidiaries and affiliates, including DBSI 2008 Notes Corporation, filed for bankruptcy protection in the District of Delaware. (Am. Compl. ¶ 26 [Doc. No. 42].) Upon DBSI's collapse, the Bankruptcy Court appointed a Trustee, who sued Questar to claw back approximately $2.2 million in commissions and other fees that DBSI paid to Questar for the sale of DBSI securities. (Id. ¶¶ 3, 53; Zazzali v. Advisory Group Equity Servs. Ltd. et al., No. 1:11-cv-475-GMS (D. Del.).) The Bankruptcy Court also appointed an Examiner, who filed an Interim Report and Final Report. (Am. Compl. ¶ 54 [Doc. No. 42].) The Examiner's Interim Report focused on DBSI's misuse of proceeds from the DBSI 2008 Notes Corporation offering. (Id. ¶ 55.) The Examiner's Final Report showed that as early as 2005, DBSI constantly needed new investor funds in order to meet pre-existing obligations. (Id. ¶ 56.)
The Amended Complaint alleges that due diligence reports were readily available to Questar, and they identified warning signs about DBSI. (Id. ¶ 41.) For example, the law firm of Mick & Associates ("Mick") in Omaha, Nebraska, conducted due diligence on private placement offerings made by DBSI to the public. (Id. ¶ 30.) Mick completed a due diligence report on the DBSI 2008 Notes Corporation offering on February 1, 2008, revised it on February 14, 2008, and disseminated the revised report to Questar. (Id.) The Mick report gave the DBSI 2008 Notes Corporation offering a "qualified recommendation, " meaning that there was an element of uncertainty or risk involved in the offering. (Id. ¶ 30.) This "qualified recommendation" was not disclosed to Smith or the putative class. (Id.)
The Mick report purportedly raised other warning signs that Plaintiff argues should have prompted Questar to undertake its own due diligence, listen to due diligence advisors, and question the legitimacy of the offering. (Id. ¶ 31.) For example:
The Mick report was not independently audited or otherwise verified, contrary to industry practice under FINRA NTM 03-71. (Id.)
All of the financial information in the Mick report came directly from DBSI. (Id. ¶ 32.) The Amended Complaint alleges that Questar did not verify this financial information independently, and it concealed the lack of independent financial verification from its customers. (Id.)
The interest rate of the DBSI 2008 Notes Corporation at 9.5% was appreciably higher than bank CD rates in 2008, which ranged from 3.75% to approximately 5.3%. (Id. ¶ 33.)
Additional warning signs allegedly included DBSI's issuance of regular, successive offerings, and the failure of DBSI's financial statements to comply with Generally Accepted Accounting Principles ("GAAP"). (Id. ¶¶ 34, 42-44.)
Smith claims that Questar failed to act in several ways, such as not disclosing the Mick report and the warning signs it contained to Questar's customers; not investigating the risks with DBSI independently; and not demanding DBSI to amend its PPMs to include risk disclosures, as urged by due diligence advisors. (Id. ¶¶ 38, 40.)
The Amended Complaint alleges that Questar knew, or was deliberately reckless or negligent in not knowing, that their statements were materially false and misleading. (Id. ¶ 47.) Relying on Questar's representations, Smith and the putative class members sustained substantial losses in DBSI's now-worthless securities. (Id. ¶¶ 26, 52.)
On October 18, 2012, Smith filed a Class Action complaint, alleging the following causes of action: violations of the Minnesota Securities Act under Minnesota Statutes §§ 80A.68(1), 80A.68(2), 80A.76(g)(3), 80A.86(3),  and 80.76(g)(1) (Counts 1, 2, 3, 6, and 7); common law negligence (Count 4); and common law negligent misrepresentation (Count 5). (Compl. [Doc. No. 1].) On January 2, 2013, Defendants moved to dismiss the Complaint. (Defs.' Mot. to Dismiss [Doc. No. 29].) On August 2, 2013, the Court granted in part and denied in part Defendants' motion to dismiss, specifically:
1. Granting without prejudice Defendants' motion to dismiss Counts 1, 2, 3, 6, and 7 of the Class Action Complaint alleging violations of the Minnesota Securities Act;
2. Granting with prejudice Defendants' motion to dismiss Count 4 of the Class Action Complaint alleging common law negligence; and
3. Granting without prejudice Defendants' motion to dismiss Count 5 of the Class Action Complaint alleging common law negligent misrepresentation.
(Aug. 2, 2013, Order at 28 [Doc. No. 41].)
On September 3, 2013, Smith filed an Amended Complaint, alleging the following causes of action: violations of Minnesota Securities Act under Minnesota Statutes §§ 80A.68(1), 80A.68(2), 80A.76(g)(4), 80A.68(3), and 80.76(g)(1) (Counts 1, 2, 3, 6, and 8); common law negligence (Count 4); common law negligent misrepresentation (Count 5); and common law breach of contract (Count 7). (Am. Compl. [Doc. No. 42].) On September 30, 2013, Defendants moved to dismiss the Amended Complaint, which Plaintiff opposed on October 21, 2013. (Defs.' Mot. to Dismiss [Doc. No. 48]; Pl.'s Opp'n to Defs.' Mot. to Dismiss [Doc. No. 54].) On November 4, 2013, Defendants filed a reply brief. (Defs.' Reply Mem. of Law in Supp. of Their Mot. to Dismiss the First Am. Class Action Compl. [Doc. No. 55].) On December 3, 2013, the Court heard oral argument. (Min. Entry for Mot. Hr'g [Doc. No. 56].)
Defendants bring this motion under Rule 9(b) and Rule 12(b)(6) of the Federal Rules of Civil Procedure. (Defs.' Mot. to Dismiss at 1 [Doc. No. 48].)
A. Standard of Review
Certain claims that include allegations of fraud must be pled with particularity under Rule 9(b) of the Federal Rules of Civil Procedure. Claims subject to the particularity requirements must be pled to include "such matters as the time, place and contents of false representations, as well as the identity of the person making the misrepresentations and what was obtained or given up thereby." Parnes v. Gateway 2000, Inc., 122 F.3d 539, 549 (8th Cir. 1997) (citations omitted). "[C]onclusory allegations that a defendant's conduct was fraudulent and deceptive are not sufficient to satisfy the rule." Id . (citations omitted). As a general matter, the "who, what, when, where, and how" of any fraud claim must be pled in detail. Id. at 550 (citations omitted). In the securities fraud context, Rule 9(b) requires that the pleading set forth facts explaining why it is claimed that each of the defendants knew the representations to be untrue or misleading when they were made. In re Buffets, Inc. Sec. Litig., 906 F.Supp. 1293, 1300 (D. Minn. 1995). The Court is mindful that the issue here is not whether the plaintiff will prevail at trial, but rather whether he is entitled to proceed with his claims. In re Digi Int'l, Inc. Sec. Litig., 6 F.Supp.2d 1089, 1095 (D. Minn. 1998).
When evaluating a motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil Procedure, the Court assumes the facts in the Complaint to be true and construes all reasonable inferences from those facts in the light most favorable to the plaintiff. Morton v. Becker, 793 F.2d 185, 187 (8th Cir. 1986). The Court, however, need not accept as true wholly conclusory allegations, Hanten v. Sch. Dist. of Riverview Gardens, 183 F.3d 799, 805 (8th Cir. 1999), or legal conclusions that the plaintiff draws from the facts pled. Westcott v. City of Omaha, 901 F.2d 1486, 1488 (8th Cir. 1990).
To survive a motion to dismiss, a complaint must contain "enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 545 (2007). Although a complaint need not contain "detailed factual allegations, " it must contain facts with enough specificity "to raise a right to relief above the speculative level." Id. at 555. "Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, " will not pass muster under Twombly. Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (citing Twombly, 550 U.S. at 555). In short, this standard "calls for enough fact to raise a reasonable expectation that discovery will reveal evidence of [the claim]." Twombly, 550 U.S. at 556.
B. Materials Considered
A court may consider the complaint, matters of public record, orders, materials embraced by the complaint, and exhibits attached to the complaint in deciding a motion to dismiss under Rule 12(b)(6). Porous Media Corp. v. Pall Corp., 186 F.3d 1077, 1079 (8th Cir. 1999); see Piper Jaffray Cos., Inc. v. Nat'l Union Fire Ins. Co., 967 F.Supp. 1148, 1152 (D. Minn. 1997) (finding that on a motion to dismiss, "the Court simply may not... resolve factual disputes on the basis of preemptive (and untested) submissions" and may only "consider extra-pleading material necessarily embraced by the pleadings... and all documents they incorporate by reference").
For purposes of this motion, materials embraced by the Amended Complaint include: (1) the DBSI 2008 Notes Corporation Private Placement Memorandum ("PPM"), (2) the DBSI 2008 Notes Corporation Subscription Agreement ("Subscription Agreement"), (3) the Questar Capital New Account Form ("New Account Form"), and (4) the Questar Capital Sponsorship Program Disclosure ("Sponsorship Program Disclosure"). (Private Placement Memorandum, Ex. A to Aff. of Anthony N. Cicchetti [Doc. No. 19-1]; Subscription Agreement, Ex. C to Cicchetti Aff. [Doc. No. 19-3]; New Account Form and Sponsorship Program Disclosure, Ex. F to Am. Compl. [Doc. No. 42-6].) The Court considers the PPM because it is referenced in the Amended Complaint and forms the basis of the dispute. (E.g., Am. Compl. ¶¶ 12, 28, 40, 45-49 [Doc. No. 42].) The Court considers the Subscription Agreement despite its lack of reference in the Amended Complaint, because it forms the basis of the dispute. The Court considers the New Account Form because it is referenced in and attached to the Amended Complaint, and it forms the basis of the dispute. (Id. ¶¶ 7, 24, 25, 111-14 [Doc. No. 42].) Finally, the Court considers the Sponsorship Program Disclosure because it is referenced in and attached to the Amended Complaint, and it forms the basis of the dispute. (Id. ¶¶ 24, 110.)
C. Rule 9(b)
Defendants argue that Smith's allegations of Questar's omissions or misrepresentations do not meet the heightened pleading standard of Rule 9(b). (Defs.' Mem. of Law in Supp. of Their Mot. to Dismiss the First Am. Class Action Compl. at 23-25 [Doc. No. 50].) Smith responds that he has complied fully with Rule 9(b) because the Amended Complaint pleads "numerous additional factual allegations... that enumerate the time, place, and ...