Opinion
Case No. 85-4297.
November 20, 1989
MEMORANDUM AND ORDER
This is a statutory and common law fraud action. This case is now before the court upon several long-pending motions to dismiss. Before considering the motions directly, it is important to review the history of the allegations in this matter.
This case was first filed on behalf of seven plaintiffs against fifteen defendants. The first complaint made the following substantive allegations:
15. During April and May, 1985, in the District of Kansas, defendants promised and represented to plaintiffs that there was an extremely high market demand for "cultures" to be grown in cottage industry operations from "activator kits" by a very limited number of select "growers" who would certainly reap large profits therefrom; that if plaintiffs would invest money with defendants for said "kits" and "grow" said "cultures" defendants would contract with plaintiffs to provide an exclusive market to buy all the "cultures" plaintiffs could grow, thereby assuring plaintiffs of huge profits on said investments. Such was the essence of defendants representations to plaintiffs. Said representations were false, and known by defendants to be false when made, and were made as statements of existing and material fact to deceive plaintiffs and induce plaintiffs to believe and act thereon by investing money in said investment contracts with defendants and receiving certificates of interest or participation in profit-sharing agreements with defendants. Plaintiffs did reasonably believe and rely upon said representations . . .
Appended to the complaint is a preliminary injunction order issued from an Arizona state court and an investigative complaint presented to the Kansas Securities Commission.
Later, the complaint was amended three times to add thirty more plaintiffs, five more defendants, and the following substantive allegations:
15a. Beginning in 1984, the exact date of which is unknown, and continuing up to and including this date, in the District of Kansas, and elsewhere, defendants, and others, did unlawfully, willfully and knowingly combine, conspire, confederate and agree together and with each other to commit offenses against the United States, that is to use, or cause to be used, the United States mail in furtherance and execution of a scheme and artifice to defraud various persons throughout the United States, including these plaintiffs, who were desirous of investing in and realizing profits from money-making ventures, and to obtain from plaintiffs sums of money by means of false representations, omissions of material facts and fraudulent promises, well knowing that said representations and promises were false when made, and well knowing that omissions of material facts were being made. Specifically, and in furtherance of said conspiracy (and the conspiracy more particularly described in the original Complaint herein, now incorporated by this reference, including specifically as to these additional defendants), the following acts were done: (a) On or about June of 1984 defendant Gert Theron brought the culture process at issue herein into the United States, and began developing an international market for the culture process; (b) on or about July of 1984 defendant Bass caused certain letters to be prepared to legitimize the culture growing process in the Republic of South Africa as it existed there for the purpose of obtaining money for the scheme development in the United States, and on or about October, 1984, caused an affidavit to be filed in the Supreme Court of South Africa; (c) on or about July of 1984 defendant Wagner caused certain letters to be composed to legitimize the culture growing process in the Republic of South Africa as it existed there to obtain money for the scheme development in the United States, on or about September, 1984, traveled from the United States to the Republic of South Africa to file an affidavit in the Supreme Court of South Africa and meet with representatives of the government of the Republic of South Africa concerning the release of money and to legitimize the scheme, and, on or about May, 1985, prepared a letter on the letterhead of Advanced Culture Systems; (d) on or about August, 1984, defendant Frans Theron, caused the formation of defendants Kubus Nursery (USA), Inc. and Cleopatra's Secret, Inc., in the State of Nevada, on or about November, 1984, caused the formation of defendants Activator Supply Company, Inc., in Nevada and Culture Farms, Inc., in the State of Kansas, and of Diversified Labs, Inc., in the State of Kansas, and traveled to Lawrence, Kansas, to meet with a representative of the Lawrence Chamber of Commerce, and throughout the scheme promoted and guided the scheme through the guise of being a consultant and representative; (e) on or about November, 1984, defendant Stemm caused the formation of defendants Activator Supply Company, Inc., in Nevada, and Culture Farms, Inc., in Kansas, and of Diversified Labs, Inc., in Kansas, assisted in the preparation of promotional material of Activator Supply Company, Inc., and on or about March, 1985, testified on behalf of defendant Activator Supply Company, Inc., in its efforts to obtain a city business license from the City of Las Vegas, Nevada; (f) on or about August, 1984, defendant Gunn acted in the guise of president of defendant Cleopatra's Secret, Inc., and on or about November, 1984, met with Robert Saute, a cosmetics manufacturer, and negotiated with him a method to extract the lactic culture; (g) on or about October, 1984, defendant Huff arranged for the packaging of Activators with Unit Dose Packaging, Inc., in Phoenix, Arizona, on or about November, 1984, assisted in the preparation of promotional material of Activator Supply Company, Inc., on or about December, 1984, directed the creation of purported agreements between Rontel Tele-Marketing Corporation and Cleopatra's Secret, Inc.; Culture Farms, Inc., and Cleopatra's Secret, Inc.; Activator Supply Company, Inc. and Culture Farms, Inc.; and between Culture Farms, Inc., and Ariate N.V., on or about January, 1985, came to Overland Park, Kansas, to promote the growing of cultures, and, throughout the scheme, promoted, directed, and guided the scheme through the guise of being a consultant and representative; (h) on or about February, 1985, defendant Rakow falsely represented at a promotional sales meeting in Las Vegas, Nevada, that the demand for cultures was unlimited; (i) on or about November, 1984, defendant Mancuso assisted in the arrangement for the packaging of Activators with Unit Dose Packaging, Inc., in Phoenix, Arizona, on or about January, 1985, assisted in the arrangements for the packaging of Activators at Kansas City, Missouri, by Jianas Brothers Packaging Company, and, throughout the scheme, directed, promoted and managed the operations of Culture Farms, Inc., Lawrence, Kansas, as an officer, representative and as a consultant for Commonwealth Business Systems; (j) throughout the scheme, defendant Taylor acted in the guise of President of Culture Farms, Inc., of Lawrence, Kansas, from on or about November, 1984, controlled payments to culture growers for cultures, and, on or about May, 1985, promoted in Overland Park, Kansas, the growing of cultures; (k) from on or about December, 1984, defendant Nocera acted in the guise of President of Activator Supply Company, Inc., of Nevada, and controlled bank accounts containing money received from Investors; (1) from on or about February, 1985, defendant West controlled bank accounts for the deposit of Investors' money, and caused money of investors, including plaintiffs, to be withdrawn from bank accounts and deposited in to the accounts of purported consultants and representatives; and, (m) most if not all of the natural person defendants, including these additional defendants, diverted and converted proceeds from the scheme at issue herein to his/her own benefit.
The amendments also expanded the time frame and geographic scope of the alleged fraudulent actions.
Motions to dismiss have been filed on behalf of five defendants in this case: Sam J. Walters, Jerry W. Ballah, Frans J.S. Theron, C. Allen West, and Frank J. Nall, Jr. A common thread to the motions is an argument that plaintiffs have failed to plead fraud with sufficient specificity. This argument is founded on FED.R.CIV.P. 9(b) which provides:
In 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 more precise question in this case is how specifically must a plaintiff delineate the role of a defendant in allegedly fraudulent acts when several individual defendants and corporate defendants, all allegedly acting as agents for one another, are being sued. Many cases have addressed this matter.
The Tenth Circuit adopted the following statement of Rule 9(b) requirements in Seattle-First National Bank v. Carlstedt, 800 F.2d 1008, 1011 (10th Cir. 1986):
Rule 9(b) does not . . . require the pleading of detailed evidentiary matter, nor does it require any particularity in connection with an averment of intent, knowledge, or condition of mind. It only requires identification of the circumstances constituting fraud or mistake. That requirement means . . . that individual plaintiffs should identify particular defendants with whom they dealt directly, and from whom they purchased stock; that individual plaintiffs should designate the occasions on which affirmative statements were allegedly made to them — and by whom; and that individual plaintiffs should designate what affirmative misstatements or half-truths were directed to them — and how.
(Quoting Trussell v. United Underwriters, Ltd., 228 F. Supp. 757, 774-75 (D.Colo. 1964)) (emphasis supplied).
Various Kansas cases have enforced these standards when a complaint or counterclaim failed to specifically identify who made an allegedly fraudulent statement or committed an allegedly fraudulent act. See NAL II, Ltd. v. Tonkin, 705 F. Supp. 522, 525-26 (D.Kan. 1989); Wichita Federal Savings Loan Ass'n v. Landmark Group, 657 F. Supp. 1182, 1187 (D.Kan. 1987); NL Industries, Inc. v. Gulf Western Industries, 650 F. Supp. 1115, 1129-30 (D.Kan. 1986).
Many other cases have held that Rule 9 must be read to prevent plaintiffs from lumping defendants together in making accusations of fraud. E.g., Saporito v. Combustion Engineering, Inc., 843 F.2d 666, 675 (3d Cir. 1988); Design Time v. Synthetic Diamond Technology, 674 F. Supp. 1564, 1569-71 (N.D.Ind. 1987); Bower v. Weisman, 639 F. Supp. 532, 539 (S.D.N.Y. 1986); UNR Industries, Inc. v. Continental Ins. Co., 623 F. Supp. 1319, 1328 (N.D.Ill. 1985); Beck v. Cantor, Fitzgerald Co., Inc., 621 F. Supp. 1547, 1551 (N.D.Ill. 1985); McKee v. Pope Ballard Shepard Fowle, Ltd., 604 F. Supp. 927, 931 (N.D.Ill. 1985); Arndt v. Prudential Bache Securities, Inc., 603 F. Supp. 674 (S.D.Cal. 1984); Bosio v. Norbay Securities, Inc., 599 F. Supp. 1563, 1570 (E.D.N.Y. 1985); Bruns v. Ledbetter, 583 F. Supp. 1050, 1052 (S.D.Cal. 1984); D. G. Enterprises v. Continental Illinois National Bank, 574 F. Supp. 263 (N.D.Ill. 1983); Stewart v. Fry, 575 F. Supp. 753, 756 (E.D.Mo. 1983); Hokama v. E.F. Hutton Co., Inc., 566 F. Supp. 636, 645 (C.D.Cal. 1983); Natowitz v. Mehlman, 542 F. Supp. 674, 676 (S.D.N.Y. 1982); Benoay v. Decker, 517 F. Supp. 490, 493 (E.D.Mich. 1981) aff'd, 735 F.2d 1363 (6th Cir. 1984); National Egg Co. v. Bank Leumi le-Israel B.M., 504 F. Supp. 305, 308 (N.D.Ga. 1980); Kennedy v. Nicastro, 503 F. Supp. 1116, 1122 (N.D.Ill. 1980); In re Haven Industries, Inc., 462 F. Supp. 172, 182 (S.D.N.Y. 1978);Jacobson v. Peat, Marwick, Mitchell Co., 445 F. Supp. 518, 522 n. 7 (S.D.N.Y. 1977).
An "exception" to this rule has been developed when a group of defendants is responsible for a document or statement containing fraudulent misrepresentations. Luce v. Edelstein, 802 F.2d 49, 55 (2d Cir. 1986); Quantum Overseas, N.V. v. Touche Ross Co., 663 F. Supp. 658, 667-68 (S.D.N.Y. 1987); Black v. First Blood Associates, 663 F. Supp. 50, 52 (S.D.N.Y. 1987); Management Assistance, Inc. v. Edelman, 584 F. Supp. 1016, 1018 (S.D.N.Y. 1984); Somerville v. Major Exploration, Inc., 576 F. Supp. 902 (S.D.N.Y. 1983); Pellman v. Cinerama, Inc., 503 F. Supp. 107, 111 (S.D.N.Y. 1980). Another mitigating circumstance to the strict application of Rule 9 has been if defendants are in the exclusive possession of information or if defendants are considered liable as members of a control group. Black v. First Blood Associates, supra; Kravetz v. Brukenfeld, 591 F. Supp. 1383 (S.D.N.Y. 1984); Somerville v. Major Exploration, Inc., supra; Pridgen v. Farmer, 567 F. Supp. 1457 (E.D.N.C. 1983);Keyes v. Wolfe, 540 F. Supp. 1054, 1065-66 (N.D.Tex. 1982);rev'd in part on other grds, 709 F.2d 413 (5th Cir. 1983).
Reviewing the motions to dismiss of the five defendants in light of our study of the above-cited cases, the court has reached the following conclusions. Plaintiffs have not met the particularity standard of Rule 9 with regard to defendant Walters, who is not specifically mentioned in the complaint or the appended materials to the complaint. In other words, Walters is simply lumped together with the other fourteen defendants in plaintiffs' broadly-worded charges of fraud. When or how he participated in false misrepresentations and who was deceived by his actions is not delineated in the complaint.
Plaintiffs have not met the particularity requirement of Rule 9 with regard to defendant Ballah. Defendant Ballah is not specifically mentioned in the complaint. He is mentioned in the findings filed before the Kansas Securities Commission. There it is stated that Ballah is alleged by the Kansas Securities Commissioner to be: a major stockholder and director of Culture Farms, Inc., an agent for Activator Supply Company and a partner in Diversified Labs, ICS. The findings further state: that Ballah assisted other defendants with local arrangements in Lawrence, Kansas; that he did not inform officials of his connections with the other defendants; that at some point he had authority to sign checks for Activator Supply Company; that he attended a meeting with another defendant and representatives of the Kansas Attorney General; and that he stated he was receiving commissions to recruit culture growers for the Culture Farms program. The court does not believe these allegations state with sufficient particularity how defendant Ballah was involved in making misrepresentations which plaintiffs relied upon to their detriment.
Plaintiffs have not met the particularity requirement of Rule 9 in alleging fraud by defendant Frans Theron. The only allegation against this defendant is that:
on or about August, 1984, defendant Frans Theron, caused the formation of defendants Kubus Nursery (USA), Inc. and Cleopatra's Secret, Inc., in the State of Nevada, on or about November, 1984, caused the formation of defendants Activator Supply Company, Inc., in Nevada and Culture Farms, Inc., in the State of Kansas, and of Diversified Labs, Inc., in the State of Kansas, and traveled to Lawrence, Kansas, to meet with a representative of the Lawrence Chamber of Commerce, and throughout the scheme promoted and guided the scheme through the guise of being a consultant and representative.
This statement does not link defendant to specific misrepresentations which deceived plaintiffs. The allegations suggest that defendant was a member of a control group in charge of a fraudulent scheme. But, this is not made clear either. The complaint should state with particularity that the defendant made specific misrepresentations or was in charge of a corporation which in identified documents made misrepresentations that plaintiffs relied upon to their detriment.
Plaintiffs have also failed to state with the requisite particularity a claim of fraud against defendant C. Allen West. The only allegation against defendant West is:
from on or about February, 1985, defendant West controlled bank accounts for deposit of Investors' money, and, caused money of investors, including plaintiffs, to be withdrawn from bank accounts and deposited in to the accounts of purposed consultants and representatives . . .
Defendant West is not charged with making, directing or authorizing a specific misrepresentation. Nor is he specifically alleged to be in control of a fraudulent enterprise, although this may be suggested by the claim that he controlled bank accounts for the deposit of the investors' money.
Before considering the application of Rule 9 to the allegations plaintiffs make against defendant Nall, the court must first examine plaintiffs' argument, under FED.R.CIV.P. 12(b), that defendant Nall has waived any Rule 9 objection by filing an answer before filing his motion to dismiss. Defendant Nall's answer directly raises his Rule 9 objection. The answer was filed three months before defendant filed the motion to dismiss.
FED.R.CIV.P. 12(b) states: "A motion making any of these defenses shall be made before pleading if a further pleading is permitted." Nevertheless, it is clear from FED.R.CIV.P. 12(h) that a motion arguing a defense of failure to state a claim or failure to join an indispensable party (both defenses under Rule 12(b)), may be made after an answer is filed without fear of waiver. It is not clear from Rule 9 or Rule 12(h), when a Rule 9 objection must be made to prevent waiver. In general, the goal of Rule 12 is to insure that certain defenses are asserted at the earliest possible date. See Rauch v. Day Night Manufacturing Corp., 576 F.2d 697 (6th Cir. 1978); Index Fund, Inc. v. Hagopian, 107 F.R.D. 95 (S.D.N.Y. 1985).
We believe it is consistent with that goal and the language of Rule 12 to hold that defendant Nall did not waive his Rule 9 objection. We must emphasize that defendant Nall clearly raised his Rule 9 objection in his answer and did not wait a long time, in the context of this case, to file a motion to dismiss based upon that objection. Had defendant Nall waited to raise his objection in a summary judgment motion or asked that the fraud allegations be stricken under Rule 12(f), the court's ruling would be different. See United National Records, Inc. v. MCA, Inc., 609 F. Supp. 33, 38-39 (N.D.Ill. 1984). But, under the circumstances in this case, the court does not believe defendant Nall should be held to have waived his Rule 9 objection.
The only allegations specifically mentioning defendant Nall are contained in the findings filed before the Kansas Securities Commission. These allegations do not link defendant Nall to misrepresentations. Nor do they seem to connect defendant Nall to the control group of the alleged scheme to defraud plaintiffs. We find that defendant Nall's Rule 9 objection is valid.
The common course when Rule 9 flaws are found in a complaint is to permit leave to amend the complaint. Luce v. Edelstein, supra, 802 F.2d at 56. We shall follow that course in this case. Plaintiffs are granted thirty days to amend the complaint to satisfy the Rule 9 particularity standard with regard to the above-mentioned defendants.
Defendants Nall and West have also argued that plaintiffs' RICO claims and plaintiffs' claims under Section 12(2) of the 1933 Securities Act should be dismissed. Since plaintiffs shall be required to file an amended complaint to specify their allegations against these defendants, the court shall not rule upon these arguments. If defendants wish to raise the arguments again after the filing of the amended complaint, the court shall permit them to do so. Before doing so, however, counsel should consider the newer cases in these areas. E.g., H.J. Inc. v. Northwestern Bell Telephone Co., ___ U.S. ___, 109 S.Ct. 2893, 106 L.Ed.2d 195 (1989) (RICO) and Capri v. Murphy, 856 F.2d 473 (2d Cir. 1988) (Section 12(2)).
In conclusion, plaintiffs are granted 30 days to amend the complaint to state with greater particularity their claims of fraud against defendants Walters, Ballah, Theron, West and Nall. If the complaint is not amended within this time, these defendants shall be dismissed. Following amendment to the complaint, defendants West and Nall may reassert their motion to dismiss regarding plaintiffs' RICO and Securities Act claims.