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Jensen v. Thompson

United States District Court, D. South Dakota, Southern Division

March 22, 2018

WADE K. JENSEN, as trustee of the DeAnna W. Jensen Living Trust dated January 26, 2012, and any amendments thereto; DAN KENSINGER; RAYMOND SHERMAN, trustee of the Raymond Sherman Trust, and any amendments thereto; STEVEN STOKESBARY; STEVE MEYER; GRANT SHUMAKER; THOMAS KENNY; TOM JACOB SON; ELISABETH NOEL, as trustee of the Elisabeth J. Noel Trust, and any amendments thereto; SARAH POWELL; RYAN MEIS; and MATTHEW JOHNSON, Plaintiffs,
v.
WAYNE THOMPSON; MICHAEL HURLBURT; DANIEL RISSING; DANIEL NEWELL, Defendants.

          MEMORANDUM OPINION AND ORDER ON DEFENDANTS' MOTIONS TO DISMISS, DOC. 26 & 28

          LAWRENCE L. PIERSOL ATTEST UNITED STATES DISTRICT JUDGE.

         Pending before the Court is Defendants Wayne Thompson, Michael Hurlburt, and Daniel Rissing's (Management Defendants) Motion to Dismiss, Doc. 26, pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure. In their motion, Management Defendants ask that the federal security claims be dismissed for several reasons, including: 1) the claims are barred by the statute of limitations; 2) the complaint fails to meet the heightened pleading standards required under the Private Securities Litigation Reform Act (PSLRA) and Rule 9(b) of the Federal Rules of Civil Procedure; and 3) the complaint fails to raise a strong inference of scienter, show materiality of the alleged misrepresentations or omissions, or adequately allege reliance or loss causation. Additionally, Management Defendants ask that the state law claims be dismissed as they 1) necessarily rely on supplemental jurisdiction, which would be lacking should the motion to dismiss the federal securities claims be granted, and 2) are also inadequately pled as they do not meet the standards of Rule 9(b). Management Defendants also assert that South Dakota law does recognize claims for "Fraud in Relation to a Contract" and that they did not contract with the Plaintiffs, a necessary requirement of the cause of action for Fraud in Relation to Contract under S.D. Code § 53-4-5. Finally, Management Defendants argue that the claim for Breach of State-Law Fiduciary Duty is a derivative action and the necessary procedural prerequisites for bringing a derivative action in federal court have not been met. For the following reasons, Management Defendants' motion is granted in part and denied in part.

         Also pending before the Court is Defendant Daniel Newell's Motion to Dismiss, Doc. 28. With the exception of Count I, Plaintiffs complaint alleges all of the same causes of action against Defendant Newell. Similarly, for the reasons below, Defendant Newell's motion is granted in part and denied in part.

         BACKGROUND

         Accepting Plaintiffs' allegations as true and giving Plaintiffs the benefit of all reasonable inferences, the Court lays out the following facts in accordance with the pleadings. See Frey v. City of Herculaneum, 44 F.3d 667, 671 (8th Cir. 1995) (providing the standard for granting a motion to dismiss under Rule 12(b)(6)). Plaintiffs-eleven physicians and one widow of a deceased physician-allege they were defrauded by Defendants, who are managers and/or directors of non-party Progressive Acute Care, LLC (PAC), when Defendants solicited the Physicians' investment in PAC by misrepresenting or omitting material information regarding historical and projected financial performance of the investment. PAC was founded in 2008 under the laws of the state of South Carolina and engages in the for-profit acquisition and management of rural hospitals. PAC is managed by three individuals, the Management Defendants-Thompson as Chief Financial Officer, Hurlburt as Chief Operating Officer, and Rissing as Chief Executive Officer. Each of the Management Defendants also sits on PAC's Board of Directors along with Defendant Newell. Newell is a licensed CPA and was a member of PAC's Audit Committee at all times during the relevant period.

         In 2009, PAC acquired and began operating three rural hospitals in central Louisiana, thanks in part to the investments of Plaintiffs and others. Sometime around late 2012 to early 2013, Management Defendants suggested that PAC purchase a fourth hospital-Dauterive Hospital (Dauterive). Defendants solicited additional capital from the Plaintiffs for this investment through a private placement memorandum (PPM) and in-person meetings. An in-person meeting took place in Dakota Dunes, South Dakota in February of 2013, where Management Defendants "walked [Plaintiffs] through key parts of the PPM. Defendant Newell was evidently not present at this meeting. In April 2013, Plaintiffs were presented with the PPM itself, which also contains a Due Diligence Report, dated February 8, 2013, which purportedly discussed the historical performance of Dauterive. The PPM contained a table which purports to "[set] forth the summary historical financial information" of Dauterive for the fiscal years ended December 31, 2011 and 2012. Doc. 32-1 at 75. The PPM states that the information "was derived from Dauterive Hospital's internal unaudited financial statements which were prepared by the seller and are not reflective or in accordance with generally accepted accounting principles (GAAP)". Id. "Therefore, " the PPM advised, "this unaudited historical financial information may differ materially and completely from GAAP and may be substantially incomplete for your purposes in evaluating Dauterive Hospital's financial results." Id. According to the provided information, Dauterive's net income with interest, taxes, depreciation, and amortization (EBITDA) was $3.72 million in 2011 and $2, 434 million in 2012. Id.

         The next section of the PPM is entitled "Projected Pro Forma Financial Information" and contains a summary of a four year projection for fiscal years 2013-2016. Id. at 76. The projections were prepared "based solely upon our analysis and on the assumptions...listed related to revenues, expenses, and other factors." Id. The PPM states that its authors had not "verified or confirmed the reasonableness of the assumptions contained in the projections" and lists a total of eleven assumptions the financial projects are based on. Id. The projected EBITDA for 2013 was $4, 131 million, $9, 169 million in 2014, $9, 625 million in 2015, and $8, 122 million in 2016. Id. at 77. Finally, the PPM contains a lengthy description of risk factors associated with the acquisition, including risks that accompany running a business in the healthcare industry, government regulations and taxes that may impact the business, problems with deriving financial projections from unaudited information prepared by the seller, and the fact that PAC's accounting department had yet to operate in a company as large as PAC would become after the potential Dauterive acquisition. Id. at 84-119.

         Plaintiffs state in their complaint that Plaintiffs agreed to invest the $3 million in equity required for PAC to complete the Dauterive acquisition following the February 2013 in-person meeting in Dakota Dunes. The final version of the PPM was dated April 8, 2013 and stated that the signed participation agreement and check had to be returned by April 22, 2013. The signed participation agreements that were dated all had dates after April 8, 2013. In return for their investment, they received a number of Series B Preferred Units in proportion to their existing equity ownership of PAC. It is uncontested that these Series B Preferred Units and their exchange fall under the Securities Exchange Act of 1934. Plaintiffs also approved the Management Defendants obtaining financing for the remainder of the $15 million purchase price with bank debt. Plaintiffs were also promised that each of the Management Defendants would enter into a $1 million personal guarantee for the bank loan. Plaintiffs maintain these guarantees were illusory.

         PAC formally agreed to purchase Dauterive in May 2013. Following the Dauterive acquisition, the PAC Board of Directors increased the Management Defendants' compensation to $400, 000 annually, along with short-term incentive compensation of up to 100% of the base salary. Management Defendants were also entitled to 25% of the cash distributions if the 3-year average EBITDA fell between $0-$3.39 million and could obtain as much as 40% of cash distributions with an EBITDA of $19.1 million or more.

         Plaintiffs "received little information regarding PAC's financial health outside of an annual investors update and/or PowerPoint presentation from the Management Defendants" but by early 2014, PAC began defaulting on its bank loans. Dauterive's cash flow from operations sunk to -$4.7 million in 2014 and -$6.1 million in 2015, a far cry from the projected EBITDA of $6 million as provided by the PPM. Though PAC's other three hospitals continued to remain profitable, Plaintiffs received information in the spring of 2016 that PAC would potentially need to file for bankruptcy.

         On May 18, 2016, some of the Plaintiffs met with "some or all of the Management Defendants" and PAC's legal counsel in Dakota Dunes. Multiple Plaintiffs were unable to attend the meeting other than by proxy, which was entrusted to Management Defendant Hurlburt. Hurlburt informed the Plaintiffs "that the 'perfect storm' of factors had hit PAC and left the company insolvent." Management Defendants briefly summarized PAC's financial state, advised the Plaintiffs that were present that PAC was defaulting on payments due, and informed them that a group of emergency-room physicians had obtained a $1.2 million judgment against PAC, making time of the essence because PAC could not currently pay that judgment.

         Management Defendants called for a vote, with Defendant Hurlburt casting the proxy votes for each absent member. Feeling under pressure and ill-prepared to discuss the company's financial situation due to a lack of prior information, Plaintiffs authorized the filing of the bankruptcy. It was through the Bankruptcy process that Plaintiffs came to discover documents which they assert would have drastically altered their decision to invest in Dauterive: 1) a PAC Board internal memorandum dated January 9, 2013 in which the seller's projection of 2013 EBITDA for Dauterive was a $50, 000 loss; and 2) an audit report from the accounting firm Crowe Horwath LLP which the Defendants received in April just days before releasing the finalized PPM to Plaintiffs which was harshly critical of PAC's internal financial controls. Further, Plaintiffs allege that Defendants were told by a PAC employee in December 2012 that they would not be able to obtain their projected savings related to benefits at Dauterive, which were presumably part of the assumptions made in PAC's calculations of projected future EBITDAs. In light of this information, Plaintiffs allege Defendants' projections were materially misleading because they failed to disclose material facts. Plaintiffs allege that they relied on these material misrepresentations in deciding to invest in PAC, which ultimately resulted in a total loss of their investment.

         Plaintiffs now seek damages for violations of securities laws, fraudulent and negligent misrepresentations and omissions, and breaches of fiduciary duty. Specifically, Plaintiffs allege that Defendants Wayne Thompson, Michael Hurlburt, and Daniel Rissing (Management Defendants) violated § 10(b) of the Securities Exchange Act (SEA) and Rule 10b-5. Further, Plaintiffs allege that all Defendants, Defendant Daniel Newell and the Management Defendants: 1) violated § 20(a) of the SEA; 2) engaged in deceit in contravention to S.D. Code § 20-10-1; 3) committed actual fraud in relation to contract in violation of S.D. Code § 53-4-5; 4) committed constructive fraud in relation to contract under S.D. Code § 53-4-6; 5) engaged in common law fraud; 6) made negligent misrepresentations; and 7) breached their state law fiduciary duties.

         DISCUSSION

         I. Rule 12(b)

         As a preliminary matter, the Court must address the Plaintiffs' assertion that the Court must not consider the documents attached to Defendants' briefs in support of their respective motions to dismiss. Management Defendants attached numerous documents to their Memorandum in Support of Their Motion to Dismiss including: 1) the Private Placement Memorandum (PPM) dated April 8, 2013 which itself contains multiple appendices, such as the "Dauterive Due Diligence Report" (DDR) dated February 8, 2013; 2) a table purporting to point out cautionary language provided to Plaintiffs in the PPM and the DDR; 3) a 2013 Monthly Budget Report updated January 9, 2013; 4) an April 5, 2013 letter from Crowe Horwath LLP reporting the results of an audit of financial statements of PAC; 5) a PAC "Annual Investor Update" for fiscal year 2013 dated January 20, 2014; 6) a PAC Investor UpDated: 2013 Final Audit, dated July 2014; and 7) Subscription Agreements signed by the Plaintiffs to purchase Series B preferred Units of PAC to fund the Dauterive acquisition. Defendant Newell attached also attached a copies of the PPM, 2013 Budget Report, Crowe Horwath Letter, and July 2014 Investor Update.

         In response, Plaintiffs submitted by declaration portions of the "PAC Offering Packet" which includes "Consent Minutes Approving Transaction and Second Amended and Related Operating Agreement, " an "Exercise Notice and Subscription Agreement, " and what appears to be a more complete version of the PPM and its appendices. Stating that they would not "admit the authenticity of the edited documents Defendants attached to their briefs, Plaintiffs argue that considering the documents presented by Management Defendants would be inappropriate because they improperly contradict the complaint, are facially incomplete, and have not been tested in discovery. Management Defendants assert that the Court can "incorporate and consider the documents referenced by Plaintiffs in their Complaint" and that "[b]y the Plaintiffs' own pleading they 'opened the door' to consideration of the Investor Updates." Management Defendants also argue that because they are not relying on the Investor Updates for the truth of their contents, they are not using the documents to contradict statements made in the complaint, but to provide evidence that the Plaintiffs received information that would have caused the statute of limitations to run. Further, and in light of Plaintiffs' challenge to the authenticity of the documents, Management Defendants attached the full and complete versions of the Investor Updates to their reply memorandum.

         "If, on a motion asserting the defense numbered (6)... matters outside the pleading are presented to and not excluded by the court, the motion shall be treated as one for summary judgment... and all parties shall be given reasonable opportunity to present all material made pertinent to such a motion by Rule 56." FED. R. Civ. P. 12(b). However, the Court is "not strictly limited to the four corners of the complaint" in adjudicating a Rule 12(b) motion. Dittmer Prop., L.P. v. Fed. Deposit Ins. Corp., 708 F.3d 1011, 1021 (8th Cir. 2013). In addressing a motion to dismiss, "[t]he court may consider the pleadings themselves, materials embraced by the pleadings, exhibits attached to the pleadings, and matters of public record" without converting the motion into a motion for summary judgment. Porous Media Corp. v. Pall Corp., 186 F.3d 1077, 1079 (8th Cir. 1999); see also Mills v. City of Grand Forks, 614 F.3d 495, 498 (8th Cir. 2010), Illig v. Union Elec. Co., 652 F.3d 971, 976 (8th Cir. 2011). As the documents attached to Management Defendants' memorandum are not matters of public record, the court must determine if the materials are embraced by the pleadings themselves. Matters embraced by the pleadings include "matters incorporated by reference or integral to the claim" as well as "exhibits attached to the complaint whose authenticity is unquestioned." Miller v. Redwood Toxicology Lab, Inc., 688 F.3d 928, 931 n. 3 (8th Cir. 2011) (quoting 5B Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure § 1357 (3d ed. 2004). "Most courts ... view 'matters, outside the pleadings' as including any written or oral evidence in support of or in opposition to the pleading that provides some substantiation for and does not merely reiterate what is said in the pleadings." Gibb v. Scott, 958 F.2d 814, 816 (8th Cir. 1992) (quoting Wright & Miller, Federal Practice and Procedure § 1366). Therefore, for Management Defendants' documents to be considered on this motion to dismiss without converting the matter into a motion for summary judgment, the documents must be incorporated by reference or integral to the claim, cannot be offered either in support of or opposition to what is said in the pleadings, and their authenticity must remain unquestioned.

         Case law provides for a few specific examples of documents considered on a motion to dismiss that meet these requirements. For example, a contract upon which a claim rests is a document necessarily embraced by the pleadings. See Gorog v. Best Buy Co., 760 F.3d 787 (8th Cir. 2014). However, that contract must be specifically alleged, undisputed, and the sole basis of the complaint. See BJC Health Sys. v. Columbia Cas. Co., 348 F.3d 685 (8th Cir. 2003). SEC filings have also been considered documents necessarily embraced by the pleadings when those filings are required by law and are not offered for the truth of the document's contents. Compare Florida State Bd. of Admin, v. Green Tree, 270 F.3d 645, 661 (8th Cir. 2001) with Kushner v. Beverly Enters., Inc., 317 F.3d 820 (8th Cir. 2003).

         The crux of Plaintiffs' complaint is that Management Defendants fraudulently solicited capital from the Plaintiffs to invest in a hospital. The complaint alleges that this was done "through a private placement memorandum (the 'PPM') and in-person meetings." Doc.l, para. 4. Because Plaintiffs have submitted a complete copy of the PPM within the exhibit attached to the declaration in opposition to Defendants' motion to dismiss, the authenticity of which Management Defendants did not dispute in their reply, the Court may consider this document as its contents are alleged in the complaint. However, the Court notes that Plaintiffs' complaint alleges it was both the PPM and information presented in in-person meetings that led the Plaintiffs to invest in the hospital. The Court will also consider the Subscription Agreements attached as Exhibit G to Management Defendants memorandum, as they are the agreements Plaintiffs allege they were fraudulently induced to enter into. See Gorog, 760 F.3d 787 (a contract upon which a claim rests is a document necessarily embraced by the pleadings).

         Plaintiffs also allege that, following the acquisition of that hospital, Plaintiffs "received little information regarding PAC's financial health outside of an annual investors update and/or PowerPoint presentation from the Management Defendants." Id. at para. 62. Management Defendants argue that by pleading this, Plaintiffs "opened the door" to consideration of the Investor Updates. Management Defendants also assert that consideration of the Investor Updates is proper because they are not submitted for their truth, but instead "to evidence that the Plaintiffs received information relating to the financial health of PAC in January and July 2014, and coupled with PAC's earlier bank loan default and the 'whopping projections' made in the PPM, would have caused a reasonable investor to conduct an investigation that would have discovered the alleged violation."

         The Court may consider "documents whose contents are alleged in a complaint and whose authenticity no party questions." Kushner, 317 F.3d at 831-32. Contrary to Management Defendants' assertions, Plaintiffs do not "open the door" to the consideration of documents on a motion to dismiss by merely pleading the existence of outside information. Plaintiffs' complaint does not state what specific documents were received by Plaintiffs following their investment, other than that there was an annual investor update. Indeed, Management Defendants have attached numerous investor updates to their memorandum, not just one. See BJC Health Sys., 348 F.3d 685 (requiring a document be specifically alleged, undisputed, and the sole basis of the complaint in order to be considered on a motion to dismiss). Further, Management Defendants stated reasoning for attaching the documents is exactly what is impermissible at the motion to dismiss stage-to contradict the assertion on the face of the complaint that the action is not barred by the statute of limitations. See Porous Media Corp., 186 F.3d at 1079 ("the court...may consider some materials that are part of the public record or do not contradict the complaint"); see also Illig v. Union v. Elec. Co., 652 F.3d 971, 976 (8th Cir. 2011) ("A court may dismiss a claim under Rule 12(b)(6) as barred by the statute of limitations if the complaint itself establishes that the claim is time-barred."). As laid out below, regardless of whether or not the Court considered the documents, which it does not, the question of when the statute of limitations began to run is a factual question that cannot be resolved on this motion to dismiss.[1]

         II. Statute of Limitations

         Plaintiffs have brought an action for fraud under § 10(b) of the Securities Exchange Act of 1934 (SEA). A complaint alleging private securities fraud is timely if filed "not later than the earlier of-

"(1) 2 years after the discovery of the facts constituting the violation"; or
"(2) 5 years after such violation." 28 U.S.C. § 1658(b).

         The complaint in this case was filed on February 10, 2017, and no one has called into doubt that it was filed within five years of the alleged violation. Therefore, the critical date for timeliness purposes is February 10, 2015-two years before this complaint was filed. In construing this limitations statute for the first time, the Supreme Court in Merck & Co., Inc. v. Reynolds, 559 U.S. 633 (2010) held that "a cause of action accrues (1) when the plaintiff did in fact discover, or (2) when a reasonably diligent plaintiff would have discovered, 'the facts constituting the violation'-whichever comes first." Merck, 559 U.S. at 637. "[T]he 'facts constituting the violation' include the fact of scienter, 'a mental state embracing intent to deceive, manipulate, or defraud." Id. (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, n. 12 (1976)). Applying this standard, the complaint is timely.

         Plaintiffs contend that the issue of whether they were on notice is a factual question that should not be resolved on a 12(b)(6) motion.[2] Indeed, the Court recognizes that

[b]ar by a statute of limitation is typically an affirmative defense, which the defendant must plead and prove. See John R. Sand & Gravel Co. v. United States, 552 U.S. 130 (2008); Fed.R.Civ.P. 8(c). A defendant does not render a complaint defective by pleading an affirmative defense, Gomez v. Toledo, 446 U.S. 635, 640 (1980), and therefore the possible existence of a statute of limitations defense is not ordinarily a ground for 12(b)(6) dismissal unless the complaint itself establishes the defense. See Varner v. Peterson Farmers, 371 F.3d 1011, 1017-18 (8th Cir. 2004) (dismissal proper because complaint ruled out tolling of statute of limitations).

Jessie v. Potter, 516 F.3d 709, 713 n.2 (8th Cir. 2008); see also Cohen v. Northwestern Growth Corp., 385 F.Supp.2d 935, 945 (D.S.D. 2005) ("the issue of whether a plaintiff was on [ ] notice is 'often inappropriate for resolution on a motion to dismiss under Rule 12(b)(6)'"). Nevertheless, a motion to dismiss may be granted "in the unusual case in which a plaintiff includes allegations that show on the face of the complaint that there is some insuperable bar to relief." Frey, 44 F.3d at 671 (quotation marks and citations omitted).

         Management Defendants claim Plaintiffs received sufficient information through their annual investor updates to put them on notice of the alleged securities violations by no later than July 2014. Relying on Ritchey v. Horner, 244 F.3d 635 (8th Cir. 2001) and Great Rivers Coop. v. Farmland Indus., Inc., 120 F.3d 893 (8th Cir. 1997), Management Defendants argue that the investor updates contained sufficient information "to trigger Plaintiffs' responsibility to inquire further.. .yet they failed to exercise reasonable diligence by not seeking more information." In response, Plaintiffs assert that the "inquiry notice" standard required in Ritchey and Great Rivers was rejected by the Supreme Court in Merck & Co. v. Reynolds, 559 U.S. 633 (2010) and by the Eighth Circuit in Zarecor v. Morgan Keegan & Co., 801 F.3d 882 (8th Cir. 2015); therefore, Plaintiffs argue, Management Defendants cannot show that Plaintiffs had actual notice of the alleged fraud before February 10, 2015.

         The complaint is timely if it was filed "not later than two years after the discovery of the facts constituting the violation." 28 U.S.C. § 1658(b). As explained in depth in Merck, the term "discovery" as used in the statute "encompasses not only those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known." Merck, 559 U.S. at 648. In Merck, the term "inquiry notice" was used "to refer to the point at which a plaintiff possesses a quantum of information sufficiently suggestive of wrongdoing that he should conduct a further inquiry." Id. at 650 (international citations omitted). The Court also noted that the Eighth Circuit used the term in a "roughly similar" way. Id. at 650-51 (citing Great Rivers, 120 F.3d at 896 ("Inquiry notice exists when the victim is aware of facts that would lead a reasonable person to investigation and consequently acquire actual knowledge of the defendant's misrepresentations." (emphasis added))). The Court, disagreed, saying:

If the term "inquiry notice" refers to the point where the facts would lead a reasonably diligent plaintiff to investigate further, that point is not necessarily the point at which the plaintiff would already have discovered facts showing scienter or other "facts constituting the violation." But the statute says that the plaintiffs claim accrues only after the "discovery" of those latter facts. Nothing in the text suggests that the limitations period can sometimes begin before "discovery can take place.... Because the statute contains no indication that the limitations period should occur at some earlier moment before "discovery, " when a plaintiff would have begun investigation, we cannot accept Merck's argument.

Id. at 651. Therefore, in concluding that the "discovery" of facts that put a plaintiff on "inquiry notice" was not sufficient to begin the running of the limitations period, the Court concluded:

[T]he limitations period in § 1658(b)(1) begins to run once the plaintiff did discover or a reasonably diligent plaintiff would have "discovered" the facts constituting the violation"-whichever comes first. In determining the time at which "discovery" of those "facts" occurred, terms such as "inquiry notice" and "storm warnings" may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating. But the limitations period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered "the facts constituting the violation, " including scienter-irrespective of whether the actual plaintiff undertook a reasonably diligent investigation.

Id. at 653.

         Since the Merck decision, the Eighth Circuit has twice discussed the issue of inquiry notice and the statute of limitations in securities fraud cases. See generally W.Va. Pipe Trades Health & Welfare Fund v. Medtronic, Inc., 845 F.3d 384, 389-91 (8th Cir. 2016) and Zarecor, 801 F.3d at 886-87; see also Barnes v. Oldner, 359 F.Supp.3d 926, 933-35 (E.D. Ark. 2017). Management Defendants suggest that post-Merck case law is consistent with pre-Merck case law. This is clearly not the case. Both Great Rivers and Ritchey concluded that the statute of limitations began when the duty to exercise due diligence was triggered, i.e., when the plaintiffs had inquiry notice. See Great Rivers, 120 F.3d at 896-99 (concluding that the statute of limitations began running shortly after information was printed in an article because the knowledge of that information would have triggered the duty to exercise due diligence which, in turn, would have resulted in actual notice); Ritchey, 244 F.3d at 638-41 (finding that the effect of the prior relationship with defendant on whether plaintiffs had sufficient facts beyond a level of mere suspicion to reach a point which the victims would be incited to investigate was a factual question that could not be resolved on summary judgment). Merck and the Eighth Circuit's post- Merck case law adamantly state that inquiry notice is not enough-the statute of limitations does not begin to run at the point at which the duty to exercise due diligence was triggered. Instead, the statute of limitations begins at the point at which, having exercised due diligence, a reasonable plaintiff would have discovered the facts constituting the cause of action. Specifically, and contrary to Management Defendants' analysis, the Zarecor court provided:

The limitations period does not begin to run when a plaintiff is put merely on "inquiry notice, " or when there are "storm warnings, " such that "the facts would have prompted a reasonably diligent plaintiff to begin investigation." Instead, the statute of limitations is triggered when the reasonably diligent plaintiff would have discovered "the facts constituting the violation" after an appropriate investigation."

         Indeed, the Eighth Circuit found the claims in Zarecor to be time-barred, but it did not do so by relying on the inquiry notice standard. The mutual funds at issue had begun to decline and a class action complaint had been filed by the end of 2007. While the court determined that a reasonably diligent plaintiff would have began investigating at this time, the court found it unnecessary to determine when exactly a reasonably diligent plaintiff would have then discovered "the facts constituting the violation" under the federal discovery rule because, by July of 2009, the Zarecors themselves had filed a statement of claim in arbitration alleging misrepresentation, suggesting they had indeed actually discovered the facts constituting the violation more than two years before their federal claim was filed in November of 2011.

         Thus, fraud is deemed to be "discovered" not only when the plaintiff actually knows those facts constituting fraud, but also when a reasonably diligent plaintiff would have known the facts constituting fraud. This, of course, requires the discovery of the facts constituting the violation, and one of those facts, in the case of fraud, is scienter-"a mental state embracing intent to deceive, manipulate, or defraud." Merck, 599 U.S. at 637, 648-49. Therefore, fraud is not "discovered" until facts-including those which would prove that a defendant made a material misstatement with an intent to deceive, not merely innocently or negligently-are actually known by the plaintiff or would have been known by a reasonably diligent plaintiff. Id. It is not enough for a plaintiff to know of an incorrect prediction about a firm's future earnings. See Id. at 650. Instead, there must be facts suggesting that a reasonably diligent plaintiff would have known someone had deliberately lied or withheld information in their representation about that firm's future earnings. See Id. This is particularly important in federal securities cases due to the heightened pleading standards required for the scienter element of § 10(b). See 15 U.S.C. § 78u-4(b)(2). To adequately plead scienter, plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." Id. A "strong inference" is "more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent." W.Va. Pipe Trades, 845 F.3d at 390 (quoting Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007)). In W.Va. Pipe Trades, the court found the appellants did not discover or with reasonable diligence would not have discovered facts constituting the deceptive act as well as an intent to deceive when articles published found that corporate-sponsored research studies had over-emphasized favorable reported results because the articles themselves attributed the problems with the studies to be due to the nature of corporate-sponsored research, not to fraud. It wasn't until the Senate Finance Committee released its finding that the appellee company had intentionally edited studies to omit unfavorable results that appellants were charged with having discovered "facts constituting the violation."

         For the cause of action at hand to be timely, this Court must examine the facts known or what facts should have been known to a reasonably diligent plaintiff before February 10, 2015, two years before the complaint in this case was filed. Management Defendants assert that, even if Plaintiffs had not actually discovered the alleged misrepresentations and omissions, a "reasonable investor" would have conducted an investigation and discovered the facts constituting the violation by, "at the latest, July 2014." Management Defendants argue that the complaint itself establishes that within 12 months of the Dauterive acquisition, PAC had defaulted on its bank loans, and widely missed its projected earnings. However, "[a]n incorrect prediction about a firm's future earnings, by itself, does not automatically tell us whether the speaker deliberately lied or just made an innocent (and therefore nonactionable) error." Merck, 559 U.S. at 650. Nevertheless, Management Defendants argue that after seeing the large discrepancy between the predicted earnings and the actual earnings, a reasonable investor would have begun an investigation via a simple request for information to PAC, which would have led to the discovery of the internal memorandum and Crowe Horwath Audit report.

         Similar to the facts presented in Rit'chey, Plaintiffs have pled that they were involved in a prior relationship with Management Defendants through their prior investments in PAC. The extent of this prior relationship and its impact on the trust Plaintiffs had in Management Defendants raises a factual issue inappropriate for resolution on a motion to dismiss. See Ritchey, 244 F.3d at 638-41 (finding that the effect of the prior relationship with defendant on whether plaintiffs had sufficient facts beyond a level of mere suspicion to reach a point which the victims would be incited to investigate was a factual question that could not be resolved on summary judgment). Further, the PPM went to great lengths to lay out all of the risk factors involved in investing in Dauterive. "It is well settled that financial performance, standing alone, does not necessarily suggest fraud at the time of the sale, but could also be explained by poor management, general market conditions, or other events unrelated to fraud, creating a jury question on [ ] notice." Gray v. First Winthrop Corp., 82 F.3d 877, 881 (9th Cir. 1996). See also La Grasta v. First Union Securities, Inc., 358 F.3d 840, 847 (2004) ("There may be numerous reasons, other than fraud, for a stock to decline (even steeply) in price."); LaSalle v. Medco Research, Inc., 54 F.3d 443, 446 (7th Cir. 1995) (declining to find that a big drop in price is notice per se of the possibility of securities fraud in light of other circumstances, such as the stock's history of volatility).

         Plaintiffs complaint alleges that they were not aware of an intent to deceive until after the bankruptcy proceedings began in 2016, when they received copies of an internal memorandum and audit. Predictions about future earnings that turn out to be incorrect are alone not enough to plead scienter-'"a mental state embracing intent to deceive, manipulate, or defraud." Merck, 599 U.S. at 637 (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, n. 12 (1976)). It cannot be said, as a matter of law, "[accepting Plaintiffs' allegations as true and giving Plaintiffs the benefit of all reasonable inferences, " that the discrepancy between the projected and the real EBITDA, by itself, was enough to give the Plaintiffs notice of the "facts constituting the violation, " including scienter, nor that a reasonably prudent plaintiff, in light of the circumstances, would have conducted an investigation leading to discovery of such facts before April of 2015. Cohen, 385 F.Supp.2d at 946 (citing Frey, 44 F.3d at 671 (providing the standard for a motion to dismiss)). Therefore, the complaint is timely.

         III. Federal Securities Claims

         a. Section 10(b) and Rule 10b-5

         1. Heightened Pleading Standards

         Section 10(b) of the Securities Exchange Act makes it unlawful for any person to "use or employ, in connection with the purchase or sale of any security... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j(b). "SEC Rule 10b-5 implements this provision by making it unlawful to, among other things, 'make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.'" Matrixx Initiatives, Inc. v. Siracusano,563 U.S. 27, 37 (2011) (quoting 17 CFR § 240.10b-5(b)). A cause of action for private securities fraud based on violations of § 10(b) and Rule 10b-5 requires: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Stoneridge Inv. Partners, LLC v. Scientific-Atlanta,552 U.S. 148, 157 (2008). Congress, in the Private Securities Litigation Reform Act (PSLRA), enacted two heightened pleading requirements for § 10(b) private securities fraud cases. See 15 U.S.C. § 78u-4(b)(2) ("Rule 9(b)"). "The first requires that the complaint specify each false statement or misleading omission and explain why the [false statement or] omission was misleading." In re Navarre Corp. Sec. Litig.,299 F.3d 735, 741-42 (8th Cir. 2002) (quoting Florida State Bd. of Admin, v. Green Tree Fin. Corp., 270 F.3d 645, 654 (8th Cir. 2001)). The second requires that "the complaint state 'with particularity' facts giving rise to a 'strong inference' that the defendant acted with the scienter required for the cause of action." Id. (quoting Green Tree, 270 F.3d at 654). The purpose of these heightened standards "was ...


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