QUAAK v. DEXIA

357 F.Supp.2d 330 (2005) | Cited 8 times | D. Massachusetts | February 9, 2005

MEMORANDUM AND ORDER

I. INTRODUCTION

Class plaintiffs bring claims for securities fraud against Dexia BankBelgium ("Dexia"), the successor to Artesia Banking Corp., S.A.("Artesia"), the former chief commercial banker for Lernout & HauspieSpeech Products N.V. ("L&H").1 Defendant has moved to dismiss,arguing that the claims are time-barred and that their allegations failto support a claim for primary liability under Section 10(b) of theSecurities Exchange Act ofPage 21934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated by the Securitiesand Exchange Commission (SEC), 17 C.F.R. § 240.10b-5. After hearing, themotion to dismiss is DENIED.

II. FACTUAL BACKGROUND

The Second Amended Class Action Complaint alleges the followingfacts.2

In March of 1997, the Brussels Translation Group N.V. ("BTG") wasestablished, purportedly to develop machine translation software. (¶81.) Artesia provided the initial financing to allow BTG to operate. Id.That same year, L&H purported to license software and provideengineering services to BTG in exchange for millions of dollars in feesand royalties. (¶¶ 82, 83.) Artesia loaned BTG $22.9 million. (¶ 81.) Itloaned these funds to BTG so that BTG would use them to pay L&H, whichwould then pass the money off to investors as legitimate L&H licensingrevenue. Id. From 1997 through 1999, L&H improperly recorded almost $35million in revenues from the BTG transaction. (¶ 84.) At the end of thecontract, in June 1999, L&H purchased BTG for $59 million. Id. The solepurpose of the BTG transactionPage 3was to inflate L&H's reported financial results. (¶ 85.)

Beginning in 1998, Artesia provided L&H and L&H's senior officers —Lernout, Hauspie, and Willaert ("Senior Officers") — with funding for theLanguage Development Companies ("LDCs") and Cross-Language DevelopmentCompanies ("CLDCs") in order to expand L&H's generation of fictitiousrevenue. (¶ 97.) Artesia and L&H agreed that L&H would create a seriesof holding companies financed by Artesia. (Id.) These holding companieswere used to finance multiple LDCs. (Id.)

One such holding company was Radial Belgium N.V. ("Radial"). (¶ 98.)On September 29, 1998, Artesia loaned Radial approximately $6 million,which Radial wired in three $2 million installments to three LDCs. (Id.)These LDCs used all $2 million to pay L&H licensing fees, which L&Hbooked as $6 million of revenue in the third quarter of 1998. (Id.)

Because Artesia knew that none of these LDCs had any bona fide officesor operations that would have enabled them to develop speech recognitionproducts, and that the money would be used by the LDCs to pay licensingfees to L&H, it refused to lend any money to these LDCs unless theSenior Officers guaranteed these loans by means of credit default swaps.(¶¶ 98-99.) Artesia and the Senior Officers agreed to structure theseguarantees in a manner designed to enable L&H fraudulently to concealthe guarantees from the SEC and the investing public. (¶ 99.) In aSeptember 21, 1999 e-mail, P. Rabaey at Artesia wrotePage 4to G. Dauwe and other Artesia employees, "The private guarantees . . .were not signed by Jo [Lernout], Pol [Hauspie] and Nico [Willaert] so asto avoid possible problems with the SEC. We have therefore no securityand look for a solution via credit default swaps." (¶¶ 100, 103.)

Artesia knew that the credit default swaps were highly unusual forindividuals on commercial loans and were used on the LDC/CLDC loansspecifically to mislead L&H investors. (¶ 119.) An internal Artesiadocument notes that the reference to the credit default swaps had beendeleted from one of the letters of credit issued in connection with theLDC loans and that the letter "was not signed by the borrowers (refusedbecause of possible fiscal and auditing problems when filing thefinancial statements)." (¶ 120.)

On December 22, 1998, Artesia loaned Language Investment Company("LIC") — an entity equivalent to Radial — $6 million for theestablishment and funding of four more LDCs. (¶ 107.) Again, Artesiaknew that the entities were shams and that the loans would be used to paylicensing fees to L&H, and were backed by credit default swaps enteredinto by the Senior Officers to avoid SEC disclosure problems. (¶¶108-109.)

L&H and Artesia continued to perpetuate this fraudulent scheme in1999. (¶ 111.) On March 31, 1999, L&H set up the Language DevelopmentFund ("LDF") and transferred $12 million to the bank accounts of sevenLDCs. (Id.) In the second quarter ofPage 51999, L&H requested that LDF receive a $20 million loan from Artesia.(¶ 113.) Artesia was aware that the $20 million sought by L&H was anintegral part of the fraud being perpetrated at L&H. (Id.) B. Ferrand ofArtesia wrote in an e-mail dated June 21, 1999: In view of the fact that [L&H] books the sale of licenses as revenue, it is essential under GAAP rules that LDF be totally independent from [L&H]. Therefore, [L&H] cannot under any circumstances be a party involved in an agreement whose subject is the repayment of the requested financing. A credit default swap with Messrs. Lernout, Hauspie, and Willaert is however possible.(Id.)

On June 25, 1999, Artesia granted a personal $20 million line of creditto the Senior Officers to take the place of an LDF loan in furtherance ofthe fraudulent scheme to inflate L&H's revenue and earnings. (¶ 114.)This time, Artesia demanded that the three individuals pledge 650,000registered shares of L&H as collateral for the loan. (Id.) The vastmajority of this $20 million was used to fund six new LDCs, and thismoney was ultimately booked as revenue on L&H's financial statements.(Id.) L&H did not reveal the source of the funds received by the LDCs inL&H's SEC Form 10-Q for the quarter ended June 30, 1999, or in its SECForm 10-K for the year ended December 31, 1999. (Id.)

By mid to late 1999, Artesia became increasingly concerned thatits loans would not be repaid. (¶ 115.) The loans toPage 6Radial and LIC were due on June 30, 1999, and the $20 million personalloan to the Senior Officers was due in October 1999. (Id.) Artesianonetheless extended the loans to December 15, 1999 and subsequentlyengaged in multiple discussions with the Senior Officers to track theirprogress in attracting new investors whose funds would be used by L&H torepay Artesia. (Id.)

After Artesia had begun funding L&H's fraudulent LDC operationsthrough Radial, it knowingly participated in another L&H improperrevenue recognition scheme involving Vasco Data Security International("Vasco"). (¶ 122.) In 1998 and 1999, Vasco entered into two purportedlicensing agreements for L&H software, for $800,000 and $900,000respectively. (¶ 123.) In fact, Vasco had no use for the L&H software.(Id.) L&H loaned Vasco $3 million at about the same time. (Id.) L&Hinsisted that Vasco backdate the second licensing agreement, and recordedrevenue for both agreements in 1998, despite the outstanding loan toVasco. (¶ 126.)

L&H allowed Vasco to repay its $3 million dollar loan in the secondquarter of 1999 through a private placement of Vasco stock organized byArtesia at the behest of Lernout and Hauspie. (¶ 124.) Top investorsincluded various L&H related entities, including Mercator and LHIC, acompany formed by Lernout and Hauspie. (Id.) On April 15, 1999, Artesiawired approximately $11.5 million, the proceeds of the privateplacement, to Vasco'sPage 7account. (¶ 125.)

III. DISCUSSION

A. Sarbanes-Oxley

The principal issue in this motion to dismiss is whether plaintiffs'claims are timely. Prior to the passage of the Sarbanes-Oxley Act of 2002("Sarbanes-Oxley"),3 Section 10(b) claims had to be "commenced withinone year after the discovery of the facts constituting the violation andwithin three years after such violation." Bamberg, 236 F. Supp. 2d at 84(quoting Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,501 U.S. 350, 364 (1991)).

Section 804 of Sarbanes-Oxley amends 28 U.S.C. § 1658 by lengtheningthe statute of limitations for private causes of action alleging fraud,providing: (a) . . . [A] private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws, as defined in section 3(a)(47) of the Securities Exchange Act of 1934 . . . may be brought 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.

(b) EFFECTIVE DATE. — The limitations period provided by section 1658(b) of title 28, United State Code, as added by this section, shall apply to all proceedings addressed byPage 8 this section that are commenced on or after the date of enactment of this Act.

(c) NO CREATION OF ACTIONS. — Nothing in this section shall create a new, private right of action.Public Company Accounting Reform and Investor Protection Act of 2002,Pub.L. 107-204 § 804, 116 Stat. 745, 801 (2002).

B. Is this a New Proceeding?

Plaintiffs filed a consolidated complaint related to the L&H fraud onSeptember 21, 2001 against L&H Senior Officers and directors, L&H'spublic accountants, and other individuals and entities that they allegedwere involved. Plaintiffs filed the complaint in this case on August 19,2003. Defendant argues that the longer limitations period ofSarbanes-Oxley does not apply to this complaint because it is not a newproceeding commenced after July 30, 2002, but rather a de facto amendmentto the pending L&H action. (See Def.'s Mem. at 5-6.)

Following oral argument in this case, both parties submittedsupplemental briefs concerning the legislative history of the term"proceedings" in Section 804(b) of the Act. The committee reports do notelucidate Congress's intent in using this term. Both parties cite theCongressional Record statements of Senator Leahy, one of the sponsors ofthe legislation. Senator Leahy stated:

[Section 804] is intended to lengthen any statute of limitations under federal securities law, and to shorten none. The section, by its plain terms, applies to any and all cases filed after the effective date of the Act, regardlessPage 9 of when the underlying conduct occurred. . . . [Section 804] applies to all private securities fraud actions for which private causes of actions are permitted and applies to any case filed after the date of enactment, no matter when the conduct occurred.

148 Cong. Rec. S7418, S7419-420 (July 26, 2002). Although both partiesargue that these passages resolve the issue in their favor, thestatements are simply too ambiguous to provide meaningful support foreither side.

Legal precedent on the issue is scant. Friedman v. Rayovac Corp.,295 F. Supp. 2d 957 (W.D. Wis. 2003) involved a consolidated classaction in which all the underlying cases had been filed before July 30,2002, but plaintiffs amended the complaint in January 2003 to add a newdefendant. Id. at 975. The court held that the amendment initiated a new"proceeding" for the purposes of applying the extended statute oflimitations under Sarbanes-Oxley. Id. at 975-76. It reasoned that if theplaintiffs had filed a new separate action against the defendants afterJuly 2002, rather than amending the complaint, "there could be no disputeover the application of the new statute of limitations." Id. at 976.Thus, "[i]t would make little sense to create a rule encouraging judicialinefficiency by requiring separate lawsuits for claims against differentdefendants arising out of the same conduct." Id.

The court in In re Enron Corp. Securities, Derivative & ERISALitigation, docket no. H-01-3624, 2004 WL 405886 (S.D. Tex.Page 10Feb. 25, 2004) rejected the Friedman court's reasoning on similar facts.The plaintiffs in the case filed a complaint before July 30, 2002, andthen filed an amended complaint on May 14, 2003, adding new defendants.Id. at *10. The court held that "because the latest complaint istechnically an amendment of the previous consolidated complaint, relatingto matters that occurred prior to the filing of the previous consolidatedpleading," it is not a "new proceeding" governed by the lengthened statuteof limitations. Id. at *13. The court reasoned that [t]o permit a plaintiff to file a new second suit or a new claim or add a new party in order to circumvent a statute of limitations and expand his legal rights, especially where the clear language of the statute expresses Congress' intent not to permit such expansion, as here, would create legal chaos.Id. at *16 n. 42. The court in Enron relied on Gerber v. MTC ElectronicTechnologies Co., Ltd., 329 F.3d 297 (2d Cir. 2003), a decisionconsidering a similar issue in the context of the Private SecuritiesLitigation Reform Act (PSLRA), 15 U.S.C. § 78u-4(b). Certain provisionsof the PSLRA did "not affect or apply to any private action . . .commenced before or pending" on December 22, 1995. 109 Stat. 737, 758(1995). In Gerber, the original complaint was filed in January 1995, andan amendment adding new plaintiffs was filed after December 1995.Gerber, 329 F.3d at 300-01. The Gerber court noted that the statutorylanguage referred to "actions" rather than "claims," and held thatbecause the amendment did not create a new "action," thePage 11PSLRA provisions did not apply to the new plaintiffs. Id. at 309-10. Itstated: In the absence of any indication to the contrary, we doubt that Congress intended that courts would apply different sets of substantive and procedural rules to groups of plaintiffs asserting identical claims in a single action, depending on when those plaintiffs were added to the complaint.Id. at 310.

A more recent decision discussing the issue, In re Dynegy, Inc.Securities Litigation, 339 F. Supp. 2d 804 (S.D. Tex. 2004), involved aconsolidated class action in which the underlying cases were filed beforeJuly 30, 2002, and the complaint was amended to add a new defendant afterthat date. Id. at 888. The Court adopted the reasoning in Enron, citingthe Gerber decision, and rejected the Friedman court's approach. Id. at888-89.

It is notable, though not decisive, that unlike any of the casesabove, this case involves the filing of a new complaint, rather than theamendment of an existing complaint.4 Moreover, the logic of theGerber case is not entirely applicable here, inPage 12part because it involved the addition of new plaintiffs rather than newdefendants, and in part because the PSLRA provision includes the word"action," as specifically emphasized by the Gerber court, whileSarbanes-Oxley includes the somewhat more ambiguous term "proceeding."While the issue is a close one, given the remedial nature ofSarbanes-Oxley, this Court concludes that the August 2003 complaintagainst a new defendant constitutes a new "proceeding" within the meaningof Section 804(b), and that the longer statute of limitations periodprovided by Sarbanes-Oxley applies.

C. Retroactivity

Plaintiffs argue that the extended two-year/five-year limitationsperiod under Sarbanes-Oxley applies retroactively to revive claims thatwere barred at the time of its passage. Generally, "congressionalenactments . . . will not be construed to have retroactive effect unlesstheir language requires this result." Landgraf v. USI Film Prods.,511 U.S. 244, 264 (1994) (quoting Bowen v. Georgetown Univ. Hosp.,488 U.S. 204, 208 (1988)). Moreover, the weight of the caselaw arguesstrongly against plaintiffs' interpretation. See, e.g., Foss v. Bear,Stearns & Co., Inc., 394 F.3d 540, 542 (7th Cir. 2005) (holding thatSarbanes-Oxley does not revive time-barred claims); In re Enter. MortgageAcceptance Co., LLC, Sec. Lit., 391 F.3d 401, 406-10 (2d Cir. 2004)(same); Swack v. Credit Suisse FirstPage 13Boston, docket no. 02-11943, 2004 WL 2203482, at *5 n. 10 (D. Mass.Sept. 21, 2004) (stating same in dicta); In re ADC Telecomm., Inc. Sec.Litig., 331 F. Supp. 2d 799, 804 (D. Minn. 2004) (holding same);Enron, 2004 WL 405886 at *17 (same); Glaser v. Enzo Biochem, Inc.,303 F. Supp. 2d 724, 734 (E.D. Va. 2003) (same); In re Heritage BondLitig., 289 F. Supp. 2d 1132, 1148 (C.D. Cal. 2003) (same). But seeRoberts v. Dean Witter Reynolds, Inc., docket no. 8:02-CV-2115-T-26EAJ,2003 WL 1936116, at *2-*4 (M.D. Fla. Mar. 31, 2003) (examininglegislative history referring to victims of Enron debacle and finding"intent to retroactively apply the statute of limitations"). This Courtagrees with the overwhelming majority of courts, which have found thatSarbanes-Oxley did not revive time-barred claims.

D. When Did the Repose Period Begin?

Plaintiffs argue that L&H's issuance of false financial statements,the last of which was issued on June 30, 2000, constituted the violationof Section 10(b) and Rule 10b-5 that triggered the repose period in thiscase. (See Pl.'s Mem. in Opp. at 7.) Under this interpretation,plaintiffs' claims were not extinguished before Sarbanes-Oxley waspassed, and under the five-year Sarbanes-Oxley repose period, their claimsare not time-barred. Defendant suggests, however, that the trigger of therepose period must be the defendant's own act, not L&H's, and that allof Artesia's complained of conduct took place prior toPage 14July 30, 1999. See Beard v. J.I. Case Co., 823 F.2d 1095, 1097 n. 1 (7thCir. 1987) ("A period of limitation bars an action if the plaintiff doesnot file suit within a set period of time from the date on which thecause of action accrued. In contrast, a period of repose bars a suit afixed number of years after an action by the defendant. . . .") Underthis reading, defendant argues that the Lampf three-year repose periodextinguished any potential claim prior to July 30, 2002, whenSarbanes-Oxley was passed.5

Most courts have held that the statute of limitations for Section 10(b)claims begins to run when the alleged misrepresentation is made. See,e.g., Cont'l Bank, Nat'l Ass'n v. Vill. of Ludlow, 777 F. Supp. 92, 102(D. Mass. 1991) ("[T]he repose period begins when the last allegedmisrepresentation was made by any of the Participants."); Waldock exrel. John H. Waldock Trust v. M.J. Select Global, Ltd., 2004 WL 2278549at *4 (N.D. Ill. Oct. 7, 2004) ("The Court agrees with the reasoning ofthose cases holding that the statute of repose is triggered for a Section10(b) and Rule 10b-5 violation when the defendant makes themisrepresentation or omission in connection with the sale orPage 15purchase of a security to a particular plaintiff."); Bovee v. Coopers &Lybrand, 216 F.R.D. 596, 604 (S.D. Ohio 2003) ("[T]he statute oflimitations is triggered by the misrepresentation that constitutes thesecurities violation.").

However, none of these courts was faced with misrepresentations made bysomeone other than a named defendant as part of a deceptive scheme inwhich the defendant substantially participated. This Court previouslyheld that Section 10(b) and Rule 10b-5

impose primary liability on any person who substantially participates in a manipulative or deceptive scheme by directly or indirectly employing a manipulative or deceptive device (like the creation or financing of a sham entity) intended to mislead investors, even if a material misstatement by another person creates the nexus between the scheme and the securities market.In re Lernout & Hauspie, 236 F. Supp. 2d at 173. Neither this Courtnor any other court has had occasion to address how a statute oflimitations or period of repose is applied to a fraudulent scheme such asthe one alleged in this case.

Defendant argues that plaintiffs are trying to have it both ways —arguing that Artesia's acts show that it is a primary violator of Rule10b-5 but relying on the subsequent disclosures by L&H to avoid theperiod of repose that relates to those very acts. No contradiction isinherent in this position, however.Page 16Plaintiffs have alleged a primary violation of Rule 10b-5 by defendantthrough its participation in a manipulative or deceptive scheme intendedto mislead investors. Integral to the violation of Rule 10b-5 throughthis fraudulent scheme is the fraudulent misrepresentation by L&H,improperly recognizing revenue. Under Section 10(b), the statute ofrepose runs from the date of the last fraudulent misrepresentation, andthe unique role of the defendant in this particular scheme does notaffect this rule. Thus, the period of repose in this case was triggeredon June 30, 2000, the date of L&H's last allegedly false financialstatement.

Next, defendant argues that even if L&H's financial disclosures arethe appropriate trigger for the repose period, only those claims byArtesia that allege effects on L&H's June 2000 financial statement arevalid, because all previous financial statements occurred before June30, 1999, and claims based on them are thus time-barred. Defendant arguesthat none of plaintiffs' claims in this action include such allegations,with the exception of Artesia's loan to the L&H principals in June1999.

All of plaintiffs' claims involve allegations of improper revenuerecognition by L&H in 1998 or 1999. Plaintiffs state that L&H's June30, 2000 public filing necessarily reflected L&H's financial results forboth 1998 and 1999. At the motion toPage 17dismiss stage, this provides a sufficient nexus between the allegedactions of Artesia and L&H's June 2000 financial statement.Accordingly, the statute of repose does not bar this action.

E. Plaintiffs' Motion to Strike Articles Submitted by Defendant

Plaintiffs have moved to strike exhibits submitted by defendantconsisting of news articles reporting on Artesia's relationship withL&H, which were not submitted with or referenced in the complaint."Under Rule 12(b), `any consideration of documents not attached to thecomplaint, or not expressly incorporated therein, is forbidden, unlessthe proceeding is properly converted into one for summary judgment under[Fed.R.Civ.P.] 56.'" Cooperativa de Ahorro y Credito Aguada v. Kidder,Peabody & Co., 993 F.2d 269, 272 (1st Cir. 1993) (quoting Watterson v.Page, 987 F.2d 1, 3 (1st Cir. 1993)). See Cooperativa, 993 F.2d at272-73(holding that district court erred in sua sponte relyingextensively on newspaper articles "in reaching its conclusions as to whenthe statute of limitations began to run"). However, narrow exceptions tothis rule exist "for documents the authenticity of which are not disputedby the parties; for official public records; for documents central toplaintiffs' claim; or for documents sufficiently referred to in thecomplaint." Watterson, 987 F.2d at 3 (citations omitted).

In the complaint, plaintiffs stated that their allegationsPage 18were based on a thorough investigation of all "reasonably availablesources of information" including articles in print and electronicmedia. (§ 21.) They also alleged that the first suggestion that Artesiawas involved in the fraudulent L&H scheme appeared in a June 24, 2003article in the Belgian press. (§ 23.) Defendant argues that thesestatements essentially incorporate by reference the articles submitted bydefendant, as those articles were published in the Belgian press beforeJune 24, 2003, and suggest criminal conduct by Artesia in connection withL&H.

Precedent in this Circuit suggests, however, that a stronger connectionbetween the submitted articles and the complaint is necessary before suchextraneous material may be considered on a motion to dismiss. See, e.g.,Young v. Lepone, 305 F.3d 1, 11 (1st Cir. 2002) (allowing considerationof documents submitted by defendant on motion to dismiss where the"complaint contained extensive excerpts from, and references to" thedocuments and "the factual allegations of [the] complaint revolve around"the documents); Beddall v. State Street Bank & Trust Co., 137 F.3d 12,16-17 (1st Cir. 1998) (allowing consideration of trust agreementsubmitted by defendant on motion to dismiss where complaint discussedagreement "at considerable length," complaint's "factual allegations[were] expressly linked to — and admittedly dependent upon" agreement,and plaintiff did not move to strike agreement from record); Romani v.Shearson LehmanPage 19Hutton, 929 F.2d 875, 879 n. 3 (1st Cir. 1991) superceded by statute onother grounds (holding that where complaint alleged misrepresentations inoffering materials, defendant's attachment of those offering materials tomotion to dismiss was proper); Fudge v. Penthouse Int'l, Inc.,840 F.2d 1012, 1015 (1st Cir. 1988) (allowing consideration of articlesubmitted by defendants on motion to dismiss where article was "notmerely referred to in plaintiffs' complaint but was absolutely central toit" and plaintiffs "unquestionably would have had to offer a copy of thearticle in order to prove their case"); Schaffer v. Timberland Co.,924 F. Supp. 1298, 1305-06 (D.N.H. 1996) (noting that while in recentyears some federal courts have adopted a flexible approach toconsideration of extrinsic documents on a motion to dismiss, "the FirstCircuit continues to adhere to the traditional view" that suchconsideration is ordinarily forbidden without conversion to summaryjudgment).

In this case, plaintiffs did not refer to the relevant articles intheir complaint, nor were the articles somehow central to the allegationsin the complaint. The more tenuous connection between the articles andthe complaint in this case is not sufficient to allow their considerationat this stage. Therefore, plaintiffs' motion to strike is allowed.

F. Inquiry Notice

Defendant argues that even under the Sarbanes-Oxley regime,Page 20plaintiffs' claims are untimely because plaintiffs were on inquiry noticeof their claims more than two years before they filed suit.

The statute of limitations does not begin to run until "the time whenplaintiff in the exercise of reasonable diligence discovered or shouldhave discovered the fraud of which he complains." Cooperativa de Ahorro yCredito Aguada v. Kidder, Peabody & Co., 129 F.3d 222, 224 (1st Cir.1997) (citations and internal quotation marks omitted). The First Circuithas developed a two-step procedure to apply this analytic framework tothe facts of specific cases. The first is to determine the time when"storm warnings" were evident that would put a reasonable investor onnotice of a possible fraud. See Young, 305 F.3d at 8. Once the timing ofsuch warning signs is established, the second step is to determinewhether after the signs emerged a plaintiff was reasonably diligent ininvestigating them. See id. "[F]ollowing the receipt of sufficient stormwarnings, a plaintiff's cause of action is deemed to accrue on the datewhen, exercising reasonable diligence, she would have unearthed thefraud." Id. at 10.

This Court previously found with respect to the L&H fraud that"throughout the fall of 2000 and into the spring of 2001 there were morethan `storm warning[s]' afoot — the winds were howling, the rains werepouring, and reasonably prudent investorsPage 21were battening down the hatches to preserve their legal rights."Bamberg, 236 F. Supp. 2d at 85 (describing unraveling of fraud atL&H). These same warnings were sufficient to put plaintiffs on inquirynotice of a potential claim against Dexia. Thus, the critical inquiry iswhether plaintiffs were reasonably diligent in investigating potentialclaims against this defendant once those storm warnings appeared.

"[O]nce the defendant has shown the presence of storm warnings, theplaintiff must `counter with a showing that she fulfilled hercorresponding duty of making a reasonably diligent inquiry into thepossibility of fraudulent activity.'" Id. (quoting Young, 305 F.3d at 9)."It is plaintiff's burden to show compliance with the statute oflimitations. The exercise of reasonable diligence is determined byexamining `the nature of the misleading statements alleged, theopportunity to discover the misleading nature of the statements, and thesubsequent actions of the parties.'" Slavin v. Morgan Stanley & Co.,Inc., 791 F. Supp. 327, 331 (D. Mass. 1992) (quoting Cook v. Avien,Inc., 573 F.2d 685, 696-97 (1st Cir. 1978)). In short, the plaintiff mustallege "facts which could lead to an inference of reasonable diligence."Slavin, 791 F. Supp. at 331.

"Inquiry notice is triggered by evidence of the possibility of fraud,not full exposition of the scam itself." Kennedy v. Josephthal & Co.,Inc., 814 F.2d 798, 802 (1st Cir. 1987) (citations omitted). However,courts have recognized thatPage 22uncovering evidence of actionable fraud may take a long time. The FirstCircuit has noted that "a reasonably diligent investigation following thereceipt of storm warnings may consume as little as a few days or as muchas a few years to get to the bottom of the matter." Young, 305 F.3d at 9.Whether a plaintiff is on inquiry notice and whether she exercisedreasonable diligence are often factual questions. The First Circuit hasstated: In the archetypical case . . . it is for the factfinder to determine whether a particular collection of data was sufficiently aposematic to place an investor on inquiry notice. So too the related question of whether a particular plaintiff exercised reasonable diligence in the face of such warnings.Id. (citations omitted); see also Marks v. CDW Computer Centers, Inc.,122 F.3d 363, 367 (7th Cir. 1997) ("Whether a plaintiff had sufficientfacts to place him on inquiry notice of a claim for securities fraudunder S.E.C. Rule 10b-5 is a question of fact, and as such is ofteninappropriate for resolution on a motion to dismiss under Rule12(b)(6)."); In re Global Crossing, Ltd. Sec. Litig.,313 F. Supp. 2d 189, 199 (S.D.N.Y. 2003) ("The question of whether aplaintiff exercised due diligence is usually a question of fact for thejury to decide. . . . A fortiori, caution is warranted in approaching amotion for judgment on the pleadings on such issues.") (citations andquotation marks omitted).

In considering whether the plaintiffs exercised duePage 23diligence in investigating storm warnings, this case presents aparticularly complex problem because the defendant is alleged to haveparticipated in a scheme orchestrated by others. In Levitt v. Bear Stearns& Co., Inc., 340 F.3d 94 (2d Cir. 2003), the Second Circuit faced asimilar case under Section 10(b), involving a defendant, Bear Stearns,that allegedly acted as a "clearing agency" for Sterling Foster, whichwas alleged to have improperly manipulated the market. Id. at 96-97. TheLevitt court noted that in Central Bank of Denver, N.A. v. FirstInterstate Bank of Denver, N.A., 511 U.S. 164 (1994), the Supreme Courtestablished stringent requirements for demonstrating a primary Section10(b) violation, and that under this standard, "once Plaintiffs were oninquiry notice that they had been defrauded, they were required toexercise reasonable diligence in discovering the facts establishing BearStearns' knowing participation in Sterling Foster's fraudulent schemebefore filing suit." Levitt, 340 F.3d at 103. The court determined thatthe factual issues inherent in such an analysis could not be resolved onthe motion to dismiss record. Id. On this basis among others, the courtvacated the district court's dismissal of the suit, stating that "thereare factual disputes concerning the scope of the inquiry conducted byPlaintiffs and the question of whether a reasonable inquiry could haverevealed enough information to satisfy the pleading requirements for §10(b) primary violator liability." Id. at 104.Page 24

Similar considerations apply here. Plaintiffs allege that they madesubstantial efforts to investigate their claims, and that they uncoveredno evidence demonstrating that the defendant was an active participant inthe L&H fraud until June 2003. (Complaint at ¶¶ 21, 23.) They state thatthey analyzed "all reasonably available sources of information,"including L&H filings and press releases for the relevant years,articles and reports in print and electronic media, documents produced byL&H to the SEC, and interviews of various relevant individuals.(Complaint at ¶ 21.) Drawing all inferences in plaintiffs' favor, itcannot be said as a matter of law, on the current record, that plaintiffsfailed to exercise reasonable diligence in pursuing their claim againstDexia. Thus, the Court denies the motion to dismiss until a more amplerecord is developed.

G. Primary Liability

Defendant argues that plaintiffs' allegations against Dexia at mostamount to a claim for aiding and abetting, and are therefore barred byCentral Bank. See Central Bank, 511 U.S. at 191 (holding that "a privateplaintiff may not maintain an aiding and abetting suit under § 10(b).")However, the Central Bank Court did not conclude that secondary actorssuch as lawyers, accountants, banks, and underwriters were alwaysshielded from primary liability. The Court stated:

The absence of § 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free fromPage 25 liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met. In any complex securities fraud, moreover, there are likely to be multiple violators. . . .

Id. (internal citation omitted).

As discussed above, this Court has held that primary liability underSection 10(b) and Rule 10b-5 may in some cases be found where a person"substantially participates in a manipulative or deceptive scheme . . .even if a material misstatement by another person creates the nexusbetween the scheme and the securities market." Lernout,236 F. Supp. 2d at 173. In that case, this Court found that plaintiffs'allegations that defendants FLV and Mercator set up, funded, and operatedsham entities designed to enter into fraudulent licensing agreements withL&H in order to artificially inflate L&H's profits provided a stronginference of scienter and satisfied the requirements for liability underSection 10(b). Id. at 174-76. The Court also noted that plaintiffsdemonstrated reliance on the manipulative or deceptive device "byalleging facts sufficient to show (1) that defendants substantiallyparticipated in a fraudulent scheme; and (2) when the scheme is viewed asa whole, the plaintiffs relied on it." Id. at 174.

In this case, plaintiffs have alleged that Artesia (a)Page 26helped to finance the sham LDCs (¶¶ 7-8, 87); (b) loaned money to thenominal owner of certain LDCs with the knowledge that the LDCs would usethose funds to engage in transactions that would allow L&H to bookfictitious revenue from "licensing fees" (¶¶ 7, 95, 97-117); (c)intentionally structured the loans artificially to inflate L&H's revenuein a manner designed to conceal the fact that those loans were guaranteedby L&H's principal officers (¶¶ 7, 96, 106, 110, 113, 118); (d) actedwith the specific purpose of hiding the guarantees provided by L&H'sofficers from the SEC and investors (¶¶ 96, 106, 110, 113, 118); (e) tookaffirmative steps to conceal its role in the L&H fraud from thecompany's Audit Committee investigators (¶¶ 127-128); and (f) extended a$20 million line of credit to L&H's principal officers with fullknowledge that those funds would be utilized to record fictitious revenuesupposedly generated from licensing transactions with LDCs. (¶ 114). Seealso Pl.'s Surreply Br. at 12-13. These allegations, taken as a whole,are sufficient to satisfy the Section 10(b) standard for primaryliability, as described by this Court in Lernout,236 F. Supp. 2d at 173-74.6

The Court declines defendant's invitation to reconsider itsPage 27holding in Lernout in light of limited subsequent district courtcaselaw. See In re Homestore.com Inc. Sec. Litig., 252 F. Supp. 2d 1018,1041 (C.D. Cal. 2003) (holding that because plaintiffs relied onmaterial statements and omissions and not on the "scheme" itself,participants in the scheme who did not make the statements and omissionswere not primarily liable under Section 10(b)). But see In re EnronCorp. Sec., Derivative, & ERISA Litig., 235 F. Supp. 2d 549, 577(S.D. Tex. 2002) (holding that subsection (a) and (c) of Rule 10b-5"allow suit against defendants who, with scienter, participated in acourse of business or a device, scheme or artifice that operated as afraud on sellers or purchasers of stock even if these defendants did notmake a materially false or misleading statement or omission") (internalcitations and quotation marks omitted).

In addition, the Court does not find persuasive defendant's argumentthat the alleged conduct in this case amounts to commonplace businesstransactions in which Artesia was a conventional lender. (See Def.'s Br.at 15.) On the contrary, plaintiffs allege that defendant's actions wereintegral to the fraudulent scheme, and that defendant was a primaryarchitect of the scheme to finance the sham entities. Therefore,plaintiffs have alleged facts sufficient to establish primary liability bydefendant under Section 10(b).

IV. ORDER

Dexia's Motion to Dismiss (Docket No. 30) is DENIED.Page 28Plaintiffs' Motion to Strike Exhibits C Through M to the Declaration ofBreton Leone-Quick (Docket No. 39) is ALLOWED.

1. Plaintiffs had also brought claims against Dexia S.A. but agreed todismiss Dexia S.A. based on defendant's representation that Dexia S.A.assumed no liabilities of Artesia.

2. This Court has written several extensive opinions concerning thealleged fraudulent scheme at L&H. Familiarity with the facts set out inthose opinions is assumed. See, e.g., In re Lernout & Hauspie Sec.Litig., 208 F. Supp. 2d 74 (D. Mass. June 19, 2002); In re Lernout &Hauspie Sec. Litig., 230 F. Supp. 2d 152 (D. Mass. Aug. 19, 2002); Inre Lernout & Hauspie Sec. Litig., 286 B.R. 33 (D. Mass. Nov. 18, 2002);Bamberg v. SG Cowen, 236 F. Supp. 2d 79 (D. Mass. Dec. 9, 2002); In reLernout & Hauspie Sec. Litig., 236 F. Supp. 2d 161 (D. Mass. Jan. 13,2003).

3. Public Company Accounting and Investor Protection Act of 2002(Sarbanes Oxley Act of 2002), Pub.L. 107-204, § 804, 116 Stat. 745, 801(codified in part at 28 U.S.C. § 1658(b)), was signed into law byPresident Bush on July 30, 2002.

4. Defendants cite to James v. AT&T Corp., 334 F. Supp. 2d 410(S.D.N.Y. 2004), in which the court dismissed a complaint filed afterJuly 30, 2002 that was essentially identical to a complaint filed beforethat date, where the duplicative filing was specifically intended to takeadvantage of the Sarbanes-Oxley limitations period. Id. at 411-13. As thecomplaint in this case is not simply a duplicate of the pending L&Haction, James is inapposite here.

5. At the hearing, plaintiffs argued that even if the Court measuresthe period of repose based on the acts of the defendant, the last actcommitted by Artesia was the extension of the loan in October 1999, andtherefore the Lampf three-year period had not ended by June 2002. TheCourt need not consider this argument, based on the ruling below.

6. Plaintiffs' allegation that Artesia extended the Senior Officers a$20 million line of credit is not in itself sufficient to demonstrateprimary liability under Section 10(b), as this would constitute aiding andabetting activity under Central Bank. However, plaintiffs have alleged amuch more extensive pattern of activity by defendant in this case.Page 1

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