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Ohio Bureau of Workers' Compensation v. MDL Active Duration Fund

January 29, 2007


The opinion of the court was delivered by: James L. Graham United States District Judge


This is an action filed by the Ohio Bureau of Workers' Compensation, an agency of the state of Ohio, against the MDL Active Duration Fund, LTD. ("the Fund"), MDL Capital Management Inc. ("MDL Capital"), and Mark D. Lay. The complaint alleges violations of Ohio law, and jurisdiction in this court is based on diversity of citizenship. Other defendants named in the complaint were previously dismissed from this action due to lack of personal jurisdiction in an opinion and order filed on June 1, 2006.

This matter is before the court on the motion of the remaining defendants to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6) for failure to state a claim for which relief may be granted. A complaint may be dismissed for failure to state a claim only where it appears beyond doubt that the plaintiff can prove no set of facts in support of its claim which would entitle it to relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957). The court must construe the complaint in a light most favorable to the plaintiff and accept all well-pleaded allegations in the complaint as true. Scheuer v. Rhodes, 416 U.S. 232 (1974). A motion to dismiss under Rule 12(b)(6) will be granted if the complaint is without merit due to an absence of law to support a claim of the type made or of facts sufficient to make a valid claim, or where the face of the complaint reveals that there is an insurmountable bar to relief. Rauch v. Day & Night Mfg. Corp., 576 F.2d 697 (6th Cir. 1978).

A complaint must contain either direct or inferential allegations with respect to all material elements necessary to sustain a recovery under some viable legal theory. Weiner v. Klais & Co., Inc., 108 F.3d 86, 88 96th Cir. 1997). The court is not required to accept as true unwarranted legal conclusions or factual inferences. Morgan v. Church's Fried Chicken, 829 F.2d 10 (6th Cir. 1987).

As a general rule, matters outside the pleadings may not be considered in ruling on a 12(b)(6) motion to dismiss unless the motion is converted to one for summary judgment under Fed.R.Civ.P. 56. Jackson v. City of Columbus, 194 F.3d 737, 745 (6th Cir. 1999); Weiner, 108 F.3d at 88. However, courts may consider matters of public record. Jackson, 194 F.3d at 745. See also new England Health Care Employees Pension Fund v. Ernst & Young, LLP, 336 F.3d 495, 501 (6th Cir. 2003)("A court that is ruling on a Rule 12(b)(6) motion may consider materials in addition to the complaint if such materials are public records or are otherwise appropriate for the taking of judicial notice."). The court may also consider a document or instrument which is attached to the complaint, or which is referred to in the complaint and is central to the plaintiff's claim. See Fed.R.Civ.P. 10(c)("[a] copy of any written instrument which is an exhibit to a pleading is a part thereof for all purposes."); Weiner, 108 F.3d at 89.

I. Common Law Fraud (Count I) and Fraudulent Inducement (Count II)

Defendants allege that the allegations of common law fraud alleged in Count I and fraudulent inducement alleged in Count II fail to state a claim. Defendants also argue that these allegations fail to satisfy the particularity requirement of Fed.R.Civ.P. 9(b).

While state law governs the burden of proving fraud at trial in a diversity action, the procedure for pleading fraud is governed by the pleading requirements of Rule 9(b). Minger v. Green, 239 F.3d 793, 800 (6th Cir. 2001). Rule 9(b) requires that averments of fraud must be stated with particularity. The Sixth Circuit requires a plaintiff, at a minimum, to allege the time, place, and content of the alleged misrepresentation relied upon, the fraudulent scheme, the fraudulent intent of the defendants, and the injury resulting from the fraud. Coffey v. Foamex L.P., 2 F.3d 157, 161-62 (6th Cir. 1993). Allegations of fraudulent misrepresentation must be made with sufficient particularity and with a sufficient factual basis to support an inference that they were knowingly made. Id. at 162.

However, when deciding a motion to dismiss for failure to comply with Rule 9(b), this court must also consider the policy favoring simplicity in pleading codified in Fed.R.Civ.P. 8, which requires a "short and plain statement of the claim." Sanderson v. HCA-The Healthcare Co., 447 F.3d 873, 876 (6th Cir. 2006)(Rule 9(b)'s particularity requirement must be read in harmony with the requirements of Rule 8). The threshold test is whether the complaint places the defendant on sufficient notice of the misrepresentation, thus allowing the defendants to answer and address the plaintiff's claim of fraud in an informed manner. Coffey, 2 F.3d at 162; United States ex rel. Bledsoe v. Community Health Systems, Inc., 342 F.3d 634, 643 (6th Cir. 2003)(complaint should provide fair notice to defendants and enable them to prepare an informed pleading responsive to the specific allegations of fraud).

The elements of a claim of fraud under Ohio law are: (1) a representation, or, where there is a duty to disclose, concealment of a fact; (2) which is material to the transaction at hand; (3) made falsely, with knowledge of its falsity, or with such utter disregard and recklessness as to whether it is true or false that knowledge may be inferred; (4) with the intent of misleading another into relying upon it; (5) justifiable reliance upon the representation or concealment; and (6) a resulting injury proximately caused by the reliance. Gaines v. Preterm-Cleveland, Inc., 33 Ohio St.3d 54, 55, 514 N.E.2d 709 (1987).

The complaint includes allegations of the alleged misrepresentations and concealment of facts on the part of the defendants which form the basis for plaintiff's fraud claims. The alleged misrepresentations include statements in the Private Placement Memorandum ("PPM") submitted by the Fund, as well as other statements and correspondence. The complaint alleges the nature of these statements and omissions, as well as the approximate time and place of these statements and omissions.

Defendants argue that the plaintiff could not have reasonably relied on the language concerning the leverage guideline contained in the PPM in deciding to invest in the Fund. The leverage provision states:

The Fund is expected to leverage the Fund's investment portfolio as a means to increase yield and enhance total return. Up to 150% of the Fund's assets, at the time of investment, may be leveraged (i.e., the combined value of borrowings and short positions). Leveraging will include, but is not limited to, short selling of securities, reverse repurchase agreements, certain option and futures transactions plus any borrowings to leverage the Fund's assets. Although the use of leverage may enhance returns on the Fund's portfolio and increase the number of investments that may be made by the Fund, it may also substantially increase the risk of loss. The percentage included above is intended as a guideline and may be changed from time to time at the sole discretion of the Board of Directors.

Complaint, Ex. 1, p. 3.

Defendants argue that in light of the language that the limit on leveraging of 150% "is intended as a guideline and may be changed from time to time at the sole discretion of the Board of Directors," the limit was not a sufficiently definite representation to form the basis for a fraud claim. However, this argument is based on defendants' interpretation of the leveraging provision. The leveraging provision is arguably subject to different interpretations. Further, plaintiff's allegations are sufficient to allege that the leveraging guideline provision, even as interpreted by defendants, was not followed. Plaintiff alleges that the Fund's board of directors never took any action to change the leverage percentage. Amended Complaint, ¶ 65. In other words, the board never exercised its discretion to change the PPM guideline of 150%, yet the funds were leveraged well beyond the 150% guideline. Plaintiff has alleged that from April 2004 through December 2004, the Fund frequently exceeded the leverage guideline, without disclosure of this fact to plaintiff. Amended Complaint, ¶ 60. Plaintiff also argues that the 150% figure was so far exceeded that it could not reasonably have been deemed to have been used as a "guideline." It cannot be said that the plaintiff's fraud claim, insofar as it is based on the leverage percentage in the PPM, is insufficient to allege justifiable reliance as a matter of law. In addition, there are other alleged representations and omissions described in the complaint which form a basis for plaintiff's fraud claims.

Defendants also argue that the complaint fails to adequately allege intent or scienter. Rule 9(b) provides that "[m]alice, intent, knowledge, and other condition of mind of a person may be averred generally." Green, 239 F.3d at 800. Plaintiff has alleged that the defendants knowingly made false representations and knowingly failed to disclose facts concerning the amount being leveraged and the investment strategies of the Fund, and that such representations and concealment of facts were made with knowledge of falsity and with the intent to deceive. Amended Complaint, ¶¶ 100-108, 113. Plaintiff has adequately alleged the necessary element of intent.

The court finds that Counts I and II of the amended complaint comply with the requirements of Rule 9(b). However, even if plaintiff's allegations fail to satisfy those requirements, dismissal on this basis alone would not be appropriate in the absence of a motion for a more definite statement under Fed.R.Civ.P. 12(e). See Coffey, 2 F.3d at 162. No such motion has been filed in this case.

II. Ohio Securities Law Violations (Counts III, IV and V)

Defendants have moved to dismiss Counts III, IV and V, which allege violations of Ohio's securities laws. Count III alleges a violation of Ohio Rev. Code § 1707.41(A), which provides:

In addition to the other liabilities imposed by law, any person that, by a written or printed circular, prospectus, or advertisement, offers any security for sale, or receives the profits accruing from such sale, is liable, to any person that purchased the security relying on the circular, prospectus, or advertisement, for the loss or damage sustained by the relying person by reason of the falsity of any material statement contained therein or for the omission of material facts, unless the offeror or person that receives the profits establishes that the offeror or person had no knowledge of the publication prior to the transaction complained of, or had just and reasonable grounds to believe the statement to be true or the omitted facts to be not material.

All the defendants are named in this count.

Count IV alleges a violation of Ohio Rev. Code §1707.42(B) against MDL Capital. Section 1707.42(B) provides that an investment adviser is liable for damages resulting from acts of an investment advisor which violate Ohio Rev. Code Chapter 1707. Count V, which names all defendants, invokes Ohio Rev. Code §1707.43(A), which provides for a recision remedy at the election of the purchaser.

The above sections create no new civil liabilities beyond those established by common law, and do not limit or restrict common law liabilities for deception or fraud other than as specified in those sections. Ohio Rev. Code §1707.40.

Defendants argue that the complaint fails to comply with the requirements of Rule 9(b) that the fraud which is the underlying basis for the above statutory violations be pleaded with particularity. Defendants rely on Nickels v. Koehler Management Corp., 541 F.2d 611, 616-17 (6th Cir. 1976), in which the court stated that an action under ยง1707.41 required either knowledge of the falsity of the representation or lack of diligence in ascertaining its truth or falsity on the part of the seller. Nickels was cited by the court in Citizens National Bank v. Barge-In, Inc., No. CA83-07-008 (12th Dist. unreported), 1984 WL 4329 (Ohio App. Sept. 28, 1984). However, as noted ...

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