alleged knowingly false representation occurred when KPMG issued
the 1997 audit on March 27, 1998, outside the three-year repose
period. The claims against KPMG based on the 1997 audit are barred.
C. Reasonable Reliance

Ehmann and Landeck (“the Officers”) and KPMG argue that the
securities claims against each of them are barred because Wafra
cannot demonstrate reasonable reliance. Justifiable or reasonable
reliance, although often considered an independent element of a
Rule 10b-5 cause of action, “is no more than the combination of a
material misstatement (or omission) and causation.” Astor
Chauffeured Limousine Co. v..Runnfeldt Inv. Corp., 910 F.2d 1540,
1546 (7th Cir. 1990).

1. The Officers

Wafra alleges that the PPM was misleading because it described
the operation of the “Lock-Box” account and Prime’s obligations
with respect to misdirected payments, but failed to disclose the
existence of the kiting scheme. Compl. f@ 90. Wafra also alleges
that it relied on oral statements by several of the Officers. The
Officers argue that, as a matter of law, Wafra could not reasonably
have relied on statements outside the PPM because of a non-reliance
clause in the PPM, which states that “[n]o person has been
authorized to give any information or to make any representations
other than those contained in this [PPM] and, if given or made,

such information or representations must not be relied upon.” Def.

19


cae a

the material facts upon which misrepresentation cases rest must be
a past or existing fact rather than an opinion or promise of future
action,” Buzzard v. Bolger, 453 N.E.2d 1129, 1131 (Ill. App. Ct.
1983), but another court, on facts similar to this case, has held
more recently that an attorney’s opinion letter in a stock purchase
transaction could be the basis of a negligent misrepresentation
claim. Geaslen v. Berkson, Gorov & Levin, Ltd., 581 N.E.2d 138, 142
(Ill. App. Ct. 1991) (Duty to nonclient plaintiff existed where
opinion letter was addressed to plaintiff.), partially rev’d on
other grounds, 613 N.E.2d 702 (Ill. 1993).

Bischoff and B&S rely on Peaceful Family Limited Partnership
v. Van Hedge Fund Advisors, Inc., No. 98 C 1539, 1999 U.S. Dist.
LEXIS 1838 (N.D. Ill. Feb. 17, 1999) (Schenkier, M.J.) for the
proposition that a law firm is not liable to third parties for
misrepresentations made in the course of providing legal services
to its clients. Id. at *25-26. There the letter on which the
plaintiffs sued was directed to the client, not the plaintiffs, id.
at *8, *26, but here B&S’s opinion letter was addressed to Wafra,
Compl. 9 88. In Geaslen, the court held that, although the primary
purpose of the defendant-law firm’s relationship with its client
was to protect the client’s interest, an opinion letter issued to
third parties as the direction of the client was intended to
benefit the third parties, and the law firm assumed a duty of due

care toward the third parties with respect to the accuracy of the

40


However, the Illinois Appellate Court has since rejected the
interpretation and approach of Robin. Chestnut Corp. v. Pestine,
Brinati, Gamer, Ltd., 667 N.E.2d 543, 546-47 (Till. App. Ct. 1996),
appeal denied, 671 N.E.2d 727 (Ill. 1996) (finding that resort to
legislative history was unnecessary because the legislative intent
was clear from the plain language of the statute). Chestnut holds
that the second clause of paragraph (2) applies only when the
accountant writes a letter; when, as here, there is no writing, a
plaintiff may state a claim against the accountant by “show[ing]
the intent of the client [that the plaintiff rely on the
accountant’s representations] and knowledge of the accountant of
that intent.” Id. at 547. The Illinois Supreme Court has not
decided this issue, and KPMG-argues that the Robin interpretation
is more reasonable, but intervening “decisions of the state
appellate courts control, unless there are persuasive indications
that the state supreme court would decide the issue differently.”
Lexington Ins. Co. v. Rugg & Knopp, Inc., 165 F.3d 1087, 1090 (7th
Cir. 1999). The Illinois Supreme Court has recently reaffirmed that
where “the language of [the statute] is unambiguous, it [is]
improvident for the appellate court to look beyond the language of

“

the statute to the legislative history,” Petersen v. Wallach, --
N.B.2d --, No. 89947, 2002 WL 93108, at *4 (Ill. Jan. 25, 2002
(slip op.), accord Chestnut, 667 N.E.2d at 546-47, so there is no

indication that it would reject the Chestnut court’s

36


before the plaintiffs discover the actual fraud.” Id.

Wafra argues that there is nothing it could have done, without
legal process, to discover that the failure to disclose the
mishandled payments was knowing, much less to discover that Prime
was diverting and kiting the funds. Under the agreement with Prime,
Wafra says that it was entitled only to monthly statements showing
the amounts of money collected and disbursed under the financial
contracts and the amount to which Wafra was entitled under the
Indenture, Compl. JI 45, and that, because of the kiting scheme, the
monthly statements would not have revealed the misappropriation and
diversion that is the essence of the fraud. Moreover, Wafra alleges
that it had no access to Prime’s books and records under the
securitization because the securitization Trustee was interposed
between the investors and Prime. Pl’s Resp. to B&S’s Motion at 8.
Although “{iJnvestors are not entitled to nail down ‘every last
detail of a transaction’ before they may be charged with knowledge
sufficient to start the running of the limitations period,” Donohoe
v. Consolidated Operating & Prod. Corp., 982 F.2d 1130, 1141 (7th
Cir. 1992) (§ 13 context), the defendants have not demonstrated
what information Wafra could have obtained prior to Prime’s
disclosure of the misappropriation and diversion that would have
revealed even the general nature of the fraud. See Law, 113 F.3d at
786. If Wafra lacked notice of the fraud by Prime and the

individual defendants, it could not have had notice of KPMG’s or

13


purposes.

KPMG’s Ex. A at 6. Wafra alleges that KPMG’s representation that it
has not “performed additional procedures” was knowingly false
because it had already performed the procedures for the 1998 Audit,
which was issued only sixteen days after the closing, and that the
audit procedures disclosed the alleged kiting scheme. The kiting
scheme, in turn, rendered the calculations and verifications in the
letter misleading, because the projected income from the contracts
was based on the “knowingly false assumption that no such [kiting
scheme] existed.” Compl. ¢ 152. Wafra alleges that it received the
letter at the closing and relied on it in its investment decision;
in essence, it says that it would not have invested if KPMG had
disclosed the kiting scheme: Id. 7 154. KPMG argues that Wafra
could not reasonably have relied on its May 4, 1999, letter because
it contained “cautionary language” and because it was restricted to
the use of the addressees, which included only Prime and Merrill
Lynch.

Read liberally, the complaint alleges that the letter
contained both a false statement (that no audit had been conducted)
and an omission (the failure to mention the diversion,
misappropriation and kiting scheme). Wafra does not explain how it
could reasonably have relied on the statement that no audit had
been conducted in making its investment decision; reliance on an

auditor’s statement that it had not conducted an audit as

23


contents of the letter. 581 N.E.2d at 142. Wafra therefore states
a claim against Bischoff and B&S for negligent misrepresentation on
the basis of the opinion letter.
V. Conclusion
KPMG’s motion to dismiss is GRaNTzD as to Count VIII, and
GRANTED IN PART and DENIED IN PART as to Count IX. The officers’ motion
is DENIED as moot as to Count IV and otherwise Drmwiep. Bischoff and

B&S’s motion is DENIED.

ENTER wee

Beaks Ay

Elaine E. Backlo
United States District Judge

Dated: Maxch9¢ , 2002

41


y

of Prime’s officers, the description of the securitization in the
PPM, and on opinion and valuation letters from B&S and KPMG,
respectively its attorneys and auditors. Nobody disclosed the
diversion, misappropriation or kiting prior to the closing.

After the closing, however, certain “red flags” about Prime’s
financial condition surfaced. The delayed 1998 10-K was issued on
May 28, 1999, and included an auditor’s report by KPMG dated May
20, 1999--just sixteen days after the closing--in which KPMG stated
that Prime had transferred several million dollars to the SPVs in
1999 that were required to’ have been transferred in 1998. In
Prime’s August 1999 second quarter quarterly report, Prime reported
that it needed more capital to “meet its ongoing liquidity needs.”
In a July 1999 proxy statement, two and a half months after the
closing, Prime disclosed that, in January 1999, more than three
months before the closing, its president and CEO had made a loan of
$900,000 to Prime. Prime announced in November 1999 that KPMG, its
auditor of many years, had resigned, and that KPMG had brought to
Prime’s attention “the existence of certain irreconcilable
differences between the account detail and the general ledger”
relating to transactions in prior years, but that KPMG had not
required an adjustment. Prime’s third quarter report in November
1999 indicated that its liquidity problems had worsened. Despite
its financial difficulties, Prime still continued to make the

required monthly payments to Wafra.


vase coats.

incomplete was knowing, or at least reckless. The federal claims
against Bischoff and B&S stand.
Iv. State Law Claims
A. Individual Defendants

The Officers argue that, because there are no viable federal
claims, I lack supplemental jurisdiction over the state law claims
against them.*® Bischoff and B&S join this argument. However, I have
held that the federal claims against the Officers, Bischoff and B&S
survive the motion to dismiss. In any event, Wafra has also pleaded
subject matter jurisdiction based on 28 U.S.C. § 1332. Compl. @{ 20.
Wafra is a Cayman Islands Corporation with its principal place of
business in the Cayman Islands. Id. 4 7. The defendants are all
alleged to be domiciliaries of Illinois or New York. Id. II 8-18.
Section 1332(a) (2) confers subject matter jurisdiction in actions
between “citizens of a State and citizens of a foreign state,” so
I have jurisdiction over this suit by a foreign corporation against
citizens of New York and Illinois. 14A Wright Miller & Cooper:
Federal Practice & Procedure § 3661, at 133-34 (3d ed. 1998). The
only other arguments that the Officers made in support of dismissal
of the state law claims against them were raised in reply, and are

therefore waived for the purposes of this motion. See United States

® The First Amended Complaint, filed on January 15, 2002,
drops the negligent misrepresentation claim in Count IV against
Friedman, Landeck and Ehmann. The amended complaint also adds Count
X, a claim against all defendants under the Illinois Consumer Fraud
Act, which is the subject of a separately filed motion to dismiss.

34


Ex. A at iv. They rely on Rissman v. Rissman, 213 F.3d 381 (7th
Cir. 2000), which held that “a written anti-reliance clause
precludes any claim of deceit by prior representations.” Id. at
384. However, Rissman involved a stock-purchase agreement, in which
the plaintiff had bargained for broader assurances, but had settled
for an anti-reliance provision in a contract. Id. at 383. The court
held that, where the plaintiff had signed a contract saying it
would not rely on oral statements outside of the contract,
“[s]ecurities law does not permit a party to a stock transaction to
disavow such representations--to say, in effect, ‘I lied when I
told you I wasn’t relying on your prior statements’ and then to
seek damages for their contents.” Id. Here, however, the PPM was
not a contract; it was merely an offer to sell the Notes, and there
is no allegation or evidence to suggest that Wafra agreed to be
bound by the anti-reliance provision of the PPM. Rissman does not
apply here.

Moreover, the PPM, on its face, did not apply to the Owner

Certificate;° it states that “{t]he Issuers also anticipate issuing

5 The Officers seize on language from the complaint which says
that the Owner Certificate was issued “pursuant to” the PPM, and
say that Wafra cannot contradict the complaint now and say that the
Owner Certificate was not subject to the non-reliance clause of the
PPM. Paragraph 34 of the complaint says that the securitization
documents for the 1999 securitization “are described in detail in
the [PPM]” prepared by Merrill Lynch. Paragraph 36 says: “Pursuant
to the PPM, the Issuers proceeded to sell three classes of notes

and one class of ‘Owners Certificate.’” Drawing all inferences
in favor of Wafra, as I must for the purposes of this motion, J 36
simply says that, as described in the PPM, the Issuers sold the

20


KPMG’s silence about the kiting scheme violated Rules 10b-5 because
it had a duty to blow the whistle on Prime, it has not established
that an auditor has any such duty. The duty to speak in the context
of a Rule 10b-5 claim comes from state law, Ackerman, 947 F.2d at
846, and Illinois does not recognize an independent duty of an
auditor to reveal the misleading nature of its client’s statements.
See DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir. 1990)
(“Although accountants must exercise care in giving opinions on the
accuracy and adequacy of firms’ financial statements, they owe no
broader duty to search and sing.”). Because Wafra fails to state a
Rule 10b-5 claim against KPMG for either the 1997 audit or the May
4, 1999, letter, I need not consider whether it adequately pleaded
scienter,.
D. “Bootstrapping”

The Officers characterize Wafra’s claim as one for breach of
the Indenture, which they argue cannot be “bootstrapped” onto a
securities fraud claim under Rule 10b-5. In order to demonstrate
the element of deception required by Rule 10b-5, the cause of
action must be one based on “the omission or misrepresentation of
a material fact, [not] merely . . . a claim for breach of a state
law duty.” Panter v. Marshall Field & Co., 646 F.2d 271, 288 (7th
Cir. 1981). In Panter, the court held that the plaintiff’s claims
of the failure to disclose corporate mismanagement and self-dealing

amounted to “no more than [an] attempt to dress up a claim for

26


have relied on statements by Prime and its agents, including Ehmann
and Landeck. The question is whether Prime’s agents can disclaim
their own representations with such a disclaimer, and Gabriel says
that they may not.

Even if the anti-reliance clause were applicable to the
purchase of the Owner Certificate and barred reliance on prior oral
statements, it would not .preclude Wafra’s reliance on the
representations in the PPM itself, which Wafra alleges was
misleading because it described the operation of the “Lock-Box”
account and Prime’s obligations with respect to misdirected
payments, but failed to disclose the existence of the kiting
scheme. Compl. @ 90. The Officers have not demonstrated that, as a
matter of law, Wafra’s reliance on their statements and on the PPM
was unreasonable.

2. KPMG

At the May 4, 1999, closing, KPMG delivered a letter to Prime
and its placement agent, Merrill Lynch & Co., which calculated the
payments due under the securitized financial contracts. Compl.
148. In that letter, KPMG stated that:

We were not engaged to perform an audit, the objective of
which would be the expression of an opinion on the specified
elements, accounts, or items. Accordingly, we do not express
such an opinion. Had we performed additional procedures, other
matters might have come to our attention that would have been
reported to you.

This report is intended solely for the use of the
addressees [Prime and Merrill Lynch] and should not be used by

those who have not agreed to the procedures taken and taken
responsibility for the sufficiency of the procedures for their

22


v. Matchopatow, 259 F.3d 847, 851 (7th Cir. 2001).
B. KPMG
The Illinois Public Accounting Act, 225 ILCS § 450/30.1 (the
“Accounting Act”), limits the liability of public accountants to
persons in privity of contract, except for:
(1) such acts, omissions, decisions or conduct that constitute
fraud or intentional misrepresentations, or
(2) such other acts, omissions, decisions or conduct, if such
person, partnership or corporation was aware that a primary
intent of the client was for the professional services to
benefit or influence the particular person bringing the
action; provided, however, for the purposes of this
subparagraph (2), if such person, partnership or corporation
(1) identifies in writing to the client those persons who are
intended to rely on the services, and (ii) sends a copy of
such writing or similar statement to those persons identified
in the writing or statement, then such person, partnership or
corporation or any of its employees, partners, members,
officers or shareholders may be held liable only to such
persons intended to so rely, in addition to those persons in
privity of contract with such person, partnership or
corporation.
Id, Several courts in this district have interpreted the “provided,
however” clause of paragraph (2) as a condition of liability, which
means that an accountant is not liable unless there is a writing
giving notice to the third party that the third party may rely on
the accountant’s representations. Robin v. Falbo, No. 91 C 2894,
1992 WL 188429, at *9 (N.D. Ill. July 24, 1992) (Holderman, J.)
(relying on legislative debates); see also Endo v. Albertine, 812
F. Supp. 1479, 1495-96 (N.D. Ill. 1993) (Alesia, J.) (following
Robin); Dougherty v. Zimbler, 922 F. Supp. 110, 116 (N.D. Ill.

1996) (Castillo, J.) (same).

35


triggering event of a repose period. Hinkle v. Henderson, 85 F.3d
298, 301 (7th Cir. 1996). In a securities case pre-dating Lampf,
the court held that “[a] period of limitation bars an action if the
plaintiff does not file suit within a set period of time from the
date on which the cause of action accrued. In contrast, a period of
repose bars a suit a fixed number of years after an action by the
defendant . . . , even if this period ends before the plaintiff
suffers any injury.” Beard v. J.I. Case Co., 823 F.2d 1095, 1097
n.l (7th Cir. 1987); see also Kaplan v. Shure Bros., Inc., 153 F.3d
413, 422 (7th Cir. 1998) (applying Illinois law) (“As a general
proposition . . . the time the action accrued is immaterial to the
application of a statute of repose.”).

The Ninth Circuit has also held that the repose period for
Rule 10b-5 “begins to run .. . when a person commits the act that
gives rise to liability under that section.” Asdar Group v.
Pillsbury, Madison & Sutro, 99 F.3d 289, 294-95 (9th Cir. 1996). It
is the misrepresentation “in connection with the purchase or sale,”
not the sale itself, that violates Rule 10b-5. Thus it appears that
a “violation” under Rule 10b-5 is distinct from the concept of a
“cause of action” under that rule. A defendant who makes a
knowingly false xepresentation with the purpose of inducing a sale
of securities violates Rule 10b-5 even if no purchaser is taken in
by the lies and no purchase has actually occurred. That the cause

of action has not accrued at that point is beside the point,

17


financial contracts, id. @ 52. The defendants say that these
announcements contradicted Prime’s alleged oral representations of
financial health, so that there were “suspicious circumstances”
that obligated Wafra to investigate further.

The complaint contains lengthy allegations about the failure
to disclose information about Prime’s finances, and the defendants
ask me to infer therefore that the financial failure, and not the
misappropriation, diversion and kiting scheme, was the essence of
the fraud. However, in response to Ehmann and Landeck’s motion to
dismiss, Wafra explains that the lock-box account and the Indenture
agreement, as well as the provision for a back-up servicer, were
established to protect Wafra’s interests in the event of Prime’s
financial failure, and that the only way that Wafra could be
injured under the arrangement was from a compromise of the lock-box
account. Resp. to Ehmann and Landeck’s Mot. at 11-12; see also
Resp. to KPMG’s Mot. at 4 (“Wafra is not suing KPMG for failing to
disclose any of [the] information” about Prime’s deteriorating
financial status.). According to Wafra, the fraud alleged is more

than Prime’s misrepresentation of its financial condition; it is

2? The defendants also point to {@ 54 of the complaint, which
states that in April 2000, “the Trustee in the 1999-A
Securitization[] provided notice to Prime Leasing of the existence
of several events of default under the indentures and servicing
agreements applicable to the ‘Prime Trusts.’” Drawing all
reasonable inferences in favor of Wafra, this paragraph speaks only
to Prime’s knowledge of the defaults, but says nothing about
Wafra’s notice of the situation.


(“[C]autionary language, if sufficient, renders the alleged
omissions or misrepresentations immaterial as a matter of law.”).
However, the letter also said that B&S claimed not to have any
information that would disabuse it of the assumption that Primeé’s
information was true and accurate, and Wafra alleges that it did.
Compl. @ 90. The so-called “bespeaks caution” doctrine, which
denies liability for predictions or opinions if the speaker
includes sufficient cautionary language tailored to the risk
involved, see Rubinstein v. Collins, 20 F.3d 160, 167 & n.21 (5th
Cir. 1994) (describing evolution of doctrine), does not, as a
matter of law, insulate misrepresentations of “hard facts” from
liability. See Harden, 65 F.3d at 1406. Here the alleged
misrepresentation was not a prediction or a mere opinion, but a
misrepresentation of a “hard fact”: that B&S knew of nothing that
would make Prime’s statements misleading. The “bespeaks caution”
doctrine does not apply here.

B&S also invokes the particularity requirements of Fed. R.
Civ. P. 9(b) and the PSLRA, 15 U.S.C. 78u~4(b). Rule 9(b) “requires
the plaintiff to state ‘with particularity’ any ‘circumstances
constituting fraud.’ . . . This means the who, what, when, where,
and how: the first paragraph of any newspaper story.” DiLeo, 901
F.2d at 627. B&S argues that Wafra’s allegations that there is a
“strong inference” of fraud fail because Wafra does not allege the

facts from which such an inference can be drawn. However, it points

32


Nevertheless, even if, counterfactually, the proxy statements
showed that Ehmann was not an officer or a member as of the
“control group” as of December 21, 1998, Ehmann may not be excused
from the complaint on that basis. “Control-person” liability for a
Rule 10b-5 violation exists under § 20(a) if the individual
defendant (1) “actually participated in, that is, exercised control
over the operations of” the violating entity, and (2) “possessed
the power or ability to control the specific transaction” on which
the Rule 10b-5 violation is predicated. Harrison v. Dean Witter
Reynolds, Inc., 974 F.2d 873, 881 (7th Cir. 1992). Ehmann claims
that he was not a control person when the alleged fraud occurred
because he was not an officer when Prime defaulted on its payments
to Wafra in June 2000. However, Wafra alleges that the kiting
scheme began in or before 1997, long before Ehmann says he resigned
his position as an officer. Moreover, Wafra says that Ehmann made
statements on December 11, 1998, ten days before Ehmann says he
resigned, about Prime’s ability to meet its obligations to
investors that were materially misleading because of Ehmann’s
knowledge of the kiting scheme. Compl. { 80-81. This is sufficient
to state a claim for control-person liability based on Ehmann’s own
actual participation in the alleged scheme.

F. The Bischoff Defendants
Mark Bischoff was a member of Prime’s Board of Directors,

Secretary of the Board, outside counsel, and a large shareholder in

29


complaint and that are central to its claim without converting this
motion to one for summary judgment. See Menominee Indian Tribe of
Wisc. v. Thompson, 161 F.3d 449, 456 (7th Cir. 1998); Help At Home
Inc. v. Medical Capital, L.L.C., 260 F.3d 748, 752 (7th Cir. 2001).
But see Berthold Types Ltd. v. Adobe Systems Inc., 242 F.3d 772,
775 (7th Cir. 2001). In addition, a plaintiff is entitled to
supplement its complaint with factual narration that is consistent
with the complaint, and I may consider those additional facts for
the purposes of this motion. See Help At Home Inc., 260 F.3d at
752-53.
III. Federal Claims

To state a claim under SEC Rule 10b-5, promulgated under §
10(b) of the Securities Exchange Act of 1934, “a plaintiff must
allege that the defendant (1) made a misstatement or omission, (2)
of material fact, (3) with scienter, (4) in connection with the
purchase or sale of securities, (5) upon which the plaintiff
relied, and [that] (6) that reliance proximately caused plaintiff's
injuries.” In re HealthCare Compare Corp. Secs. Litig., 75 F.3d
276, 280 (7th Cir. 1996). The allegations of the complaint must
also comply with the Private Securities Litigation Reform Act of
1995 (“PSLRA”), 15 U.S.C. § 78u-4(b).

All of the defendants argue that Wafra’s federal securities
claims are barred by the statute of limitations, and KPMG argues

that certain claims against it are barred by the statute of repose.


In April 2000, the securitization trustee notified Prime that
there had been several defaults under the indentures and servicing
agreements. On June 9, 2000, Prime held a conference call in which
Wafra’s president participated. Prime’s vice president disclosed
that Prime had misappropriated funds from the securitization trusts
and used some of those funds for its own purposes, and that it
would be unable to continue servicing the financial contracts.
Wafra says this is the first whiff it had of any wrongdoing. Prime
defaulted on the principal payment due to Wafra on June 15, 2000,
and, although Wafra continues to receive interest payments, Wafra
has not received any principal payments from Prime since May 2000.

|
Wafra claims that it has lost $3.4 million, plus interest and

expenses, as a result of the defendants’ alleged fraud.
|

On a motion to dismiss, I accept all well-pleaded factual

II.

allegations in the complaint as true and draw all inferences in
favor of the non-moving party. Johnson v. Rivera, 272 F.3d 519, 520
(7th Cir. 2001). I may not dismiss a complaint for failure to state
a claim “unless it appears beyond doubt that the plaintiff can
prove no set of facts in support of his claim which would entitle
him to relief.” Conley ¥j Gibson, 355 U.S. 41, 45-46 (1957).
Ordinarily, I may not consider facts outside of the complaint

on a motion to dismiss, but there is a well-recognized exception:

I may consider documents, that are referred to in the plaintiff’s
|

|
j 5


ern ee

because the defendant has committed a fraudulent act. See, e.g.,
Eckstein, 8 F.3d at 1128 (“Discovery of the fraud means the
discovery of the misrepresentation.”) (statute of limitations
context). This distinction is particularly clear where, as here,
the defendant accused of misrepresentation is not the seller; the
last act committed by KPMG with regard to the fraudulent audit was
its alleged misrepresentations.

In view of the Seventh Circuit’s distinction between an act of
the defendant that triggers the repose period and the accrual of
the cause of action, and of the Ninth’s Circuit’s conclusion that
it is the offending act itself that starts the repose clock, I
reconsider my opinion in Kleban and hold that the “violation” for
the purposes of the Rule 10b-5 statute of repose occurs when the
defendant makes a misrepresentation in connection with the sale or
purchase of securities; the sale itself need not have occurred to
start the running of the répose period. This interpretation of
“violation” for the purposes of the repose period is consistent
with the Seventh Circuit’s treatment of the statute of limitations,
which runs from the date of the “facts constituting the violation”:
the statute begins to run when the plaintiff knows or should know
that the defendant made a statement that is knowingly false. Law,
113 F.3d at 786; Eckstein, 8 F.3d at 1128; see also Antell, 1998 WL
245878, at *5 (holding that, to be consistent, “violation” must be

construed same way for statute of repose and limitation). Here, the

18


moving defendants argue’ that Wafra’s securities fraud claim is
barred by the statute of limitations. The defendants say that the
clock started running as early as 1999, when Prime made public
disclosures that indicated its financial distress. Wafra, however,
argues that the time began to run only when it was first injured;
i.e., when Prime failed to make the securitization payment due on
June 15, 2000; or at the earliest on June 9, 2000, when Prime
disclosed its misappropriation and diversion to Wafra in a
conference call. ; ; a

Prime’s poor financial condition was revealed by a series of
public disclosures in 1999: the July 1999 proxy statement that
disclosed a January 1999 (pre-closing) loan to Prime of nearly a
million dollars from its CEO, Compl. @I 49; Prime’s August 1999
quarterly report that stated that Prime would need more capital
resources to meet its liquidity needs, id. 9 48; Prime’s November
1999 announcement of the resignation of KPMG, its longtime
auditors, in which Prime revealed some undefined accounting
irregularities involving past transactions, id. @ 50; and the
November 1999 quarterly report that indicated more serious

liquidity problems, specifically Prime’s inability to fund new

1 Ehmann and Landeck’s motion to dismiss, which raises the
statute of limitations argument, is adopted by William Smithburg,
John Walter, James Friedman, and by Bischoff and B&S. KPMG filed a
separate motion to dismiss, also raising the statute of
limitations.


nob atm

confirmation that everything was okay with the transaction is both
implausible and unreasonable. One can imagine an investor relying
on an auditor’s statement that it had conducted an audit and found
nothing, but not on a statement that no audit had been conducted,
and that the auditor could not say one way or another whether
anything was wrong with the client’s figures. Even assuming that
KPMG’s statement was false, what was there to rely on? The only way
that Wafra could have relied’ on the statement that there had been
no audit (and, implicit in that statement, that KPMG had not
performed any “additional procedures”) would be if Wafra believed
that KPMG was lying, and that it really had done an audit and had
found nothing questionable. Reliance on a statement of one whom one
reasonably suspects of lying is unreasonable as a matter of law.
See Shaw Steel, Inc. v. Morris, 240 B.R. 553, 558 (N.D. Ill. 1999

(Bucklo, J.) (bankruptcy context) (“fhe attitude of an ostrich is
not one protected by the courts.”).

The omission of any information that KPMG might have had about
the misappropriation and kiting by Prime is really the heart of
Wafra’s claim about the letter, and the claim fails for reasons
other than justifiable reliance. Wafra alleges that, by delivering
the letter at the closing, KPMG chose to speak, and in doing so
assumed the duty to speak the truth about material issues. See

Ackerman v. Schwartz, 947 F.2d 841, 846 (7th Cir. 1991) (“Federal

law requires persons to tell the truth about material issues once

24


{ nfftive Orde?*Form (06/97)

United States District Court, Northern District of Illinois

Name of Assigned Jud; i Sitting Judge if Other
or Magistrate Judge Elaine E, Bucklo tha signed Judge
CASE NUMBER 01C 4314 DATE 3/25/2002
CASE Watfta Leasing Corp. vs. Prime Capital Corp., et al.
TITLE

[In the following box (a) indicate the party filing the motion, e.g., plaintiff, defendant, 3rd party plaintiff, and (b) state briefly the nature
of the motion being presented.]

MOTION:

DOCKET ENTRY:

(ly oO Filed motion of [ use listing in “Motion” box above.]

(2) oO Brief in support of motion due

(3) a Answer brief to motion due___. Reply to answer briefdue___.

(4) a Ruling/Hearing on___—sset fort

(5) im} Status hearing[heid/continued to] [set for/re-set for]on__—ssetfor at
(6) a Pretrial conference[held/continued to] [set for/re-set for]on___—ssetfor ss at_— ty
7) oO Trial[set for/re-set for]on at.

(8) o [Bench/Sury trial] [Hearing] held/continued to_____at

9) a This case is dismissed [with/without] prejudice and without costs[by/agreement/pursuant to]

OOFRCP4¢n) OlGeneral Rule2i CIFRCP41(a\(1) 4 FRCP41(a)(2).

ao) «il [Other docket entry] | KPMG’s motion to dismiss (13-1) is granted as to Count VIII, and granted
in part and denied in part as to Count IX. Motion to dismiss by Thomas Ehmann and Vern Landeck (32-
1) is denied as moot as to Count IV and otherwise denied. Bischoff and B&S’ motion to dismiss (46-1)
is denied. Enter Memorandum Opinion and Order.

a) ff [For further detail see order attached to the original minute order.]

msent::

No notices required, advised in open court. D
Number:

1

No notices required. number of notices

MAR 26 2002

date docketed

J | Notices mailed by judge's staff.

Notified counsel by telephone.

Docketing to mail notices.

Mail AO 450 form.

Copy to judge/magistrate judge.

date mailed notice

courtroom Gis ily G28
MPI deputy’s : -
initials

MPI6

Datertime received in’ J
centkal Clerk's Office + mailing deputy initia



i
|
|
1993) (citations omitted) . Wafra may not have known until June 2000
]

that its investment was a total loss, but the relevant question is

not when it appreciated the scope of its loss; rather, the question
|

is when it had access to enough information to know that it had

|

been knowingly lied to, which is all that inquiry notice requires.
|

See Law v. Medco Research, Inc., 113 F.3d 781, 786 (7th Cir. 1997)

(“In a fraud case . . . [w]hen the plaintiff knows or should know

[that the defendant knowingly made a false statement], the statute
of limitations begins to run.”).

Wafra alleges that it could not reasonably have discovered the
existence of a possible fraud before Prime admitted to the fraud on
June 9, 2000. Compl. 97 56. KPMG made the following statement in the

consolidated financial statements attached to Prime’s 1998 Form 10-
\

K, which was filed sixteen days after the closing, on May 28, 1999:
[Prime] acts as a servicer for each of its securitizations as
well as its assets in various credit facilities. As servicer,
[Prime] receives funds due its affiliated special purpose
entities[, of which Wafra is one, id. @ 7]. These funds,
certain of which were required to be transferred to these
entities in 1998 and were transferred in 1999, are included in
accrued expenses and other liabilities and totaled $6,742,681
and $3,563,195, at December 31, 1998 and 1997, respectively.

Id. 4 147(b) (emphasis added) . Wafra alleges that this statement,
i

\
which appeared in Note 4 \to the financial statement:
reveals that sometime prior to the filing of the 1998 10-K,
KPMG certainly knew that as of December 31, 1997, Prime
Capital had on hand $3,563,195 which consisted, in whole or in
part, of diverted and misappropriated funds which were
required to have been transferred to the SPVs in 1997 and
which had not in fact been so transferred. That is, sometime
prior to the filing of the 1998 10-K, KPMG certainly knew of
\
| 11


also, and more importantly, the alleged kiting scheme (which Wafra
says was designed specifically to prevent discovery of Prime’s
insolvency) that compromised the lock-box mechanism. Drawing all
reasonable inferences in favor of Wafra at this stage, see In re
Healthcare, 75 F.3d at 279, the complaint and Wafra’s additional
factual narration allege that, if Prime had properly handled its
financial problems, the backup servicer would have prevented a loss
to the investors, but because Prime diverted and misappropriated
funds and hid that fact from investors through the kiting scheme,
the lock-box arrangement failed and the investors lost money. Mere
notice of Prime’s failing finances was insufficient to give notice
of the fraud without knowing that the funds from the lock-box
account had been misappropriated.

Wafra suggests that it should not be charged with notice of
the alleged fraud until its injury actually occurred, i.e., until
Prime failed to make the payment due on June 15, 2000, because it
could not have sued without an injury, and that it was not injured
until the monthly payments stopped. This theory has been
conclusively rejected by the Seventh Circuit:

Discovering that one has lost money is not the same as

discovering that one has been defrauded. . . . [T]he question

. is when the investors discovered (or should have
discovered) the deceit, not when the full consequences of that
deceit are felt. An investor can be defrauded before any loss
is realized. Discovery of the fraud means the discovery of the

misrepresentation.

Eckstein v. Balcor Film Investors, 8 F.3d 1121, 1127-28 (7th Cir.

10


of Rule 10b-5) .7 Moreover, as a factual matter, Bé&S
mischaracterizes the claim. Wafra’s claims against B&S are based,
at least in part, on the statement in B&S’s opinion letter,
addressed to Wafra and other investors, that:

no information has come to our attention which would give us

actual knowledge or actual notice [that] any . . . of the

foregoing documents, certificates, reports and information on

which we have relied are not accurate and complete.
Compl. 4@ 88. Landeck’s officer’s certificate, which was attached to
the opinion letter, stated that Landeck was unaware of anything
that would make statements in the PPM untrue or misleading. Id. 1
89. Wafra alleges that both Landeck and Bischoff knew that the PPM
was false or misleading because it described the operation of the
lock~box account without disclosing the diversion and
misappropriation scheme. Id. 4 90. Thus, Wafra alleges, Bischoff
and B&S knew that Landeck’s statement in the officer’s certificate
was inaccurate, so the opinion letter was misleading. This claim is
based neither on omissions nor on future conduct by Prime.

B&S argues that Wafra could not reasonably have relied on its
opinion letter because it stated that the opinion was based facts
supplied by Prime and that it had assumed that all representations

in the documents from Prime were true. See Harden v. Raffensperger,

Hughes & Co, Inc., 65 F.3d 1392, 1404 (7th Cir. 1995

’ To the extent that I understand B&S to advance the same
arguments under these cases that were advanced by the Officers, I
reject them for the reasons stated above.

31


Prime. Compl. 9 13. He was also the senior and managing partner of
B&S, which acted as Prime’s general counsel, id., and which issued
an opinion letter to Wafra an others in connection with the closing
on May 4, 1999, id. § 87.

Bischoff argues that he is not personally liable because he
did no more than draft an opinion letter in his capacity as an
agent of B&S. However, the complaint also alleges that Bischoff, as
a director, officer and major shareholder of Prime, knew of and
directed the kiting scheme, and was a “controlling person,” liable
under § 20(a) of the 1934 Act for Prime’s violations. See Harrison,
974 F.2d at 881. Wafra has adequately stated a claim against
Bischoff individually for his direct participation in the alleged
fraud in addition to the claim against B&S based on the opinion
letter,

B&S argues that the Rule 10b-5 claims against it should be
dismissed “because those claims are largely dependent upon
allegations of omission and opinions about Prime’s anticipated
future conduct.” B&S Mem. at 3. The two cases that it cites in
support of this proposition have nothing to do with this argument
and are irrelevant. See Rissman, 213 F.3d at 383-84 (discussing
effect of anti~reliance provision in a stock purchase agreement) ;
Panter, 646 F.2d at 288 (holding that mere claim for breach of
state law fiduciary duty, without allegation of fraudulent

misrepresentation or omission, does not state claim for violation

30


The Officers and KPMG argue that Wafra’s claims fail for a lack of
justifiable reliance. The Officers and the Bischoff defendants also
argue, for several independent reasons, that Wafra fails to state
a claim for securities fraud.
A. Statute of Limitations

Rule 10b-5 claims are - governed by a one~year statute of
limitations and a three-year statute of repose. Lampf, Pleva,
Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364 (1991).
The one-year period:

begins to run not when the fraud occurs, and not when the

fraud is discovered, but when (often between the date of

occurrence and the date of the discovery of the fraud) the

plaintiff learns, or should have learned through the exercise

of ordinary diligence in the protection of one’s legal rights,

enough facts to enable him by such further investigation as

the facts would induce in a reasonable person to sue within a

year.
Fujisawa Pharm. Co., Ltd. v. Kapoor, 115 F.3d 1332, 1334 (7th Cir.
1997). Whether a plaintiff had sufficient information to place it
on. inquiry notice is a question of fact, Marks v. CDW Computer
Ctrs., Inc., 122 F.3d 363, 367 (7th Cir. 1997), but “if a plaintiff
pleads facts that show its suit barred by a statute of limitations,
it may plead itself out of court under a Rule 12(b) (6) analysis.”
Whirlpool Fin. Corp. v. GN Holdings, Inc., 67 F.3d 605, 608 (7th
Cir. 1995).

Wafra filed the complaint in this case on June 8, 2001. The


the [Owner Certificate] which is not offered hereby.” Def. Ex. A at
ii. The disclaimer paragraph on which the Officers rely, which says
that “this private placement memorandum does not constitute an
offer to sell or a solicitation of an offer to buy any securities
other than the notes,” which are defined in the first paragraph of
the PPM as the Class A, B and C Notes, but not the Owner
Certificate. If the defendants were not bound by the PPM for
transactions other than the solicitation and sale of the Notes,
Wafra is not bound by the PPM’s non-reliance clause for the
solicitation and sale of the Owner Certificate.

Furthermore, in an analogous case, one court held that note
issuers could not disclaim their own authority to make
representations by stating that “[n]o dealer, salesperson or other
person has been authorized [by the note issuer} . . . to give any
information or to make any representation not contained in this
Offering Memorandum.” Gabriel Capital, L.P. v. Natwest Fin., Inc.,
94 F. Supp. 2d 491, 507 (S.D.N.Y. 2000). The Officers argue that
Gabriel Capital is distinguishable because the disclaimer there was
narrower than the disclaimer in the PPM, but that is not so. Both
clauses state that “no person” has been authorized to make
representations outside of the offering memorandum and that any

such representations cannot be relied upon. Here Wafra claims to

Owner Certificate, and it is not inconsistent with Wafra’s
additional allegations.

21


oh ae ala

KPMG issued the 1997 audit on March 27, 1998, Compl. 7 132,
six months before Prime approached Wafra about investing in the
1999 securitization, id. 4 69. KPMG may be liable under the
Accounting Act only if it knew that it was a primary intent of
Prime that “the particular person bringing the action” benefit from
KPMG’s services. KPMG argues that, because it did not know of
Wafra’s intent to invest when it prepared the 1997 Audit, it cannot
be liable. But the Accounting Act is silent about when the
accountant must know of the client’s intent for the plaintiff to
rely on the accountant’s work, The Illinois Appellate court has
held that, when an accountant prepares an audit for its client’s
benefit and is unaware of any particular investor that may rely on
the audit, the accountant may nevertheless be liable to third-party
investors for statements in the audit if it discovers later that
its audit was furnished to investors and if it verified the audit’s
accuracy to the particular plaintiff at that time. Brumley v.
Touche, Ross & Co., 487 N.E.2d 641, 644-45 (Ill. App. Ct. 1985).
Although Brumley was decided before the enactment of the Accounting
Act, “[a] legislative intent to abrogate the common law must be
clearly and plainly expressed, and such an intent will not be
presumed from ambiguous or doubtful language.” Maksimovic v.
Tsogalis, 687 N.E.2d 21, 24 (Ill. 1997). Because the Accounting Act
does not specifically say that an accountant must know of its

client’s intent at the time it provides its services, I do not read

38


the Act to alter the rule stated in Brumley. Thus Wafra’s
allegations that KPMG knew before the closing that Prime provided
its 1997 10-K (which included KPMG’s 1997 Audit) to Wafra, and that
Wafra was relying on it, Compl. 9171 70, 147(d), 164, are sufficient
to withstand a motion to dismiss. The motion to dismiss Count IX is
granted as to the claims based on the May 4, 1999, letter, but
denied as to the claims based on the 1997 audit.
C. Bischoff and B&S

wafra brings fraud and negligence claims based on B&S’s May 4,
1999, opinion letter, addressed to Wafra, in which B&S stated that
it had no information that would make any of the closing documents
inaccurate or incomplete. Compl. @ 88. The only objection to the
fraud claim is that, like the Rule 10b-5 claim, it was pleaded with
insufficient particularity, and I reject that argument for the
reasons stated above.

For an attorney to be liable to a third party for negligent
misrepresentation, the plaintiff must prove “that the intent of the
client to benefit the nonclient third party was the primary or
direct purpose of the transaction or relationship.” Pelham v.
Griesheimer, 440 N.E.2d 96, 99 (Ill. 1982). Bischoff and B&S argue
that Wafra cannot establish the existence of a duty, and that even
if it could, it should not be liable for its May 4, 1999, opinion
letter because it was merely an opinion. One Illinois court has

stated, in a case against a real estate broker, that “[o]rdinarily,

39


breach of fiduciary duty by alleging a failure to disclose a motive
to act contrary to shareholders’ interests.” Id. at 291. Panter
held that breach of a state duty, which presumably includes
contractual as well as fiduciary duties, or the failure to disclose
the breach of the duty is not actionable under Rule 10b-5 unless it
is also “manipulati[ve] or decepti[ve]” within the meaning of §
10(b), 15 U.S.C. § 78(j). Id. at 288.

State law remedies and relief under Rule 10b-5 are not
mutually exclusive. See Fry v. UAL Corp., 895 F. Supp. 1018, 1043
(N.D. Ill. 1995) (Castillo, J.) (“[{T]he mere fact that the conduct
complained of involves a breach of fiduciary duty does not, alone,
preclude a cognizable claim under the federal securities laws.”);
see also DeLeo v. Swirsky, No. 00 C 6917, 2001 WL 687458 (N.D. Ill.
June 19, 2001) (Andersen, J.) (“A plaintiff may bring a cause of
action under both state law and Section 10(b).”). Here Wafra
alleges not only that Prime breached the Indenture agreement by
compromising the lock-box mechanism through the kiting scheme, but
also that it used the kiting scheme to conceal its insolvency from
investors, Compl. 9 33, and that the PPM’s description of the lock-
box mechanism and Ehmann’s assurances on December 11, 1998, that
Prime would continue to be able to fund its flow of monthly
securitization payment were misleading because of the failure to
disclose the existence of the kiting scheme. These are sufficient

allegations of “manipulative or deceptive” conduct to bring Wafra’s

27


Placement Memorandum (“PPM”). The money in the lock-box account was
the property of the SPVs, not Prime, and was to be used for payment
on the notes issued by the SPVs.

However, as early as 1997, according to the complaint, Prime
was diverting and misappropriating rent payments belonging to the
SPVs by holding the funds for more than two days and commingling
the funds with its own. This resulted in shortfalls of money
required to be deposited in the lock-box account for the benefit of
the SPVs, so Prime allegedly kited misdirected funds from the next
month’s receipts to pay its investors, which created a shortfall
for the next month as well. Wafra alleges that the diversion and
misappropriation raises an inference that Prime was insolvent, and
that it hid this fact from investors by kiting misdirected payments
from the following month.

In May 1999, in the midst of this alleged scheme, Wafra
invested in the 1999 securitization. Wafra alleges that Prime’s
financial stability was critical to its ability to service the
contracts and ensure that investors received a full return on their
investments. According to the complaint, Prime’s financial failure
could only lead to a breakdown of the servicing arrangement and a
loss to the holders of notes issued by the SPVs. As of the closing
on May 4, 1999, Prime’s annual Form 10-K report for 1998 had not
been filed, so Wafra relied on financial information from the 1997

10-K and on representations of Prime’s financial health by various


B&S’s alleged role in the coverup. The defendants have the burden
of proving that the claims are time-barred, and they have not shown
what Wafra possibly could have done before June 9, 2000, to
discover the diversion, misappropriation and kiting scheme. Wafra’s
federal claims for securities fraud are not barred by the one-year
statute of limitations.
B. Statute of Repose

KPMG also argues that the three-year statute of repose bars
any claims based on KPMG’s 1997 Audit opinion, which was attached
to Prime’s 1997 10-K filing and provided to Wafra during
negotiations. In Lampf, the Supreme Court held that an action under
§ 10(b) and Rule 10b-5 must be commenced within three years after
the “violation.” 501 U.S. at 364. KPMG issued the 1997 Audit on
March 27, 1998, and Wafra filed the complaint on June 8, 2001, more
than three years later, so the only question is when the alleged
violation occurred for the purpose of the statute of repose: on the
date of the alleged misrepresentation or on the date of the sale?

In Lampf, the Supreme Court held that the plaintiff’s
complaint was untimely because it “was filed more than three years
after petitioner’s alleged misrepresentations.” Id. The Court also
noted that, to the extent “that the various l-and-3 periods
contained in the 1934 and 1933 Acts differ slightly in
terminology,” the governing standard for Rule 10b-5 actions came

from the language of § 9(e) of the 1934 Act, 15 U.S.C. 78i(e),

14


but there are cases on both sides of the debate. Since I decided
Kleban, two judges in this district have held that the statute of
repose begins to run with the misrepresentation. See Stauffer v.
Westmoreland Obstetric & Gynecologic Assocs., S.C., No. 00 C 1242,
2001 WL 585510, at *5 (N.D. Ill. May 25, 2001) (Moran, J.)
(holding, without analysis, that claims based on misrepresentations
made outside of the statute of repose were barred); Antell v.
Arthur Andersen LLP, No. 97 C 3456, 1998 WL 245878, at *6 (N.D.
Ill. May 4, 1998) (andersen, 3.) (same, with analysis); see also In
re the Prudential Ins. Co. of Am. Sales Practices Litig., 975 F.
Supp. 584, 603-04 (D.N.J. 1997) (same, with analysis). Other cases,
like my decision in Kleban, have equated a “violation” of Rule 10-
b5 with the accrual of a cause of action. See Otto v. Variable
Annuity Life Ins. Co., 816 F. Supp. 458, 461 & n.3 (N.D. Ill. 1992)
(Conlon, J.) (noting that “a violation of § 10(b) and Rule 10b-5 is
comprised not only of a misrepresentation or omission of material
facts, but also includes ‘the purchase or sale of any security’”).

In an intervening state tort case, the Seventh Circuit
considered two different formulations of the distinction between
statutes of repose and statutes of limitations, both of which

considered the accrual of the cause of action as unrelated to the

Cir. 2000). Section 77m, the first section cited, specifies that
the depose runs from “the sale.” Both § 78i(e) and § 25506 refer to
the “violation.” I do not conclude from this dictum that the
Seventh Circuit has conclusively held that the “violation” for the
purposes of Rule 10b-5 occurs at the time of “the sale.”

16


I.

Prime is a specialty finance company that originated and
serviced financial contracts including equipment leases, loans and
installment purchase agreements. From 1993 to 1999, Prime
securitized the financial contracts to raise capital. Wafra

invested in the 1999 securitization.

For all of the. securitizations, including the 1999
transaction, Prime formed special purpose vehicles (“SPVs”), to
which it transferred the financial contracts, and the SPVs would
issue and sell promissory notes to third parties using the
financial contracts as collateral, with an agreement that Prime

would continue to service the financial contracts. The

securitizations also required that the proceeds of the financial
contracts (“rent payments”) be used to make payments of principal
and interest on the notes issued by the SPVs. Under the
\
securitization documents, Prime, as the servicer, was authorized to
collect payments, and all rent payments were required to be
deposited in a “lock-box” account, kept separate from Prime’s
funds, and turned over to the securitization trustee within two
business days. Prime was required to instruct all payers on the
financial contracts to make payments directly to the lock~box
account, and if payments were misdirected to Prime, Prime was

required to turn them over to the lock-box account within two

business days. This procedure was described in the Private


interpretation.

KPMG argues that, even if Chestnut applies, and I hold that it
does, KPMG cannot be liable because, as to the 1997 audit, there
are no allegations that KPMG was aware that a primary intent of
Prime was that KPMG’s services benefit Wafra, and as to the May 4,
1999 Valuation Letter, the letter expressly limited the parties who
could rely on the letter and specifically excluded “those who have
not agreed to the procedures and taken responsibility for the
sufficiency of the procedures for their purposes.” KPMG’s Ex. A at
6. The May 4, 1999, valuation letter, addressed to Prime Leasing,
Prime Financial, and Merrill Lynch, states that: “(tjhis report is
intended solely for the use of the addressees and should not be
used by those who have not agreed to the procedures and taken
responsibility for the sufficiency of the procedures for their
purposes.” KPMG Ex. A at 6. Wafra argues that “[g]iven that KPMG
knew that Wafra intended to rely on the letter, it follows that
KPMG knew that Wafra did agree to and take responsibility for the
sufficiency of the procedures.” Resp. at 24. However, the letter
states that the addressees agreed to and took responsibility for
the procedures, and says nothing about Wafra, so no reasonable
reading of the letter shows that Wafra was intended to rely on it.
Under the plain language of § 30.1, KPMG limited its liability for
the May 4, 1999, letter to the addressees, and Wafra cannot state

a claim for negligent misrepresentation on this basis.

37


they commence speaking... .”). But Rule 10b-5 makes it unlawful
for any person to “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 the light of the circumstances under which they
were made, not misleading.” (emphasis added). The highlighted
portion demonstrates that a defendant is liable only for those
omissions that make his own statements misleading. Here KPMG
specifically disclaimed any opinion about the truth or reliability
of the information provided by Prime; it said that it had not
performed any procedures to verify the information in the schedules
provided by Prime. KPMG’s Ex. A at 3. Wafra does not point to any
specific statement by KPMG in the letter that was rendered
misleading, in light of its disclaimer of opinion, by KPMG’s
failure to disclose the kiting scheme. The mathematic procedures
performed by KPMG were subject to the express qualification that
KPMG had not verified the information provided by Prime. Wafra
apparently alleges that the 1998 audit violated Rule 10b-5 because
it recklessly turned a blind eye to Prime’s alleged diversion,
misappropriation and kiting, Compl. § 147, but that audit cannot
form the basis of a claim here because it was issued after the
closing. See Latigo Ventures v. Laventhol & Horwath, 876 F.2d 1322,
1326 (7th Cir. 1989) (Misrepresentation that post-dates sale cannot
form basis of Rule 10b-5 claim.).

To the extent that Wafra may be understood to argue that

25


IN THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION

WAFRA LEASING CORPORATION 1999-A-1,

|
|
Plaintiff,

v.

i
PRIME CAPITAL CORPORATION

LEASING CORPORATION, PRI
CORPORATION 1999-A~-1, P.

CORPORATION 1999-A-2, KPMG LLP,
BISCHOFF & SWABOWSKI, LTD., MARK

BISCHOFF, JAMES FRIEDMAN,
LANDECK,

Defendants.

|

THOMAS EHMANN, WILLIAM
SMITHBURG and JOHN WALTER,

poe

MA

&

ee
=
ay
sof

ED

002

a

aw

o
ny

, PRIME
FINANCE

ME FINANCE No. 01 C 4314

VERN

MEMORANDUM OPINION AND ORDER

Wafra Leasing Co.

securitization of financi
and Prime Leasing corps
investment went bad. Waf
and directors, as well

Bischoff & Swabowski (“B

rporation (“Wafra”) invested in a

al contracts by Prime Capital Corporation

ration (collectively “Prime”), and its

a sued Prime and several of its officers

as KPMG L.L.P., Prime’s auditor, and

S”), its attorneys, for securities fraud

under § 10(b) and § 20(a) of the Securities Exchange Act of 1934,
15 U.S.C. §§ 78} (b), 78t(a), Securities and Exchange Commission
Rule 10b-5, 17 C.F.R. §, 240.10b-5, and several state causes of

action. The Prime defend
Bischoff and B&S,

dismiss Wafra’s complain

ants answered the complaint. KPMG, Mark

and Thomas Ehmann and Vern Landeck move to

t. I grant the motions in part and deny

them in part.


only to paragraph 73, which contains allegations against Prime and
Landeck, and not to any of the allegations against Bischoff and
B&S, which say that B&S, at the direction of and through the
actions of Bischoff (“who”), issued the May 4, 1999, opinion letter
by B&S (“when” and “what”) at the closing (“where”), and that
Bischoff knew of the diversion and kiting scheme, so Bischoff and
B&S knew that the PPM, on which they knew Wafra would rely, was
false and misleading, but they said that they were not aware of
anything that would suggests that Prime’s documents were misleading
(“how”). Compl. 99 84, 87-94. This satisfies Rule 9(b).

The PSLRA adds pleading requirements, in addition to those in
Rule 9(b), for securities fraud actions. Bischoff and B&S do not
identify how the allegations fail to comply with § 78u-4(b), so
they have waived any argument on that basis. See Commodity Futures
Trading Comm'n v. Tokheim, 153 F.3d 474, 476 n.3 (7th Cir. 1998)
(Perfunctory and undeveloped arguments are waived.). To the extent
that I understand their argument to be that Wafra failed to “state
with particularity facts giving rise to a strong inference that the
defendant acted with [scienter],” the complaint alleges that
Landeck told Wafra’s president that Bischoff, in his position as an
officer of Prime, “was aware of and controlled” the diversion and
misappropriation scheme. Compl. @ 62. This is sufficient to allege
that Bischoff’s and B&S’s statement that they were aware of nothing

that would suggest that Prime’s documents were inaccurate or

33


claim under the ambit of Rule 10b-5. See Fry, 895 F. Supp. at 1043-
44,
E. “Control Person” Liability
Ehmann asks to be dismissed from this case because he claims
he was not a “control person” for the purposes of § 20(a) at the
time of the alleged Rule 10b-5 violation, but his claim directly
contradicts the allegations of Wafra’s complaint. See Compl. J 16
(“At all times relevant to this complaint, Defendant Thomas Ehmann
. was Vice President, Finance _ - [and] a ‘control person’ of
Prime Capital . . . .”). Ehmann says that he resigned from his
position as an officer Prime on December 21, 1998, and he asks me
to take judicial notice of Prime’s April 30, 1998, and June 17,
1999, proxy statements filed with the SEC.® The 1998 proxy
statement lists Ehmann as an officer, and the 1999 statement does
not; Ehmann offers this as evidence that he ceased to be an officer
and became a mere employee in December 1998. However, the proxy
statements do not actually state when Ehmann resigned the vice
presidency; drawing all inferences in favor of Wafra, as I must for
the purposes of this motion, the most they show is that Ehmann was
not an officer as of June 17, 1999, after all of the relevant

allegations in the complaint.

® Under Fed. R. Evid. 201(d), I must take judicial notice if
requested by a party and supplied with the necessary information.
The proxy statements are public records, so I may consider them
without converting the motion to one for summary judgment. Henson
v. CSC Credit Servs., 29 F.3d 280, 284 (7th Cir. 1994).

28


seen 3; een: SoS

|
Prime Capital’s Diversion and Misappropriation scheme and that
this scheme went back at least as far as 1997.
|

Id. Wafra argues that, KPMG’s statement that the funds were
transferred late was ' sintentionally opaque,” “obscure” and
“ambiguous” rather than “simple, plain language that a reasonable
investor can understand.” Resp. at 6-7 (citing McCool v. Strata
Oil Co., 972 F.2d 1452, 1463 (7th Cir. 1992)).

Note 4 says that payments that should have been transferred in
1998 were not clanatereah until 1999. Wafra alleges that any such
“misdirected payments” were to be transferred to the lock-box
account within two business days, Compl. 9 23, so a statement that
more than $3.5 million (an amount slightly more than the loss
claimed by Wafra here) in misdirected rent payments had not been
properly deposited might have alerted investors to some accounting
irregularities, or to the possibility that Prime had made some
misleading assurances about the proper operation of the lock-box
account. In a fraud case, however, a plaintiff needs to know more
than just that the defendant made a false statement (or misleading
omission) before the statute of limitations begins to run: a
plaintiff needs to know “that the defendant has made a
representation that was knowingly false.” Law, 113 F.3d at 786
(emphasis in original). Mere suspicion is not enough, but
“{s]luspicious circumstances, coupled with ease of discovering,

without the use of legal process, whether the suspicion is well

grounded, may cause the statute of limitations to start to run

12


which refers to a “violation.” See id. at 364 n.9. Cf. 15 U.S.C. §
78xr(c) (statute of repose runs from date when “cause of action
accrued”); 15 U.S.C. § 77m (statute of repose runs from date of
“the sale”). I previously considered these portions of the Lampf
opinion, but concluded nevertheless that, because a “violation”
requires a purchase or sale of a security, the three-year statute
of repose runs from the date of the sale. See Kleban v. S.Y.S.
Restaurant Mgmt., Inc., 912 F. Supp 361, 367 (N.D. Ill. 1995)
(Bucklo, J.). Wafra relies on Kleban, and on the Seventh Circuit’s
opinions in McCool v. Strata Oil Co., 972 F.2d 1452 (7th Cir.
1992),° and Ferguson v. Roberts, 11 F.3d 696 (7th Cir. 1993), in
support of its argument that the repose period does not begin until
the sale, when the cause of action accrues. McCool and Ferguson
were both decided under § 27A, 15 U.S.C. § 78aa-1, which required
application of pre-Lampf standards, and discussed state statutes,
so neither case is dispositive here.

The Seventh Circuit has not decided, since Lampf, what the

“triggering event” for the statute of repose in § 10(b) claims is,‘

? Although I recently cited to McCool for the proposition that
a repose period runs from the date of sale, that case arose under
§ 15(a) (1), 29 U.S.C. § 780(a) (1), which prohibits the sale of a
security unless a broker is registered with the SEC, not under Rule
10b-5. Celsion Corp. v. Stearns Mgmt. Corp., 157 F. Supp. 2d 942,
949 (N.D. Ill. 2001).

‘ The Seventh Circuit has noted, in dictum, that a statute of
repose “runs from some fixed date such as the date on which the
security was purchased. E.g., 15 U.S.C. §$§ 77m, 78i(e); Cal Corp.
Code § 25506.” J.E. Liss & Co. v. Levin, 201 F.3d 848, 850 (7th

15