Cape Ann Investors v. Lepone

United States Court of Appeals
For the First Circuit

No. 01-2622

JAMES R. YOUNG, AS TRUSTEE OF THE NUTRAMAX LITIGATION TRUST,
Plaintiff, Appellant,

v.

DONALD E. LEPONE ET AL.,
Defendants, Appellees.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Richard G. Stearns, U.S. District Judge]

Before

Boudin, Chief Judge,

Selya, Circuit Judge,

and Greenberg,* Senior Circuit Judge.

David C. Frederick, with whom Mark C. Hansen, Silvija A.
Strikis, Leo R. Tsao, Kellogg, Huber, Hansen, Todd & Evans,
P.L.L.C., Robert M. Thomas, Jr., and Thomas & Associates were on
brief, for appellant.
Thomas J. Dougherty, with whom David S. Clancy, Kara E. Fay,
and Skadden, Arps, Slate, Meagher & Flom LLP were on brief, for
appellee Deloitte & Touche LLP.

September 10, 2002

_______________
*Of the Third Circuit, sitting by designation.
 SELYA, Circuit Judge. We confront here two intricate

variations on a standard theme — the invocation of a limitations

defense to federal securities claims. The general scenario is

distressingly familiar: shareholders of a publicly-held company

allege that the corporate officers systematically inflated

earnings, concealed losses, and treated the company's books as

works of fiction. The shareholders further allege that their

natural guardians — the company's outside accountants — perpetuated

this massive fraud through perfunctory audits and certified

financial statements that they knew (or consciously avoided

knowing) were materially false and misleading.

The district court ruled that all the federal securities

claims were barred by the applicable one-year statute of

limitations. See Cape Ann Investors, LLC v. Lepone, 171 F. Supp.

2d 22 (D. Mass. 2001). We conclude that this ruling is partially

correct and partially incorrect. As to the federal securities

claim asserted by the original plaintiff, the primary issue is

whether management letters from the accounting firm effectively

placed this plaintiff (an investor who held a seat on the company's

board of directors and the audit committee) on inquiry notice of

possible fraud. Given our inability to resolve that highly nuanced

issue based solely on the face of the amended complaint, we vacate

the lower court's order of dismissal in pertinent part and remand

for further proceedings. As to the later-filed claims asserted by

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the remaining shareholders, we reach a different result. Because

those plaintiffs (and their claims) lacked a sufficient identity of

interest with the original complainant (and its claims), Federal

Rule of Civil Procedure 15(c)(3) does not apply; the claims are not

entitled to relate back to the date when the suit was first filed;

and, accordingly, the claims are time-barred. We therefore affirm

that portion of the district court's ukase.

I. BACKGROUND

We glean the facts from the amended complaint, stripped

of any rhetorical gloss. Aulson v. Blanchard, 83 F.3d 1, 3 (1st

Cir. 1996). We then trace the travel of the case and offer a

roadmap for our exploration of the instant appeal.

A. The Facts.

At the times relevant hereto, NutraMax Products, Inc.

("NutraMax" or "the company") was a Delaware corporation that

maintained its principal offices in Gloucester, Massachusetts. The

company's shares were traded on the NASDAQ stock exchange. Donald

E. Lepone served as its chief executive officer, Robert F. Burns as

its chief financial officer, and Noreen Gottfredsen as its

controller.

NutraMax's fiscal year ran from October 1 through

September 30. Like all publicly-held corporations, it issued

annual financial statements within ninety days after the close of

each fiscal year. For each of the years here in question – 1996,

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1997, and 1998 – it represented that these financial statements

were prepared in accordance with generally accepted accounting

principles ("GAAP").1 The company's independent auditor, Deloitte

& Touche LLP ("Deloitte"), placed its imprimatur on each of these

financial statements. In so doing, Deloitte expressly certified

that: (1) it had conducted its audit in accordance with generally

accepted auditing standards ("GAAS");2 (2) NutraMax's financial

statements had been prepared in accordance with GAAP and fairly

presented the company's financial position and operational results

in all material respects; and (3) Deloitte could provide reasonable

assurances, based on its audits, that the financial statements

contained no material misrepresentations.

In connection with its presentation of audited financial

statements, Deloitte wrote an annual "management letter" to the

audit committee designated by NutraMax's board of directors. Those

letters contained comments that Deloitte deemed pertinent to

management's assessment of the financial condition of the company

1
The GAAP rules embody the prevailing principles, conventions,
and procedures defined by the accounting industry from time to
time. See Sanders v. Jackson, 209 F.3d 998, 1001 n.3 (7th Cir.
2000) (citing American Institute of Certified Public Accountants,
Statement of Auditing Standards No. 69, ¶ 69.02 (1992)).
2
The GAAS compilation consists of general criteria relating to
the inquiry undertaken, and the judgments exercised, by the auditor
in the performance of its examination and the issuance of its
report. In Deloitte's own words, these standards "require that
[the auditor] plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement."

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and the reliability of its accounting systems. In the management

letter submitted under date of November 28, 1997, Deloitte

concluded that certain deficiencies in the company's internal

control structure constituted "reportable conditions."3

Specifically, that letter highlighted a number of weaknesses in

NutraMax's inventory control and valuation procedures, identified

a $291,000 variance in an inventory account, pointed out under-

accruals of various expenses, and noted that the company had failed

to earmark adequate reserves for bad debts. Deloitte nonetheless

certified the 1997 financial statements without any substantial

qualification. Much the same pas de deux occurred the following

year. On November 24, 1998, Deloitte wrote to NutraMax's audit

committee identifying reportable conditions involving inventory

control and valuation, but proceeded to certify the company's

financial statements for fiscal 1998 without substantial

3
A reportable condition is generally regarded as a weakness in
the design or operation of the internal control structure that, in
the auditor's judgment, reflects a significant shortcoming that
"could adversely affect the organization's ability to record,
process, summarize, and report financial data consistent with the
assertions of management in the financial statements." Monroe v.
Hughes, 31 F.3d 772, 774 (9th Cir. 1994) (quoting American
Institute of Certified Professional Accountants, Professional
Standards (CCH), AU § 325.02). This squares with Deloitte's 1997
and 1998 management letters, each of which states that
"[r]eportable conditions involve matters coming to our attention
relating to significant deficiencies in the design or operation of
the internal control structure that, in our judgment, could
adversely affect the Company's ability to record, process,
summarize, and report financial data consistent with the assertions
of management in the consolidated financial statements."

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qualification. On both occasions, Deloitte's representatives

assured the audit committee that the reportable conditions did not

denote material weaknesses in NutraMax's reporting systems (and,

therefore, did not pose a significant risk of skewing the company's

financial statements). Moreover, Deloitte assured the audit

committee that, "as required by GAAS," its audit for each of these

years "would provide reasonable assurance of detecting

irregularities or illegal acts by NutraMax management and

employees."

In 1999, NutraMax's board of directors installed a new

chief operating officer ("COO"). It did not take him long to note

glaring inadequacies in the company's accounting procedures and

internal controls. Suspecting that the books and records contained

serious irregularities, the COO recommended that the board engage

outside counsel to conduct a full investigation into the company's

accounting records, systems, and procedures. The board complied,

and the law firm designated by the board engaged a team of forensic

accountants. In the spring or summer of 1999 – the amended

complaint is vague as to the exact timing – the investigators

concluded that NutraMax's management had failed to write down

worthless inventory, improperly accrued expenses, booked bogus

journal entries, and incorrectly adjusted the accrual dates on

various receivables. As a result, a myriad of accounts required

multimillion dollar adjustments.

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 The denouement occurred on August 18, 1999, when NutraMax

publicly announced that it had (1) ousted Lepone and Burns, (2)

delayed the release of an earnings report for the third quarter,

and (3) decided that it would be necessary to restate its

financials for certain previous years. In the wake of this

announcement, the price of NutraMax's common stock plummeted.

NutraMax subsequently wrote down its assets by over $75,000,000 and

restated its net worth from a positive figure of $21,200,000 to a

negative figure of $46,600,000. On October 15, 1999, NASDAQ

delisted the company. On November 12, 1999, Deloitte withdrew its

audit reports for the 1996, 1997, and 1998 fiscal years.4 Less

than six months later, NutraMax filed for bankruptcy protection

under Chapter 11. See 11 U.S.C. §§ 1101-1174.

B. The Proceedings Below.

On August 1, 2000, Cape Ann Investors, LLC ("Cape Ann"),

a major NutraMax shareholder, sued Lepone, Burns, Gottfredsen, and

Deloitte in the United States District Court for the District of

Massachusetts. Cape Ann's complaint charged that the three former

officers had systematically falsified NutraMax's financial

statements by inflating earnings, refusing to write off outdated

inventory, and manipulating the company's accounting records to

misrepresent its financial performance and condition. The

4
Although the amended complaint is inexplicit as to the date
when NutraMax and Deloitte parted company, it is apparent that the
separation occurred prior to this date.

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complaint further charged that Deloitte had facilitated the former

officers' fraudulent misconduct by conducting perfunctory audits of

the company's finances — audits that fell far short of GAAS. Cape

Ann alleged that the defendants' malfeasance violated both federal

securities law, see Securities Exchange Act of 1934, 15 U.S.C. §

78j; SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, and state law.

At this point, we shift our focus momentarily to

NutraMax's Chapter 11 reorganization. In the course of that

proceeding — which is pending in Delaware — the bankruptcy court

established the NutraMax Litigation Trust ("the Trust"). The Trust

became the assignee of several sets of claims. Only one such set

is of interest here: all claims by persons who held NutraMax

common stock prior to the bankruptcy filing and who either voted to

approve the reorganization plan or elected thereafter to assign

their claims to the Trust. By voting in favor of the

reorganization plan, Cape Ann became a participant in the Trust.

Since Cape Ann's position is distinct from that of the other

shareholders who have assigned their rights to the Trust, we

emulate the district court, see Cape Ann, 171 F. Supp. 2d at 23-24,

and refer to Cape Ann by name while referring to the other electing

shareholders as the "new plaintiffs."

On March 9, 2001, the Trust filed an amended complaint

that, inter alia, sought to substitute the Trust for Cape Ann as

the named plaintiff in the securities fraud action and to add

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claims assigned to it by the new plaintiffs.5 Deloitte moved to

dismiss the amended complaint, asserting, inter alia, that the

federal securities claims were time-barred by the applicable one-

year statute of limitations. Following briefing and oral argument,

the district court granted the motion. Id. at 27-28.

The district court's decision sets the stage for our

discussion of the issues on appeal. To begin with, the court

recognized that Cape Ann's claims and the new plaintiffs' claims

had to be analyzed differently. Turning first to Cape Ann, the

court emphasized that, unlike an ordinary investor, it had a

presence on the company's board of directors and audit committee

during 1997 and 1998. On this basis, the court concluded that a

reasonable director in Cape Ann's shoes (i.e., a director who had

received Deloitte's 1997 and 1998 management letters) would have

realized the need for an immediate investigation "if not in 1997,

certainly by 1998." Id. at 27. Based on this conclusion, the

court ruled that Cape Ann (which had not brought suit until August

1, 2000) had missed the one-year statute of limitations vis-à-vis

its federal securities claim. Id. at 28.

Turning to the federal securities claims brought by the

new plaintiffs, the district court rejected the Trust's argument

5
These included various state-law claims that have no bearing
on this appeal. We refrain from any discussion of those claims.
We likewise refrain from any mention of other persons (e.g.,
creditors) who assigned claims to the Trust.

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that those claims related back to the date on which Cape Ann had

filed the original complaint. Id. at 28-30. Apparently concluding

that the limitations period for the new plaintiffs began to run no

later than November 12, 1999 (the date on which Deloitte withdrew

its audit reports), the court determined that these claims, first

asserted on March 9, 2001, had emerged too late. Id. at 30.

Having found all the federal claims time-barred, the court declined

to exercise supplemental jurisdiction over the remaining state-law

claims, see supra note 5, and dismissed those claims without

prejudice to their renewal in an appropriate forum. This timely

appeal ensued.

C. The Anatomy of the Appeal.

Although this appeal originally encompassed all the

federal securities claims, the former officers recently bought

their peace, and we approved a stipulation dismissing the case as

to them. See Fed. R. App. P. 42(b). Consequently, the appeal

proceeds only with respect to the remaining defendant (Deloitte).

In the pages that follow, we examine whether the district

court erred in assessing the timeliness of the plaintiffs' federal

securities claims against Deloitte. Because the district court

dismissed the claims pursuant to Rule 12(b)(6) of the Federal Rules

of Civil Procedure, we afford plenary review, giving credence to

all well-pleaded factual averments limned in the amended complaint

and indulging all reasonable inferences therefrom in the

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plaintiffs' favor. Aulson, 83 F.3d at 3. "If the facts contained

in the complaint, viewed in this favorable light, justify recovery

under any applicable legal theory, we must set aside the order of

dismissal." SEC v. SG Ltd., 265 F.3d 42, 46 (1st Cir. 2001).

Where, as here, an order of dismissal is predicated on the statute

of limitations, we will affirm only if "the pleader's allegations

leave no doubt that an asserted claim is time-barred." LaChappelle

v. Berkshire Life Ins. Co., 142 F.3d 507, 509 (1st Cir. 1998).

II. THE LEGAL LANDSCAPE

Rule 10b-5 claims "must be commenced within one year

after the discovery of the facts constituting the violation and

within three years after such violation." Lampf, Pleva, Lipkind,

Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 364 (1991). In this

case, Deloitte concedes that suit was brought within three years of

the alleged violation. Our focus, then, is on the date of

discovery.

With respect to a Rule 10b-5 violation that involves

fraudulent concealment, the one-year interval does not begin to run

"until the time when the plaintiff in the exercise of reasonable

diligence discovered or should have discovered the fraud of which

he complains." Cooperativa de Ahorro y Credito Aguada v. Kidder,

Peabody & Co., 129 F.3d 222, 224 (1st Cir. 1997) (citations and

internal quotation marks omitted). This formulation is not self-

executing, and the circumstances of each case must be explored

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independently. When telltale warning signs augur that fraud is

afoot, however, such signs, if sufficiently portentous, may as a

matter of law be deemed to alert a reasonable investor to the

possibility of fraudulent conduct. See Mathews v. Kidder, Peabody

& Co., 260 F.3d 239, 251 n.15 (3d Cir. 2001) (collecting cases).

We have dubbed such signs "storm warnings," and have

established a two-part process for handling a defendant's claim

that such precursors should have sufficed to put investors on

inquiry notice. Maggio v. Gerard Freezer & Ice Co., 824 F.2d 123,

128 (1st Cir. 1987). The first step in the pavane requires a

reviewing court to ascertain whether, when, and to what extent,

storm warnings actually existed in a given situation. Because

sufficient storm warnings would lead a reasonable investor to check

carefully into the possibility of fraud, this step necessarily

entails a determination as to whether a harbinger, or series of

harbingers, should have alerted a similarly situated investor that

fraud was in the wind. Id. The next step requires the court to

assay whether, once sufficient storm warnings were apparent, the

investor probed the matter in a reasonably diligent manner. Id.

This issue lends itself to a more individualized inquiry — an

inquiry that focuses on the particulars of each investor's

situation. See id.

When the defendant in a securities fraud case pleads the

statute of limitations as an affirmative defense, the plaintiff

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normally has the burden of pleading and proving facts demonstrating

the timeliness of her action. See Gen. Builders Supply Co. v.

River Hill Coal Venture, 796 F.2d 8, 11-12 (1st Cir. 1986); Cook v.

Avien, 573 F.2d 685, 695 (1st Cir. 1978). If, however, a defendant

seeks to truncate the limitations period by claiming that the

plaintiff had advance notice of the fraud through the incidence of

storm warnings, then the defendant bears the initial burden of

establishing the existence of such warnings. Mathews, 260 F.3d at

252. Only if the defendant succeeds in this endeavor must the

plaintiff counter with a showing that she fulfilled her

corresponding duty of making a reasonably diligent inquiry into the

possibility of fraudulent activity. Maggio, 824 F.2d at 128.

As this discussion makes plain, the existence vel non of

storm warnings has important ramifications for determining when the

statute of limitations in a Rule 10b-5 case begins to run. The

multifaceted question of whether storm warnings were apparent

involves issues of fact. Id. In the archetypical case, therefore,

it is for the factfinder to determine whether a particular

collection of data was sufficiently aposematic to place an investor

on inquiry notice. Marks v. CDW Computer Ctrs., Inc., 122 F.3d

363, 368-69 (7th Cir. 1997); see also Gen. Builders, 796 F.2d at 12

(emphasizing that this sort of factual question may be determined

as a matter of law only when the underlying facts are either

admitted or undisputed). So too the related question of whether a

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particular plaintiff exercised reasonable diligence in the face of

such warnings. Maggio, 824 F.2d at 128; Kennedy v. Josephthal &

Co., 814 F.2d 798, 803 (1st Cir. 1987).

There is one lingering question. In Cooperativa, we left

open the question of whether the statute of limitations begins to

accrue on the date that sufficient storm warnings first appear or

the later date on which an investor, alerted by storm warnings and

thereafter exercising reasonable diligence, would have discovered

the fraud. 129 F.3d at 225. In the case at hand, this difference

is potentially meaningful. We turn, then, to that question.

A number of considerations drive us to choose the latter

answer. First, we believe that the purpose of the discovery rule

is to afford a suitable degree of protection to plaintiffs who have

exercised reasonable diligence consistent with the information

available to them. Depending on the individual circumstances, a

reasonably diligent investigation following the receipt of storm

warnings may consume as little as a few days or as much as a few

years to get to the bottom of the matter. Given the wide range of

possibilities, we think it is fair that the one-year limitations

period begin to accrue only at the point when the Rule 10b-5

violation reasonably could have been discovered.

Second, and perhaps more importantly, we look to the

principles underlying the one-year limitations period. As the

Tenth Circuit noted in Sterlin v. Biomune Sys., Inc., 154 F.3d

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1191, 1202 (10th Cir. 1998), the proper administration of a

discovery rule must strike a delicate balance between the staunch

federal interest in requiring plaintiffs to bring suit promptly

once they have been apprised of their claims (thus securing repose

for deserving defendants) and the equally strong interest in not

driving plaintiffs to bring suit prematurely, that is, before they

are able, in the exercise of reasonable diligence, to discover the

facts necessary to support their claims. It makes no more sense to

reconcile this balance in a way that causes the one-year

limitations period to begin to run before a reasonably diligent

investor has had an adequate opportunity to discover the facts

underlying the alleged fraud than it would to reconcile it in a way

that allows an investor to dawdle endlessly after sufficient storm

warnings are apparent. In the end, a limitations period that

begins when a plaintiff reasonably should have discovered the fraud

treats both plaintiffs and defendants even-handedly.

This interpretation of the limitations standard has

metamorphosed into the majority view. See, e.g., Rothman v.

Gregor, 220 F.3d 81, 97-98 (2d Cir. 2000); Morton's Mkt. Inc. v.

Gustafson's Dairy, Inc., 198 F.3d 823, 836 (11th Cir. 1999);

Sterlin, 154 F.3d at 1201; Marks, 122 F.3d at 368; Byelick v.

Vivadelli, 79 F. Supp. 2d 610, 619 (E.D. Va. 1999); see also Berry

v. Valence Tech., Inc., 175 F.3d 699, 704 (9th Cir. 1999)

(predicting that the Ninth Circuit, were it to adopt the inquiry

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notice rule, would subscribe to the Sterlin court's approach).6

This consensus has become particularly evident since Lampf. In

etching the bounds of the one-year limitations period, the Lampf

Court explained that equitable tolling is both "unnecessary" and

"fundamentally inconsistent" with the one-year limit because this

period, "by its terms, begins after discovery of the facts

constituting the violation." 501 U.S. at 363. From this, we can

extrapolate a standard that starts the limitations clock only when

a plaintiff, in the exercise of reasonable diligence, should have

discovered her cause of action. Accord Sterlin, 154 F.3d at 1202.

We hold, therefore, that following the receipt of sufficient storm

warnings, a plaintiff's cause of action is deemed to accrue on the

date when, exercising reasonable diligence, she would have

unearthed the fraud.

III. THE ORIGINAL CLAIM

We now determine where Cape Ann's federal securities

claim falls in this taxonomy. The critical date is August 1, 1999

— one year before Cape Ann brought suit. The question, then, is

6
Even though we declined in Cooperativa to discrepate between
the date that storm warnings first appeared and the date that a
reasonably diligent investor would have discovered the fraud, 129
F.3d at 225, we wrote in Maggio that "storm warnings of the
possibility of fraud trigger a plaintiff's duty to investigate in
a reasonably diligent manner . . . and his cause of action is
deemed to accrue on the date when he should have discovered the
alleged fraud." 824 F.2d at 128 (emphasis in original; citation
and internal quotation marks omitted). That dictum correctly
anticipated the rule that we adopt today.

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whether it can be said, as a matter of law, that Cape Ann should

have discovered the fraud before that date.

The district court apparently concluded — we say

"apparently" because the court's opinion is not explicit on this

point — that the sequential 1997 and 1998 management letters

amounted to sufficient storm warnings, and, therefore, put Cape Ann

on inquiry notice of the alleged fraud no later than November of

1998. Cape Ann, 171 F. Supp. 2d at 27-28. Noting that the

management letters were directed to the audit committee of the

NutraMax board, and that a Cape Ann representative held a seat on

that committee, the court reasoned that those letters should have

led Cape Ann, as a fiduciary of NutraMax, to recognize the need for

an immediate investigation (which, the court surmised, would have

uncovered the fraudulent scheme). Id. We test this hypothesis.

Distilled to bare essence, Deloitte can prevail at this

procedural stage only if the trial court properly concluded that

the management letters amounted to storm warnings for a shareholder

who (like Cape Ann) held a seat on the company's board of directors

and audit committee; that Cape Ann failed to exercise reasonable

diligence in the face of those portents; and that, had Cape Ann

investigated, it would have discovered the fraud prior to August 1,

1999.

The fate of a motion to dismiss under Rule 12(b)(6)

ordinarily depends on the allegations contained within the four

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corners of the plaintiff's complaint. Here, however, the

management letters were neither attached to the amended complaint

nor incorporated by reference therein. We nonetheless conclude

that it was proper for the trial court to consider those letters in

ruling on Deloitte's motion to dismiss.

The key fact is that the amended complaint contained

extensive excerpts from, and references to, these letters. When

the factual allegations of a complaint revolve around a document

whose authenticity is unchallenged, "that document effectively

merges into the pleadings and the trial court can review it in

deciding a motion to dismiss under Rule 12(b)(6)." Beddall v.

State St. Bank & Trust Co., 137 F.3d 12, 17 (1st Cir. 1998); see

also 2 James Wm. Moore et al., Moore's Federal Practice ¶ 12.34[2]

(3d ed. 1997) (explaining that courts may consider "[u]ndisputed

documents alleged or referenced in the complaint" in deciding a

motion to dismiss). Both sides agree that this principle is

controlling here.

The significance of this ruling is readily apparent. It

is undisputed that Cape Ann held a seat on NutraMax's audit

committee, and that Deloitte addressed the management letters to

that committee. On that basis, the district court correctly

assumed, for the purposes of its Rule 12(b)(6) analysis, that Cape

Ann knew or should have known about this correspondence. It

follows logically that the substance of those missives may be

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incorporated into the objective prong of the Maggio test. Cf.

Constructora Maza, Inc. v. Banco de Ponce, 616 F.2d 573, 578-79

(1st Cir. 1980) (incorporating facts known to or ascertainable by

creditor into resolution of objective "prudent business person"

standard). This leaves us with the following legal question:

Would Deloitte's management letters necessarily have placed a

reasonable investor on inquiry notice concerning the possibility of

fraud?

For present purposes, the import of the management

letters lies in the reportable conditions identified therein, but

those references cannot be considered in a vacuum. There are

countervailing considerations here. In the first place, the

letters themselves contained specific reassurances that the

reportable conditions did not represent material weaknesses in the

company's reporting systems. In the second place, Deloitte gave

NutraMax a clean bill of financial health notwithstanding the

contents of the management letters: it certified NutraMax's 1997

and 1998 consolidated financial statements without any significant

qualification. And, finally, the amended complaint alleges that

Deloitte provided Cape Ann with independent assurances that tended

to palliate the import of the reportable conditions. For example,

the amended complaint alleges that Deloitte offered reassurances

that it had adjusted each of its audits "to respond to the risks"

posed by the problems it had discovered in NutraMax's internal

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controls. Moreover, Deloitte represented that, in addition to

providing reasonable assurances of detecting irregularities and

illegal acts, its audits had "focus[ed] on areas that were material

to NutraMax's consolidated financial statements, even if those

areas were not considered to be high risk." The complaint further

alleges that after Deloitte issued its 1998 management letter, Cape

Ann's representative asked Deloitte point-blank whether the letter

raised any cause for concern and was assured that it did not.

Given this steady stream of comforting words, we are not persuaded

that the management letters necessarily placed Cape Ann on inquiry

notice of the possibility that fraud was afoot.

It is, of course, true that Cape Ann, qua fiduciary,

received other unsettling information between November of 1998 and

August of 1999 (e.g., the COO's discoveries and the board's

decision to engage outside counsel and authorize a forensic audit).

But on the present record, we are unable to say with the requisite

level of certainty that the newly appointed COO had discovered the

fraud and so advised the board by the end of July 1999 (even though

the amended complaint acknowledges that the fraud had been

uncovered by mid-1999). And, moreover, to the extent that these

developments may have comprised storm warnings, they simultaneously

put Cape Ann on notice that a thorough investigation was in

progress. Cape Ann hardly can be faulted, as a matter of law, for

awaiting the results of that investigation before jumping to the

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conclusion that management was cooking the books. Cf. Jarrett v.

Kassel, 972 F.2d 1415, 1424-28 (6th Cir. 1992) (allowing plaintiffs

benefit of reasonably diligent investigation conducted on behalf of

another); Jensen v. Snellings, 841 F.2d 600, 608 (5th Cir. 1988)

(suggesting that limitations period did not begin to accrue until

plaintiffs received results of investigation). In short, the

complaint, on its face, permits the inference that NutraMax's board

neither knew of nor fully appreciated the true state of NutraMax's

finances, much less Deloitte's role in the situation, until after

August 1, 1999.

We also reject the district court's conclusion that, as

a matter of law, Cape Ann failed to exercise reasonable diligence.

While the fact that an investor is a director and a member of the

company's audit committee is plainly relevant to an evaluation of

the investor's diligence, fiduciary status, in and of itself, is

not dispositive of the reasonable diligence issue:

While the existence of a fiduciary
relationship is one factor which a court
should consider in determining whether the
plaintiff has exerted due diligence, a mere
allegation that such a fiduciary relationship
existed is not necessarily determinative. We
must also consider other factors, including
the nature of the fraud alleged, the
opportunity to discover the fraud, and the
subsequent actions of the defendants.

Gen. Builders, 796 F.2d at 12; accord Rowe v. Marietta Corp., 955

F. Supp. 836, 842-43 (W.D. Tenn. 1997) (rejecting summary judgment

predicated, in part, on plaintiff's status as a director and his

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receipt of storm warnings in that capacity). We hold, therefore,

that Cape Ann's status as a fiduciary does not justify an

irresistible inference that it acted in willful disregard of a

known risk. From the information contained in the amended

complaint, it is a jury question as to whether Cape Ann acted with

reasonable diligence.7

Drawing all reasonable inferences in Cape Ann's favor, we

do not think that a court could conclude, on the bare bones of the

amended complaint, either that the management letters amounted to

storm warnings or that those communications inexorably placed Cape

Ann on inquiry notice. By like token, it cannot be said, as a

matter of law, that Cape Ann failed to exercise diligence

commensurate with its knowledge. Given these conclusions, we must

vacate the order of dismissal insofar as that order pertains to

Cape Ann's Rule 10b-5 claim.8 See, e.g., Rothman, 220 F.3d at 96-

98; Marks, 122 F.3d at 368-69; Olcott v. Del. Flood Co., 76 F.3d

1538, 1549 (10th Cir. 1996). We fully appreciate that this is a

7
We recognize that pretrial discovery, not yet conducted, may
change the picture. Consequently, we express no opinion as to
whether summary judgment may be in order on a better-developed
record.
8
In reaching a contrary conclusion, the district court relied
heavily on Hathaway v. Huntley, 188 N.E. 616 (Mass. 1933).
Hathaway, however, arose in a markedly different procedural
posture: the case had been referred to a master, who made
extensive factual findings. Id. at 617. The Hathaway court relied
on those findings in concluding that the defendant-director had
failed to exercise reasonable diligence. Id.

-22-
close case on the facts, but we review a Rule 12(b)(6) disposition

de novo — and in this instance we do not think that the amended

complaint itself offers a sufficient basis for dismissal.

We add two brief observations designed to assist the

district court on remand. First, we note that Deloitte has

questioned whether Cape Ann's federal securities claim should be

dismissed on the ground that the allegations set forth in the

amended complaint were insufficiently specific. The district court

did not address this asseveration, and we take no view of it.

We also note that courts generally refer to the law of

the state of incorporation, rather than the law of the forum state,

to determine the duties of corporate directors. 1 William E.

Knepper & Dan A. Bailey, Liability of Corporate Officers &

Directors § 1-5, at 16 (6th ed. 1998). In light of this tenet, we

encourage the district court to take a closer look at whether

Delaware law, rather than Massachusetts law, should be applied to

ascertain the scope of Cape Ann's fiduciary duty for purposes of a

Maggio analysis. We leave open the possibility, however, that a

formal choice-of-law ruling will prove unnecessary. See, e.g.,

Royal Bus. Group, Inc. v. Realist, Inc., 933 F.2d 1056, 1064-65

(1st Cir. 1991) (declining to make such a ruling when choice of law

will not affect the outcome).

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IV. THE ADDED CLAIMS

We turn next to the new plaintiffs' federal securities

claims. Although the viability of this set of claims also hinges

on temporal considerations, our evaluation traverses a much

different analytical path.

The new plaintiffs first asserted their claims in the

amended complaint, filed March 9, 2001. They did not argue in the

district court that the one-year limitations period was still open

on that date.9 By failing to advance such a theory below, they

have forfeited the right to raise it on appeal. See Teamsters

Union Local No. 59 v. Superline Transp. Co., 953 F.2d 17, 21 (1st

Cir. 1992) ("If any principle is settled in this circuit, it is

that, absent the most extraordinary circumstances, legal theories

not squarely raised in the lower court cannot be broached for the

first time on appeal."); McCoy v. MIT, 950 F.2d 13, 22 (1st Cir.

1991) (similar).

This leaves the new plaintiffs with the argument that

they urged below. That argument depends upon Rule 15(c)(3) of the

Civil Rules, which states in pertinent part:

9
This hardly seems surprising. The date of suit — March 9,
2001 — was more than one year after (1) NutraMax's blockbuster
announcement of August 18, 1999 and the resultant 40% drop in the
price of the company's stock, (2) NASDAQ's delisting of the
company's shares, and (3) Deloitte's withdrawal of its audit
reports. It strains credulity to maintain either that these
events, collectively, did not amount to sufficient storm warnings
or that the fraud was not readily discoverable by March of 2000.

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 An amendment of a pleading relates back to the
date of the original pleading when . . . the
amendment changes the party or the naming of
the party against whom a claim is asserted if
. . . the party to be brought in by amendment
(A) has received such notice of the
institution of the action that the party will
not be prejudiced in maintaining a defense on
the merits, and (B) knew or should have known
that, but for a mistake concerning the
identity of the proper party, the action would
have been brought against the party.

Fed. R. Civ. P. 15(c)(3). The new plaintiffs take the position

that, under this rule, their federal securities claims relate back

to August 1, 2000 — the date on which Cape Ann filed its original

complaint – and, thus, come within the one-year prescriptive

period. We find this argument unpersuasive.

At the outset, we acknowledge that the new plaintiffs'

argument is theoretically available. Although the text of Rule

15(c)(3) seems to contemplate changes in the identity of

defendants, we have recognized that the rule can be applied to

amendments that change the identity of plaintiffs. See Allied

Int'l, Inc. v. Int'l Longshoremen's Ass'n, 814 F.2d 32, 35 (1st

Cir. 1987) (discussing potential applicability of the rule to an

amendment "substituting a fresh plaintiff for the original one");

see also Fed. R. Civ. P. advisory committee note (1966)

(emphasizing that Rule 15(c)(3) "extends by analogy to amendments

changing plaintiffs"). In theory, then, the benefits of Rule

15(c)(3) are within the reach of new plaintiffs.

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 In practice, however, relation back is far from

automatic. Rule 15(c)(3) is not an open invitation to every

plaintiff whose claim otherwise would be time-barred to salvage it

by joining an earlier-filed action. Rather, the rule strikes a

carefully calibrated balance. Properly construed, it allows some

claims that otherwise might be dismissed on the basis of procedural

technicalities to prosper while at the same time keeping the door

closed to other claims that have been allowed to wither on the

vine. See Nelson v. County of Allegheny, 60 F.3d 1010, 1014 (3d

Cir. 1995); see also 3 Moore's Federal Practice, supra, ¶

15.19[3][a]. To separate wheat from chaff, we have laid down three

separate requirements applicable to plaintiffs who seek succor

under Rule 15(c)(3):

[T]he amended complaint must arise out of the
conduct, transaction, or occurrence set forth
or attempted to be set forth in the original
pleading; there must be a sufficient identity
of interest between the new plaintiff, the old
plaintiff, and their respective claims so that
the defendants can be said to have been given
fair notice of the latecomer's claim against
them; and undue prejudice must be absent.

Allied Int'l, 814 F.2d at 35-36.

We ordinarily review a trial court's decision to grant or

deny motions under Rule 15(c)(3) for abuse of discretion. E.g.,

id. at 37. It is, however, settled beyond peradventure that an

error of law constitutes an abuse of discretion. See United States

v. Keene, 287 F.3d 229, 233 (1st Cir. 2002); In re Grand Jury

-26-
Subpoena, 138 F.3d 442, 444 (1st Cir. 1998). Here, the district

court rejected the new plaintiffs' claim that they were eligible

for "relation back" principally on the ground that they and their

claims lacked a sufficient identity of interest with the original

plaintiff and its claims. Cape Ann, 171 F. Supp. 2d at 30. This

was a quintessentially legal determination, made on undisputed

facts, and thus engenders de novo review.

The guideposts for evaluating whether two parties possess

a sufficient identity of interest to permit relation back are not

well-defined. As to defendants, identity of interest typically

means that parties are "so closely related in their business

operations or other activities that the institution of an action

against one serves to provide notice of the litigation to the

other." Singletary v. Pa. Dep't of Corr., 266 F.3d 186, 197 (3d

Cir. 2001) (citing 6A Charles A. Wright et al., Federal Practice

and Procedure § 1499, at 146 (2d ed. 1990)). "The substitution of

such parties after the applicable statute of limitations may have

run is not significant when the change is merely formal and in no

way alters the known facts and issues on which the action is

based." Staren v. Am. Nat'l Bank & Trust Co., 529 F.2d 1257, 1263

(7th Cir. 1976). The identity of interest requirement reflects

this line of thought; it "ensures that the old and new plaintiffs

are sufficiently related so that the new plaintiff was in effect

involved in [the proceedings] unofficially from an early stage."

-27-
Leachman v. Beech Aircraft Corp., 694 F.2d 1301, 1309 (D.C. Cir.

1982) (citation and internal quotation marks omitted).

That formulation is not readily transferrable to

plaintiffs. Nevertheless, it suggests that when a new plaintiff

attempts to enter a pending action under the aegis of Rule

15(c)(3), courts should require substantial structural and

corporate overlap to ensure that the defendant is not called upon

to defend against new facts and issues. This, then, should be the

focal point of the identity of interest requirement vis-à-vis a new

plaintiff.

The case law runs along these lines. See 3 Moore's

Federal Practice, supra, ¶ 15.19[3][c] (collecting cases). Some

concrete examples may prove helpful. Courts have found a

sufficient identity of interest when the original and added

plaintiffs are a parent corporation and a wholly-owned subsidiary.

Hernandez Jimenez v. Calero Toledo, 604 F.2d 99, 103 (1st Cir.

1979). So too when they are "related corporations whose officers,

directors, or shareholders are substantially identical and who have

similar names or share office space, past and present forms of the

same enterprise." Id. Similarly, in Raynor Bros. v. Am. Cyanimid

Co., 695 F.2d 382, 384-85 (9th Cir. 1982), the court sanctioned the

substitution of a family partnership for a family-owned corporate

plaintiff upon a showing that each partner also was a major

shareholder in the corporation. And in Staren, 529 F.2d at 1263,

-28-
the court permitted the substitution of a corporation in lieu of

two individuals (the president of the corporation and his business

associate) to head off a claim that the corporation, rather than

the individuals, was the purchaser in a particular transaction.

These cases sound a common theme. To use an old-

fashioned word, they require a fairly advanced degree of privity to

ground the substitution or addition of new plaintiffs under Rule

15(c)(3). Our decision in Allied International fits such a mold.

There, we allowed the substitution, under Rule 15(c)(3), of a

corporation that had purchased all the assets of the original

complainant (and, afterwards, continued to operate the acquired

business). 814 F.2d at 35-38.

The case at hand presents a variation on this theme: the

question is whether stockholders in a publicly-held corporation,

not related to each other except by that status, share a sufficient

identity of interest to meet the requirements of Rule 15(c)(3). We

answer that question in the negative. Persons who are identified

with each other only by their ownership of stock in the same

publicly-traded corporation share some of the same rights, but that

fact, standing alone, does not place them in the kind of proximity

needed to invoke Rule 15(c)(3).

In so holding, we repudiate the conceit that an action

filed by one plaintiff gives a defendant notice of the impending

joinder of any or all similarly situated plaintiffs. Such a rule

-29-
would undermine applicable statutes of limitations and make a

mockery of the promise of repose. We, like other courts, flatly

reject the proposition that relation back is available merely

because a new plaintiff's claims arise from the same transaction or

occurrence as the original plaintiff's claims. See In re Syntex

Corp. Sec. Litig., 95 F.3d 922, 935 (9th Cir. 1996) (disallowing

relation back for newly proposed investor plaintiffs who bought

stock at different values and after different disclosures and

statements than original plaintiffs); Page v. Pension Ben. Guar.

Corp., 130 F.R.D. 510, 513 (D.D.C. 1990) (similar). This means,

then, that the happenstance that individuals have invested in the

same publicly-traded stock, without more, cannot suffice to confer

identity of interest.

It is readily apparent, then, that the new plaintiffs in

this case are facing an uphill climb — and the raw facts make the

slope even steeper. The new plaintiffs' underlying Rule 10b-5

claims differ from Cape Ann's in significant respects. The

pleadings reveal that Cape Ann invested in NutraMax stock with the

avowed intention of becoming a "strategic partner" in the ownership

and management of a third company whose later acquisition Cape Ann

funded. Pursuant to this transaction and a subsequent private

placement, Cape Ann acquired its NutraMax stock at negotiated

prices and proceeded to take an active role in the company's

affairs. In contrast, the new plaintiffs purchased their shares on

-30-
the open market at a much wider range of times and prices, and

thereafter were purely passive investors. Clearly, Cape Ann and

the new plaintiffs had different vantage points from which to

observe how NutraMax was being run. By the same token, they had

different incentives and opportunities to investigate the ongoing

fraud.

Given this broad disparity, we find it difficult to

credit the new plaintiffs' blithe assertion that the filing of suit

by Cape Ann gave Deloitte notice that the new plaintiffs also would

sue. Cape Ann's complaint was not couched as a class action — and

on these facts, Deloitte had no reason to believe that Cape Ann was

speaking on behalf, or acting to the behoof, of other shareholders.

In fact, as the district court noted, Cape Ann, 171 F. Supp. 2d at

29-30, Cape Ann has no beneficial interest whatever in the claims

of the new plaintiffs. Similarly, the new plaintiffs harbor no

beneficial interest in Cape Ann's claims, save for their desire to

ride piggyback on Cape Ann's filing date.7 And the parties'

injuries, although arising out of the same set of occurrences, are

completely separate and distinct. Accordingly, Deloitte could not

have had notice that the injuries of the one were in any way

dependent upon the existence of the other. Cf. Williams v. United

States, 405 F.2d 234, 239 (5th Cir. 1968) (holding that since

7
Far from being beneficially interested in one another's
claims, the two groups of plaintiffs, as shareholders in a bankrupt
corporation, may have adverse interests.

-31-
mother's derivative loss-of-services claim predictably arose from

tortious injury to son, defendant was put on notice because the

"circumstances of these individuals was such as would reasonably

indicate a likelihood that the parent would incur losses of a

recoverable kind").

The short of the matter is that the amended complaint

does not allege any facts showing that Cape Ann and the new

plaintiffs were linked through any preexisting relationship. This

is a decisive consideration because the absence of a sufficient

identity of interest between Cape Ann and the new plaintiffs

resulted in a lack of fair notice to Deloitte. The Supreme Court

has emphasized that "notice within the limitations period" is the

linchpin of a Rule 15(c) analysis. Schiavone v. Fortune, 477 U.S.

21, 31 (1986). In our view, lack of notice and unfair prejudice go

hand in hand. Thus, while Cape Ann's original complaint may have

given Deloitte reason to fear that other shareholders might pursue

similar claims, such minimal notice hardly suffices to avert undue

prejudice to Deloitte within the meaning of Rule 15(c)(3) should we

permit relation back. That prejudice is obvious: it is the

prejudice "suffered by one who, for lack of timely notice that a

suit has been instituted, must set about assembling evidence and

constructing a defense when the case is already stale." Nelson, 60

F.3d at 1014-15.

-32-
 To say more on this point would be supererogatory.

Where, as here, real issues of fact still hover as to what

representations and reassurances were proffered and who owed what

duties to whom, the accession of new plaintiffs and claims will

likely entail new legal theories and tactics against which Deloitte

must defend and a geometric increase in its potential liability.

When this occurs long after the statute of limitations has run,

prejudice is manifest. The Third Circuit summed it up well:

Statutes of limitations ensure that defendants
are protected against the prejudice of having
to defend against stale claims . . . . In
order to preserve this protection, the
relation-back rule requires plaintiffs to show
that the already commenced action sufficiently
embraces the amended complaint so that
defendants are not unfairly prejudiced by
these late-coming plaintiffs and that
plaintiffs have not slept on their rights.

Id. at 1014 (citation and internal quotation marks omitted); see

also Leachman, 694 F.2d at 1309 (emphasizing that defendants are

entitled to "have notice of who their adversaries are").

The fact that the new plaintiffs have assigned their

claims to the Trust does not alter the decisional calculus. An

assignee ordinarily stands in the shoes of the assignor. E.g., In

re SPM Mfg. Corp., 984 F.2d 1305, 1318 (1st Cir. 1993); R.I. Hosp.

Trust Nat'l Bank v. Ohio Cas. Ins. Co., 789 F.2d 74, 81 (1st Cir.

1986). Consequently, an assignee cannot maintain a claim in the

face of a limitations defense that would have trumped the same

claim had it been brought by the assignor. See Ass'n of

-33-
Commonwealth Claimants v. Moylan, 71 F.3d 1398, 1402 (8th Cir.

1995); Fox-Greenwald Sheet Metal Co. v. Markowitz Bros., Inc., 452

F.2d 1346, 1357 n.69 (D.C. Cir. 1970). That is as it should be.

Were the law otherwise, the efficacy of a limitations defense could

be destroyed by the simple expedient of assigning the claim in

question to a party who already had sued the defendant.

To summarize, we hold, based upon the lack of a

sufficient identity of interest between Cape Ann and the new

plaintiffs, that the latter are precluded from invoking Rule

15(c)(3) in order to salvage their time-barred federal securities

claims. Because this holding forecloses the only available route

to recovery, we affirm the district court's dismissal of those

claims.

V. CONCLUSION

We need go no further. To recapitulate, we reverse the

district court's dismissal of Cape Ann's Rule 10b-5 claim because

it cannot be said, as a matter of law, that the statute of

limitations expired before Cape Ann sued. Conversely, we uphold

the district court's refusal to permit the new plaintiffs to hitch

their wagon to Cape Ann's star because the new plaintiffs do not

share a sufficient identity of interest with Cape Ann. We direct

the district court, on remand, to reconsider the dismissal of the

supplemental state-law claims, but we take no view as to whether

the court should exercise supplemental jurisdiction over those

-34-
claims. See Carnegie-Mellon Univ. v. Cohill, 484 U.S. 343, 350

(1988) (emphasizing that exercise of pendent jurisdiction is at the

district court's discretion); Rodriguez v. Doral Mortg. Corp., 57

F.3d 1168, 1176 (1st Cir. 1995) (similar).

Affirmed in part, reversed in part, and remanded for further

proceedings consistent with this opinion. All parties shall bear

their own costs.

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