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May 9, 1983

MATTHEW JAFFEE, et al., Defendants; MATTHEW JAFFE, Plaintiff, v. FALLER INDUSTRIES, INC., et al., Defendants.

The opinion of the court was delivered by: LEVAL


These are causes of action for fraud and counterclaims for breach of contract in connection with the purchase by plaintiff The Faller Group, Inc. from defendant Matthew Jaffe of companies engaged in aspects of the insurance business (the "Jaffee Companies"). The jurisdiction of the federal courts is appropriately based on the federal securities laws and diversity of citizenship.

 The gist of the Faller claims is that Jaffe fraudulently concealed an investigation which was being conducted by the New York State Department of Insurance into excessive fees charged by the Jaffe Companies, which investigation later resulted in reduction of the fees and serious financial detriment to the companies. Jaffe counterclaims that the Faller Group breached its obligations under his employment contract by dismissing him.


 Prior to the purchase of the Jaffe Companies, Gerald (Bud) Faller had been a successful employee and salesman for the Great-West Life Assurance Company ("Great West"). Through his work Faller had become acquainted with Matt Jaffe, who, together with his brother Dan Jaffe, owned companies engaged in "third party administration" of group insurance policies. A third party administrator (TPA) does administrative work, processing and payment of claims and record-keeping for the underwriter. Such third party administrators are characteristically paid fees by the underwriter which are calculated as a percentage of the premiums on the policies being administered.

 The customers of the Jaffe Companies were primarily labor union health and welfare plans. Much of the insurance of these customers was placed by the Jaffe Companies with Trans-World Life Insurance Company, for which the Jaffe Companies performed TPA services. The Jaffe Companies had been very successful and by February, 1979 had accumulated earnings of approximately $6-1/2 million which were held in certificates of deposit.

 In late 1977 Bud Faller entered into negotiations to buy the Jaffe Companies. Faller was interested in making an entrepreneurial venture. Jaffe was interested in selling the companies, in part because the accumulated $6-1/2 million could not be distributed as dividends without incurring very high income tax liabilities and could not be held indefinitely as idle funds without risking imposition of an Accumulated Earnings Tax. See I.R.C. §§ 531-37.

 Jaffe, however, had another reason to be interested in selling. The Insurance Department of the State of New York was engaged, during the period of the negotiations with Faller, in an investigation which threatened the Jaffe Companies with substantial potential liabilities and a severe diminution in revenues.

 As noted above, the Jaffe Companies had placed a very large part of their customers' insurance with Trans-World and performed third party administration services for Trans-World on those accounts. The two Jaffe Companies primarily involved in this work were Fringe Plan Administrators, Ltd. and Group Writers, Inc. These Jaffe Companies received fees from Trans-World aggregating approximately 9-1/2% of Trans-World's premiums on this business. These fees constituted the major part of the Jaffe Companies' revenues. The Insurance Department's investigation centered on Trans-World and its relationship with Group Writers and Fringe Plan. It was premised on the view that Trans-World was charging unreasonably high retentions (the retention being the difference between premiums collected and sums paid out for claims) and, as a part of its excessive retentions, was paying excessive third-party administration fees to Fringe Plan and Group Writers.

 The fact of this investigation was well known to Matt Jaffe long prior to the sale of the Jaffe Companies on February 16, 1979. Over a year earlier Jaffe had written to a minority shareholder to the effect that the Insurance Department's actions "could result in large and substantial retroactive refunds of fees paid to Fringe Plan Administrators, Ltd. over the past several years." Jaffe had kept himself advised during 1978 and early 1979 of Trans-World's meetings and correspondence with the Insurance Department. He caused an employee to prepare a report for submission to the Insurance Department which sought to justify the TPA fees being charged.

 On January 2, 1979, Sidney B. Glaser, Associate Counsel of the Insurance Department was formally appointed and authorized to proceed with an investigation into the affairs of Trans-World, Fringe Plan and Group Writers. Glaser telephoned the Jaffe Companies on January 23, 1978 to arrange a date for Matt Jaffe to testify. On January 25, Jaffe called Glaser to arrange such a date. Shortly thereafter Jaffe's nephew and in-house counsel Barry Chaifetz telephoned Glaser to discuss Jaffe's appearance. On February 2, 1979, Jaffe met with the President of Trans-World, discussed the investigation and requested copies of the Insurance Department's order of investigation and subpoena, which expressly named Group Writers and Fringe Plan as subjects of the investigation. Jaffe received a copy of the requested documents sometime before February 6, 1979. On February 13, only three days before the sale of the Jaffe Companies, Chaifetz and Jaffe's consultant Solomon Bendet met with Mr. Glaser. Glaser discussed with Chaifetz and Bendet the nature of the investigation into the fees of Group Writers and Fringe Plan and delivered to them a copy of the formal authorization.

 By this and other evidence, it is overwhelmingly established that Jaffe was fully aware of the investigation into the Jaffe Companies. Faller, on the other hand, was unaware of the investigation and unaware of any threat to the continuation of Trans-World's service fees at 9-1/2%.

 Jaffe took steps to prevent Bud Faller from finding out about the investigation. He suggested to Faller, in the interests of discretion, that Faller not talk to Trans-World about the proposed acquisition. Furthermore, in the fall of 1978, Faller's employer (and prospective financier) Great West was discussing the possibility of purchasing Trans-World. In connection with that possibility, George Dinney of Great West visited Matt Jaffe. When Dinney asked Jaffe whether it would be advisable for him to visit the New York Insurance Department to see how receptive it would be to Great West's entry into New York through the Trans-World acquisition, Jaffe counseled Dinney against such an approach.

 Jaffe's draft agreement with Faller, which was in negotiation throughout this period, contained a representation and warranty that "to the knowledge of the Sellers [Jaffe and his brother], there is no . . . investigation before or by any governmental . . . authority pending or threatened against or affecting any of the Jaffe Companies . . . or affairs of any of the Jaffe Companies". On one of the copies of the draft in the Jaffe Company files, in the margin next to the text of this warranty someone had written, "other than TW matter."

 On February 16, 1979, the purchase and sale agreement was signed and closed. It contained in paragraph 3.18 (Exh. F 69) the above-quoted assurance that there were no known investigations, and made no reference to the Insurance Department investigation.

 This was a willful fraudulent misrepresentation of a material fact and a false warranty.

 The materially of the false representation is not open to dispute. The Trans-World policies were the principal source of the Jaffe Companies' income.The investigation pointed towards a mandatory reduction of those fees. Such a reduction necessarily would have a significant impact on the income and value of the Jaffe Companies.

 Five days after the closing, on February 21, 1979, a subpeona was served by the Insurance Department on Matthew Jaffe by one Murray Zaroff, an insurance department official. Jaffe contrived to obtain from Zaroff an affidavit to the effect that the service of the subpoena on that date constituted the "first official notice" of the investigation. There was evidence of the existence of a relationship between Jaffe and Zaroff. The affidavit which Zaroff obligingly ...

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