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DYMM v. CAHILL

February 13, 1990

MANDEL DYMM, PLAINTIFF,
v.
GERALD CAHILL, RAYMOND BOGERT, STANLEY SCHWARTZ, JAMES P. CASEY, KT BUILDING ASSOCIATES, INC., ERNEST HAMMER AND GEORGE DEVINS, DEFENDANTS.



The opinion of the court was delivered by: Mukasey, District Judge.

    OPINION AND ORDER

This case arises out of plaintiff's investment in two limited partnership tax shelters — New Castle and Decker Malls — on the advice of his accountant, who allegedly misrepresented material facts about the partnerships and conspired with the insiders of the New Castle partnership to defraud plaintiff and other investors through a complex scheme involving forged promissory notes, excessive prices and fees to insiders. Plaintiff has sued the accountant, George Devins, and the alleged insiders of the New Castle partnership including the managing agent, McCorhill Publishing, Inc., the general partner, KT Associates, and the officers and principals of these two corporations. Plaintiff brings five claims against all defendants in connection with the New Castle partnership based on § 10(b) of the Securities and Exchange Act and Rule 10b-5 promulgated thereunder, § 17(a) of the Securities Act of 1933, RICO, and common law claims of fraud and breach of fiduciary duty. He also brings four claims solely against Devins in connection with the Decker Malls partnership based on § 10(b) and Rule 10b-5, § 17 and common law claims of fraud and negligence.

Two of the defendants, Devins and Bogert, move to dismiss the complaint for failure to plead fraud with particularity pursuant to Fed.R.Civ.P. 9(b), and for failure to state a claim upon which relief may be granted pursuant to Fed.R.Civ.P. 12(b)(6). For the reasons set forth below, defendants' motion is granted as to plaintiff's claims under § 17 of the Securities Act of 1933, and denied as to all other claims.

I.

Plaintiff alleges that starting in December, 1984, defendant Gerald Cahill, the chairman, principal and shareholder of McCorhill Publishing ("McCorhill"), defendant Raymond Bogert, vice-president of KT Building Associates, Inc. ("KT") and a principal of McCorhill, and other defendants who were officers and associates of KT and McCorhill, executed a complex scheme to defraud investors. This scheme involved the purchase and sale of property in New Castle, New York called the Kraus-Thompson Building. McCorhill was the managing agent of the New Castle partnership; KT was the partnership's sole general partner.

McCorhill bought both the building and part of the publishing businesses of Kraus-Thomson Organization, Ltd., and then allegedly sold only the property to New Castle at an inflated price and kept the rights to the businesses. Plaintiff alleges that New Castle structured the transaction using features including a wraparound mortgage and excessive fees to KT and McCorhill so as to divert funds to defendants without the knowledge of investors. Further, plaintiff alleges that New Castle, by its general partner KT, forged the signatures of investors on promissory notes, falsely notarized these notes and pledged them as collateral for loans from two lending institutions, Citytrust and Ingersoll-Rand. Later, New Castle defaulted on the loans and declared bankruptcy, and investors received demands on the notes from the banks.

Plaintiff asserts that defendants authorized Devins to make misrepresentations to plaintiff regarding the New Castle investment, including, inter alia, that the building owned by New Castle was completely rented or soon would be, that the building was about to be sold at a high profit, that each limited partner would receive substantial tax-free distributions, and that the limited partners would be liable only for the amount they invested. Neither Devins nor the other defendants disclosed certain facts to plaintiff, such as, inter alia, that the borrowed money had been secured by forged promissory notes, and that KT and another company had not paid the capital contribution required by the partnership agreement.

Plaintiff also sues Devins with regard to another limited partnership investment Devins advised plaintiff to purchase in September, 1985. Plaintiff alleges that Devins told him that he would soon be receiving profits from the New Castle investment, and that he should immediately reinvest these profits in Decker Malls by becoming a limited partner in that partnership. Plaintiff in fact did not wait for a return on his New Castle investment before committing himself to buy an interest in Decker Malls, allegedly relying on Devins' statement that he would not have to pay for his Decker Malls interest until he received a return on his New Castle investment. On September 30, 1985, plaintiff purchased a one-unit investment in Decker Malls for $75,000, exclusive of interest, and made payments over the course of the next two years totalling $99,191.99. These payments did not comport with a capital contribution schedule listed in documents plaintiff never received.

Plaintiff sues the New Castle defendants, including Devins, based on § 10(b) of the Securities and Exchange Act of 1934, § 17(a) of the Securities Act of 1933, RICO, and common law fraud and breach of fiduciary duty. Plaintiff also sues Devins for his misrepresentations regarding Decker Malls based on § 10(b), § 17(a), and common law fraud and negligence. Only defendants Bogert and Devins have moved to dismiss the complaint.

II.

In his first claim, plaintiff charges that all defendants conspired to violate and aided and abetted each other in violating § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 under that act, 17 C.F.R. § 240.10b-5, through their misrepresentations in connection with the purchase and sale of securities in the New Castle partnership. In his seventh claim, plaintiff alleges that Devins violated § 10(b) and Rule 10b-5 by making misrepresentations in connection with the sale of securities in Decker Malls. Defendants Bogert and Devins, in their motion to dismiss, assert that plaintiff fails to plead fraud with sufficient particularity under Fed.R.Civ.P. 9(b), fails to plead scienter, and cannot bring this claim because it is barred by the statute of limitations. Because plaintiff has pleaded fraud particularly enough, and has pleaded scienter adequately to state a § 10(b) claim against both Devins and Bogert, defendant's motion to dismiss the first and seventh claims on those bases is denied. Further, because plaintiff has sufficiently pleaded that the statute of limitations has been tolled by fraudulent concealment, plaintiff's § 10(b) claims survive a motion to dismiss based on the statute of limitations.

A.  Particularity

Rule 9(b) requires that in "all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Rule 9(b)'s strict requirements are tempered, however, by the general pleading rule set forth in Fed.R. Civ.P. 8(a) that a complaint consist of "short and plain statement[s]" of claims for relief. See DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242 (2d Cir. 1987). Section 10(b) claims, which are based upon fraudulent acts, must satisfy the pleading requirements of Fed.R. Civ.P. 9(b). See Luce v. Edelstein, 802 F.2d 49, 54 (2d Cir. 1986). In order to plead fraud with particularity, "a complaint must adequately specify the statements it claims were false or misleading, give particulars as to the respect in which plaintiff contends the statements were fraudulent, state when and where the statements were made, and identify those responsible for the statements." Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). Such allegations cannot be conclusory, but must be supported by assertions of fact. Luce, 802 F.2d at 54. On a motion to dismiss, a court must read the complaint generously and draw all inferences in favor of the pleader. Yoder v. Orthomolecular Nutrition Inst., Inc., 751 F.2d 555, 562 (2d Cir. 1985).

In the case at bar, plaintiff asserts his § 10(b) claim against all defendants as a group for taking part in the New Castle scheme, including the forgery of notes, and for making misrepresentations through Devins, whom plaintiff alleges was their agent. "Where multiple defendants are asked to respond to allegations of fraud, the complaint should inform each defendant of the nature of his alleged participation in the fraud." DiVittorio, 822 F.2d at 1247. Plaintiff need not specify the role of each particular defendant in an alleged securities fraud if the misrepresentations were embodied in an offering memorandum, and if the defendants are "insiders or affiliates participating in the offer of the securities in question." Luce, 802 F.2d at 55.

Dymm, however, does not allege that the misrepresentations were conveyed through an offering memorandum; in fact, he asserts that "[n]o offering memorandum for New Castle was provided to plaintiff for his review." (Compl. ¶ 41) Therefore, he must provide each defendant with sufficient notice of that defendant's part in the fraud by alleging, at a minimum:

  "(1) the nature of each individual defendant's
  participation in the fraud, including the facts
  constituting scienter and an explanation of the
  defendant's duty toward the plaintiff; (2)
  whether the defendant is being sued as a primary
  defendant or as an aider and abettor; and (3) as
  to allegations on information and belief, a
  statement of the source of the information and
  the reasons upon which the belief is founded."

The Limited, Inc. v. McCrory Corp., 645 F. Supp. 1038, 1043 (S.D.N.Y. 1986).

The complaint alleges that Bogert was Vice President of KT Building Associates, Inc., the general partner of the New Castle partnership, and a principal of McCorhill Publishing, the managing agent of the partnership. (Compl. ¶ 6(B)) The complaint alleges also that Bogert and other defendants were controlling persons of KT Building and McCorhill within the meaning of § 20(a) of the Exchange Act and thus liable for the acts of KT Building and McCorhill. (Compl. ¶ 8) In paragraphs 15 through 43, plaintiff sets forth in detail the nuts and bolts of the New Castle fraud, first by detailing the real estate transaction upon which the partnership allegedly was based, and then by describing the various misrepresentations and omissions which induced plaintiff to buy and pay for interests in the partnership. Most of these allegations are directed toward actions of "defendants" or "New Castle" or Devins, and not toward Bogert in particular, with the exception of paragraphs 40(e) and 42(a) and (d), which accuse the partnership of failing to disclose that "the forged indemnification agreements would be falsely executed by Bogert or others at the direction of the defendants" (Compl. ¶ 40(e)), and allege scienter by claiming that defendants knew the statements made about New Castle were false because "defendants Cahill, Bogert, Schwartz, Casey and Hammer had agreed in or about December, 1984 to secure the forged notes" (Compl. ¶ 42(a)), and because "Bogert and Hammer notarized certain of the forged notes." (Compl. ¶ 42(d))

The allegations in paragraph 40 regarding the failure of Bogert and other defendants to disclose material facts to plaintiff, along with preceding informational paragraphs about Bogert's role in the partnership, are sufficient to satisfy Rule 9(b), as they assert the nature of Bogert's participation in the fraud by alleging his insider status and his position as an officer and controlling person in the general partner of the New Castle partnership and then describe the failure of the insiders to disclose material information to plaintiff. The complaint sufficiently shows also that Bogert had a duty toward plaintiff to disclose material information regarding the New Castle partnership when it alleges his position as an officer and controlling person in the general partner of the partnership and his status as an insider based upon that position. Therefore, plaintiff's first claim against Bogert survives the motion to dismiss for failure to plead fraud with particularity.

Paragraphs 38 and 39, which allege that defendants made misrepresentations to plaintiff through Devins, also allege fraud with sufficient particularity, as they specify in great detail the allegedly fraudulent or misleading statements, describe how the statements were fraudulent, and identify who made the statements. See Cosmas, 886 F.2d at 11. The first claim against Devins, therefore, survives defendants' motion to dismiss for failure to plead fraud with particularity.

In his seventh claim, plaintiff alleges also that Devins violated § 10(b) and Rule 10b-5 by making fraudulent representations about the Decker Malls partnership. In paragraphs 52 through 65 of the complaint, plaintiff sets forth specific facts regarding Devins' advice to invest in Decker Malls, including the time of Devins' representations, the content of these representations and the reasons these statements were untrue. Paragraph 54 recites the specific misrepresentations — namely, that Devins had researched the investment adequately, that plaintiff would not have to pay for the investment until he received a return from his New Castle investment, and that Decker Malls "was secure, was potentially profitable and would provide substantial tax benefits." Paragraph 55 then alleges that exactly the opposite was true with respect to every representation described in paragraph 54.

Concededly, some of these allegations of fraud illustrate only that Devins' predictions were not correct forecasts, and do not show how the representations were fraudulent at the time they were made. For example, plaintiff claims that Devins' representation that plaintiff would not have to pay for his Decker Malls investment until he received a return from New Castle was untrue because, as it turned out, "plaintiff would have to pay for his investment in Decker Malls prior to receiving a return of all of his investment from New Castle." (Compl. ¶ 55(e)) Nevertheless, plaintiff alleges enough particulars as to how the statements described in paragraphs 52 through 65 were fraudulent and specifies the speaker, time and content of the representations sufficiently to satisfy the requirements of Fed.R.Civ.P. 9(b).

B.  Scienter

Defendants argue also that plaintiff fails to plead scienter in his § 10(b) and Rule 10b-5 claims. To state a § 10(b) claim with the requisite particularity, plaintiff must plead scienter.*fn1 Cosmas, 886 F.2d at 12-13. Thus, a complaint must allege material misstatements or omissions indicating an intent to deceive or defraud in connection with the purchase or sale of a security. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); Luce, 802 F.2d at 55. Although Rule 9(b) "allows 'condition of mind' to be averred generally, plaintiffs must at least present those circumstances that provide a minimal factual basis for the allegations of scienter." Eickhorst v. Am. Completion and Development, 706 F. Supp. 1087, 1091 (S.D.N.Y. 1989). Plaintiff must plead facts that support a "strong inference" that defendants possessed the requisite fraudulent intent. Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2d Cir. 1987), cert. denied, 484 U.S. 1005, 108 S.Ct. 698, 98 L.Ed.2d 650 (1988), overruled on other grounds, United States v. Indelicato, 865 F.2d 1370 (2d Cir. 1989) (en banc). See Cosmas, 886 F.2d at 12-13; Devaney v. Chester, 813 F.2d 566, 568 (2d Cir. 1987); Connecticut Nat'l Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir. 1987). One way of supporting an inference of scienter is to allege facts showing a motive for committing fraud and a clear opportunity to do so. Beck, 820 F.2d at 50.

The complaint sufficiently alleges Bogert's scienter as to the fraudulent note scheme and as to failure to disclose material information to plaintiff and other investors when it avers in paragraph 42 that Bogert secured and notarized forged notes which were shown to banks to secure loans. This reveals that Bogert knew of and participated in the scheme to defraud investors, and raises at least an inference of scienter. "Where motive is not apparent, it is still possible to plead scienter by identifying circumstances indicating conscious behavior by the defendant . . . though the strength of the circumstantial allegations must be correspondingly greater." Beck, 820 F.2d at 50 (cites omitted).

Because plaintiff bases his § 10(b) claim on misrepresentations communicated by a single person, as opposed to misrepresentations contained in an offering memorandum, Bogert's insider status does not provide a basis for inferring a connection with these misrepresentations. Nonetheless, plaintiff sufficiently supports an inference of Bogert's scienter with facts showing Devins' connection with the New Castle insiders, including Bogert. In paragraph 40(j), plaintiff alleges that "Devins was to receive a substantial commission on plaintiff's purchases of interests in New Castle, and that, in the absence of a commission, Devins would not have recommended the investment to plaintiff." In paragraph 42(j), plaintiff alleges that "Devins was in frequent communication with Cahill," and in paragraph 42(k), plaintiff alleges that Devins later admitted to knowing that the notes were forged. These connections between Devins and the New Castle insiders, including Bogert, provided Bogert and the other defendants with a clear opportunity to commit fraud by using Devins as their medium for misrepresentations. The motive for endorsing such misrepresentations — finding victims for an already fraudulent investment scheme — is supported by numerous fact allegations about the structure of the New Castle ...


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