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LANDY v. MITCHELL PETROLEUM TECHNOLOGY
April 5, 1990
THOMAS M. LANDY, ET AL., PLAINTIFFS,
MITCHELL PETROLEUM TECHNOLOGY CORPORATION; WORLDCO SERVICES GROUP, INC.; HERMAN FINESOD; PETRO-TECH LIMITED PARTNERSHIP I; PETRO-TECH LIMITED PARTNERSHIP II; PETRO-TECH LIMITED PARTNERSHIP III; PETRO-TECH LIMITED PARTNERSHIP IV; PETRO-TECH LIMITED PARTNERSHIP V; RAY WILSON; AQUANETICS, INC.; ROBERT HAIG HACHADOORIAN; CNA INVESTOR SERVICES, INC.; FRIEDMAN & SHAFTAN, P.C.; WILFRED T. FRIEDMAN; MARCIA SHAFTAN, AS EXECUTRIX OF THE ESTATE OF ROBERT P. SHAFTAN; MICHAEL E. GREENE; HELLER, WHITE & COMPANY; AND WORLD INFORMATION SYSTEMS, DEFENDANTS.
The opinion of the court was delivered by: Leisure, District Judge.
This is a securities fraud action brought pursuant to §§
10(b) and 20(a) of the Securities Exchange Act of 1934,
15 U.S.C. § 78j(b) and 78t(a), § 17(a) of the Securities Act of
1933, 15 U.S.C. § 77q(a), the Racketeer Influenced and Corrupt
Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq., and
common law principles. Defendants*fn1 have moved on various
grounds to dismiss the claims against them.
Since the early years of this century, industry has
attempted to reclaim used lubricating oils. By removing
impurities, including air, gases, and particulates, that
accumulate during the lubricating process, the original
lubricating properties of the oil can be restored and the oil
can be reused. In 1977, defendant Robert Haig Hachadoorian
("Hachadoorian") received a patent for a new oil reclamation
process. The process was developed through the auspices of
defendant Aquanetics, Inc. ("Aquanetics"), a New York
corporation, of which Hachadoorian was president. From 1978 to
1983, when the offerings of the partnerships were prepared,
Aquanetics managed to sell only 40 of its oil reclamation
systems. Nonetheless, in 1981, defendant Mitchell Petroleum
Technology Corporation ("Mitchell") signed an agreement with
Aquanetics whereby Mitchell was granted a five year exclusive
right to market Aquanetics' products in the United States. The
agreement further provided that Mitchell had non-exclusive
marketing rights for an additional 20 years after the initial
five year period.
Upon signing its agreement with Aquanetics, Mitchell then
subdivided its licensing rights geographically, and marketed
those rights through partnerships which would be given
marketing sublicensing rights for a fee. Mitchell acted as the
promoter of the partnerships. Defendant Worldco Service Group
("Worldco") was a broker of interests in the partnerships.
Defendant Herman Finesod ("Finesod") was a principal in both
Mitchell and Worldco. Defendant Ray Wilson ("Wilson") was
allegedly a general partner of the partnerships.*fn4
Defendant Friedman & Shaftan is a New York City law firm that
prepared legal opinions, including tax opinions, which
appeared in the offering memoranda of the partnerships.
Defendants Wilfred T. Friedman and Michael Greene are members
of that law firm, and defendant Marcia Shaftan represents the
estate of Robert Shaftan, a deceased member of the firm.
Defendant Heller & White, apparently a market research firm,
prepared a report on the current state of and potential for
the oil reclamation industry, and defendant World Information
Systems ("WIS") prepared a report on the market potential of
the Aquanetics product. Defendant CNA Investor Services
("CNA"), a financial services and brokerage firm, sold units
in the partnerships to certain of the plaintiffs.
The purpose of the partnerships is described in detail in
the offering memoranda. Each partnership received from
Mitchell a sublicense which permitted the partnership to
market Aquanetics' product in a specified geographic region.
For that right, each partnership was to pay Mitchell a fee far
greater than the license fee Mitchell was paying to
Aquanetics. Potential investors were repeatedly warned in the
offering memoranda that investment in the partnerships was
risky, and that the potential for profit was speculative.
Indeed, each offering memorandum included on its first page a
notice in bold type and all capital letters, set off from the
rest of the print on the page by spaces and lines which
stated, "These securities involve a high degree of risk (See
`Risk Factors')". The body of each offering memorandum
contained approximately five pages under the heading "Risk
Factors," outlining management risks, transactional risks and
tax risks, among others. Further, the offering memoranda
indicated that potential investors in the partnership should
have a liquid net worth of at least $250,000, and annual
income placing the individual in the Federal income tax
bracket then taxed at a 49% marginal rate.
It appears from the offering memoranda that the focus of the
partnerships was the potential tax advantages that could be
reaped from the probable losses to be suffered during at least
the first few years of the partnerships. A significant portion
of each offering memorandum was dedicated to the potential tax
advantages for an investor. Each memorandum included an
extensive tax analysis and opinion prepared by defendant
Friedman & Shaftan. The analysis opined that it was likely
that investors, who would become limited partners, would be
able to deduct a portion of the partnership losses for income
tax purposes. Further, the second page of the offering
memoranda trumpeted the potential tax consequences for an
investor, estimating that tax deductions could reach 400%, of
initial cash investments.
However, the offering memoranda also were explicit in
warning potential investors that the potential tax benefits of
the partnerships could not be guaranteed. On the fourth page
of each memorandum, investors were warned, "THERE IS ALSO A
SUBSTANTIAL RISK THAT THE INTERNAL REVENUE SERVICE WILL SEEK
TO SET ASIDE ALL OR A PORTION OF THE DEDUCTIONS CLAIMED BY THE
PARTNERS. . . ." This warning was repeated in detail under the
heading "Risk Factors," and also in the tax opinion letter
prepared by Friedman & Shaftan. Despite this focus on tax
losses, the offerings did not state that the partnerships were
without profit potential. While the offerings do not indicate
great optimism about future profits, it could be implied from
the offerings that the promoters expected that profit might be
realized, despite the risks.
Irrespective of the explicit references to risk in the
offering memoranda, plaintiffs in this action invested in
these partnerships. Each investor signed a subscription
agreement, describing the obligations of the investor, and
certifying that said investor had received and reviewed
carefully the offering memorandum, the partnership agreement,
and the subscription agreement. The investor further certified
by signature that he or she had sufficient financial acumen to
understand the offering memorandum and partnership agreement,
understood that the investment had a high degree of risk, and
understood that the potential tax advantages of the
partnership might be disallowed by the Internal Revenue
In July 1986, three years after the formation of the
partnerships, the eventuality occurred about which the
investors had been forewarned: the Internal Revenue Service
disallowed all income tax deductions arising from
participation in the partnerships. Eighteen months after the
tax disallowance, plaintiffs filed the instant action.
Plaintiffs allege that defendants acted individually and in
concert to defraud investors, by intentionally misrepresenting
the value of the partnerships. In particular, they allege that
defendants represented that the partnerships had profit
potential when defendants knew or should have known that in
fact there was absolutely no possibility of the partnerships
ever showing a profit. The gravamen of plaintiffs' amended
complaint is that defendants Mitchell, Finesod, Aquanetics,
Hachadoorian and the partnerships conspired "to organize
limited partnerships involving the sublicense of the
[Aquanetics] system which was grossly overvalued, so that
significant tax benefits and profits could be promised to
investors." Amended Complaint ¶ 10. The other defendants, who
supplied supporting data for the offering memoranda or marketed
the partnerships, allegedly knew or should have known of the
Defendants have moved jointly and individually to dismiss
various portions of plaintiffs' amended complaint pursuant to
Fed.R.Civ.P. 9(b), 12(b)(1), 12(b)(6), and 56. The Court will
address defendants' various arguments in turn.
Plaintiffs' second claim for relief arises under § 17(a) of
the Securities Act of 1933. Until the issue is squarely before
it, the Second Circuit has not found it necessary to consider
overruling Kirshner v. United States, 603 F.2d 234 (2d Cir.
1978) (there is a private right of action under § 17(a)), cert.
denied, 442 U.S. 909, 99 S.Ct. 2821, 61 L.Ed.2d 274 (1979), to
be consistent with the holdings of several other circuit
courts. See Ronzani v. Sanofi S.A., 899 F.2d 195, 198 (2d Cir.
1990). However, following Judge Friendly's pointed suggestion
that there be a reexamination of this question, Yoder v.
Orthomolecular Nutrition Inst., Inc., 751 F.2d 555, 559 n. 3
(2d Cir. 1985), this Court has repeatedly found there to be no
private right of action under § 17(a). See., e.g., O'Brien v.
Nat'l Property Analysts Partners, 719 F. Supp. 222, 231
(S.D.N.Y. 1989); Huang v. Sentinel Gov't Securities,
709 F. Supp. 1290, 1294-95 (S.D. N.Y. 1989); Goldman v. McMahan,
Brafman, Morgan & Co., 706 F. Supp. 256, 258 (S.D.N.Y. 1989);
Dubin v. E.F. Hutton Group, Inc., 695 F. Supp. 138 (S.D.N Y
1988). See also, Eickhorst v. American Completion and
Development Corp., 706 F. Supp. 1087, 1098 (S.D.N.Y. 1989)
("[T]he Court is aware of no recent voice substantively arguing
the correctness of the conclusion that section 17(a) carries
with it an implied private right of action."). The Court finds
nothing in plaintiffs' argument to require a change of heart on
the justiciability of claims under § 17(a). Accordingly,
plaintiffs' second claim for relief under § 17(a) in their
amended complaint is dismissed with prejudice.
B) CNA's Motion For Summary Judgment
Only plaintiffs Joe K. George, Joe David House, M. Stephen
Brandon, Thomas J. Welsh, George Sennett and Edith Sennett
purchased their investment in the partnerships through CNA.
None of the other plaintiffs had any contact with CNA in
connection with the partnerships. CNA has moved thus for
summary judgment pursuant to Fed.R.Civ.P. 56 against all
plaintiffs except those who purchased their interests in the
partnership from CNA. Plaintiffs have indicated that they do
not oppose CNA's motion for summary judgment against these
plaintiffs. Plaintiffs' Memorandum of Law at 1. Accordingly,
defendant CNA's motion for summary judgment on all claims
against all plaintiffs except Joe K. George, Joe David House,
M. Stephen Brandon, Thomas J. Welsh, George Sennett and Edith
Sennett, is granted.
C) Defendant Petro-Tech Partnership IV's Motion to Dismiss
Defendant Petro-Tech Limited Partnership IV ("Petro-Tech
IV") has moved for dismissal of all claims against it. By
admission, none of the plaintiffs purchased units of
Petro-Tech IV. See Amended Complaint, Exhibit A. Accordingly,
Petro-Tech IV has moved for dismissal for plaintiffs' lack of
Under the standing doctrine, "a plaintiff must allege that
he or she is suffering from an injury directly traceable to
the actions of the defendant(s)." Fletcher v. Marino,
882 F.2d 605, 610 (2d Cir. 1989). See also Gladstone, Realtors v.
Village of Bellwood, 441 U.S. 91, 99, 99 S.Ct. 1601, 1607-08,
60 L.Ed.2d 66 (1979) (the injury alleged must be the result of
the "putatively illegal conduct of the defendant"). A plaintiff
may not rest his or her claim for relief on the legal rights of
some third party. Allen v. Wright, 468 U.S. 737, 750-52, 104
S.Ct. 3315., 3324-25, 82 L.Ed.2d 556,
reh'g denied, 468 U.S. 1250, 105 S.Ct. 51, 82 L.Ed.2d 942
It is abundantly clear that to maintain a securities fraud
claim under § 10(b) and Rule 10b-5,*fn5 a plaintiff must be an
actual purchaser or seller of the security in question. Blue
Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730-31, 95
S.Ct. 1917, 1922-23, 44 L.Ed.2d 539 (1975); Birnbaum v. Newport
Steel Co., 193 F.2d 461, 463-64 (2d Cir.), cert. denied,
343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952); Baum v.
Phillips, Appel & Walden, Inc., 648 F. Supp. 1518, 1525
(S.D.N.Y. 1986). Thus, plaintiffs in the instant action do not
have standing to assert securities law violations against
Petro-Tech IV as they are neither purchasers or sellers of
units of that partnership. Further, plaintiffs may not maintain
RICO claims against Petro-Tech IV. RICO claims are dependent
upon the proper allegation of predicate acts, and plaintiffs
have no basis to allege any predicate acts against Petro-Tech
IV. As already noted, their securities fraud claim cannot
survive, nor can their claims of mail or wire fraud against
Petro-Tech IV. Plaintiffs do not allege that they received any
correspondence from Petro-Tech IV, or were in any way misled by
any materials related to Petro-Tech IV.
Plaintiffs rely on Marshall & Ilsley Trust Co. v. Pate,
819 F.2d 806 (7th Cir. 1987) to challenge this conclusion. However,
Pate only stands for the proposition that in a RICO claim, a
plaintiff does not have to show that he was individually
injured by all the predicate acts alleged. The situation
covered by Pate is where a single defendant in a RICO case
takes a variety of actions, only some of which affect the
plaintiff. Pate states that the plaintiff can allege all of the
defendant's actions as predicate acts to the RICO claim, even
though the plaintiff was not harmed by every one of those acts.
It does not stand for the notion that a plaintiff in a RICO
action may allege injury against defendants against whom he or
she would normally not have standing. Accordingly, the Court
finds that plaintiffs do not have standing to state a claim
against Petro-Tech IV. Thus, all claims against Petro-Tech IV
D) Defendants' Motion to Dismiss the § 10(b)
"Dismissal of a complaint for failure to state a claim is a
`drastic step.'" Meyer v. Oppenheimer Management Corp.,
764 F.2d 76, 80 (2d Cir. 1985) (citations omitted). "The function
of a motion to dismiss is merely to assess the legal
feasibility of the complaint, not to assay the weight of the
evidence which might be offered in support thereof." Ryder
Energy Distribution Corp. v. Merrill Lynch Commodities, Inc.,
748 F.2d 774, 779 (2d Cir. 1984) (citations omitted). Thus, a
motion to dismiss must be denied "unless it appears beyond a
doubt that the plaintiff can prove no set of facts in support
of his claim which would entitle him to relief." Scheuer v.
Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90
(1974), citing Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct.
99, 101-02, 2 L.Ed.2d 80 (1957); Morales v. N.Y. State Dep't of
Corrections, 842 F.2d 27, 30 (2d Cir. 1988). In deciding a
motion to dismiss, the Court must accept the plaintiff's
allegation of facts as true together with such reasonable
inferences as may be drawn in its favor. Murray v. City of
Milford, Connecticut, 380 F.2d 468, 470 (2d Cir. 1967). See
also Scheuer, supra, 416 U.S. at 236, 94 S.Ct. at 1686.
However, the Court is not required to accept a strained
interpretation of such allegations. See Ronzani v. Sanofi S.A.,
supra 899 F.2d at 197.
Defendants first assert that plaintiffs failed to bring
their action within the applicable statute of limitation.
Defendants allege that the Court must apply a uniform federal
statute of limitation to all § 10(b) claims. Traditionally,
federal courts have adopted analogous state law statutes of
limitation where the federal law at issue does not provide a
limitation provision of its own. Such has long been the case
with private actions brought under § 10(b). However, recently
the Third Circuit adopted a one year statute of limitation for
claims arising under § 10(b). In Re Data Access Systems
Securities Litigation, 843 F.2d 1537 (3rd Cir.) (en banc),
cert. denied, ___ U.S. ___, 109 S.Ct. 131, 102 L.Ed.2d 103
(1988). The Third Circuit acted in response to two Supreme
Court decisions which adopted uniform federal statutes of
limitation for two specific federal claims. See Agency Holding
Corp. v. Malley-Duff & Associates, Inc., 483 U.S. 143, 107
S.Ct. 2759, 97 L.Ed.2d 121 (1987) (RICO); Del Costello v.
International Brotherhood of Teamsters, 462 U.S. 151, 103 S.Ct.
2281, 76 L.Ed.2d 476 (1983) (collective bargaining
agreements.). Defendants urge the Court to follow the lead of
the Third Circuit and to adopt a uniform one year statute of
limitation for actions under § 10(b).
The Second Circuit has long applied the analogous state law
statute of limitation to actions brought under § 10(b).
Armstrong v. McAlpin, 699 F.2d 79, 86-87 (2d Cir. 1983). This
Court and other courts in this District have faced similar
requests to adopt the Third Circuit's decision in Data Access,
and have repeatedly declined that request. See, e.g., Azurite
Corp., Ltd. v. Amster & Co., 730 F. Supp. 571, 582 (S.D.N Y
1990); Matignon Finance, Inc. v. Ameritel Communications Corp.,
1989 WL 153282, 1989 U.S.Dist. LEXIS 14937, 15-16 (S.D.N Y
1989); Huang v. Sentinel Government Securities, 709 F. Supp. 1290,
1301 n. 10 (S.D.N.Y. 1989); Eickhorst v. American
Completion and Development Corp., 706 F. Supp. 1087, 1102
(S.D.N.Y. 1989); Metropolitan Securities v. Occidental
Petroleum Corp., ...