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GRIFFIN v. MCNIFF

August 17, 1990

ROBERT J. GRIFFIN, ET AL., PLAINTIFFS,
v.
JOHN A. MCNIFF, ET AL., DEFENDANTS.



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

      Plaintiffs seek to recover for losses sustained as a result of their investment in certain oil and gas limited partnerships. Defendants Crown Energy, Inc. ("Crown"), Wiener, Zuckerbrot, Weiss & Brecher ("Wiener"), Ruffa & Hanover, P.C. ("Ruffa & Hanover"), Price Waterhouse, J.H. Cohn & Company ("J.H. Cohn"), and Grant Thornton ("Thornton") move to dismiss the First Amended Consolidated Complaint (the "Second Amended Complaint" or "S.A.C.")*fn1 pursuant to Rules 9(b), 12(b)(6), and/or 12(b)(1), Fed.R.Civ.P. For the reasons that follow, the motions of Price Waterhouse, J.H. Cohn and Thornton are granted, the motions of Crown and Wiener are granted in part and denied in part, and the motion of Ruffa & Hanover is denied.

BACKGROUND

The general background of this action is recounted in this Court's March 13, 1989 Decision, familiarity with which is presumed.*fn2 Because the Second Amended Complaint differs in certain respects from the previous pleading considered by the Court, the basic facts currently alleged by plaintiffs are summarized below.

The Second Amended Complaint alleges that plaintiffs, who now consist of forty-five (45) investors, purchased interests in one or more of eleven (11) oil and gas limited partnerships (the "partnerships") as they were created in 1982 and 1983.*fn3 Plaintiffs contend that the partnerships were ostensibly formed to acquire, own and operate certain oil and gas producing properties located in Texas and Oklahoma, but actually were part of a scheme by defendants to defraud the limited partners of their investments.

Plaintiffs assert that they invested in the partnerships with the dual expectations of earning a profit from the operation of the oil and gas properties and deriving a tax benefit from the ownership of the partnership interests. S.A.C. ¶¶ 4, 76. These two goals were linked in more than just plaintiffs' expectations, as the partnerships needed to be able to earn a profit in order to generate tax deductions for the investors which would withstand scrutiny by the Internal Revenue Service.

In making their decisions to invest in the partnerships, plaintiffs maintain that they relied upon private placement memoranda ("PPMs"), prepared, issued, and distributed by certain defendants in connection with each partnership. According to plaintiffs, these PPMs contained material misrepresentations and omissions concerning the future profitability of the partnerships and the tax benefits available to the limited partners. S.A.C. ¶ 9. It is also alleged that the tax opinions, financial projections, geology reports, and production evaluations regarding the oil and gas reserves contained in the drilling properties, all attached as exhibits to the PPMs, were materially misleading.

The crux of the Second Amended Complaint is that defendants knew it was not reasonable to expect the partnerships to be commercially profitable in producing oil or to generate legitimate tax deductions, given the properties on which they were drilling, the manner in which they were organized, and the expenses they were to incur. Plaintiffs maintain the partnerships were in fact not profitable, and that the Internal Revenue Service concluded that each of the partnerships was formed without an actual objective of making a profit and disallowed the tax deductions taken by plaintiffs. S.A.C. ¶¶ 5-8. As a result of the fraudulent scheme, plaintiffs allege that they have lost their initial investment and been subjected to penalties and interest on the disallowed tax deductions. S.A.C. ¶ 9.

The fifteen defendants involved in this lawsuit include seven entities and individuals allegedly involved with creating and managing the partnerships. These defendants, none of whom are involved in the instant motions to dismiss the Second Amended Complaint, include Wycombe Energy Group, Inc. ("Wycombe"), the corporate general partner for each of the partnerships, as well as John A. McNiff II ("McNiff"), Caryl Wilkie, John A. McNiff III, Kristen M. McNiff and Mallory Moore, all reportedly insiders and/or directors of Wycombe (collectively the "McNiff Defendants").

The various entities involved in operating or leasing the oil and gas prospects are also named as defendants. They include (1) Phoenix Oil & Gas, Inc. ("Phoenix"), the successor to Gillham Petroleum, Inc. ("Gillham"), the driller-operator for the 1982 limited partnerships, (2) Crown, the sublessor of the drilling prospects for the 1982 partnerships, and (3) William Kester ("Kester"), the director of Star Dust Mines, Inc., the parent corporation of Trans-Tennessee Energy, Inc. which was the driller-operator for the 1983 Devon Energy, Fairfield Energy, Groton Energy and Harwinton Energy Limited Partnerships.

In addition, plaintiffs named as defendants three law firms, Wiener, Ruffa & Hanover, and Martin & Deacon, which allegedly prepared the PPMs and rendered other services to certain of the limited partnerships at various points in time. The final defendants are three accounting firms, Price Waterhouse, J.H. Cohn, and Thornton*fn4, which were involved in reviewing the financial projections and/or approving the tax opinions prepared by the law firm defendants.

Previously, a number of defendants moved to dismiss the First Amended Complaint. On March 13, 1989, this Court granted the motions of Crown, Wiener, Martin & Deacon, Price Waterhouse, J.H. Cohn, and Thornton, dismissing the First Amended Complaint against them for failure to plead fraud with the requisite particularity demanded by Rule 9(b).*fn5 The Court found that plaintiffs failed adequately to differentiate among the various defendants, to specify what fraudulent acts each defendant was charged with having committed, and to allege facts which could support an inference of scienter. In accordance with the general practice regarding Rule 9(b) motions, plaintiffs were afforded leave to replead the dismissed fraud claims.

The motions of the McNiff Defendants to dismiss the fraud claims against them were denied.*fn6 The Court found that the First Amended Complaint was "rife with the type of generalized, conclusory allegations that Rule 9(b) was designed to discourage," but nonetheless held that the allegations were sufficiently detailed to withstand motions to dismiss by the McNiff Defendants, as they could all be fairly characterized as insiders participating in the offer of the securities in question. Griffin I, ¶ 94,389 at 92,531.

The moving defendants once again argue that plaintiffs have failed to plead fraud with the particularity required by Rule 9(b). They also maintain that the claims in the Second Amended Complaint must be dismissed pursuant to Rules 12(b)(6) and 12(b)(1), Fed.R.Civ.P.

DISCUSSION

A.  Rule 9(b) — Pleading Fraud With
    Particularity

Rule 9(b) provides that:

  In all averments of fraud or mistake, the
  circumstances constituting fraud or mistake shall
  be stated with particularity. Malice, intent,
  knowledge, and other condition of mind may be
  averred generally.*fn7

As the Court explained in Griffin I, in a motion to dismiss a complaint for failure to plead fraud with particularity as required by Rule 9(b), plaintiffs' allegations must be taken as true. E.g., Luce v. Edelstein, 802 F.2d 49, 52 (2d Cir. 1986). The Court must read the complaint generously, and draw all inferences in favor of plaintiffs. Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). Furthermore, Rule 9(b) must be read in conjunction with Rule 8(a), Fed.R.Civ.P., which requires plaintiffs to plead only a short, plain statement of the grounds upon which they are entitled to relief. Ross v. A.H. Robins Co., 607 F.2d 545, 557 n. 20 (2d Cir. 1979), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 64 L.Ed.2d 802 (1980). The serious nature of a charge of fraud, however, renders mere conclusory allegations that defendants acted fraudulently insufficient to satisfy Rule 9(b). Segal v. Gordon, 467 F.2d 602, 607 (2d Cir. 1972); Center Savings & Loan Assoc. v. Prudential-Bache Securities, Inc., 679 F. Supp. 274, 276 (S.D.N.Y. 1987).

Rule 9(b) is designed to provide a defendant with fair notice of a plaintiff's claim in order to enable the defendant to prepare a defense, to protect his or her reputation or goodwill from harm flowing from baseless allegations of fraud, and to reduce the number of strike suits. Cosmas v. Hassett, supra, 886 F.2d at 11; DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1247 (2d Cir. 1987).

In order to satisfy Rule 9(b) "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, supra, 886 F.2d at 11. See also Griffin I, ¶ 94,389 at 92,531 (citing Conan Properties, Inc. v. Mattel, Inc., 619 F. Supp. 1167, 1172 (S.D.N.Y. 1985)). Where there are multiple defendants, the complaint must disclose the specific nature of each defendant's participation in the alleged fraud. DiVittorio v. Equidyne Extractive Industries, Inc., supra, 822 F.2d at 1247. In an action alleging securities fraud, "reference to an offering memorandum satisfies 9(b)'s requirement of identifying time, place, speaker and content of representations where . . . defendants are insiders or affiliates participating in the offering of securities." Ouaknine v. MacFarlane, 897 F.2d 75, 80 (2d Cir. 1990); Luce v. Edelstein, supra, 802 F.2d at 55.

While 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. E.g., Connecticut National Bank v. Fluor Corp., 808 F.2d 957, 962 (2d Cir. 1987). In other words, plaintiffs must "`specifically plead those events' which `give rise to a strong inference' that defendants had an intent to defraud, knowledge of the falsity, or a reckless disregard for the truth." Id. at 962 (citing Ross v. A.H. Robbins, supra, 607 F.2d at 558); Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990) ("Although scienter need not be alleged with great specificity, plaintiffs are still required to plead the factual basis which gives rise to a `strong inference' of fraudulent intent").

1. Crown

Plaintiffs assert claims against Crown for (1) securities fraud under section 10(b) and Rule 10b-5, (2) aiding and abetting securities fraud, (3) common law fraud, and (4) RICO, predicated on fraud.

In Griffin I, the Court found that the First Amended Complaint failed to allege adequately Crown's participation in the fraud. The allegations of fraud which plaintiffs claimed involved Crown were either framed generally against a group of defendants, or specifically against defendants other than Crown. For example, plaintiffs alleged that certain reports, projections and evaluations were false and misleading, but failed to identify how Crown was connected to these items. See Griffin I, ¶ 94,389 at 92,532-33. Such generalized pleading was clearly insufficient under Rule 9(b).

The Second Amended Complaint responded to the deficiencies noted by the Court in Griffin I by adding needed particularity to the allegations concerning Crown. Crown is alleged to have been the sublessor of the drilling prospects for the 1982 partnerships, S.A.C. ¶¶ 26, 121. These drilling rights had been acquired by Crown from Gillham. S.A.C. ¶¶ 28-29, 121. The subleases to the partnerships provided that Crown would receive sixty percent (60%) of all revenues generated by the partnerships' oil and gas production, of which it would retain fourteen percent (14%). S.A.C. ¶¶ 30, 32.

The partnerships also agreed to pay Crown certain Minimum Annual Royalties ("MARs") as an advance against production royalties. S.A.C. ¶¶ 33-38. Apparently, a minimum annual royalty payment could be tax deductible if it met certain requirements. The MARs paid to Crown, however, were found not to meet these requirements by the Internal Revenue Service, and were not deductible. S.A.C. ¶¶ 7, 129-131. Plaintiffs contend that the explicit structure of the MARs by definition precluded them from satisfying the criteria necessary for favorable tax treatment under the prevailing tax regulations. Id.

Crown participated in the preparation of the financial projections contained in the PPMs. S.A.C. ¶ 50. Plaintiffs contend that the projections overstated the size and profitability of the partnerships' oil reserves, and created the false impression that it was reasonable to assume that the partnerships would locate and produce commercial quantities of oil. ¶¶ 51, 55, 126.*fn8

Despite the added particularity in the Second Amended Complaint regarding it, Crown argues that plaintiffs have failed adequately to plead scienter. Plaintiffs, however, can plead scienter by alleging facts "showing a motive for committing fraud and a clear opportunity for doing so." Beck v. Manufacturers Hanover, supra, 820 F.2d at 50. Indeed, the lenient standard for pleading scienter will be satisfied even if plaintiffs do not allege facts which demonstrate that defendants had a motive for committing fraud, so long as plaintiffs adequately identify circumstances indicating conscious behavior by defendants. Cosmas v. Hassett, supra, 886 F.2d at 13.

Here, plaintiffs have alleged that Crown had a significant financial interest in the partnerships and ready access to the actual condition of the drilling properties as the sublessor of the drilling prospects. These allegations, combined with the allegations that Crown participated in the preparation of the misleading financial projections which were distributed to the investors as attachments to the PPMs, are sufficient to satisfy the threshold requirements for pleading scienter under Rule 9(b). See Cosmas v. Hassett, supra, 886 F.2d at 13. Accordingly, that aspect of Crown's motion seeking to dismiss the Second Amended Complaint against it under Rule 9(b) is denied.

  2.  The Law Firms — Wiener and Ruffa &
      Hanover

Plaintiffs assert claims against Wiener and Ruffa & Hanover for (1) securities fraud under section 10(b) and Rule 10b-5, (2) aiding and abetting securities fraud, (3) common law fraud and (4) RICO, predicated on fraud.

a. Wiener

The Second Amended Complaint alleges that Wiener, legal counsel to the 1982 partnerships, as well as Wycombe and Crown, prepared the PPMs and tax opinions for the 1982 partnerships. S.A.C. ¶¶ 165, 168-169. Plaintiffs contend that material misrepresentations were made in both the PPMs and the tax opinions, and that Wiener knew these representations were false at the time the documents were distributed to the investors. It is also alleged that Wiener had a direct financial interest in the production of the partnership operations, as it was to receive two percent (2%) of the production royalties paid to Crown by each partnership. S.A.C. ¶ 32.

In a document entitled "Special Report to Limited Partners", dated February 24, 1983, (the "Special Report") the 1982 limited partners were informed by Wycombe that Price Waterhouse was withdrawing its report on the financial projections and its tax opinion letters as a result of an independent investigation which uncovered that the estimated oil reserves for the partnerships might be only a small fraction of what was stated in the offering memorandum and because of questions which had come to light regarding the authorship of the original geologist's reports. Exhibit I annexed to Second Amended Complaint. As a result of Price Waterhouse's withdrawal, Wiener withdrew its tax opinions, noting that these opinions had been predicated, in part, on both Price Waterhouse's projections and the geologist's reports.

In considering the First Amended Complaint, the Court found that plaintiffs had failed to allege sufficient facts to support finding an inference that Wiener knew of the alleged falsity of the representations in the PPMs or the tax opinions. Indeed, while plaintiffs argued that Wiener's scienter could be inferred from its financial interest in the partnerships, they had not even alleged this in the First Amended Complaint, which the Court concluded was an indication of plaintiffs' "inadequate treatment of their responsibilities under Rule 9(b)." Griffin I, ¶ 94,389 at 92,534.

In the mass of allegations contained in the Second Amended Complaint, Wiener's role in the fraud is only marginally expanded upon from the allegations of the prior pleading. Furthermore, the manner in which many of these allegations are presented, using cross-references to various paragraphs and exhibits which frequently concern other ...


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