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United States District Court, Southern District of New York

December 11, 1990


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


Plaintiffs bring the above-captioned securities fraud action pursuant to sections 10(b) & 20(a) of the Securities Exchange Act of 1934, see 15 U.S.C. § 78j(b), 78t(a); Rule 10b-5, see 17 C.F.R. § 240.10b-5; sections 5, 12(2) and 15 of the Securities Act of 1933, see 15 U.S.C. § 77e, 77l(2), 77o; and the Racketeer Influenced and Corruption Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq. Plaintiffs also allege pendent state-law claims of fraud, negligence and breach of fiduciary duty. Currently before the Court is defendants' joint motion to dismiss plaintiffs' Third Amended Complaint ("Complaint")*fn1 for failure to particularize the allegations of fraud, see Fed.R.Civ.P. 9(b), and for failure to state a claim. See Fed.R.Civ.P. 12(b)(6). For the reasons that follow, the motion is granted.*fn2


The relevant allegations of this lengthy complaint may be simply summarized and of course must be assumed to be true. See Luce v. Edelstein, 802 F.2d 49, 52 (2d Cir. 1986). Each of the over 100 plaintiffs purchased interests, called "units," in one or more of the fifteen limited partnership defendants ("Cralin partnerships" or "partnerships") offered to the public from 1979 to December 1984. See Complaint at ¶ 5. The remaining defendants are the inside defendants, i.e., the individuals who organized, promoted and/or managed the Cralin partnerships and the affiliated corporations controlled by these individuals, see id. at ¶ 6(a)-(o); and the outside defendants, i.e., the law firm of Paul, Weiss, Rifkind, Wharton & Garrison ("Paul Weiss"), see id. at ¶ 6(p), and the accounting firm of Price Waterhouse ("Price"). See id. at 6(q).

Plaintiffs allege that they invested in the various partnerships relying on private placement memoranda ("PPMs")*fn3, tax opinions and financial statements issued by the defendants which represented that each of the limited partnerships would "act as commodities broker-dealers trading primarily in metals and government-backed securities," id. at ¶¶ 5, 8(a), 37(a), and that plaintiffs would be entitled to declare their share of the partnerships' profits as ordinary income and to deduct any losses under the federal tax laws. Id. at ¶¶ 4, 37(d).

Plaintiffs contend that these representations were false because the defendants never intended to operate the partnerships as broker-dealers but instead intended to and did operate the partnerships as commodities traders, see id. at ¶¶ 8(g), 39(a)-(b), with the result that the Internal Revenue Service ("IRS") disallowed the deductions taken by the plaintiffs and imposed interest and penalties charges. Id. at ¶ 39(b). Moreover, plaintiffs allege that defendants looted the partnerships' assets through a series of "sham" monetary transfers between the partnerships and the affiliated corporations in the form of commissions and fees. See id. at ¶¶ 8(c)-(f), 40.

Price and Paul Weiss are alleged to have participated in this scheme by preparing the PPMs, tax opinions and financial statements which failed to disclose*fn4 the true nature of the partnerships and the extent of the inter-entity transfers. See id. at ¶¶ 9A, 37, 38, 40, 41, 44-51. Moreover, plaintiffs further allege that the mere association of these firms with the offerings clothed the "scheme" with needed credibility which enhanced the desirability of the investment to the plaintiffs. Id. at ¶¶ 9A, 14, 46, 50.*fn5


To satisfy Fed.R.Civ.P. 9(b), a securities fraud complaint must contain particularized allegations identifying the statements relied on, the respect in which those statements are fraudulent, the time and place of the statements, and the identity of those responsible for the statements. See Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989).*fn6 Moreover, although scienter may be pleaded generally, the plaintiff must nevertheless "allege facts which give rise to a strong inference that the defendants possessed the requisite fraudulent intent." Id. at 12-13.

In this case, it is clear, and indeed not disputed, that plaintiffs' reference to the PPMs satisfies their burden of identifying time, place, speaker, and content of the representations at least with respect to the inside defendants. See DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247-49 (2d Cir. 1987). However, the plaintiffs have failed to allege, as they must, any facts supporting a rational inference that the representations were false and known to be so when made.

An unperformed promise can be actionable under Section 10(b) where the facts pleaded permit a rational inference that the defendant did not intend to or could not perform that promise at the time that it was made. See Luce, supra, 802 F.2d at 55; Pross v. Katz, 784 F.2d 455, 457-58 (2d Cir. 1986). However, here there are no facts pleaded which rationally support the claim that defendant did not intend to operate the Cralin partnerships as broker-dealers, cf., Sirota v. Solitron Devices, Inc., 673 F.2d 566, 573 (2d Cir.) (an admission), cert. denied, 459 U.S. 838, 103 S.Ct. 86, 74 L.Ed.2d 80 (1982), or that the defendants knew that the partnerships could not in fact operate as broker-dealers. See Ross v. A.H. Robins Co., 607 F.2d 545, 558 (2d Cir. 1979), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 64 L.Ed.2d 802 (1980); see also Wexner v. First Manhattan Co., 902 F.2d 169, 172 (2d Cir. 1990). Indeed, at best all plaintiffs allege is a claim of breach of contract and not securities fraud, i.e. that the defendants promised that the partnerships would operate as broker-dealers and that the partnerships did in fact not so operate. See Denny v. Barber, 576 F.2d 465, 469-70 (2d Cir. 1978) (pleading "fraud by hindsight" insufficient); see also Luce, supra, 802 F.2d at 54.*fn7

Similarly, plaintiffs have not alleged any facts from which the Court can reasonably infer in what way inter-entity transactions were fraudulent. In fact, plaintiffs admit that some of these transfers "would otherwise have been proper if . . . the Cralin . . . defendants . . . [operated] the partnerships as legitimate commodities broker-dealers." Complaint at ¶ 18; Plaintiffs' Memo at 4-5. Thus, this allegation is dependent on the failure of the partnerships to operate as broker-dealers, which the Court has found is a legally insufficient predicate for section 10(b) liability. See Wexner, supra, 902 F.2d at 173. Moreover, plaintiffs do not indicate which transfers were fraudulent or why or how they were fraudulent independent of the partnerships' failure to operate as broker-dealers.*fn8 The complaint is therefore clearly insufficient as to the insider defendants.

It follows that the complaint is necessarily insufficient as to the outside defendants as well. See Denny, supra, 576 F.2d at 470 n. 4. This is especially true since plaintiffs have failed to identify, as they must, who at either Price or Paul Weiss prepared the PPMs or in fact which PPM they prepared.*fn9 See Devaney v. Chester, 813 F.2d 566, 568 (2d Cir. 1987); see also Ouaknine, supra, 897 F.2d at 80; DiVittorio, 822 F.2d at 1249.*fn10

In addition, the complaint nowhere alleges what facts either Price or Paul Weiss should have discovered that would have put them on notice of the alleged fraud. In the face of that failure, the fact that Price and Paul Weiss were involved in the preparation of the PPMs and tax opinions cannot support any rational inference of aiding and abetting a fraud. Nor do the allegations that Price and Paul Weiss had access to and extensively reviewed Cralin's business materials, see Complaint at ¶¶ 45-47, 49-51, support the conclusory assertion that these materials should have made the fraudulent nature of the partnerships apparent. See Gross v. Diversified Mortgage Investors, 438 F. Supp. 190, 195 (S.D.N.Y. 1977); see, also Devaney, supra, 813 at 568; Ross v. Warner, 480 F. Supp. 268, 272 (S.D.N.Y. 1979). The same is true with respect to the allegation that Price or Paul Weiss had an ongoing relationship with the Cralin defendants.*fn11 See Dannenberg v. Dorison, 603 F. Supp. 1238, 1241 (S.D.N.Y. 1985).

In any event, the complaint is also deficient as a matter of law because it negates any inference of reasonable reliance. More specifically, with reference to the inter-entity transfers, plaintiffs concede that the PPMs disclosed those transfers and that they were aware that "they were disclosed in such a way that it was impossible for a non participant in the fraud" to discover the scheme. See Complaint at ¶¶ 18-19; Plaintiffs' Memo at 29. In short, plaintiffs acknowledge that they were aware that they did not have sufficient information on which to predicate an informed investment decision.

Moreover, a claim of fraud may not be predicated, as plaintiffs seek to do here, on an alleged reliance on the reputations of Price and Paul Weiss in the face of plaintiffs' conceded failure to seek more information.*fn12 This is especially true since the PPMs and the tax opinions specifically cautioned plaintiffs that the investment was speculative and that they should seek outside advice before investing. Luce, supra, 802 F.2d at 56 ("we are not inclined to impose liability on the basis of statements that clearly `bespeak caution'") (quotations omitted); Feinman v. Schulman Berlin & Davis, 677 F. Supp. 168, 170-71 (S.D.N.Y. 1988).

From the foregoing it is clear that the complaint must be dismissed in its entirety.*fn13 Although leave to replead should be liberally granted, the Court finds that under the circumstances of this case plaintiffs have had a sufficient opportunity to plead fraud, especially since the Court expressed its willingness at Oral Argument to afford plaintiffs another opportunity to amend the complaint, but plaintiffs' counsel advised the Court that it had no other facts to plead. In light of these circumstances, the Court believes that it is appropriate to dismiss the complaint without leave to replead, except as indicated below.*fn14


Accordingly, the defendants' motion to dismiss is granted and the Third Amended Complaint is dismissed with prejudice. The Clerk shall enter judgment for the defendants and close the above-captioned action.


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