The Supreme Court granted certiorari in Beauford, vacated the
Second Circuit's judgment, and remanded the case to that court
for further consideration in light of H.J., 109 S.Ct. 2893. The
Second Circuit gave Beauford that mandated further
consideration and adhered to its en banc decision.
893 F.2d 1433.
In the case at bar, plaintiffs' original complaint alleged
that all defendants had defrauded them by misrepresentations
in and omissions from Southwest's Private Placement
Memorandum. Defendants move to dismiss the securities fraud
claims on the ground that they did not comply with the
particularity requirements of Rule 9(b). Plaintiffs did not
oppose that motion. Instead, they filed the amended complaint
which is the subject of the present motions to dismiss. The
amended complaint abandons the theory that plaintiffs'
investments were induced by the Memorandum. Plaintiff now
allege at ¶ 46:
These allegations have consequences in the context of
plaintiffs' § 10(b) claim, discussed infra. However, they are
also relevant to RICO continuity analysis. What the amended
complaint alleges is the formation
of the Partnership in March 1984, initial selling efforts on
May 21, 1984, and the placement of all Units of the
Partnership only three days thereafter.
Plaintiffs do not allege closed-end continuity sufficient to
satisfy the RICO statute as interpreted by the Supreme Court
Closed-end continuity is not established by even a
substantial number of predicate acts, if those acts all take
place within a brief period of time. That is because
"continuity", of either the closed-end or open-ended variety,
is "centrally a temporal concept," H.J., 109 S.Ct. at 2902. A
number of similar acts may establish relatedness for RICO
purposes, but relatedness and continuity are "distinct
requirements," and related predicate acts do not satisfy the
continuity requirement unless they extend "over a substantial
period of time." Ibid. That cannot be said of the predicate
acts alleged in the amended complaint.
The amended complaint is equally deficient in allegations of
open-ended continuity. No threat of continuity in respect of
the Southwest Partnership is demonstrated by the pleading; the
Partnership is alleged to have been fully subscribed, and
there is no allegation that it is seeking new subscribers.
The case at bar may therefore be contrasted with
Beauford v. Helmsley, supra, which dealt with the mailings of
allegedly fraudulent materials relating to the sale of
condominium apartments. The complaint alleged that "some 40%"
of the apartments in question remained unsold, and "that there
was reason to believe that similarly fraudulent mailings would
be made over an additional period of years. 865 F.2d at 1292.
There being no allegation of open-ended continuity in
respect of the particular venture giving rise to plaintiffs'
claims, they cast a wider net and allege in the amended
complaint at ¶¶ 141-142 that defendants, having "represented
that they are engaged in the business of investments . . . and
managing real estate and real estate related investments . . .
will continue to offer limited partnership investments to
investors throughout the United States," so that "there is a
threat of continuing racketeering activity within the meaning
The most that can be said for this aspect of the pleading is
that it alleges the defendants, corporate and individual, are
continuing to do business. If the corporate and individual
defendants were associated with organized crime, those
allegations would be sufficient to plead open-ended continuity
under United States v. Indelicato, supra. But defendants may
not be so characterized; and plaintiffs' concept of a "threat
of continuing racketeering activity" on the part of these
defendants is far too conjectural to satisfy the requirements
of RICO pleading. Something more concrete, as in Beauford v.
Helmsley, is required. The threat of continued activity of the
sort of conduct alleged in the amended complaint is
particularly unlikely, given the fact, which I can judicially
notice, that the Tax Reform Act of 1986 came close to
eliminating the deductibility of losses claimed by participants
in tax shelter investments such as this Partnership.
I conclude that these plaintiffs do not and cannot allege a
viable RICO claim. Accordingly I will dismiss the sixth claim
for relief without leave to replead. In the view I take of the
case I need not reach the other issues concerning RICO
addressed by the briefs, including the constitutionality of
The § 10(b) Claims
The moving defendants challenge the sufficiency of
plaintiffs' allegations of fraud. They rely in large measure
upon Rule 9(b) Fed.R.Civ.P.
Before analyzing the amended complaint, it is useful to
review pertinent Second Circuit authority.
Rule 9(b) provides: "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 of a person may be averred generally."
Rule 9(b) must be read together with Rule 8(a) which requires
"only a `short and plain statement' of the claims for relief."
v. MacFarlane, 897 F.2d 75, 79 (2d Cir. 1990); DiVittorio v.
Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1247 (2d
Cir. 1987). On a motion to dismiss, the court assumes the truth
of plaintiff's factual allegations, Ouaknine at 78, reads the
complaint generously, and draws all inferences in favor of the
pleader. Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989);
Yoder v. Orthomolecular Nutrition Institute, Inc., supra at
562. But Rule 9(b) must be enforced so as to accomplish its
three goals: (1) providing a defendant fair notice of
plaintiff's claim, to enable preparation of his defense; (2)
protecting a defendant from harm to his reputation or goodwill;
and (3) reducing the number of strike suits. DiVittorio at
To satisfy the particularity requirement of 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 at 11. 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 at 1247.
However, no specific connection between fraudulent
representations or omissions need be pleaded as to defendants
who are insiders or affiliates personally participating in the
statements at issue. DiVittorio at 1247 (offering memorandum);
Luce v. Edelstein, 802 F.2d 49, 55 (2d Cir. 1986) (same).
A complaint may adequately identify the statements alleged
to be misrepresentations and properly indicate when, where and
by whom they were made, yet still fail Rule 9(b) scrutiny if
the complaint does not allege circumstances giving rise to a
strong inference that defendant knew the statements to be
false, Wexner v. First Manhattan Co., 902 F.2d 169, 173 (2d
Cir. 1990), and intended to defraud plaintiff, Ouaknine at 80;
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).
Knowledge is a state of mind. So is intent to defraud, or
"scienter." While Rule 9(b) permits conditions of mind to be
averred generally, the rule also requires that allegations of
scienter be supported by facts giving rise to a "strong
inference" of fraudulent intent. Ouaknine at 80; Beck at 50;
Connecticut National Bank v. Fluor Corp., 808 F.2d 957, 962 (2d
Allegations supporting an inference of fraudulent intent
frequently include defendant's statement that a fact exists or
an event will come to pass coupled with allegations that the
fact did not exist or the event did not occur, and
circumstances indicating that the statement was false when
made. See, e.g., Luce at 56 (alleged misrepresentation in
offering memorandum that general partners would make an initial
capital contribution of $385,000 and guarantee a $4.5 million
construction loan accompanied by allegations that general
partners contributed only $80,000 and did not guarantee the
loan); DiVittorio at 1248 (offering memorandum's statement that
proceeds of offering would be expended as quickly as possible
accompanied by allegation that proceeds were never so applied,
and estimate that property contained approximately 9,260,000
tons of coal accompanied by allegation that mines did not
contain nearly that much). See Ouaknine at 81 for a comparable
To satisfy the scienter requirement, a plaintiff need not
allege facts which show a defendant had a motive for
committing fraud, so long as plaintiff adequately identifies
circumstances indicating "conscious behavior" by the defendant
from which an intent to defraud may fairly be inferred.
Cosmas at 13. However, where a particular defendant's motive to
defraud is not apparent, the strength of the circumstantial
allegations must be correspondingly greater. Beck at 50.
The defendant's status and function are important factors.
For example, an outside director's liability, if any, must be
that of an aider and abettor, a conspirator, or a
substantial participant in fraud perpetrated by others; and
conclusory allegations of aiding and abetting or conspiracy
are not enough. Decker v. Massey-Ferguson, Ltd., 681 F.2d 111,
119 (2d Cir. 1982). Where third-party advisers are concerned,
the complaint must allege circumstances allowing a strong
inference of knowledge of liability. Devaney v. A.P. Chester,
813 F.2d 566, 568 (2d Cir. 1987) (investment banker).
Allegations may be based on information and belief when
facts are peculiarly within the opposing party's knowledge.
Luce at 54 n. 1; DiVittorio at 1247-48. However, that exception
to Rule 9(b)'s general requirement of particularized pleading
does not constitute a license to base claims of fraud on
speculation or conclusory allegations. Where pleading is
permitted on information and belief, a complaint must adduce
specific facts supporting a strong inference of fraud or it
will not satisfy a relaxed pleading standard. Wexner at 172.
In analyzing the amended complaint at bar, I disregard the
allegations of fraudulent misrepresentations or omissions in
the Memorandum and accompanying sales materials. While such
allegations are spread throughout the amended complaint, they
cannot form the basis for an action for fraud under
plaintiffs' theory of fraudulent inducement as now alleged in
the amended complaint. As noted, plaintiffs now allege that
the Memorandum and accompanying sales materials were not sent
to investors until "subsequent to the sale." ¶ 46. In those
circumstances, these materials cannot in law be regarded as
furthering a fraudulent scheme "in connection with the purchase
or sale of any security," as required by § 10(b). See Bourdages
v. Metals Refining Ltd., [1984-85 Transfer Binder] CCH
Fed.Sec.L.Rep. § 91,828 at 90,168, 1984 WL 1209 (S.D.N.Y. 1984)
and cases there cited.
The pleading therefore comes down to such sweeping,
conclusory allegations as "Hutton's national network of
brokers used high pressure sales tactics," ¶ 43, and that all
defendants (without specifying among them) concealed material
information or misled plaintiffs, again without giving
particulars. ¶ 88, 89.
These allegations of fraud are deficient in a number of the
respects discussed in the cases cited supra. See also Center
Savings & Loan Association v. Prudential Bache Securities,
Inc., 679 F. Supp. 274, 278 (S.D.N.Y. 1987).
An extended discussion is not necessary, but it is worth
noting that the requirement that the pleading inform each of
multiple defendants of the nature of the alleged participation
in the fraud is not satisfied by this sort of all-inclusive
allegations. The amended complaint's reference to Hutton's
"national network of brokers" narrows the field somewhat, at
least in relation to those defendants not employed by Hutton;
but even on that aspect of the case, the amended complaint
does not give the required particulars. Plaintiffs' conclusory
allegation that all defendants should be characterized as the
sort of insiders who share each others' knowledge is not
sufficient, given the different status and functions of some
Secondly, to the extent that declarations of unidentified
brokers to unidentified investors are quoted, they are for the
most part not actionable in fraud. An example is ¶ 44, which
alleges that Hutton brokers told clients that Southwest II "was
the `hottest thing to come down the pike' and that Units in
Southwest II were difficult to obtain and selling fast." Quite
apart from the pleading's failure to allege which brokers made
such statements to which investors, these utterances do not
constitute representations of fact that could be actionable
under the securities laws. See, e.g., Zerman v. Ball,
735 F.2d 15, 20-21 (2d Cir. 1984) and cases cited.
Plaintiffs' first claim alleging violation of § 10(b) of the
1934 Act is dismissed for failure to allege fraud with the
specificity required by Rule 9(b). If they can do so consistent
with the requirements of Rule 11, plaintiffs are granted leave
to replead this claim within forty-five (45) days of the date
of this Opinion and Order.
The Remaining Claims
The third, fourth and fifth claims are based upon the common
law.*fn1 No independent source of federal subject matter
jurisdiction is alleged, and so these claims are based upon
principles of pendent jurisdiction. I decline to retain
jurisdiction over them. See United Mine Workers of America v.
Gibbs, 383 U.S. 715, 726, 86 S.Ct. 1130, 16 L.Ed.2d 218 (1966).
The question may be reconsidered if plaintiffs are in a
position to plead federal securities fraud with the requisite
The Clerk of the Court is directed to dismiss the amended
complaint, with leave to replead consistent with this Opinion
and Order. Since the bases for the Court's decision are
universal in their application, the amended complaint will be
dismissed as to all defendants.
It is SO ORDERED.