United States District Court, Southern District of New York
May 29, 1991
ROBERT H. HAGGERTY, ROBERT C. GRAHAM, AND KIRK PARRISH, INDIVIDUALLY AND ON BEHALF OF ALL OTHER PERSONS WHO ARE CLASS I LIMITED PARTNERS OF COMSTOCK GOLD COMPANY, L.P., PLAINTIFFS,
COMSTOCK GOLD COMPANY, L.P., UNITED MINING CORPORATION, RAYNHAM HALL CONTRACTING, INC., TIMOTHY COLLINS, MAURICE CASTAGNE, GEORGE WERK AND ALICE WERK, DEFENDANTS. HOWARD T. BELLIN, M.D. AND ROBERT M. GILLER, M.D., INTERVENOR-PLAINTIFFS, V. COMSTOCK GOLD COMPANY, L.P., UNITED MINING CORPORATION, RAYNHAM HALL CONTRACTING, INC., TIMOTHY COLLINS, MAURICE CASTAGNE, GEORGE WERK AND ALICE WERK, DEFENDANTS.
The opinion of the court was delivered by: Leisure, District Judge:
ORDER AND OPINION
This is an action for violation of § 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b
promulgated thereunder, as well as pendent state law claims for
fraud, rescission, and breach of contract and fiduciary duties.
The parties have cross-moved for summary judgment. For the
reasons set forth below, the cross-motion of defendants
Comstock Gold Company, L.P., United Mining Corporation, Raynham
Hall Contracting, Inc., Timothy Collins and Maurice Castagne
(collectively "the Moving Defendants") is granted, and
plaintiffs' cross-motion is denied.*fn1
The instant action arises out of the sale to plaintiffs of
limited partnership shares in defendant Comstock Gold Company,
L.P. ("Comstock") in 1978 and 1979. Comstock was organized in
1978 by defendants United Mining Corporation ("UMC") and
Timothy Collins ("Collins") to explore for and mine gold and
silver in the Comstock Lode near Virginia City, Nevada. The
first offering occurred in December 1978, when Comstock, UMC
and Collins issued a private placement memorandum (the "1978
Memorandum") offering for sale $1,600,000 in Class I limited
partnership interests, in ten units of $160,000 each. When this
offering did not result in a sale of all ten units, a second
offering was made in March 1979 with the issuance of a
substantially identical private placement memorandum (the "1979
Memorandum"), offering sufficient units, again at $160,000 per
unit, to reach the original goal of raising $1,600,000.
Plaintiff Robert C. Haggerty was at the time of his
investment a senior partner with the New York law firm of
Dewey, Ballentine, Bushby, Palmer & Wood. Plaintiff Robert C.
Graham was the president of a real estate company and president
of the Graham Gallery, Ltd. Plaintiff Kirk Parrish was the
executive vice president of an advertising company, and had
previously been president of Life Savers, Inc., the American
Chicle Company, and Lanvin Charles of the Ritz, and a director
of the Squibb Corporation. Plaintiff Howard T. Bellin, M.D. was
a surgeon in New York, as well as president of Bellin's
Department Store, Bellin Aviation, and Speed Flying Service.
Plaintiff Robert Giller, M.D. was a doctor in New York. All of
the plaintiffs were experienced in tax shelter investments, all
were college graduates,
and all had incomes that placed them in the top tax bracket.
The 1978 Memorandum and 1979 Memorandum (collectively, "the
Offering Memoranda") included the following warnings regarding
the proposed investment in Comstock:
THE INVESTMENT DESCRIBED HEREIN INVOLVES
SUBSTANTIAL RISKS AND IS OFFERED ONLY TO
INDIVIDUALS WHO CAN AFFORD SUCH RISKS. SEE
"PRINCIPAL RISK FACTORS" HEREIN. THERE WILL BE NO
PUBLIC MARKET FOR THE UNITS, AND RESALES AND OTHER
TRANSFERS ARE LIMITED BY FEDERAL AND STATE
SECURITIES LAWS, THE INTERNAL REVENUE CODE, AND
THE LIMITED PARTNERSHIP AGREEMENT. SEE ALSO
"CONFLICTS OF INTERESTS," AND "FEDERAL INCOME TAX
CONSEQUENCES" FOR ADDITIONAL RISK CONSIDERATIONS.
Offering Memoranda at cover page.
Of course, there can be no assurance that [gold
and silver] reserves will be discovered in
commercially recoverable quantities or, if
reserves are discovered, that a sufficient
quantity of gold and silver will be extracted to
pay operating expenses and/or a return on the
investment made in the Partnership.
Offering Memoranda at 2.
Estimates of profit, loss and cash flow have been
made by the General Partners through 1984.
However, there is no assurance whatsoever that the
Partnership will ever operate at a profit or that
distributions, if made, will equal those estimated
by the General Partners at the present time.
1979 Memorandum at 3.*fn2
Each prospective Class I Limited Partner must take
into account the fact that all of his notes will
be presented for payment and that the Partnership
may never be in a position to make any cash
distributions. The risk factors relating to
investment in the Partnership are set forth in
this memorandum; they should be carefully reviewed
by any prospective investor before subscribing for
any Class I Limited Partnership interest in the
Offering Memoranda at 4.
Each prospective Limited Partner is urged to study
this memorandum very carefully and to review the
risks discussed therein with his own income tax
advisor. Neither this memorandum nor the financial
estimates made by the General Partners represent
assurances of financial or tax results or purport
to represent income tax advice to prospective
Offering Memoranda at 5.
INVESTORS SHOULD NOT CONSTRUE THE CONTENTS OF THIS
MEMORANDUM OR ANY COMMUNICATION, WHETHER WRITTEN
OR ORAL, FROM THE PARTNERSHIP OR ITS GENERAL
PARTNER, EMPLOYEES OR AGENTS, AS LEGAL, TAX,
ACCOUNTING, INVESTMENT OR OTHER EXPERT ADVICE.
EACH INVESTOR SHOULD CONSULT HIS OWN COUNSEL,
ACCOUNTANTS, AND OTHER PROFESSIONAL ADVISORS AS TO
LEGAL, TAX, ACCOUNTING AND RELATED MATTERS
CONCERNING HIS INVESTMENT.
Offering Memoranda at 6.
THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK
(SEE "PRINCIPAL RISK FACTORS") AND, CONSEQUENTLY,
THE PURCHASE OF UNITS SHOULD BE CONSIDERED ONLY BY
PERSONS WHO CAN AFFORD A TOTAL LOSS OF THEIR
Offering Memoranda at 6 (emphasis in original).
Each investor seeking an interest as a Limited
Partner will be required to represent that his net
worth is in excess of three times his proposed
maximum investment or $480,000 per unit and that
he is experienced in business and/or investments.
It will further be required that such investor
represent that by virtue
of his own investment acumen and business
experience he is capable of evaluating the hazards
and merits of participation in this offering, or
that he has consulted with and is relying upon the
advice of his own personal legal and tax advisors
in making this investment decision. Additionally,
he will have to represent that he can bear the
economic risks attendant upon this investment by
holding for an indefinite period the securities
offered hereby with the possibility of loss of his
Offering Memoranda at 8.
Following these statements, the Offering Memoranda identify
thirteen "Principal Risk Factors," six of which are identified
as "Partnership Risks" and seven as "Mining and Business
Risks." These include statements that:
The Partnership has never before engaged in its
proposed business and has not undertaken any
mining activities to date.
Offering Memoranda at 18.
Although the report of Maurice Castagne, P.E.
dated November 3, 1978 . . . indicates the
likelihood of substantial economically recoverable
gold and silver reserves, based upon the available
geological data described in the report, there is
no assurance as to the actual amount or quality of
Offering Memoranda at 19.
The project ultimately failed and plaintiffs commenced this
action, asserting a securities fraud claim, as well as pendent
state law claims. Plaintiffs allege, inter alia, that the
Offering Memoranda contained false or materially misleading
statements, or material omissions, in violation of § 10(b) of
the Securities Exchange Act of 1934.
I. Section 10(b) Claim
It is well settled in this Circuit that in order to sustain
a claim under § 10(b) a plaintiff must allege and prove
"`material misstatements or omissions indicating an intent to
deceive or defraud in connection with the purchase or sale of a
security.'" McMahan & Co. v. Wherehouse Entertainment, Inc.,
900 F.2d 576, 581 (2d Cir. 1990) (quoting Luce v. Edelstein,
802 F.2d 49, 55 (2d Cir. 1986)). Plaintiffs allege that the
Offering Memoranda contain several material misstatements and
omissions. The Court will discuss these seriatim.
Plaintiffs argue that several statements in the Offering
Memoranda were materially misleading in making estimates of ore
reserves at the property, in making cost estimates, in making
estimates as to the amounts of recoverable gold and silver
reserves, and in making estimates as to profits, losses and
cash flow. However, courts in this Circuit have repeatedly held
that, with respect to future projections, there is no liability
under § 10(b) for statements in an offering memorandum that
"bespeaks caution." See Luce, supra, 802 F.2d at 56; Griffin v.
McNiff, 744 F. Supp. 1237, 1253 (S.D.N.Y. 1990) ("warnings and
disclaimers may limit the extent to which an investor can rely
on the offering documents as a forecast of future events.");
CL-Alexanders Laing & Cruickshank v. Goldfeld, 739 F. Supp. 158,
162 (S.D.N.Y. 1990) (cautionary language in a prospectus limits
the extent to which a plaintiff may reasonably rely on
statements and data therein); Brown v. E.F. Hutton Group,
735 F. Supp. 1196, 1201-02 (S.D.N.Y. 1990) (Walker, J., sitting by
designation); Friedman v. Arizona World Nurseries Limited
Partnership, 730 F. Supp. 521, 541 (S.D.N.Y. 1990) (warnings and
disclaimers limit degree to which an investor may reasonably
rely on offering memoranda as forecast of future), aff'd
without opinion, 927 F.2d 594 (2d Cir. 1991); O'Brien v.
National Property Analysts Partners, 719 F. Supp. 222, 227
(S.D.N.Y. 1989) (Leisure, J.); Stevens v. Equidyne Extractive
Industries 1980, Petro/Coal Program 1, 694 F. Supp. 1057, 1063
(S.D.N.Y. 1988) ("no liability attaches to an offering
memorandum that purports to be speculative."); Feinman v.
Schulman Berlin & Davis, 677 F. Supp. 168, 171 (S.D.N.Y. 1988)
(no reasonable reliance where offering memorandum stated that
estimates were speculative).
In the case at bar, the Offering Memoranda did far more than
"bespeak caution." Luce, supra, 802 F.2d at 56. Rather, they
"virtually bristle with warnings" as to the extremely risky
nature of the investment described therein, as well as the
highly speculative nature of the memoranda's projections as to
future results. See CL-Alexanders Laing, supra, 739 F. Supp. at
162.*fn3 Sophisticated investors such as the plaintiffs herein
cannot, therefore, have reasonably relied on the Offering
Memoranda as an accurate forecast of the future performance of
Plaintiffs also claim, incredibly, that they did not realize
that the proceeds of their investments in Comstock would be
sufficient only to carry out the initial exploration and
development phase of the project, and would not support the
project through the production phase. Plaintiffs point to a
"preliminary report" prepared in August 1978 by defendant
Maurice Castagne ("Castagne"), a professional mining engineer,
that indicates that "Phase I" of the project would cost
$1,480,000. The "preliminary report" also indicates that Phase
I would consist of initial exploration and development of the
mining site, after which a decision could be made as to whether
production would be economically feasible. The preliminary
report was not included with the Offering Memoranda, however,
a "supplement report," prepared by Castagne in November 1978,
Plaintiffs argue that the failure to include the "preliminary
report" with the Offering Memoranda or to otherwise indicate
that the investment proceeds would be used only for exploration
and development and not production was a materially misleading
omission. This argument must fail on the ground that there
simply was no such omission. The section in the Offering
Memoranda entitled "Use of Proceeds" plainly states that the
funds contributed by the limited partners will "pay for
exploration and development of the Partnership's gold
property." Offering Memoranda at 10. There is no indication
that plaintiffs' investments would finance production.
Moreover, Castagne's "supplement report" concludes only that
"PHASE I of the development program" is feasible, and that
"[t]his program is important for the initial assessment of the
. . . properties." Supplement Report at 2 (emphasis added). The
"supplement report" then clearly states that "[e]ntry into the
ore zone would allow studies determining a course of action
relative to additional development and production." Supplement
Report at 2. "Ground conditions, relative to controls, and/or
support, will only be known after the area has been opened and
tested." Supplement Report at 4. Castagne's cost estimates for
Phase I alone, as detailed in the supplement report, totalled
at least $1,200,000, making it even more obvious that
full-scale development and production would not be funded
solely by the monies raised from plaintiffs' limited
partnership shares. Accordingly, if experienced investors such
as plaintiffs — having read the offering memorandum and the
"supplement report" attached thereto — actually believed that
their investments would pay for the complete exploration,
development and production of the mining properties, such a
belief was unreasonable as a matter of law and cannot support
an action for securities fraud. See O'Brien, supra, 719 F. Supp.
at 227-28. "`The securities laws were not enacted to protect
sophisticated businessmen from their own errors of judgment.'"
Edwards & Hanly v. Wells Fargo Securities Clearance Corp.,
602 F.2d 478, 486 (2d Cir. 1979) (quoting Hirsch v. du Pont,
553 F.2d 750,
763 (2d Cir. 1977)), cert. denied, 444 U.S. 1045, 100 S.Ct.
734, 62 L.Ed.2d 731 (1980).
Finally, plaintiffs allege that defendants UMC and Collins
organized defendant Raynham Hall Contracting, Inc. ("Raynham
Hall") for the purpose of contracting with Comstock to perform
developmental and production work. Plaintiffs further assert
that the contract with Raynham Hall provided for fixed
compensation insufficient to permit the contract to be
economically performed by Raynham Hall, and that defendants
UMC, Collins and Castagne "knew or should have known" this to
be true. Amended Complaint ¶ 35.
There is, however, no evidence that the Moving Defendants
made any misleading statements or failed to disclose any
information that was not known to the rest of the market.
See Brown, supra, 735 F. Supp. at 1203. Moreover, there is no
evidence that the Moving Defendants had the requisite scienter,
rather than that they merely underestimated the cost of the
mining operations. The mere fact that an estimate is
understated or overstated does not give rise to an inference of
fraudulent intent. See Quantum Overseas, N.V. v. Touche Ross &
Co., 663 F. Supp. 658, 668 (S.D.N.Y. 1987); Schwartz v. Novo
Industri, A/S, 658 F. Supp. 795, 799 (S.D.N.Y. 1987) (Weinfeld,
J.). As is true of much of their complaint, plaintiffs'
argument with respect to the Raynham Hall contract is an
example of alleging "fraud by hindsight," and thus it must
fail. Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978)
(Friendly, J.); Schwartz, supra, 658 F. Supp. at 795.*fn4
II. Pendent Claims
Dismissal of pendent state law claims is appropriate where
the federal claims to which they were appended have been
dismissed by the Court. See United Mine Workers v. Gibbs,
383 U.S. 715, 86 S.Ct. 1130, 16 L.Ed.2d 218 (1966); CL-Alexanders
Laing, supra, 739 F. Supp. at 167 ("Absent exceptional
circumstances . . . a federal court should refrain from
exercising pendent jurisdiction when federal claims are
disposed of by summary judgment."). Accordingly, those claims
are dismissed for lack of subject matter jurisdiction.
For the reasons set forth above, the Moving Defendants'
cross-motion for summary judgment with respect to the federal
securities law claim is granted. The pendent state law claims
are dismissed for lack of subject matter jurisdiction.
Plaintiffs' cross-motion for summary judgment is denied.
Plaintiffs are directed to inform the Court within 30 days of
the date of this order as to the status of this action
vis-a-vis defendants George Werk and Alice Werk.