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COHEN v. PRUDENTIAL-BACHE SECURITIES

November 1, 1991

SARAH COHEN AND LEOPOLD COHEN, INDIVIDUALLY AND ON BEHALF OF ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS,
v.
PRUDENTIAL-BACHE SECURITIES, INC., ET AL., DEFENDANTS.



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

OPINION AND ORDER

The instant action arises out of the sale of limited partnership units in Jefferson Hotel Associates Limited Partnership ("Jefferson Hotel Partnership" or "Partnership"), a Connecticut limited partnership. The plaintiffs, Sarah Cohen and Leopold Cohen, investors in the Jefferson Hotel Partnership, bring this suit individually and on behalf of all others similarly situated. The defendants are Prudential-Bache Securities, Inc. ("Prudential Securities") and Prudential-Bache Properties, Inc. ("Prudential Properties"), both Delaware corporations; Sybedon Corporation ("Sybedon") and Wilrock Appraisal & Consulting, Inc. ("Wilrock"), both New York corporations; Laventhol & Horwath ("Laventhol"), a California partnership; National Union Insurance Company of Pittsburgh ("National Union"), a Pennsylvania corporation; and Edwin J. Glickman, Mitchell Davis and Betram Lewis, individual defendants. Plaintiffs assert federal claims under sections 12(2) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 771, Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. They also assert pendent state law claims of common law fraud, negligent misrepresentation, breach of fiduciary duty and violation of the California Corporations Code.

Based on the Supreme Court's recent holdings in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, ___ U.S. ___, 111 S.Ct. 2773, 115 L.Ed.2d 321 (1991), and James B. Beam Distilling Co. v. Georgia, ___ U.S. ___, 111 S.Ct. 2439, 115 L.Ed.2d 481 (1991), and subsequent cases applying these precedents, this Court is compelled to dismiss plaintiffs' securities fraud claims. Since this dismissal eliminates the federal jurisdictional basis, plaintiffs' pendent state law claims are also dismissed.

BACKGROUND

For the purposes of this motion, the Court assumes the truth of the facts alleged by plaintiffs in their Complaint. See O'Brien v. National Property Analysts Partners, 936 F.2d 674, 677 (2d Cir. 1991); DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987).

Between September 1983 and March 1984, Prudential Securities sold 140 limited partnership units in the Jefferson Hotel Partnership to investors in 28 states. Complaint ¶ 106. Information about the partnership offering was disseminated, beginning in September 1983, via the Jefferson Hotel Partnership Private Placement Memorandum ("Placement Memo"), which stated that the goal of the Partnership was to raise $14 million, to "acquire, substantially rehabilitate and refurbish, own and lease a 275-room hotel located in Richmond, Virginia, to be known as the Jefferson Sheraton Hotel ("Jefferson Sheraton")." Placement Memo, at i.*fn1 The offering was exempt from SEC registration requirements under Regulation D, 17 C.F.R. §§ 230.501-.508, which is a safe harbor provision that applies to securities offerings to "accredited investors," having substantial net worth or income. Complaint ¶ 2. After opening in March 1986, the Jefferson Sheraton suffered losses for 43 consecutive months, and went into bankruptcy in October 1989. Complaint ¶ 111. The purchasers of partnership units appear to have suffered a total loss, leading to this action. Complaint ¶ 98.

Plaintiffs claim that the sale of the Partnership securities was characterized by fraudulent conduct, alleging that:

  Through material omissions defendants fraudulently
  overstated the prospects for the Hotel's economic
  success and at the same time failed to disclose
  the severe financial straits into which the
  restoration project was falling. In so doing,
  defendants acted with the full knowledge of
  contemporaneous projections on the hotel and
  problems incurred by the developer which pointed
  toward the inevitable doom of the JHA investors
  [sic] interests. Unbeknownst to plaintiffs, the
  projections contained in the PPM were inflated;
  drafted to obscure the economics of the
  investment; and unreasonable under the
  circumstances.

Complaint ¶ 100. Specifically, defendants allege that the following material facts were omitted from the offering memorandum:

  That the Hotel, when acquired by [the
  Partnership], was substantially deteriorated and
  that prior attempts to raise funds for the Hotel
  were unsuccessful due to the excessive cost of
  such renovation;
  Laventhol tailored the amount of the [offering
  memo] Jefferson Hotel income projections to meet
  [Prudential Securities'] and Sybedon's
  [Partnership] Unit marketing objectives. These
  projections were prepared to obscure the economics
  of the investment and not with an eye toward
  protecting investors;
  The Jefferson Hotel appraised value of $37 million
  included in the [offering memo] did not reflect
  the non-recourse nature of the Jefferson Hotel
  lease. Reflecting the non-recourse nature of the
  lease would have materially lowered the appraised
  value of the lease by substantially raising the
  discount rate by which the net present value of
  the Jefferson Hotel was determined;
  The Jefferson Hotel's renovation "cost per room"
  was approximately $116 thousand, which
  substantially, exceeded the renovation costs of
  similar hotels in the area; and
  The [offering memo] was drafted to obscure the
  economics of the investment; to disguise the
  primary wrong as described herein; and to deprive
  investors of the historical and current financial
  information concerning the expenses of the
  rehabilitation. It was not drafted for the
  ordinary investor or the sophisticated investor;
  it was ...

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