The opinion of the court was delivered by: THOMAS P. GRIESA
The motions before the court have been brought in 27 consolidated actions involving limited partnerships promoted by DBG Property Investors, Inc. A total of 31 limited partnerships are covered in these actions. Most of the actions attack a single limited partnership. A few of the actions relate to more than one partnership.
These are not class actions. The individual investors on whose behalf the actions are brought are named as plaintiffs. There are a total of over 200 plaintiffs in the actions.
The suits are brought under the federal securities laws, under RICO and under the common law.
In some of the actions the original complaints are still operative, and in some the complaints have been amended. Defendants in all the actions have moved to dismiss the complaints under Fed. R. Civ. P. 9(b) and (12)(b)(6). Since certain materials, particularly the private placement memoranda relating to the partnerships, have been submitted to the court and have been considered on these motions, the court will treat the motions as requesting summary judgment, as contemplated by Fed. R. Civ. P. 12(b). Defendants have also moved for sanctions.
There is a group of defendants who are sued in all the actions. They are DBG Property Investors, Inc. and seven persons and entities connected with that company. These defendants include a law firm by the name of Fruitbine, Weiner, Harwin & Herman. This law firm is alleged to have participated in the preparation of the private placement memoranda and the procurement of certain appraisals of properties. Also, the individuals, Messrs. Fruitbine, Weiner, Harwin and Herman, are sued individually in certain cases.
Aside from the above law firm, no other professional entity is sued - i.e., there are no claims against appraisers or accountants.
In addition to the eight defendants connected with DBG Property Investors, Inc., a total of 22 other defendants are named in various actions. These defendants include Ira D. Orshan, Jerome Rubin and Joel Katz, who were associated with Arandale Management Corp. and were co-promoters and co-managing partners of all or most of the partnerships.
The complaints consist mainly of standard allegations repeated in all of the cases, varied, to a limited extent, to take into account certain facts alleged about particular partnerships.
These cases are mainly attacks upon the private placement memoranda. There are also claims that certain subsequent documents were issued to conceal the frauds perpetrated by the private placement memoranda. The claims are initially alleged under the federal securities laws.
There are also claims under RICO. Predicate acts are alleged under the federal securities laws and also under the federal mail fraud and wire fraud statutes. However, all the alleged predicate acts are claims of misrepresentation in connection with the private placement memoranda and the other documents. See Stern complaint, pars. 76-81.
In dealing with the present motions the court will first discuss certain groups of allegations which appear to be central to the claims of plaintiffs. The amended complaint in the Stern case will be used as a typical example of the other complaints. Stern involves the East Fifty-Sixth Street Associates partnership, the private placement memorandum of which is dated December 15, 1983.
The Stern complaint contains a section entitled "The Fraudulent Scheme." It is alleged that the partnerships were designed to yield sizeable benefits, which depended on the partnership having "a substantial fair market value basis in the property which it was to acquire." The complaint goes on to assert that in order to produce "an appearance to the investors that the limited partnerships' basis in the property was at the fair market value," the apartment building or other similar property was sold to the partnership "through affiliated intermediaries in nearly simultaneous, back-to-back transactions, at increasing higher prices, which resulted in a stepped up basis." These back-to-back transactions are said to have resulted in the partnership purchasing the property at an inflated price (Stern pars. 10-13). The allegations in this section are typical of the other complaints.
The Stern complaint also has a section entitled "The Back-To-Back Transactions." In the Stern complaint, it is alleged that DBG Property Corporation and one Arnold Gumowitz purchased the property from an outside party under an agreement dated October 20, 1983 for $ 14.7 million; that on December 5, 1983 Gumowitz assigned his interest to Rodeo, an affiliate of DBG Property Corporation, for $ 16.6 million; that on or about February 10, 1984 the partnership purchased the property from Rodeo for $ 20.1 million. It is alleged that the fair market value of the property was $ 14.7 million and that the purchase price paid by the partnership was inflated by at least $ 5.4 million (Stern pars. 16-24). Similar allegations are contained in the other complaints.
A later section in the Stern complaint is entitled "The Memorandum," referring to the private placement memorandum for the particular partnership. The section contains a summary of certain alleged representations contained in the private placement memorandum, followed by allegations as to how some representations in the memorandum were false, or failed to disclose material facts.
The Stern complaint, in paragraph 37(a), alleges that the memorandum for East Fifty-Sixth Street Associates represented to the investors that Rodeo would assign its rights under the property contract to the partnership for $ 20.1 million. Except for certain allegations about material in the memorandum regarding mortgages (a subject which will be dealt with later in this opinion), the Stern complaint gives no further indication that the memorandum contains material describing back-to-back transactions. The allegations in Stern are typical.
Paragraph 38 of the Stern complaint, containing allegations as to the falsity of the memorandum, has nothing in it directly relating to the back-to-back transactions. This is typical of the other complaints.
Paragraph 44 of the Stern complaint, in subparagraphs (i) and (j), alleges that the private placement memorandum failed to disclose that there was a series of purchases and sales transactions - i.e., back-to-back transactions - at increasingly inflated prices so that the property was ultimately acquired by the partnership at an inflated price. Subparagraph (m) alleges that the memorandum failed to disclose that the fair market value of the property was no higher than the price paid in the first of the back-to-back transactions. These allegations are typical.
In the section of the Stern complaint entitled "Scienter," it is alleged that defendants knew, or recklessly disregarded, that the sale of the property by the affiliates to the partnership had "excessive mark-ups" (Stern par. 48(c)). Again, this is a typical allegation.
With regard to the so-called back-to-back transactions, the allegations in the complaints purporting to describe the contents of the private placement memoranda are so deficient as to be nothing short of fraudulent. The fact is that the memoranda describe the back-to-back transactions in meticulous detail. The memorandum for East Fifty Sixth Street Associates, involved in the Stern case, fully describes the October 20, 1983 purchase of the property by Gumowitz and DBG Property Corporation for $ 14.7 million; the later assignment by Gumowitz of his interest to Rodeo for $ 16.75 million; the assignment of DBG's interest to Rodeo for nominal consideration; and the ultimate purchase by the partnership for $ 20.1 million (Memorandum p. 8). The parties to the transactions, their affiliation with DBG, and the other aspects of these transactions are fully set forth. In addition, the amount of the profit to be received by both Gumowitz and Rodeo at closing is stated in full (Memorandum pp. 9 and 60).
There is no showing of any claim of possible merit regarding the back-to-back transactions. There is no indication of any issue deserving trial. Defendants are entitled to summary judgment dismissing the allegations regarding the back-to-back transactions.
There are allegations about the wraparound mortgages in all the complaints with respect to all the partnerships. In the section of the Stern complaint entitled "The Fraudulent Scheme," it is alleged that the partnerships used wraparound mortgages for the ostensible purpose of financing the purchase of the property, whereas in reality the wraparound mortgages were of no benefit to the partnerships or its limited partners and were a part of the scheme to defraud plaintiffs by generating profits for the promoters and their associates (See Stern par. 14). These allegations are typical of the other complaints.
In the section of the Stern complaint entitled "The Back-To-Back Transactions," there is an allegation that on February 10, 1984, when the partnership purchased the property from Rodeo, Rodeo received, as part of its profit on the sale, the difference between the interest rate on the wraparound mortgage and the aggregate interest paid on the underlying mortgages. It is alleged that the obligation of the partnership to Rodeo was secured by a wraparound mortgage in the amount of $ 15,600,000 (Stern pars. 21-22). Attached to the Stern complaint are pages 44-50 of the private placement memorandum, dealing with the various mortgages. Similar treatment is contained in the other complaints.
There are certain allegations in the section of the Stern complaint entitled "The Memorandum," which incidentally allude to the wraparound mortgages but relate mainly to other points. See Stern pars. 37(a), (i) and (k), and 38(a) and (j). These allegations will be dealt with in other portions of this opinion.
In the portion of the complaints dealing with alleged omissions from the private placement memoranda, it is stated that the private placement memoranda failed to disclose that there was no legitimate economic reason for placing wraparound mortgages on the property, that the projections were inflated to conceal this fact, that the partnerships used wraparound mortgages to generate enormous profits for the promoters and their affiliates without any corresponding benefit to the limited partners, and that the wraparound mortgages burdened the property with excessive debt, which the reasonable income of the property could not support. See Stern pars. 44(a), (b), (1) and (k).
Unlike the situation with the back-to-back transactions, the complaints incorporate much of the detailed information in the private placement memoranda regarding the wraparound mortgages.
In dealing with defendants' motion in respect to the subject of the wraparound mortgages, the first point to note is that the complaints do not (with one or two isolated exceptions to be noted later) allege that any of the detailed descriptions in the memoranda about various mortgages, including the wraparound mortgages, are incorrect. Nor is there any claim that any specific detailed facts are omitted. The claims on this subject are that the private placement memoranda failed to disclose that the wraparound mortgages have no legitimate economic reason or benefit to the limited partners, and exist solely to generate "enormous profits for the promoters and their affiliates."
It is certainly true that the private placement memoranda nowhere arrive at such conclusions. But the issue is not whether the memoranda contain a particular damning epithet suggested by plaintiffs, but whether the facts about the mortgages are set forth truthfully and completely.
It must be concluded that the private placement memoranda did indeed set forth the facts regarding the mortgages in a full and accurate fashion. The details about the principal amounts, interest rates, duration, and identity of mortgagors and mortgagees, were laid out in meticulous detail as to both the underlying mortgages and the wraparound mortgages. Moreover, it was specifically disclosed that DBG and its affiliates were expected to earn profits from the wraparound mortgages. Quoted below is a paragraph from the memorandum involved in the Stern case (p. 60), which is typical of the memoranda for all the partnerships. It is important to note that the allegations in plaintiffs' complaints ignore the existence of such statements in the memoranda.
Rodeo has a potential profit under the Partnership Wraparound Mortgage by virtue of the difference between (a) the interest to be paid by the Partnership to Rodeo pursuant to the terms of the Partnership Wraparound Mortgage and (b) the aggregate interest which Rodeo will be obligated to pay on the Underlying Mortgages pursuant to the terms of the Partnership Wraparound Mortgage. Because of the variable interest rates payable under the terms of the Second Mortgage, the Third Mortgage and the Partnership Wraparound Mortgage, Rodeo cannot estimate the amount of profit which it will realize by virtue of the foregoing (See "The Property - Mortgages on the Property" and "-The Partnership Wraparound Mortgage").
The conclusion is that the facts regarding the wraparound mortgages and their economic effect were sufficiently disclosed in the private placement memoranda. There is no issue deserving trial on this subject. Defendants are entitled to summary judgment dismissing the allegations regarding the wraparound mortgages.
Conflicts of Interest, Fees and Expenses
All of the complaints allege that defendants had conflicts of interest with respect to the partnerships and that defendants paid themselves excessive fees and expenses.
In the section of the Stern complaint entitled "The Fraudulent Scheme," it is alleged (par. 15) that the "property had excessive expenses which were in part generated by contracts entered into between the partnership and affiliates of the promoters of the partnership which were intended to direct excessive fees to the defendants," and involved conflicts of interest. As examples of this allegation, the Stern complaint alleges that the DBG partnership was to pay the following fees and commissions to affiliates: $ 343,000 to the managing agent as a pre-paid management fee, and a percentage of annual gross rents collected; $ 330,000 to the managing general partner as a pre-paid fee; commissions to the real estate broker and the insurance broker; and commissions of $ 1,394,817 to the placement agent and other selling agents. These allegations, with variations in the dollar amounts of fees and expenses alleged for particular partnerships, are typical of the other complaints.
The section of the Stern complaint entitled "The Memorandum" contains the alleged misrepresentations and omissions on the subject of conflicts of interest, fees and expenses.
Paragraph 38(b) alleges that certain assurances about profits, tax benefits and projections were false "because enormous fees were to be taken by the promoters and their affiliates leaving inadequate monies in the partnership for the limited partners to share in." A later section of this opinion will deal with the issue of assurances about the future performance of the partnership. In addition to misrepresentations, the Stern complaint alleges that the private placement memorandum involved certain material omissions. Paragraph 44 of the Stern complaint, in subparagraph (c), alleges that the private placement memorandum failed to disclose that sales agents would not have recommended investments in the partnership in the absence of sales commissions. Subparagraph (e) alleges that the memorandum omitted to disclose that the "true purpose of the partnership was only to lure investors into the partnership in order to provide commissions and fees to the promoters of the partnerships and their affiliates." These allegations of misrepresentations and omissions are typical of the complaints.
Finally, the section of the Stern complaint captioned "Scienter" alleges that defendants were aware of, or were reckless in not knowing about, the above misrepresentations and omissions. The Stern complaint alleges that defendants were aware that "a disproportionately large percentage of the monies raised were designated to be up front payments to the promoters or their affiliates and the amounts so designated bore no fair relationship to the services for which they were purportedly given." Similarly, the Stern complaint alleges that defendants knew or should have known that "based upon the high percentage of up-front fees taken by the promoters and their affiliates and the large wraparound mortgages, that it was improbable that the property would meet the projections" (Stern pars. 47(c) and 48(g)). These allegations are also typical.
The allegations in the complaints ignore the fact that the private placement memoranda repeatedly disclose the inherent conflicts of interest, and the substantial fees and expenses to be paid affiliates. The first page of the private placement memorandum involved in the Stern action, like the first page of all the memoranda, warns, in block letters, that "AN INVESTMENT IN THE INTERESTS INVOLVES A HIGH DEGREE OF RISK, POTENTIAL CONFLICTS OF INTEREST AND PAYMENT OF SUBSTANTIAL FEES TO THE GENERAL PARTNERS OF THAT PARTNERSHIP AND THEIR AFFILIATES" (p. 1). This introductory warning is only the beginning.
Three sections of the private placement memorandum involved in Stern specifically treat the subject of conflicts of interest. The memorandum contains a separate section entitled "Conflicts of Interest" which discloses, at length, the "inherent conflicts of interest due to the fact that D.B.G., Rodeo, the Managing Agent and the Placement Agent are Affiliates of the Managing General Partner" (pp. 17-19). This section repeatedly warns that the terms of the offering were established without arm's length negotiation. This disclosure is contained in all of the memoranda.
These general warnings of conflicts of interests are supported by an exhaustive disclosure of the relationships between all the participants in a section in the Stern memorandum captioned "Participants" (pp. 51-58). This section discloses the names and backgrounds of all individual participants and also the officers of all corporate entities. Among other things, the affiliate status of the general partners, the managing general partner, the managing agent, and Rodeo is explored. The role of the law firm, Fruitbine, Weiner, Harwin & Herman, P.C., is disclosed, along with the fact that Messrs. Fruitbine, Weiner and Herman are directors and officers of the Managing General Partner, DBG Property Corporation, and the Managing Agent.
The fees and expenses are given exhaustive treatment in the Stern memorandum. For instance, in the "Summary of the Offering" found in the beginning, under the subheading "Compensation to the General Partners and their Affiliates," the memorandum states that the general partners and their affiliates will receive "substantial fees in connection with the Offering, the operation of the Partnership and the sale and/or refinancing of the Property" (p. 6).
The prospective investor is referred to the sections of the memorandum captioned "Use of Proceeds" and "Compensation to the General Partners and Their Affiliates." Between these two sections, the fees paid to affiliates are described in exhaustive detail (pp. 12-15 and 59-61). The managing agent's prepaid fee of $ 343,000 is disclosed (pp. 13 and 60). The managing general partner was to receive a pre-paid fee of $ 300,000 at the closing of the partnership, and the general partners' salary is stated as being $ 330,000 a year (p. 59). The affiliate status of, and commissions to be paid to, the real estate broker and the insurance broker are similarly disclosed (pp. 59-60).
To return to the allegations in the complaint, it is alleged that there was a fraudulent scheme to have certain fees paid to affiliates. It can hardly be a fraudulent scheme if it was disclosed. The fees and expenses to be paid to the managing agent, the managing general partner, the real estate broker and the insurance broker are all described.
There are slight discrepancies in the nomenclature and in the dollar amount of one payment alleged as examples of a fraudulent scheme in the Stern complaint (par. 15). These differences are not, however, material. There is no attempt through these allegations to allege falsity in the memorandum because of these differences. Every single payment is stated in the memorandum except for one point; in the Stern memorandum, there is no mention of the managing agent receiving a percentage of annual gross rents collected. In a number of the memoranda, this payment is disclosed (See, e.g., Alley Pond Associates Memorandum, p. 51; Amherst Associates Memorandum, p. 76). This presents a de minimus issue in the overall picture.
Other than this one discrepancy, the very fees and expenses, described as the basis of a fraudulent scheme in paragraph 15 of the Stern complaint, are repeatedly disclosed in the East 56th Street Associates private placement memorandum. This disclosure is typical of all of the private placement memoranda attacked in the complaints.
The general, conclusory claims about misrepresentations and omissions in connection with the conflicts of interest, fees and expenses are of no weight in light of the extensive disclosure. The complaint gives no recognition of such disclosure and makes no real attempt to specify in any way the respect in which it is wrong. Indeed, the allegation in the complaints that defendants committed fraud by not "disclosing" that sales agents would not have recommended the partnership interests in the absence of commissions is ludicrous. See Brown v. The E.F. Hutton Group, 735 F. Supp. 1196 (S.D.N.Y. 1990).
Expectation of Profit and Tax Benefits
Each of the complaints alleges that the private placement memoranda represented that the offering was conducted with an expectation of profit and tax benefits.
The Stern complaint is typical of the other complaints on this topic. The allegations concerning profit and tax benefits ore found in the section of the Stern complaint entitled "The Memorandum". The complaint (par. 37) purports to characterize the representations in the East 56th Street memorandum. It alleges (par. 37(b)) that the offering memorandum represented to investors that "the partnership was conducting its activities with an expectation of profit." The complaint refers "by way of illustration [to] the section of the Memorandum captioned 'Profit Objective.'" The complaint alleges (par. 37(c)) that the memorandum represented to investors that "the investments in the partnership were secure, were potentially profitable and would provide substantial tax benefits." Finally, the Stern complaint (par. 37(d)) alleges that the memorandum represented that "there would be a significant pre-tax economic return to the investors (see by way of illustration the projections)".
Paragraph 38 of the Stern complaint alleges that these representations in the memorandum were false in that
an investment in the partnership was not secure, would not meet the profit projections and would not provide substantial tax benefits and the projections in the Memorandum were false, because enormous fees were to be taken by the promoters and their affiliates leaving inadequate monies in the partnership for the limited partners to share in.
It is further alleged that the representations were false because "there would not be significant pre-tax ...