MEMORANDUM OPINION AND ORDER
Plaintiffs, investors in certain limited partnerships organized and managed by the defendants, assert claims for relief based upon section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5, sections 12(2) and 17(a) of the Securities Act of 1933, 15 U.S.C. §§ 771(2), 77q(a), and pendent state law claims for common law fraud, negligence and breach of fiduciary duties. Defendants move for summary judgment pursuant to Fed. R. Civ. P. 56. For the reasons that follow, defendants' motion is granted.
The question presented by this motion is whether an action for securities fraud will lie where, a here, fee payments to general partners made from investors' capital contributions to limited partnerships, though fully disclosed to the public and the investors, are not disclosed to appraisers hired to appraise the value of the fee simple interest in properties owned by the partnerships.
Defendants Equity Programs, Ltd. ("Equity"), Allstate Property Investors Corporation ("Allstate"), Equity Securities Realty Corporation ("Equity Security"), APR Investment Corporation ("APR"), Equity Realty Management Corporation ("Equity Management"), National Realty Leasing Corporation ("National Realty"), and Defendant Richard H. Dinar, C.P.M., Inc. ("Dinar, Inc.") are corporations controlled by individual defendants Harold S. Pomeranz, Andrew H. Lynette, Richard H. Diller, and Richard H. Dinar (collectively "defendants"). See Second Amended Complaint ("Compl."), P 4(a).
Defendants were involved in the syndication and subsequent operation of the three limited partnerships at issue in this case, the Sun Chase Associates, L.P., the Courtyard Manor Associates, L.P. and the Garden Manor Associates, L.P. See Compl., P 4(b); Defendants' Statement pursuant to Local Civil Rule 3(g) of the United States District Courts for the Southern and Eastern Districts of New York ("Defs. 3(g) Statement"), PP 1-2.
Defendants formed those limited partnerships for the purpose of acquiring title to and owning and operating apartment buildings in Texas and Arizona. The general mechanics of those ventures were as follows: for a small amount of cash and a note, an affiliate of defendants purchased property which was soon thereafter transferred to one of the partnerships. In connection with those transactions, the partnerships entered into various agreements to pay to the original seller a restrictive covenant fee and, to the general partner and various affiliated defendants, certain other fees out of the investors' capital contributions. These other fees included a General Partners' fee, an Administrative fee, a Real Estate Consulting fee, a Financial Consulting fee, a Transitional Management fee (only as to the Sun Chase and Garden Manor partnerships), and a Management fee (collectively the "management fees"). See Compl., P 7(a); Affidavit of Andrew H. Lynette sworn to October 19, 1992 ("Lynette II Aff."), Exs. A - T.
In or about 1985, plaintiffs Dr. Kalman Low, Dr. Russell S. Asnes, Terrence R. Conway, Richard L. Lehman, Dominick and Lynn Gadaleta, and Daniel R. Schwarzwalder (collectively "plaintiffs"), each invested in one or more of the three limited partnerships. Plaintiffs allege that each partnership's basic investment objective was (1) to preserve each limited partner's initial investment, (2) to provide capital gains through potential appreciation, (3) to provide cash distributions from operations, (4) to increase the value of each limited partners' equity through full amortization of mortgage loans and (5) to provide ancillary tax benefits. See Compl., P 8.
To induce these investments in the limited partnerships, defendants prepared offering materials consisting of Private Placement Memoranda for the sale of limited partnership interests in each of the three limited partnerships (the "PPMs") and distributed them to prospective investors. Compl., PP 9-10; Affidavit of Andrew H. Lynette sworn to May 27 19, 1992 ("Lynette Aff."), Exs. F, G, I. Those materials disclosed the amount of each of the fees and contained appraisals by two appraisers from the Merrill Lynch Real Estate Advisory and Appraisal Group who had been hired by defendants to determine the fair market value of each of the properties owned by the limited partnerships. Lynette Aff., Exs. F, G, I. The management fees were not disclosed to either appraiser.
The two appraisers, James A. Runnels ("Runnels") and James H. McColgan ("McColgan"), determined the market value of the properties by three different appraisal methods: the cost approach, the market approach, and the income approach. See Affidavit of Brian M. Greenman sworn to May 12, 1992 ("Greenman Aff."), P 4; Defs. 3(g) Statement, P 12. The appraisers selected the income approach as the best measure of each property's actual value and utilizing, as the best form of that approach, the Discounted Cash Flow Method. Greenman Aff., P 4. Under the Discount Cash Flow Method, and under the income approach in general, an appraiser will prepare income projections over a period of time and subtract out either known or estimated expenses associated with the property being appraised. Id.; Affidavit of Stanley H. Freundlich sworn to May 28, 1992 ("Freundlich Aff.") P 4. Specifically, the appraisers' discounted cash flow model was based on an eleven-year projection of each property's income and expenses to calculate its net income. They then subjected that calculation to a present value analysis to arrive at the properties' market values. Plaintiffs allege that defendants' failure to reveal the fees paid to the general partners caused the appraisers to overstate the value of real estate since the appraised value of the property would have been reduced had those costs been included. Compl., PP 20-24. The appraisers are not defendants in this action.
On or about October 4, 1988, plaintiffs filed their original Complaint, and later the instant Second Amended Complaint, claiming that the appraisals were inaccurate, that the management fees and restrictive covenant fees paid were unreasonable, and that the investment therefore lacked potential to be a fruitful one. Compl., PP 28-30. Specifically, plaintiffs allege that defendants misrepresented: (1) the accuracy of the PPMs and the appraisals, (2) the reasonableness of and the need for both the management fee and the restrictive covenant fee agreements, and (3) that there was a reasonable possibility for investors to experience economic gain from this investment Compl., PP 31, 33. Plaintiffs further allege that defendants' omissions include: (1) that the restrictive covenant served no legitimate purpose, (2) that the restrictive covenant fee and the management fees were inflated and designed solely to generate substantial profit for the defendants and the sellers, not the partnerships, and (3) that the appraisal value of the property was overinflated because it failed to consider the relevant fees and expenses in its calculations. Compl., P 34.
In 1989, defendants moved to dismiss plaintiffs' Second Amended Complaint. Although the Court recognized that "some allegations of the complaint . . . might not withstand legal analysis," in view of the more than adequate disclosure made in the PPMs of the nature and amount of the fees at issue, Transcript of Oral Argument dated February 1, 1991 ("Feb. 1, 1991 Tr.") at 10, the Court denied the motion without prejudice to being renewed after the trial of the arguably sufficient claims, stating:
When the time comes that the case is tried, [those frivolous issues] will probably not be sent to the jury if there is no evidence to support them. But I think there is a colorable theory here that at least the real estate appraisals were inflated by information which might have been disclosed to others but not to the people who gave the appraisals. . . . That is why I can't grant [the motion].
Id. Therefore, by Order dated April 11, 1991, the Court ordered that the parties conduct discovery limited to this sole remaining issue, i.e., whether the undisclosed fees, if known to the appraisers, would have impacted their appraisal of the market value of the properties.
At the appraisers' depositions, where they were subject to cross-examination, and later in affidavits, McColgan and Runnels testified that their conclusions would not have been affected had they known of the fees at the time they performed their appraisals since such fees were expenses of the partnerships and therefore would not have affected the value of a fee simple interest in real property. See Defs. 3(g) Statement, Exs. D, E. That viewpoint is supported by "The Appraisal of Real Estate" (9th Edition), a treatise on the subject of appraisals published by the American Institute of Real Estate Appraisers, see Freundlich Aff., Ex. C, and by the affidavit and opinion of defendants' expert Stanley H. Freundlich, a certified public accountant and tax attorney. Id. at 10.
Freundlich stated, consistent with viewpoints presented by McColgan and Runnels, that appraisals made pursuant to the income approach should not include either non-recurring expenses or "special corporation costs" as expenses to reduce the total income on which the appraisal is based since such expenses are not "periodic expenditures necessary to maintain the real property and continue the production of effective gross income," but are expenditures made out of the capital of the business entity's structure to cover its business costs. Freundlich Aff. at 10; see also McColgan Aff., P 10; Runnels Aff., P 11. It was his conclusion, therefore, that the non-disclosure of the fees was not germane to an accurate evaluation of the value of the properties.
In view of this testimony, defendants moved for summary judgment dismissing the Second Amended Complaint. By Order dated July 6, 1992, the Court denied this motion for summary judgment because management fees, even if not recurring expenses of the partnership might as a practical matter arguably have affected the marketability of the properties. See Transcript of Oral Argument dated June 26, 1992 ("June 26, 1992 Tr."), at 2-5. The following colloquy took place at Oral Argument:
THE COURT: I think I am very clear.