The opinion of the court was delivered by: DEARIE
Plaintiffs, 116 limited partners who together invested approximately $ 13 million in seven limited partnerships, bring this action against the limited partnerships and the principals, promoters, employees, and retained professionals of the limited partnerships, alleging that defendants failed to disclose material facts, made material misrepresentations, committed a series of fraudulent activities, and engaged in a pattern of racketeering activity. In essence, plaintiffs allege that they were fraudulently induced to invest in the limited partnerships by three misleading private placement memoranda (the "Offering Memoranda") that included as exhibits financial projections prepared by accountants and proposed tax opinions prepared by lawyers.
Plaintiffs bring this action for violations of section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), Rule 10b-5 promulgated thereunder, section 12(2) of the Securities Act of 1933 ("1933 Act"), the Racketeer Influenced and Corrupt Organizations Act ("RICO"), and the Martin Act. In addition, plaintiffs assert claims based on the common law of fraud, negligence, breach of fiduciary duty, and legal malpractice. Plaintiffs seek rescission, injunctive relief, and damages.
Defendants move to dismiss the amended complaint ("the complaint") on various grounds. The Primary Defendants (the Principals, the Limited Partnerships, the General Partners, the Managing Companies, and C & G Ventures) move to dismiss the section 10(b) and RICO claims under Rules 9(b) and 12(b)(6), to dismiss the RICO claims and the section 12(2) claim as time-barred, to dismiss the Martin Act claim for lack of a private cause of action, to dismiss the negligent misrepresentation and breach of fiduciary duty claims under Rule 9(b), and to dismiss the state law claims for lack of pendent jurisdiction. The Accountant Defendants (Touche Ross & Co., its successor in interest, Deloitte & Touche, and Touche Ross employees Alan Friedman and Jerry Cohen) move to dismiss the section 10(b) and RICO claims as time-barred, to dismiss the section 10(b) and RICO claims under Rules 9(b) and 12(b)(6), to dismiss the section 12(2) claim as time-barred, and to dismiss the state law claims for lack of pendent jurisdiction. Mast Capital moves to dismiss the section 10(b) and RICO claims under Rules 9(b) and 12(b)(6), to dismiss the RICO and section 12(2) claims as time-barred, and to dismiss the state law claims for lack of pendent jurisdiction. The Attorney Defendants (Ruffa & Hanover and Samuel Konigsberg) have not moved to dismiss the complaint.
With respect to the Primary Defendants, the Court declines to dismiss the section 10(b) claims, dismisses the section 1962(d) RICO claim for failure to state a claim, dismisses the section 12(2) claim as time-barred, dismisses the Martin Act claim for lack of a private cause of action, and retains pendent jurisdiction over the remaining state law claims. With respect to the Accountant Defendants and Mast Capital, the Court dismisses the complaint in its entirety. Plaintiffs' request to amend the complaint is granted in part and denied in part.
The complaint essentially alleges that defendants made material misrepresentations and omissions in connection with the sale of limited partnership interests, including the failure to disclose that David Greenberg, a convicted felon, was intimately involved in the offering of the limited partnership interests. The complaint goes on to allege that defendants installed themselves in salaried positions in various entities affiliated with the limited partnerships, misappropriated funds belonging to the limited partnerships, committed a series of insurance frauds, and concealed their fraudulent activities from plaintiffs. The Court notes the prolixity of the complaint and finds that the relatively straightforward fraudulent conduct that forms the basis of plaintiffs' allegations in no way justifies the 99-page, 14-cause-of-action, 307-paragraph complaint cluttered with boilerplate legalese.
Because this is a motion to dismiss, the Court accepts as true all of the allegations in plaintiffs' complaint and draws all inferences in plaintiffs' favor. Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). Defendants Bruce and David Greenberg, Norman Nick, Stephen Cantor and Marvin Greenfield (the "Principals" or "Principal Defendants") established seven limited partnerships, the stated purpose of which was to operate 92 video retail and rental outlets.
The Principals created various corporations, Video USA Associates, Inc. - #1, Video USA Associates, Inc. - #2, and Video USA Associates, Inc. - #4 (the "General Partners"), to serve as general partners of the Limited Partnerships. In addition, the Principals created Video USA Ltd. and Video USA International Corp (collectively the "Managing Companies") to manage and operate the 92 Video USA stores. Defendant Bernard Teitelbaum was the office manager of Video USA Ltd., and defendant Martin Cianciaruso was its internal comptroller after April 1986.
According to the complaint, the Principals, in offering the sale of interests in the Limited Partnerships, created and distributed three misleading private placement Offering Memoranda.
Specifically, the Offering Memoranda failed to disclose that defendant David Greenberg, a convicted felon, was intimately involved in the offering of the Limited Partnership interests and in the planning and operation of the purported video retail chain. According to the complaint, David Greenberg was convicted of mail fraud and obstruction of justice in 1978. Moreover, although the Offering Memoranda identified D.A.G. Enterprises, Inc. as a shareholder of Video USA, Ltd., they did not disclose the fact that Adam Greenberg, the sole director, officer and shareholder of D.A.G. Enterprises, Inc., was David Greenberg's twelve-year-old son. Had these material facts been included in the Offering Memoranda, plaintiffs allege that they would not have invested in the Limited Partnerships.
The Principals were aided in the offer and sale of the Limited Partnerships interests by their broker/dealer, Mast Capital Investors, Ltd. ("Mast Capital"), who helped to prepare the three Offering Memoranda, and by their attorneys, the law firm of Ruffa & Hanover, P.C. and attorney Samuel Konigsberg ("Ruffa & Hanover"), who helped to prepare and review the Offering Memoranda and provided legal and tax advice to the Principals, General Partners, Managing Companies, Limited Partnerships, and Mast Capital.
The complaint alleges that Touche Ross, Cianciaruso, Cohen, and Friedland (collectively "Touche Ross") provided accounting, auditing, financial analysis and other non-auditing services to defendants in the preparation of the Offering Memoranda and accompanying exhibits. Cianciaruso, Cohen, and Friedman were certified public accountants employed by Touche Ross from 1984 until 1986. Complaint, P 245. As a result of performing these services for defendants, the complaint alleges that Touche Ross became intimately familiar with the operations of Video USA, Ltd. and the other related entities. Specifically, plaintiffs allege that Touche Ross allowed the Principals to represent in the Offering Memoranda that Touche Ross had prepared the financial projections, had been retained to oversee internal controls and would conduct annual audits of the Limited Partnerships. Complaint P 247. Plaintiffs allege that the Accountant Defendants "performed financial projections . . . with the knowledge and intent . . . that prospective purchasers of the limited partnership interests would rely on it." Complaint, P 248. The Accountant Defendants failed to disclose material facts to plaintiffs, including, inter alia, the involvement of David Greenberg, defendants' misappropriations, self-dealing, insurance frauds and other wrongful conduct. Complaint P 251-253. The Accountant Defendants also aided and abetted defendants in their fraudulent activities. Complaint, P 254-255.
Finally, the complaint alleges that the Principals were also aided in this fraudulent scheme by C&G Ventures, Inc. Principal Defendants Bruce and David Greenberg were shareholders of C&G and Principal Defendant Steve Cantor was its president. C&G was itself a shareholder of Video USA, Ltd.
After creating the General Partners and Managing Companies, the Principals installed themselves as officers and directors of those corporations and paid themselves preferential allocations in the form of purported management fees, start-up fees, broker fees, and commissions. The Principals misappropriated the funds of the Limited Partnerships, engaging repeatedly in acts of self-dealing, mismanagement, and waste. Among other things, the Principals put "phony" employees on the payroll and, through their managing company Video USA Ltd., submitted invoices to the Limited Partnerships that overstated the price paid for prerecorded tapes and then retained the difference.
In 1989, defendants David Greenberg, Bruce Greenberg, Samuel Konigsberg, and Bernard Teitelbaum allegedly submitted four false insurance claims for a total of $ 1.3 million. These defendants then sought to conceal their insurance frauds by falsifying business records, tampering with and intimidating witnesses, and otherwise obstructing justice. In the summer of 1989, these fraudulent schemes came to light when newspapers reported the arrest and subsequent indictment of David Greenberg, Bruce Greenberg, Samuel Konigsberg, and Bernard Teitelbaum on charges of insurance fraud.
In an attempt to discourage plaintiffs from pursuing legal remedies, Principal Defendant Norman Nick sent a letter dated September 26, 1989 to the limited partners, in which he falsely stated that the limited partners' interests were not being managed by Bruce or David Greenberg or anyone involved in fraudulent activities. Norman Nick's statements, however, were belied by the filing of a superseding indictment on or about August 21, 1989, against David Greenberg, Bruce Greenberg, Samuel Konigsberg, and Bernard Teitelbaum, and the disclosure in newspaper articles that Bruce and David Greenberg were principals of Video USA, Ltd, the managing agent for the Limited Partnership. Furthermore, in his September 26, 1989 letter, Norman Nick falsely stated that Grodsky, Caporrino & Kaufman, the Limited Partnership's accountants at the time, were unable to complete an audit because postal inspectors had seized relevant documents. According to the complaint, the real reason that the accountants were unable to complete the audit was because Nick, Stephen Cantor, Marvin Greenfield and the General Partners refused to produce certain documents.
On November 16, 1989, Norman Nick and Marvin Greenfield sent another letter to plaintiffs, stating that they intended to install new entities and officers in the Limited Partnerships to "completely sever" all relationships with Video USA, Ltd. The November 16, 1989 letter, however, did not disclose the affiliations of the new entities and officers to the old Video USA, Ltd., and the fact that the changes were only in form, not substance. Nor did the November 16, 1989 letter disclose that Martin Cianciaruso was under investigation for insurance fraud. On November 20, 1989, the superseding indictment was amended to charge Martin Cianciaruso with participating in the insurance fraud conspiracy with Bruce Greenberg, David Greenberg, Konigsberg, and Tietelbaum. On November 30, 1989, Norman Nick and Marvin Greenfield sent a third letter to plaintiffs, containing numerous false statements, including the denial of David Greenberg's involvement in Video USA, Ltd. and the denial that Bernard Teitelbaum had been under indictment at the time he was hired by Equivid, the corporate entity that replaced Video USA Ltd.
Plaintiffs seek a declaration that their Limited Partnership investments are null and void, an order enjoining defendants from engaging in any future sale of securities or other investment instruments, rescission of their purchases of the Limited Partnership interests, compensatory damages amounting to at least their Limited Partnership contributions plus interest and attorney's fees, and punitive damages of not less than $ 16 million.
The complaint alleges that the Principals, through the Limited Partnerships, General Partners, Managing Companies, and C&G Ventures (collectively the "Primary Defendants"), (1) established a fraudulent enterprise engaged in a pattern of racketeering activity in violation of 18 U.S.C. §§ 1962(a)-(d); and (2) offered and sold securities by means of an intentionally misleading Offering Memoranda in violation of section 10(b), Rule 10(b)-5, section 12(2),
the Martin Act, and the New York common law of fraud and negligent misrepresentation, and breach of fiduciary duty.
The Primary Defendants move to dismiss the section 10(b) claim for lack of particularity under Rule 9(b) and for failure to state a claim under Rule 12(b)(6); to dismiss the RICO claims for lack of particularity under Rule 9(b) and as time-barred; to dismiss the section 12(2) claim as time-barred; to dismiss the Martin Act claim for lack of a private right of action; to dismiss the claims of negligent misrepresentation and breach of fiduciary duty for lack of particularity; and to dismiss the state law claims for lack of pendent jurisdiction.
I. Section 10(b) and 10b-5 Claims
To state a claim under section 10(b), plaintiffs must allege: (1) material misstatements or omissions, (2) indicating an intent to deceive or defraud (scienter), (3) in connection with the purchase or sale of any security, (4) through the use of interstate commerce or a national securities exchange, (5) upon which the plaintiff detrimentally relied, and (6) that the fraud in fact caused plaintiff's injuries. Feinman v. Schulman Berlin & Davis, 677 F. Supp. 168, 170 (S.D.N.Y. 1988); see also Luce v. Edelstein, 802 F.2d 49, 55 (2d Cir. 1986).
The Primary Defendants argue that the complaint fails to allege scienter with sufficient particularity. This argument does not withstand analysis. Rule 9(b) requires that:
In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Motive, intent, knowledge, and other conditions of mind of a person may be averred generally.
The particularity requirement of Rule 9(b) is designed to provide a defendant with fair notice of plaintiff's claims, to safeguard a defendant's reputation from improvident charges of wrongdoing, and to reduce the number of strike suits. Shields v. Citytrust Bancorp., Inc., 25 F.3d 1124, 1128 (2d Cir. 1994).
Under Rule 9(b), the time, place and nature of the misrepresentations must be set forth with sufficient particularity to reveal the defendants' intent to perpetrate a securities fraud. Ross v. Bolton, 904 F.2d 819, 823 (2d Cir. 1990). Although each determination of compliance with this rule "necessarily rests on its particular facts," Denny v. Barber, 576 F.2d 465, 470 (2d Cir. 1978), courts in this circuit have usually required a plaintiff to specify:
(1) precisely what statements were made in what documents or oral misrepresentations or what omissions were made, (2) the time and place of each such statement and the person responsible for making (or, in the case of omissions, not making) the same, (3) the context of such statements and the manner in which they misled the plaintiffs, and (4) what the defendants obtained as a consequence of the fraud.
While a fraud complaint must apprise each individual defendant of the specific nature of his or her participation in the fraud, Sanderson v. Roethenmund, 682 F. Supp. 205, 207 (S.D.N.Y. 1988), the particularity requirement is somewhat relaxed when the defendants are "insiders." DiVittorio v. Equidyne Extractive Indus., Inc., 822 F.2d 1242, 1247 (2d Cir. 1987). Where "defendants are insiders or affiliates participating in the offer of the securities in question," the complaint need not allege a specific connection between the memorandum's fraudulent representations and particular defendants. Luce, 802 F.2d at 55.
Under the relaxed pleading standards applicable to insiders, plaintiffs' claims against the Primary Defendants satisfy Rule 9(b). These defendants, being "corporate officials making stock offerings, general partners offering limited partnerships, and principals in general" are clearly insiders for the purposes of Rule 9(b). Morin v. Trupin, 823 F. Supp. 201, 206 (S.D.N.Y. 1993) (citing DiVittorio, 822 F.2d at 1247). The complaint alleges that in 1984 the Primary Defendants made statements -- that the Limited Partnership interests were "a sound and financially suitable investment" -- and that the Offering Memoranda contained material misrepresentations and omissions which "defendants knew or had reason to know were false," upon which plaintiffs relied to their detriment.
Furthermore, plaintiffs have provided the Primary Defendants with fair notice of the alleged fraud and a sufficient factual basis for scienter. Although fraudulent intent may be averred generally, a complaint must nevertheless allege facts giving rise to a "strong inference" of scienter, Mills v. Polar Molecular Corp., 12 F.3d 1170, 1176 (2d Cir. 1993), that is, an actual intent to defraud, knowledge of the falsity, or a reckless disregard for the truth. 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), overruled on other grounds, United States v. Indelicato, 865 F.2d 1370 (2d Cir. 1989). One way that plaintiffs may establish scienter is to allege facts showing a motive to commit the fraud and a clear opportunity for doing so. Beck, 820 F.2d at 50.
Plaintiffs allege that in 1984 the Principals "developed a plan to sell interests in the Limited Partnerships to plaintiffs and other investors through fraud, misrepresentations and willful omissions designed to conceal material facts regarding the Limited Partnerships." Complaint P 155. Additionally, the complaint alleges that prior to plaintiffs' purchase of the Limited Partnership interests, the Primary Defendants "made representations intended to induce and which did induce the purchases by plaintiffs and other investors." Complaint P 157.
Although the Primary Defendants allegedly represented that "the limited partnership interests being offered were a sound and financially suitable investment," plaintiffs claim that the representations were entirely false and contained material omissions, most significantly the omission to disclose the critical role of defendant David Greenberg and his status as a convicted felon and the fact that Adam Greenberg, the sole director, officer and shareholder of D.A.G. Enterprises, was David Greenberg's twelve year-old son. Finally, the complaint alleges that the "three private placement memoranda and the exhibits to these memoranda each contained various material misrepresentations and omissions which defendants knew or had reason to know were false and which plaintiffs relied on to their detriment in their decisions to purchase their limited partnership interests." Complaint P 162 (emphasis added).
The Court finds that plaintiff's section 10(b) fraud allegations against the insider Primary Defendants are pleaded with sufficient particularity to satisfy Rule 9(b). In addition, the Court finds that plaintiffs have stated a claim against the Primary Defendants under section 10(b) and therefore denies their motion to dismiss the claims under Rule 12(b)(6).
Section 12(2) of the Securities Act of 1933 provides that any person who:
(2) offers or sells a security . . . by means of a prospectus or oral communication which includes an untrue statement of a material fact necessary in order to make the statements, in light of the circumstances in which they were made, not misleading . . . ...