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HAYDEN v. PAUL

February 20, 1997

RAYMOND P. HAYDEN; RACIA JAME NEWMAN; ALAN S FISHBONE; DAVID I. SAMUELS; HYMAN ASKOWITZ; HILL RIVKINS, CAREY, LOESBERG, O'BRIEN & MULRAY; BARRY TALLERING; TARTAN OIL CORP.; J. EDWIN CAREY; GERALDINE BURA, Executrix for the Estate of Mark Bura; BURTON TRINKOFF; JOSEPH KANDEL; MILES R. INGBER; NAT SORKIN; ALAN S. LOESBERG; VINCENT J. RYAN; STATE REALTY CO.; NATHAN L. FREEDMAN; ANTOINETTE M. SALINITRO, Executrix for the Estate of Nicholas Salinitro; M. JOHN GERMAIN; MURRAY WOLFKIND; AMP ASSOCIATES; JAME & JAME MANAGEMENT; HARVEY JAME; MICHAEL ROSEN; ABRAHAM WEISSMAN; BERNARD SILVER; NEIL M. SILVERMAN; RICHARD WARSOFF; TAMP ENTERPRISES; WILLIAM M. FEINGOLD; THOMAS & CHERYL DOWD; HAROLD RICHMAN; POLES, TUBLIN, PATESTIDES & STRATAKIS; GEOFFREY A. MATTANA; A. MATHEW MILLER; DANIEL SUSSMAN; HAROLD & DORIS SACHS; MORTON; PARNES; JEROME PARNES; KENNETH DORMAN; AVRAM DORMAN; M. JOHN GERMAIN, Executor for the Estate of Irving A. Germain; BRUCE ALTMAN; HARRY LEVENTHAL; ANDREW JIRITANO; ARTHUR KAPLAN; GORDON A.A. & DARLENE R. SMITH; JAY R. THALHEIM; THOMAS KALB; JACK SCHUSS; RICHARD DAVID; SEYMOUR S. KANE; STEVEN SELTZER; VICTOR DORMAN; ESTATE OF R.C. KOPF; RICHARD REITMAN; FRIEDMAN & GABRINER INVESTMENT CO.; CHARLES MUELLER; ALAN HAGLER; HERBERT SOLOMON; MICHAEL SOLOMON; MATSIL ASSOCIATES; MATSIL ASSOCIATES II; MATSIL ASSOCIATES III; ROSEMAR ASSOCIATES; WALLACE CHAVKIN; DOUGLAS LEONETTI; FRED H. LEONETTI; FRED R. LEONETTI; LEWIS G. ZIRKLE, M.D.; HAROLD FRIEDMAN; LEIGHTON WOOD; SUSAN WOOD; JAMES BERGER; IRVING GERSTEIN; ROBERT HIRSCH; BRUCE L. MILLER; BRUCE MILLER, II; BARRY R. MILLER; JAMES A. DUFFY; KENNETH M. KROLL; JOHN KAMB; GEORGE B. DEWEY; WAYNE CLOUGH; MIKE PEGRAM; DAVID HANSEN; STEVE JOHNSON; WILLIAM MOFFAT; EDWARD J. WATSON, JR.; IRA C. YATES; MAX W. & PAULINE E. DALE; CHARLES POTTER; WILLIAM DORMAN; ALLAN E. REIN; RICHARD L. TOMASETTI; CHARLES THORNTON; LEO WANG; STANLEY J. SEREN; LEO SCHACHTER; ELLIOT TANNENBAUM; ERIC AUSTEIN; JOSEPH E. & MARIE T. MANION; NEIL DORMAN; MARJORIE DORMAN; FRANCIS J. O'BRIEN; SANFORD COHEN; MARTIN L. REIN; IRWIN COHEN; RONALD P. ERICKSON; RUSSEL A. AUSTIN, JR.; DON GULLIFORD; GEORGE KARGIANIS; JOHN I. WESTON, JR.; and BERNARD FORSETER; MATTHEW F. HOGAN; JOHN E. CROWTHER, EUGENE GATTI; WILLIAM A. SAMPLE; JOHN A. RODGERS; T & R. INVESTMENTS; DENNIS GARCELON; HAROLD JAY ROSENBLATT,1 Plaintiffs, against PAUL, WEISS, RIFKIND, WHARTON & GARRISON and PRICE WATERHOUSE, Defendants.


The opinion of the court was delivered by: SPRIZZO

 SPRIZZO, D.J.:

 Plaintiffs, investors in certain limited partnerships, assert claims against defendant Price Waterhouse ("Price") based upon a primary violation of § 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, aiding and abetting violations of the same, common law fraud, negligence, and violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961 et seq. Price moves for summary judgment dismissing the Fourth Amended Complaint pursuant to Fed. R. Civ. P. 56 and for sanctions pursuant to Fed. R. Civ. P. 11. For the reasons that follow, Price's motion for summary judgment is granted.

 BACKGROUND

 In or about 1979, Cralin & Co., Inc. ("Cralin") organized and solicited investments in a series of limited partnerships marketed as tax shelter investments. See Affidavit of Jeffrey L. Feldman dated October 26, 1993 ("Feldman Aff.") P 4. Cralin offered these limited partnerships to the investing public with the representation that each partnership would act as a dealer or broker-dealer in various government securities, commodities and options, to provide tax shelters by creating tax deductible ordinary income losses up to four times the amount of capital invested per year while eventually reaping profits from the partnerships' broker-dealer activities. *fn2" See Fourth Amended Complaint ("FAC") PP 4, 5.

 During 1979 and 1980, Cralin's tax shelters took the form of commodities straddles, *fn3" see Feldman Aff. P 4, in which each year Cralin repeated the transactions on an even larger scale to generate proportionally more losses and to postpone investors' realization of the second year's gain in each transaction. See id. Plaintiffs allege that the "'snowball' effect" of Cralin's straddles reached the point by 1981 that it "needed $ 140,000,000 in losses to offset gains of the previous years' limited partnerships and provide the promised tax-write-offs to investors." FAC P 14.

 In August 1981, however, Congress enacted the Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, 95 Stat. 172 (1981), which eliminated tax recognition of losses attributable to straddle transactions. See Economic Recovery Tax Act §§ 501-509. Following this amendment, Cralin directed the limited partnerships' investment activities to government securities repurchase agreements *fn4" as an alternative means to create deductible tax losses for the limited partnerships without reporting or realizing offsetting gains until sometime in the future. See FAC P 16. Although market interest rate fluctuations normally create a risk of profit or loss upon the maturity of a repurchase agreement, Cralin allegedly negotiated with New York Hanseatic ("Hanseatic"), a volume trader of government securities, a riskless repurchase agreement whereby Hanseatic created records substantiating certain false transactions by the Cralin partnerships in government securities in support of "the losses needed . . . in return for a fee equal to 1% of the losses generated." Id. PP 16, 19, 24.

 Plaintiffs allege that since interest rates fell in the latter part of 1981, the repurchase agreement transactions, if subject to ordinary market risk, "would have generated a profit of over $ 20,000,000 for the Cralin limited partnerships had the partnerships liquidated their repo positions" upon the maturity of the first repurchase agreement. Id. P 20. Plaintiffs further allege that, in accordance with its agreement with Hanseatic, Cralin, rather than liquidating the positions, "directed the limited partnerships to hold the T-bills and notes and entered into the second step repos . . . thereby preserving their $ 140 million loss, and eliminating the $ 20 million gain." Id.; see also Feldman Aff. P 12.

 In 1982, the Internal Revenue Service ("IRS") reviewed and disallowed certain Cralin tax transactions and corresponding deductions taken by the limited partnerships in 1979, 1980, and 1981. Defendant's Evidentiary Appendix ("Def. Evid. App.") at A1145-1226. The IRS also later raised challenges to the 1982 and 1983 deductions taken by the limited partnerships. See id. at A15-88, A764-65.

 The broader securities business that Feldman and his partners attempted to create using the proceeds of their limited partnership offerings was no more successful. Approximately twenty-five percent of the capital raised in the various partnership offerings was immediately consumed by organization costs and syndication fees, including sales commissions. See id. at A574, A616, A689, A714-15; Affidavit of Daniel R. Fischel and Kenneth R. Cone dated May 12, 1993 ("Fischel Aff.") P 10. The remaining capital funded the investments in Cralin and the operations of the partnerships. See Def. Evid. App. at A689-90, A714-15, A727-29. Cralin used this partnership capital to develop its broker-dealer business, see Fischel Aff. PP 16-20, to dramatically increase its staff from six in 1979, to 250 by the end of 1984, see id. P 15; Def. Evid. App. at A1416, A1452, to open nine branch offices, see Def. Evid. App. at 1065-70; Fischel Aff. P 16, to become a member on several stock exchanges, see Fischel Aff. P 17, to register with the Securities and Exchange Commission and the Commodity Futures Trading Commission, see Def. Evid. App. at A746, A749, to acquire a market-making firm on the New York Stock Exchange and another brokerage firm, see id. at A1055, A1067-68, A1448, to form merchant banking and venture capital divisions, to act as an underwriter for several offerings, see id. at A746-48, A1059-60, and to develop a research department, compliance department, and other support operations, see id. at A1056-57, A1414.

 Subsequently, in 1987, all of the Cralin partnerships eventually reached settlements with the IRS which allowed investors to deduct as ordinary losses amounts exceeding their cash investments. See Def. Evid. App. at A15-90, A1485-1507. In October 1989, Feldman and Paul Foont, Cralin's designated chief trader, were indicted for their participation in creating and concealing fraudulent income deferral devices aimed at evading taxes for the 1981 tax year. See United States v. Feldman, 731 F. Supp. 1189, 1191 (S.D.N.Y. 1990). *fn5"

 In or about September 1980, Cralin engaged Price as the accountant for the Cralin corporate entities and limited partnerships to prepare audited financial statements to mail to investors and to include in the partnerships' private placement memoranda ("PPMs"). See FAC P 8; Def. Evid. App. at A1391, A599 - A622. In or about 1981, Price also became responsible for reviewing and approving each of the PPMs. See FAC P 8. In or about 1982, Price prepared, signed, and mailed to the IRS each of the Cralin limited partnerships' tax returns and mailed to the individual investors their K-1 forms in connection with the limited partnerships. See id.

 Plaintiffs allege that they invested in the various limited partnerships in reliance upon the tax opinions and financial statements issued by Price and the PPMs reviewed by Price which represented that each of the limited partnerships would "act as commodities broker-dealers trading primarily in metals and government-backed securities," id. PP 6, 43, and that plaintiffs would be entitled to declare their share of the ...


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