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VANNEST v. SAGE

March 31, 1997

DEAN G. VANNEST, et al, Plaintiffs,
v.
SAGE, RUTTY & CO., INC., et al, Defendants.



The opinion of the court was delivered by: LARIMER

 This case arises out of the sale of limited partnership interests. Plaintiffs purchased interests in a limited partnership formed for the purpose of purchasing a first mortgage on an apartment building. The partnership was called Pfeiffer House Mortgage Associates (Pfeiffer House). The general partner was Kenver Assurance Corporation (Kenver), which was owned principally by Robert Welch (Welch). The mortgage was purchased from Follansbee Merion Historic Associates (Follansbee).

 Shares in the limited partnership were available pursuant to an August 15, 1986 Private Placement Memorandum (PPM). The plaintiffs made their purchases into the limited partnership through their agent Karpus Investment Management, Inc. (Karpus). Purchases were made via subscription agreements. Sage Rutty was the sales agent or broker/dealer who sold the subscription agreements to Karpus. PNC Bank (PNC) was the escrow agent for the partnership. *fn1"

 In their original complaint, filed in 1990, plaintiffs asserted a RICO claim, federal securities law claims, and common law claims against the defendants, based upon alleged fraud and misrepresentation in the sale of the partnership interests. In Vannest I, I dismissed several claims, including plaintiffs' RICO claim. The RICO claim was dismissed with prejudice but plaintiffs were allowed to replead certain other claims and did so by amended complaint dated June 1993. In Vannest II, I dismissed additional claims, thus further reducing plaintiffs' claims against the defendants.

 Presently before me are four motions: defendant Sage, Rutty's motion for partial summary judgment; defendant PNC's motion for summary judgment; plaintiffs' cross-motion to amend the amended complaint; and PNC's motion for sanctions against plaintiffs.

 1) Sage Rutty's Motion for Partial Summary Judgment:

 To date, the following claims remain against Sage, Rutty:

 
Count I) Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j; and S.E.C. Rule 10b-5
 
Count II) Section 12(2) of the Securities Act of 1933, 15 U.S.C. § 771 (for purchases made on or after November 6, 1987)
 
Count III) fraud
 
Count IV) breach of contract/warranty/fiduciary duty
 
Count V) negligence and gross negligence (for purchases made on or after November 6, 1987)

 Sage, Rutty moves for partial summary judgment seeking dismissal of Count II, plaintiffs' Section 12(2) claim; Count IV, plaintiffs' claim for breach of fiduciary duty; and Count V, their claim for negligent misrepresentation. Additionally, Sage, Rutty moves to dismiss all claims of plaintiff Vannest.

 A) Plaintiffs' Section 12(2) Claim:

 In relevant part, Section 12(2) states as follows:

 
Any person who ... offers or sells a security ..., by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements ... not misleading ... shall be liable to the person purchasing such security from him, who may sue ... to recover the consideration paid for such security with interest thereon ....
 
Securities Act of 1933, Section 12(2), 15 U.S.C. § 771(2).

 Sage, Rutty asserts that this claim cannot be sustained against it because, as a matter of law, Section 12(2) is applicable to "public" offerings only and this case involves a "private placement" of securities. *fn2" Sage, Rutty relies on Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 115 S. Ct. 1061, 131 L. Ed. 2d 1 (1995). There, the Supreme Court determined that "prospectus" as used in Section 12(2) is a document used only in a public offering of securities by an issuer or controlling shareholder. Because a prospectus must contain the information contained in the registration statement -- see Section 10, 15 U.S.C. § 77j --, and because only public offerings require a registration statement, the Supreme Court concluded that a prospectus "is a term of art referring to a document that describes a public offering of securities by an issuer or controlling shareholder." 115 S. Ct. at 1073-74. Thus, in that case, a private sale of securities was determined to be exempt from the requirements of Section 12(2). Id. at 1074.

 Sage, Rutty asserts that this case is controlled by Gustafson because the securities here were purchased through a Private Placement Memorandum. Plaintiffs assert that since Gustafson, courts routinely have dismissed Section 12(2) claims based upon statements made in private placement memoranda. See Lennon v. Christoph, 1996 U.S. Dist. LEXIS 9943, *52 (N.D.Ill. 1996); Glamorgan Coal Corp. v. Ratner's Group, P.L.C., 1995 U.S. Dist. LEXIS 9548, 1995 WL 406167 (S.D.N.Y. July 1995).

 Plaintiffs counter that Sage, Rutty has the burden of proving that the transaction was not a public offering, and that in order not to be a public offering, the transaction must have certain characteristics such as the number of offerees, the offerees' sophistication, the size and manner of the offering and the issuer's relationship to the offerees. See Koehler v. Pulvers, 614 F. Supp. 829 (S.D. Cal. 1985). At oral argument, plaintiffs further asserted that the criteria set forth in the Security and Exchange Commission's Rule 506 of Regulation D (concerning the number of purchasers and their sophistication) must be met to qualify as a private offering. See 17 C.F.R. 230.506. Thus, plaintiffs assert that a material issue of fact exists as to whether the transactions at issue in this case are public or private offerings.

 The Gustafson decision has been criticized for making a complex area of law even more confusing. See, e.g., Janet E. Kerr, Ralston Redux: Determining Which Section 3 Offerings are Public under Section 12(2) after Gustafson, 50 SMU L. Rev. 175 (1996); Stephen M. Bainbridge, Securities Act Section 12(2) After the Gustafson Debacle, 50 Bus. Law. 1231 (1995); Elliott J. Weiss, Securities Act Section 12(2) After Gustafson v. Alloyd Co.: What Questions Remain?, 50 Bus. Law. 1209 (1995). The Supreme Court's simple conclusion that Section 12(2) applies only to public offerings does not make the process of determining what is and is not a public offering any simpler. As one commentator has found, the Gustafson court's attempt to equate public offerings with those that are registered ignores the important fact that not all public offerings are registered. Kerr, 50 SMU L.Rev. at 187-188. The complex relationship of statutory and regulatory provisions that comprises the federal securities laws insures that determining whether an offer is public, in the shadow of Gustafson, is more complex than ever.

 Since Gustafson, some courts addressing the issue have determined that, by definition, offerings made via a private placement memorandum are not public offerings. See In re J.W.P. Inc. Securities Litigation, 928 F. Supp. 1239, 1259 (S.D.N.Y. 1996)("Courts in this district have held that under Gustafson, private placement memoranda like those at issue are not 'prospectuses' for the purposes of a claim under § 12(2)"); Glamorgan Coal Corp., 1995 U.S. Dist. LEXIS 9548 at *2-*3, 1995 WL at *2-*3 (offering made by private placement memorandum not public for Section 12(2) purposes); see also Whirlpool Financial Corp. v. GN Holdings, Inc., 67 F.3d 605, 609, n.2 (7th Cir. 1995), reh'g denied, (where the court noted that because a 'prospectus' for Section 12(2) purposes includes only public offerings, Section 12(2) claims arising from sale of securities offered through a private placement memorandum had been properly dismissed).

 Other courts have ruled otherwise. See Fisk v. SuperAnnuities, Inc., 927 F. Supp. 718 (S.D.N.Y. 1996)(where the court refused to dismiss Section 12(2) claims even where securities were offered via private placement memorandum where plaintiffs contended that offering was not truly private); but cf., ESI Montgomery County, Inc. v. Montenay Intern. Corp., 899 F. Supp. 1061 (S.D.N.Y. 1995)(where court dismissed Section 12(2) claims where plaintiff acknowledged the offering was made by private offering memoranda, but noted that "had plaintiff alleged that the ...


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