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IN RE MERRILL LYNCH LTD. PARTNERSHIPS LITIG.

August 25, 1997

IN RE MERRILL LYNCH LIMITED PARTNERSHIPS LITIGATION; THIS DOCUMENT RELATES TO ALL ACTIONS


The opinion of the court was delivered by: MUKASEY

OPINION AND ORDER

 MICHAEL B. MUKASEY, U.S.D.J.

 Investors in a series of Merrill Lynch real estate limited partnerships sue Merrill Lynch & Company, Inc. ("Merrill Lynch & Co."), their wholly-owned subsidiaries, Merrill Lynch, Pierce Fenner & Smith & Co. ("Merrill Lynch, Pierce") and Merrill Lynch, Hubbard Inc. ("MLH"), and 18 limited partnerships or corporations wholly-owned or controlled by MLH, which functioned as the general partners or associate general partners of the limited partnerships at issue. Plaintiffs assert class claims under the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. § 1961 et seq. ("RICO"), as well as assorted state common law and statutory claims. Defendants move to dismiss pursuant to Fed. R. Civ. P. 12(b)(6), arguing both that plaintiffs have failed to state claims entitling them to relief, and that their claims are barred by the statute of limitations. For the reasons outlined below, plaintiffs' RICO claims are dismissed on statute of limitations grounds, and I decline to exercise supplemental jurisdiction over plaintiffs' state law claims.

 I.

 Plaintiffs' claims relate to a series of real estate limited partnerships which defendants created and offered for sale from 1979 to 1987. The limited partnerships fall into two groups. The MLH Properties Limited Partnerships I-III ("MLH Prop. I-III") were to invest in leveraged real estate transactions. Initially, these limited partnerships were to provide investors with losses yielding tax benefits. Over time, MLH Prop. I-III were to yield annual income payments and long-term capital appreciation. (Compl. P 82) *fn1" MLH Income Realty Partnerships I-VI ("MLHIRP I-VI") were to invest in real estate on an all-cash basis and provide investors with an immediate annual cash flow and long-term capital appreciation. (Id.) The named plaintiffs represent investors in each of these nine partnerships and the class they represent has been defined as "all investors who purchased units [in the initial offering or in the secondary market created by defendants] in any of MLH Properties Limited Partnership I-III or MLH Income Realty Partnerships I-VI (The "Partnerships") from the inception of the offer and sale of such Partnerships to the present." (Id. P 54) The final closing dates of the public offerings of these investments were: MLH Prop. I -- November 29, 1979; MLH Prop. II -- December 16, 1980; MLH Prop. III -- December 1, 1982; MLHIRP I -- February 16, 1982; MLHIRP II -- January 31, 1983; MLHIRP III -- July 1, 1983; MLHIRP IV -- August 1, 1984; MLHIRP V -- July 8, 1985; MLHIRP VI -- May 7, 1987. (Def. Mem. at 4 n.4)

 Plaintiffs allege that each defendant had a role in these limited partnerships. They claim that Merrill Lynch & Co. or its subsidiaries or employees "were responsible for the development, organization, sale, operation, or management of the Partnerships in the [alleged] scheme" (Compl. P 41); that Merrill Lynch, Pierce acted as the offeror and/or underwriter for the sale of some of these partnerships (id. P 43); that MLH, through its subsidiaries, acted as general partner, managing general partner, or associate general partner of these partnerships and controlled their operations (id. P 45); and that 18 of MLH's subsidiaries served as general partners or associated general partners of the limited partnerships (id. P 46).

 Plaintiffs allege violations of RICO, 18 U.S.C. §§ 1962(a),(c) & (d). As predicate acts for their RICO claims, plaintiffs allege mail and wire fraud in violation 18 U.S.C. §§ 1341 and 1343, and securities fraud in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, and §§ 11 and 12(2) of the Securities Act of 1933, 15 U.S.C. §§ 77k & 771(2). (Id. PP 187-88)

 The allegedly fraudulent misrepresentations or omissions plaintiffs allege fall into several categories. Plaintiffs claim first that defendants "guaranteed" specific annual yields and long-term capital appreciation, even though they knew from prior experience, and from their internal projections of expected yields from real property, that these guaranteed yields could not be achieved. (Compl. PP 2, 58, 62, 63, 66, 67, 73, 75, 93, 98, 103-05, 108, 117-18, 132) Plaintiffs assert that "defendants' entire marketing scheme thus represented, promised, characterized, and fostered the reasonable expectation that the percentage priority returns of each of the Partnerships was, as Defendants' own internal written materials stated, a 'yield guarantee.'" (Id. P 66)

 Relatedly, plaintiffs allege that defendants marketed the investments as safe and conservative. They claim that defendants emphasized their expertise in real estate investments, their careful investigation of properties, and in relation to the MLHIRP Limited Partnerships, the all-cash nature of the investment, and represented that these features would allow the investments to achieve the alleged guaranteed returns. (Id. PP 85-87, 89-92) Plaintiffs claim that in fact, the investments were not safe because their guaranteed yields and long-term capital appreciation were unattainable. (See, e.g., id. PP 95-96) Further, they claim that the statements relating to defendants' expertise and the all-cash nature of the MLHIRP limited partnerships were misleading because defendants were aware that these features would not assist the limited partnerships in attaining the guaranteed yields. (Id. P 93)

 Plaintiffs claim second that defendants led them to believe that "the limited partnership sponsors would not make money until the limited partners had received their capital back plus the cumulative per annum yields promised." (Id. P 2) For example, plaintiffs allege that internal marketing guides for MLHIRP I reported that "the MLHIRP product tied compensation of the managing general partner to the availability of net distributable cash every year and that the managing general partner of the MLHIRP series was then required to 'subordinate its 10% share of distributable cash if that is necessary to enable the Limited Partners to receive a minimum 8% cumulative yield on their investment.'" (Id. P 65)

 Third, plaintiffs claim that defendants represented that prior partnerships were meeting their objectives, including guaranteed annual distributions, but failed to disclose that those annual distributions were being funded in part from return on capital and return from non-real estate investments. (Id. PP 2, 60, 64, 68, 96, 108, 109-114, 119-21, 132, 136)

 Fourth, plaintiffs claim that defendants failed to disclose the returns that the properties would have to generate for the limited partnerships to reach their stated objectives. (Id. PP 4, 61, 62, 64, 68, 102, 108)

 Fifth, plaintiffs claim that defendants did not disclose their intention of keeping cash reserves, uninvested in real estate, to supplement shortfalls in income from the properties and thereby to keep limited partner distributions at the promised levels. (Id. PP 6, 74, 84, 102, 108, 122-29) Plaintiffs claim that defendants maintained uninvested capital reserves in amounts ranging from 6.3% for MLHIRP I to 13.9% for MLHIRP VI, well above the levels of reserves disclosed the prospectuses. (Id. P 125)

 In addition to these alleged misrepresentations or omissions, which form the basis for most of the mail and wire fraud and for all of the securities fraud claims -- the predicate acts for the RICO claims -- plaintiffs allege other improprieties. They claim that defendants knowingly or recklessly purchased properties that did not meet the criteria necessary to deliver the guaranteed annual yields and long-term capital appreciation. (Id. PP 3, 69, 70-73, 75, 76, 78, 103, 106). Further, plaintiffs claim that defendants used the illusion of a secondary market to create an aura of liquidity and made no attempt to obtain the best price for sellers of limited partnership units. (Id. PP 139-44)

 Finally, plaintiffs allege that defendants concealed these misrepresentations, omissions and breaches in performance by continually reassuring investors that the partnerships were "on-track," and that shortfalls were temporary. (Id. PP 77, 146-179) They claim also that defendants' account statements concealed the fraud by "listing the original cost of the unit on client account statements and by labeling such valuation as 'current price' or 'market price.'" (Id. PP 78, 174) These allegations form the basis of the other mail and wire fraud claims, i.e., that defendants mailed fraudulent reports and statements to investors to mislead them.

 In addition to the RICO claims, plaintiffs allege state law claims, including fraud, negligent misrepresentation, breach of fiduciary duty, breach of contract, tortious interference with contract, and violation of the New Jersey Uniform Securities Act, N.J. Stat. Ann. § 49:3-71, and the New Jersey Criminal Justice Act of 1970, N.J. Stat. Ann. § 2C:41-2.c-2.d.

 Several cases were filed against defendants relating to these limited partnerships. See Lanza v. Merrill Lynch & Co., 95 Civ. 10657 (MBM) (S.D.N.Y. filed Dec. 15, 1995); Rose v. Merrill Lynch & Co., 95 Civ. 10894 (MBM) (S.D.N.Y. filed Dec. 22, 1995); Keleman v. Merrill Lynch & Co., 96 Civ. 0898 (MBM) (S.D.N.Y. filed Feb. 6, 1996); Carnegie v. Merrill Lynch & Co., Civ. Action No. 95-4030-B (RBB) (S.D. Cal. filed Nov. 29, 1995). On February 25, 1996, I issued stipulated Case Management Order No. 1, which consolidated these actions and provided that:

 
Plaintiffs' First Consolidated Class Action Complaint shall be filed by March 29, 1996 and shall be deemed the operative complaint superseding all complaints filed in any of the actions consolidated hereunder or in any Related Action. . . . Plaintiffs, without being required to file a motion pursuant to Rule 15 of the Federal Rules of Civil Procedure, shall be permitted to file a Second Consolidated Amended Class Action Complaint after Plaintiffs have had a reasonable opportunity to take document discovery.

 On March 29, 1996, plaintiffs filed their First Consolidated Amended Class Action Complaint. Instead of responding to document discovery, defendants stated that they would file a motion to dismiss. (Chimicles Decl. P 5)

 The parties then agreed to Case Management Order No. 2, which I issued on July 7, 1996, and under which a class was certified and document discovery was to proceed. The Order provided further that defendants could file a motion to dismiss the First Amended Class Action Complaint no later than 60 days after the entry of the Order and that plaintiffs would then inform defendants whether they intended to stand on their complaint. If plaintiffs chose to file a second amended complaint, defendants would then have 45 days from service of that complaint to supplement, modify or withdraw any previously filed motion to dismiss. Document discovery then proceeded, although plaintiffs claim that defendants did not produce all pertinent documents.

 On September 27, 1996, defendants filed a motion to dismiss the First Consolidated Amended Complaint and to stay further discovery. On October 15, 1996, at a pre-trial conference, plaintiffs sought to compel further discovery and to postpone consideration of the motion to dismiss. I denied that motion and gave plaintiffs the option of either filing opposition papers to the motion to dismiss, in which they could specify the discovery they required to answer that motion, or filing a second amended complaint. I emphasized to plaintiffs that if they chose the second route, leave to amend their complaint for the third time would likely not be granted. Plaintiffs opted to file a second amended complaint, and pursuant to an order dated October 21, 1996, defendants' motion to dismiss was deemed withdrawn.

 On January 17, 1997, plaintiffs filed a Second Consolidated Amended Complaint. On February 14, 1997, defendants again moved to dismiss.

 II.

 Defendants argue first that plaintiffs' RICO claims are barred by the statute of limitations. They claim that plaintiffs sustained their RICO injury when they bought the allegedly fraudulent limited partnerships and that the statute of limitations began to run when plaintiffs had inquiry notice of the probability that they had been defrauded. Defendants claim that disclosures in the original prospectuses and in subsequent partnership communications put plaintiffs on inquiry notice more than four years before they filed this action. Further, defendants claim that plaintiffs have failed to plead adequately any fraudulent concealment of the fraud and therefore the action must be dismissed as time-barred.

 A. Consideration of Materials Outside the Complaint

 To prove their claim that plaintiffs were on inquiry notice before November 1991, defendants rely on the limited partnership prospectuses and on the annual reports distributed to the limited partners. Usually, evidence on a motion to dismiss is limited to the face of the complaint and all allegations are accepted as true. However, on a motion to dismiss in a securities fraud or RICO action, the Second Circuit permits consideration of: 1) documents attached as exhibits to or incorporated by reference into the complaint, see Cosmas v. Hassett, 886 F.2d 8, 13 (2d Cir. 1989); 2) documents "integral" to the complaint, even if the complaint contains only limited quotation from those documents, see San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 808 (2d Cir. 1996) (citing I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d Cir. 1991)); and 3) documents filed with the Securities and Exchange Commission of which plaintiff has notice in responding to the motion to dismiss, see Kramer v. Time Warner, Inc., 937 F.2d 767, 773-74 (2d Cir. 1991). Further, the Second Circuit has found that when a plaintiff is given notice that the defendant wishes the court to consider such documents and argues their contents, this weighs in favor of consideration. See San Leandro, 75 F.3d at 809; Kramer, 937 F.2d at 774; see also Salinger v. Projectavision, Inc., 934 F. Supp. 1402, 1405 (S.D.N.Y. 1996); Behette v. Saleeby, 842 F. Supp. 657, 662 (E.D.N.Y. 1994).

 Here, the prospectuses and the annual reports to limited partners may be considered. First, defendants represent that the prospectuses and the annual reports were filed with the Securities and Exchange Commission (Def. Reply Mem. at 5 n. 5), and therefore I may take judicial notice of them. See, e.g., Siebert v. Nives, 871 F. Supp. 110, 114 (D. Conn. 1994) (Cabranes, J.) (considering publicly-filed annual report); In re Integrated Resources, Inc. Real Estate Ltd. Partnerships Sec. Litig. ("Integrated Resources II"), 850 F. Supp. 1105, 1125-26 (S.D.N.Y. 1993) (considering publicly-filed 10-K statements); In re General Dev. Corp. Bond Litig., 800 F. Supp. 1128, 1136 (S.D.N.Y. 1992) (considering publicly-filed annual and quarterly reports), aff'd sub. nom. Menowitz v. Brown, 991 F.2d 36 (2d Cir. 1993). Second, because of their centrality to any offering and because plaintiffs claim that they reinforced the misrepresentations made in other marketing materials (Compl. PP 101-08), the prospectuses are integral to this complaint. See, e.g., I. Meyer Pincus, 936 F.2d at 762; Geiger v. Solomon-Page Group, Ltd., 933 F. Supp. 1180, 1182 (S.D.N.Y. 1996); Integrated Resources II, 850 F. Supp. at 1122 n.21. In addition, plaintiffs' complaint relies heavily on and quotes from the annual reports to show that defendants concealed the fraud. (Compl. PP 156(b), (d), 157, 159, 161, 162, 163) Third, plaintiffs have not contested reliance on these documents; in fact, plaintiffs have submitted further excerpts from the prospectuses and the annual reports in the appendix to their memorandum of law. (See also Reply Mem. in Support of Motion to Convert to Summary Judgment at 2) In sum, plaintiffs had notice that these prospectuses and annual reports would be considered on this motion, did not object, and actually responded to them.

 B. RICO Injury

 Civil RICO claims are subject to a four-year statute of limitations. See Agency Holding Corp. v. Malley-Duff & Assoc., Inc., 483 U.S. 143, 156, 97 L. Ed. 2d 121, 107 S. Ct. 2759 (1987). The statute cannot begin to run until the RICO action is ripe, and a RICO action is ripe when the plaintiff suffers an injury. Bankers Trust Co. v. Rhoades, 859 F.2d 1096, 1103 (2d Cir. 1988), cert. denied, 490 U.S. 1007, 104 L. Ed. 2d 158, 109 S. Ct. 1642 (1989).

 1. Plaintiffs Sustained RICO Injury When They Bought the Limited Partnerships

 Defendants claim that plaintiffs sustained RICO injury when they purchased their limited partnership interests. Defendants argue that because plaintiffs allege that the limited partnerships were fraudulent at the time the partnerships were offered to them, plaintiffs were injured immediately upon investment when they paid more money than the partnership units were actually worth. Accordingly, defendants argue, because the limited partnerships were offered from 1979 to 1987, the latest a plaintiff could have sustained RICO injury was 1987.

 Several courts in this District have held that "where . . . plaintiffs acquired limited partnership interests based upon defendants' alleged fraudulent statements and offering material, the injury to plaintiffs is the purchase of the partnership interests." Fisher v. Reich, No. 92 Civ. 4158, 1995 WL 23966, at *3 (S.D.N.Y. Jan. 10, 1995); see also In re PaineWebber Ltd. Partnerships Litig., 171 F.R.D. 104, 128 (S.D.N.Y. 1997); Butala v. Agashiwala, 916 F. Supp. 314, 317 (S.D.N.Y. 1996) ("The plaintiffs allege that these investments were fraudulent from their inception. Consequently, the plaintiffs were injured when they purchased them."); Ackerman v. National Property Analysts, Inc., 887 F. Supp. 494, 503 (S.D.N.Y. 1992); Lenz v. Associated Inns and Restaurants Co. of Amer., 833 F. Supp. 362, 370 (S.D.N.Y. 1993). Plaintiffs' RICO claims are based upon defendants' alleged fraudulent statements and omissions which induced plaintiffs to invest in the limited partnerships. Therefore, under the rule of these cases, plaintiffs sustained injury at the time of their investment.

 However, plaintiffs claim that RICO injury does not occur until the damages are clear and definite. They claim their damages were speculative and indefinite at the time they bought their limited partnership interests and that damages became clear and definite only when plaintiffs were notified in 1994 that the partnerships had suffered permanent impairments in value and that the previously promised returns would not be met. Until then, plaintiffs argue, they suffered no injury, their RICO claims were not ripe, and the statute of limitations did not begin to run.

 Plaintiffs rely on First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 767 (2d Cir. 1994), cert. denied, 513 U.S. 1079, 130 L. Ed. 2d 632, 115 S. Ct. 728 (1995) and Cruden v. Bank of New York, 957 F.2d 961, 977-78 (2d Cir. 1992). In First Nationwide Bank, the plaintiff bank claimed that the defendants misrepresented the value of collateral securing certain loans, and brought a RICO action. The Second Circuit found that the plaintiff had not sustained RICO injury and the claim was not ripe because the plaintiff had not exhausted its remedies under the notes. The Court held that "a plaintiff who claims that a debt is uncollectible because of the defendant's conduct can only pursue the RICO treble damages remedy after his contractual rights to payment have been frustrated." 27 F.3d at 768. The Court reasoned that a note holder has not really suffered injury until he has exhausted his bargained-for remedies under the note. Id.; see also Burke v. Dowling, 944 F. Supp. 1036, 1052 (E.D.N.Y. 1995) ("Until these plaintiffs can demonstrate that the orthodox methods of recovery have failed them, and that defendants' acts of racketeering have in fact caused them a loss, they should not be entitled to treble damages under RICO.").

 In Cruden, debenture holders brought RICO claims against the issuers, alleging fraudulent transfer of assets. 957 F.2d at 977. The Second Circuit held that plaintiffs suffered no RICO injury until the defendants defaulted on the principal and interest payments on the debentures held by the plaintiffs. Cruden, 957 F.2d at 977-78.

 Both Cruden and First Nationwide Bank relied on Bankers Trust. In Bankers Trust, the plaintiff claimed that it had been deprived of full payment on its loans to the defendants because it had agreed to a reduced settlement with the defendants in a bankruptcy proceeding in which the defendants had engaged in fraud. 859 F.2d at 1005-06. However, at the time of the suit, the bankruptcy proceeding had been reinstated, and the court held that because plaintiff could receive full payment on its loans in the reinstated bankruptcy proceeding, plaintiff had not yet suffered RICO injury and its RICO claim was not ripe. The Court found that it was "impossible to determine the amount of damages that would be necessary to make plaintiff whole, because it [was] not known whether some or all of the fraudulently transferred funds [would] be recovered by the corporation [in the bankruptcy proceeding]," and therefore the injury was speculative. Id.

 This trilogy of cases stands for the proposition that when a creditor has been defrauded, but contractual or other legal remedies remain which hold out a "real possibility" that the debt, and therefore the injury, may be eliminated, RICO injury is speculative, and a RICO claim is not ripe until those remedies are exhausted. See, e.g., Turkish v. Kasenetz, No. 92 Civ. 4036, 4037, 964 F. Supp. 689, 1997 WL 282834, at *6 (E.D.N.Y. May 22, 1997) ("If a plaintiff has an unexplored alternative means of recovery, the RICO action is not considered 'ripe.'"); Burke, 944 F. Supp. at 1051. However, that trilogy does not control this case.

 Here, unlike the above cases which involved debt instruments, plaintiffs had no contractual or legal remedy that might have reduced or eliminated their injury. Rather, the limited partnerships were equity investments with no basis for recovery other than the limited partnerships' performance. The above cases are therefore limited to actions involving debt instruments which contain bargained-for remedies after default which the debtor is expected to pursue. In fact, First Nationwide Bank relies on cases dealing with the determination of damages relating to fraudulently induced loans. 27 F.3d at 768. Moreover, plaintiffs' injuries were not speculative at the time of their investment. Plaintiffs allege that the limited partnerships were fraudulent because even at the outset, the limited partnerships could never achieve their promised objectives. Accepting that allegation as true, plaintiffs sustained recoverable out-of-pocket losses when they invested. Even if plaintiffs had sued at that time, plaintiffs' damages -- that is, the difference between the value of the investment they were promised and the value of the investment they received -- would not ...


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