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FROMER v. YOGEL

March 23, 1999

DAVID M. FROMER AND THE FOUR DAUGHTERS TRUST, PLAINTIFFS,
v.
LARRY D. YOGEL, MRS. LARRY D. YOGEL, NTG PARTNERS, OMNI FINANCIAL, L.P., LEO S. SCHWARTZ, WILMINGTON TRUST COMPANY AND WILLIAM T. SAUNDERS, DEFENDANTS.



The opinion of the court was delivered by: Scheindlin, District Judge.

      OPINION AND ORDER

Having invested in excess of $1.3 million in several product arbitrage companies, Plaintiff David M. Fromer ("Fromer") allegedly discovered that these companies were actually part of an elaborate "Ponzi" scheme. Having then been sued in a class action by other third-party investors caught up in the scheme (the Restifo action), Fromer and the other Restifo defendants negotiated a settlement agreement, ending the Restifo action as to all parties.*fn1 Then, having paid the Restifo plaintiffs approximately $2.3 million to settle their claims, Fromer and the Four Daughters Trust ("FDT") (together "Plaintiffs" in this action) allege that the other Restifo defendants refused to reimburse Plaintiffs for amounts allegedly due them under the settlement agreement.*fn2

Plaintiffs are now seeking both the return of their initial investments in the arbitrage companies and the reimbursement of money they paid to settle the Restifo lawsuit. Plaintiffs bring federal claims for contribution based on violations of § 10(b) of the 1934 Securities Exchange Act and Rule 10b-5 promulgated thereunder against Defendants Larry D. Yogel ("Yogel"), Mrs. Larry D. Yogel ("Mrs.Yogel"), Leo S. Schwartz ("Schwartz"), Wilmington Trust Company ("Wilmington"), William T. Saunders ("Saunders") and Omni Financial, L.P. ("Omni"), and federal claims for indemnity based on Exchange Act violations against Yogel, Mrs. Yogel, Wilmington, Saunders and Omni. Plaintiffs also assert numerous pendent state law claims under theories of contract, fraud, negligence and equitable principles.*fn3

Subject matter jurisdiction is premised upon a federal question, 28 U.S.C. § 1331, and principles of supplemental jurisdiction, 28 U.S.C. § 1367(a).

Defendants move to dismiss the claims against them pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6), claiming that the Complaint fails to plead fraud with particularity, fails to state a claim upon which relief can be granted, or states claims which are time-barred.

I. Standards of Review Under Rule 12(b)(6)

In considering a Rule 12(b)(6) motion to dismiss, a district court must limit itself to "facts stated in the complaint or in documents attached to the complaint as exhibits or incorporated in the complaint by reference." Newman & Schwartz v. Asplundh Tree Expert Co., 102 F.3d 660, 661 (2d Cir. 1996). Dismissal of a complaint pursuant to Rule 12(b)(6) is proper "only where it appears beyond doubt that the plaintiff can prove no set of facts in support of the claim which would entitle him to relief." Scotto v. Almenas, 143 F.3d 105, 109-10 (2d Cir. 1998) (quoting Branham v. Meachum, 77 F.3d 626, 628 (2d Cir. 1996) (internal quotations omitted)). "The task of the court in ruling on a Rule 12(b)(6) motion `is merely to assess the legal feasibility of the complaint, not to assay the weight of the evidence which might be offered in support thereof.'" Cooper v. Parsky, 140 F.3d 433, 440 (2d Cir. 1998) (quoting Ryder Energy Distribution Corp. v. Merrill Lynch Commodities, Inc., 748 F.2d 774, 779 (2d Cir. 1984)). Thus, in deciding such a motion, the court must accept as true all material facts alleged in the complaint and draw all reasonable inferences in the nonmovant's favor. See Thomas v. City of New York, 143 F.3d 31, 36 (2d Cir. 1998). Nevertheless, "[a] complaint which consists of conclusory allegations unsupported by factual assertions fails even the liberal standard of Rule 12(b)(6)." De Jesus v. Sears, Roebuck & Co., 87 F.3d 65, 70 (2d Cir. 1996) (internal quotations omitted).

II. Background

The facts described in this section are drawn exclusively from the allegations in the Complaint. At this time, they are presumed to be true. Plaintiff Fromer invested more than $1.3 million in several companies, including the Premium Sales Corporation ("PSC"), Premium Sales LDL ("LDL") and Premium Sales RMS ("RMS") (together, the "Premium Sales entities"). See Complaint ("Cmplt.") at ¶ 1. With this investment, Fromer became one of three shareholders in PSH Management, Inc. ("PSH"), the corporate general partner of LDL and RMS. See Cmplt. at ¶¶ 14, 36. Apparently, Fromer was also involved in the management of the Premium Sales entities. See Cmplt. at ¶ 55. These companies engaged in the arbitrage of food, health and beauty products, a practice known as "diverting."*fn4 While these entities engaged in some amount of legitimate diverting, their primary source of funds came from monies received from subsequent investors and constituted a Ponzi scheme. See Cmplt. at ¶ 19.

Defendants Yogel and Schwartz were the remaining two shareholders of PSH, with Yogel as President and CEO. See Cmplt. at ¶¶ 14, 34. Yogel, Mrs. Yogel and Schwartz made material misrepresentations and omissions regarding the business practices of the entities to induce Fromer to make his initial investments in the Premium Sales entities. See Cmplt. at ¶ 2. Defendants portrayed the entities as a legitimate enterprise when they knew or should have known that it was a Ponzi scheme. See Cmplt. at ¶¶ 3, 20-23.

Mrs. Yogel worked with Yogel at the Pennsylvania offices of PSH Management, allegedly running much of the day-to-day operations of the Premium Sales entities. See Cmplt. at ¶¶ 8, 47-48. In that capacity she signed false confirmations of purchases and sales of goods that she knew or should have known did not actually take place, thereby perpetrating and/or aiding and abetting the fraud and Exchange Act violations committed by Yogel. See Cmplt. at ¶¶ 49-50. In addition, Yogel has attempted to hide his assets from current and potential creditors by transferring substantial amounts of personal assets to Mrs. Yogel. See Cmplt. at ¶ 51.

Defendants NTG Partners and Omni Finance, L.P. are Pennsylvania entities owned and/or controlled by Yogel. Cmplt. at ¶¶ 10, 11. Yogel purchased his way into the PSC scheme through payments passed through Omni and NTG to other principals of PSC. See Cmplt. at ¶ 22. Yogel also solicited investments in PSC through Omni. See Cmplt. at ¶ 24.

Ultimately, the Premium Sales scheme collapsed. See Cmplt. at ¶¶ 3, 24. On June 9, 1993, the SEC placed PSC into receivership, resulting in the loss of investments by Fromer and numerous others. In 1993, several investors commenced the Restifo action against Fromer, Yogel and Schwartz. See Cmplt. at ¶¶ 4, 45. In December 1996, all defendants settled the Restifo action for approximately $2.3 million. See Cmplt. at ¶¶ 4, 46. Fromer agreed to pay and allegedly did pay the full amount of the settlement, plus associated fees. See Cmplt. at ¶ 46. During the settlement negotiations, Yogel and Schwartz acknowledged to Fromer that they would compensate him for the sums he paid to the Restifo Plaintiffs. See Cmplt. at ¶ 4. Fromer now alleges that Yogel and Schwartz breached this purported promise to reimburse him for the entirety of the settlement. See Cmplt. at ¶¶ 4, 46.

Defendants Wilmington and Saunders (together "the Wilmington Defendants") were not named as defendants in the Restifo action. Nevertheless, to preclude the possibility of being sued, Wilmington and Saunders settled any claims that the Restifo plaintiffs may have had against them for $1 million and obtained a release. See Wilmington Defendants' Memorandum of Law ("Wilmington Defs.' Memo.") at 3.

Defendant Wilmington is a commercial bank and trust company organized under Delaware law. See Cmplt. at ¶ 12. Wilmington never entered into any contractual relationship with the Premium Sales entities, Fromer, FDT, Yogel or Schwartz. Its involvement arose when a Wilmington client asked Saunders, a Wilmington Vice President in its Business Development Division, to review certain documents relating to LDL and RMS and advise him as to whether they would be suitable investments. Saunders reviewed these materials and also asked Wilmington lawyers to review the LDL and RMS partnership agreements. See Cmplt. at ¶¶ 13, 25. This client eventually invested in LDL and RMS and later became a plaintiff in the Restifo action against Fromer, Yogel and Schwartz. The documents reviewed by Saunders contained numerous false and misleading statements regarding the Premium Sales entities. While Saunders knew or should have known of the falsity of these statements, he nevertheless disseminated them with the intention that Fromer and others rely on their truth. See Cmplt. at ¶¶ 25-32.

III. Analysis of Plaintiffs' Federal Claims

A. Contribution

Settling defendants in a federal securities action may sue for contribution. See, e.g., In re Del-Val Financial Corp. Securities Litigation, 868 F. Supp. 547, 553-4 (S.D.N.Y. 1994) (citing Musick, Peeler & Garrett v. Employers Insurance of Wausau, 508 U.S. 286, 113 S.Ct. 2085, 124 L.Ed.2d 194, (1993)). Contribution provides that one of two or more joint wrongdoers should not be required to pay more than its share of a common burden. See Epstein v. Haas Securities Corp., 731 F. Supp. 1166 (S.D.N.Y. 1990); Stratton Group, Ltd. v. Sprayregen, 466 F. Supp. 1180, 1185 (S.D.N.Y. 1979).

In Musick, the Supreme Court noted that "parties against whom contribution is sought are, by definition, persons or entities alleged to have violated existing securities laws and who share joint liability for that wrong under a remedial scheme established by the federal courts." Musick, 508 U.S. at 292, 113 S.Ct. 2085. Accordingly, as in common law claims, contribution for a § 10(b) violation is allowed only among "joint tortfeasors". See also, In re Leslie Fay Companies, Inc. Securities Litig., 918 F. Supp. 749, 756 (S.D.N.Y. 1996); Stratton, 466 F. Supp. at 1185 ("The essence of contribution, therefore, is the presence of joint tortfeasors").

1. Plaintiffs fail to allege they are joint tortfeasors

The definition of a joint tortfeasor is fairly broad. A finding of liability is not required. Therefore, the fact that the Restifo action settled, making an ultimate determination of liability unavailable, does not preclude a contribution action. See, e.g., In re Del-Val, 868 F. Supp. at 554 ("A party need not actually be adjudged liable to the injured party to be a joint tortfeasor.") (citing Stratton, 466 F. Supp. at 1185). Indeed, a party need not even be sued by the plaintiff in the underlying action in order to be liable for contribution. See Musick, 508 U.S. at 286, 113 S.Ct. 2085 (settling defendants' subrogated insurers may sue non-parties for contribution).

What is required, however, is that the Complaint allege that the parties — the Plaintiff and those Defendants from whom contribution is sought — committed a tort, in this case securities fraud. Yet this Complaint fails to allege that Plaintiffs are tortfeasors. Nor does the Complaint allege that Plaintiffs and any of the Defendants are joint tortfeasors. See Cmplt. at ¶ 67 ("[r]esponsibility for the damages caused by the plaintiffs herein rests on these defendants by reason of their violations of Section 10(b) and Rule 10b-5 as alleged herein.") (emphasis added). It is insufficient to claim, as Plaintiffs do, that Yogel and the other Defendants are the tortfeasors and that Fromer was merely an unwitting participant in the scheme.*fn5

What is unusual here is that Plaintiffs steadfastly insist that they did not violate the securities laws. Disputes over the term "joint tortfeasor" typically arise when a defendant in a securities fraud action seeks contribution from third parties: The defendant becomes a third-party plaintiff but fails to allege that the injuries suffered by plaintiffs in the underlying action were caused by the third-party defendants' violation of the securities laws. See, e.g., Monisoff v. American Eagle Investments, Inc., 955 F. Supp. 40, 41-42 (S.D.N.Y. 1997); Ades v. Deloitte & Touche, 90 Civ. 4959, 90 Civ. 5056, 1993 WL 362364, at *10 (S.D.N.Y. Sept.17, 1993); Department of Economic Development v. Arthur Andersen & Co. (U.S.A.), 747 F. Supp. 922, 933 (S.D.N.Y. 1990). As stated in Ades:

  A claim for contribution under the federal securities
  laws . . . requires a third-party plaintiff to allege
  all the elements of the offense[,] . . . namely that
  the Third-Party Defendants either knowingly or
  reckless[ly] made material misrepresentations to the
  [injured parties] on which [these parties] relied in
  the purchase of the [securities] and which
  proximately caused loss to [the parties].

Here, the problem is that there is nothing in the Complaint that can be read as an allegation or concession of fraudulent conduct by the Plaintiffs. All that is alleged is Defendants' fraud in the original Restifo action, see Cmplt. at ¶¶ 18-44, and an independent fraud by Defendants on Plaintiffs in refusing to contribute to the settlement. See Cmplt. at ¶ 46. These allegations will not support a claim for contribution. Under the federal securities laws, such a claim must be based on allegations that all the parties violated securities laws, not based on allegations that the Defendants defrauded Plaintiffs. See Arthur Andersen, 747 F. Supp. at 934 ("claim for contribution under the federal securities laws must be based on allegations that the third-party defendant violated securities laws, not based on allegations that the third-party defendants defrauded [the third-party plaintiff]").

To present a valid claim that the parties are joint tortfeasors subject to contribution, the use of certain words is not required. All that is required are "allegations that the [parties] were joint participants in the fraud alleged." In re Del-Val, 868 F. Supp. at 554 (quoting Greene v. Emersons, Ltd., 102 F.R.D. 33, 36 (S.D.N.Y. 1983), aff'd on other grounds sub nom. Kenneth Leventhal & Co. v. Joyner Wholesale Co., 736 F.2d 29 (2d. Cir. 1984); see also, Stratton, 466 F. Supp. at 1185 n. 6 (S.D.N.Y. 1979) ("The term `joint tortfeasors' means that two or more persons are the joint participants or joint actors in the wrongful production of an injury to a third person."); In re Crazy Eddie Securities Litigation, 740 F. Supp. 149, 152 (S.D.N.Y. 1990) (same).

2. Plaintiffs fail to satisfy the scienter requirement

In this case, however, Plaintiffs try to have it both ways. They acknowledge that they knowingly acted jointly with Defendants but refuse to concede that they themselves knowingly committed fraud. Plaintiffs argue that they are "not required to concede [their] liability in order to assert a claim for contribution." Plaintiffs' Memorandum of Law ("Pls.' Memo.") at 8, (quoting Epstein, 731 F. Supp. at 1186-87). Plaintiffs' argument fails for several reasons.

First, Epstein itself does not support Plaintiffs' position. While the Epstein court did not require a concession of liability at the pleading stage, it did require that to prevail on the claim, defendant (third-party plaintiff) must be "found" liable or concede its own liability. See Epstein, 731 F. Supp. at 1187 ("in order to assert a claim . . . [i]t is enough that third-party plaintiffs assert that if they are adjudged liable to plaintiffs, then they and third-party defendants are joint tortfeasors.") (emphasis added). Because the underlying action was pending, an issue remained as to whether each of the parties would be found liable. Id. Here, a judicial finding of liability is precluded as the parties have settled the Restifo action and the statute of limitations on related actions has run. A finding of liability here can only occur through an admission.*fn6

Second, simply claiming to be an unwitting participant is insufficient in a fraud claim. In failing to concede liability, Fromer suggests that he did not knowingly participate in the fraud, but relied on the other Defendants to supply him and other investors with truthful and accurate information. An essential element of a claim under § 10(b), and therefore any claim for contribution arising thereunder, is scienter. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). The scienter element requires a showing that the party — in this case Plaintiffs — knowingly or recklessly violated the federal securities laws. See, e.g., In re Leslie Fay, 918 F. Supp. at 756 (S.D.N.Y. 1996). Each party must be liable for the injury to third persons to be considered a joint tortfeasor. Accordingly, to be considered a joint tortfeasor, the requisite elements must be alleged or conceded by every party, Plaintiffs included.

Third, by arguing that one can knowingly act jointly to unwittingly commit fraud, Plaintiffs appear to confuse one issue — knowingly acting jointly — about which there is some dispute in this circuit, with another issue — scienter as an element of fraud — about which there is no dispute. District courts in this circuit have defined "joint tortfeasors" in one of two ways. A contribution claim may be based either on a fraud committed jointly (and thus participants were acting jointly knowingly), or on individual acts of fraud lumped together and considered jointly (and thus participants were not acting jointly knowingly, though each was still committing fraud knowingly).

The majority view appears to be that contribution among joint tortfeasors is limited to "joint participants" in the fraud alleged by the plaintiff. See, e.g., Advanced Magnetics, Inc. v. Bayfront Partners, Inc. v. Painewebber Inc., 92 Civ. 6879, 1998 WL 647167, at *4 (S.D.N.Y. Sept.22, 1998); see also, In re Crazy Eddie, 740 F. Supp. at 152 (E.D.N.Y. 1990); Connecticut National Bank v. Reliance Insurance Co., 704 F. Supp. 506, 509 (S.D.N Y 1989); Greene, 102 F.R.D. at 36; Stratton, 466 F. Supp. at 1185. Other district courts have applied a more expansive definition, holding that contribution among joint tortfeasors is available among independent tortfeasors so long as the parties are concurrently liable for damages. See, e.g., In re Leslie Fay, 918 F. Supp. at 756; In re Del-Val, 868 F. Supp. at 554; Ades, 1993 WL 362364, at *15; McCoy v. Goldberg, 778 F. Supp. 201 (S.D.N.Y. 1991). The Second Circuit has not resolved the split. See Kenneth Leventhal & Co. v. Joyner Wholesale Co., 736 F.2d 29, 31 n. 1 (2d Cir. 1984) ("We do not reach this issue" of the definition of joint participants in fraud).

This issue, however, is not presented here. Plaintiffs' contribution claim is equally deficient under either definition of "joint tortfeasor." This is not a case like In re Del-Val or Ades where the "joint tortfeasor" standard was held to be satisfied by separate fraudulent actions upon which third parties relied. Those cases only hold that the parties need not have knowingly acted jointly to injure a plaintiff. But all the parties must have knowingly committed fraud. "Independent violations of the securities laws that injure the same plaintiff are sufficient to support actions for contribution as long as the third-party complaint adequately alleges that the third-party defendant has violated the securities laws and participated in the underlying fraud." In re Del-Val, 868 F. Supp. at 554 n. 8 (citing McCoy v. Goldberg, 778 F. Supp. 201, 204-5 (S.D.N.Y. 1991)). There is no reason to exempt Plaintiffs from this requirement.

Fourth, and finally, Plaintiffs display a fundamental misunderstanding of the theory of contribution, which is designed to achieve "a fair distribution of fault among parties involved in a wrong." See Greene, 102 F.R.D. at 36. As currently alleged, however, Plaintiffs' ...


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