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November 26, 2001


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


Plaintiffs Daniel Z. Nelson, Lloyd Zeiderman and Harold Greenberg, former shareholders, officers and directors of NewVest Capital Corporation ("Plaintiffs"), bring this action against Rosalie Stahl, Scott G. Savastano, NewVest Capital Corporation ("NewVest"), NewVest Portfolio 96-A, L.L.C., NewVest Portfolio 96-B, L.L.C., Han Kook, L.L.C. (the "LLCs"), Marks Paneth & Shron LLP., Steven Eliach, Thelen, Reid & Priest LLP, Timothy E. Andrews, and Harry G. Heching ("Defendants"), alleging fraud in connection with the assignment of their stock in NewVest, as well as their interests in the LLCs, to defendant Stahl. The complaint asserts claims under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"),*fn1 and Rule l0b-5 promulgated thereunder*fn2 (First Cause of Action), as well as a variety of state law claims (Second through Eleventh Causes of Action) as to which Plaintiffs assert the Court should exercise supplemental jurisdiction pursuant to 28 U.S.C. § 1367 . Before the Court are motions to dismiss the complaint pursuant to Federal Rules of Civil Procedure 12(b)(1) and 12(b)(6) and Federal Rule of Civil Procedure 9(b) for lack of subject matter jurisdiction, failure to state a claim upon which relief may be granted, and failure to plead fraud with particularity.*fn3

For the reasons set forth below, Defendants' motion pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure is granted insofar as the complaint asserts federal securities law claims based on the transfer of interests in the LLCs. The Court will exercise supplemental jurisdiction with respect to Plaintiffs' claims asserted in the Second through Fifth Causes of Action, and declines to exercise supplemental jurisdiction with respect to the claims asserted in the Sixth through Eleventh Causes of Action. Defendants' motion is denied on all grounds with respect to Plaintiffs' federal securities law claims relating to the transfer of Plaintiffs' shares of NewVest stock.


In evaluating a motion to dismiss, the Court is obliged to take as true the facts as alleged in the complaint and draw all reasonable inferences in favor of the plaintiff. Grandon v. Merrill Lynch & Co., 147 F.3d 184, 188 (2d Cir. 1998). The Court is also permitted to take into account the contents of documents attached to or incorporated in the complaint, Cosmas v. Hassett, 886 F.2d 8, 13 (2d Cir. 1989), as well as those documents which are "integral" to the complaint. San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 808 (2d Cir. 1996). Here, the complaint refers in material respects to a certain Stockholders Agreement, dated April 1, 1994 ("Stockholders Agreement" or "St. Agrmt."), (Compl. ¶¶ 27-28) and to the creation of the LLCs (Id. ¶¶ 18-20), all of which exist pursuant to limited liability company agreements ("LLC Agreements"). The Court finds that the Stockholders Agreement and the LLC Agreements are integral to the complaint and, accordingly, has considered their contents in evaluating the sufficiency of the complaint. The following factual recitation as well as that of the complaint.*fn4

In 1994 Plaintiffs, along with defendants Stahl and Savastano, established NewVest. (Compl. ¶¶ 1, 17, 27.) NewVest was organized for the purpose of engaging in real estate activities and the acquisition of low cost mortgages and other mortgage-related investments. (Id. ¶ 17.) In accordance with the Stockholders Agreement, NewVest, which was a New York corporation, issued twenty per cent of its stock to each of Plaintiffs, and defendants Stahl and Savastano. (St. Agrmt. at 1.) The Stockholders Agreement provided that Plaintiffs and defendant Stahl would make additional investments by way of loans to other entities that would in turn invest in real estate. (Id. at 2-3.) The other entities were ultimately organized as LLCs. (Compl. ¶¶ 34, 35.) The Stockholders Agreement provided that, upon the sale of investments, any net profit earned by the LLCs would be channeled through NewVest for distribution to stockholders. (St. Agrmt. at 2.) NewVest was entitled to receive a fee for acquiring mortgages and a servicing fee payable from income earned by the LLCs. (Id. at 3.)

After NewVest's*fn5 initial investments in June 1995, defendant Savastano was responsible for all of NewVest's operations and investments. (Compl. ¶ 38.) In February of 1998, defendant Savastano presented NewVest's 1997 consolidated financial statements, which had been prepared under his supervision, to the corporation's shareholders. (Id. ¶ 39.) According to the financial statements, NewVest had a positive net worth of approximately $11,000,000, which included $5,000,000 in investment loans owed to defendant Stahl and Plaintiffs, at that time. (Id.) At approximately the same time, defendant Savastano prepared for plaintiff Zeiderman a financial report indicating that NewVest had a net worth (including repayment of investment loans) of approximately $10,000,000. (Id. ¶ 40.) In early 1998, defendant Stahl asked defendant Savastano to prepare a schedule comparing her rate of return to that of the other NewVest shareholders. (Id. ¶ 41.) In March 1998, Savastano produced schedules showing that Plaintiffs had achieved a higher rate of return than defendant Stahl. (Id.)

Shortly after defendant Savastano had produced the schedules for Stahl, Savastano began indicating to NewVest's stockholders that NewVest was facing substantial financial difficulties, including a significant cash shortfall. (Id. ¶ 42.) In April 1998, Savastano delivered a schedule concerning a hypothetical sale that would leave an insufficient cash flow to continue NewVest's operations. (Id. ¶ 43.) On May 19, 1998, Savastano informed the board that an asset sale over 180 days would generate $4,000,000, not enough to repay the investors' loans, and leaving no profits. (Id. ¶ 45.) On May 19, 1998, Savastano made a capital call for $30,000 from each shareholder, which was followed up with a call on June 4, 1998, for $10,000 from each shareholder and a subsequent call on July 8, 1998, for $30,000 from each shareholder. (Id. ¶ 45-46.) Defendant Savastano faxed one of the capital call memoranda to plaintiff Greenberg. (Id. ¶ 45.)

A few weeks after the July 8, 1998, board meeting, plaintiff Greenberg spoke by telephone to Stahl's senior advisor and attorney who informed him that, unless Plaintiffs conveyed their interest in NewVest to defendant Stahl for no consideration, Stahl's lawyers would sue Plaintiffs. (Id. ¶ 49.) Based on the false information provided to Plaintiffs concerning NewVest's finances, and unaware of the pending payoff of the Los Alamitos mortgage, Plaintiffs, on July 28, 1998, assigned their interests in NewVest and its related LLCs to defendant Stahl for no consideration. (Id. ¶ 51.) On or about July 28, 1998, Plaintiffs executed a final Assignment Agreement, dated as of July 1, 1998 (the "Assignment Agreement"), pursuant to which the transfer was completed. (Id.) The Assignment Agreement also included a broad general release running between defendant Stahl, on the one hand, and Plaintiffs, on the other hand. (Id. ¶ 52.) The general release covered claims in connection with NewVest, the LLCs, and their business activities. (Id.)

On August 5, 1998, the Los Alamitos mortgage was paid off and NewVest received more than $800,000 in cash, which NewVest then distributed directly to defendants Stahl and Savastano. (Id. ¶ 58.) By late July 1999, Plaintiffs had not received their 1998 K-1 income tax schedules for NewVest and the related LLCs. (Id. ¶ 71.) Defendants engaged in a pattern of delay, repeatedly refusing to provide essential tax and financial information to Plaintiffs. (Id. ¶ 72, 74-77, 84.) Further, the Schedules K-1 ultimately received by Plaintiffs were flawed, in that they reported and allocated income improperly. (Id. ¶¶ 81, 84.) The improper allocation of ordinary income in NewVest's Schedules K-1 was designed specifically to transfer tax liability from Defendants to Plaintiffs. (Id. ¶ 84.) When Plaintiffs discovered the impermissible and erroneous allocations, they raised the issue with Defendants. (Id.) Rather than remedy the situation, Defendants refused to release information, delayed the process, and ultimately did not correct the errors. (Id.)


Rule 12(b)(1) Motion

A case is properly dismissed for lack of subject matter jurisdiction under Rule 12(b)(1) of the Federal Rules of Civil Procedure when the district court lacks the statutory or constitutional power to adjudicate it. See Makarova v. United States, 201 F.3d 110, 113 (2d Cir. 2000). A plaintiff asserting subject matter jurisdiction generally has the burden, once challenged, of proving by a preponderance of the evidence that jurisdiction exists. See id. Unlike a motion to dismiss under Rule 12(b)(6), a motion to dismiss for lack of subject matter jurisdiction is not directed to the claim's merits. See Exchange Nat'l Bank of Chicago v. Touche Ross & Co., 544 F.2d 1126, 1130-1 (2d Cir. 1976).

In this case, Plaintiffs claim violations of the federal securities laws and seek damages and injunctive relief based on their allegations that Defendants engaged in acts, transactions and practices that operated as fraud upon Plaintiffs, and that Defendants made various untrue statements of material fact and omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading to Plaintiffs, and that instrumentalities of interstate commerce were employed in connection with the alleged fraud. The federal claims asserted in Plaintiffs' complaint are not "wholly insubstantial," nor do they appear to be "immaterial and made solely for the purpose of obtaining jurisdiction" over their asserted state law claims. The Court therefore finds dismissal of the complaint under Rule 12(b)(1) inappropriate and turns instead to the question of whether Plaintiffs' complaint states a claim upon which relief can be granted.

Rule 12(b)(6) Motion

As noted above, in deciding a motion to dismiss for failure to state a claim upon which relief may be granted, a court must accept as true the material facts alleged in the complaint and draw all reasonable inferences in plaintiffs favor. Grandon, 147 F.3d at 188. The court must not dismiss the action unless "`it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.'" Cohen v. Koenig, 25 F.3d 1168, 1172 (2d Cir. 1994) (quoting Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)); Sims v. Artuz, 230 F.3d 14, 20 (2d Cir. 2000).

The instant complaint asserts federal claims under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. Defendants assert that the complaint's allegations are insufficient to sustain these claims and that the First Cause of Action, which is the only federal law cause of action in the complaint, should therefore be dismissed.

Section 10(b) of the Securities Exchange Act provides that:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of ...

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