Introduction
You have asked us to research,
identify and summarize the key cases on the issue of what
might be held to constitute reasonable reliance on representations
made in a private placement memorandum offering interests
in a fund. These issues require discussion of:
1. New York, New Jersey,
Delaware State and Federal case law.
Relevant Cases
NEW YORK
1. First Lincoln Holdings,
Inc. v. The Equitable Life Assurance Society of The United
States, 43 Fed. Appx. 462 (2nd Cir. 2002)
Plaintiff Corporation alleged
breach of contract, common law fraud, and violations of the
federal securities law, due to defendant society's decision
to terminate its ability to execute trades by telephone, fax,
or other electronic means on its account. The United States
District Court for the Southern District of New York denied
the corporation's preliminary injunction motion and granted
the society's motion to dismiss. The corporation appealed.
The corporation claimed
that by restricting its trading, the society effectively prevented
it from engaging in its preferred investment strategy, a form
of arbitrage known as market timing. The instant court agreed
with the district court that the annuity fund contract unambiguously
granted the society the right to determine the terms on which
investors in the fund could have traded on their accounts.
Nor could the corporation have relied on its contention that
the society's agents assured it that it could have engaged
in market timing or on indications of its intent to do so
in its application materials. The fund application clearly
stated that no agent had the authority to make or modify any
contract, or to waive or alter any of the society's rights
and regulations. Furthermore, the prospectus made abundantly
clear that market timing was forbidden. The corporation could
not have relied on parol evidence to vary the express terms
of the written contract. The fraud claims were properly dismissed
because a sophisticated investor could not have reasonably
relied on the alleged fraudulent representation of the society's
agents directly contradicted by the society's documents.
The Court agreed with the
district Court in that the plaintiff's fraud claims were properly
dismissed, because a sophisticated investor could not have
reasonably relied on the alleged fraudulent representation
of Equitable agents directly contradicted by Equitable's documents.
The Court also noted the
general rule that reasonable reliance must be proved as an
element of a securities fraud claim. Id at 464.
2. Opher Pail v Precise Imports
Corporation, 1999 U.S. Dist. LEXIS 13401 (S.D.N.Y., 1999)
Plaintiff employee sued
defendant’s employers who induced him to spend his own
time inventing products for the defendant, in exchange for
stock in an acquisition company. No shares were ever issued,
and the acquisition company was dissolved. Plaintiff alleged
common law fraud and securities law fraud under the Securities
and Exchange Act, rule 10b-5, 15 U.S.C.S. § 78j(b). Defendants
moved for dismissal, claiming plaintiff did not plead reasonable
reliance, did not plead with sufficient particularity for
fraud, and did not allege misrepresentations. The court denied
the motion, finding that plaintiff plead reasonable reliance
as an employee who relied upon the representations of his
employer, so no heightened standard of diligence was applied.
Plaintiff also pled with particularity, fraudulent statements
made by defendant as to the stock exchange. Finally, plaintiff
alleged misrepresentation of the value of the stock, which
induced him to continue inventing products in exchange for
it. Defendants' motion to dismiss plaintiff's claims was denied.
Plaintiff pled common law and securities fraud with sufficient
particularity for claims to survive motion to dismiss, pled
reasonable reliance as to stock representations, and sufficiently
claimed misrepresentation which induced him to purchase stock
by inventing products for defendants.
The Court held that Reasonable
reliance is an element of both common law fraud under New
York law and securities fraud.
3. Igor Azrielli v. Zamaryonov,
21 F.3d 512 (2nd Cir. 1994)
Plaintiff purchasers challenged
the district court's judgment inasmuch as it dismissed plaintiff's
complaint asserting claims of securities fraud in violation
of 15 U.S.C.S. § 78j(b) and 17 C.F.R. § 240.10b-5
(1993) promulgated thereunder, claims of violations of the
Racketeer Influenced and Corrupt Organizations Act (RICO),
18 U.S.C.S. § § 1961-1968, and various claims under
state law. The court affirmed in part and vacated in part.
The court held that evidence in the record revealed genuine
issues of material fact with respect to plaintiffs' claims
against defendant attorney, other than the RICO claims against
defendant attorney, and with respect to their federal claims
against other defendants such as an adequate showing that
the claimed misrepresentations were material and in connection
with the purchase of the shares by plaintiffs and that a pattern
of such misrepresentations could have been found by a jury,
making summary judgment inappropriate. The court vacated so
much of the judgment as dismissed plaintiffs' federal claims,
other than the RICO claims against defendant attorney, dismissal
of which it affirmed and reinstated the state law claims.
The Court observed that
the fundamental purpose of the Securities Exchange Act 1934,
15 U.S.C.S. § § 77b-78kk (1988) is to implement
a philosophy of full disclosure, in order to make sure that
buyers of securities get what they think they are getting.
17 C.F.R. § 240.10b-5(1993) thus makes unlawful any misrepresentation
that would cause reasonable investors to rely thereon, and,
in connection therewith, so relying, cause them to purchase
or sell a corporation's securities. Liability under rule 10b-5
may be imposed not only on persons who made fraudulent misrepresentations
but also on those who had knowledge of the fraud and assisted
in its perpetration. Id at 518
A fact is to be considered
material if there is a substantial likelihood that a reasonable
person would consider it important in deciding whether to
buy or sell shares. A fraud claim may not properly be dismissed
summarily on the ground that the alleged misstatements were
not material unless they would have been so obviously unimportant
to a reasonable investor that reasonable minds could not differ
on the question of their importance. Representations tending
to indicate that the valuation of the shares to be purchased
has been inflated may obviously be material. Id at 519
4. Harsco Corporation v.
Rene Segui, 91 F.3d 337 (2nd Cir. 1996)
The parties executed a purchase
agreement for appellees' company. In the agreement, appellees
made express representations and appellant expressly waived
reliance on outside representations. Appellant later sued
appellees for federal securities fraud, under 17 C.F.R. §
240.10b-5, common law fraud, breach of contract, and other
related allegations. The court dismissed appellant's complaint
under Fed. R. Civ. P. 12(b)(6). The appellate court held that
since appellant specifically disclaimed reliance on representations
made outside of the contract and the parties were sophisticated
business entities, appellant could not claim reasonable reliance
on appellees' outside representations. Therefore, it affirmed
the dismissal of the common law and federal securities fraud
claims, pursuant to Fed. R. Civ. P. 12(b)(6). Because the
federal claims were dismissed, the court held that state law
claims were properly dismissed because supplemental jurisdiction
could no longer be exercised, but noted that state claims
could be brought in state court.
The Court held that Reasonable
reliance must be proven as an element of a securities fraud
claim. Rule 10b-5 makes unlawful any misrepresentation that
would cause reasonable investors to rely thereon. Id at 344.
5. Adler v. Berg Harmon Assoc.,
790 F. Supp. 1222 (S.D.N.Y. 1992)
Defendant securities promoter
filed a motion to dismiss plaintiff investors' second amended
complaint pursuant to Fed. R. Civ. P. 9(b), 12(b)(6). The
investors' complaint sought damages pursuant to the Racketeering
and Corrupt Organizations Act (RICO), 18 U.S.C.S. § 1961
et seq, for fraud, negligence, and breach of fiduciary duty
in connection with the sale of securities related to real
estate limited partnerships.
The investors had purchased
real estate limited partnerships based upon memorandums that
were generated by the securities promoter. The investors claimed
that the promoter was engaged in fraud in selling the partnerships
through a complicated scheme of financing, mortgages, excessive
fees and fees for non-existent services. The promoter filed
a motion to dismiss the investors' second amended complaint,
which was granted by the court. The court held that 1) under
Fed. R. Civ. P. 9(b), the investors had failed to sufficiently
attribute the alleged wrongdoings to the promoters because
of the broad allegations that had combined the acts of several
promoters to create the impression that all of them had engaged
in the fraud; 2) the investors had not alleged the necessary
elements of a claim under 18 U.S.C.S. § 1962(a), having
only alleged injury that resulted from the racketeering acts,
as opposed to injury by reason of the use or investment of
racketeering income; and 3) the investors had failed to allege
that each of the promoters had acted with a fraudulent intent.
The court dismissed the investors' second amended complaint
without prejudice.
The Private Placement Memorandums
in the instant action were replete with warnings of the speculative
nature of the investments and the risk that any investment
may result in a loss. The Court held that although plaintiffs
argue that they were misled into believing that the respective
projects could operate profitably, such an argument is untenable.
One glance at the financial projections in the offering memoranda
before the Court indicates that tax deductions, rather than
profits, were the immediate benefit to be expected by an investor
-- the immediate prospects for the partnerships were for substantial
losses. Although investors may have hoped for additional benefits
from the ultimate sale or refinancing of the property, none
was promised in the PPMs, which virtually abound with warnings
of the risks and imponderables. Accordingly, the allegations
in the Complaint suggesting that defendants misrepresented
the extent of the economic benefits that would flow to the
limited partners from an investment in the partnership and
the allegations respecting the misleading nature of the financial
projections and risk estimates must fail. Id at 1232
6. Luce v. Edelstein, 802
F.2d 49 (2nd Cir. 1986)
Plaintiffs appealed the
dismissal, without leave to amend, of their complaint alleging
defendants' violation of Section 10(b) of the Securities Exchange
Act of 1934, 15 U.S.C.S. § 78j(b), by the United States
District Court for the Southern District of New York. Plaintiff
limited partners sued defendant general partners, alleging
defendants had violated Section 10(b) of the Securities Exchange
Act of 1934, 15 U.S.C.S. § 78j(b), in the sale of partnership
interests. The district court dismissed the complaint, finding
fraud had not been pled with particularity as required by
Fed. R. Civ. P. 9(b), and leave to amend was denied. The court
reversed, finding several allegations were sufficiently based
on specific facts. For example, defendants allegedly represented
they would make capital contributions to the partnership in
the amount of $ 385,000 when only $ 80,000 was actually contributed.
In addition, the renovation of properties undertaken by the
partnership had cost nearly $ 6 million more than plaintiffs
had been led to believe, with the renovations still incomplete.
These allegations also sufficiently stated Section 10(b) violations,
and it was an abuse of discretion to dismiss the complaint
without leave to amend. Dismissal of complaint alleging violation
of the Securities and Exchange Act of 1934 was reversed. The
court found that several allegations were sufficiently based
on specific facts as required to plead fraud with particularity,
and that the allegations also sufficiently stated claims under
the Act.
Reference to the Offering
Memorandum satisfies 9(b)'s requirements as to identification
of the time, place, and content of the alleged misrepresentations.
See, e.g., Klein v. Computer Devices, Inc., 591 F. Supp. 270,
279 (S.D.N.Y. 1984); Somerville v. Major Exploration, Inc.,
576 F. Supp. 902, 911 (S.D.N.Y. 1983). Furthermore, no specific
connection between fraudulent representations in the Offering
Memorandum and particular defendants is necessary where, as
here, defendants are insiders or affiliates participating
in the offer of the securities in question. See, e.g., Somerville,
576 F. Supp. at 911; Pellman v. Cinerama, Inc., 503 F. Supp.
107, 111 (S.D.N.Y. 1980).
Many allegations grounded
in the Offering Memorandum are based on specific facts. For
example, plaintiffs assert that although the Offering Memorandum
represented that the general partners would make capital contributions
to the partnership of $385,000, the general partners actually
contributed only approximately $80,000. Plaintiffs also claim
that the Offering memorandum falsely represented that the
cost of the renovation would be $4.5 million, when in fact
liabilities for the still incomplete project already exceed
$10.2 million. Thus, some claims grounded in the Offering
Memorandum are sufficiently pleaded to pass muster under Rule
9(b).
Those representations involved
specific promises by the general partners to perform particular
acts that they did not intend to carry out or knew could not
be carried out. Id at 56
An examination of the complaint
reveals some claims that fall within this category. Plaintiffs
allege that the Offering Memorandum represented the following:
that the general partners would make an initial capital contribution
of $385,000 and guarantee the $4.5 million construction loan,
that at least one of the general partners had maintained and
would continue to maintain its net worth at a level sufficient
to ensure the partnership's profitability, n3 that the general
partners would collect management fees from the partnership
for only one year, and that no assignment or transfer of the
general partners' interest in the partnership could occur
without notice to and consent of the limited partners. Plaintiffs
also allege that these promises were not kept: the general
partners contributed only approximately $80,000 and did not
guarantee the loan; the general partners did not have and
never had the net worth necessary to participate in the limited
partnership; the general partners continued to collect management
fees for well over one year; and the general partners entered
into an agreement to transfer their partnership interests
to F.M. Capital without the knowledge and consent of the limited
partners. While the failure to carry out a promise made as
consideration for a sale of securities may be an element of
a Section 10(b) claim, that failure does not constitute fraud
if the promise was made with a good faith expectation that
it would be carried out. Cf. Ernst & Ernst, 425 U.S. 185,
47 L. Ed. 2d 668, 96 S. Ct. 1375. However, in the instant
case, plaintiffs also allege that these promises were known
by defendants to be false when made. Plausible allegations
that defendants made specific promises to induce a securities
transaction while secretly intending not to carry them out
or knowing they could not be carried out, and that they were
not carried out, are sufficient under Pross to state a claim
for relief under Section 10(b). Id at 57
7. Friedman v. Arizona World
Nurseries Ltd. Partnership, 730 F. Supp. 521 (S.D.N.Y. 1990)
Defendants, limited partnership,
accountants, attorneys, former owners and/or managers of partnership
(owners), promoters, and individual corporation, filed motions
to dismiss plaintiff investors' consolidated complaint for
violations of federal securities laws and the Racketeer Influenced
and Corrupt Organizations Act (RICO), 18 U.S.C.S. § 1961
et seq., and claims of fraud, negligence, conspiracy, and
breach of fiduciary responsibility. Investors in limited partnership
sought relief arising out of the "scheme" to sell
an unsuccessful business to limited partnership. The motions
to dismiss were filed under Fed. R. Civ. P. 9(b), 12(b)(6),
and the court held that (1) investors did not adequately plead
scienter under § 10(b) of the Securities Exchange Act
of 1934, 15 U.S.C.S. § 78j(b) or show attributable statements,
as to accountants and attorneys, regarding the tax opinion
and offering memorandum that they drafted. (2) The §
10(b) claims against individual corporation were inadequate.
(3) The § 10(b) claims were adequately pled against owners
and promoters because they were insiders, and specific facts
were alleged as to their actions and motive. (4) There was
no liability under § 10(b), as to accountants and attorneys,
due to the financial documents' cautionary language. (5) No
claim, under § 12(2) of the Securities Act of 1933, 15
U.S.C.S. § 771(2), was stated against accountants, attorneys,
or individual corporation because they were not statutory
sellers. And (6) the securities fraud predicates for RICO
claims, against limited partnership, owners, and promoters,
were adequately pled.
The court granted the motions
to dismiss by accountants, attorneys, and the individual corporation.
The court denied the motions to dismiss by owners, limited
partnership, and promoters for the claims pursuant to §
12(2) and 18 U.S.C.S. § 1962(c), granted their motions
as to the claims under § 17(a) of the Securities Act
of 1933 and 18 U.S.C.S. § 1962(a) and (d), and granted
in part and denied in part their motions as to 15 U.S.C.S.
§ 78j(b).
In this case, the projections
in issue make clear that they "are based upon assumptions
made by Arizona World Nurseries Limited Partnership of the
income and expenses and cash flow from the operations of the
nursery." Offering Memorandum, Ex. F: "Notes and
Assumptions" section of the Financial Projections at
1. Furthermore, the projections expressly cautioned that they
were based upon these assumptions and appraisals, and that
some of the assumptions may not materialize, and thus, that
the actual results achieved could then vary from the projections
substantially. In addition, the cover letter which accompanied
the projections made clear the limited role that the Andersen
defendants assumed with reference to the projections (that
they did not perform an audit and that they did not verify
the assumptions provided by the general partner), and once
again, explicitly warned, as set out above, as to the accuracy
and achievability of the projections. Certainly, then, no
misrepresentation claim can be predicated upon the fact that
the projections did not bear out.
Furthermore, as can be seen
from the warnings in the front of the offering memorandum
also quoted above, as well as the "Tax Risks" section
of the Memorandum, and as stated on page two of the tax opinion
letter, Andersen relied on the factual information provided
to it by the management of the partnership. Tax Opinion Letter
at 2 (Andersen "relied on management and their legal
counsel for business and legal matters"); Offering Memorandum
at 22 ("INVESTORS ARE CAUTIONED THAT THE CONCLUSIONS
IN THE TAX OPINION ARE BASED UPON CERTAIN REPRESENTATIONS
TO ARTHUR ANDERSEN BY THE GENERAL PARTNER"). The Court
concluded that, given all of the cautionary language, Andersen's
tax opinion cannot be read to mean that Andersen undertook
to make representations of any kind regarding the value of
the nursery stock. Id at 541.
|
