S.E.C. v. Saltzman

Decision Date29 December 2000
Docket NumberNo. CIV.A. 00-2468.,CIV.A. 00-2468.
Citation127 F.Supp.2d 660
PartiesSECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. James S. SALTZMAN, Defendant.
CourtU.S. District Court — Eastern District of Pennsylvania

Gary E. Jackson, Celeste Chase, U.S S.E.C., Philadelphia, PA, for plaintiff.

Alexander D. Bono, Frederick D. Lipman, Timothy D. Katsiff, James J. Reynolds, Blank Rome Comisky & McCauley, LLP, Philadelphia, PA, for defendant.

Ronald H. Surkin, Richard Di Santi, Gallagher, Schoenfeld & Surkin, Media, PA, for movant.

MEMORANDUM and ORDER

ANITA B. BRODY, District Judge.

Defendant James B. Saltzman moves to dismiss for failure to state a claim pursuant to Federal Rules of Procedure 12(b)(6) and 9(b). Saltzman alternatively moves for a more definite statement. Having considered the defendant's motion, the response of the plaintiff, Securities and Exchange Commission ("SEC"), and the written and oral arguments of the parties in support of their positions, I conclude that the Defendant's Motion to Dismiss or for a More Definite Statement should be denied.

The Securities and Exchange Commission ("SEC") pleads two causes of action against Saltzman. First, the SEC alleges violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a)1; Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b)2, and Rule 10b-5 thereunder, 17 C.F.R. 240.10b-5.3 The second cause of action alleges violations of Sections 206(1) and 206(2) of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-6(1) and 80b-6(2).4 The SEC asks the court to enjoin Saltzman from committing those violations, order him to disgorge all unlawfully obtained proceeds, and order him to pay civil penalties.

I. FACTUAL and PROCEDURAL BACKGROUND

At the time of the alleged violations, James Saltzman was both the managing general partner and a limited partner of Saltzman Partners L.P., a private investment partnership. The partnership was formed in 1992 and includes 36 limited partners. Saltzman, while managing general partner, maintained exclusive control of the partnership's investment portfolio, bank account, and brokerage accounts. In return for his services as managing partner, Saltzman received an annual performance fee equal to 20% of the difference between the current cumulative portfolio value as of the end of any fiscal year and the preceding highest cumulative portfolio value. From 1985 to 2000, Saltzman earned at least $1.3 million in performance fees.

In 1994, the SEC alleges, Saltzman began taking out loans from the partnership in violation of the partnership agreement. From 1994 to February 2000, Saltzman allegedly took out several loans totaling $1.78 million. The partnership agreement authorized the managing general partner to make loans to any requesting partner, including himself. However, such loans had to meet the requirements provided in section 11 of the partnership agreement. During the relevant time period, section 11 set forth the following requirements: 1) the aggregate principal amount of loans outstanding to any partner could not exceed 50% of the partner's capital account; 2) loans were to bear interest, payable monthly; 3) loans were due and payable no later than 60 days after the end of the fiscal year in which the loan was made; and 4) all loans had to be requested in writing and evidenced by a note. As managing general partner and the person who provided information about the partnership to current and prospective investors, the SEC alleges, Saltzman knew or was reckless in not knowing the terms of the partnership agreement, and therefore knew or was reckless in not knowing that his personal loans violated the agreement.

The SEC alleges that Saltzman knowingly violated several of the agreement's loan requirements, and therefore misappropriated $1.78 million from the partnership. First, Saltzman's loan total exceeded 50% of his capital account balance with the partnership. As of December 31, 1997, Saltzman had a balance of $564,484 in his capital account, which permitted him to take out $282,242 in loans; however, at that time, he carried an outstanding loan balance of $1,296,476 including principal and interest. Although his capital account balance did not increase over the next two years, Saltzman continued to take out loans from the partnership, bringing his total up to $1.78 million by February 5, 2000. Second, Saltzman did not make any interest payments on the loans. Third, Saltzman did not repay outstanding loan balances within 60 days of the end of the fiscal year in which the loans were made. Finally, the SEC alleges that Saltzman did not execute the documentation necessary to evidence the loans; nor did he securitize his loans. By failing to repay the money he misappropriated from the partnership, the SEC charges, Saltzman defrauded the limited partners in violation of federal securities law.

The SEC further charges that Saltzman misled the limited partners by failing to disclose material facts in the partnership's annual financial statements. Saltzman, as managing general partner, created the financial statements or caused the financial statements to be created; he therefore knowingly or recklessly distributed materially misleading statements. The SEC alleges that the audited financial statements for fiscal year 1998 misled the limited partners in three ways. First, note 2 to those statements stated, correctly, that several limited partners had taken out loans from the partnership; however, note 2 did not disclose the fact that loans attributable to Saltzman represented over 80% of all outstanding loans. Second, note 2 did not disclose the fact that Saltzman's loans were improper — that he had taken out loans far in excess of the authorized amount, had not paid monthly interest, and had not timely repaid his loans. Third, the financial statements characterized the interest due on the loans as investment income, giving the partners the false impression that the interest attributable to Saltzman's loans was collectible.

In addition, the SEC alleges, at the beginning of calendar years 1998, 1999, and 2000, Saltzman encouraged and accepted reinvestment in the partnership fund while failing to disclose his misappropriation of the partnership's money. At the beginning of each year, limited partners have the option of withdrawing all or part of their capital accounts from the partnership fund. Saltzman violated his fiduciary duty as an investment adviser by failing to disclose information necessary for the limited partners to make informed decisions on reinvestment in the partnership.

This action was filed on May 12, 2000. Two days before filing, the partnership amended section 11 to authorize unsecured loans to the managing partner of up to $2 million. The partnership also removed Saltzman from the position of managing general partner and committed the partnership's accounts to the stewardship of an independent accounting firm.

On May 23, 2000, the parties agreed to enter into an order of preliminary injunction and other equitable relief. On November 2, 2000, after hearing oral argument, I vacated the section of the preliminary injunction related to the freeze on Saltzman's assets. On December 8, 2000, I stayed discovery pending resolution of the motion now before me.

II. DISCUSSION

Defendant, James Saltzman, has filed a motion to dismiss under Federal Rules of Procedure 12(b)(6) and 9(b), or, in the alternative, for a more definite statement. In his motion, Saltzman challenges the legal sufficiency of both causes of action brought against him. Saltzman contends that the first cause of action does not state a claim cognizable under the fraud provisions of the federal securities laws. As for the second cause of action, Saltzman argues that he is not an "investment adviser" as defined by the Investment Advisers Act, and therefore the claim must fail.

A. Standard of Review
1. Rule 12(b)(6)

Rule 12(b)(6) permits the court to dismiss an action for failure to state a claim upon which relief can be granted. Fed. R.Civ.P. 12(b)(6). In order to survive the Rule 12(b)(6) motion, the SEC must provide enough evidence to support its claims; however, it does not need to demonstrate that it will prevail on the merits. See Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 81 L.Ed.2d 59 (1984). The claim may be dismissed only if the SEC cannot demonstrate any set of facts in support of the claim that would entitle it to relief. See Conley v. Gibson, 355 U.S. 41, 45-6, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957); Williams v. New Castle County, 970 F.2d 1260, 1266 (3d Cir.1992). In considering the motion to dismiss, the court must accept as true all factual allegations in the complaint and all reasonable inferences that may be drawn therefrom, construing the complaint in the light most favorable to the SEC. See Hishon, 467 U.S. at 73, 104 S.Ct. 2229; Weiner v. Quaker Oats Co., 129 F.3d 310, 315 (3d Cir.1997).

2. Rule 9(b)

Rule 9(b) states: "In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind may be averred generally." Fed.R.Civ.P. 9(b). To allege fraud, a plaintiff generally must plead (1) a specific false representation of material fact, (2) knowledge of its falsity by the person who made it, (3) ignorance of the falsity by the person to whom it was made, (4) the maker's intention that it should be acted upon, and (5) detrimental reliance by the plaintiff. In re Burlington Coat Factory Securities Litigation, 114 F.3d 1410, 1421 (3d Cir.1997) (citing In re Westinghouse Securities Litigation, 90 F.3d 696, 710 (3d Cir.1996)).

In the securities fraud context, a complaint must plead the circumstances of the fraud with adequate particularity to place defendant on notice of the precise misconduct with which they are charged. Seville Industrial Machinery...

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