Spatz v. Borenstein
| Decision Date | 01 May 1981 |
| Docket Number | No. 76 C 4477.,76 C 4477. |
| Citation | 513 F. Supp. 571 |
| Parties | David SPATZ and Charles Janda, Plaintiffs, v. Joseph BORENSTEIN and Stanley Melnick, Defendants. |
| Court | U.S. District Court — Northern District of Illinois |
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Michael K. Wolf, Michael A. Weinberg, Levy & Erens, Michael G. Erens, Kamensky & Landan, Chicago, Ill., for plaintiffs.
Margaret Maxwell, Hubachek & Kelly Ltd., Chicago, Ill., for defendant Borenstein.
Richard M. Kates, Chicago, Ill., for defendant Melnick.
Plaintiffs David Spatz ("Spatz") and Charles A. Janda ("Janda") have moved for summary judgment on Counts III through VI in this action alleging violations of § 12(2) and § 17(a) of the Securities Act of 1933, 15 U.S.C. §§ 77a-77aa (the "Securities Act"), § 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. §§ 78a-78hh (the "Exchange Act"), Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5, and § 12 of the Illinois Securities Law of 1953, Ill.Rev.Stat. ch. 121½, § 137.1 et seq., by defendants Joseph Borenstein ("Borenstein") and Stanley Melnick ("Melnick"). Plaintiffs also seek summary disposition against Borenstein for alleged breach of fiduciary duty.1 The court has examined the pleadings, discovery and affidavits submitted in conjunction with the joint motion. This review indicates that although genuine issues of fact remain with respect to certain discrete issues in the action, a great majority of questions are amenable to resolution as a matter of law. And on the basis of these matters plaintiffs have established violations of the securities laws. Accordingly, summary judgment is granted in favor of plaintiffs against Borenstein and denied against Melnick.
The instant dispute concerns the sale of limited partnership interests by defendant Borenstein to Spatz and Janda. The sale of the partnership interests was part of a more complicated three-tiered transaction, the underlying purpose of which was to acquire an interest in an apartment complex known as Laurel Glen Apartments (the "Apartments" or the "Property"), located in State College, Pennsylvania.
The apartment complex was constructed in 1973 and upon its completion was managed by its owner, Laurel Glen, Inc. ("L. G., Inc."). The property was originally financed by securing first and second mortgages, the latter with the National Union Fire Insurance Company ("National Union"). During late 1974, L. G., Inc. defaulted on the first mortgage. In order to protect its interests, National Union cured these defaults and took possession of the property under the terms of the second deed of trust.
In April, 1975, defendant Melnick assumed management of the apartments from, and at the request of, National Union.2 In accordance with Melnick's stated desire to acquire an equity interest in the property, National Union contacted defendant Borenstein with a view toward putting together a syndicate of investors to acquire the apartment complex.3 As a result of discussions between Borenstein, Melnick and National Union, an arrangement for acquiring the property was conceived in the fall of 1975.
In basic part, the contemplated transaction was structured as follows: Borenstein would organize and become the sole General Partner of an Illinois limited partnership to be called Laurel Glen, Ltd. ("Limited"). The 595 units in Limited would then be offered for sale to investors at a price of one thousand dollars per unit. When and if the offering of units was fully subscribed, Limited and Melnick would each purchase fifty per cent interests in, and become sole General Partners of, a general partnership to be known as Laurel Properties ("Laurel Properties").
At the same time, Melnick, through U. S. Management, would acquire all of the stock of L. G., Inc., which still held legal title to the property. Laurel Properties would purchase the property from L. G., Inc. pursuant to a document entitled Articles of Agreement for Warranty Deed (the "Agreement"). Finally, Laurel Properties would lease the apartment complex to L. G., Inc. and Melnick personally, for a period of three years. As security for performance of its obligations as lessee, L. G., Inc. agreed to pledge all of its stock to Laurel Properties.
To implement the deal, Borenstein sent plaintiffs copies of a document entitled "Laurel Glen, Ltd. Private Placement Memorandum," dated October 15, 1975 (the "Prospectus"). On the basis of this document, Spatz and Janda purchased 102 and 100 units in Limited. When the offering of Limited's units was fully subscribed, the remainder of the transaction described above was effected.
As is often the case in deals that end in litigation, the expectations of Limited's investors were not satisfactorily fulfilled. The results, in this instance, are Spatz' and Janda's claims of securities fraud based on what they allege to be certain material misrepresentations in the Prospectus and other material omissions which induced them to invest in the deal. In opposition to the joint motion for summary judgment, Borenstein and Melnick resist the conclusion that any misrepresentations or omissions existed, or, if they did, defendants deny that they were material.
Initially, defendant Borenstein has raised two "blanket" defenses. First, he claims that no private right of action exists under § 17(a) of the Securities Act. However, at least in this circuit, this issue already has been decided adversely to him. Lincoln National Bank v. Herber, 604 F.2d 1038, 1040 n.2 (7th Cir. 1979); Daniel v. International Brotherhood of Teamsters, etc., 561 F.2d 1223, 1244-1246 (7th Cir. 1977), reversed on other grounds sub nom. International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 99 S.Ct. 790, 58 L.Ed.2d 808 (1979); Schaefer v. First National Bank of Lincolnwood, 509 F.2d 1287 (7th Cir. 1975).4
Defendant's second preliminary defense is no more viable than his first. Borenstein claims that a genuine issue of fact exists as to whether the sale of the limited partnership interests in Laurel Glen, Ltd. qualified for the private placement exemption of § 77d(2). If so, Borenstein argues, then the anti-fraud provisions of the 1933 and 1934 Acts, § 12(2), § 17(a) and 10(b) respectively, are inapplicable to the transaction at issue.
Several courts have addressed this issue head-on, holding that the private placement exemption does not diminish the force or reach of the anti-fraud provisions of the securities laws. Ballard & Cordell Corp. v. Zoller & Danneberg Exploration, Ltd., 544 F.2d 1059, 1064 (10th Cir. 1976); Nor-Tex Agencies, Inc. v. Jones, 482 F.2d 1093 (5th Cir. 1973); Sohns v. Dahl, 392 F.Supp. 1208 (W.D.Va.1975). And although the Seventh Circuit has not considered the issue in the specific context of the exemption in § 4(2), in the Daniel case, supra, the court did hold that employee pension funds, exempted from the registration requirements of § 5 of the 1933 Act, 15 U.S.C. § 77e, by § 3(a)(2)(A) of the same statute, 15 U.S.C. § 77c(a)(2)(A), were still subject to the constraints imposed by sections 17(a), 10(b) and Rule 10b-5.
The presence of a different exemption here does not suggest a result different from that reached in Daniel. The language of the anti-fraud provisions specifically encompass registered and unregistered securities.5 Moreover, the conclusion reached herein is consistent with the Supreme Court's well-worn admonition that the securities laws should be enforced "flexibly to effectuate ... their remedial purposes." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195, 84 S.Ct. 275, 284, 11 L.Ed.2d 237 (1963).6
As a final "preliminary" matter, since the contours of securities law have changed rather dramatically in the recent past, it is helpful briefly to sketch the elements of plaintiffs' case on summary judgment. Spatz and Janda rely on several provisions of the federal securities laws here, and the elements of each claim vary significantly. Count III alleges a violation of § 12(2)7 of the Securities Act. The elements of such a violation were set out in Sanders v. John Nuveen & Co., Inc., 619 F.2d 1222 (7th Cir. 1980), where the Seventh Circuit reasoned that liability attaches to one who offers or sells a security8 by means of a prospectus which includes "an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements ... not misleading. ..", without proof of reliance or scienter.
In contrast to § 12(2), it is well-established that to establish a violation of § 10(b) of the Exchange Act, proof of scienter and reliance, as well as material misrepresentations or omissions, is required. See, Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); TSC Industries, Inc. v. Northway, 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1977); Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977).
The elements of a violation of § 17(a) of the Securities Act have never been delineated as clearly as those for § 10(b). This is hardly surprising in view of the fact that these two provisions are largely complementary, and because plaintiffs have often "boot-strapped" § 17(a) allegations to their 10b-5 claims. Until recently, the elements of proof for the two sections were regarded as identical. However, the Supreme Court in Aaron v. Securities Exchange Commission, 446 U.S. 680, 100 S.Ct. 1945, 64 L.Ed.2d 611 (1980), recently held that, although scienter is an element required by § 17(a)(1), the language of §§ 17(a)(2) and 17(a)(3) requires only negligence to complete the violation.9
Given the legal context set out above, the question addressed to the court is whether plaintiffs have established that no...
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