Farlow v. Peat Marwick Mitchell & Co.

• Decision Date: 20 July 1987
• Docket Number: No. CIV 86-0487-P.,CIV 86-0487-P.
• Citation: 666 F. Supp. 1500
• Court: U.S. District Court — Western District of Oklahoma
• Parties: David FARLOW, Jack R. Frymire, David Frymire, Richard A. Frymire, Kathleen Frymire-Brinati, Harvey Jaunich, David Fisher, and K & D Partnership, on behalf of themselves and all others similarly situated, Plaintiffs, v. PEAT MARWICK MITCHELL & CO.; Westinghouse Credit Corporation; and Marsha Powers, Defendants.

666 F. Supp. 1500

David FARLOW, Jack R. Frymire, David Frymire, Richard A. Frymire, Kathleen Frymire-Brinati, Harvey Jaunich, David Fisher, and K & D Partnership, on behalf of themselves and all others similarly situated, Plaintiffs, v. PEAT MARWICK MITCHELL & CO.; Westinghouse Credit Corporation; and Marsha Powers, Defendants.

No. CIV 86-0487-P.

United States District Court, W.D. Oklahoma.

July 20, 1987.

COPYRIGHT MATERIAL OMITTED

Stuart Weltman, Chicago, Ill., and Ronald E. Stakem, Oklahoma City, Okl., for plaintiffs.

William Conger, Oklahoma City, Okl., for defendant Peat Marwick Mitchell.

William L. Peterson, Oklahoma City, Okl., for defendant Westinghouse Credit.

James S. Matthews, Jr., Oklahoma City, Okl., for defendant Phillip Kidd, III.

ORDER GRANTING IN PART AND DENYING IN PART MOTIONS TO DISMISS

PHILLIPS, District Judge.

I. BACKGROUND

This matter comes before the Court upon defendants Peat Marwick Mitchell and Westinghouse's Motions to Dismiss plaintiffs' Second Amended Complaint against them pursuant to Rules 9(b), 12(b)(1), and 12(b)(6) of the Federal Rules of Civil Procedure. Portions of plaintiffs' original Complaint and Amended Complaint were dismissed without prejudice with leave to amend by the previous judge assigned to this matter due primarily to plaintiffs' failure to plead their fraud claims with particularity under Rule 9(b), Fed.R.Civ.P. See Order, CIV-86-487-R (W.D.Okla. December 10, 1986). For the reasons hereinafter set forth, the motions to dismiss plaintiffs' Second Amended Complaint are GRANTED in part and DENIED in part.

Plaintiffs bring this action pursuant to the Racketeer Influenced and Corrupt Organization Act ("RICO"), 18, U.S.C. § 1961 et seq; § 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l(2); § 17(a) of that Act, 15 U.S.C. § 77q(a); § 10(b) of the 1934 Securities Exchange Act, 15 U.S.C. § 78j(b) and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. 240.10b-5; 71 O.S. § 408; and common law fraud.

When a motion to dismiss is before the Court, under Rule 12(b)(6), the factual allegations of the complaint must be taken as true and all reasonable inferences from them must be indulged in favor of the complainant. Mitchell v. King, 537 F.2d 385, 386 (10th Cir.1976). A complaint should not be dismissed unless it appears beyond doubt that plaintiff can prove no set of facts in support of his claim which would entitle him to relief. Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 101-02, 2 L.Ed.2d 80 (1957). Further, the complaint should not be dismissed merely because plaintiffs' allegations do not support a stated legal theory, for the Court is obligated to determine whether the allegations support relief on any possible theory. See Perington Wholesale, Inc. v. Burger King Corp., 631 F.2d 1369 (10th Cir.1980).

Plaintiffs allege that sometime prior to 1980, Patrick E. Powers, Jr. ("Powers"), who is not a named defendant herein, devised a "ponzi" type scheme to fraudulently obtain funds for himself and others through the sale of limited partnerships, notes, commercial paper and other forms of indebtedness alleged to be securities. Powers, Pepco, Inc., and the related entities are alleged to have accomplished their fraudulent scheme by misrepresenting that funds invested in the limited partnerships would be used to purchase real estate and to preserve and increase the investors' capital investment (¶¶ 22-24),¹ when in reality these investment properties were financially unsound. (¶¶ 25-28). According to the Second Amended Complaint, the scheme also involved the forming of Pepco as a clearinghouse for Powers' commingling and misuse of investor funds (¶ 34); loaning, without documentation, the investors' capital contributions to Pepco in return for worthless unsecured promissory notes (¶ 34) and using said capital contributions to support the failing properties and embezzle or waste the difference (¶¶ 35-38); nondisclosure and misrepresentation of the risks associated with this investment scheme (¶¶ 39-41) and failure to file Certificates of Limited Partnership with the Secretary of State of Oklahoma thereby exposing investors to greater liability.

Defendant Peat Marwick is alleged to have certified without qualification the following financial statements of Pepco: (1) interim statement as of April 30, 1981 (issued May 8, 1981); (2) statement for year ending December 31, 1981; (3) statement for year ending December 31, 1982; (4) statement for year ending December 31, 1983; and (5) statement for Pepco Development, Inc., for year ending December 31, 1981. Plaintiff alleges further that Peat Marwick knew at the time it certified these financial statements that Powers was orchestrating the above referenced fraudulent scheme and the complaint itemizes the facts which Peat Marwick allegedly knew when it certified the stated financial statements (¶¶ 46-47 and 50-56). However, plaintiff only alleges specific items which were undisclosed in the December 31, 1982, and December 31, 1983, financial statements of Pepco certified by Peat Marwick.

In an effort to comply with Judge Russell's Order of December 10, 1986, dismissing with leave to amend plaintiffs' complaint for failure to comply with Rule 9(b), Fed.R.Civ.P., plaintiffs next attempt to allege direct "misrepresentations" and omissions made by Peat Marwick to the named plaintiffs and class members. (¶ 57-61). Of these allegations, the only specific occasion where a financial statement certified by Peat Marwick is alleged to have been included in an offering memorandum was the Southroads Mall Village, Ltd., offering with the December 31, 1981 financial statement for which no specific allegations of impropriety have been made. However, plaintiff alleges inclusion of financial statements in "some of the offering memoranda" sent to investors while others were hand delivered by Powers. (¶¶ 76-77). Plaintiffs claim that had the investors known the financial statements delivered to them with Peat Marwick's knowledge and consent were false, they would not have purchased their units. (¶¶ 78-81).

In a further attempt to comply with Judge Russell's Order of particularity under Rule 9(b), plaintiffs list some specific purchases of named plaintiffs. (¶¶ 82-93). These generally contain the plaintiff's name, the amount he or she invested, what he or she invested in, and that the plaintiff "received personally from Powers or through the mails," the particular offering memorandum and "the then-most-recent PMM certified Pepco financial statement." Id. Each and every one of these paragraphs ends with the allegation: "In making his (her) purchase, (plaintiff) relied upon the representations contained in the offering memorandum and financial statement."

Defendant Westinghouse is alleged to have extended credit in excess of $10,000,000.00 to Powers and Pepco in the Fall of 1982, knowing Powers and Pepco were currently violating securities laws. (¶¶ 62-63). In addition, Westinghouse is alleged to have "aided Powers' cover-up of prior frauds by keeping the true financial picture of Pepco operations from the then-current investors." (¶ 66). Plaintiffs' allegations as to Westinghouse's knowledge of Powers' scheme are sufficiently pled for Rule 9(b) purposes. However, as detailed below, this does not end this Court's inquiry.

II. PLAINTIFFS' SECTION 12(2) CLAIMS (COUNT IV)

Section 12(2) of the Securities Act imposes liability on "any person who offers or sells a security" by means of a prospectus or oral communication "which includes an untrue statement of material fact or omits to state a material fact necessary in order to make the statements not misleading." As stated in Judge Russell's December 10, 1986 Order, the Tenth Circuit has not defined "seller" for Section 12(2) purposes. This district has, however, previously adopted the definition of "seller" under Section 12(2) formulated by the Fifth Circuit. Resler v. Financial Group, Inc., 668 F.Supp. 1454 (W.D.Okla. 1985); Croes v. Rotan Mosle, Inc., Civ-82-1247-W (W.D. Okla. Feb. 14, 1983). According to this definition, a person may be considered a seller under Section 12(2) if (1) he is in privity with the purchaser or (2) his participation in the buy-sell transaction is a substantial factor in causing the transaction to take place. Pharo v. Smith, 621 F.2d 656, 667 (5th Cir.1980).

The "substantial factor" test relates exclusively to primary liability under Section 12(2). Rather than an adoption of secondary liability under Section 12(2), the "substantial factor" test is simply an expansion of the term "seller." Initially, it is not entirely clear to this Court from plaintiffs' Complaint and briefs whether they are alleging primary liability under Section 12(2) (substantial factor) or secondary liability (aiding and abetting or conspiracy). In its earlier Order of dismissal, Judge Russell noted that plaintiffs were claiming they had not alleged a primary violation of Section 12(2) but rather that Peat Marwick was liable as an aider, abettor or co-conspirator. Order of December 10, 1986 at 10. Plaintiffs once again allege they have stated a claim against Peat Marwick for its conspiracy with, or aiding and abetting of, Powers' primary securities violations and mail fraud. However, they also allege Peat Marwick was a substantial factor in the subject sales, which is a concept of primary liability. (¶ 97). For these reasons, the Court will analyze plaintiffs' Section 12(2) claims under both primary and secondary theories of liability.

Plaintiffs make no allegation that Peat Marwick was a direct seller in privity with plaintiffs, thus, plaintiffs' Section 12(2) claim of primary liability must stand or fall on the substantial factor test of Pharo v. Smith.

In ¶ 97 of Count IV of the Second Amended Complaint (Section 12(2) claims), the following allegation is telling in this analysis:

PMM was a substantial factor in the sale of these securities to class members because, but

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