Farlow v. Peat, Marwick, Mitchell & Co.

• Decision Date: 13 February 1992
• Docket Number: No. 89-6310,89-6310
• Citation: 956 F.2d 982
• Parties: Fed. Sec. L. Rep. P 96,536, 22 Fed.R.Serv.3d 101, RICO Bus.Disp.Guide 7935 David FARLOW, et al., Plaintiffs-Appellants, v. PEAT, MARWICK, MITCHELL & CO., Defendant-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 982

956 F.2d 982

Fed. Sec. L. Rep. P 96,536, 22 Fed.R.Serv.3d 101,

RICO Bus.Disp.Guide 7935

David FARLOW, et al., Plaintiffs-Appellants, v. PEAT, MARWICK, MITCHELL & CO., Defendant-Appellee.

No. 89-6310.

United States Court of Appeals, Tenth Circuit Feb. 13, 1992.

Michael J. Freed of Much Shelist Freed Denenberg Ament & Eiger, Chicago, Ill. (Anthony C. Valiulis, Stewart M. Weltman, Christopher J. Stuart, Much Shelist Freed Denenberg Ament & Eiger, P.C., Chicago, Ill., Ronald E. Stakem, Clark, Stakem, Pherigo & Douglas, Oklahoma City, Okl., Roger B. Greenberg, Richie & Greenberg, Houston, Tex., Jack S. Dawson, Janice M. Dansby, Miller, Dollarhide, Dawson & Shaw, Oklahoma City, Okl., with him on the briefs) for plaintiffs-appellants.

Jeffrey R. Tone of Sidley & Austin, Chicago, Ill. (J. William Conger, James C. Prince, Hartzog Conger Cason & Hargis, Oklahoma City, Okl., of counsel, Robert D. McLean, Frank B. Vanker, Sidley & Austin, Chicago, Ill., Leonard P. Novello, General Counsel, Anthony J. Costantini, Associate General Counsel, KPMG Peat Marwick, New York City, with him on the brief), for defendant-appellee.

Before McKAY and MOORE, Circuit Judges, and BROWN, Senior District Judge. ^*

WESLEY E. BROWN, Senior District Judge.

This appeal arises from plaintiff-appellants' complaint against defendant-appellee accounting firm, Peat, Marwick, Mitchell & Company (hereafter Peat Marwick), and other defendants, based upon the offer and sale of interests in over fifty limited partnerships by Patrick Powers, and his related entities during a period of August, 1979 until March 4, 1986, the date on which plaintiffs' original complaint was filed. ¹

Patrick Powers and his company, Pepco, Inc., were never named as defendants in the action. As the case has progressed through the district court to this appeal, Peat Marwick became the sole defendant appellant before us, and all issues on appeal are limited to questions of the effectiveness of plaintiffs' Second Amended Complaint, as it relates to Peat Marwick. In particular, our review is limited to the question of the sufficiency of that complaint in connection with the elements of a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) and Securities and Exchange Commission Rule 10b-5, 17 C.F.R. 240-10b-5, and whether plaintiffs have pled a claim under the Racketeer Influenced and Corrupt Organizations Act (RICO) 18 U.S.C. Sec. 1961 et seq. ²

On December 10, 1986, Judge Russell of the district court found that plaintiffs' Amended Complaint failed to plead Section 10b fraud with particularity since plaintiffs had failed to specify those plaintiffs who had dealt directly with Peat Marwick, and the names of those persons from whom plaintiffs had purchased interests, and had failed to specify the occasions on which alleged misrepresentations were made, and how they were directed to plaintiffs. Plaintiffs' allegations of RICO violations were likewise found to be lacking in specifics, and all claims against Peat Marwick in the Amended Complaint were dismissed, without prejudice. Plaintiffs were granted leave to amend their complaint and to comply with an attached order specifying the allegations necessary to establish a RICO claim. ³

On January 12, 1987, plaintiffs filed their Second Amended Complaint. Upon motion of Peat Marwick, Judge Phillips ⁴ dismissed this Second Amended Complaint, with prejudice, upon a finding that plaintiffs had failed to state a claim under Section 10(b) of the Securities Exchange Act and had failed to comply with Judge Russell's prior order requiring plaintiffs to comply with Rule 9(b), Federal Rules of Civil Procedure, by giving specific details of the alleged RICO violations. Farlow v. Peat Marwick Mitchell & Co., 666 F.Supp. 1500 (W.D.Okl.1987). ⁵

Just prior to the second dismissal of their complaint, plaintiffs filed a Motion for Leave to File Amendment to the Second Amended Complaint. Leave to amend, and a Motion to Reconsider the order of dismissal were denied. (Vol. I, Record Docs. 127, 147, 163.)

For the reasons hereafter discussed, we find that plaintiffs claims were properly dismissed with prejudice and that the denial of leave to amend was not an abuse of discretion.

In the Second Amended Complaint, which was filed in response to Judge Russell's dismissal without prejudice, plaintiffs claimed that Pepco and its president, Powers, defrauded investors in 58 limited partnerships offered between 1979 and 1983 by making numerous misrepresentations in partnership offering memoranda and other materials while the property partnerships were "worthless shells," without value. ⁶

Plaintiffs claim that Peat Marwick became "involved in the fraud" on April 1, 1981, when it agreed to certify Pepco's financial statements, which it knew to be "materially false and inaccurate." Peat Marwick audited and certified Pepco interim statements as of April 30, 1981, and year-end statements for 1981, 1982, and 1983. ⁷

Without mentioning any specific financial statement, plaintiffs alleged that Peat Marwick knew that the statements grossly inflated assets and net worth, that the firm failed to disclose contingent liabilities arising from securities violations, concealed the fact that operations were "financially unsound," and improperly used the equity method of accounting to reflect Pepco's relationship to the limited partnerships.

The only specific allegations of misrepresentations in statements were for those of December 31, 1982 and 1983, wherein plaintiffs claim that Peat Marwick failed to reveal that assets consisted of "unsecured and worthless" notes receivable and investments in Powers' business entities. It is also alleged that these statements failed to disclose that Powers owed money to his corporation and that he inflated the value of Pepco assets.

The complaint fails to make any specific allegation that Peat Marwick participated in Powers' misrepresentations--the claim is that Peat Marwick knew "at the time PMM certified" the Pepco statements that Powers intended to provide them to prospective investors. However in this respect, the only particular partnership memorandum alleged to include Pepco financial statements was the memo for the Southroads Mall Village partnership, which contained only the statement for December 31, 1981. Some newsletters (not identified) were sent to investors (not identified) after they had invested and the complaint alleges that a July 12, 1982, newsletter included a financial statement for year-end 1981. It is claimed that these newsletters "induced" future investments, but no specific facts are provided concerning what these future investments might have been, who made them, or what newsletters contained information concerning these investments. The complaint charges that Powers, with Peat Marwick's knowledge and consent, sent copies of financial reports to prospective investors; but, again, no facts are alleged indicating which financial statements were sent to whom or in what context.

In the December 10, 1986 dismissal order, Judge Russell ruled that plaintiffs must specify which financial statements appeared in which offering circular and what was fraudulent about those statements. In the Second Amended Complaint, plaintiffs identified only one offering circular, for Southroads Mall Village, which contained Pepco financial statements, but they did not allege any specific problem with those financial statements. Judge Phillips found that the redrafted allegations of the Second Amended Complaint did not satisfy the requirements of Rule 9(b) and dismissed the complaint with prejudice. In particular it was noted that plaintiffs claimed defects in only the 1982 and 1983 statements but not with respect to any 1981 statement.

Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. Sec. 78j(b) provides that it is unlawful:

To use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Rule 10b(5), 17 C.F.R. 240-10b-5, covering the "Employment of manipulative and deceptive devices," provides in pertinent part 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 any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

The provisions of Section 10(b), Rule 10b-5, are to be "read flexibly, not technically and restrictively." Windon Third Oil and Gas v. Federal Deposit Ins., 805 F.2d 342, 346 (10th Cir.1986), cert. denied 480 U.S. 947, 107 S.Ct. 1605, 94 L.Ed.2d 791.

An action for damages under Section 10(b) may not be maintained in the absence of allegations of fraud, with intent to deceive, manipulate or defraud on the part of the defendant. An element of scienter must be present, and liability may not be imposed for simple negligent conduct. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668, rehearing denied, 425 U.S. 986, 96 S.Ct. 2194, 48 L.Ed.2d 811 (1976).

In order to establish primary liability under Section 10(b), a party must allege and prove facts showing that the conduct complained of occurred "in connection with" the purchase or sale of a security--that the actor made an untrue statement of a material fact, or failed to state a material fact, that in...