Goldman v. McMahan, Brafman, Morgan & Co.

• Decision Date: 08 February 1989
• Docket Number: No. 85 Civ. 2236 (PKL).,85 Civ. 2236 (PKL).
• Citation: 706 F. Supp. 256
• Parties: Irving GOLDMAN, Individually and doing business as Bridgehampton Estates; and S.I.B. Company, Plaintiffs, v. McMAHAN, BRAFMAN, MORGAN & CO., a New York Limited Partnership; D. Bruce McMahan, Milton Brafman, and Louis J. Morgan and Victor M. Wexler, Individually and as General Partners of McMahan, Brafman, Morgan & Co.; John G. Lane, Individually and as President of Gill & Duffus Securities, Inc.; and Gill & Duffus Securities, Inc., Defendants.
• Court: U.S. District Court — Southern District of New York

706 F. Supp. 256

Irving GOLDMAN, Individually and doing business as Bridgehampton Estates; and S.I.B. Company, Plaintiffs, v. McMAHAN, BRAFMAN, MORGAN & CO., a New York Limited Partnership; D. Bruce McMahan, Milton Brafman, and Louis J. Morgan and Victor M. Wexler, Individually and as General Partners of McMahan, Brafman, Morgan & Co.; John G. Lane, Individually and as President of Gill & Duffus Securities, Inc.; and Gill & Duffus Securities, Inc., Defendants.

No. 85 Civ. 2236 (PKL).

United States District Court, S.D. New York.

February 8, 1989.

Gold & Wachtel, New York City (William B. Wachtel, Elliot Silverman, Jose P. Sierra, of counsel), for plaintiffs.

Strook & Strook & Lavan, New York City (Marvin G. Pickholz, Andrew R. Kaplan, of counsel), for defendants.

OPINION AND ORDER

LEISURE, District Judge:

This action involves various claims arising from the sales of partnership interests in defendant McMahan, Brafman, Morgan & Co. ("MBM") in the early 1980's.

The matter is presently before the Court on a motion by the defendant accounting firm of Oppenheim, Appel, Dixon & Co. ("OAD"), to dismiss plaintiffs' amended complaint ("the Amended Complaint").

OAD, as well as other defendants, moved to dismiss that original complaint in this action.¹ This Court granted that motion in part and denied it in part, and granted plaintiffs² leave to amend their complaint to the extent consistent with the Court's opinion. Goldman v. McMahan, 1987 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 93,354 (S.D.N.Y.1987) 1987 WL 12820.

Plaintiffs subsequently filed their Amended Complaint on September 4, 1987. The present complaint retains the claims pursuant to RICO, §§ 10(b) and 20 of the 1934 Act, § 17(a) of the 1933 Act, New York General Business Law § 352-c and common law fraud. The claims pursuant to the Declaratory Judgment Act and Rule 20 of the 1934 Act, as well as the claim for breach of fiduciary duty, have been dropped against OAD, while a claim for malpractice has been added. In the present motion, OAD moves to dismiss all of plaintiffs' remaining claims against it.

On a motion to dismiss, the factual allegations of the complaint must be accepted as true, Dwyer v. Regan, 777 F.2d 825, 828-28 (2d Cir.1985), and the complaint must be construed in the light most favorable to the plaintiffs. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974). A complaint should not be dismissed for insufficiency unless the plaintiff would not be entitled to relief under any set of facts which might support the claims made. The question is not whether the plaintiff will prevail, but whether he is entitled to offer evidence to support the claims made. Id. at 236, 94 S.Ct. at 1686. See also, Bruce v. Martin, 691 F.Supp. 716, 721 (S.D.N.Y.1988).

1. SECTION 17(a) OF THE 1933 ACT.

Plaintiffs seek to impose liability on OAD, both as principals and as aiders and abettors, under § 17(a) of the 1933 Act. In its prior opinion, this Court did not dismiss plaintiffs' § 17(a) claim. However, consistent with recent and ever-increasing case authority, this Court has subsequently held that no private right of action exists under § 17(a). See generally, Yoder v. Orthomolecular Nutrition Institute, Inc., 751 F.2d 555, 559 n. 3 (2d Cir.1985) (Friendly, J.); Dubin v. E.F. Hutton Group, Inc., 695 F.Supp. 138 (S.D.N.Y.1988). Consequently, plaintiffs' claim under § 17(a) is dismissed.

2. SECTION 10(b) OF THE 1934 ACT AND RULE 10b-5.

Plaintiffs allege that OAD is liable to them, both as principals and as aiders and abettors, for violations of § 10(b) of the 1934 Act and Rule 10b-5 promulgated thereunder.

A. Principal Liability.

Defendants challenge the sufficiency of the Amended Complaint, by asserting that plaintiffs have failed to allege the requisite scienter element for a § 10(b) claim.

The Second Circuit has enunciated the essential elements of a § 10(b) and Rule 10b-5 claim:

A plaintiff must allege that, in connection with the purchase or sale of securities, the defendant, acting with scienter, made a false material representation or omitted to disclose material information and that plaintiffs' reliance on defendant's actions caused his injury.

Bloor v. Carro, Spanbock, Londin, Rodman & Fass, 754 F.2d. 57, 61 (2d Cir.1985) (citations omitted).

In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201, 96 S.Ct. 1375, 1385, 47 L.Ed. 2d 668 (1976), the Supreme Court established that the scienter element of a § 10(b) claim cannot be satisfied by a showing of mere negligence. However, in the Second Circuit, "proof of reckless conduct will generally satisfy the requirement of scienter in a Section 10(b) claim." In Re Investors Funding Corp. Sec. Litig., 523 F.Supp. 550, 558 (S.D.N.Y.1980) (emphasis added). Accord, Bozsi Ltd. Partnership v. Lynott, 676 F.Supp. 505, 511 (S.D.N.Y.1987). An egregious refusal to see the obvious, or to investigate the doubtful, may in some cases give rise to an inference of gross negligence which can be the functional equivalent of recklessness. Jordan v. Madison Leasing Co., 596 F.Supp. 707, 710 (S.D.N. Y.1984).

Plaintiffs' 10(b) claims for damages arise from purchases of securities in 1980 and 1981. Amended Complaint ¶¶ 95(a), 96, 107(a), 108. OAD had nothing to do with the activities involving the 1980 purchase of securities.³ Plaintiffs base their claim on the fact that financial statements prepared by OAD were incorporated into the 1981 offering. Amended Complaint ¶ 36. With regard to scienter, the Amended Complaint summarily states that OAD prepared these financial statements in a grossly negligent and reckless fashion (Amended Complaint ¶¶ 40, 141).

Fed.R.Civ.P. 9(b) mandates that fraud "be stated with particularity." Moreover,

although Rule 9(b) provides that intent and "other condition of mind" may be averred generally, plaintiffs must nonetheless provide some factual basis for conclusory allegations of intent. These factual allegations must give rise to a "strong inference" that the defendants possessed the requisite fraudulent intent.

Beck v. Manufacturers Hanover Trust Co., 820 F.2d 46, 50 (2d Cir.1987), cert. denied, ___ U.S. ___, 108 S.Ct. 698, 98 L.Ed.2d 650 (1988) (citations omitted). In its earlier opinion, this Court noted that plaintiffs had "failed to provide a sufficient basis for the inference that OAD committed fraud with respect to any of its activities prior to 1983." Goldman, 1987 Transfer Binder Fed.Sec.L.Rep. (CCH) ¶ 93,354 at 96,821. The Court directed plaintiffs to provide a more adequate factual basis for such an inference in their Amended Complaint.

Despite the Court's admonition, plaintiffs have not added any further factual basis for their allegations that OAD possessed the requisite scienter in preparing the financial statements used in connection with the 1981 offering. For example, plaintiffs allege that OAD "failed to properly audit McMahan, Brafman, Morgan & Co. ("MBM")'s books and records," and that "OAD should have, among other things, independently confirmed and verified that transactions through defendant Gill & Duffus Securities, Inc. were at arm's length and that MBM had actually put capital at risk in connection with such transactions." Amended Complaint, ¶¶ 40-41.

These allegations do not essentially alter the "boilerplate charges of recklessness and/or fraud" that this Court determined were insufficient in the original complaint. Goldman, 1987 Transfer Binder Fed.Sec. L.Rep. (CCH) ¶ 93,354 at 96,821. At most, the allegations could only support an inference that OAD might have acted negligently, and under no set of facts could these assertions give rise to the required inference of recklessness. While specific intent is not specifically required for Section 10(b) liability in this Circuit, Ernst & Ernst, 425 U.S. at 201, 96 S.Ct. at 1385, clearly mandates something more than mere negligence.

Absent a factual basis which gives rise to a strong inference of recklessness or gross negligence, plaintiffs' conclusory allegations of scienter fail to satisfy the particularity requirement of Rule 9(b). Consequently, plaintiffs' claim of primary liability under § 10(b) and Rule 10b-5 is dismissed as to OAD.⁴

B. Secondary Liability.

Plaintiffs further allege that OAD "had knowledge of and participated in the fraud perpetrated by MBM upon plaintiffs and is therefore secondarily liable as an aider and abettor of MBM's violations ..." Amended Complaint, ¶ 104.

The required elements of a claim predicated on aiding and abetting a securities law violation are also well established. As was stated in Bloor, supra, a plaintiff bringing an aiding and abetting claim must show:

(1) the existence of a securities law violation by the primary (as opposed to the aiding and abetting) party;

(2) "knowledge" of this violation on the part of the aider and abettor; and

(3) "substantial assistance" by the aider and abettor in the achievement of the primary violation.

Id. at 62. See also, IIT, Int'l Investors Trust v. Cornfeld, 619 F.2d 909, 922 (2d Cir.1980).

Additionally, when pleading such a claim, plaintiff must satisfy the particularity requirements of Rule 9(b). See Kirshner v. Goldberg, 506 F.Supp. 454, 458 (S.D. N.Y.1981), aff'd, 742 F.2d 1430 (2d Cir. 1983); Reingold v. Deloitte Haskins & Sells, 599 F.Supp. 1241, 1270 (S.D.N.Y. 1984).

The Supreme Court has not determined whether a reckless disregard of the facts is enough to satisfy the "knowledge" requirement of an aiding and abetting claim. See Ernst & Ernst, supra, 425 U.S. at 193-94 n. 12, 96 S.Ct. at 1381 n. 12. In the Second Circuit, recklessness has been found sufficient where "the alleged aider and abettor owes a fiduciary duty to the defrauded party." Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 44 (2d Cir.), cert. denied, 439 U.S. 1039, 99 S.Ct. 642, 58 L.Ed.2d 698 (1978).⁵ Whether, absent such a duty, recklessness could ever satisfy the scienter requirement has not been expressly decided in this...