Ouaknine v. MacFarlane

Decision Date26 February 1990
Docket NumberNo. 463,D,463
Citation897 F.2d 75
Parties, Fed. Sec. L. Rep. P 94,951, RICO Bus.Disp.Guide 7430 Elie OUAKNINE and Lockton Perry Corp., Plaintiffs-Appellants, v. Robert A. MacFARLANE, Perry West Associates, MacFarlane Perry Company, MacFarlane Development Company, Inc., and Ozzie Greenberg, Defendants-Appellees. ocket 89-7668.
CourtU.S. Court of Appeals — Second Circuit

Charles L. Rosenzweig (Geoffrey S. Pope, Rand Rosenzweig Smith & Radley New York City, of Counsel), for plaintiffs-appellants.

Dominick D'Alleva, New York City, for defendants-appellees.

Before OAKES, Chief Judge, PRATT, Circuit Judge, and SAND, District Judge for the Southern District of New York, sitting by designation.

GEORGE C. PRATT, Circuit Judge:

Plaintiffs Elie Ouaknine and Lockton Perry Corp. appeal from a judgment of the United States District Court for the Southern District of New York, John M. Cannella, Judge, that (1) dismissed securities fraud claims, a civil RICO claim under 18 U.S.C. Sec. 1962(c) premised on predicate acts of securities fraud, and a portion of a state-law claim based on fraud, all for failure to sufficiently plead fraud as required by Fed.R.Civ.P. 9(b); (2) dismissed a civil RICO claim under 18 U.S.C. Sec. 1962(a) for failure to state a claim because plaintiffs did not aver injury by reason of defendants' investment of racketeering income in the racketeering enterprise; and (3) dismissed state-law claims for lack of pendent jurisdiction. The two principal issues on appeal are (1) whether the complaint pled fraud with sufficient particularity to withstand dismissal and (2) whether, in order to state a civil RICO claim under 18 U.S.C. Sec. 1962(a), plaintiffs must allege injury in business or property by reason of defendants' investment of racketeering income in an enterprise.

We hold that fraud was pled with sufficient specificity with respect to some defendants, and that a civil RICO claim under Sec. 1962(a) must be premised on injury by means of defendants' investment of racketeering income. We therefore affirm in part, reverse in part, and remand for further proceedings.

I. BACKGROUND

On May 28, 1987, plaintiffs Ouaknine and Lockton Perry Corp. (collectively Ouaknine) filed a complaint against Michael Milea, Robert A. MacFarlane, Perry West Associates, the Lockton Corporation, MacFarlane Perry Company, MacFarlane Development Company, Inc., William Jarblum, and Ozzie Greenberg. Count one of the complaint charged all defendants with violating Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), and rule 10b-5, 17 C.F.R. Sec. 240.10b-5 promulgated thereunder. Count two charged all defendants with violating Sec. 17(a) of the Securities Act of 1933, 15 U.S.C. Sec. 77q(a). Count three charged all defendants with violating 18 U.S.C. Sec. 1962(a) and Sec. 1962(c) of the Racketeer Influenced and Corrupt Organizations Act (RICO). The underlying predicate acts of racketeering activity for the RICO claims were the securities fraud violations alleged in counts one and two, and wire and mail fraud claims that were related to the alleged securities fraud. The complaint also alleged pendent state-law claims against various defendants, including wasting of assets, breach of fiduciary duty, failure to provide required accounting, breach of contract, and conversion.

According to the original complaint these violations arose during the course of three transactions: (1) Ouaknine's $500,000 subscription for stock in Lockton Perry Corp. (Lockton Perry), a corporation created for the purpose of investing in a project to rehabilitate and sell cooperative apartments in New York City (the Perry Street project); (2) defendants' procurement of Ouaknine's assent to the sale of all stock of a second corporation, MacFarlane 95th Street Development Corp. (MacFarlane 95th), by false assurances that Ouaknine's $575,000 capital investment in MacFarlane 95th would be repaid in full from the first proceeds of the stock sale; and (3) false representations made by defendants to induce Ouaknine's acceptance, in lieu of cash, of a nonrecourse promissory note secured only by shares in Lockton Perry.

Defendants Milea, Lockton Corporation, and Jarblum moved to dismiss the securities fraud counts, the RICO claims based on securities fraud, and a portion of a common law claim, for failure to particularize fraud as required by rule 9(b); they also moved for a more definite statement under Fed.R.Civ.P. 12(e). By order dated June 17, 1988, the district court dismissed all counts premised on fraud for failure to adequately particularize fraud and also granted the motion for a more definite statement with respect to two state-law claims.

On July 25, 1988, Ouaknine served an amended complaint, which is the subject of this appeal. By judgment dated June 15, 1989, Judge Cannella again dismissed all claims alleging fraud for failure to satisfy the pleading requirements of rule 9(b). For the purpose of determining whether fraud was pled sufficiently, we assume the truth of plaintiffs' allegations. DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1244 (2d Cir.1987); Luce v. Edelstein, 802 F.2d 49, 52 (2d Cir.1986).

A. Perry Street Project

On May 25, 1984, Milea, Jarblum, and MacFarlane solicited Ouaknine to subscribe, for the sum of $500,000, to fifty percent of the common stock of Lockton Perry, a corporation formed as a vehicle for investment in Perry West Associates (Perry West). Perry West is a partnership between Lockton Perry and defendant MacFarlane Perry Company (MacFarlane Perry). Perry West was formed to own, renovate, and sell cooperative apartments located at 155-59 Perry Street in New York City. Ouaknine's $500,000 investment was to be Lockton Perry's sole cash contribution to the Perry Street project.

To induce his investment in Lockton Perry stock, Milea, on behalf of Jarblum, MacFarlane, Perry West, and MacFarlane Perry, gave Ouaknine an offering memorandum which contained false representations. Among other representations, the offering memorandum set forth a total construction cost of $2,137,000 for the completed project, a sellout date of September 1, 1985, and a projected profit of approximately $2,495,000. None of these objectives was realized.

To further induce Ouaknine's subscription to Lockton Perry stock, Jarblum and Milea also gave Ouaknine the Perry West partnership agreement which provided that Perry West would enter into a construction contract with MacFarlane Development, an affiliate of MacFarlane and MacFarlane Perry, substantially in accord with previous projections. Section 10 of the partnership agreement provided that Perry West would (1) keep full and true books of account; (2) make its books and records available to Ouaknine; and (3) require its accountant to prepare timely annual reports and tax statements. In reliance on these representations, Ouaknine subscribed to fifty percent of the Lockton Perry stock. He then transferred ten percent of his interest to one Gladys Bagley. Ouaknine also entered a shareholders agreement that made Milea chief executive of Lockton Perry and permitted Milea to name two of the corporation's three directors, thereby giving him control of the corporation. Finally, the amended complaint alleged upon information and belief that the representations made in the offering memorandum and partnership agreement were false and misleading and were known by the various defendants to be false and misleading when made.

B. MacFarlane 95th Project

On or about September 18, 1984, Ouaknine, upon the solicitation of Milea and MacFarlane, purchased for $575,000 a twenty-five percent beneficial interest in MacFarlane 95th and in a contract MacFarlane 95th had to purchase the Knickerbocker Hotel in Manhattan, New York. Ouaknine again transferred a portion of his interest in MacFarlane 95th to Bagley. On or about November 7, 1984, MacFarlane, Milea, and Greenberg, an accountant working for MacFarlane, representing themselves as the sole owners of MacFarlane 95th, entered into an agreement for the sale of the stock of MacFarlane 95th for $3,218,000. The purchase price was payable as follows: (1) $500,000 to MacFarlane, Milea, and Greenberg upon execution of the stock purchase agreement; (2) $650,000 to the sellers' law firm, Jarblum Solomon & Fornari, P.C., to be paid on or before December 3, 1984; and (3) the balance to the sellers at closing. On or about December 21, 1984, the stock purchase agreement was amended to reflect, among other changes, a change in the buyer and an increase in the purchase price.

To induce Ouaknine's consent to this agreement, MacFarlane, Milea, Jarblum, and Greenberg represented that Ouaknine's and Bagley's $575,000 investment would be returned from the first proceeds on the closing of the stock purchase agreement. Although $1,162,000 was available for distribution at closing, none of those proceeds were delivered to Ouaknine because, according to the complaint, they were diverted to another project involving MacFarlane and Milea. Milea offered Ouaknine instead, $212,500 in cash and the balance of $212,500 by promissory note secured by shares of Milea's Lockton Perry stock; he also promised a full accounting of the sale of the shares of MacFarlane 95th.

C. Nonrecourse Note

The proposal to accept a nonrecourse note in lieu of cash formed the basis of the final fraudulent transaction alleged by Ouaknine. According to the amended complaint, to induce Ouaknine's acceptance of a note backed by Lockton Perry stock in lieu of cash, Milea represented that the Perry Street project was progressing as forecast and the Lockton Perry stock was worth far more than the promissory note amount of $212,500. Ouaknine thereafter asked Jarblum, MacFarlane, Greenberg, and Perry West about the financial status of Lockton Perry and the Perry Street project and all of them represented that the project was...

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