Schatz v. Rosenberg

• Decision Date: 09 October 1991
• Docket Number: No. 90-1889,90-1889
• Citation: 943 F.2d 485
• Parties: , 60 USLW 2171, Fed. Sec. L. Rep. P 96,222 Ivan N. SCHATZ; Joann B. Schatz, Plaintiffs-Appellants, v. Mark E. ROSENBERG; MER Enterprises, Incorporated; Stephen Jaeger; Weinberg & Green, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 485

943 F.2d 485

112 A.L.R.Fed. 743, 60 USLW 2171, Fed.

Sec. L. Rep. P 96,222

Ivan N. SCHATZ; Joann B. Schatz, Plaintiffs-Appellants, v. Mark E. ROSENBERG; MER Enterprises, Incorporated; Stephen

Jaeger; Weinberg & Green, Defendants-Appellees.

No. 90-1889.

United States Court of Appeals, Fourth Circuit.

Argued May 8, 1991.

Decided Aug. 26, 1991.

As Amended Oct. 9, 1991.

Carlos Marco Recio, Casson, Harkins & Greenberg, Washington, D.C., argued (Robert E. Greenberg, Michael F. Moses, Casson, Harkins & Greenberg, on the brief), for plaintiffs-appellants.

Nancy F. Preiss, Williams & Connolly, Washington, D.C., argued (Brendan V. Sullivan, Jr., Michael S. Sundermeyer, Leigh A. Kenny, Williams & Connolly, on the brief), for defendants-appellees.

Before WILKINSON, Circuit Judge, CHAPMAN, Senior Circuit Judge, and HILTON, District Judge for the Eastern District of Virginia, sitting by designation.

OPINION

CHAPMAN, Senior Circuit Judge:

Plaintiffs/appellants Ivan and Joanne Schatz sued defendants Mark E. Rosenberg, MER Enterprises ("MER") and the law firm of Weinberg & Green alleging RICO violations, fraud and securities laws violations. The district judge referred the case to a magistrate judge who recommended that five counts of the seven count complaint be dismissed for failure to state a claim upon which relief can be granted. The district judge agreed and dismissed these five counts under Federal Rule of Civil Procedure 12(b)(6). Three of these counts involved Weinberg & Green. In this appeal, plaintiffs only challenge the dismissal of the three counts against Weinberg & Green. ¹

I.

On December 31, 1986, MER purchased an eighty percent (80%) interest in two companies the plaintiffs owned, Virginia Adjustable Bed Manufacturing Corporation ("VAMCO") and Advanced Bed Concepts ("ABC"). MER is a holding company which Mark Rosenberg created to purchase the VAMCO and ABC stock. As payment for their eighty percent (80%) interests in VAMCO and ABC, Mr. and Mrs. Schatz received $1.5 million in promissory notes issued by MER, which Rosenberg personally guaranteed. The plaintiffs relied on a financial statement dated March 31, 1986 and an update letter delivered at closing on December 31, 1986 which indicated that Rosenberg's net worth exceeded $7 million. These financial documents contained several misrepresentations obscuring the fact that Rosenberg's financial empire had crumbled between April and December of 1986. Rosenberg's largest business, Yale Sportswear Corporation ("Yale"), filed for bankruptcy in September 1987, and Rosenberg filed for personal bankruptcy thereafter. The law firm of Weinberg & Green represented Rosenberg and his entities throughout this period.

The plaintiffs never received payment on their promissory notes and lost an additional $150,000 when they made a "bridge loan" to BBC, the company which was formed when VAMCO and ABC merged with the Back Center, Inc. ("BCI"), another of Rosenberg's companies. To add insult to injury, Rosenberg paid Weinberg & Green's legal fees for the transaction out of VAMCO and ABC's cash reserves. Rosenberg siphoned off operating capital from VAMCO and ABC to prop up Yale. By the time Rosenberg and Yale filed for bankruptcy, VAMCO and ABC were essentially worthless, and plaintiffs had no control over the businesses. Thereafter, plaintiffs filed a seven-count complaint asserting: a violation of the Racketeer Influence and Corrupt Organizations Act ("RICO") against defendants Rosenberg and Jaeger (Count I), violations of section 10(b) of the Securities Exchange Act of 1934 against Rosenberg and Jaeger (Count II), and Weinberg and Green (Count III), violations of section 12 of the Securities Act of 1933 against Rosenberg and MER (Count IV), common law fraud against Rosenberg and Jaeger (Count V), aiding and abetting liability under the securities laws against Weinberg & Green (Count VI), common law misrepresentation against Weinberg & Green (Count VII), and declaration of non-dischargeability in bankruptcy of debts owed by Rosenberg (Count VIII).

In response to the complaint, the defendants filed motions to dismiss. Before the district judge ruled on these motions, the Schatzes filed an amended complaint on July 29, 1988. The defendants again filed motions to dismiss, and before the district judge ruled on the second round of motions, the Schatzes filed a second amended complaint, which added several factual allegations in support of the claims. The defendants then filed a third set of motions, which the district judge referred to a federal magistrate judge, who issued her report on March 8, 1990. She recommended that count III against Weinberg & Green, which alleges primary liability under section 10(b) of the Securities Act of 1934, be dismissed without prejudice. The magistrate judge reasoned that plaintiffs could not recover under this cause of action because they did not allege a relationship with Weinberg & Green that would give rise to an independent duty to disclose to them nor did they allege that the law firm made any affirmative misrepresentations.

Similarly, she recommended that plaintiffs' securities claims charging Weinberg & Green with aider and abettor liability be dismissed, and found that "nowhere, in the many pages of opposition, do plaintiffs even hint at what Weinberg & Green did to cause Rosenberg to commit fraud." Finally, she found that plaintiffs' third claim against Weinberg & Green for misrepresentation under Maryland state law was deficient for the same reason as their claim for liability under section 10(b): absent a duty to disclose, mere silence or failure to disclose material facts do not constitute fraud under Maryland law.

On March 8, 1990, the district judge issued an opinion in which he accepted the recommendations to dismiss the counts against Weinberg & Green, but rejected the recommendation that plaintiffs be granted leave to amend these counts. Although the district judge noted that leave to amend should usually be freely granted, he concluded that since plaintiffs had amended the complaint twice, they did not deserve another opportunity to cure their defective pleadings. The judge noted that the plaintiffs never claimed that they could allege that Weinberg & Green had made any affirmative misstatements or other misrepresentations. Therefore, he doubted whether plaintiffs could ever plead a viable cause of action against these defendants.

On September 12, 1990, the Schatzes moved for reconsideration based on an opinion they had obtained from the Maryland State Bar Association's Committee on Ethics. The district court denied this motion, and the Schatzes appeal.

II.

We review de novo a district court's decision to dismiss a complaint for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6). Korb v. Lehman, 919 F.2d 243, 246 (4th Cir.1990). In reviewing the legal sufficiency of the complaint, we construe the factual allegations "in the light most favorable to plaintiff." Battlefield Builders, Inc. v. Swango, 743 F.2d 1060, 1062 (4th Cir.1984). However, we are "not so bound with respect to [the complaint's] legal conclusions. Were it otherwise, Rule 12(b)(6) would serve no function, for its purpose is to provide a defendant with a mechanism for testing the legal sufficiency of the complaint." District 28, United Mine Workers, Inc. v. Wellmore Coal Corp., 609 F.2d 1083, 1085-86 (4th Cir.1979). Accordingly, we will affirm a dismissal for failure to state a claim if it appears that the plaintiffs would not be entitled to relief under any facts which could be proved in support of their claim.

III.

Plaintiffs argue that Weinberg & Green committed fraud by remaining silent even though it knew that its client, Rosenberg, was financially insolvent. Plaintiffs allege in their second amended complaint that:

--Weinberg & Green provided legal services to Rosenberg in the past and in connection to the purchase of plaintiffs' business;

--Weinberg & Green had a copy of Rosenberg's financial statement, which it knew to be false as a result of legal services to Rosenberg and his various companies;

--Weinberg & Green prepared draft closing documents for the purchase of plaintiffs' business, which Weinberg & Green then delivered to plaintiffs' lawyers;

--Weinberg & Green gave plaintiffs a letter from Rosenberg at closing in which Rosenberg stated that no material adverse changes had occurred in his financial condition; and

--Weinberg & Green and plaintiffs' lawyers jointly agreed on language in the purchase agreement stating that Rosenberg had delivered his 1986 financial statement and an update letter to the plaintiffs, and that the letters were accurate in all material respects.

Based on these facts, plaintiffs argue that Weinberg & Green is liable (1) for violating section 10(b) of the 1934 Securities Act, (2) for aiding and abetting a violation of the securities laws, and (3) for knowingly perpetrating or assisting in misrepresentations under Maryland tort law.

A. Section 10(b) and Rule 10b-5

To state a claim for a primary violation of section 10(b) and Rule 10b-5, a plaintiff must allege that the defendant (1) made an untrue statement of material fact or omitted a material fact that rendered the statements misleading, (2) in connection with the purchase or sale of a security, (3) with scienter, and (4) which caused plaintiff's losses. Schlifke v. Seafirst Corp., 866 F.2d 935, 943 (7th Cir.1989). Plaintiffs claim that Weinberg & Green violated section 10(b) and Rule 10b-5 by failing to disclose Rosenberg's misrepresentations and by making affirmative misrepresentations about Rosenberg's financial condition.

1. Weinberg & Green's Nondisclosure of Rosenberg's Misrepresentations

We first address whether Weinberg & Green's failure to disclose Rosenberg's misrepresentations to the Schatzes subjects the law firm to liability under section 10(b) and Rule 10b-5. Silence, absent a duty to disclose, does not...