Welch v. Cadre Capital, Civ. No. H-88-717(AHN).

CourtUnited States District Courts. 2nd Circuit. United States District Court (Connecticut)
Citation735 F. Supp. 467
Docket NumberCiv. No. H-88-717(AHN).
PartiesDr. William WELCH III, et al. v. CADRE CAPITAL, et al.
Decision Date12 April 1990

Peter Luria, West Hartford, Conn., for plaintiffs.

Jeffrey A. Blueweiss, Bai, Pollock & Dunnigan, Bridgeport, Conn., for defendant Cadre Capital.

R. Laken Mitchell, Nashville, Tenn., for defendant R. Laken Mitchell, Esq.

Antoinette Leone Ruzzier, Ward, Sevarino & Ruzzier, Hartford, Conn., for defendants John Roberts, Ednalou Ballard, Norman Ballard and Financial Center Securities.

Russell J. Ober, Rose, Schmidt, Hasley & DiSalle, Pittsburgh, Pa., for defendant Northwest Mut. Sav. Ass'n.

Linda Karter, Schatz & Schatz, Ribicoff & Kotkin, Hartford, Conn., for defendant Mutual Fire & Marine Inland Ins. Co.

PARTIAL RULING ON PENDING MOTIONS TO DISMISS

NEVAS, District Judge.

The three plaintiffs in this case alleging investment fraud purchased interests in May 1984 in a limited partnership known as the "Keystone 84-1 Oil and Gas Drilling Partnership" ("Keystone"). In their six-count complaint, the plaintiffs allege violations of several federal securities statutes, a Connecticut securities statute, and common law. They have sued eight defendants purportedly either directly or peripherally associated with Keystone. Pending are motions to dismiss filed by six defendants; the motions raise a host of challenges to the complaint and are brought under Rules 9(b) and 12(b)(6), Fed.R.Civ.P. For the following reasons, the defendants' motions are granted in part. The court dismisses the plaintiffs' causes of action brought under the Securities Act of 1933 ("1933 Act"), 15 U.S.C. Section 77a et seq. As noted infra, see section II.A.2., the court requests further briefing on an issue relating to the plaintiffs' cause of action brought pursuant to the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. Section 78a et seq. Until that issue is resolved, the court reserves decision on the remaining challenges to the complaint.

I. Background
A. Factual

The well-pleaded allegations of the complaint support the following story line: After being contacted by plaintiff Dr. William Welch in the spring of 1984, defendant John Roberts, a broker with defendant Financial Center Securities ("FCS") of Farmington, Connecticut, recommended Keystone to Welch as an investment opportunity.1 Keystone involved the drilling of six oil and gas wells. Limited partners in Keystone could subscribe in units of $20,000 each — $5,000 down in cash and $15,000 from an interest-bearing promissory note. Total capital contributions from limited partners were to range from $880,000 to $1,760,000. On May 25, 1984 Welch met with Roberts and purchased two units in Keystone, executing two promissory notes totalling $30,000. By July of the same year, Welch had paid the necessary $10,000 cash.

Under the terms of the Keystone program, its general partners could assign the investors' promissory notes to lending institutions as security for loans made to Keystone to finance drilling operations. Defendant Cadre Capital was the managing general partner for Keystone. On July 24, 1984 defendant R. Laken Mitchell, the attorney for the general partnership, notified Welch by letter that his two notes had been assigned to Northwest Mutual Savings Association, now defendant Northwest Savings Bank ("Northwest"), as security for a Keystone loan. At about that time defendant Mutual Fire and Marine Inland Insurance Company ("Mutual Fire") issued a surety bond on behalf of Keystone's general partners guaranteeing Northwest payment of the plaintiff's notes.

Also in May 1984, defendants Ednalou and Norman Ballard, principals in FCS, solicited plaintiffs Dr. Andrew Guest and his wife, Elizabeth, for a series of financial seminars. After attending these seminars, the Guests were induced to purchase six limited partnerships in Keystone. On May 10, 1984 they paid $30,000 cash for these units and executed a promissory note for $90,000. On the same day that he wrote to Welch, Attorney Mitchell notified the Guests that their note had also been assigned to Northwest. As it had for the Welch transaction, Mutual Fire provided a surety bond pledging payment of the Guests' note.

In May 1985 Welch contacted Roberts about inadequate status reports on the drilling operations. FCS represented that it had retained an outside advisor to evaluate Keystone: the advisor produced a report, dated October 15, 1985 and forwarded to the plaintiffs on November 4, 1985, which concluded that Keystone was being properly operated. Also in May 1985 Welch inquired of Roberts and FCS about the possibility of refinancing his promissory notes at a lower interest rate. A Keystone general partner, Commonwealth Enterprises, Inc. ("Commonwealth"), told Welch that his subscription funds had been placed in interest-bearing escrow accounts and that refinancing would not then be economically sound.

FCS wrote the plaintiffs on May 14, 1986 to inform them of a second outside evaluation of Keystone. FCS told the plaintiffs that it would update them as soon as FCS received a report. On June 3, 1986 the Guests received a letter from a Keystone general partner reassuring them of the soundness of the program. In January 1987 Roberts informed Welch that Keystone was suffering financial difficulties. Two months later the Guests received word from FCS that Keystone was insolvent and Commonwealth bankrupt.

B. Causes of Action

The plaintiffs brought suit on October 17, 1988. Count one of the complaint alleges violations of sections 5(a) and (c) of the 1933 Act, 15 U.S.C. Section 77e(a) & (c). According to the complaint, the defendants never registered the security interests in Keystone with the Securities and Exchange Commission ("SEC").

Count two invokes the anti-fraud provisions of the 1933 Actsections 12 and 17, codified at 15 U.S.C. Sections 77l and 77q(a), respectively — and section 10(b) of the 1934 Act, 15 U.S.C. Section 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. Section 204.10b-5. From May 1985, according to the plaintiffs, the defendants have defrauded them about Keystone. The fraudulent scheme has allegedly included dissemination of false and misleading information, both oral and written, about the suitability of limited partnership interests in Keystone. The documents provided the plaintiffs failed to disclose, among other things, prior litigation by the SEC against John Meatte, the president of Commonwealth, fiduciary conflicts of interest among the general partners in Keystone, and the diversion of Keystone monies for the private use of Meatte and Commonwealth. According to the complaint, at the times of their initial contacts with the plaintiffs, Roberts, the Ballards, and FCS knew of Meatte's litigation history and chose not to reveal it. Defendant Mitchell, the attorney, prepared a "Private Placement Memorandum" for Keystone; the document omitted mention of Meatte's litigation history and the plaintiffs relied on the memorandum to their detriments. At some unspecific time before the sales of the Keystone units to the plaintiffs, Northwest and Mutual Fire purportedly performed their own investigations into Keystone, discovered or should have discovered Meatte's troubled past, and withheld this information from the plaintiffs.

As to the remaining four counts the plaintiffs invoke the count's pendent jurisdiction over their state law claims. In count three the plaintiffs allege violations of the anti-fraud provision of the Connecticut Uniform Securities Act ("CUSA"), Conn.Gen.Stat. Section 36-498. The alleged misrepresentations and omissions underlying count two also support the CUSA cause of action, according to the plaintiffs. Counts four, five, and six hinge on common law fraud, breach of fiduciary duty, and negligent misrepresentation, respectively.

II. Discussion

Motions to dismiss have been filed by all defendants except Mitchell and Mutual Fire. The motions raise sundry challenges, some specific to an individual defendant, others common to all defendants. In this partial ruling on the motions to dismiss, the court addresses the following challenges to the complaint.

A. Federal Causes of Action
1. 1933 Act

The complaint alleges violations of three sections of the 1933 Act: section 5 (count one); section 12 (count two); and section 17(a)(count two). Section 5 prohibits a person or entity from selling or delivering unregistered securities in interstate commerce. See 15 U.S.C. Section 77e. Section 12(1) of the 1933 Act creates a private cause of action for section 5 violations. Under section 12(1), aggrieved holders of unregistered securities may rescind the transactions and recover the consideration paid for the securities or, if the securities have been sold to third parties, may recover damages. See id. Section 77l(1). Section 12(2) permits a cause of action for the fraudulent sale of securities in interstate commerce. See id. Section 77l(2). Section 17(a) also prohibits the fraudulent offer or sale of securities in interstate commerce. See id. Section 77q(a).

Causes of action brought pursuant to sections 12(1) and (2) are governed by the statute of limitations set forth in section 13 of the 1933 Act, which states in relevant part:

No action shall be maintained to enforce any liability created under section ... 12(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created under section 12(1) of this title, unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under section ... 12(1) of this title more than three years after the security was bona fide offered
...

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