Appendix — Schatz v. Weinberg

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91 1062 | FiLteD

DEC 30 399}

No. ORIG OF THE CLERK

IN THE

Supreme Court of the Gnited States

OCTOBER TERM, 1991

IVAN AND JOANNE SCHATZ,

Petitioners,

WEINBERG AND GREEN,

Respondent.

Appendix to

Petition for a Writ of Certiorari

To the United States Court of

Appeals for the Fourth Circuit

CaRLos M. REcI0*

ROBERT E. GREENBERG

KeEcK, MAHIN & CATE

1201 New York Avenue, N.W.

Penthouse

Washington, D.C. 20005

(202) 789-3400

Attorneys for:

Petitioners Ivan and Joanne Schatz

*Counsel of Record

PRESS OF BYRON S. ADAMS, WASHINGTON, D.C. (202) 347-8203

im Mie

APPENDIX

TABLE OF CONTENTS

Opinion of the U.S. Court of

Appeals for the Fourth Circuit,

filed August 26, 1991. ...... 1

Report and Recommendation

of the U.S. Magistrate,

filed January 20, 1990 ...... 51

Opinion and Order

of the District Court,

filea Wareh ©, 1990. . «sees 136

Opinion and Order

of the District Court

denying Plaintiffs' Motion for

Reconsideration, filed

GCouemee aae See « «© © ees -« « eo ESS

Order of the U.S. Court

of Appeals for the Fourth

Circuit denying the

Petition for Rehearing,

Sige Gecewer 2b, 198). « . « +s « «| RR

Applicable statutes and

ee a ee

Ivan N SCHATZ; Joann B. Schatz,

Plaintiffs-Appellants,

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

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.?*!

i/ Before oral argument, plaintiffs moved

to amend the record on appeal to include

(continued...)

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

/(.. continued)

the deposition of defendant Stephen Jaeger.

This deposition was taken after the

district judge dismissed the claims against

Weinberg & Green. Initially, we granted

the plaintiffs' motion; however, upon

Weinberg & Green's motion for

reconsideration, we now deny the motion to

supplement the record. We must review the

district judge's decision on the’ same

record as that before the district court.

However, we note that even the inclusion of

Jaeger's deposition would not change the

result, because it is not relevant to the

legal sufficiency of the complaint.

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

mlic_epresentations 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 & £4Green

represented Rosenberg and his entities

throughout this periods.

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 decl ration 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 cismissed

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 misrepresentation.

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 cu 2 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 i2(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." attlefie ilders S. Vv,

wango, 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.

IttI.

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 the 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. e3 a u Ob-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 violate section

10(b) and Rule 10b-5. Chiareila v. United

States, 445 U.S. 222, 228, 100 S. Ct. 1108,

1114, 63 L.Ed.2d 348 (1980); accord Barker

v. Henderson, Franklin, Starnes & Holt, 797

F.2d 490, 496 (7th Cir. 1986) (When the

Claimed violation arises not from a

misstatement, but from a "failure to blow

the whistle," liability will not attach

unless the defendant has "a duty to blow

the whistle."). Plaintiffs argue that

Weinberg & Green had a duty to disclose

Rosenberg's misrepresentations on the basis

of federal securities cases, Maryland

common law, and the Maryland Code of

Professional Responsibility. In addition,

plaintiffs argue that as a matter of public

policy, lawyers should have a duty to

disclose a client's fraudulent activity to

a third party. We review these claims

seriatin.

a. Duty to Disclose Based on Federal

Securities Laws

We first address whether the federal

securities laws impose upon an attorney a

duty of disclosure to third parties who are

not the attorney's clients. The Supreme

Court has decreed that under the federal

securities laws, a duty to disclose "arises

from the relationship between parties,"

Dirks v. SEC, 463 U.S. 646, 658, 103 S. Ct.

3255, 3263, 77 L.Ed2d 911 (1983), and will

exist if there is "a fiduciary or other

Similar relation of trust and confidence

between them." Chiarella, 445 U.S. at 228,

100 S. Ct. at 1114. Thus, the Supreme

Court has established the type of

relationship which will create a duty of

disclosure. The Court has never determined

whether, under circumstances other than

fiduciary relationships, the securities

laws impose a duty of disclosure to third

parties. Plaintiffs urge us to adopt the

approach of several federal district courts

which have held that a law firm can be

liable for misrepresentation under section

10(b) if it disseminates false information

"with an intent, knowledge or awareness

that the intent, knowledge or awareness

that the information will be communicated

or disseminated to persons...in connection

with the purchase or sale of a security."

Rose _v. Arkansas Valley Envtl & . Util.

Author., 562 F. Supp. 1180, 1206 (W.D.Mo.

1983). We decline this invitation and hold

that a lawyer or law firm cannot be held

liable for misrepresentation under section

10(b) for failing to disclose information

about a client to a third party absent some

fiduciary or other confidential

relationship with the third party. See

Barker v. Henderson, Franklin, Starnes &

Holt, 797 F.2d 490, 496 (7th Cir. 1986)

(Because neither section 10(b) nor Rule

10b-5 imposes a duty to disclose, any such

duty "must come from a fiduciary relation

outside securities law.").

Facing this identical issue, the

Seventh Circuit has ruled that lawyers have

no duty to disclose information about

clients to third party purchasers or

investors in the absence of a confidential

relationship between the attorney and the

third party.?!

2/ The Seventh Circuit has also consistently

applied this rule to accountants who do not

disclose damaging financial information

about a client to a potential third party

investor or purchaser. See, e.g., Dileo v.

Ernst & Young, 901 F.2d 624 (7th Cir.)

(accountant under no legal duty to blow

whistle on client upon discovery that

client in financial trouble), cert. denied,

--U.S.--,111 S. Ct. 347, 112 L.Ed.2d 312

(1990); j Ventu , Vv &

Horwath, 876 F.2d 1322, 1327 (7th Cir.

1989) (accountant has no duty to blow

whistle on client in order to protect

investors); LHLC Corp. v. Cluett, Peabody

(continued...)

In Barker v. Henderson, Franklin, Starnes

& Holt, 797 F.2d 4390 (7th Cir. 1986), the

Seventh Circuit considered whether a law

firm had a duty to disclose information

relevant to its clients' financial

stability to third party investors. The

court determined that unless the law firm

had some fiduciary relationship with the

third party, it had no duty of disclosure:

"Neither lawyers nor accountants’ are

2/(. . continued)

& Co., 842 F.2d 928, 933 (7th Cir.)

(accountant under no duty to disclose

client's fraud to potential investor),

cert. denied, 488 U.S. 926, 109 S. Ct. 311,

102 L.Ed.2d 329 (1988). Other federal

courts have agreed with the Seventh

Circuit. See, e.g., Windon Third Oil & Gas

Drilli tnershi Vv. ederal Deposit

Ins. Corp., 805 F.2d 342, 347 (10th Cir.

1986) (absent fiduciary relationship,

accountant had no duty to disclose

information about corporation's financial

condition during discussions with potential

investor), cert. denied, 480 U.S. 947, 107

S. Ct. 1605, 94 L.Ed.2d 791 (1987); Leoni

v. Rogers, 719 F.Supp. 555, 556 (E.D. Mich.

1989) (accounting firm owed no duty of

disclosure to potential investor of client

as long as accountant had no fiduciary

relationship with investor).

required to tattle on their clients in the

absence of some duty to disclose. To the

contrary, attorneys have privileges not to

disclose." Id. at 497 (citations omitted).

Accord Renovitch v. Kaufman, 905 F.2d 1040

(7th Cir. 1990) (outside of a fiduciary

duty to a third party investor, law firm

has no duty to - disclose financial

information about client to the investor) ;

t terst Vv man & Cutler,

837 F.2d 775, 780 n. 4 (7th Cir. 1988)

(bond counsel not liable to bond purchaser

for false opinion letter which was based on

purportedly false assumption).

Likewise, the Fifth Circuit has

determined that absent a fiduciary or other

confidential relationship, lawyers have no

duty to disclose information about clients

to third party investors. In Abell v.

omac , 858 F.2d 1104 (5th Cir.

1988), vacated on other grounds, 492 U.S.

914, 109 S.Ct.3236, 106 L.Ed.2d 584 (1989),

the Fifth Circuit held that an

underwriter's counsel owed bondholders no

duty to disclose inaccuracies in an

offering statement for the bonds, even

though counsel had a duty of "due

diligence" to investigate the

representations in the statement and even

though counsel permitted its name to appear

on the cover of the offering statement.

The court explained that

the law, as a general rule, only

rarely allows third parties to

maintain a cause of action against

lawyers for the insufficiency of their

legal opinions. In general, the law

recognizes such suits only if the non-

client plaintiff can prove that the

attorney prepared specific legal

documents that represent explicitly

the legal opinion of the attorney

preparing them, for the benefit of the

plaintiff.

In practice, this rule has meant

that an attorney is rarely liable to

any third party for his or her legal

work unless the attorney has prepared

a signed "opinion" letter designed for

the use of a third party.

Id. at 1124-25 (citations and footnote

omitted). Based on this reasoning, the

court determined that the underwriter's

counsel should not be liable to third

parties for failing to disclose

misrepresentations in the offering

circular.

In addition to these circuits, other

federal courts have come to the _ same

conclusion. See, e.g., Bush v. Rewald, 619

F.Supp. 585 (D.Haw. 1985) (lawyer owed no

duty to investors buying from organization

when organization, not investors, was

attorney's client); ui Corp. v

Citibank, 589 F.Supp. 1235 (S.D.N.Y.1984)

(counsel to partnership owed no duty of

disclosure to limited partners).

Plaintiffs rely on several federal

securities cases which have held attorneys

liable under section 10(b) for failing to

disclose misrepresentations made by clients

to third parties. First, plaintiffs cite

cases imposing liability on attorneys for

issuing a reckless and misleading bond

opinion letter. See T.J. Raney & Sons, Inc.

v. Fort Cobb, Okl. Irr. Fuel Author., 717

F.2d 1330 (10th Cir.1983), cert. denied,

4365 U.S. 1026, 104 S.CT. 1285, 79 L.Ed.2d

687 (1984); roni v. Midwestern Okl.

Develop. Author., 619 F.2d 856, 862 (10th

Cir. 1980). However, these cases are

clearly distinguishable because they

involve lawyers who issued misleading legal

opinions. In this case, however,

plaintiffs do not claim that Weinberg &

Green made inaccurate legal

representations, only that they failed to

tattle on their client for misrepresenting

his personal financial condition.

Plaintiffs also cite cases in which

courts imposed liability on attorneys who

drafted false prospectuses or other

securities documents. See Renovitch v.

Stewardship Concepts, Inc., 654 F.Supp.

353, 359 (N.D. Ill. 1987); In re Fiight

Transportation Corp. Sec. Lit., 593 F.Supp.

612, 617-18 (D.Minn. 1984); Blakely v.

Lisac, 357 F.Supp. 255, 266-67 (D.Or.

1972). These cases, however, are also

easily distinguished because they involve

affirmative misrepresentations made in the

solicitation of securities. In our case,

Weinberg & Green did not solicit any

purchase of securities or prepare any

solicitation documents. In fact, Rosenberg

and the Schatzes worked out the details of

the purchase of the business’ before

involving the attorneys for either side.

Accordingly, none of these authorities

persuade us to adopt a rule contrary to the

rule adopted by the Fifth and Seventh

Circuits. We hold that unless a

relationship of "trust and confidence"

exists between a lawyer and a third party,

the federal securities laws do not impose

on a lawyer a duty to disclose information

to a third party.

b. Duty of Disclosure based on

Maryland Law

Plaintiffs also claim that’ the

Maryland Rules of Professional Conduct

obligated Weinberg & Green to either

withdraw from representing Rosenberg or to

disclose his financial misrepresentations

to the plaintiffs. In support of this

claim, plaintiffs' counsel submitted to the

Maryland State Bar Committee on Ethics an

anonymous request for an ethics ruling on

the facts of the present case. The

committee concluded that a law firm in

Weinberg & Green's position had an ethical

duty to either withdraw from representation

or disclose the misrepresentations to the

third person. This ethical responsibility,

plaintiffs argue, establishes a legal duty

to disclose and subjects Weinberg & Green

to section 10(b) liability.

We reject this argument. An ethical

duty of disclosure does not create a

corresponding legal duty under the federal

securities laws. Courts have consistently

refused to use ethical codes to define

standards of civil liability for lawyers.

See, e.g., Bickel _v. Mackie, 447 F.Supp.

1376, 1383-84 (N.D.Iowa), aff'd mem. 590

F.2d 341 (8th Cir. 1978); Merritt-Chapman

& Scott Corp. v. Elgin Coal, Inc., 358

F.Supp. 17, 22 (E.D. Tenn. 1972), aff'd

mem., 477 F.2d 598 (6th Cir. 1973). More

specifically, courts have refused to base

a legal duty of disclosure for section

10(b) on a disciplinary rule. In Tew v.

Arky, Freed, Sterns, Watson, Greer, Weaver,

& Harris, P.A., 655 F.Supp. 1573 (S.D. Fla.

1987), aff'd mem., 846 F.2d 753 (11th

Cir.), cert. denied, 488 U.S. 854, 109

S.Ct. 142, 102 L.Ed.2d 114 (1988), the

court held that violation of a disciplinary

rule did not create a legal duty requiring

a law firm to disclose information it had

learned in a prior business meeting to a

client's auditors.

The rationale for these rulings is

clear. The ethical rules were intended by

their drafters to regulate the conduct of

the profession, not to create actionable

duties in favor of third parties. The

preliminary statement to the Model Code,

upon which the Maryland code is patterned,

warns that the Code does not “undertake to

define standards for civil liability of

lawyers for professional conduct."

Preliminary Statement, Model Code of

Professional Responsibility. We believe

this statement accurately reflects the

goals and purposes of the Maryland Code of

Professional Responsibility. Thus, we hold

that the ethical rules do not create a

legal duty of disclosure on lawyers and

that plaintiffs cannot base a securities

fraud or other misrepresentation claim on

a violation of an ethical rule.

We also hold that Maryland common law

does not impose a duty to disclose under

these circumstances. In the negligence

context, Maryland courts have held that a

lawyer only owes a duty to his clients or

third party beneficiaries of the attorney-

client relationship. See Flaherty v.

Weinberg, 303 Md. 116, 492 A.2d 618 (1985).

Applying such rule to the facts of this

case, we hold that because plaintiffs were

neither clients nor third party

beneficiaries of the attorney-client

relationship, Weinberg & Green had no duty

to disclose.

Plaintiffs rely on Crest Investment

rust nc. v. Comstock, 23 Md. App. 280,

327 A.2d 891 (1974), to establish a common

law duty of disclosure for lawyers.

However, this case says nothing about

whether an attorney owes a duty of

disclosure to persons who are not his

clients. Comstock involved a lawyer who

had a conflict of interest use he tried to

represent both sides in a transaction, and,

therefore, the lawyer owed a duty of

disclosure to both sides. Thus, Comstock

does not impose a duty of disclosure ona

lawyer to a third party the lawyer does not

represent. In this case, plaintiffs do not

allege that Weinberg & Green represented

them; in fact, plaintiffs admit that they

were represented by their own chosen

lawyers. Thus, the facts of Comstock are

not analogous to this case.

C. Duty of Disclosure Based on

Public Policy

Precedent aside, plaintiffs also argue

that, as a matter of public policy, lawyers

should not be permitted to verpetrate or

assist in a fraud without being held

responsible for their wrongdoing.

Plaintiffs' counsel urges the court to rule

that a lawyer has a duty to disclose

misrepresentations to innocent third

parties on the basis of public policy.

While we sympathize with plaintiff's

position and certainly do not condone

lawyers making misrepresentations, we find

that public policy counsels’ against

imposing such a duty. Attorney liability

to third parties should not be expanded

beyond liability for conflicts of interest.

See Flaherty, 492 A.2d at 626. Any other

result may prevent a client from reposing

complete trust in his lawyer for fear that

he might reveal a fact which would trigger

the lawyer's duty to the third party.

Similarly, if attorneys had a duty to

disclose information to third parties,

attorneys would have an incentive not to

press clients for information. The net

result would not be less securities fraud.

Instead, attorneys would more often be

unwitting accomplices to the fraud as a

result of being kept in the dark by their

clients or by their own reluctance to

obtain information. The better rule --

that attorneys have no duty to "blow the

whistle" on their clients -- allows clients

to repose complete trust in their lawyers.

Under those circumstances, the client is

more likely to disclose damaging or

problematic information, and the lawyer

will more likely be able to counsel his

client against misconduct.

Other federal courts have arrived at

Similar conclusions in addressing the

policy concerns of this identical issue.

The Fifth Circuit explained that

It is well understood in the legal

community that any significant

increase in attorney liability to

third parties could have a dramatic

effect upon our entire system of legal

ethics. An attorney required by law

to disclose "material facts' to third

parties might thus breach his or her

duty, required by good ethical

standards, to keep attorney-client

confidences. Similarly, an attorney

required to declare publicly his or

her legal opinion of a client's

actions and statements may find it

impossible to remain as loyal to the

client as legal ethics’ properly

require.

Abell v. Potomac Ins. Co., 858 F.2d 1104,

1124 (5th Cir. 1988), vacated on other

grounds, 492 U.S. 914, 109 S.ct. 3236, 106

L.Ed.2d 584 (189) (footnotes omitted).

Likewise, the Seventh Circuit, in the

accounting context, refused to impose a

duty of disclosure based upon policy

reasons:

Such a duty would prevent the client

from reposing in the accountant the

trust that is essential to an accurate

audit. Firms would withhold

documents, allow auditors to see but

not copy, and otherwise emulate the

CIA, if they feared that access might

lead to destructive disclosure -- for

even an honest firm may fear that one

of its accountant's many auditors

would misunderstand the situation and

ring the tocsin needlessly, with great

loss to the firm.

Dileo v. Ernst & Young, 901 F.2d 624, 629

(7th Cir.), cert. denied, --- U.S. ---, 111

S.Ct. 347, 112 L.Ed.2d 312 °&#(1990)

(accountant under no legal duty to blow

whistle on client upon discovery that

client was in financial trouble).

Therefore, we hold that public policy

interests protected by the attorney-client

relationship outweigh any public policy

interests served by imposing a duty of

disclosure like the one urged by the

plaintiffs in this case.

2 Affirmative Misrepresentations

by Weinberg & Green

Plaintiffs also claim that Weinberg &

Green violated section 10(b) by making

various affirmative misstatements.

Plaintiffs complain that Weinberg & Green

informed plaintiffs' attorney that it would

supply an update letter which would state

that Rosenberg's financial position had not

materially changed as of December 31, 1986.

Weinberg & Green then presented the update

letter to plaintiffs' counsel. The letter

misrepresented Rosenberg's financial

position, and the agreement and closing

documents drafted by Weinberg & Green

contained representations made by Rosenberg

that the financial statement was "true,

correct, and complete in all material

respects."

Plaintiffs never contend that Weinberg

& Green made any representations other than

those made by Rosenberg. In fact,

plaintiffs only claim that Weinberg & Green

stated that Rosenberg would supply an

update letter and that Weinberg & Green

forwarded the Rosenberg letter to

plaintiffs' attorneys. Since Weinberg &

Green made no independent affirmative

misstatements, Weinberg & Green did not

commit a primary violation of section 10(b)

See Friedman v. Arizona World Nurseries,

td., 730 F.Supp. 521 (S.D.N.Y. 1990)

(lawyers who drafted an offering which

included an offering memorandum, a legal

opinion, and a tax assistance letter not

liable for misrepresentations in the

offering memorandum since it was not a

representation from the law firm).

Weinberg & Green's drafting of closing

documents which contained representations

by Rosenberg does not mean that they

warranted or promised that Rosenberg had

been honest.’

y Plaintiffs argue that Bonavire

v. Wampler, 779 F.2d 1011, 1914-15 (4th

Cir. 1985) requires that Weinberg & Green

be held liable for misrepresentation. In

Wampler, we affirmed a jury verdict finding

an attorney liable for misrepresentation

that a promoter was an "honest

straightforward businessman." However, the

facts of Wampler differ significantly from

the facts of this case. In Wampler, the

attorney himself made personal affirmative

representations about the promoter.

Moreover, the attorney was actually

involved in the deal. First the attorney

acted as the escrow agent for the parties,

thereby creating a potential conflict of

interest. Second, the attorney made

affirmative representations to the

plaintiffs regarding personal and business

information about the defendants. [In our

case, however, Weinberg & Green only

"papered the deal," and did not participate

in negotiation or solicitation as did the

attcrneys in Wampler. In fact, Rosenberg

and the Schatzes worked out the details

before consulting with their respective

attorneys. Second, Weinberg & Green did

not make any affirmative representations

about Rosenberg to plaintiffs; rather the

law firm only put Rosenberg's

representations to paper. Finally, the

plaintiffs in Wampler clearly relied upon

the affirmative representations of the

attorney in closing the deal; in our case,

(continued...)

Plaintiffs also argue that Weinberg &

Green should be liable for the affirmative

misrepresentations that Rosenberg made

under principles of agency law. See

Restatement (Second) of Agency § 348 ("[a]n

agent who fraudulently makes

representations, . .. or knowingly assists

in the commission of tortious fraud...

by his principal . . . is subject to

liability in tort to the injured person

although the fraud or duress occurs in a

transaction on behalf of the principal.").

Plaintiffs apparently believe that, under

general principles of agency law, whenever

a lawyer incorporates a representation by

a client into a letter, contract, or other

document, the representation becomes the

lawyer's as well as the client's. This

argument inherently presents two issues:

7(...continued)

plaintiffs relied upon Rosenberg's

representations which Weinberg & Green had

put on paper.

first, as a matter of law, whether an

attorney-client relationship should be

treated as a typical agent-principal

relationship governed by the general laws

of agency; and second, as a matter of fact,

whether Weinberg & Green "knowingly

assisted" Rosenberg in his fraud in its

status as his agent as reguired by the

Restatement section. We are eeehabeine only

the legal sufficiency of the complaint, we,

therefore, will only consider the first

issue which requires a ruling of law.

There are numerous similarities

between an attorney-client relationship and

an agent-principal relationship, and a

lawyer may act as an agent for a client in

various financial transactions, such as

when the lawyer negotiates the terms of the

transaction for the client. However, the

fact that an attorney is an agent in that

he represents his client does not

automatically make the attorney liable

under agency law for misrepresentations his

client makes. Regardless of what

plaintiffs wish the law required of

lawyers, lawyers do not vouch for the

probity of their clients when they draft

documents reflecting their clients'

promises, statements, or warranties. Thus,

Weinberg & Green's alleged transmission of

Rosenberg's misrepresentations does not

transform those misrepresentations into the

representations of Weinberg & Green.

In Friedman Ws Arizona World

Nurseries, Ltd., 730 F.Supp. 521 (S.D.N.Y.

1990), the court considered whether to

dismiss a complaint under Section 10(b) and

Rule 10b-5 against a law firm that drafted

an offering memorandum and a legal opinion

and tax assistance letter included in the

memorandum. The court determined that,

with respect to "the only parts of the

memorandum which arguably contain

representations from [the law firm] to the

limited partners" -- the legal opinion and

the tax assistance letter -- plaintiffs

failed to identify any misrepresentations.

Id. at 533-34. As for the remainder of the

offering memorandum, the court declared

that “counsel who merely draft [an offering

memorandum] cannot be held liable for the

general statements in the offering

memorandum not specifically attributed to

then." Id. at $33.

We find this reasoning persuasive’ and

therefore hold that a lawyer or law firm

cannot be liable for the representations of

a client, even if the lawyer incorporates

the client's misrepresentations into legal

The two cases that plaintiffs

rely upon to support their "agency law"

theory are inapposite. In neither case did

the court impose liability on an attorney

who drafted legal documents containing his

client's representations and for his

clients's' signature. See Bechtel _v.

Liberty National Bank, 534 F.2d 1335, 1339

n. 6 (9th Cir. 1976) (holding banker liable

for misrepresentations made as agent);

Hager v. Mobley, 638 P.2d 127 £4(Wyo.

1981) (holding realtor liable for

misrepresentations made as an agent).

documents or agreements necessary for

closing the transaction. In this case,

Weinberg & Green merely "papered the deal,"

that is, put into writing the terms on

which the Schatzes and Rosenberg agreed and

prepared the documents necessary for

closing the transactions. Thus, Weinberg

& Green performed the role of a scrivener.

Under these circumstances, a law firm

cannot be held liable for

misrepresentations made by a client in a

financial disclosure statement.

B. Liability for aiding and abetting a

violation of the securities laws

Plaintiffs make claims for aider and

abettor liability under sections 12(2) and

10(b) of the 1934 Securities Act. Both

causes of action require the plaintiff to

prove the following three elements’ to

establish an aiding and abetting securities

violation: (1) a primary violation by

another person; (2) the aider and abettor's

"knowledge" of the primary violation; and

(3) substantial assistance by the aider and

abettor in the achievement or consummation

of the primary violation. Bloor v. Carro,

anboc ndin, Rodm & Fass, 754 F.2d

57, 62 (2d Cir. 1985); Martin v. Pepsi-

Cola Bottling Co., 639 F.Supp. 931, 934-35

(D.Md. 1986); In re Action Industries

Tender Offer, 572 F.Supp. 846, 853 (E.D.Va.

1983) Without deciding whether’ the

plaintiffs have adequately plead a primary

violation by Rosenberg, we hold that the

plaintiffs have not alleged facts

establishing that Weinberg & Green

possessed the requisite "knowledge" of a

securities violation or that Weinberg &

Green "substantially assisted" a securities

violation. Thus, plaintiffs' aiding and

abetting claims fail.°

. Because we hold that Weinberg &

Green did not substantially assist

Rosenberg in his’ fraudulent activity,

plaintiffs cannot assert an aider and

abettor claim under section 12(2) or 10(b).

Accordingly, we do not decide whether the

(continued...)

1. Scienter

First, we address plaintiffs'

allegation that Weinberg & Green possessed

the requisite "knowledge" or scienter of a

securities violation required for aider and

abettor liability. In their complaint, the

°(...continued)

fact that plaintiffs are not "statutory

sellers" would prevent them from asserting

a claim under section 12(2). In Pinter v.

Dahl, 486 U.S. 622, 108 S.Ct. 2063, 100

L.Ed.2d 658 (1988), the Supreme Court held

that section 12(1) can only be applied to

statutory sellers, i.e., those who actually

solicit securities purchases. Although the

Court expressly reserved the question of

aider and abettor liability under section

12(2) for non-statutory sellers, see id. at

648-49 n. 24, 108 S.Ct. at 2079 n. 24,

several lower courts have extended Dahl to

limit aider and abettor liability under

section 12(2) to statutory sellers of

securities as well. See, e.g., In re

Craftmatic Sec. Litig. v. Kraftsow, 890

F.2d 628 (3d Cir. 1989); Wilson v. Saintine

Exploration & Drilling Corp., 872 F.2d 1124

(2d Cir. 1989). We have not previously

decided whether, in light of Pinter, aider

and abettor liability under section 12(2)

should be limited to statutory sellers.

See Baker, Watts & Co. v. Miles &

Stockbridge, 876 F.2d 1101, 1106 n. 3 (4th

Cir. 1989) (citing Pinter and Wilson, but

not deciding whether law firm was "seller"

under section 12(2) so as to be liable for

aider and abettor liability).

Schatzes allege that Weinberg & Green

"knowingly and/or recklessly provided

substantial assistance" to the fraud. This

allegation, argue the plaintiffs, meets the

scienter requirement and adequately states

a cause of action for aider and abettor

liability. However, an evaluation of the

"knowledge" requirement of the aiding and

abetting liability test turns upon whether

the aider and abettor defendant owed a duty

to the plaintiff. When there is no duty

running from the alleged aider and abettor

to the plaintiff, the defendant must

possess a "high conscious intent" and a

"Conscious and specific motivation" to aid

the fraud. See Itt, an Internat'l Invest.

Trust v. Cornfeld, 619 F.2d 909, 925 (2d

Cir. 1980); Woodward v. Metro Bank of

Dallas, 522 F.2d 84, 97 (5th Cir. 1975);

Martin v. Pepsi-Cola Bottling Co., 639

F.Supp. 931, 934-35 (D.Md. 1986).

We have already held that Weinberg &

Green had no duty of disclosure, arising

under either the federal securities laws or

Maryland state law, to inform the Schatzes

that Rosenberg's financial status’ had

changed. Accordingly, plaintiffs must

allege that Weinberg & Green had a

"conscious and specific motivation" to aid

and abet the fraud to state a cause of

action for aider and abettor liability.

Plaintiffs have not, and in the opinion of

the district judge, could not allege such

a level of scienter. Therefore, the

complaint fails to state a cause of action

against Weinberg & Green for aider and

abettor liability.

2. Substantial Assistance

We also hold that plaintiffs have not

pled an aider and abettor claim, because

plaintiffs have not adequately alleged that

Weinberg & Green "substantially assisted"

Rosenberg in the fraud. Plaintiffs claim

that Weinberg & Green "substantially

assisted" Rosenberg's fraudulent activity

in two ways: first, Weinberg & Green

substantially assisted the fraud by failing

"to either disclose or correct’ the

misrepresentations or to withdraw from the

representation of Rosenberg and/or MER" and

second, Weinberg & Green substantially

assisted the fraud by "participating in

negotiations, drafting documents and

conducting the Closing of its offices."

We first address whether Weinberg &

Green can be liable for aider and abettor

liability for failing to disclose

Rosenberg's misrepresentations to the

Schatzes. Absent a duty to disclose,

allegations that a defendant knew of the

wrongdoing and did not act fail to state an

aiding and abetting clain. ee In re Gas

Reclamation, Inc. Sec. Lit., 659 F.Supp.

493 (S.D.N.Y. 1987) (allegations that

defendant accounting firm knew of alleged

fraud and failed to disclose it or

otherwise stop scheme failed to state an

aiding-abetting claim); Quintel Corp. v.

Citibank, 589 F.Supp. 1235 (S.D.N.Y. 1984)

(allegations that attorney remained silent

to aid his client's fraud did not

adequately plead an aider and abettor claim

because complaint never alleged that

attorney "had a direct involvement in the

transaction or deliberately covered up the

fraud"). We have already held that

Weinberg & Green owed no duty to disclose

Rosenberg's misrepresentations to’ the

Schatzes; thus, Weinberg & Green cannot be

held liable as aiders and abettors for

failing to disclose this information.

The plaintiffs also allege that

Weinberg & Green provided substantial

assistance to Rosenberg by representing him

in the transaction. They argue that a

lawyer provides "substantial assistance" in

aiding and abetting tortious conduct if he

prepares or disseminates documents

containing material misrepresentations or

omissions. However, the "substantial

assistance" element requires that a lawyer

be more than a scrivener for a client; the

lawyer must actively participate in

soliciting sales or negotiating terms of

the deal on behalf of a client to have

"substantially assisted" a securities

violation. In other words, a plaintiff

must prove that a defendant’ rendered

"substantial assistance" to the primary

securities law violation, not merely to the

person committing the violation.

If a lawyer, for example, is a member

of the investment group, acts as a general

agent for the investment group and not

merely its attorney, or actively

participates in the transaction by inducing

or soliciting sales or by negotiating terms

of the deal, the lawyer may be held liable

for substantially assisting a securities

violation. However, when a lawyer offers

no legal opinions or affirmative

misrepresentations to the potential

investors and merely acts as scrivener for

the investment group, the lawyer cannot be

liable as a matter of law for aider and

abettor liability under the securities laws

without an allegation of a conscious intent

to violate the securities laws. See

Woodward v. Metro Bank of Dallas, 522 F.2d

84, 96 (5th Cir. 1975) (when "transactions

constitut[e] the daily grist of the mill,"

courts are "loathe to find 10b-5 liability

without clear proof of intent to violate

the securities laws"); S_Vv.

Lokken, 644 F.2d 779, 784 (8th Cir. 1981)

(attorney's tangential involvement in

securities transaction insufficient for

aiding and abetting claim).

In this case, Weinberg & Green did no

more than “paper the deal" or act as a

scrivener for Rosenberg. These activities

cannot form the basis for a _ securities

violation since plaintiffs never allege any

facts tending to show an intent on Weinberg

& Green's part to violate the securities

laws. While it is true that some of

Rosenberg's documents prepared by Weinberg

& Green (on the basis of infcumation

provided by Rosenberg) were misleading,

this fact alone does not’ meet’ the

"substantial assistance" threshold.

Otherwise, there would be & per _se rule

holding attorneys liable : in every

securities fraud case, because in virtually

every transaction, attorneys draft the

closing documents. Clearly, the fact that

an attorney drafts a closing document does

not automatically create a warranty that

every statement and agreement made by the

client is true. Any other result would

make attorneys co-guarantors and co-

signatories, along with their clients, in

every securities transaction.

C. Liability for knowingly or recklessly

perpetuating a misrepresentation under

Maryland tort law

Count VII of the plaintiffs'

complaint purports to state a cause of

action for common law misrepresentation

under Maryland law. Under Maryland law,

concealment of material facts renders a

party liable for fraud. ish v an

Vi ini i fe) 'n., 250 Md.

24, 242 A.2d 512, 539 (1968), cert. denied,

404 U.S. 940, 92 S.Ct. 280, 30 L.Ed.2d 253

(1971). However, a plaintiff cannot state

a claim for misrepresentation based upon a

failure to disclose unless the defendant

had a duty to disclose. Impala Platinum

i mpala Sales (U.S.A. nc., 283

Md. 296, 389 A.2d 887, 903 (1978)

("nondisclosure does not constitute fraud

unless there exists a duty of disclosure") ;

Fowler v. Benton, 245 Md. 540, 226 A.2d

556, 562 (1967) (without legal duty to

disclose defect, defendant cannot be held

liable for misrepresentation), cert,

Ganiad, 389 U.8. $51, 68 &$.Cct. 42, is

L.Ed.2d 119 (1967); Walsh v. Edwards, 233

Md. 552, i97 A.2d 424, 427 (1964) (mere

silence or nondisclosure, not accompanied

by any misstatements, does not constitute

actionable fraud). We have already held

that Weinberg & Green had no duty of

disclosure, arising either from federal

securities law or Maryland state law, to

inform the Schatzes that Rosenberg's

financial status had changed. Accordingly,

plaintiffs cannot recover for

misrepresentation under state tort law.

IV.

The extent of a law firm's liability

for knowingly incorporating a client's

misrepresentations into closing documents

for a financial transaction presents

troubling legal issues. However, we do not

sit as an ethics ,or other attorney

disciplinary committee, but as a civil

court with a duty to interpret’ the

securities laws, and the solution to these

legal issues cannot be found in the

securities laws. As the Seventh Circuit

stated in Barker v. Henderson, Franklin,

Starnes & Hold, 797 F.2d 490 (7th Cir.

—.

1986):

We express no opinion on whether the

{law firm] did what [it] should,

whether there was malpractice under

state law, or whether the rules of

ethics . . . ought to require lawyers

and accountants to blow the whistle in

equivalent circumstances. We are

satisfied, however, that an award of

damages under the securities laws is

not the way to blaze the trail toward

improved ethical standards in the

legal and accounting professions.

Liability depends on an existing duty

to disclose. The securities laws

therefore must lag behind changes in

ethical and fiduciary standards.

Id. at 497 (emphasiS in original). We

agree with this statement of policy and

affirm the order of the district court.

AFFIRMED.

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MARYLAND

IVAN N. SCHATZ and )

JOANNE B. SCHATZ )

)

v; ) Civil Action No.

) JH-89-7051

MARK E. ROSENBERG, )

et al. )

MAGISTRATE'S REPORT AND RECOMMENDATION

This case has been referred to the

undersigned for proposing recommended

findings on all pretrial dispositive

matters. Currently pending are motions to

dismiss the second amended complaint filed

by all defendants.

Plaintiffs, Ivan and Joanne Schatz,

filed their second amended complaint in

February, 1989.° Named as defendants are

Mark E. Rosenberg, Steven H. Jaeger, MER

* The original complaint was filed in

Bankruptcy Court in June, 1988. (Case No.

88-5-0594-JS; Adversary No. A88-0166-JS).

Judge Harvey, acting as chambers judge,

granted plaintiffs' motion to withdraw

reference to Bankruptcy Court on March 3,

1989. (Paper No. 68).

Enterprises, Inc. (MER), and the law firm

of Weinberg and Green. Count I is a claim

under the Racketeer Influenced and Corrupt

Organizations Act (RICO), 18 U.S.C. §1961,

et seq., naming Rosenberg and Jaeger;

Counts II and III allege violations of

§10(b) of the Securities Exchange Act of

1934, 15 U.S.C. §78a et seq. Count II is

brought against Rosenberg and Jaeger while

Count III is brought against Weinberg and

Green. Count IV alleges violations of §12

of the Securities Act of 1933, 15 U.S.C.

§77a et seq, against Rosenberg and MER.

Count V is a common law fraud count against

Rosenberg and Jaeger, Count VI is aiding

and abetting securities fraud brought

against Weinberg and Green, Count VII is

misrepresentation against Weinberg and

Green and, finally, Count VIII seeks a

declaration of non-dischargeability in

bankruptcy of debts owned by Rosenberg.

Defendants Rosenberg and MER filed a

motion to dismiss which was joined by

defendant Jaeger, acting pro se (hereafter

this motion will be referred to as

Rosenberg's motion). They seek dismissal

on eee as ee, 6 «66, «C6U6dEV,:CUWVlCaarnnd «CVS.

(Paper Nos. 75 and 76). Defendant Weinberg

and Green has also filed a motion to

dismiss Counts III, VI, and VII. (Paper

No. 74). Oppositions and reply memoranda,

as well as supplementary material, have

been filed. (Paper Nos. 79, 80, 81 and

82). No hearing is deemed necessary, Local

Rule 105.6.

A motion to dismiss pursuant to Fed.

R. Civ. P. 12(b)(6) ought not be granted

unless “it appears beyond doubt that the

plaintiff can prove no set of facts in

support of his claim which would entitle

him to relief." Conley v. Gibson, 355 U.S.

41, 45-46 (1957). The Court must consider

well pled allegations in a complaint as

true, when ruling on a motion to dismiss.

Jenkins v. McKeithen, 395 U.S. 411, 421-22

(1969). Allegations are to be construed

liberally in favor of the plaintiff,

Scheuer v. Rhodes, 416 U.S. 232, 236

(1974), and the Court must disregard the

contrary allegations of the opposing party.

A.S. Abell Co. v. Chell, 412 F.2d 712, 715

(4th Cir. 1969).

I. Factual Allegations

As set out by plaintiffs, Ivan Schatz

owned a Virginia corporation known as the

Virginia Adjustable Bed Manufacturing Corp.

(VAMCO) and Joanne Schatz owned Advanced

Bed Concepts (ABC) (G24 and 25).’

Defendant Rosenberg controlled a number of

corporations including Yale Sportswear

Corp. (Yale), the Back Center, Inc. (BCI),

Vertech Management Corp., Back and Bed Co.

(BBC), RSJ Acquisitions, Inc., MER

” All paragraph references are to

the second amended complaint, unless

otherwise noted.

Enterprises, Inc., Mattco and Allied Help

[sic] Management (Allied). Defendant

Jaeger was formerly a senior vice-president

for First American Bank of Maryland and was

responsible, in whole or part, for handling

loan transactions for Rosenberg's

companies. Jaeger went to work for

Rosenberg in August or September of 1986,

shortly after the bank made substantial

loans to Yale. At all relevant times,

Weinberg and Green represented Rosenberg,

Jaeger and/or the above-named corporations.

Plaintiffs allege that Rosenberg ’9= and

Jaeger, along with other unknown persons,

conspired to defraud them and others.

(4916-18).

Vertech is concerned with marketing

and franchising stores specializing in

sales of adjustable beds and other products

for persons with bad backs. (421).°% In

® vVertech is currently owned 80% by

MER and 20% by plaintiffs.

1985, plaintiff Joanne Schatz and her

company, ABC, agreed to become a Vertech

franchisee. (429). At the same time, Mr.

Schatz' company, VAMCO, a manufacturer of

adjustable beds, was made a favored

supplier to all Vertech stores. (429).

In mid-1986, Rosenberg approached the

plaintiffs with a proposal to purchase

VAMCO and ABC. Negotiations commenced and

an agreement was entered on December 31,

1986. Jaeger assisted Rosenberg in the

negotiations. During that time, a number

of misrepresentations were made regarding

Rosenberg's personal and business financial

status. ((Q¥30-33). The representations

included the following: (a) Rosenberg and

each of his companies was’ financially

solvent; (b) Rosenberg's net worth was over

$7,000,000; (c) Yaie Sportswear Corp. was

worth over $2.5 willie and was a

profitable concern; and (da) Allied Health

and Management was a valuable and

profitable holding.

The defendants failed to reveal that

Rosenberg owed (a) "substantial alimony

payments to his first wife, Carol

Rosenberg;" (b) Rosenberg had contingent

liabilities totaling over $10,000,006, the

cause of most of this liability was loan

guaranties including loans to Yale

Sportswear; (c) on December 31, 1986, the

management contracts of Allied Health and

Management would be terminated, resulting

in the loss of one of Rosenberg's most

valuable assets; (d) Yale Sportswear was

undercapitalized and was losing money; and

(e) Rosenberg would become insolvent should

Yale Sportswear collapse. (434).

In October of 1986, the parties

entered a letter of intent providing that

Rosenberg would buy 80% of the plaintiffs'

interests in VAMCO and ABC. Plaintiffs

were to receive promissory notes totalling

$1.5 million, personally guaranteed by

Rosenberg. In November, a copy of

Rosenberg's personal financial statement

dated March 31, 1986, was provided to the

plaintiffs.’ ((35). The statement

allegedly contains the following

misrepresentations. Rosenberg owned 50% of

Yale Sportswear that was said to be worth

$1,250,000 based on a 1986 estimated cash

flow of $500,000 and a profit of $225,000.

In truth, Yale had lost $200,000 in 1985

and over $265,000 in 1986 and the cash flow

projections for 1986 were not based in

fact. (q35a). Similarly, Allied's cash

flow was estimated at $500,000 per year and

Rosenberg's 50% share was valued at

$1,250,000. In reality, the cash flow

figures were substantially lower in 1985

and 1986. Moreover, Rosenberg knew that

Allied would lose valuable contracts on

A copy of that statement was

attached to the amended complaint as

Exhibit A.

December 31, 1986, which constituted a

major portion of its assets. The expected

loss of the contracts was not made known to

the plaintiffs. Other misrepresentations

were made concerning the standing of

Rosenberg's indebtedness.”° ((35b).

Plaintiffs's counsel requested an updated

financial statement. ((50). Rosenberg

agreed to provide an update letter. (451).

At closing on December 31, 1986, the update

letter was presented, stating that no

material adverse change had occurred in

Rosenberg's financial status. (464). This

letter failed to reveal that Rosenberg had

guaranteed a line of credit in the amount

of $299,990 on October 14, 1986; had

borrowed $200,000 for Yale Sportswear on

August 26, 1986; and borrowed $550,000 for

Yale Sportswear on July 23, 1986. By

December 8, 1986, Rosenberg had guaranteed

” Several of the examples given

were transactions entered after the

financial statement was prepared. (453).

a master demand note issued by Yale

Sportswear Corp. in favor of First American

Bank of Maryland in the amount of

$2,700,000. (435g, 53 and 56).

Weinberg and Green represented

Rosenberg in the negotiations. The March

financial statement was made a part of the

closing documents that Weinberg and Green

prepared. Weinberg and Green is said to

have reviewed the financial statement prior

to including it in the closing documents.

Furthermore, through their representation

of Rosenberg and his companies, Weinberg

and Green either knew or should have known

that the March financial statement was

materially false and misleading.™ The

Other specific allegations

against Weinberg and Green include the

following. Weinberg and Green also

attended various board of directors and

shareholders' meetings of Yale and, during

those activities and general

representation of Yale, should have been

aware of the financial difficulty the

company was in. (457 and 58). Weinberg

and Green also represented Rosenberg and

(continued...)

plaintiffs allege that Weinberg and Green

should have either corrected the

nisrepresentations or withdrawn from

representation of Rosenberg. Plaintiffs

contend that had Weinberg and Green done

either, they would not have entered into an

agreement with the defendants. (445).

Other promises made to the plaintiffs

during the negotiations included a

representation that Rosenberg would

refinance existing debt plaintiffs had

previously personally guaranteed for their

businesses; that Rosenberg was a “money

partner" who would arrange for $1,150,000

in financing from either his own funds or

banks; that within five years after VAMCO

and ABC were merged into BCI, BCI would be

merged with Yale Sportswear and MER would

be taken public. (9§46a-c).

1, ..continued)

Allied in a transaction that occurred on

December +e 1986, which adversely

affected the value of Allied. (458).

In the closing documents, Rosenberg

disclosed that Yale's stock was pledged to

First American Bank of Maryland for certain

indebtedness. The March 31, 1986,

financial statement showed that amount of

indebtedness to First American Bank of

Maryland to be $350,000 incurred on March

20, 1985. However, in truth, according to

plaintiffs, in addition, the stock also

secured a $550,000 debt incurred on July

23, 1986, a guaranty for the $2,700,000

line of credit extended to Yale by December

8, 1986, and a $1,000,000 promissory note

dated January 2, 1985. (453). Plaintiffs

assert that Weinberg and Green had

represented Rosenberg and Yale in the July,

1986 transaction and, therefore, Weinberg

and Green had specific knowledge of that

indebtedness. At the same time, Yale

executed a master demand not in the amount

of $2,000,000 in First American's favor.

((56).

Rosenberg created MER prior to

purchasing his interest in plaintiffs'

corporations. The December 31st agreement

was between the plaintiffs and MER, but was

joined by Rosenberg and Jaeger. (463).

The plaintiffs claim that they reasonably

relied on the financial report, the update

letter and the representations of Rosenberg

and Jaeger in entering the agreement with

MER. (466 and 67). The negotiations were

conducted in person as well as over the

telephone and through the U.S. mail.

(467).

After closing the agreement on

December 31, 1986, VAMCO and ABC were

merged into BCI. The newly merged company

was thereafter known as BBC. The amount of

BBC's preexisting debt had been understated

to the plaintiffs by over $200,000. (471).

The plaintiffs worked at BBC, but were

unable to cope with its business problems.

Plaintiffs were directed to use the ready

cash they had brought with them from their

companies to pay BBC's’- back bills,

including $50,000 to Weinberg and Green.

(72). Because of the financial problems

facing Rosenberg and Yale, the refinancing

efforts failed. Rosenberg and Jaeger knew

that they could not get financing, yet

continued to misrepresent this fact to the

plaintiffs. (474).

Sometime in 1984, Barry Rothberg and

Rosenberg had formed Yale Sportswear. Also

in 1984, Rosenberg acquired a 50% interest

in BBC, then owned by Brian Schiner and

Stephen Rutkovitz. (475). A partner of

Weinberg and Green, Michael Hodes,

introduced Rosenberg to these three men and

represented that Rosenberg had a net worth

in excess of $7,000,000. (Q75).

Plaintiffs also allege that Rosenberg knew

that Hodes had represented him as being

worth over $7,000,000 and perpetuated the

image of a successful millionaire until his

EEE

bankruptcy filing and that Rosenberg

deliberately concealed his financial

problems and de facto insolvency in 1986

and 1987 from Schiner, Rutkovitz ~

Rothberg. (475).

In the spring of 1987, Rosenberg and

Jaeger told the plaintiffs that a buyer for

Yale had been found and that a sale was

imminent. In reliance on their

representations and believing Rosenberg to

be in good financial health, plaintiffs

made a "bridge" loan of $150,000 to BBC out

of their personal funds. The loan was

personally guaranteed by Rosenberg. (476).

In truth, Yale had a high debt/equity ratio

which meant that it had little equity to

sell and no sale was imminent. (q82).

Rosenberg and Jaeger willfully and

maliciously misrepresented the possible

sale of Yale to induce the plaintiffs to

loan BBC $150,000 and continue to work for

BBC. (483). The plaintiffs did not become

aware of the true financial problems facing

Yale and Rosenberg until Yale filed for

protection under Chapter 11 of the

Bankruptcy Code. (476).

Through the misrepresentations of

Rosenberg's and Yale's financial

situations, Rosenberg and Jaeger intended

to deceive their victims, plaintiffs,

Schiner, Rutkovitz and Rothberg, to provide

services to Rosenberg's companies and to

cooperate by guaranteeing loans or

subordinating debt. (477). In December of

1986, Schiner and Rutkovitz, believing in

Rosenberg's financial health, agreed to

sell their stock in BCI. (478). They also

accepted unsecured promissory notes in

exchange for their MER stock in July of

1987. Barry Rothberg and his’ wife

personally guaranteed loans from First

American Bank of Maryland to Rosenberg and

Yale made on July 23, 1986. (479). In the

spring of 1987, Rothberg sold 20% of his

stock in Yale to Rosenberg, becoming a

minority shareholder. Plaintiffs contend

that Rosenberg knew he was insolvent by

November or December of 1986, yet continued

to represent himself as being wealthy and

solvent in order to keep his victims

working for his companies. (4480 and 81).

Rosenberg transferred assets’ into

tenancy by the entirety property, placing

them beyond the reach of creditors with the

intent of retaining his assets in the event

of bankruptcy. (484).

In his bankruptcy proceeding,

Rosenberg has asserted $1,200,000 in exempt

tenancy by the entirety property. He seeks

to discharge debt and liabilities on

personal guaranties in excess of

$20,000,000. (Q87). Plaintiffs believe

that the funds used to amass those tenancy

by the entirety properties came from

themselves and other creditors. (Id.).

II. RICO

Rosenberg and Jaeger move to dismiss

the RICO count on the ground that

plaintiffs fail to allege a pattern of

racketeering activity. (Paper No. 75 at 2-

6).*7 The applicable sections, 18 U.S.C.

§1962(a), (b), and (c), impose criminal and

civil liability on any person who, through

a pattern of racketeering activity, (a)

uses or invests income to acquire an

2 Other arguments were raised in

Rosenberg's motion to dismiss the first

amended complaint. (Paper No. 18). These

were adopted and incorporated along with a

supplemental memorandum in support thereof

(which itself incorporated defendant

Weinberg and Green's motion to dismiss the

first amended complaint) and the reply

memorandum, as well as defendant Weinberg

and Green's motion to dismiss the second

amended complaint. (Paper No. 75 at 3 n.2

and 11). Just the two sets of papers on

the Rosenberg motions number over 100

pages and run afoul of the _ length

restrictions of Local Rule 105.3.

Furthermore, it is unclear which of the

earlier RICO arguments remain relevant in

light of the additional facts in the

second amended complaint. For these

reasons, the undersigned will only

consider the other papers where specific

pages are referenced and the arguments are

obviously relevant.

interest in, or to operate an enterprise

engaged in interstate commerce; (b)

acquires or maintains an interest in or

control of such an enterprise; and (c) when

employed by or associated with such an

enterprise, conducts or participates in the

conduct of its affairs. Bad css Va

Northwestern Bell Telephone Co., 109 S.Ct.

2893 (1989). Section 1964(c) provides for

treble damages, costs and attorneys fees

for successful plaintiffs. In H.J., Inc.,

the Supreme Court considered what was

necessary to establish a pattern of

racketeering. First, the definition of

"nattern of racketeering activity" in

§1961(5) “requires at least two acts of

racketeering activity one of which occurred

after [October 15, 1970] and the last of

which occurred within 10 years (excluding

any period of imprisonment) after the

commission of a prior act of racketeering

activity." 109 §.ct. at 2899.

Additionally, it is necessary to show "that

the racketeering predicates are related and

a fe) e eat _o

continued criminal activity." 109 S.Ct. at

2900. "'[(Cjriminal conduct forms a pattern

if it embraces criminal acts that have the

same or similar purposes, results,

participants, victims, or methods of

commission, or otherwise are interrelated

by distinguishing characteristics and are

not isolated events.'" 109 S.Ct. at 2901

(quoting 18 U.S.C. §3575(e)).

It is more difficult to enunciate a

general test for continuity, but guidance

was provided to lower courts.

"'Continuity' is both a closed- and open-

ended concept, referring either to a closed

period cf repeated conduct, or to past

conduct that by its nature projects into

the future with a threat of repetition."

109 S.Ct. at 2902 (citation omitted).

Further:

A party alleging a RICO violation

may demonstrate continuity over

a closed period by proving a

series of related predicates

extending over aé_e substantial

period of time. Predicate acts

extending over a few weeks or

months and threatening no future

criminal conduct do not satisfy

this requirement: Congress was

concerned in RICO with long term

criminal conduct. Often a RICO

action will be brought before

continuity can be established in

this way. In such’ cases

liability depends on whether the

threat of continuity is

demonstrated.

Id. (citation omitted).

The determination of continuity is

fact-based and the Court provided several

examples of how the continuity element

might be satisfied. One such situation is

where the related predicates themselves

involve a distinct threat of long-term

racketeering activity, either implicit or

explicit. As illustration the Court cited

a case where hoodlums sell insurance to

storekeepers in a neighborhood, returning

each month to collect their premiun. A

separate situation is where the predicate

acts "are part of an ongoing entity's

regular way of doing business" such as "a

long-term association that exists for

criminal purposes." This is not limited to

organized crime. In accordance with the

foregoing analysis, the Court reversed and

remanded the district court dismissal of a

case where it was alleged that, over at

least a six-year period, numerous bribes

were given to five members of the Minnesota

Public Utilities Commission to persuade

them to approve unfair and unreasonable

rates for Northwestern Bell. The Court

reasoned that the alleged acts of bribery

had a common purpose of influencing the

commissioners, that a six-year period may

be sufficient to satisfy the continuity

requirements or, alternatively, that a

threat of continuing racketeering activity

might be established if the bribes were

shown to be a regular way of conducting

business.

The Fourth Circuit reconsidered the

case of Walk v. Baltimore and Ohio

Railroad, 890 F.2d 688 (4th Cir. 1989), in

light of H.J., Inc. This time, the court

reversed the dismissal of RICO claims ina

case where the minority shareholders were

forced out of a single corporate structure.

The prior dismissal had focused improperly

on the closed ended character of the acts

and had not given sufficient consideration

to the many alleged acts of mail and wire

fraud over a ten-year period. The Fourth

Circuit noted the Supreme Court suggestion

in H.J., Inc. that the substantial duration

requirement would not be satisfied by

conduct lasting "only a few weeks or months

and threatening no future criminal conduct

- « «," but held that a six-year period

might satisfy the requirement.

Another case decided since H.J., Inc.

is particularly helpful in illustrating the

test for a pattern. In Menasco, Inc. Vv.

Wasserman, 886 F.2d 681 (4th Cir. 1989),

the Court of Appeals for the Fourth Circuit

upheld the lower court's dismissal of the

RICO claims, but granted leave to amend in

light of the decision in H.J., Inc. A

defendant in that case, Barry Wasserman,

allegedly induced two physicians to invest

in the oil business. Two new oil companies

would be formed, Menasco, Inc. and Lucky

Two, Inc. The two doctors would serve as

presidents and directors of the

corporations. Wasserman was an attorney

and principal of Sounion Petroleum, Inc.,

also named as a defendant. The plaintiffs

contended, inter alia, that Wasserman acted

to benefit Sounion by soliciting

assignments of Rights of Action from

plaintiffs and renegotiating a lease on an

oil well, to the detriment of plaintiffs

and the benefit of Sounion, and then

transferring funds from Sounion to other

companies to shelter his funds and render

himself judgment proof. 886 F.2d at 682.

The Menasco court noted that the test of

continuity plus’ relationship is’ fact

specific and commensensical rather than

formulaic and said:

Continuity, in turn, refers

"teither to a closed period of

repeated conduct, or to past

conduct that by its’ nature

projects into the future with a

threat of repetition' FF

Inc.]) at 2909 (emphasis added).

To satisfy the continuity

element, a plaintiff must show

that ‘the predicates themselves

amount to, or . . . otherwise

constitute a threat of,

continuing racketeering

activity." (Id. at 2901)

(emphasis in original).

Significantly, "({p]redicate acts

extending over a few weeks or

months and threatening no future

criminal conduct do not satisfy

this requirement: Congress was

concerned in RICO with long-term

criminal conduct." (Id. at

2902).

886 F.2d at 683-84. The court found that

the plaintiff's allegations failed to

satisfy the continuity prong of

RICO's pattern requirement.

Defendants' action were narrowly

directed toward a single

fraudulent goal. They involved

a limited purpose: to defraud

Menasco, Inc. and Lucky Two, Inc.

with respect to their oil

interests. They involved but one

perpetrator: Wasserman. They

involved but one set of victims:

Menasco and Lucky Two. Finally,

the transaction took place over

approximately one year. Clearly,

these acts do not’ constitute

"ongoing unlawful activities

whose scope and persistence pose

a special threat to social well-

being."

886 F.2d at 684 (quoting International Data

Bank Ltd. v. Zepkin, 812 F.2d 149, 155 (4th

Cir. 1987)).

Plaintiffs contend that Rosenberg

committed multiple acts of wire, mail and

securities fraud in connection with (1)

acquiring VAMCO and ABC; (2) inducing the

$150,000 loan; (3) acquiring the interests

of Schiner and Rutkovitz in BCI and later,

MER; (4) inducing the Rothbergs to guaranty

debt for Yale; and (5) acquiring 20% of

Rothberg's interest in Yale. The complaint

states that "[t]he essence of Rosenberg and

Jaeger's scheme to defraud was to .. .

induce the plaintiffs and additional

victims, Schiner, Rutkovitz or Barry

Rothberg, to continue to provide services

cee Rosenberg or Rosenberg-controlled

companies . .." (477). Rosenberg aimed

to keep his companies "viable and [to]

rescue Rosenberg from insolvency." (481).

Plaintiffs are, therefore, alleging a

single scheme by Rosenberg and Jaeger to

keep Rosenberg's companies afloat. This

scheme was ended in failure when Yale and

then Rosenberg filed for bankruptcy.”

Therefore, it is a closed-ended scheme and

must be analyzed as such.

While it is true that multiple

predicates within a single scheme may

constitute criminal activities which have

long-term and widespread consequences that

might constitute ongoing, unlawful

3 The date of Rosenberg's personal

bankruptcy filing is not contained in the

second amended complaint. Yale is said to

have filed in September, 1987 (4125), but

that information is not in any of the

paragraphs contained in the RICO count

((G1-110).

activities whose scope and persistence pose

a special threat to social well-being, this

scheme does not qualify. Here, plaintiffs

have alleged, at most, five victims. These

are Ivan and Joanne Schatz, Schiner,

Rutkovitz and Rothberg.** The Menasco court

viewed Wasserman and his company, Sounion,

as one defendant. Similarly, here,

defendant Rosenberg and MER may be viewed

as one defendant. Even adding defendant

Jaeger would not significantly change the

scenario because the purpose of the

defendants' actions was said to be to keep

the companies they controlled viable.

Thus, there are, at most, two defendants

with one goal. There are no more than five

victims and the acts allegedly took place

ms The paragraphs pertaining to

other victims are nos. 18, 20, 23, 27, 28,

38, 75, 77 and 8g5. Plaintiffs several

times allege that "others" were

victimized. The vague allusion to other

unidentified victims cannot be enough to

satisfy RICO's requirement of a pattern.

over no more than a 1 1/2 year period.’

The nature of the alleged fraud does not

lend itself to repetition - but instead had

to succeed or fail (as it did) in a

relatively short period of time. As in

Menasco, these acts clearly do not

constitute "ongoing unlawful activities

whose scope and persistence posed a special

threat to social well-being."

Accordingly, it is respectfully

recommended that plaintiffs' RICO claim be

dismissed. The second amended complaint

was filed before the Supreme Court decided

H.J., Inc., raising the question whether

the dismissal should be with or without

a The defendants claim that the

wire and mail fraud occurred during 1986

and 1987. (({¥107-108). They also stated

that they were approached by Rosenberg

with this business proposition in mid-

1986. (30). No specific acts of wire,

mail or securities fraud were alleged as

occurring any earlier than that. Despite

plaintiffs' claims in 4432 and 67 that

communications were made over the

telephone and through the aail, no

specific incidents are detailed in the

complaint.

prejudice. The Fourth Circuit has

expressed an inclination to allow leave to

amend a complaint filed before H.J., Inc.

was decided, Menasco, 886 F.2d at 685.

Here, plaintiffs have already amended

twice, albeit not based on any deficiency

declared by a court. Therefore, dismissal

without prejudice is appropriate.

III. Securities Claims

A. Statute of Limitations

The defendants claim that all counts

making securities claims are time barred

because they were not brought within the

one-year statute of limitations.

Plaintiffs concede that a one-year statute

____ of limitations applies both to §12(2) of

the 1933 Act*® and to §10(b) of the 1934

No action shall be maintained to

enforce any liability created

under section 77k or 771(2) of

this-title unless brought within

one year after the discovery of

the untrue statement or the

(continued...)

not." They further agree that facts

indicating that a §12(2) securities claim

is timely brought must be affirmatively

plead, but argue that the same is not

necessary for the §10(b) violations.

*©(,..continued)

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 771(1) of this

title, unless brought within one

year after the violation upon

which it is based.

‘7 When the federal statute creating

a cause of action contains no statute of

limitations, an analogous’ statute of

limitations of the forum state is applied.

Here, that period is one year under Md.

Corp. & Ass'ns. Code Ann. §11-703(f)

(Maryland's blue sky law). O'Hara _ v.

Kovens, 625 F.2d 15, 17 (4th Cir. 1980),

cert. denied, 449 U.S. 1124 (1981); Morley

v. Cohen, 610 F. Supp. 798, 818 (D.Md'

1985). That section provides, in part:

An action may not be maintained

- « »- unless brought within one

year after the discovery of the

untrue statement or omission, or

after the discovery should have

been made by the exercise of

reasonable diligence.

Finally, plaintiffs claim that they have

alleged sufficient facts, in any event.

The original complaint was filed on

June 27, 1988, and the securities law

violations allegedly occurred on or about

December 31, 1986, when the plaintiffs

transferred their stock in VAMCO and ABC

and received the promissory notes. The

second amended complaint contains sparse

reference to plaintiffs' discovery of the

alleged fraud . First, 476 asserts that

"when Yale filed for bankruptcy, plaintiffs

first became aware of the true outs of

Yale's financial problems and Rosenberg's

true financial situation." Significantly,

no date is given for the bankruptcy filing.

This is the only reference to discovery

through the end of Count III. In Count IV,

in qi25, plaintiffs first recite

specifically that:

Plaintiffs were unaware of the

material misrepresentations and

omissions, and in the exercise of

reasonable care, could not have

known of such misrepresentations

and omissions until September of

1987 when Yale declared

bankruptcy. The Plaintiffs acted

diligently at all times, but

failed to discover the true facts

because they received convincing

explanations and assurances from

Rosenberg and Jaeger from January

through September of 1987 and

because they were busy working

for BCI under Rosenberg's and

Jaeger's direction.

Beyond that, plaintiffs argue that other

facts alleged in the second amended

complaint imply that they had no earlier

knowledge of the fraud and that they acted

diligently.

Concededly, a plaintiff's burden under

15 U.S.C. §77m is to plead compliance with

the statute of limitations, including a

statement of the due diligence in seeking

discovery of the misstatements, Shotto v.

Laub, 635 F. Supp 835, 837 (D.Md. 1986).

Thus, for Count IV and a portion of Count

VI, at least, plaintiffs must meet that

requirement. They contend that this

affirmative pleading requirement does not

apply to Counts II and III, but is instead

an affirmative defense to be plead by

defendants. The cases they cite do not so

hold.

The court in Brick vv. Dominion

Mortgage & Realty Trust, 442 F. Supp. 283,

304 (W.D.N.Y. 1977), did not hold that it

was unnecessary to allege fraudulent

concealment in the complaint, but only that

such allegations as were made there were

sufficient to withstand a motion to

dismiss. Further, In re: U.S. Oil and Gas

Litigation, 1988 U.S. Dist. Lexis 2217*

(S.D.Fla. 1988), makes the unremarkable

statement that the plaintiffs' contention

that "the fraud was not’ reasonably

discoverable before it was made public by

the filing of the FTC enforcement action"

‘ - “raises a fact question not

resolvable as a matter of law." The cases

cited by the Florida court are no more

helpful. Cavic v. Grand Bahama Development

Co., Ltd., 701 F.2d 879, 888 n.6 (11th Cir.

1983), dealt with the issue after a jury

determination; Briskin v. Ernst & Ernst,

589 F.2d 1363, 1367 n.3 (9th Cir. 1978),

applied California law on a_-— summary

judgment motion; and Boyd v. Merrill Lynch,

Pierce, Fenne= & Smith, 611 F. Supp. 218,

220 (S.D. Fla. 1985), found the allegations

sufficient to toll the Florida statute of

limitations, although the court would "be

more comfortable had plaintiff alleged that

defendants concealed their activities

despite her numerous inquiries."

On the other hand, other decisions

have found "no significant difference, with

respect to the pleading requirements,

between tolling a limitation period by

express beakekney provisions and by the

equitable doctrine of fraudulent

concealment." Conley v. First Jersey

Securities, Inc., 543 F. Supp. 368, 374

(D.Del. 1982).

As stated above, the second amended

complaint is silent through Count III as to

when the Yale and Rosenberg bankruptcies

were filed or why the alleged fraud could

not have been discovered earlier.

Accordingly, it is respectfully recommended

that Counts II and III be dismissed, unless

plaintiffs amend within an appropriate

period of time to allege facts sufficient

to overcome ae statute of limitations

problen.

Defendants' claim that allegations

made earlier in the first amended ccmplaint

preclude the making of such assertions

should be rejected. Whatever evidentiary

use defendants may later make of a now

discarded pleading does not affect

plaintiffs' ability to plead facts as they

claim them to be.

Count IV and Count VI are not subject

to dismissal on these grounds. Count IV,

in 4125, makes the necessary factual

allegations that plaintiffs discovered the

misrepresentations in September, 1987, and

that they were sufficiently diligent before

that because "they received convincing

explanations and assurances from Rosenberg

and Jaeger from January through September

of 1987 and because they were busy working

for BCI under Rosenberg's and Jaeger's

direction." Count VI, as all counts from

II on, incorporates all earlier paragraphs,

including the necessary allegations in

q125. For these reasons, Counts IV and VI

should not be dismissed on statute of

limitations grounds.

B. Promissory Notes as Securities

The Rosenberg defendants raise a

threshold issue regarding Count IVs

whether the promissory notes here

constitute securities within the meaning of

q12 of the 1933 Act.

Plaintiffs contend that they exchanged

an 80% interest in their businesses for

unsecured promissory notes, issued by MER

and personally guaranteed by neoenewe,

totalling $1.5 million. (4435, 37, 62, and

121-28). They also state that they would

not have entered the agreement without

Rosenberg's guaranty. ((122). The notes

are tendered to MER and Rosenberg in 4127.

Defendants move to dismiss this count

arguing that the promissory notes in

question were not securities. The basis

for the argument is that plaintiffs could

not have reasonably expected to derive

profits from the entrepreneurial or

managerial efforts of others because Mr.

Schatz was the president and chief

operating officer of BCI and Vertech.*

(Paper No. 75 at 7-9). Defendants refer to

the December 31, 1986, agreement (the

- Defendants also state that when

promissory notes are given as partial

consideration for the acquisition of a

business they are not generally held to be

securities. The argument is not

developed.

agreement) between the parties to support

this argument and invite the Court to

convert this portion of the motion into a

motion for summary judgment. (Id. at 9

n.5).

Plaintiffs admit that the ultimate

question of whether an investment is a

security is one of law, but argue that

where the facts are in dispute the question

cannot be decided on a motion to dismiss

and that the defendant bears the burden of

demonstrating that the notes are not

securities. (Paper No. 50 at 34-35).

Plaintiffs, however, have not pointed to

any disputed facts. Rather, they set out

the uncontroverted terms of the notes and

allege that, despite the fact that Mr.

Schatz was the president of BCI, the

company was “owned and controlled by Mark

E. Rosenberg through MER Enterprises, Inc."

(Id. at 36).°°

The parties to the agreement are MER

and Mr. and Mrs. Schatz.” MER is

identified by plaintiffs as a holding

company, owned 5% by them and 95% by

Rosenberg, established to purchase some

portion of the stock in VAMCO, ABC and BCI.

(G19, 35, 36 and 61). Plaintiffs identify

its assets as Vertech and BBC.”* (4420 and

21). Plaintiffs allege that the parties

9 Plaintiffs also point to §5.2.2 of

the agreement providing for additional

compensation should the companies' cash

flow exceed $400,000. That provision comes

within the purchase price section, payment

of which is not tied to the notes. Copies

of the notes attached to plaintiffs'

opposition show they are to earn 9%

interest and that all principal and accrued

interest remaining unpaid on December 31,

1996, “shall be due and payable on such

date." (§b).

” Rosenberg and Jaeger join the

agreement "for the purposes of making

certain covenants in their presentations

to the Plaintiffs." (463).

2+ BBC is the current name of the

company formerly known as BCI and

consisting of BCI, VAMCO and ABC.

planned eventually to merge BCI with Yale,

said to be owned and controlled by

Rosenberg, and then to take MER public.

(¥46c). It was understood that Rosenberg

would handle financing and raise enough

money to pay existing debts and provide

working capital for the new firm. (446b).

Attached to plaintiffs' opposition are

copies of the agreement and the promissory

notes. (Paper No. 80, Exhibit B). Each

note was in the amount of $375,000 with the

interest payable quarterly beginning March

31, 1987, at a rate of 9% per annum. The

borrower could defer the interest payments

in the years 1987 and 1988. Principal was

payable annually on March 31st beginning in

1988. Payment was to be 6.25% of the net

cash flow of the Back Companies for the

preceding years.” All principal and

accrued interest remaining unpaid on

*2 The Back Companies are defined as

BCI, Vertech, VAMCO and ABC.

December 31, 1996, "shall be due and

payable in full on such date." Rosenberg

personally guaranteed the notes and

warranted that he and the borrower are

related entities and share financial

interests.

"Whether a particular interest is a

‘security' is both a question of subject

matter jurisdiction and an element of [a

plaintiff's] asserted claims under the

federal securities laws." Rivanna Trawlers

v. Thompson Trawlers, 840 F.2d 236, 289

(4th Cir. 1988); Goldman _v. Gallant

Securities, Inc., 878 F.2d 71 (2d Cir.

1989). In Rivanna Trawlers, plaintiffs

claimed that a general partnership interest

was a security. Defendants moved to

dismiss and, according to Justice Powell,

the lower court appropriately converted a

motion to dismiss into a motion for summary

judgment and decided the issue on the

merits. Similarly, here, the defendants

invite the Court to convert this portion of

the motion to a motion for. summary

judgment.

In a motion for summary judgment,

the moving party is entitled to

summary judgment if, viewing the

evidence in the light most

favorable to the nonmoving party,

there is no genuine issue as to

any material fact and if the

moving party is entitled to

judgment as a matter of law.

Anderson v. Liberty Lobby, Inc.,

477 U.S. 242, 250, 106 S.Ct.

2505, 2511, 91 L.Ed.2d 202

(1986). The party opposing a

properly supported motion for

summary judgment may not rest

upon mere allegations or denials

of his pleading, but must set

forth specific facts showing that

there is a genuine issue for

trial. 34. 106 8.Ct. @¢ 2814.

Rivanna, 840 F.2d at 239-40.

The Securities Act of 1933, 15 U.S.C.

§77(b) (1) defines a security as follows:

The term "security" means any

note, stock, treasury stock,

bond, debenture, evidence of

indebtedness, certificate of

interest or participation in any

profit sharing agreement,

collateral-trust certificate,

pre-organization certificate or

subscription, transferable share,

investment contract, voting-trust

certificate, certificate of

deposit for a security,

fractional undivided interest in

oil, gas or other mineral rights,

or, in general, any interestor

instrument commonly known as a

"security", or any certificate of

interest or participation in,

temporary or interim certificate

for, receipt for, guarantee of,

or warrant or right to subscribe

to or purchase any of the

foregoing.

Despite the "any note" language, not

every note is ae security. Oliver v.

Bostetter, 426 F. Supp. 1082, 1085 (D.Md.

1977) (Blair, J.), and cases cited therein.

Most circuits that have considered the

question have adopted the commercial-

investment test to determine when a

promissory note is a security:

Under this test, the court looks

to see whether a transaction more

closely resembles typical

investment situations or typical

mercantile or commercial

transactions to determine the

applicability of the security

laws. The ‘investment vs.

commercial' approach focuses on

the degree to which the plaintiff

is dependent upon the expertise

and efforts of others.

Futura Development Corp. v. Center Corp.,

761 F.2d 33, 40-41 (1st Cir.), cert.

denied, 474 U.S. 850 (1985). Accord,

Association of American R.R. v. U.S., 603

F.2d 953 (D.C. Cir. 1979); CNS Enterprises,

Inc. v. G & G Enterprises, Inc., 508 F.2d

1354 (7th Cir.), cert. denied, 423 U.S. 825

(1975); McClure v. First National Bank, 497

F.2d 490 (5th Cir. 1974), cert. denied, 420

U.S. 930 (1975); Zabriskie v. Lewis, 507

F.2d 546 (10th Cir. 1974); Lino v. City

Investing Co., 487 F.2d 689 (3d Cir. 1973).

Judge Blair concluded that the Fourth

Circuit would adopt that test if faced with

the questions. Oliver, 426 F. Supp. at

1085. Later, Judge Wilkins, in South

Carolina National Bank v. Darmstetter, 622

F. Supp. 226, 229 (D.C.S.C. 1985), aff'd,

813 F.2d 1227 (4th Cir. 1986), cert.

denied, 479 U.S. 1065 (1987), echoed that

conclusion and pointed out that language in

Lawler v. Gilliam, 569 F.2d 1283, 1287 (4th

Cir. 1987), supported their view.

It is less clear how to gauge the

nature of the note. The First Circuit

examines each case considering the combined

effect of:

[t]he size of the offering;

whether there is, by necessity,

reliance on the expertise of the

issuer; the purpose of the issuer

in executing the note; and the

economic inducements held out to

the prospect .. . the degree to

which the profit on the note is

in the hands of the maker rather

than the payee; whether’ the

object of the holder was to

acquire an interest in the

property or enterprise; whether

the note was primarily commercial

because it was serving as a "cash

substitute" for the purchase

price; and whether the return on

the note was predetermined or

could reasonably be anticipated

or was subject to the managerial

efforts of the maker.

Futura Development Corp. v. Center Corp.,

761 F.2d at 41. The Fifth Circuit also

follows a case by case approach examining

"(t)he economic realities underlying (the)

transaction . . ." Williamson v. Tucker,

645 F.2d 404, 427 (5th Cir.), cert. denied,

454 U.S. 897 (1981), quoting United Housing

Foundation, Inc. v. Forman, 421 U.S. 837,

849, reh'g denied, 423 U.S. 884 (1975).

Without identifying all potentially

relevant factors, the Fifth Circuit has

considered significant: an expectation of

profit from the enterprise, Bellah v. First

National Bank of Hereford, Texas, 495 F.2d

1109 (5th Cir. 1974); and whether notes

were offered to some class of investors or

acquired for speculation or investment, or

issued to rejuvenate an enterprise. S.E.C.

Continental Commodities Corp., 497 F.2d 516

(5th Cir. 1974).

Judge Blair believed the better

approach to be "to examine the note sub

judice for its investment aspects. If the

note meets the test set forth in SEC v.

W.J. Howey Co., [328 U.S. 293 (1946)] for

determining whether an investment contract

is a security, then the note is a security

- « « -" Qliver, 426 F. Supp. at 1185-86.

The Howey test for an investment contract

requires (1) the investment of money (2) in

a common enterprise from which (3) profits

are expected solely from the efforts of a

promoter or third party. 328 U.S. at 298-

99. The Supreme Court has said that the

touchstone of the test is "an investment in

a common venture premised on a reasonable

expectation of profits to be derived from

the entrepreneurial or managerial efforts

of others." Forman, 421 U.S. at 852.

The third prong of the test is the one

at issue in this case and the one over

which most disputes have centered. It has

been liberalized in several circuits so

that "solely" is not given a literal

interpretation. In Williamson, 645 F.2d at

418, the Fifth Circuit agreed with the

Ninth Circuit's view that the test is

“whether the efforts made by those other

than the investor are the undeniably

significant ones, those essential

managerial efforts which affect the failure

or success of the enterprise," S.E.C. v.

Glenn W. Turner Enterprises, Inc., 474 F.2d

476, 482 (9th Cir. 1973), cert. denied, 414

U.S. 821 (1973). The Williamson approach

was applied by the Eleventh Circuit in

Gordon v. Terry, 684 F.2d 736, 741 (11th

Cir. 1982), cert. denied, 459 U.S. 1203

(1983).

To support their argument, defendants

point to the agreement, §3.7, providing for

the employment of Mr. Schatz as president

and chief operating officer of BCI and

Vertech and the employment of Mrs. Schatz

in a management and consulting capacity.”

*> The test of §3.7 provides:

for the employment of Mr. Schatz

for the years 1987 and 1988 as

President and Chief Operating

Officer of BCI, Vertech, VAMCO

and ABC and their successors

with broad operating authority

and responsibilities, subject

only to supervision of the

(continued...)

100

At first blush, defendants' argument

appears well-taken. Mr. Schatz was

president and chief operating officer of

the Back Companies. Thus, the argument

that Rosenberg controlled the companies and

that they were dependent on his efforts for

23(...continued)

Boards of Directors of such

corporations and to the business

plans inclusive of operating

budgets and personnel policies

approved by the Boards of

Directors of such corporations.

Mr. Schatz' compensation under

the Employment Agreement shall

consist of (i) an annual salary

of $75,000; (ii) an annual

business expense of $25,000; and

(iii) a new automobile selected

by Mr. Schatz with the purchase

price not the exceed $25,000.

The combined budgets for BCI,

Vertech, VAMCO and ABC for the

years 1987 and 1988 shall

include the following

compensation for Joanne B.

Schatz in consideration of

consulting and management

services to be rendered by Mrs.

Schatz: (i) an annual salary of

$48,000; and (ii) a new

automobile selected by Mrs.

Schatz with a purchase price not

to exceed $20,000.

(Paper No. 80, Ex. B at §3.7).

101

their expected profits falters. A close

examination of the record, however, reveals

the potential flaws in the defendants'

position. The agreement itself muddies the

water and prevents a grant of summary

judgment. Although none of the parties

contend in their moving papers that MER

owned Yale, §3.1 - titled "Corporate

Status" - asserts that "[b]uyer [MER] has

at least a fifty percent (50%) ownership

interest in Yale Sportswear Corporation

- « « -" Yale has been identified as a

Rosenberg controlled corporation whose

financial status played an important role

in inducing plaintiffs to enter’ the

agreement. It is not contested that

plaintiffs had no role in Yale's

management. If, as the agreement reflects,

MER owned half of Yale, there is at least

a question raised about whether Rosenberg's

efforts in managing Yale were’ the

undeniably significant ones required to

102

convert these promissory notes into

securities. Furthermore, the notes were

not to be paid in full until the end of

1996, long after the time frame covered in

the employment contracts. Finally, the

payment of the notes from the net cash flow

of the Back Companies implicates their

overall financial health, including payment

of other debts. Rosenberg was’ surely

involved in that aspect of the Back

Companies.

Given the current state of the record,

granting summary judgment would not be

appropriate and it is respectfully

recommended that the defendants' motion for

summary judgment on Count IV be denied.

C. The Fraud Counts - Particularity

Rosenberg's attempts to incorporate

earlier motions and memoranda are

especially unfortunate in regard to their

argument that the fraud counts are not

plead with sufficient particularity. This

103

Court should not have to compare the prior

complaints with the current one and then

divine which arguments still apply.

D. Weinberg and Green

Defendant Weinberg and Green moves to

dismiss Count III, alleging a _ primary

violation of §10(b) of the Securities

Exchange Act of 1934 and Count VI, alleging

aiding and abetting liability under §10(b)

of the 1934 Act and §12(2) of the

Securities Act of 1933.

1. Count IIT

This count alleges primary liability

of Weinberg and Green for violations of

§10(b) of the Securities Exchange Act of

1934 and Rule 10(b) (5) set out in 17 C.F.R.

240.10b-5.

Section 10(b) is codified as 15 U.S.c.

§78j)(b). That section makes it unlawful

for any person, directly or indirectly, in

connection with the purchase or sale of a

security to use or employ any "manipulative

104

or deceptive device or contrivance in

contravention [of federal securities

regulations]."

i7 C.F.R §240.10b-5 provides:

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

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.

17 C.F.R. §240.10b-5.

In its motion to dismiss, Weinberg and

Green argues that transmitting information

provided by a client or drafting documents

containing a client's misrepresentations do

105

not equal a misrepresentation by an

attorney and that, in the absence of

misleading statements, a duty to disclose

only exists when there is a fiduciary

relationship between the parties.

In Schlifke v. Seafirst Corp., 866

F.2d 935, 943 (7th Cir. 1989), a case

relied on by both plaintiffs and

defendants, the court set out the elements

of primary liability under §10(b) and Rule

10b-5. These include (1) an _ untrue

statement of material fact or an omitted

material fact that rendered the statements

made misleading, (2) in connection with a

securities transaction, (3) with the intent

to mislead, and (4) which caused

plaintiff's loss. Before liability can

attach to omissions, a further element must

be shown: "When an allegation of fraud is

based upon non-disclosure, there can be no

fraud absent a duty to speak." Chiarella v.

United States, 445 U.S. 222, 235 (1979);

106

Jett v. Sunderman, 840 F.2d 1487, 1493-97

(9th Cir. 1988); Barker v. Henderson,

Franklin, Starns and Hold, 797 F.2d 490,

495-96 (7th Circ. 1986). Accord, Rose v.

Arkansas Valley Environmental and Utility

Authority, 562 F. Supp. 1180, 1206-1207

(W.D.Mo. 1987). The mere possession of

nonpublic information does not trigger a

duty to disclose under §10(b). The duty

cannot come from the securities

regulations. Rather, the duty arises "from

a relationship of trust and confidence

between parties to a transaction," i.e., an

outside fiduciary relation, Chiarella, 445

U.S. at 230; Jett, 840 F.2d at 1493. To

hold otherwise would result in a circular

inquiry. Barker v. Henderson, Franklin,

Starns & Hold, 797 F.2d 490, 496 (7th Cir.

1986). Thus, in order to state a claim of

primary liability against Weinberg and

Green, plaintiffs must allege either a

fiduciary duty running to them or an

107

affirmative misrepresentation by Weinberg

and Green.

a. Duty

Cases cited by plaintiffs to establish

a duty are inapposite. For example, in

Renovitch v. Stewardship Concepts, Inc.,

654 F. Supp. 353, 359 (N.D.Il1l. 1987), the

attorneys were alleged to have either

helped prepare or approved statements made

in the brochures used to induce the sale of

the securities and liability on an aiding

and abetting theory was urged. Here,

plaintiffs do not allejye that’ this

defendant had any role in the preparation

of the March 31st financial statement or

even that it had seen the statement before

it was presented to them by Rosenberg. The

allegations concerning the update letter

merely state that the firm drafted or

assisted in drafting the letter for

Rosenberg, forwarded a copy of the letter

to Arent, Fox and discussed and agreed on

108

the language, referencing the letter, to be

used in the agreement. Nor does the

plaintiffs' attempted reliance on the

Fourth Circuit's decision in Bonavire v.

Wampler, 779 F.2d 1011, 1014-16 (4th Cir.

1985), support the argument that Weinberg

and Green was under a duty to disclose

Rosenberg's alleged misrepresentation.

Bonavire involved common law fraud where an

attorney had affirmatively represented to

certain investors that her client was an

honest man who was capable of performing as

promised.

In Schlifke, the court rejected -an

argument that a bank had an independent

duty arising from a quasi-fiduciary

relationship with investors based upon a

contractual relationship between plaintiffs

and the bank. The court said:

(T)he Supreme Court has held that

parties to an impersonal market

transaction owe no duty of

disclosure absent a fiduciary or

agency relationship, prior

dealings or circumstances such

109

that one party has placed trust

and confidence in the other. See

Dirks v. SEC, 463 U.S. 646, 653-

54, 103 S.Ct. 3255, 3260-61, 77

L.Ed.2d 911 (1983); Chiarella,

445 U.S. at 232, 100 S.Ct. at

1116. In a factually similar

case, Jett v. Sunderman, 840 F.2d

1487, the Ninth Circuit recently

held that a bank that had made a

loan to a limited partnership

owed no duty of disclosure to the

investors because

[the Bank] had no relationship

with the investors prior to their

making the investment ... [T]he

Bank had no communications with

the investors and did not

initiate the transaction oor

participate in it in any way that

would induce the investors to

rely on the bank to disclose

information... .

Id. at 1493.

Schlifke, 866 F.2d at 945. The court went

on to find that the contract between the

parties did not create aie fiduciary

relationship, and the bank's lack of direct

dealings with the investors and mere

drafting of loan documents and

establishment of requirements to insure its

interests as a lender was "not the sort of

prior dealings or circumstances creating a

110

relationship of trust and confidence as

envisioned by Chiarella." (Id. at 945-46)

(footnote omitted).

Barker v. Henderson, 797 F.2d at 493,

concerned the issuance of bonds and notes

secured by its interest in land to be

developed as a retirement village by the

Michigan Baptist Foundation, Inc. (the

Foundation). Named as defendants, among

others, were a law firm and an accounting

firm, who had provided, respectively, legal

advice and accounting services to the

Foundation. In October of 1976, the

trustee for the bonds refused to

participate further. For the next

seventeen months, the Foundation continued

to sell unsecured notes. The court assumed

that material information was omitted from

the materials used to sell the bonds and

assumed that the firms should have been

aware that there were substantial risks

involved in the sale of the bonds and the

111

development project. Each firm reviewed

the selling documents during 1974-78.

Neither attempted to prevent further sales

and both facilitated sales by answering

questions from the trustee that led to its

continued dealing with the Foundation

through 1976. Specifically cited as an

example of the Law Firm's acts is that it

allowed the trustee to "conclude that there

were '‘'[{njJo known defaults' under’ the

indenture . . . but a jury might conclude

that the Law Firm should have known the

trustee was interested in whether any legal

problems, such as potential liabilities

under the securities law, had arisen." 797

F.2d at 493. It was undisputed that, inter

alia, neither firm had (1) received or

approved the materials used to sell the

securities in the relevant time period, nor

(2) received proceeds from the sales, or

had a representative on the Foundation's

board. Nor had the Firm's name been used

112

on any documents used to sell _ the

securities.

In granting summary judgment, the

court commented that "[nJeither lawyers nor

accountants are required to tattle on their

clients in the absence of some duty to

disclose. To the contrary, attorneys have

privileges not to disclose." (Id. at 497)

(citations omitted).

Plaintiffs here do not allege a

relationship with Weinberg and Green that

would give rise to independent duty to

disclose to them.” There is not the

** Plaintiffs' attempted reliance on

Maryland Rules of Professional

Responsibility 7-102(B) also fails. There

is no support in either of the cases cited

that Weinberg and Green owed the Shatz' a

duty to withdraw. See, In re Flight

Transportation Corporation Securities

Litigation, 593 F. Supp. 612, 617-18

(D.Minn. 1984) (duty arose from the

defendant's preparation of allegedly

fraudulent and misleading prospectuses) ;

Flaherty v. Wineberg, 492 A.2d 618 (Md.

1985) (misrepresentation claim

sufficiently alleged duty arising from

intent to benefit plaintiffs). The source

of any duty is distinct from the standards

(continued...)

113

slightest indication that plaintiffs had

any contact with the defendant prior to the

incident in question. Plaintiffs do not

allege any direct connection between them

and Weinberg and Green. The communications

they point to in 4948-59 took place between

two law firms representing separate

clients. To find that this "relationship,"

standing alone, created a fiduciary

relationship between Weinberg and Green and

the Schatz' files in the face of long-

established legal practice. Therefore, the

only way this defendant can have violated

§10(b) is if it affirmatively acted to

mislead the Schatz'.

b. Allegations of Affirmative

Misrepresentations

Most of the allegations against

Weinberg and Green do not involve

statements or misrepresentations of the law

**(...continued)

of care in performing a duty, e.g. Waldman

v. Levine, 544 A.2d 683 (D.C.App. 1988).

114

firm. For example, in 451 plaintiffs say

that Weinberg and Green told Arent, Fox

that Rosenberg would supply an_ update

letter to be used in the closing documents.

Even assuming the letter omitted material

information, merely drafting or assisting

to draft a letter containing a client's

misrepresentations signed by the client

does not render the letter a

misrepresentation of the attorney. One

paragraph of the complaint, however, is

ambiguous. Paragraph 55 reads:

Weinberg and Green knew at the

time they represented to Arent,

Fox that no material change had

occurred in Resenberg's financial

position since the March 31,

1986, financial statement that,

in fact, there had occurred

several material adverse changes

in Rosenberg's financial

Situation.

(Emphasis added). If Weinberg and Green

made a separate representation of its own

to Arent, Fox, as the above’ language

implies, it may have made its own

representation and might have been obliged

115

to correct any misrepresentation. While

plaintiffs may be able to amend their

compliant to state a claim against this

defendant, this vague allusion to an

affirmative act is too slender a reed on

which to allow this count to go forward.

This is particularly so under the

requirement that allegations of fraud be

plead with particularity, Fed. R. Civ. P.

9b, specifying time, place and content of

alleged misrepresentation. Before a law

firm should be held to answer for allegedly

fraudulent acts, plaintiffs should be

required, at a minimum, to specify what was

said to whom and where and when the

communication occurred.

Accordingly, 4t is respectfully

recommended that Count III be dismissed

without prejudice to allow plaintiffs the

opportunity to cure, if they can, this

pleading deficiency.

116

ae Count VI

Count VI alleges aiding and abetting

liability under §§12(2) of the Securities

Act of 1933 and 10(b) of the Securities

Exchange Act of 1934 and 17 C.F.R.

§240.10b-5.”° Plaintiffs allege that

2° The provisions of §10(b) of the

1934 Act and Rule 10b-5 are set forth in

the discussion of Count III. Section 12

of the 1933 Act provides:

Any person who -

(1) offers or sells a security

in violation of section 77e of

this title, or

(2) offers or sells a security

(whether or not exempted by the

provisions of section 77c of

this title, other than paragraph

(2) of subsection (a) of said

section), by the use of any

means or instruments of

transportation or communication

in interstate commerce or of the

mails, by means of a prospectus

or oral communication, which

includes an untrue statement of

a material fact or omits to

state a material fact necessary

in order to make the statements,

in light of the circumstances

under which they were made, not

misleading (the purchaser not

knowing of such’ untruth = or

(continued...)

i17

Weinberg and Green knowingly or recklessly

assisted Rosenberg and Jaeger's

misrepresentations by providing substantial

assistance to them in participating in the

negotiations, drafting documents and

conducting the closing. (¥¥136-147). It

is claimed that Weinberg and Green owed the

plaintiffs a duty either to disclose the

misrepresentation or to withdraw from

representing Rosenberg or his companies.

Because they did neither, the plaintiffs

2°(,..continued)

omission), and who shall not

sustain the burden of proof that

he did not know, and in the

exercise of reasonable care

could not have known of such

untruth or omission, shall be

liable to the person purchasing

such security from him, who may

sue either at law or in equity

in any court of competent

jurisdiction, to recover’ the

consideration paid for such

security interest thereon, less

the amount of any income

received thereon, upon the _

tender of such security, or for

damages if he no longer owns the

security.

15 U.S.C. §771 (1988).

118

claim they justifiably relied on Weinberg

and Green's failure to act in entering the

agreement.

An aiding and abetting claim has, at

a minimum, three requirements: i a

primary violation by a primary party; (2)

knowledge of the violation; and (3)

substantial assistance in the achievement

of the primary violation.*° Bloor v. Carro,

Spanbock, Londin, Rodman and Fass, 754 F.2d

57, 62 (2a ir. 1985); Monsen _v.

Consolidated Dressed Beef Co., Inc., 579

F.2d 793, 799 (3d Cir.), cert. denied, 439

U.S. 30 (1978). But see, Schlifke, 866

F.2d at 947 (requiring that a plaintiff

must show that the alleged aider and

- Some courts have said that the

last two prongs of the test should be

considered relatively so that the less

evidence there is of assistance, the

greater the degree of knowledge required

to be proven. Metge, 762 F.2d at 624;

Woodward v. Metro Bank of Dallas, 522 F.2d

84, 95 (Sth Cir. 1975). However, when

"proof is lacking on any one part...

there can be no liability." Stokes v.

Lokken, 644 F.2d 779, 784 (8th Cir. 1981).

119

abettor committed a manipulative or

deceptive act proscribed under 10(b) and

10b-5 with the same degree of scienter

required for primary liability).

Under common law theories of aider and

abettor liability, it is not essential that

a defendant actually provide affirmative

assistance. Rather, it may be sufficient

if one is present, ready, willing and able

to render assistance if required. Under

these circumstances, it is necessary that

the primary violator know of - and receive

encouragement from - the intent of the

secondary party to be of assistance. In

the securities area, the cases speak of a

"high conscious intent" and a "conscious

and specific motivation to aid and abet

fraud." See, e.g., Martin v. Pepsi-Cola

Bottling Co., 639 F. Supp. 931, 935 (D.Md.

1986) (Young, J.). As put by Judge Heaney,

in Metge, 762 F.2d at 625: "(Ijn the

absence of a duty to act or disclose, an

120

aider-abettor case predicated on inaction

of the secondary party must meet a high

standard of ian. Here, plaintiffs rely

on their allegations of affirmative

substantial assistance in closing the deal,

and do not appear to premise liability in

this count on inaction by Weinberg and

Green.

Weinberg and Green argues that

plaintiffs cannot meet the second prong of

the test because they fail to allege a

conscious intent to aid Rosenberg and a

duty to the plaintiffs requiring disclosure

of known misrepresentations. Further, as

to the third prong, defendant argues that

its alleged actions do not meet the

requirements of "substantial assistance"

for the purposes of aiding and abetting

liability.?’ Although as a matter of proof,

*7 Defendant challenges plaintiffs'

§12(2) claim on the additional ground that

to be liable for aiding and abetting, one

must be a statutory seller under §12(1)'s

(continued...)

121

these two elements may vary inversely, it

is still necessary for a plaintiff to

allege both when affirmative assistance is

at issue. A fatal flaw in plaintiffs'

allegations can be found in the third

element, that of substantial assistance.

The "substantial assistance"

requirement is described in and -

Federal Deposit Insurance Corp., 486 F.2d

139, 163 (3d Cir.), cert. denied, 416 U.S.

960 (1973), as follows:

If the encouragement or

assistance is ‘%&@_ substantial

factor in causing the resulting

tort, the one giving it is

himself a tortfeasor and is

responsible for the consequences

of the other's act.

(Referring to Restatement of Torts §436).

Later cases have stated that substantial

27’, ..continued)

definition set out in Pinter v. Dahl, 108

S.ct.. 2063 (1988), citing Wilson v.

Saintine Exploration & Drilling Corp.,

Fed. Sec. L. Rep. 994,358 (2d Cir. 1989)

and Craftmatic Securities Litigation, Fed.

Sec. L. Rep. 494,805 (3d Cir. 1989).

Fortunately, it will not be necessary to

decide this question.

122

assistance requires an allegation that the

actions of the aider and abettor

"proximately caused the harm [to the

plaintiff] on which the primary liability

is predicated." Bloor, 754 F.2d at 62

(footnote omitted). Accord, First

terstate Bank of vada v. apman and

Cutler, 837 F.2d 775, 779 (7th Cir. 1988);

e v ehler, 762 F.2d 621, 624 (8th

Cir. 1985), cert. denied 474 U.S 1057

(1986).

The plaintiffs here have alleged that

had Weinberg and Green disclosed the

misrepresentation or withdrawn from

representing Rosenberg they would not have

entered the agreement. (445). Proximate

cause involves more than that and this mere

"but for" allegation alone is not enough to

make out an aiding and abetting claim. The

test is whether Weinberg and Green was a

substantial factor in bringing about

Rosenberg's fraud. Nowhere, in the many

123

pages of opposition, do plaintiffs even

hint at what Weinberg and Green did to

cause Rosenberg to commit fraud. They

devote the entire section on aiding and

abetting (pp. 20-29) discussing scienter

and intent. But without some assistance in

causing the misrepresentation, this claim

cannot succeed.

Reliance on Adalman v. Baker, Watts &

Co., 807 F.2d 359 (4th Cir. 1986), is

misplaced. Plaintiffs confuse the use of

the substantial assistance test as it

applies to define "seller" under 412(2),

for purposes of a primary violations, with

the substantial assistance prong of aiding

and abetting liability. The former, which

was at issue in Adalman, focuses on what

help the defendant provided in bringing

about the sale. The latter focuses on what

help the defendant provided to the primary

violator in committing the

misrepresentation.

124

Rosenberg is not alleged to have used

Weinberg and Green's help ine first

misrepresenting his financial situation.

Nor do plaintiffs claim that Weinberg and

Green's assistance was necessary to

Rosenberg's misrepresentations in the

financial statements. Rather, Weinberg and

Green's actions facilitated drafting

documents and preparing for the closing.

Without a single allegation that Weinberg

and Green assisted Rosenberg in making the

critical misrepresentations, the aiding and

abetting claim must fail.

Accordingly, it is respectfully

recommended that Count VI dealing with

aider and abettor liability be dismissed.

IV. Misrepresentation

Count VII

In Count VII, plaintiffs allege that

the conduct of Weinberg and Green "violated

applicable duties imposed upon an attorney

125

and agent by the law of the State of

Maryland to not knowingly or recklessly

perpetuate or assist in

misrepresentations." (4149). This duty

allegedly required them either to withdraw

from representation of Rosenberg or to

disclose his material representations to

the plaintiffs. Plaintiffs stated that

they justifiably relied on the conduct of

Weinberg and Green in entering into the

agreement and suffered damages proximately

caused by that conduct. ((Q150-153). In

their opposition to Weinberg and Green's

motion to dismiss, the plaintiffs state

that:

for the same reasons that Ivan

and Joanne Schatz have pleaded a

viable cause of action against

Weinberg and Green for securities

fraud, either on a primary or

aiding and abexcting theory of

liability, they have pleaded a

cause of action against Weinberg

and Green for misrepresentation

under Maryland law.

(Paper No. 74 at 41-42).

126

Weinberg and Green moves to dismiss

arguing that (1) absent an affirmative

misrepresentation made by it, it had no

duty to disclose its client's

misrepresentations; (2) plaintiffs have not

alleged a misrepresentation by Weinberg and

Green; and (3) the Professional Rules of

Responsibility, in particular, Rule 7-

102(B), create no duty or liability from an

attorney to third parties.”

In order to state: a claim for

misrepresentation (deceit) under Maryland

law, one must allege:

(1) that the representation made

is false; (2) that its falsity

was either known to the speaker,

or the misrepresentation was made

with such a reckless indifference

to truth as to be equivalent to

actual knowledge; (3) that it was

made for the purpose of

defrauding the person claiming to

be injured thereby; (4) that such

person not only relied upon the

misrepresentation, but had a

28 Incorporated into its motion is

defendants' argument on this count in the

original complaint. (Paper No. 8, pp. 6-

‘33,

127

right to rely upon it in the full

belief of its truth, and that he

would hot have done the thing

from which the injury result had

not such misrepresentation been

made; and (5) that he actually

suffered damage directly

resulting from such fraudulent

misrepresentation.

Martens Chevrolet, Inc. v. Seney, 292 Md.

328, 333, 439 A.2d 534, 539 (1982). As in

a securities action under §10(b), absent a

duty, mere silence or failure to disclose

material facts does not generally

constitute actionable fraud under Maryland

law. Under some circumstances, though, a

failure to disclose may be actionable, such

as where it is coupled with an affirmative

misstatement. Walsh v. Edwards, 233 Md.

552, 197 A.2d 424, 427 (1964).

The analysis of the plaintiffs' claim

for this common law action parallels that

for the securities claims. Absent

sufficient allegation of duty, liability

can only be premised on affirmative

misrepresentations by Weinberg and Green

128

or, at least, substantial assistance to

Rosenberg. This claim should be dismissed,

albeit with leave to amend if, in fact, 455

is meant to encompass allegations of direct

misstatements by Weinberg and Green.

V. Bankruptcy Issues

Mr. Rosenberg has, as all now know,

filed for personal bankruptcy. He claims

that the RICO claim for treble damages

(assuming it survives the motion to

dismiss) as well as the claims for punitive

damages and attorneys' fees under the other

counts are dischargeable in that bankruptcy

and should be dismissed from this action.

Plaintiffs respond (1) that damages for

injuries that were willfully and

maliciously inflicted are not

dischargeable, and (2) that the issue

should be deferred until a jury has

determined liability.

Plaintiffs assert that there are

potentially at least two categories in 11

129

U.S.C. §523 under which the claims would be

excepted from discharge:

§(a) (2): a debt for money to the

extent obtained (A) by actual

fraud or (B) by use of a

materially false statement in a

writing, and

§(a) (6): a debt for willful and

malicious injury.

Mr. Rosenberg argues that only the more

specific category can be applicable and

that, if the provisions of §a(2)(A) or (B)

are not met, then the debt is

dischargeable.

Rosenberg's sole argument for applying

only a(2) is that general rules of

statutory construction require application

of the more specific provision in

precedence to the more general provision,

citing 2A MN. Singer, Sutherland on

Statutory Construction at 501 (4th ed.

1984) (Sutherland). That, of course, is

only part of the analysis. In context, the

general rule is:

130

Where one statute deals with a

subject in general terms, and

another deals with a part of the

same subject in a more detailed

way, the two should be harmonized

if possible; but if there is any

conflict, the latter will

prevail, regardless of whether it

was passed prior to the general

statute, unless it appears that

the legislature intended to make

the general act controlling.”~*

This argument should be rejected. First,

the relationship of (a) (2) to (a)(6) is not

necessarily specific to general. and,

second, the proper overall interpretation

of §523 does not compel that result.

Rosenberg cites no cases for the

proposition that any particular claim must

be measured against only one category. The

case relied upon by plaintiffs, on the

other hand, considered whether the claim

was excepted from discharge under

§523(a) (2), (4) and (6) and concluded that

the punitive damages were not dischargeable

- This general rule applies to

various provisions in a single statute, if

unreconcilable. Sutherland §46.05 at 92.

131

under §523({a)(4) and (6), In re Austin, 93

B.R. 723 (Bkrtcy.D. Colo. 1988). Accord,

In re Kroh, 88 BR. 972, 986

(Bkrtcy.W.D.Mo. 1988) (punitive damages for

willful and malicious injury not

dischargeable under §523(a)(6)).

The case cited by Rosenberg, Matter of

Suter, 59 B.R. 944 (Bkrtcy.N.D.I1l1. 1986),

considered only whether RICO treble damages

were excepted from discharge under

§523(a)(2)(A).*° In concluding that they

were not so exempt, the court took solace

from the fact that its result harmonized

with §523(a)(7). There is no mention

whatsoever of §(a) (6).

It is respectfully recommended that

Rosenberg's motion to dismiss the RICO

claim for treble damages, punitive damages,

and attorneys' fees on the ground that any

such debts have_ been ischarged in

” The court did not decide the

issue with regard to attorneys' fees, 59

B.R. at 947 and n.8.

132

bankruptcy be denied. While the general

purpose of bankruptcy is to grant a debtor

a "fresh start" and, thus, the exceptions

to discharge in §523 are each to be

narrowly construed, there is no valid

reason to preclude plaintiffs from proving

that any damages awarded here are debts for

willful and malicious injury under §(a) (6)

even if they do not fit within §(a) (2).

Proof of willful and malicious injury may

require proof beyond that necessary to

prove fraud and thus should be analyzed

separately. At this point, it cannot be

said as a matter of law that plaintiffs can

prove no set of facts giving rise to

nondischargeability under §523.

Mr. Rosenberg also contends’ that

plaintiffs are limited to filing a proof of

claim in bankruptcy court and may not

proceed against him in this’- court.

Plaintiffs, on the other hand, assert that

Chief Judge Harvey already ruled that this

133

action is properly before this Court when

he withdrew the reference to bankruptcy

court. Plaintiffs are correct. This case

weeen. by the filing of ” adversary

proceeding in bankruptcy court. On

November 22, 1989, the bankruptcy court

approved a Stipulation and Settlement

Agreement resolving the status of the

Schatz' claim in the bankruptcy proceeding.

That settlement has no effect on this suit.

Once the issues in Count I through V

against Rosenberg are determined, the Court

will have to address Count VIII, i.e.,

whether any amounts awarded against

Rosenberg were excepted from discharge in

bankruptcy. At that time, the matter can

be decided by the Court or referred to the

bankruptcy court for determination. In any

event, this complaint should not _ be

dismissed because of the bankruptcy filing.

VI. Conclusion

134

For the foregoing reasons, it is

respectfully recommended that the motions

to dismiss be granted in part as follows:

1. Count I (RICO) be dismissed

against all defendants for

failure to allege a pattern.

Ze Counts II and III be

dismissed, unless amended to

overcome the statute of

limitations problems. |

Ze Counts III, VI and VII,

against Weinberg and Green be

dismissed. (Counts III and VII

may be subject to amendment if

particular allegations of

affirmative misrepresentation can

be made).

The motions to dismiss (and partial motion

for summary judgment) should otherwise be

denied, leaving Count IV (securities fraud

against Rosenberg and MER), Count V (common

law fraud against Rosenberg and Jaeger) and

135

Count VIII (declaration cof

dischargeability), in tact.

DEBORAH K. CHASANOW

United States Magistrate

Date

136

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MARYLAND

IVAN N. SCHATZ, et al.

Civil No.

JH-89-705

Vv.

ROSENBERG,

al.

fee ee ee ee eee ee”

MARK R.

MEMORANDUM OPINION

The matter now pending for the Court's

consideration is Magistrate Chasanow's

comprehensive report and recommendation on

the defendants' motions to dismiss, which

recommends that Counts I, Ii, III, VI, and

VII be dismissed. Plaintiffs Ivan and

Joanne Schatz and defendant Weinberg &

Green have filed objections to the report.

Defendants Mark E. Rosenberg (Rosenberg)

and MER Enterprises, Inc. (MER) have filed

a response to the plaintiffs' objections.

Upon de novo consideration of the report,

the record, and the objections’ and

responses submitted, the Court shall adopt

the report and recommendation in full,

137

except that the Court will dismiss Counts

I, III, VI, and VII without leave to amend.

In December 31, 1986, MER purchased

and 80% interest in two companies the

plaintiffs owned, Virginia Adjustable Bed

Manufacturing Corp. (VAMCO) and Advanced

Bed Concepts (ABC). MER is a holding

company which Mark Rosenberg created to

purchase the stock of these two companies.

Mark Rosenberg and Stephen H. Jaeger, a

former senior vice-president for First

American Bank of Maryland, also joined the

agreement. Mr. Jaeger had been responsible

for handling loan transactions for the many

companies Mr. Rosenberg owned, which

included Yale Sportswear Corp. (Yale), the

Back Center, Inc. (BCI), and Vertech

- Management Corp. (Vertech).

As payment for their 80% interests in

VAMCO and ABC, Mr. and Mrs. Schatz received

$1.5 million in promissory notes which Mr.

Rosenberg personally guaranteed. The

138

plaintiffs relied on a financial statement

dated March 31, 1986 and an update letter

delivered at closing which indicated that

Mr. Rosenberg's net worth exceeded $7

million. These financial documents

contained several misrepresentations and in

reality, Mr. Rosenberg's financial empire

crumbled between April and December of

1986. Yale filed for bankruptcy in

September 1987 and Mr. Rosenberg filed for

personal bankruptcy thereafter. The law

firm of Weinberg & Green represented Mr.

Rosenberg and his entities throughout this

entire 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 that was

formed when VAMCO and ABC merged with BCI.

As a result of this economic loss and the

misrepresentations made, the plaintiffs

have filed a seven-count complaint

139

asserting: a violation of the Racketeer

Influenced and Corrupt Organizations Act

(RICO) against defendants Rosenberg and

Jaeger (Count I), violations of §10(b) of

the Securities Exchange Act of 1934 against

Rosenberg and Jaeger (Count II), and

Weinberg & Green (Count III), violations of

§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 VIII), and

declaration of non-dischargeability in

bankruptcy of debts owed by Rosenberg.

(Count VIII).

In their motions, defendants Rosenberg

and Jaeger challenge plaintiffs' RICO claim

for failure to allege a pattern of

racketeering activity. Relying on the

Supreme Court's recent decision in H.J.,

140

Inc.v. Northwestern Bell Telephone Co., 109

S. Ct. 2893 (1989), and this Circuit's

recent decision in Menasco, Inc. v.

Wasserman, 886 F. 2d 681 (4th Cir. 1989),

Magistrate Chasanow concluded that

plaintiffs' complaint describes a closed

ended scheme. (Magistrate's Report at 15).

Because this scheme involved two defendants

with one goal (maintaining the viability of

Rosenberg's entities), five victims, and

acts spanning over a 1 1/2 year period

without threat of repetition, Magistrate

Chasanow recommended that this count be

dismissed without prejudice, pursuant to

the Fourth Circuit's suggestion for RICO

claims filed prior to the Supreme Court's

opinion in H.J., Inc. Menasco, 886 F. 2d

at 685. The relevant parties have

addressed this issue in their objections.

This Court shall dismiss Count I with

prejudice because it is factually

dissimilar to Menasco. There, the lower

141

court did not permit the plaintiffs to

amend their complaint at all, and on

appeal, the "[pjlaintiffs claimed that if

permitted leave to amend, they would

clearly and unequivocally establish the

existence of a pattern of racketeering

activity." 886 F. 2d 681. The plaintiffs

asserted they would allege ae scheme

involving approximately twenty-five

victims. The Fourth Circuit held that if

plaintiffs did plead these allegations with

sufficient particularity, this would

satisfy H.J., Inc.'s requirement of a

""regular way of conducting defendant's

ongoing legitimate business...that carries

with it a distinct threat of future

racketeering activity'" Id.

In their objections, plaintiffs do not

claim that they can allege a pattern of

racketeering activity with respect to other

victims, nor can they allege facts to

support a distinct threat of future

142

racketeering activity, because the scheme

which they describe ended when Yale filed

for bankruptcy. Because it appears futile

to grant plaintiffs yet a third opportunity

to amend their complaint, the Court shall

dismiss Count I without leave to amend.

Magistrate Chasanow recommended

dismissal of Counts II and III, alleging

claims under §10(b) of the 1934 Act,

because the plaintiffs have not

affirmatively established that they brought

this action within one year after

discovering defendant's misrepresentations

as required by 15 U.S.C. §77m.

Counts II and III are silent as to

when the plaintiffs discovered the

defendants' misrepresentations. The first

reference to this occurs in Count IV, a

claim under §12 of the 1933 Act, where Mr.

and Mrs. Schatz first assert that they

"could not have known of such

misrepresentations and omissions’ until

143

September of 1987 when Yale declared

bankruptcy." (Para. 125). Count VI, which

asserts a claim for aider and abetter

liability incorporates paragraph 125.

Therefore, the plaintiffs have failed to

meet their burden of proving that Counts II

and III were brought timely.

Because reference is made elsewhere in

the complaint regarding discovery of the

defendants' misrepresentations, omission of

this fact in Counts II and III is a

technical error. Accordingly, leave to

amend these counts should be granted.”

Count IV asserts a claim under §12 of

the Securities Act of 1933 against

defendants Rosenberg and MER. These

defendants urged the Court to convert this

portion of the motion to a motion for

summary judgment, which the Magistrate did,

*+ Weinberg & Green has also moved

to dismiss this count for failure to state

a claim. On this alternative ground, this

Court finds that dismissal without leave

to amend is proper. Infra, at p. 10.

144

pursuant to the Fourth Circuit's dicta in

Rivanna Trawlers v. Thompson Trawlers, 840

F. 2d 71 (2d Cir. 1989).

These defendants assert that the

promissory notes in dispute were not

securities. The Magistrate's report

contains a most comprehensive discussion of

the various tests the circuits have

employed in resolving this issue--the

commercial investment test, the economic

realities test, and the investment contract

test.

Critical to both the commercial

investment and the investment contract

tests is the degree to which the plaintiff

is dependent upon the efforts of others to

realize a profit on his investment. The

agreement between the parties points out

that even though Mr. Schatz was president

of the Back Companies,*” MER had at least a

*2 The Back Companies are defined as

BCI, Vertech, VAMCO and ABC.

145

50% ownership interest in Yale Sportswear

Corporation. The Magistrate concluded that

this fact raises a question as to whether

Mr. Rosenberg's efforts in managing Yale

were significant enough t:o convert these

promissory notes into securities, and

therefore, summary judgment must be denied.

Since the report was issued, the

Supreme Court has rejected the investment

contract test as applied to promissory

notes and announced its preference for the

Second Circuit's family resemblance test in

Reeves v. Ernst & Yeung, 58 U.S.L.W. 4208

(February 21, 1990). The family

resemblance test is similar to the

commercial investment test, which several

judges within this circuit have cited with

approval. See e.g., South Carolina

National Bank v. Darmstetter, 622 F. Supp.

226, 229 (D.C.S.C. 1985) aff'd, 813 F. 2d

403 (4th Cir. 1986), cert. denied, 479 U.S.

146

1065 (1987); Oliver _v. Bostetter, 426 F.

Supp. 1082, 1085 (D. Md. 1977).

The family resemblance test looks first

to the Securities Acts, which define

"security" as including any note; therefore

there is a rebuttable presumption that

every note is a security. 58 U.S.L.W.

4210. Typically excluded from this

category are notes delivered in consumer

financing, notes secured by a mortgage on

a home, the short-term note secured by a

lien on a small business or some of its

assets, notes evidencing a 'character' loan

to a bank customer, short-term notes

secured by an é3signment of accounts

receivable, or notes which simply formalize

an open-account debt incurred in the

ordinary course of business. 58 U.S.L.W.

4210, citing, Exchange National Bank of

Chicago v. Touche Ross & Co., 544 F. 2d

1126, 1137 (2d Cir. 1976).

147

The Court in Reeves expanded the Second

Circuit's test by requiring consideration

of four additional factors. First, if the

seller's purpose is to raise money for a

business enterprise or to finance

substantial investments and the buyer is

interested primarily in the profit the note

is expected to generate, the instrument is

likely to be a security. Second, courts

must determine whether the note is an

instrument in which there is common trading

for speculation or investment. Third,

courts should consider the reasonable

expectations of the investing public, and

finally, whether some other regulatory

scheme exists which would significantly

reduce the risk of the investment. 58

U.S.L.W. 4210-11. (citations omitted).

The promissory notes in question do not

fall within the category of either a

consumer or short-term business loan, which

are typically excluded from the Second

148

Circuit's definition of a security.

Moreover, Mr. Rosenberg was interested in

financing a substantial investment and the

plaintiffs were interested in realizing a

profit from these notes. Therefore, from

both sides, the transaction was most

naturally conceived as an investment in a

business enterprise, rather than as a

purely commercial or consumer transaction.

Id., SS U.S.LW. 4211. -Because these

promissory notes were uncollateralized and

uninsured, no regulatory scheme exists

which would have significantly reduced the

risk of these instruments. Id.

However, in reviewing the plan of

distribution, there is no evidence to

suggest that these notes involved "'common

trading for speculation or investment.'".

58 U.S.L.W. 4210. Nor is there any evidence

regarding the public's reasonable

expectations that these notes were

securities, because they were not offered

149

to a broad segment of the public. Because

it is unclear whether these promissory

notes are securities under Reeves, summary

judgment cannot be granted.

Count III against Weinberg & Green

alleges primary liability under §10(b) of

1934 Act, which makes it unlawful for any

person, directly or indirectly, in

connection with the purchase or sale of a

security to use or employ any "manipulative

or deceptive device or contrivance in

contravention fof federal securities

regulations]."

The elements of primary liability

include: (1) an untrue statement of

material fact or an omitted material fact

that wendeiai the statements made

misleading, (2) in connection with a

securities transaction, (3) with the intent

to mislead, and (4) which caused a

plaintiff's loss. Schlifke v. Seafirst

Corp., 866 F. 2d 935, 943 (7th Cir. 1989).

150

If liability is based on nondisclosure,

there can be no fraud absent a duty to

speak. Chiarella v. United States, 445

U.S. 222, 235 (1980). A duty to disclose

arises not from the securities regulations,

but rather, from a relationship of trust

and confidence and trust and confidence

between parties to a transaction.

In recommending that this count be

dismissed without prejudice, Magistrate

Chasanow found that the plaintiffs 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, Magistrate Chasanow

recommended that plaintiffs' securities

claim charging Weinberg & Green with aider

and abettor liability be dismissed. In

order to withstand defendants' motion, the

plaintiffs must_ show: (1) a primary

L932

violation by a primary party; (2)

knowledge of the violation; and (3)

substantial assistance in the achievement

of the primary violation. Bloor v. Carro,

Spanbock, Londin, Rodman and Fass, 754 F.

2a 57, 62 (2d Cir. 1985). The report

recommends dismissal of this clain,

because, “[n]Jowhere, in the many pages of

opposition, do plaintiffs even hint at what

Weinberg & Green did to cause Rosenberg to

commit fraud." (Report at 41).

The Schatz' third and final claim

against Weinberg & Creen for

misrepresentation is also deficient for the

same reason as their claim for primary

liability under §10(b); absent a duty, mere

Silence or failure to disclose material

facts does not generally constitute

actionable fraud under Maryland law.

Martens Chevrolet, Inc. v. Seney, 292 Md.

328, 333, 439 A. 2d 534, 539 (1982). As

with Count fans Magistrate Chasanow

152

recommends that this claim be dismissed,

with leave to amend.

Weinberg & Green's sole objection to

the report is to the recommendation that

Counts III and VII be dismissed with leave

to amend. They persuasively urge this

Court to dismiss these claims with

prejudice because the "'"salutary

objective'" of granting leave to amend yet

a third time is “"'outweighed by eiinkin

compelling policy considerations.'"

(Objections of Weinberg and Green at 4,

citing, Sanders v. Thrall Car Manufacturing

Co., 582 F. Supp. 945, 952 (S.D.N.Y. 1983)

aff'd, 730 F. 2d 910 (2d Cir. 1984)).

While leave to amend should be freely

granted absent undue delay, bad faith or

dilatory motive, Foman v. Davis, 371 U.S.

178, 182 (1962), courts should consider

whether the plaintiff has belatedly moved

to amend after his opponent has fully

briefed a motion to dismiss or for summary

153

judgment. Sandcrest Outpatient Services v.

Cumberland County Hospital, 853 F. 2d 1139,

1148-49 (4th Cir. 1988); Sanders’ v.

Cumberland, supra, 582 F. Supp 945, 952.

This Court concludes that it is proper to

dismiss Counts III and VII without leave to

amend. The plaintiffs have had three

opportunities to attribute affirmative

misstatements to this defendant and they

have failed to do so. This Court would

grant hia to amend had plaintiffs claimed

in their objections to the report that they

could allege such. misrepresentations.

However, they merely restate their previous

arguments. Accordingly, the salutary

objective for granting leave to amend is

outweighed by countervailing policy

considerations and shall be denied.

Finally, Mr. Rosenberg has moved to

dismiss plaintiffs' claims for punitive ,

damages and attorneys' fees on the ground

that these are dischargeable in bankruptcy.

154

This Court agrees with Magistrate Chasanow

that at this point, it cannot be said as a

matter of law that plaintiffs can prove no

set of facts giving rise to

nondischargeability under §523 of the

Bankruptcy Code.

The Court is grateful to Magistrate

Chasanow for her persuasive and

meticulously-well researched report and

recommendation.

The Court shall enter ae separate

consistent with this opinion.

Date Joseph C. Howard

United States

District Judge

155

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MARYLAND

IVAN N. SCHATZ, et al.

)

Plaintiffs )

)

Vv. ) Civil No.

) JH-89-705

MARK R. ROSENBERG, )

et al. )

)

Defendants )

ORDER

Upon de novo review of the report and

recommendation of the Honorable Deborah K.

Chasanow dated January 24, 1990, the

record, the objections of defendant

Weinberg nk creas and the plaintiffs, as

well as the responses of defendants Mark E.

Rosenberg (Rosenberg) and MER Enterprises,

Inc. (MER), it is this 8th day of March,

1990, by the United States District Court

for the District of Maryland, ORDERED: e

‘” that the report and recommendation

dated January 24, 1990 BE, and the same

hereby, IS ADOPTED, but for that portion

156

that recommends that Counts I, III, and VII

be dismissed without le*ve to amend; and

2. that defendants Rosenberg) and

Stephen H. Jaeger's (Jaeger) uation to

dismiss Count I BE, and the same hereby IS,

GRANTED; and

3 that defendants Rosenberg and

Jaeger's motion to dismiss Count II BE, and

the same hereby IS, GRANTED. Plaintiffs

may amend this count within twenty (20)

days of the date of this Order; and

4. that defendant Weinberg and

Green's motion to dismiss Counts III, VI,

and VII, BE, and the same hereby MIS,

GRANTED,

S$. that defendants Rosenberg’ and

MER's motion to dismiss Count IV, which has

been converted to a motion for summary

judgment BE, and the same hereby IS,

DENIED; and

157

6. that defendants Rosenberg and

MER's motion to dismiss Count V and VIII,

bE, and the same hereby IS, DENIED; and

that the Clerk mail copies of this

Order and the foregoing memorandum opinion

to the Honcrable Deborah K. Chasanow and

counsel of record.

Joseph C. Howard

United States

District Judge

158

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MARYLAND

IVAN N. SCHATZ, et al. )

)

Plaintiffs )

)

Vv. ) Civil No.

) JH-89-705

MARK E. ROSENBERG, )

et al. )

)

Defendants )

MEMORANDUM AND ORDER

Presently before the Court is

plaintiffs' motion for reconsideration of

the Court's March 8, 1990 Order dismissing

the counts in the complaint pertaining to

defendant Weinberg and Green. Defendant

has filed an opposition. With these

memoranda, the Court determines the motion

is ready for disposition. No hearing is

deemed necessary. Local Rule 105.6.

Plaintiffs' motion for reconsideration

is grounded upon an opinion they sought

from the Maryland State Bar Association's

Committee on Ethics (the "Committee")

159

regarding a law firms ethical obligation to

disclose the misrepresentations of a

client. (Paper No. 115, Ex. A). In

requesting the opinion, plaintiffs' factual

scenario refers to a law firm "with actual

knowledge of the misstatements." Id.

The Committee's conclusion that ". ..

the attorney would be obligated to disclose

- » material facts underlying its clients

fraud," was clearly premised upon the

scenario described by plaintiff in which

the law firm had "actual knowledge" of its

clients misstatements. (Plaintiffs' Ex.

B). Plaintiffs assert that the Committee's

opinion “shows what Maryland public policy

is concerning these facts" and they contend

that, in dismissing the defendants, the

Court did not adequately consider "the

public policy considerations underlying the

Code and Disciplinary Rules."

Although the Court has the utmost

respect for the Committee, its opinion is

160

not relevant to this case. Plaintiffs have

never alleged that the defendant had actual

knowledge of misstatements by its client,

a fact the Committee was led to believe

existed in the hypothetical posed to then.

Indeed, the Court noted in the Memorandum

Opinion that accompanied its March 8 Order

dismissing defendant that "plaintiffs did

not allege a relationship with Weinberg and

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." (Mem Op.

at 9). Additionally, in denying plaintiffs

leave to amend, the Court observed that

"plaintiffs have had three opportunities to

attribute affirmative misstatements to this

defendant and they have failed to do so."

(Mem Op. at 10). Therefore, the Court

finds no basis for plaintiffs' motion.

Accordingly, it is this 15th day of

October, 1990, by the United States

161

District Court ffor the District of

Maryland;

ORDERED:

(1) That plaintiffs' motion for

reconsideration BE, and the same hereby is,

DENIED; and

(2} That the Clerk of the Court mail

copies of this Order to counsel of record.

Joseph C. Howard

United States

District Judge

162

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

-~ FILED

October 1, 1991

No. 90-1889

IVAN N. SCHATZ; JOANN B. SCHATZ

Plaintiffs ~ Appellants

Vv.

MARK E. ROSENBERG; MER ENTERPRISES, INC.

STEPHEN JAEGER; WEINBERG & GREEN

Defendants - Appellees

On Petition for Rehearing with Suggestion

for Rehearing In Banc

Appellant filed a petition for rehearing

with suggestion for rehearing in banc. No

member of the Court requested a poll on the

suggestion for rehearing in banc, and the

original judicial panel voted to deny the

petition for rehearing.

The Court denies the petition for

rehearing with suggestion for rehearing in

banc.

163

Entered at the direction of Judge

Chapman, with the concurrence of Judge

Wilkinson and Judge Hilton, United States

District Judge, sitting by designation.

For the Court,

Clerk

164

Applicable statute and regulation

15 U.S.C. § 78(b)

Regulation of the Use of Manipulative

and Deceptive Devices

Sec. 10. 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--

* * * *

(b) To use or employ, in connection

with the purchase or sale of any security

registered on ae national securities

exchange or any security not so registered,

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.

* * * *

Employment of Manipulative and

165

Deceptive Devices

Rule 10b-5. 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,

(1) to employ any device, scheme,

or artifice to defraud,

(2) 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

(3) 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.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.