# Appendix — Schatz v. Weinberg

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_2266%3A2

## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1992
- **Citation:** 503 U.S. 936

## Text

we

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,

V.

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...)

I.

On December 31, 1986, MER purchased an
eighty percent (80%) interest in two
companies the plaintiffs owned, Virginia
Adjustable Bed Manufacturing Corporation
(VAMCO") and Advanced Bed Concepts ("ABC").
MER is a holding company which Mark
Rosenberg created to purchase the VAMCO and
ABC stock. As payment for their eighty
percent (80%) interests in VAMCO and ABC,
Mr. and Mrs. Schatz received $1.5 million
in promissory notes issued by MER, which
Rosenberg personally guaranteed. The

plaintiffs relied on a financial statement

/(.. 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

10

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

11

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

12

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.

13

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,

14

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

zS

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

16

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...)

17

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).

18

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),

19

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.

20

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

21

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.

22

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

23

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.

24

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

25

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

26

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

27

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

28

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

29

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

30

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).

31

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,

32

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)

It

(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

33

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...)

34

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.

23

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

36

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

4

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).

38

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

39

(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...)

40

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).

41

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).

42

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

43

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

44

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

45

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

46

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

47

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.

48

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

49

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

50

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.

51

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).

52

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.

53

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

54

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.

55

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.

56

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

57

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

58

$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.

59

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).

60

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...)

61

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).

62

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).

63

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

64

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

66

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

67

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.).

68

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.

69

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.

70

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:

71

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

72

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.

73

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.

74

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

75

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

76

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

77

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).

78

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.

79

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.

80

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

© Title 15 U.S.C. §77m provides:

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...)

81

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.

82

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

83

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

84

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

85

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).

86

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

87

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

88

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.

89

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

90

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.

91

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.

92

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

93

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

94

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.

95

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

96

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,

97

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

98

- « « -" 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

99

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

(c) 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.

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

6

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 5

[Text truncated at 120,000 characters. The full text is on the page linked above.]

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385010_2266%3A2. Public record. Not legal advice.