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GILMORE v. BERG

April 5, 1991

ROBERT J. GILMORE AND NOAH LIFF, PLAINTIFFS,
v.
JOHN GORDON BERG, HAROLD M. WINSTON, STEPHEN T. MARCOE, JR., ROSALIND SCHNEIDER, MARTIN R. BARKER, HOWARD GREEN, GILBERT TUCKER, COOPER RIVER OFFICE BUILDING ASSOCIATES, AMERICAN REAL ESTATE ASSOCIATES, INC., MANAGEMENT OF COOPER RIVER, INC., OFFICE BUILDINGS OF COOPER RIVER, INC., PAT CHARLES, CHARLES, STURM & MASTERS AND NORMAN S. COHEN, DEFENDANTS.



The opinion of the court was delivered by: Brotman, District Judge.

  This matter is presently before the court on the separate motions of defendant Pat Charles and Charles, Sturm & Masters (hereinafter "Charles"), and defendant Norman Cohen to dismiss or stay these proceedings pending the outcome of a related tax court case, or in the alternative, to dismiss or grant summary judgment on various counts of the complaint. These defendants played limited roles in the offering of a private placement memorandum (offering memorandum) on which plaintiffs allegedly relied in their purchase of stock in a real estate limited partnership venture. Combined, these two defendants argue that, as to them, (1) the statute of limitations bars plaintiffs' Section 10(b) and Rule 10(b)(5) claims,*fn1 (2) scienter cannot be established, (3) there could be no justifiable reliance on the offering memorandum, (4) the RICO counts should be dismissed because of certain pleading deficiencies, for failure to prove a pattern of racketeering activity, and because the statute is unconstitutionally vague, and (5) the pendent state claims should be dismissed on several separate grounds.

BACKGROUND

In December of 1980, plaintiffs Robert J. Gilmore and Noah Liff purchased unregistered securities in Cooper River Office Building Associates ("CROBA"), a New Jersey limited partnership. The information regarding the limited partnership was contained in the offering memorandum, dated September 19, 1980.

The Amended Complaint alleges that on December 13, 1980, Office Buildings of Cooper River, Inc. ("OBCR"), a Nevada corporation owned by defendants Berg (50 percent), Green (25 percent) and Tucker (25 percent), purchased two commercial office buildings and the underlying parcel of land, located in Pennsauken Township, New Jersey, from a bankrupt entity in Camden New Jersey, for a price of $2,500,000. Plaintiffs allege that on that same day, OBCR sold the two buildings for a sum of $4,700,000 and leased the accompanying land for a 17-year term to defendant Management of Cooper River, Inc. ("MCR"), a wholly owned subsidiary of defendant American Real Estate Associates, Inc. ("AREA"), a company controlled by Berg. Also on that same day, MCR sold the two buildings and assigned the lease to its parent AREA for the sum of $5,300,000. Plaintiffs describe the December 13, 1980 transactions as an "illegal scheme" concocted by defendants to impair the value of their investment.

Specifically, plaintiffs allege that defendants failed to disclose the "step-up" in the purchase of the two buildings (i.e., the difference between the purchase price of $2,500,000 originally paid by AREA and the $5,300,000 purchase price ultimately paid by the limited partnership), which "substantially diminished the likelihood that the plaintiffs and the other investors would realize the desired profits and appreciation, caused an inflated basis on the property for federal income tax purposes, and misled the plaintiffs and other investors into believing, inter alia, that they would be afforded substantial depreciation and interest deductions." Plaintiffs' Amended Complaint at ¶ 38.

Plaintiffs filed suit in this court on November 26, 1986 alleging financial injury in the form of loss of investment, lost tax deductions and credits, and substantial interest and penalties due to defendants' fraudulent misrepresentations, concealments and omissions. Plaintiffs allege violations of Section 10(b) of the Securities and Exchange Act of 1934, Sections 1962(a)-(d) of the Racketeering Influenced and Corrupt Organizations Act (RICO) and numerous state common law and statutory provisions.

On June 24, 1987, this court denied defendants' motions to dismiss without prejudice and granted plaintiffs leave to amend their complaint. Defendants then renewed their motions to dismiss primarily on grounds that plaintiffs' federal claims were barred by New Jersey's two-year discovery rule of limitations and that their RICO claims did not state a claim upon which relief could be granted. This court, on July 28, 1988, denied all of defendants' motions to dismiss except as to claims under the Tennessee Consumer Protection Act. In doing so, this court found that a disputed issue of material fact existed as to when plaintiffs knew or should have known of defendants' fraudulent acts. Plaintiffs then sought an order certifying the suit as a class action, which was denied July 21, 1989 for failure to satisfy the numerosity requirement.

The facts relevant to the present motions involve the limited roles played by Charles, an attorney who prepared a tax opinion letter, and Cohen, an accountant who prepared a report on the projected financial performance of the partnership. Both documents were attached to the offering memorandum, which referred to Charles and Cohen as "experts." According to Charles' certification provided to the court, Berg contacted Charles in April of 1980 and retained him to represent AREA in connection with the purchase of CROBA out of bankruptcy. In May of 1980, Berg informed Charles that if AREA were successful, Berg would probably syndicate the property, and asked Charles to prepare a tax opinion letter, which AREA would use in syndicating the property. Berg told Charles that Berg and a tax attorney had drafted a tax opinion letter, which was then submitted to Charles for his review, along with the proposed offering memorandum. Prior to this time, Charles had never been hired to render tax advice relating to any syndication. Charles reviewed the letter conducted legal research, revised the letter and agreed to sign it as revised. Berg and Charles agreed on the revised letter on June 13, 1980, and Berg then put it on Charles' stationary. The letter states that the purchase price of $5.3 million reflects the fair market value of the property as determined by AREA, and that the opinion would be amended to reflect any variation between information in the offering memorandum and later developed facts.

Several weeks later, Berg told Charles that he would not request Charles to sign the letter and would not send it to proposed investors until after the closing of title on the property. Plaintiffs say that, according to his own deposition testimony, Charles understood the letter was to be included in the offering memorandum. Plaintiffs' Brief in Opposition, p. 5. Sometime prior to December, 1980, Charles learned that Berg was selling interests in the syndication but he says he was not aware that his tax opinion letter was part of it. In fact, Berg started actively soliciting limited partners through the offering memorandum, which included Charles' tax opinion letter, sometime in July of 1980.

Around this same time, Charles helped obtain bankruptcy court approval of the proposed AREA purchase and prepared the documentation necessary to close title, which took place at two meetings — December 15, 1980 and January 13, 1981. Charles and Berg agreed on a flat fee of $9,000, plus costs, for all of Charles' legal services, which was paid in full at the final closing. Two weeks later, at Berg's request, Charles executed the tax opinion letter and sent it to Berg. Thereafter, Charles provided limited legal services to Berg and his controlled entities.

An important event during the syndication of CROBA was the preparation of a draft "errata" sheet that was meant to inform prospective investors of, inter alia, (1) the purchase out of bankruptcy for $2,500,000, (2) Berg's full role in the transaction, and (3) the step-up in price from $2.5 million to $5.3 million. Charles received the errata sheet sometime in November of 1980 and was told by Berg not to worry about it. Plaintiffs Gilmore and Liff claim that there is no evidence they ever received the errata sheet and, therefore, they never knew these material facts before purchasing their interest in CROBA.

As to defendant Cohen, Berg retained him in June of 1980 to review a set of financial projections for the limited partnership and to prepare and sign a forecast letter to be included in the offering memorandum. Cohen had been Berg's personal accountant for many years, and had prepared financial statements and tax returns for Berg's Fidelity America Mortgage Company (FAMCO) limited partnerships. Berg gave Cohen a set of projections, assumptions to the projections and a draft forecast letter. Cohen prepared the forecast letter and delivered it to Berg in July of 1980 for inclusion in the offering memorandum. The disputed language of that letter on which plaintiffs stake their claims against Cohen reads:

  My review [of AREA's projections and assumptions]
  included tests of the computations, inquiries as
  to the methods of compiling the data set forth in
  the projections, discussions with officials of the
  General Partner [AREA] and such other procedures
  as I considered necessary in the circumstances. No
  other verification procedures were applied. I
  believe that the assumptions and rationale
  underlying the projected financial statements are
  reasonable for the purposes of these projections.
  Since the projections are based on assumptions,
  the reliability of which is dependent on future
  events and transactions, as an independent
  accountant, I do not express an opinion on the
  fairness of these projections.

Cohen's work on the letter was limited to one meeting with Berg, and several hours performing computations, for which he was paid $3,000.

DISCUSSION

A. Motion to Stay

This court already has denied previous motions to stay — in 1987 and 1988. Defendants Charles and Cohen assert that new information is now before the court that shows that a substantial portion of the damages claimed by plaintiffs will be determined by a pending tax court proceeding. Therefore, since plaintiffs' damages are hypothetical, the court should exercise its discretion to stay this entire proceeding pending the outcome of the tax court's ruling. Alternatively, the court should find the dispute unripe.

Even accepting defendants' argument, plaintiff has alleged loss of investment as well as potential tax disallowances, penalties and interest assessments. The power to stay is discretionary. Bechtel Corp. v. Local 215, Laborers' Int'l Union, 544 F.2d 1207, 1215 (3d Cir.1976). This litigation has continued for over four years and the court thinks it would be unwise to issue a stay or find the dispute unripe at this juncture. The motion will be denied.

B. Statute of Limitations for § 10(b) Claims

Both defendants are now raising the argument for the first time that the one year/three year rule of In re Data Access Systems Securities Litigation, 843 F.2d 1537 (3d Cir.) (en banc), cert. denied sub nom. Vitiello v. Kahlowsky, 488 U.S. 849, 109 S.Ct. 131, 102 L.Ed.2d 103 (1988) should be retroactively applied to bar plaintiffs' claims of federal securities fraud. The, court had an opportunity recently to address this question in a similar case, Panna v. Firstrust Sav. Bank, 749 F. Supp. 1372 (D.N.J.1990), modified on other grounds, 760 F. Supp. 432 (1991).

The Third Circuit in Data Access established that the limitations period applicable to § 10(b) and Rule 10b-5 claims was one year after plaintiffs discovered facts constituting the violation, and in no event more than three years after such violation. 843 F.2d at 1550. In that case, the Third Circuit reviewed recent Supreme Court pronouncements on the proper method for borrowing analogous limitations periods. See Agency Holding Corp. v. Malley-Duff & Assocs., Inc., 483 U.S. 143, 107 S.Ct. 2759, 97 L.Ed.2d 121 (1987), Wilson v. Garcia, 471 U.S. 261, 105 S.Ct. 1938, 85 L.Ed.2d 254 (1985) and DelCostello v. International Bhd. of Teamsters, 462 U.S. 151, 103 S.Ct. 2281, 76 L.Ed.2d 476 (1983). It then rejected this court's determination that the analogous state common law fraud limitations period should apply. Instead, it looked to the analogous federal limitations period and concluded that the express limitations provisions of the Securities and Exchange Act of 1934 should apply.

A straightforward application of the Data Access rule to this case would require plaintiffs to have filed suit within one year from the time of discovery and in any event within three years from the time the violation occurred. Since the violation allegedly occurred in connection with the offering and sale of securities between September and December, 1980, and the complaint was not filed until November, 1986, plaintiffs are clearly time-barred. They must persuade the court, therefore, that the rule of Data Access should not be applied retroactively.

The question of retroactive application of the new one year/three year rule established by Data Access was not answered by the court on that occasion. The Third Circuit resolved that question in 1988 in the case of Hill v. Equitable Trust Co., 851 F.2d 691, cert. denied, 488 U.S. 1008, 109 S.Ct. 791, 102 L.Ed.2d 782 (1989), and has considered it since in McCarter v. Mitcham, 883 F.2d 196 (1989), Gatto v. Meridian Medical Associates, Inc., 882 F.2d 840 (1989), cert. denied, ___ U.S. ___, 110 S.Ct. 1136, 107 L.Ed.2d 1041 (1990), and most recently in Gruber v. Price Waterhouse, 911 F.2d 960 (1990). The limitations period should be applied retroactively unless the party attempting to avoid retroactive application persuades the court that the rule should be applied prospectively only. Hill, 851 F.2d at 696-97. The method for applying the "uncommon exception" of prospective application of the Data Access rule requires a case-by-case analysis of the three-part test enunciated by the Supreme Court in Chevron Oil Co. v. Huson, 404 U.S. 97, 92 S.Ct. 349, 30 L.Ed.2d 296 (1971). Id., at 697; Gruber, 911 F.2d at 964-65. These factors are premised on a general assumption that judicial decisions should be applied retroactively. In Re National Smelting of New Jersey, Inc., 722 F. Supp. 152, 157 (D.N.J.1989).

The three-part test of Chevron Oil states:

  First, the decision to be applied nonretroactively
  must establish a new principle of law, either by
  overruling clear past precedent on which litigants
  may have relied, or by deciding an issue of first
  impression whose resolution was not clearly
  foreshadowed. Second, it has been stressed that
  "we must . . . weigh the merits and demerits in
  each case by looking to the prior history of the
  rule in question, its purpose and effect, and
  whether retrospective operation will further or
  retard its operation." Finally, we have weighed
  the inequity imposed by retroactive application,
  for "[w]here a decision of this Court could
  produce substantial inequitable results if applied
  retroactively, there is ample basis for avoiding
  the 'injustice or hardship' by a holding of
  nonretroactivity."

Chevron Oil, 404 U.S. at 106-07, 92 S.Ct. at 355 (citations omitted). In applying the first part, "[p]rior precedent must be 'sufficiently clear that a plaintiff could have reasonably relied upon it in delaying suit, a criteria that was not met where the law was erratic and inconsistent.'" Hill, 851 F.2d at 696, quoting Fitzgerald v. Larson, 769 F.2d 160, 163 (3rd. Cir.1985). Although the court in Hill, McCarter and Gatto found that Data Access did not overrule clear past precedent which was sufficient to warrant justifiable reliance by plaintiff, the inquiry is "fact sensitive," requiring the court to examine whether the facts of this case have been clearly decided in prior cases. Gruber, 911 F.2d at 965 (citations omitted). Therefore, the court must examine the law as it existed at the time plaintiffs' cause of action arose and any changes which may have occurred prior to the time the complaint was filed. Id.

Plaintiffs in this case stand in an almost identical position to those in Gatto. At the time they purchased limited partnership interests in CROBA as a tax shelter in 1980, Third Circuit precedent regarding the New Jersey limitations period for 10b-5 violations brought by buyers against sellers of securities was no clearer than in 1981, when the claim in Gatto accrued.*fn2 The court must accept this as a matter of law and need not repeat the Data Access, Hill and Gatto courts' analysis of conflicting Circuit precedent on this issue.

Another important factor weighing against plaintiffs is the Gatto court's analysis of justifiable reliance, which is an important element of the first Chevron factor. If plaintiffs could not know the significant operative facts underlying their cause of action until after the absolute bar period of Data Access had passed, they could not possibly have relied on a longer statute of limitations period. Gatto, 882 F.2d at 843. Here, plaintiff Liff alleges in the amended complaint that he "became aware of the fraudulent and other wrongful conduct . . . on or about April 2, 1986, when he received an IRS agent's examination report that disclosed many of the facts that defendants had concealed and misrepresented." Amended Complaint at ¶ 54. Plaintiff Gilmore alleges his discovery through identical circumstances on June 14, 1986. However, this was at least twenty-eight months after the three-year absolute bar of Data Access had lapsed. As long as plaintiffs were ignorant of their causes of action, they could not possibly have relied on any limitations period. Therefore, the court concludes that plaintiffs have failed to show that, as to their particular claim and the factual circumstances surrounding it, Data Access overruled clear past precedent on which they could have relied.

In an effort to persuade the court otherwise, plaintiffs draw our attention to Chief Judge Gerry's opinion in In Re National Smelting, supra. In that case, Judge Gerry interpreted Data Access to mean that its one year/three year rule should not be applied retroactively when plaintiffs' claims would have been timely under both of the analogous state limitations periods. In Re National Smelting, 722 F. Supp. at 158. "When this is the situation, we believe that Data Access is appropriately seen as overruling clear past precedent upon which plaintiffs could have reasonably relied." Id. Plaintiffs argue that since their complaint would be timely filed under either the ...


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