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LegalEase Sample – Memorandum on Private Placement NEW YORK

Memorandum on Private Placement NEW YORK

To: Large Law Firm, New York, NY

From: LegalEase Solutions, LLC

Date: 1/16/2006

Re: Private Placement Memorandum/Fraud Allegations/Reasonable Reliance


You have asked us to research, identify and summarize the key cases on the issue of what might be held to constitute reasonable reliance on representations made in a private placement memorandum offering interests in a fund. These issues require discussion of:

Relevant Cases


1. First Lincoln Holdings, Inc. v. The Equitable Life Assurance Society of The United States, 43 Fed. Appx. 462 (2nd Cir. 2002)

Plaintiff Corporation alleged breach of contract, common law fraud, and violations of the federal securities law, due to defendant society’s decision to terminate its ability to execute trades by telephone, fax, or other electronic means on its account. The United States District Court for the Southern District of New York denied the corporation’s preliminary injunction motion and granted the society’s motion to dismiss. The corporation appealed.

The corporation claimed that by restricting its trading, the society effectively prevented it from engaging in its preferred investment strategy, a form of arbitrage known as market timing. The instant court agreed with the district court that the annuity fund contract unambiguously granted the society the right to determine the terms on which investors in the fund could have traded on their accounts. Nor could the corporation have relied on its contention that the society’s agents assured it that it could have engaged in market timing or on indications of its intent to do so in its application materials. The fund application clearly stated that no agent had the authority to make or modify any contract, or to waive or alter any of the society’s rights and regulations. Furthermore, the prospectus made abundantly clear that market timing was forbidden. The corporation could not have relied on parol evidence to vary the express terms of the written contract. The fraud claims were properly dismissed because a sophisticated investor could not have reasonably relied on the alleged fraudulent representation of the society’s agents directly contradicted by the society’s documents.

The Court agreed with the district Court in that the plaintiff’s fraud claims were properly dismissed, because a sophisticated investor could not have reasonably relied on the alleged fraudulent representation of Equitable agents directly contradicted by Equitable’s documents.

The Court also noted the general rule that reasonable reliance must be proved as an element of a securities fraud claim. Id at 464.

2. Opher Pail v Precise Imports Corporation, 1999 U.S. Dist. LEXIS 13401 (S.D.N.Y., 1999)

Plaintiff employee sued defendant’s employers who induced him to spend his own time inventing products for the defendant, in exchange for stock in an acquisition company. No shares were ever issued, and the acquisition company was dissolved. Plaintiff alleged common law fraud and securities law fraud under the Securities and Exchange Act, rule 10b-5, 15 U.S.C.S. § 78j(b). Defendants moved for dismissal, claiming plaintiff did not plead reasonable reliance, did not plead with sufficient particularity for fraud, and did not allege misrepresentations. The court denied the motion, finding that plaintiff plead reasonable reliance as an employee who relied upon the representations of his employer, so no heightened standard of diligence was applied. Plaintiff also pled with particularity, fraudulent statements made by defendant as to the stock exchange. Finally, plaintiff alleged misrepresentation of the value of the stock, which induced him to continue inventing products in exchange for it. Defendants’ motion to dismiss plaintiff’s claims was denied. Plaintiff pled common law and securities fraud with sufficient particularity for claims to survive motion to dismiss, pled reasonable reliance as to stock representations, and sufficiently claimed misrepresentation which induced him to purchase stock by inventing products for defendants.

The Court held that Reasonable reliance is an element of both common law fraud under New York law and securities fraud.

3. Igor Azrielli v. Zamaryonov, 21 F.3d 512 (2nd Cir. 1994)

Plaintiff purchasers challenged the district court’s judgment inasmuch as it dismissed plaintiff’s complaint asserting claims of securities fraud in violation of 15 U.S.C.S. § 78j(b) and 17 C.F.R. § 240.10b-5 (1993) promulgated thereunder, claims of violations of the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C.S. § § 1961-1968, and various claims under state law. The court affirmed in part and vacated in part. The court held that evidence in the record revealed genuine issues of material fact with respect to plaintiffs’ claims against defendant attorney, other than the RICO claims against defendant attorney, and with respect to their federal claims against other defendants such as an adequate showing that the claimed misrepresentations were material and in connection with the purchase of the shares by plaintiffs and that a pattern of such misrepresentations could have been found by a jury, making summary judgment inappropriate. The court vacated so much of the judgment as dismissed plaintiffs’ federal claims, other than the RICO claims against defendant attorney, dismissal of which it affirmed and reinstated the state law claims.

The Court observed that the fundamental purpose of the Securities Exchange Act 1934, 15 U.S.C.S. § § 77b-78kk (1988) is to implement a philosophy of full disclosure, in order to make sure that buyers of securities get what they think they are getting. 17 C.F.R. § 240.10b-5(1993) thus makes unlawful any misrepresentation that would cause reasonable investors to rely thereon, and, in connection therewith, so relying, cause them to purchase or sell a corporation’s securities. Liability under rule 10b-5 may be imposed not only on persons who made fraudulent misrepresentations but also on those who had knowledge of the fraud and assisted in its perpetration. Id at 518

A fact is to be considered material if there is a substantial likelihood that a reasonable person would consider it important in deciding whether to buy or sell shares. A fraud claim may not properly be dismissed summarily on the ground that the alleged misstatements were not material unless they would have been so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance. Representations tending to indicate that the valuation of the shares to be purchased has been inflated may obviously be material. Id at 519

4. Harsco Corporation v. Rene Segui, 91 F.3d 337 (2nd Cir. 1996)

The parties executed a purchase agreement for appellees’ company. In the agreement, appellees made express representations and appellant expressly waived reliance on outside representations. Appellant later sued appellees for federal securities fraud, under 17 C.F.R. § 240.10b-5, common law fraud, breach of contract, and other related allegations. The court dismissed appellant’s complaint under Fed. R. Civ. P. 12(b)(6). The appellate court held that since appellant specifically disclaimed reliance on representations made outside of the contract and the parties were sophisticated business entities, appellant could not claim reasonable reliance on appellees’ outside representations. Therefore, it affirmed the dismissal of the common law and federal securities fraud claims, pursuant to Fed. R. Civ. P. 12(b)(6). Because the federal claims were dismissed, the court held that state law claims were properly dismissed because supplemental jurisdiction could no longer be exercised, but noted that state claims could be brought in state court.

The Court held that Reasonable reliance must be proven as an element of a securities fraud claim. Rule 10b-5 makes unlawful any misrepresentation that would cause reasonable investors to rely thereon. Id at 344.

5. Adler v. Berg Harmon Assoc., 790 F. Supp. 1222 (S.D.N.Y. 1992)

Defendant securities promoter filed a motion to dismiss plaintiff investors’ second amended complaint pursuant to Fed. R. Civ. P. 9(b), 12(b)(6). The investors’ complaint sought damages pursuant to the Racketeering and Corrupt Organizations Act (RICO), 18 U.S.C.S. § 1961 et seq, for fraud, negligence, and breach of fiduciary duty in connection with the sale of securities related to real estate limited partnerships.

The investors had purchased real estate limited partnerships based upon memorandums that were generated by the securities promoter. The investors claimed that the promoter was engaged in fraud in selling the partnerships through a complicated scheme of financing, mortgages, excessive fees and fees for non-existent services. The promoter filed a motion to dismiss the investors’ second amended complaint, which was granted by the court. The court held that 1) under Fed. R. Civ. P. 9(b), the investors had failed to sufficiently attribute the alleged wrongdoings to the promoters because of the broad allegations that had combined the acts of several promoters to create the impression that all of them had engaged in the fraud; 2) the investors had not alleged the necessary elements of a claim under 18 U.S.C.S. § 1962(a), having only alleged injury that resulted from the racketeering acts, as opposed to injury by reason of the use or investment of racketeering income; and 3) the investors had failed to allege that each of the promoters had acted with a fraudulent intent. The court dismissed the investors’ second amended complaint without prejudice.

The Private Placement Memorandums in the instant action were replete with warnings of the speculative nature of the investments and the risk that any investment may result in a loss. The Court held that although plaintiffs argue that they were misled into believing that the respective projects could operate profitably, such an argument is untenable. One glance at the financial projections in the offering memoranda before the Court indicates that tax deductions, rather than profits, were the immediate benefit to be expected by an investor — the immediate prospects for the partnerships were for substantial losses. Although investors may have hoped for additional benefits from the ultimate sale or refinancing of the property, none was promised in the PPMs, which virtually abound with warnings of the risks and imponderables. Accordingly, the allegations in the Complaint suggesting that defendants misrepresented the extent of the economic benefits that would flow to the limited partners from an investment in the partnership and the allegations respecting the misleading nature of the financial projections and risk estimates must fail. Id at 1232

6. Luce v. Edelstein, 802 F.2d 49 (2nd Cir. 1986)

Plaintiffs appealed the dismissal, without leave to amend, of their complaint alleging defendants’ violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78j(b), by the United States District Court for the Southern District of New York. Plaintiff limited partners sued defendant general partners, alleging defendants had violated Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78j(b), in the sale of partnership interests. The district court dismissed the complaint, finding fraud had not been pled with particularity as required by Fed. R. Civ. P. 9(b), and leave to amend was denied. The court reversed, finding several allegations were sufficiently based on specific facts. For example, defendants allegedly represented they would make capital contributions to the partnership in the amount of $ 385,000 when only $ 80,000 was actually contributed. In addition, the renovation of properties undertaken by the partnership had cost nearly $ 6 million more than plaintiffs had been led to believe, with the renovations still incomplete. These allegations also sufficiently stated Section 10(b) violations, and it was an abuse of discretion to dismiss the complaint without leave to amend. Dismissal of complaint alleging violation of the Securities and Exchange Act of 1934 was reversed. The court found that several allegations were sufficiently based on specific facts as required to plead fraud with particularity, and that the allegations also sufficiently stated claims under the Act.

Reference to the Offering Memorandum satisfies 9(b)’s requirements as to identification of the time, place, and content of the alleged misrepresentations. See, e.g., Klein v. Computer Devices, Inc., 591 F. Supp. 270, 279 (S.D.N.Y. 1984); Somerville v. Major Exploration, Inc., 576 F. Supp. 902, 911 (S.D.N.Y. 1983). Furthermore, no specific connection between fraudulent representations in the Offering Memorandum and particular defendants is necessary where, as here, defendants are insiders or affiliates participating in the offer of the securities in question. See, e.g., Somerville, 576 F. Supp. at 911; Pellman v. Cinerama, Inc., 503 F. Supp. 107, 111 (S.D.N.Y. 1980).

Many allegations grounded in the Offering Memorandum are based on specific facts. For example, plaintiffs assert that although the Offering Memorandum represented that the general partners would make capital contributions to the partnership of $385,000, the general partners actually contributed only approximately $80,000. Plaintiffs also claim that the Offering memorandum falsely represented that the cost of the renovation would be $4.5 million, when in fact liabilities for the still incomplete project already exceed $10.2 million. Thus, some claims grounded in the Offering Memorandum are sufficiently pleaded to pass muster under Rule 9(b).

Those representations involved specific promises by the general partners to perform particular acts that they did not intend to carry out or knew could not be carried out. Id at 56

An examination of the complaint reveals some claims that fall within this category. Plaintiffs allege that the Offering Memorandum represented the following: that the general partners would make an initial capital contribution of $385,000 and guarantee the $4.5 million construction loan, that at least one of the general partners had maintained and would continue to maintain its net worth at a level sufficient to ensure the partnership’s profitability, n3 that the general partners would collect management fees from the partnership for only one year, and that no assignment or transfer of the general partners’ interest in the partnership could occur without notice to and consent of the limited partners. Plaintiffs also allege that these promises were not kept: the general partners contributed only approximately $80,000 and did not guarantee the loan; the general partners did not have and never had the net worth necessary to participate in the limited partnership; the general partners continued to collect management fees for well over one year; and the general partners entered into an agreement to transfer their partnership interests to F.M. Capital without the knowledge and consent of the limited partners. While the failure to carry out a promise made as consideration for a sale of securities may be an element of a Section 10(b) claim, that failure does not constitute fraud if the promise was made with a good faith expectation that it would be carried out. Cf. Ernst & Ernst, 425 U.S. 185, 47 L. Ed. 2d 668, 96 S. Ct. 1375. However, in the instant case, plaintiffs also allege that these promises were known by defendants to be false when made. Plausible allegations that defendants made specific promises to induce a securities transaction while secretly intending not to carry them out or knowing they could not be carried out, and that they were not carried out, are sufficient under Pross to state a claim for relief under Section 10(b). Id at 57

7. Friedman v. Arizona World Nurseries Ltd. Partnership, 730 F. Supp. 521 (S.D.N.Y. 1990)

Defendants, limited partnership, accountants, attorneys, former owners and/or managers of partnership (owners), promoters, and individual corporation, filed motions to dismiss plaintiff investors’ consolidated complaint for violations of federal securities laws and the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C.S. § 1961 et seq., and claims of fraud, negligence, conspiracy, and breach of fiduciary responsibility. Investors in limited partnership sought relief arising out of the “scheme” to sell an unsuccessful business to limited partnership. The motions to dismiss were filed under Fed. R. Civ. P. 9(b), 12(b)(6), and the court held that (1) investors did not adequately plead scienter under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78j(b) or show attributable statements, as to accountants and attorneys, regarding the tax opinion and offering memorandum that they drafted. (2) The § 10(b) claims against individual corporation were inadequate. (3) The § 10(b) claims were adequately pled against owners and promoters because they were insiders, and specific facts were alleged as to their actions and motive. (4) There was no liability under § 10(b), as to accountants and attorneys, due to the financial documents’ cautionary language. (5) No claim, under § 12(2) of the Securities Act of 1933, 15 U.S.C.S. § 771(2), was stated against accountants, attorneys, or individual corporation because they were not statutory sellers. And (6) the securities fraud predicates for RICO claims, against limited partnership, owners, and promoters, were adequately pled.

The court granted the motions to dismiss by accountants, attorneys, and the individual corporation. The court denied the motions to dismiss by owners, limited partnership, and promoters for the claims pursuant to § 12(2) and 18 U.S.C.S. § 1962(c), granted their motions as to the claims under § 17(a) of the Securities Act of 1933 and 18 U.S.C.S. § 1962(a) and (d), and granted in part and denied in part their motions as to 15 U.S.C.S. § 78j(b).

In this case, the projections in issue make clear that they “are based upon assumptions made by Arizona World Nurseries Limited Partnership of the income and expenses and cash flow from the operations of the nursery.” Offering Memorandum, Ex. F: “Notes and Assumptions” section of the Financial Projections at 1. Furthermore, the projections expressly cautioned that they were based upon these assumptions and appraisals, and that some of the assumptions may not materialize, and thus, that the actual results achieved could then vary from the projections substantially. In addition, the cover letter which accompanied the projections made clear the limited role that the Andersen defendants assumed with reference to the projections (that they did not perform an audit and that they did not verify the assumptions provided by the general partner), and once again, explicitly warned, as set out above, as to the accuracy and achievability of the projections. Certainly, then, no misrepresentation claim can be predicated upon the fact that the projections did not bear out.

Furthermore, as can be seen from the warnings in the front of the offering memorandum also quoted above, as well as the “Tax Risks” section of the Memorandum, and as stated on page two of the tax opinion letter, Andersen relied on the factual information provided to it by the management of the partnership. Tax Opinion Letter at 2 (Andersen “relied on management and their legal counsel for business and legal matters”); Offering Memorandum at 22 (“INVESTORS ARE CAUTIONED THAT THE CONCLUSIONS IN THE TAX OPINION ARE BASED UPON CERTAIN REPRESENTATIONS TO ARTHUR ANDERSEN BY THE GENERAL PARTNER”). The Court concluded that, given all of the cautionary language, Andersen’s tax opinion cannot be read to mean that Andersen undertook to make representations of any kind regarding the value of the nursery stock. Id at 541.