United States District Court, Middle District of Pennsylvania
March 20, 1991
RICHARD M. PELL, JAMES R. MILLER AND JAMES O'BRIEN, PLAINTIFFS,
MICHAEL WEINSTEIN, ERNEST GLANZ, RICHARD BOBER, BRUCE M. BLOOM, PHILIP KAGAN, PHILIP ERARD, FINKLE & ROSS, CERTIFIED PUBLIC ACCOUNTANTS, AND DENIS LUSTIG, A CERTIFIED PUBLIC ACCOUNTANT, DEFENDANTS.
The opinion of the court was delivered by: McCLURE, District Judge.
This action was commenced by plaintiffs on November 26, 1988.
In response to the defendants' motions to dismiss the
complaint, plaintiffs filed an amended complaint on March 7,
1989, pursuant to Fed.R.Civ.P. 15(a). Once again, all of the
defendants have filed motions to dismiss the complaint.
This action arises from the acquisition of PacStar
Corporation, Inc., ("PacStar"), by a corporation known as
Coated Sales, Inc., ("Coated Sales"). The plaintiffs, Richard
Pell, James Miller and James O'Brien, were all shareholders in
PacStar at the time of its acquisition. The complaint alleges
that Coated Sales' acquisition of PacStar was completed
through, and accompanied by, violations of federal and state
securities laws, federal criminal statutes and other tortious
II. RELEVANT FACTS
The facts as alleged in the amended complaint may be
summarized as follows:
PacStar and Coated Sales were in the textile business. Coated
Sales publicly touted a corporate strategy of acquiring other
textile companies and approached PacStar for that purpose.
Subsequently, Coated Sales acquired PacStar through three
agreements: an Agency Agreement dated July 1, 1986; an
Employment Agreement dated July 1, 1986; and an Agreement and
Plan of Merger ("Merger Agreement") dated March 2, 1987
(collectively "the Agreements").
Pursuant to the Agency Agreement, PacStar was to act as
Coated Sales' exclusive sales agent for certain products. The
Agency Agreement also granted Coated Sales the option to merge
PacStar into Coated Sales or an affiliate by purchasing the
PacStar stock for cash and 100,000 shares of Coated Sales
restricted common stock. Coated Sales' option was exercisable
at its discretion, throughout the term of the Agency Agreement,
which expired on June 30, 1988.
At the time the Agency Agreement was entered into, plaintiff
Richard Pell was the sole shareholder of PacStar. Pell agreed
that his PacStar stock would remain subject to Coated Sales'
option, that he would not dispose of his stock in any manner
which would preclude the option and, in the event Pell chose to
use his PacStar stock to compensate Timothy Lafferty and
plaintiffs James Miller and James O'Brien, Pell agreed to
transfer the stock to these employees "subject to the option".
On January 13, 1987 Coated Sales notified plaintiffs of its
intention to exercise the option and sometime thereafter
provided the plaintiffs with Coated Sales' Prospectus, dated
July 10, 1986, and Form 10-Q for the period ending November 30,
1986. Pursuant to the Merger Agreement, on March 2, 1987,
Coated Sales acquired from the plaintiffs and Lafferty the
PacStar stock for cash and 100,000 shares of restricted Coated
Sales common stock, as provided in the Agency Agreement. In or
about May of 1988 plaintiffs first became aware of the
existence of some amount of fraudulent activity in the internal
operation of Coated Sales. Subsequently, on November 26, 1988,
plaintiffs initiated this action.
The plaintiffs claim that they were induced into entering
this obligation by misrepresentations contained in Coated
Sales' Prospectus and Form 10-Q, and that the sale violated,
inter alia, the Securities Act 1933 ("1933 Act"), the
Securities and change Act of 1934 ("1934 Act") and state
securities law. The plaintiffs maintain that each defendant
occupied a key position or relationship with Coated Sales that
facilitated the alleged scheme. Defendants Michael Weinstein,
Ernest Glantz, Richard Bober, Bruce Bloom, Philip Kagan and
Philip Erard ("officer/director defendants") were officers
and/or directors of Coated Sales during the relevant periods.
The remaining defendants, Finkle & Ross and Denis Lustig, were
involved in the preparation and dissemination of Coated Sales'
III. SALE OF UNREGISTERED SECURITIES
Counts I and III allege violations of Section 12(1) of the
1933 Act, 15 U.S.C. § 77l(1), by the officer/director
defendants and Denis Lustig, as an aider and abettor,
respectively. Section 12(1) creates civil liability for the
offer or sale of an unregistered security in violation of
Section 5 of the 1933 Act, 15 U.S.C. § 77e. Section 5 prohibits
the use of any means or instruments of transportation or
communication in interstate commerce or of the mails for the
purpose of delivering or selling an unregistered security. The
defendants maintain that this claim is barred by the relevant
Section 13 of the 1933 Act, 15 U.S.C. § 77m, provides:
No action shall be maintained . . . to enforce a
liability created under section 77l(1) of this
title, unless brought within one year after the
violation upon which it is based. In no event shall
any such action be brought to enforce a liability
created under section . . . 77l(1) of this title
more than three years after the security was bona
fide offered to the public.
Courts have interpreted the date of the violation as the later
of the offer, sale or delivery of the stock. See Doran v.
Petroleum Management Corp., 576 F.2d 91, 93 (5th Cir. 1978).
In the instant case, the limitations period began to run on
March 2, 1987, when the securities were delivered to the
plaintiffs, and the original complaint was not filed until
November 22, 1988, more than one and a half years later.
However, plaintiffs claim that the statute should be equitably
tolled because they did not discover the alleged fraud until
after the limitations period had expired. This argument lacks
At no time were the plaintiffs led to believe that the
securities were registered. In fact, the plaintiffs knew from
the outset that the securities would not be registered.
Moreover, although there is a split of authority concerning the
application of the discovery rule and equitable tolling to the
one-year limitation period governing nonregistration claims, a
vast majority of the cases have concluded that the limitations
period runs from the date of the violation regardless of
whether the plaintiff knew of the violation. See Cook v. Avien,
573 F.2d 685, 691 (1st Cir. 1978); Gridley v. Cunningham,
550 F.2d 551, 552-53 (8th Cir. 1977); McCullough v. Leede Oil &
Gas, Inc., 617 F. Supp. 384, 387 (W.D.Okl. 1985); Felts v.
National Account System Assoc., Inc., 469 F. Supp. 54, 64 (N.D.
Miss. 1978); Mason v. Marshall, 412 F. Supp. 294, 299 (N.D.Tex.
1974), aff'd, 531 F.2d 1274 (5th Cir. 1976); Ferland v. Orange
Groves of Florida, Inc., 377 F. Supp. 690, 703 (M.D.Fla. 1974);
Shuman v. Sherman, 356 F. Supp. 911, 912-13 (D.Md. 1973);
Moerman v. Zipco, Inc., 302 F. Supp. 439, 445 (E.D.N.Y. 1969),
aff'd, 422 F.2d 871 (2d Cir. 1970).
Based on these cases, this Court also concludes that neither
the discovery rule nor equitable tolling are applicable to the
one-year limitation period governing nonregistration claims
because the language of the statute militates against such an
application, and there is little justification for the
application of this rule outside fraud-based causes of action.
See McCullough v. Leede Oil & Gas, Inc., 617 F. Supp. at
Therefore, since these claims were not asserted within the
applicable limitations period, Counts I and III of the amended
complaint will be dismissed.
IV. SALE OF SECURITIES BY MEANS OF PROSPECTUS OR ORAL
Counts II and IV allege violations of Section 12(2) of the
1933 Act, 15 U.S.C. § 771(2), by the officer/director
defendants and Denis Lustig, as an aider and abettor,
respectively. The officer/director defendants and Lustig have
made motions to dismiss these counts for failure to state a
claim upon which relief can be granted, pursuant to
A. Standard of Review
A motion to dismiss under Fed.R.Civ.P. 12(b)(6) admits the
well pleaded allegations of the complaint, but denies their
legal sufficiency. Hospital Building Co. v. Trustees of the Rex
Hospital, 425 U.S. 738, 740, 96 S.Ct. 1848, 1850, 48 L.Ed.2d
338, 341 (1976). "It is the settled rule that `a complaint
should not be dismissed for failure to state a claim 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.'" Leone v. Aetna Cas. & Sur. Co., 599 F.2d 566, 567
(3rd Cir. 1979), quoting Conley v. Gibson, 355 U.S. 41, 45-46,
78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957).
The complaint must be read in a light most favorable to the
plaintiff with every doubt resolved in plaintiff's favor.
In Re Arthur Treacher's Franchisee Litigation, 92 F.R.D. 398,
422 (E.D.Pa. 1981).*fn3
B. Section 12(2)
Section 12(2) of the 1933 Act, 15 U.S.C. § 77l(2) imposes
liability upon any person who:
offers or sells a security . . . 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 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.*fn4
Plaintiffs' amended complaint does not refer to any oral
communication. They claim that untrue material facts were
contained in and material facts were omitted from the
prospectus, dated July 10, 1986, and Form 10-Q, for the period
ending November 30, 1986, which were provided to them after
January 13, 1987, the date Coated Sales notified the plaintiffs
of its intention to exercise the option.
The defendants contend that by the time the prospectus and
Form 10-Q came into existence, and were allegedly reviewed by
the plaintiffs, Coated Sales had already obtained the
contractual right to sell its stock to Pell, and to Miller and
O'Brien to the extent that they would later acquire
PacStar stock from Pell. Simply stated, the defendants claim
that the purchase of Coated Sales stock was completed on July
1, 1986, when the option was created, and since the prospectus
and Form 10-Q both came into existence after July 1, 1986, the
offer or sale could not have possibly been made "by means of a
The plaintiffs argue that the sale did not occur until March
2, 1987, when the Merger Agreement was signed and the exchange
C. Date of the Sale
The date of the "sale" of securities occurs when the parties
become obligated to perform. Radiation Dynamics, Inc. v.
Goldmuntz, 464 F.2d 876, 891 (2d Cir. 1972).
`Commitment' is a simple and direct way of
designating the point at which, in the classical
sense, there was a meeting of the minds of the
parties; it, marks the point at which the parties
obligated themselves to perform even if the formal
performance of their agreement is to be after a
lapse of time.
Plaintiffs contend that the Agency Agreement was fully
revocable and, as such, could not be considered a "sale" of
securities as a matter of law. They argue that the Agency
Agreement did not obligate them to purchase Coated Sales stock,
but merely created an option allowing Coated Sales to merge
with PacStar upon the occurrence of various conditions. The
only conditions plaintiffs refer to are contained in paragraphs
6(B), 12 and 13(H) of the Agency Agreement.
Paragraph 13(H) states, "The option contained herein shall
terminate upon termination of the Agency Agreement or default."
The Agency Agreement states at paragraph 13(A) that the
termination date was June 30, 1988; however, it does not
contain any specific default provisions. Since Coated Sales
exercised the option before the termination date, the
plaintiffs were not empowered to renege on the transaction
under this paragraph.
Likewise, paragraph 6(B) of the Agency Agreement did not
release the plaintiffs from their binding commitment. Paragraph
For the calendar year ended December 31, 1987,
Coated Sales shall provide audited results of
Booked Sales Orders, not later than February 28,
1988. PacStar shall have 30 days to review said
results and to avail itself of Audit and
Accounting procedures provided for in Paragraph 12
below. In the event that booked orders are less
than Fifteen Million Dollars ($15,000,000) for the
period from the date of this Agreement through
December 31, 1987, then either party shall have
the right to terminate the Agreement effective
June 30, 1988, provided that written notice is
given the other party no later than March 31,
Plaintiffs do not allege that booked sales were less than
fifteen million dollars for this period. Moreover, under
paragraph 6(B) plaintiffs were granted the right to terminate
the agreement after December 31, 1987 and Coated Sales
exercised its option on January 13, 1987, before this right
Paragraph 12 merely provides for the arbitration of any
dispute regarding the accounting of PacStar's gross profits.
The fact that a disagreement regarding the calculation of
PacStar's gross profits could be submitted for arbitration in
no way relieved the plaintiffs from their obligations under the
Agency Agreement. Arbitration of such a dispute would not have
resulted in the termination of the Agency Agreement.
Thus, the terms of the Agency Agreement clearly reflect that
plaintiffs, on July 1, 1986, granted to Coated Sales the option
to merge with PacStar and purchase plaintiffs' PacStar stock in
partial exchange for Coated Sales stock. As long as the Agency
Agreement had not expired before Coated Sales elected to
exercise the option, plaintiffs were legally obligated to sell
their stock for cash and Coated Sales stock. The material terms
were agreed to and the price, including the specific allocation
of cash and Coated Sales stock, was set forth in detail in the
Agency Agreement, which also included, in paragraph 13(E), an
adjustment as to the amount of Coated Sales stock to be
provided to plaintiffs in the event that at the date of the
merger the value of Coated Sales stock had fallen below $7.00
It is clear from the terms of the Agency Agreement that the
plaintiffs were committed to the merger, which included the
exchange of Coated Sales stock, until the expiration of the
Agency Agreement on June 30, 1988. In short, the plaintiffs
lacked the power or authority to back out of the merger with
Coated Sales at any time prior to the expiration date.
Therefore, the plaintiffs were obligated to perform under the
Agency Agreement from the time they entered into the Agency
Agreement on July 1, 1986 up until the termination date of June
30, 1988. Accordingly, since this would place the date of the
sale of the Coated Sales stock on July 1, 1986, before the
prospectus and Form 10-Q came into existence, the sale could
not possibly have been made by means of a prospectus as
required by Section 12(2), 15 U.S.C. § 77l(2).
The plaintiffs' reliance on S.E.C. v. National Student
Marketing Corp., 457 F. Supp. 682 (D.D.C. 1978) is misplaced.
National Student involved a merger agreement and sale of stock
which was dependent upon the occurrence of the merger. Before
the parties entered into the merger agreement they determined
the price and number of shares of stock to be involved in the
post-merger transaction. The merger agreement provided for
various conditions precedent to the occurrence of the merger
including, inter alia, the receipt by each party of a "comfort
letter" detailing the financial condition of the other party.
The comfort letter provided by the defendant at the closing did
not conform with the requirements of the merger agreement and
indicated that the nine month financial statement used to
secure shareholder approval for the merger was inaccurate.
However, relying on the defendant's assurances that the stated
adjustments in the comfort letter were the only ones to be made
to the company's financial statements and that earnings for the
year would be as predicted, the closing was consummated.
The S.E.C. filed suit against the defendants alleging fraud
in the sale of the stock after the merger based on the failure
to disclose to the shareholders the adjustments contained in
the comfort letter. The defendants contended that the parties
became committed to the sale of stock when they agreed on the
price and number of shares to be sold following the merger. The
Court held that the sale did not occur until after the merger
was consummated because the parties had no expectation or duty
to proceed if the merger was aborted.
Such a conditional commitment is not what the
courts had in mind when setting the time of
commitment as the critical point for antifraud
analysis. It is not some magical incantation of
"commitment" that sets the point at which
disclosure is no longer mandated, but rather the
nature of the commitment. In order to prevent the
unfair use of material inside information, the
commitment must irrevocably bind the parties to
their agreement, without regard to further action
or inaction on their part.
Id. at 704 (emphasis added).
In National Student the defendants were not irrevocably bound
to the stock sale because there were bilateral conditions for
the merger, and one of those conditions was not complied with.
In the instant case, it is beyond question that the plaintiffs
were irrevocably bound by the Agency Agreement to purchase the
stock at Coated Sales' option regardless of whether the
plaintiffs had second thoughts about the transaction.
Therefore, since the date of the sale was July 1, 1986,
plaintiffs cannot claim that the sale was made by means of the
prospectus or Form 10-Q, both of which came into existence
after July 1, 1986, and Counts II and IV of the amended
complaint will be dismissed.
V. SECURITIES FRAUD
Several of the plaintiffs' claims sound in fraud: Count V
alleges violations of Section 17 of the 1933 Act, 15 U.S.C. § 77q,
Section 10(b) of the 1934 Act, 15 U.S.C. § 78j, and
Section 1-401 of the Pennsylvania Securities Act, 70 P.S. §
1-401, by the officer/director defendants; Count VII asserts a
claim based on common law fraud against the officer/director
defendants and Lustig; and Count VIII asserts a claim based on
negligent misrepresentation against the officer/director
defendants and Lustig.
All of the defendants named in these counts have made motions
to dismiss these counts for failure to state a claim upon which
relief can be granted, pursuant to Fed.R.Civ.P. 12(b)(6).
The one common thread which permeates all of the plaintiffs'
fraud-based claims is reliance. See Zlotnick v. TIE
Communications, 836 F.2d 818, 821 (3d Cir. 1988) (reliance is a
necessary element for a cause of action under section 10(b) of
the 1934 Act, 15 U.S.C. § 78j); Goodman v. Moyer, 523 F. Supp. 35,
38 (E.D.Pa. 1981) (70 P.S. § 1-401 and section 10(b) of the
1934 Act require similar elements of proof); McDaniel v.
Compania Minera de Cortes, Etc., 528 F. Supp. 152,166 (D.Ariz.
1981) (reliance is an element of a private cause of action
under section 17 of the 1933 Act, 15 U.S.C.77q); English v.
Lehigh County Authority, 286 Pa. Super. 312, 428 A.2d 1343
(1981) (reliance is an element of a cause of action based on
negligent misrepresentation); Klemow v. Time, Inc., 466 Pa. 189,
352 A.2d 12 (1976) (reliance is an element of common law
The untrue or omitted material facts which the plaintiffs
claim they relied upon in making their decision to accept
Coated Sales stock in exchange for their PacStar stock are
contained in the prospectus and Form 10-Q. However, as noted
earlier, the prospectus, which was dated July 10, 1986, and
Form 10-Q, which was for the period ending November 30, 1986,
did not even exist on July 1, 1986, the date the plaintiffs
committed themselves to the transaction by entering into the
Agency Agreement. Furthermore, even the plaintiffs admit that
they did not review the prospectus and Form 10-Q until after
Coated Sales notified them of its intention to exercise the
option on January 13, 1987.
As established above, even if the plaintiffs were not
satisfied with the information contained in the prospectus and
Form 10-Q, they were powerless to avoid the transaction which
they committed to on July 1, 1986 once Coated Sales chose to
exercise the option. Therefore, plaintiffs could not possibly
have relied on the prospectus or Form 10-Q in reaching their
decision to enter into the transaction with Coated Sales.
Since the date of the sale was July 1, 1986, plaintiffs
cannot, as a matter of law, claim that they relied on the
prospectus or Form 10-Q, both of which came into existence
after July 1, 1986, in reaching their decision to purchase
Coated Sales stock and Counts V, VII and VIII of the amended
complaint will be dismissed.
VI. BREACH OF CONTRACT
Count VI seeks to hold the officer/director defendants liable
for breach of contract. The amended complaint alleges that the
"officer/director defendants, as controlling persons of Coated
Sales, failed to perform the obligations required by the terms
and conditions of the Agreements and the acquisition
contemplated thereby because of the failure of consideration
and their fraudulent activities, and thus breached the
An individual corporate officer, however, is not liable for
the breach of contract by the corporation. "Whenever a
corporation makes a contract it is the contract
of the legal entity of the artificial being created by the
charter, not the contract of the individual members." Bala
Corporation v. McGlinn, 295 Pa. 74, 79, 144 A. 823, 824 (1929).
"Where a party contracts with a corporation through a corporate
agent who acts within the scope of his authority and reveals
his principal, the corporate principal alone is liable for
breach of the contract." Daniel Adams Associates v. Rimbach
Publishing, Inc., 360 Pa. Super. 72, 79-80, 519 A.2d 997,
1000-01 (1987); see Revere Press, Inc. v. Blumberg, 431 Pa. 370,
373, 246 A.2d 407, 409 (1968); Rossi v. Pennsylvania State
University, 340 Pa. Super. 39, 56, 489 A.2d 828, 837 (1985).
Since, plaintiffs do not allege that Coated Sales was a sham
or the alter ego of the officer/director defendants, they are
unable to pierce the corporate veil. Wicks v. Milzoco Builders,
Inc., 503 Pa. 614, 470 A.2d 86 (1983). Therefore, this breach
of contract claim is legally insufficient and, as such, is
subject to dismissal.*fn6 However, plaintiffs will be provided
the opportunity to amend this Count to comply with the
requirements of the law, if possible.
Count IX asserts a civil RICO (Racketeer Influenced and
Corrupt Organizations Act) claim against the officer/director
defendants. Although not specifically stated in the amended
complaint, plaintiffs' RICO claim appears to be based upon a
violation of 18 U.S.C. § 1962(c), which provides that:
It shall be unlawful for any person employed by
or associated with any enterprises engaged in, or
the activities of which affect, interstate or
foreign commerce, to conduct or participate,
directly or indirectly, in the conduct of such
enterprise's affairs through a pattern of
racketeering activity or collection of an unlawful
The officer/director defendants contest plaintiffs' RICO claim
on several grounds.
A. The Enterprise Element
A claim under Section 1962(c) requires that the culpable
"person" engaged in conduct of an "enterprise" through a
pattern of racketeering activity. See Sedima, S.P. R.L. v.
Imrex Company, 473 U.S. 479
, 500, 105 S.Ct. 3275, 3287, 87
L.Ed.2d 346, 361 (1985).
In the Third Circuit, the culpable "person" and the
"enterprise" must be separate and distinct entities.
Saporito v. Combustion Engineering, Inc., 843 F.2d 666, 678 (3d
Cir. 1988); Petro-Tech, Inc. v. Western Co. of North America,
824 F.2d 1349, 1359 (3d Cir. 1987). That is, the person charged
with the RICO violation under § 1962(c) cannot be the same
entity as the alleged enterprise. B.F. Hirsch v. Enright
Refining Corp., 751 F.2d 628, 633 (3d Cir. 1984). Since a
corporation cannot operate except through its officers and
agents, a corporate "enterprise" and its employees are not
separate and distinct for the purposes of § 1962(c). Tarasi v.
Dravo Corp., 613 F. Supp. 1235, 1237 (W.D.Pa. 1985).
[A] corporation can only operate through its
officers and agents. Thus, for the purpose of
ascertaining § 1962(c) liability, [the chief
executive officer of the corporation] is the same
entity as and should be treated in the same manner
as [the corporate defendant].
Ellis v. Merrill Lynch & Co., 664 F. Supp. 979, 982 (E.D.Pa.
1987). See PetroTech Inc., v. The Western Company of North
America, 824 F.2d 1349
, 1359 (3d Cir. 1987) (a corporation is
not liable under § 1962(c) for the predicate acts committed by
its employees); Newfield v. Shearson LehMan Bros., 699 F. Supp. 1124,
1126-27 (E.D.Pa. 1988) ("Since Shearson is a corporation,
which cannot act but through its agents, plaintiff [in alleging
that the enterprise consisted of Shearson and two of its
employees] has in effect pleaded the existence of an
association-in-fact of a corporation with its agents . . . This
will not satisfy the nonidentity requirement."); Medallion TV
Enterprises, Inc. v. SelecTV of
California, Inc., 627 F. Supp. 1290, 1294-95 (C.D.Cal. 1986);
Waldo v. North American Van Lines, Inc., 669 F. Supp. 722,
737-39 (W.D.Pa. 1987); Minnesota Odd Fellows Home Foundation v.
Engler & Budd Co., 630 F. Supp. 797, 800 (D.Minn. 1986); cf.
Chambers Development Co. v. Browning-Ferris Industries,
590 F. Supp. 1528, 1542-42 (W.D.Pa. 1984) (a corporation and its
agents are not capable of conspiracy together because they are
legally the same person.)
Significantly, plaintiffs do not allege that the
officer/director defendants committed acts of racketeering
activity in their individual capacities. Instead, they allege
that the officer/director defendants acted "[a]s officers of
Coated Sales." (Amended Complaint at ¶ 143). Thus, the alleged
acts of the officer/director defendants were clearly the
alleged acts of Coated Sales. See Girard v. 94th Street and
Fifth Avenue Corp., 530 F.2d 66, 76 (2d Cir. 1975).
Consequently, because the amended complaint alleges that the
"enterprise" is Coated Sales and that the culpable persons are
the officer/director defendants, each claimed to have been
officers and/or directors and controlling persons of Coated
Sales, the plaintiffs have failed to allege a separate
Since Coated Sales, the claimed RICO enterprise, is not
separate and distinct from the officer/director defendants, the
RICO allegations contained in Count IX of the amended complaint
are legally insufficient.
B. Predicate Acts
The predicate racketeering activity central to the
plaintiffs' RICO claim is the alleged federal securities fraud.
Since plaintiffs' securities fraud claims have been dismissed,
they cannot serve as RICO predicate acts. See International
Data Bank, Ltd. v. Zepkin, 812 F.2d 149
, 151 (4th Cir. 1987)
Nutis v. Penn. Merchandise Corp., 610 F. Supp. 1573 (E.D.Pa.
1985) (since plaintiff failed to state a securities fraud cause
of action, the claim could not serve as a RICO predicate
offense); see also Hill v. Equitable Bank, 655 F. Supp. 631, 646
(D.Del. 1987); Alfaro v. E.F. Hutton & Co., Inc., 606 F. Supp. 1100,
1119 (E.D.Pa. 1985); In re Catanella and E.F. Hutton and
Co., Securities Litigation, 583 F. Supp. 1388 (E.D.Pa. 1984).
Although plaintiffs also claim that the officer/director
defendants used the mails and telecommunications "to perpetrate
a fraud upon the plaintiffs" (Amended Complaint at ¶¶ 145(a)
and (b)), the essence of the RICO claim is the alleged
fraudulent sale of Coated Sales stock. Therefore, the dismissal
of the securities fraud claims necessitates the dismissal of
the RICO claim.
[S]ince our dismissal of the securities fraud
claim so undercut the existence of any
"racketeering activity" in the complaint, we
affirm the district court's dismissal of
plaintiff's RICO claim.
Moss v. Morgan Stanley, Inc., 719 F.2d 5
, 19-20 (2d Cir. 1983).
As to violations of the mail and wire fraud statutes,
18 U.S.C. § 1341, 1343, plaintiffs do not allege that the
officer/director defendants committed an "indictable" act of
mail or wire fraud as required by 18 U.S.C. § 1961(1).
Plaintiffs do not properly allege a scheme to defraud and the
use of the mails or wires in furtherance of the scheme, United
States v. Pisani, 773 F.2d 397, 409 (2d Cir. 1985), or the
officer/director defendants' participation and specific intent
to defraud. Beck v. Manufacturers Hanover Trust Co.,
820 F.2d 46, 49 (2d Cir. 1987).
Plaintiffs' sole allegation concerning a mail or wire fraud
offense is that "materially inaccurate, incomplete and
misleading information audited by accountant defendants was
communicated to plaintiffs by means of the United States mails
and telephonic communications." (Amended Complaint at ¶ 55.)
Plaintiffs do not state who communicated this information, what
was communicated, or when and how it was communicated. Indeed,
plaintiffs do not even claim that the information was
"communicated" by any of the officer/director defendants.
Plaintiffs have clearly not alleged that the officer/director
defendants committed "indictable" acts of criminal mail or wire
Therefore, because the Court has dismissed the plaintiffs'
claims of securities fraud, which serve as the essence of the
RICO claim, and the plaintiffs have failed to allege any other
indictable acts, Count IX of the amended complaint will be
Count XI asserts a claim based on common law fraud against
Finkle & Ross and Denis Lustig ("accountant defendants"). The
amended complaint alleges that the financial statements audited
by the accountant defendants were false and fraudulent, that
the accountant defendants knew that the financial statements
were false and that the plaintiffs justifiably relied on these
false financial statements when they entered into the
agreements with Coated Sales.*fn8 The accountant defendants
maintain that the amended complaint fails to state the alleged
fraud with sufficient particularity as required by Fed.R.Civ.P.
9(b).*fn9 The Court agrees.
In order to satisfy the pleading requirements of Rule 9(b),
"a party must at a minimum, `state the time, place and content
of the false misrepresentation, the fact misrepresented and
what was obtained or given up as a consequence of the fraud.'"
DuSesoi v. United Refining Co., 540 F. Supp. 1260, 1272 (W.D.Pa.
1982), quoting, In re Sugar Industry Antitrust Litigation, 73
F.R.D. 322, 349 (E.D.Pa. 1976). Even where the plaintiff's
allegations of fraud are based on information and belief,
supporting facts on which this belief is
founded must be set forth in the complaint. Hayduk v. Lanna,
775 F.2d 441, 444 (1st Cir. 1985).
The amended complaint fails to set forth any specifics
regarding the alleged fraud. In particular, the plaintiffs do
not even attempt to identify the errors in the financial
statements or the amount of any inaccuracies, nor do they
identify any specific accounting principle or auditing standard
which was violated. Rather, the plaintiffs simply state that
the financial statements were false and that the Accountant
defendants knew that they were false. This clearly does not
satisfy the requirements of Rule 9(b). See Christidis v. First
Pennsylvania Mortgage Trust, 717 F.2d 96 (3d Cir. 1983)
(affirmed dismissal of fraud claim against an accounting firm
for failure to identify the particular accounting practices
Therefore, plaintiff will be permitted to amend Count XI of
the amended complaint to conform with the requirements of Rule
9(b) as set forth above.
IX. BREACH OF THIRD PARTY BENEFICIARY CONTRACT
Count X of the amended complaint alleges breach of a third
party beneficiary contract by Finkle & Ross. Plaintiffs contend
that they were injured by the alleged breach of Coated Sales'
contract with Finkle & Ross in accordance with which Finkle &
Ross was obligated to provide accurate statements of Coated
Sales' financial position.
Under Pennsylvania law, "a promisor cannot be held liable to
an alleged beneficiary of a contract unless the latter was
within his contemplation at the time the contract was entered
into and such liability was intentionally assumed by him in his
undertaking; the obligation to the third party must be created,
and must affirmatively appear, in the contract itself." Dept.
of General Services v. Celli-Flynn, 115 Pa. Commw. 494, 499,
540 A.2d 1365, 1368 (1988), citing Spires v. Hanover Fire Insurance
Co., 364 Pa. 52, 57, 70 A.2d 828, 830-31 (1950); Schmidt v.
Leader Dogs for the Blind, Inc., 544 F. Supp. 42, 45 (E.D.Pa.
The plaintiffs do not allege that any obligation to them
affirmatively appears in the Coated Sales contract with Finkle
& Ross. Instead, they argue that as potential investors they
were contemplated users of the financial statements and,
therefore were third party beneficiaries to the contract. This,
however, falls short of the requirements for a third party
beneficiary claim under Pennsylvania law. Accordingly, Count X
of the amended complaint will be dismissed.
X. PROFESSIONAL NEGLIGENCE
Plaintiffs have asserted claims based on the sweeping
allegation that Finkle & Ross and Denis Lustig failed in their
obligation to provide accurate accounting and auditing services
for Coated Sales. Counts XII and XIII allege negligence and
gross negligence, respectively, on the part of Finkle & Ross
and Denis Lustig in the performance of accounting and auditing
services for Coated Sales. The plaintiffs seek to recover on
these claims based on the theory that they were the
contemplated and foreseeable users of Coated Sales financial
statements with respect to which Finkle & Ross and Denis Lustig
rendered professional services. Significantly, the plaintiffs
do not allege that they had any contractual relationship with
In Pennsylvania, an action for professional negligence cannot
be maintained unless there is privity of contract between the
parties. See Landell v. Lybrand, 264 Pa. 406, 107 A. 783 (1919)
(where plaintiff-shareholder claimed that the corporation's
financial statements were incomplete and misleading, the
Pennsylvania Supreme Court held that, as a matter of law, the
plaintiff failed to state a claim against the corporation's
accountants because privity of contract did not exist);
Hartford Accident and Indemnity Co. v. Parente, Randolph,
Orlando, Carey and Associates, 642 F. Supp. 38 (M.D.Pa. 1985)
(citing Landell, Judge Caldwell dismissed third party complaint
filed against accounting firm for lack of privity); Guy v.
501 Pa. 47, 459 A.2d 744 (1983) (Pennsylvania Supreme Court
reversed Superior Court's holding that privity was not required
to maintain a professional negligence action against an
attorney); Raymond Rosen & Co. v. Seidman & Seidman, ___
Pa.Super. ___, 579 A.2d 424 (1990) (court affirmed dismissal of
malpractice action against certified public accountant for lack
The plaintiffs argue that the current business environment
demands the establishment of a new benchmark for accountant
liability in Pennsylvania which abandons the requirement of
privity. However, this is an argument more properly presented
to the Pennsylvania courts. It is beyond question that under
current Pennsylvania law, privity is required in an action for
professional negligence. Therefore, since Pennsylvania does not
recognize the theories of liability set forth in Counts XII and
XIII, these counts will be dismissed.
We therefore enter the following Order.
For the reasons stated in the accompanying memorandum, it is
1. Counts I, II, III, IV, V, VII, VIII, IX, X, XII, XIII of
plaintiffs' amended complaint filed on March 7, 1989 are
2. Plaintiffs are granted leave to amend Counts VI and XI of
the amended complaint in accordance with the attached
memorandum. Failure to amend these counts within twenty days of
receipt of this Order will subject them to dismissal.