Securities Exchange Act claims of the MILP III, MIF an Land Fund II subclasses are precluded by the statute of limitations. Accordingly, counts one, five and eight are dismissed.
Failure to comply with the statute of limitations is but one of several reasons for dismissing the 1934 Act claims of the Income Trust, MILP I an Land Trust subclasses. The plaintiffs representing these subclasses failed to allege the dates they purchased their securities. This omission is fatal to the claims of these plaintiffs, for plaintiffs are obliged to plead affirmative facts showing compliance with the statute of limitations. Fisher, 691 F. Supp at 71; Ambling, 658 F. Supp. at 1462. The three-year maximum limitations period under § 13 of the 1933 Act begins to run on the date of sale. Plaintiffs cannot show that they filed suit within three years of the date of sale if they have not alleged these dates.
Therefore, counts two, three and seven must be dismissed.
Plaintiffs representing the Hotel Fund subclass, Marie Matson and David E. Robbins, allege that they purchased Hotel Fund securities during the initial public offering, between July 12, 1985 and January 6, 1986. Complaint paras. 12(v, bb). Even assuming that both Matson and Robbins purchased securities on the last day of the initial public offering, more than three years elapsed before the January 11, 1990 class action was filed.
Thus, the Hotel Fund plaintiffs have not met their burden of pleading facts to show compliance with the three-year period of limitations under § 13. Count six is dismissed.
Plaintiffs John and Ilana Falco, and Atlantic Electric Supply Corporation Pension Plan invested in MILP II between January 2, 1986 and July 3, 1986. Complaint paras. 12(c, k, l). As with the Hotel Fund subclass, the MILP II plaintiffs cannot escape the mandate of § 13's absolute three-year limitation period. That period expired on July 3, 1989, before any claim against any defendant was filed. The court must therefore dismiss count four with prejudice.
Plaintiffs bring their remaining 1934 Securities Exchange Act claim on behalf of the entire class against all defendants for violations of §§ 10(b), 20(a) and Rule 10b-5. As none of the subclasses have complied with the statute of limitations, the claims on behalf of all eight subclasses collectively are also time-barred. Accordingly, count nine is dismissed.
C. RICO Claims
Plaintiffs' RICO claims are governed by a four-year limitations period. Agency Holding Corp. v. Malley-Duff & Assocs., Inc., 483 U.S. 143, 97 L. Ed. 2d 121, 107 S. Ct. 2759 (1987); Davenport, 903 F.2d at 1143. The Seventh Circuit has yet to determine when a RICO cause of action accrues for limitations period purposes. Other judges of this court and courts in other circuits have adopted one of two standards for RICO accrual. Under the first standard -- the "last predicate act" rule -- the limitations period begins to run when a defendant commits the last predicate act of the racketeering pattern. Norris v. Wirtz, 703 F. Supp. 1322, 1326 (N.D. Ill. 1989) (Marovich, J.). Several judges of this court adhere to this standard. See id.; Citicorp Savings of Illinois v. Streit, No. 84 C 7471 (N.D. Ill. April 3, 1987) (1987 WL 9318) (McGarr, J.); County of Cook v. Berger, 648 F. Supp. 433, 433-35 (N.D. Ill. 1986) (Kocoras, J.); Newman v. Wanland, 651 F. Supp. 20, 22 (N.D. Ill. 1986) (Williams, J.).
Under the second standard, the RICO claim accrues at the time the plaintiff discovers or should have discovered that she sustained an injury from a RICO violation. McCool v. Strata Oil Co., 724 F. Supp. 1232, 1237 (N.D. Ill. 1989) (Bua, J.); Bowling v. Founders Title Co., 773 F.2d 1175, 1178 (11th Cir. 1985), cert. denied, 475 U.S. 1109, 106 S. Ct. 1516, 89 L. Ed. 2d 915 (1986). The "discovery" rule enjoys widespread support among other circuits. See, e.g., id.; Riddell v. Riddell Washington Corp., 275 U.S. App. D.C. 362, 866 F.2d 1480, 1489-90 (D.C. Cir. 1989); Pocahontas Supreme Coal Co., Inc. v. Bethlehem Steel Corp., 828 F.2d 211, 230 (4th Cir. 1987); Compton v. Ide, 732 F.2d 1429, 1433 (9th Cir. 1984); Alexander v. Perkin Elmer Corp., 729 F.2d 576, 577 (8th Cir. 1984). In addition, at least two other judges in this district follow the discovery rule. See McCool, 724 F. Supp. at 1237 (Bua, J.); Abernathy v. Erickson, 657 F. Supp. 504, 507-08 (N.D. Ill. 1987) (Bua, J.); Electronic Relays (India) Pvt., Ltd. v. Pascente, 610 F. Supp. 648, 653 (N.D. Ill. 1985) (Hart, J.). In the present case, the task of determining the appropriate rule is made easier by the parties, who agree that the discovery rule should govern. Response at 42; Reply at 10. Therefore, the statute of limitations for plaintiffs' RICO claims began to run when plaintiffs either discovered or should have discovered that they sustained an injury from defendants' alleged acts of racketeering activity.
We must first determine when these alleged racketeering acts occurred. The alleged pattern of racketeering activity consists of defendants' acts of securities fraud, in violation of § 10(b) of the 1934 Securities Exchange Act, mail fraud, in violation of 18 U.S.C. § 1341, and wire fraud, in violation of 18 U.S.C. § 1343. The securities fraud allegations center around defendants' sale of the Funds' securities. Complaint para. 358. The wire fraud allegations are based on defendants' alleged use of telephones in connection with the sale of the Funds' securities. Id. Plaintiffs base their mail fraud claims on defendants' alleged use of the mails to disseminate information relating to the Funds "in order to induce persons to purchase the Funds' securities." Id. Therefore, all of the alleged predicate racketeering acts occurred either on the dates the prospectuses were issued, or on the dates plaintiffs purchased their securities. Since none of the plaintiffs who purchased securities during the initial public offering allege their precise date of purchase, the court assumes, for the purposes of the statute of limitations, that the plaintiffs purchased their securities on the first day of the initial public offering for each of the Funds. The prospectuses for each Fund were also issued on the first day of the Funds' public offerings. Thus, the court considers the first date of the initial public offering for each Fund as the date defendants allegedly committed a predicate racketeering act.
The initial public offerings for the Land Trust, Land Fund II, MIF and MILP III all took place less than four years before January 11, 1990, when all Funds were named as defendants for the first time.
Thus, the RICO claims with respect to these Funds do not run afoul of the statute of limitations. As for the remaining four Funds, the court need not decide at this time whether any equitable tolling doctrines forestall the statute of limitations. Plaintiffs' RICO claims suffer from numerous deficiencies that require dismissal under Fed. R. Civ. P. 9(b) and 12(b)(6).
D. Common Law Fraud Claims
The common law claims in counts fifteen through thirty-nine are governed by a five-year period of limitations. Ill. Stat. Ann. ch. 110, para. 13-205 (Smith-Hurd 1984). Except for the Income Trust and MILP I securities, all of the Funds' securities were sold within five years of the latest possible date this suit could be considered filed, April 30, 1990. As to the Income Trust and MILP I, plaintiffs fail to allege any purchase dates. Thus, it is impossible to determine whether the statute of limitations bars plaintiffs' common law claims with respect to their purchase of the Income Trust and MILP I securities.
II. Motion to Dismiss Based on Rule 9(b)
Defendants move to dismiss all counts sounding in fraud for failure to comply with Fed. R. Civ. P. 9(b). Rule 9(b) requires that
In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally.
Rule 9(b)'s particularity requirement furthers two basic purposes: (1) to reasonably notify defendants of their roles in the alleged scheme so that they may prepare a responsive pleading; and (2) to "safeguard potential defendants from lightly made claims charging commission of acts that involve some degree of moral turpitude." Bankers Trust Co. v. Old Republic Ins. Co., 697 F. Supp. 1483, 1484-85 (N.D. Ill. 1988) (citations omitted). See also O'Brien v. Nat'l Property Analysts Partners, 719 F. Supp. 222, 225 (S.D.N.Y. 1989). These purposes are usually satisfied if the complaint sets forth the time, place, and substance of the alleged misrepresentations, as well as who made the statements and the method by which the misrepresentation was communicated to the plaintiff. Sears v. Likens, 912 F.2d 889 (7th Cir. 1990); Flournoy v. Peyson, 701 F. Supp. 1370, 1374 (N.D. Ill. 1988). However, conclusory allegations of fraud and averments of state of mind are insufficient to satisfy Rule 9(b). Flynn v. Merrick, 881 F.2d 446, 449 (7th Cir. 1989). In addition, a complaint does not satisfy Rule 9(b) if it makes blanket allegations that fail to specifically identify the defendants who made each misrepresentation or omission. Likens, at p. 893 (complaint deficient because it "lumped all the defendants together and d[id] not specify who was involved in what activity"); Coronet Ins. Co. v. Seyfarth, 665 F. Supp. 661, 666 (N.D. Ill. 1987) ("plaintiffs may not 'lump' defendants together in general allegations of fraudulent activity, implying that each defendant is responsible for the statements and actions of others").
Defendants contend that the complaint defies Rule 9(b)'s mandate for particularity in four ways: (1) the complaint fails to differentiate the roles of each defendant; (2) the complaint does not identify the source of alleged misrepresentations; (3) the complaint does not properly plead fraud upon information and belief; and (4) the complaint fails to state when the alleged violations occurred.
Contrary to defendants' assertion, the complaint for the most part does not lump all defendants together without alleging each defendant's fraudulent conduct. The complaint lists, in painstaking detail, all forty-nine defendants and their alleged roles in the fraudulent scheme. In addition, plaintiffs allege the dates of the public offering of each Fund's securities, and the date each Fund issued its prospectus in connection with the public offering. Furthermore, plaintiffs quote extensively from the offering prospectus of each Fund and explain why they believe the statements were misleading.
Complaint paras. 65-66, 68-69, 72, 92-93, 109-10, 113, 130, 132-33, 137, 154-57, 175, 177, 179, 196-97, 212-15. Therefore, plaintiffs have set forth the requisite "who, what, when, where and how" with respect to the securities fraud charges against each defendant. DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.) reh'g denied, 1990 U.S. App. LEXIS 9787 (1990). See also Flournoy, 701 F. Supp. at 1374-75 (finding plaintiffs' allegations of fraud sufficient); Ambling, 658 F. Supp. at 1467 (plaintiffs adequately alleged defendants' fraudulent scheme of obtaining investors in limited partnership by issuing misleading prospectus).
Similarly, defendants' objection to allegations based on information and belief are without merit as to many of plaintiffs' allegations. Plaintiffs aptly point out that in securities fraud cases where matters are particularly within the knowledge of the defendants, Rule 9(b) does not preclude pleadings of fraud on information and belief, so long as the complaint includes facts upon which the belief is based. Duane v. Altenburg, 297 F.2d 515, 518 (7th Cir. 1962); Bruss Co. v. Allnet Communication Services, Inc., 606 F. Supp. 401, 405 (N.D. Ill. 1985). Plaintiffs' 184-page complaint includes a number of facts to support their allegations of fraud. However, some of plaintiffs' fraud claims are not based on factual allegations. Because application of Rule 9(b) to these information and belief pleadings overlaps with the considerations attendant to a Rule 12(b)(6) motion, the 9(b) concerns are addressed in the Rule 12(b)(6) discussion. In addition, the Rule 9(b) deficiencies regarding the RICO allegations are taken up in the Rule 12(b)(6) discussion of the RICO claims.
Defendants' contention that count nine fails to comply with Rule 9(b)'s mandate has merit. In count nine, plaintiffs assert §§ 10(b) and 20(a) claims on behalf of all plaintiffs against all defendants for alleged misrepresentations and omissions in "public statements [made] during the Class Period." Count nine effectively charges each defendant with fraud in connection with all eight Funds, despite the fact that many defendants remained uninvolved with VMS Realty Partners or the Funds until quite late in the alleged fraudulent scheme. For example, the Xerox defendants did not become involved with the Funds until February 1987, when XCC became a 25 percent owner of VMS Realty Partners. Thus, the Xerox defendants cannot share liability in connection with any of the six offering prospectuses issued before February 1987. Similarly, count nine charges Prudential-Bache Securities and Prudential-Bache Properties with liability for fraud in connection with all the Funds, even though plaintiffs allege that Prudential-Bache Securities was involved with the offerings of only four of the eight Funds, and Prudential-Bache Properties in only two. In addition, many of the defendants served on the board of directors for some, but not all, of the Funds. Nevertheless, count nine charges these defendants with fraud in connection with all eight Funds.
As the foregoing examples show, count nine impermissibly lumps all defendants together and makes blanket allegations against them without alleging the place, time or substance of the fraud, much less the individual role each defendant played. Plaintiffs contend that count nine should be considered in the context of counts one through eight, which provide detailed allegations about each defendant's role in connection with a particular Fund. "Count nine," say plaintiffs, "build[s] on the details previously set forth in the fraud counts brought on behalf of each of the eight subclasses, [and] charges all defendants with having participated in a single overall fraudulent scheme." Response at 22. While this may be true, the court cannot accept the vague allegations in count nine, especially because count nine seeks to hold all defendants responsible for all alleged misrepresentations, regardless of the extent of each defendant's involvement in the misrepresentation. The court recognizes that in a fraud claim against a group of corporate insiders who acted collectively, the requirements of particularity may be relaxed, particularly when the defendants control much of the information concerning the fraud. Carter v. Signode Industries, Inc., 694 F. Supp. 493, 500 (N.D. Ill. 1988). However, in this case, plaintiffs already have information as to each defendant's involvement in each of the Funds; such information is admittedly alleged in the complaint. The allegations of fraud against the various defendants in the first eight counts exhaust the extent of liability for each defendant under the 1934 Securities Exchange Act. Count nine adds nothing to the first eight counts; it merely attempts to impose liability on all defendants for all fraudulent acts. Count nine must be dismissed.
As to the remaining counts sounding in fraud, the particular Rule 9(b) objections raised by defendants lack merit. Nevertheless, the court finds that plaintiffs have failed to comply with Rule 9(b) in alleging certain elements of their fraud and RICO claims. Because the failure to adequately allege the elements of a cause of action is the focus of a motion to dismiss under Rule 12(b)(6), the Rule 9(b) deficiencies in this respect are taken up in the discussion of the motion to dismiss for failure to state a claim.
III. Rule 12(b)(6) Motion to Dismiss
Dismissal on a Rule 12(b)(6) motion is proper where it is clear that no relief could be granted under any set of facts consistent with the allegations in the complaint. Robin v. Doctors Officenters Corp., 686 F. Supp. 199, 207 (N.D. Ill. 1988), citing Hishon v. King & Spalding, 467 U.S. 69, 73, 81 L. Ed. 2d 59, 104 S. Ct. 2229 (1984).
A. Securities Fraud Claims Under the 1934 Securities Exchange Act
Counts one through nine allege primary and aiding and abetting liability under § 10(b) and Rule 10b-5, and controlling person liability pursuant to § 20(a) of the 1934 Securities Exchange Act.
The second paragraph of each count lists the defendants charged with liability for conduct in connection with the particular Fund. The plaintiffs sue each particular Fund, all "controlling persons" of the Fund, the advisors and guarantors of the Fund, and the underwriters for the Fund's securities, on theories of primary liability, aiding and abetting liability, and controlling person liability.
1. Primary Liability
To establish a primary violation of § 10(b) and Rule 5(b), plaintiffs must demonstrate that the defendants
(1) in connection with a securities transaction, (2) made an untrue statement of material fact or omitted a material fact that rendered the statements made misleading, (3) with the intent to mislead, and (4) which caused the plaintiffs' loss.
Schlifke v. Seafirst Corp., 866 F.2d 935, 943 (7th Cir. 1989). The court addresses each of these four criteria separately.
a. The Transaction Requirement
It is well settled that only purchasers or sellers of securities may assert claims for securities fraud under the 1934 Act. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 731, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975) ("plaintiff class for purposes of § 10(b) and Rule 10b-5 private damage actions is limited to purchasers and sellers of securities"); Norris v. Wirtz, 719 F.2d 256, 258 (7th Cir. 1983), cert. denied, 466 U.S. 929, 80 L. Ed. 2d 185, 104 S. Ct. 1713 (1984); Beck v. Cantor, Fitzgerald & Co., Inc., 621 F. Supp. 1547, 1555 (N.D. Ill. 1985) (rejecting liability premised upon alleged misrepresentations and omissions that occurred after plaintiff purchased his stock). While the complaint alleges that each named plaintiff purchased securities from a particular Fund, defendants are correct in observing an "egregious" defect in the complaint: plaintiffs' failure to allege specific purchase dates. Because liability under § 10(b) and Rule 10b-5 must be premised on plaintiffs' reliance on misrepresentations in purchasing the Funds' securities, the dates of purchase are essential to their claim. Without purchase dates, it is impossible to determine whether certain investors could have purchased their securities "in connection with" the alleged misrepresentations contained in the eight offering prospectuses, the Forms 10-K and 10-Q for each Fund, and the year-end shareholder reports for each Fund. It is also impossible to determine whether the 1934 Act claims are barred by the statute of limitations, which expires three years after the sale of the security, without exception. Thus, the court must dismiss the claims of all plaintiffs who failed to provide any references to when they made their investments in a particular Fund.
The only indication of purchase dates for any plaintiff is found in the complaint's allegations that some plaintiffs invested in a particular Fund during the Fund's initial public offering. At that time, the only documents these plaintiffs could have relied on were the offering prospectuses. Thus, the court must limit its consideration of plaintiffs' 1934 Act claims to the statements made in the prospectuses. Any misleading statements in subsequent documents, such as annual shareholder reports or Forms 10-k and 10-Q are not relevant to plaintiffs' securities fraud claims because the statements were not made "in connection with" a purchase or sale of securities.
b. Material Misrepresentations or Omissions
For every defendant charged with primary liability under § 10(b) and Rule 10b-5, plaintiffs must establish that he or she made misrepresentations or omissions of material fact. Plaintiffs allege primary liability against the Funds, the Funds' officers, directors, trustees, underwriters, guarantors, advisors and appraisers. In addition, plaintiffs charge various defendants with primary liability because of their association with VMS Realty Partners. Plaintiffs' dragnet approach to establishing liability must be stopped short at this point, because the vast majority of the forty-nine defendants could not possibly be primary violators. All of the alleged misleading statements were issued by the eight Funds. The guarantors, underwriters, advisors and appraisers were not responsible for issuing the prospectuses or any other alleged misleading document.
Thus, the only defendants who could conceivably be charged with primary liability are the Funds, and certain "controlling persons."
DiLeo, 901 F.2d at 626-28.
The Seventh Circuit explained in Rowe v. Maremont Corp., 850 F.2d 1226, 1223 (7th Cir. 1988) that "an omission or misstatement is material under Rule 10b-5 if it is substantially likely that a reasonable investor would have viewed the omitted or misstated fact as significantly altering the 'total mix' of information made available." Id., quoting Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 99 L. Ed. 2d 194, 108 S. Ct. 978 (1988). Plaintiffs' allegations essentially fall into four different categories of misleading statements.
First, plaintiffs claim that the prospectuses misled investors into believing that the Funds' securities were a "safe" or "conservative" investment. Although a review of the prospectuses
reveals no express assurances of conservatism, the prospectuses do contain various statements that plaintiffs contend imply a low-risk venture. For example, each of the prospectuses describes the Fund's primary objectives as preserving the Fund's capital and providing quarterly distributions to stockholders. Complaint paras. 66, 93, 110, 132, 155, 177, 197, 212. In addition, the prospectuses assure investors that various entities will guarantee the Funds' investments and cash flow. Complaint paras. 66, 93, 197, 212.
Defendants do not debate the notion that mischaracterizations of risk may constitute misrepresentations of material fact. Bastian v. Petren Resources Corp., 892 F.2d 680, 685-86 (7th Cir.), cert. denied, 496 U.S. 906, 110 S. Ct. 2590, 110 L. Ed. 2d 270 (1990). Cf. Fisher v. Samuels, 691 F. Supp. 63, 69 (N.D. Ill. 1988). Defendants argue that even if plaintiffs could draw an inference of "safety" from snippets of the prospectuses, any such inference is thoroughly dispelled by the prospectuses' extensive disclosures concerning inherent risks. Defendants ask this court to determine, on a motion to dismiss, that the prospectuses adequately disclosed the risks as a matter of law.
In Acme Propane, Inc. v. Tenexco, Inc., 844 F.2d 1317 (7th Cir. 1988), the Seventh Circuit affirmed the dismissal of certain securities fraud claims because the defendants had adequately disclosed the nature of the investment in a document provided to the plaintiffs before they made their investment. In Acme Propane, the plaintiffs claimed the defendants made misleading oral statements to them regarding the productivity of certain oil wells. However, accurate productivity information was disclosed in a written "Reserve Estimate" given to plaintiffs prior to their investment. The district court determined that some of defendants' deceitful oral statements were not material to the investment decision because the plaintiffs were told the truth before investing. The Seventh Circuit upheld the district court's Rule 12(b)(6) dismissal of some of the securities fraud claims, based on defendants' written disclosure. The Seventh Circuit noted, however, that "the need to deter deceit, both oral and written, . . . [requires] that the written words be true, clear, and complete, in order to be dispositive."
Id. at 1325.
The court finds the Acme Propane reasoning applies to the present case. In the prospectuses, defendants adequately disclaimed any promises that the Funds' securities were a safe or conservative investment. Each Fund's prospectus begins with a preliminary disclosure of the nature of the risks involved:
THIS OFFERING INVOLVES CERTAIN RISKS AND CONFLICTS OF INTEREST, including conflicts of interest inherent in each and every transaction into which the Fund intends to enter with Affiliated Borrowers; economic risks relating to the ability of Borrowers to repay the loans; risks associated with mortgage investments in real estate; risks of ownership of real property; the risk that VMS Financial Guarantee Limited Partnership (the "Guarantor") may not be able to honor its guarantees to the Fund; the inability of prospective investors to evaluate specific investments; the possible inability of the Fund promptly to invest and reinvest its assets in loans or real property on favorable terms; the possible concentration in the type and number of investments; the payment of certain fees to the Advisor and its Affiliates; . . . federal income tax risks; and various other risks. See "Conflicts of Interest," "Risk Factors" and "Income Tax Consequences."
MIF prospectus at 2. See also prospectuses of: the Income Trust at 1; MILP I at 1; MILP II at 1; MILP III at 1; the Hotel Fund at 2; the Land Trust at 2; Land Fund II at 3. In addition, each prospectus contains a more detailed risk disclosure about inherent conflicts of interest, and the possibility that the guarantors would be unable to honor their guarantees.
As to the prospectuses' declared objectives to "preserve and protect the [Fund's] capital," and to "provide for quarterly cash distributions," each and every prospectus states that "there can be no assurance that [the Fund's] objectives will be attained."
Furthermore, regarding the assurance at page 3 of the Income Trust's prospectus that the Fund would "utilize the services of unaffiliated MAI real estate appraisers in determining whether to make short term loans," the prospectus stated at page 9 that
appraisals and/or preliminary valuation letters are merely opinions by individuals as to the value of real property. . . . There will be no assurance that [property securing a loan] could be resold or refinanced at its appraised value.
The foregoing disclosures are clear and unambiguous. Thus, none of the paragraphs to which plaintiffs refer supports a reasonable inference that the prospectuses misrepresented the Funds as safe or conservative investments. Moreover, nowhere in the prospectuses can one find an express assurance that an investment in a Fund would be "safe" or "conservative." Hence, plaintiffs have failed to properly allege that the prospectuses contained affirmative misrepresentations of material fact concerning the Funds' risks.
Second, plaintiffs allege that the prospectuses failed to apprise potential investors of the extent to which the Funds depended on VMS Realty Partners. According to plaintiffs, VMS Realty Partners routinely advanced money to the Funds' borrowers so that the borrowers would be able to make their loan payments to the Funds. Plaintiffs argue that this somewhat incestuous financial arrangement should have been disclosed to potential investors in the prospectuses. In the first place, the court notes that the prospectus for each Fund was issued and the securities were sold before each Fund made any loans to borrowers. Nevertheless, plaintiffs advance the palpable theory that after the first Fund had been operating for some time, defendants should have been on notice that subsequent Funds would make loans to borrowers who relied on VMS Realty Partners for financial assistance. Thus, argue plaintiffs, each offering prospectus should have reflected anticipation that VMS Realty Partners would provide subsidies to the Fund's borrowers. For several reasons, the court does not agree.
Liability under § 10(b) and Rule 10b-5 does not attach to omissions absent a duty to disclose. Schlifke v. Seafirst Corp., 866 F.2d 935, 944 (7th Cir. 1989). A duty to disclose arises in two ways. Incomplete disclosures or half-truths give rise to a duty to disclose whatever additional information is necessary to rectify misleading statements. Id. In addition, a duty to disclose may be triggered by a fiduciary-type relationship, even absent any misleading statements. Id. It is well established that a seller of securities owes no fiduciary duty to a prospective purchaser. Ambrosino, 635 F. Supp. at 973. Thus, any duty to disclose VMS Realty Partners' alleged practice of subsidizing the Funds' borrowers must stem from incomplete disclosures in the prospectuses that would render the prospectuses misleading without further disclosure.
The prospectuses advise investors that the Funds' success depends largely on the ability of borrowers to meet their loan obligations. Plaintiffs argue that this disclosure is misleading without further informing investors that VMS Realty Partners would regularly advance money to the borrowers. However, defendants correctly assert that VMS Realty Partners' subsidies did not in any way make the Funds' securities more risky. To the contrary, the policy of subsidizing borrowers provided less risk to the Funds, as they were more likely to collect payment from borrowers. Thus, the failure to disclose this practice could not have caused investors to underestimate the level of risk involved. Under the Rowe standard, the omissions were not materially misleading and defendants had no duty to disclose them.
Third, plaintiffs charge defendants with failing to disclose the Funds' practice of making loans secured by overleveraged properties. The Funds' prospectuses state that loans to affiliated borrowers would be on terms approximating those of arm's-length transactions, or would be as favorable to the Fund as loans to an unaffiliated borrower in similar circumstances. Complaint paras. 66, 110, 132, 155, 177, 212. Plaintiffs allege that in violation of these promises, the Funds routinely made loans secured by overcollateralized properties. Plaintiffs contend that the annual reports and other documents issued subsequent to the prospectus were materially misleading because they did not disclose the overleveraged loans.
In the foregoing discussion on the transaction requirement, the court explained that plaintiffs cannot base their securities fraud claims on these subsequent documents. In any event, plaintiffs' allegations of overleveraging fail to meet Rule 9(b)'s requirement of particularity. Except for the Income Trust (para. 92) and MILP I (para. 109), plaintiffs simply recite the allegation that the prospectuses for the Funds were materially misleading because
VMS Realty Partners and its affiliates, including the . . . Funds, repeatedly engaged in a practice of making loans on properties where the aggregate amount of financing greatly exceeded the value of the property.
Complaint para. 130. See also paras. 65, 154, 175, 196, 212. Plaintiffs make these conclusory allegations on information and belief, yet fail to support them with allegations of fact, as required by Rule 9(b). Duane v. Altenburg, 297 F.2d 515, 518 (7th Cir. 1962); Bruss Co. v. Allnet Communication Services, Inc., 606 F. Supp. 401, 405 (N.D.Ill. 1985). Therefore, as to all of the Funds except MILP I and the Income Trust, plaintiffs have failed to allege overleveraging with specificity under Rule 9(b).
Despite compliance with the particularity requirement of Rule 9(b), the allegations of overleveraged loans for the Income Trust and MILP I do not support plaintiffs' claims that the prospectuses misrepresented material facts. The prospectuses merely promise that the Funds' loans will approximate arm's-length transactions or contain favorable terms. As Judge Shadur explained, "expressions of opinion and promises or predictions of future fact ordinarily cannot ground fraud charges." SFM Corp. v. Sundstrand Corp., 99 F.R.D. 101, 105 (N.D. Ill. 1983).
Finally, plaintiffs maintain that the prospectuses should have disclosed that the Funds engaged in loan churning, and that VMS Realty Partners thereby engaged in a Ponzi, or pyramiding, scheme to keep creating new Funds in order to bail out failing borrowers of existing Funds.
Defendants are correct in observing that allegations of loan churning are properly viewed as charges of breach of fiduciary duty and mismanagement. It is well established that investors cannot recover under § 10(b) and Rule 10b-5 for breach of fiduciary duty. Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 97 S. Ct. 1292, 51 L. Ed. 2d 480 (1977); DiLeo, 901 F.2d at 627. Nor can plaintiffs make out a securities fraud claim by alleging that defendants failed to disclose their intent to breach fiduciary duties:
courts have consistently held that since a shareholder cannot recover under 10b-5 for a breach of fiduciary duty, neither can he "bootstrap" such a claim into a federal securities action by alleging that the disclosure philosophy of the statute obligates defendants to reveal either the culpability of their activities, or their impure motives for entering the allegedly improper transaction.