3. Count VII -- Violation of Section 12(2) of the Securities Act of 1933
R&S argues that Count VII which alleges claims for both primary and secondary liability under Section 12(2) of the Securities Act of 1933, 15 U.S.C. § 771(2) ("Section 12(2)"), should be dismissed because the investor class failed to allege that any of the defendants sold or solicited the sale of any securities. Specifically, R&S argues that proximate cause and aider and abettor allegations are insufficient to state a cause of action under Section 12(2). Section 12(2) of the Securities Act imposes liability on any person who "offers or sells a security . . . 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 . . . not misleading. . . ." 15 U.S.C. § 771(2).
R&S cites Pinter v. Dahl, 486 U.S. 622, 108 S. Ct. 2063, 100 L. Ed. 2d 658 (1988), for the proposition that the term "seller" under Section 12(1) is limited to only those who actually pass title to the securities and to those who solicit the purchase of securities for financial gain. R&S argues that because they did not pass title to securities nor solicit the purchase of securities they are not "sellers" under Section 12(1). We agree with R&S that this is an accurate reading of Pinter. Pinter did not expand liability under Section 12(1) to participants who may have facilitated the sale but were not statutory sellers. Pinter, 108 S. Ct. at 2080; Ackerman v. Schwartz, 947 F.2d 841, 844 (7th Cir. 1991). While Pinter dealt exclusively with primary liability under Section 12(1), numerous authorities (including this circuit) have applied the Pinter analysis to claims under Section 12(2) because the word "sell" has the identical meaning in Section 12(1) as in Section 12(2). Ackerman, 947 F.2d at 844-45; Wilson v. Saintine Exploration & Drilling Corp., 872 F.2d 114, 1125-26 (2d Cir. 1989); Moore v. Kayport Package Exp., Inc., 885 F.2d 531, 536 (9th Cir. 1989).
In our view, the class plaintiffs attempt to pin liability on R&S under 12(2) for "controlling the issuers" and "generally contributing to the selling momentum" (Amendment to Compl., par. 114) is wholly defective. As a matter of law, R&S cannot be liable to the class plaintiffs for allegedly substantially participating in or leading the investor plaintiffs to purchase securities from Douglas. The Supreme Court in Pinter has expressly "considered and rejected the 'substantial factor' approach to liability under § 12." Ackerman, 947 F.2d at 845; Pinter, 108 S. Ct. at 2079-82. The class plaintiffs claim against R&S for primary liability under Section 12(2) is accordingly, dismissed with prejudice.
In addition, R&S argues that the Seventh Circuit has not recognized a right of action for aiding and abetting liability under Section 12(2). For this proposition, R&S cites Schlifke v. Seafirst Corp., 866 F.2d 935 (7th Cir. 1989). In Schlifke, investors in a limited partnership investment program sued the bank that financed the program. The plaintiffs attempted to impose aiding and abetting liability on the defendant bank under Section 12(2). In declining to recognize a new implied right of action under Section 12(2), the Seventh Circuit stated that "notions of aiding and abetting liability would be inconsistent with the intent and language of the statutory provision which expressly limits to offerors and sellers the categories of persons who may be sued." Schlifke, 866 F.2d at 942. In Ackerman the Seventh Circuit reaffirmed this view and stated "we stand with Schlifke in holding that there is no liability for aiding or abetting a violation of § 12." Ackerman, 947 F.2d at 845 (citing numerous authorities therein). R&S' motion to dismiss the class plaintiffs' claim for aiding and abetting liability under Section 12(2) is granted. Count VII is dismissed with prejudice.
4. Count VIII -- Violation of Section 10(b) of the Securities Exchange Act of 1934
a. Primary Liability
The class plaintiffs allege that R& S violated Section 10(b)
of the Exchange Act and Rule 10b-5 promulgated thereunder under theories of primary and secondary liability. In order to state a claim under Section 10(b) and Rule 10b-5 for primary liability, a plaintiff must demonstrate that defendant "(1) made an untrue statement of material fact or omitted a material fact that rendered the statements made misleading, (2) in connection with a securities transaction, (3) with the intent to mislead, and (4) which caused plaintiff's loss." Schlifke v. Seafirst Corp., 866 F.2d 935, 943 (7th Cir. 1989). Equally important, only an issuer, director, signatory of a prospectus, identified drafter of documents, offeror or seller of securities or those who control them may be primarily liable. Barker v. Henderson, Franklin, Starnes & Holt, 797 F.2d 490, 494 (7th Cir. 1986). R&S argues that Count VIII is defective because plaintiffs failed to allege all four requisite elements. For the first time in its reply brief, R&S argues that it is not primarily liable because it was not a drafter, or issuer of documents, or an offeror or seller of securities.
i) Material Misrepresentations and Omissions
R&S argues that Count VIII fails to allege that Weiss or R&S made any misrepresentations of material fact to anyone.
R&S argues that Douglas and other nonparties only made misrepresentations or omissions, not R&S. The class plaintiffs allege that Weiss drafted the documents used to implement the rescission offers in Illinois and Wisconsin. The class further alleges that these rescission documents omitted material facts which, if included, would have affected the class plaintiffs' investment decisions. The class also alleges that Weiss drafted Douglas' affidavit and a letter containing false statements which were then sent to the Illinois and Wisconsin securities departments. After discovering that the statements made in the affidavit and letter were false, Weiss corrected the letter to the Wisconsin authorities but never corrected Douglas' affidavit tendered to the ISD.
Furthermore, Section 10(b) and Rule 10b-5 are not limited to misrepresentations and omissions. Rule 10b-5 prohibits the engagement in "any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security." 17 C.F.R. Section 240.10b-5(c). Here, the class plaintiffs allege that R&S actively perpetuated Douglas' fraudulent schemes by concealing his criminal record and advising him on how to continue in business when they knew of his illegal activities.
Lastly, a failure to disclose material information when one has a duty to disclose is actionable under Rule 10b-5. Robin v. Arthur Young & Co., 915 F.2d 1120, 1125 (7th Cir. 1990), cert. denied, 113 L. Ed. 2d 250, 111 S. Ct. 1317 (1991). As discussed above, R&S had a duty to inform the receivership entities of Douglas' fraudulent activities. Therefore, the class plaintiffs have sufficiently alleged facts to state a claim for primary liability under Section 10(b) and Rule 10b-5.
ii) In Connection With a Transaction
R&S next takes issue with the class plaintiffs' failure to allege that defendants made untrue statements or omissions "in connection with a securities transaction." However, the class plaintiffs allege throughout their complaint that R&S' omissions, misrepresentations, and other acts were connected with securities transactions. Indeed, R&S in its memorandum in support of its motion to dismiss devotes only two sentences to this argument. Thus, this cursory argument is rejected without further discussion.
As their third line of attach, R&S asserts that the class plaintiffs failed to allege scienter. This argument must fail. The Seventh Circuit has held that scienter under Section 10(b) and Rule 10b-5 is satisfied by "reckless conduct." Robin v. Arthur Young & Co., 915 F.2d at 1126. Here, the class has alleged sufficient facts showing reckless conduct by R&S. The class alleges that R&S knew of Douglas' fraudulent activities and advised him to, and took affirmative steps toward, keeping him in business. Therefore, the class has sufficiently pled scienter.
Finally, R&S briefly argues that the class plaintiffs failed to satisfy the causation requirement because they failed to allege that any investors relied on any omissions or misrepresentations. This argument must also fail. The class alleges that R&S omitted material facts and that they participated in the fraud. In such circumstances, it is unnecessary to allege reliance by the class plaintiffs. Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1972). Therefore, this argument cannot stand.
b. Secondary Liability
In order to establish a claim for secondary liability, a plaintiff must satisfy the following two elements: "(1) that the alleged aider and abettor, in connection with the purchase or sale of a security, committed one of the 'manipulative or deceptive' acts prohibited under § 10(b) and Rule 10b-5, and (2) that the alleged aider and abettor acted with scienter, which is the same mental state required for primary liability." Renovitch, 905 F.2d at 1045. R&S argues that the class plaintiffs have failed to sufficiently allege either of these two elements rendering its secondary liability claim fatally defective. We do not agree. As the class plaintiffs have sufficiently alleged a primary liability claim it logically follows that the secondary liability claim is likewise sufficient. R&S' motion to dismiss Count VIII is denied.
5. Count IX -- Fraud
R&S argues that Count IX must be dismissed for failure to allege the requisite elements of fraud. We do not agree. As previously discussed with regard to SMB, the class plaintiffs have sufficiently pleaded a claim for fraud against R&S. In Illinois, "a person who knowingly participates in a fraud or who knowingly accepts the fruits of fraudulent conduct is also guilty of that fraud." Shacket v. Philko Aviation, Inc., 590 F. Supp. 664, 668 (N.D. Ill. 1984). Therefore, because the class plaintiffs alleged that R&S knowingly participated in Douglas' fraud, R&S motion to dismiss Count IX is denied.
VI. ATTORNEYS' FEES AND COSTS
Finally, consistent with our decision to deny SMB's motion to dismiss Counts I through IV of plaintiffs' complaint, we also reject SMB's argument that sanctions be awarded against Prior and his client, Scholes, under Rule 11 of the Federal Rules of Civil Procedure. As an initial matter, SMB argues that the advisory committee notes to Rule 11 recommends that a motion for sanctions be entered and continued and resolved at the conclusion of the litigation. (SMB's Reply in Support of Sanctions, p. 1). In this same vein, SMB requests that before the court addresses its Rule 11 motion, the parties be given an opportunity to more fully address the issues raised by its motion. (SMB's Reply in Support of Sanctions, p. 9). We disagree with SMB on both scores.
First, the advisory committee notes to Rule 11 provide, in relevant part, that "the time when sanctions are to be imposed rests in the discretion of the trial judge. However, it is anticipated that in the case of pleadings the sanctions issue under Rule 11 normally will be determined at the end of the litigation, and in the case of motions at the time when the motion is decided or shortly thereafter." Fed. R. Civ. P. 11 advisory committee's note. In this court's view, it is particularly appropriate to evaluate SMB's motion for sanctions at this time in light of this court's resolution of the dismissal motion. After careful consideration of SMB's motion to dismiss, the court is fully conversant with the facts and issues of the case. The court will exercise its discretion and entertain SMB's motion for sanctions in order to promote judicial economy, efficiency and fairness to the litigants.
Second, the court strongly disagrees with SMB's suggestion that the parties be given a second chance to more fully address the issues raised in its motion for sanctions. Both parties are represented by capable counsel who have already been afforded one opportunity to fully brief this issue. In fact, this court has devoted considerable time and energy combing through the briefs and voluminous exhibits with respect to both the Rule 11 motion and the underlying 12(b)(6) motion to dismiss. We have thoroughly considered all pleadings in this case and have no intention of entertaining a second round of briefs on the very same point. We now address SMB's motion for sanctions.
SMB argues that Prior and the Receiver should be sanctioned for filing a complaint that is ungrounded in fact and law. SMB asserts that plaintiffs' lawsuit is without legal basis in four principal respects:
(a) Stone McGuire represented Michael S. Douglas individually as criminal counsel from June 1, 1988 to November 13, 1989 and at no time represented D&S, AT Systems or AT Service in connection with the purchase or sale of any securities or in any capacity;
(2) Stone McGuire never counselled, represented or sought to furnish legal advice to any investors or class of investors;
(3) Stone McGuire owed no duty to any of the plaintiffs' herein; and