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IN RE VMS LTD. PSHP. SECS. LITIG.

September 23, 1992

In The Matter of VMS LIMITED PARTNERSHIP SECURITIES LITIGATION; Consolidated Pretrial Proceeding

Zagel


The opinion of the court was delivered by: JAMES B. ZAGEL

MEMORANDUM OPINION AND ORDER

HONORABLE JAMES B. ZAGEL

 Plaintiffs are a group of disappointed investors who purchased real estate limited partnership interests in 1983. The partnerships were formed to acquire, own, operate, and eventually sell numerous hotels, office buildings and apartment complexes throughout the country. After their investments soured plaintiffs commenced this action for damages. Plaintiffs allege that defendants conspired to defraud them, and in the process violated federal securities and racketeering statutes, as well as various provisions of state law. In four "representative" cases, plaintiffs seek to recover their investment losses from one of the placement agents for the offerings (defendant CIGNA), and from various appraisers who allegedly overvalued the properties. *fn1" For the reasons stated below, defendants' joint motion to dismiss is granted. *fn2"

 As befits the procedural posture of this action, we must accept as true all the well-pleaded factual allegations and inferences reasonably drawn from them. Illinois Health Care Assoc. v. Illinois Dep't of Public Health, 879 F.2d 286, 288 (7th Cir. 1989). Dismissal is proper if it appears beyond doubt that the plaintiffs can prove no set of facts that would entitle them to relief. Id.

 Plaintiffs allege that in 1982 defendants embarked on a scheme to defraud them through the organization, marketing and control of real estate investment programs. Of course, such a scheme cannot succeed without investors. And a potential investor will not commit unless he is convinced that the probability of success of the investment outweighs the risk of a bust. So defendants conspired, according to plaintiffs, to wrongfully induce them to purchase limited partnership securities by deceiving them about the probable success of the investments and the risks involved.

 Plaintiffs aver that defendant CIGNA wooed them by emphasizing that CIGNA thoroughly investigated dozens of investments before choosing an investment that it would recommend. They allege that CIGNA stated it would choose only the most conservative tax-advantaged investments, and that CIGNA prepared detailed financial plans for plaintiffs to gain their trust and confidence. According to plaintiffs, however, the centerpiece of defendants' fraudulent scheme was the offering materials wherein defendants described the limited partnership offerings.

 The offering materials consisted of private placement memoranda, prospectuses, an undated VMS National Hotel Investment Summary, information from CIGNA's "red book," and other information and representations communicated by defendants. The private placement memoranda concerning the six properties in question consisted of a textual section describing the offering and multiple exhibits including financial forecasts and a subscription agreement. Generally speaking, projections in the private placement memoranda indicated that tax benefits would result in the early years of an investment in the partnerships. After 11 to 14 years, upon the sale of the properties, the partnerships would receive proceeds sufficient to return a profit.

 The plaintiffs allege that the offering materials included a number of intentional misrepresentations bind omissions and that defendants relied on false or misleading assumptions to arrive at projections. Specifically, the plaintiffs allege that defendants made the following misrepresentations:

 (a) the cost of the various properties to the partnership would be either less than the appraised value or substantially less than their replacement cost;

 (b) the partnerships were reasonably expected to be profitable or rents for the properties were substantially below market and rental revenues and could be reasonably expected to rise significantly;

 (c) the partnership's cost of acquiring the properties was favorable;

 (d) investments in the partnerships were secure, would likely be profitable, and would provide substantial tax benefits;

 (e) the projections as to rent increases were based on reasonable assumptions, supported by "due diligence," "analysis of market conditions," and "market studies";

 (f) the properties could support a minimum 10% cumulative return to investors; and

 (e) investors would enjoy an after-tax gain even if the properties were sold [at a certain date] for only $ 1 above existing indebtedness.

 Plaintiffs contend that the above representations were false in that

 (a) the true appraised value of the properties was substantially below what defendants represented;

 (b) the properties' rents were not substantially below market and could not be raised as represented; and

 (c) the partnership was a high risk investment with investors facing a substantial risk of losing their entire investment, not a conservative means to preserve capital or earn at least a 10% return on funds invested, as CIGNA represented to plaintiffs. (Emphasis in complaint.)

 In addition, plaintiffs allege that defendants failed to disclose material facts about investment in the partnerships. These alleged material omissions include:

 (a) that defendant CIGNA (who was also acting as the financial planner for plaintiffs) was to receive substantial fees as a result of plaintiffs' purchase of interests in the partnership, and that CIGNA would not have recommended the partnership to plaintiffs in the absence of such commissions;

 (b) truly independent appraisals of the properties were substantially less than the partnerships paid;

 (c) the partnership's use of negative amortization financing had a detrimental effect on equity build-up and also increased the risk created from even a small decline or only moderate growth in the value of the properties; and

 (d) the projections in the offering materials were based on unreasonable assumptions.

 The private placement memoranda contained information other than the alleged misrepresentations and omissions: the memoranda emphasized the risks inherent in the offering. The cover page of the memoranda stated unequivocally that the "offering involves a high degree of risk," and referred to the section of the memoranda discussing "risk factors." The cover page also noted prominently:

 PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THE CONTENTS OF THIS MEMORANDUM OR ANY PRIOR OR SUBSEQUENT COMMUNICATION FROM THE GENERAL PARTNERS . . . AS LEGAL OR TAX ADVICE. EACH INVESTOR SHOULD CONSULT HIS OWN PERSONAL COUNSEL, ACCOUNTANT AND OTHER ADVISERS AS TO LEGAL, TAX, ECONOMIC AND RELATED MATTERS CONCERNING THE INVESTMENT DESCRIBED HEREIN AND ITS SUITABILITY FOR HIM.

 Furthermore, the memoranda warned that, except for other information authorized by the general partners, "NO PERSON HAS BEEN AUTHORIZED TO MAKE REPRESENTATIONS OR GIVE ANY INFORMATION, WITH RESPECT TO THESE UNITS, EXCEPT THE INFORMATION CONTAINED HEREIN."

 The cover page of the memoranda also contained the following admonishment: "INVESTMENT IN THE UNITS IS SUITABLE ONLY FOR INVESTORS WHO MEET THE SUITABILITY STANDARDS DESCRIBED UNDER 'WHO SHOULD INVEST.'" That section stated that "investment in the units involves a high degree of risk" and is suitable only for persons who "could withstand a loss of their entire investment in the Units." Four of the six memoranda went on to state, in these or similar words, that an investor should, either alone or with his purchaser representative, have "such ...


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