Fraud: Sale of Interests to General Partners

By Alvin Arnold
A federal district court ruled that investors in a Section 8 project can pursue securities fraud claims against the general partners for inducing them to sell their interests without disclosing the prospects for increased returns through sale, refinancing, or participation in the mark-up-to-market program. (Gerber v. Bowditch, 2006 WL 1284232) (D. Mass.).

Background
The plaintiffs were investor limited partners in Old Salem Associates Limited Partnership, the owner of a 321 unit apartment project with Section 8 contracts for 220 units. Defendants Robert S. Bowditch and Gerald Slavet were the general partners, and defendant Steven Rioff was the Class A limited partner.

In a September 30, 2004 letter, the general partners offered to purchase the limited partners' interests for $50,000 a unit, about half the initial capital contribution. The tender offer was good for 30 days.

While disclaiming any representation as to the fairness of the offer, the letter said the limited partners were unlikely to recoup their investment through a sale or refinancing. The letter also noted that the Section 8 contracts would expire on March 31, 2005, and although the general partners would request a renewal, "it is not known what rent level HUD will approve at this time."

Tender Offer Accepted
The plaintiffs tendered their interests. After the transaction was completed, they learned the project was eligible for the mark-up-to-market program. The defendants submitted a mark-up-to-market application on November 10, 2004, and HUD approved it on April 5, 2005. The plaintiffs alleged the project thereby stood to realize about $621,000 in additional annual rent.

According to the plaintiffs, they also received information that MassHousing was willing to refinance the partnership's debt for about $15 million and that AHP Holdings Company LLC offered to purchase the partnership assets for about $14.5 million.

Based upon these allegations, the plaintiffs asserted a number of causes of action, including securities fraud in violation of Section 10(b) of the Securities and Exchange Act and Securities and Exchange Commission (SEC) Rule lOb-5. The defendants moved to dismiss the claims.

Elements of Claim
To state a claim under Rule lOb-5, the court explained, a plaintiff must allege the following elements with particularity: a material misstatement or omission, intent to deceive or defraud; connection with a sale of a security; reliance; causation; and economic loss. In this case, the court said, the plaintiffs satisfied the pleading requirements for the last four elements; so it addressed the first two.

Material Misstatement or Omission

With respect to the first element, the plaintiffs argued that the September 30 letter was material and misleading because it failed to disclose the prospects for increased rental income through the mark-up-to-market program and misrepresented the project's market value.

The defendants contended that the plaintiffs did not meet the pleading standards because they did not explain why the September 30 letter was misleading. The defendants said the statement about the possible MassHousing refinancing was hearsay, that the AHP purchase offer was illusory because it lacked detail, and that the potential Section 8 rent increases were too uncertain to guarantee a return on plaintiffs' investment.

Rejecting the defendants' arguments, the court ruled that the plaintiffs had met the requirement for pleading material misstatements and omissions, though it noted they must provide additional evidence to prove their case.

Alvin Arnold is the editor of the Monitor. He can be reached at (212) 885-8235.

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Alvin L. Arnold at (212) 885-8235.