Effort to Hold Attorney's Liable on Client's Securities Frraud Rejected

7^th Circuit Reject Efforts to Hold Attorneys Liable for Client’s Securities Fraud

      In a recent decision, the 7^th Circuit Court of Appeals determined that the attorneys to the promoter of an investment security plan were not responsible to make good the investor’s losses when the venture ultimately failed.  Rosenbaum v. White, No. 11-3224 (7^th Cir. Aug. 16, 2012). 

      Chad Seybold, a securities broker turned real estate investor, enlisted the aid of attorneys Beau Jack White and James Beaman to assist in organizing an investment vehicle, a LLC, through which to purchase, rehabilitate, and then either sell or rent commercial real estate properties in Marion, Indiana.  To that end, a pair of business entities were organized, one of which would be partially owned by private investors.  Seybold was successful in soliciting investments in excess of $1 million for his plan.  However, it failed shortly after launch; the opinion does not indicate exactly how long it took for the venture to fail, but it can be inferred it took place within a matter of mere months.  In response, the investors filed suit against not only Seybold but also the attorneys.  Seybold, individually, filed for bankruptcy.  Ultimately, the suit was either dismissed or settled as all of the defendants save the attorneys.  They sought and were granted summary judgment by the trial court, and the plaintiffs appealed to the 7^th Circuit.

      With respect to claims for legal malpractice, constructive fraud and securities fraud, the Court found that all three hinged on whether the attorneys owed the plaintiffs a legal duty, that being a question of law.  Slip op. at 12.  With respect to the claims of legal malpractice and constructive fraud, the court found that the facts did not support the existence of an attorney/fiduciary relationship between the attorneys and the individual investors in the venture, it being organized as an LLC.  Arguing against the defendants’ position was the fact that Seybold, in the course of an oral presentation to some of the ultimate investors in the LLC, had indicated that the attorneys were working on their behalf, a statement not corrected by the attorney.  However, analyzing the broader context of the discussion, including the explanation that the attorneys were hired to organize the LLC’s in question, the Court determined that these facts were not sufficient to create an attorney/client relationship.  Rather, the statement was not made to all investors, many of the investors never met the attorneys, and language in the operating agreement inviting each investor to consult with their own counsel.

       The court also rejected efforts to impose liability based on alleged violations of standards set forth in the Indiana Rules of Professional Conduct Governing Attorneys.  Essentially, the Court upheld the rule, recited in those rules of professional conduct, that they do themselves create duties, rather those duties must arise at common law.

      With respect to the alleged violations of federal and state securities laws, the 7^th Circuit cited various holdings such Chiarella holding that the failure to speak cannot give rise to a claim for fraud absent a duty to speak based upon a fiduciary relationship.  In that the attorneys did not stand in a fiduciary relationship with the individual investors, they had no obligation to speak in order to address the either ambiguous or misleading statements by Seybold as to the attorneys’ role in the transaction.

      Ultimately, the attorneys work in the organization of the ventures and the related financing were not subject to criticism, and that being the case it is somewhat difficult to ascertain what would be the ultimate theory of recovery by the plaintiffs.  Even in the absence of a breach of duty, there must be shown damages consequent to that breach.  The attorneys in this case were not managing the venture and were not involved in its ultimate collapse, so the suggestion of their culpability for damages is at best questionable.  With dismissal, they at least avoid having to make that demonstration.