Academic journal article Washington and Lee Law Review

The Fourth Circuit Review: Securities Law

Academic journal article Washington and Lee Law Review

The Fourth Circuit Review: Securities Law

Article excerpt


The Securities and Exchange Act of 1934 section 10(b), 15 U.S.C. sec 78j(b) (1934), requires disclosure of material information in the purchase and sale of securities. In order to state a claim for violations of section 10(b)and its corresponding Rule 10b-5, plaintiffs must allege that the defendant, in the course of a securities transaction, either knowingly made a false statement of material fact or knowingly omitted a material fact that made the transaction misleading, such that the plaintiff suffered a loss. However, the defendant's silence or omission of a material fact only violates section 10(b) if the defendant also has a duty to the plaintiff to disclose the misrepresentation.(55)

The Maryland Rules of Professional Conduct for attorneys impose a similar responsibility on lawyers. That is, an attorney may have an ethical duty either to withdraw from the representation or to disclose a misrepresentation made by one of the parties in a securities transaction.(56) However, the ethical duty the Rules of Professional Conduct impose does not correspond exactly with a legal duty to disclose under the federal securities laws.(57) Although a plaintiff cannot base a claim for a violation of federal securities laws solely on a defendant's violation of ethical standards, this situation obviously creates tension between ethical and legal considerations. The question of whether an attorney owes a duty to third parties, in a business transaction involving fraud by the attorney's client, makes the situation more problematic.

The Fourth Circuit, in Schatz v. Rosenberg, 943 F.2d 485 (4th Cir. 1991), cert. denied sub nom. Schatz v. Weinberg & Green, 112 S. Ct. 1475 (1992), considered whether an attorney who failed to disclose material information to a third party in a securities transaction had violated a legal or ethical duty to disclose. Ivan and Joann Schats, the plaintiffs, sold several businesses to Mark E. Rosenberg and MER Enterprises, a holding company Rosenberg had created for the purchases. The Schatzes sued Rosenberg, MER Enterprises, and Rosenberg's law firm, Weinberg & Green, alleging that the defendants had violated Federal securities laws.

The case against Weinberg & Green stems from Rosenberg's purchase of two companies owned by the Schatses. In December 1986, MER Enterprises (MER) bought an eighty percent interest in the two Schatz companies, paying for the purchase with $1.5 million in promissory notes. Rosenberg personally guaranteed the notes, The Schatses relied on a financial statement from March 1986, and an update letter delivered on the closing date. These documents, indicating Rosenberg's net worth to be more than $7 million, contained several misrepresentations. In fact, Rosenberg's largest business filed for bankruptcy in September 1987, and Rosenberg himself filed for personal bankruptcy soon afterward. Weinberg & Green represented Rosenberg throughout.

Rosenberg defaulted on his promissory notes, never paying the Schatses. In addition, the Schatzes lost $150,000 that they had loaned to the company formed by merging their companies (of which Rosenberg owned eighty percent) with another Rosenberg company. Rosenberg siphoned off much of the operating capital from the Schatz companies, used some of the cash reserves to pay Weinberg & Green's legal fees, and generally rendered the companies worthless by the time he filed for bankruptcy in 1987.

The Schatzes filed a seven-count complaint, including three counts against Weinberg & Green. The Schatzes alleged that the law firm violated section 10(b) of the Securities and Exchange Act (Count III); that the firm aided and abetted Rosenberg in his securities violations (Count IV); and that the firm was guilty of common law misrepresentation (Count VII). The Federal District Court referred the case to a magistrate judge, who recommended that all three counts against the law firm be dismissed.

The magistrate dismissed Count III, finding that the plaintiffs did not state a cause of action for violation of section 10(b). …

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