Fraud – Limitations – Discovery rule

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Where a plaintiff who lost money in a fraudulent investment scheme has brought suit seeking to hold liable the employer of the individual responsible for the fraud, the applicability of the discovery rule renders some of the plaintiff’s claims timely.

Threshold issues

“In this action, plaintiff Deborah J. Scott (‘Scott’) seeks recovery of money lost in a fraudulent investment scheme. Defendant Mage, LLC (‘Mage’) employed the individual responsible for the fraud, Stephen Hochberg. Defendants Jeffrey S. Davis and Jonathan Freedman were and are members and officers of Mage. Defendants move for summary judgment on all counts. …

“Defendants assert two threshold arguments that they contend bar all of Scott’s claims. The two arguments are estoppel and lack of survival of the claims after Robert Scott’s death. …

“Defendants assert that Scott is estopped from asserting all of her claims in this action by the fact that she represented, under oath, in her 2008 federal income tax return that she did not intend to pursue a third-party for her investment loss from Realty Funding. As a result of that representation, Scott received a substantial tax refund. Alternatively, defendants argue that Scott’s representation acts to waive her claims against them. …

“Two factors weigh against a finding that Scott’s tax return election acts in an unconscionable manner toward defendants. First, Scott’s representation regarding her 2008-2009 intent to pursue a third-party claim was not relied upon by defendants. It was a representation made to the IRS and is, therefore, subject to whatever the tax laws and regulations require as a result of Scott pursuit of this lawsuit. It is a matter between Scott and the IRS, not defendants. Second, when Scott signed the tax return in 2009 and represented whether she intended to pursue a third-party claim ‘as of the last day of the discovery year [2008]’ she had not commenced this action. Instead, she had commenced a direct claim against Hochberg in 2008. It was not inconsistent for her to declare a lack of present intent to sue a third-party, such as one or more of defendants, based on what she knew then. Accordingly, defendants’ estoppel argument is rejected.

“Likewise, defendants’ argument that Scott’s representation in her 2008 tax return was a waiver of her claims fails. The representation, by its terms, was not an intentional waiver of a known right. At most, it was a statement of present intent. …

“Another threshold argument raised by defendants concerns whether the death of Robert Scott in 2006 extinguished any tort -based claim against defendants. …

“Among the flaws in defendants’ argument is the fact that the evidence supports a finding the purchase of the Realty Funding investment was by the Robert K. Scott Revocable Trust. …”

Limitations defense

“The principal basis for the motion for summary judgment is that all of Scott’s claims are barred by the applicable statute of limitations. … Scott contends that all three of the defendants owed her a fiduciary duty, the scope of which included disclosing to her, and protecting her from, Hochberg’s untrustworthiness. Defendants, on the other hand, assert that no fiduciary duty existed. …

“There is a triable issue of fact with respect to whether a fiduciary relationship existed between Hochberg and both Scott and Robert Scott. …

“Throughout the entire relationship between Hochberg and the Scotts, Hochberg was acting as CEO of Mage. Through Hochberg’s continuing relationship as an agent, Mage, the principal, is deemed to have the same relationship. Thus, based upon a finding that a fiduciary relationship existed between Hochberg and the Scotts, a fiduciary relationship between Mage and the Scotts also existed. …

“Mage argues that the scope of any fiduciary relationship with the Scotts did not include investment advice. In particular, Mage argues that Hochberg’s solicitation to invest in Realty Funding (a fact unknown to Mage) was outside the scope of Hochberg’s employment duties and beyond his actual or apparent authority from Mage. As a result, Mage contends it cannot be held liable for Hochberg’s fraud on a respondeat superior basis. The foundation of this argument is the November 23, 2005 email from Hochberg to the Scotts where Hochberg made it clear that the investment in Realty Funding had nothing to do with Mage and that Hochberg was running the investment entirely on his own.

“The November 23, 2005 email does, in fact, operate to relieve Mage from respondeat superior liability for Hochberg’s fraud. …

“Hochberg’s conduct in soliciting the Scotts to invest in a real estate fund run entirely by himself was not in the scope of his employment. Moreover, the conduct was motivated entirely to benefit himself, not Mage. Finally, the November 23, 2005 email makes it impossible for Scott to rely upon apparent authority. This is true notwithstanding Hochberg using his Mage email address when corresponding with the Scotts about the investment. … Because Hochberg’s conduct in soliciting the Realty Funding investment was not within the scope of his employment, Mage cannot be held to be vicariously liable for Hochberg’s fraud.

“That said, the question of whether Mage may be held directly liable for breach of fiduciary duty remains vital. As described above, a jury could find that Mage had an ongoing fiduciary relationship with the Scotts from the original engagement until at least the time of the firing of Hochberg. The scope of that fiduciary duty as described by Mage was to provide ‘comprehensive financial advisory services’ to its clients. Mage could be found to have a duty to disclose to its client that Hochberg was untrustworthy when it came to handling money, was living beyond his means, and the client should be wary about investing in any fund that was controlled by Hochberg. The scope of the fiduciary duty could also be found to include protecting a client by properly supervising or firing a rogue employee who Mage has put in contact with the client. …

“… A fiduciary relationship is not … imputed to Davis and Freedman as a result of Hochberg’s relationship. Further, as members or managers of a LLC, they are not liable for the LLC’s breach of fiduciary duty. …

“… Here, Scott arguably suffered an injury when the undocumented investment in Realty Funding was first made or, at the latest, when a quarterly distribution check was not timely provided. If the latter date is used, Scott’s claims based upon Hochberg’s fraudulent conduct accrued as early as April 2006. …

“The summary judgment record contains no evidence suggesting that Scott knew or had reason to know, prior to August 13, 2007 (three years before filing of this action), that the conduct of Davis, Freedman or Mage caused her harm. Her claim is that defendants failed to inform her of information they had regarding Hochberg’s untrustworthiness and to protect her by supervising or firing Hochberg. Nothing in the summary judgment record indicates when Scott became aware of what Davis, Freedman or Mage knew regarding Hochberg untrustworthiness but which they did not disclose. A reasonable inference may be drawn that such awareness was long after August 15, 2007, when her lawyer ([Robert] Kunes) wrote a demand letter to Hochberg at Mage and said nothing about any potential liability of Davis, Freedman or Mage. When she sued Hochberg in 2008, she did not assert claims against Mage, Davis and Freedman. The inference is further buttressed by Scott’s statement that she was not aware of facts to support a claim against third-parties when she signed her 2008 tax return in October 2009. Finally, because ‘[i]n most instances, the question when a plaintiff knew or should have known of its cause of action is one of fact that will be decided by the trier of fact’ the question of when Scott became aware of the wrongful conduct of Davis, Freedman and Mage should be left to the jury. … As a result, Scott’s direct claims against Davis, Freedman and Mage survive a summary judgment challenge based upon the applicable statutes of limitations.”

Economic loss doctrine

“The amended complaint alleges that defendants knew of Hochberg’s improper investment activities and his untrustworthiness but failed to do anything about it. They assert a claim for negligent employment, retention and supervision of Hochberg, as well as a claim that defendants negligently failed to inform the Scotts of their knowledge of Hochberg’s financial irregularities and to warn the Scotts not to invest with Hochberg. … Because Scott’s only alleged loss is the loss of her investment, defendants contend that her claims of negligence are barred. …

“Defendants cite no Massachusetts authority applying the economic loss doctrine to a claim for negligent supervision. … Scott’s claim seeks to hold liable the two principals in a small firm who allegedly allowed, with direct knowledge, an untrustworthy business partner to continue to deal with the financial affairs of a client to benefit the firm and, indirectly themselves, without properly supervising their third business partner. In substance, there was an implicit misrepresentation by Davis and Freedman that their business partner, Hochberg, was worthy of their clients’ trust. These facts do not fit into the policy rationale for the economic loss doctrine which acts to limit negligence liability for unforeseeable losses. Consequently, defendants’ motion for summary judgment on the negligence claims will be denied.”

Chapter 93A

“… There is sufficient evidence for a fact finder to conclude that there was a business relationship between Mage and Scott. …

“… Mere negligence is not usually a violation of c. 93A. Scott contends, however, that the failure of defendants to warn Scott about Hochberg even after they had removed Hochberg as a signatory to Mage’s bank accounts (arguably to protect themselves), and to allow Hochberg, improperly supervised, to deal with Scott’s financial affairs, was unfair and deceptive. At this stage, indulging all inferences in favor of Scott, the c.93A claim cannot be dismissed on summary judgment.”

G.L.c. 110A

“… Scott alleges that Hochberg was a ‘seller’ and Mage, Davis and Freedman were ‘control persons’ under this statute.

“As described above, Mage did not sell and was not involved in the sale of Realty Funding shares. It is beyond dispute that Hochberg sold the Realty Funding interest separately from Mage and explicitly represented as much to the Scotts. Thus, Davis and Freedman are not control persons merely because they are officers of Mage. In addition, the record establishes that Mage, Davis and Freedman were not aware of Hochberg’s sale of Realty Funding to the Scotts. Accordingly, the only issue is whether defendants controlled the seller, Hochberg, ‘directly or indirectly’ with respect to his illegal activity of selling unregistered interests in Realty Funding. Scott contends that the ability of defendants to supervise and discipline Hochberg generally in his capacity as officer/principal of Mage is enough. Her contention fails.

“… [T]here is no evidence in this case that Mage, Davis or Freedman exercised any control over Hochberg with respect to Realty Funding. Summary judgment is appropriate to dismiss Scott’s claim under the MUSA.”

Conclusion

“For the reasons stated above, defendants’ motion for summary judgment is allowed in part and denied in part. The motion is allowed with respect to Counts III and VI asserting liability of defendants on a respondeat superior basis for Hochberg’s fraudulent activity. The motion is allowed with respect to Count II, breach of fiduciary duty, in favor of defendants Jeffrey Davis and Jonathan Freedman. The motion is allowed with respect to Count IV, alleged violation of the Massachusetts Uniform Securities Act. The motion is denied in all other respects.”

Scott v. Mage, LLC, et al. (Lawyers Weekly No. 12-027-14) (33 pages) (Leibensperger, J.) (Suffolk Superior Court) (Civil Action No. 2010-03232-H) (Feb. 21, 2014).

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