The opinion of the court was delivered by: BONSAL
Defendants in the above actions have moved, pursuant to Rule 12(b) (1) of the Federal Rules of Civil Procedure, for orders dismissing the complaints for lack of subject matter jurisdiction and have moved for other relief. Since both motions involve the same questions, they are treated together.
The plaintiffs in each action are citizens of the State of Washington. The defendants in each action are, Reynolds & Co., a New York partnership engaged in the stock brokerage business, and Ralph E. Carpenter, a citizen of the State of New York and a partner of the defendant Reynolds & Co., and during all times relevant to the action a director of Alside, Inc. (Alside), the stock of which is listed on the New York Stock Exchange.
Both plaintiffs maintained securities brokerage accounts with defendant Reynolds & Co. from January 1963 to August 1964. Plaintiffs' actions are based on alleged misrepresentation of material facts and failure to disclose material facts on the part of the defendants, as a consequence of which the plaintiffs were induced to retain their shares in Alside when they desired to sell them, and in the case of the plaintiff Arneil, that he was induced to purchase additional shares of Alside.
The two complaints are similar, each containing five counts - three against both defendants and two against the defendant Carpenter alone. The first count charges defendants with violating Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j) and Rule 10b-5 promulgated thereunder. The second count charges common law fraud, and the third count common law negligence. The fourth count repeats the charge of violation of Section 10(b) and Rule 10b-5 by defendant Carpenter alone, and the fifth count charges Carpenter with breach of his fiduciary duty as a director of Alside.
The defendants in both actions have moved, pursuant to Rule 12(b) (1) of the Federal Rules of Civil Procedure, to dismiss Counts I and IV of the Stockwell complaint and so much of Counts I and IV of the Arneil complaint as are based on the retention of the plaintiffs' Alside shares, for lack of subject matter jurisdiction. Defendants further move, pursuant to Rule 12(b) (6), for an order dismissing both complaints for failure to state a claim upon which relief can be granted. Defendants further move for an order directing that the matters alleged in Counts II, III and V be submitted to arbitration pursuant to the arbitration clause in the Customer's Agreements executed by defendant Reynolds & Co. with each of the plaintiffs. Finally, as an alternative prayer for relief, the defendants move, pursuant to Rule 12(e) and 12(f) for an order to strike certain allegations of each complaint and to make the complaint more definite and certain.
For the purposes of these motions, the factual allegations of the complaints are to be taken as true, and the complaints may not be dismissed unless it is clear from the complaints that the plaintiffs are not entitled to any relief. Arfons v. E.I. DuPont De Nemours & Co., 261 F.2d 434 (2d Cir. 1958); Dioguardi v. Durning, 139 F.2d 774 (2d Cir. 1944); Cochran v. Channing Corp., 211 F. Supp. 239 (S.D.N.Y. 1962); 2 Moore, Federal Practice P12.08, pp. 2244-45 (2d ed. 1964).
The complaints allege that each plaintiff opened a securities brokerage account with defendant Reynolds & Co. in or about January 1963, and that each plaintiff was informed at the time that defendant Carpenter was a director of Alside and that they would be kept fully informed of any circumstances which would affect the price of Alside stock. By August of 1963 Reynolds & Co. held 3,900 shares of Alside for plaintiff Stockwell's account, and by September 1963, 600 shares for plaintiff Arneil's account. Plaintiffs' Alside shares were purchased through defendant Reynolds & Co., with the exception of 1,400 shares held by plaintiff Stockwell (only plaintiff Stockwell alleges that he purchased his Alside shares on the basis of representations made by defendant Reynolds & Co.).
It is alleged that in September 1963 each plaintiff told the defendants that he wished to sell his Alside shares, and that defendants advised the plaintiffs not to sell their shares but, indeed, to purchase more shares, this advice being based on the fact that defendant Carpenter was a director of Alside and was thus in a position to know the financial condition of the company. Defendants are charged with representing to the plaintiffs: (a) that the decline in the price of Alside shares was caused by specialized selling and was not due to any financial or business problems of the company; (b) that it was time to buy Alside shares; (c) that defendant Reynolds & Co. would issue in the near future an institutional report concerning Alside; (d) that the financial condition and business situation of Alside assured the rise in price of Alside shares; and (e) that Alside, through its divisions and subsidiaries, was entering into the business of "producing houses and financing the sales thereof," and that, as a result of this new venture, Alside's earnings would be materially increased and the price of the shares would rise. Plaintiffs allege that the defendants knew, or should have known, that each of the foregoing representations was false or, alternatively (Count III), that they were made negligently. Each complaint also alleges that the defendant Carpenter failed to disclose the true facts concerning Alside, namely, that Alside and its home division or subsidiary was experiencing substantial financial difficulties. Each complaint alleges that the defendants made these representations in order to induce the plaintiff to retain his Alside stock and, in the case of plaintiff Arneil, to purchase additional shares. Both plaintiffs allege that they believed and relied on the representations in not selling their shares at the time and, in the case of plaintiff Arneil, in purchasing additional shares. The price of Alside shares thereafter declined, but it is alleged that the defendants, by means of the same representations, dissuaded the plaintiffs from selling until about February of 1964 when each plaintiff alleges he learned of the falsity of the representations and later sold his shares at a loss.
The issues presented by the motions are: first, whether Counts I and IV of each complaint state a cause of action under Section 10(b) of the Securities Exchange Act of 1934 and under Rule 10b-5 issued thereunder; second, whether the provisions of the Customer's Agreement executed by the defendant Reynolds & Co. with each of the plaintiffs require that the controversy alleged in Counts II, III and V be submitted to arbitration; and third, whether any matters contained in the complaints which are found not to be arbitrable state a cause of action. Counts I and IV of each complaint charge violations by the defendants of Section 10(b) of the Securities Exchange Act of 1934 and of Rule 10b-5 promulgated thereunder.
Defendants urge that Section 10(b) and Rule 10b-5 are not applicable because the alleged fraud was not "in connection with the purchase or sale of any security." At most, according to the defendants, the alleged misrepresentations and reliance thereon induced the plaintiffs to hold their Alside shares, and although they later sold their shares after discovering the alleged fraud, the sale was in no way connected with the alleged fraud. The plaintiffs, on the other hand, argue that the subsequent sale at a loss was directly connected with the alleged fraud and that they can establish this at the trial.
The words "in connection with the purchase or sale of any security" contained in Section 10(b) and in Rule 10b-5 do not require that the purchase or sale immediately follow the alleged fraud. The words have been construed more liberally in order to carry out the intent of the Act, which is designed to protect investors against fraud. Cooper v. North Jersey Trust Co., 226 F. Supp. 972 (S.D.N.Y. 1964); New Park Mining Co. v. Cranmer, 225 F. Supp. 261 (S.D.N.Y. 1963); Pettit v. American Stock Exchange, 217 F. Supp. 21 (S.D.N.Y. 1963). If plaintiffs indeed wished to sell their Alside shares and were induced to defer the sale by the fraudulent representations of the defendants, with the result that they ultimately sold at a greater loss, it follows, under the foregoing decisions, that the fraud was in connection with the sale of securities as that term is used in Section 10(b) and Rule 10b-5. Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952), relied on by the defendants, did not involve either a purchase or sale of stock by the plaintiffs, and the court found that in such a situation no cause of action was stated under Section 10(b) or Rule 10b-5. The rationale of Birnbaum was that the case involved fraudulent mismanagement of corporate affairs rather than fraudulent practices in connection with the purchase or sale of securities. Similarly, in Keers and Co. v. American Steel and Pump Corp., 234 F. Supp. 201, 1965 CCH Federal Securities Law Reporter, P91,433 (S.D.N.Y. 1964) there was no sale or purchase of stock by the plaintiffs.
Plaintiffs here allege that they sold their shares after they learned of the alleged fraud, and if that is the case and they suffered greater loss by reason thereof, it would follow that their loss was a consequence of the defendants' fraud. Considering the purposes underlying the Securities Exchange Act and Section 10(b) and Rule 10b-5, which are to protect investors from fraud, it follows that a seller is injured as much when he suffers a loss on the sale of securities which he has been fraudulently induced to retain as when he is fraudulently induced to sell them. Accordingly, for the purposes of this motion, Counts I and IV of each complaint state a cause of action under Section 10(b) and Rule 10b-5, and defendants' motions as to these counts must be denied.
With respect to defendants' motion to compel arbitration of Counts II, III and V,
this is based on paragraph 14 of the Customer's Agreement executed between defendant Reynolds & Co. and each of the plaintiffs, which provides, in part, as follows:
"14. Any controversy between us arising out of or relating to this contract or the breach thereof shall be settled by arbitration, in accordance with the rules, then obtaining, of either the Arbitration Committee of the Chamber of Commerce of the State of New York, or the American Arbitration Association, or ...