The opinion of the court was delivered by: BRIEANT
Plaintiffs' second amended complaint, filed June 11, 1975, premises this Court's subject matter jurisdiction upon § 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa, and principles of pendent jurisdiction. This complaint pleads two claims of fraud based upon §§ 10(b) and 18 of the 1934 Act, 15 U.S.C. §§ 78j(b) and 78r, and related rules of the Securities and Exchange Commission, and a third claim charging common law negligence or accountant's malpractice. The Court has previously dismissed plaintiffs' amended complaint for failure to plead the fraud with the particularity required by Rule 9(b), F.R. Civ. P., but granted plaintiffs leave to file this second amended complaint.
Defendant moves, pursuant to Rule 12(b)(6), Fed. R. Civ. P., for an order dismissing this third complaint for failure to state a federal claim upon which relief can be granted, and for consequent lack of pendent subject matter jurisdiction as to the common law claim. In the alternative, if a claim is stated under § 18 of the 1934 Act, defendant seeks an order requiring plaintiffs to post security for the costs of this action.
This complaint, like its predecessors, is captioned as a class action, in which plaintiffs seek to represent all customers of Weis Securities, Inc. as of May 24, 1973, when a Securities Investor Protection Corporation trustee was appointed for that stock brokerage firm. The plaintiff trustees were cash account customers of Weis, and plaintiff Shurpin maintained a margin account with that firm.
Until May 24, 1973, Weis was a member of the New York Stock Exchange and other securities exchanges. Between January 1971 and May 24, 1973, defendant was Weis' independent certified public accountant. The complaint alleges that, in this capacity, Touche Ross certified three financial statements that were materially false and misleading, and also prepared a false Form X-17A-5 which was filed with the SEC.
Two of these statements, those dated as of November 24, 1972 and February 23, 1973, were not audited by Touche Ross and are plainly marked "Unaudited." As to these financial statements, there can be no reliance upon misrepresentations by these defendant accountants. We therefore find that the allegations relating to the unaudited financials fail to state a claim.
Plaintiffs' first amended complaint was dismissed without prejudice for failure to comply with Rule 9(b), F.R. Civ. P. This Court believes that the second amended complaint has cured this defect. The specific misrepresentations and omissions in the audited May 26, 1972 annual report and Form X-17A-5 may be characterized generally, for purposes of this Memorandum, as understating Weis' liabilities and inflating its assets.
An alleged fraud under § 10(b) and Rule 10b-5 must be "in connection with the purchase or sale of any security." See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975); Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 96 L. Ed. 1356, 72 S. Ct. 1051 (1952). At issue here is whether the allegedly fraudulent misrepresentations and omissions were so proximately related either to a purchase or a sale, as to be actionable as "in connection with" such a transaction.
The complaint alleges that the trustee plaintiffs, in reliance upon defendant's certified financial statements, made four purchases through Weis, as broker. It is not alleged, nor could it be, that the misrepresentations or omissions caused the plaintiffs to enter into these particular purchase transactions or purchase these particular securities.
Moreover, no claim is made that the loss incurred by these plaintiffs was caused by the decision to invest in any particular issue. See Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 380 (2d Cir. 1974), cert. denied, 421 U.S. 976, 44 L. Ed. 2d 467, 95 S. Ct. 1976 (1975).
Under the circumstances of this case, the purchase transaction was complete when Weis acquired possession of the securities issued in the name of the purchaser, or when Weis sent its customer confirmation of the purchase and identified the street name security on its books and records as belonging to its customer. See New York Uniform Commercial Code §§ 8-313(1)(b), (c). Thereafter, when the plaintiff trustees, as cash account customers, allowed their shares to remain in the possession of Weis, they made a separate decision quite apart from the investment decision to purchase the shares. This decision was to permit Weis to act as custodian or bailee of these securities.
No loss resulted from the decisions to make the purchases, but rather, the damage flowed from the decision to place or leave the stock certificates in Weis' cage. See Rich v. New York Stock Exchange, 379 F. Supp. 1122 (S.D.N.Y. 1974), rev'd on other grounds, 522 F.2d 153 (2d Cir. 1975).
Viewed most favorably to the plaintiffs, they entered into this bailment in reliance upon the solvency of Weis as certified by these accountants. The alleged misrepresentations and omissions were not made in connection with any purchase of securities, but rather, in connection with a bailment.
Plaintiffs contend that they were "forced sellers" of their securities and that the fraud occurred in connection with this forced sale. The Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq., authorizes a SIPC trustee to distribute to customers, pro rata to the extent available, securities which he finds in the possession of the defunct brokerage firm, and to satisfy the remainder of the claims in cash within the statutory limit. The complaint alleges that the plaintiffs had securities sold for them when, pursuant to Court authorization under SIPA, they received cash in lieu of a portion of the securities which they owned.
Defendants contend that this liquidation does not qualify as a "sale" for purposes of Rule 10b-5. Defendants rely upon Ingenito v. Bermec Corporation, 376 F. Supp. 1154 (S.D.N.Y. 1974), where the Court held that a bankruptcy liquidation of the issuer was not a "sale" for purposes of Rule 10b-5. This analogy is inapposite. In SIPC liquidation, as in a sale, a security holder's investment is reduced to its market price cash equivalent. The case varies from a bankruptcy liquidation in that the conversion from securities to cash does not occur as to all holders of a particular class of securities of the issuer. In SIPC liquidation, securities of various issuers are returned to the extent they are available; missing securities, as to which there is a shortage, are deemed reduced to their cash equivalent as of the close of business on the SIPA filing date, and claims are paid from SIPC's insurance fund or the general assets of the defunct stockbroker. For reasons not within the control of the investor, a portion of his shares are converted to cash. However, if the customer's claim for securities of a particular issuer can be fully satisfied in kind, the customer is not forced to accept cash. Holders of securities of the same issuer whose certificates were not with Weis retained their investment intact. A SIPC liquidation of customers' accounts more nearly resembles a sale transaction than a bankruptcy liquidation of the issuer. We hold that the SIPC liquidation qualifies as a sale of securities, where and to the extent customers' claims to specific shares are satisfied in cash due to shortage. Vine v. Beneficial Finance Company, 374 F.2d 627, 634-35 (2d Cir.), cert. denied 389 U.S. 970, 19 L. Ed. 2d 460, 88 S. Ct. 463 (1967).
There remains the issue whether there exists the requisite nexus between the alleged fraud and such a sale, so as to be actionable under Rule 10b-5. To satisfy the "in connection with" requirement, the injury caused to plaintiff must have been "a result of deceptive practices touching its sale of securities as an investor." Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 12-13, 30 L. Ed. 2d 128, 92 S. Ct. 165 (1971). To satisfy the requirement, "the alleged fraud must be intrinsic to the securities transaction itself." In re R. Hoe & Co., Fed. Sec. L. Rep. (CCH) P94,552 at 95,923 (S.D.N.Y. 1974). See also, Bolger v. Laventhol, Krekstein, Horwath & Horwath, 381 F. Supp. 260, 267 (S.D.N.Y. 1974).
In Competitive Associates, Inc. v. Laventhol, Krekstein, Horwath & Horwath, 516 F.2d 811 (2d Cir. 1975), relied upon by plaintiffs, the Court held that a Rule 10b-5 claim was stated against accountants who certified financial statements of a private investment fund which were false and misleading, and on which plaintiff relied in selecting the same investment adviser to manage a portion of its portfolio. The Court found that the plaintiff alleged a fraudulent scheme, in which the defendant accountants actively collaborated, "the accomplishment of which [was] directly related to the trading process." 516 F.2d at 815. There, the plaintiffs, in reliance upon the fraudulent financial statements, selected the investment adviser who caused the plaintiff to enter into fraudulent securities transactions ...