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ALDRICH v. NEW YORK STOCK EXCH.

September 12, 1977.

Aldrich, et al.
v.
New York Stock Exchange, Inc., et al.



The opinion of the court was delivered by: WERKER

WERKER, District Judge: Defendant New York Stock Exchange (the "Exchange") has made a motion to dismiss the complaint under Rule 12(b)(6) of the Federal Rules of Civil Procedure with respect to those allegations in the complain based upon section 10(b) of the Securities Exchange Act of 1934 (the "1934 Act"), 15 U.S.C. § 78j(b), and rule 10b-5, C.F.R. 240.10b-5, on the ground that they fail to state a claim upon which relief can be granted. The Exchange also moves to strike so much of the complaint pursuant to Rule 12(f) as alleges violations of section 9(c) of the Securities Investor Protection Act of 1970, 15 U.S.C. § 78iii(c), upon the ground that such allegations are redundant, immaterial, impertinent and scandalous matter. In a subsequently filed motion the Exchange also moves to dismiss the claims in the complaint based on section 6 of the 1934 Act. Defendant Touche Ross & Co. ("Touche Ross" has moved under Rule 12(b) to dismiss so much of the complaint as applies to it. Both motions by the Exchange and the one by Touche Ross will be disposed of in this opinion.

Plaintiffs assert claims against the Exchange directly under sections 6 and 10 and rule 10b-5 and also for aiding and abetting a violation of section 10 and rule 10b-5, and although this claim is not explicitly stated, it appears that plaintiffs also assert a claim based on section 9(c) of the Securities Investor Protection Act.The claims against Touche Ross are brought directly under section 10 and rule 10b-5 and for aiding and abetting liability, and Touche Ross is further charged with pendent claims of common law fraud and a violation of § 352-C of the General Business Law of New York.

The case is another chapter in the continuing saga resulting from the failure of Weis Securities, Inc. Plaintiffs allege that in 1969 they were customers of and subordinated lenders to Winslow, Cohu & Stetson, Inc. ("WCS"), a broker-dealer registered with the SEC and a member of the Exchange. In September 1969, WCS was purchased by Weis, Voisin and Cannon, Inc. ("Weis"), similarly an SEC-registered broker-dealer and a member of the Exchange.Weis acquired most of the assets of WCS but assumed almost none of WCS's liabilities. The purchase agreement provided that plaintiffs, as subordinated lenders to WCS, would execute subordination loan agreements (the "1969 Weis Agreements") with Weis whereby the assets in plaintiffs' accounts would be subordinated first to claims of creditors of WCS on obligations arising prior to September 30, 1969 and second to claims of Weis creditors on obligations arising from September 30, 1969 through September 30, 1972 when the 1969 Weis Agreements expired. The total value of plaintiffs' accounts subordinated was approximately $3,700,000. The 1969 Weis Agreements were submitted to the Exchange and approved in September of 1969.

 In connection with the approval of the 1969 Weis Agreements, the Exchange permitted Weis to consider all the assets in Plaintiffs' accounts as capital in the computation of Weis' net capital under Rule 325 of the Board of Governors of the Exchange. In June of 1970 the accumulated, allowed claims of creditors against WCS required that Weis liquidate and utilize plaintiff's subordinated accounts to the extent of approximately $1,100,000. Plaintiffs claim that this circumstance demonstrated the questionable financial condition of Weis at that time and that the Exchange failed to exercise its authority to supervise Weis to assure itself that Weis was in compliance with all rules relating to its financial capacity by permitting its continued membership in the Exchange.

 In June, 1972 Weis solicited plaintiffs to renew the 1969 Weis Agreements which were to expire on September 30, 1972. Weis furnished to plaintiffs copies of its financials as at May 26, 1972 which had been filed with the Exchange. I do not think that there is any quarrel with the fact that these financials were materially false and misleading in that they overstated Weis' earnings and net worth by approximately $2,000,000.

 Plaintiff Higginson, allegedly on behalf of himself and the other plaintiffs, discussed the proposed renewed subordination agreements with representatives of the Exchange. It is further alleged that at no time did the Exchange express concern over the financial condition of Weis or disclose to plaintiffs the fact that the Weis financial statements which had been filed with the Exchange were fraudulent and misleading or that Weis had been operating in violation of the net capital requirements of the Exchange or that the Exchange had failed to perform its obligations to supervise Weis' financial condition on a close and continuing basis.

 Plaintiffs say they relied not only upon the financial statements of Weis but also upon the Exchange's proper supervision of Weis in executing the new subordination loan agreements in August, 1972 that would mature on May 31, 1974.

 After the execution of the new subordination loan agreements in August of 1972, Weis prepared and distributed to the plaintiffs two additional financial statements as at November, 1972 and as at February, 1973 each of which incorporated the material omissions and misrepresentations contained in each earlier statement in addition to contributing new omissions and misrepresentations. Touche Ross reported on neither the November, 1972 nor the February, 1973 statements.

 In May of 1973 it was first learned that Weis had made numerous false entries in its books and records since April, 1972 which resulted in material overstatements of income and profit and underaccruals of liabilities. The discovery of the falsity of these entries revealed that Weis was operating in violation of the net capital rule of the Exchange. The SEC thereupon filed suit against Weis and its officers, and the Securities Investor Protection Corporation brought suit seeking the appointment of a trustee to liquidate Weis.On May 24, 1973 the Exchange suspended Weis which is now bankrupt and in liquidation.

 Touche Ross is charged primarily with breaching its duty to inquire into Weis' financial condition and to disclose to the plaintiffs material facts which it would have discovered if it had conducted an audit of Weis in accordance with generally accepted auditing standards and with having acted with gross negligence and in reckless disregard of the true facts of Weis' financial condition. Through its conduct Touche Ross is claimed to have aided and abetted Weis' violation of section 10(b) of the 1934 Act and to have incurred liability under pendent state claims.

 The Claims Against The Exchange

 The claims which are based upon section 6 of the 1934 Act have been disposed of by the Court of Appeals for this Circuit. In Lank v. New York Stock Exchange, 548 F.2d 61 (2d Cir. 1977), the Second Circuit held that a member or the receiver of a member has no cause of action under section 6 for failure by a securities exchange to force a member to comply with the exchange's rules. In Arneil v. Ramsey, 550 F.2d 774 (2d. Cir. 1977), the Second Circuit restricted further the availability of a remedy under section 6 by ruling that limited partners, subordinated lenders or purchasers of non-publically traded securities of a member of the exchange have no cause of action under section 6. The Second Circuit reaffirmed the fact that no claim under section 6 may be asserted by subordinated lenders in Murphy v. McDonnell & Co., 553 F.2d 292 (2d Cir. 1977). As a consesequence these plaintiffs as subordinated lenders may not assert a section 6 claim.

 Moreover, the complaint fails to state a cause of action against the Exchange for either direct or aider and abetter liability under section 10(b) and rule 10b-5. There is no allegation that the Exchange made any affirmative misrepresentation to plaintiffs of which the Exchange had knowledge. Its liability therefore must be based upon some duty to disclose unless the Exchange can be said to be an aider or abettor or that it substantially participated in concealment. Murphy v. McDonnell, 552 F.2d at 295; Lanza v. Drexel & Co., 479 F.2d 1277 (2d Cir. 1973) (en banc).

 At no point do plaintiffs allege that the Exchange had knowledge of the fraud which was perpetrated by Weis in the May 26, 1972 financials. In fact, as the Exchange notes, plaintiffs specifically admit, in paragraph 24 of ...


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