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POSNER v. MERRILL LYNCH

April 26, 1979

Burton POSNER and Iris N. Posner, Plaintiffs,
v.
MERRILL LYNCH, PIERCE, FENNER & SMITH, INC. and Lionel D. Edie & Co., Inc., Defendants



The opinion of the court was delivered by: HAIGHT

MEMORANDUM OPINION & ORDER

Defendants' omnibus motion under Rules 12(b)(1) and (6), 12(c) and 56, Fed.R.Civ.P., seeking dismissal of this action on various grounds, raises interesting if not altogether novel questions of law under the Securities Act of 1933 (the 1933 Act), 15 U.S.C. § 77a Et seq., and the Securities Exchange Act of 1934 (the 1934 Act), 15 U.S.C. § 78a Et seq. Before proceeding to a discussion of these legal questions, a summary of the facts, essentially undisputed for the purpose of this motion, is in order. *fn1"

 I.

 Plaintiffs Burton and Iris Posner, husband and wife, are residents of the State of Arkansas who maintain a place of business in Memphis, Tennessee. On February 27, 1969, plaintiffs opened a securities account with defendant Merrill Lynch, a Delaware corporation with its principal place of business in New York, through Merrill Lynch's Memphis, Tennessee office. Arthur J. Livingston, a Merrill Lynch salesman employed at the Tennessee office, was the account executive in charge of the Posner account.

 In a June 1, 1971 letter to Mr. Posner at an Earle, Arkansas address, Mr. Livingston suggested that the Posners might be interested in a "new service" provided by defendant "Lionel D. Edie and Company, the investment counselling subsidiary of Merrill Lynch . . . providing full discretionary management . . . to customers with investment portfolios of $ 25,000 or more." *fn2" The Posners apparently acted on their broker's suggestion. On June 8, 1971, they executed two documents: the first, an account management agreement between the Posners and Edie, retaining Edie to manage the Posners' portfolio and naming Merrill Lynch custodian to carry out transactions as authorized by Edie; *fn3" the second, a limited power of attorney appointing Edie as the Posners' attorney-in-fact to manage the Posners' Merrill Lynch account. *fn4"

 The account management agreement became operative on June 15, 1971, and terminated on October 4, 1972, the date that Edie received notice of the Posners' decision to cancel the agreement. *fn5" The Posners' letter terminating the agreement was dated September 29, 1972, bore an Earle, Arkansas address, and was directed to Edie in New York with a copy to Mr. Livingston in Tennessee. *fn6"

 During the period that the agreement was in effect, Edie authorized numerous transactions in the Posners' account which were consummated by Merrill Lynch as broker-custodian. Defendants assert (and provide supporting documentation) that Merrill Lynch forwarded confirmations of account transactions to the Posners at their Arkansas address and provided the Posners with monthly statements summarizing transactions in the account for each such monthly period. Edie has submitted copies of various billing statements for its service management fees, which were sent to the Posners in Earle, Arkansas.

 The parties have stipulated *fn7" that the value of the Posner account on June 15, 1971 (the date Edie assumed control) was $ 38,612.50 and that its value on October 4, 1972 (the date the Posners resumed control) was $ 32,371.50.

 Plaintiffs' dissatisfaction with the handling of their account apparently prompted the cancellation of their agreement with Edie. Further, they placed the matter in the hands of their attorney. By letter dated August 8, 1973, Kent J. Rubens, an Arkansas attorney, informed defendants that his "office has been associated by Memphis counsel with regard to an account handled by (Edie) for the benefit of the Posners. . . . At this time I want to put both (Edie) and Merrill Lynch on notice that the Posners are asking this office to investigate the handling of their account. There seems to be the possibility that the stocks may have been churned and/or there was a breach of fiduciary duty in that the stated purpose of the account was for investment as the Posners were not traders." *fn8"

 On April 22, 1974, the Posners brought suit in the United States District Court for the Western District of Tennessee, naming Merrill Lynch, Edie and Arthur Livingston as defendants. The suit was based on the same alleged mishandling of the Posners' account that forms the basis of the instant litigation. It charged defendants with violations of the 1933 Act, the 1934 Act and Rule 10b-5, and sought recovery of lost profits, lost income, fees paid to defendants, and punitive damages. *fn9" By order dated February 12, 1975, the Tennessee District Court granted a motion to quash the return of service on Edie, on the ground that plaintiffs had failed to establish that Merrill Lynch was Edie's agent for service of process. *fn10" Defendants assert that this order constituted a dismissal of the action without prejudice; it does not appear that the Tennessee action was further prosecuted.

 On November 12, 1976 plaintiffs instituted this action. The "four count" complaint here premises jurisdiction on section 22 of the 1933 Act, 15 U.S.C. § 77v, section 27 of the 1934 Act, 15 U.S.C. § 78aa, 28 U.S.C. §§ 1331 and 1337, and diversity of citizenship, 28 U.S.C. § 1332. Count I seeks to recover losses in the plaintiffs' account based on the defendants' alleged violations of the federal securities laws; Count II seeks the same damages based on breach of contract, breach of fiduciary duty and common law fraud; Count III seeks the recovery of the lost investment potential of plaintiffs' capital based on the allegedly fraudulent mismanagement of their account; and Count IV seeks punitive damages for fraud.

 The gist of plaintiffs' factual contentions is that Edie, with the aid of its parent corporation Merrill Lynch, fraudulently secured discretionary management of plaintiffs' account; that Edie then fraudulently mismanaged the account, turning a portfolio of high quality long-range growth and income stock into one of highly volatile and risky securities, *fn11" "churned" *fn12" the account to generate commissions for Merrill Lynch, and bought and sold securities for plaintiffs' account as though plaintiffs were traders rather than investors, all in violation of the contract between the parties, and state and federal law.

 II.

 Under the first count of the complaint, plaintiffs assert violations of "15 U.S.C. 77(e) and (q)(aa)(v)," section 10 of the 1934 Act and Rule 10b-5, 17 C.F.R. § 240.10b-5. Defendants, in what I take to be a curative motion, seek dismissal of various of these claims under Fed.R.Civ.P. 12(b)(6) for failure to state claims upon which relief can be granted.

 Plaintiffs' submissions on this motion make clear that recovery is sought for violations of the general anti-fraud provisions of the federal securities laws, common law fraud, and breach of contract. There are no allegations in this case relevant to violations of 15 U.S.C. §§ 77e and 77aa, which concern the registration of securities under the 1933 Act. Indeed, the only reference to these provisions is plaintiffs' conclusory statement, in paragraph 16 of the complaint, that they were violated. Since these alleged violations are unsupported by any factual allegations, any claims based on 15 U.S.C. §§ 77e and 77 aa are dismissed.

 With respect to claims asserted under 15 U.S.C. §§ 77v and 78aa I simply note that these are the jurisdictional provisions of the 1933 and 1934 Acts respectively. As such, they create no substantive rights and any "claims" based on these provisions are likewise dismissed.

 What remain are the federal securities fraud claims based on § 17(a) of the 1933 Act, § 10 of the 1934 Act and Rule 10b-5, and the common law fraud, breach of contract, and breach of fiduciary duty claims.

 III.

 Defendants move for dismissal of the § 17(a) claim on the ground that that section does not support an implied private cause of action. I am foreclosed from agreeing with defendants on this point by virtue of the Second Circuit's recent decision in Kirshner v. U.S.A, 603 F.2d 234 (1978), upholding a private claim under § 17(a). There, the Court noted "that there (is) little practical point in denying the existence of an action under § 17 once it is established that an aggrieved buyer has a private action under § 10(b) of the 1934 Act." Id., at -- (citing SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 867 (2d Cir. 1968) (Friendly, J., concurring) ).

 The Kirshner panel implicitly recognized that an implied private cause of action under § 17 runs only in favor of an aggrieved buyer of securities, whereas a 10b-5 claim may be raised by either buyers or sellers. (Compare 15 U.S.C. § 77q With Rule 10b-5). *fn13" In this case, plaintiffs' complaint alleges fraudulent conduct on defendants' part, injuring them in their capacity as both buyers and sellers of securities. Since they have pled their status as both, and the scienter required for a Rule 10b-5 action, knowledge and intent to defraud, E. g. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976); Superintendent of Ins. v. Bankers Life & Cas. Co., 404 ...


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