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March 13, 1980

Shearson Hayden Stone, Inc.

The opinion of the court was delivered by: DUFFY


Plaintiff, Cornelius K. Sutton, Jr., commenced this action in February, 1977, against the brokerage firm of Shearson Hayden Stone, Inc. (hereinafter referred to as "Shearson"), three of its brokers, Stanley Katz, Andre Pappas and Robert Nash, as well as one of Shearson's branch managers, Lee Beattie, charging them with multiple violations of the federal securities laws. Defendants filed timely answers and discovery proceeded apace.

Thereafter, in May, 1979, a pre-trial conference was held before me during which counsel revealed that the action would be discontinued with respect to Messrs. Katz, Nash and Beattie. I directed that the complaint be amended in the pre-trial order to reflect these recent developments.

 In June, plaintiff served his proposed pre-trial order which accurately reflected the discontinuance with respect to Katz, Nash and Beattie. In addition, plaintiff apparently abandoned his quest for punitive damages which were sought in the original complaint. Before the pre-trial order was entered, however, the plaintiff requested, and was granted, leave to amend his complaint to recite additional claims for relief. And, based upon "newly discovered evidence", the amended complaint alleged a new claim against Lee Beattie against whom the action was previously, albeit informally, discontinued. Plaintiff also renewed his request for punitive damages.

 As amended, plaintiff's complaint contains four separate claims for relief. The facts underlying these claims are as follows.

 In 1971, the plaintiff opened a non-discretionary account with Shearson in order to participate in the firm's widely publicized "Uncommon Values in Common Stock" portfolio. The account was apparently handled from its inception through November, 1972, by Stanley Katz, one of Shearson's registered representatives. After Katz left Shearson's employ in 1972, the account was handled by Andre Pappas, an account representative recommended to plaintiff by Lee Beattie, Shearson's branch manager.

 The complaint charges that during the time Pappas handled plaintiff's account, from November, 1972 through November, 1973, despite substantial investments of capital, the net value of his account dropped approximately $ 100,000. Plaintiff reasons that this drastic depreciation was the direct result of Pappas' general mishandling of the account as well as his engaging in unauthorized, unsuitable and excessive trading while generating commissions for himself in excess of $ 13,000.

 In addition, plaintiff recently discovered that while Pappas was handling his account at Shearson, numerous customer complaints had been filed against him. These complaints charged Pappas with mishandling brokerage accounts and engaging in unauthorized trades. As a result of these complaints, Shearson was forced to enter into monetary settlements totaling $ 34,500 with the disgruntled customers.

 During this same period, Pappas had incurred a $ 50,200 debit in his personal trading account at Shearson. This debt, together with the amount paid by Shearson to its irate customers, amounted to $ 84,700. This is the precise amount recited in a promissory note dated May, 1973, which Pappas signed in favor of Shearson. Pappas was informed prior to execution of the note that he would be paid a base salary of $ 3,500 per month and that any commissions earned over that amount would be applied against the promissory note.

 Plaintiff concludes that Pappas' conduct while handling his account at Shearson constituted a violation of federal securities laws. In addition, plaintiff charges that Shearson's failure to disclose the numerous customer complaints filed against Pappas amounted to a material omission in connection with the purchase or sale of a security in violation of ┬ž 10(b) and Rule 10b-5.

 More particularly, plaintiff's first claim charges a 10(b) violation based upon the alleged activities of Pappas which included churning, unsuitable and unauthorized trading. Plaintiff's second and third claims in essence restate his first claim but seek exemplary and punitive damages for the alleged violations.

 Finally, plaintiff's fourth claim is directed to the defendant Beattie and charges that although aware of Pappas' fraudulent conduct he permitted the broker to continue this course of conduct to the detriment of plaintiff.

 Defendants now seek to dismiss counts two, three and four of plaintiff's amended complaint on the ground that each fails to state a claim upon which relief can be granted. Defendants also seek to dismiss the entire complaint as to defendant Beattie on the dual grounds that plaintiff failed to effect timely service upon Beattie and plaintiff has failed to diligently prosecute the instant action against him. And, inasmuch as defendants do not challenge count 1 of plaintiff's amended complaint, they seek leave to file a responsive pleading thereto within a reasonable time.

 Defendants' attack upon plaintiff's complaint is two-pronged. First, defendants urge that although Pappas may have engaged in certain questionable investments while handling plaintiff's account, the plaintiff was aware of this conduct and yet, he continued to trade through Pappas thereafter. Defendants reason that plaintiff is either estopped from relying upon this conduct to allege a ...

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